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AnthologyI N T E R N AT I O N A L G R O W T H

THIS PAPER IS INTENDED SOLELY FOR THE USE OF PROFESSIONAL INVESTORS AND SHOULD NOT BE RELIED UPON BY ANY OTHER PERSON. IT IS NOT INTENDED FOR USE BY RETAIL CLIENTS.

The views expressed in this article are those of the authors and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect personal opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.

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

Potential for Profit and Loss

All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk. Past performance is not a guide to future returns. It should not be assumed that recommendations/transactions made in the future will be profitable or will equal performance of the securities mentioned.

Stock Examples

Any stock examples and images used in this article 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.

This article contains information on investments which does not constitute independent research. Accordingly, it is not subject to the protections afforded to independent research, but is classified as advertising under Art 68 of the Financial Services Act (‘FinSA’) and Baillie Gifford and its staff may have dealt in the investments concerned.

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.

RISK FACTORS

CM15802 International Growth Anthology WP 062021Ref: 52748 INS AR 0837

Baillie Gifford– Anthology

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ESG RATINGS DON’T CAPTURE THE POSITIVE SOCIAL IMPACTS OF INVESTINGBY ABHISHEK PARAJULIA MEMBER OF OUR EMERGING MARKETS TEAM LOOKS AT HOW PROPER ESG ANALYSIS MIGHT LOOK.

28AUTHOR BIOGRAPHIES

CLIENT CONVERSATIONS UPDATEFIND OUT WHAT THE INTERNATIONAL GROWTH TEAM HAVE BEEN TALKING TO CLIENTS ABOUT.

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WHY MOST THINGS BELIEVED ABOUT INVESTING ARE WRONG

BY LAWRENCE BURNSCHALLENGE YOUR VIEWS ON WHAT

INVESTING IS REALLY ABOUT.

THE PRIVATE OPPORTUNITYBY ROBERT NATZLER

COMPANIES NO LONGER FOLLOW THE TRADITIONAL LIFECYCLE

FROM FOUNDING TO IPO.

Summer 2021

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©SpaceX

WHY MOST THINGS BELIEVED ABOUT

INVESTING ARE WRONG

BY LAWRENCE BURNS

FEBRUARY 2021

Investment manager Lawrence Burns shares the views of brilliant minds outside the industry that will reshape your view of what equity investing is all about.

A conversation remains stuck in my head from early 2020, when the terms ‘lockdown’ and ‘social distancing’ were largely unheard of. My meeting with a Chief Investment Officer was coming to an end. We were discussing a US automotive company, which at the time was finally being recognised by the market and thus being rewarded with massive share price growth. He leaned across the table and said, “tell me you have been selling your shares.” What struck me was not his belief that we should sell, rather that he appeared to hold it with such absolute certainty. His assertion wasn’t anything to do with the company itself, but rather the ingrained belief that when a share price goes up a lot, you should sell. This was common sense. To do different would be foolish, greedy and undisciplined.

It is a conventional wisdom that pervades much of the financial industry. As the old saying goes ‘it’s never wrong to take a profit’. There is some validity in this approach, hence why it pervades and endures. A client is unlikely to be unhappy or indeed notice if you sell a stock that subsequently goes up significantly. That loss – of foregone upside – is not captured in performance data, but perhaps it should be. On the other hand, if the stock in question continues to be held and goes in the other direction it will become a clear detractor in performance data and you should

expect to be asked, if not chastised, about it. And so, from the investment manager’s point of view, perhaps it can be said that it is never wrong to take a profit.

But what, I hope you ask, about the client? For the client, equity investing is asymmetric, the upside of not selling is near unlimited, while the downside is naturally capped. Surely, for the client it can be very wrong to take a profit? This goes to the heart of why so much of investing is wrong. Sadly, as an industry, institutional money managers seldom try to get investment right for investors. Most conventions and practices exist to serve, protect and enrich investment managers’ interests.

The realities of investment therefore are often very different from the dogma. At Baillie Gifford, we are fortunate to be informed by a range of thinkers from outside our industry that have no incentive to prop-up the myths of investment management. Instead, they deal in observable facts, not the self-serving mantras beloved by professional investment bodies. This note tries to share a few of their perspectives that have been crucial to how we invest and, in the process, demonstrate that it is often not just wrong to take a profit, but it can be the worst possible mistake.

– Anthology

Let’s take Bessembinder’s paper Do Stocks Outperform US Treasury Bills? as our starting point. We have all been told the answer is yes because stocks carry significantly more risk, so, of course the factual answer is no. Nearly 60 per cent of global stocks over the past 28 years did not outperform one-month treasury bills.

Equity investing as a whole though is thankfully still worthwhile. This is because of a small number of superstar companies. Bessembinder notes that a mere 1 per cent of companies accounted for all of the global net wealth creation. The other 99 per cent of companies were, it turns out, a distraction to the task of making money for clients. The capital asset price model (CAPM) so beloved by the financial industry is therefore nonsense because the normal distribution of stock returns that underpins it is imaginary.

This should shake the very foundations of the investment industry. It provides not an opinion but a collection of facts as to where returns come from and what investors should focus on. The entire active

management industry should be trying to identify these superstar companies since nothing else really matters. Investing is a game of extremes.

But, here lies the problem, it requires a vastly different mentality to that displayed by the financial industry today. It requires focus on the possibility of extreme upside, not the crippling fear of capped downside. This requires genuine imagination should there be any hope to grasp the potential of superstar companies.

In addition to imagination, Bessembinder makes it clear that it is the long-term compounding of superstar companies’ share prices that matters. Investing thus requires patience to deal with the inevitable ups and downs such companies experience as well as the ability to delay significant gratification. Sadly, such behaviours are difficult and wholly inconsistent with the incentives and annual bonuses of traditional finance. Nevertheless, they are prerequisites. After all, the point of superstar companies is that they can go up five-fold and then go up five-fold again. If you sell after the share price merely

P R O F E S S O R H E N D R I K B E S S E M B I N D E R

doubles, crow and take your profits, you undermine the whole point of identifying companies with extreme return potential in the first place.

