Baillie Gifford European Growth 29 January 2025
Disclaimer
This is a non-independent marketing communication commissioned by Baillie Gifford. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.
Baillie Gifford European Growth (BGEU) owns a portfolio of companies that managers Stephen Paice and Chris Davies consider to be growth outliers in Europe. Stephen and Chris look for companies they think can at least double their money over five years and aim to outperform by taking a longer-term view than the market. The trust has cheap structural Gearing which contributes to the growth potential as well as the volatility in the shares and amounts to c. 14% of NAV.
BGEU’s portfolio has a strong growth bias and a heavy tilt to the mid-caps. This, along with some stock-specific issues with private companies, has led to some disappointing Performance since 2022. However, the listed portfolio outperformed the FTSE Europe ex-UK Index over the latest financial year, which is one promising sign, buoyed by some strong performances from companies like Spotify. Stephen and Chris argue that growth is still being undervalued by the market, and they have made a number of new additions to the Portfolio. In their view, the secular growth drivers behind their portfolio are as strong as ever, and some cyclical headwinds are abating which is promising for 2025.
In response to the troubled performance, the board has decided to implement a tender offer for 100% of the shares if the trust doesn’t outperform the index over the four years to 30/09/2028. At the time of writing, the shares trade on a 15% Discount to NAV, the widest in the peer group. The managers have retained their same core strategy, but have made some minor adjustments, determining they should be quicker to take some profits in their winners if they become expensive.
BGEU has a number of characteristics which should be attractive to a long-term investor. It has a portfolio full of companies with strong growth prospects, a bias to the mid-caps (which have outperformed over the long run) and structural gearing with exceptionally low rates. It also trades on a 15% discount at the time of writing, which, in our view, is verging on excessive for a listed equity portfolio. However, style and stock-picking just haven’t worked in BGEU’s favour for a number of years now.
The write-down of two unlisted investments in 2024 was the key factor behind the trust’s underperformance over that year. Whist disappointing, we think that the effective reduction of the position in private companies reduces one of the sources of uncertainty around the portfolio and at 95% listed, it makes the proposition cleaner. In our view, the exceptionally wide discount is now much more attractive with this hard-to-value bucket much smaller. One way to think about this is to consider how difficult it would be to deliver 13 percentage points of alpha, which would have the same effect on performance as the discount moving from 16% to 5%.
The performance-conditional tender offer is welcome, in our view, although we would not expect it to have too much impact on the discount unless considerable underperformance was to build in the next year or two.
Bull
- High-conviction approach brings outperformance potential
- Managers’ compensation package is designed to align long-term interests with shareholders
- Wide discount could close over time
Bear
- Gearing can enhance losses on the downside
- Active approach also increases chance of underperformance
- Likely to continue to be volatile thanks to portfolio makeup and gearing