The investment trust’s patience with biggest holding Tesla has been rewarded
Thursday 27 Feb 2020 Author: Daniel Coatsworth

Shares in £9.6bn investment trust Scottish Mortgage (SMT) are trading at an all-time high of 659p, thanks in part to the soaring success of electric vehicle maker Tesla which is the largest holding in its portfolio.

Tesla’s share price has gone up by 119% so far this year as investors react positively to production numbers and signs that it could be close to making an annual profit. Also contributing to Scottish Mortgage’s march upwards have been share price rallies in other key holdings including retail giant Amazon, Google’s parent company Alphabet, streaming provider Netflix and food ordering platform Delivery Hero.

HOW MUCH HAVE INVESTORS MADE?

It wasn’t long ago that Scottish Mortgage talked about a period of underperformance in its half-year results (8 Nov 2019), with net asset value growth of 3.2% versus 9.9% from the FTSE All-World index for the six months to 30 September.

In those results the trust made it very clear there would be periods of underperformance. After all, it is extremely rare for a fund manager, or even a private investor, to consistently achieve market-beating results.

Picking the right assets and being patient is the key to long-term investing success and Scottish Mortgage has a superb track record of rewarding its investors. In the 10 years to 30 September 2019 its net asset value had increased by 415% against 204% for the FTSE All-World index – so more than double the return.

HOW WOULD YOU SUMMARISE SCOTTISH MORTGAGE?

The trust describes itself as a way for investors to access the world’s most exciting growth companies. It is quick to shoot down suggestions that it is a technology fund; instead, the trust says its approach is to look at companies enabled by technology.

Its strategy is to identify companies which it believes have the potential to be much greater in size in the future thanks to having a proposition which is scalable and could be market-leading in time. It still holds on to these investments once investee companies become market leaders.

‘We never buy a stock in the belief that we won’t hold it for a long time,’ says James Anderson, co-manager of Scottish Mortgage. ‘Companies that are successful these days have a greater probability of more success, so we think very carefully about cutting back exposure.

‘With digital businesses you tend to have a period where there is a battle over establishing the market. You then find out who is leading it and very often the valuation will go up. At that point the probability and scale of your success rise very sharply and often we find ourselves increasing our position (in the stock) at that point.’

WHY IS TESLA SO IMPORTANT?

Scottish Mortgage has come under a lot of fire in recent years for having such a large position in Tesla. Many cynics say the business is overvalued, is burning through cash, and won’t be the market leader in electric vehicles. All the time Scottish Mortgage has remained supportive of the business and now it is having the last laugh given how Tesla’s share price has soared.

‘Tesla has been profoundly misunderstood,’ says Anderson. ‘That bothers me in the sense that our media and investment landscape prefer to obsess about failure than celebrate potential success on a huge scale. I always think it would be better for the world that Tesla succeeded.’

The fund manager says he first bought shares in Tesla seven years ago when they were trading in the mid-$20s. They are now trading at $917.

‘At one level (when we first invested) the company had already obtained a lot because you could see that they had managed to make a car that was electric which was competitive with the external, traditional car industry. By demonstrating that, it was further on than people thought it was.’

WHY IS AMAZON IMPORTANT?

Scottish Mortgage has been invested in Amazon for even longer, having first bought in 2004. Assuming no change to the reported position of 541,480 shares at the end of 2019, the trust’s stake in Amazon is now worth £911m which is just under 10% of its whole portfolio. That means Amazon’s performance will have a major influence on the direction of the investment trust’s shares.

When he first bought into Amazon, Anderson says people were still worried about its financial sustainability as well as its business model more generally.

‘We look for huge opportunities that are almost unimaginable in their scale, certainly how they are perceived at the time.

‘We could see that Moore’s Law was enabling Amazon to have a much greater set of opportunities than was once thought and on Tesla’s side progress in battery technology and in solar technology was enabling Tesla to have greater opportunities.’

