Has Scottish Mortgage turned a corner? Analysts consider what’s next

Is it time to forgive and forget? For years, investors in Scottish Mortgage (LSE:SMT) Investment Trust enjoyed stellar returns courtesy of manager Baillie Gifford’s growth-oriented investment style and strong stock-picking skills. Then the fund came crashing down, with a dreadful period of performance that began in autumn 2021 and continued until summer 2023. Since then, however, Scottish Mortgage appears to have turned a corner. The question is where the investment trust goes from here.

• Invest with ii: Trade Investment Trusts | Cashback Offers | What is a Managed ISA?

It's certainly been a roller-coaster ride. Between January 2020 and November 2021, Scottish Mortgage more than doubled investors’ money, delivering a return of just over 160%. Then, over the following 18 months, it went into reverse, giving up more than 60% of its value. Performance stabilised during the second half of last year and the investment trust has returned to form in 2024, with gains of over 10% since January. Over one year, SMT is up 30.2%, but over three years investors are sitting on losses of -27.4%.

“It has been encouraging to see a turnaround in Scottish Mortgage’s performance following the declines of 2022 and 2023,” says Alex Watts, investment data analyst at interactive investor. But he is careful to stress that investors in the fund are backing a very distinct proposition.

Managers Tom Slater and Lawrence Burns have a mandate to identify major drivers of global change, and then to choose a select number of companies set to benefit from these themes. Today, those ideas include the digitised world, decarbonisation, technology and healthcare, as well as “and beyond” – which includes holdings such as the exploration company SpaceX.

“It is a long-term and differentiated approach, and management are unconstrained in where and how they can invest,” explains Watts. That includes substantial holdings in privately owned companies, as well as those listed on a stock market, and a willingness to take on gearing, which will exacerbate share price volatility.

Watts adds: “Accordingly, the portfolio little resembles any benchmark. The speculative nature of picking the world’s fast-growing future winners, coupled with the trust’s propensity to leverage, can make for extreme short-term performance.”

Has Scottish Mortgage picked the right themes?

Overall, however, Watts is a fan, pointing to Scottish Mortgage’s historic track record of strong outperformance, and the long-term potential of the businesses in which the fund invests.

Still, that’s not to say that now is the perfect moment to invest. Investors will want to be convinced the recovery of recent months can be sustained, and that will depend on a range of factors.

• Scottish Mortgage AGM: a guide to what the resolutions mean
• Sign up to our free newsletter for share, fund and trust ideas, and the latest news and analysis

First, the most fundamental question for would-be Scottish Mortgage investors is whether the themes it is betting so big on right now are the right ones – or whether its wagers are simply too large.

In particular, some analysts have raised eyebrows about the fact that more than a third of the fund’s portfolio is now held in businesses that are effectively a play on artificial intelligence (AI). These include hardware companies such as Scottish Mortgage’s biggest holding NVIDIA Corp (NASDAQ:NVDA), which has soared in value because it makes most of the chips used by generative AI models, infrastructure businesses such as cloud providers like Amazon.com Inc (NASDAQ:AMZN) and application providers such as Tesla Inc (NASDAQ:TSLA) and Spotify Technology SA (NYSE:SPOT).

One of the fund’s own managers, Lawrence Burns, has conceded that hardware companies in particular can be “viciously cyclical” and that there might now be a pause in the returns generated by AI holdings, as the excitement of the past year eases back. Given that Nvidia, Amazon and ASML Holding NV (EURONEXT:ASML), another business involved in chip manufacturing, have driven most of Scottish Mortgage’s recent outperformance, that would be concerning.

These are very real risks, warns ii’s Alex Watts. “Technical constraints in AI models or a down cycle of demand could create short-term stress for AI hardware, infrastructure or application businesses, while any miss of earnings estimates by Nvidia could spook markets,” he warns.

Unlisted stocks, is the price right?

Another major consideration for investors is that Scottish Mortgage holds nearly 30% (its maximum limit) of its portfolio in privately owned companies. These are led by SpaceX, Elon Musk’s much-followed spacecraft manufacturer and explorer, where there is still huge uncertainty about the future. Other major holdings include Swedish lithium battery manufacture Northvolt and Bytedance, the Chinese technology company best known as the owner of social media platform TikTok.

