Fund profile: Scottish Mortgage

With total assets of £3.5 billion Scottish Mortgage is the largest global generalist investment trust in the UK, having taken the title from Alliance Trust in 2014. Aside from the private equity giant 3i Group it is also now the UK's largest investment trust by total assets and by market capitalisation.

The Baillie Gifford-managed trust is also the best performer among its peers, topping the global sector over one, three, five and 10 years to 1 January 2015; in the latter 10-year period it delivered over 355% in share price gains compared to an average of just 135% from the sector.

The trust has been managed by Baillie Gifford's James Anderson since 2000 with co-manager Tom Slater coming on board in 2009. According to Slater, the last 15 years have marked a drastic transformation period for the 106-year-old trust, as the managers have streamlined the portfolio and honed the investment process.

Slimmed-down portfolio

From a portfolio of 130 to 150 stocks invested 50% in the UK and 50% globally Scottish Mortgage has slimmed down to just 70 stocks and now has the freedom to invest any proportion of the trust anywhere in the world.

It is also highly concentrated; its top 30 holdings represent over 80% of the portfolio. This makes the trust highly volatile, however like all of Baillie Gifford's managers Anderson and Slater take a minimum five-year view, believing that short-term volatility is the price investors must pay for superior long-term returns.

"The starting point for us is absolutely the end investor; what are we trying to do for our shareholders? There has been a lot of soul-searching over the past 15 years; we have said that we want to deliver long-term capital growth and our investors are prepared to accept short-term volatility to achieve that," says Slater.

The manager says the board of Scottish Mortgage were fully supportive of the trust's new direction from the outset, and worked with the managers to cleanse the register of "legacy shareholders"; those who had perhaps held shares for "reasons they could no longer remember."

The trust has slowly bought back shares from these investors, which accounted for around a third of the register, since 2000. As well as helping to transition the shareholder base toward more active investors, it has also helped to maintain share price stability - a key objective for the board and managers.

Technology exposure

In terms of its holdings, Scottish Mortgage invests heavily in what are generally categorised as technology stocks, and its top 10 holdings include a number of well-known 'tech' names including Facebook, Google, Amazon and Chinese internet giants Alibaba (BABA) and Tencent (TCEHY).

However, Slater is keen to stress that Scottish Mortgage is not a "tech fund" and that, in fact, industry definitions need to catch up with realities in an evolving market place. "I'm sceptical of the label 'tech' as it implies a level of homogeneity which was maybe true 20 years ago, but that just isn't true now.

"I would suggest that Facebook or Tencent are really advertising businesses and are very different from Amazon, which is a retailer, or LinkedIn, which is a recruitment business. Their businesses wouldn't be possible without technology, but really what you're talking about is traditional business model disruption," he says.

"Disruptive technology" is fast becoming one of the investment industry's favourite buzzwords; however, like "tech stock", Slater believes that the term is often "bandied about" without consideration for what it really means.

For him, the term refers to a group of companies that are "re-defining the business models in their sector" - and these are the businesses that Scottish Mortgage seeks to invest in.

"Firms like Amazon have done well to train their customers through prime/next day delivery etc. to go straight to them when they want to buy something. They have changed people's behaviour and it's now incredibly difficult to compete with them," explains Slater.

Generating demand

Away from the large established internet firms the manager is also looking at other online retail models that, unlike Amazon and eBay, are working to generate demand, rather than just meet it. These include "boutique" US website zulily, which showcases the products of small fashion brands for a maximum of 72 hours at a time, encouraging buyers to regularly visit the site to browse new items.

Slater also mentions German ecommerce business Rocket Internet, which rolls out online models that have been successful in developed markets - such as take-away food services, cheap fashion websites and peer-to-peer lending - to developing markets that larger businesses would be reluctant to access.

"The objective is always to find businesses that we think are exceptional with management teams that we believe offer something quite unique in their approach," says Slater.

Other areas of interest include biotechnology, which is reflected in the trust's largest holding, genomic-testing machine manufacturer Illumina. Accounting for 8.5% of Scottish Mortgage's portfolio, Illumina has seen its share price sky-rocket over 265% during the past three years as the biotechnology sector has exploded.

Despite these already impressive gains, however, Slater believes that we have barely "scratched the surface" of biotechnology and as such he has no plans to sell Illumina. Indeed, the manager believes that over the next five years the portfolio will likely be harbouring many more biotechnology firms.

"We've been very sceptical of the big pharmaceutical companies because we think that they aren't helping the system; they aren't reducing costs, they aren't improving clinical outcomes, but the exception to that would be in genomics where costs have come down massively and you're starting to see real clinical progress.

"We're only just scratching the surface of this technology; the computer power we're able to bring to bear on it the speed at which we're able to do it and what that opens up in terms of research is very, very real," says Slater.

Aside from new opportunities in biotechnology, in the near future Slater says that he is most excited about seeing some of his current holdings flourish, adding that he expects to see a number of the internet firms continue to expand their business models and transform their sectors.

However, as the evolution of the portfolio over the past 15 years contests (just five years ago it was dominated by Chinese infrastructure firms), Slater and Anderson are unafraid to move into new sectors and regions when they see a strong, and disruptive, investment prospect.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.