Scottish Mortgage Investment Trust: Proven Approach Could Deliver Again

U.K. investment trust Scottish Mortgage (OTCPK:STMZF) has certainly lost a lot of its shine over the past year.

Since my last, positive, piece on the company last April (Scottish Mortgage Investment Trust: Becoming Attractive Again) the shares have lost 34%. At that point I said there may be more turbulence in the coming months, which there has been, but I remain bullish. Accordingly I maintain a “buy” rating.

Humbling year

The Financial Times reports that the fund manager told an investor forum in London that 2022 was a “humbling year” after stakes held by the fund manager (Baillie Gifford) in Tesla (TSLA) and Shopify (SHOP) contracted by over $8bn and $6bn respectively. Note that those numbers refer to the loss across Baillie Gifford’s funds overall, not Scottish Mortgage specifically. Still, 2022 was hardly a banner year for Scottish Mortgage.

While the final results are not due until next month, the interim results gave a flavour.

The first paragraph of the interim management report makes interesting reading for its long-term perspective and storytelling, but also the message the trust managers clearly wish to convey:

Scottish Mortgage’s long-term capital appreciation has come from financing and patiently supporting the development of growth companies. The trust was founded to provide capital to businesses with big opportunities but restricted access to funding following the market panic of 1907. It is important at times of stress to remember this founding story: corporate potential has little to do with the cycles of greed and fear in stock markets.

In other words, this too shall pass.

But while few doubt that long-term investing in future growth stories can work as a strategy, the question is whether it can work as well for Scottish Mortgage in coming years as it has in the recent past.

One of the drivers of Scottish Mortgage’s performance in recent years has been its holdings in Chinese companies. In its interim results, it noted that it has “reduced several Chinese holdings, including long-standing investments in Alibaba (BABA) and Tencent (OTCPK:TCEHY). The regulatory environment in China remains challenging, and we are concerned that ongoing uncertainty will harm the risk-tolerant culture that has driven the long-term success of China’s private sector.”

Whether this turns out to be a wise call or not in the long run remains to be seen. I do see it as a fairly significant about turn, though, given the trust’s significant exposure to the China growth story in recent years.

Current Portfolio

The trust’s portfolio and broad strategy is listed on its website. The strategy is focussed on three main thematic pillars (technology meets healthcare, decarbonisation, and a digitalised world) along with a mop up catchall (“and beyond”).

The top ten holdings currently (accounting for 43% of the total) are Moderna (MRNA), ASML (ASML),Tesla (TSLA), MercadoLibre (MELI), SpaceX, Northvolt, Illumina (ILMN), Kering (OTCPK:PPRUF), Meituan (MEIT) and ByteDance.

With its tech orientation, it is no surprise that the trust has done poorly over the past 12 to 18 months. The portfolio remains heavily weighted towards tech although pharma has increased in importance in the past several years.

Looking at the portfolio, I think the trust’s approach is broadly similar to how it has been for a while, including the period during which it performed very well over the past few years. There have been changes: The Tesla stake is much reduced and China exposure is on the way down not up. But essentially, Scottish Mortgage is doing the same as it has for decades, as pointed out in its interim results: trying to buy into strong growth stories early on.

Valuation: A Possible Long-Term Bargain

Lately the shares have been trading at a discount to net asset value, currently of around 20% based on the fair ex NAV and 17% on par ex NAV. That is substantial, suggesting that a lot of the investor enthusiasm previously seen for Scottish Mortgage has fallen away.

Is it a bargain? I think so. Putting aside the net asset valuation discount, which in itself is attractive to me, the trust has a proven track record of finding some great companies in which to invest. I think that needs to form a large part of one’s valuation approach to it. How exactly does one value this? There is no clear way, beyond looking at the current portfolio and assessing its likely long-term value, as well as crediting (or not) for the management skill of the (newish) fund manager and established investment strategy of the trust.

On that basis I see the current share price as offering value in the long term, as I expect future price appreciation from holdings such as Tesla, SpaceX, Northvolt, and ByteDance. I also expect the gap between share price and NAV to narrow.

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