Scottish Mortgage Investment Trust : Inv Tst PLC - Half-year Report

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Scottish Mortgage Investment Trust PLC
Legal Entity Identifier: 213800G37DCS3Q9IJM38
Results for the six months to 30 September 2018
The following is the unaudited Interim Financial Report for the six months to 30 September 2018 which was approved by the Board on 1 November 2018.
Interim management report

Investment Approach

The Managers have not changed their investment approach. If a company, public or private, has the potential to grow substantially over the next 5 to 10 years, then it is a good place to start looking for long term value creation for shareholders. Over this timeframe and beyond, equity investment returns are primarily driven by just a very few, extraordinary companies. There is a real asymmetry to the possible returns from investing in such businesses, as the potential upside is significantly larger than the possible risk to the capital invested. The Managers are focused on trying to find and own these outliers on behalf of Scottish Mortgage's shareholders.

The discipline to focus on your core skill set where you might be able to have a competitive advantage matters in investment, just as it does for the portfolio's businesses. The Managers believe it is much easier to search for the potential for value creation within companies which are capitalising on relatively predictable long run structural trends, than to divine the movement of equity markets in the near term. For these reasons, they focus on their task and do not also try to decipher the intervening path of their portfolio companies' share prices. The value of Scottish Mortgage's shares will therefore be subject to the same vagaries of short term markets as those of the portfolio's own companies. This means that Scottish Mortgage is best suited to those who share the Managers' long term approach to investing.

Performance

The six months results are set out in the table below, but once again the Managers provide them only with the caution that this is too short a time over which to judge the success or otherwise of this investment approach. The value of the portfolio can and will fluctuate over such short periods. We are inclined to view such times more as an opportunity than a cause for serious concern

Results for 6 months to 30 September 2018	%
Net Asset Value per share	19.0
Share price	22.4
FTSE All-World Index	11.3

Source: Baillie Gifford/Refinitiv. Net asset value is after deducting borrowings at book.

The Managers are proud to say that they have continued to deliver good long term returns for shareholders. The total return from investing in Scottish Mortgage over the last 5 years to the end of September was 206%, with a corresponding performance in the underlying net asset value (NAV) of 188%. For comparison, the return from simply passively investing in the broader global equity market as a whole over the same time period was considerably lower. The FTSE All-World Index's total return over the last 5 years was just under 94%. The five year and ten year performance records are illustrated in the graphs attached (see link below).

http://www.rns-pdf.londonstockexchange.com/rns/1112G_1-2018-11-1.pdf

Earnings and Dividend

The Managers look for companies which prioritise investing for their future growth, rather than returning cash to shareholders. As a result, the portfolio tends to generate a relatively low level of income. Earnings per share were 1.35p over the six months to 30 September 2018, whilst the earnings per share over the same period last year were 0.82p. The majority of the year on year increase resulted from the decision to allocate all of the management fee and finance costs to capital, as highlighted in the Company's most recent Annual Report. Without this accounting change, earnings would have been 0.90p per share.

As a reminder, while Scottish Mortgage has a total return based investment objective, shareholders should anticipate that returns will primarily come through in the form of long term capital appreciation, rather than from the Company's dividend payments. The Board acknowledges, however, that many investors do value the income received from their shares in the Company and stands by its guidance on the Company's dividend policy provided by the Chairman in the 2018 Annual Report. Provided that it remains appropriate, the Board intends to continue to pay a relatively small dividend, with a modest year on year increase. This will be paid from the Company's earnings and supplemented from capital profits, provided that Scottish Mortgage's long term returns continue to justify this. With this in mind and the earnings received so far this year, the Board proposes to pay an interim dividend of 1.39p. This is unchanged from the same period last year.

The Board will review the position again at the end of the financial year, once the final figures are known.

Liquidity

There continued to be a good level of natural market liquidity in Scottish Mortgage's shares on the London Stock Exchange. The Company also robustly supported strong net demand for its shares through its liquidity policy, as set out in the Annual Report. Scottish Mortgage issued nearly 55 million shares over the period. As a result, shareholders' funds increased by over £286 million over the period. The Company did not buy back any shares into treasury over this period.

Portfolio

In recent years, Scottish Mortgage has taken advantage of its investment trust structure to provide its shareholders with access to unquoted companies, which would not normally be accessible to public equity market investors, and to do so within its own low cost structure. Many of these investments have still only been held for a relatively short period, and, of those now listed on an exchange, most have only been public for a few months, so it is still relatively early days.

Until now, the Managers have focused their published comments on this unquoted part of the portfolio on the individual companies themselves. It is only now that the beginnings of a sensible data set is emerging, from which it might be possible to draw out some overall observations. The Managers have therefore taken this opportunity to highlight the progress to date from such investments. It should be emphasised, however, that these companies are not a separate or homogenous group within the portfolio.

In total, such holdings have so far made an absolute contribution in sterling terms to portfolio returns of just under 17%, if one only takes account of the returns generated in the period for which they remained private. This misses one of the important advantages that Scottish Mortgage has when investing in such companies, which is the potential for continued or increased ownership in the event of a public listing. The absolute contribution in sterling terms to the portfolio returns from holding such companies to the end of September was actually just under 30%, when the subsequent returns they generated in the public markets are included.

