The Scottish Investment Trust’s Alasdair McKinnon: ‘Value investing will never die’

Alasdair McKinnon used to be something of a technology enthusiast. Today, he doesn’t hold a single Big Tech stock in his portfolio.

Studying at Edinburgh University in the 1990s, the manager of FTSE 250 constituent Scottish Investment Trust (SCIN) describes seeing first hand the early days of the web, email and the video game DOOM. Starting his investment career after graduation, he was shocked to discover his office didn’t have internet access.

“It was like going back to the dark ages,” he says. “My colleagues were completely clueless.” 

During these formative years working for a UK small-cap fund, Mr McKinnon says he was “pretty clueless” himself when it came to reading financial statements. But, he adds: “I was ahead of my colleagues, because of my youth if nothing else.”

The budding investor was convinced that everybody was going to get a mobile phone, and that technology companies could be set for huge growth. When the share prices of these companies also started to rise exponentially, he says, “all my colleagues then treated me like a guru”.

The tech stocks kept soaring – until they crashed spectacularly at the turn of the millennium. Investors who had piled money into any company with a dot-com at the end of its name saw their gains wiped out almost overnight, as a litany of overvalued businesses started to drop like flies.

But fast forward two decades and once again technology rules the markets. Everybody does have a mobile phone, as well as email and internet at work. And besides his holdings in telecommunications companies, Mr McKinnon is one of a diminishing number without money in Chinese tech and the world-leading FAANG stocks: Facebook (US:FB), Amazon (US:AMZN), Apple (US:AAPL), Netflix (US:NFLX) and Google, owned by Alphabet (US:GOOGL).

In the midst of the tech bubble in the late 1990s, “I was just sort of caught up in the whole group psychology of it”, he recalls. When the dot-com bust eventually happened, “it was a great learning experience for me to say I was… wrong to get caught up in that psychology”.

Since taking the helm of Scottish Investment Trust in 2015, which had £660.9m in assets in October, Mr McKinnon has pursued a “contrarian” approach to investing. The man who was once “clueless” about navigating a balance sheet now goes in search of unloved businesses with solid financials – what his firm calls “ugly ducklings”. 

While the trust prioritises long-term gains, it's a strategy that has also achieved less than attractive returns in recent years. The fund’s net asset value, which has broadly been tracked by its share price, is up 40 per cent since 2015. The firm says its contrarian approach has no formal benchmark, but MSCI’s flagship global equity index has grown 62 per cent over the same period. 

Investors in equity funds have gone shopping elsewhere. Within a group of 16 London-listed peers compiled by Investors’ Chronicle, Scottish Investment Trust’s share price has seen the third lowest increase since 2015. Long-time investor favourite Baillie Gifford’s growth-focused Scottish Mortgage Investment Trust (SMT), has little in common with Mr McKinnon’s fund besides its Caledonian links. Reaping the rewards from its big bet on electric carmaker Tesla (US:TSLA), its shares are up 343 per cent in five years.

After years of kneeling at the feet of Warren Buffett and other value investors who made millions seeking out underpriced companies, much of the investment community today only wants exposure to the hottest stocks on the market. In a sense, Mr McKinnon’s career has taken him in the opposite direction of this broader trend. Having started out “thinking in a momentum-type way”, the fund manager is now a value investor in the classical sense, who today finds himself swimming against the tide of another tech bubble.

“‘I bought this electric car company because I thought it was the future.’ If you believe that, that’s fine. But the trouble is if you don’t believe it, you just bought it because you thought it was going up,” he says.

“Going back to my early career, when I wasn’t so value-focused, you kind of learnt the hard way... If you buy something just because you think somebody else will pay more for it, when it falls heavily one day you don’t know what to do.”

With worldwide lockdowns fuelling huge growth in the digital economy this year, the question is when or even if Tesla and its tech peers will suffer a fall from grace, and Scottish Investment Trust can start to gain ground on Baillie Gifford and co.

