TRANSCRIPT: EPISODE 224
17 November 2022 (pre-recorded 31 October 2022)
Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.
James Yardley (JY):
Hello and welcome to the Investing on the Go podcast. Today I’m joined by Bill Chater, the investment specialist for the Baillie Gifford Global Discovery fund. Bill, thank you very much for joining us today.
Bill Chater (BC):
Hi, thank you.
(JY):
Now, Bill, your fund has worked very well for the past decade, but it’s had a really tough last 18 months or so. Can you explain why that is, and if the strategy can still work in a higher interest rate environment?
(BC):
[00:33] Yes, of course. Thank you very much for your questions. You’re absolutely right. The fund has had a more challenging 18-month period, albeit that the longer-term track record still remains decent.
I think we need to reflect on the fact that the environment has changed, that the convergence of multiple external factors within [the] market has created a high degree of uncertainty, which has brought in investors’ time horizons.
As a fund which is predominantly looking at long duration, growth assets, we want to find early-stage businesses which could go on to achieve great things over the coming decade. It has felt that we are in the eye of the storm of this uncertainty. We appreciate that this is distinctly uncomfortable for clients and it’s not an outcome that we find desirable, but in some ways, with long-term growth investing, there are going to be periods where your style is out of favour with the market.
(JY):
I mean, it always has been the case with this strategy. I mean, it does occasionally have quite nasty drawdowns because of the nature of the businesses which you’re investing in. Is that fair?
(BC):
[01:58] Absolutely. I mean, I think there have been periods where the strategy’s performance in the past has been out of kilter with that of the market. I mean, I think if we were to reflect on what we’ve seen recently, it feels though that the market is applying pretty broad deratings to a lot of the companies that we’ve been looking at. In some ways, the market is almost equating an ambition to grow with inherent fragility, and as a concept that just feels quite alien to us. But I mean, if we are to kind of reflect on what we’re trying to achieve with the fund, I don’t think our core mission has really changed. We’re continuing to look for those early-stage businesses with a high degree of potential that we think could go on to generate meaningful earnings over the long-term.
Look, the new environment isn’t going to be especially helpful for this, but neither do we feel that it is necessarily undermining the approach. We think execution, company execution, the strength of propositions, the ability of management; these will be much more determining factors for the success or not of the portfolio’s holdings, rather than macroeconomic factors.
(JY):
And obviously, we’ve seen a big hit to share prices, but what about the actual fundamentals in the businesses you own? I mean, has the growth actually slowed much in any of your companies, or are we just seeing a general derating across all of these growth strategies?
(BC):
[03:39] So, the Discovery fund is a fund of a hundred or so names. Within that number, there are always going to be those which are performing well, and those which are hitting air pockets or seeing missteps. I think if I was to characterise the fund at an aggregate level, we’re very satisfied with what we’re seeing in terms of operational progress. We’re continuing to see growth from the portfolio as a whole, that is comparable to previous years. We’re seeing that growth delivered at an attractive margin structure. So, the portfolio is delivering gross margins, roughly double that of the benchmark, suggesting that these are valuable propositions that there aren’t alternatives for, within the market. So, I think we are encouraged with what we’re seeing.
It’s also worth saying that we have been doing some work around the resilience of the portfolio and how well-funded these companies are going forward, and what’s their ability to fund future growth – we know growth doesn’t come for free – and I think that we’re satisfied . Also, [in] the portfolio, we’re sitting in aggregate on net cash – about 60% of the names have net cash on their balance sheet. So, it is something we will continue to monitor, and it’s probably a slight evolution in our process, but I think as we stand today, we’re satisfied with the operational development scene.
(JY):
Great. And another area which has been a bit tricky more recently for investors, is China. And we’ve seen a number of Chinese stocks, particularly the Chinese tech stocks, get hit very heavily. I know Baillie Gifford have been big investors in that area in the past. Has that impacted on the fund there? Do you have any thoughts on that going forward? Are you continuing with your investments in China? And does it have particular impact for this fund in particular?
(BC):
[05:45] So, to be clear, the Global Discovery fund has never had an especially high allocation to Chinese businesses. That’s not a reflection of any thoughts on the country and the opportunities there as a whole. It’s more a reflection of where we were finding the best opportunities, to be honest. We had thought that there was interesting innovation taking place within China, but a lot of that was actually being consumed and owned by the largest tech companies. And not a lot was happening within our market cap range of below 10 billion dollars.
That being said, we did own a handful of Chinese businesses. We have reduced that allocation slightly, more on the basis of company fundamentals. We have a couple of Chinese names at the moment within the portfolio that we have continued conviction in. So, for example, we have a company called ZaiLab, which is a Chinese biotech business, whose strength at the moment is bringing overseas propositions to China and working that through the Chinese domestic approval process. We think it’s a high-quality business that aligns quite nicely with the state’s objectives within that country. So, for the time being, we’re happy to hold it, albeit within that portfolio context I’ve mentioned.
(JY):
And smaller companies have struggled recently, more in some areas than others. What is your outlook on the different markets going forward, in terms of US versus Europe versus Asia, that sort of thing, versus Japan?
(BC):
[07:41] So, James, you might be slightly frustrated by this answer. I think you would probably get better answers on that if you speak to other managers! We look at things entirely on a bottom-up, company-specific basis. We believe that that is where we’re able to add returns for our clients rather than looking at things on a top-down style. So, I think on a relative basis, it is challenging for me to give you a good answer here.
