Baillie Gifford US Growth Trust — Emerging from the eye of the storm?

Baillie Gifford US Growth Trust (LSE: USA)

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Last close As at 26/01/2023

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Market capitalisation

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Research: Investment Companies

Baillie Gifford US Growth Trust — Emerging from the eye of the storm?

Baillie Gifford US Growth Trust (USA) has seen its net asset value (NAV) significantly fall in 2022 as growth stocks have fallen out of favour with investors. In addition, USA’s share price has moved to a material discount to NAV for the first time since launch in March 2018. As a long-term fundamental investor, Baillie Gifford believes that the current investment opportunities in long-duration, high-growth stocks provide a tremendous opportunity for conviction investors, which could lay the foundations for the long-term outperformance of the fund.

David Holder

Written by

David Holder

Associate Director, Investment Trusts

Investment Companies

Baillie Gifford US Growth Trust

Emerging from the eye of the storm?

Investment trusts
North America

30 September 2022

Price

175.8p

Market cap

£536.5m

Total assets

£708m

NAV*

217.1p

Discount to NAV

19%

*Including income. At 28 September 2022.

Yield

0.0%

Shares in issue

305.1m

Code/ISIN

USA/GB00BDFGHW41

Primary exchange

LSE

AIC sector

North America

52-week high/low

353.0p

146.0p

NAV* high/low

360.2p

175.7p

*Including income

Net gearing*

6%

*As at 28 September 2022

Fund objective

Baillie Gifford US Growth Trust (USA) aims to produce long-term capital growth by investing predominantly in equities of companies that are incorporated, domiciled or conducting a significant portion of their business in the United States of America. The trust invests in both publicly listed and privately owned companies. Its benchmark is the S&P 500 Index TR (GBP).

Bull points

Truly collegiate investment approach.

Strategy has outperformed over the long term.

Competitive fees.

Bear points

Investment style is currently out of favour.

Unquoted investments bring additional risk.

Limited buy backs thus far.

Analyst

David Holder

+44 (0)77 962 68072

Baillie Gifford US Growth Trust is a research client of Edison Investment Research Limited

Baillie Gifford US Growth Trust (USA) has seen its net asset value (NAV) significantly fall in 2022 as growth stocks have fallen out of favour with investors. In addition, USA’s share price has moved to a material discount to NAV for the first time since launch in March 2018. As a long-term fundamental investor, Baillie Gifford believes that the current investment opportunities in long-duration, high-growth stocks provide a tremendous opportunity for conviction investors, which could lay the foundations for the long-term outperformance of the fund.

Growth is underperforming in the United States so far in 2022

Source: Refinitiv, Edison Investment Research. Note: Total returns in sterling.

Why invest in Baillie Gifford US Growth Trust now?

Baillie Gifford is well known for its growth investment style; however, the US team arguably take this further than almost any other team. Its relentless focus on identifying tomorrow’s leaders, often at a very early stage of their development in nascent and dramatically evolving markets within what is possibly the most prominent growth market in the world, sets it apart from the majority of its peers. In addition, the material weighting towards unquoted investments adds a further layer of differentiation. In 2022, growth as a style has fallen dramatically out of favour, which has negatively affected USA investor returns in both NAV and share price terms. However, the collegiate management team and long-term process have been in place over many years, over which time investors have been well rewarded. There are clearly risks in owning in some cases pre-profit and unquoted investments, which may guide investors to consider the position size for investments of this nature within diversified portfolios. The current discount to NAV of 19% could prove to be an attractive level to add to or initiate positions in USA.

Continued focus on the resilience of the portfolio

Soaring inflation, rising interest rates, slowing economic growth and the ongoing war in Ukraine have led to equity market weakness and volatility so far in 2022. In particular, the path of interest rates has been of especial concern for high-growth, long-duration assets as their valuations become more expensive when longer-term cash flows are discounted at a higher risk-free rate. The investment process at Baillie Gifford does not tend to focus on the macroeconomic outlook, rather the portfolio managers’ ongoing focus is to drill down to establish that in each and every holding the original buy case remains, with associated upside potential, that companies have resilient business models, are well capitalised and able to ride out the volatility in markets and prosper in the medium to long term. According to work done by Morningstar, the portfolio has good historical and forecast sales, earnings and cash flow growth versus peers and the index, which is what one might expect, but in aggregate the portfolio also has substantially lower debt to capital, which aligns with the managers’ insistence that the portfolio companies should be financially robust.

A well-resourced and collegiate US investment team

USA is managed by Gary Robinson and Kirsty Gibson supported by the wider US equities team. They are part of a team of nine investors, which has average industry experience of almost 12 years, and is headed up by Tom Slater, who is head of US equities. As with most Baillie Gifford investment teams, it is made up of a core of permanent members, including Gary Robinson, Kirsty Gibson, Tom Slater, Saad Malik, Dave Bujnowski, Michael Taylor and Sacha Meyers. It is fairly common within investment teams at Baillie Gifford that the majority of personnel have spent their entire career at the company and this is the case with this team, with only Bujnowski and Taylor having experience outside of Baillie Gifford. In addition, Gary Robinson, Tom Slater and Dave Bujnowski are all partners at Baillie Gifford. Baillie Gifford is run as an unlimited liability partnership, which could be said to be the ultimate alignment of interests with investors and serves as a powerful force for a positive and responsible investment culture.

There are two rotating junior members of the team: Rue Veja Chaladauskaite and Laura Gonzalez-Salmeron. Each year there is a rotation of the more junior members of the firm so that they are exposed to a variety of investment styles, regions and asset classes, while occasionally more senior members change teams. The newest member of the team is Mike Taylor, who joined in January 2022 and who was previously at the firm to bolster the research capacity specifically with regard to the compound growth opportunities in US equities.

