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Scottish Mortgage Investment Trust – update

Scottish Mortgage Investment Trust backs some of the world’s most innovative and exciting businesses and is a popular holding among private investors.

| 8 min read

With exposure to electric car makers Tesla and Nio, Chinese e-commerce giants Tencent and Alibaba and biotech companies Moderna and Illumina (both at the forefront of finding a solution to the Covid crisis), it’s fair to say that Scottish Mortgage Investment Trust has fully harnessed the strong performing areas of global stock markets in recent years.

The Trust is a long-term member of our Direct Investment Service Preferred List of preferred ideas for new investment, having been a constituent since outset in 2013. 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.

The managers are passionate investors and free thinkers. They place little emphasis on traditional valuation metrics for stocks and reject the idea that ‘cheap’ companies will ‘mean revert’ in any meaningful way. 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.

Private investments have contributed significantly to the Trust’s returns and represent, perhaps, the biggest ‘edge’ the managers possess. Just over a third of the current portfolio started off in the unquoted arena and increasingly the managers see non-listed investments – ones to which regular investors cannot gain access – as offering the best potential in the future. That’s because 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.

The long term performance of the Trust has been nothing short of spectacular and has been boosted by a remarkable period in the past year as the share price recovered strongly from the depths of the Covid crisis. Since the inauguration of the Direct Investment Service Preferred List at the start of January 2013 the Trust has turned an investment of £1,000 into £8,982 (data to 31/01/2021), total return basis with net income reinvested, source: FE Analytics), though past performance is not an indication of future returns.

Table: Year to date and discrete annual performance of Scottish Mortgage versus its benchmark

Year to date and discrete annual performance of Scottish Mortgage versus its benchmark
Past performance is not a reliable indicator of future returns. Figures are shown on a % total return basis, bid to bid price with net income reinvested; Source: FE Analytics, 2021 YTD data: 31/12/2020 to 17/02/2021.

After such spectacular returns investors are right to question whether the Trust can match these going forward. The areas the managers invest in are prone to rapid changes in sentiment, and a cooling towards the technology sector and high-growth stocks would certainly be a difficult backdrop for the Trust. However, looking to the longer term the managers there is plenty to be optimistic about, pointing to rapid developments in areas such as energy, transport and healthcare.

Importantly, as the Trust has increased in size the managers’ reputation has grown, taking their engagement with companies to new levels. While access to large, listed companies such as Tesla and Amazon was already strong, this is increasingly true of private companies, which the managers suggest not only gives them an edge in terms of finding new investments at an early stage of development but also provides them with significant insights as to how industries might develop.

One recent successful find was Affirm, a financial technology company that provides point-of-sale credit. Shares in the company jumped nearly 90% above their initial public offering price when they started trading on the Nasdaq on 13 January this year. Around 40% of the Scottish Mortgage portfolio is invested in companies first bought when private.

The managers believe their opportunity set is broadening as innovative companies take on wider variety of industries and addressable markets. Many of these involve Moore’s Law – the principle that computing processing power doubles every two years. They highlight Dutch-based firm ASML, the leading supplier of machines that make the next generation of microchips as “critical to the survival of Moore’s law” and having the potential to transform the development of online retail, transport, digital finance, healthcare, enterprise software and more.

Transport is one industry where the managers see the ability to handle vast amounts of data and ubiquitous mobile connectivity as leading to highly scalable and sustainable business models built on electrification and self-driving. As well as already-successful holdings in Tesla and Nio, the managers also hold autonomous vehicle pioneer Aurora, whose technology could help some of the traditional auto manufacturers to compete in this market. In addition, the portfolio includes Northvolt, a Swedish battery maker; America’s Convoy and China’s Full Truck Alliance, which use machine learning to match freight to trucks; and Nuro, which makes autonomous electric robots for kerbside delivery.

Tesla remains, to some, a controversial holding in respect of its valuation, but the managers retain a positive view. They have, however, been trimming their stake to reflect the diminishing prospects of ‘outsized’ gains and for risk management purposes. According to Numis Securities, corporate broker the Trust, the managers have sold 83% of their stake in Tesla over the past year, which would have equated to a third of the portfolio if left untouched.

Elsewhere, the managers highlight healthcare remains a rapidly evolving space powered by the combination of advanced gene sequencing and artificial intelligence. Tempus, an unquoted holding, has developed a small voice-enabled device that oncologists can use to get real-time access to data and insights.

Overall, the managers believe that the opportunities for growth investing remain substantial owing to the pace of change and innovation occurring in two main hubs, the San Francisco Bay area and, increasingly, the East cost of China where they find a growing nexus of exciting companies. Baillie Gifford has a dedicated Shanghai office to help them build the pipeline of opportunities, as well as monitor the operating conditions of existing holdings. This is certainly relevant presently with long-term holding Alibaba being probed by Chinese anti-trust authorities who are apparently concerned about its dominance. However, the managers are, for now, content the Chinese tech giants they hold can adapt to a changing regulatory environment.

Our view

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 great advertisement for active fund management and we remain positive on longer term prospects, not least due to the outstanding record of the managers in identifying long term winners in their respective industries.

The drawback is a 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 if they don't keep delivering.

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.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

Scottish Mortgage Investment Trust – update

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