I mean, I think there’s no shying away from the fact that small caps, as a whole, have been challenged over the last year. It’s kind of quite understandable, really. I mean, previous performance shows that in periods of downturn, small caps do tend to fall faster than other asset classes. I think the thing we’re considering, is what opportunities that presents for us. So, we’re finding companies that we think have been unfairly discounted in that, where the market is not recognising the potential of those names, and it is creating some interesting opportunities for the fund.
We’re also kind of aware of the idea that out of previous downturns, small caps have been amongst those assets which have recovered most quickly. So, I think we’re optimistic for the future from here. But I probably can’t give you a great answer on small caps kind of relative to others or countries relative to others.
(JY):
And what are some of the most exciting themes and ideas in the portfolio? Can you give us some examples and some stock examples?
(BC):
[09:09] Absolutely. So again, to be perfectly clear, we think about things entirely on a bottom-up basis.
So, we look at individual companies rather than themes or trends. What emerges though from the portfolio is certain commonalities, and it kind of gives you an idea of areas which the investors are individually interested in. Some of the most exciting companies within the portfolio, are all looking at deepening our understanding of human genetics or conversely, actually looking to manipulate that to treat troubling conditions.
(JY):
Yeah, I mean, you’ve got a lot in healthcare at the moment.
(BC):
[09:56] Exactly. I think if I was to pick out maybe one more established name from the portfolio and maybe an earlier stage name from the portfolio which are playing into that trend, I pick out Alnylam Pharmaceutical[s], the more established name, which is a US biotech business, which is attempting to develop a suite of different treatments all based around amplifying or silencing the body’s RNA makeup.
And then if I was to pick a more tentative name, I’d discuss a name closer to home, Oxford Nanopore [Technologies Limited], the UK-based business, which has developed really highly adaptable and more accessible genetic sequencing devices. Genetic sequencing is a technology which has made really impressive gains over the last couple of decades in particular, but we’ve been quite frustrated that it’s remained really within academic and research settings. We think Oxford Nanopore with its device, which is cheaper, smaller, easy to use, shows a real promise in moving that technology out into more different settings and for different applications.
(JY):
Interesting. So, are we going to see these machines popping up in your local GP surgery eventually, or at least in your local hospital?
(BC):
[11:24] I mean, that would be the hope over time. And that’s the kind of scale of the ambition and why we are so excited about a company like Oxford Nanopore.
I think the other trend that we’re considering, and is perhaps particularly pertinent at the moment, is the move towards increased automation. We’re seeing that really with our holding in Ocado, the UK business, I think most will be familiar with. And just the potential for that business to really solve grocers’ issue with margins globally. So, how do they move from kind of 3% margins up to 6% margins? And we think Ocado’s picking and packing technology, and the efficiency of that, actually provides a pretty compelling route to be able to make that jump. And then the other area …
(JY):
So, just on that, because that’s quite interesting. So, I mean, in this more inflationary environment we’re in with, you know, wages and things going up, is that adding to Ocado’s sort of competitive advantage against more of the traditional grocers, where you’ve got to employ somebody to go around a warehouse and things, and they’ve got everything sort of automated on robots?
(BC):
[12:40] I think it’s still early stages, but that would be the hope we’re seeing. One of the emerging trends of the last kind of year or so has been this idea of reshoring; so, businesses moving operations closer, making investments in fulfillment sites/warehouses, closer to home. And one of the things we’re observing from that, is just how automated these facilities are and how they are looking to take human cost out of these operations.
I think that that trend makes Ocado’s proposition even more compelling. And the efficiency that it offers relative to a more manual alternative. So, obviously we’ve seen that and observed their deal in the US with Kroger [The Kroger Company]. They’ve made other deals in other countries, they’ve discussed…
(JY):
So, just for our listeners, can you tell us a little bit about that deal, just so we understand; is this, was this, a licensing deal or how did it work exactly in terms of Ocado’s technology?
(BC):
Exactly.
(JY):
I mean, a lot of our listeners probably think of Ocado just as a grocer where you get your online, get your shopping, but actually it’s really more about their technology, isn’t it?
(BC):
[14:03] For us and the basis on which we hold it, we hold it really primarily for their international solutions operations. The basis of these deals is a licensing agreement, where they are entered into Ocado providing the technology and then receiving ongoing licensing payments for that, for its continued use over the life of the deal. They have signed out a significant deal, as I say, with the large grocer Kroger, and they are in the relative early stages of rolling that deal out. So, they’ve launched …
(JY):
So, do they go and just set the factory up for Kroger? Is that how it works? And then receive a licensing fee based on that or … ?
(BC):
[14:51] Exactly. So, they work with Kroger to establish the factory. They launch it and then they allow Kroger to operate it and use it for their grocery fulfillment. And then they receive ongoing licensing payments for that.
So, it’s a very different margin structure to the UK operation. And it is one of the things, combined with just the size of the potential opportunity, that we find very attractive on a long-term basis for Ocado, albeit particularly within this market; it’s not the side of the business that attracts most of the headlines. Most of the headlines focus really on the UK retail operation, which is clearly challenged at the moment.
(JY):
Yes. Well, I mean, that’s been a really interesting insight, Bill. Thank you very much for all of that and we’ll speak to you again soon, I’m sure.
(BC):
That’s great. Thank you very much for your time.
(JY):
And if you’d like to learn more about the Baillie Gifford Global Discovery Fund, please visit FundCalibre.com. And please also remember to subscribe to the ‘Investing on the Go’ podcast. Thank you very much for listening.
OUTRO
Please remember, we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at the time of listening. Elite Ratings are based on FundCalibre’s research methodology and are the opinion of FundCalibre’s research team only.
