Agenda item

In their presentation to the Sub-Committee, Baillie Gifford highlighted the valuations of their three portfolios – Global Alpha (global equities), Diversified Growth, and Fixed income – as at 30^th November 2014, in comparison to valuation of the Portfolios at 30^th September 2014. 

For the Diversified Growth Portfolio, Baillie Gifford’s objective was to outperform UK base rate by at least 3.5% per annum (net of fees) over rolling five year periods with an annualised volatility of less than 10% over the same periods. On performance to 30^th September 2014 for Diversified Growth funds, Baillie Gifford had achieved a net return for the fund of 6% per annum since inception, outperforming the UK base rate by 4%. The presentation also highlighted the performance of Baillie Gifford’s Diversified Growth Pension Fund between 31^st December 2008 and 30^th September 2014 to illustrate a positive performance delivered with low volatility. Performance attribution and commentary on certain DGF asset classes in the 12 months to 30^th September 2014 was also outlined, with an indication that the fund returned 7.8% gross of fees over the year. In discussion the impact of fees was outlined to Members. It was also noted that the Active Currency asset class had delivered a return of 1.3%. In theory it was possible to lose money on any one of the asset classes but the involvement of research was highlighted and currency as an asset class was suited to Baillie Gifford’s investment approach. Overall performance of economies was the ultimate driver and a difference could be made over the long term. It was explained that a typical holding period by Baillie Gifford for a currency asset was six months rather than have a short term approach to the asset class. In terms of outlook for the future, Baillie Gifford was encouraged by improvements in economic data in parts of the developed world and improving fundamentals gave grounds for optimism. However, Baillie Gifford felt that risks remained. It was felt that the end of Quantative Easing (QE) and increase in interest rates might have a negative impact on higher yielding assets. The US in particular was curtailing its use of QE although it was suggested to Members that the extent of QE across other parts of the world could rise, with Europe in particular increasing QE.

Further detail on Baillie Gifford’s Diversified Growth Fund Portfolio was appended to the presentation. This included details of asset types the Fund invests in, asset class returns within the fund, and asset attribution. The portfolio continued to be invested across a broad range of asset classes. There were substantial allocations to more defensive asset classes e.g. cash, investment grade bonds and structured finance. Baillie Gifford remained confident that the fund could deliver a worthwhile return in a range of environments. Returns had been supported by improving economic factors with most asset classes performing well. However, the pace of recovery remained modest, continuing to diverge across regions. Emerging market assets experienced sharp falls early during the 12 months to 30^th September 2014, with some recovery in recent months. 

However, on expectations for long term return, a number of assets looked to offer higher than average ten year expected returns against cash; Baillie Gifford continued to expect a particularly low return on cash. Nominal returns and returns relative to inflation were likely to be lower than average across all asset classes. Equity valuations were higher than 12 months previously, hence a lower return expectation. This also applied to a lesser extent for infrastructure, high yield credit, and insurance-linked allocations. Government bonds, investment grade bonds and emerging market bonds were on lower valuations. 

It was noted that some 13% of the Diversified Growth fund was allocated to Emerging Market Bonds, including exposure in Mexico, Peru and Columbia. It was explained that Baillie Gifford focused on companies rather than countries, considering how companies can grow their earnings. For Mexico there was a new Government and the US was more confident. There appeared to be keenness on re-structures and the largest trading partner for Mexico was the US.  Longer term Bonds issued by emerging market countries (in their local currencies) could be expected to achieve a real return of 2% over cash. However, risks varied by country and there was a limited correlation to equities. On a nearer term view, the current index yield at 6.4% was attractive. However certain countries were struggling with current account deficits and some selectivity amongst countries was appropriate. The purchase of the Baillie Gifford Emerging Market Bond Fund had been implemented and there was selective additional exposure to stronger economies.

It was noted that the Bromley Pension Fund could go cash negative in a further five to six years. It was explained that the Diversified Growth Fund aimed to beat base rates and there was a strong absolute return over the medium term. Diversified Growth was a better strategy. For Treasury Management, there would be no intention to invest in equity. Treasury management was different and it was necessary to rely on fund managers taking a long term approach. 

