What’s next for Scottish Mortgage?

And when the share price of the trust rose sharply, much of this was a consequence of investments in large technology companies. 

However, since interest rates began to rise in the US its performance has gone into reverse. Meanwhile, a boardroom spat about the level of scrutiny placed on fund manager Tom Slater and his colleagues at the trust's management company, Baillie Gifford, has caused a blizzard of publicity and controversy to engulf the trust.

The situation raises questions over the long-term prospects for Scottish Mortgage investors. Some of the recent criticism was about whether the fund managers are challenged enough about their process, and the length of time many of the directors had been on the trust’s board.

This was crystallised by Amar Bhide, a recently departed director of the trust, who claimed that Scottish Mortgage’s managers have become too attached to certain themes and ideas. 

Slater, who is now the lead manager of the trust, which was more than £13bn in size at its peak, has told a story about how he was disturbed by a call from Elon Musk, the chief executive of Tesla, Space X and others, while in the process of bathing his child. Both Tesla and Space X are significant investments in the funds managed by Slater.  

The manager got to know some of the biggest names in Silicon Valley after spending a period of time there at the behest of his Edinburgh-based employer. 

Meanwhile, James Anderson, the recently retired joint manager of Scottish Mortgage, liked to discuss the books he was reading, the academics with whom he was on friendly terms, and how all of this fitted into the investment process for the trust.

Some might suggest that this served Scottish Mortgage well.

The trust’s share price topped £15 in November 2021, due to the prevailing low interest rate environment, coupled with optimism around the reopening of global economies after the pandemic, meant many investors were keen to own stocks that would generate the bulk of their returns in the future, particularly in sectors with connections to mavericks such as Musk or to cutting-edge academics. 

But subsequently higher interest rates and inflation since the start of 2022 have sent Scottish Mortgage shares spiralling downwards to £6 as investors ponder whether the trust’s board and Baillie Gifford are prepared for a world likely to be very different to the one in which the trust’s fortunes soared.

Lack of investment experience

The main thrust of Bhide’s criticisms, himself a professional academic, were that there was a lack of investment experience on the trust’s board.

He also questioned whether Baillie Gifford had sufficient resources to invest in early-stage private companies, something that had become the hallmark of the trust in recent years after it divested from established tech names such as Alphabet to invest in what they hope will be the winners from the next generation of technological change.

Bhide’s concerns were such that he reported Scottish Mortgage to the Financial Conduct Authority. 

In a statement to FTAdviser, a spokesperson for the trust’s board said they considered themselves as having adequate investment experience, and cited the professional careers of outgoing chair Fiona McBain and senior independent director Justin Dowley. 

In the trust’s favour, the performance of Scottish Mortgage Investment Trust remains strong when viewed on a five year time horizon, returning 52 per cent over the past five years, compared with 21 per cent for the AIC global peer group in the same time period.

But over the past year the trust has lost 38 per cent in share price terms, compared with a loss of 10 per cent for the peer group. (See chart.)

In addition to his role as joint manager at Scottish Mortgage, Slater is also head of the US equity team at Baillie Gifford, a desk that is responsible for managing tens of billions of pounds of client assets across multiple portfolios.

At the time he was made head of the US equity desk, a role which carries a seven-figure salary, Baillie Gifford said it had scoured the world to find someone for the job, prior to settling on Slater as the best candidate. 

This is relevant because another of Bhide’s criticisms revolves around the level of resource he feels needs to be deployed by those seeking to invest in relatively early-stage and unquoted companies. 

He feels that by choosing to invest in this space, the trust is effectively competing against US venture capital funds with infinitely more resources.

The frequency of revaluations is the most active/frequent of anyone in the industry. They are not venture capital majority stakes, requiring large operational teams, operational influence, board seats, etc Ewan Lovett-Turner, Numis

In a statement to FTAdviser on how much of his time Slater can devote to Scottish Mortgage, a representative of Baillie Gifford said: “The vast majority of Tom’s time is focused on researching stocks that are either current holdings within the Scottish Mortgage portfolio or potential candidates for the portfolio.

“There is a very high degree of natural overlap with his US equity responsibilities. The US desk is very well resourced. It includes two other Baillie Gifford partners and a number of other senior investors, so the management responsibilities for the US desk are shared broadly — they do not all fall to Tom.”

