Scottish Mortgage calls for patience after year of underperformance

It has been a tough period of performance for the investment trust. Kyle Caldwell examines the annual results. 

Both the chair and fund managers of Scottish Mortgage (LSE:SMT) have called on shareholders to think long term and be patient following significant underperformance of the investment trust's benchmark over its latest financial year.

Scottish Mortgage's results, released this morning and to the end of March 2022, show that over the one-year period, the share price fell by 9.5% and the net asset value (NAV) declined by 13.1%. In contrast, the FTSE All-World Index was up 12.8%, which is the trust’s benchmark.  

The global trust, which focuses on companies with a technological edge over competitors, also fell short of peers. The average global trust posted share price and NAV declines of 2.5% and 2.3%.

• Listen to our interview with Scottish Mortgage 
• How to play the market rotation: fund, trust and ETF ideas
• Why fund managers are trimming and not ditching tech shares

The trust, which has a low dividend yield of 0.5%, has proposed to increase its dividend by 5% to 3.59 pence.

The short-term underperformance follows the trust a year earlier delivering its strongest-ever yearly return in its 112-year history.  

It also comes in the last year of James Anderson’s management of Scottish Mortgage. Anderson, who has managed the trust since 2000, with Tom Slater becoming joint manager in 2015, retired from fund management at the end of last month.

The types of companies Scottish Mortgage invests in – high-growth shares, including a quarter of the portfolio in more speculative unlisted companies – have been firmly out of favour for the past six months or so on the back of high inflation levels and increases in interest rates.

High-growth shares, which include technology companies, have more expensive valuations that are hinged on their future earnings potential. Increases in inflation and interest rates both devalue their expected future earnings, which is why such companies have become less attractive and their share prices have come under pressure.  

Scottish Mortgage’s share price has almost halved since early November. At the time, it was at an all-time high of 1544p, but prior to the market opening this morning it stood at 786p.

Fiona McBain, chair of Scottish Mortgage, urged investors to think long term, pointing out that “these last couple of years have been extraordinary and do not offer a suitable time frame over which to judge investment returns”.

McBain said: “In such times, one must not let the stress induced by such volatility shorten time horizons or prompt decisions taken to reduce discomfort, to the potential detriment of maximising long-term shareholder value.”

She added that whole investor confidence in companies' growth prospects will rise and fall, and that this creates opportunities for “patient long-term investors”, such as the fund managers of Scottish Mortgage.

• Fund and trust alternatives to Scottish Mortgage and Fundsmith Equity
• Find out why Scottish Mortgage Investment Trust is on the ii Super 60 list
• Ian Cowie: why I can’t quite bring myself to buy Scottish Mortgage

Slater, the lead manager of Scottish Mortgage, last year sounded a note of caution when the trust produced record yearly returns. He urged shareholders to judge performance over longer-term time horizons.  

Slater made the same point following this period of underperformance, urging investors to have a minimum time horizon of five years.

He said: “Our purpose is to provide long-term funding and support for growth companies and the entrepreneurs building the future of our economy. This approach will sometimes be popular and sometimes, as now, be out of favour.

“Because of such swings, we discourage those with a time horizon under five years from investing in our shares. While we do not enjoy discomfiting our fellow shareholders, we believe resilience during drawdowns is necessary for generating long-term return.”

Over five years, the trust’s NAV and share price returns (as at end of March 2022) are 198.4% and 187.5%, compared to 68.1% for the FTSE All-World Index.

Lawrence Burns, the deputy fund manager of Scottish Mortgage, also called for investors to be patient and play the long game.

He said: “What makes long-term investing difficult is that progress is rarely a straight line. Genuine long-term investing requires not just patience but the ability to endure periods of intense discomfort. We have experienced such discomfort often with our holdings.”

The question going forward is whether the underperformance of growth shares will prove to be short term or more sustained.

This was a question that we asked Burns last week when he appeared on interactive investor’s Funds Fan podcast.

His response was: “I think it’s very hard to say when the mood of the market will change, Benjamin Graham used to say, ‘in the short-term the market is a voting machine, in the long-term it’s a weighing machine’, and I very much agree with the spirit of that, in that knowing how the market behaves in the short term is really very difficult.

“It’s a complex system where a huge range of factors can matter and influence share prices in the short term, and it’s driven by people’s opinions, and people’s voting of those events.

“And that I think is really very hard to make any sensible prediction about, and so what we’re focused on is looking at the fundamental progress of our companies, and most importantly their long-term future potential. And about this, we do remain enthused because we’re continuing to see operational progress.”

• Scottish Mortgage no longer UK’s largest trust as tech sell-off intensifies
• Are Scottish Mortgage’s private holdings overvalued?

Burns acknowledged that the past decade has been a good period for growth shares, driven by “the increasing digitisation of our world”.

He noted that while the big tech giants have dominated this trend “what we’re seeing today is the broadening impact of that digitisation as computing power, and digital technologies become relevant in a wider range of industries, and we’ll start to offer the potential to reshape them”.

He added: “And so, when we look out over the next 10 years, we see that the world needs areas to change, we see that there’s some of the tools emerging to enable that change, and I think it is our role as investors to support and deliver the companies and founders that can deliver that change.”

ii analyst view 

Scottish Mortgage is classified as an adventurous option in interactive investor’s Super 60 list.

Dzmitry Lipski, head of funds research at interactive investor, says: “While past performance is not an indicator of future results, Scottish Mortgage Investment Trust’s track record over the long term speaks for itself, underpinned by a solid investment strategy, which targets disruptive growth companies, public and private – which are inherently long-term investments.

“Investors should remember that it is a higher-risk investment due to high portfolio concentration, exposure to tech and unquoted companies and gearing, so it works better as a satellite holding in a well-diversified portfolio.”

The author owns shares in Scottish Mortgage, along with other investment trusts and funds.