"Exceptional companies” will drive stock market returns over the long-term, but there will be setbacks along the way, according to James Anderson, manager of the £14 billion Scottish Mortgage investment trust (SMT).
In the trust’s half-year report, the manager has attributed his stellar performance to the success of a handful of big winners including three-star rated Amazon (AMZN), Tencent (00700) and Tesla (TSLA).
Scottish Mortgage has defied the gloom in 2020 and has seen its net asset value rise by a staggering 76% since the depths of the sell-off at the end of March. That compares to a 24% increase in the FTSE All World Index over the same period. Those stellar returns are also evident over the long term, and the fund’s NAV has grown by 340% and 674% over five and 10 years, versus a 96% and 181% increase in its benchmark.
“Over the long run, stock market returns are driven by a small number of exceptional companies. The progress of such companies is rarely smooth or linear, they have breakthroughs and they have setbacks,” says Anderson. “When we believe we have identified an exceptional company that is pursuing a large opportunity, we look beyond this cycle of feast and famine.”
So, who are the winners?
Tesla & Friends
Scottish Mortgage’s returns have been concentrated in a handful of big winners, such as Amazon and Tencent over the past decade. But this year, in particular, the fund has benefitted from the meteoric rise in Tesla's share price. “While the company and its colourful founder attract an unusually high degree of attention, emotion and noise, the underlying return picture is far from an aberration,” says Anderson.
The manager has had to offload shares in the electric car giant after such a strong run as its position size in the portfolio had grown too large. But Anderson, who has held shares in the firm since 2013, maintains his conviction in the stock, even after reducing his position by 40%. He adds: “Tesla has made significant operational progress. It has successfully added capacity and the production ramp of its latest model has progressed far more smoothly than for any of its previous vehicles. Demand for its products is strong and the response from its traditional competitors remains muted.”
Other names in the portfolio which tap into the electric car theme include Chinese EV maker Nio (NIO), electric vehicle-charging network operator ChargePoint. Anderson’s reputation as a long-term investor often takes him to unlisted holdings, which can account for up to 25% of the fund’s assets and one of his unquoted holdings is EV battery developer Northvolt.
While Nio has endured difficult trading conditions since it listed on the stock market in late 2018, Anderson is confident the business is back on track and “its balance sheet has been strengthened by continued investment from its founder and through local government support.”. Meanwhile, Northvolt has access to cheap hydroelectric power in Swedish Laplan, which gives it a cost advantage as the industry grows rapidly.
"The investment approach followed here focuses on identifying high-growth companies and holding them for the long-term to gain the benefit of compounded growth, says Morningstar analyst Robert Starkey. "These companies will often have been new entrants or disruptors into a region or industry, radically changing the landscape and challenging the business model for the traditional incumbents."
Lockdown Winners
Anderson’s investment strategy means the fund seeks out so-called disruptor companies, which are shaking up their industry. One such firm is furniture retailer Wayfair, which has benefited from a surge in demand this year as people have spent more time at home and invested in upgrading their living environment.
“Whilst this may be a temporary, Covid-related phenomenon, the company has also moved decisively into profitability after an extended investment phase,” says Anderson. “The long-term profitability of Wayfair's business model has been hotly debated and the demonstration of a clear ability to make money is much more important for the company's value than a temporary spike in demand.”
Elsewhere, food delivery companies Meituan and Delivery Hero have enjoyed a pick-up in takeaways as national lockdowns have been enforced this year. Meituan has now grown beyond its nearest rival to become the dominant food delivery company in China. “The impact of Covid has been to drive up demand for its other delivery services such as grocery and general merchandise,” says Anderson. “The addressable market in meal delivery is many times larger than Meituan's business today and we now must also factor in the possibility of success in these other categories.”
Despite the fund’s strong performance, it was downgraded from a Gold to Silver rating by Morningstar analysts earlier this year as a result of changes to the Morningstar Analyst Rating methodology. Investment trusts are allow to borrow, or gear, and there are concerns that the trust’s level of gearing could add to its costs.
Morningstar analysts said at the time: "An ongoing charge of 0.36% is offset when the cost of debt is considered, pushing the representative cost up to 0.77%. This is not as attractive as the management fee alone, although it is still attractive given the access the trust offers to unquoted assets."
