Interactive Investor

Scottish Mortgage: should you hold, fold or be bold?

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We are dedicating this week's episode to Scottish Mortgage (LSE:SMT) – the popular FTSE 100-listed investment trust that has seen its performance come off the boil over the past 18 months or so. Kyle is joined by Sam Benstead to look at what’s been happening, including the evolution of the portfolio, your main concerns as investors and where Scottish Mortgage goes from here.

Kyle Caldwell, collectives editor at interactive investor: Hello, I’m Kyle Caldwell and this is On the Money, a weekly look at how to get the best out of your savings and investments. Before we get into this week’s episode, I wanted to tell you that the new series of The ii Family Money Show, with Gabby Logan is coming soon. Series three begins with Lord Sebastian Coe, and you can find it and follow it in your usual podcast app now, by searching for “interactive investor” or “The ii Family Money Show.”

So, back to this episode; we’re going to focus the entire episode on Scottish Mortgage, the FTSE 100 listed investment trust that invests in global shares. The trust has seen its performance come off the boil over the past 18 months to two years, and Sam Benstead [deputy collectives editor] is in the studio with me, and we’ll be looking at what’s been happening, including looking at the evolution of the portfolio, the main concerns of investors and where Scottish Mortgage goes from here.

Both Sam and I have personal investments in Scottish Mortgage, and we’ll be talking from our position as DIY investors.

So, to kick off, let’s look at the long-term performance, and then I’m going to switch to Sam to run through the short-term numbers. I think it is fair to start with the long-term returns; Scottish Mortgage asks its shareholders to judge their track record over at least five years, and ideally longer than that, such as 10 years. So, over 10 years, for shareholders who have bought and held on, they’ve more than quadrupled their money as the trust is up 343%. This compares very favourably to the average global trust, which is up 211% over the same period. Now, over five years, it is much tighter, which reflects the recent weakness in the short-term performance. So, over five years, Scottish Mortgage is up 52% versus 48% for the average global trust.

So, why has Scottish Mortgage performed so well over 10 years? Well, there’s a whole bunch of reasons but for me, its approach of trying to identify exceptional growth companies, has clearly paid off over that time, so you have to give credit where credit’s due. It was actually further back than that, in the early 1990s, when James Anderson, who was the long-standing fund manager who retired last year, decided to build the portfolio around the underestimated power of structural, technological change, seeking to identify companies with disruptive technologies that would be able to change the business models of the traditional corporate giants.

And I think it’s fair to say that Anderson was a true visionary; over the past 20 years, Scottish Mortgage has been an early investor in several companies that have become household names including Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), Alphabet (NASDAQ:GOOGL), Baidu (NASDAQ:BIDU), Tesla (NASDAQ:TSLA), Tencent (SEHK:700) and Moderna (NASDAQ:MRNA). And prior to the pandemic, it already had an excellent long-term track record, but its performance was then turbo-charged even more, due to its focus on companies with a technological edge over competitors. So, during the lockdown periods, those companies with strong tech saw their share prices soar. And in addition, it had a big exposure to Tesla, which saw its share price soar by over 700% in 2020, so this, naturally, had a big influence on Scottish Mortgage’s share price sizzling.

As mentioned, James Anderson, the long-standing manager has now retired. He stepped down last April and as our columnist Ian Cowie quipped in one of his recent weekly pieces, it was probably the best planned timing since Sir Alex Ferguson left Manchester United, although a key difference is that Tom Slater, who is now the lead manager of Scottish Mortgage, had been the joint manager of the trust since 2015. So, there was, in my view, much more smoother succession planning going on at Scottish Mortgage compared to Man United, and I’m not just saying that as a Liverpool fan. The deputy manager, who was installed two years ago, is Lawrence Burns.

So, Sam, I’ll now pass the baton to you now to explain why the trust’s performance has struggled over the past 18 months to two years.   

