Scottish Mortgage Investment Trust PLC Long term progress remains impressive

Scottish Mortgage Investment Trust PLC (LON:SMT), today announced final results for the year to 31 March 2019.

Source: Refinitiv / Baillie Gifford. All figures are total return^*. See disclaimer at the end of this announcement.

*      Alternative Performance Measure – see Glossary of Terms and Alternative Performance Measures at the end of this announcement.

†      Benchmark: FTSE All-World index (in sterling terms)

Chairman’s Statement

Corporate Strategy

The Board and Managers focus on pursuing a truly distinctive global investment proposition, working to maximise the Company’s competitive advantages. In a frantic world, obsessed with predicting the next ‘thing’ which might go wrong, Scottish Mortgage’s consistent long term approach of patiently investing in outstanding growth businesses across the globe, whether those businesses are public or private, continues to set it apart.

Performance

The Managers and the Board believe strongly in the advantages of being very clear as to the investment proposition that Scottish Mortgage offers shareholders, to ensure everyone’s time horizons are aligned. Scottish Mortgage is not intended to be all things for all people and is most suited to those who share its patient, long term approach to investment. We aim to report on Scottish Mortgage’s results in a manner consistent with this approach, drawing on the lessons from the Managers themselves on the challenges of being long term shareholders and the dangers of short term distractions. I am delighted to say that the Company’s long term progress remains impressive.

Long Term Returns

This table shows the five and ten year total returns for the Company to 31 March 2019, alongside the Association of Investment Companies (AIC) Global Sector average for comparison.

Source: AIC/Refinitiv/Baillie Gifford. NAV after deducting borrowings at fair value^*.

*      Alternative Performance Measure – see Glossary of Terms and Alternative Performance Measures at the end of this announcement.

We report performance figures over the 12 month period within the Annual Report because of the nature of the document and, as it happens, once again these look attractive. However, granting these figures undue prominence is not particularly helpful for shareholders of this Company and I urge readers to pay little heed to them, whether they be good, bad or indifferent. They reveal little about the success or otherwise of the Company in pursuing its aims.

12 Months

Source: AIC/Refinitiv/Baillie Gifford. NAV after deducting borrowings at fair value^*.

*      Alternative Performance Measure – see Alternative Performance Measures and Glossary of Terms at the end of this announcement.

Progress this year

The considerable growth in the Company’s assets over the last five years was predominantly a result of long term investment performance, also augmented by the net new capital raised under the Company’s long-standing liquidity policy. I am pleased to say that, during this financial year, over £400 million in new capital has been generated in this way and there were no share buy-backs undertaken. The Board views this as indicative of the degree to which Scottish Mortgage’s unique investment proposition continues to resonate with investors. The Board does not anticipate making any changes to the liquidity policy over the coming year.

Due to the growth in the assets over time, the Company has also raised additional long term borrowings; the Board authorised these in order to maintain what it views as the strategically appropriate level of gearing in the portfolio. In June 2018, Scottish Mortgage raised a further £170 million through additional private placement agreements at very competitive rates of under 3% per annum. The Board believes this offers a potential source of additional value for shareholders over time. The Board will continue to keep the level of gearing under review.

Earnings and Dividend

Over the year, earnings per share for Scottish Mortgage rose to 1.64 pence, a significant increase of nearly 37% over last year (1.20 pence). However, this was due to the impact of the change in accounting treatment to allocate management and finance costs entirely to capital, highlighted in the previous Annual Report as well as this year’s Interim Report. Previously 75% of the costs had been allocated against capital, with the remainder set against income. The basis was revised from the start of this financial year to reflect better the split of returns in the portfolio between capital and income. While the overall position for the Company is not affected, the new allocation policy does mean that more of the modest income from the portfolio becomes distributable earnings.

By now there can be few investors who seek a significant dividend yield from their shares in Scottish Mortgage. The Board has repeatedly highlighted that, while the formal investment objective is “to maximise total return … enabling the Company to provide capital and dividend growth” shareholders should anticipate that returns will primarily come through long term capital appreciation. One common characteristic of many of the businesses in the portfolio is the retention and investment of most if not all of their earnings to support future growth. This tends to result in a relatively low level of dividend income for Scottish Mortgage.

However the Board acknowledges that a significant number of shareholders value the modest level of income they do receive and has therefore maintained the policy of paying a small and growing dividend. The consistent application of this policy allows those shareholders to plan their own portfolio income. The Board has therefore decided not to change the current dividend policy. Those who do not require the income may elect to reinvest their cash dividend.

The Board proposes paying a final dividend of 1.74 pence which, together with the interim dividend, would give a total of 3.13 pence per share for the year. This is an increase of 2% over last year (3.07 pence). As the Company’s revenue earnings for the year are insufficient to cover the entire dividend, the balance is paid from realised capital reserves. The Board believes this to be appropriate, given the relatively immaterial size of the element paid from capital, compared with the scale of the distributable capital gains over the long term.

