International Alpha: valuing variety

Please indulge us for a moment with a brief journey back in time. In the late 1970s, a period not dissimilar to today when the market backdrop was challenging and performance turned down sharply, Baillie Gifford’s success was closely linked to that of its three largest UK clients. The loss of the Edinburgh & Dundee investment trust, which generated fees that exceeded annual profits at the time, placed the firm in a vulnerable position. This troublesome time was an equally important one in Baillie Gifford’s history: it brought to the partnership agenda a strong desire to diversify the firm’s income and make it more resilient, to enable it to navigate difficult times more easily in the future.

Fast forward to 2022, and although the other two largest clients remain, Baillie Gifford is now well diversified by client type, geography, and strategy. As at end December 2022, we serviced clients in 46 countries (up from 23, a decade earlier). Our clients’ assets are also now spread across a range of areas, including public and private pensions; charities; foundations; financial institutions; sovereign wealth funds; and sub-advisory relationships.

Importantly we have also embraced diversity through our investment approach. This starts with our people. The International Alpha Portfolio Construction Group (PCG) of six investors embodies a variety of personality types and perspectives. It represents different areas of expertise and investment teams from across the firm. We also like to breathe new life into the group from time to time, with the addition of Steve Vaughan – who has several years of experience covering small cap mandates – a case in point.

The International Alpha team also welcomed a new analyst in September, bringing another fresh perspective to our debate. While we have always prided ourselves in recruiting graduates from a broad church of academic backgrounds, this year’s intake of 10 is perhaps the most diverse yet, with degrees including archaeology, stem cell research and anthropology, among others. We are also pleased to say that this year’s intake is highly diverse by ethnicity and evenly split between genders.

Although it may not feel like it, given recent investment outcomes, the International Alpha portfolio is a diverse collection of growth opportunities from across the world and the market cap spectrum. As well as allocating our clients’ capital to the most exceptional businesses we can find within the global ex US universe, the strategy also invests in four distinct types of growth opportunities which the team refer to as ‘shades of growth’. As a reminder, these are quality compounders, rapid growers, through the cycle winners, and capital allocators. Allocations to each growth shades are an outcome of bottom-up stock picking, categorisations are based on a qualitative judgement rather than science, and we do not target a specific allocation to each one. What we have found, however, is that using the four shades has promoted a flexible approach to growth investing, provided the portfolio with a helpful degree of balance and encouraged the PCG to consider a variety of different types of opportunities.

As we have explained to many of our clients recently, the fact that all four growth shades have performed poorly in tandem for an extended period is highly unusual. In the past, we have seen the respective growth opportunities perform well at different points in the cycle and in different market conditions. At the current juncture, investors favour businesses with most of their value based on near-term cash flows, regardless of their earnings quality, where the earnings are generated from, and the types of growth they are exposed to. Although we can’t predict when sentiment will turn, our experience running the International Alpha strategy since 2002 gives us confidence that share prices will ultimately follow fundamentals. Investors will again pay attention to the specifics of each opportunity rather than the generalities of a macro-driven market narrative.

When we delve into the portfolio, there is also a large degree of variety within each growth shade which we believe provides the comfort of portfolio resilience. Among the quality compounders, there is exposure to a Japanese premium skincare brand, an Italian online bank, a French specialist in single-use medical instruments and a leading Chinese contract research organisation (CRO), among others. The potential success of each of these businesses will be driven by entirely different growth drivers, with the common factor being that they are all high-quality companies run by able management teams that we respect.

Similarly, although many of the portfolio’s rapid growth names have fallen out of favour in concert, it is worth highlighting how different some of the opportunities we have classified within this category are. As well as being exposed to disruptive internet platforms in very different markets ranging from Brazil (MercadoLibre) to China (Tencent, Meituan, Alibaba) to Sweden (Spotify), there are also holdings in a variety of different industries, including carbon capture (Aker Carbon Capture), long read genetic sequencing (Oxford Nanopore), Biotech (WuXi Biologics) and online healthcare (Ping An Healthcare).

So, it seems illogical to us that share prices have moved together between quality compounders and rapid growers, and it speaks to the state of current investor sentiment. The market has tarnished virtually all high growth and quality stocks with the same ‘long duration’ brush, placing them out of favour with investors that have become increasingly short-term in their perspective.

There is a wide variety of structural drivers that the holdings give you exposure to. We recently tried to map these and found the exercise both fascinating and reassuring. As well as fuelling excitement over the potential size of the opportunities available over the next decade, it illustrates that the portfolio contains exposure to multiple different profit pools and sources of demand. Some holdings, such as the innovative German biotech company, which is disrupting the field of immunology, BioNTech, are exposed to just one very large end market, and we have included it in the single structural driver: Healthcare Revolution. Other holdings, like the Chinese internet behemoth Tencent, have exposure to a number of profit pools through their ecosystem and underlying investments. Here we have allocated it to Future of Finance (owing to the strength of the WeChat payment system in China) and Rising Emerging Markets due to its role in the Chinese domestic economy, where around a third of spending takes place online. In the Euler diagram below, you can see the portfolio’s exposure to each of the eight portfolio drivers. The overlaps between the circles represent stocks, like Tencent, with multiple exposures.

