Riding growth waves

This communication was produced and approved in November 2021 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.

Around the time Baillie Gifford was founded, the American sage Elbert Hubbard wrote: “The world is moving so fast that the person who says it can’t be done is generally interrupted by someone doing it.”

Over a century later, the truth of that insight, which has long informed the way Baillie Gifford seeks investment opportunities, is obvious to all. Like competitors in the first Olympic surfing event at Tokyo 2020, our investors see successive growth waves ahead. Like them, we dare to ride these big opportunities.

What do we mean by growth waves? As long-term investors we’re not hostage to any short-term growth index, which fails to recognise and reward strong cultures and aligned interests. In the words of Charlie Munger: “Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns.” We would go further. It’s not about precise modelling or the search for a smooth trajectory. We want growth that reaches the heights – and stays there.

Baillie Gifford has no house view, no 'buy list' and no Chief Investment Officer. We believe in autonomous, open-minded analysis. Our strategy teams spur each other on through robust debate and research-sharing.

Innovation waves: stepping back

Innovation through the decades has come in a series of giant waves. So too has growth.  

Joseph Schumpeter’s Capitalism, Socialism and Democracy (1942), featuring his theory of ‘creative destruction’ is one of the best guides to business cycles and long waves of innovation. He describes how, as markets are disrupted, key industry clusters have outsized effects on economic growth and development.

Earlier waves cited include the industrial evolution from British cotton mills: how steam and railways proliferated their networks and boosted urbanisation. That extended to other developments including steam, heavy engineering and electricity. The 1900s brought the Ford Model T and the assembly line which revolutionised mass production manufacturing. Then came aviation, telecoms and the internet.

All these innovations boosted growth and improved living standards. The disruptors tended to form monopolies, or at least achieve strong pricing power. The strongest players increased margins, built defensive ‘moats’, and fended off competition. Our investigations with the economist Professor Carlota Perez have reinforced these lessons, revealing the pattern of technological breakthroughs. According to this model, a small segment of the economy is upended, large companies grow to become monopolies, industries are impacted more widely, and a golden era dawns, where a wide range of industries benefit, customers reap the rewards, employment increases, social inequality improves, and the cycle starts again.

Today’s leaders are in big tech, with its dominance in search, social networks and advertising. Some businesses endure, evolve and continue to be extremely successful over time. Others will be sunk by the next big wave.

The current tech wave is multi-faceted, spanning the internet, ecommerce, artificial intelligence and digitisation across the internet of things (IoT), robotics, and automation. It has implications for every industry, and wide-ranging ramifications for consumption, services, industrial, tech advancement, healthcare and arguably every segment of the market. Physical goods and services are already partly digitised and that will increase. Even with our workloads, the time to complete tasks could shift from hours to seconds.

Being creative

For us, idea generation is a multi-faceted, gradual process. We develop our thinking and insight over time and base decisions on solid foundations. 

Meeting companies is essential. We have built up years of goodwill with many companies, understanding their long-term intentions, and asking the ‘what if?’ questions.

All this builds on the institutional memory we have with holdings, on some of which we have 20-50 research notes in our library. It’s about collective knowledge, not just about one meeting or one person’s view. All knowledge is connected, the trick is to make the connections.

Also important is the use of alternative sources of information. Our investors have strong relationships with over 25 academic institutions around the world. From Santa Fe and Phoenix, via Edinburgh and Oxford to Beijing. We interact with industry experts from scientists and academics or experts spanning many industries – semiconductors, healthcare and beyond. This extends to the use of inquisitive researchers, and our preference for seeing companies in their own environment, interacting with customers and suppliers. It helps shape our thinking about the businesses and the industries in which they operate.

Growth waves and our research

Baillie Gifford’s digital research library houses content from across the investment floor. By regularly dipping in, investors can access and share each other’s thoughts day-to-day, or dig deeply into a company or topic.

Two outputs in particular offer a window on our research efforts. The first is a 'quilt' infographic which summarises research work over a given timeframe. It takes all meeting notes and reports – several thousands of them – and uses word groupings to capture the content.

Within these quilts, the bigger the box the more prominent the topic. It enables us to consider what we have been asking companies and what we have been getting from alternative sources and tells us what opportunities we’re focusing on.

The infographics show how four primary areas of research over the past year, but also over the past 25 years or more, have been in healthcare and pharmaceuticals, software, industrial engineering and semiconductors. The list then goes on and one can examine how other growth waves build over time, for example the rise of luxury goods, gaming and payments. On the flip side to this, we can see how others have fallen back or completely disappeared over time – oil, gas and coal for example, food, beverage and tobacco, or energy and utilities. 

This presentation of the data also shows how environmental, social and governance (ESG) factors have become more integral to our work, what we discuss with companies, what issues are rising and falling in importance, and what’s coming down the track in terms of new ideas. Looking behind the headlines shows how, over the long run, we have placed an ever-larger importance on culture and management teams. Dissected over time, it allows for a fascinating ‘game’ of spot the difference to see how our research efforts have evolved.