Let’s take a practical example. In early 2000, the founder of SoftBank, Masayoshi Son, made what may have been the greatest investment in history. He invested $20m in a Chinese ecommerce company. Two decades later his remaining investment is worth in excess of $180bn. A wonderful example of an extreme return.

This is a well-known story and one I’ve been lucky enough to be told first-hand by Masayoshi Son. However, less well-known is the story of Goldman Sachs. Goldman invested in the same company a year before Son on far better terms. Shirley Lin, who worked for its private equity fund, had an agreement to invest $5m for a 50 per cent stake. Unfortunately, her colleagues deemed $5m too risky and so they opted for investing a ‘safer’ $3m. Five years later their stake was worth $22m, a seven-fold return. At this point, the decision was taken to sell under the guise it’s never wrong to take a profit.

WHERE RETURNS ACTUALLY COME FROM

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Investing is a game of extremes.

In many ways, this was a remarkably successful investment, until you realise that today those shares would be notionally worth more than $200bn before dilutions are taken into account.

It would seem Goldman Sachs got the identification, and perhaps even the imagination part, right. They spotted one of the greatest superstar companies of our era early on. Yet, when asked why Goldman Sachs sold, Shirley gives a depressing but predictable answer: “they wanted quicker results”. Though this example is extreme and straddles public and

private ownership, the point is clear: in investing, it is often not only wrong to bank profits, it can be the worst mistake you make. Despite this, in almost every client meeting I am asked about our sell-discipline. No one has ever asked me about our hold-discipline, which is a shame, as the greater cost to clients’ returns comes from the inability to hold onto superstar companies when their returns are ticking upwards. Investment managers are usually very good at selling.

Bloomberg Pictures Of The Year 2019: Extreme Business. Masayoshi Son, chairman and chief executive officer of SoftBank Group Corp. © Bloomberg/Getty Images

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The notion that companies can even produce such extreme returns goes against much of economic theory which exhibits an overzealous equilibrium-mindset that likely has deep religious and spiritual roots. This mindset is the progenitor of a mindset of a different name common in finance, namely a belief in ‘reversion to mean’.

Bessembinder’s data falsifies the assumption that company returns stabilise over time. Moreover, he shows when looking at nearly a century of US stock market returns the concentration of wealth creation is becoming yet more skewed towards a small number of companies. The returns are becoming extreme. The superstar companies are becoming more super.

This is particularly odd given that economics focuses on diminishing returns to scale. It takes the work of Professor Brian Arthur of the Santa Fe Institute, to understand that this concept is rooted in observing the returns to scale of the “bulk-processing, smokestack” industrial companies of the 19th century. He notes that western economies have shifted “from processing of resources to processing of information, from application of raw energy to application of ideas”. Far from diminishing returns, today’s knowledge-based companies tend to exhibit increasing returns to scale and so, in the digital era, reversion to the mean is even less common. Returns are yet more extreme.

INCREASING

RETURNS

TO SCALE

P R O F E S S O R B R I A N A RT H U R

Professor Brian Arthur. © Corbis Historical/Getty Images.

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Brian Arthur came up with this early explanation of emerging economic reality on America’s west coast, while observing both Silicon Valley and the rise of Microsoft further north. However, as with most things today, if we wish to better understand the economic reality of tomorrow, we must look east. To help us here we have the academic Ming Zeng. He became Alibaba’s Chief Strategy Officer in 2006, a job he took to further his studies by giving him a ringside seat to history in the making.

For Ming, the greatest superstar companies of the future will be what he calls “smart businesses” harnessing network coordination and data intelligence. These organisations will look less like a company and more like a network. He notes:

The old, diversified conglomerate was like a complex machine of the old industrial age. It collapsed when it reached a certain complexity. But the future of business is more biological rather than mechanical… an ecological system grows and becomes more and more sophisticated, even more robust when it becomes richer and more diverse.

Network companies, such as Amazon, Uber or MercadoLibre, coordinate millions of entrepreneurs, guiding them with data intelligence in real-time so both the network companies and entrepreneurs can adapt to conditions instantly in ways traditional companies could never have dreamt. This marries the benefits of enormous scale with rapid adaptability. Moreover, the larger these network companies become, the more data they have and thus the more intelligent and effective the network can become. If Ming is right, then it is logical to assume the importance of superstar companies will grow even further with the application of machine learning.

P R O F E S S O R M I N G Z E N G

NETWORK COMPANIES UNLEASH UNIMAGINABLE SCALE

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Despite the above, we must not forget that the prevalence of new superstar companies will be determined by the amount of economic and social change that takes place from here. Indeed, I would go further still and posit that the single greatest determinant of whether returns will swing from growth to value is whether the pace of change in the world increases or decreases. For it is change which creates new markets and disrupts old ones. It is change that fuels the rise of superstar companies.

We therefore need to believe the conditions for change will persist. To give us that conviction we have Moore’s law. The observation and projection made by Gordon Moore, the co-founder of Intel, that, for the same price computing power would double every 24 months. This projection has now become seen as a law, given its predictive power over the last 50 years. In doing so it has set the pace for the semi-conductor industry and thus for human progress.

What this means is that come the early 2030s computing power should be at least some 60x more powerful than today for the same cost. The implications of such a large increase are difficult to imagine. At the very least, the disruption should spread from industries like advertising and retail to those of even greater importance such as healthcare, finance, education, and many more.

Nevertheless, it would of course be wrong for us to have confidence in past patterns, however long and persisting, without due cause. Here we are very much helped by the insights of Martin van den Brink, ASML’s Chief Technology Officer, whose lithography machines have been largely responsible for extending Moore’s law in recent times. Van den Brink makes two points. First, that Moore’s law is older than we think. It dates back not 50 years but an entire century in all but name to when computing power was vacuum tube rather than transistor based. His second point, is even more significant and far reaching, because he believes ASML already has the technology roadmap in place to ensure Moore’s Law extends into the 2030s.