Portfolio drivers

One final example of diversification is the wide range of new investment ideas from across the world that the team have been generating. Within the past few months alone, we have discussed a UK domiciled disruptor in the foreign exchange market, a local Chinese skincare brand, a family-owned Dutch listed holding company with an excellent record of allocating capital and executing business turnarounds, a well-known French luxury brand and a French manufacturer of single-use medical instruments used for biologic drugs. All these businesses are worthy candidates for ownership in the portfolio and would offer exposure to a unique growth opportunity and end markets. There is no shortage of new ideas; the challenge is finding an appropriate source of funds in a portfolio of excellent businesses.

Following our usual process of robust analysis and debate, we have taken new positions during the quarter in Sartorius Stedim (single-use devices for biologic drugs) and Kering (the French luxury Group with exposure to the coveted and highly durable brands Gucci and Bottega Veneta). These new stocks will increase the portfolio’s exposure to special brands, the healthcare revolution and the rise of emerging markets, further enhancing its diversity. We are also hopeful they will add to its overall growth prospects and upside potential.

Risk Factors

This content contains information on investments which does not constitute independent research. Accordingly, it is not subject to the protections afforded to independent research and Baillie Gifford and its staff may have dealt in the investments concerned.

Any stock examples, or images, used in this content are not intended to represent recommendations to buy or sell, neither is it implied that they will prove profitable in the future. It is not known whether they will feature in any future portfolio produced by us. Any individual examples will represent only a small part of the overall portfolio and are inserted purely to help illustrate our investment style.

As with all mutual funds, the value of an investment in the fund could decline, so you could lose money.

The most significant risks of an investment in the Baillie Gifford International Alpha Fund are Investment Style Risk, Growth Stock Risk, Long-Term Investment Strategy Risk and Non-U.S. Investment Risk. The Fund is managed on a bottom up basis and stock selection is likely to be the main driver of investment returns. Returns are unlikely to track the movements of the benchmark. The prices of growth stocks can be based largely on expectations of future earnings and can decline significantly in reaction to negative news. The Fund is managed on a long-term outlook, meaning that the Fund managers look for investments that they think will make returns over a number of years, rather than over shorter time periods. Non-U.S. securities are subject to additional risks, including less liquidity, increased volatility, less transparency, withholding or other taxes and increased vulnerability to adverse changes in local and global economic conditions. There can be less regulation and possible fluctuation in value due to adverse political conditions. Other Fund risks include: Asia Risk, China Risk, Conflicts of Interest Risk, Currency Risk, Emerging Markets Risk, Equity Securities Risk, Environmental, Social and Governance Risk, Focused Investment Risk, Geographic Focus Risk, Government and Regulatory Risk, Information Technology Risk, Initial Public Offering Risk, Japan Risk, Large-Capitialization Securities Risk, Liquidity Risk, Market Disruption and Geopolitical Risk, Market Risk, Service Provider Risk, Settlement Risk, Small-and Medium-Capitalization Securities Risk and Valuation Risk.

For more information about these and other risks of an investment in the fund, see “Principal Investment Risks” and “Additional Investment Strategies” in the prospectus. The Baillie Gifford International Alpha Fund seeks capital appreciation. There can be no assurance, however, that the fund will achieve its investment objective.

The fund is distributed by Baillie Gifford Funds Services LLC. Baillie Gifford Funds Services LLC is registered as a broker-dealer with the SEC, a member of FINRA and is an affiliate of Baillie Gifford Overseas Limited.

All information is sourced from Baillie Gifford & Co and is current unless otherwise stated.

The images used in this article are for illustrative purposes only.

Source: Bank of New York Mellon and relevant underlying index provider(s). Net of fees, US dollars. Returns are based on the K share class from 28 April 2017. Prior to that date returns are calculated based on the oldest share class of the Fund adjusted to reflect the K share class fees where these fees are higher. The MSCI All Country World ex US Index is a free float-adjusted market capitalization weighted index that is designed to measure equity market performance in the global developed and emerging markets, excluding the United States. This unmanaged index does not reflect fees and expenses and is not available for direct investment.

The performance data quoted represents past performance and is no guarantee of future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted. For the most recent month-end performance please visit our website at www.bailliegifford.com/usmutualfund/internationalalphafund 

The Baillie Gifford fund’s performance shown assumes the reinvestment of dividend and capital gain distributions and is net of management fees and expenses. Returns for periods less than one year are not annualised. From time to time, certain fees and/or expenses have been voluntarily or contractually waived or reimbursed, which has resulted in higher returns. Without these waivers or reimbursements, the returns would have been lower. Voluntary waivers or reimbursements may be applied or discontinued at any time without notice. Only the Board of Trustees may modify or terminate contractual fee waivers or expense reimbursements. Fees and expenses apply to a continued investment in the funds. All fees are described in each fund’s current prospectus.

Expense Ratios: All mutual funds have expense ratios which represent what shareholders pay for operating expenses and management fees. Expense ratios are expressed as an annualized percentage of a fund’s average net assets paid out in expenses. Expense ratio information is as of the fund’s current prospectus, as revised and supplemented from time to time.

It should not be assumed that recommendations/transactions made in the future will be profitable or will equal performance of the securities mentioned. The composition of the Fund's holdings is subject to change. Percentages are based on securities at market value.