Can this successful investment trust continue to outperform?

Scottish Mortgage backs some of the world’s most innovative and exciting businesses.

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  1. Rob Morgan

Scottish Mortgage is no ordinary investment trust. A founder member of the Foundation Fundlist in 2013, it has since cemented its reputation as one of the UK’s leading investments and 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. 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 accessible through their network of contacts.

The managers have long been keen supporters of the internet giants, investing at an early stage in Google, Facebook and Amazon, and backing China’s Alibaba, Baidu and Tencent. 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.

Mr Anderson asserts the rate 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.

By way of illustration, over the past year the largest contributors to the Trust’s latest annual performance were three stocks held for over five years: Web services giant Amazon grew by a third and accounts for over 9% of assets, while shares in gene sequencer manufacturer Illumina and Kering, the French luxury goods retailer behind Gucci and Yves Saint Laurent, both rose by more than 40%.

The managers’ far-sighted approach is not without its controversies, notably electric car company Tesla which seems to divide opinion like no other stock. Sceptics argue that while global electric-vehicle penetration is going to rise, and there could be substantial amounts of money to be made, the internal combustion engine is likely to remain dominant for many years to come and Tesla’s path to profitability is a long and difficult one, especially given the competition from established manufacturers transitioning to electric.  Yet Mr Anderson and Mr Slater have upped their position over the past few months, maintaining it as the portfolio’s fifth largest holding in the belief that the company’s technology platform is unparalleled.

Tesla is good example of how the manager’s investment process places little emphasis on traditional valuation metrics others might employ. Assessing innovative businesses with the power to disrupt whole sectors against current earnings or tangible assets is not, the managers argue, particularly informative. Instead, they concentrate on identifying the future winners from a changing world whose potential market is misunderstood by the majority of investors. This includes both established businesses and newer ones.

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 16% in such firms.

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. This year, the managers made their largest single investment in a private company to date, Chinese financial services and online payments giant Ant Financial. This opportunity arose as direct result of the long-standing investment in its parent company, Alibaba.

Among the other, smaller positions in unlisted businesses are a number of healthcare firms, including Grail, which is involved in the early detection of cancer, HeartFlow, which uses innovative software to treat cardiovascular conditions, and genetic engineering firm Ginkgo Bioworks. In addition, there are investments in meal-kit firm HelloFresh, online shopping site Home24, Indian low-cost airline IndiGo and Transferwise, a UK-based service that lets users digitally transfer money overseas quickly and cheaply.

The managers believe they have successfully refined their approach to venture capital investing over the years. As well as being experts in this field, they claim they represent an appealing backer for the managers of earlier-stage companies due to their genuinely long term outlook and intention of keeping or increasing their stake if and when the company comes to list on the stock market. Traditional venture capitalists would often exit at this point. This approach is underlined by holdings in music streaming service Spotify, on-demand taxi service Lyft and Chinese electric car company Nio, all of which the managers added to in the past year in during their respective IPOs.

 

Our view

It’s easy to see why Scottish Mortgage has become a favourite holding of many private investors. The Trust 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.

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 and are happy to ride out significant short term volatility. It remains part of our Foundation Fundlist of preferred investments across the major sectors.

 

Past performance is not a reliable guide to future returns. This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

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