Baillie Gifford’s new trust gives investors the chance to buy innovative start-ups before they go big.
At last count a year ago, there were 223 “unicorn” companies globally, with a combined value of $774bn. Nearly half of this is accounted for by the top 12, which includes household names such as Uber and Airbnb.
Unicorn is the name given to start-up companies with a value of more than $1bn, which are still privately held. As this implies, these companies have created immense value through the investment of intellectual and human, but not physical, capital – otherwise they would have sought a stockmarket listing at a much earlier stage of their development.
The capital they needed initially came from friends and family, then from a growing list of entrepreneurs and tech giants. As the pool of available capital expands, so the need for external investors diminishes. Eventually, these companies do seek a listing, but to give the early investors an exit rather than to finance growth.
This presents a growing problem for investors in listed equities; many of the growth companies they want to back remain resolutely in private hands. Facebook, for example, only sought a listing when it had reached a billion users. Without access to the fastest-growing areas of the global economy, the prospective returns available to stockmarket investors are correspondingly lower.
Embracing private equity
Baillie Gifford is one of the few investment-management companies that has grasped the solution and embraced investment in private equity (PE). This is easier said than done, as the opportunity to invest in the best private companies is by invitation only. Tech-savvy entrepreneurs don’t like the regulatory and reporting requirements of being listed, investors focused on the short term, or strangers. As Tom Slater, co-manager of Baillie Gifford’s Scottish Mortgage Trust, explains, a great deal of time has to be spent on obtaining an introduction, often from other private companies, and building a relationship before the first penny is invested.
With a fixed pool of capital, investment trusts are the ideal vehicle for PE investment, but Scottish Mortgage has limited its global exposure to 25% of net assets. Consequently, the firm is launching a new trust, Baillie Gifford US Growth, to take the strategy further, investing in US companies valued at more than $500m.
Initially, the new trust – managed by Slater’s team, with Gary Robinson as lead manager – will invest in a portfolio of 30-50 listed US equities, similar to the $1bn American open-ended fund. This fund has comfortably outperformed the S&P 500 index over the last five years and since its launch in 1997. Over time, up to half of total assets, which will be augmented by borrowings of up to 30% of the listed portfolio, will be shifted into unlisted companies for a total of up to 90 holdings.
One to hold for a long time
“We aren’t venture capitalists,” says Slater, by which he means that they will focus on follow-on investment rather than start-ups. “Five years ago, there were just 15 unicorns, so firms are remaining private for longer. We see eight to ten new investment ideas each year, an increasing proportion of which are unlisted.” As with Baillie Gifford’s other trusts, the new trust will follow a buy-and-hold strategy, focusing on long-term opportunity rather than short-term valuation.
The trust is targeted to raise £250m, with an upper limit of £500m. Management costs – 0.7% on the first £100m, 0.55% thereafter – are reasonable, especially given investing in and monitoring private investments is more time consuming than with listed equities.
Inevitably, it will take time for the PE proportion to get anywhere near 50% of total assets, but the shares are still virtually certain to trade at a healthy premium to net asset value (the value of the underlying portfolio) from the start, such is the regard in which Baillie Gifford is held. Buy and hold for the long run.
Energy company Hess has “headed off” a potential proxy fight with activist fund Elliott Management by announcing plans to buy back an additional $1bn in shares, says The Wall Street Journal. The news came just one day before the firm’s deadline for nominating new directors, and brings the total value of shares it has bought to $1.5bn. The hedge fund, which owns 6% of the company’s shares, is “supportive of the changes at Hess”, and reportedly no longer wishes to oust chief executive John Hess.
Hess has spent six months rallying shareholders behind a strategy for improving performance that is largely centred on a “looming payoff” from an oil discovery in South America, but some shareholders, including Elliott, remained “frustrated in the short term”.
Short positions… VCT rules tighten
• Neil Woodford’s Equity Income Fund sold its stake in online broker AJ Bell shortly before the group announced plans to list on the London Stock Exchange, says Josephine Cumbo in the Financial Times. The firm’s flagship fund sold its 8% stake in AJ Bell in February to Woodford’s former employer Invesco Perpetual, for £40m.
The disposal came “as concerns grew” that the fund was close to meeting the 10% regulatory ceiling on the proportion of its portfolio that can be invested in unquoted securities, which stood at 9.69% at the end of January. (After the sale of AJ Bell, unlisted stocks made up 9.66% of the portfolio.)
• The rules on which companies are eligible for inclusion in the tax-efficient Enterprise Investment Scheme (EIS) and venture-capital trusts (VCTs) are set to tighten, says The Daily Telegraph. It’s expected that asset-backed businesses such as storage sites and pubs, and companies with guaranteed contracts, will no longer be eligible, “due to the protection they offer to investors”. The rules were expected to receive royal assent on 15 March, although “there’s a slim chance” that this could be brought forward.
• The £34m of compensation for investors in closet tracker funds is “chicken-feed” given the size of the alleged fouls, says Mark Gilbert on Bloomberg’s Gadfly column. As much as £109bn is tied up in funds of this type, estimates the Financial Conduct Authority. Although the FCA’s action is to be applauded for the warning it sends to the industry, “it doesn’t go far enough”. The regulator would “better serve consumers” by publishing a list of closet tracker funds.