Interim Results: Scottish Mortgage
This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. This material should be considered as general market commentary.
We look at the recently published results of SMT, diving into whether this extraordinary run can continue…
Last week Scottish Mortgage published its interim report for the six months ending 30 September 2020.
During the six month period, the trust saw it’s NAV rise 76%, compared to a 24% increase from the benchmark FTSE All-World Index.
This now means that over five years Scottish Mortgage (SMT) has delivered NAV total returns of 340% versus a 96% from the index.
SMT has been particularly buoyed this year by its exposure to some of the Corona-virus pandemic’s biggest beneficiaries; with strong returns concentrated among a selection of holdings among which Amazon is a key example, but also by its long held exposure to electric car manufacturer cum-lifestyle brand Tesla.
Whether these extraordinary returns can continue remains to be seen, but the chairman was keen to stress that – even after significant moves upward – the portfolio has exposure to companies with real long-term potential.
“…The oddities of the pandemic will fade, some long-running shifts in our economy will have been accelerated and the stresses we have experienced will spark new waves of innovation. More importantly for your portfolio, several holdings have made considerable progress and we have greater clarity on both the size of opportunity and the companies’ ability to execute.
“The increase in Tesla’s stock price and its dramatic impact on the Trust’s returns should be seen in context. Whilst the company and its colourful founder attract an unusually high degree of attention, emotion and noise, the underlying return picture is far from an aberration.
“…This picture of strong execution and greater clarity on the investment case is shared by a number of the portfolio’s other significant winners.”
The success of SMT has been little short of extraordinary. The managers, James Anderson and Tom Slater, have maintained conviction in their long-term expectations for companies despite vicious volatility and concerns about valuations.
Their patience has been rewarded and, as described above, the trust has far exceeded the benchmark and peers in terms of NAV growth.
The big question for shareholders, of course, is whether this outperformance can continue. The managers continue to believe that there are an abundance of opportunities across the globe, and their high conviction approach (with the top ten making up more than 50%) looks to take advantage of that.
We, at Kepler Trust Intelligence, believe the outlook for the trust is likely to revolve around four key considerations which could impact both short-term and longer-term returns either positively or negatively:
Where are interest rates heading? Many of the holdings have very high valuation multiples. However, against a nearly 40-year trend of declining interest rates, these valuations have increasingly been supported by very low discount rates being applied to the value of future cash flows against present value.
Any sign of a sustained move higher in discount rates may cause valuation deratings across a host of growth areas. Conversely, ongoing support from monetary policy could prove a tailwind. It is notable that, even as we write, technology and associated sectors are trailing as the markets digest the possibility of a Covid-19 vaccine and economic normalisation.
Will inflation remain low? In order for rates to remain low, inflation also needs to remain at levels deemed tolerable by policy makers. With massive debt piles, this may prove rather higher than previously.
The IMF has recently voiced support for global fiscal reflationary policies, which could expand the velocity of money.
Currently, governments can borrow extremely cheaply to spend and should be able to generate positive multipliers. Yet restive populaces will typically have a limit on how much inflation they will tolerate.
How will the West’s relationship with China develop? Currently, more than 30% of the portfolio is invested in Chinese companies, with the managers highlighting East Asia as their outstanding growth opportunity for the coming years, supported by the supposed rising middle class.
However, if China regresses even further into totalitarian dictatorship, a breakout from the middle-income trap seems less likely. Against this, the sheer weight of the population should continue to offer growth opportunities.
Antitrust concerns? Alphabet has recently become subject to antitrust action from the US Department of Justice. Although this will have limited direct impact upon SMT (with only 1.1%), it has potential implications for many of their earlier stage holdings.
Judging by current valuations of many of the small cap, blue-sky companies held in SMT, the market is essentially assuming future monopoly status and, as such, greater ability to convert revenues into positive cash flow, typically by squeezing suppliers.
If there are signs the US government will not tolerate such market power, irrespective of the impact on the consumer, the future cash flows assumed will be negatively impacted.
SMT has performed so well for so long that it is tempting to assume that, sooner or later, the gig will be up. However, to steal another quote from the chairman: “A clear lesson from this year’s events is that we should treat confident pronouncements about the future with scepticism.”
SMT has enjoyed a period of performance supported by a number of structural tailwinds and, for as long as those tailwinds remain in place, and with the proviso that investors should be alert to any change in wind direction, we see no reason why the Scottish giant cannot continue to deliver the goods.
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