Thomas McMahon, investment trust research manager at Kepler Trust Intelligence, discusses one of the country's most-popular and widely held investments. The trust has seen its share price halve in value, and McMahon explains the impact of interest rates, exposure to China and unlisted companies, as well as his expectations for returns going forward.
Lee Wild, head of equity strategy, interactive investor: Hello, with me today, I have Thomas McMahon, investment trust research manager at Kepler Trust Intelligence. Hi, Thomas.
Thomas McMahon, investment trust research manager at Kepler Trust Intelligence: Hi Lee.
Lee: Good to see you again. Scottish Mortgage Ord (LSE:SMT) remains one of the most popular and widely held investment trusts, 2022 was a tough year and the share price halved in value. What's gone wrong and what's your view on prospects for 2023?
Thomas: Well everything's gone wrong really. I mean, you know, the fundamental thing I think it's well known that interest rates have been increased faster and further than expected. And that means that companies whose valuation is dependent more on earnings further into the future, have been hit the most, and Scottish Mortgage has a lot of those type of companies. So you know that's the key reason.
I think what's been unfortunate for them is that things in other environments have been diversifying, exposures haven't really worked, so they've built up a significant exposure to China. And China has had its own problems so that's hurt them, you know in another environment you can imagine where the China exposure might have offset some of the US tech exposure, but it hasn't worked out that way. Concerns around regulation and heavy-handed interference in China, global political concerns and then concerns about lockdowns in China continuing. All these reasons mean that Chinese stocks have come under pressure as well.
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So nothing's really going right for them this year. In terms of sort of looking forward, I think, I wouldn't expect an immediate reversion to 2019, 2020 returns where it was a stellar performer. There's obviously a lot of things need to be worked through the portfolio, so I don't think investors should expect to see those types of returns necessarily again. But it's true that it has sold off a lot and at a certain point that becomes interesting.
Lee: Yes, I mean with the share price at the moment it's hit a level, it's bounced and as you say, we're not seeing that massive sort of recovery, it's very steady, perhaps a sideways movement if anything. Is there anything in 2023 that that could trigger a bigger sort of recovery than perhaps you anticipate?
Thomas: In Scottish Mortgage?
Thomas: I think if rates are cut earlier and more than expected, then I do think there will be massive decrease in pressure on the ratings of its growth stocks and I think the other element is the Chinese exposure. So at the moment, at time we're speaking, there's ongoing unrest in China around lockdowns and so on, not particularly positive, but you know, for 2023, this is a long period of time, China finds a way to deal with Covid, if the Communist Party's bit more lighter touch with regulation and so forth, you can see it's surprises really that would cause an outsized rally I think.
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So, is the good news even better than expected in those directions? That would be what would cause that I suppose. But I think, you know, we're in a different environment now, so rates are going to be, in my view, I can't see the future, rates are going to be higher than they were pre-pandemic for all of 2023 and probably some time longer. It's a different environment, I wouldn't expect exactly the same level of outperformance.
Lee: But what about its exposure to unlisted companies? Are you comfortable with that exposure currently?
Thomas: Well that's an area of uncertainty I think. So if you're looking for other reasons for an outsized jump in the share price, it would be clarity on that sort of issue. It's something that needs to be worked through. You know, we've discussed private equity, similar issues in terms of asset space, these things are valued with a lag, so investors will apply a greater discount until they see where the land lies, so to speak. So that's another potential source of recovery if the news is good, but equally valuations can be written down more than people expect. It's a double-edged sword, so there's a reason that the trust has been trading on a discount.
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