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Scottish Mortgage restricts 'unicorns' to 15%

Managers of UK’s biggest investment trust told to limit holdings in risky, but fast-growing unquoted internet companies.

Scottish Mortgage restricts 'unicorns' to 15%

The managers of the top performing Scottish Mortgage (SMT ) investment trust have agreed to cap the amount they hold in unquoted companies to 15% of the £3.3 billion fund.

As we revealed last November, in the past year SMT managers James Anderson and Tom Slater have doubled the trust’s holdings in unlisted companies to 10% in a bid to capture the dramatic growth in privately-owned internet businesses that are disrupting a wide range of sectors.

As our table below shows, SMT now has 20 unlisted investments, up from 16 three months ago. These include Airbnb, the online travel and accommodation booking website that has been valued at $25 billion.

New additions

The latest additions to the unquoted holdings range from HelloFresh, an online food subscription service, and CureVac, a German biotechnology firm developing treatments that teach the body to fight diseases like cancer. SMT’s investments in these were valued at a total of £35.6 million at the end of October.

Since then the fund has also invested in China Internet Plus, which it labels a ‘local service provider’, and Udacity, an online education provider that has become the latest ‘unicorn’, or internet start-up with a valuation of over $1 billion.

The 15% cap agreed with the board, which is chaired by former investment banker John Scott, gives the managers further capacity to invest in high growth innovators such as Funding Circle, the US peer-to-peer lender.

However, it also protects shareholders in the country’s biggest investment trust from becoming over exposed to unlisted holdings, which are harder to sell and value than shares in publicly traded companies.

Limit could be exceeded

Tom Slater told investors at a meeting in London last week: ‘We’ve agreed with the board we won’t go over 15% with new investment.’

He added: ‘We would be unlikely to go beyond that without consulting more widely with the shareholder base.’

However, Baillie Gifford, the investment group that manages SMT, admitted the 15% limit could be exceeded as a result of market movements affecting the £3.8 billion portfolio.

In a statement to Citywire Baillie Gifford said: ