Baillie Gifford US Growth Trust — Seeking tomorrow’s mega caps

USA’s managers, Gary Robinson and Kirsty Gibson, seek out exceptional US businesses they believe have the potential to grow substantially faster than the market, with the objective of delivering above market returns. Specifically, they target stocks with the potential to grow the returns of publicly listed companies by 2.5x or more over rolling five-year periods and by 5x for unlisted companies. The managers believe such businesses tend to operate at the cutting edge of technology-led change, and they actively seek companies with unique corporate cultures, which they view as the best and most meaningful indicator of an enterprise’s long-term performance potential and capacity to seize market opportunities.

In essence, Robinson and Gibson are on a quest to find the mega caps of tomorrow. They cite Amazon as a prime example. When Amazon floated in May 1997, it was simply an online bookstore and was valued at US$300m. It is now valued at US$2.0tn. The company has used the internet to grow quickly and cheaply, by broadening its product and services offering from books to a myriad of consumer products, advertising and streaming services. It has prioritised keeping prices low for customers. Amazon competes on selection and convenience, as well as price. This formula has helped the company grow the number of buyers and sellers using its platform. USA’s managers believe Amazon’s culture is distinctive as it is run with a uniquely long-term perspective, which allows it to be bold and to scale up new areas of business as it grows. This culture means Amazon possesses the rare and attractive combination of operating at scale, yet still being early in its opportunity.

USA invested in Amazon at its inception, and it was also an early investor in Tesla, the electric vehicle manufacturer, and NVIDIA, which makes cutting-edge semiconductors, an essential component of AI tools. While the portfolio still holds these established household names, the managers are now looking beyond them, towards the next generation of winners. In their view, contenders for this status include USA top 10 holdings The Trade Desk, whose platform sells advertising to targeted audiences, Stripe, a payments technology company, Shopify, which provides retailers with business software, and DoorDash, a local delivery platform.

Robinson and Gibson have observed that since the rises in US interest rates, its portfolio companies have shifted from concentrating solely on growth towards a more balanced focus on both growth and profitability. Reviews of strategy and operations, cost cutting and greater investment in R&D have left portfolio holdings leaner, and more agile. These efforts are already yielding tangible benefits in the form of improved financial metrics. At end May 2024, 67% of USA’s investments were registering positive cash flow or positive earnings, up from 48% a year earlier. For example, Shopify is now margin positive due to cost cutting and the implementation of AI to refresh websites and offer better products to vendors, while Meta is using AI to improve ad targeting and customer engagement.

USA’s returns were very strong in the first few years following its launch in March 2018, and many of its portfolio holdings benefited from the rally in growth stocks early in the pandemic (see chart at the beginning of this note). However, subsequent performance has been more muted, but still strongly positive in absolute terms. During the year to end September 2024, the trust returned 18.5% in NAV terms, compared to the market return of 24.1%, although the share price rose 35.4% over this period. Over the five years to end September 2024, cumulative returns totalled 75.5% in NAV terms and 54.4% on a share price basis, lagging the benchmark return of 92.8%.

USA’s holdings are doing ‘exceptionally well’ on an operational basis, according to USA’s managers. This has been reflected in the share prices of many of its holdings of listed companies over the past year, led by the ongoing strong performance of large tech stocks. NVIDIA has been the stand-out performer as its advanced chips are in high demand as businesses invest in AI infrastructure.

Many of USA’s private companies are also doing very well, notably Space X, which has displayed exceptional operational achievements. It boasts a 90% share of the market in reusable rockets and space craft, and Starlink, its satellite provider, is now cash generative, with three million users. Stripe, another private holding, is also performing strongly. Its payments software is used for transactions that total 1% of global GDP. However, higher interest rates have pushed up the discount rates used to value smaller, long-duration growth companies. This has eroded the valuations of USA’s unlisted holdings over the past two years, especially those that are not yet profitable and those with high financing costs. The performance of the trust’s unlisted positions has thus been a drag on relative returns over this period.

USA’s managers are optimistic about the company’s prospects. They believe the US is the best place to find the exceptional growth companies they target. It is the ‘innovation capital of the world’ in their view, having led the way in previous technological developments such as the internet and mobile, and is doing so again now, in new fields such as space and AI.

Furthermore, Robinson and Gibson believe that the excitement about AI is warranted. In their view, ‘recent advances in AI represent some of the most important technological developments of the century… (the technology is) outperforming humans in some tasks and improving at a remarkable rate’. They expect the AI revolution to continue and accelerate, making large swathes of the global economy more efficient. While the market is currently very concentrated on a small number AI-related stocks, market gains are likely to disperse as AI integrates into more and more areas of the economy and daily life. They expect this seismic change in technology to generate ‘huge structural opportunities’ that will allow adaptable businesses to realise outsized returns for long-term investors such as USA.