Concerning Baillie Gifford’s Global Alpha strategy focusing on long term global equity, this was described as “bottom up stock picking”, well diversified and with a low turnover. The objective was to outperform the MSCI All Country World Index by 2 – 3% p.a. (before fees) over rolling five year periods. As at 30^th November 2014 the Portfolio Value stood at £230,177,343 and the portfolio had returned 4.8% (gross of fees) since inception on 31^st December 2013 against a benchmark of 6.4%. The intention was to hold investments in the portfolio for about five years to see real benefit. Details of the top ten stock contributors were provided for the portfolio along with the bottom ten stock contributors. A brief update was provided on Baillie Gifford’s research related to the portfolio and the composition of the portfolio by stock holding. 

Noting that Baillie Gifford’s objective to outperform the MSCI All Country World Index by 2 – 3% p.a. over rolling five year periods was before fees, Members asked that the objective also be provided net of fees. As such Baillie Gifford was happy to provide performance figures gross of fees and net of fees. It was suggested that net of fees the return would change from 4.8% to about 4.5%. It was also explained that the actuarial assumption is long term and for actuarial purposes the expectation of return is about 7% per annum.

The presentation document included details of Baillie Gifford’s investment philosophy for the Global Alpha portfolio along with a summary of the investment process. Growth profiles were also provided according to Stalwart, Rapid, Cyclical and Latent types with particular company characteristics attributed to each growth profile type. An outline of Global Alpha activity in companies identified new buys, additions, complete sales and reductions. The top ten holdings were highlighted as were sector weights and regional weights. A Global Alpha list of stock holdings identified the percentage holding in various stock as at 30^th September 2014.

Concerning Bailie Gifford’s Fixed Income Portfolio, this had an objective to outperform 50% Gilt / 50% Corporate Bond benchmark by 1.5% p.a. over rolling three year periods. The value of the Portfolio at 30^th September 2014 stood at £48,144,437. Baillie Gifford’s fixed income approach was outlined in respect of Corporate Bonds (bottom-up credit analysis), Government Bonds (Global approach covering interest rates and currencies) and Asset Allocation (Government versus credit – selective investment in high yield and emerging market bonds). The Fixed Income portfolio had achieved a return of 9% against a benchmark of 7% to 30^th September 2014 from its inception on 9^th December 2013. In terms of general outlook for Fixed Income the presentation advised that long term interest rates might not return to previous average levels in view of factors such as lower trend economic growth, ageing populations and excess global savings. In the short term, interest rates were influenced by continuing loose central bank policy. It was felt that yields might be lower for some time. In regard to Corporate Bonds, Baillie Gifford also felt that there were overweight securitised bonds with real assets. Reference was also made to underweight banks. On Government bonds, it was felt that yields were too high in some emerging markets; Baillie Gifford was also positioned to benefit from falling Eurozone inflation. Regarding currency, Baillie Gifford favoured recovering economies such as the U.S. and Mexico.

In view of the UK Government looking to provide the Scottish Parliament with increased tax raising powers and anticipating any possible increase to personal taxation rates in Scotland, the Chairman enquired whether there might be a risk of Bailie Gifford losing key personnel as a result. Additionally the Chairman enquired whether there might also be a risk that the Scottish Government might raise increased company tax levies on Bailie Gifford. It was explained that VAT continued to be controlled by the UK Government and Baillie Gifford had a keen focus on people in its business. There was a low turnover of staff. It was suggested there is only some 18,000 in Scotland paying the higher tax rate of 45%. Higher rate earners in the company could potentially have to pay a 50% tax rate were income tax levels to rise to that extent but the company would impress upon the Scottish Government that it would be foolhardy to make Scotland uncompetitive through such levels of taxation.

RESOLVED that in the context of Baillie Gifford’s Global Alpha strategy, Baillie Gifford provide performance returns (i) gross of fees and (ii) net of fees.