Scottish Mortgage manager review

As with any investment, your capital is at risk. 

We live in a world of ongoing geopolitical tensions, shifting monetary policies and disruptive technology. Against this dynamic backdrop, Scottish Mortgage remains steadfast in its mission: seeking out exceptional companies capable of delivering long-term growth and transformative change.

The volatility of economies, company profitability and our own stock price prompts the question of whether investing as we do has become riskier. We do not believe that it has. Instead, our diagnosis is that volatility reflects the world becoming a more uncertain place. We must adapt to life with greater uncertainty.

That does not mean a flight to the perceived safety of dull companies with low growth and established entry barriers. That would increase our risk profile with the world in flux. What it does mean is that for our companies to achieve their potential, they must first be resilient, and they must be able to adapt.

Events like the Covid-19 pandemic, supply chain disruptions, two global conflicts and an emerging cold war between the US and China are eroding trust in the fundamental arrangement of the economy.

People are more uncertain about trade agreements, financial structures, democratic provisions, the reasonableness of judicial decisions, and the dependability of public health provisions. This feeling of instability makes the idea of rational decision-making less reliable.

With basic economic assumptions in question, globalisation is slowing. For reasons of stability and national security, countries are hesitant to rely as heavily on foreign partners. There's a push to bring the manufacturing of critical goods and resources back within domestic control.

The US has decided that semiconductor manufacturing is far too sensitive and important to leave to China or even to Taiwan and has passed the Creating Helpful Incentives to Produce Semiconductors (CHIPS) and Science Act, stimulating hundreds of billions of dollars of domestic investment. Similarly, the EU, as a result of the war in Ukraine, had to bring home a lot of energy production previously farmed out to Russia.

This economic shift is a major adjustment after a long period of relative stability post-World War II. It's unclear when, or even if, the previous stability will return. The tension between China and America may prove manageable within current frameworks. There is the small but growing possibility of rupture and a move towards a multi-polar world order. There is a strong incentive for some of the world's big growing economies to seek alternatives to dollar-denominated trade.

Ongoing disruptions from technology (particularly generative artificial intelligence, covered by my partner Lawrence Burns later in this report), climate change, and geopolitics will force continued economic transformation. Optimisation and profit maximisation are desirable and rational in a settled environment, but they can be dangerous in an uncertain one. Optimised systems are brittle and can break despite even modest disruptions.

We are placing greater emphasis on resilience. Adaptability is a crucial attribute in a world of uncertainty. It is a multifaceted quality with financial components, such as high margins or strong balance sheets, and cultural elements that are equally important. Diverse organisations are more likely to contain the ingredients for success in a shifting environment than are monocultures.

This change in emphasis doesn't diminish our focus on imagining what a company will look like 10 years from now. It is an acknowledgement that businesses must face challenges in the interim as they exist today.

A pertinent example of this is last year's largest holding (and biggest headwind), Moderna. Vaccine fatigue has presented a challenge for the company, with vaccination levels for endemic Covid-19 well below expectations. There are several possible explanations for this, but the virus remains more lethal than influenza and vaccination rates are less than half.

Moderna is resilient in the face of these events. The windfall it received from its Covid-19 vaccine has given it a substantial cash position to fund the deployment of its technology into other areas.

Our reasons for having a significant investment in the company remain unchanged. In the near term, the company's respiratory vaccine franchise will grow. It has seen promising results from its trials of RNA-based vaccines for flu and respiratory syncytial virus (RSV) and ought to be able to combine these vaccines with Covid-19 into a single shot, which will be better for patients and cheaper for the healthcare system.

As its work on other respiratory viruses comes to fruition, it should be able to add these and update for prevalent strains to ensure maximum efficacy. Reducing hospital bed occupancy in the winter flu season will be highly beneficial.

The work the company is doing on several other viruses, such as Epstein-Barr virus (EBV) and cytomegalovirus (CMV), will help prevent these infections and, importantly, address the impact that they can have on health later in life. The data from trials of a personalised cancer vaccine that enables the body's immune system to identify cancerous cells and remove them continue to be very encouraging.

Our largest holdings, NVIDIA and ASML, are in the semiconductor industry. Demand for NVIDIA's chips has vastly exceeded expectations, which has been an important driver of our returns. Without NVIDIA’s silicon or software, we would not be seeing such remarkable progress from AI systems. Our key consideration is the duration of the edge it has built over the competition.

ASML, the Dutch manufacturer of the lithography equipment needed to produce cutting-edge semiconductors, has one of the most apparent competitive advantages we’ve ever encountered. Its innovations are the central enablers of miniaturisation in semiconductors. Growth in data centres and AI applications augment the growing demand for chips in many industries.

At the same time, chips are getting bigger, and the desire for greater sovereignty in semiconductors is fuelling demand for capital equipment. The offset to these encouraging trends is geopolitics impinging on the company's equipment sales in China. The immediate challenge is demonstrating that innovation can continue following the retirement of chief executive (CEO) Peter Wennink and president and chief technology officer Martin van den Brink.