Figure – Research Quilt – top 30 research topics from 2020 (1,185 articles)

Figure – Research Quilt – top 30 research topics from 25 years (27,077 articles)

Over time, we will look for growth opportunities, and underpinning these irrespective of time frame is looking for disruption, significant growth or change. Let’s call this ‘D’. Then there is trust, which we will take as the first ‘T’ and that is in reference to business quality type with regards to products or services, also the management and underlying culture. Plus, also a second ‘T’ for technology. With all of these, end markets and companies’ technology is ubiquitous. It has always been there, and discovery, invention or advancement continue to inspire us in what we see in end company types.

We can also interrogate our research library using more standard index-type classifications such as MSCI sector classifications. The figure below shows the evolution of our research and helps capture the growth areas we’ve homed in on. These have evolved over time.

Figure – Research Sector 'Waves' by MSCI Sector Classifications

Examining this for the past year against the MSCI ACWI categories gives us an insight as to how we differ in our research efforts. We will not be held hostage to the index, we want to think differently. Prominent areas include consumer discretionary, healthcare technology and industrials. We can highlight these as areas we ‘over focus’ on and in turn that leads to holdings in those areas in our client portfolios. Areas we ‘under focus’ on include financials, telecoms, basic materials and utilities.

This gives us a top-down take on all of this and one can start to unpick these and explore trends within them. One notable riser is healthcare. It has expanded in prominence and broadened to cover biotech, cancer treatments and diagnostics. The thrust of our research inquiry here has also changed to ‘what’s the opportunity?’.

Western societies tend to operate ‘sickcare’ systems, not healthcare systems. When we get ill and start to exhibit symptoms, we go to a doctor for a diagnosis and then begin treatment for those symptoms. The opportunity now is to move towards a more personalised system, where disease is detected before it has an impact and treatment is administered before symptoms present. This strategy seeks to identify the companies that can drive this revolution. We aren’t speculating on binary outcomes of trials or single products and incremental change. We want to see a cure for cancer, not a drug that extends life by three months. We want the devices and systems that will detect and prevent life-changing illness. And we want to research, uncover and back the companies leading that.

A second example is China and its rise to prominence in our research efforts. At the time of writing, despite making up 17 per cent of world GDP, it only comprises 5 per cent of the MSCI ACWI index. Despite the A-share market being the second largest in the world, foreigners own less than 3 per cent.

China has come a long way, but this fact is being missed by many. Looking in the rear-view mirror and making broad generalisations about geopolitical and governance risks delivered by a state owned entity-led model of exports, infrastructure and debt will miss the opportunities being delivered by an economy increasingly shifting to domestic demand, consumption, healthcare, technology and the environment. Our research within any sector or country evolves over time.

We see innovation as critical to China’s economic growth and private companies are critical to innovation. China has gone from being the ultimate copycat, low-cost manufacturer to leading in sectors that will form the infrastructure of the future. This shows in our investment research over the years, and China has featured for a very long time. At time of writing our library contained 112 notes on Tencent alone. But it isn’t the quantity but the quality of this research that matters. One of our investors’ notes from the mid-2000s captures our view:

“I’ve never looked at a company with such a broad range of outcomes. It’s possible that the business becomes worthless because a disruptive technology nullifies the network effects, or the Government changes the rules. On the other hand, with its network effects, entrenched competitive position, rising returns and monumental growth potential, this could become the most valuable internet asset in the world over the next decade.”  

China offers persistent growth, a large and expanding consumer market, a continued technological upgrade and rapid digitisation. Its focus on innovation across many sectors provides a fascinating opportunity for fundamental investors. Baillie Gifford has made huge strides in researching Chinese companies, getting to know them well, and building on that relationship through both our Edinburgh and our Shanghai presence. We expect to keep building on that. The process has helped bolster idea generation, conviction in great companies, and has led us to back what we see as being world-class exceptional growth companies for the long term.

It’s also the case within other regions. In Europe, former obsessions with telecoms companies, an Austrian brickmaker, a Swiss toilet manufacturer, Scandinavian banks etc. are distant memories. The opportunity set has changed – significantly so. Digital and tech companies are up to a third of the attractive opportunities in Europe, up from almost zero a decade ago. Some topics simply weren’t there a decade back, such as cashless payments. Others have been, gone and returned – renewables for example.

For us at Baillie Gifford, it is also about the depth of research, spanning many years and, in some instances, decades. Our digital library helps us, but we have research notes dating back much further. Atlas Copco is one of the firm’s longest standing holdings for clients. One can quite easily get enthralled looking at the eloquent notes and summaries from the 1980s, one highlighting Atlas’s strong operational growth, the high quality of its business leading to high margins and strong returns.

Being different: our growth lens

To return to where we started, our view of growth differs from that of the market. Comparing and contrasting our research focus reveals big differences in what interests and excites us.

Our approach also differs markedly from that of the index providers. We see growth investing as an art as well as a science. We look left of the decimal point and our idea of the long term starts at three-to-five years. We applaud companies for investing in themselves, focusing on the long term. We look for world-class businesses irrespective of current size, sector or industry label.

Conclusion

At Baillie Gifford we aim to combine being long-term with a willingness to be curious, patient and brave and seeking out the next big growth waves.

We think ‘what if?’ not what is. We seek to back businesses. We aim for world-class returns through long-term ownership of growth companies. We are independent thinkers and take pride in our in-depth, fundamental research. We are focused. We specialise in a handful of favoured business models. Good investment opportunities are rare. Our idea generation will evolve through the years. Like those Olympic surfers we will look to ride those successive waves of growth now just appearing on the horizon.