How Scottish Mortgage aims to weather the storm


Lawrence Burns has big shoes to fill. Rise as Deputy Director of Scottish Mortgage Investment Trust (SMT) Last spring, when James Anderson (who had led the trust for more than two decades) announced retirement plans, the trust was in the final stages of a phenomenal growth spurt. Between the trough of the pandemic sell-off in March 2020 and the peak of the trust in November 2022, its stock price rose more than 220%.

Since then, it has collapsed by 55%. But Burns is undeterred. Despite a very different macroeconomic environment – inflation and tighter monetary policy – he believes we are still in a period of rapid technological change and that owning the companies at the forefront of this change offers the best chance of return on a 5 to 10 view. of the year.

Click here to listen to the full interview (45 min)

“If you think back to the last 20 years of change, I think the biggest influence has been Moore’s Law – that doubling of computing power that we’ve told you about in the past,” Burns says. “But the impact of that has been focused on sectors like retail, media and advertising. [which are] a relatively small part of most economies. Now what we see with this doubling in computing power is its widespread impact across a wider range of industries. He is particularly optimistic about the opportunities related to health and the energy transition.

Because Burns and the trust’s lead manager, Tom Slater, evaluate companies based on a long-term view, they tolerate higher stock price volatility than most fund managers. They value companies based on a probability-adjusted calculation of what they estimate the companies might be worth in five to ten years. The hope is that the portfolio, which has just over 100 stocks, will catch some of the stock market’s next stars early and own them throughout their life cycle.

There are people who think this task is just too difficult over multiple market cycles. Although Scottish Mortgage has been trading since 1909, it was Anderson who redefined the approach to target high octane growth. Burns explains how he thinks the strategy will still work, despite tougher macro conditions.

“What we’re really looking for is actually a few needles in what is a very, very big haystack,” he explains. “And that’s a challenge. But I think we’re lucky to have a number of things that help us in this challenge. The first is access to some of the best academics and scientists in the world, to help them understand how and where change is coming from.

The second is the ability to take a long-term view. “Take the practical example of Tesla. We didn’t know when there would be an inflection point in electric vehicles. But we knew that due to improvements in battery technology, the further you looked, the more likely it became,” says Burns.

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The trust bought its first unlisted stake 10 years ago. Today, 30 percent of the trust’s assets are now in unlisted holdings amounting to about half the number of holdings in the portfolio. As companies come to market later, managers say this allows them to capture growth sooner. However, it has raised questions about how these companies are valued and whether there might be reason to fear that their values ​​may be lower than public markets.

Burns explains that the trust has an independent valuation committee for its private holdings that follows international guidelines and that he and Slater have no say in the matter. “That fair market value is really the amount of money we would get for this business, if we were to go to private markets and sell it today,” he says. While he admits judging this accurately is a “difficult task” for the valuation committee, he says they base valuations on comparable rated peers and available secondary market data.

In terms of timing, private equity interests are assessed quarterly on a rolling basis, with approximately one-third being assessed every 30 days. Trigger events – such as a new funding round, an IPO, a deterioration in a company’s operating mechanisms, or a substantial movement in the share price among its listed peers – can also lead to changes in valuation.

Burns says there “wasn’t really a secondary market” when Scottish Mortgage started investing in private companies, but it is becoming “increasingly vibrant”. But Scottish Mortgage has not used it to sell or reduce its stakes in private companies, Burns says. “We did this because part of our element of going in and supporting these companies is saying we’re going to support them for the long term. Trying to sell two years later on the secondary market doesn’t quite match that.

According to the trust’s latest annual report, it has 10 private company holdings that have been in the trust for five years or more, and 18 that have been in the portfolio for two to five years. Eight of these holdings are venture capital funds. Nine of the listed companies held by the trust for at least five years were bought as private companies and 10 in the two to five year tranche.

Earnings and cash positions

Of the trust’s public stock earnings, Burns says about 75% produces positive earnings. Based on free cash flow, which is arguably what matters most, he says, about 10% of the portfolio produces negative cash flow.

“In this context, I think it’s probably worth pointing out that there will be a number of companies that may be profitable, but choose to continue investing to create that long-term opportunity,” he said. he.

Burns says conversations he and Slater are having with a number of founders suggest that so far demand and structural drivers are holding up well for trust companies, and they encourage them to stress test and understand what will happen if things go really wrong. “What we constantly repeat is that these stress tests are really taken to heart and taken seriously within these companies,” he says.

Portfolio leverage has increased as asset values ​​have fallen and is currently around 16%. Burns is not concerned about this and says that on average over the past decade it has been around 12%. “It’s something that’s being monitored on a daily basis and we feel like we have enough leeway to deal with it,” he says.

Chin a

The trust has significant exposure to China, a place where managers believe some of the best innovation has come in recent years. In March 2022, 16% of the portfolio was made up of Chinese holdings, compared to 24% the previous year, as share prices collapsed.

“I think we need to be open about this, the level of government intervention and the breakdown or potential for continued breakdown in US-China relations has been broader and stronger than we would have anticipated,” he said. said Burns.

He says if government intervention means there is a ceiling on the scale or profitability that Chinese companies can achieve, it is something they need to take “very seriously” as they seek growth outliers. And while he thinks the likelihood of relations between China and the West deteriorating with sanctions preventing foreign investors from accessing their money is “very low”, he says it has become a possibility and that feeds into its scenario analysis.

However, he does not think China is uninvestable. “It’s a huge part of the world, a huge part of the economy, [it has] a great deal of innovation and dynamism. I think cutting shareholders off from any exposure to that for a generation would be pretty extreme.” He also believes that the societal benefits these companies bring are recognized by the Chinese government, and he pays close attention to how the Chinese government perceives these benefits. In the case of Nio (US: NIO) it improves air pollution in cities via electric cars, he says, while Pinduoduo (US: PDD) concerns the efficient consumption of agricultural products.

Recordt activity

Burns says the main stake he recently added to is Moderna (US: MRNA), which has fallen more than 70% since its peak last August. “We think it has a very broad platform, but it was looked at through a very Covid-specific lens,” he says. “In fact, his platform can be applied to HIV, Zika, cancer and a range of respiratory diseases.” According to FactSet, the company now trades at 6 times forward earnings and Burns says it has about a third of its market capitalization in cash.

The main company they continued to take money from is Amazon (US: AMZN) where, over a five- to ten-year perspective, the possibility of a significant return seems increasingly difficult. “I think it was a combination of being a bit more mature in the e-commerce core, Jeff Bezos and Jeff Wilke stepping down, and having to share the cloud market with more and more players. ”

The trust was trading at a discount to net assets of 15.6% on June 16 according to Winterflood – the widest it has been in the past 12 months. Year over year, it has the worst net asset value and worst share price performance in Winterflood’s global equity investment trust sector. However, over three and five years, it still has the best returns.

Click here to listen to the full interview (45 min)

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Source: Winter Flood, 16.06.22

Laurent Burns CV

2021 – present, Assistant Manager, Scottish Mortgage

2019, appointed Vice President of International Growth Strategy at Baillie Gifford

2009, joined Baillie Gifford

2009, graduated from Cambridge University (BA, Geography)


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