Scottish Mortgage responds to three big concerns investors have

Managers Tom Slater and Lawrence Burns address concerns over its unlisted exposure being at the 30% limit, its notable short-term underperformance, and its rising discount. 

Scottish Mortgage investors are having a torrid time at the moment. Shares have dropped 40% in the past year, sending the discount to around 20%, as higher interest rates take the life out of the fast-growing shares it buys.

Besides poor performance, investors are also concerned about its exposure to private companies, currently at its 30% portfolio cap, and whether the valuations are accurate.

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Speaking to professional and private investors, fund managers Tom Slater and Lawrence Burns both apologised for poor recent performance, and discussed in depth three areas that investors are worried about: private companies, performance and the stubbornly wide discount.

Private companies

The managers said the valuation process for private companies, which they are not involved directly in, is robust.

The private company valuation process is carried out by a “valuations committee” at Baillie Gifford, which takes advice from an independent third party. It values a third of the private component of the portfolio each month, so each three-month period provides a full portfolio valuation.

Nevertheless, the 20% discount on the trust suggests that the 29.9% of the portfolio in unquoted stocks, accounting for about 50 companies, is overvalued.

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Slater said that being so close to their 30% cap on unlisted companies, applied at the time of investment, had not been a constraint, and being able to invest in public as well as private companies was key to their mission.

Burns added, however, that there was one company last year that they could not invest in because of the cap and said it was something they were “monitoring and thinking about”.

Half of private company exposure is from five stocks, and companies are staying private for longer, according to Slater. “These are some of our best ideas,” he said.

One question referenced Neil Woodford’s collapsed fund group, and the issues he faced investing in private companies. Slater said that Scottish Mortgage would not face similar problems.

“The average private company we buy has a $10 billion (£8 billion) market cap and is global, versus a £200 million market cap for Woodford’s private stocks. As a closed-ended investment trust, we are also not a forced seller of assets,” he said.

The share of the portfolio in private companies is volatile, impacted by currency exchange rates, as well as the value of public shares and initial public offerings. This means that the allocation to private companies can be volatile and out of the control of the fund managers, Slater noted.

Performance

The fund managers admitted that performance had been poor recently, and apologised for this, but said they would not waver from their investment approach.

Burns said they don’t want to give up on incredible companies, referencing Amazon’s crash in 2001 and Apple’s in 2008, as evidence that even the best firms go through tough periods.

He added that their companies are now focusing more on costs to adapt to more challenging conditions, and being long term in their investment approach when times are bad was as crucial as being long term when they are good.

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While Burns recognised that rising and falling interest rates affected share valuations, he said that the focus should be on finding exceptional companies, not focusing on macroeconomics.

For example, he said Intel was founded in the 1970s and went through a number of share price busts as the world grappled with higher inflation, but “if you are doing something transformative you will be successful irrespective of the macro environment”, he said.

Discount

Scottish Mortgage is trading at a rare discount, and has been for more than a year. Its policy, without having a numeric objective, is to try and keep the share price as close to the net asset value (NAV) as possible.

Burns said that the board approved 45 share buybacks last year to help achieve this, spending £230 million to do so.

However, Slater said it was key to strike a balance between discount management and investing in companies.

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“We want to identify long term winners as a priority for spending capital, but also want to look out for shareholders as well. We don’t tie ourselves to numeric targets on discount.”

Slater said he bought Scottish Mortgage shares for his personal account last week, and noted that other Baillie Gifford employees had been buying shares in the group’s funds, which is something that the group’s leadership encourages.