After slumping 42% last year, what's next for Scottish Mortgage?

After a spectacular couple of decades, the Scottish Mortgage Investment Trust fell by 42% last year. We take a look at the trust's performance and discuss what's next for the business.

The Scottish Mortgage Investment Trust (LSE: SMT) has been part of the MoneyWeek investment trust portfolio since its launch in 2012.  

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

After their outstanding run, shares in the trust plunged 46% last year. 

Meanwhile, the trust’s discount to its underlying net asset value (NAV) has exceeded 10% in recent months.

These declines have wiped out most of the gains the trust achieved during 2020 and 2021, but its long-term performance is still impressive

Over the past five years, the stock has returned 11.5% per annum including dividends, while the trust’s NAV has risen 13.8%. Over the past 10 and 15 years respectively, the stock has produced a total return of 18.2% and 14.7% per annum. 

Max King took a look at the trust in this week’s issue of MoneyWeek and here’s his view.

The MoneyWeek view on the Scottish Mortgage Investment Trust 

The £11 billion Scottish Mortgage Investment Trust was one of the worst performers in the market in 2022, with an investment return of -42%. 

The shares, which reached £15.00 in November 2021, halved by June and now trade at a 9% discount to net asset value. There is no shortage of pundits writing it off. Yet the strategy hasn’t changed. 

“We seek to invest in the world’s greatest growth companies, whether they are public or private,” says Tom Slater, the lead manager.

 Over 20 years, in which the share price has risen 15-fold, “we have owned 700 companies, but less than 5% of them have driven all our returns. That is what we expect – an exceptional impact from a small number of companies... Our companies are relatively early in exploiting the opportunity for growth. They have suffered a significant decline in valuation, but 2022 brought an exceptional number of breakthroughs in their businesses.” 

Slater admits that it was “a humbling year... some of our assumptions were wrong”. 

Changes in consumer and business practices induced by the pandemic have been less persistent than expected and China has been very problematic. 

E-commerce penetration in China is double that in the US, at 30%, so competition is increasing. In addition, the state has clamped down on platform companies. So exposure has been halved to 13% in the last two years with several exits, including Alibaba, which was the first private- equity investment by Scottish Mortgage, made ten years ago. 

Scottish Mortgage Investment Trust’s private holdings 

Private equity now accounts for 30% of the portfolio, close to the cap. Most of the holdings are small, but nine are in its top 30, including Northvolt (3.6%), SpaceX (3.2%) and ByteDance, the owner of TikTok (2.2%). 

All of the holdings were revalued at least three times last year, implying that valuations are now realistic. Listed holdings account for 70% of the portfolio, and two- thirds of these are profitable. There are 100 holdings in all, but the top 30 account for 74% of the portfolio and the top ten for 44%. The valuation of the top ten fell from seven to five times sales last year. 

Immense potential Moderna is the largest holding, accounting for 9.9% of the portfolio. “The market is treating Moderna and its Covid vaccine as a one-trick pony and has failed to price in that the mRNA technology platform, developed before the pandemic, is highly scalable.” 

Positive phase-two trial data for Moderna’s cancer vaccine for the treatment of melanoma has led to Merck investing $250 million.

“We are on the cusp of abundant low-cost energy becoming a reality,” which makes energy transition a key theme. Battery technology is critical, accounting for the investment in Northvolt, and is an important part of the rationale for the hugely successful investment in Tesla. 

Investments in China make a return

Pinduoduo, whose online platform connects farmers with consumers, was Scottish Mortgage Investment Trust’s most successful investment last year, gaining 60% as profits tripled, although it’s still only half the price of two years ago. 

It shows that the trust was right not to abandon China and illustrates the recovery potential of growth companies that deliver profits. 

SpaceX has reduced the cost of sending a satellite into orbit to $1,400 per kilogram, just 3% of the cost in the space shuttle. There were 90 launches last year and Starlink, SpaceX’s satellite mobile service, reached a million active subscribers. 

Slater is also bullish on delivery-drone firm Zipline, arguing that this is coming to the US sooner than expected. “We are trying to back companies for the very long term that are radically changing the way business is done... This will create value regardless of the market environment and matters far more than the prevailing preference for or against growth companies.”

The Scottish Mortgage Investment Trust is still a compelling proposition and fully deserves its place in the MoneyWeek portfolio.

• Additional contributions from Ruth Emery and Max King

• The authors of this article do not have holdings in Scottish Mortgage Investment Trust

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