Baillie Gifford is well known as a growth investor, and the US market is arguably home to growth investing. This makes the US team a valuable resource within the company. The development of the personnel and the process at Baillie Gifford, including the collaborative exchange of ideas and views, ensures a collective strength, drawing upon experience across the firm to add value for clients. As a small example, there are shared holdings in USA with Scottish Mortgage (SMT) (22 shared holdings), Edinburgh Worldwide (EWI) (eight) and Monks (MNKS) (24). This ensures that there are always lots of eyes on the stocks across Baillie Gifford, with dissenting or alternative views to add to the stock evaluation process.

USA differentiation from Baillie Gifford American OEIC

USA seeks to invest predominantly in listed and unlisted US companies, which it believes have the potential to grow substantially faster than the average company, and to hold onto them for long periods of time, in order to produce long-term capital growth, while the Baillie Gifford American open ended investment company (OEIC) has a more formal objective to outperform (after deduction of costs) the S&P 500 Index, as stated in sterling, by at least 1.5% per annum over rolling five-year periods. However, the two funds share the same investment philosophy and process.

As at the end of June 2022, both vehicles shared significant overlap in their listed stocks. However, the OEIC (as a daily dealing fund) does not invest in unquoted assets, which accounted for 36.2% of USA at the end of July 2022, which provides a significant differentiator between the two portfolios.

Exhibit 1: Comparison of the top 10 holdings at 30 June 2022 (% unless stated) of USA and the Baillie Gifford American fund

USA (pp)

Baillie Gifford American (pp)

Difference (pp)

S&P 500 weight (pp)

Tesla

5.1

9.3

(4.2)

1.7

The Trade Desk

4.4

6.2

(1.8)

N/A

Space Exploration Technologies*

4.3

N/A

4.3

N/A

Stripe*

4.0

N/A

4.0

N/A

Moderna

3.5

6.9

(3.4)

0.1

Amazon.com

3.3

6.6

(3.3)

2.9

Faire Wholesale*

3.3

N/A

3.3

N/A

Brex*

3.3

N/A

3.3

N/A

Shopify

3.2

4.4

(1.2)

N/A

Illumina

2.6

2.7

(0.1)

0.1

Total

37.1

36.1

Source: Baillie Gifford, Edison Investment Research. Note: *Unquoted.

USA’s named managers are Kirsty Gibson and Gary Robinson, both of whom are managers for the OEIC, alongside Tom Slater and Dave Bujnowski. Both vehicles are managed with a shared philosophy, with the main divergence between the listed element of USA and the OEIC generally due to a small number of holdings that have transitioned from private to public within USA but have not been bought for the OEIC. In general, investors can expect the listed holdings to continue to mirror each other closely, although as per Exhibit 1 the weightings can differ as around a third of the portfolio is in unquoted investments and USA does employ gearing.

Current portfolio positioning

USA has around 70% of its holdings in the technology, healthcare and consumer discretionary sectors. Key (listed) positions in technology include The Trade Desk, Shopify and NVIDIA, while healthcare is dominated by Moderna and within consumer discretionary the largest holdings are Tesla and Amazon. There is a strong theme of utilising emerging trends in artificial intelligence (AI), data analytics and technology through all of these businesses that leads the managers to believe that these companies will continue to be and indeed extend their market leadership for the long term. Conversely there is a very limited exposure to areas such as financials, communication services, real estate, utilities, energy, materials and consumer staples, which in aggregate accounted for 13.6% of the portfolio at the end of July 2022. Baillie Gifford uses its own bucket methodology to cut and dice the portfolio and at the end of June 2022 the Future of Commerce accounted for 19.7%, Innovative Healthcare 17.9%, New Enterprise 16.6% and Digitisation of Finance 10.5%. Prominent positions in these various buckets include The Trade Desk, Faire Wholesale, Datadog and Brex. These thematic buckets can help investors frame the fund’s positioning.

Exhibit 2: Top 10 holdings (at 31 August 2022)

Company

Sector

Portfolio weight %

Change
(pp)

Benchmark weight

Active weight vs benchmark

31 August 2022

31 August 2021*

Tesla Inc

Electric vehicles & energy storage

5.2

3.7

1.5

2.1

3.1

The Trade Desk

Advertising buying platform

4.6

3.7

0.9

0.0

4.6

Moderna

Pharmaceuticals

3.7

5.9

(2.2)

0.1

3.6

Amazon.com

E-commerce platform

3.7

4.3

(0.6)

3.3

0.4

Stripe

Payments systems

3.4

2.8

0.6

0.0

3.4

Space Exploration

Commercial space

2.9

N/A

2.9

0.0

2.9

Shopify

E-commerce platform

2.6

6.9

(4.3)

0.0

2.6

CoStar Group

Digital real estate

2.3

N/A

2.3

0.0

2.3

Alnylam Pharmaceuticals

Pharmaceuticals

2.0

N/A

2.0

0.0

2.0

Top 10 (% of holdings)

30.4

27.3

2.5

5.5x

22.3

Source: Baillie Gifford US Growth Trust, Edison Investment Research, Bloomberg, Morningstar. Note: *N/A where not in end-August 2021 top 10.

Listed portfolio

The listed portfolio accounts for the bulk of USA’s assets (63.9% at end of July 2022). Over the last 12 months, new listed holdings were initiated via initial public offerings (IPOs) in Rivian Automotive, HashiCorp and Duolingo. Each of these holdings fits with the process in that they operate in areas supported by strong and long-lasting secular tailwinds, the addressable market is potentially vast and they are led by management who share and embrace Ballie Gifford’s vision of the full potential for the business.

Rivian is an automotive technology company that the team bought into at IPO. It develops products and services to advance the shift to sustainable mobility. It aims to decarbonise consumer and commercial transportation and has in development an electric pickup and 4x4 truck, as well as its electric delivery vehicles for Amazon (which is an important endorsement). It is early stage but is well-funded and can draw lessons from Tesla with a large and profitable addressable market (4X4 and commercial EVs) that is currently without significant competition. It has a strong brand, clear vision and is led by a successful founder.