It therefore perplexes me why with the power and predictability of Moore’s law, our industry decides instead to focus far more on what interest rates or GDP growth rates mean for investing. Frankly, I think we would all be much better investors if we concentrated on the future implications of Moore’s law. A 60x increase in computing power will profoundly shape our world. The question we must grapple with is what this new world will look like.

EXTENDING MOORE’S LAW

M A RT I N VA N D E N B R I N K

It is change that fuels the rise of superstar companies.

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The number of transistors incorporated in a chip will approximately double every 24 months.

GORDON MOORE

Intel co-founder Gordon Moore. © Getty Images North America.

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MASSIVE OVER DIVERSIFICATION

If we follow the facts and focus on superstar companies as the only real creators of value in long-run equity returns, then it also follows that portfolios need to be constructed radically differently. Given superstar companies are by their definition rare, this calls for concentration. Alternatively, perhaps we should call concentration what it really is: an attempt to undertake actual stock picking. An attempt at being actual investors.

The case for concentration is well made in several academic studies. Yeung et al (2012) looked at nearly 5,000 funds and found that the top ideas in these portfolios consistently outperformed the diversified funds from which they were derived. Similarly, Best Ideas by Cohen, Polk and Silli (2010) highlighted that the top 5 per cent of fund managers’ ideas are consistently the best performers across portfolios, a point that is well supported by our own experience. The authors provocatively argue that stocks added ostensibly for risk control reasons are not just a mistake but a cynical exercise in enabling investment managers to add assets well beyond their alpha-generating capabilities. Our guess at the motivation for fund managers to diversify is somewhat different, but hardly better. We think investment managers embrace adding stocks so they can diversify their own business risk from the inherent volatility that comes with stock picking.

This raises a key question for institutional portfolio construction. Whose risk are we really trying to diversify? It can only rationally be that of the investment manager. For whilst the investment manager may have a few portfolios at most, the client often has many. Indeed, I have yet to meet a client for whom our portfolio represents their entire equity allocation. The investment manager therefore benefits from the diversification within their portfolio, not the client. They already own many thousands of stocks. The real problem for the client is not lack of diversification, but radical over-diversification.

If we combine this with what we know from Bessembinder, the client has two means by which they might capture the tiny number of superstar companies that have the potential to be meaningful for long-term returns. Pay low fees to own the index and never miss out on superstar companies but have them heavily diluted. Or, attempt genuine concentrated stock picking of superstar companies that actually justifies active fees. The middle ground between those two options often serves investment managers, not the clients, providing only the worse of both worlds – active fees for index-like returns.

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Whose risk are we really trying to diversify? It can only rationally be that of the investment manager.

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Finally, we should return to our opening and that conversation back in early 2020.

The progress of that US automotive company since then has shown that we

were wrong to hold. We should have added substantially. Of course, this shows that

one never can be certain about the future. It is only through the brilliance of minds

such as those noted here that we can start to grasp what actions and approaches might be most advantageous for our

clients. This goes for building relationships not just with academics and scientists but corporate visionaries as well. It was the chance to talk to that company’s CEO to hear the ambition and vision that made

it clear, though not certain, that the possibility of extreme upside was there.

CONCLUSION

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Summer 2021

ESG RATINGS DON’T CAPTURE THE POSITIVE SOCIAL IMPACTS

OF INVESTING

BY ABHISHEK PARAJULI

FEBRUARY 2021

Abhishek joined Baillie Gifford in 2019 and is an Investment Analyst in the Emerging Markets Equity Team. In his PhD Abhi studied how minorities are often punished more harshly for mistakes, and in this paper he offers a perspective on the challenges of traditional ESG investing and how this approach might hurt the poor. For clarity Reliance Industries, which is cited in this paper, is held in some Baillie Gifford portfolios but is not held in any International Growth portfolios.

Growing up in India in the early 2000s, making a phone call was a luxury. Data was unaffordable too.

Even in 2015, it cost $3 per gigabyte in a country where the average daily wage was $3.70. In 2016, everything changed. Data prices collapsed to 9¢ — the cheapest in the world — and domestic calls became free.

Millions clamoured to get connected and rural areas, where the poorest Indians live, saw internet access increase threefold overnight. Farmers could now call and query grain prices and families could stay in touch with the millions of migrant labourers working in the big cities.

Since then, an entire technology ecosystem has grown on the back of this shift. Most Indian start-ups I’ve met point to the 2016 data revolution as a turning point for their business.

So, what happened in 2016? Mukesh Ambani, an Indian tycoon, ploughed billions from his oil company Reliance into a new data subsidiary called Jio. In three years, he amassed 400 million customers and India was yanked into the internet age.

Rarely in history has a single company had this much social impact. And yet, in the world of ESG ratings it is a very lowly rated stock. A leading ESG researcher, Sustainalytics, rates Reliance as ‘high risk.’ RepRisk gives it a measly CCC.

How could a company that has transformed the lives of hundreds of millions of people end up in the ESG doghouse?

The reason is simple. The sometimes enormous positive impact of the ‘S’ in ESG is silent. Because social change is hard to measure, it often gets ignored. As a result, ESG ratings penalise companies that have governance and environmental concerns even if they are completely transforming society.

– Anthology

It is relatively easy to measure a firm’s direct carbon emissions and add those of its power providers or even its supply chain. At the end of it all, you have a neat number to present.

Governance metrics also fit in a form, with nice neat boxes for the experience or diversity of a board. Find the answer, tick the box, move on.

That is not true of social metrics. Try measuring the benefits of the technology ecosystem that has been built on Reliance’s data. Try putting a number on the impact that technology ecosystem has had on remote education and healthcare during Covid. You cannot. There are no neat numbers.

Proper ESG analysis is a company-specific, resource-intensive activity. The quantitative approaches of ratings providers and index providers to ESG may actually highlight issues in a useful way. But they can never be more than an input, and never used directly to create portfolios for those who are serious about tackling the world’s challenges. Looking at narrower metrics for Social such as data privacy, community relations or employee pay is useful, but they do not come close to capturing what we should be asking: Is society better off because this company exists?

