Scottish Mortgage Investment Trust portfolio of growth investments in robust health

Scottish Mortgage Investment Trust PLC (LON:SMT) has announced its results for the six months to 30 September 2023.

The following is the unaudited Interim Financial Report for the six months to 30 September 2023 which was approved by the Board on 3 November 2023.

Interim Management Report

Our portfolio of growth investments is in robust health. Financial conditions have pushed companies to focus and prioritise profitable growth. Declines in stock prices have made valuations more attractive. This combination provides a strong underpinning for the long-term outlook.

We will have periods when we underperform the market, and the six months in question was one. Since the end of March, our net asset value per share, with debt at fair value (‘NAV’), fell by 2.7% compared with a rise of 4.3% for the FTSE All-World Index (both in total return terms). The longer-term performance record remains good. Over five years, the NAV has gained 59.6% versus 49.6%, and over 10 years it has increased by 358.1% against 189.5% (both against the index).

Although our focus remains on long-term capital appreciation, we know that a small and consistent dividend is of value to many shareholders. The Board is therefore recommending an interim dividend of 1.60p per share, no increase over last year’s payment.

Our objective is to find companies with the potential for exceptional growth and then own them patiently as they deliver. There are times when stock markets reward this approach and times, as now, when they do not. We constantly revisit the case for our investments and expect that we will sometimes find our optimism misplaced. However, we do not revisit the underlying investment philosophy that has served us well for many years. The value created by the innovation and dedication of exceptional companies will deliver returns for our fellow shareholders. In turn, Scottish Mortgage’s patient ownership and support can increase the likelihood of entrepreneurial success.

Not all large companies capable of outsized growth are listed on public stock markets. Accessing such opportunities at a reasonable cost is a distinctive part of our role for shareholders. The operational performance of our major private businesses has been strong despite the difficult prevailing conditions. The average revenue growth rate of the top ten private holdings was 38% in 2022. Market scepticism around the performance and valuation of our private assets is misplaced, and we believe they will be a significant source of value creation for the Trust in the coming years. We deployed approximately £74m into 6 private companies in the half year, and one of our private holdings, the beauty company Oddity, went public.

Divining much that is useful from stock markets over a six-month period is challenging. The market’s positive return has been driven by a handful of large technology companies that would seem to be the early beneficiaries of developments in Artificial Intelligence (‘AI’). The capabilities of today’s AI systems are sufficient for widespread commercial deployment. Their ability to communicate in natural language based on an ‘understanding’ of the relevant concepts lends itself to many different use cases. Building a foundational AI model can cost billions of dollars, so only those with the deepest pockets can compete. Giant consumer technology companies have those resources and vast user bases to whom they can deploy the resulting applications.

Chipmaker NVIDIA, whose shares we bought in 2016, has been the key provider of the necessary computing infrastructure for AI, or as CEO Jensen Huang put it, ‘if you don’t build it, they won’t show up’. The acceleration in its business has been breathtaking. Revenue guidance for the third quarter is $16bn, which compares to less than $6bn a year ago. The step change that we have seen in AI’s capabilities would have been impossible without NVIDIA’s silicon. The pace of progress has exceeded our expectations and has been well ahead of what Moore’s Law would have dictated for traditional computing. Instead of seeing the end of an aberrant growth era, we may be entering a period of even faster development. If so, the consequences will be yet more profound.

We are mindful that the pioneers may be the easiest to identify when seismic shifts occur in the technology landscape, but they are not always the biggest beneficiaries. Often, nimble new entrants emerge and arrogate opportunities before a dominant incumbent can react. This creates dramatic and long-lasting investment opportunities, as we saw in the PC, Internet and Mobile transformations.

We do not claim to be able to predict macroeconomic developments and are often bemused by the level of coverage given to the future course of interest rates. We can, though, observe the changes we have seen at the companies we own. Unable to assume that markets will provide capital, they are generating their own supply. They are trimming costs and focusing on the most promising projects. We are encouraged that they continue to spend heavily on research and development but believe a higher cost of capital introduces a healthy dose of prioritisation. The free cash flow from our listed portfolio more than doubled in the twelve months to the end of June.

