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Scottish Mortgage looks to disruptive technology and unlisteds

Top 100 Funds update: The managers of this popular investment trust favour "disruptive" companies and have found opportunities in the technology sector and among unlisted companies.
January 14, 2015

Scottish Mortgage Investment Trust (SMT) has a very strong performance record, having beaten its benchmark, the FTSE All World Index, by a considerable amount over one, three, five and 10 years. Several investment advisers favour it as a long-term option, and last year Investors Chronicle readers voted Scottish Mortgage their favourite investment trust by some margin.

247.48p

Although this IC Top 100 Fund has made strong long-term returns, over the shorter term its share price can be volatile - it fell 44.77 per cent in 2008 but shot up 52.87 per cent in 2009, for example. Part of the reason for this volatility is because the portfolio bears little resemblance to the benchmark index, and an unconstrained approach is taken with no fixed limits on geographical and sector exposures.

Analysts at Winterflood say that shareholders should be aware that there are risks involved in this approach and not just from relative underperformance of notional benchmarks. "The risk, in our view, is that the performance may be extremely volatile," they say. "To a long-term shareholder this may just be a passing footnote, but for anyone who sold their holding in late 2008 the experience must have been a painful one."

However, Tom Slater, co-manager of the trust, argues that risk is not volatility - indeed it is maybe the opposite. "It is a terrible notion that risk is volatility around an index - that is completely wrong," he argues. "What we are trying to avoid are those companies that are permanently declining."

The trust takes a long-term view and has an average holding period of just under eight years. Baillie Gifford, the company that manages Scottish Mortgage's investment portfolio, says that companies welcome the trust as a supportive long-term holder.

"Because we are long-term holders we get meetings with senior company executives, for example Elon Musk, chairman of electronic carmaker Tesla," adds Mr Slater.

At the end of November the trust had 2.3 per cent of its assets in Tesla Motors (TSLA:NSQ), after putting in another £50m last year.

Scottish Mortgage also holds a number of companies it bought at initial public offering (IPO). These include Facebook (FB:NSQ), Rocket Internet (RKETX:GER), Zulily (ZU:NSQ), Zalando (ZALX:GER), Workday (WDAY:NYQ), LinkedIn (LNKD:NYQ) and LendingClub (LC:NYSE).

But over the year to 30 November 2014 the trust made complete disposals of 20 holdings that failed to live up to expectations. These included internet retailer eBay (EBAY:NSQ). "We owned eBay because it owns payment and money transfer company PayPal, which we thought would bring significant change to this area," says Mr Slater. "But we are increasingly disillusioned with PayPal as it doesn't seem to be bringing in change but trying to join the likes of Visa and MasterCard."

Scottish Mortgage's managers like to invest in "disruptive companies" with the potential for asymmetric returns. The trust's managers find a lot of exciting ideas in the technology sector, where technology is facilitating a new and better business model, but stress that Scottish Mortgage is not a technology trust.

They believe "the internet of things" is changing how people communicate, consume and work. They express this investment theme via companies such as Advantest (ATE:NYSE), which produces semiconductor test equipment and was added to over the year to 30 November 2014, as well as ARM (ARM), ASML (ASML:AEX) and Splunk (SPLK:NSQ).

The trust's holding in Apple (AAPL:NSQ), however, has been reduced. "We simply cannot see how Apple can make enough money to be judged on our criteria," says Mr Anderson. "And we think that Steve (Jobs, Apple's founder and former chief executive officer) did matter."

The trust also offers exposure to unlisted investments, some of which it has held post IPO such as Chinese ecommerce company Alibaba (BABA: NYSE). "This experience shows us that owning a business through an IPO can be a great way to get closer to companies," says Mr Slater. "We have to be in a position to make sure we can capture some of that value for our shareholders. The closed-end structure is a particular advantage when you hold unlisted companies, in contrast to the liquidity constraints of an open-ended vehicle."

Open-ended funds are obliged to return money to investors if they want to pull out of the fund, whereas investment trusts are not. If investors want to dispose of their shares in investment trusts they have to sell them in the market.

"Unlisted companies will be important in generating returns and insights over the coming years," adds Mr Slater. "I expect the unlisted area will be one where we continue to expend energy and capital in the coming year."

• The trust has recently promoted Mr Slater to joint manager of the trust with James Anderson. Mr Slater had been deputy manager since 2009, and worked at Baillie Gifford since 2000. Mr Anderson says this is done with the next 30 years of the trust in mind, although Baillie Gifford says that Mr Anderson, aged 55, is not due to retire at the moment and that the promotion is an acknowledgment of the contribution Mr Slater has made.

SCOTTISH MORTGAGE INVESTMENT TRUST (SMT)

PRICE247.48pGEARING14%
AIC SECTOR GlobalNAV242.8p
FUND TYPEInvestment trustPRICE PREMIUM TO NAV2.69%
MARKET CAP£3.07bnYIELD1.17%
No OF HOLDINGS74*ONGOING CHARGE0.50%
SET UP DATE1909MORE DETAILSwww.bailliegifford.com

Source: Morningstar, *Baillie Gifford.

 1 year share price return (%)3 year cumulative share price return (%)5 year cumulative share price return (%)10 year cumulative share price return (%)
Scottish Mortgage Ord21.99118.86144.85356.92
AIC Global sector average7.7147.5562.32151.79
FTSE All World NR GBP13.1648.5657.02131.57

Source: Morningstar as at 9 January 2014

TOP TEN HOLDINGS as at 30 November 2014

Illumina8.1
Baidu.com ADR7.9
Amazon.com7
Tencent5.9
Alibaba Group5.3
Inditex4.6
Facebook3.1
Fiat Chrysler Automobiles3
Banco Santander2.8
Kering2.5

Geographic Breakdown

North America36
Continental Europe27.2
Asia Pacific23.3
United Kingdom6.8
Net Liquid Assets and Bonds3.4
Emerging Markets2.7
Japan0.7