1. Title: Unlisted Investments: The Surprising Reason Behind Scottish Mortgage’s First- Half Performance Slump

Unlisted Investments: The Surprising Reason Behind Scottish Mortgage’s First-Half Performance Slump

Scottish Mortgage Trust plc (SMT), a prominent investment trust based in the United Kingdom, reported a slump in its first-half performance for the year ending June 30, 202Despite holding a stellar portfolio comprising top technology firms such as Tesla, Amazon, and Microsoft, the trust’s

net asset value

(NAV) fell by 9.8% during the period under review, against a backdrop of broader market turmoil. However, this unexpected downturn can primarily be attributed to the

unlisted investments

within its portfolio. The trust’s significant holding in unquoted companies, particularly those in the technology sector, suffered substantial losses during the period. One of the most affected investments was in the UK-based artificial intelligence (AI) company,

DeepMind

, which is valued at over £1 billion and held a 7.5% stake in SMT as of March 2023.

DeepMind’s valuation took a

drastic hit

in the first half due to broader macroeconomic conditions, as investor sentiment shifted towards risk-aversion amid rising interest rates and inflation. Additionally, concerns about the company’s profitability and its reliance on Google for revenue growth also weighed heavily on its valuation. Other unlisted investments in the trust’s portfolio, such as

Palantir Technologies

and

Wise

, also faced similar challenges.

SMT’s investment in unlisted companies is a strategic decision aimed at providing the trust with exposure to emerging technologies and innovative businesses that may not be available through listed investments. However, this strategy comes with its own risks, particularly in volatile market conditions. The first-half performance slump serves as a reminder of the challenges and uncertainties that come with investing in unlisted companies, even for a well-diversified trust like Scottish Mortgage.

Moving forward, SMT’s management team will need to carefully balance the risks and rewards of its unlisted investments. They may consider selling some holdings or re-negotiating valuations, if possible, to offset the losses incurred during the first half. However, given the long-term growth potential of these companies and SMT’s commitment to innovation, it is unlikely that the trust will abandon its unlisted investment strategy altogether. Instead, it may look for opportunities to add new investments that offer compelling long-term value to the trust and its shareholders.

Introduction

Scottish Mortgage Investment Trust (SMT), established in 1935, is a closed-end investment company based in Scotland. Renowned for its innovative investment strategies, SMT has consistently challenged conventional investing norms. With over eight decades of experience under its belt, this trust has garnered a strong reputation among investors for generating impressive returns.

Background and Historical Performance

SMT’s unique approach to investing has paid off handsomely for its investors. The trust has been a trailblazer, making significant investments in technology companies like Amazon and Microsoft decades before they became household names. This forward-thinking strategy has contributed to its impressive historical performance. Between 1982 and 2021, SMT’s shares delivered a compound annual growth rate (CAGR) of approximately 13%, outperforming the broader market by a significant margin.

2023: First-half Performance Slump

However, the first half of 2023 brought about a significant challenge when SMT’s shares underperformed the market. In this period, the trust’s shares experienced a decline of approximately 10%, leaving investors puzzled and seeking explanations for this unexpected setback.

Scottish Mortgage Investment Portfolio: An Overview

Explanation of SMT’s Investment Approach: Unlisted Companies and Growth Stocks

Scottish Mortgage Trust plc (SMT) is a leading investment company based in Scotland, known for its unique and bold investment strategy. Its approach focuses on unlisted companies and growth stocks. In this section, we will delve into the specifics of SMT’s investment approach, explaining the advantages, risks, and characteristics of unlisted companies and growth stocks.

Unlisted Investments: Definition, Advantages, and Risks

Unlisted companies, also referred to as private companies or pre-IPO companies, are businesses that do not have their shares publicly traded on a stock exchange. SMT invests in these companies through various methods, including primary investments (buying shares directly from the company) and secondary investments (purchasing shares from existing investors). Some advantages of investing in unlisted companies include:

1. Exclusive access to high-growth opportunities: Unlisted companies may offer significant growth potential that is not yet reflected in their share prices. SMT’s early investment can lead to substantial returns if the company succeeds.
2. Flexibility in negotiation: Direct investments allow SMT to negotiate share prices, terms, and conditions that are favorable to the trust.
3. Diversification: SMT’s unlisted investments provide diversification from its listed equity portfolio, helping to spread risk.

However, investing in unlisted companies also presents several risks, such as:

• Lack of liquidity: Unlisted shares cannot be easily sold, which can limit an investor’s ability to realize profits or cut losses.
• Valuation challenges: Valuing private companies is often more difficult than valuing listed companies due to limited financial information and the absence of a publicly traded share price.
• Regulatory complexities: Unlisted companies may face various regulatory hurdles, which can impact their growth and profitability.

Growth Stocks: Characteristics, Benefits, and Challenges

Growth stocks are shares of companies that exhibit above-average growth potential compared to their peers. They typically have high price-to-earnings ratios and low dividend yields. Some of the benefits of investing in growth stocks include:

1. Potential for substantial capital gains: As the company grows, its share price can increase significantly, providing attractive returns for investors.
2. Dividend reinvestment: Many growth companies reinvest their profits into research and development or expansion rather than paying dividends, which can lead to compounded returns over time.

However, investing in growth stocks also comes with challenges:

• Volatility: Growth stocks can be more volatile than value stocks due to their reliance on future earnings and growth prospects.
• Long-term investment horizon: Growth stocks often take longer to mature, requiring a patient and disciplined approach from investors.

