At one point Scottish Mortgage (LSE: SMT) was the UK’s biggest investment trust by market capitalisation, championing a generation of disruptors from Amazon to Tesla. But if you look at the investor bulletin boards, it is now the subject of much scorn and vitriol.
The most recent trading update showed that net asset value (NAV) total returns for the year to 31 March were negative 13.1%, compared with a 12.8% gain for the FTSE All World index. The share price currently trades at 692p, a 55% decline from its 1,543p peak. It’s now on a wide 16% discount to NAV (the average discount over the past year is 1.3%).
The struggle isn’t over
The headwinds facing Scottish Mortgage are unlikely to abate soon. The fund bet big on technology; now, rising interest rates have triggered a sell-off in those growth stocks. There’s also the question of venture capital-style investments and what these are worth in today’s markets.
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At first, Scottish Mortgage found itself somewhat insulated from the growth stock sell-off because a large part of its portfolio was in unlisted private investments; unquoted holdings represented 24.6% of the portfolio at 31 March, up from 20.2% a year ago. Initially, valuations for these companies weren’t hit as hard as the price of quoted stocks. That’s about to change: the current round of haircuts to valuations will be only the beginning of a long and painful process for many late-stage venture capital investments.
To be fair to Scottish Mortgage, there is a robust valuation system in place for these private companies. They are valued on a rolling three-month cycle (ie, roughly a third revalued every month), except for the half-year and full-year-end of the fund, or where there is a trigger event that indicates the fair value of the holding has changed, such as a funding round. I estimate we have at least another six months of cuts of anything between 10% and 30%.
Still, not all of Scottish Mortgage’s pain is external. Management has made some poor decisions, of which the big strategic mistake was a focus on Chinese internet platforms; one didn’t need a crystal ball to predict Tencent and Alibaba were in trouble with the Chinese government. That said, on pure valuation terms, firms such as Tencent are now some of the cheapest tech stocks on the planet (perhaps for a good reason).
So the rap sheet against Scottish Mortgage’s record is long and detailed; I can’t see the share price improving much this year. On paper this means I should sell my own holding, but I’m choosing to sit tight. The current portfolio is still unique – unlike many global equity funds, there’s diversification between both public and private assets, while maintaining a continuing focus on global businesses that can grow as technology disrupts more and more sectors.
Lower-risk alternatives
If you think the driving forces around technology and disruption are set to reverse, Scottish Mortgage is not for you. However, if you think otherwise, the situation calls for patience. I would argue that, as we face a more inflationary world, with more on-shoring of production and tighter supply chains, large-cap businesses with intellectual property assets and an ability to pass on extra costs to consumers will continue to thrive. In other words, the tech-enabled global brand platforms are precisely the businesses that might flourish in this new world.
Still, if you are yet to invest, perhaps you should wait for the discount to push out to 20%. Meanwhile, invest in a fund that actively benefits from market volatility, such as BH Macro (LSE: BHMU) or the Ruffer Investment Company (LSE: RICA), and move back into Scottish Mortgage once the mood shifts. If the fund’s focus on private, unlisted firms and its Chinese exposure still feels troubling, look at sister fund Edinburgh Worldwide (LSE: EWI), which has a more explicit mid- to small-cap tech and healthcare focus and is currently trading at a 13% discount to NAV.
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