Baillie Gifford Sustainable Income fund: July 2023 update

• The focus of this fund is on providing a resilient level of income for today and into the future
• The fund places a big emphasis on responsible investing and all investments are made on the basis that they are compatible with a sustainable economy
• We think this is a good option for diversified exposure to stock and bond markets across the globe, where the focus is on income generation
• The fund doesn’t feature on our Wealth Shortlist of funds chosen by our analysts for their long-term performance potential

How it fits in a portfolio

Baillie Gifford Sustainable Income invests across three broad investment areas: shares, real assets and bonds. The aim of the fund is to increase the distribution paid to investors by more than the increase in the consumer prices index, over the long term. This means the fund is focused on providing a resilient income over time, meaning that while the income provided by this fund may not be the highest available, it can be expected to be consistent over time.

The long-term asset allocation is an equal split of the three areas noted above, but the real assets section is accessed through listed companies, meaning most of the fund is invested in shares.

The income bias of the fund means that Baillie Gifford’s growth investment style is less pronounced than in some of their other multi-asset funds. We think this is more appropriate for a fund focused on income and should mean that this fund does not exhibit the same swings in performance that other Baillie Gifford funds have seen in recent years.

We think the fund could be used to provide diversification to a portfolio focused on growth or be a useful addition to a portfolio focused on income provision.

Manager

James Dow, Nicoleta Dumitru, Lesley Dunn and Steven Hay are named managers for the fund. They each have different areas of investment specialism and are managers on other funds at Baillie Gifford. James Dow is Co-Head of Global Income and also manages the Baillie Gifford Global Income Growth fund. Lesley Dunn is Head of the Credit Team and also manages the Baillie Gifford Strategic Bond fund. Nicoleta Dumitru is a multi-asset investment manager, specialising in real assets and specifically infrastructure investments. Steven Hay is Head of Income Research and also manages the Baillie Gifford Managed fund. His focus is on fixed income.

The managers all have significant and relevant experience within their areas of specialism, as well as lots of experience of working at Baillie Gifford. Of the four, Dunn joined Baillie Gifford most recently in 2016.

The managers also make use of the wider teams that they work with on other funds at Baillie Gifford to help with idea generation and wider economic views. This means that the fund has a wide range of views and inputs, and therefore key person risk is significantly reduced.

Process

There are three broad categories of investments in the fund: shares, real assets and bonds. All of the managers are looking for investments that will contribute to the income provision of the fund, so that the fund is not reliant on any specific asset class to generate the income. This diversification of income provision helps the level of income provided be more consistent over time. That being said, it can be expected that the bond part of the fund will be the largest contributor to the funds’ income over time.

The fund invests globally, with each individual position size being small, resulting in a highly diversified offering, with usually between 200-300 holdings. At the end of June, the fund held 281 investments. While there is debate and challenge across the team on individual investments in the fund, the individual managers are given authority to select investments from their specialist areas for inclusion in the fund.

The shares portion of the fund is globally invested in large companies that the team expect to be able to pay and grow their dividend a long way into the future.

The bonds portion of the fund is currently largely made up of corporate bonds and will often include exposure to high yield and emerging market bonds. These bonds usually pay a higher income than other areas within fixed interest, however they are also higher risk.

The real assets section of the fund is an area that differentiates it from some of its peers. This section is focused on investing in infrastructure, property and commodities. The team invest in companies that operate in each of these areas, some of which are investment trusts. These companies typically have revenues that are linked in some way to inflation, for example property rents that are increased in line with inflation each year. Because of the more consistent and predictable earnings that these companies achieve, their performance profile over the long term of five years or more is usually more consistent. That being said, as these are still company shares, over the short term they can behave very similarly to the other company shares held in the fund.

The asset allocation of the fund varies over time, with the team using a combination of long term and shorter-term views on the world that will influence where they are positioned. However, over the long term it is expected that the fund will have roughly a third of its assets in each of the sections outlined above.

At the end of June 2023, the fund had 37.1% of its assets in shares, 21.1% in real assets and 39.4% in bonds, with the remainder in cash.

