Scottish Mortgage (SMT ) fund manager Tom Slater has said 2022 was a ‘humbling year’ for the popular global growth investment trust which plunged 46% as rising interest rates and inflation smashed many of the disruptive technology stocks it holds.

Addressing professional investors in London yesterday, Slater admitted he and co-manager Lawrence Burns had made mistakes in their pursuit of exceptional growth stocks, such as Amazon, Tesla and Tencent which in the past have helped make the £10bn closed-end fund the top performer in its sector with an impressive 430% ten-year shareholder return. 

Slater (below), who became Scottish Mortgage’s lead manager last year after the departure of James Anderson, the architect of its high-conviction strategy, told wealth managers at the City forum that some of their assumptions had been wrong.

Tom Slater with Scottish Mortgage’s Citywire 2021 award for best performing global investment trust.

‘We thought some Covid changes would be more permanent,’ he said in reference to consumers reverting to pre-lockdown behaviour after spending lockdown online. This contributed to the dramatic unwinding of Scottish Mortgage’s historic gains in 2020 when its shares more than doubled in the surge in e-commerce caused by pandemic lockdowns.

From their peak in November 2021, the shares have almost halved, their second worst slump since the 2008 financial crisis when they plummetted over 60%. 

China risks

The Baillie Gifford fund manager said he and Burns had also been slow in recognising the significance of the deterioration in US-China relations. US-led sanctions against Russia after its invasion of Ukraine had wiped out investments in the country, he said. 

The possibility of that happening to China had increased, he warned, saying he and Burns had halved the trust’s China exposure to 13% in the past two years, recently selling Alibaba, the e-commerce giant founded by Jack Ma; along with Full Truck Alliance, China’s leading commercial freight platform; and housing group KE Holdings, in response to Beijing’s crackdown on dominant technology platforms.

The managers are monitoring the portfolio’s remaining Chinese platforms Meituan Dianping, Pinduoduo, Bytedance and Ant International on whether increased regulation and political oversight would make them more cautious and limit their growth. They account for just over 8% of the trust.

However, Slater stressed the trust’s long-term growth approach was intact and would pull through the current macroeconomic storm.

‘The underlying drum beat of technology changes continues and is not driven by the availability of cheap money,’ said Slater, who has worked on the trust since 2013.

He said there had been ‘a lot to be optimistic about’ in 2022 which had been an ‘exceptional’ year for commercial and technological breakthroughs. For example, Moderna, the US drug developer that is Scottish Mortgage’s top holding at 6.9% of assets, had demonstrated a 44% survival rate for melanoma patients from one of the many treatments spun off its MRNA platform.

Northvolt, the unquoted Swedish battery developer in which the trust is 3.7% invested, had produced the first lithium-ion battery using recycled nickel, cobalt and manganese. 

At the other end of the portfolio, Upside Foods, the private California food technology group that accounts for just 0.1% of assets, had become the first company to get US regulatory approval from meat grown in its bioreactors, he said.

Burns (above), who became Slater’s co-manager at the end of 2021 when Anderson announced his retirement, referred to historian Adam Tooze’s term of ‘poly crisis’ to describe the challenging combination of supply chains delays, the Ukraine war, US-Sino tensions and climate change that confronted the trust last year.

‘We’re not blind to the discomfort of our shareholders, but the worst thing we can do is shorten our time horizon,’ Burns said.

Revolutionary companies

He added: ‘When you’re building truly revolutionary companies it’s whether these companies progress or not,’ that was key, not the level of interest rates and inflation or whether growth investing was in fashion or not. 

The co-manager gave the example of Mercado Libre, the Latin American online market place, whose shares had risen 20-fold in the past 12 years, despite a period of economic, political and currency turmoil on the continent.

While stagflation was currently painful for Scottish Mortgage’s companies, Burns suggested it was worse for many of their competitors. Delivery Hero, the German online food delivery company, a 1.8% holding, had used its strong market position to reduce price discounts and increase sales in Korea, its largest market, he said.

Data disclosed to the meeting purported to show the portfolio was also financially strong. Nearly half of the assets are in quoted companies with net cash while 48% are profitable, against 21% with net debt and 22% that are unprofitable. Of the latter, 8% generated positive free cash flow, the company said.

Private equity challenge

However, these statistics did not include the 30% of the trust invested in unquoted companies. Concerns about the long tail of private equity positions has been a factor in Scottish Mortgage shares falling to a 9% discount below net asset value. 

Baillie Gifford has sought to reassure investors that Scottish Mortgage’s unlisted valuations are up to date with the fall in quoted companies, saying each of the 47 holdings had been revalued at least three times last year.

Nevertheless, conditions have become more difficult for the private equity sub-portfolio. Although the managers invested £280m in unquoted companies last year, they were now at their limit on unlisteds and had to decline one investment opportunity in 2022. 

Part of the problem, Slater said, was the reluctance of private companies to accept their valuations had fallen. ‘That’s pushed us more into public markets,’ he said, though he believed some of the recent investments were still promising. These had been done through ‘convertibles’, a type of bond that can be converted into equity at a discounted price, increasing the potential future upside

Nevertheless, Slater said he and Burns would not seek an increase in the 30% private equity limit unless there was a ‘compelling opportunity’.

Low valuation

He suggested the steep falls in Scottish Mortgage’s listed holdings had also made them compelling, with some positions he said trading back at 2008 financial crisis lows. The top 10 stocks in the concentrated portfolio account for 43% of assets and include ASML, the Dutch semiconductor manufacturer, and Elon Musk’s SpaceX.

Their combined valuation had fallen from seven times sales to a multiple of just five, with forecast earnings compounding the decline with a 10% decline. 

‘They could get cheaper,’ said Slater, ‘but the starting point is cheaper.’

‘That’s nothing to do with their long-term potential,’ he added.

The hit that Scottish Mortgage has taken could make it attractive to new investors who don’t hold the shares. For existing shareholders, the questions are likely to be how long it will take the trust to regain its previous highs, and how much of their savings they allocate to this volatile fund.