21 Sep 2022
Princes Street Gardens in Edinburgh separate the old town from the new and were created in 1820 following the draining of the North Loch. The gardens are spread over 37 acres and are divided into two parts by The Mound, an artificial hill that connects the new and old town where the Scottish National Gallery is located. The site of the Gardens ‘Nor Loch’ was first a marshland on the north side of Edinburgh and had initially been used as a natural medieval defence along with Edinburgh Castle.
While European small companies are an area out of favour, abrdn, through the old Standard Life franchise, have a strong team of smaller company experts who have delivered excellent returns dating back over a decade. I had an update meeting with Head of Smaller Companies Andrew Paisley and a dedicated ESG Analyst Tzoulianna Leventi. The fund has suffered year to date in the market rotation from growth stocks and Andrew stated that the principal move hitting performance had been a de-rating of stocks rather than huge downgrades to the earnings forecasts of stocks held within the portfolio. The investment process has remained unchanged for over 20 years and focuses on companies with strong earnings momentum, share price momentum and high quality (Altman Z) scores.
The market is in the process of re-adjusting to a new inflation and interest rate outlook which has hit growth stocks and in particular small cap growth stocks hard after the upward re-rating these businesses enjoyed in 2020. In fact, valuations are now back below long-run averages. Going forward, Andrew believes that markets will focus on prospects for corporate profitability with an emphasis on the underlying fundamentals of the individual companies. Traditionally, when there is an economic slowdown, quality growth stocks outperform. The emphasis on quality means that the portfolio has not been exposed to smaller oil and gas companies (some of the best performers this year) which very often have binary outcomes to their exploration activities. The businesses held continue to have a return on equity around 50% higher than the market average. There is an emphasis on companies with structural growth drivers rather than businesses dependent on a strong macroeconomic environment.
The businesses in the fund in general have pricing power, but those in the industrial sector may see a short-term dislocation before they can increase prices already agreed to cover higher levels of raw material costs. Many of the top holdings have been held for a considerable time such as Swedish listed Addtech, a technical solutions products provider and Italian listed Interpump, a producer of high-pressure plunger pumps. The top holdings are diversified and exposed to sectors such as perfumes and other consumer products, fintech, consumer staples companies producing home and speciality goods, pharmaceuticals, online event ticketing, and German real estate. Some businesses have suffered from supply chain delays such as forklift manufacturer Jungheinrich, also a manufacturer of warehouse automation equipment and Troax which operates in the automation space, but these stocks are being held for the longer term.
There are some structural themes within the portfolio such as ageing population, alternative assets, ESG opportunities and warehouse automation.
Dedicated ESG Analyst Tzoulianna explained that there was constant engagement with companies on how to improve ESG ratings, that most of the stocks within the portfolio are classified by MSCI as ‘A’ or better and the fund has much lower carbon intensity than the benchmark. The team undertake their own fundamental research to identify possible ESG issues and engage over these. With a high proportion of owner-managed companies held, business owners have an incentive to align for the long-term. Some smaller companies provide solutions to ESG issues such as Vidrala in the war against plastic and Borregaard with its alternatives to oil based chemicals.
While the fund has had a difficult period, historically the process has only struggled around one year in five and is proven over its 20-year plus history and although Europe is currently out of favour as an investment area, at some stage it will hold good recovery potential and may appeal to contrarian minded investors.
Baillie Gifford is well known in the equity space, but they have also developed a strong capability in bonds, especially in corporate credit where they focus on understanding long-term fundamentals in companies and look to lend to companies of the future rather than the past. Typically, corporate debt held belongs to companies that are growing and making products or services which will continue to have relevance well into the future and these businesses have sustainable or improving balance sheets and are likely to be resilient at times of economic uncertainty. I caught up with Torcail Stewart, one of the Co-Managers of the fund.
The portfolio managers are not active traders of macro news but take a strategic view on asset allocation which would typically have exposure of around 70% to investment grade credit and 30% in high yield credit. This is adjusted for prevailing economic conditions and in more troubled market environments there can be increased exposure to government bonds, but the fund takes a global approach to investing, looking for idiosyncratic bond ideas from across the world. This involves detailed fundamental research to ensure companies whose bonds are held have strong resilience and many of the businesses benefit from the pace of societal, technological, and environmental change. The fund takes a best ideas approach to bond markets and often focuses on something called crossover bonds which straddle the investment grade/high yield boundary as these are areas of market inefficiency (mispricing).
