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Why the future is private

Tom Stevenson

Tom Stevenson - Fidelity Personal Investing

The hint is quite definitely not in the name when it comes to Scottish Mortgage. This long-established investment trust from the Edinburgh-based Baillie Gifford stable is very much global rather than focused north of the border and not since before the First World War has it had anything to do with mortgages.

If you look at the list of investments in the trust, run for the past 20 years by James Anderson, it reads like a catalogue of some of the most exciting growth stocks in the world today. Top of the list, at around a tenth of the trust’s assets is Amazon, but you’ll also find Chinese e-commerce giants Alibaba and Tencent as well as the likes of Netflix, Spotify and lesser-known but interesting prospects like Ant Financial and Grubhub.

Scottish Mortgage is a long-term investor, looking to find companies with the potential to grow substantially over the next 5-10 years. Its fundamental belief is that the lion’s share of total stock market returns is accounted for by the performance of just a handful of super-growth stocks, so it unashamedly looks for these superstars.

Looking at the full portfolio (helpfully laid out in the company’s annual and interim reports which you’ll find at the trust’s website) you get a sense of how Anderson achieves this challenging goal. There’s a small number of large holdings which he has built up over many years, adding to the holding as he gains in confidence that he has found a genuine long-term winner. Standing behind that short-list is a much longer tail of holdings, accounting in each case for maybe only 0.1% of the trust’s assets where Scottish Mortgage is testing the water and building a relationship with a company’s management.

What is striking about the list is just how many of the trust’s investments are still unquoted. This is deliberate. As James Anderson explained to me in a fascinating interview recently, more and more of the value created by companies is now happening before they ever reach the public markets via a flotation. Private companies are where the real action is for an investor today.

There are a few reasons why this might be the case. Most important is the fact that many companies these days are relatively capital-light - they just don’t need lots of money in their early development stage. So, it’s quite an easy decision for managers to avoid the onerous reporting and regulatory requirements of becoming a public company.

In addition, as Anderson says, ‘capital markets are not very good these days at providing the risk capital needed to grow businesses. True risk taking is now taking place in private markets.’ He goes further, challenging other fund managers to explain why they think they can avoid investing in unquoted companies given the changes that have taken place.

Anderson believes that an investment trust like Scottish Mortgage has an important role to play in bringing private investments to ordinary personal investors who do not have the access to this part of the market. There’s an important cost element too. Venture capital funds often charge expensive performance-related fees while Scottish Mortgage currently has an ongoing charge of just 0.37%, with the expectation that it could fall further if economies of scale can be achieved.

Growing companies like the Scottish Mortgage approach because it offers the prospect of genuinely ‘permanent capital’. If a company stages an IPO in due course, the trust’s default is to put more money into the company rather than take a profit and move on.

Scottish Mortgage, therefore, represents a good way for investors to access a broad spread of high-growth companies in both the quoted and unquoted arenas. With a co-manager, Tom Slater, in place there is moreover the prospect of today’s investment approach continuing for many years to come.

The major caveat with regard to the trust is the fact that the investment story is already pretty well known. Scottish Mortgage has a strong following and this has resulted in its shares trading at a small premium to the value of its underlying assets. Currently this premium is 4.0%.

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Important information

The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Overseas investments will be affected by movements in currency exchange rates. This fund invests in emerging markets which can be more volatile than other more developed markets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Investors should note that the views expressed may no longer be current and may have already been acted upon. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.