Sam Benstead, deputy collectives editor, interactive investor: So, just to get the numbers out there, the shares are down 56% from their November 2021 peak, and that is not because the companies are struggling; it’s because of the change in the macroeconomic environment. So, what have we seen over the past 18 months? We’ve seen inflation go up and in response interest rates have gone up, and when interest rates go up, this means that the yield on bonds also rises. So, from getting next to nothing from lending money to the government, you can now get about 4%, effectively risk-free, by buying bonds from the UK and US government.

So why has that led to Scottish Mortgage shares falling so dramatically over this period? Well, it’s to do with the types of stocks that they invest in. Scottish Mortgage owns high-risk, speculative companies, whose profits are generally going to come a long way into the future, so they’re long-duration assets in industry-speak. So, these investments suffer a lot when the return on risk-free assets increases. Why would you risk buying a company that doesn’t make a lot of money today, but could make a lot of money in the future, if suddenly, you can get a stable and quite good return from a safe investment? So that causes their valuations to fall.

Another element is the widening of the discount to around 20%, and that’s linked to the high allocation to private stocks. Scottish Mortgage can invest up to 30% of its portfolio in private companies.

 And then, finally, I would just say that Scottish Mortgage is a volatile investment trust by its very nature. It’s big, it’s a bellwether for growth shares, so when sentiment is positive, then investors are very excited; you might get a premium, you get a lot of shares traded. On the other hand, if sentiment is very negative, then you get the opposite. So Scottish Mortgage tends to swing in value quite a lot, which explains why you’ve seen such a big downturn over the past 18 months.

Kyle Caldwell: I think, to be fair to the fund managers, Tom Slater and Lawrence Burns, they’ve not been using the wider macro backdrop as an excuse for their performance turning sour over this period. In their view, over the long term, it’s the stock picking that matters the most rather than the macro backdrop, so they’re relatively unfazed by this painful period for shareholders. And in terms of interactive investor customers, generally customers have been keeping the faith; some have been trying to buy the dip, particularly due to the wide discount. So, since June 2019, each month we publish a list of the top 10 most-bought funds and investment trusts on the platform, and in terms of the top 10 investment trusts, Scottish Mortgage has been the most popular investment trust each month since June 2019.

We’re now going to look at how the portfolio has changed or evolved over the years. I’d say in terms of the investment approach, what you want to see is a fund manager sticking to their knitting. It’s very important that a fund manager does this when times are tough and when performance takes a turn for the worst. What would be more of a concern is if the approach changed, as this would be a sign of a lack of confidence in the overall investment strategy. The investment approach is the same; the team believe that over the long term, there are only a small number of exceptional growth companies, and these are the stocks that they’re seeking to invest in.

And one thing I like about it – there’s several reasons but one stand-out for me - is that it’s a very active fund: it’s completely different from the index and very different from other strategies. And there’s certainly no basing decisions here around [how] each share is weighted in the index; I’d be surprised if the fund managers look at the index.

What has evolved over the years, and I think will continue to broaden, is the themes that the trust is seeking their profit from. So, there’s three big themes at the moment, and within those three, there are various sub-themes. But just to give you the three big ones that they’re seeking profit from: a digitalised world, decarbonisation and technology meets healthcare.

What’s also evolved is the unlisted or private equity exposure. In 2015, it had under 5% in unlisted stocks, at the start of 2021 unlisted exposure was around 16%; it’s now just under 30% which is the maximum amount that it can have. Now increasing exposure to private companies is part of a wider trend, so if you go back to the technology boom in the late 1990s, various companies, they were just scrambling to get their hands on a stock market listing. Today, however, many early stage businesses are turning to private capital to fund their expansion, rather than list on the stock market. So going down the IPO route, this comes with both regulation and scrutiny due to the obligation to report your financial data on a quarterly basis. And this can bring unwelcome, short-term scrutiny for companies trying to grow for the long term.

And there’s also the risk of listing on the stock market too early, or not being profitable for several years. The stock market can take a dim view of that, and reprice the share price accordingly, and not be very forgiving.

