Annus Horribilis For Edinburgh Worldwide

It has been a year to forget for the global small cap investment trust Edinburgh Worldwide (LON: EWI), whose growth-oriented portfolio saw its NAV drop 40.3% in its annual accounts to the end of October. Baillie Gifford’s funds have been under pressure right across the board as higher interest rates have taken their toll on their hitherto successful house style, yet the broker Numis believes that the investment case for Edinburgh remains compelling over the long-term.

EWI invests in a diversified portfolio of around 110 global smaller companies that offer significant long-term growth potential. The focus is on stocks with a market cap of less than $5bn at the time of investment that have the scope to deliver multiples on the committed capital.

It is heavily skewed towards technology and health care, which represent about 68% of the total assets, reflecting the innovation and pace of development in these areas. Positions tend to be initiated at the start of the commercialisation phase, when the technology is proven but the market has not yet priced in its potential.

In these types of situations the competitive edge is not fully defined and so smaller position sizes of 0.75 to one percent are typically taken. Additional purchases will be made as the managers get greater conviction, or they will sell if a stock’s potential is not realised.

Under The Bonnet

At the end of December the ten largest positions accounted for 38.6% of the portfolio with many of them taking a real hit during the reporting period. Molecular Screening company Exact Sciences was down 56.5%; online food retailer Ocado 73.8% and the electronic bond trading platform MarketAxess 28.2%; although the therapeutic gene silencing business, Alnylam Pharmaceuticals rose 54.9%.

Manager Douglas Brodie says that despite these sharp deratings, many portfolio companies continue to make progress. For example, Ocado has risen sharply after the reporting period after announcing a new partnership with the leading grocery chain in South Korea, while healthcare companies like Alnylam continued to show successful read out data.

Like some of Baillie Gifford’s other funds, Edinburgh can also hold unquoted investments with the limit on this area being increased to 25% (at time of investment) during the financial year. The allocation currently stands at 21% with 124 revaluations performed on the 24 holdings during the period, most of which were downward with an average decline of 26.5%.

Outlook

Brodie points out that the conflict in Ukraine and the pandemic have created instability and an environment: where capital is less freely available, the hurdle rate for returns is higher and the tolerance of uncertainty is lower. He says that despite this, “the legacy of innovation remains” and the “fundamental opportunity for innovation and tech-led progress are as strong as we have seen”.

Numis think that Edinburgh Worldwide is an attractive vehicle that is significantly differentiated from other global equity funds. They acknowledge that it has been a brutal period for growth investors, particularly small caps, yet they believe that the investment case remains compelling over the long-term.

Many of the issues affecting Edinburgh are also relevant for Baillie Gifford’s flagship trust, Scottish Mortgage (LON: SMT) that I covered last week. It is interesting to note that Investec have downgraded it to a sell in anticipation of a second leg of the sell-off in the coming months, so it is best to tread carefully if you are thinking of investing in this area in the near future.