Investors in Scottish Mortgage who have seen the value of their holding halve since November should be reassured that such falls are nothing new for the trust, according to deputy manager Lawrence Burns, who said some of its most successful holdings have experienced declines of up to 90% at times.
The trust has been one of the highest-profile casualties of the spike in inflation and the re-rating of growth stocks. A recent article on Trustnet noted the decline has been so severe that Scottish Mortgage has lost its title of the UK’s largest investment trust.
Performance of trust vs sector and index since 4 Nov 2021
Source: FE Analytics
However, writing in the trust’s annual report, Burns said what makes long-term investing difficult is that progress rarely moves in a straight line and that it requires not just patience, but the ability to endure periods of “intense discomfort”.
“We have experienced such discomfort often with our holdings,” he explained. “Tesla was first purchased by Scottish Mortgage in January 2013. It experienced a fall of 40% that first year alone.
“During the course of our ownership, it has now fallen by 30% or more on seven occasions.
“Yet more extreme was NIO, the Chinese electric car maker. It endured a near 90% drawdown in the year following its IPO, before experiencing its tremendous rise.”
Other significant contributors to the trust’s long-term performance such as Amazon, Illumina and Tencent have been hit by similar declines before going on to deliver spectacular gains. Burns said that had the trust’s managers lost their nerve and cut their losses on any of these holdings, it would have had a “catastrophic” impact on their long-term returns.
He noted that this pattern wasn’t as unusual as it may sound. For example, in a study of US equity market returns over the last seven decades, professor Hendrik Bessembinder of Arizona State University found that “even those investments that are the most successful at long horizons involve painful losses over shorter horizons”, with drawdowns of 40% or more shown to be common and often lasting around a year.
Scottish Mortgage itself fell more than 60% during the financial crisis.
Performance of trust in 2008
Source: FE Analytics
Burns admitted the world has changed in the past six months and it is possible the investment case for some of the trust’s holdings is no longer valid. As a result, the managers have sketched out a range of possible scenarios as to how each company may look in five to 10 years. In most cases, this has underlined the motivation for continuing to back some of the biggest fallers in the portfolio.
“Moderna has experienced a 70% fall from the highs of last year,” Burns said.
“While the market focus has been on the longevity of Covid vaccine revenues, we have felt this overlooks the progress being made to apply its mRNA technology to a broader range of healthcare problems such as flu, Zika, HIV and even cancer.
“It is hard to argue significant value is being placed upon that broader potential platform when the company is valued by the market on a mere 5x earnings and has nearly one-third of its market cap in cash.”
As a result, Scottish Mortgage's managers have used the decline in Moderna’s share price as an opportunity to buy more of the stock at a lower price.
Delivery Hero has fallen even further, down 79% from its peak in early 2021, yet Burns said that when the team revisited its investment case, it found the likelihood of success had actually increased.
“Our biggest concern had been competition in the key market of South Korea,” he continued.
“Nonetheless, the most recent evidence is that it is growing rapidly and continuing to hold its near 80% market share in the country.
“Looking across all the markets it operates in, revenues grew over 50% annually in the first three months of this year, with a significant long-term growth opportunity still remaining. Continued progress does not appear to be recognised by the market: over the last two years, revenues have increased nearly four-fold and yet the share price has fallen over 50%.”
Burns admitted the investment rationale hasn’t held for every holding that has crashed. For example, last summer the trust sold out of German biotechnology company CureVac, which had been in the portfolio for six years.
However, he pointed out this was because a lack of progress in multiple clinical trials meant the trust’s managers ascribed a substantially lower likelihood of success to the company – it had nothing to do with the macro environment or increased pressure to deliver results.
“In periods of stress, people's time horizons contract, and the pressure to sacrifice long-term gains for immediate respite grows by the day,” he explained.
“Should our own time horizon ever meaningfully shorten, we would be destroying our greatest advantage. We have no intention of ever doing this, but if we did, our shareholders should sell.
“For it is precisely at such difficult times that the distinctiveness, and importance, of taking a long-term perspective is greatest – for us as investors, for the companies in which we invest, and for our shareholders. We are deeply appreciative of the trust our shareholders place in us, and of their support in our task.”
Scottish Mortgage has made 561.9% over the past 10 years, compared with 223.5% from its FTSE All World benchmark and 172.4% from its IT Global sector.
Performance of trust vs sector and index over 10yrs
Source: FE Analytics
The trust has ongoing charges of 0.34% and is on a discount of 8.7%