HashiCorp was initiated at IPO and is a provider of infrastructure software, which the team believes will benefit from the migration of IT to multiple online clouds. This transition is a complicated process, but HashiCorp simplifies it via an automated software code. This enables its users to save time and cost and to improve the performance of their IT.

The team participated in the IPO of education provider Duolingo, which is best known for its language teaching app, which is the most downloaded app in the education category globally. It utilises AI and machine learning to bring personalised lessons while ‘gamifying’ the experience, so users remain engaged with courses. These factors should allow it to increase the number of users, with more subscriptions and advertising revenues to follow.

Roblox, which was added in June 2022, is a user-generated content game company. It faces a long runway for growth in bookings because of the multiple avenues for monetisation available to it. This includes growth in traditional in-game transactions, initiatives underway to expand supply in the avatar marketplace, and partnerships with brands and musicians, which have the potential to unlock significant and underappreciated revenue streams. Growth has been primarily organic with very little customer acquisition cost, which underpins attractive free cash margins. Finally, the company's founder has demonstrated persistence in sticking to his vision, which the team believes raises the likelihood that the company can continue adapting over long periods.

USA sold a number of holdings over the past 12 months:

Zillow is the largest online real estate portal in the United States and the team initiated a position in 2019, when the company was attempting to revolutionise the real estate market by directly buying and selling homes. It was an ambitious objective, but one with a $1.8tn addressable US real estate market. The company found forecasting prices in the aftermath of the pandemic difficult, which led to balance sheet and cash flow volatility, and so it is now winding down this business, which prompted the sale. This is an example of where the Baillie Gifford team felt that the management failed to stay the course to truly maximise the potential for and value in the business.

With Vroom, the long-term structural shift that is taking used car inventory online remains, as does the view that online platforms offer the promise of a lower-friction and more transparent customer experience. However, Vroom’s financial position made the shares vulnerable and limited the company's ability to pursue business growth.

Glaukos is a pioneer of minimally invasive glaucoma surgery. The team’s initial investment hypothesis was based on Glaukos rapidly taking share in the glaucoma market and building a broad ophthalmology franchise over time. However, since the initial investment, competition within the glaucoma market has been more intense than expected due to the launch of competing procedures by Ivantis and Omni, which makes it much less likely that the company will dominate the market.

Lyft, a ride hailing and journey sharing platform, had become a very small holding, and while the team rates the founder-led team, there are still question marks around the competitive environment, with Uber benefiting from strength in its food delivery business at a time when ride hailing has suffered, and so it was decided to sell the holding.

Reduced positions

Wayfair has been in the portfolio since launch in March 2018 (and in the OEIC since 2015), but its growth has slowed, and the team is cognisant of the headwinds facing the company from slowing consumer spending.

Illumina was first bought in August 2018 but was reduced in a meaningful way in Q222 after the company lost the BGI patent infringement case, added to which the EU has also deemed Illumina’s acquisition of Grail anticompetitive. These outcomes may well reduce Illumina’s competitive position and have caused the team to take stock of the position.

Tesla was reduced at the end of 2021 as the team felt that given the success of the company and its share price appreciation, it was sensible to take profits and reduce the position. Some of the proceeds were invested into Rivian Automotive. The research work that the team had done with Tesla over many years helped them to analyse the investment case for Rivian.

Tesla: A deeper dive

The story of Tesla has been synonymous with Baillie Gifford. It has been a key position in stablemate Scottish Mortgage (SMT) where it has been held since June 2013, while the Baillie Gifford American OEIC, which currently has a 9.3% weighting (at the end of July), has held the stock since November 2015. Tesla has been a significant contributor to returns for USA and a good case study in what investment characteristics the process is seeking to identify.

Despite the substantial contribution to returns that Tesla has historically generated for the fund, the team continues to see enormous potential for the company as one of a small number of major players in the electric vehicle market over the next five years and more. It believes that Tesla will help move the world from primarily internal combustion engine use to electric (on a 10-year view) and towards a sustainable energy future. In doing so, Tesla will, the team believes, create a large, high-margin revenue stream from selling automotive and energy products. Given Tesla’s head start and competitive position, it will be difficult for the competition to match the cost or capability of the products. In addition, as battery cell constraints lessen and prices fall, the stationary storage business will grow into a huge addressable market, as power grids seek to incorporate renewable energy sources. Although this is a lower-margin business, the team believes that its top line and profitability will grow strongly. Bailie Gifford believes that the combination of automotive and stationary storage will drive Tesla’s sales at close to 50% per annum over the next decade, while simultaneously allowing it to grow profitability. The team only invests in opportunities where it can realistically see a 2.5x return on its investment and currently attaches a high probability to its base case of annual earnings before interest and taxes (EBIT) of near $70bn in five years’ time (12 months to the end of June EBIT was $10.6bn).

Exhibit 3: Tesla performance and weighting within USA

% of Tesla in USA and S&P 500

Five-year performance (%) of Tesla versus the S&P 500

Source: Refinitiv, Edison Investment Research, Morningstar.

Unlisted portfolio

The unlisted portfolio consists of 24 companies, accounting for 36.7% of the portfolio at the end of August 2022, which compares to the end of July 2021 when the portfolio had 20 unlisted holdings equating to 16.5% of the portfolio. Seven new unlisted positions were added in the 12 months to the end of August 2022: BillionToOne, Blockstream, Databricks, Discord, Faire Wholesale, Snyk and Solugen. Three unlisted companies went public during the period: Aurora Innovation, Ginkgo Bioworks and Warby Parker.