So increasingly, there’s been other investment trusts, as well as Scottish Mortgage, that have been looking to unlist the companies to capture growth opportunities and Scottish Mortgage, probably the highest profile example of that, doesn’t just invest in private equity stocks. And for me – we’ll get Sam’s thoughts on this, as well, in a moment – the increased exposure to unlisted stocks, it doesn’t change the risk profile of the trust; it was already an adventurous strategy. In my view, it’s better placed as a satellite holding rather than a core holding. And, again, in my view, if the managers are seeking more opportunities in unlisted stocks, which has obviously been the case, then I’d sooner the fund manager goes there if the strategy allows them to.

But what having more unlisted exposure does do, is make some investors nervous during more volatile periods. As investors in an unlisted company, you’re unable to see how much the valuation has changed in response to the falling share prices and valuations in public markets. And that’s been a big factor recently, hasn’t it, Sam, behind Scottish Mortgage being out of form?

Sam Benstead: That’s right. So, the main reason for this 20% discount at the moment, is that investors just don’t believe the valuations that Scottish Mortgage is putting on its private portfolio. So, the way it values its portfolio, is that it does a third of it every month, so every three months, they get a full, fresh valuation for all the private companies. However, investors are looking at similar companies that are now public, that used to be private in the Scottish Mortgage portfolio and saying, ‘Hold on a minute; these public companies have dropped a lot, and yet the private companies’, which are arguably similar, ‘have only dropped a little bit’. So, for example, a biotech stock that Baillie Gifford and Scottish Mortgage owned was Gingko Bioworks, and it listed its shares in 2021, and from their peak to trough, they’ve fallen 90%, and that was a top 10 position for Scottish Mortgage; that’s a huge drop, I haven’t seen drops near as big as that in the NAV, in the net asset value of the private portfolio.

There’s a similar thing happening at other private equity trusts, so it’s not just a venture capital, Scottish Mortgage-related thing. You can pick up shares in most of the big private equity trusts; people like Pantheon International Ord (LSE:PIN) or HarbourVest Global Private Equity (LSE:HVPE) also at big discounts, so they’re at 50%. So, this is why it’s spread across the whole private equity world: investors just don’t think the valuations they’re putting on their portfolio are correct, considering what public stocks are doing.

And there are clear signs that these private portfolios are overvalued. So, for example, Klarna, which isn’t a Scottish Mortgage position, but is a private Swedish “Buy now, pay later,” fintech company, when it raised money in summer 2022, which was after the bubble had burst, it had to write down its portfolio value by 85%. Investors just weren’t willing to lend it money and give it the same valuation that they had done in 2021.

The other issue with Scottish Mortgage and its private companies now is that they have a hard 30% cap on private stocks. So, this cap works when they invest in new companies, but it doesn’t apply if the allocation to private stocks goes over 30% because of changing valuations of the private portfolio. So, if the public market falls, for example, but the private stocks stay relatively the same in valuation, you’ll see that allocation naturally shift up, that’s fine; it can go over 30% in that instance, but it just can’t make new investments in private companies, that would take it over that 30% allocation. And this could be a problem because it means it can’t add money to existing positions or invest in new private companies that it may see opportunities in.

And that’s particularly relevant now, because a lot of special companies are struggling and looking for new investors, so Baillie Gifford and Scottish Mortgage could get a bargain by investing in these companies now, but it’s restricted in doing so because of that 30% cap.

Kyle Caldwell: There’s been a lot of articles written on the unlisted/private equity exposure of the trust, and that has increased even more of late, as there was a boardroom bust-up over the assessment of the risks posed by the trust’s unlisted investments. So, Sam, could you run through what was said and what’s gone on here.

Sam Benstead: So, there was some unusual drama in the often-dull world of investment trusts’ boards. One of the non-executive directors at Scottish Mortgage is a chap called Amar Bhide, who’s an academic and an author and is connected to a university in the US. He basically said that Scottish Mortgage and Baillie Gifford, more widely, didn’t have the resources or expertise to monitor and invest in private companies. So, Scottish Mortgage has 52 private positions, and he was saying “Actually, that’s too many for a team of your size.” He was also concerned that there was not enough investment expertise on the board, and it was being packed with academics, and the chair, Fiona McBain, was too controlling and wasn’t allowing this diversity of thought and challenge in the board of Scottish Mortgage.

