Challenging Year For Scottish Mortgage

It has been a tough year for investors in Scottish Mortgage (LON: SMT) with the recently released annual results to the end of March revealing an NAV total return of -17.8%, which was well below the -0.9% achieved by its FTSE All-World benchmark. The share price was even weaker with a decline of 33.5%, as sentiment towards growth stocks nose-dived and the discount widened.

Since the end of reporting period the NAV is down a further 5.8% compared with a 0.4% fall for the index. This has left the shares languishing at around 650 pence, down from their all-time high of over £15 last October and trading on a 22% discount.

Scottish Mortgage is the flagship fund run by Baillie Gifford and dates back to the founding of the firm in 1909. Its managers aim to identify ‘the world’s most exceptional growth companies’ on an unconstrained basis, across the global listed and private investable universe.

Despite the disappointing recent performance the longer term picture is still impressive with a 10-year increase in the NAV per share of 432%, versus a gain of just 181% in the FTSE All-World index. The strong track record has given the managers a reputation for identifying high-growth companies that can transform society.

Portfolio

Typically the portfolio contains 50 to 100 holdings, although 43.8% of the NAV is currently concentrated in the 10 largest positions. These include significant loss makers last year like Tesla and Amazon, as well as more profitable companies such as the online marketplace MercadoLibre and luxury clothing retailer Kering.

The managers take a long-term view and have conviction in their holdings, which is why portfolio turnover remains low. Their only full sale from the top 30 positions was Alibaba that was part of a wider move to reduce exposure to China following regulatory intervention and worsening relations with the US.

Writing in the accounts, co-manager Tom Slater listed the various macro-economic factors that had made it such a difficult market environment for the fund, but longer term he thinks these are less significant than the major growth trends they try to capitalise on. A good example is the merger of healthcare and technology, which is enabling innovative treatments to be developed faster and cheaper than ever before.

Another is the step change in favour of decarbonisation, with the world moving away from carbon-based energy generation and transport towards electrification and renewables. There is also the broadening of the digital transformation into fields such as food, finance and enterprise, as well as a catch-all category that covers companies that are pioneering progress elsewhere.

Unlisted Holdings

One of the most controversial aspects is the large exposure to private companies with the fund having a 30% limit on this area, based on total assets measured at the time of the initial investment. The managers say that this gives them the flexibility to invest in the most exceptional growth companies and that they concentrate on late-stage businesses with a global footprint and an average size of around $10bn.

A third of the private portfolio is revalued each month, as well as on an ad-hoc basis for trigger events including: share price moves in public comparables, changes in fundamentals, takeovers and IPOs. This means that during the year there were 532 revaluations performed on the 87 unquoted companies that resulted in an aggregate write down of 28% across the allocation.

The manager has faced significant questions over its exposure to unquoted investments that led to a boardroom spat, but the broker Numis believe that it has access to a differentiated, proprietary deal flow and sufficient resources to invest in minority stakes in late stage businesses. They think that the unlisted holdings have the potential to continue to drive the medium-term returns.

Numis continue to believe that Scottish Mortgage warrants a place in investors’ portfolios. They say that its focus on long-term growth drivers stands it apart from almost all other investment approaches and while this may be uncomfortable in times of stress they think it can deliver an attractive return over the long-term.