This was very much a Baillie Gifford show but Scottish Mortgage (SMT ) fund managers Tom Slater and Lawrence Burns looked somewhat strained as they faced a series of probing shareholder questions put to them by Stewart Heggie, the investment trust’s commercial director I interviewed last week.

The managers’ serious and contrite manner follow a tough year and a half in which the shares of this global top performer have crashed nearly 60%. The period has been rounded off by unprecedented upheaval on the investment trust’s boardroom, caused by former non-executive director Amar Bhidé publicly voicing concerns over the board and Baillie Gifford’s ability to oversee its extensive £3.8bn portfolio of private investments.

Here’s what we learned. 

Private equity limit could be raised

A main focus of investor questions was the 30% limit on unquoted investments which Scottish Mortgage has hit, raising questions over whether it can continue to support its private companies or step up share buybacks to prop up a stock that has fallen to a yawning 21% discount to net asset value.

Referring to previous shareholder approvals to raise the limit, which stood at 15% six years ago, Tom Slater (pictured below at his office last year) said: ‘If it was a problem we could come back.’

‘If we think there are missed opportunities we will come back and have that conversation with shareholders.’

Slater said the 30% constraint so far had not caused a problem apart from stopping one investment last year. 

He said the reasons for hitting the limit had been private companies raising money last year at higher valuations, while the trust invested another £260m in the unquoted pool last year. 

Meanwhile falls in the trust’s publicly listed holdings meant the proportion in the unlisteds had swung higher.

Currency movements between the dollar and the pound were also a factor, he said.

Burns said so far the trust had not let companies down on its obligation to provide follow-on investments but he and Slater were monitoring the situation.

Although there is a long tail of 52 private companies held by Scottish Mortgage, the top five positions account for nearly half of the exposure, or 13.7% of the total portfolio. These are Elon Musk’s SpaceX, EV battery maker Northvolt, retail website operator Brandtech, short video sharing platform Bytedance and US payments processor Stripe.

‘These are our best ideas. This is not asset allocation,’ said Slater explaining he and Burns looked for the best growth businesses whether they are private or trade on public stock markets.

The focus on unquoted companies might give the impression that Scottish Mortgage backs early-stage companies with few revenues and even less profits. Burns said in fact only 13% of its listed companies were non-cash generative, rising to 20% of the unlisted stocks.

Explaining that the valuations of the private companies were as up-to-date as they could be, Slater said other Baillie Gifford trusts invested in some of Scottish Mortgage’s private companies. That meant the three-monthly rolling review by independent analysts at S&P Global, who fed their valuations into a separate Baillie Gifford valuations committee, were effectively augmented by the external auditors and boards of those other funds.  

Are you doing a Woodford? 

Slater was at his most steely in rejecting the comparison some investors have made between Scottish Mortgage and Neil Woodford. 

It’s been four years since the open-ended Woodford UK Equity Income fund was forced to suspend after the former star fund manager struggled to keep the amount of unquoted stocks below a 10% cap. 

As investors pulled their money out due to poor performance and concerns over the portfolio’s imbalance, the manager was unable to sell assets quickly enough to give investors back their money. The fund closed, locking investors into a long wait for their money.

Slater said there were two crucial differences between Scottish Mortgage and Woodford Equity Income. Whereas the later focused on UK smaller companies worth an average £200m, the Baillie Gifford flagship bought big, established global businesses worth £10bn on average.

Secondly,  Scottish Mortgage was a ‘closed-end’ fund with a fixed pool of capital which was unaffected by investors selling their shares. He and Burns were therefore not forced to sell assets if investors sold their Scottish Mortgage stock. 

‘Those are two fundamental differences in approach,’ he said.

Regrets? Maybe one or two

Scottish Mortgage shareholders are back to where they were three years ago, which doesn’t mean the trust’s long-term returns are poor. Far from it, over 10 years it still tops the AIC Global sector with a 323% total shareholder return.

But the managers are rightly apologetic for taking investors all the way to the top and then back all the way down again with a painful thump.

In the first ever hint of regret that the trust got sucked into a post-pandemic internet bubble, Burns said of the historic 2020-21 surge in tech stocks that has since unwound.

‘We could have been cognisant of where the market valuations were pushing them’, he said.

Burns (above) later added that with ‘perfect hindsight’ growth rates had ‘accelerated to remarkable levels’ in 2020-21 but had fallen back to pre-pandemic levels. 

As a result Amazon was now valued on a share price multiple to sales that was last seen in the 2008 financial crisis. Burns said the important question was to ask what had happened to the operational performance of such businesses and not get too caught up in short-term price movements.

Slater said: ‘In the long run share prices follow fundamentals. I know that hasn’t produced a good outcome in the past 18 months.’

He explained that Scottish Mortgage required a time frame of at least five years and the managers were not there to ‘ameliorate’ stock market volatility. 

More skin in the game

Slater said he ‘bought shares last week’ and added: ‘It’s not just the individual managers’ with partners and employees at Baillie Gifford included, ‘there has been a lot of buying in recent weeks and months’.

