Scottish Mortgage, the country’s largest publicly traded investment company, will hold its annual meeting at the Royal College of Physicians in Edinburgh at the end of this month.
While annual trust meetings, like other events at the college which was granted a royal charter in 1681, are not normally boisterous affairs, this one can be quite fiery.
Baillie Gifford, the trust’s Edinburgh-based investment manager, and members of the fund’s board of directors are expected to face tough questioning from shareholders about the fund’s dismal recent performance. Investors will want to know what went wrong – and more importantly, what the future holds. Will things get worse or does the future look brighter?
There certainly won’t be any Just Stop Oil-style protests, but it won’t be a normal lukewarm annual meeting where most shareholders show up mainly for a free drink and a few cheese and pickle sandwiches. It can get prickly.
Shareholder concerns are understandable. In the financial year to April, the £9.7bn trust saw its share price fall by a third as the focus on tech growth companies loosened against a backdrop of rising inflation and higher interest rates in the US and UK. The poor performance prompted Baillie Gifford chief executive Tom Slater to admit that the past 12 months had been ‘painful for shareholders’.
Slater took over full responsibility for running the trust last April when longtime manager James Anderson stepped down after 22 hugely successful years at the helm.
Adding to investors’ concerns, there was an almighty outburst in the boardroom, with an outgoing executive Amar Bhide accusing the company of poor governance and “seriously misleading investors” about the reasons behind his departure. While Slater says confidence won’t deviate from its focus on exceptional growth companies, some leading mutual fund analysts are concerned.
They fear the fund’s significant exposure to privately held companies — accounting for nearly 30 percent of the trust’s assets — remains a huge investment risk. They are also concerned about the high level of borrowing to buy even more risky assets. As a result, they recommend that shareholders sell their shares.
Other experts take the opposite view. Interactive Investor continues to include the trust in its list of 60 “super” funds, arguing that it remains a “good long-term option for investors seeking access to high-growth and blue stocks.”
According to the investment platform, Scottish Mortgage is the eighth most purchased investment – including individual stocks and funds – by its clients over the past six months. No other fund or mutual fund has been so popular.
The buying was driven by the trust’s low share price (“it couldn’t get any worse”) and the shares’ large discount to the trust’s underlying assets (“they’re a bargain”).
Few mutual funds have attracted as much attention from private investors in recent years as Scottish Mortgage. For better or for worse, it has been the talk of the town. Weird name, but a provider of rocket-driven investment returns for a while now.
Its meteoric rise, which began in the aftermath of the 2008 financial crisis, has made it the country’s largest and most popular publicly traded trust. In March 2017, it entered the FTSE 100 Index as one of the top 100 companies in the country by market capitalization – valued at over £5 billion.
Those who bought into the trust in early 2009 and held on to their shares saw the value of their investments increase tenfold.
But at one point, just before interest rates and inflation started to rise in late 2021, those same investors would have been sitting on stocks that were 22 times higher.
Established in 1909, the transformation of Scottish Mortgage was due to Anderson. At Baillie Gifford, he spearheaded a drive to transform the employee-owned investment business into a major financier of exceptional growth companies – and technology companies in particular.
Many Baillie Gifford funds now reflect this emphasis on growth companies, but none more so than Scottish Mortgage. An early financier of the likes of Amazon and Tesla, Anderson delivered great returns for the trust.
In his tenure as manager – from April 30, 2000 to March 31 last year – the trust generated a return to shareholders of 1,155 percent. Over the same period, the FTSE All-World Index returned 354 percent.
Anderson, who has since returned to managing money on behalf of Italian industrial conglomerate Agnelli, couldn’t have timed his departure from Scottish Mortgage more perfectly from a reputation standpoint. He left just as an era of low interest rates and cheap loans came to an end – ideal conditions for new tech companies to grow and prosper.
Jason Hollands, managing director of investment platform Bestinvest, explains: “Growth companies such as those targeted by Scottish Mortgage have been valued by the stock market on expected cash flows, to a lesser extent on current earnings. When money was cheap and real borrowing costs were close to zero, this helped the way growth companies were valued, hence the trust’s explosive performance from 2009 onwards.
“Yet the aggressive rise in interest rates around the world since late 2021 has shattered that, making future cash flows from growth companies seem less valuable in today’s money, resulting in the stock price correction of 55 percent since early December 2021.”
While Hollands says there’s no reason why the trust’s growth approach couldn’t work again, he believes it’s going to “take a while to get past the near-challenges” — especially as interest rates continue to rise and the recession deepens. the US is looming. He therefore does not advise investors to buy the shares.
But the trust’s fault isn’t its rigid tenacity to invest in growth companies. Slater argues, “There is no going back to a world of static and immutable industries.”
It’s the fund’s exposure to privately held companies that has some experts worried – companies that often need new capital injections on their way to profitability. These holdings – at 29.9 percent – match the 30 percent cap imposed by the trust’s board of directors, making it difficult for the asset manager to participate in future rounds of funding from any of the non- -listed participations. Non-participation means that the interest of the trust is diluted. It also curtails the trust’s ability to invest in exciting new opportunities such as artificial intelligence.
Alan Brierley, investment confidence analyst at Investec Bank, released a detailed research note on Scottish Mortgage in January, advising investors to sell. He has expressed a number of concerns: the trust’s high indebtedness and the difficulty of making follow-on investments in unlisted holding companies. Still, his big fear is that the current value put into the unlisted positions is unsustainable and likely to take a significant dent.
Last week, Brierley said nothing had happened that caused him to change the sell position. He said: ‘When equity markets are buoyant, Scottish Mortgage’s exposure to unlisted equities will act as a dragging anchor for investors. Moving back to a risk-free environment where investor sentiment is negative could accelerate the valuation reset.”
Enough food for thought for investors in the run-up to the annual meeting.
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