Data from FE Analytics shows that 51 per cent of Scottish Mortgage’s holdings as of March 30 2023 are in US-listed entities. 

The Scottish Mortgage board says it frequently questions Baillie Gifford about the level of resource available to the trust.

Stages of development

Another of Bhide’s concerns is about Scottish Mortgage’s increased propensity to invest in unquoted companies. At present, the trust can invest up to 30 per cent of its assets in this space. 

Because unquoted companies are not priced daily on stock markets, some investors fear that when the assets are revalued in portfolios, the valuations will be much lower and that will lead to future, further declines in the net asset values of the trust.

Numis director of investment companies research Ewan Lovett-Turner believes that many of these fears are overblown. He says: “[The] frequency of revaluations is the most active/frequent of anyone in the industry. They are not venture capital majority stakes, requiring large operational teams, operational influence, board seats, etc — which requires large teams.

“Instead, they invest in minority stakes in established businesses that happen to still [be] private. To do this I think they have appropriate resources.”

But Investec director of investment company research Alan Brierley, who placed a “sell” recommendation on Scottish Mortgage shares in January, says nothing has changed. 

Ultimately, there will be price discovery, and for many this may be brutal. So far this has been limited to companies that have run out of cash, but the reduction in valuations may gather momentum Alan Brierley, Investec

“We have previously expressed concern about the valuation lag, the disconnect that exists between late-stage VC investments and listed companies with similar higher-growth characteristics, and the post-IPO performance of recently listed VC-backed companies,” he says.

“From November 2021 peaks to end-2022, the Pitchbook VC-Backed IPO index and Baillie Gifford Long Term Global Growth fund (a proxy for listed exceptional global growth) fell 65 per cent and 57.2 per cent respectively. While the Morningstar Pitchbook Global Unicorn index was off just 1.5 per cent, many valuations are still anchored at last fundraising rounds.

“Ultimately, though, there will be price discovery, and for many this may be brutal. So far this has been limited to companies that have run out of cash, but the reduction in valuations may gather momentum as audited year-end numbers begin to feed through for those funds where there is a valuation lag.”

Baillie Gifford says it has an independent valuation process for the unquoted holdings. 

Mick Gilligan runs the model portfolio service at Killik & Co, and at present his clients tend to have about 1 per cent in Scottish Mortgage.

He says: “I think they have enough capacity. A big part of the rationale for investing in private companies is that more companies are staying private for longer and, in many cases, it is the only way to get exposure to some really disruptive businesses with large addressable end markets.

“SMT is very different from most VC investors in that its time horizon is extraordinarily long and so may not be under the same level of pressure that other VCs are. I think Scottish Mortgage is well suited to investing in such companies, given its resources and time horizon.

“My main concern about SMT would be that it is close to its unquoted limit and this might hamper its ability to make further follow-on investments.”

Gilligan’s view is that while Scottish Mortgage invests in unquoted companies, those tend to be quite mature businesses, rather than the very early-stage entities invested in by venture capital businesses, which makes the comparison between the two rather otiose. 

Buying time 

An issue for funds that invest in unquoted assets is that, if performance means the fund shrinks in size, then the unquoted assets become a larger proportion of the total assets of the trust and could breach the 30 per cent limit. 

Despite those risks, the Scottish Mortgage board has been deliberately shrinking the size of the trust by buying back more than 36mn shares.

Scottish Mortgage is very different from most VC investors in that its time horizon is extraordinarily long and so may not be under the same level of pressure that other VCs are Mick Gilligan, Killik & Co

The board justifies this by saying that share buybacks benefit shareholders in the immediate term by narrowing the discount. This boosts the share price of the trust as it effectively creates a major buyer of the shares in the market. 

This is relevant because the buybacks may soon have to stop since every time the trust shrinks in size, the proportion held in unquoted assets rises and increases the risk that the unquoted limit is exceeded. 

In the event share buybacks have to stop, that would be expected to put downwards pressure on the share price.

Scottish Mortgage reached a size that meant it was in the portfolios of a huge array of clients. As the share price tumbles, where it is at present will either be viewed in future as an attractive entry point, or as another peak on the way down for a fund that has been one of the most popular, but also most innovative in the market in recent years.  

David Thorpe is investment editor at FTAdviser