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The stock that’s re-energising the Scottish Mortgage Investment Trust

05 May 2015

Tom Slater, deputy manager of the UK’s biggest global investment trust, explains why electric car manufacturer Tesla is joining his list of favoured tech stocks.

By Lauren Mason,

Reporter, FE Trustnet

Tesla is a big investment risk following the poor consumer reception of other electric cars in the past but if the company succeeds the rewards will pay off, according to Baillie Gifford’s Tom Slater (pictured).


The manager, who has worked as deputy on Scottish Mortgage under James Anderson since 2009, believes that the trust’s consistently impressive performance is down to unearthing undervalued sectors.

“One of the critical drivers for us over the past five years has been the view that markets are underestimating technological change,” he said.

The £3.3bn investment vehicle is renowned for doing particularly well during rising markets due to this skew towards innovative tech stocks.

Over five years the trust has achieved total returns of 141.88 per cent, which is more than double the returns of its average peer and benchmark.

Performance of fund vs benchmark and sector over 5yrs

 

Source: FE Analytics

Its holdings in innovative areas include companies that have cashed in on the rise of e-commerce such as Amazon.com and Alibaba and transformational health companies like Illumina and Genomic Health.

However, Tesla, one of the newer companies in the trust’s portfolio of longstanding holdings, bears no correlation to these other technology stock picks and may surprise investors who are familiar with the trust.

“If you go back to when the idea of electric cars became mainstream again in 2008, it was when oil prices were spiking. Lots of conventional auto-manufacturers talked about electronic vehicles but, actually, you’ve seen pretty much zero progress,” Slater admitted.

“You’ve seen lots of platforms where people have ripped out the conventional engine, stuck a new battery pack in and that’s an electric car.”


“Contrast that with the huge progress that’s been made by Tesla and their S Sedan model. When you go back to the first half of 2013 when we were buying the shares, this vehicle was winning all the accolades from the motoring magazines, not because it’s electric but just because it’s a better project than competitors.”

The manager believes this is a prime example of the ability that the technology sector has to create a successful new business model within a conventional industry.

He says that another pull-factor towards Tesla is the difficulty that competitors with well-established brands have in responding to innovation.

“If you’re BMW or Mercedes, you have a very valuable franchise which you want to protect,” Slater explained. “It makes sense from one year to the next not to change things a great deal – any change has to go through a series of committees.”

“So we think progress in that area is driven by an exceptional company. If we’re right, they are creating a new breed of automotive brand from scratch over 10 years and that’s a franchise that will be worth several times the price that you see today.”

Tesla also hit the headlines last week following chief executive and product architect Elon Musk’s unveiling of a product called the Power Wall, a wall-mounted energy storage unit that holds 10 kilowatt hours of electric energy.

In fact, Musk believes that businesses, homes and industries will adopt this as their primary source of power, which would change how electricity is produced and consumed globally.

However, Slater admits that if Tesla’s ambitious goals don’t go to plan, the 1.9 per cent holding the trust has in the American car manufacturer will become no more than a failed experiment with little long-term value.

However, he thinks that if an investor is able to successfully identify innovative stocks and has the confidence to hold enough of them, the success of just one of these companies will pay for any inevitable mistakes made elsewhere in the portfolio.

“Investment trusts should be uniquely positioned to do this type of investment because you don’t have this time-limited fund. Equally you don’t have the liquidity constraints of an open-ended fund – we have permanent capital,” he continued.

Slater and Anderson invest in companies such as Tesla because they lean towards unique and cutting-edge investments which they choose in terms of corporate attraction and not through index construction.

What’s more, they believe that their long-term approach turns both time and volatility to the investor’s advantage.


However, in the case of Tesla, while the oil price slump will potentially be no more than a blip when investing long term, should the previous unsuccessful attempts at breaking electronic cars into the mainstream market serve as a warning?

“There are all sorts of issues there,” Slater said. “Tesla’s Model S is the equivalent of maybe an Audi A8 or a Mercedes S Class. You have to start there because the cost of producing the vehicle takes you to those price-points, so that was where it was competitive initially.”

“Tesla will do 30-odd thousand units this year, so that is commercial volumes and it’s a significant part of that sector of the market. There was certainly one point where I was selling Mercedes and Audi in that category.”

The manager says that stocks begin to get really interesting when their products reach mass-market price-points. Tesla’s next car model, an SUV set to be available to consumers in the third quarter of this year, is a product that Slater believes will be particularly appealing to mass markets.

“You’re talking BMW 3 Series price-points, and there the marketplace is several hundred thousand units – I think BMW maybe do just in the two-hundred thousands, same with Audi. If you get to that stage you’re getting into very large-scale production,” he said.

“If you look at the growth rates and the scaling, [the electric SUV] is getting somewhere quite quickly. But you come to this point where the conventional guys have not really put much behind this and BMW has got the furthest with it. They came to see me a few months ago – they’ve got the I8 which is a supercar and the I3a family-sized hatchback,” he said.

“What became clear is the I8 isn’t an electric car – it does 15 miles on a fully-charged battery –  and it’s more about the branding of the project. Then the I3 was a more worthy attempt, but that is the best of the encumbrance – it cost them $4bn to do this.”

Despite Tesla being the operable electric car manufacturers, according to Slater, should the extra infrastructure needed to push the industry into the mainstream, such as charging points, be a cause for concern?

“It’s definitely is a constraint,” he admitted. “You have to get the range of vehicles up to a point where people aren’t anxious about that and that’s one of the things about the Model S: the fact that it can do 280 miles between charges.”

“The cost of infrastructure is actually relatively modest in terms of these super-charging stations. They don’t take a huge amount of money to do. The other point is you can just plug these things into the wall – you can charge them anywhere.”

“So it is a constraint to growth, but I don’t think it’s the limiting factor. I think the only limiting factor is Tesla’s ability to execute, because nobody else is doing what they’re doing.”

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.