The managers of Baillie Gifford American are refusing to take profits from their biggest winners of last year, even though their surging share prices propelled the fund to the number-one position in the Investment Association universe.
Baillie Gifford American made 121.84 per cent in 2020, compared with 16.17 per cent from its IA North America sector and 14.12 per cent from its S&P 500 benchmark. However, while most professional investors would look upon such short-term numbers as a reason to take some money out of their best performers to crystallise their gains, the Baillie Gifford American managers are resisting the temptation to quit while they are ahead, maintaining 18 of their top-20 positions from this time last year.
Performance of fund vs sector and index in 2020
Source: FE Analytics
“It would be all too easy to sell a stock simply because it has gone up a lot, like many share prices did last year,” said Kirsty Gibson (pictured), who co-manages the fund.
“However, [I want] to avoid knee-jerk reactions. In times of dramatic change, what we must do is double down on our philosophy and process. While we cannot predict returns in the future, what we can control is how we react today. We remain resolute in our search for exceptional growth companies.”
Gibson defines “exceptional growth companies” as those that can deliver a 2.5x return over a period of five years. Baillie Gifford carried out research into the distribution of returns in the S&P 500 over the past three decades and found that, over rolling five-year periods, 20 per cent of stocks delivered the sought-after 2.5x gain while, on average, the rest of the index’s constituents barely budged.
Yet even though Baillie Gifford American almost delivered the targeted five-year return in 2020 alone, Gibson said this does not mean the underlying holdings are now overvalued.
“It is commonly assumed that growth investors are not interested in valuation, but for us, that is certainly not the case,” she explained.
“That's not to say that we focus on the short-term numbers or the spot P/Es. We see valuation discipline through a long-term lens: we consider the next five to 10 years and we look to ascribe a probability to our investment hypothesis of how we can make at least 2.5x our money over that time.
“Given fundamentals and share prices have seen significant moves over the past year, we have been revisiting the upside case for a number of our largest holdings in order to try to get our bearings in what has been a very unusual environment.
“It might be surprising to hear that for the most part, this did not lead to many changes in the portfolio. While share prices have seen significant increases, fundamentals have also shown huge progress, and most of our long-term investment hypotheses remain intact.”
Gibson went further, pointing out that last year reinforced an argument about “exceptional growth companies” that she already suspected to be true: even after a period of spectacular growth, their opportunity set is not necessarily exhausted. “In fact, many of them are just getting started,” she added.
There are three main reasons for this, which the manager said are also among the same characteristics that define exceptional growth companies in the first place.
“The first is that exceptional growth companies are addressing vast market opportunities and they have the headroom to grow unimpeded for very long periods of time,” she explained.
“The second is that these businesses have strong competitive advantages, which get stronger as they scale. As you scale in the digital space, your ability to sustain or even accelerate your growth rate increases. As we have seen before, businesses are able to go faster when they scale and this is due to inherent flywheels within their business models.”
For example, she said that if an online platform gains more users, it allows it to gather more data. This data gives it the opportunity to build better products, which attract more users, and the cycle starts again.
The final characteristic Gibson looks for in exceptional growth companies, and another reason she believes they can continue to grow after periods of supernormal growth, is culture.
“Exceptional growth companies have distinctive cultures,” she continued. “They are run for the long run, often by founders who have skin in the game, and who have an attachment to the company rather than the share price.
“And this enables them to unlock new growth and opportunities, some of which we cannot even imagine when we first invest.”
Data from FE Analytics shows Baillie Gifford American has made 947.24 per cent over the past 10 years, compared with 294.82 per cent from the S&P 500 and 250.69 per cent from its sector.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
The £8bn fund has ongoing charges of 0.52 per cent.