Scottish Mortgage managers reassure investors about its recent poor performance
After a spectacular couple of decades, the Scottish Mortgage Investment Trust has fallen by 40% this year. As its managers address shareholder concerns, we ask if now is the time to buy.
It’s likely this trust features in many of our readers’ portfolios and it has been a winning bet for much of the past decade.
At one point, the shares were up 1,000% on our purchase price, making it a key contributor to the 17% annual return the portfolio achieved between launch and the end of 2021.
As the trust has soared in value over the last decade, we’ve resisted the temptation to take profits mainly as a hedge against being wrong.
However, after a decade of market-beating returns, we’re now seeing what happens when the market turns against growth stocks. Shares in the investment trust have slumped nearly 42% this year. Meanwhile, the trust’s discount to its underlying net asset value (NAV) has exceeded 10% in recent months.
But rather than hiding from the issues, the trust’s managers Tom Slater and Lawrence Burns recently addressed shareholders’ concerns about the poor performance, as well as discussing where they’re investing and the future outlook.
We take a close look at what the managers said, and ask whether now is the right time for investors to bulk up their holdings in Scottish Mortgage.
Scottish Mortgage Trust’s year of poor performance
In an interview last month, the managers stressed the long-term nature of the investment trust, and said they wanted to thank shareholders for their support, “because we couldn't take the approach that we do unless we had buy-in to this approach of long-termism and really sticking to our guns, regardless of the market environment.”
Slater said there were two things that Scottish Mortgage was focussing on right now.
The first is “getting into the details of the companies that we own” to ensure the “engines of growth that have driven the performance that we've seen over the past 10 years are still in place, and still robust”.
The second is looking for new ideas: “looking for the companies that are adaptable, that are dealing with this difficult environment and are building the foundations of the next decade of growth.”
Burns added that it was “challenging to maintain their long-term approach in the
face of markets lurching downwards”, and he acknowledged that it was difficult for the shareholders and for the entrepreneurs that are managing the companies.
“But it is in periods like these where it's also really valuable to be long term.”
Burns pointed out that big drops in share prices does not mean companies will not go on to be successful. For example, Apple has had falls of 70% or more in the past, while Amazon has endured falls of 90%.
Scottish Mortgage is looking to take advantage of the volatility
The fund managers have been taking advantage of the stock market falls by adding companies that are now at “really attractive valuations”, such as gaming firm Roblox Corp, and Climeworks, which does carbon sequestration. They have also added to their position in Mercado Libre, the Latin American e-commerce and fintech platform.
Burns argued: “Because this is an environment where innovation will still matter five to ten years from now. It will still be valuable. But it's a market where we can take this as both an
opportunity and challenge because innovation is effectively today on sale.”
A complex investing environment in China
Chinese companies like Tencent, Alibaba, Baidu and Meituan have turbo-charged the investment trust’s growth over the past decade.
Scottish Mortgage’s exposure to China has at times exceeded 20%, although it is currently hovering around 16%.
The managers say the investing environment in China is complex, due to the possibility of US sanctions on China, which would have a “catastrophic impact”. It is also concerned about the Chinese government’s actions towards companies that the trust owns, and potential rule changes, which could make companies less likely to take risks and increase profitability.
On the flipside, Burns said: “I think it would be wrong to cut our Scottish Mortgage shareholders completely off from the upside of the world's second largest economy at this point.”
To manage the uncertainty in China, the trust has sold some smaller Chinese positions, such as digital freight platform Small Truck Alliance, and reduced its stake in internet giants Alibaba Group and Tencent.
Scottish Mortgage Trust’s 2023 outlook
With continued pressure on growth stocks, and rising interest rates making accessing affordable capital more difficult for companies, what is the outlook for Scottish Mortgage’s holdings?
Slater said: “The vast majority of our portfolio is profitable and generates cash. For those companies, the difficult stock market environment has no bearing on their fundamental progress.”
There is also a small number of businesses that are still dependent on external investors to provide financing. “When you look at those companies, the questions that you're asking are, is this investment valuable? Is it going to drive returns in the long run? And if you can answer
yes, then actually, that being there and being able to supply capital is really important to the company, but it's also likely to generate returns.”
