Scottish Mortgage issues new shares, but warns over future dividend threat

SMT posted a net asset value (NAV) return of 27.7 per cent and share price total return of 29.6 per cent for the 2014-15 financial year to March 2015, beating the FTSE All-World's 19.2 per cent return. It has delivered solid returns over the long term, beating its benchmark substantially over one, three and five years by investing in long-term growth companies with very little reference to the underlying index.

Despite the stellar results, the trust has been forced to dip into its revenue reserves in order to pay out an increased dividend. In 2014 the trust removed its dividend policy, which required dividend payment growth in real terms. However, the trust said "the intention to grow the dividend remains" and pledged to increase its 2013-14 payout by 1 per cent to a final dividend of 1.55p a share and a total dividend of 2.93p.

In order to meet the increase, the trust is using 0.7p a share of its revenue reserves, leaving around 4p a share available to support future distributions. SMT is facing declining earnings per share as the companies it invests in reinvest profits rather than paying them out as dividends.

Chairman John Scott warned that "as revenue reserves deplete dividends may be constrained by prevailing earnings", revealing the trust's ongoing choice between diminishing its reserves or paying out smaller dividends in the future.

Consistently solid results mean SMT has long been a fixture on adviser and investor wishlists for long-term growth. Joint fund manager Tom Slater, who took over as joint manager in January 2015, is careful to point out that the trust is "volatile" and has suffered dips in short-term results. But Mr Slater says he looks for companies "that have the kind of pay-offs that pay for the inevitable mistakes".

He took over as joint manager in the middle of one of the most interesting years yet for the investment company, which for the first time in its 26-year history issued around 25.6m shares from treasury to meet investor demand and keep a lid on its rising premium.

Following the end of the financial year, when the shares were trading at a 3.3 per cent premium, the company has issued two new rounds of shares from Treasury. On 8 May 2015 the company issued 2.5m shares of 5p at a premium to NAV. Four days later it announced a further issuance of 1m shares at 5p, also at a premium to NAV.

Mr Slater says the trust is still firmly set on the theme of technological change, with advertising, electric cars and e-commerce in his sights. He says: "Looking at the next five-10 years the pace of change is broadening out from the narrowly defined tech sector into a broader part of the economy."

In e-commerce that means companies such as Amazon (US: AMZN), which the fund has an 8.8 per cent exposure to, and which contributed 15.9 per cent to the fund's total return over the past five years. Amazon is closely followed by Chinese web giant, Baidu (US: BIDU) and Chinese internet company Tencent (HKG:700). Mr Slater believes in accessing the Chinese growth story through tech and internet giants making a name for themselves on the global stage.

He says. "We've been enthusiastic about prospects for China's growth for most of the past decade but we don't own China staple stocks because they are not attractively valued." He says that consumer giants, known as bond proxies, have seen large inflows in the past year, but he prefers to play the consumer story through Chinese internet growth companies, which are more appealing and trading at better valuations.

His fondness for all things tech extends to his belief in the potential for a greener future. He backs electric cars via Tesla Motors (US: TSLA), one of his favoured stocks. It makes up 1.9 per cent of the portfolio and he believes they are "on the brink of creating a new automobile brand".

He believes renewable energy offers potential for market disruption despite being the most damaging area of his portfolio in the past five years. Solar company First Solar (US: FSLR) and Vestas Wind Systems (DK: VWS) made losses for the trust during this period.

He is also evangelical about the value potential that comes from investing in unlisted companies. He says tech companies with lower requirements for start-up capital have much lower reliance on the stock markets and are able to expand enormously before listing, offering potential for those who invest.

"Capital markets are changing," he says. "If you are Twitter, what's the role of the stock market - you don't need capital to fund that business." Another example of one of those "remarkable" companies is Alibaba, which the trust bought in 2012 when it was an unlisted company.

Scottish Mortgage Trust, which Mr Slater claims is "volatile but not risky", has also dipped its toe in new water this year, by investing in unlisted peer-to-peer lender Funding Circle. The holding is worth around £15m, 0.42 per cent of the trust's assets. The trust also recently purchased US peer-to-peer company Lending Club (US: LC) based on Mr Slater's view that: "The financial services sector has not seen much technological displacement and some of these peer-to-peer businesses might offer that."

Source: Morningstar, as at 12 May 2015

Cumulative performance (% total share price return)

Source: FE Trustnet, as at 12 May 2015

TOP TEN HOLDINGS as at March 2015

Source: Baillie Gifford

GEOGRAPHIC EXPOSURE

Source: AIC, as at 12 May 2015