This problem is particularly acute if you are investing in emerging markets. Developing world companies sometimes have laxer governance standards or measuring emissions might be harder because supply chains are unmapped. And yet, these are the places that need the most capital for development.

Quantitative ESG analysts who are fixated only on readily observable data points would have us ignore these companies, hoarding our capital for pristine western alternatives. We may be more ‘ESG compliant’ in the eyes of ratings providers if we do this, but we will be smothering the very companies we should support to drive progress.

On top of being misguided, the current system is potentially misunderstood. Different ESG analysts can look at the same company and come to apparently contradictory conclusions: an MIT study found scores from leading ESG ratings providers have a correlation of just 0.61. The OECD says it is even lower at 0.4. For reference, credit rating agencies have correlations approaching 1. The providers themselves have different methodologies and the ratings may in fact just tell us different things: the key point is that quantitative approaches do not guide us definitively to ‘good’ or ‘bad’ companies.

None of this is an argument against the idea of ESG investing. Any long-term investor must care about the impact a company has on all its stakeholders. It’s not even an argument that Reliance is definitely an ESG-friendly company – it has serious environmental challenges in its fossil fuel operations. But a system that stops capital from flowing to the most transformative companies or the neediest nations is broken. We must fix it. If we fail, the poorest in the world will pay the price.

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© SpaceX

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THE PRIVATE OPPORTUNITY

DECEMBER 2020

All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk. Past performance is not a guide to future returns.

We may be on the cusp of a once-in-a-century change in how rapidly growing companies access capital. Many are staying private for longer, approaching late-stage venture capital rounds with altogether different intentions than they had even two decades ago.

This is not the first time the classic finance textbook story of how companies grow has been challenged. We believe that it is by understanding how we ended up with the current system of company financing, that we can best understand the new, evolved system emerging in front of us today.

BY ROBERT NATZLER

THIS PAPER IS INTENDED SOLELY FOR THE USE OF PROFESSIONAL INVESTORS AND SHOULD NOT BE RELIED UPON BY ANY OTHER PERSON. IT IS NOT INTENDED FOR USE BY RETAIL CLIENTS.

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The classic textbook story about a company’s lifecycle tends to start with an entrepreneur raising capital from friends and relatives then possibly giving some equity to a knowledgeable angel investor or taking out a bank loan. As the business grows, the company may turn to venture capitalists (VCs), who will provide larger amounts of funds as well as useful expertise around recruiting, marketing and legal support.

If everything goes well, the company then ‘graduates’ into public markets via an initial public offering (IPO). The shares will pass into the hands of public market investors, who will be looking for different specific characteristics – perhaps the ability to reinvest and grow even larger, or perhaps a clear framework for paying profits back out in the form of dividends. After a period of time, as the business ages, it may pass into the hands of private equity (PE) buyout funds, which would look to start the process of either rejuvenating the business under new management, or else beginning to close the business down and release its resources for deployment in other businesses elsewhere.

HOW WE GOT HERE

Classic Model

New Model

IPO Line

IPO Line

Dislocation of

Natural Buyers

Our Focus

Angels fund start-up

Angels fund start-up

VCs help build organisation

Public growth investors fund expansion of business

Public growth investors fund expansion of business

PE firms and public dividend investors harvest capital

PE firms and public dividend investors harvest capital

VCs help build organisation

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Such is the classic model, drawn from the experience of the second half of the 20th century. As well as describing how companies access capital, it shapes how pension funds and other investors think about allocating it.

What’s important to realise is that this model didn’t apply for much of the 19th century. Until the railways appeared, Wall Street’s purpose was to help governments raise debt. In London, a few hundred companies were traded on exchanges by public shareholders, but these were the exception, not the rule. Most companies around the world achieved scale entirely off the back of private capital, gathered from retained earnings, local banking networks or inter-family alliances.

The railways challenged this model because of the enormous amounts of money they needed to spend up-front in order to buy land and lay track. No family network alone could support such an effort, and so companies were forced to go to Wall Street. Once these railways were built, companies were able to sell their products to a much wider market, forcing their rivals to gain scale or be put out of business. The public markets were born as these local manufacturers raised capital on Wall Street to

fund mergers in pursuit of national dominance.

Ron Chernow’s 1990 history, House of Morgan, describes in detail how the classic Wall Street banks were slow to recognise these changes. They left space for new challengers,

banks such as Goldman Sachs and Lehman Brothers, which rose to prominence by specialising in financing businesses and factories. The incumbents were left behind because they failed to learn the different financial analysis skills needed for anything that wasn’t a railroad or government.

And the public markets didn’t stop there. The new industries of the 20th century – in autos, petrochemicals and mass manufacturing – proved incredibly capital hungry at early stages. Before products could reach customers, entrepreneurs

needed to raise huge amounts of money to build factories and distribution systems. With founders ever more dependent on venture capital support to get their ideas off the ground, companies were increasingly likely to IPO into public markets when the venture capitalists wanted to get their money back. And so it was that the 20th century textbook model, described above, took shape.

© ImageChina/Alamy Stock Photo

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At Baillie Gifford, we see signs that this system is evolving once again. Fewer companies are listing at IPO, and the ones that do are doing so significantly later in their lives than they were previously. The average age of a US company at listing now stands at 12 years, up 50 per cent since the start of the millennium. The aggregate valuation of late-stage private companies has also exploded. In 2006, there was a little under $10bn of value in ‘unicorn’ companies – private businesses with a value of over $1bn. As of 2019, there was more than $1.8tn of value in these businesses. Something is clearly going on!

WHAT WE SEE TODAY

I think there are three big factors at work. The fundamental economics of starting a business are changing. Government rules have changed. And, never to be discounted, cultural norms among founders are changing. Let me touch on each in turn.

