Scottish Mortgage: Staying the course
The coronavirus (Covid-19) pandemic is creating testing times for us all. We wish to begin by acknowledging the immediate challenges many are facing, far beyond the narrow world of investment.
Candidly, we are no better placed than any other investors to comment on the circumstances around or the duration of the spread of the virus, so we have not done so here.
Scottish Mortgage Investment Trust PLC’s financial year end fell on 31 March 2020 and we are in the process of creating the Annual Report, which will include pieces from both Tom Slater and James Anderson.
In the meantime, the purpose of this article is to give reassurance that we remain steadfast and focused on managing the assets of Scottish Mortgage in the long-term interests of our shareholders and on supporting our portfolio of businesses around the world.
Importance of endurance
At Baillie Gifford, we have been investing in companies around the world for more than a century for Scottish Mortgage. But we know that it is not always easy.
Over the last 20 years alone we have experienced several global crises. Each was different from the last, but with the same recurring lesson – keep calm and endure.
Scottish Mortgage’s investment philosophy is very long term, with a time horizon of five years and beyond.
Investments are selected based on a company’s fundamental business characteristics and potential for growth to generate returns. That is simple to state but hard to do, even at the best of times.
No change to investment approach
The temptation during such extraordinary times is always to ‘do something’. But as actual investors in great growth companies with strong competitive advantages, which are themselves run for the long term, the best (and hardest) option is usually to do nothing.
We never attempt to predict the immediate future path of stock markets. There will be considerable challenges ahead for all companies, with both a demand and supply side impact on many, but these will not be uniform across every business.
Many of the holdings in Scottish Mortgage’s portfolio were already at the forefront of the broadening shift online across a host of industries.
The first group of the holdings that might come to shareholders’ minds in this regard would probably be the digital commerce businesses (Amazon and Alibaba, Pinduoduo, Zalando or Shopify), likely closely followed by the social media and digital entertainment companies (Tencent, ByteDance, Netflix, Spotify, Facebook and Google).
But it is also those companies in which we invest that are changing the way people access food (Meituan-Dianping, Delivery Hero, HelloFresh), financial services (Ant Financial, Affirm, Stripe, TransferWise) and work (Workday, Slack or Zoom), that are leading the way.
Two of the companies we hold are even using digital mobile technology to make the haulage industry far more efficient (Convoy and Full Truck Alliance).
In healthcare, Vir Biotechnology is one example of a holding focused on treatment and prevention of infectious diseases.
It is also possible that there will be a greater use of genomic sequencing in the future, potentially impacting our largest healthcare holding (Illumina) while another aims to produce a simple and reliable sequencing-based test for as many cancers as possible as early as possible (Grail).
We are thinking through those areas where the adoption rates of the new business models in the portfolio might accelerate, but also considering the potential impacts on all the businesses we hold and the prospects for future returns.
‘continue to focus on assessing the long-term prospects for the companies held in the portfolio’
As a starting point, companies must be able to endure through such times and to fulfil their societal role. We will therefore continue to focus on assessing the long-term prospects for the companies held in the portfolio.
There are likely to be significant dislocations between share prices and companies’ fundamentals in market conditions such as these, which may offer attractive buying opportunities.
Yet often that is only one side of any investment decision. Scottish Mortgage always maintains a fully invested portfolio.
Any new opportunity must be balanced against the prospects for the holding we would have to sell to fund that purchase. This is part of the ongoing healthy competition for capital in the portfolio. Many of our current holdings appear to us to offer attractive buying opportunities on a long-term view.
Now more than ever we believe that it will pay to be a patient stock picker. Shareholders can be reassured that we have not changed our approach for Scottish Mortgage.
Private companies fair valuations
Over the last decade, Scottish Mortgage has invested in a number of private companies. Given the recent turbulent nature of global public stock markets, we thought it might be helpful to provide a brief recap here on the valuation process for these unlisted assets during such periods.
These unlisted assets are held at ‘fair value’, i.e. the price we would be paid today in an open market transaction. This means that we have to review the pricing of these regularly.
That process is carried out for Scottish Mortgage by Baillie Gifford on a rolling three-month cycle, with a third of these assets reviewed each month by a separate valuation group (not including any fund manager responsible for making the investments).
As an investment trust and a public company, the prices of these assets are also reviewed in depth twice a year by the independent Board of non-executive directors for Scottish Mortgage (none of whom have ever worked for Baillie Gifford).
They are also subject to the scrutiny of the Company’s independent auditor, PricewaterhouseCoopers, as part of the annual audit process. Full details can be found in the Annual and Interim Reports elsewhere on this site.
Outwith that regular cycle, should a so-called ‘trigger event’ take place (either based on the information with which the individual companies supply us on a regular basis or by virtue of a change in public stock market conditions) which might materially impact the price we could obtain in the market, we will call an ad hoc fair valuation review at Baillie Gifford.
If the determination of this review is that it is appropriate to change the holding valuation, then this will be reflected in the next published Net Asset Value (NAV). There is no delay.
So, for example, in the event of large swings in the level of public equity markets, either in a specific sector or more broadly, we would consider whether an ad hoc review was required for any of our relevant unlisted holdings.
In many such circumstances, the current price obtainable for private companies in the same area might also be materially impacted, whether or not there had been any significant change at the underlying businesses themselves.
The relative weighting of the unlisted holdings overall in the portfolio would not, therefore, automatically see a steep increase as a result of broad and substantial public market falls as it is likely that in such circumstances many of these assets would also see a decline in their ‘fair valuations’.
There has been no change to our long-standing published valuation policy and, as would be expected, we have held multiple ad hoc pricing reviews through the recent turbulent period.
As a result, the unlisted assets continue to represent roughly the same proportion of the overall portfolio as they did before the impact of Covid-19 on global stock markets.
While we appreciate that it may be of rather cold comfort for our shareholders through such challenging times, this robust policy does help to ensure that the published NAVs for Scottish Mortgage remain reflective of the current fair values of all the assets in the portfolio.
The Annual Report and Financial Statements for the financial year ended 31 March 2020 for Scottish Mortgage Investment Trust PLC will be published and available on our website in due course.
Disclosure – This is a non-independent marketing communication dated 23rd April 2020
The analyst who has prepared this report is aware that Kepler Partners LLP has a relationship with the company covered in this report or an affiliate company and that there may be a conflict of interest which could impair the objectivity of the research.
The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.
The value of shares in Scottish Mortgage, and any income from them, can fall as well as rise and investors may not get back the amount invested.
IMPORTANT INFORMATION AND RISK FACTORS
Investment markets and conditions can change rapidly.
The views expressed in this article are those of Scottish Mortgage and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect personal opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.
The Trust has a significant exposure to unlisted investments. The Trust’s risk could be increased as these assets may be more difficult to buy or sell, so changes in their prices may be greater.
This article contains information on investments which does not constitute independent research. Accordingly, it is not subject to the protections afforded to independent research and Baillie Gifford and its staff may have dealt in the investments concerned.
Baillie Gifford & Co Limited is authorised and regulated by the Financial Conduct Authority (FCA). The investment trusts managed by Baillie Gifford & Co Limited are listed UK companies. Scottish Mortgage Investment Trust PLC (Scottish Mortgage) is listed on the London Stock Exchange and is not authorised or regulated by the FCA.
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