Moore’s Law states that processing power for computers should double every two years. As for Tesla, the market often underappreciates the fact that the business is more than just electric vehicles – it also has a solar power and storage battery business.

IS IT ONLY ABOUT TECH?

Despite a lot of focus given to Scottish Mortgage’s disruptive company investments, there are a few names in the portfolio which have a much longer heritage. They include 147-year-old Swedish industrial company Atlas Copco whose activities include generators and pumps. Anderson is particularly enamoured with how the company has made a name for itself with air compressors for semiconductor and electronics production.

‘They’ve done an astonishing job in generating real growth and real change to the business, with brilliant people running it,’ he says.

Ferrari also sits in the portfolio, with Scottish Mortgage having originally invested when it was part of Fiat Chrysler. The fund manager said he became a ‘devoted follower’ of the late Ferrari boss Sergio Marchionne and believes he was ‘as much of a genius as the people we talk about more commonly with US or China market disruption’.

Anderson says many fund managers make the mistake of spreading themselves too thinly, namely investing in too many companies so that the portfolio cannot be managed properly. He prefers to limit Scottish Mortgage’s portfolio to no more than 100 holdings.

Anderson and his co-manager Tom Slater whittle down the investment universe by only focusing on companies that are run by inspirational entrepreneurs and where there is a very large opportunity for the business to grow.

DOESN’T IT INVEST IN PRIVATELY-OWNED COMPANIES?

A small chunk of the portfolio contains unquoted companies, namely businesses which aren’t listed on a stock market. For Scottish Mortgage to crystalise any value creation from unquoted investments it would need to find a buyer for its holdings privately or wait until a business lists on a stock market so it can freely trade the shares. However, remember that it likes to hold on to investments for a long time, so don’t think that a stock market listing is the point at which it would necessarily get out.

Several unquoted investments in the portfolio are expected to float on a stock market in the near future including accommodation platform Airbnb; Ant Financial which is a subsidiary of Chinese internet giant Alibaba; and ByteDance which owns the social media phenomenon that is TikTok, a video-sharing service.

Companies often see their valuation increase when they join the stock market as a wider pool of investors bid to own the shares. It also means a company has to be more transparent about its actions and financial accounts.

Should you invest in Scottish Mortgage?

The answer is ‘yes’ if you have at least a five-year time horizon and can be patient. It perhaps isn’t suitable for people in the latter stage of retirement as most of the returns will come through capital gains rather than income. However, for everyone else happy to risk some of their money then it is a very attractive investment proposition.

Scottish Mortgage has been a very successful investment for a long time and we see no reason why this should change. We view it as an essential holding for a diversified portfolio and an excellent choice for regular investment, putting money in every month.

HIGH HOPES FOR SPOTIFY

Music and podcast streaming platform Spotify was an unquoted business when it joined Scottish Mortgage’s portfolio and is now listed on the New York Stock Exchange. Despite a few ups and downs along the way, Spotify’s shares are now trading almost at the same price as when it hit the market in 2018. However, the business does appear to be gaining traction with nearly half of all users now paying a subscription fee.

‘It is incredible how little the whole spoken word is valued by the stock market relative to what we do on our on screens,’ says Anderson. ‘I think Spotify has a manager and founder who is playing a really long term game and really believes the whole structure of the industry needs to change.

‘We’ve been increasing our stake but we are not convinced the stock market will recognise the transformation of the industry in the imminent future.

‘We are extremely confident that in 10 years’ time Spotify’s importance relative to the (record) labels and its role to artists and podcasts will be enormously greater than it is now. We think adding at this sort of share price is a very good thing to do for the long term.’


LISTEN TO OUR PODCAST FOR MORE INSIGHT INTO SCOTTISH MORTGAGE

Don’t miss this episode of the Shares / AJ Bell Money & Markets podcast as it contains an exclusive interview with Scottish Mortgage fund manager James Anderson. He gives more information on Tesla and Amazon, as well as discussing hot topics such as the impact of the Coronavirus on companies in the portfolio.

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