Scottish Mortgage Investment Trust: June 2023 update

• The managers hunt for private and public companies with high-growth potential
• Veteran manager James Anderson stepped down from the trust in April 2022, Tom Slater and deputy manager Lawrence Burns continue to manage the trust
• Long-term performance has been strong, but 2022 was a tough year for the trust

How it fits in a portfolio

Scottish Mortgage Investment Trust is managed by Baillie Gifford. It aims for long-term growth by investing in some of the stock market’s most exciting companies. From healthcare to transportation, the trust provides exposure to some of the most disruptive businesses around the world. This includes both public and higher-risk private companies. With a focus on growth, the trust could work well alongside others investing in out-of-favour ‘value’ companies to form part of an adventurous portfolio. Investors in closed-ended funds should be aware the trust can trade at a discount or premium to Net Asset Value (NAV).

Manager

James Anderson, the long-standing manager of this trust since 2000, stepped down and retired at the end of April 2022. Baillie Gifford takes succession planning seriously, especially as Anderson has been integral to the trust’s development and performance over the past two decades.

Tom Slater is a partner at Baillie Gifford and is now lead manager of the trust. He was joint manager alongside Anderson from 2015 after spending five years as deputy manager. He joined Baillie Gifford in 2000 and has spent time analysing both Asian and UK companies. He’s also Head of US Equities and manages other global and US portfolios, including the Baillie Gifford American Fund. Given there is regional overlap and a shared investment philosophy across these strategies, we believe Slater can devote enough time to each.

Lawrence Burns was appointed deputy manager in March 2021 and continues to support Slater following Anderson’s retirement. He joined the firm in 2009 and has experience covering the UK, emerging markets, and managing global growth portfolios. He’s also a partner at Baillie Gifford.

The team also benefit from the wider resource available at Baillie Gifford, which consists of over 100 investment professionals.

Process

The managers believe that markets are driven by extreme events and success, which propels society forward. Their research suggests that only a handful of companies generate wealth over the longer term and these are the ones they seek to invest in. The trust is invested in a way that means it looks very different from the index and peers.

New ideas are generated from a wide range of sources such as industry specialists, roadshows and the expertise of colleagues at Baillie Gifford. The team then conduct detailed research into each potential company – they spend a lot of time building a deep understanding of a company’s business model, its quality of management and the growth potential of the industry they operate in. Typically, these are financially robust companies that have hard-to-replicate advantages over competitors. The managers are optimists and focus on what could go right and, if successful, how big could the opportunity be?

The managers are true long-term investors as they believe it’s the best way to capture the potential growth of the companies they invest in. At the end of April 2023, the trust is invested in 100 companies, nine of which have been held for over ten years, including technology firm Amazon, semiconductor firm ASML and Indian bank HDFC.

This patient approach is well suited to investing in private companies (those not listed on the stock market). The trust can invest up to 30% of its assets in these unquoted companies (measured at the time of investment). Investors should be aware that investment in unquoted companies is higher risk and they can be considerably less liquid (more difficult to buy and sell) than those traded on established stock exchanges. At the end of April 2023, there were 53 unlisted investments, making up 29.9% of the trust’s assets. This has increased from 24.6% last year.

Around 55% of the trust is invested in North America, with the remainder split across Europe and higher-risk emerging markets like China. The managers view the trust’s sector allocation differently to most others, and in a way that expresses their view of the world. ‘Transformational Healthcare’ is the largest theme and is home to the likes of drug discovery firm Moderna and one of their longest held holdings, biotechnology equipment manufacturer Illumina. Other notable themes include,‘Changing Media Habits’ and ‘Evolution of Transportation’. All have qualities in common, including the ability to cause dramatic change and disrupt the status quo.

New investments this year include gaming company Roblox. Its audience use it as an entertainment platform initially and the conversion of those players into creators and paid users, which is something the managers believe will underpin substantial growth. The managers also took a position in cloud networking provider Cloudflare. The managers think they will be essential in enabling the next generation of software systems.

To pay for new investments, the managers reduced their exposure to China and sold Alibaba, Full Truck Alliance Co and KE Holdings. The sales were driven by concerns about the growth of big online platform companies in China after several regulatory interventions, as well as deteriorating Sino-US relations.