Economics first. There has been a sharp change in the levels of capital investment most companies need before they’re ready to enter their chosen markets. Historically, an entrepreneur might have to build a factory, set up bricks-and-mortar outlets to achieve national coverage and invest heavily in servers to run IT. Today, it’s possible to rent Chinese manufacturing capacity through Alibaba, hire digital targeted advertising from Facebook and Alphabet, and access the exact amount of required computing

capacity through the cloud services of giants such as Amazon Web Services (AWS). The result is that many companies can scale for a much longer time before the founders have their ownership stakes diluted by outside capital providers, whose limited-life vehicles made them historically impatient for an IPO ‘exit’ event.

On top of this, there’s been a revolution in staff count. The biggest employers today have far fewer employees than juggernauts of yesteryear such as GE or Ford. In the 1930s, Ford’s River Rouge Complex in Michigan employed more than 100,000 workers on just a single site. Today, tech companies such as TransferWise are generating hundreds of millions in revenue with barely 2,000 staff members.

The average age of a US company at listing now stands at 12 years, up 50 per cent since the start of the millennium

Time to IPO and Market Capitalisation at IPOIllustrative Examples:

Source: Baillie Gifford. SpaceX valuation as of August 2020.

1994 Amazon founded 2004

listed $23bn

1998 Google founded

2018listed $27bn

2006 Spotify founded

2012listed $104bn

2004 Facebook founded

2002 SpaceX founded

Still not listed, latest valuation $46bn

1997listed $0.4bn

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Where hierarchies are needed, modern management software lets them be more flexible than ever before. Effective business systems are easier, cheaper and less reliant on the expertise of senior chiefs from large organisations. The result is that founding teams of talented engineers can run their organisations for much longer before they need to lure in bosses from large corporations with promises of big pay-outs and a company listing.

These fundamental changes in the economics of building and running firms means that founders have more control of their organisations and have it for longer. With these outside pressures to list removed, many are taking the option to stay private for longer, selling down a bit more of

their ownership stake rather than rushing into IPO.

Along the way, there have also been helpful changes in government rules. The 2002 Sarbanes-Oxley Act made IPO conditions significantly more stringent, while subsequent regulatory actions have substantially increased the reporting burden on public companies. Some chief financial officers have gone as far as claiming that the cost of being public has risen more than five-fold since 2010 alone! On the other side, the tax changes enshrined in the US JOBS Act of 2017 have made it easier for emerging growth companies to share rewards with employees while remaining private, removing one more historic source of pressure to IPO.

Take that combination of regulatory change and increased founder power, and it’s not surprising that we see another great driver of this trend. Norms are shifting within the founder community. For companies such as Facebook, ringing the stock exchange bell at IPO was a prestigious coming-of-age moment. But as more and more large and famous companies – Airbnb, SpaceX, Stripe, ByteDance (owners of TikTok) – have stayed private, the association between being listed and being successful has weakened. Talking to founders today, we are struck by how many view public markets with distaste, noting the arms-length mistrustful relationships that develop between managers and often all too short-term shareholders.

Facebook CEO Mark Zuckerberg Rings Nasdaq Opening Be, © Bloomberg/Getty Images.

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These changing trends of business economics, government rules and corporate norms have resulted in a late-stage private market containing increasingly valuable and large companies. That combination points to a 21st century where the classic finance textbook’s neat account seems ever more out of date.

The simple truth is that the kind of companies that are staying private for longer are very different from the young and immature operations that talented early stage VCs specialise in finding and helping. These are not companies that require investor help in making key hires, writing HR policies or designing marketing plans. Far from desiring it, the last thing many of these founders want is one more investor telling them how to run their already highly successful and expanding business.

THE WORLD AHEAD

This matters, as private markets have never just been about access to capital. Management teams get to choose their investors, determining the terms and prices at which they offer stakes in their company. Any investor can write a cheque; but it’s the investor the company wants that gets the chance to write that cheque at an attractive valuation. This is why the best early-stage venture capitalists have specialised for so long on the support areas outlined above; and why it’s so important for us to understand what it takes to be a natural buyer in the rapidly growing late-stage private market.

At Baillie Gifford, we believe that we are natural buyers for these businesses. This began as a tentative hypothesis but has strengthened over the last decade into a core belief. We review it with the help of two key reference points.

First, we look at our ability to source proprietary deals. We can access investment opportunities through our own relationships and reputation, rather than through just joining in on bank-promoted rounds. Over the last two years, over 75 per cent of the deals we’ve made have come through these proprietary channels. Second, we look to the frequency with which we receive our full allocations in private funding rounds. In 2019, we received our full allocations more than 95 per cent of the time. For 2020, the figure is standing at a little over 97 per cent. We know this is an exceptionally high level relative to many other participants.

So why do founders choose to partner with Baillie Gifford? For us, this comes down to three points. We are long-term in our approach and understanding, with a proven record of supporting growth businesses both at scale and globally. We use vehicles and structures that let us offer continuous support, walking with the founders through multiple private funding rounds and then staying with them long into the public markets. Using the insight this gives us means we can be aligned with the management as the company grows. Let me take each point in turn.

Any investor can write a cheque; but it’s the investor the company wants that gets the chance to write that cheque at an attractive valuation.

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At Baillie Gifford, long-termism has never just been a punchline. In public markets globally, the average investor has a holding period measured in months. At Baillie Gifford, our average holding period is above seven years. For the flagship strategy that began our private market practice in 2012, that period is nearer 12 years. We’ve always focused much more on the long-term strategic opportunities in front of businesses than on worrying about every potential short-term tactical misstep; and we’ve always been very upfront in sharing our perspectives with boards and fellow investors whenever management have needed our support.

We’ve brought this perspective with us to private markets. The companies we invest in know that we’re in no rush to push them into an IPO. We support them in many cases through multiple private rounds before they seek a listing. And when they do seek that listing, we have the firepower to support them, and then continue to stand by them. At the time of writing, Baillie Gifford clients have almost $5bn deployed into private companies around the world – and around another $40bn deployed into public companies that we first invested in when they were private. This behaviour, in both public and private markets, in turn goes to build our reputation among board members and management teams, helping us secure further introductions to other private opportunities.