Rising rates have little impact on our company. During the years of exceptionally low interest rates we proactively extended the term of our debt. The majority of our borrowings do not come due until after 2036 and our interest cost is below 3%.

Progress is being made across a broad swathe of technologies. What makes this so exciting for growth investors is that the number of ways companies can combine these technologies grows exponentially. Accelerated computing drives artificial intelligence, which can be applied to vast datasets in the Cloud, enabling breakthroughs in healthcare and so on. Our companies are fitter for the future, and the opportunity they address grows at an accelerating pace. Economic news is usually dreary, and geopolitics rarely reassuring, but entrepreneurs’ collective creativity and productivity are a source of great confidence and optimism.

The principal risks and uncertainties facing Scottish Mortgage Investment Trust are set out at the end of this document.

Tom Slater

Baillie Gifford & Co Limited

Managers and Secretaries

Responsibility Statement

We confirm that to the best of our knowledge:

a)   the condensed set of Financial Statements has been prepared in accordance with FRS 104 ‘Interim Financial Reporting’;

b)   the Interim Management Report includes a fair review of the information required by Disclosure and Transparency Rule 4.2.7R (indication of important events during the first six months, their impact on the condensed set of Financial Statements and a description of the principal risks and uncertainties for the remaining six months of the year); and

c)   the Interim Financial Report includes a fair review of the information required by Disclosure and Transparency Rule 4.2.8R (disclosure of related party transactions and changes therein).

By order of the Board

Justin Dowley

Chair

3 November 2023

Valuing Private Companies

We aim to hold our private company investments at ‘fair value’, i.e. the price that would be paid in an open-market transaction. Valuations are adjusted both during regular valuation cycles and on an ad hoc basis in response to ‘trigger events’. Our valuation process ensures that private companies are valued in both a fair and timely manner.

The valuation process is overseen by a valuations group at Baillie Gifford, which takes advice from an independent third party (S&P Global). The valuations group is independent from the investment team with all voting members being from different operational areas of the firm, and the investment managers only receive final valuation notifications once they have been applied.

We revalue the private holdings on a three-month rolling cycle, with one-third of the holdings reassessed each month. During stable market conditions, and assuming all else is equal, each investment would be valued twice in a six-month period. For Scottish Mortgage, as well as all other investment trusts, the prices are also reviewed twice per year by the respective boards and are subject to the scrutiny of external auditors in the annual audit process.

Beyond the regular cycle, the valuations team also monitors the portfolio for certain ‘trigger events’. These may include changes in fundamentals, a takeover approach, an intention to carry out an Initial Public Offering (‘IPO’), company news which is identified by the valuation team or by the portfolio managers, or meaningful changes to the valuation of comparable public companies. Any ad hoc change to the fair valuation of any holding is implemented swiftly and reflected in the next published net asset value (‘NAV’). There is no delay.

The valuations team also monitors relevant market indices on a weekly basis and updates valuations in a manner consistent with our external valuer’s (S&P Global) most recent valuation report where appropriate.

Continued market volatility has meant that recent asset pricing has moved much more frequently than during stable market conditions. The data below quantifies the revaluations carried out during the six months to 30 September 2023, however doesn’t reflect the ongoing monitoring of the private investment portfolio that hasn’t resulted in a change in valuation.

Year to date, most revaluations have been decreases, with a small number of companies successfully raising capital, and in some cases easing short-term liquidity pressures. The average movement in company valuations and share prices for those are shown below.

*Each private holding valuation is assessed at least once in a six-month period, in accordance with the Baillie Gifford valuation policy.

During the six-month period ended 30 September 2023 we have written down some of the valuations as a result of company specific circumstances which have challenged the economic reality of the liquidation preferences. This has contributed to the divergence in the average movement in valuation at instrument level in comparison to the underlying company value.

Performance, Portfolio executive summary, and List of Investments at 30 September 2023: