Trying hard in a difficult market

Baillie Giffford & Co is one of Scotland’s largest independently owned investment management firms. It is wholly owned and run by its 27 partners, and is the largest UK fund manager to be structured as a partnership. Founded in 1909, the Edinburgh-based firm runs a range of Oeics, institutional portfolios and investment trusts, including the Scottish Mortgage and Scottish American trusts. Baillie Gifford had £28.66bn under management at the end of June 2004.

An established presence in the Edinburgh fund management community, Baillie Gifford is perhaps better known for its management of investment trusts than for its open-ended funds. But performance in its Oeic range is better than average, with 10 out of the 16 funds with a three-year record placed in the top half of their respective sectors, rising to 18 out of 22 funds over one year.

Head of retail Chris Fletcher accepts that the Oeic side is less well publicised, but argues that the disciplines involved are the same: “On the retail side, investment trusts are mostly what we do. But our main philosophy is that we like companies whose share prices go up.

“We come from strong equity roots, and have found that over the long term, shares that go up in price tend to have four main characteristics. First, there needs to be a good market for what they do. Second, they need a strong balance sheet – we like companies that are cash-generative. Third, they must be a real competitor in their market. And, finally, we want the management to put shareholders first. We don’t invest in companies where the management favours the interests of other stakeholders – such as directors or staff – over those of investors.”

Baillie Gifford favours a team-based approach to fund management rather than the star culture that has been so lauded in recent years. Fletcher says: “Even if some of our managers are accorded star status by Citywire, they are representative of their teams. The focus is clearly on small teams, who work under the desk heads.”

Fletcher describes Baillie Gifford’s fund managers as longer-term investors, with a portfolio turnover of about two-and-a-half years. But he says the firm will not shout about its purchases, even though stocks are likely to be in the portfolios for a while: “We don’t like to talk about the stocks we have picked until it is old news – otherwise you find people stealing your ideas. We don’t release data until a couple of weeks after decisions have been made. But as we are not at the value end, we are not making a position out of trading.”

BestInvest fund research analyst James Calder says his firm currently recommends the British 350 fund run by the UK desk: “Baillie Gifford has a strong house approach – any portfolio will have similar characteristics because of the tight approach to portfolio construction. It is more focused on the qualitative side than the quantitative.”

Staff retention at Baillie Gifford is high. Calder says: “When you go through the team profiles, you find things like ‘years’ experience: 30; years at Baillie Gifford: 30′. The firm tends to hold on to its managers. If they reach partner level, it can be very rewarding.” However, within the last year the group has lost US team member Andrew Holliman to Threadneedle, and Japan team member Anja Balfour to Framlington. Both are now lead fund managers.

Hargreaves Lansdown head of research Mark Dampier does not currently recommend any of the funds. He says: “I’ve got nothing against the firm – we have looked at its American, Far East and Emerging Markets funds, but we have other favourites in those areas. You’ve got to be really top-notch to succeed in this market; Baillie Gifford is not bad, but it is nothing exemplary.”

Aidan Kearney, investment director at Artemis’s Premier Funds fund of funds arm, holds no Baillie Gifford funds either. “Given the length of its experience and its name, it’s surprising some of the funds aren’t bigger. It has good products and fund managers, but maybe it doesn’t push hard enough,” he says.

However, Kearney is not writing off the group: “Ken Barker on the bond side is a very solid fund manager. It also has a very good equity income fund manager in Patrick Edwardson, but his fund is very small at around £20m. Baillie Gifford has other responsibilities – it is big on the institutional side, and I imagine it has a loyal and close client base. As a fund manager, it is solid and very diligent, but it is not going to shoot the lights out.”

Fletcher echoes this last point: “We don’t try to shoot the lights out. Some of our funds do meet the funds of funds’ criteria, and some discretionary managers find our funds just right for spreading risk – for example, with the British 350 or the Corporate Bond funds.

“The Oeic funds are basically what we use for our institutional investors, so they are run in that way, but what is good for institutions can be good for retail investors too. We like to think of it as ‘the professionals’ choice’ – our institutional clients can’t all be wrong.” Within the Oeic range, the best performer in absolute terms over three years is the Emerging Markets fund, up 61.11% against a sector average return of 66.16%. Last year Baillie Gifford merged its Latin American fund into the Emerging Markets portfolio.

But Fletcher disagrees that Baillie Gifford is better known for its expertise in the Far East and emerging markets than for its success in the core markets: “As the institutional market begins to recognise our skills in emerging markets and Japan, so we are trying to put the case that our £30bn-odd under management is there because we are good at the core stuff. We couldn’t run a business if all we did was emerging markets and Japan.”

Calder concurs: “Baillie Gifford has all the bells and whistles and the full range of desks you would expect for a company of its size. It can be difficult for companies that become associated with one or two products, but anyone digging would see there is more substance to Baillie Gifford than that.”

Worst performer over three years is the European fund, fourth-quartile in its sector with a decline of 1.44% compared with a sector average gain of 11.06%. Fletcher acknowledges that this fund could do better: “It reflects our European performance throughout the house. We have found the larger-cap European market difficult, but we have put some effort in to turn it around, and the changes have borne some fruit.”

Performance is respectable in the hard-to-get-right American market, and also in fixed interest. Of the American fund, under the control of Mick Brewis and Malcolm MacColl, Fletcher says: “We missed out on both the upturn and the downturn surrounding the tech bubble. There is still some feeling now that US tech stocks are overvalued. Their share prices might be going up, but they are not generating cash. We prefer banks, retailers and so on.” The fund is top-quartile over both one and three years.

The Corporate Bond fund is a slightly odd creature, sitting in the UK Other Bond sector, where its performance is broadly in line with the sector average. Were it in the UK Corporate Bond sector, it would be a star performer, but Fletcher says the management team is unwilling to restrict the fund to the 20% maximum weighting in high-yield required by the IMA sector rules.

“We’d love a better system of classification for bond funds, and we have taken it up with the IMA. But you can’t have too many sectors,” he says. “The fund management team under Ken Barker feel that a 70/30 split between investment-grade and high-yield is the right mix to balance the interest-rate linkage of investment-grade with the added income of high-yield. The 80/20 split we would need to qualify for the UK Corporate Bond sector would not supply enough income.”

In 2002 Baillie Gifford announced its intention to be regarded as a leading player in the intermediary market within five years. So how is it doing? Fletcher says: “Our market share is up in each of the last three years, in both gross and net terms. But our market ambitions have not been achieved, as Oeic sales across the market have gone into reverse over this period, and only now are beginning to turn round.

“We are trying to achieve our ambitions at a very tough time – and we are doing it, though not as quickly as we would like. We are trying to sell the usefulness of our style in a time when growth has been out of favour – maybe we will come into our own when the world market comes round.”

Dampier says the group is starting from a low base: “Baillie Gifford was late into the retail market – it’s a big institutional and investment trust player, but has been a bit slow on the unit trust side. It has improved that a bit, but at the moment nothing hits us between the eyes. In the cautious market we’re in, 75% of the retail money is going into about 30 funds. Confidence is so poor that you’ve got to have something really special to attract funds.”

Kearney feels Baillie Gifford could be more proactive in achieving its aims: “The fact that Baillie Gifford’s funds are not widely held says something – it doesn’t push itself around. On its timetable, it has got another three years to achieve its aim, but at the moment we certainly don’t have to push them back at the doors.”

Calder says achieving a leading position in the market is every fund manager’s goal, though it will be difficult for Baillie Gifford: “Baillie Gifford is making strides into retail, but it takes time to get the message across and get the performance to stack up. Most groups want to increase their retail presence, as it is the most profitable business if you can get it, but it is a competitive market. In the past, a top-quartile fund would have pretty much guaranteed you decent fund flows, but now you need to be top-decile to be considered. It’s a good thing for investors, but for fund companies it is hard to get there, and those that do not are left lying around.”

While few commentators would put Baillie Gifford in the latter category, it is clear that in a difficult environment it will have to try harder if it wants to attract a greater share of the retail fund management market.