Second, the way in which we approach this means that we can offer continuous support. Not for us the seven- or 10-year limited life fund timelines that have been typical of VCs.

The vast majority of our private investments have been made from permanent capital vehicles – closed-ended investment companies whose shares are available for trading on stock exchanges. Our clients can buy and sell shares in these vehicles, allowing us to promise companies that we will never pressure them into timing a financing event simply to provide us with liquidity. These vehicles also have the ability to hold companies into public markets. Rather than just passing holdings as an introduction to a separate team, we can then continue to support them as they progress to public markets over many years from within the same team and vehicle that first invested.

This continuity point applies at a broader level too. There is no firewall at Baillie Gifford between our private company specialists and the public market teams. Indeed, our core team of seven private investment specialists is joined by over 30 other Baillie Gifford investment managers who split their time between private and public investing. Each of those 30 has individually led a private investment within Baillie Gifford. The research that this group generates is then shared within our central research hub, which it is accessible to all the 120-plus Baillie Gifford investors, wherever they are based in the world. The result is that Baillie Gifford has a seamless relationship with the management of private holdings when the companies eventually move into public markets. This lets us forge deep relationships and thus understanding of them while they are private – and reassures founders that in Baillie Gifford they have a potential public market investor who truly knows them.

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Finally, these relationships allow us to work closely with founders and their management teams. As one of the few investors in the world that walks with companies through multiple private rounds with the intention of being a long-term public markets holder, we stand out as an obvious source of advice on how to prepare for listing. Whether it is engaging on individual corporate governance policies or discussing how to behave at IPO to attract good long-term public markets funds, we frequently find ourselves engaging with the companies we invest in to help them think about their future on a multi-year time period. We continue to work hard at improving this

offering, doubling down on making sure we remain the investor of choice for long-term oriented private company founders.

We believe that the world of capital provision is changing in ways that have not been seen since the early 20th century. With over $1.8tn of value now found in private company unicorns, we believe that late stage private companies can no longer be considered as an afterthought. This is a new space, and it requires a new kind of private investor.

At Baillie Gifford, we are striving to be that investor.

© Airbnb, Inc.

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INTERNATIONAL GROWTH UPDATE CLIENT CONVERSATIONS

23–30 MARCH 2021

Key takeaways — There is no change to our philosophy and process.

— Transaction activity is in line with our normal tempo.

— We are making no shorter-term timing decisions in response to recent rotational trends.

— We have refreshed our ‘portfolio insights’ to provide a better sense of the opportunity set.

— Healthcare innovation and the continuing re-emergence of China are two very exciting long-term growth areas.

Introduction

This was the third in our series of client calls, following sessions in March and September last year. Having previously discussed our thoughts in relation to portfolio resilience and upside potential, we now turned our attention to what we see as two of the key long-term structural growth opportunities facing investors, namely the dramatic changes in the healthcare landscape and the re-emergence of China.

Recent trends

First however, what have we been doing over the last six months? To state the obvious, 2020 was highly unusual in many ways. More recently, economic ‘reopening’ hopes have driven some rotation into

companies that were left behind during lockdown. We recognise that stocks such as banks, where the portfolio has no exposure, might continue to recover in the short term, even though we would argue that their structural decline has been accelerated by the pandemic. At the same time, the prospect of interest rate ‘normalisation’ is leading to questions about the valuation levels of long duration growth stocks and putting some pressure on share prices.

Even though these two performance headwinds have emerged, you will not be surprised to hear that we are making no attempt to finesse the short term. In our view they have no impact on the long-term prospects for the portfolio. We remain focused on finding the stocks that can really make a difference to long-term returns. Transaction activity has therefore been based on the same philosophy and process as before.

We have taken the opportunity to upgrade the quality of the portfolio through some new buys and additions to existing holdings, while recycling capital out of selected stocks that have either performed well or are facing fundamental challenges.

We have also updated our ‘portfolio insights’, so that they better represent where the most exciting growth opportunities might lie. New insights include energy transition, which we covered during the last series of calls, and digital infrastructure, which can be thought of as the picks and shovels that facilitate digitisation across a range of industries. Two of the insights are healthcare innovation and the re-emergence of China.

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Portfolio insights

Health innovation

The issue at hand here is how healthcare innovation can be translated into investment opportunities for the strategy. It is not a new subject – we have been looking at it for many years and have gradually discovered the stocks that have allowed us to build out portfolio exposure to this exciting area. The events of 2020 further strengthened our conviction that something really exciting is going on. Think of the extensive worldwide collaboration to treat Covid-19 and the incredibly rapid identification of its genetic code and discovery of a vaccine.

On average it takes more than a decade to develop a vaccine. That the entire Covid-19 vaccine discovery and development process took less than one year is extraordinary, but it did not happen by accident. Many

billions of dollars have been, and continue to be, invested in a range of new technologies, such as gene sequencing and machine learning, to enable such progress. And, looking beyond vaccines, it is this convergence of technologies that is driving the wider transformation of healthcare. Human health is incredibly complicated, and a multitude of biological and behavioural issues are at play, factors that have contributed to disease management being more about treatment rather than prevention and cure. Now, however, we are able to generate and collect vast amounts of data, while using machine learning capabilities to make sense of it all. This is beginning to transform the landscape, and we are now seeing the development of a range of approaches based on technologies such as mRNA and gene editing. We call it the great convergence.

The bubble sizes are the output of our bottom up stock selection process and do not reflect a top down, or target, allocation.

Pioneering Industrials

Chinese Re-Emergence

Digital Infrastructure

Health Innovation

Digital Consumption

Unique Brands

Energy Transition

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The radical reshaping of healthcare

For us, this means we must take a differentiated research approach to the sector. Deep, but narrow, medical expertise is not the best way forward. Rapid industry developments, driven by the technological convergence noted above, mean that a more generalist approach should work better than deep specialism. We can outsource specific knowledge to our growing network of academics, industry specialists and entrepreneurs, while retaining the breadth of perspective required to allow for better decision making. We have developed a research framework around this for our Health Innovation strategy, which we are confident is benefiting International Growth. Arguably, healthcare is now at the same stage as the IT industry was in the 1970s, and we expect similar levels of progress to be made. This is great news for growth investors.

