The Good, the Bad and the Ugly, February 2018

Equities are up, bonds are up, it seems like everything is up bar the interest rate on bank deposits. Yet in this buoyant market the vehicles de jour are Exchange Traded Index funds (ETFs), funds that seek to replicate and track the market. Those funds where the received wisdom adheres to the good, the bad and the ugly thesis. The alleged good, ever buoyant markets, the alleged bad, costs, and the hopefully spuriously alleged ugly, active managers like myself. All three received wisdoms can be challenged by our strategic bond offering: the Baillie Gifford Corporate fund.

So what is our good, better and beautiful offering?

The Good

If one is of the inclination that bond markets might go down as well as up, if you believe markets are not always efficient, and if you believe following the herd is an insufficient strategy when market valuations look stretched, then stock selection, plus strategic asset allocation, may be of interest. The Baillie Gifford Corporate Bond fund seeks to identify bonds from companies whose balance sheets are on an improving trajectory, namely those that should provide differentiated performance to that of the broader market. In addition, with the capability to invest in both high quality investment grade bonds and income generating high yield bonds, the fund has the flexibility to adjust asset allocation relative to market conditions. Since inception in 1999, the fund has successfully followed the same investment philosophy which has enabled it to, over the long-term, weather numerous economic scenarios, including the eurozone crisis, taper tantrum, oil crisis et al.

The Better

Fund management costs are an important element of performance that one should always consider, but a bit like Oscar Wilde’s cynic, a person who knows the “price of everything and the value of nothing”, focusing exclusively on costs may have a trade-off. For example, in bond markets, where the availability of smaller issuers’ bonds can be difficult to source, I would suspect it must be tough for leviathan index-tracking funds to replicate bond markets in their entirety. It is easy to buy the bonds of corporate debt behemoths, those with sizeable amounts of debt in the market, but what about the small-to-medium sized bond issuers? Smaller funds, like our £735m Corporate Bond fund, can seek to be nimble in actively accessing some of the more moderate sized eclectic bond issuers. Furthermore, with our B Income shares only carrying an ongoing charge of 0.52% per annum, we are in the lowest fee-quartile, relative to our peers in the Investment Association (IA) Strategic Bond sector. So active management at a low price, hopefully that offers value.

The Beautiful

Needless to say we are believers in the validity of active management. We are struck however that even in this low-yield environment, we continue to identify bonds from companies whose yields look interesting when compared to the positive trajectory of the balance sheet of the business. For example, UK bulk annuity providers Rothesay Life and Pension Insurance Corporation have solid capital positions and continue to scale in size, yet bonds trade on yields of 4.6% and 4.0% respectively. Equally, we believe Netflix - the online media portal - has great long-term potential as it scales in size and continues to improve its pricing power through high quality content such as ‘The Crown’. Netflix bonds currently trade on a 3.5% yield.

Not following the crowd and being focused upon stock selection we believe is a key differentiating feature of the Baillie Gifford Corporate Bond fund, and one which has worked well over the long term. Over the last five years our fund is first quartile versus its IA Strategic Bond peer group.

Source: FE Analytics, single pricing basis, total return.
Returns reflect the annual charges but exclude and initial charge paid.
Past performance is not a guide to future returns.

Torcail Stewart, January 2018

Important Information and Risk Factors
All data to end December 2017 and source Baillie Gifford unless otherwise stated. The information contained within this article has been issued and approved by Baillie Gifford & Co Limited, which is authorised and regulated by the Financial Conduct Authority (FCA). Baillie Gifford & Co Limited is a unit trust management company and the OEICs’ Authorised Corporate Director.

The value of your investment and any income from it is not guaranteed and may go down as well as up and you may get back less than you invested. The fund’s concentrated portfolio and long-term approach to investment may result in large movements in the share price. Bonds issued by companies and governments may be adversely affected by changes in interest rates, expectations of inflation and a decline in the creditworthiness of the bond issuer. The issuers of bonds in which the fund invests may not be able to pay the bond income as promised or could fail to repay the capital amount. Derivatives may be used to obtain, increase or reduce exposure to assets and may result in the fund being leveraged. This may result in greater movements (down or up) in the price of shares in the fund. It is not our intention that the use of derivatives will significantly alter the overall risk profile of the fund.

The views expressed in this article should not be considered as advice or a recommendation to buy, sell or hold a particular investment. The article contains information and opinion on investments that does not constitute independent investment research, and is therefore not subject to the protections afforded to independent research. Some of the views expressed are not necessarily those of Baillie Gifford. Investment markets and conditions can change rapidly, therefore the views expressed should not be taken as statements of fact nor should reliance be placed on them when making investment decisions.