17 June 2022

Tough times

Tom Slater, of Baillie Gifford, managers of Scottish Mortgage Investment Trust review one of the trust’s most challenging periods.

It has been a tough year. Markets have been driven by macroeconomic concerns, geopolitics and the ongoing shockwaves from Covid-19. Investing in this environment requires resilience and clarity of purpose. Our purpose is to provide long-term funding and support for Growth companies and the entrepreneurs building the future of our economy. This approach will sometimes be popular and sometimes, as now, be out of favour. While we do not enjoy discomfiting our fellow shareholders, we believe resilience during drawdowns is necessary for generating long-term returns.

It is more useful to observe and analyse geopolitical and macroeconomic developments than to engage in futile attempts at prediction. A standout lesson from the past two years is that our world is, in Sir John Kay’s terms, radically uncertain. We must be wary of those making confident assertions about the future. Instead, our job is to acknowledge the limits of prediction, build a portfolio that is robust to changing conditions and focus on answering the question, "What is going on here?"  

We think many of the challenges the world faces today are the negative consequences of two contentions that have driven our portfolio construction over the last decade. Firstly, China’s economic development is disrupting the established world order. Secondly, technological progress has created companies of increasing geopolitical importance and a complex network of global interconnection. China’s rise has brought a vast swathe of humanity out of poverty and created opportunities for workers and investors alike. However, this success has fuelled greater geopolitical ambition and a challenge to US hegemony. Online network companies have built an infrastructure that creates economic opportunity for millions, but the scale of their impact raises questions of governance and trade-offs to limit the influence of bad actors. It will not be possible to resolve these issues quickly or easily.

Diverse processes of significant change underpin the growth of our companies. We believe that a greater understanding of disease's genomic and molecular causes will result in targeted and personalised healthcare. People’s attention is shifting from traditional forms of media to online. The retail business is going mobile and payments companies are becoming aggregators of information and services. Enterprises are increasingly turning to the Cloud for the provision of IT services.

We are moving away from a world of carbon-based energy generation and transport. It is helpful to measure recent events and stock prices against these contentions. Has healthcare become less likely to personalise? Will people go back to offline forms of media and commerce? Are we more likely to be using fossil fuels ten years from now?

For us, the answer to these questions is “No!” Indeed, recent events are likely to have accelerated some of these processes. Consequently, we have not made meaningful changes to the portfolio. We still own all the top 30 stocks we owned a year ago. Moderna, the mRNA company responsible for one of the key Covid vaccines, is now our largest holding, partly because of additions. It is the only company in our top ten held for less than five years. We think the approach that led to its Covid vaccine will offer critical medical breakthroughs in the years to come. Tesla, the electric car producer, is our second-largest holding despite further reductions. Demand for its products far outstrips supply, and its operational execution has been remarkable.

A standout lesson from the past two years is that our world is, in Sir John Kay’s terms, radically uncertain.

The most significant reduction has been Amazon, our largest holding for many years. We still have enormous respect for the company and believe it has a substantial opportunity ahead of it, particularly in providing Cloud infrastructure through Amazon Web Services. However, founder Jeff Bezos stepping back from the CEO role is a source of concern given how central he has been to the corporate culture. At the same time, the maths of future growth is more challenging. E-commerce has grown from 5% to 15% of the US retail market over the past ten years, tripling the market for online retailers. Suppose e-commerce takes another ten percentage points of market share over the next decade. In that case, the opportunity will only have grown by two thirds. Given our focus on Growth, it now makes sense for us to redeploy capital in other areas.

Most companies in the portfolio have delivered exceptional levels of growth over the past two years in a challenging operating environment. Despite geopolitical uncertainty, significant increases in the cost of living and rapidly rising interest rate expectations in many parts of the world, we are still expecting most to deliver high levels of growth this year. These companies are well capitalised, led by exceptional leaders and have already demonstrated high levels of adaptability and resilience. A small number of companies create the majority of stock market returns regardless of the prevailing economic conditions. We aim to identify companies with that potential and, where we find them, to support them for as long as possible.

Scottish Mortgage Annual Past PerformanceSource: Morningstar, share price, total return

Past performance is not a guide to future returns. As with any investment, capital is at risk. 

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 is 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.

A Key Information Document is available at www.bailliegifford.com.

Illustration by Adam Mallett

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