In the meantime, investors in the fund should still continue to enjoy a healthy income. Despite its NAV falling this year, the trust's board decided to draw on its substantial reserves and raise the dividend for the 37th consecutive year. Even if the trust was receiving zero income from its investments, it would have enough spare cash to pay dividends for three whole years, says Mr McKinnon. 

Big on boring

While avoiding Silicon Valley, the fund manager has made bets on some of this year’s other winning sectors.

His portfolio is small on Big Tech, but big on Big Pharma. Shares in its largest healthcare holding, Pfizer (US:PFE), have jumped nearly a third since July, as a string of positive results for its coronavirus vaccine propelled the company to household-name status around the world. But this investment was not a bet on Pfizer’s Covid jab, says Mr McKinnon, who points to the political pressure around the pricing of these vaccines.

In fact, Scottish Investment Trust bought the company long before 2020, back when it looked “boring”. After Big Pharma’s blockbuster years towards the end of the 20th century, Pfizer was written off as “never returning to growth”, says Mr McKinnon, who also has large investments in pharmaceutical giants Roche (CH:ROG), Gilead Sciences (US:GILD), Sanofi (FR:SAN) and GlaxoSmithKline (GSK). Pfizer’s pipeline of drugs seemed so well regarded, he adds, that its low valuation didn’t justify the success it was likely to achieve.

As of October, the trust’s three biggest holdings were all gold miners: Newmont (US:NEM), Barrick Gold (CA:ABX) and Newcrest Mining (AU:NCM). These less than glamorous companies had also been losing favour with investors for years – Mr McKinnon recalls that early in his career he dismissed gold as an asset. But since the fallout from the pandemic ricocheted through the markets, investors have flocked to the security of the precious metal – Newmont’s stock is up 39 per cent in the year to date. 

Mr McKinnon nonetheless adds that investments in these companies, which he bought before 2020, are also long-term plays – the fund’s “view on gold is in no way a defensive view, it is purely an inflationary view”. With governments printing streams of money to support their economies, we’re probably heading for “1970s’ style inflation” in the coming years, he adds. And when the value of money goes down, the demand for gold tends to go up. 

Mr McKinnon points out that inflation will be less good for online streaming services. After seeing the “best demand environment ever” for their video platforms this year, these businesses may only lose subscribers if they hike prices. 

Generally, the pandemic could be the “final uber-boost” for a tech sector that has now enjoyed about 10 great years of growth, the fund manager suggests. Going forward, streaming services will “need to stop burning cash” in order to keep expanding. Investors could soon question how a ride-hailing service that subsidises its users works as a business, he adds. The speculative hype this year around Nikola (US:NKLA), which was recently accused of rolling a truck down a hill for a promo of its battery-powered vehicles “in motion”, reminds him of the mentality during the dot-com era.

For years, Mr McKinnon has patiently been making a virtue of choosing “boring” companies, from oil companies to legacy retailers, as other investors were enthralled by the tech sector’s charismatic chief executives. With vaccines now lighting the road to recovery, if consumers around the world eventually leave their screens and head out into the real world, maybe boring will be due a comeback.

“This is kind of what happened post the dot-com era. The money was all in one area and suddenly it broadened out to the parts of the market that everybody thought was too boring,” Mr McKinnon says. “That’s when we think they’ll start saying: ‘Well actually, there’s some really attractive companies in valuation terms elsewhere in the market'.”

So whether or not the tech bubble actually bursts this time round, Mr McKinnon seems happy to wait for the tide to turn. 

“[Value investing] will never die,” he says. “If anything, the stars are aligned for a big rotation. But it's been talked about before, and it won’t necessarily happen any time soon… Markets can do crazy things for an awfully long time.”

Alasdair McKinnon CV

Alasdair McKinnon became manager of The Scottish Investment Trust in 2015, before which he was assistant manager. He was previously an investment officer for the Lothian Pension Fund and a small companies analyst at Tilney Investment Management. He has a Master of Science degree in investment analysis from the University of Stirling and a masters in economic and social history from the University of Edinburgh.