Scottish Mortgage: underperformance, and the next $1tn stocks
Lawrence Burns, deputy manager of the investment trust, discusses recent underperformance vs the benchmark, and reveals the firms and themes he's most excited about in the portfolio.
4th December 2024 09:17
Lawrence Burns, the deputy manager of Scottish Mortgage Ord (LSE:SMT), sits down with ii's Sam Benstead to discuss how he manages his portfolio.
He speaks about the fund's recent underperformance versus its benchmark, but says that the investment process hasn't changed. Burns also reveals the companies and themes he's most excited about in the portfolio, including the unlisted shares he thinks could grow to be some of the biggest businesses on the planet.
Scottish Mortgage is one of ii's Super 60 list of fund ideas.
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Sam Benstead, fixed income lead, interactive investor: Hello and welcome to the latest Insider Interview. Our guest today is Lawrence Burns, deputy manager of Scottish Mortgage Investment Trust. Lawrence, thanks very much for coming into the studio.
Lawrence Burns, deputy manager of Scottish Mortgage: Thank you for having me.
Sam Benstead: Scottish Mortgage is a very popular trust among our customers. It's on our Super 60 list of recommended funds. But since about 2021, performance has been disappointing. Why is this?
Lawrence Burns: I think it's important just to very briefly start with what Scottish Mortgage is trying to do and then it feeds into that question.
What we're trying to do is own the most exceptional growth companies in the world, wherever they are, whether they're public or private. That's everything from NVIDIA Corp (NASDAQ:NVDA) in the public markets, where it has been the driver of the AI revolution, to SpaceX in the private markets.
And what we're trying to do is, over the long term, benefit from the change that they lead to in our society and in our economy, and own them through the turbulent periods, and take advantage of the asymmetry that's within equity markets.
So, Nvidia is a great example of that. We invested £64 million back in 2016 and today we've been able to sell at a profit £1.2 billion, and we still have a £555 million stake remaining.
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But the problem is the path that those companies go on, it's rarely a straight line. So, that leads us to the last few years, which have, as you say, been a bit more disappointing.
I think there's a few different reasons for that. The first reason would be, if you look at the big picture, you had a really significant hike in interest rates in 2022 and 2023. What did that do? It made the earnings that were further out for growth companies less valuable, so it compressed the valuations.
And in addition, it's worth talking about some of the individual stock selection, where they've been a bit disappointing. The biggest by far for us has been Moderna Inc (NASDAQ:MRNA). It's been our largest detractor.
Moderna is the company that created that life-saving vaccine back in the pandemic. It's not quite commercialised some of its developments as well as we would have thought. Execution has been a bit subpar, as is communication with stakeholders.
But the scientific validation of the platform has been really good because it's given us, and developed, a leading flu vaccine, an RSV vaccine. It's [making] good progress on a respiratory vaccine and with a cancer treatment reducing deaths by 44% versus the standard of care. So, I think we really need to try and think about the long-term progress of all these companies.
We're very happy with the shape of the portfolio. Operationally, a lot of these companies have come through this difficult period very well, and we're quite excited about the portfolio that we have both in the public and the private space.
Sam Benstead: During this difficult period, have you made any changes to the investment process and the portfolio?
Lawrence Burns: In terms of process, when you go through both good periods and bad periods, there's always things you learn, and you try and improve. But I think the really important thing is, our philosophy is not changing. We think it works.
Scottish Mortgage has had an exceptionally long history of outperformance. As you say, the last few years have been difficult, but I think our advantages are as strong today as they've ever been. And what are they? We're long term, so we're thinking out five years. That's harder in these conditions for all active managers than it's been for quite a while. We have an edge in terms of the access we get to companies to learn and understand both them and how the world is changing. That's even stronger on the private side. And because of our structure, we're able to withstand the uncertainty and volatility that comes with long-term investing.
And again, just to re-emphasize it, I gave the example of Nvidia earlier. Nvidia now looks like a great investment. It didn't always look that way. In 2022, the share price fell by over 60%. We did not look particularly smart holding Nvidia at that point, and that's true for several other companies. Spotify Technology SA (NYSE:SPOT) and MercadoLibre Inc (NASDAQ:MELI) all had very large falls, but have now recovered back above the pandemic-period highs.