The difficulty for Scottish Mortgage’s investors is that it isn’t always easy to track the progress of these businesses – and many of them are immature and high risk by their very nature. With no stock market listing to monitor, investors also have to trust that Scottish Mortgage’s valuations of these businesses are realistic; the risk of a nasty surprise is otherwise heightened. Certainly, the performance of the fund’s unlisted holdings this year have lagged returns from the listed portfolio.

To be fair, investment trust analysts describe the fund’s valuation processes as cautious and conservative. At Jefferies, for example, analysts Matthew Hose and Fiona Huang say Scottish Mortgage’s annual results to the end of March “provide additional evidence of the robustness of the valuation process and the general conservatism”.

• Scottish Mortgage: discount plan succeeds as share price soars over 30%
• How to invest ahead of the general election

Still, until a private company crystallises its value – typically through a stock market IPO – investors are dependent on theoretical assessments. And things can change rapidly. In November, for example, Scottish Mortgage valued Bytedance at $248 billion; now it thinks an IPO would raise more like $207 billion.

The question of valuation is also pertinent to Scottish Mortgage itself. In recent times, the market has not always been keen to pay full value for the investment trust. One major driver of improved performance has therefore been the board’s efforts to get on top of the discount at which shares in the fund trade relative to its net asset value (NAV).

In March, the board announced it would buy back up to £1 billion worth of its own shares over the following two years – the biggest ever investment trust buyback – and it has already made purchases worth £452 million. The fund’s discount has fallen accordingly, from a high of around -15% earlier this year to below -8% today.

Jury is out on discount and performance turnaround

Getting the discount down further will require sustained effort and careful work, warns Iain Scouller, who leads the investment trust analysis team at Stifel. “The board makes comments about trading around NAV in 'normal market conditions' and we think conditions are pretty normal now,” he says. In the immediate aftermath of its most recent foray into the market, Scottish Mortgage saw its discount drop to -6%, but that subsequently widened once again. “It does indicate [the board] needs to use the buyback more effectively,” adds Scouller.

Where does all this leave those considering a return to Scottish Mortgage now it seems to have put the bad times behind it? In truth, the jury is out. Some analysts are more positive than others.

The investment trust team at Numis, for example, is an enthusiastic supporter of Scottish Mortgage. “We believe the managers have a unique approach and a long-term view that is difficult to replicate and hard for others to replicate, particularly in an increasingly benchmark-focused investment world,” Numis argues. “As a result, we believe Scottish Mortgage deserves a place in almost every portfolio and has the potential to deliver strong returns over the long term, although as recent years have demonstrated it is never likely to be a smooth ride.”

• Six ‘hidden’ investment trust dividend heroes
• Nvidia and Scottish Mortgage made me an ISA millionaire, but now I back these funds too

Stifel’s Scouller is also in the optimistic camp. “With recent performance relatively strong, and the six-month NAV total return up 14%, we think there is scope for further discount narrowing,” he argues, pointing to Stifel’s “positive” recommendation on the fund.

By contrast, Alan Brierley, an investment trust analyst at Investec does not see any reason to reverse the view his firm has held of the trust since the end of last year. “Putting aside whether the company is able to sustain its initial positive steps on discount control, we maintain our sell recommendation on the basis of the underlying fundamentals, including the balance sheet and the private book, which has been a significant drag on returns in the past year.”

In the end, every investor must make their own decision. It’s worth pointing out that over the past 10 years, Scottish Mortgage shares are up 382% compared to a 218% from the FTSE All-World index on a total return basis. The fund is also an Association of Investment Companies (AIC) “dividend hero”, having increased its payout for 41 consecutive years, so may appeal to income seekers, although it has a very small dividend yield of 0.5%. It also has low fees, with a yearly ongoing charges ratio of 0.35%.

Equally, however, this is an investment trust you should not be invested in unless you have the stomach for the kind of ups and downs to which it has previously been vulnerable.