Put another way, from June 2010 when the Managers made their first unquoted investment to the end of September 2018, the entire Scottish Mortgage portfolio generated a total return of 344%, but the total return from just the subset of holdings that had started out as unlisted investments over the same period was 419%. For context the FTSE All-World Index's total return over the same period was 163%.

The Managers would suggest that, just as with the overall portfolio, the performance of these private and private/public company holdings should be judged over the long term and over their full holding periods.

The chart attached (see link below) shows the individual returns from all of the private company investments which have now become public.

http://www.rns-pdf.londonstockexchange.com/rns/1112G_1-2018-11-1.pdf

For each company, there are three lines: the absolute return from the company as a private investment (purple line), the return from the initial public offering (IPO) date to the end of September 2018 (grey line) and the return from the investment throughout its holding period (the lilac line). An example may help. Scottish Mortgage invested in Alibaba in 2012 as a private company. The return from holding this as a private company in the portfolio until its IPO in September 2014 was over 270%. As at the end of September, the sterling based return from the investment since the IPO was roughly 200%. The total holding period return, however, was over 1,000%.

The power of long term compounding returns is, though, only one aspect of the importance of access to such companies. The European success story, Spotify, was highlighted in the last Annual Report and became a public company in April this year. Already the benefits in return terms of being able to invest in the company at an earlier stage can be seen but, while the value of the relationship developed with Daniel Ek is harder to measure, it may be at least as important to generating long term returns for Scottish Mortgage shareholders from here.

The Managers have frequently commented on the benefits of being able to develop relationships in this way with those at the companies which are driving significant changes in their industries. For private companies, such insights are not available to purely public equity investors, yet, for example, understanding the business model and growth of Airbnb is crucial to thinking about the future of the hotel and broader travel industry, as well as that particular company. Hearing the thoughts of Jack Ma at Alibaba, both before and after the IPO in 2014, has been critical to understanding the development of the consumption economy within China.

There are more benefits too in terms of the ability to access new investments. This can be direct, as with Grail and Illumina and with Alibaba and Ant Financial. Alternatively, it may simply be by virtue of earning a reputation in the sector for being long term constructive shareholders, as with Uptake.

Illumina and Grail have already been commented on at length, though both remain important. The relationship developed with Alibaba as a private company and then the Managers' steady support through the inevitable market volatility in the share price post IPO, led to the Managers getting the opportunity to invest a significant amount into Alibaba's financial technology company, Ant Financial. This business is driving the digital provision of a wide range of financial services in China, but it has the potential to become a global, financial services platform business. It is hardly an undiscovered gem but few can actually gain access to invest.

Of course some of these companies will encounter challenges. Digital survey and data analytics company, Survey Monkey, struggled following the tragic sudden death of its Chief Executive, Dave Goldberg. The Managers gave the company time and patient support. It has found its way forward and is now a public company. Two companies that have so far been more disappointing in terms of their returns, are HelloFresh (delivered meal kits) and Home24 (online furniture retail).

To date, there have been very few of the private companies where the Managers have sold the position and these have all been the result of takeovers. The return of 40% in one year (2015-2016) for Skyscanner, due to its takeover by Ctrip, might have seemed respectable in isolation, but was in fact disappointing as it capped the investment's upside. The same can be said of the investments in Chewy and Flatiron.

The Board and Managers are keen to set realistic expectations for Scottish Mortgage's own shareholders. Overall the Managers would suggest that, if anything, the results from investing in such companies so far for Scottish Mortgage have been unduly good. Just as with the publicly listed holdings, some will not work and a number may fail outright. Only a handful will really drive the returns.

It is hard to predict exactly where the level of the unlisted holdings might be in future, given that the number of new investments, IPOs, takeovers and public market returns all play a part, but it is anticipated that private companies will remain an important part of the portfolio. The Managers and Board continue to believe that the range of benefits from Scottish Mortgage's ability to invest in these businesses while they are still private companies will continue to be a key differentiating factor in creating value for shareholders over the years to come.

Outlook

The Managers believe in the benefits of listening to and learning from those who are cleverer than they are. Jack Ma, in his last letter to shareholders as Chairman of Alibaba, made the following observations: 'Recently, the global economy has found itself in a state of turmoil. Uncertainties abound in trade relations, consumer trends, stock markets and the manufacturing industry. US-China trade tensions create increased risk of instability.…our past experience tells us there are huge opportunities behind the anxiety and friction. The only question is how we should pivot. Monumental challenges give rise to monumental opportunities...' The Managers agree. In the long run, only businesses which retain this flexibility to change direction thrive.

The principal risks and uncertainties facing the Company are set out at the end of this document.

1 November 2018

Past performance is not a guide to future performance.

Total return information sourced from Morningstar.

See disclaimer at end of this document.

Automatic Exchange of Information

In order to fulfil its obligations under UK tax legislation relating to the automatic exchange of information, Scottish Mortgage Investment Trust PLC is required to collect and report certain information about certain shareholders.

The legislation requires investment trust companies to provide personal information to HMRC on certain investors who purchase shares in investment trusts. Accordingly, Scottish Mortgage Investment Trust PLC will have to provide information annually to the local tax authority on the tax residencies of a number of non-UK based certificated shareholders and corporate entities. Shareholders, excluding those whose shares are held in CREST, who come on to the share register will be sent a certification form for the purposes of collecting this information.

For further information, please see HMRC's Quick Guide: Automatic Exchange of Information - information for account holders on https://www.gov.uk/government/publications/exchange-of-information-account-holders.

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