Baillie Gifford: How the Scottish firm started investing in Silicon Valley unicorns

By September 19, 2018 No Comments

If you’re an investment manager, what qualifies as a mistake?

Obviously picking a stock that absolutely tanks is a regrettable decision. But to Baillie Gifford— a 110-year-old Scottish investment firm that manages $255 billion — the biggest error is not being in the game at all.

“For us, a mistake is foregone upside,” Tom Slater, the firm’s head of the US equities, said in an interview with Business Insider. “Businesses you’ve missed out on that you looked at that ended up growing, but you didn’t own them. That’s how you really destroy value for clients.”

It’s this fear of missing the next big thing that informs much of what Baillie Gifford does on the investment front. The firm is not content to wait around for a company’s stock price to surge before buying on the open market.

Instead, it’s engaged in a relentless pursuit of fledgling companies that possess enormous growth potential — many of which aren’t yet public.

A quick glance at Baillie Gifford’s flagship close-ended mutual fund — the Scottish Mortgage Investment Trust (SMIT) — shows this approach in action. The private company representation is immediately noticeable, with holdings in so-called unicorns like Lyft, Airbnb, and Dropbox prominently featured.

There are also companies that are either recently public, like Chinese electric-car maker Nio. Or firms that are on the precipice of an initial public offering, like Eventbrite.

But that’s not to overshadow Baillie Gifford’s investments in some of the stock market’s foremost juggernauts. Facebook, Alphabet, Netflix, and Alibaba are all present in the SMIT.

For us, a mistake is foregone upside.

And then there’s Tesla, the holding for which Baillie Gifford is perhaps best known, since it owns a bigger chunk than any institution in the world.

All of these investments have combined to generate an annualized average return of roughly 21% for the SMIT over the past 10 years. That’s almost two times the 12% annual return for the FTSE World TR Index, according to Bloomberg data.

Over the past six years — a period that better encompasses the firm’s foray into private companies — the SMIT has enjoyed a whopping 26% annual return, again nearly doubling the benchmark.

Whether it’s the index-leading performance of the firm’s mega-cap tech cohort, the immediate post-IPO returns it’s gotten from companies like Nio, or the ever-climbing valuations of Silicon Valley’s favorite unicorns, one thing is certain: Baillie Gifford is doing something right.

An important strategic realization

Before we get into how Baillie Gifford has gotten so heavily involved during the early stages of companies, it’s valuable to understand why the firm shifted their strategy in the first place.

It all started in the period following the tech bubble. After the market went bust, the century-old firm didn’t turn its back on the sector, as many did. Instead, it recognized that some of the industry’s growth characteristics were actually valid, and began hunting for cheap opportunities.

“If we got anything right during that period, it was breaking down some of the barriers that I think the industry in general had sort of imposed on itself,” Slater, who also co-manages the SMIT and serves as a decision-maker for the firm’s long-term global growth strategy, said.

“What we did quite well was snip the strings that were holding us into that straightjacket,” he added.

That led to an investment in Amazon in 2004. At a time when the company was still viewed by most as an unprofitable online retailer, Baillie Gifford saw the big-picture potential that’s been so crucial to the company’s recent success.

Yet while Amazon has performed admirably in the period since — having surged 4,300% since the start of 2005 — Baillie Gifford wasn’t yet satisfied. It asked itself why it didn’t get into Amazon way back in 1996.

It performed similar soul-searching around its Google investment. The firm had made a pretty penny buying shares in 2008, but what if it had bought on the IPO, back in 2004? By not doing so, they’d missed out on the stock already tripling.

Baillie Gifford decided it needed to get into these companies even earlier. So it set out to do so.

Getting familiar with the venture pipeline

Armed with their new early-stage initiative, Slater and his colleagues set out to make it happen.

“We realized that we needed to get to know the later stages of the venture pipeline better,” said Slater. “We put more effort into building relationships with some of the more interesting venture capitalists, and got to know their portfolio companies.”

That included Slater — an Edinburgh resident — moving his family to San Francisco for several months on three separate occasions, according to a Bloomberg report. His intention was to network and gain a better understanding of how things work in Silicon Valley.

We realized that we needed to get to know the later stages of the venture pipeline better.

And it appears to have worked, largely because, as Slater notes, companies don’t necessarily want to engage in the whole Wall Street song and dance.

“There’s a real open door there, in that these companies don’t want to play Wall Street’s game of having their stock pumped out to their best hedge fund clients,” he said. “They want to transition their shareholder base over time.”

Slater also found a receptive audience in the form of venture capitalists, who make seed investments in companies they hope will blossom into something much larger. Since these firms put so much effort into identifying and nurturing young companies, they’re similarly hesitant to cede stakes to Wall Street parties that may not share their vision.

“They want to find partners that can be long-term owners,” said Slater. “We built up relationships in that area.”

Many companies want to stay private longer

Of course, no early-stage investment idea is worth anything unless the company is on board with institutions owning chunks of shares.

But to hear Slater tell it, many upstarts — particularly in the tech space — are keen to circumvent Wall Street traditions like IPOs. Or, at the very least, they’re looking to stay private longer.

Slater points out that large-platform companies are so loaded with capital that they don’t even really need external financing.

“Breakthrough businesses enjoy huge scale without getting financial investors,” he said. “Therefore, they don’t have financiers running their boardrooms, putting pressure on them to go public.”

Staying private also saves long-term-focused entrepreneurs from having to constantly answer to an investor base that’s obsessed with the near term.

Breakthrough businesses enjoy huge scale without getting financial investors.

Slater provides the example of CEO Marc Benioff, who he says has built his company into a juggernaut by thinking carefully about the future. But when Benioff is on quarterly earnings calls, many of the questions are backward-looking and near-sighted. (Note: Baillie Gifford owns a stake in Salesforce.)

“Entrepreneurs don’t want to spend their time talking about that type of stuff,” Slater said.

Meanwhile, Baillie Gifford has won companies over by focusing on the big picture. And now, given the firm’s track record as a long-term growth partner — one that won’t turn its back on a company at the first sign of trouble — the firm has found startups to be responsive to investment inquiries.

This has been a crucial development in Baillie Gifford’s stated goal of finding opportunities in their nascent stage, then buying and holding on indefinitely.

Because any number of the companies in Baillie Gifford’s portfolio could wind up being the next Amazon. And this time around, they don’t want to make the “mistake” of waiting too long.

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