Saturday, 20 April 2024

Unraveling the Tale of Scottish Mortgage: From Beloved Fund to Investor Losses

Unraveling the Tale of Scottish Mortgage: From Beloved Fund to Investor Losses
Saturday, 20 January 2024 14:36

Riding the Rollercoaster: The Rise and Fall of Scottish Mortgage Investment Trust

The Scottish Mortgage investment trust, once hailed as a fearless venture into high-growth companies poised to change the world, now faces a challenging chapter in its storied 115-year history. Valued at around £10 billion today, the fund has been a beacon of success, boasting a remarkable 277% total return over the past decade. However, the recent downturn in its fortunes has left investors grappling with substantial losses.

The fund's strategy, which heavily relies on identifying and supporting fast-growing companies, catapulted its share price to new heights. A £1,000 investment in 2013 would have swelled to approximately £3,760 today. Yet, the era of cheap money has cast a shadow over Scottish Mortgage. Since its peak in November 2021, its share price has plummeted by 50%, a casualty of surging interest rates that have pummeled the predominantly technology-focused stocks within its portfolio.

Currently, the fund's shares trade at a 10% discount to the value of its underlying assets, prompting influential brokers to advise clients to divest. Despite the challenging environment, manager Tom Slater remains optimistic about the portfolio's outlook, downplaying the impact of rising interest rates.

The analyst community, however, remains divided on the fund's prospects. Jefferies maintains a "Buy" rating, while Investec has labeled it a "Sell" since January 2023. The fund's exposure to highly profitable private companies has been both a boon and a controversy. Last year, Questor tipped the fund, citing its impressive track record and attractive discount.

In a recent interview with Lawrence Burns, co-manager of Scottish Mortgage, Telegraph Money delved into the fund's recent underperformance. Burns acknowledged mistakes, citing a slow response to rising geopolitical tensions between the US and China as a critical oversight.

As 2024 unfolds, the question looms: Can Scottish Mortgage rebound from its recent setbacks, or is this the year that growth investing takes a back seat? The fund's journey, once a beacon of success, now faces uncertainties as investors seek clarity amid a shifting investment landscape.

Scottish Mortgage's Strategic Gambit: Navigating Geopolitical Waves and Investment Surprises

In a bold move defying the industry trend, Scottish Mortgage took a contrarian stance by increasing its allocation to China amid a regulatory crackdown that prompted other asset managers to slash their exposure. While Beijing had proposed new regulations to rein in the power of its internet platforms in 2020, it wasn't until 2022 that Scottish Mortgage decided to reduce its stakes in tech giants Tencent and Alibaba. Lawrence Burns, co-manager of the fund, acknowledged the challenges posed by a geopolitically volatile world and stressed the need to scrutinize the geopolitical implications of their investments more thoroughly.

One notable example of their recalibrated approach is the investment in Northvolt, a Swedish battery company comprising 3.2% of the portfolio. Scottish Mortgage is banking on Northvolt's strategic importance as Europe seeks to pivot away from Chinese manufacturers dominating the industry.

However, Burns candidly admitted two critical mistakes. First, there was a delay in responding to the geopolitical uncertainties surrounding China, a lesson prompting a more diligent assessment of geopolitical implications in future investments. Second, there was an underestimation of the impact of deteriorating market conditions on companies' growth. Burns reflected, "I think we were probably too optimistic in terms of – as those lockdowns ended – the growth rates that those companies would be able to produce.

In 2023, despite the market's rebound defying expectations, Scottish Mortgage saw modest gains of just 13%, trailing behind other growth-focused trusts like Polar Capital Technology Trust, which soared almost 50%. The trust's decision not to invest in some of the top-performing stocks of the year, such as Microsoft, Apple, and Alphabet, contributed to this relative underperformance.

Alan Brierley, an investment trust expert at Investec, noted, "The numbers were ok. But they were well behind what other growth managers, like Polar Capital and Allianz, achieved." The absence of exposure to the so-called "Magnificent Seven" played a role, but Burns defended the decision, emphasizing a selective approach.

As Scottish Mortgage navigates the complex landscape of geopolitical shifts and market dynamics, the fund's journey continues to unfold, prompting reflection on lessons learned and strategic adjustments in the pursuit of future success.

Unlocking Potential: Scottish Mortgage's Pursuit of Outliers in Unlisted Holdings

In the ever-evolving landscape of investment strategy, Scottish Mortgage stands out for its relentless pursuit of exceptional returns through a focused approach. Lawrence Burns, co-manager of the fund, articulates the fund's mission: "What we’re looking for is a small number of companies that can deliver exceptional outlier-like returns." The emphasis is not merely on identifying good companies but on pinpointing those that can truly make a transformative impact for shareholders over the long haul.

