Trust in progress: from headwinds to tailwinds

As with any investment, your capital is at risk.

In recent years, companies within the Scottish Mortgage portfolio have faced combined headwinds from slowing growth, reducing earnings estimates and multiple compression. But as we move into 2024 and beyond, the managers believe those headwinds are being replaced by tailwinds.

Manager Tom Slater, and deputy manager, Lawrence Burns explained what those tailwinds are by focusing on four key areas of their enthusiasm in an update to professional investors at two events in London and Edinburgh in January 2024.

Digitalisation is more valuable in developing markets

Burns noted that the digitalisation of commerce and finance remains a significant opportunity to provide a “revolutionarily better model”. Especially in regions where traditional banking and retail infrastructure is lacking or inefficient.

Digital platforms can service a larger population profitably, enabling financial inclusion and providing a more convenient and efficient way to access goods and services.

Burns illustrated this with portfolio holding, MercadoLibre. He noted it is at “the centre of digital life across Latin America,” as an online shopping platform, digital payments provider and digital bank.

With about half of the region’s population unbanked or underbanked, there is an outsized opportunity for MercadoLibre to service these customers profitably and help them access credit for the first time.

Burns also spotlighted the Chinese ecommerce platform PDD. “The key to PDD has been connecting factories and farmers directly to consumers,” he said.

By cutting out the layers of distributors, wholesalers and retailers, it can offer dramatically lower prices. Since rolling out its global model in 2022, its Temu app has become the world’s most downloaded app.

Because Scottish Mortgage had been “open to the possibility that Temu might have a positive value,” and the market had not, it provided an opportunity to add to holdings.

Burns also highlighted the recent purchase, Coupang, which is digitising retail in South Korea. The “dislocation between operating performance and fundamentals” provided an investment opportunity where once again the growth potential had “not been recognised by the financial market”.

Cleaning up

Burns emphasised that the post-hydrocarbon economy was another significant opportunity, enabling Scottish Mortgage to invest in companies addressing climate change and providing a more sustainable future.

The demand for innovative technologies and sustainable solutions is growing. Businesses worldwide are investing in meeting their net-zero goals and want to take advantage of ever-cheaper renewable energy.

This creates a large market for three of the private companies within the portfolio: Northvolt (battery production), Climeworks (carbon capture) and Solugen (decarbonising the chemical industry).

He suggested that these companies are particularly valuable because they were addressing climate challenges beyond transportation. “The vast majority of private venture capital today is focused on transportation – about two-thirds – but transportation only makes up about 16 per cent of carbon emissions.”

Burns singled out Northvolt, suggesting “The demand outlook for Northvolt is as bright as it could possibly be.” This is because we will need millions more batteries for electric vehicles and for renewable energy storage to smooth energy supply.

Additionally, Burns noted that “for customers in Europe and the US, it can provide supply chains that are more geopolitically secure and aligned with political interests.”

A new technology paradigm is born

Slater shared his enthusiasm for artificial intelligence (AI). He suggested that what was special about the release of ChatGPT in November 2022 was that OpenAI had “found a way of putting technology into the hands of users everywhere. And the world woke up to the potential, the seed of a new technology paradigm was born.”

The specific implications of this progress are not yet clear. However, Slater highlighted the explosion of AI-generated content as beneficial for platform business models, such as Spotify, and the potential for AI systems to be deployed in the physical world, with Tesla well-positioned for this. Robotics and drones were also mentioned as areas where AI could unlock value.

He emphasised the importance of finding companies with the culture and business models to rapidly adopt and exploit AI technology, citing Roblox as an example.

AI can help create engaging content and introduce targeted ads for new revenue streams, which was the reason for Scottish Mortgage’s re-investment in Meta, which owns Facebook, Messenger, Instagram and WhatsApp.

Slater stressed that it would take time for the winners to emerge in this area but that we need to be prepared to embrace a philosophy of “growth at an unreasonable price” where we see signs of traction. As he explained, “For the winners, the opportunity will be vastly underestimated.”

In good health

Slater expressed the challenges of discovering and developing new medicines, highlighting the complexity of biology and chemistry, the steep research and development costs as well as the high failure rate of drugs in clinical trials.

Most drugs fail because of safety concerns. However, “With Moderna, it’s the same mRNA molecule with some minor edits that creates everything from vaccines to cancer treatments.”

The billions of doses of its Covid-19 vaccine proved that the molecule is a safe and effective approach. Investing in a wide range of clinical programmes, “[Moderna’s] likelihood of success in bringing these programmes to fruition is much higher than the market anticipates”.

AI-driven systems are also gaining traction in diagnostics and healthcare. Slater spoke of Tempus which is using genome sequencing on cancer patients and then deploying AI algorithms to spot care gaps and recommend treatment pathways to physicians.

Slater emphasised the potential for significant advances in healthcare through the combination of digital approaches and new technologies such as CRISPR and mRNA production techniques. These could usher in a new era of more effective and efficient medicines.

He highlighted Recursion, which is industrialising drug discovery by building maps of biology and leveraging technology to scale up, and 10x Genomics, which enables scientists to sequence human cells individually, providing a higher-definition view of the biology involved.

Looking to the future

Scottish Mortgage remains focused on “capturing the outsized impact” to be had over time from identifying and investing in “a small number of exceptional companies”.

Slater and Burns remain optimistic about the outlook for the companies in the portfolio. This is due to the combination of strong revenue growth, rising cash flow and long-term structural tailwinds in areas such as the digitisation of retail and finance, the post-hydrocarbon economy, AI and healthcare.

Past performance is not a guide to future returns.