Why Scottish Mortgage’s troubles tell a positive story

Public disagreements are always uncomfortable for companies. Those in charge at Scottish Mortgage Investment Trust will be unsettled by the departure of its chair following a fall-out over the running of the fund and its investment strategy. All the more so given the fund’s former status as one of the star performers of the investment sector.

Here’s the thing though: what has happened at Scottish Mortgage should actually give shareholders in investment companies a degree of comfort.

To step back for a moment, it’s worth a reminder about how investment companies operate. As stock market-listed companies, they must appoint boards of directors with a legal responsibility to act in the best interests of shareholders. The board’s role is to agree a direction of travel for the business and to hold its senior management to account as they try to execute on this vision.

Compare this structure to other types of collective investment vehicles. Most funds are products, launched by asset management firms that hope to sell them to as many investors as possible. It is a completely different type of relationship with investors – open-ended fund investors are customers, rather than shareholders who own part of the business, with all the rights that brings.

This distinction can often feel rather abstract, but it has important real-world implications, as the current situation at Scottish Mortgage shows. After a number of years of delivering stellar returns, the fund has had a tough time over the past year or so, suffering from its exposure to tech stocks, which have fallen steeply. That has prompted difficult conversations at board level – both about the fund’s risk management practices and its governance. The recent departure of Fiona McBain, who has chaired the company since 2017, is part of the fall-out.

There will be plenty of people who feel Scottish Mortgage has not handled its problems well. And there’s no escaping the fact that performance has taken a turn for the worse, albeit after a long period of hugely impressive delivery. However, it’s encouraging to see the board of the fund taking its responsibilities seriously – this ongoing period of soul-searching reflects directors’ efforts to fulfil their duties to Scottish Mortgage shareholders.

There have been plenty of similar examples of interventions by investment company boards in recent years. We’ve seen independent directors fire underperforming fund managers, demand lower fees and order action where shares have slipped to discounts to the value of the underlying assets. In other words, investment company boards are flexing their muscles.

That doesn’t mean they’ll always get it right, of course. In any given situation, there will be investors who feel the board should have intervened more quickly, or that directors have taken the wrong decisions. That is their prerogative, but the point of principle is important here: investment companies create a legally binding structure in which investors’ interests take priority.

In an industry often criticised for failures to put investors first, that is crucial. Other types of investment fund do not come with similar checks and balances. If you’re stuck in a poorly-performing open-ended fund, there is no-one looking out for you – your choice is essentially between getting out (thus crystallising your losses), and hoping something will turn up to drive improved returns.

None of which is to say any investment company will automatically deliver better performance. But as the Scottish Mortgage saga shows, there will at least be an inquest when that doesn’t happen – hopefully with valuable lessons learned.