So, what happened? Well, Bhide left the board; chair Fiona McBain said she was stepping down, so that’s going to come after the AGM in June this year, and shareholders will vote on the new chair, which is expected to be Justin Dowley. He is a former investment banker, currently the chair of engineering firm Melrose Industries, and has been an independent director of Scottish Mortgage since 2015.

So, should investors be worried about this? My personal view is that Baillie Gifford, as a company, does have the resources to invest in private companies. But it might have got a bit ahead of itself in believing that that’s where you find the very best companies. Scottish Mortgage has 52 private companies compared with 47 public ones, so there’s more private companies than public companies, even though it’s only 30% of the portfolio. That, for me, doesn’t seem like the right balance. There are amazing public companies out there, and it’s easier to evaluate public companies because the share prices change so much, so you can be a bit more opportunistic. So that ratio, I don’t think, is right.

Does it have the resources and expertise? I think it does; it’s bought some amazing private companies in the past and they do know what they’re doing, and that comes across every time I see the managers speak. As for the board row, I think it’s good to see that there were challenges in there, and Amar did speak up and say that they needed to get a bit more expertise in there, so that’s quite a good thing, I think, and now there are going to be changes. So, I’m not too worried about the board shifting around, but I am a bit concerned that private companies have become so important to Scottish Mortgage.

Kyle Caldwell: I completely agree with you, Sam, in terms of the boardroom row. As a shareholder, I was glad that the former board member came out and expressed his views, so that other shareholders could take note. Independent boards are a key advantage of investment trusts; it’s one of the reasons I do favour investment trusts over funds. And over the last couple of years, we’ve seen that one trend has been that boards have driven down costs and passed on economies of scale to shareholders, whereas with open-ended funds, that very rarely happens.

And in terms of the listed versus unlisted exposure, we’ve seen in the first quarter of this year that several tech stocks, particularly the FANGs, have had a strong three-month period, which perhaps reflects that last year, the valuations and share price falls for some of those tech companies; they fell too much in response to interest rates rising. And it’s not comparing apples with apples because Scottish Mortgage does not invest in the same way that the main two tech trusts do: Allianz Technology Trust (LSE:ATT) and Polar Capital Technology (LSE:PCT). But I do find it interesting that in the first quarter of this year, Allianz Technology and Polar Capital Technology, they’re both up, respectively, 10% and 16%.

I am scratching my head a bit, wondering why Scottish Mortgage has posted a small loss over that period, when some tech companies have had a rally, and it has to be down to the valuations of the unlisted exposure that some investors are very sceptical of. And, as Sam mentioned, it’s having a big bearing on the discount, which is just under 20%, and the current discount for Scottish Mortgage is much higher than usual. For the past couple of years, Scottish Mortgage has typically traded close to par, so close to the value of its underlying investments.

Now Scottish Mortgage does try and limit discount volatility through buying back its own shares; it was one of the largest share repurchasers in 2022, and in theory, buying back shares, should help to adjust the disparity between supply and demand, thereby pushing the share price up, improving investor sentiment and reducing the discount.

However, that doesn’t always work in practice; share buybacks, ultimately, they are not a panacea to fix negative sentiment, and this is the point that one of our listeners, Stuart Brown, made to me in an email conversation, and I completely agree with what he says. He pointed out that, “I’m sceptical of the value of share buybacks when the market doesn’t, for the moment, trust private equity valuations,” and I think that’s spot-on. And in the case of Scottish Mortgage, I think if the market wasn’t sceptical about those unlisted stock valuations, then it wouldn’t be on such a wide discount. And the same is true of other trusts that solely invest in private equity, which as Sam mentions, are also on very notable discounts.

