Scottish Mortgage: ‘2022 was humbling – but the trust is now cheap’

The flagship ‘growth’ investment trust from Baillie Gifford is not deviating from its investment approach despite big losses last year. 

Scottish Mortgage investment trust lead manager Tom Slater has admitted that 2022 was a “humbling year”, with the shares dropping 46% as interest rate rises took the air out of the richly valued “growth” shares.

“We hate losing our shareholders’ money but unfortunately setbacks are an inevitable consequence of the way we manage the trust,” Slater said at an investment event last week.  

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Slater added that while some volatility was inevitable, alongside deputy manager Lawrence Burns they made some wrong assumptions about the world.

“We have been slow to recognise the consequences of the shattering China-US relationship, and we had thought that a number of Covid-induced changes would be more permanent.”

Nevertheless, the managers are not wavering from their approach of adopting a long-term focus to attempt to find the most exciting companies in the world, and ignoring macroeconomic noise.

Slater said that while 2022 may be remembered as a bad year in terms of Scottish Mortgage’s share price performance, there was some notable progress from some of its portfolio companies.

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For example, Slater said top position Moderna began trials for a cancer vaccine and increased the survival rate for melanoma (skin cancer) by 44%.

“That scale of improvement is highly unusual in this field,” he said. Slater said there could be more cancer trials from Moderna launching this year.

Another breakthrough was in solar power and batteries, with solar generation capacity globally doubling in the three years to 2022.

Northvolt, a private company in the portfolio that makes batteries for electric cars, now has $55 billion (£45 billion) worth of contracts.

“This is likely to be the Western champion for batteries. The manufacturing footprint is expanding out of Sweden and into Germany as it scales to meet the industry’s needs,” Slater said.

The production and storage of electricity is part of the growth story for Zipline, a drone delivery company that now has delivery contracts with Walmart (NYSE:WMT) in the US; and Joby Aviation, a flying car company that now has deals with Delta Air Lines (NYSE:DAL).

“This energy transition theme is likely to be a theme for the portfolio and global economy for at least the next decade.

“While stock markets are going down and interest rates are going up, that underlying drum beat of technology-driven change and progress has not shifted, and is only getting stronger. It was not a phenomenon that was driven by cheap money,” Slater said.

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Portfolio now cheaper

The advantage of the Scottish Mortgage share price crash is that its companies are now far cheaper than a year ago.

Slater said that most of the holdings are now cheaper relative to their sales and profits than they were before the pandemic, with some now approaching the lows of the 2008 financial crisis.

He said: “That’s not to say they cannot go cheaper. Who knows where markets will go in the short term, but the starting point is interesting. Looking at our top 10 holdings, they have gone from an average sales multiple of seven times to around five times in a year. That’s a 30% fall in the value of the assets, which has little to do with their long-term potential.

“We have a set of companies here that are all relatively early in their growth opportunity, from Moderna in healthcare, through to how early we are in the penetration of electric vehicles, to new areas such as autonomous drones.

“These companies have suffered a significant decline in valuations relative to their prospects, which are largely unchanged, and you have at the same time exposure to a set of private companies that are extremely difficult for individual investors to get access to.

“You get a universe of growth companies across public and private markets at what I see as a really attractive entry point.”  

Private companies limit to stay at 30%

Scottish Mortgage’s exposure to private companies is capped at 30% for new investments, but can move above that level due to market movements.

Given that 29.2% of the portfolio is in private companies, as of 30 November 2022, and it has been greater than 30% at points during 2022, there have been questions about whether this limit is appropriate.

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However, Slater said that there was no intention of asking the board and shareholders to approve a change.

He said: “At the moment, there is no plan to change that 30% limit. We have been able to support our existing investments when we have needed to and deployed about £280 million of capital into private markets in 2022. So it has not been as issue.

“The circumstances in which we would go back to shareholders would be if we thought there was now a compelling opportunity in private markets.”

Burns and Slater revealed the trust missed out on just one investment opportunity from the private stocks cap, and said that communication with private companies about the 30% limit was key.

“Companies appreciate the transparency up front and some have been able to offer us flexibility in terms of timing. It has not been a major impediment to what we have wanted to do in private markets,” Burns said.