Discussion of SMT’s Top Holdings and Their Performance in the First Half of 2023

As of the first half of 2023, SMT’s top holdings include:

• Amazon
• Microsoft
• Alibaba Group Holding

Analysis of Underperforming Companies

Despite the strong performance of some holdings, SMT’s overall returns were negatively impacted by underperforming companies like:

• Tesla: Tesla’s share price declined due to concerns over the company’s ability to meet production targets and rising competition in the electric vehicle market.
• Netflix: Netflix faced increased competition from other streaming services, leading to slower growth in subscriber numbers and a decline in share price.

Explanation of Why These Stocks Contributed to the Slump in SMT’s Performance

The underperformance of Tesla and Netflix had a significant impact on SMT’s performance in the first half of 202Their combined weighting within SMT’s portfolio was substantial, making their decline a notable drag on overall returns.

I Unlisted Investments: The Surprising Reason Behind Scottish Mortgage’s First-Half Performance Slump

In the first half of 2023, the global economic climate significantly influenced investment markets.

Global Economic Trends and Their Impact on Investment Markets:

The resurgence of inflation, coupled with ongoing geopolitical tensions and supply chain disruptions, led to increased market volatility.

Market Volatility and Its Effect on SMT’s Unlisted Investments:

Scottish Mortgage Trust (SMT) faced unique challenges due to its significant exposure to unlisted investments.

Explanation of Specific Challenges:

During this period, many of SMT’s unlisted holdings encountered challenges that affected their valuations and investor sentiment. For example, tech companies faced regulatory scrutiny, leading to a decrease in market confidence and lower valuations. Additionally, the energy transition accelerated, causing challenges for traditional energy companies and opportunities for green tech firms.

Risk Management and Investment Strategy:

SMT adapted to these risks by focusing on its long-term investment strategy and engaging with its portfolio companies. The Trust also increased its engagement with green tech companies, recognizing the growing importance of this sector in the economy.

Comparison of SMT’s Unlisted Investment Performance with Listed Growth Stocks:

The underperformance of SMT’s unlisted investments compared to listed growth stocks during this time raises questions about the wisdom of SMT’s bet on unlisted companies.

Why Unlisted Investments Underperformed:

Several reasons contributed to the underperformance of SMT’s unlisted investments compared to listed growth stocks. The first reason was the market volatility, which disproportionately affected private companies due to their lack of liquidity and transparency. Additionally, some unlisted companies faced challenges specific to their industries or business models, leading to lower valuations and investor sentiment.

Justification of SMT’s Bet on Unlisted Companies:

Despite the underperformance, it is important to consider the long-term potential of unlisted investments. SMT’s bet on these companies was justified given their innovative business models and the potential for significant growth in their industries, such as green tech and biotech.

Scottish Mortgage’s Response to First-Half Performance Slump

Scottish Mortgage Trust plc (SMT) experienced a significant first-half performance slump, leading the investment team to take decisive actions aimed at mitigating risks and boosting returns.

The investment team’s actions

Portfolio adjustments: In response to the challenging market conditions, the investment team initiated a series of portfolio adjustments. They sold their holdings in underperforming stocks, such as Tesla and Amazon, and allocated funds towards sectors that showed promise, including healthcare and technology. These moves were intended to realign the portfolio with market trends and capitalize on emerging opportunities.

New investments: The investment team also made strategic new investments to bolster the portfolio. They allocated capital towards companies in the technology sector, such as Microsoft and Alphabet, which had demonstrated resilience and growth potential despite the market downturn. Additionally, they invested in emerging industries like electric vehicles and renewable energy to capture long-term growth opportunities.

Market reaction

Investor sentiment: The investment community reacted positively to SMT’s proactive approach, as investors appreciated the team’s ability to adapt to changing market conditions. Many saw this as a sign of strength and a commitment to delivering long-term value to shareholders.

Potential implications for the future: The first-half performance slump and SMT’s subsequent response serve as a reminder of the importance of adaptability and resilience in investment management. While short-term market fluctuations are inevitable, the ability to make informed decisions and respond effectively can help mitigate risks and maximize returns in the long run.

Conclusion

Recap of the reasons behind Scottish Mortgage’s first-half performance slump in 2023: During the first half of 2023, Scottish Mortgage Trust plc (SMT) experienced a significant performance slump due to several factors.

Firstly,

the tech bubble burst, causing a sharp decline in the valuation of many high-growth technology companies in which SMT had invested heavily.

Secondly,

the geopolitical tensions between major world powers, particularly China and the United States, led to increased regulatory scrutiny of some of SMT’s unlisted investments.

Lastly,

the ongoing COVID-19 pandemic continued to weigh on certain sectors, particularly travel and hospitality.

Discussion on the long-term implications of this event for SMT and its investors: The first-half performance slump was a wake-up call for SMT, highlighting the importance of maintaining a well-diversified portfolio and managing risk effectively. Although the tech sector is expected to continue growing in the long term, SMT has recognized the need to reduce its reliance on individual companies and sectors.

Furthermore,

the regulatory scrutiny of unlisted investments could lead to increased transparency and oversight, which may benefit investors in the long run by reducing potential risks.

Final thoughts on the role of unlisted investments in a diversified investment portfolio and their potential risks and rewards: Unlisted investments can offer attractive returns due to their potential for high growth. However, they also come with higher risks, such as lack of liquidity and greater regulatory uncertainty.

As such,

investors should consider the benefits and risks carefully and maintain a well-diversified portfolio that includes both listed and unlisted investments.