My guest on this week’s weekly show was Nick Wood, head of Investment Fund Research at Quilter Cheviot (you can listen back here). He enthused about Baillie Gifford US Growth, which is the second-best performing investment company over the past six months (after Golden Prospect). The Baillie Gifford trust’s NAV is up by 48% over the six months ended 16 July 2020. Its share price is up 44.4% over the same period. I figured that I should have a closer look.
The trust is only a couple of years old, having launched in March 2018. For most of that period it has traded at a premium to asset value. This has allowed it to expand. From £173m of assets raised at launch, it has issued another 96m shares and its market cap has grown 3.3x.
The co-managers on the trust are Helen Xiong and Gary Robinson. Their goal is to identify the exceptional growth businesses in America and own them for long enough that the advantages of their business models and cultural strengths become the dominant drivers of their valuations.
Baillie Gifford has published plenty of evidence to support its theory that a handful of best stocks in each market generate most of the returns of the whole market – in other words, over time, almost everything else drops in value or moves sideways. Picking the winners is hard, however.
The approach has some similarities with that adopted by Ben Rogoff, manager of Polar Capital Technology (which published a decent set of annual results this week). He tries to capture the supernormal returns that can be earned as a new technology moves from the experimental/early adopter phase to becoming ubiquitous, and crucially selling out of yesterday’s winners before the market realises that new competitors are coming to eat their lunch.
Early stage investments
The Baillie Gifford trust will often target earlier stage investments, however. This is facilitated by its willingness to have a sizeable exposure to unquoted investments. That ramps up the risk but, if they pick right, it magnifies the returns. Baillie Gifford US Growth can invest up to half of its assets in unquoted stocks. These take time to acquire, however. At 31 May, the trust had 17 such investments and these made up 12.2% of the fund.
A quick glance at the trust’s largest holdings gives a strong indication of where its recent success has been coming from. At the end of May, the largest investment (7.7% of the portfolio) was Shopify. This Canadian stock provides the digital equivalent of the picks and shovels needed to build an online shop. The sales made through its software already make it the second largest online retailer (behind Amazon) but its business is growing almost exponentially.
Q2 results (covering the height of the COVID lockdowns) will be published on 29 July. Revenue for the first three months of 2020 was 47% higher than the equivalent period in 2019. 2019’s revenue was 47% higher than 2018’s and almost 8x 2015’s revenue. With gross margins of 56%, it has the potential to be very profitable too, just not yet.
Memories of the tech boom
Shopify is trading on about 68x sales. That brings back memories of the tech boom for me. Baillie Gifford might argue though that, if Shopify can realise its potential, it is still reasonably valued.
Second on the list, also 7.7% of the portfolio, is Amazon. Love it or loathe it, it is everywhere. Again, the COVID-related boom in online shopping is working in its favour but, in addition, its quarterly revenue from its cloud services business broke the $10bn mark for the first time in the first three months of 2020. It has already cautioned investors to expect a short-term hit to earnings as it repositions itself to cope with social distancing measures and increased demand. Baillie Gifford points out that investors frequently struggle to value companies that are investing for the long term. Right now, though, they seem to be giving Amazon the benefit of the doubt. Its shares are up 50% year-to-date.
The third largest stock (7.1%) is Tesla. Here, Baillie Gifford say that the important thing to remember is that Tesla’s modest sales are not cannibalising a pre-existing business in the way that the shift to electric vehicles affects VW or Toyota, for example. Baillie Gifford’s Catherine Flood talked about this when we met her a few weeks ago (listen back here). Baillie Gifford also has an investment in SpaceX. This is its largest unlisted exposure, 1.9% of the portfolio at the end of November 2019. I’m conscious that this represents quite a big overall exposure to Elon Musk.
Making a call on when a portfolio such as that of Baillie Gifford US Growth is overvalued is nigh on impossible. It has all the right ingredients to make it fly in a world of low growth, low risk-free returns and low inflation, however, and that backdrop isn’t going away in a hurry. The ride may be bumpy, but the trust’s early success may not be a flash in the pan, it may still be headed to the moon.