The managers can use gearing (borrowing to invest), which can boost gains but also increases losses, so is a higher-risk approach. As at the end of April 2023 the gearing stood at 17%. They can invest in derivatives too, which if used also adds risk.

Culture

Scottish Mortgage was established in 1909 and is a member of the FTSE 100 index, home to the biggest companies in the UK stock market. The trust is managed by Baillie Gifford, an independent private partnership founded in 1908. It's owned by its partners, who work full time at the firm. This ownership structure means senior managers have a vested interest in the company, and its funds and investment trusts, performing well. We think this has helped cultivate a culture with a long-term focus, where investors' interests are at the centre of decision making. We also like that fund managers are incentivised in a way that aligns their interests with those of long-term investors and should retain talented managers.

ESG integration

All of Baillie Gifford’s funds are run with a long-term investment horizon in mind – they see themselves as long-term owners of a business, not short-term renters. So, assessing whether society will support, or at the very least, tolerate, the business model over the long term, and whether management will act as good stewards of shareholders’ capital is an important part of the investment process. Dedicated ESG analysts sit with and report into their respective investment teams, and the firm’s ESG efforts are supported by a dedicated climate specialist team, an ESG Services team (responsible for voting operations and ESG data) and an ESG Client team (responsible for ESG-related client communications). Individual investment teams are responsible for voting and engagement for the companies they invest in. Investment in controversial weapons is prohibited across the firm.

The firm reports all its voting decisions and provides rationale in situations where it voted against management or abstained, in a detailed quarterly voting report. There is also a quarterly engagement report which details the companies engaged with, and the topic discussed, and further engagement case studies are available on the website. All this information is brought together in the firm’s annual Stewardship Activities report.

We are comfortable that ESG risks are considered suitably at Baillie Gifford. However, this trust does not have a specific ESG or responsible investing remit, meaning that it has the option to invest in companies that are considered ESG sinners.

Cost

The trust’s net ongoing annual charge is 0.84%. Investors should refer to the latest annual reports and accounts, and Key Information Document for details of the risks and charging structure. If held in a SIPP or ISA, the HL platform charge of 0.45% (capped at £200 per annum for a SIPP and £45 for an ISA) per annum also applies. The platform charge doesn’t apply if the trust is held in a Fund and Share Account.

Investment trusts trade like shares, both a buy and sell instruction will be subject to the HL share dealing charges within any Hargreaves Lansdown account.

Performance

The trust has grown 182.26%* in share price terms since Slater was appointed co-manager in 2015. This compares with 132.96% for the broader global market, as measured by the FTSE All World Index. During the same time the funds NAV has increased 247.16%. Past performance is not a guide to the future though and investments fall as well as rise so you could get back less than you invest.

While the managers’ growth-focused investment style led to strong returns for several years, the trust has struggled and fallen in value since November 2021. Higher inflation and rising interest rates have put pressure on growth investing, as this erodes the value of cashflows expected to be generated further out in the future.

During the trusts latest financial year to the end of March 2023, the trust’s share price fell -33.55%. This compares with -0.88% of the FTSE All World Index. American biotech company Ginkgo BioWorks was one of the largest detractors to performance. It has struggled to convince investors on its potential growth since listing in 2021. The managers believe they have delivered operationally and that they are in a good position to consolidate its market. American electric car manufacturer Tesla also detracted over this period. Tesla has suffered a slowdown in new vehicle sales as consumers face higher interest rates, in response the company cut prices in an attempt to boost demand. The managers still believe Tesla is the leading electric car manufacturer and in the long run its software and AI capabilities will be deployed to a larger fleet.

We believe the trust has long-term performance potential, but periods of volatility should be expected. As always, we suggest investors build diversified portfolios with exposure to a variety of investment styles, sectors, countries, and asset classes. Plus, you should regularly review your investments to make sure they continue to meet your needs and objectives.

At the time of writing the trust currently trades at a 17.57% discount to NAV.

Annual percentage growth

Past performance is not a guide to the future. Source: *Lipper IM to 31/05/2023.

FIND OUT MORE ABOUT SCOTTISH MORTGAGE INVESTMENT TRUST INCLUDING CHARGES

VIEW SCOTTISH MORTGAGE INVESTMENT TRUST KEY INFORMATION DOCUMENT

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