A compelling comeback play – courtesy of Baillie Gifford

Plenty of Baillie Gifford portfolios, including ESG vehicle Keystone Positive Change (KPC) and several of its US equity funds, have suffered big shifts in fortune due to the particular type of growth stock on which they focus.

Fast forward to 2024, however, and many such funds could be in line for better things. If interest rates have peaked, the huge rally at the end of last year might be a sign of things to come. This bodes well for the likes of Scottish Mortgage, but there are other, lesser known Baillie Gifford vehicles with a compelling story of their own that still look cheap – for now.

A lesser known Baillie Gifford heavyweight

With a market capitalisation of around £500mn, Asia-focused Pacific Horizon (PHI) is a minnow compared with the biggest Baillie Gifford trusts (Scottish Mortgage is valued at over £10.5bn). It has done plenty to warrant attention, however.

Pacific Horizon was one of the best-performing investment trusts of 2020 thanks to its focus on internet companies such as China giants Tencent (HK:700) and Alibaba (HK:9988) that blossomed during lockdown. Impressively, the portfolio also fared well in 2021, a difficult year for Asian markets, thanks to a well-timed pivot that saw the team drastically reduce exposure to China and focus more heavily on India just before the former embarked on a big regulatory crackdown.

And yet the fund subsequently struggled to escape the impact of higher interest rates, meaning shareholders had to stomach a paper loss of more than 30 per cent in 2022, as well as a modest hit last year. With the shares recently trading on a discount of around 10 per cent to the net asset value (NAV) of the underlying portfolio, investors who believe growth investing will come good again can still point to this name as one of the many bargain buys available in the investment trust space.

As QuotedData's Matthew Read put it in a note published in early December: "With signs that interest rates have peaked, particularly in the US, there is potential both for a rerating of its underlying holdings and a narrowing of its above long-term average discount." 

Going for growth

The fund comes with some of the usual selling points and drawbacks of Baillie Gifford vehicles. The investment managers favour companies with good structural growth stories and very high risk/reward profiles. As noted in the trust's latest annual results, this involves backing businesses "that can grow their profits faster than the market, in hard currency terms, over the long term", and names that can at least double their share prices over five years, with most of the progress stemming from earnings growth.

The managers also attempt to find "underappreciated growth duration". This refers to situations where profits are volatile from one quarter to the next, but where a company has excellent long-term prospects. They also look for cases where the market underestimates the likelihood of rapid earnings growth, noting that that most investors "cluster around a narrow range of earnings growth predictions, which can in turn lead to significant mispricing of those companies with the potential to grow very rapidly". Such a growth mindset can be appealing in a region associated with compelling demographics and opportunities for innovation.

Like many Baillie Gifford teams the Pacific Horizon managers take some reasonably large positions, with number one holding Samsung (KR:005930) making up 7.1 per cent of the portfolio at the end of November and the top 10 holdings holdings making up slightly more than a third of the fund.

They also tend to be bottom-up stockpickers, meaning the portfolio often bears little resemblance to the MSCI AC Asia ex-Japan index, which many investment teams in the region use as a comparator.

Still, they do not fit the mould of some purist stockpickers who pride themselves on focusing solely on company fundamentals and paying little or no attention to political and macroeconomic shifts. In their own words, the managers feel they do not have "the luxury of ignoring macroeconomics" given that external factors – from economic cycles to political upheaval – can have a huge effect on companies listed in Asia.

As such they focus on specific risks and opportunities that arise because of these factors, most recently resulting in a return to the region's biggest beast.

Re-enter the dragon

The ability to be flexible protected the fund when Chinese authorities intervened in industries such as gaming, education and real estate in 2021. The pragmatism of the managers may now help investors make the most of another shift in fortunes.

Chinese equities have been a disappointment in recent years for several reasons. The regulatory crackdown gave many investors a fright, lockdowns persisted for longer than first thought, the property sector has been a big source of concern, and the great reopening trade of 2023 turned out to be fairly lacklustre, at least in terms of market returns.

But patient contrarians can argue that Chinese stocks do look undervalued, and may well have left the worst behind them in terms of stricter regulation and the pandemic.

The Pacific Horizon team has certainly taken this view, arguing late last year that "events in China will continue to play an important role for investors, and while acknowledging the country faces several headwinds including increasing geopolitical tensions, we believe fears of an imminent collapse of the economy are misplaced." 

They added that "the government has moved to support the domestic economy, the regulatory crackdown on the technology sector has receded, and fears over the domestic property market appear overly pessimistic."

That stance has seen the team take a far greater interest in China: in July last year the portfolio’s exposure stood at 34 per cent, compared with 17 per cent two years earlier. Most additions were made to internet names, from Alibaba to ecommerce play JD.com (HK:9618), online property portal KE (HL:2423) and Baidu (HK:9888).

The team also added to names such as finance giant Ping An Insurance (HK:2318). It is notable that the team continues to focus on some of the other big Asian economies, too, with India representing 30.7 per cent of the portfolio at the end of November, compared with 29 per cent in China (the weighting affected by the continued poor performance of Chinese shares in the intervening period), 17.6 per cent in South Korea, 7.9 per cent in Taiwan and 7 per cent in Vietnam.

Pacific Horizon is keeping an eye on whether India can build up a successful export manufacturing industry, something that it thinks is more likely thanks to government reforms and the establishment of special economic zones. Meanwhile, the managers note that, outside of China, Vietnam “remains the best structural growth story of any Asian economy” thanks to already having a strong export manufacturing base.

The trust is clearly not immune to threats. Growth stocks could fall out of favour again, or face diminished returns due to higher rates. China could still have some nasty surprises up its sleeve. But Pacific Horizon remains a dedicated play on the region’s potential growth stars with a very tempting valuation.