Share buybacks: should trust buy more?

Burns said the trust’s aim was to get the share price as close to net asset value (NAV) as possible. Buying back shares was an important way of doing this by raising the share price, and by boosting the NAV by effectively buying the portfolio at a cheap level. 

He said the board spent £230m on buying back shares in 45 transactions last year and we ‘haven’t felt constrains in our ability to do so’. He was not asked if the private equity limit was preventing the board from increasing the level of buybacks.

Slater indicated that might be unlikely. He said shareholder capital wentt to three places: investments, debt reduction and buybacks. The first, backing long-term winners was the priority, he said.

Scottish Mortgage had no specific discount target, as the ‘evidence shows that fails’, he said.

Intel and the impact of interest rates 

Scottish Mortgage’s share price plunge has accompanied a de-rating in growth stocks worldwide as interest rates have soared in response to surging inflation.

Burns said it was not high interest rates themselves that were the problem, but the change in direction in the cost of borrowing which meant the cash flows of its companies were rated at a lower level, hitting the current valuations of the business. 

He suggested the worst was over from an macroeconomic point of view: ‘If interest rates come down that will be helpful’; if there is no change in interest rates then ‘the pain is behind us’; but if they go up again it would be ‘a headwind’ for the trust, he admitted.

As an example of a growth company that could do well regardless of the economic environment, he recalled Intel, the US computer chip manufacturer that listed in October 1971 and which defied soaring inflation, high interest rates, and the energy shock to deliver an 18-20-fold return to shareholders by the end of the decade, although it had been a volatile ride through a bear stock market.

‘We won’t give up on companies’

Burns said it was important to back the best growth companies through thick and thin, pointing out it would have been a mistake to sell Amazon in 2001 after its shares crashed 90% in the dotcom bubble implosion or to offload Apple after its 60% plunge in the 2008 financial crisis.

‘We don’t want to give up on these amazingly special companies when they hit a rough patch. It’s very easy to be long term when things are good’.

The implication would not have been lost on the audience that investors should stick with Scottish Mortgage.

Why so much in Moderna?

Moderna’s 66% share price plunge since the top of the market in late 2021 has infuriated some Scottish Mortgage shareholders. The managers have continued to add to the position that at 6.9% of assets was its top holding at the end of February. 

Burns said the market had focused on declining sales of coronavirus vaccine, and ‘missed’ the ‘broad value’ the company had achieved in validating its MRNA drug development platform that was poised to deliver important breakthroughs in respiratory diseases and personalised cancer treatments.

Slater referred again to the ‘astonishing data’ Moderna had produced last year in cancer trials. He said the success of its Covid-19 vaccine had left Moderna with a $20bn cash pile that it could plough into other opportunities like this. 

Tesla, Musk and SpaceX

Tesla, Elon Musk’s electric car company, is Scottish Mortgage’s third biggest holding at 5.2% of assets. With its controversial founder and volatile share price, the stock generates even more questions from shareholders than Moderna. 

Slater reiterated the managers’ view that Tesla had demonstrated ‘fantastic execution’ by increasing production and growing profits amid the challenges of the last three years.

While Musk had for a long time exhibited ‘incredible bandwidth’ in taking on multiple projects, such as his recent takeover of Twitter, there had been a genuine question over whether there was the right management infrastructure to support him at Tesla. ‘They have resoundingly positively answered that question in the last three years,’ Slater said. 

The managers don’t want be too critical of Musk given his unquoted SpaceX rocket company could provide a catalyst to re-rate Scottish Mortgage’s battered share price if it decided to float all or part of its business, such as the Starlink satellite-based internet access provider.

Slater said he did not know when that might happen. ‘As a closed-end fund we can be pretty relaxed about that.’

Perhaps not too relaxed. SpaceX is one of the trust’s biggest unquoted holdings at 3.5% of assets at 28 February. A flotation would not only endorse its valuation and by implication those of the other private stocks in Scottish Mortgage’s portfolio, it would also reduce the overall private company exposure and give the managers room to invest in these companies again.

China risks

Quizzed about Scottish Mortgage’s reduction in its holdings to China, and whether it had gone far enough, Burns said: ‘We’ve had to recognise that the bar has effectively gone up for Scottish Mortgage holdings’ due to increased geopolitical risk and the danger of crippling US sanctions; and the more interventionist approach of Beijing regulators. 

Burns said he and Slater should have incorporated those facts into their ‘mental model of investing’ earlier.

But exceptional growth companies remained such as electric vehicle maker Neo and Horizon Robotics.

‘There are still large opportunities - we’re not saying we have to avoid the world’s second largest economy.’

Bytedance ‘once in a generation’

Sticking with China, the sight of the US Congress grilling Bytedance’s management and the threat of its American business being hived off to address Pentagon security concerns should not detract from the fact that the video-sharing platform remained a ‘once in a generation’ investment, said Burns. 

He said Bytedance had an incredibly valuable business in its home market which as its business grows ‘quite frankly raises questions for some of our other holdings’.

Scottish Mortgage said it would publish a full transcript of the webinar on its website.