28 August 2020

At the annual general meeting of Scottish Mortgage Investment Trust on June 16, I retired as the senior independent director after a 12-year stint on the board (I remain a shareholder). During that period, the share price had increased tenfold, making Scottish Mortgage by far the largest investment trust in the UK with assets approaching £15bn. In a world where investors are increasingly drawn to low-cost passive funds and ETFs, where do investment trusts fit in? After almost 40 years as an investor and board director of investment trusts, reflecting on my own experiences may help readers answer that question. Investing through history The world’s oldest example of a collective investment vehicle, investment trusts came into being before the first world war. They allowed middle-class investors in the UK to benefit from British imperialism — economic and political — in Asia, Africa and Latin America. That history survives in the name of the oldest investment trust, Foreign and Colonial, which celebrated its 150th anniversary in 2018 and now prefers the more discreet title F&C. Scottish Mortgage Investment Trust was formed in 1909, just as Henry Ford was launching his Model T, to raise funds for what seemed attractive opportunities in Malaysian rubber plantations. These would provide materials for the nascent automobile industry. Evidently the demand for rubber plantation finance was more limited than had been thought, so the company broadened its remit. The connection to automobiles remains, however. Scottish Mortgage’s largest holding today — and the one every shareholder and financial adviser wants to talk about — is Tesla. Investment companies were culpably implicated in the Wall Street crash of 1929. The Goldman Sachs Trading Corporation, launched in 1928, was only one of a dizzying range of leveraged investment companies promoted by that bank and others as the roaring twenties roared. By 1931, it had lost 99 per cent of its value. The anxiety of small investors to be part of the boom had also led to the creation of the first US mutual funds. These also fell in the crash, but did retain some value. US investors have preferred mutual funds ever since. The mutual fund format was copied in the UK with the brave establishment in 1931 of the first unit trust by M&G. The key difference between an investment trust (a closed-ended investment company) and a unit trust (an open-ended investment company) is that an investor in a closed-ended fund must buy from or sell to another investor. By contrast, the investor in an open-ended fund deals directly with the manager, who must then buy or sell shares from the underlying portfolio. An investment trust may therefore be priced at a discount or (less often) a premium to its net asset value, while an open end fund is, in principle at least, always worth its share of the underlying assets. Unit trusts historically had two marketing advantages over investment trusts — they could be advertised to potential investors, and they could pay commission to intermediaries. Subsequent regulatory changes have largely addressed these anomalies. The advantages were to the promoter of the trust rather than to the investor. But as a result, far more money is today invested in open- ended vehicles. However, this apparent vote of confidence is not necessarily to the investor’s advantage. Retail investors frequently get trapped in daily-traded funds that invest in illiquid assets, such as commercial property or early-stage companies, which cannot easily be sold. This is a problem that regulators have been grappling with for years. Investment trusts have proved a better structure for holding more esoteric assets — and furthermore, a variety of studies have suggested that closed-ended funds outperform similar open- ended equivalents. Deep discounts Nevertheless, for much of the postwar era, the investment trust seemed to be a dying vehicle. Insurance companies and pension funds had once used investment trusts as they began to add equities to the bonds in their portfolios, but they reduced their holdings as they took over direct control of their funds and the shares of most investment companies traded at a discount to their net asset value (NAV). The investment trust discount tends to reflect the popularity or otherwise of the fund manager — mainly a reflection of relative recent performance — and the fashionability of the sector in which the trust is invested. Currently, Scottish Mortgage stands at a small premium to its net asset value and so do most trusts specialising in infrastructure or renewables which are both in vogue with investors. Investment trusts with an Asian focus, however, have recently traded at large discounts to NAV, reflecting Covid-19 fears. There are also yawning discounts on most real estate investment trusts (commonly known as Reits) particularly those exposed to retail property as online sales surge. These discounts may reflect scepticism about reported asset values in the commercial property sector. Some investment trusts now profess “discount management policies” which involve buying back shares when a significant discount emerges and issuing shares when it is possible to do so at a premium. Scottish Mortgage is one of the few to have implemented such a policy successfully, with the result that for several years now the shares have traded close to asset value. This is true even though a significant proportion of the portfolio is illiquid. So what is the secret? For any investor, successful stockpicking requires the pursuit of a group of related investment themes, and the construction of a concentrated portfolio focused on these themes. In the case of Scottish Mortgage’s fund manager James Anderson and his co-manager Tom Slater, the key investment theme is that the centre of growth in the world economy has shifted to Asia. Everyone understands that a large proportion of the manufactured goods we buy today come from China. But the corollary is the evolution of a Chinese middle class with demand for consumer goods and more importantly services. The investment opportunity is in the emergent companies which meet these needs. During my time on the board,