Scottish Mortgage does it its own way

A key determinant of whether shares in an investment trust trade above or below their underlying net asset value (NAV) is the fund's investment performance. In theory, strong investment performance drives the demand that closes the gap between price and NAV. However, this logic seems to break down in the case of Scottish Mortgage. According to data from Winterflood Securities, the investment trust is the best performing of the 20-strong Global Growth sector over both one and five years. Yet the discount of its share price to NAV, which arguably should be the lowest, is the eighth highest.

True, there are reason for this discrepancy. Scottish Mortgage is not run conventionally. It is a so-called conviction portfolio targeted at growth stocks, and it employs borrowing to enhance returns for shareholders (though that enlarges losses as well as gains). And, while the performance of the portfolio is measured against a benchmark - the sterling-denominated FTSE World index - Scottish Mortgage's portfolio bears little relation to this benchmark. All this means the trust's short term performance can be very volatile, which is the reason the trust's manager prefers to measure its achievements on a rolling five-year basis.

The discount suggests investors are stubbornly focused on the short-term outlook and fears of a slowdown in the global recovery, given the austerity budgets in the West and stimulus withdrawal in China. Nevertheless it seems odd to award Scottish Mortgage's strong performance with such a lowly rating.

The trust has been active buying back its shares in the hope of narrowing the discount. While buy backs at less than NAV do enhance performance, the board is wary about shrinking the size of the fund to the extent that it significantly increases the cost of running the trust for shareholders. Indeed, as things stand, the trust boasts one of the lowest total expense ratios among its peer group, and the trust's directors see this as a key attraction. That said, the board is understood to be keen to get the discount down and is considering a number of options.

The five-year focus has proved valuable for the trust's shareholders in the past financial year, though. Back in 2008-09 Scottish Mortgage endured a horrible 12 months. Despite that, it resolutely backed three investment themes: shifting economic power to Asia, especially China; technology; and the West's flawed financial system. The trust certainly benefited from its steely resolve, as 2008-09's underperformance was followed by massive outperformance in its 2009-10 financial year, during which it delivered an 81 per cent increase in NAV, compared with a 45 per cent rise from its benchmark.

The trust's manager, James Anderson of Baillie Gifford, says there is no shortage of growth opportunities, despite current fears about the state of the global recovery. The central theme remains the shift of power from the West to rapidly growing powers, particularly in Asia. Mr Anderson is keen on companies exposed to growth in countries where wealth is increasing fast. However, he is also keen on exporters to these markets, and is particularly eager to target young companies at an early stage of potentially rapid growth.