Investors need to accept some short-term underperformance in order to outperform the market in the long run, according to Iain McCombie, manager of the £341m Baillie Gifford UK Growth investment trust.
In recent months, there has been a rotation out of growth stocks into value and cyclicals, hurting the performance of many growth-orientated funds.
Despite this, investors shouldn’t lose sight of what direction fundamentals like earnings and cash flows are headed, McCombie argued.
“To outperform you have to be different than the market, you also have to accept short-term underperformance,” he said. “We'll have ups and downs in our short-term performance and I'm not going to apologise for short-term underperformance.
“We'll make mistakes in terms of our stocks, but we think our style is the right one for the long term.
“We have no idea what the market is going to do in the short term, but we think in the long run you're rewarded if you hold a portfolio of companies with superior fundamentals.”
Despite the current market backdrop, McCombie believes Baillie Gifford UK Growth has a portfolio of companies that can grow their earnings and cashflows faster than the rest of the market.
In his view, the types of companies that have superior fundamentals are those that have got growth characteristics.
“One thing you'll see is that ability of the company and its management team to exploit the long-term growth opportunity,” he explained. “What we want them to do is to reinvest in the business.
“We don’t have a problem with companies paying out a dividend or income, but if they think they have superior opportunities to invest in the business to grow it, we'd rather they do it.”
For example, during the coronavirus pandemic McCombie was encouraging some companies to not pay a dividend and to reinvest in the business instead.
“We think is really important for the long-term health of the business to invest in the business and not to pay the money out to shareholders, and we think the shareholder gets rewarded in the long term for that,” he said.
Indeed on a short-term basis, performance of the trust has dipped to fourth quartile over the last six months. But, on a three-year time horizon it is still ranked first quartile.
Performance of trust over six months
Source: FE Analytics
When it comes to growth investing, people wrongly assume it's all about technology when in fact McCombie believes growth can be found in many different areas.
He highlighted UK-listed industrial equipment rental company Ashtead, which is in the trust’s top-10 holdings.
Most people assume an equipment hire business is very cyclical and linked to the construction industry. However, McCombie believes this misses some key secular trends.
“Ashtead is basically is mainly based in the US now – they are a number two player in a very fragmented market,” he said.
“But what is interesting is the fact that the propensity to rent is much lower in the US than it is in the UK, but actually the Americans are finally catching to the to the beauty of renting rather than buying and that penetration is going up. So that's one area of growth.”
Share price performance of Ashtead group over 5yrs
Source: FE Analytics
Another area of growth is linked to the expansion of e-commerce in the US. Some of Ashtead’s key customers now are e-commerce businesses.
The company sells these firms air conditioning units to regulate the temperature of their huge warehouses and it also has a growing business renting out cleaning equipment.
McCombie said: “Management have done a very good job of diversifying away from construction and they're actually tapping into growth markets that didn't exist before.”
He said Ashtead has virtually invented the market of renting out cleaning equipment to warehouses.
“Before people had to buy this equipment, they'd use it once a week and it'd be shoved into the into a cupboard and never used again. Whereas it's much more efficient to rent it, by the day or the hour even.”
McCombie believes Ashtead is a great example of a company that looks for new growth opportunities and expands its market, playing into the winners of the new economy.
Whilst the managers of the Baillie Gifford UK Growth trust invest with a minimum of a five-year view, co-manager Milena Mileva pointed out that portfolio turnover in the last financial year was 4 per cent.
She said: “Essentially what that implies is that our holding period is 25 years. The simple truth is that great companies and wildly successful companies aren't built in a day.”
“It takes a lot of time and a lot of patience for investors to be able to fully benefit from the potential, which is inherent in what we think are select few enterprises that can show enduring corporate excellence.”
Baillie Gifford UK Growth has delivered a total return of 74.69 per cent over the last five years, compared to 57.27 per cent from the average IT UK All Companies investment trust, and 37.49 per cent from the FTSE All Share benchmark.
Performance of the trust over 5yrs
Source: FE Analytics
It has ongoing charges of 0.66 per cent, trades at a 2.7 per cent premium and currently yields 1.3 per cent.