Scottish Mortgage has become a favourite holding of many private investors – and with good reason. A founder member of the Direct Investment Service Preferred List in 2013, it has since cemented its reputation as the UK’s leading investment trust and has profited from some of the world’s fastest-growing businesses.
The Trust's managers, James Anderson and Tom Slater of Baillie Gifford, aim to invest in companies that harness the power of technological change, create new markets or disrupt existing ones, and in doing so provide investors with substantial growth opportunities. With no limits regarding geographical or sectoral exposure they are free to invest in what they consider to be the world’s most exciting companies. That’s whether they are listed on a stock market or are private companies accessed through their network of contacts.
A key part of the managers’ process is to understand emergent technologies before they get to public markets by speaking to businesspeople, emerging companies and academics. This farsighted approach has seen the managers back many winners among the global internet giants, investing at an early stage in Google, Facebook and Amazon. The Trust has reaped the rewards of exposure to these businesses and produced exceptional performance, though past performance is not a guide to the future.
The pace of change is accelerating
The managers believe the pace of technological change is faster today than ever before, and only an exclusive band of businesses will benefit significantly from this progress – often disrupting incumbent businesses or even entire sectors along the way. In order to maximise returns they take large stakes in companies they believe have exceptional potential for the very long term.
Around half the portfolio is invested in the US, with some of the largest positions in Amazon, Netflix, Tesla and gene-sequencing biotech Illumina. Just over 20% is invested in China, which the manager believe is rapidly catching up with the US in terms of technology innovation and invention. This includes long-standing investments in Chinese internet giants Tencent and Alibaba and the latter’s financial spinoff Ant Financial.
The managers recently re-emphasised the increasing importance of private investments to returns. Just over a third of the current portfolio started off in the unquoted arena and increasingly they see non-listed investments – ones to which regular investors cannot gain access – as offering the best potential. Mr Anderson explains that some of the most innovative companies in the world today are private businesses, often because they are technology based and have lower costs meaning there is little need to raise capital via the stock market to grow. Staying private can also help those running a business make longer-term plans without having to worry about regular reporting, where any negative news can panic shareholders and bring about shorter term pressures.
This has important ramifications for all investors. If the growth engines of the global economy are increasingly in private hands rather than widely accessible via stock exchanges then vehicles like Scottish Mortgage could represent rare and vital access for the ordinary investor. The Trust can currently invest up to 25% of its assets in unlisted companies and currently has around 21% in such firms, which is spread over around 40 holdings.
Access to most of the private companies held by Scottish Mortgage come about as a result of the managers’ reputation as long term and supportive investors, as well as established relationships with other companies in the portfolio. One example is Bytedance, a company set up by a group of Baidu (a Chinese company similar to Google) executives whose idea for a short-form video sharing platform was dismissed internally. The managers point out that Bytedance now commands a quarter of the advertising market in China and is expanding overseas through its popular TikTok platform, which has emerged as a challenger to Facebook. For now, it remains entirely in private hands.
It doesn’t always work out
One investment that hasn’t worked out for the Trust is online food delivery service Grubhub. Interestingly, the managers believe this is partly because the company is listed and under pressure from investors to grow quarterly numbers. They suggest that unlisted rivals without this pressure have been able to take the long-term view and invest to gain market share rather than grow profit, which has undermined Grubhub’s market position.
Besides individual company failures, which are inevitable when targeting higher-growth investments, a more general risk facing Scottish Mortgage is that it could suffer from a shift in investor sentiment. In recent years, investors have increasingly favoured the high growth but relatively expensive companies the managers invest in, and this has helped boost returns. However, if they switch more to backing cheaper ‘value’ or high-yield investments this could impact performance.
The managers concede that a temporary ‘mean reversion’ could occur, but in the longer term they believe many companies that seem cheap will be significantly challenged – and that their apparent value is illusory. A case in point is the energy sector where large-scale battery storage costs are falling rapidly, allowing renewable energy to become significantly cheaper than traditional forms of energy generation. This potentially leaves more traditional companies with ‘stranded assets’, such as fossil fuel reserves, that are ultimately left close to worthless.
Scottish Mortgage has a clearly defined identity of backing fast-growing and potentially world-changing businesses, a high-conviction approach and very competitive annual charges. It’s a good advertisement for active fund management and we remain positive on longer term prospects.
The drawback is risk to capital in the shorter term. A good deal of optimism can already be factored into the share prices of high-growth companies, meaning any disappointing news can be severely punished. In addition, there is gearing (borrowing to invest) within the Trust, which serves to increase the risk of the investment further, exacerbating the price movements of an already-adventurous portfolio.
We therefore believe the Trust should be considered a higher risk global equity option for those who share the managers’ long-term perspective – as well as their assertion that a small band of companies will dominate market returns – and are happy to ride out significant short-term volatility. It remains part of our Direct Investment Service Preferred List our curated list of investments for new investment in their respective sectors.
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