Amazon and Spotify have taken drastic action to increase their resilience in the past year, and stock markets have strongly rewarded them both. We added to Amazon, and it has regained its position as one of our top holdings. It is now reaping the benefits of substantial capacity increases made during Covid-19.

Periods of investment and cost increases at both companies have ended, and there has been a much greater focus on efficiency, reflected in margin improvement. The growth opportunities are exciting, and both exemplify the types of businesses that seem likely to benefit from developments in AI.

We are seeing many companies invest in AI systems to improve their operations but for investors, there is an essential question of whether this generates additional returns or ends up being a zero-sum game.

Spotify is a platform business that benefits from the breadth and scale of content on its platform. AI will likely lead to an explosion in available content, improving its economics in a way that others cannot mitigate. If AI revolutionises how we purchase products, this is likely to favour Amazon, the company with the most consumer data and a vast physical infrastructure for getting products to those consumers.

Tesla, which we reduced partway through the year, is at a fascinating juncture. Its recent products have been hugely successful, and preliminary sales data indicate that the Model Y was the best-selling vehicle in the world last year. However, the rise in interest rates has reduced the affordability of all high-ticket items, including Tesla vehicles, depressing demand.

At the same time, the rapid scaling of Chinese electric vehicle production, along with improving quality, is a powerful source of competition and pricing pressure. All of this may be irrelevant to the long-term investment story.

Tesla’s massive investment in AI looks to be paying off with the rapid improvement in its self-driving software. User reports on the latest version, now entirely AI-controlled, are very favourable, and the company is installing it in all new US vehicles. Tesla is harnessing the same investments to produce humanoid robots, whose capabilities are progressing along an exponential trajectory.

Our largest private position, SpaceX, now a bigger holding than Tesla, launched 96 rockets last year (accounting for two-thirds of all commercial launches). It has no peers when it comes to scale and cost efficiency. The company’s latest rocket, Starship, has unprecedented capabilities and will transport 150 metric tonnes of payload. It is close to commercial launch.

Starlink, the satellite communications subsidiary, has 2.3 million subscribers and is growing rapidly bringing connectivity to underserved parts of the world. Its unique access to launch capacity puts it way ahead of potential competitors. It already has sufficient scale to generate cash.

There has been little change elsewhere in our private portfolio. Our top 10 private holdings represent approximately two-thirds of our private exposure, and the operating performance of these companies has been encouraging. We selectively supported holdings that raised money in the year. With financial market activity subdued, very few companies moved from private to public markets.

The combination of a weak domestic economy, an uncertain regulatory environment and geopolitical concerns have made the inclusion criteria for Chinese stocks in the portfolio more demanding. However, the vast domestic market and exceptional entrepreneurs mean we continue to take Chinese investments seriously.

Ecommerce giant Pinduoduo has a proven track record of building a discount retail offering in China and turning it into a profitable business. It is now attempting the same thing overseas, and the pace of rollout for its platform, Temu, has been very impressive. The international pattern of profitability is tracking what we have seen previously in China. We added to Meituan, the local services company, which has proven leadership and the scope for meaningful profit growth in the years to come.

We have sold our position in Tencent, the Chinese mobile platform, which has been a prominent holding for us over the past 15 years (a transaction which completed after the year-end date). We have massive respect for the team there, who have proven to be phenomenal operators and astute investors.

We think that ongoing political and regulatory developments mean that the constraints that go with scale for Chinese businesses have increased substantially. As a result, it will be difficult for Tencent to meet our more demanding inclusion criteria over the coming years.

We also sold another long-standing holding, Illumina. We believe that genomic sequencing is a fundamental building block for improving healthcare in the coming decades. However, the company's execution could have been better, and the work required to drive demand and lower costs will be challenging for some time.

Several other holdings are utilising genomic sequencing to improve health outcomes. The progress made by Tempus in using sequencing data to guide the treatment of US cancer patients is impressive, and potential applications of the approach continue to multiply.

There is a lot to be excited about. Artificial intelligence, digitalisation, scientific and engineering progress, and the opportunities presented by transitioning our energy model will provide fertile investment territory for years to come.

Jeff Bezos stressed the importance of focusing on the things that don't change as you build a business. For Scottish Mortgage, that means seeking the most exceptional growth companies, being patient and constructive owners, and harnessing the outsized impact of the small number of extraordinary companies to drive our returns.

Risk factors

The trust invests in overseas securities. Changes in the rates of exchange may also cause the value of your investment (and any income it may pay) to go down or up.

Unlisted investments such as private companies, in which the Trust has a significant investment, can increase risk. These assets may be more difficult to sell, so changes in their prices may be greater.

The Trust invests in emerging markets, which includes China, where difficulties with market volatility, political and economic instability including the risk of market shutdown, trading, liquidity, settlement, corporate governance, regulation, legislation and taxation could arise, resulting in a negative impact on the value of your investment.