Gearing on Scottish Mortgage soars to £735m

The board of the investment trust, which is the largest in the UK, said gearing has fallen in the trust since assets have grown. Gearing is appropriate due to long-term investment opportunities, the board said.

The investment trust’s largest holdings are tech names from the US and Asia, like Amazon and Tesla, as well as Alibaba and Tencent. Consumer brands also feature strongly in the top 10, including Zara-owner Inditex, Ferrari and luxury brands conglomerate Kering.

The senior unsecured placement notes, denominated in sterling at a fixed rate, involves three issues: 20-year note for £30m with a fixed coupon of 2.91%; a 23-year note for £50m with a fixed coupon of 2.94% and a 30-year note for £90m with a fixed coupon of 2.96%.

Fair value of loans and debentures now totals £735m, just under 10% of total assets. Previously gearing was 8% at £565m total.

Racy portfolio

AJ Bell investment director Russ Mould said Scottish Mortgage’s “racier” portfolio meant he did not expect the board would let gearing run too high, although he thought 10% was not extreme.

The average investment trust’s borrowing totals 7% of total assets, according to the Association for Investment Companies.

While Mould said the gearing signals the board’s confidence in the portfolio, he noted rising interest rates theoretically should be negative for early stage companies that are valued on a discounted cashflow basis.

“In theory, rising interest rates are potentially quite bad for long-duration assets like tech companies, because it can effect their valuation,” he said.

Interactive Investor analyst Dzmitry Lipski said it makes sense for the investment trust to increase borrowing while costs are low.

The trust is able to take gearing to 30%. In 2009 it hit 26%, but Lipski said it had been falling since that point.

Rivals

Over a three-year period, Scottish Mortgage was third in the Investment Trust Global sector for performance, behind the £364.7m Independent Investment Trust and the £155.9m Lindsell Train investment trust. Neither investment trust currently uses gearing, according to the AIC.

While Scottish Mortgage, which is managed by James Anderson and Tom Slater (pictured), trades at a modest premium of 1.6%, the Independent Investment Trust is trading at a premium of 13.9% and Lindsell Train is trading 34.1% above net asset value.

Scottish Mortgage performance

Source: FE Analytics

The £1.8bn Monks and £500.3m Edinburgh Worldwide investment trusts, both managed by Baillie Gifford, also sit in the IT Global sector, sitting just behind Scottish Mortgage for three-year investment performance, returning 90.3% and 84.5% respectively. However, both investment trusts use relatively little to no gearing, with Monks having 0%, while Edinburgh Worldwide has just 1%.

A Baillie Gifford spokesperson said gearing is a decision for each independent board to agree separately.

While Monks has quite a bit of crossover with Scottish Mortgage, holding the likes of Amazon and Alibaba in its top 10, Edinburgh Worldwide holds “immature entrepreneurial” companies.

Mould said the relative gearing on Scottish Mortgage versus Monks was one feature for investors to consider when assessing the investment trusts.

Cheap debt

Scottish Mortgage chair Fiona McBain said the borrowings were at competitive rates and create long-term growth opportunities for investors.

While assets in the investment trust have increased three fold over 10 years, gearing has only increased 10%, the Scottish Mortgage annual report noted in May.

In April 2017 the investment trust borrowed £125m in a similar fashion to this week’s announcement with a blended rate just over 3%. The annual report confirmed the board was looking to increase borrowing.

Santander UK was the placement agent for the transaction.