New positions

BillionToOne’s objective is to make molecular diagnostics more accurate, efficient and accessible via an innovative technology platform. Its technology has enabled the first single-gene non-invasive pre-natal test, which could redefine the accuracy with which pregnancy screening can be carried out. Moreover, the company wants to expand into oncology, with the long-term goal of tackling early cancer detection via liquid biopsy. This is an enormous opportunity with good progress to date and the company has a single-minded founding team.

Blockstream is a leader in Bitcoin mining hardware, as well as the operation of mining facilities for large financial institutions such as Fidelity and Macquarie. Baillie Gifford participated in a capital raising that is intended to capitalise on the growth of mining operations, including a new division called Blockstream Energy, devoted to derisking renewables projects. The longer-term vision, and a key attraction, is the Liquid Network, a software project that aims to move as many capital markets securities as possible onto infrastructure built on Bitcoin.

Databricks builds and sells software and aims to build a data platform to store and manage data for all analytics workloads. It is a beneficiary of the expansion in machine learning (ML) applications. Databricks makes it a lot easier for businesses to make and implement useful ML models, which have previously been confined to the niches of the most sophisticated businesses and are now becoming increasingly important in many more areas and many more businesses.

Discord is an instant messaging and digital distribution platform where communities are private, but still social, blending live audio conversations with video streaming and the sharing of text and image. It has a large number of users, and is primarily used by different gaming communities.

Faire Wholesale operates a B2B marketplace that allows independent retailers to source products from popular and in demand brands. It aims to provide small stores with the advantages of inventory management historically only available to big box and large e-commerce firms, and independent retailers have turned to Faire in increasing numbers throughout the pandemic. Faire currently has only a tiny fraction of an enormous addressable market with significant scope for share gains over the next five years and beyond.

Snyk is well positioned to benefit from twin demands that have become key requirements for companies: security and speed of app development. The company has pioneered a way to address both that lets developers fix bugs quickly and easily themselves. Snyk has a combination of advantages that add up to a strong competitive edge as its products appeal to the unique needs of developers.

Solugen is a synthetic biology and chemicals company that designs and manufactures enzymes, which it uses to transform feedstock into finished chemicals. Its approach leads to production of chemicals with much better yields, lower cost and less environmental footprint. With two products available now and a versatile technology in an enormous market, the scope for growth is very large.

Exhibit 4: Portfolio sector exposure at 31 August 2022 (% unless stated)

Portfolio end- Aug-2022

Portfolio end- Aug 2021

Change (pp)

Index weight

Active weight vs index (pp)

Information technology

33.2

33.3

(0.1)

27.3

5.9

Consumer discretionary

19.8

23.1

(3.3)

11.4

8.4

Healthcare

17.5

19.0

(1.5)

14.1

3.4

Communication services

4.5

7.7

(3.2)

8.4

(3.9)

Industrials

15.1

7.0

8.1

7.9

7.2

Financials

5.9

4.9

1.0

10.9

5.0

Materials

2.9

1.3

1.6

2.5

0.4

Real estate

0.3

0.9

(0.6)

2.9

(2.6)

Consumer staples

0.4

0.3

0.1

6.8

(6.2)

Energy

0.0

0.0

0.0

4.7

(4.7)

Utilities

0.0

0.0

0.0

3.1

(3.1)

Cash

0.5

2.5

(2.0)

0.0

0.5

100.1

100.0

(0.1)

100.0

Source: Baillie Gifford US Growth Trust, Edison Investment Research. Note: Figures may not add up to 100 due to rounding.

Performance: A factor of growth’s underperformance

Such are the stylistic biases within the USA portfolio that much of the performance seen over the last year can be attributed to the underperformance of growth stocks globally and particularly in the United States. The effects of slowing economic growth, soaring inflation and increasing interest rates have exposed the lofty valuations within growth sectors.

Performance over 12 months to the end of July 2022 was -40.4% in NAV terms, which compares with the S&P 500 index return of 8.9% and the Morningstar US Growth Large-Cap Growth category return of 3.8% (all returns in sterling). Overall sector allocation marginally detracted from returns, with the underweight communications services position contributing positively while the underweight energy position detracted. In the context of the returns over this period, the sector weightings detracted only 2.5pp relative to the benchmark with the overwhelming majority of underperformance due to stock selection, the bulk of which was within the overweight positions in consumer discretionary, healthcare and information technology. Stocks held that positively contributed to performance over the period included the overweight positions in Space Exploration, Tesla and Solugen, while not holding Meta Platforms (Facebook), PayPal and Walt Disney was also positive for relative performance to the tune of 4.6%. Off benchmark positions in Shopify (unquoted), Roku (unquoted) and Twilio (unquoted) were the largest stock detractors and cost the fund 12.7% of relative underperformance. Looking at performance through a stylistic lens, c 70% of USA’s quoted assets are categorised as growth stylistically. According to Morningstar analysis, USA’s weighting to growth assets contributed around a third of the relative underperformance, with stock selection accounting for the balance.

By any measure, the fund’s performance over the last 12 months has been volatile and disappointing for investors and Baillie Gifford alike, which has resulted in performance since launch in March 2018 ending up only very slightly ahead of the index over this period to the end of July 2022. Over this longer period, the underweight positioning to energy was accretive to returns as were the overweight weightings to consumer discretionary and to communication services. Overweight stock positions in Tesla, Shopify and The Trade Desk contributed 27.7% to relative returns, while holdings in Grubhub, Twilio and Snap were the largest detractors alongside not holding Apple and Microsoft.

