The respective managers of the £2.3bn Scottish Mortgage and £215m Edinburgh Worldwide investment trusts have been given permission by their separate boards to invest up to 5 per cent of their portfolios in unlisted stocks, in the manner of private equity funds, with the belief they will reach an initial public offering (IPO) stage. Anderson (pictured) says that to gain high returns in technology stocks investment increasingly needs to take place before the company is listed, because high growth companies don’t need as much capital to achieve growth and therefore will list at higher prices.
“It is an incredibly different investment world now that companies don't need as much capital to grow their businesses now,” he said
“Look at the companies that have grown a lot over the last 10 years - they didn't need much capital to achieve growth.”
“The companies that are jostling to be the largest companies in the world at the moment are Google and Exxon.”
“We all know that Exxon needs lots of capital to grow and that Google doesn't, their return structures are completely different and the limitations on growth are completely different.”
Anderson says this trend is underappreciated by investment managers and is only likely to continue or accelerate rather than reverse.
“People assume that these companies are not going to last, but what we know is that this view is priced in,” he said.
“Look at Microsoft and Bloomberg, they have had base returns of huge dimensions for lives that are longer than the medium company's life.”
The decision by the board to allow the two managers to invest in unlisted companies reflects the belief that many fast growing companies will not need to access public capital markets for growth, according to Numis’ Charles Cade.
“Historically, several funds have made pre-IPO investments that failed to IPO once market conditions changed,” he said.
“Countering this, in mid-2012 Scottish Mortgage made a highly profitable investment of $50m in Alibaba, China’s equivalent of eBay, which is now valued at 2.4 per cent of the portfolio with the potential for a further uplift on the forthcoming IPO.”
Alibaba filed for a New York listing last week, although a data or entry price has not been established.
Another recent unquoted investment in the trust is Dropbox, a cloud data storage company, representing 0.5 per cent of the trust’s portfolio.
Both funds have outperformed their IT Global sector over five years. Scottish Mortgage has returned 148.22 per cent whilst Edinburgh Worldwide Investment has returned 93.52 per cent compared to a sector average of 79.63 per cent.
Performance of trusts and sector over 5yrs
Source: FE Analytics
Both funds have also shown themselves to be top quartile performers in rising markets such as 2013, 2012, 2010 and 2009 but have dropped to the bottom quartile, as markets have fallen suggesting their attractiveness is relative to investors’ view on the near term performance of the markets.
Both trusts have a generally high conviction selection of technology companies as their largest holdings, despite concerns of a bubble in the sector.
Scottish Mortgage has also added several businesses at the IPO stage including Facebook.
It has six out of 10 of its largest holdings in tech companies, two of them Chinese: Baidu and Tencent.
All of the Edinburgh Worldwide trust’s top ten holdings are technology companies or those heavily geared toward the technology sector, making up 25 per cent of the portfolio.
The stocks include the IP group, Ocado, Tesla and Novadaq.
The managers of the two investment trusts are also taking a wider thematic bet on what they term ‘disruptive technology’ stocks in their portfolios
Technology companies with disruptive technologies tend to come from smaller businesses with the entrepreneurial founder still directing the company making them ideal for pre-IPO investing, says Brodie.
“They tend to avoid that bureaucracy and complexity that comes with larger businesses,” he said.
Baillie Gifford has always focused on a stock’s growth potential, but the emphasis has increasingly shifted towards high growth, particularly the power of technology to disrupt traditional industries, says Cade.
“This approach has delivered strong performance in recent years, but we would emphasise that it is likely to lead to volatile returns, with the potential for significant losses when investors become risk averse and less willing to “pay-up” for growth stocks,” he said.
Anderson is also taking a regional bet on technology stocks with a bias away from the UK. The trust is focused on Silicon Valley, Germany and China, according to the manager.
“If people had told me that three of the top 10 technology companies in world by market capitalisation would be Chinese I wouldn't have believed them or anyone that would have told me,” he said.
“It is not just that these people [Chinese entrepreneurs] are really innovative, but they have profoundly different attitude towards capitalism to most people outside Silicon Valley and certainly most people in London and New York.”
