Scotland’s Unicorn Hunter
Jeff Bezos, the billionaire founder and chief executive officer of Amazon.com Inc., doesn’t spend much time schmoozing with investors. He takes just a handful of meetings with the fund managers who own Amazon’s shares each year. And when he comes to the U.K., there’s just one investor he regularly meets with: Baillie Gifford.
Baillie who? The 109-year old asset management firm, which manages 159 billion pounds and is based in Edinburgh, Scotland, isn’t exactly a household name, even in the U.K.
And yet in the past decade, Baillie Gifford has emerged as one of the world’s most active technology investors, and one of a tiny number of European investment houses that matter in Silicon Valley and Shenzhen. Besides Amazon, Baillie Gifford owns significant stakes in Facebook Inc., Alphabet Inc., Netflix Inc., salesforce.com Inc., NVIDIA Corp.. and Tesla Inc. as well as Baidu Inc., Tencent Holdings Ltd and Alibaba Group Holding Ltd.
So how has an old-line Scottish investment manager located far from the world’s leading tech centers become a top-ranked tech investor?
The firm got its start in 1907 as law partnership between Colonel Augustus Baillie and T.J. Carlyle Gifford. The duo switched to investment management the following year when they saw an opportunity to lend money to Malaysian and Sri Lankan rubber plantations providing tires for Ford’s new Model T. The firm soon branched out, backing U.S. railroads in the 1920s, and then automakers and steel mills – the growth stocks of mid-20th Century America. It was one of the first international investment companies to venture into Japan in the 1960s. But Baillie Gifford remained rooted in Edinburgh, where most of its 43 partners are based.
In the past five years, the Scottish firm has joined a handful of U.S. asset managers, like Fidelity and T. Rowe Price, in backing fast-growing private tech companies with globe-spanning ambitions. Its stable of “unicorns” – private companies with valuations north of $1 billion -- now includes Airbnb Inc., Spotify Ltd., Dropbox Inc., Palantir Technologies Inc., Indian e-commerce giant Flipkart Ltd. and Indian Uber-rival Ola, and U.K. peer-to-peer lender Funding Circle Ltd., among others.
In mid-April, it added another: Baillie Gifford was one of a half-dozen investors in a $600 million funding round for the ride-hailing service Lyft Inc. that valued the Uber Technologies Inc. competitor at $7.5 billion.
These tech investments have helped boost Baillie Gifford’s signature fund, the Scottish Mortgage Investment Trust PLC -- a publicly-listed, closed-end investment fund that has a market value of 5.1 billion pounds -- to annualized average return before expenses of 14.6 percent in the decade through the end of April, according to Bloomberg data. That compares to just about 9 percent for other global equity funds and the benchmark FTSE World TR Index, according to fund research company Morningstar.
Not everything Baillie Gifford has invested in has done well. The Scottish firm is a major backer of Rocket Internet SE, the controversial Berlin-based technology incubator run by entrepreneur Oliver Samwer and his brothers that are famous for copying the business models of Silicon Valley startups. Baillie Gifford is Rocket’s fourth largest shareholder, holding 6.5 percent of the incubator’s stock across several portfolios. It has also been a leading investor in individual funding rounds for some of Rocket’s bigger portfolio companies, such as meals delivery business HelloFresh and online furniture seller Home24.
Rocket shares have fallen 58 percent since the company’s initial public offering in October 2014. Tom Slater, who co-manages the Scottish Mortgage Investment Trust, defends Baillie Gifford’s involvement with the German “startup factory,” saying the firm believed Berlin could become a tech hub to rival Silicon Valley and that investing in Rocket was a good way to get a slice of the Berlin tech scene.
David Holder, a senior analyst at fund research firm Morningstar Inc., warns that Baillie Gifford’s Scottish Mortgage Investment Trust “is not a fund for widows and orphans.” The fund was hammered during 2008 financial crisis, losing almost 45 percent of its value, and also lost more than 15 percent in 2011 due to poor performance of its holdings in biotech firm Illumina Inc., Spain’s Banco Santander SA, farm equipment maker Deere & Co., and several mining companies, like Vale SA and KGHM Polska Miedz SA. In 2016, despite double-digit gains, it trailed the benchmark by more than seven percentage points and its peers by more than 5 percentage points. “But if you hold it over the long-term you have a pretty good chance of making money,” Holder said.
Slater, who in addition to his role at the Scottish Mortgage Investment Trust is one of the decision makers for Baillie Gifford’s tech-heavy Long-term Global Growth Fund and runs the firm's North American investment desk, said the firm has always been tech-focused in a way: from the Model T to the Tesla Model 3 is not such a leap, he argues. (Baillie Gifford is Tesla’s third largest shareholder, with an 8 percent stake.)
Baillie Gifford’s contemporary interest in tech investing stems from a revamp of the firm’s portfolio in 2004, following a period of inconsistent performance during which it lagged the FTSE World Index. That’s when Slater’s Scottish Mortgage co-manager, 57-year old James Anderson, dropped long-standing investments in Western oil majors and started investing in Amazon and eBay, two survivors of the first dot com boom-turned-bust that were shaking up retailing.
“Our investment in Amazon has a lot to do with how we got to where we are today in terms of tech investment,” Slater said. “We learned a lot from Bezos and his approach.”
One of those lessons was about focusing less on profits and more on growth, a company’s on-going investment in innovation, and the size of the market it is trying to address. "Profits are what you get when you run out of ideas" is a Bezos quote that Slater says he and his fellow Baillie Gifford portfolio managers love.
The first year Baillie Gifford owned Amazon, the stock dropped almost 50 percent. But the Scottish investors held fast. Their initial investment has now increased 15 fold.