Since USA’s launch on 23 March 2018, the fund has returned 108.9% in terms of NAV and 108.1% in terms of share price, versus 95.9% for the S&P 500 and 74.3% for peers (Morningstar US Large-Cap Blend category (to the end of August 2022)). This hides a high level in volatility of returns. For a majority of the calendar year returns since launch until 2020, USA’s NAV returns have been broadly similar to comparators; however, in 2020 the fund performed exceptionally strongly returning 118.4% versus the S&P 500 return of 14.7% and peers of 13.6%. 2021 saw somewhat of a reversal with the fund retuning 5.7% versus the index returns of 29.9% and peers of 26%, while 2022 has seen the fund return -34% versus the index return of -2.4% and the peer group return of 4.3%.

Exhibit 5: Investment trust performance to 12 September 2022

Price, NAV and benchmark total return performance, one-year rebased

Price, NAV and benchmark total return performance (%)

Source: Refinitiv, Edison Investment Research. Note: Three- and five-year performance figures annualised.

Exhibit 6: Five-year discrete performance data

12 months ending

Total share price return (%)

Total NAV return (%)

S&P 500 TR GBP (%)

CBOE UK All Companies (%)

31/08/18

--

--

18.6

4.3

31/08/19

7.9

6.8

9.8

0.3

31/08/20

67.0

72.5

10.9

(13.5)

31/08/21

41.6

39.8

27.6

27.1

31/08/22

(51.2)

(39.3)

5.0

1.8

Source: Refinitiv. Note: All % on a total return basis in pounds sterling.

AIC North America peer group comparison

Baillie Gifford US Growth Trust is one of seven constituents within the Association of Investment Companies (AIC) North America sector. As a sign of the historical lack of income in financial markets, three of the cohort have an income focus and two specialise in Canadian investments (predominantly invested in the country’s banks, real estate investment trusts and energy companies) while one has a dedicated sustainability mandate. USA distinguishes itself by having the highest growth characteristics within the cohort, with a material weighting to unquoted investments. Added to which the fees are competitive for USA, especially for what is an exceptionally actively managed portfolio. The active share for USA is 92% at 31 July 2022 (active share measures the commonality between two portfolios, with 0% indicating complete similarity and 100% no commonality at all). The active investment approach is also illustrated via the very high historical tracking error, standard deviation of returns and beta that USA has demonstrated relative to peers and the benchmark.

Exhibit 7: AIC North America peer group comparison

% unless stated

Market cap £m

NAV TR
1 year

NAV TR
3 year

NAV TR
5 year

NAV TR
10 year

Ongoing
charge

Perf.
fee

Discount
(cum-fair)

Net
gearing

Dividend
yield

Baillie Gifford US Growth

536

(34.2)

69.4

0.62

No

(19.0)

106

0.0

BlackRock Sustainable American Income

156

8.4

26.8

55.9

1.06

No

(8.7)

104

4.1

Canadian General Investments

420

(20.1)

41.2

66.6

171.8

1.37

No

(35.8)

115

3.1

JPMorgan American

1350

8.2

58.2

103.8

368.1

0.36

No

(8.1)

106

1.0

Middlefield Canadian Income

131

11.1

31.5

50.1

110.8

1.24

No

(10.8)

-2

4.1

North American Income Trust

431

11.9

20.6

46.2

213.3

0.89

No

(6.5)

104

3.3

Pershing Square Holdings

5532

(7.3)

83.7

194.8

1.56

Yes

(32.8)

104

1.6

AIC average

1222

(3.1)

47.3

86.2

216.0

1.01

16.00

(17.4)

91

2.5

USA rank in peer group

3

7

2

N/A

N/A

2

N/A

3

=2

7

Source: Morningstar, Edison Investment Research. Note: Performance as at 28 September 2022 based on ex-par NAV. TR = total return. Net gearing is total assets less cash and equivalents as a percentage of net assets.

Exhibit 8: AIC North America peer group comparison (portfolio characteristics)

% unless stated

Average market cap (£m)

Core
(pp)

Growth
(pp)

Value
(pp)

Consumer Cyclical (pp)

Healthcare (pp)

Technology (pp)

Financial services (pp)

Baillie Gifford US Growth

£27,773

10.2

78.8

11.1

20.8

25.1

29.9

4.2

JPMorgan American

£108,655

38.9

42.2

18.9

15.7

13.3

21.9

16.5

North American Income Trust

£40,170

43.1

0.0

56.9

8.3

19.4

9.4

18.1

Middlefield Canadian Income

£14,444

41.8

0.0

58.2

0.0

0.0

5.3

31.8

Canadian General Investments

£28,616

26.9

54.9

18.2

11.5

1.0

14.7

13.5

Pershing Square Holdings

£39,803

72.0

18.5

9.5

90.5

0.0

0.0

0.0

AIC peer group average

£43,243

38.8

32.4

28.8

24.5

9.8

13.5

14.0

S&P 500 TR USD

£181,998

41.6

37.6

20.8

10.6

15.2

24.7

13.9

USA rank in peer group

Source: Edison Investment Research, Morningstar. Note: Morningstar portfolio data at: NAIT/CGI: Aug 22, USA/JAM: July 22; BRSA: Apr 22, PSH: Dec 20. BRSA: no holding data available. Core, Growth & Value as defined by Morningstar.

Exhibit 8 above outlines within the AIC category the differences in the varying investment approaches. Clearly Baillie Gifford US Growth is by some margin the most growth-orientated on a stylistic basis. Baillie Gifford is known as a growth house, with perhaps the most growth-focused team being the long-term global growth team. This is the team (alongside US team head Tom Slater) that manages the ultra-high growth Scottish Mortgage Investment Trust (SMT), and while there are only some 22 shared holdings (at April 2022) between USA and SMT, the shared investment philosophy of SMT and former co-fund manager James Anderson, whom Tom Slater worked alongside for 12 years, continues to influence the management of USA.