The Board will continue to keep the dividend policy and use of realised capital reserves under review.

Low Cost

Scottish Mortgage has led the way in providing investors with access to great growth businesses at a highly competitive cost level. Through the twin advantages of the Company’s own increasing scale and its enduring relationship with Baillie Gifford, we have brought the management and administrative costs down over time to one of the lowest levels available for an actively managed portfolio. This means that, as a shareholder, you keep more of the returns generated with your capital. Very unusually, Scottish Mortgage has also extended this low cost mantra to the unlisted area of the capital markets. This year I am pleased to report that the total ‘Ongoing Charges Ratio’ for Scottish Mortgage remains at a market leading rate of 0.37%. I am sure you will agree with the Board that this provides excellent long term value for shareholders.

Accessibility

Access to most of the private companies held by Scottish Mortgage came about as a result of the Managers’ hard-won global reputation as genuine long term custodians of businesses and long established relationships with those at other companies in the portfolio, built over many years of supportive investment by the Managers. The Board believes that it would be very hard for others to replicate this distinguishing feature of Scottish Mortgage and that the importance of this competitive advantage is often underestimated. This year, the Managers made their largest single investment in a private company to date: Chinese financial services giant, Ant Financial. The opportunity came about as direct result of the long-standing investment in its parent company, Alibaba. Ant Financial has the potential to disrupt our own industry and it reminds us that all companies, including this one, must be prepared to adapt to the changes taking place.

Diversity and Board Independence

Ensuring that there is real diversity of thought informing the decisions taken for the Company, both at a Board and operational level, remains just as vital for Scottish Mortgage as for any other business. Maintaining this will help Scottish Mortgage to continue to adapt to change so that it can progress through its second century.

Achieving diversity of thought cannot be reduced to ticking a selection of predefined boxes. However, the Board and Managers do consider it more likely to arise within discussions between a group of individuals who can bring together a mix of experiences, whether those arise through their variety of professional disciplines, cultural backgrounds, gender or other factors.

There are currently five Non-Executive Directors on the Board, three men and two women, none of whom has ever worked for Baillie Gifford. The Board believes each of the Directors to be independent of the Managers and considers this to be essential for the delivery of their individual responsibility to act in the best interests of shareholders.

Each Director brings a fresh perspective to the Board’s central tasks. Current members include two economists, two chartered accountants and a professor of clinical medicine. The Board believes that this broad range of experience is particularly valuable. When considering any future recruitment requirements, the Board will seek to draw upon as diverse a pool of candidates as possible, including men and women from across all ethnic backgrounds, working in the fields of science and industry as well as finance, to ensure this remains the case.

Baillie Gifford has always carried out all of the executive functions of the Company and so Scottish Mortgage itself has no employees. Baillie Gifford similarly strives for diversity in its own business and reports on its progress in this area to the Board every year. The Board also encourages all major third-party suppliers to the Company to consider such issues and to report progress on this topic to the Board.

Just as with diversity, the Board does not believe the simple imposition of a hard limit on the tenure of individual members to be the best way to ensure ongoing diversity and Board refreshment. In determining the appropriate length of service for each Director, including the Chairman, the Board must judge the appropriate overall balance between the retention of the corporate memory and a suitable rate of refreshment at any given point in time. The Board also wishes to retain the flexibility to be able to recruit outstanding candidates when they become available, rather than simply adding new Directors based upon a predetermined timetable.

As the new Corporate Governance Code comes into effect over the course of this year, the Board will continue to monitor the development of best practice and align its policies in these related areas as appropriate, to include a formal statement of these policies.

This year we will be asking shareholders at the Annual General Meeting to approve an increase in the total permitted level of Board remuneration. The Board is not seeking to raise the current level of remuneration for existing Directors this year; the increase is to allow sufficient flexibility to recruit new Non-Executive Directors as and when the Board finds suitable candidates. It will also provide the necessary headroom to accommodate modest increases in the Directors’ remuneration levels where appropriate in years to come to enable the Company to continue to recruit the best candidates.

Shareholders should be reassured that the Board remains mindful of Scottish Mortgage’s low-cost focus and, in common with the Managers, the members of the Board remain committed to playing their part in ensuring the maintenance of this key competitive advantage for shareholders’ benefit.

Just as the Managers do with the investee companies, so as a Board we aim to offer support and a discussion forum for ideas to help the Managers to maximise their competitive advantages within the strategic framework set by the Board and to resist the inevitable countervailing short term pressures of the public markets. As an independent Board, this is one of the most valuable tasks we can undertake for shareholders.

