Long ReadFeb 28 2022

Baillie Gifford’s £30bn problem

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Baillie Gifford’s £30bn problem

From understated offices in central Edinburgh, Baillie Gifford emerged from the financial crisis as a behemoth of the asset management world, managing more than £338bn across institutional, retail and advised books of business.

But it declined 10 per cent in 30 days over January, losing more than £30bn, according to UK fund flows data from Morningstar. That drop is from a combination of outflows and a steep decline in the value of the investments. The £338bn figure is the number cited on Baillie Gifford's own website as at end of December 2021.

This may prompt questions around what comes next for the business that rode the wave of technology and other investments associated with the growth style of investing, as the market may be about to embark on an extended period where the value investment style does best. 

The concentrated nature of the Baillie Gifford investment process – that is, building portfolios with relatively few stocks even as the funds got bigger – means that any shift in sentiment can have an outsized impact.

The business was sharply in favour in 2021 with retail investors, topping the net sales charts at £3.8bn, according to the latest Pridham Report. But in January alone £875m of retail open-ended funds went out the door, according to the Morningstar data. The data company described the month as the "worst on record" for Baillie Gifford, as the momentum of the previous decade went into reverse. 

However, the downward trend began earlier than January, with the same Pridham Report noting that the inflows came mostly in the first half of the year. 

The decline in Baillie Gifford AUM has mostly been the result of the sharp decline in the share price performance of the very same tech, biotech and other growth shares that carried the business upwards. Baillie Gifford has never hidden its fund managers' preference for using the growth style of investing, a style that has come under pressure as a result of the changed interest rate environment. 

But it is not just the growth shares angle. Baillie Gifford has in recent years also shifted focus to investing more in China, with the company's flagship Scottish Mortgage Investment Trust currently having around 16 per cent of its £14bn of assets invested in the country.

Chinese government interventions in the economy and concerns about the country’s economic growth as it exits the pandemic have caused a steep underperformance of the Chinese equity market, and also of several Chinese equities listed abroad, causing losses for investors in those shares. 

Scottish Mortgage is the largest investment trust in the UK market, but its share price has fallen by more than a third from its peak of more than £15 in November 2021, to below £9 now.

The second largest investment trust in the Baillie Gifford stable, the Monks Investment Trust, has seen its share price fall from £14 to £10 over the past six months.

Those share price declines help contribute to the massive fall in AUM over the course of the past month. 

Monks has a wider focus than Scottish Mortgage as it is not entirely tech or new-economy focused, but it does deploy the growth style of investing that is the hallmark of the company. 

Mick Gilligan, who runs the model portfolio service at Killik and Co and also tends to focus on investment trusts, says: “I don’t think this is about size. I think it’s simply about an investment style that is currently on the wrong side of a very aggressive market rotation.

"The rise in market interest rates has led to higher market discount rates and a reappraisal of the value of future profits. The most heavily impacted investments in this type of environment are stocks where: a) the profits are far in the future; and b) those profits are more uncertain than for the average stock.

"This describes Baillie Gifford portfolios quite well and Scottish Mortgage in particular. I still see merit in holding these types of investment, but I think the level of exposure in portfolios should be relatively low right now.” 

Anthony Leatham, investment trusts analyst at Peel Hunt, says: "We certainly point to style as being the leading cause of this drawdown. 

"While some of the trusts managed by Baillie Gifford are large and the firm itself has experienced strong growth in funds under management over recent years, there are measures in place to prevent size from being an issue.

"For their trusts, the closed-ended fund structure suits the investment approach which is long term in nature and has, on average, seen portfolio turnover of between 10 per cent to 20 per cent, implying an investment horizon of five to 10 years. 

"One of the other benefits of size is the investment in people and systems and the trusts benefit from this deep and experienced manager and analyst resource, as well as the network effect that comes from being such a well-regarded growth equity investor."

Data from Morningstar shows the Baillie Gifford American fund, which is managed by some of the same team as the Scottish Mortgage trust, had outflows of more than £400m in the three months to the end of January 2022, and has shrunk by £3bn since the end of November 2021 to £4.3bn in size. 

Another mandate to suffer sustained outflows is the company's Managed fund, which shrank by £1.2bn in the month of January alone, while the Diversified Growth fund lost about £600m. 

Baillie Gifford's Global Discovery – a small and mid-cap mandate that returned 78 per cent in 2020 but lost 19 per cent in 2021 and has lost 23 per cent since the start of this year – has shrunk in size by around £400m since November 2021. 

Baillie Gifford is a partnership, wholly owned by its employees, and the company has long emphasised that macro-economic factors do not play a role in how it manages money. Unusually for a business of its size it does not employ professional economists or market strategists.

Baillie Gifford said it does not comment on short-term flows data, but in a recent note to clients James Budden, director of marketing and distribution at Baillie Gifford, said that a combination of worries about China, style rotation and the impact of higher inflation on early stage companies are the reasons for the decline in performance.

Budden wrote: “What is certain is that as long-term growth investors we will not divert from our tried and tested approach. Style drift can be lethal in investing as it betrays investor expectation and incurs needless cost. We fully acknowledge that there will be times when our style is out of fashion – 2021 being an example. Yet we remain committed to finding exceptional companies and supporting them in finding solutions to some of the world’s great problems.” 

Ben Yearsley, co-founder of Fairview Consulting, says: "The last thing you should want to happen is that a firm changes its investment style. It's important clients have a blend of different styles and if they have Baillie Gifford funds for the growth style, then they don't want that to change." 

Of the merits or otherwise of being invested in one particular style, Ben Seager Scott, head of multi-asset funds at Tilney Smith and Williamson, says: “Even allocating within equities is a multi-dimensional task where you need to consider elements including geography and sector before you even get into factors and styles, before even thinking about the idiosyncratic characteristics of the company.

"If we focus just on styles and factors, there is clearly different strokes for different folks here, but what I think is important is that investors go in with their eyes open and are conscious of their exposures.

"Diversification applies just as much to different style exposures as it does to countries and sectors, and so I think most investors should consider a blend of different styles to benefit from the ‘free lunch’ of diversification. If they are focused in one style, that can be fine for a given investor, they just need to be aware of the risks that come with such concentration.”

As at the end of 2021, 71 per cent of Baillie Gifford’s AUM is in global equity mandates, while just over 5 per cent is in fixed income, meaning the business is more reliant on equity market performance and sentiment than is the case for many of its peers.