Scottish Mortgage Investment Trust has fallen hard. But is now the time to buy?
After a spectacular couple of decades, the Scottish Mortgage Investment Trust has fallen by almost 45% so far this year. Rupert Hargreaves asks if now is the time to buy.
The Scottish Mortgage Investment Trust (LSE: SMT) has been part of the MoneyWeek investment trust portfolio since its launch in 2012. It’s likely that 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% per annum 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. At MoneyWeek we’ve always had a value bias, but we’re also aware that value doesn’t always work. Some growth stocks have achieved far better returns than value equities and it wouldn’t be sensible to ignore this fact.
Putting all of your investing eggs in one basket is never a sensible strategy (even the best investors make mistakes occasionally). So, owning a growth-focused trust such as Scottish Mortgage alongside more value-focused entities such as the Law Debenture Trust (LSE: LWDB) offers the best of both worlds.
Unfortunately, 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 45% this year. Meanwhile, its discount to its underlying net asset value has blown out to around 13%, one of the highest levels in recent memory.
This performance will certainly have a negative effect on the performance of the MoneyWeek investment trust portfolio, but diversification across the equally-weighted portfolio should cushion that.
The question investors might be asking after recent declines is if now is the right time to bulk up their holdings in the Scottish Mortgage Investment trust?
The Scottish Mortgage Investment trust’s mentality should persevere
The last time Merryn reviewed the MoneyWeek investment trust portfolio at the end of March, the investment advisory panel recommended that investors take a long-term view of the trust’s recent losses.
Simon Elliot of Winterflood pointed out that while SMT 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.
The man responsible for the trust’s market-beating performance was James Anderson, who recently stepped down from his position at Baillie Gifford, the fund manager behind Scottish Mortgage.
In a recent interview with MoneyWeek, Anderson explained that much of Baillie Gifford’s (and as a result Scottish Mortgage’s) performance can be traced back to the decisions the organisation made after the great financial crisis. The group reviewed its entire business model and decided to become a “truly global, truly long-term investment firm.” Its analysts realised that the majority of long-term returns come from just a tiny fraction of stocks (the estimate is 4%). So, Baillie Gifford decided to focus on finding these super-star businesses.
Of course, there was never any guarantee this strategy would work. Trying to find the top 4% of stocks means there’s a 96% chance of failure – the odds are stacked against the fund managers. That’s why even after the firm’s run of success over the past 20 years, Scottish Mortgage still has its critics.
A sprinkling of luck combined with a long-term mentality
Some critics have argued that the firm got lucky with its bets on companies such as Tesla (Nasdaq: TSLA), which have seen their valuations explode beyond any reasonable expectation.
There is always going to be an element of luck in investing, that’s just part of the process. Still, I think it would be a mistake for investors to attribute too much of Scottish Mortgage’s recent success on luck alone.
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. Anderson noted that after the financial crisis, the firm “ended up buying Apple on three to four times earnings.”
Many investors do not have the “strength to endure” the vicious ups and downs that come with growth investing, giving Baillie Gifford’s managers an edge. The fact that 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.
While I think investors should be focusing on the trust’s process, not its performance or indeed the performance of individual equity holdings, I do think it’s worth looking at some of the top holdings in the portfolio.
According to its latest factsheet, the two top holdings in the portfolio at the end of April were the biotech Moderna (Nasdaa: MRNA) and industrial technology group ASML (Nasdaq: ASML). Both of these companies have substantial competitive advantages. Moderna is the world’s leading mRNA vaccine developer while ASML is one of the world’s largest producers of equipment for the semiconductor industry.
After falling 44% and 31% respectively in the year to date, Moderna is selling at a forward price/earnings (p/e) ratio of just 4.7 while ASML’s multiple is around 10% below its five-year average.
These holdings are a great example of Scottish Mortgage’s investment style in action. What’s more, their current valuations hint that maybe the sell-off in both the trust’s shares and those of the underlying holdings has gone too far.
Rupert Hargreaves owns shares in the Law Debenture Investment Trust