Scottish Mortgage (SMT ), the top-performing global trust that has been battered in the technology selloff, believes the worst has passed for its investments in China but regrets prioritising its internet companies over their US rivals.

Beijing’s crackdown on internet companies a year ago caused China’s stock market to plunge in what was a prelude to the global tech retreat that has halved the trust’s share price in the past six months.

Writing in the trust’s annual report, Slater admitted in retrospect it had been a ‘mistake’ for he and Anderson to reduce their holdings in Western online platforms, such as Facebook owner Meta and Google owner Alphabet, rather than China’s Alibaba, Meituan Dianping and Tencent.

State control

The censure of Ant Group, that led to Alibaba’s digital payments spinoff suspending a planned flotation at the end of 2020, was followed by a ‘slew’ of anti-monopoly and privacy measures to reinforce state control against the internet titans. 

But this was not a rejection of Western capital by China, Slater said, as the country’s worsening geopolitical situation following Russia’s invasion of Ukraine, and big job losses in the technology and education sectors, had made the government’s aggressive regulatory stance untenable. 

‘Vice Premier Liu He’s statement in March that the authorities should deliver “policies favourable to markets and be cautious in introducing contractionary measures” may signal that the worst of the crackdown is behind us,’ Slater (below) said. 

‘The challenge now for Western investors is twofold: incorporating the low but increased chances of future US sanctions into their evaluation of Chinese investments and considering how the Chinese state may limit the upside in stock prices for the breakthrough winners. Our Chinese holdings have remained largely unchanged through this period of turbulence.’

Scottish Mortgage held 16% in China companies in March, down from nearly 24% a year earlier, which Slater suggested reflected falls in their value rather than reductions in the stakes. It also holds NIO, the electric car manufacturer, and ByteDance, the internet platform that owns video-sharing website TikTok.

Painful slump

Annual results for the year to 31 March show the widely held FTSE 100-listed fund suffered a 13.1% fall in net asset value (NAV) after the stunning 110% total return its best ever – garnered in the online pandemic boom of the previous 12 months.

However, this masks the full pain of a recent downturn that has seen shares in the Baillie Gifford flagship slump 51% since November to stand on a comparatively wide 6.5% discount to NAV. 

This has been a particularly unnerving slide for investors, coinciding with the departure last month of James Anderson, the former lead fund manager who refashioned Scottish Mortgage into a pioneering, high-conviction fund over a 22-year tenure.

Fiona McBain, the trust’s chair, said the board had full confidence in Tom Slater, who co-managed the trust with Anderson for seven years, and deputy manager Lawrence Burns, who joined the team last year.

She urged shareholders not to focus on the short-term peak-to-trough slide but to look at the longer-term gains of 187.5% and 697% the trust had made over five and 10 years. 

‘I would reiterate my annual caution against drawing any meaningful conclusions from this datapoint, other than this time round to see it as an expected shorter-term cost when the longer-term rewards on offer are potentially so high.

‘Over five and 10 years, respectively, the share price has increased on an annualised, total return basis by 23.5% and 23.1%,’ she said.

Slater reiterated his faith in the trust’s broad exposure to innovators making the best use of technological breakthroughs, such as US biotech Moderna, its top holding at 7.1% of assets, Tesla, Elon Musk’s electric car company, and ASML, the Dutch maker of photolithography systems used to make computer chips.

He said that despite the markets’ obsession with how rising inflation and interest rates might alter the valuation of growth companies, the lineup of Scottish Mortgage’s top 30 position had not changed in the past year. ‘We believe that technological progress is not captured well in aggregate statistics and will be the primary determinant of both growth and inflation in the long term,’ he said.

Amazon cut again

The only significant stock reduction had been in former top holding Amazon. At its peak the e-commerce group accounted for 10% of the trust’s assets, but now represented just 3% as the managers continued to question how fast the company could grow without founder Jeff Bezos (above) at the helm, and with the US online retail market having trebled in 10 years.

‘Given our focus on growth, it now makes sense for us to redeploy capital in other areas,’ he said.

New ideas

More than half of the top 30 holdings – which make up 74% of assets – were bought as private companies. The managers continue to regard the burgeoning private equity portfolio, which accounts for the remaining quarter of the portfolio, as the main route to find new ideas. 

In the year under review, they added three US unquoted companies: Solugen, a synthetic biology company in Houston, Texas, making chemicals through low-carbon process; Redwood Materials, a battery recycling company in Carson City, Nevada; and Capsule, a New York-based online pharmacist.

Slater said he and Burns’ pursuit of the small number of exceptional growth companies was undimmed by the challenging market conditions. ‘Despite geopolitical uncertainty, significant increases in the cost of living and rapidly rising interest rate expectations in many parts of the world, we are still expecting most [portfolio companies] to deliver high levels of growth this year. These firms are well capitalised, led by exceptional leaders and have already demonstrated high levels of adaptability and resilience,’ he said.

The duo had used the trust’s low-cost debt to take advantage of steep share price slides to add to their favourite holdings in the selloff, he said. Scottish Mortgage was 14% geared at the end of March – a higher level than normal – but that did not reflect an increase in the managers’ confidence, more the fall in the rest of the portfolio.