Dividends: Not a feature of USA

USA’s objective is long-term capital growth, and it does not ordinarily seek to provide shareholders with dividends. The focus on investing into high-growth companies may also stand at odds with receiving regular dividends, as cash flows are preferably reinvested to enhance future growth. The net revenue return for FY22 was a negative 1.88p per share (FY21: -1.78p). As the revenue account is running at a deficit, the board is recommending no final dividend is paid for FY22. If the level of underlying income increases in future, the board will seek to distribute, by way of a final dividend, the minimum permissible to maintain USA’s investment trust status. The lack of dividend here compares with the AIC North America peer group average yield of 2.3% (September 2022) and the S&P 500 yield of 1.7% (August 2022).

Discount: Recent significant derating an opportunity

Since inception, USA’s share price has, on average, traded at a small premium to its cum-income NAV. Recently, weaker performance and a deterioration in investor sentiment have seen the share price fall, leaving the trust currently trading on a discount to cum income (fair value) NAV of 19%. Later in the note we discuss how the unlisted assets are valued, as this will have an impact on how accurate the NAV is; however, given the frequency with which the unlisted holdings are revalued investors can have confidence that the daily NAV is largely reflecting the value of the underlying assets. This is not always the case with private equity funds, which typically value on a biannual or quarterly basis.

Since launch the board has been proactive in meeting investor demand through issuance and to 8 May 2022 had issued 134,360,000 shares (roughly doubling the number of shares in issue). Since USA has moved out to a wider discount there have been repurchases (into treasury) of 2.2m shares at a cost of £3.6m. The board aims to keep the share price close to par and will consider buying back shares when the discount is substantial in absolute terms and relative to its peers.

Exhibit 9: Premium/discount since launch

Exhibit 10: Issuance and buybacks

Source: Refinitiv, Edison Investment Research

Source: Morningstar, Edison Investment Research

Exhibit 9: Premium/discount since launch

Source: Refinitiv, Edison Investment Research

Exhibit 10: Issuance and buybacks

Source: Morningstar, Edison Investment Research

Fund profile: Growth in the USA

USA was launched in March 2018 and is listed on the London Stock Exchange. The trust’s alternative investment fund manager (AIFM) is Ballie Gifford & Co Ltd, which has delegated portfolio management services to Baillie Gifford & Co. It has been managed by Gary Robinson since inception. Kirsty Gibson joined him as co-manager in March 2021.

The trust aims to produce long-term capital growth by investing predominantly in companies that are listed or conduct a significant portion of their business in the United States. The team aims to deliver outstanding investment performance by identifying the US’s exceptional growth businesses and owning them for long enough that the advantages of their business models and cultural strengths become the dominant drivers of their valuations. The trust targets investment returns of 2.5x over the next five years. It is benchmark agnostic but uses the S&P 500 Index as a reference. USA is a constituent of the AIC’s North America sector.

With the approval of the board, USA’s managers may use derivatives for the purposes of efficient portfolio management, to reduce, transfer or eliminate investment risk in the portfolio. However, the board does not expect the managers to enter into derivative or hedging transactions to mitigate against currency or interest rate risk.

Investment process: Growth but not at any price

Baillie Gifford has been investing in innovative US companies for over 100 years and across the company has significant funds invested in US equities. Within a broad investment universe of about 1,700 sufficiently liquid listed stocks, the managers believe about 350 companies offer the potential to meet their investment criteria. In addition, their search for exceptional growth companies extends into the realm of private companies and the managers have increased their focus on unlisted companies. This shift has been motivated by the view that US companies are choosing to remain private for longer and, as such, the public equity markets no longer offer the full spectrum of growth investment opportunities. The managers will consider private companies with pre-money valuations of US$500m or more and they usually invest in the late stages of a company’s venture capital funding process. The trust has scope to invest up to 50% of its NAV in unlisted companies and the managers are largely indifferent as to whether a company is publicly or privately owned. They will conduct due diligence and allocate capital wherever they see the highest returns.

Robinson and Gibson are active, bottom-up investors who do not look at the index or target a specific tracking error. They seek to identify a small number of new investment ideas each year. Robinson and Gibson are part of Baillie Gifford’s seven-strong US equities research team and their work benefits directly from their colleagues’ insights and challenges. They also draw on ideas and perspectives from across Baillie Gifford’s global investment teams, including its specialist healthcare/biomedical team, and they seek to foster links with external sources of ideas and information, including academics and visionary thinkers, inquisitive journalists and industry experts. In normal times, the managers also conduct in-depth research trips to technology innovation hubs and healthcare clusters. However, they do not use broker research, as the time frame of such reports tends to be too short to be useful, given that USA targets returns over a five-year time horizon.

The trust’s research process casts a wide net over many disparate sources of information, so the team has constructed a framework for analysis and valuation that distils this information into a consistent format that facilitates comparison across potential investments. Capital is allocated according to its potential to generate the managers’ target 2.5x investment return. Each potential and existing investment is assessed via the same eight questions intended to determine:

what the world might look like if the company is successful.

what aspects of the company’s culture increase the likelihood that it will achieve long-term success.

the company’s enduring sources of ‘edge’, such as deep competitive advantages or ‘moats’.

what is exciting about the market opportunity.

the company’s important forward-looking financial characteristics and whether the long-run incremental returns are attractive.

how the company might meet the trust’s target of 2.5x investment returns over the next five years and the probability of this outcome.

the potential for the company to be a real outlier.

what to do next – buy, hold, sell, watch or conduct further research.

The managers use this same research framework to assess private companies, but they apply a higher valuation hurdle. Instead of seeking an investment return of 2.5x, the target return for private companies is 5x. This higher target is intended to compensate for the lack of liquidity in private company holdings and also reflects the earlier-stage nature of such investments. Private company valuations are updated every three months by Baillie Gifford in accordance with International Private Equity Valuation (IPEV) guidelines. In addition, USA’s board conducts detailed biannual reviews and can challenge Baillie Gifford’s valuations.

