Scottish Mortgage: A long-term winner with short-term struggles

Scottish Mortgage Investment Trust [LON:SMT] (SMIT), a closed-ended investment trust with around GBP14bn of assets under management has persistently been one of the top fund picks by investors and commentators over the last ten years.

It’s been a while since The Armchair Trader examined the fund, which falls under the Baillie Gifford umbrella, but SMIT has kept on doing what it does best, and had you put your money into SMIT a decade ago, you’d be looking at having nearly four times as much today.

• Manchester & London leading the pack
• UK sees largest ever investment trust merger between Alliance and Witan
• Witan Investment Trust set for a strategic overhaul

The investment trust was established in 1909 as the Straits Mortgage and Trust Company Limited in Edinburgh by Lieutenant Colonel Augustus Baillie and Carlyle Gifford, who had one-year previously founded the law firm that would evolve into asset management firm, Baillie Gifford. Having seen these new-fangled contraptions, horseless carriages, or automobiles, whizzing around the fashionable districts of Auld Reekie at up to 14 miles per hour, Baillie and Gifford realised what a revolutionary development they were, and looked to capitalise on the industry’s growth.

Things had definitely moved on in a decade when Walter Arnold was picking up a speeding ticket in Peckham for driving his Benz at 8 miles an hour – four times the legal speed limit.

It soon emerged that automobiles couldn’t reach their white-knuckle velocities without running on soft rubber tyres, and Baille and Gifford decided that their new investment vehicle would aim to support the emerging rubber plantation industry in the far outposts of Empire in Malaya. Within four years the Straits Mortgage and Trust Company had moved on from Malaya and had adopted a global mandate, changing its name to the Scottish Mortgage and Trust Company.

Global search for growth

The fund has maintained its global mandate and still today looks for exposure to the high tech industries of the future. Within 50-years the fund grew from GBP50,000 to GBP100m, absorbing two other investment trust also managed by Baillie Gifford. By 2017 the investment trust had assets under management of GBP5bn and was a constituent of the FTSE100 index; its growth spurred by its focus on technology and emerging markets, the fund started to explore private equity investment under the guidance of lead manager, Tom Slater, who had been with Baillie Gifford since 2000, deputy manager since 2009 and lead in 2015. The fund expanded its mandate to include up to 30% of assets in private capital and Slater was joined in the control room by Lawrence Burns, who became deputy manager in 2021.

Benchmarked against the FTSE All-World Index, the fund aims to maximise total returns over the long term through investment in both public and private growth companies. Slater said: “The returns we aim to produce for shareholders will appeal to many, but the road travelled in achieving them may not.”

The company is playing close to its public/private equity allocations, and at the close of December 2023, the fund had invested 27.3% of total assets into private companies, which represented 52 individual holdings. On the flip side of the coin 72.7% of the fund was invested in listed global equities, which equated to 47 individual holdings making a total portfolio of 99 companies.

Long-term outlook, low churn

The managers do not take a broad-brush approach and prefer to invest in a more concentrated portfolio (99 stocks in a GBP14bn portfolio is pretty concentrated) that offers great growth potential and then holds its picks over the long term. The top-30 holdings as of December equated to 76.9% of the total portfolio with a low churn and annual turnover of just 5% AUM, which implies an average holding period of 20-years..

The fund can gear up to 14% of AUM, in December the gearing was at 13% with total borrowing of GBP1.33bn.

The fund wouldn’t have grown into the vast entity it is now had performance been poor. As explained, the managers take a long-term buy-and-hold approach, so they should be judged on their long-term performance.

And over 10-years to the end of December 2023, when comparing the NAV to the benchmark, the fund beat the index by 155 percentage points to return 348.2%. Over five years, the fund returned a quite respectable 99.3% compared to a 77.8% return for the benchmark.

Over the shorter term, however, cumulative performance over three-years was -23.9%, some 52 percentage points behind the index, and over one-year also lagged behind the benchmark, which returned 15.7% to Scottish Mortgages’ 10.1%.

Avoiding impulsive decisions

On a discrete annual basis between 31st December 2018 and 31st December 2023, the company outperformed the benchmark on NAV terms in two out of five annual periods (2018/19 and 2019/20) but the outperformance it achieved in 2019/20 was so great – +106.5% against a benchmark return of +13% – that its underperformance between 2020/21 and 2022/23 was eclipsed by its positive performance. The fund’s worst year was 2021/22 where it returned -39% against a benchmark return of -7.3%.

Slater wrote last year: “We know this has been painful for shareholders, but history shows that periods of poor performance are inevitable. Our approach will never be consistently in favour, and we should not deviate from it to avoid short-term headwinds. If patient ownership of growth companies was easy, there would be far more competition.”

He continued: “We cannot know when stock markets will reflect the progress we see, but in the long run, share prices follow company fundamentals. In the meantime, we will focus on the bigger picture and avoid impulsive decisions based on market movements.”

On a geographical basis the fund was – to no surprise given its technology/growth bias – heavily allocated to North America, with 54.3% of AUM in the market. The next biggest asset allocation was to Europe at 24.2%.

Conviction-driven approach

The managers are very conviction-driven and believe in the process and philosophy of the fund, notwithstanding the macro conditions. Slater, writing last year said: “Growth and innovation are not dependent on the direction of macro-economic developments. Instead, we pay close attention to exponential trends such as Moore’s Law in semiconductors, Carlson’s Curve in genomic sequencing or Wright’s Law in manufacturing.”

He explained: “These predictable trajectories of progress are a valuable way to understand what is happening in the world. A feature of these laws is that progress each year can underwhelm but cumulative progress over a decade or more is remarkable. The past year was an exception because there were breakthroughs across various industries and technologies.”

Scottish Mortgage Investment Trust top five holdings

Source: Baillie Gifford 31/12/23

The fund has an ongoing charge of 0.34% a dividend yield of 0.5% and is available on most investment platforms or to buy as a share.