Ever since Neil Woodford’s funds collapsed nearly four years ago, investors have been worried at the first mention of liquidity issues.

It should not be surprising, then, that questions surrounding the number of unquoted companies held by Scottish Mortgage (SMT ), with the £9bn investment trust bumping against its 30% cap, have some financial advisers concerned about the future of the strategy.

Others, though, are reassuring their clients that the global equity fund’s closed-end structure and Baillie Gifford’s private investment selection mean this is a very different case from the run  on the open-ended Woodford Equity Income fund. With the shares in Baillie Gifford’s FTSE-listed flagship trading at a wide 21% discount, some even see a buying opportunity. 

Unquoted

Debate around Scottish Mortgage sharpened last month after one of the trust’s non-executive directors, Amar Bhidé, publicly criticised its 30% exposure to unquoted companies before stepping down from the board.

Bhidé claimed the trust lacked the resources to oversee its private investments, valued at almost £3.8bn of the fund’s £9.6bn market capitalisation at the end of January. Investment trust boards set their own limits on private investment exposure, and Scottish Mortgage’s 30% limit is significantly higher than that set by many other large peers. It should be noted that the higher limit was agreed by the trust’s shareholders. 

The scrutiny comes after Scottish Mortgage experienced its most disappointing year of returns in over a decade in 2022, losing more than a third of its value over the year (see graph below). 

Investor sentiment has turned on Scottish Mortgage as a result of this slump with the previously popular top-performer derating to an average 10% discount over 12 months. That’s raised the question over whether the shares are good value now that Baillie Gifford has convinced analysts its valuation of the unquoteds is up to date.

Among advisers, though, views are split between selling and sticking.

Folding

One person in the bearish camp is Paul Dennis, investment director at London-based Holden & Partners, who believes the trust shares too many worrying similarities with Woodford’s collapsed Equity Income fund.

Dennis said the trust’s high exposure to private companies, though typically larger than those held in the Woodford fund, was ’definitely a concern’.

‘Woodford was buying small private [companies],’ he said. ‘[Scottish Mortgage’s] argument is that their stuff is considerably larger. My argument is, yes something can be valued at £40bn, but it can become £1bn very quickly. When you mark to market a lot of these private assets, that’s precisely the problem.’

Dennis’ portfolios have not held Scottish Mortgage for several years. He said the trust ‘will have a downside issue’ if the private companies it holds underperform and he raised fears about liquidity should the companies fail. 

Holding

Other IFAs have not wavered in their support for Scottish Mortgage though. One investment analyst at a Citywire New Model Adviser Top 100 advice firm, who requested not to be named, said their firm was ‘supportive’ of the trust’s 30% exposure limit and was optimistic about its future performance.

‘Although [Bhidé’s criticism] triggered a review among our team last week – and it is one of those things that is, of course, worth checking – [its private companies exposure] is an aspect of the trust we support,’ they said. ‘We view it as a good policy, even in light of changing market conditions.

‘[Baillie Gifford’s] expertise in investing in private companies represents a significant competitive advantage... [and it has] considerable resources specifically to analyse private companies.

‘We believe this unquoted exposure is reasonably managed as the portfolio managers ensure position sizes are only built to a significant level when companies have proven they are financially stable, fast-growing and large enough.’ 

The analyst, whose firm holds the trust across its more adventurous model portfolios but sold out in its ‘more balanced’ offerings last year, said selling the trust now would be ‘dangerous’ for investors.

They also pointed to the fund’s stabilisation in 2023 with the underlying net asset value up 2.9% year to date, although the shares have declined a further 10.6%.

‘We’ve taken the view that if there is any bear market rally, the trust should benefit,’ they said. 

‘After the poorer performance last year, for newer clients, selling would mean selling it on a decent sized loss. But some [have made] a big gain and some [have made] a big loss. Of course, we should have sold at the start of last year, but we’re happy holding it now.’  

Baillie Gifford’s view

Baillie Gifford disagrees that there was a liquidity issue.

‘Open-ended funds expand or contract depending on demand as investors move their money in and out of the fund,’ said Stewart Heggie (pictured above), the trust’s commercial director, who spoke to Investment Trust Insider last month.

‘Open-ended funds must be ready to give investors their money back at any time. That means they normally invest only in assets that can be sold very quickly. If they do not, they risk a “liquidity mismatch” arising, whereby giving their investors the option of short-term redemptions while being unable to meet redemptions because they invested in assets that cannot easily be liquidated at short notice. In simple terms, that’s what happened to the Woodford Equity Income fund.’

Heggie said a closed-end structure like a trust was much better placed than an open-ended fund for investors to access private companies since traded shares would ensure investors had liquidity. 

‘A liquidity mismatch cannot, in theory, happen for Scottish Mortgage unless transactions between shareholders ceased,’ he said.

‘Shareholders always have the option of buying or selling shares in Scottish Mortgage because it is listed on the London Stock Exchange and they do so by buying/selling its shares with other investors on the stock market. Therefore, as long as everything has a price, trades in shares take place. Therefore, the private company holdings do not directly impact liquidity or create a liquidity mismatch.’  

Heggie added that Scottish Mortgage’s valuation process also protected it and its holdings. 

‘On the downside issue, we have a robust valuation process that updates valuations in a timely fashion. In 2022, 585 revaluations took place. During that time, the private companies in the Scottish Mortgage portfolio were, in many cases, written down, and significantly so. In 2022, the average change at company level was -34.4%, and once the positive contributors were removed, it was down -44.8%,’ he said.

‘I take the point that companies could fall from $40bn to $1bn on certain occasions, but I disagree this will happen at scale. In many cases, Scottish Mortgage is invested in late-growth companies employing thousands of people, with strong revenues. As at 31/12/22, 29.5% was invested in private companies, and 5.8% were worth beneath $2bn. These are mature large companies that are robust and display financial resilience.’