Managers of the Scottish Mortgage Investment Trust were in a reflective mood as they highlighted mistakes made over the last 12 months at the fund’s annual investors forum.
A note published by Jefferies’ analysts Matthew Hose and Fiona Huang revealed that, at the meeting, manager Tom Slater admitted being slow to recognise that China-US relations were deteriorating in 2022.
The £13.8bn trust’s exposure to China has fallen from historical levels following its decision to sell stakes in Alibaba, KE Holdings, and Full Truck Alliance.
Currently, 13% of the trust’s portfolio is made up of Chinese assets. Moving forward, the Scottish Mortgage management team said its investments in China will be decided by whether the companies are aligned with domestic policy objectives.
Hose and Huang wrote: “To this end, Scottish Mortgage has put its current holdings in two camps. NIO, Horizon Robotics and Jiangxiobai are companies with good alignment, while Meituan, Pinduoduo, Bytedance and Ant International are platform businesses that will be monitored for regulatory changes that could limit their profitability and scale.”
At the event in London, Slater also said it had been a mistake to assume that shifts in consumer behaviour seen during the Covid pandemic would continue.
Impediment to growth companies
The investment approach of the UK’s largest trust centres on backing exceptional growth companies across the globe. However, such firms have been hindered by 2022’s high inflationary environment.
In the Baillie Gifford trust’s November factsheet, it disclosed a 41.3% hit to its net asset value over the last year, while its share price tumbled 48.1% in a period Slater described as “humbling”.
Hose and Huang said: “One interesting recurring theme from the presentation was that although there are understandable impediments to growth companies amid a higher interest rate environment, there has been a weakening of the competitive environment for disruptive companies. In turn, market leaders are now able to gain a larger market share in their respective fields, to the benefit of free cash flow generation.
“In light of the weakness in valuations over the past year, new disclosure was usefully provided on the earnings and free cash flow generation of portfolio companies. 48% of the portfolio is in public companies with positive earnings, against 22% with negative earnings,” they added.
Of this 22%, the Jefferies analysts noted that 8% had a positive free cash flow. While a similar breakdown was not provided for private companies, which represents 30% of the overall portfolio, the presentation pointed out that some of these holdings are cash-generating.
“This is important as 21% of the portfolio is invested in public companies with net debt, as opposed to net cash, highlighting that at least some of these will be free cash flow generating and therefore reducing net debt balances.”
Jefferies reaffirmed Scottish Mortgage’s ‘buy’ rating, which it awards to securities it expects to provide a total return of 15% or more within a 12-month period.