A distinguishing feature of Scottish Mortgage's strategy lies in its allocation of up to 30% to unlisted holdings. This unique approach enables ordinary investors to access companies that might otherwise be challenging to reach, such as ByteDance, the Chinese powerhouse behind TikTok. Among its private holdings, the standout is Elon Musk's SpaceX, a quintessential asset targeting significant industry growth, boasting stellar profitability, and now valued at a reported $180 billion (£142 billion).

The rationale behind investing in unlisted companies is to capture more of their growth potential before they go public. With the average company now taking 20 years to go public (compared to four years in 2000), this strategy provides a unique avenue for investors. However, the path is not without its challenges, as demonstrated by a write-down on Convoy, a freight start-up that faced a swift downturn due to a slump in shipping demand.

Scottish Mortgage's private company investments have come under scrutiny, particularly following the departure of former director Amar Bhidé, who raised questions about the management of unlisted holdings. In response, the trust released additional information on its top 10 private firms, reassuring shareholders with insights into their average growth—164% over three years, or 58% excluding one exceptional company.

In the ever-unpredictable world of investing, Scottish Mortgage's commitment to identifying and nurturing potential outliers remains a key driver, creating a unique investment narrative that unfolds against the backdrop of both triumphs and challenges in the realm of unlisted holdings.

Navigating Challenges and Seizing Opportunities: Scottish Mortgage's Path Forward

As Scottish Mortgage grapples with evolving market dynamics, analysts and investors are divided on the fund's strategy and risk exposure. Ewan Lovett-Turner of broker Numis sees promise in the disclosed portfolio, asserting that it "has the potential to deliver growth, even in a higher interest environment." However, concerns persist, particularly regarding the fund's substantial exposure to private companies, constituting nearly a third of its asset value.

JP Morgan analysts, in a cautionary note last summer, expressed worry that the 30% limit on private companies could hinder the trust's ability to repurchase shares and provide follow-on capital to such firms. Co-manager Lawrence Burns countered these concerns, stating that the 30% limit did not impede the exploration of new private company opportunities in 2023. The fund deployed £193 million into private companies last year, including follow-on investments in software companies Databricks and Stripe, and a new investment in tech platform Oddity.

Another area of contention is Scottish Mortgage's use of borrowing, or "gearing," currently standing at 12%—slightly above its long-term average of 10% and higher than the industry average of 7%. Analysts, such as Mr. Brierley, view this as a high level of gearing for an already high-risk strategy. However, Burns highlighted the trust's strength, noting a manageable average cost of debt at 2.7%, and minimal impact from higher interest rates due to debt reduction.

Looking ahead, potential developments such as Northvolt's rumored stock market flotation and SpaceX's potential spin-off of Starlink could play pivotal roles in shaping Scottish Mortgage's trajectory. Numis noted that these events would provide "a highly visible valuation point for investors" and potentially alleviate pressure on the 30% limit for unlisted firms.

Amidst uncertainty about the IPO market's resurgence in 2024, a successful private company going public emerges as Scottish Mortgage's prime opportunity to bolster investor confidence and initiate a recovery. The fund's journey forward unfolds against the backdrop of strategic recalibrations, risk assessments, and the anticipation of key market events that could redefine its path in the coming months.

As Scottish Mortgage navigates the intricate landscape of market challenges and opportunities, the fund's future is marked by a tapestry of divergent perspectives. While some see potential for growth in the disclosed portfolio, others harbor reservations about the fund's exposure to private companies, accounting for nearly a third of its asset value. Concerns about the 30% limit on private companies and the fund's gearing have sparked debates among analysts and investors.

In response to skepticism, co-manager Lawrence Burns counters that the 30% limit did not impede the fund's exploration of new private company opportunities in 2023. The fund's strategic deployment of £193 million into private companies, including follow-on investments and a new venture, reflects a commitment to navigating the complexities of the market.

The debate over gearing continues, with differing opinions on whether the current 12% level is too high for an already high-risk strategy. Burns, however, emphasizes the trust's resilience, citing a manageable average cost of debt and minimal impact from higher interest rates due to prudent debt reduction.

Looking forward, potential developments such as Northvolt's rumored stock market flotation and SpaceX's potential spin-off of Starlink hold the promise of influencing Scottish Mortgage's trajectory. These events could provide visible valuation points for investors and potentially alleviate pressure on the 30% limit for unlisted firms.

As 2024 unfolds, uncertainties persist about the resurgence of the IPO market. Nonetheless, a successful transition of private companies into the public sphere emerges as Scottish Mortgage's key opportunity to rebuild investor confidence and spur a recovery. The fund's forward journey is marked by strategic recalibrations, risk assessments, and the anticipation of market events that will undoubtedly shape its narrative in the months ahead.


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