Interactive Investor

Why Scottish Mortgage shares have slumped and are now on a discount

10th March 2021 12:53

Kyle Caldwell from interactive investor

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The trust has been caught up in the technology sell-off that has taken place since mid-February.

Time will tell, but since hitting 950p per share on Monday morning Scottish Mortgage’s (LSE:SMT) share price has been starting to claw back some of the losses it sustained in recent weeks.

  • How have you responded to Scottish Mortgage’s share price fall? We would love to hear your views, email editorial@ii.co.uk

As we previously noted the trust’s share price sell-off started on 15 February, falling from 1,415p per share to 1,124p per share (at midday this morning), a 20.6% decline.

While an uncomfortable period, shareholders will be comforted by its strong longer-term performance numbers. In particular, the trust had a stellar 2020 with its share price up 111%.

Scottish Mortgage has been caught up in the technology sell-off that has taken place since mid-February, due to its focus on disruptive companies that have a technological edge over competitors.

As a result, the trust’s premium has vanished and prior to the market open today was on a discount of 5.4%.

The wider market declines were triggered by concerns that inflation will rear its ugly head at the same time the global economy is set to accelerate – the ‘reflation trade’.

In theory, this would be a favourable backdrop for value stocks that are more cyclical and economically sensitive. As a result of this, investors have been questioning the valuations of growth stocks, which has led share prices to fall.

Tesla (NASDAQ:TSLA) has been a notable faller, with its share price down by 30% over the past month until the US market opened yesterday. In yesterday’s session, however, Elon Musk’s firm saw its share price recover plenty of lost ground, with its share price up 20%.

In turn, this will have boosted investor sentiment for Scottish Mortgage today given that Tesla is one of its top holdings. At the end of January, Tesla accounted for 5.1% of Scottish Mortgage’s portfolio. Over the past couple of months, Scottish Mortgage has been taking profits in the electric car maker, following its strong share price performance in 2020. In July, Tesla comprised 13.4% of Scottish Mortgage.

Its three biggest weightings are to Tencent (SEHK:700)Illumina (NASDAQ:ILMN) and Amazon (NASDAQ:AMZN), at 6.5%, 6.1% and 5.9% respectively.

The trust also backs unlisted companies, representing just over 16% of the portfolio at the end of January. This was another factor behind Scottish Mortgage’s share price slump over the past couple of weeks, according to Numis, the investment trust analyst. It said: “We understand that part of the reason for this volatility was concerns around valuation of unquoted investments.”

Numis points out that the valuations of the unlisted companies held in the trust are reviewed on a rolling three-month basis, with a third of the assets reviewed each month by Baillie Gifford.

In addition, Numis adds a ‘trigger event’, such as a change in market conditions, can lead to “an ad hoc fair valuation review” being called by Baillie Gifford. “If the review determines that it is appropriate to revalue a position then this is reflected in the value of its underlying investments (NAV), which is published daily,” says Numis.   

Following the market sell-off, there are now question marks regarding the present value of the unlisted companies as no update has been provided.

Numis adds: “We would welcome additional information about when significant valuation adjustments have been made, although we understand this may be difficult if there are multiple ongoing changes and there may be disclosure restrictions on individual investments.

“We understand that has not been a ‘trigger point’ downgrade to valuations given recent market volatility, but also that there were not significant upgrades in January for the strong markets, which provides some cushion to the valuations, although clearly further market falls have the potential to have an impact.”

The benefits of rebalancing  

Just as Scottish Mortgage took profits in Tesla following its strong share price run, it would have been prudent (with the benefit of hindsight) for investors to have banked some of their gains in Scottish Mortgage.

When to take profits, though, is notoriously tricky to time. Last August investment trust analyst Stifel said it was a good time to “lock in some gains”. At the time Scottish Mortgage’s share price was up 55% for the year, but as we now know it carried on rising and ended 2020 up over 100%.

Carrying out an annual or twice a year spring clean stops complacency creeping into a portfolio. This involves taking a look at the winners and converting some paper gains into real profits, some of which could then be reinvested into areas of the portfolio that have been underperforming but may soon recover their poise.

It can be tempting to hold on or buy more of a fund or investment trust that is performing well, but doing so increases risk as it becomes an even larger part of the overall portfolio.   

The investment case for Scottish Mortgage, a member of interactive investor’s Super 60 list, has not changed following the sell-off, and as Numis notes “some investors may regard its discount as an attractive entry point”.

But it is a timely reminder that Scottish Mortgage is an adventurous option for investors due to how it invests and that short-term periods of volatility are to be expected.

Dzmitry Lipski, head of fund research at interactive investor, says: “The strength of their stock-picking skills combined with strong risk-adjusted performance and competitive fees make this a good choice for long-term investors.

Investors should remember that it is higher-risk investment due to high portfolio concentration, exposure to unquoted companies and exercised gearing, so works better as a satellite holding in a well-diversified portfolio. The style bias of the trust is towards growth, with less attention paid to valuation, meaning it can complement other funds with a core or value-style orientation.”

The author owns shares in Scottish Mortgage (LSE:SMT), alongside other investment trusts and funds.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

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