Data

Collect data Interpret data

Target diseases

DNA AI

Gene therapy

Microbes Proteins

DNA

Nutrition

Soc

ia

l Activity

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Healthcare Q&A

— Do new technologies mean a different type of company is attractive?

Yes, in the sense that younger, more flexible biotech companies are innovating at a faster rate than traditional ‘big pharma’. We can, and do, support them with capital, which helps them to remain independent and build for the long term. Further, our interdisciplinary mindset means that we can include stocks such as data companies in the scope of our research.

— Would a basket approach be appropriate given the risks of biotech investment?

We believe that the underlying nature of the industry is changing, in that the understanding of human biology has improved, while there are now better tools available to deal with disease. Having said that, we do not want to own stocks at what we consider to be the very risky end of biotech. The International Growth strategy has a strong bias to companies that are substantially derisked, for example with strong balance sheets, or where the science has been proven, and where we can see a platform that should allow them to bring a range of drugs to the market.We think our process should give us a good chance of identifying individual winners.

— Where in the world are the best opportunities to be found?

The opportunity set has expanded dramatically in the last few years. Historically the US has been the most fertile hunting ground, but this has been changing. Increasingly we are seeing opportunities in Europe and Asia. Interestingly, Covid-19 has revealed that Europe has some strong companies and science. BioNTech, which has partnered with Pfizer on one of the vaccines, is a German company, as is Curevac, which is held in some client portfolios. And there has been a cluster of strong companies in Denmark for many years. Looking further afield, China is not far from delivering differentiated products at scale, so it may be home to the next wave. We are looking at several companies, aided by our Shanghai office, and hope to repeat the success we have had with Chinese internet stocks.

— Do you need to be a deep specialist to cover the sector?

No. When the pace of change is fast, as it is today, it is helpful to be a generalist because the future will look very different to the past. Other advantages of the generalist approach are that (a) innovation is taking place at a cross-disciplinary level and that requires a wider perspective, incorporating machine learning and software for example, and (b) we mitigate the risk of behavioural biases so we can simply gather information from the best people and put their knowledge through our process. Yes there is science complexity, but the real skill for an investor is in understanding the interplay of different disciplines and technologies.

— Will there be a transformation in medicine delivery as well as discovery?

This is another exciting area. Telemedicine is one obvious industry, where Covid-19 has accelerated acceptance of the concept. Elsewhere, the ability to deliver diagnostic tools through mobile devices should also improve over time, with personal healthcare eventually looking more like a continuous monitoring process.

— Is the private sector the key driver of innovation?

Yes, but companies sometimes come to market too quickly. Government has always played a role, most recently in the development of the Covid-19 vaccine, but only as part of a greater whole.

Chinese re-emergence

The rise of China has been one of our core contentions over the last decade. Our thinking has evolved, however. It is no longer necessary to differentiate China from other emerging market opportunities (remember the BRIC acronym?), rather the focus is now on what its re-emergence as a leading geopolitical, economic and technological power will mean for China itself, as well as for the rest of the world. China does matter – it represents a much bigger share of global GDP and GDP growth than of international equity allocations.

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China matters

It is worth underlining that, although we may talk about China as a whole, we are investing in a very small subset of highly attractive transformational growth stocks, often led by founder managers that have more in common with the US west coast than domestic China. We think there are four key characteristics that define why the opportunity set will remain positive for such companies:

— The unrivalled scale China can offer for growth. For example, while the US is home to 10 cities with over 1 million people, China has over 160 of them.

— A population that is eager to embrace new ways of doing things and new technologies. In food delivery, in the US, Grubhub currently delivers around 600,000 meals per day while, in China, Meituan is delivering almost 30 million meals per day.

— The extent of available infrastructure that allows for innovation and new business models. Take internet connectivity, where China has more 5G base stations than the rest of the world combined.

— Finally, we believe that AI is going to be an important technology. The sheer extent of data availability in a highly connected population gives China an automatic lead.

We would contend that to understand the future and how business models might evolve then the best place in the world to spend time is China’s east coast. For example, our contacts there helped us better understand Latin American ecommerce stock MercadoLibre’s payments business earlier than would otherwise have been the case for example, while online fashion company Zalando pivoted its entire business model having been inspired by what it saw there.

High growth has created tensions of course. To mitigate the risk of investing in companies that run up against the authorities, our starting point is to back companies that help solve long-term societal problems or, put another way, that run with the grain of society. We have invested in stocks that provide the infrastructure for online consumption, education and clean energy. The dispersion of power to these platforms has created challenges for the State, however, so we should not expect a smooth ride. Indeed, there have been previous instances of temporary clampdowns in areas such as gaming and medical advertising that impacted portfolio holdings for a period of time. Note that this is not a problem unique to China. All around the world regulators are trying to get to grips with issues such as free speech and privacy.

19% of global ex-US population

34% of global ex-US GDP growth 5% allocation in global ex-US funds

22% of global ex-US GDP

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China Q&A

— What happened to the Ant IPO?

It looks like the proximate cause for the postponement was Jack Ma’s speech in front of a regulatory and state bank audience, during which his open criticisms crossed a line. There has always been a tension within the authorities between those advocating a more accommodating approach to the private sector’s involvement in the financial system and those favouring a firmer line on innovation and stability, and it appears that the speech tipped the balance towards the latter. A number of issues such as management change have since been resolved, but if the IPO returns to the table it may look a bit different to what we thought it would. More broadly, such a public flashpoint is unusual in China. Regulation mostly occurs in tandem with companies, which are able to tweak their business models and adapt to state requirements.

— How is our Shanghai office helping us?