One example of the recent opportunities the managers have grasped is their investment in Block, made in May 2024. Block is a financial company that owns Square, a merchant software company, and Cash App, a consumer financial services app, and Robinson and Gibson believe it has scope to rival Mastercard or Visa. They see recent developments at Block as emblematic of what is happening across the market. Higher capital costs are forcing many companies to cut costs and rethink strategy. Block’s founder, Jack Dorsey, has increased focus on stringent financial targets. As a result, the managers believe that the business has become more adaptable and innovative, which should manifest in greater profitability over time. In their view it now looks ‘very cheap’ on a forward basis, given its consensus three-year forward valuation of just 12x earnings.

Lineage Logistics is another recent acquisition. Robinson and Gibson say this a good example of the kind of business they favour, as it is ‘under the radar of most investors’. The company operates temperature-controlled transportation and cold storage facilities. This is a very fragmented sector, and Lineage is making acquisitions and integrating these businesses into its operations. It is also utilising automation and other cutting-edge tech. The company is growing briskly, and its increasing reach is allowing it to become an essential part of its customers’ supply chains, seeing off competition in the process. USA’s managers expect it to generate compound earnings of 15% y-o-y ‘for years and years’.

Robinson and Gibson have also spotted opportunities among healthcare names. There has been much negative sentiment about the potentially adverse impact of anti-obesity drugs on demand for conventional diabetes treatments. They view these concerns as misguided. Share price dips allowed them to purchase Insulet, which produces insulin delivery systems, and Inspire Medical Systems, which makes surgical implants for sleep apnoea, at attractive levels and both these positions have done well since acquisition. They also bought Guardant Health, a provider of molecular diagnostic tests for cancer, although this holding has since struggled.

These and other acquisitions have been funded by reductions in the position size of some of USA’s most successful holdings, including NVIDIA and Shopify. Other tech-related disposals included the sale of Zoom, a video conferencing app. This company was a foundational holding for USA, but the managers felt that its very strong performance meant that further major gains were unlikely, especially as Zoom faced severe competition from Microsoft Teams. They also feel they can maintain equivalent exposure to AI and related tech via their positions in Amazon, especially its web services, Cloudflare, which offers cloud services, Tesla and others that use AI in their products and services. HashiCorp, which provides software to assist companies operating in the cloud, was also sold before it was purchased by IBM.

The managers closed a position in Novocure, one of the key detractors from relative performance in FY24. This medical devices and services company had early success with a treatment that broke up tumours, but recent trials on different cancers were less successful, so its investment thesis became challenged. They also wrote off USA’s holding in another FY24 detractor, Convoy. This unlisted trucking company was executing well and increasing its market share until it was forced to close due to falling freight volumes and haulage rates, declining demand and rising inventories.

At end May 2024, private companies comprised 34.1% of USA’s total assets, virtually unchanged from the previous year. The company held 24 unlisted names, down from 25 at the same time the previous year. In addition to the write-off of Convoy, cosmetic company Oddity listed during the year. One new unlisted name was added during FY24: Human Interest, which provides pension plan services to small and medium-sized businesses. Since then, the managers have purchased Cosm, a private company offering immersive media experiences based in both physical and viral venues, taking total unlisted holdings back to 25.

Three of USA’s unlisted holdings feature in the company’s top 10 holdings (Space X, Stripe and Brex – see Exhibit 3). This underlines the managers’ claim that USA’s private holdings are not small-scale businesses with uncertain futures. On the contrary, its unlisted names are all late-stage investments, eight years or more into their development (SpaceX is over 20 years old), with what the managers claim to be proven business offerings. The estimated median valuation of the trust’s private company holdings stood at more than US$2.0bn at end May 2024. All are likely to benefit from the eventual decline in interest rates and the upsurge in IPOs. All are expected to launch on public markets in due course, once their development is sufficiently advanced and market conditions are conducive.

Portfolio turnover remains relatively low at around 14%, consistent with USA’s five- to 10-year holding period and with its philosophy of long-term commitment and high conviction.

USA’s discount has narrowed significantly over the past year from over 20% to around 10% currently, which suggests that sentiment regarding the company’s growth investing style, and the investment trust sector more generally, has improved over this period. The company’s shares have also been supported by buybacks. During FY24, the company repurchased 7.9m shares, amounting to 2.6% of its issued share capital. A further 6.5m shares have been purchased so far in FY25 (as at 9 October 2024).

However, USA’s discount is still well above its long-term average of 4.3%, and we see scope for it to continue narrowing towards this level as and when relative performance improves. Meanwhile, the current discount may provide a window of opportunity for investors to acquire USA shares at an attractive level.

Baillie Gifford US Growth Trust is a member of the Association of Investment Companies (AIC) North America sector, which has seven constituent members, with varying mandates (Exhibit 5). Three of these funds focus on providing income, as well as capital growth, two (Canadian General Investments and Middlefield Canadian Income) are focused primarily on the Canadian market, and one has a dedicated sustainability mandate. The JPMorgan American Investment Trust and Pershing Square Holdings share USA’s goal to achieve capital growth from North American investments, but none of the other funds in this sector shares USA’s intense focus on exceptional growth companies.  