Now one thing that no one can accuse Scottish Mortgage of not being is transparent; it’s written articles to explain how the unlisted stocks are valued and how often. And around a year ago when I interviewed Lawrence Burns, he gave a clear explanation of the process, which I thought would be worth replaying to listeners. So here it is from the horse’s mouth.

Lawrence Burns, deputy manager of Scottish Mortgage: So first, we follow the International Private Equity and Venture Capital guidelines in terms of valuing our unlisted holdings, and this is handled by a valuation committee that exists inside Baillie Gifford, who are supported in their task by the advice of an independent party called IHS Markit. As fund managers, neither Tom or I have anything to do with that process; it’s done at arm’s length, independent from us or our views; we simply get notified of the changes after they’ve, effectively, been agreed. And what the committee are really trying to do is come to a fair value, by which we mean the price we think we would be able to achieve, if we were to sell these holdings today in the open market. And that’s very different from what the fund managers, Tom and I, might think they’re worth on a five to 10 [year-view] – it’s about if we were to go out and sell them today, what’s the best guess at what we’d be able to sell them for.

It’s very fair to ask, ‘Well, how quickly are these valuations updated in volatile and indeed falling public equity markets?’ First, the companies are reviewed on a rolling three-month basis, so the entire portfolio is always revalued every quarter. In addition to that, it’s not all at the same time; a third of the portfolio is reviewed every month. And so, one month you get one third, another month, you get another third and then the third month, you get the final third, so that creates some immediacy to it. In addition, as you probably expect, we have trigger events, so when there’s an immediate change outside this re-evaluation cycle, that happens on that three-month rolling basis, trigger events can cause the committee to look and readjust the valuation.

So, what causes a trigger event? It could be a material change in company fundamentals, it could be a new funding round, a decision to take the company public, or it could be a material change in the public market evaluations that are feeding into that fair market valuation. So, if you’ve got a company operating in one space and all its public market peers have come down a lot, you’d expect that to be a trigger event to relook at the evaluation. And so, what we’ve seen in volatile markets is that we’ve had quite a lot of those trigger events that have tried to make sure that the valuations remain fresh. It’s made it quite a busy time for our valuation committee, but I hope that gives detail and real assurance to your listeners and our shareholders about how the process works and how it’s adapting to the changing market conditions.

Kyle Caldwell: So, there you have it. Scottish Mortgage also gives regular updates to its shareholders, and it certainly can’t be accused of hiding when the going gets tough. At a recent update for investors there was a webinar, which Sam covered for the interactive investor news website. So, Sam, what were the main concerns of private investors, who submitted questions, and how did Scottish Mortgage respond?

Sam BensteadThere were three big areas Scottish Mortgage was forced to address, and those were concerns over its unlisted exposure at the 30% limit, the notable short-term underperformance, and its rising discounts. So, Tom Slater said that the 30% cap was not a big problem and hadn’t been a constraint for them, and Burns agreed, saying that there was one company, over the past year, that they could not invest in because of that cap. He said it was something they were monitoring and thinking about. Slater added that about half the company exposure comes from just five companies, and the best companies, or a lot of companies, are staying private for longer, and this is where they’re finding a lot of their best ideas, so limiting their ability to invest in private companies would be a disadvantage to the shareholders, ultimately, was his point.

 One question referenced Neil Woodford and his fall from grace from investing in private companies in his open-ended Woodford equity income funds, but Scottish Mortgage said [they] would not face similar problems and you couldn’t make comparisons between them and Woodford. One of the reasons was that the private companies they are owning are huge companies and they’re relatively more liquid, easier to sell. They said the average company they invest in, which is private, has an £8 billion market cap versus £200 million for the companies that Woodford was investing in. They also said that because it’s a close-ended investment trust, which means the shares can move around without the fund managers having to raise money to return capital to investors when they take their money out, they were not a forced seller of assets as Woodford was.

On the performance, the fund managers admitted that it had been poor recently, and they apologised for this, but they said they’ve not wavered from their investment approach. Burns, for example, said they didn’t want to give up on incredible companies during difficult periods, and he referenced Amazon and its share price crash in 2001 and Apple’s crash in 2008 as evidence that even the best firms go through tough periods.

