Manager Research

We have recently completed our review of the Baillie Gifford Worldwide Discovery Fund and have downgraded the fund from Tier 1 to Tier 2. As a Tier 2, the fund remains positively rated and we still invest in the fund on behalf of clients. However, there are a few areas that we would like to monitor going forward.

Context

This is a small-cap global equity fund that invests in disruptive businesses that Baillie Gifford expects will grow much more than the market over time. Typically, the kinds of businesses that the fund invests in are either creating new products in rapidly changing industries or they are rapidly growing demand for the products that they sell, and these companies are run by passionate and energetic entrepreneurs.

As an example, this fund invested in Tesla long before the company grew into the business it is today. Importantly, these kinds of companies are difficult to identify, primarily because they are still quite small, are typically still developing their businesses, and the growth trajectory that Baillie Gifford is investing in is still in its nascency. For that reason, Baillie Gifford tends to hold many of these companies for longer than 10 years before they start to generate meaningful outperformance. However, because the payoff associated with finding these kinds of businesses is so lucrative, Baillie Gifford only needs to find a handful of businesses like Tesla for the investment proposition to make sense.

Recently, Baillie Gifford has made several changes to the fund’s investment process, we summarise these below and comment on how we believe they influence the fund rating.

Summary of Changes to Investment Process

• The creation of a Policy Construction Group who is now responsible for portfolio management decisions, instead of Douglas Brodie being the key decision maker.


• One of the long-standing analysts on the strategy has resigned, which for Baillie Gifford is significant as most people join from university and work there until they retire.


• There have also been additional guardrails put on portfolio construction which limits the proportion of higher risk early-stage investments in the portfolio from a historical average of ~26% to 15%.


• They are also placing greater emphasis on diversification of ideas and more emphasis on reviewing positions that are not working to either back their conviction and add to the position or exit if not the case.

Our Rating View

Baillie Gifford’s business structures provide the appropriate support to this strategy which we think is essential. We also believe in the investment edge of the team although we do feel they can broaden their coverage of the investment universe.

The recent stretch of underperformance has demonstrated how hard it can be for this strategy to succeed. We are cognizant of the fact that the market environment over the past decade has been both beneficial to the fund’s investment approach and quite punitive, particularly over the last five years. We also note that this fund requires a long time horizon for proper evaluation as most of the businesses that are currently underperforming are still held in the fund. The manager has demonstrated conviction that their investment thesis is still valid, and the underlying operating results of the investments show improvement in contrast to the share price decline.

With that being said, the recent process changes are material, and we would like to assess how they influence the fund over a longer period of time. To that end, we feel that a Tier 2 rating better reflects our investment view. We continue to recommend and invest in the fund on behalf of clients and believe the investment case continues to be compelling.