Burns added that despite the tough macro backdrop there are still key advances in new technologies, and that innovation is valuable “whether the economy is booming or whether it's in a recession”. He gave the example of Mercado Libre, which has grown rapidly despite political and economic upheaval in Brazil.
Slater said he was particularly excited about the future for companies like Moderna (the trust’s largest holding), Northvolt, SpaceX and MercadoLibre.
“Moderna has a technology platform that could fundamentally change healthcare over the next decade. SpaceX could have a monopoly on access to space, which could become a much bigger industry than it is today. There is so much progress to be excited about.”
What do advisers think about Scottish Mortgage?
The last time the MoneyWeek investment trust portfolio was reviewed (at the end of March), the investment advisory panel recommended that investors take a long-term view of the trust’s recent losses.
Simon Elliott of Winterflood pointed out that while the firm is best-known for its large holdings in giant tech groups, it has also been highly successful at recycling capital into “less well-known companies with greater long-term growth prospects.”
Sandy Cross of Rossie House and Investec’s Alan Brierley also noted that the MoneyWeek investment trust portfolio was designed for long-term wealth creation and it is a “mug’s game trying to call short-term, albeit painful fluctuations.”
To put it another way, yes, recent losses might be painful to watch, but investors need to focus on the investment process used by Scottish Mortgage, rather than its performance figures.
A new generation takes over the Scottish Mortgage Investment Trust
The man responsible for the trust’s market-beating performance was James Anderson, who stepped down from his position at Baillie Gifford, the fund manager behind Scottish Mortgage, earlier this year.
Some critics have argued that he got lucky with his bets on companies like Tesla, which have seen their valuations explode beyond any reasonable expectation.
And now Anderson has left there are, quite understandably, some concerns about whether or not Slater and Burns will be able to replicate his performance.
Still, Baillie Gifford has built a culture based on long-term principles and ideals, and that allows its fund managers to look past short-term headwinds. The fact the investment trust structure also provides permanent capital is another benefit. The managers do not have to worry about selling assets to meet redemptions.
That lets the team focus on doing what it does best, finding brilliant individual companies with competitive advantages and holding onto them.
Rising interest rates and private sector businesses
Scottish Mortgage’s returns over the past decade have been boosted by low interest rates. As rates have dropped, investors, lacking alternatives, have rushed to buy growth stocks – a trend that went into overdrive in 2020/21.
However, today investors can earn 5% a year risk-free. That changes the equation. If I can earn 5% risk-free, why would I try and pick growth stocks, some of which might end up going to zero?
Higher rates are also making it harder for early-stage and growth companies to raise new funds. As these enterprises tend to devour capital, easy access to financing and more importantly cheap financing can be the difference between success and failure.
The shifting environment is already hitting Scottish Mortgage’s portfolio.
Around one third of assets are invested in private businesses. Historically, this has given the trust a bit of an edge. It has been able to access the tech stocks of tomorrow before the rest of the market.
But as early-stage company valuations feel the pressure from rising rates, the trust has had to mark down the value of these assets. In the six months to the end of September it wrote down the value of its private holdings by an average of 17.8%.
Focus on the long-term potential for SMT
There’s no doubt the Scottish Mortgage Investment Trust is struggling against some major headwinds like uncertainty in China and rising interest rates, but its portfolio is stuffed full of some of the most innovative and forward-thinking businesses in the world.
For example, a top holding is ASML, one of the only companies in the world with the ability to produce the equipment and tools required for semiconductor manufacturing.
Then there’s European battery producer Northvolt. Now the trust’s fifth-largest holding, Scottish Mortgage thinks this private battery producer is “looking increasingly well-placed to supply the rapidly growing demand for electric vehicles.”
Investors might not be willing to pay as much for growth stocks today as they were a year ago, but over the long term, company fundamentals matter more than anything else. As these businesses grow their top and bottom lines, shareholders, including the Scottish Mortgage Investment Trust, should reap the rewards.
• Additional contributions from Rupert Hargreaves
• The authors of this articles do not have holdings in Scottish Mortgage Investment Trust