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UK investment trust Scottish Mortgage (OTCPK: STMZF ) has certainly lost its luster over the past year.
From my last, positive, piece on the company last April ( Scottish Mortgage Investment Trust: Becoming attractive again) shares fell by 34 percent. At that point I said there might be more turbulence in the coming months, which there has been, but I’m bullish. Accordingly I maintain a “Buy” rating.
humble year
The Financial Times The fund manager told an investor forum in London that 2022 was a “modest year” after the fund manager (Baillie Gifford) on Tesla ( TSLA ) and Shopify ( SHOP ) made deals worth $8bn and $6bn respectively. Note that those figures refer to losses on Bally Gifford’s fund, not Scottish Mortgages specifically. Still, 2022 was hardly a banner year Scottish mortgages.
Although the final results will not be available until next month, the interim results have given a taste.
The first paragraph of the interim management report makes interesting reading for its long-term perspective and storytelling, but also for the message that trust managers clearly want to convey:
Scottish Mortgage’s long-term capital growth comes from funding and patiently supporting the growth of growth companies. The trust was established to provide capital to businesses with large opportunities, but after the market panic of 1907 access to funds was limited. Remembering this founding story is important in times of stress: corporate potential has nothing to do with the cycle of greed and fear. In stock markets.
In other words, this too will pass.
But while few doubt that long-term investment in future growth stories can work as a strategy, the question is whether it can work as well for Scottish mortgages in the 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 had “reduced several Chinese holdings, including long-standing investments in Alibaba (BABA) and Tencent (OTCPK:TCEHY). China’s regulatory environment remains challenging, and we are concerned that continued uncertainty may risk- would damage the culture of tolerance that has driven the long-term success of China’s private sector.”
Whether this is a wise call in the long run remains to be seen. I see this as a fairly significant turn of events, though, given the significant exposure the trust has had to China’s growth story in recent years.
Current portfolio
The Trust’s portfolio and broad strategy are listed on its website. The strategy focuses on three main thematic pillars (technology meets healthcare, decarbonisation and the digitalised world) as well as a mop up catchall (“and beyond”).
Moderna ( MRNA ), ASML ( ASML ), Tesla ( TSLA ), MercadoLibre ( MELI ), SpaceX, Northvolt, Illumina ( ILMN ), Kering ( OTCPK: PPRUF ) and Kering ( OTCPK: PPRUF ) currently round out the top ten holdings. Meituan (MEIT) and ByteDance.
With its technical orientation, it is no surprise that the trust has performed poorly over the past 12 to 18 months. The portfolio remains heavily weighted towards technology although the importance of pharma has increased over the past several years.
Looking at the portfolio, I think the outlook for the trust is broadly how it has been, during which it has performed very well over the past few years. There have been changes: Tesla’s stake is much lower and China exposure is not on the way up. But essentially, Scottish Mortgage is doing what it has done for decades, as pointed out in its interim results: trying to buy early on strong growth stories.
Rating: Potential long-term deal
Shares have recently been trading at a discount to net asset value, currently around 20% based on fair ex-NAV and 17% on par ex NAV. That is substantial, suggesting that much of the investor enthusiasm previously seen for Scottish mortgages has waned.
Is this 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 to invest in. I think it needs to form a bigger part of its assessment approach. How does one actually value it? There is no clear way other than to look at the current portfolio and assess its potential long-term value, as well as credit (or not) the management skills of the (new) fund manager and the trust’s established investment strategy.
On that basis I see the current share price as a value proposition over the long term, as I expect future price appreciation from holdings like Tesla, SpaceX, Northvolt, and ByteDance. I also expect the gap between share price and NAV to narrow.
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