Scottish Mortgage empasises the long term after bruising year

‘For Scottish Mortgage, our time horizons reach far beyond most others but a sunny long-term forecast is of little value if companies themselves cannot navigate the current storms.

‘It has been pleasing, therefore, to note that, whilst many portfolio companies possess the potential to shape the future, they have also continued to deliver strong operational performance and maintained a robust financial position.’

Over a ten-year period to the end of March, the trust delivered a 635% return on its net asset value, against a 232% gain for its benchmark.

The managers say: ‘This approach will sometimes be popular and sometimes, as now, be out of favour. Because of such swings, we discourage those with a time horizon under five years from investing in our shares.’

The total dividend for the year will be increased by 5% to 3.59p. Most of that will be paid from revenue reserves as the net revenue return for the year was 1.16p per share.

Looking at drivers of returns, the managers highlight the effects of President Xi’s regulatory crackdowns in the name of ‘common prosperity’, and say that in retrospect it was ‘a mistake to reduce our holdings in western online platform companies rather than their Chinese counterparts’.

The company’s results statement highlights previous periods of extreme turbulence in the share prices of stocks held by Scottish Mortgage:>

‘Tesla was first purchased by Scottish Mortgage in January 2013. It experienced a fall of 40% that first year alone. During the course of our ownership, it has now fallen by 30% or more on seven occasions. Yet more extreme was NIO, the Chinese electric car maker. It endured a near 90% drawdown in the year following its IPO before experiencing its tremendous rise. Our other significant contributors to long-term performance such as Amazon, Illumina and Tencent have all been subjected to discomforting drawdowns during their time in the portfolio. The returns generated by these companies could easily have been forgone if the endurance of steep share price declines had not been weathered. Giving up on Tesla, on any one of those seven occasions, would have been catastrophic to the returns of Scottish Mortgage shareholders.’

The recent falls in some stocks in the portfolio have been particularly severe. The statement says:

‘Moderna has experienced a 70 per cent. fall from the highs of last year. While the market focus has been on the longevity of Covid vaccine revenues we have felt this overlooks the progress being made to apply its mRNA technology to a broader range of healthcare problems such as flu, Zika, HIV and even cancer. It is hard to argue significant value is being placed upon that broader potential platform when the company is valued by the market on a mere five-times earnings and has nearly one-third of its market cap in cash. We have therefore used the falls in the share price to add. This has in large part been funded by reductions to Amazon and Tesla.

Delivery Hero, is a local delivery company headquartered in Berlin but operating across 50 countries around the world from Argentina to Singapore. It suffered a particularly precipitous fall in its share price. Nonetheless, when re-visiting our investment case and accompanying scenario analysis we assessed that, if anything, the likelihoods of success may have actually increased. Our biggest concern had been competition in the key market of South Korea. Nonetheless, the most recent evidence is that it is growing rapidly and continuing to hold its near 80 per cent. market share in the country. Looking across all the markets it operates in revenues grew over 50% annually in the first three months of this year with a significant long-term growth opportunity still remaining. Continued progress does not appear to be recognised by the market. Indeed, over the last two years revenues have increased nearly four-fold and yet the share price has fallen over 50 per cent. during that same period.

We would far rather endure painful drawdowns such as these than too readily abandon the companies and founders that have the potential to deliver the rare outlier returns we seek. We remain deeply enthused by some of the long-term changes we are seeing in the world and the companies bringing those changes to life. The continuing digitisation of our society, the intersection of biology and information technology and the much needed energy transition, each offer tremendous long-term structural opportunities.

Of course, our reaction to some drawdowns will still be to conclude that the investment case is not developing as hoped. This was the case with CureVac, the German biotechnology company which we held for six years starting as a private company. The lack of progress in multiple clinical trials compounded with several disconcerting management changes led us to ascribe a substantially lower likelihood of success and we therefore divested last summer.’

Tom Slater, Baillie Gifford’s manager of Scottish Mortgage, which has extensive Asian holdings, said the deteriorating geopolitical backdrop and major job losses in the technology and education sectors have made the Chinese government’s ‘aggressive regulatory stance less tenable’.

He added: ‘The challenge now for western investors is twofold: incorporating the low but increased chances of future US sanctions into their evaluation of Chinese investments and considering how the Chinese state may limit the upside in stock prices for the breakthrough winners.

‘Our Chinese holdings have remained largely unchanged through this period of turbulence.’