Bezos and Amazon declined to answer questions for this story.
Baillie Gifford is mostly an institutional investment manager, with 64 percent of its total assets under management coming from pensions and another 19 percent designated as “sub-advisory,” meaning they are managed on behalf of another financial firm. And about 45 percent of its investors – such as the California Public Employees Retirement System (Calpers) and the State Board Administration of Florida -- come from North America.
The firm’s decision to look beyond public markets and start backing fast-growing technology companies before initial public offerings has been driven by necessity, Slater said. Digital "marketplaces" like Uber and Airbnb can provide a service without bearing many of the associated labor and capital costs. This, in turn, allows these companies to grow much faster, without having to go to the public markets to raise capital or provide an exit for their venture capital backers. The only way for an investor to access these companies, then, is to participate in late-stage, private funding rounds.
"There’s no equivalent of Airbnb on the stock market,” Slater said. “We’re not playing VC here,” he added. “These are established businesses that in any other circumstances would likely be listed.”
But there are substantial risks to this strategy. Already there are plenty of examples of once high-flying unicorns, like U.K. ad tech company Ve Interactive Ltd., digital insurance and benefits company Zenefits and cloud computing company CloudFlare Inc., that have seen their multi-billion dollar valuations slashed. Plus, shares in unlisted companies are far less liquid than public stock.
That’s why Baillie Gifford tends to hold its private company investments only in closed-end funds, so that it is shielded from the possibility of having to sell illiquid assets to meet investor redemptions. Even then, Scottish Mortgage’s board has formally limited the fund’s total exposure to unlisted companies to no more than 25 percent. Andrew Johnston, a senior investment research analyst at Square Mile Investment Consulting and Research Ltd., said these private investments were inherently riskier, but the potential for outsize returns was significant.
Slater, who is 39, studied computer science and mathematics at the University of Edinburgh. And he’s spent a fair bit of time touring Silicon Valley – including three longer stays in which he moved his whole family out to San Francisco for several months each time -- in order to get a better sense of the ecosystem.
But he doesn’t see his strength – or the firm’s – as understanding technology itself. Baillie Gifford has, with a few notable exceptions, avoided hardware makers or pure software companies. Instead, he said, the firm looks for “big opportunity sets” – like the growth of green power for both home and transport for Tesla or “the everything store” idea of Amazon -- and disruptive business models, many of which happen to be technology-enabled, whether that’s in entertainment, like Netflix, retail like Alibaba, or in advertising driven businesses like Facebook and Tencent.
From Alibaba to Tesla, Baillie Gifford is also drawn to companies where the founder still calls the shots. “It matters that Bezos is still very hands on,” Slater said, while Pierre Omidyar, who founded EBay Inc. around the same time as Amazon, “is having a nice life in Hawaii.” Slater said this difference goes a long way to explaining Amazon's ascendance and EBay's struggles.
The firm spends a lot of time, Slater said, trying to learn from its mistakes: and by mistakes, he doesn’t mean a stock you buy at 100 that promptly goes to 50. Instead, Baillie Gifford beats itself up over the stock it only dips a toe into that goes from 50 to 250, spending a lot of time trying to figure out why it didn’t jump in with both feet. An example, Slater says, is Nvidia, which constitutes about one percent of Scottish Mortgage’s portfolio. Baillie Gifford understood Nvidia as a way to bet on the growth of artificial intelligence–the chipmaker’s graphics processing units are in high demand for machine learning applications–but Slater said the firm was concerned about the vagaries of tech hardware investing. “We were timid with our position size,” he said.
Unlike a venture capital firm, Baillie Gifford is a pure financial investor — it doesn’t take seats on the boards of its portfolio companies or offer them any operational advice. And, Slater said, unlike a VC, the firm is not thinking about possible exits when it invests. “If we get it right, we don’t want to be sellers,” he said.
This doesn’t mean, however, that Baillie Gifford is a completely passive investor. Slater’s co-manager in Scottish Mortgage, Anderson, told reporters he was unhappy with how Tesla communicated its decision to buy SolarCity in June 2016. After a lot of careful analysis and discussions with Tesla, Slater said, Baillie Gifford ultimately decided to back its decision to buy the struggling solar energy firm.
The hardest decision Baillie Gifford takes is not usually whether to invest. It’s when to sell, Slater said. One reason the firm might bail is if something changes to undermine its confidence in a business’s culture. For instance, if a founding CEO leaves. Then there are companies that, over a number of years, don’t seem to be able to execute up to their potential. “There’s nothing explicitly wrong, but there’s an erosion of the potential upside,” Slater said. Finally, there are cases where everything goes right but the company becomes a victim of its own success and the law of large numbers, running out of room to grow at the same rate. He said this is why Baillie Gifford sold Apple Inc. last year, having owned it since 2008. “There’s no new billion unit market for them,” he said of Apple.
Slater said he does not see the same dynamics impacting Baillie Gifford’s investments in Alphabet Inc. and Facebook, which many analysts have also forecast may be running out of room to generate the same level of topline growth as in the past. “I think the network effects for leaders like Facebook and Google mean they will continue to outstrip others as artificial intelligence and machine learning become key,” he said. Many machine learning techniques produce better results when trained on larger amounts of data, giving an advantage to companies like Alphabet and Facebook, that have ready access to lots of information. These companies also have access to huge amounts of computing power and top computer science talent.
Still, Slater acknowledged that Baillie Gifford is worried about putting too much weight behind just a few businesses. “There’s not a long list of companies out there with real world-changing potential,” he said. “The challenge is getting too concentrated in these names because nothing looks undervalued right now.”