Meetings with the management, staff, customers and suppliers of target companies are very important to USA’s investment process. These interactions also allow the team to understand the company’s culture and its remuneration and incentive structures, factors that are particularly relevant given the trust’s long-term investment time frame.

This fundamental analysis is discussed at weekly research meetings. The managers do not seek consensus between all team members. Rather, they focus on the potential upside of an investment and back the conviction of individual analysts. Robinson and Gibson manage the trust as a team, backing each other’s convictions, so if one wants to own a stock, it will be held in the portfolio.

This process leads to a relatively concentrated portfolio, as the managers believe it is important not to dilute its exposure exceptional businesses. The portfolio typically holds 30–50 listed holdings, with a maximum of 90, including privately owned companies. Initial investments usually represent 1–2% of portfolio value, as the managers want any holding to be significant, although some investments in new biotech companies may be smaller. The maximum direct investment in any one company is limited to 10% of the trust’s total assets at the time of the investment, although the holding is permitted to grow beyond this level due to subsequent performance. There is no maximum holding size, to give each portfolio holding the space and time to realise its full potential. The managers refer to this as their ‘hold discipline’. For example, the trust’s position in Tesla reached almost 15% before it was reduced in January 2021.

In general, the managers will assess each holding when its share performance hits their 2.5x target return on investment threshold. Depending on the outcome of this process, the stock may be held or sold. The managers will also dispose of positions if some fundamental change threatens the investment hypothesis, or if performance is muted and no longer looks likely to meet the 2.5x hurdle rate. Positions may also be trimmed or closed if the managers have better ideas or greater conviction elsewhere.

However, the managers will not sell a position simply because of short-term share price volatility. They will remain focused on the stock’s long-term prospects and do not shy away from larger, less predictable risks, if they believe the potential pay-off is worthwhile. They point to the asymmetry of equity market returns to justify this approach: an investor can only ever lose 100% of capital due to a poor investment decision, but over time, can make many multiples of an initial investment from a successful investment. This asymmetry rewards optimistic investors with far greater gains from being right, than losses if they are wrong. It also means the costliest investment mistake can be excessive risk aversion.

Inevitably, risk-taking and the pursuit of long-term outperformance will be accompanied by some volatility and performance may be lumpy over the short term. But this is not something the managers discuss or analyse. They maintain that creating narratives around short-term performance distracts from the trust’s long-term investment objective and therefore does not serve its shareholders well. The managers ask to be judged instead on their performance over longer time frames.

One of the strengths of Baillie Gifford as an investment house is the degree to which the various investment personnel interact both within their teams (aided through stock coverage rotation) and with other teams at Baillie Gifford. This is helped by the trainee analyst rotation policy, through various investment committees and by the firm’s shared outlook on investment. Indeed, Robinson has spent time on the Japanese, UK and European equity teams and Gibson has previous experience of the small- and large-cap global equities teams. This really does make the output greater than the sum of the parts and makes the company stand out from others. Another key advantage it has is the ownership structure, which is an unlimited liability partnership, the ultimate in alignment of interests between fund managers and investors.

USA unlisted valuation policy

Baillie Gifford’s holds the unlisted investments at fair value. There is a disciplined approach to ensuring that the unquoted element of the portfolio reflects as far as possible the level of an open market transaction. Valuations are based on a regular rolling three-month valuation cycle and on an ad hoc basis when an event justifies it. The valuation group at Baillie Gifford, which is independent of the investment teams at Baillie Gifford, receives independent advice from S&P Global. A final valuation is then applied to portfolio holdings at which time portfolio managers are advised. When market volatility is high, the valuations committee will check the valuations of the unlisted portfolio on a daily basis versus listed alternatives. Over the 12 months to the end of May 2022, the valuation committee has valued 51 securities within the USA portfolio, 169 revaluations have occurred, with 56% of the portfolio revalued twice and 24% of the portfolio revalued five times. While most revaluations have been negative, there have been some write ups where fresh capital had been raised at higher valuations. While market volatility in growth companies has been high, the unlisted investments are largely held via preference stock, limiting the downside participation.

Baillie Gifford US Growth Trust’s approach to ESG

The trust’s board believes it is in shareholders’ interests to consider environmental, social and governance (ESG) factors when selecting and retaining investments and has asked the managers to take these issues into account, provided the investment objectives are not compromised. The trust’s managers share the board’s view on the importance of ESG factors, viewing them as integral to their success as long-term investors. At a fundamental level, investee companies can only be financially sustainable in the long run if their approach to business aligns with changing societal values and meets the expectations not only of the company and management, but also of its customers, shareholders, suppliers and employees. The managers’ disposal of the position in Meta in November 2020, due to the lack of management responsiveness to various concerns voiced by users, regulators and employees, is one illustration of the managers’ application of this principle. Baillie Gifford has also been engaging closely with Tesla on some of its governance issues recently, and with The Trade Desk on its approach to climate change and emissions.

The managers’ ESG criteria go beyond a company’s financial sustainability. They are seeking ‘game changers’ – companies with the potential to change society for the better, directly, through the products they sell, and indirectly, via the industries that supply them. To assess a company’s potential to be a game changer, the managers create a societal contribution hypothesis as part of each investment proposition. This is a highly subjective, unquantified assessment of the benefit the company might deliver to society if it grows according to its forecast potential.

USA’s managers believe in active ownership and they use the leverage provided by their steady and often sizable stakes to encourage companies to improve where necessary and realise their full potential, as both businesses and positive contributors to society. They expect their investee companies to operate in accordance with the principles set out in the United Nation’s Global Compact on human rights, the environment, corruption and the treatment of workers. The managers will engage with a company’s management if these standards are breached, with the aim of improving the firm’s behaviour. If these efforts fail, the stock will be sold.