We are very encouraged. It is building on the work we have been doing, but in a more ambitious way. Our edge in China is in access, and the Shanghai office can help us deepen existing relationships as well as introduce new ones such as a broadening of our academic inputs. It can also help our perspectives on geopolitical issues, by allowing us to view issues through a local as opposed to a western lens. Over time, we expect to further broaden our knowledge base. One of the Shanghai team will shortly join International Growth for a three-month secondment and we hope that this can become a rolling arrangement.

— Might geopolitical differences escalate to the level that will make investment in China unattractive?

We think this is unlikely. We expect that, as two superpowers, we expect China and the US will bump up against each other in the long term, so recent tensions are not a function of any one particular administration. Our base case therefore is protracted antagonism. Our aim is to try and understand all sides of the debate, so we are casting the net well beyond Wall St and making use of our Shanghai office. The worst thing we can do is withdraw capital. As western shareholders we can play a role in encouraging companies to take a more rounded view of their role in society. And the impact is not just about what happens in China, but beyond. So we need to consider the global implications and how any company’s growth prospects might be affected by, say, the emergence of two distinct trading blocs.

— Could antagonism spiral into conflict?

Our starting point is to retain an appropriate degree of humility about our ability to offer insights into this subject. China is engaging in global problems such as climate change, while economic interdependence has grown. So the impacts of the current tensions are not one way. Further, the standoff has reduced our concerns about what might happen if, say, Amazon and Alibaba competed in the same market. This destructive scenario now seems less likely. The growth opportunity may be more limited, but so might competition.

— What sources do we use to help us think about the relationship between the private sector and the State?

It used to be a case of spending lots of time there and meeting as broad a range as possible of individuals in the ecosystem, including private companies, academics, journalists and bloggers. Diverse perspectives remain important, so we still intend to do that, but, as noted above, travel from Edinburgh has now been supplemented by the creation of our Shanghai office, which allows us to multiply our contact points. It is also worth noting that our scale and long-term investment philosophy continue to give us privileged access to the corporate sector.

— How do urban densities impact the opportunity set?

They reduce some costs so companies can emerge at an earlier stage, while also giving us the chance to observe how quickly certain business models can develop, with food delivery being a clear example. Analysis of delivery costs, the scope of the supply chain to adapt, and the ability of a company to leverage its distribution network to fill out the product range, have broadened our horizons as to what may be possible in other locations around the world.

— Where are the next Chinas?

India is an obvious one given its scale, while some countries in South East Asia and sub-Saharan Africa have the ingredients of population growth and rising wealth. At the moment, however, we are mainly at the stage of building out our domain knowledge.

AUTHOR BIOGRAPHIES

LAWRENCE BURNSInvestment Manager, Partner

Lawrence is an Investment Manager of Baillie Gifford strategies that share a focus on transformative growth companies. He has been a member of the International Growth Portfolio Construction Group since October 2012 and took over as Deputy Chair in July 2019. Lawrence is also the Deputy Manager of the Scottish Mortgage Investment Trust, a co-manager of International Concentrated Growth and Global Outliers. He joined Baillie Gifford in 2009, spent time working in both the Emerging Markets and UK Equity Departments, and became a partner in 2020. Lawrence graduated BA in Geography from the University of Cambridge in 2009.

ABHISHEK PARAJULIInvestment Analyst

Abhi is an Investment Analyst in the Emerging Markets Equity Team, having joined the firm in 2019. He previously worked as an Editorial Writer at the Financial Times while working on his PhD at the University of Oxford. He completed an MPhil in Politics with Distinction from Nuffield College at Oxford in 2017 and a BA in American Politics from Dartmouth College in 2015 as the Class Valedictorian.

ROBERT NATZLER Investment Manager

Robert is a member of the Private Companies Team at Baillie Gifford. He joined the firm in 2015 and worked on our Emerging Markets and UK Equity Teams before moving to Long Term Global Growth. There he focused on finding stocks for a set of highly concentrated long-term international growth portfolios. He also began working on private companies, in the context of both private funding rounds and existing holdings approaching IPO. In 2018 he moved to our Private Companies Team to work full-time on identifying high growth late-stage private companies. He is working to develop a best-in-class research culture and company support strategy on the team. Robert graduated with a BA (Hons) in Philosophy, Politics and Economics from the University of Oxford in 2014.

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IMPORTANT INFORMATION

Baillie Gifford & Co and Baillie Gifford & Co Limited are authorised and regulated by the Financial Conduct Authority (FCA). Baillie Gifford & Co Limited is an Authorised Corporate Director of OEICs.

Baillie Gifford Overseas Limited provides investment management and advisory services to non-UK Professional/Institutional clients only. Baillie Gifford Overseas Limited is wholly owned by Baillie Gifford & Co. Baillie Gifford & Co and Baillie Gifford Overseas Limited are authorised and regulated by the FCA in the UK.

Persons resident or domiciled outside the UK should consult with their professional advisers as to whether they require any governmental or other consents in order to enable them to invest, and with their tax advisers for advice relevant to their own particular circumstances.

Baillie Gifford International LLC is wholly owned by Baillie Gifford Overseas Limited; it was formed in Delaware in 2005 and is registered with the SEC. It is the legal entity through which Baillie Gifford Overseas Limited provides client service and marketing functions in North America. Baillie Gifford Overseas Limited is registered with the SEC in the United States of America.

The Manager is not resident in Canada, its head office and principal place of business is in Edinburgh, Scotland. Baillie Gifford Overseas Limited is regulated in Canada as a portfolio manager and exempt market dealer with the Ontario Securities Commission (‘OSC’). Its portfolio manager licence is currently passported into Alberta, Quebec, Saskatchewan, Manitoba and Newfoundland & Labrador whereas the exempt market dealer licence is passported across all Canadian provinces and territories. Baillie Gifford International LLC is regulated by the OSC as an exempt market and its licence is passported across all Canadian provinces and territories. Baillie Gifford Investment Management (Europe) Limited (‘BGE’) relies on the International Investment Fund Manager Exemption in the provinces of Ontario and Quebec.

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