Scottish Mortgage Investment Trust (SMT) manager Tom Slater is backing a new wave of technological change by putting his chips into unlisted stocks. But will his excitement over private companies solve the trust's depleting dividend problem?
Mr Slater has just returned from a summer in Silicon Valley where he has been meeting with some of the most exciting tech names of today. It is a trip he has made in three of the past four years with good results. In five years the highly regarded fund has returned 85 per cent compared with just 33 from the FTSE All World and 37 per cent from the Association of Investment Companies global sector.
The trust - Baillie Gifford's flagship fund - prides itself on tradition and its long history, but Mr Slater is setting a new tone by beefing up the fund's exposure to the world of private equity. He is backing a new wave of consumer, biotech and retail companies that are shunning the stock market in favour of racking up hefty valuations with private cash. Less than 5 per cent of Scottish Mortgage's assets are invested in up-and-coming unlisted companies, but it can to invest up to 10 per cent of its assets in this area. Unlisted holdings include music site Spotify (0.4 per cent of assets), file storage site Dropbox (0.7 per cent) and India focused online shopping site Flipkart (0.9 per cent).
"In the past six months our newest holdings have been from the unlisted market. That's where the most interesting ideas are coming from," he says. "The regulatory hurdles associated with public markets have made it unappealing to companies that would have otherwise gone public and they can easily attract capital in private markets now."
For investors in the trust this means access to some of the most talked-about stocks normally off limits to UK investors, including Indian e-commerce company Flipkart, which Mr Slater says has a "great opportunity" to tap into the nascent online retail sector in India. "Mobile internet has opened up markets such as India which were virgin territory before," he says.
Tom Slater CV Mr Slater was deputy manager of Scottish Mortgage Trust from 2009 until his promotion to joint manager in January 2015. He joined Baillie Gifford in 2000, working in the developed Asian and UK equity teams before joining the long-term global growth team in 2009. Tom became a CFA charterholder in 2003 and a partner in the company in 2012. |
Many market watchers say the world of so-called tech unicorns - private companies with $1bn or more valuations - are evidence of a tech bubble due to burst. Already this year Uber has racked up purported valuations of $50bn and Airbnb stands at around $24bn. Where does that leave Scottish Mortgage if those valuations are way out?
Mr Slater acknowledges that "there is a lot of capital sloshing around" the unquoted sector and acknowledges some areas might be "overheated". But he says "it's not obvious to us that valuations are looking stretched" and "the successful bets will prove to turn out ridiculously cheap".
However, he agrees that there are some risks around liquidity and the fact that the companies won't have gone through the types of vetting process required and the same level of regulatory scrutiny as listed businesses.
He says the nature of the stocks on public markets has changed though, with many major companies seeing slowing growth profiles and failing to reinvest, making it necessary to look to private markets for the most exciting themes of tomorrow.
"You've got a market phenomenon where the listed sector is putting more money into buybacks and investing less in their businesses and you have a smaller group of tech companies doing the opposite," he says.
But exciting tech start-ups have a reputation for high share prices and very low earnings streams. How does that align with a trust that stated at its last annual meeting in May that shareholder dividends were under threat?
Mr Slater says: "It doesn't necessarily follow that delisted companies lead to a lower earnings stream," but admits "sometimes they do". He argues that it is a wider issue. Companies across the board have been paying less into the trust in earnings, putting its ability to maintain dividend payments under strain.
That led to the trust's decision to scrap a commitment to increasing dividends in real terms last year. This year it was forced to dip into its revenue reserves in order to pay an increased dividend, using 0.7p of its revenue reserves and leaving around 4p a share to support future distributions. A decision now looms for Mr Slater about how to address the vital issue of shareholder income without running out of revenue reserves or being forced to buy companies he doesn't like just for income.
He says: "We are now starting to eat into our reserves so we need to think about what happens when we get through those," saying he has "three to five years to come to a clear decision". The options include paying dividends from capital or putting more emphasis on buying businesses that generate income. However, Mr Slater is clear: "I don't want to invest in companies just to generate income," he says.
"There are other ways we could support the dividend without having to buy companies that generate dividends.
"We could also just pay out the income we earn but our shareholders have made it clear that they do not want that," he says. "We understand the dividend is important and therefore we will consult on views but it's unlikely that we would cut or introduce a variable dividend," he adds.
In the meantime, there are companies within the portfolio still paying out income.
"Across the portfolio you have a spectrum of companies, from those achieving really good growth to those that have a slower pace that generate more income towards dividends. We have holdings such as (luxury goods brand) Kering (0IIH) or (chemical company) BASF (BFA)."
So there are still some reasonable dividend payers within the portfolio. They are just not the ones that keep him heading back to San Francisco.