The trust’s managers, Ballie Gifford & Co Ltd as AIFM and Baillie Gifford as portfolio manager, are signatories to the United Nations Principles of Responsible Investment and the Carbon Disclosure Project and members of the International Corporate Governance Network. Baillie Gifford became a supporter of the Taskforce on Climate-related Financial Disclosures (TCFD) in May 2020 and published its first firm-wide TCFD-aligned report in March 2021.

Gearing

The trust has scope to use gearing up to 30% of NAV of the listed securities held by the trust, although typically, the board expects that borrowings will be 10–20% of NAV of the listed securities. The use of gearing has been relatively modest to date (averaging c 2%) and as at 28 September 2022 stood at 6%. Gearing is funded via a combination of structural and flexible facilities. In October 2020, USA secured access to a US$25m three-year, fixed rate facility with ING Bank that expires in October 2023. This facility was in addition to the existing US$25m five-year revolving credit facility with ING Bank, which expires in August 2023.

Exhibit 11: Modest use of gearing since launch

Source: Morningstar, Edison Investment Research

Fees & charges: Highly competitive

USA’s managers endeavour to operate efficiently and economically and keep management fees and ongoing costs low, as they appreciate that even modest amounts can add up to substantial sums when compounded over long periods of time and the managers do not wish to dilute the compounding of investment returns with the compounding of costs. The annual management fee was recently lowered; with effect from 1 September 2021, it is 0.70% on the first £100m of net assets, 0.55% on the next £900m and 0.50% on net assets in excess of £1.0bn. This compares to a previous fee of 0.70% on the first £100m of net assets and 0.55% on remaining assets. With a tiered fee structure, the benefits of economies of scale are passed on to investors as the trust increases in net asset value. There are no performance fees, as the board believes that calculating the management fee on this basis is unlikely to exert any positive influence on performance. The trust’s ongoing charge declined to 0.62% in the financial year to end May 2022, from 0.68% in the previous period. The fees investors pay here are competitive when compared with the AIC North America peer group, which is a cohort of seven funds with an average ongoing charge (ex-performance fee) of 1.01%.

Capital structure

USA was launched by Baillie Gifford in March 2018. The trust is structured as an investment trust, with one class of ordinary shares. There are currently 305.1m shares in issue. The company has been established with an unlimited life.

Exhibit 12: Major shareholders

Exhibit 13: Average daily volume

Source: Bloomberg, at 28 May 2022

Source: Refinitiv. Note: Since 11 September 2020 to 12 September 2022.

Exhibit 12: Major shareholders

Source: Bloomberg, at 28 May 2022

Exhibit 13: Average daily volume

Source: Refinitiv. Note: Since 11 September 2020 to 12 September 2022.

The board: Appropriately experienced

Exhibit 14: Baillie Gifford US Growth Trust’s board of directors

Board member

Date of appointment

Remuneration in FY22

Shareholdings at end-FY22

Tom Burnet (chairman)

5 March 2018

£40,000

126,040

Graham Paterson (audit committee chair)

5 March 2018

£34,000

80,000

Sue Inglis (senior independent director)

5 March 2018

£30,500

50,000

Chris van der Kuyl

1 June 2021

£29,000

Nil

Rachael Palmer

1 June 2021

£29,000

Nil

Source: Baillie Gifford US Growth Trust, at September 2022

At IPO the board began life with a small (three-person) structure and as the portfolio gained traction new members were added. It currently numbers five, with an average tenure of around three years (to September 2022), with Tom Burnet, Sue Inglis and Graham Paterson having been appointed at launch of the company in March 2018. Both Chris van der Kuyl and Rachael Palmer were appointed in June 2021. The board has a good mix of relevant skills through asset management, investment trust experience, corporate governance, strategy and marketing. More specifically there is salient experience in private markets and technology focused businesses, which chimes with the investment process and philosophy.

Burnet was appointed chairman on 5 March 2018 and is also chairman of the nomination committee. He is chairman of Kainos Group, a London-listed IT services business, and a non-executive director of BMO Private Equity Trust. He is also chairman of two privately owned technology businesses and was previously managing director of Serco’s Defence Services division. Inglis is the senior independent director and has more than 30 years’ experience advising investment companies and financial institutions via roles included managing director corporate finance at Cantor Fitzgerald Europe and Canaccord Genuity. Paterson is chairman of the audit committee, with over 20 years’ experience in the private equity industry. He is a chartered accountant and has been a partner and board member at Standard Life Investments (Private Equity). He has also served on the board of a technology and software company acquired by eVestment (now part of NASDAQ) in 2015. Van der Kuyl is an entrepreneur operating in the technology, media, gaming and entertainment sectors. He is co-founder and chairman of games developer 4J Studios, best known for developing Minecraft for Microsoft, Sony and Nintendo games consoles and is a co-founder of Paddy Burns, which launched Chroma Ventures, the investment arm of 4J Studios, in 2021. Palmer is an experienced strategy, marketing and business development professional with extensive experience working within the technology sector. She currently leads Google's VC and Startup Partnerships for the Europe, Middle East and Africa region.


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This report has been commissioned by Baillie Gifford US Growth Trust and prepared and issued by Edison, in consideration of a fee payable by Baillie Gifford US Growth Trust. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

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This report has been commissioned by Baillie Gifford US Growth Trust and prepared and issued by Edison, in consideration of a fee payable by Baillie Gifford US Growth Trust. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

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Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

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This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

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London +44 (0)20 3077 5700

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95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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Witan Investment Trust — Turning a corner

With inflation surging, interest rates rising, regional recessions looking imminent and the continued conflict in Ukraine, there is more uncertainty and potential variances of possible outcomes than investors have been accustomed to in recent years, which may suit Witan Investment Trust’s (WTAN) broadly diversified portfolio. In our March 2022 update we reviewed WTAN’s FY21 results and in this note we review the HY22 results, highlight some incremental portfolio changes and take a closer look at three of the external managers.

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