So, for us, we really believe in that philosophy and process. We think it works, we're committed to it.
In terms of what we've been doing with the portfolio, a few different things. One has been, as I said, holding on to some of those big winners that have come through to us now as big contributors. But it's also been about moving on from some of the smaller companies that have been disappointing in terms of growth trajectory. So, I'd call out there Zalando SE (XETRA:ZAL), HelloFresh SE Bearer Shares (XETRA:HFG), and Zoom Communications Inc (NASDAQ:ZM).
But at the same time, this environment has really thrown up opportunities for us. We've been able to take new holdings in Sea Ltd ADR (NYSE:SE), the e-commerce gaming and fintech player in Southeast Asia. And Taiwan Semiconductor Manufacturing Co Ltd ADR (NYSE:TSM), the world's leading chip manufacturer, and in Nubank, the leading digital bank outside of China. And we've been able to own those at really attractive rates that we haven't been able to get in the past.
Sam Benstead: You're looking at buying innovative companies, but what themes are you finding most exciting at the moment and which companies are exposed to these?
Lawrence Burns: So, for us, what's really important is companies rather than themes. If you were really excited four or five years ago about electric vehicles and you'd invested in pretty much every electric vehicle company you could get your hands on, if you hadn't owned Tesla Inc (NASDAQ:TSLA), you wouldn't have done very well.
It's individual companies that really matter both to Scottish Mortgage and returns in the long run. I think there are individual companies that are driving some of the changes we see in the world. So, we think the impact from Nvidia's AI chips is potentially huge and we think that will have large implications for the supply chain for companies that use those chips, everyone from Tesla and their self-driving cars to Shopify for what they're able to provide merchants in terms of software.
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But if you go beyond AI, we also think we have companies that could be creating the next trillion-dollar company. Some examples there might be - and it's still early, but there is that long-term potential - PsiQuantum, which makes quantum computers.
We also own Climeworks, which is a direct air carbon-capture company that literally sucks carbon dioxide out of the atmosphere and stores it underground. So, these areas in the very long term could turn into sort of multi-hundred billion dollar industries and produce the next trillion-dollar company.
Sam Benstead: So, PsiQuantum, Climeworks, are they private companies, public companies? Are they profitable? Can we have some more information than these names?
Lawrence Burns: PsiQuantum and Climeworks are both private. At this point, they're earlier in the stage than the average private company, so they're not currently profitable, but they're making really good progress.
PsiQuantum has received $600 million (£306 million) from the Australian government to build the first utility-scale quantum computer in, I think, Brisbane. And then also they've received various forms of funding to build the first utility-scale quantum computer in Chicago, Illinois, in the US.
Climeworks have facilities in Iceland. They already have paying customers that are paying them for the carbon dioxide they're extracting out of the atmosphere. Those companies are Microsoft and, in the UK, British Airways. They are also a number of our portfolio companies, companies like Shopify, Ocado Group (LSE:OCDO) and Stripe.
Sam Benstead: Artificial intelligence is one of those themes. It's the words on everybody's lips at the moment. So, how do you approach that topic and which companies do you own that are involved in AI?
Lawrence Burns: The way we try to explain it is you can bucket it into three areas. The first is hardware. So, that includes Nvidia, who are designing the chips, but it also includes TSMC, who are making them. ASML Holding NV (EURONEXT:ASML), whose equipment is vital for shrinkage within semiconductors, and is providing their equipment to TSMC. So, you have three companies there that are very dominant and very important, both for AI and for computing as a whole. That's one area.
The second area you have is the infrastructure companies. These are companies that are making it possible for businesses to access AI. So, that would be Amazon.com Inc (NASDAQ:AMZN) with Amazon Web Services. That would be companies like Databricks, like Snowflake Inc Ordinary Shares - Class A (NYSE:SNOW) in the database area. Again, all Scottish Mortgage holdings.
And the third area, where I think in some ways we're still really early in seeing the actual developments and changes, is in the applications. I mentioned a couple of those earlier, but the big ones are Tesla with self-driving cars. We also own Aurora Innovation Inc Class A (NASDAQ:AUR), which is developing self-driving trucks.