However, there are several closed-ended funds in other AIC sectors whose investment strategies share USA’s objective of realising long-term capital growth from investment in global listed or unlisted technology companies. So, to provide a fuller picture of USA’s true peer group, Exhibit 5 also includes a selection of these funds.

USA is the third largest fund in its North America peer group, but the smallest among its technology peers. Its one-year NAV total return ranking has improved since our last report. It now ranks third among its AIC sector peers over this timeframe, although its rankings over three and five years remain unchanged at seventh and fourth, respectively, and its returns still lag the average of its broader peer group over all periods shown. Its share price discount to cum-income NAV is now below the average of its AIC sector peers, and quite close to the discounts of most of its broader technology peer group. USA’s ongoing charge is competitive, being the second lowest of all its peers, and in common with most, it does not have a performance fee. USA’s gearing level, at 4%, is lower than the average of its North America peers, but higher than the average of its technology peers. It is the only trust among its AIC peers not to pay a regular dividend, although several funds in its broader peer group adopt a dividend policy similar to USA’s.  

USA’s key priority is to generate capital growth over the long term, so the company has no dividend target and will not seek to provide shareholders with a particular level of dividend. The company’s net revenue per share was negative in the financial year ended 31 May 2024, as it has been since inception, as portfolio companies tend to reinvest cash flows to boost future growth, rather than pay dividends to shareholders. And as the revenue reserve is again running at a deficit, no final dividend will be paid in respect of FY24. However, should the level of underlying income increase in future years, the board will seek to distribute the minimum permissible to maintain investment trust status by way of a final dividend.

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 for listed companies and 5x for private companies. 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.

Seeking exceptional returns from listed and private companies

Baillie Gifford has been investing in innovative US companies for over 100 years and 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 have 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 over time. 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.

Baillie Gifford has a growing presence in private market investing, and its reputation as a large, patient investor, willing to give companies the time they need to realise their full potential, means that it is not unusual for the owners of unlisted businesses to seek out USA and other Baillie Gifford funds as investment partners. USA’s managers believe this gives them a greater ability than competitors to access exciting opportunities, unavailable in public markets or to retail investors.

USA’s 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, as mentioned above. 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 eight-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, investigative journalists and industry experts. 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:

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 to 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’.

In general, the managers will assess each holding when its share price 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 by stock coverage rotation) and with other teams at Baillie Gifford. This is helped by the trainee analyst rotation policy, various investment committees and 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 makes the output greater than the sum of the parts and 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.

The extreme market volatility of the last three years has prompted USA’s managers to undertake a review of their portfolio construction, to glean any lessons that may enhance their investment process. They are giving special consideration to the maturity profile of portfolio companies, with a view to optimising the mix of transformational, dynamic and enduring growth companies. They believe it is important for the portfolio to hold a suitable number of financially more mature companies, and they are in the process of deciding whether to place a formal cap on listed businesses in the very early stages of development, to ensure the portfolio is tilted in favour of more established businesses. However, the trust’s philosophy and approach remain unchanged.

Baillie Gifford’s holds 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 2024, the valuation committee has valued 56 securities within the USA portfolio, 288 revaluations have occurred, with 30.4% of the portfolio revalued up to four times and 69.6% of the portfolio revalued five or more times. The general improvement in market sentiment is reflected in the private company valuations at 31 May 2024. On average, company valuations rose 15.7% and share prices rose 22.7%.

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, and they view sustainability as intrinsic 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.

One illustration of the application of this principle is the managers’ engagement with CoStar, which provides information, analytics and online marketplace services to real estate companies in North America and the UK. CoStar’s large dataset is a source of competitive advantage and ongoing discussions with CoStar’s leadership have made it clear that they view data privacy, along with human capital and social issues, as most material for the long-term sustainability of their businesses. As a result of the company’s efforts, employee attrition rates have fallen, and staff engagement scores have risen. The managers also welcome the fact that CoStar has been proactive in reaching out to them on many topics.

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 Nations 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 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 Task Force on Climate-related Financial Disclosures (TCFD) in May 2020 and published its first firm-wide TCFD-aligned report in March 2021.

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 and as at end September 2024 stood at 4%, up from a net cash position of 0.5% a year earlier. Gearing is funded via a combination of structural and flexible facilities.

The company has two loan facilities in place. A US$25m three-year revolving credit facility from ING Bank is in place until 26 July 2026, while a US$25m three-year revolving credit facility from the Royal Bank of Scotland matures on 18 October 2026. As at 31 May 2024, the facilities had been drawn down in full (31 May 2023: US$50m).

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 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. 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 stood at 0.7% for the financial year ended May 2024, virtually unchanged from 0.69% in the previous year, but slightly higher than the 0.62% charged with respect to FY22. The fees investors pay 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 1.0% (Exhibit 5).