The fund applies a screening process to remove companies from their universe that are subject to UN Security Council sanctions or are non-compliant with the UN Global Compact initiative. They also screen out companies who have revenues above particular thresholds coming from fossil fuel extraction and production, thermal coal distribution, tobacco production, controversial weapons and armaments.

In addition to these exclusions, as part of their company assessments, the managers consider a number of different sustainability metrics and assign each company an overall score. This helps them to compare different companies’ sustainability credentials. Those that are considered leaders within their sector are preferred. This sustainability analysis is considered alongside their wider due diligence, which means that the managers don’t always have to invest in the highest scoring companies from a sustainability perspective. However, they won’t invest in the lowest scoring companies, regardless of how good they may be on other metrics.

The managers have the flexibility to use derivatives, which adds risk.

Culture

Baillie Gifford is an independent private partnership founded in 1908. It's owned by partners who work full time at the firm. This ownership structure means senior managers have a vested interest in the company, and its funds, performing well.

We think this has helped cultivate a culture with a long-term focus, where investors' interests are at the centre of decision making. We also like that fund managers are incentivised in a way that aligns their interests with those of long-term investors and should retain talented managers.

Of the four managers for this fund, Dow and Dunn are both partners of the business.

ESG Integration

This fund is one of Baillie Gifford’s sustainably labelled funds, meaning that ESG considerations are a meaningful part of how they assess investments for the fund.

The fund changed its name from Baillie Gifford Multi Asset Income to Baillie Gifford Sustainable Income on 31 March 2023. This reflects an increased commitment for investments in the fund to be environment, social and governance (ESG) led. The team ask the key question ‘is this investment compatible with a sustainable economy?’ for every investment. The answer has to be yes in order for them to buy the asset.

Baillie Gifford's funds are run with a long-term investment horizon in mind – they see themselves as long-term owners of a business, not short-term renters. So, assessing whether society will support, or at the very least, tolerate, the business model over the long term, and whether management will act as good stewards of shareholders' capital is an important part of the investment process. Dedicated ESG analysts sit with and report into their respective investment teams, and the firm's ESG efforts are supported by a dedicated climate specialist team, an ESG Services team (responsible for voting operations and ESG data) and an ESG Client team (responsible for ESG-related client communications). Individual investment teams are responsible for voting and engagement for the companies they invest in. Investment in controversial weapons is prohibited across the firm.

The firm reports all its voting decisions and provides rationale in situations where it voted against management or abstained, in a detailed quarterly voting report. There is also a quarterly engagement report which details the companies engaged with, and the topic discussed, and further engagement case studies are available on the Baillie Gifford website. All this information is brought together in the firm's annual Stewardship Activities report.

Cost

This fund has an ongoing annual charge of 0.66%. We think this is a reasonable price compared to other funds in the sector. The HL platform fee of up to 0.45% per year also applies.

Please note that charges are taken from capital. This can increase the income paid by the fund, but it might reduce the potential for capital growth.

Performance

The fund has performed better than the IA Mixed Investment 40-85% sector average since launch, having returned 24.81%* versus the sector average of 15.06%. Past performance is not a guide to the future.

Since the fund was launched, it’s typically had lower volatility of returns than the average fund in the sector. It’s also not lost as much value during market falls, but it hasn’t kept pace during market rises. This makes sense given the focus of the fund is on generating income and our analysis suggests that it is reasonable to expect this type of performance profile going forward.

Over the 12 months to the end of June, the fund returned 3.94%, which was broadly in line with the sector average return of 3.35%. At a high level, company shares provided the largest return for the fund, with bonds also delivering positive returns. However, the real assets section detracted from returns. The largest contributors to performance over this period were Novo Nordisk, the Danish multinational pharmaceutical company and Watsco Inc, a US air conditioning distributor. While the worst performing investments were the US gold mining company Newmont Mining and property companies Assura Group and LondonMetric Property.

The fund had a yield of 3.77% as of 30 June 2023. Income isn’t guaranteed, and yields aren’t a reliable indicator of future income.

Annual percentage growth

Past performance isn't a guide to the future. Source: *Lipper IM to 30/06/2023.

Find out more about Baillie Gifford Sustainable Income, including charges

Baillie Gifford Sustainable Income Key investor information