Future Prospects

The strengths of Scottish Mortgage’s investment strategy tend to be recognised most clearly when markets focus their attentions on company fundamentals. However there will almost inevitably also be periods of broad-based swings in sentiment when that is not the case and short term views prevail in markets. The Board does not view such oscillations as a true investment risk for the patient investor who is prepared to hold steady; it is why we continually emphasise that this a long term investment.

The ability to cope with uncertainty is key to all investment. The best long-run risk mitigation strategy remains flexibility. Scottish Mortgage can invest in companies in any industry or geography. The overall approach remains consistent, although the reflection of this within the portfolio evolves through time as countries, industries and companies themselves change.

Today, Scottish Mortgage has perhaps become best known for its holdings in the tech giants but investors are cautioned that defining the portfolio in such terms gives too narrow a perspective on this Company’s future prospects. The portfolio not only includes retail, advertising and media businesses but also a wide variety of companies in healthcare, manufacturing, transportation, financial services, food production and consumption. There will inevitably be some portfolio companies whose future progress does not match their ambitions. Yet while this is a clear investment risk, it is mitigated by the asymmetry of the capital exposure compared with the potential scale of returns from those which do succeed. As a Board a key task of ours is therefore to ensure the portfolio is sufficiently, but not overly, diversified.

The Board and Managers acknowledge the potential risk of changes to the regulatory environment for some of the larger portfolio holdings, but believe such risks are manageable as the likelihood, scope and impact of any such changes may be anticipated to a reasonable degree. There is also a range of macro level risks facing Scottish Mortgage, such as issues around global security and rising geopolitical tensions as a result of the Eastward shift of economic power and influence. Macro factors such as these have far reaching, interconnected consequences but are more properly considered general risks which all investors must acknowledge and accept. The Board predominantly focuses its efforts on analysing risk to the extent to which it is possible to predict the potential impact on individual companies and thereby the Scottish Mortgage portfolio.

Over time, the Board believes that it is likely that the winners and losers from the deep structural shifts taking place will become more apparent but that the transition period will likely be challenging and more volatile. Once again, shareholders are cautioned not to expect any attempt by the Board or Managers to mitigate short term market swings. Scottish Mortgage’s advantages lie elsewhere. The Board will continue to stand resolutely behind the long term strategy.

Brexit

This year the Company is required to comment on the potential impact of ‘Brexit’ on its future prospects. I will refrain from general speculation or comment as to the political process itself, simply observing that there are very few UK companies in the portfolio (5 holdings representing around 3% of assets), most of which are global, rather than purely domestically focused businesses.

The greatest exposure of Scottish Mortgage to potential negative impacts from Brexit is through fluctuations in foreign currency exchange rates, which impact the sterling value of the Company’s overseas assets. The following observations may therefore be helpful. The pound has already fallen considerably in recent years against a range of currencies, most notably the US dollar. A certain degree of pessimism is therefore already priced in. However if concerns over Brexit were to weigh further on sterling, this would actually benefit the portfolio due to its global nature. Conversely, if Brexit were to be resolved in a more constructive manner than is currently feared and sterling was to appreciate, this would be a headwind for our overseas assets; however, this would likely be offset to a degree by a corresponding improvement in sentiment and perhaps even in the actual business environment.

The Managers will not be turning their investment skills to attempting to predict the byzantine path of Brexit or to express any views on potential resulting currency market moves. The Board fully supports them in this and, as always, will encourage them to remain focused on the area where they have a deep competitive advantage: finding great businesses with long term growth prospects.

Shareholders may also wish to note that Scottish Mortgage already has a long term structural hedge in place for its largest foreign currency exposure, as it has both US dollar denominated assets and liabilities. Movements in the dollar/sterling exchange rate have opposing impacts on these, thereby helping to reduce the net impact of oscillations in this exchange rate. More broadly, the long-run impact of currency fluctuations is diversified by the nature of this portfolio, including as it does many global companies, listed in a wide range of countries.

Shareholder Engagement

In addition to urging all shareholders to read the Annual Report, I would also encourage all interested investors to take up the various opportunities to hear directly from the Managers. This can be done through the various digital sources which the Managers provide, as well as through attendance at one of the Scottish Mortgage Investor Forums which take place throughout the year. The details of these are available at the back of the Annual Report and at www.scottishmortgageit.com.

We hope to see as many shareholders as possible at the Scottish Mortgage AGM on 27 June. Please note that this year the meeting will be held at a new venue: The Royal College of Physicians of Edinburgh, 9 Queen Street, Edinburgh, EH2 1JQ.

Finally, I want to thank shareholders for their ongoing support of Scottish Mortgage and the Managers for all their efforts on shareholders’ behalf. Scottish Mortgage’s success very much depends on the patience of both. I would also like to thank my colleagues on the Board, our professional advisers and the teams at Baillie Gifford that provide the support necessary to best look after your interests as shareholders.

Fiona McBain

Chairman