As for the discount, Slater said that’s key to striking a balance between discount management, so buying back shares, and using that capital to invest in new companies. So, what he said was that he wanted to identify long-term winners as a priority for spending capital, but he also wanted to look out for shareholders. He said, ‘We don’t want to tie ourselves to numeric targets on discount for these reasons.’

An interesting nugget from the webinar was that Slater said he’d bought more Scottish Mortgage shares for his own personal accounts and, across Baillie Gifford more generally, employers were buying shares in the group’s funds, which was something he said the leadership of the group was encouraging.

Kyle Caldwell: Well, that’s good for shareholders to know, that the fund manager’s been increasing his skin in the game. In terms of skin in the game, fund managers are not required to announce whether they’ve been increasing – well, you’d hope they’d be increasing [and not] decreasing – exposure unless they’ve got more than 3% of a holding in the investment trust. But it’s a question that we always ask fund managers we interview; we think it’s important that they are aligned with investors. They benefit from the good times, and they suffer in the bad times, as well, which Scottish Mortgage shareholders can testify to over the past 18 months to two years

So, let’s end by summarising where investors in Scottish Mortgage go from here. Sam, what are your thoughts in terms of whether investors should hold, fold, or be bold?

Sam Benstead: I think now’s a great time to be bold if you have a long-term investment horizon. There’s so much bad news priced into the Scottish Mortgage share price at the moment; the 20% discount shows that, and a turnaround could be near, and that’s because interest rates look like they’re close to peaking in the UK and the US because inflation’s slowing down and the economies are showing signs of weakness. This’ll give central banks licence to pause interest rates increases or cut them towards the end of this year, or into next year. That would be a huge turning point for the Scottish Mortgage share price. As I said, at the start of this podcast, that kind of risk-free rate, which is linked to interest rates, is so key to valuing these high-growth companies, so if interest rates start falling again, then actually that would be a great tailwind for the valuations of the types of companies that Scottish Mortgage own.

So, if you have a long investment time horizon, now would be a good time to invest. If you need the money in the short term, I think it’s too risky and you should be holding or just looking at risk in your portfolio more generally, and making sure Scottish Mortgage is not too much of a big position.

Kyle Caldwell: Personally, I still hold it, but I was fortunate that I bought around 10 years ago, so I’m in a different place to those investors who bought it more recently and are nursing big paper losses. And normally when a fund or investment trust is out of form, I’m inclined to buy more and be bold if I’m still a big believer in the strategy. But my personal circumstances mean that my hands are tied at the moment, because I’m prioritising saving for a house extension, which I’m hoping to have done in the next year or so, so that’s where any savings I have are going at the moment, rather than being put to work in investments. So, I’m reluctantly just holding at the moment.

However, I do regret not taking some profits in Scottish Mortgage. I’ve learned a valuable lesson from the experience, which is that while investing over the long term [and] running winners to benefit from compounding is widely acknowledged as a prudent way to grow wealth, there are occasions when it can pay to take some profits, such as when a fund or investment trust has enjoyed a really strong run of performance that’s unlikely to last indefinitely.

And this was the case with how well Scottish Mortgage fared during lockdown, so from April 2021 to April 2022, [when] its share price doubled. I knew at the time, and the managers of Scottish Mortgage cautioned against elation, that those sorts of returns, were not going to keep on happening. But what I did underestimate was that, as we stand today, most of those gains during the lockdown periods have been handed back.

Thank you to Sam and thank you for listening to this episode of On the Money. If you enjoyed it, please follow the show on your podcast app and tell a friend about it. If you get a chance, leave us a review or a rating in your podcast app too. You can join the conversation, ask questions and tell us what you would like to talk about by email, which is, and in the meantime, you can find more information and practical pointers on how to get the most out of your investments, on the interactive investor website, which is See you next week.

Both Kyle and Sam invest in Scottish Mortgage. Their opinions are for information only and not personal recommendations.

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