Scottish Mortgage breaches private stock limit

Baillie Gifford’s flagship investment trust went over its 30% limit. Sam Benstead explains why. 

Tumbling public stock markets but sticky private market valuations mean that Scottish Mortgage investment trust has now breached its 30% limited on unquoted shares.

The £12 billion trust, as per its 30 June factsheet, now has 30.2% invested in 52 private companies. This is a result of its 36% share price decline this year, but less severe valuation downgrades for its private stocks, therefore increasing the share the trust has invested in unquoted shares.

The private stock limit applies at the time of investment and breaching it due to stock market moves does not require the fund manager to sell shares.

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However, it does limit their ability to add new private investments or top up existing positions. The limits are set by a trust's board and any changes must be approved by the board.

Private company valuations are set behind closed doors, rather than decided constantly by a large pool of investors, as in public stock markets. Baillie Gifford carries this process out every three months using a “valuations committee”, which takes advice from an independent third party, IHS Markit.

Even with regular portfolio valuations, there is a lag between public market and private market share prices.

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William Heathcoat Amory, head of investment trust research at analyst Kepler Trust Intelligence, says: “Private valuations are performed less regularly than public ones, which are effectively every milli-second. Typically, it is quarterly or half-yearly for private investments. Scottish Mortgage reviews all valuations quarterly, with one-third of the portfolio reviewed each month.

“When public markets fall, there will be a lag for private valuations, so as a proportion they will rise initially. Over time, when valuations catch up, there is a chance they become back towards the original balance.”

Investment trusts are well suited to holding private companies. Listed on the stock exchange, the Scottish Mortgage share price can diverge from the value of its investments, opening up a discount or premium. The discount is currently around 7.5%.

This means that when investors sell they do not force the fund manager to sell shares in order to return their capital, unlike in open-ended funds.

Therefore, Scottish Mortgage will not come up against the same problems that Neil Woodford faced. Amid surging withdrawals in 2019 in his flagship Woodford Equity Income fund because of poor performance, he struggled to raise enough money to return to investors. Part of the problem was that around 10% of the fund was in illiquid unlisted stocks.

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James Budden, marketing and distribution director at Baillie Gifford, the investment manager behind Scottish Mortgage, said: “This has happened because the public elements of the portfolio have fallen back more than the private elements.

“However, since 30 June the publicly listed equity has made strong progress, so the ratio may well have adjusted below 30% again.

“The percentage will vary owing to the respective performance of public and private companies held. Also any additions or sales to each element and any IPOs from private companies (there were 11 in 2021). So the monthly snapshot is just that and often self-corrects. However, it is something that the board and managers are monitoring on an ongoing basis.”