I mentioned Shopify earlier, but if we keep going through the list, it's a wide range of companies that are saying, actually, you know what, we're digital companies with technology. We're ambitious, we have very technical people. We have huge amounts of proprietary data, and suddenly we have this entirely new AI toolset to use.
I think what's profound about AI is that it's not clear that there are boundaries in its use. It can and probably should, if it continues on its current path, have really profound implications for insurers, for financial companies, for manufacturing companies.
It's something that spreads across industries and themes in terms of its impact because, what is it? It's about the ability to have intelligence on tap, and you can apply that to quite a wide range of problems.
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Sam Benstead: You've been early to identify the AI theme, but some of the biggest winners have come from the largest companies in the S&P 500, or if you look at the global technology index. Why is it that some of the big companies have been the biggest winners in AI?
Lawrence Burns: You're right, the recent period hasn't been what we'd wanted to deliver for shareholders. I do think there are signs that it's getting better. I mean, if you look at the end of last week and you look back over the last 12 months, we will have delivered about 28% share price versus the global index at around 23%.
I think it's really important as ever to focus here really on the long term, because going back to what I was saying before, AI isn't a one or two-year event. If it works, the potential here is enormous. The founders we talk to tell us that if the developments within AI stopped, they'd still spend years building the products around the existing technology.
But to your point on indexes, which I think is a fair one, what in some ways are the differences [between] Scottish Mortgage [and] an index? Well, one is that an index owns everything and that has an advantage, it owns all the winners.
In normal times, what you'd hope is that we have the ability - and we have done this in the past with Tesla and Amazon - to have larger holdings in those winners than the index is going to have.
The second one is that, again, the index owns everything, so it owns the winners, but it also owns the companies that, whether it's AI or anything else, are being disrupted. So, you're owning the losers as well as the winners.
So, there's an advantage there of concentrated stock picking in an active fund to try and avoid some of those areas and just focus on who the companies are that are going to drive equity returns overall.
But the third-biggest reason is that the next generation of winners are not in the index. They're private companies. They're Space X. It's not in an index. It's Databricks, a very important company within the AI area.
And that's what I think Scottish Mortgage can also offer shareholders, at a really low cost, access to private companies that are very hard to get access to otherwise, and they're able to drive transformational change over the next five to 10 years.
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Sam Benstead: You have also been adding to some of the largest companies in the world, so TSMC and Meta Platforms Inc Class A (NASDAQ:META) are new positions. Why do you like these companies so much?
Lawrence Burns: Well, again, there are a few companies that we think are on a really good trajectory. It's not a commentary overall [on] large companies.
TSMC is because if you look at the technology field, you can debate how important lithography is going to be versus advanced packaging, or other forms of improving the semiconductor industry. You can even debate whether Nvidia's chips will continue on their current trajectory or whether custom silicon will become more important.
But, if I take a quote that's been used about Nvidia and use it for TSMC, whichever route you go through, it goes through TSMC in terms of the scale of manufacturing they have and also that's true whether its AI or more general computing. So, that's some of the attractions around TSMC, a dominant competitive position and really a key part of the overall semi supply chain.
Meta is probably one of the companies at the forefront of making the earliest practical commercial use of AI. Why is that? Because it's an advertising company at heart. It has various platforms [and] it can take its data, [and] use that for better targeted and personalised advertising.
Take WhatsApp, for example, hugely used around the world, but massively under-monetised, where suddenly they are offering companies, for example, the ability to do 'click-to-message', so you can click and message and start a conversation with a company. That wasn't that valuable when there wasn't someone on the other end to talk to them. But suddenly, if you can do that with AI bots, that becomes incredibly powerful as a way to communicate with customers. So, we think a lot of the investments Meta have made within AI position them really well on that front.
Sam Benstead: Lawrence, that's great to hear. Thanks for coming into the studio.
Lawrence Burns: Great.
Sam Benstead: And that's all we've got time for today. You can check out more Insider Interviews on our YouTube channel where you can like, comment and subscribe. See you next time.
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