Scottish Mortgage: staying patient and disciplined

Market turmoil can distract us from what investing should be about: directing capital to companies that change our lives for the better. Tom Slater, manager of Scottish Mortgage Investment Trust, reflects on why in tough times, the best companies deserve investors’ loyalty.

As with any investment, capital is at risk.

New technologies and better ways of doing things are rarely adopted simply because ‘their time has come’. They happen because investors have used their capital to give entrepreneurs time and space to turn vision into reality.

Let’s take a current example, electric vehicles (EVs). Consumers have shown a clear preference for faster, safer and cheaper EVs. Manufacturers are selling all they can produce, and everyone is scrabbling around to secure supplies of components. But there is a significant capital cost associated with this green transition.

The need to find ways to supply risk capital to fund EV development is one reason Scottish Mortgage invests in the battery maker Northvolt. Even with a highly experienced management team and access to cheap power in northern Sweden, it has not been easy for the company.

That is partly because the venture capital industry has got too used to capital-light online business models. The idea of deploying billions of dollars to build physical capacity in northern Europe is anathema to many. To me, it’s the proper job of the long-term growth investor.

When Scottish Mortgage takes shares in these companies, it takes a share in their success or failure over the coming years and decades. This long-termism is profoundly unfashionable. But to take advantage of an opportunity, you need ‘hold discipline’: the resilience to hold these companies through difficult times.

Take Amazon. We first bought the company in 2004. By 2006, its share price had fallen by a third. Its management was being pilloried for launching a subscription service that offered free delivery, turning its most regular customers into its biggest loss-makers. The market hated how that hit profitability forecasts.

But that step towards launching Amazon Prime arguably underpinned the firm’s rise to becoming one of the world’s biggest retailers.

The market hates uncertainty, but uncertainty is inevitable with risky projects that can have big payoffs. I share the view of the celebrated US investor Shelby Cullom Davis: “You make most of your money in a bear market. You just don’t realise it at the time.”

The real test of being a disciplined long-term investor isn’t when you decide to sell something. It’s how you endure the periods when everyone thinks you’re wrong to stick with a stock. Despite all the stress of a market downturn, this might be when the underpinnings of growth are established.

What matters most is capturing the outsized impact that a small group of companies can have. We don’t have the data for the past 114 years, but for the past 20 Scottish Mortgage has tracked the contribution of individual holdings.

Over those two decades, we’ve owned 749 stocks and bonds. Of those, 680 – about 91 per cent – have made zero net contribution to the overall return.

The roughly 12-times return we achieved over the period was driven entirely by 69 assets – just 9 per cent of the holdings. Indeed, half of that growth came from just 14 investments.

So great is the disconnect between financial markets and the companies that create wealth that I tend not to comment about interest rates, GDP growth, or whether there will be a recession. I have my views, but they don’t matter much to my job.

What matters is finding that handful of companies that can make a difference to overall returns and hanging on to them for long enough for the returns to accrue in the portfolio.

Looking at the past decade, it’s notable that the big-winner companies have been powered not by general economic expansion but by growth in the spread of technology systems, such as smartphones or by the discovery of new ways of fulfilling existing demand, such as ecommerce.

So far, these winners have come from a narrow set of industries, including media and retail. But I’m struck by the breadth of the opportunities for further disruption in transport, healthcare, food, energy and finance.

Where we see opportunities, we must be steadfast. It takes patience and discipline to harness the growth of those few outlier companies. If we do, the payoffs can far outweigh the inevitable losses elsewhere.

A tide of change across the economy brings new opportunities. I know that even in turbulent times, as I write, visionary leaders are laying the foundations for the great growth companies of decades to come.

Scottish Mortgage Annual Past Performance To 31 December each year (%)

Source: Morningstar, share price, total return, sterling.

Past performance is not a guide to future returns.

Investments with exposure to overseas securities can be affected by changing stock market conditions and currency exchange rates.

This article does not constitute, and is not subject to the protections afforded to, independent research. Baillie Gifford and its staff may have dealt in the investments concerned. The views expressed are not statements of fact and should not be considered as advice or a recommendation to buy, sell or hold a particular investment.

Baillie Gifford & Co and Baillie Gifford & Co Limited are authorised and regulated by the Financial Conduct Authority (FCA). The investment trusts managed by Baillie Gifford & Co Limited are listed on the London Stock Exchange and are not authorised or regulated by the FCA.

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