It’s fallen hard – but is now the time to buy Scottish Mortgage Investment Trust?

After a spectacular couple of decades, the Scottish Mortgage Investment Trust has fallen by over 40% 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 the portfolio’s 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% 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.  

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 42% this year. Meanwhile, the trust’s discount to its underlying net asset value (NAV) has blown out to around 11%. On average over the past 12 months, the shares have traded at a premium to NAV of 3.6%.  

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 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 the new team 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 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.  

What’s next for the Scottish Mortgage Investment Trust?  

The trust’s performance over the past ten years has been fantastic, but past performance is no guarantee of future returns.  

So, what can investors expect going forward?  

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%.  

The new team at Scottish Mortgage is also feeling the heat with its investments in China.  This is another area where the trust has been able to build an edge over its competitors.  

Anderson was an early mover into China, a decision that’s paid vast dividends over the past decade. However, over the past year Chinese stocks have fallen out of favour as the region’s policymakers have clamped down on excessive profits.  

As the landscape shifts, Scottish Mortgage has reduced its exposure to the region.  

“The regulatory environment in China remains challenging, and we are concerned that ongoing uncertainty will harm the risk-tolerant culture that has driven the long-term success of China’s private sector,” the trust noted in its half year report.  

It has more than halved its holdings in e-commerce group Alibaba and tech giant Tencent over the past six months due to this uncertainty. Still, it’s not ready to walk away from China altogether. The fund will continue to search for the region’s most promising companies.  

Focus on the long-term potential 

There’s no doubt the Scottish Mortgage Investment Trust is struggling against some major headwinds at the moment, 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 in 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.

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