Shares in the FTSE 100 trust have fallen by a third since November. It must now juggle conflicting pressures: inflation, the Ukraine war, Chinese politics, and a resurgent pandemic.
But then blow after blow rained down on its tech-heavy holdings. First, the Omicron variant caused panic in November that heavy-handed coronavirus restrictions would make a global return.
Then in January, Western markets priced in the effect of persistent inflation. The US Consumer Prices Index inflation rate is now at 7.9%, and the Federal Reserve has just raised rates for the first time since 2018.
Then on 24 February, Russia’s invasion of Ukraine created new havoc for supply chains amid fears of a wider European crisis. China’s refusal to condemn its ‘strategic partner’ Russia stoked already elevated US-Chinese political tensions over stocks dual-listed in both countries.
By 4 March, FTSE 100 Scottish Mortgage shares had fallen to 893p, before recovering to 1,004p today.
Scottish Mortgage Investment Trust: bullish management
And management has struck a fighting tone, arguing that Scottish Mortgage’s ‘success is rooted in identifying and investing in the outliers of tomorrow – those companies capable of returning five, 10, 15 or 20 times the initial investment over a five- to 10-year period.’
And to its credit, it’s still up 180% over the past five years alone, remaining the largest UK investment trust managing over £18 billion of assets.
Deputy Manager Lawrence Burns highlighted its strong business connections, saying Scottish Mortgage is ‘quite anomalous in terms of the level of access.’
Further, he argues that its access to ‘academia is particularly fruitful because academics don’t think on a one- to two-year horizon. They think on a 10-year horizon, they think on a multidecade horizon and that aligns very well for us.’
The Trust noted how ‘sticking with transformative growth companies through the good times and the bad – gives company directors trust and reassurance,’ giving it an advantage when it comes to investing in private companies as ‘unlike public ones, they can choose their investors.’
Backing Tesla, Alibaba, Spotify and Wise long before their Initial Public Offerings, the trust’s current private holdings include TikTok owner ByteDance and Musk-founded SpaceX. Holding shares in 49 companies worth 24.8% of its portfolio, it has long demonstrated an uncanny ability to spot future successes.
And Burns is now singling out the biotech sector, given ‘Moderna's ability to address HIV, Zika, even cancer…Ginkgo Bioworks’ ability to potentially give us biodegradable plastic.’
The China factor
Tencent, Meituan and Alibaba collectively constitute 9.5% of Scottish Mortgage’s total assets. Also a long-term backer of NIO, the trust has significant exposure to Chinese tech stocks. Worryingly, more than $460 billion has been wiped off the sector so far this year.
Right now, more than 37 million Chinese citizens are in strict lockdown, as the ultra-infectious Omicron variant strains the logistical limits of the country’s ‘dynamic zero’ policy. If this containment doesn’t work, the caseload amongst its 1.4 billion-strong population will explode.
But if it does, China is re-facing the headaches of endless lockdowns. UBS economist Arend Kapteyn believes ‘this is its highest 7-day rolling case count since the start of the pandemic, and a number of large manufacturers have already reported production suspensions.’
Then there’s the political collateral damage resulting from the Russia-Ukraine war to contend with. China has refused to condemn Russia, and US President Biden has warned of ‘consequences’ if it provides military or economic aid to the aggressor. Moreover, Chinese Vice Foreign Minister Le Yucheng has called the sanctions placed on Russia ‘outrageous,’ blaming NATO for backing it ‘into a corner.’
And the US was already preparing to delist US-listed Chinese companies over general refusal to hand over audit documents. The Securities and Exchange Commission has already named the first targets in this campaign.
However, Chairman of China’s Financial Stability and Development Committee Liu He has sought to calm investors, saying ‘the Chinese government supports companies from across industries to list abroad.’ As talks to resolve the stand-off continue, the Chair has promised Beijing will ‘boost the economy in the first quarter’ by introducing ‘policies that are favourable to the market.’
If China’s neutral position gives way to outright support for Russia, US sanctions would almost certainly involve delisting Chinese stocks in the US. But if China condemns Russia, economic ties between the US and China will just as surely strengthen.
Accordingly, Scottish Mortgage must now decide whether to forfeit its unquestionable reputation and abandon its Chinese holdings or accept the heightened political risk.
And investors must weigh these encroaching hazards against an entry point that may never be this low again.
*Based on revenue excluding FX (published financial statements, June 2020).