There is a credit team of 11 investors with two ESG specialists and all team members are analysts first and foremost. Sector responsibilities are rotated every 2-3 years and country expertise comes from regional equity and sovereign debt teams. Portfolio construction looks to provide a diverse fund driven by individual stock opportunities holding between 60-85 names.
After the selloff in credit markets, Co-Manager Torcail believes credit markets are attractive on a 2 to 3-year view and for certain businesses elevated yields are available. Spreads on both investment grade and high yield credit have widened this year with multiple bond issues now trading below par as a result, offering capital upside to investors. The move up in short-term government bond yields means shorter dated corporate credit has become more attractive including names such as Telefonica, Bharti Aertel, ATT&T together with Telecom Italia. Banks are also benefitting from better net interest margins with favoured names JP Morgan, NatWest, and Svenska Handelsbanken. There is also selective exposure to European utility names such as EDP and wind generator Orsted to name two.
Some of the individual stock opportunities include Shiram Transport Finance, a specialist lender in India and Cheniere Energy which operates gas export terminals in the United States. Another very idiosyncratic idea is Annington Funding, a UK property owner, with a 174-year sale and lease back to the Ministry of Defence where there is speculation the property assets could be re-purchased leading to redemption at par for bonds trading in the region of £70-£80.
The managers firmly believe that with the setback in the market there is now upside potential in terms of capital growth in the portfolio with many names having fallen below par in this years sell-off. The managers continue to take a long-term view on asset allocation, believing investors are generally paid to take on corporate credit risk and look to add value above this through active stock picking.
The moves in the market this year have created opportunities for the fund managers, and we believe the fund is for investors looking for an above average level of income with some prospects of modest capital growth but without the volatility of equities.
The Baillie Gifford Pacific Fund has been a long-term success story. One of the co-managers has left over the last 12 months, but the well-resourced Emerging Markets Team has transferred a team member to fill the void with the Emerging Market desk having eight fund managers and several junior analysts. The team believe that returns follow earnings over the longer-term so remain focused on finding the fastest growing companies within the Asia Pacific Region. This can be longer-term growth stocks including names such as TSMC, together with faster growing companies such as SEA Limited and Meituan, but also more cyclical businesses where the market can be surprised with an earnings recovery, including stocks in the materials sector such as Vale Indonesia. The fund has had a long-term position of close to 9% in Vietnam, a country benefitting from businesses diversifying supply chains from China with the strength of the manufacturing sector also helping domestic consumption. Other favoured countries are India and Indonesia. A relatively new purchase has been Longi Green Energy Technology which is exposed to solar and continues to deliver strong results.
The fund is an interesting addition to portfolios of growth-oriented investors who can tolerate periods of shorter-term volatility.
Walking back to my hotel by Princes Gardens, the skyline is dominated by the 61-metre-high Scott monument, the largest monument to a writer in the world. Scott was born and raised in Edinburgh and from a young age, collected the folk tales of the borders, tales considered so lowly at the time that it was frowned upon to write them down. They became his source for poetry and his series of novels, starting with Waverly which Scott published anonymously in 1814. After this, even the Regent King George IV wanted to meet him. Scott created a new genre, the historical novel, and rehabilitated the international image of Scotland when many considered it dangerous and backwards. It is believed that the romantic image of Scotland today owes much to Scott’s works and he is remembered through this spectacular Victorian gothic monument. The design is the result of an architectural competition with construction beginning in 1840 and the structure contains a museum room on the first floor together with magnificent stained-glass windows. The monument was completed in 1844.
Graham O’Neill, Senior Investment Consultant, RSMR
RSMR provides impartial, qualitative, forward-looking research for advice businesses.
Click here to head to the RSMR blog for market updates and a whole host of informative, up-to-the-minute content.
Click here to sign up to RSMR research where you can access RSMR fund ratings, fund profiles, factsheets, insights, market updates and event information.
This information is for UK Professional Advisers only and should not be given to retail clients.
The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.
Rayner Spencer Mills Research Limited is a limited company registered in England and Wales under Company Registration Number 5227656. Registered office: Number 20, Ryefield Business Park, Belton Road, Silsden, BD20 0EE. RSMR is a registered trademark.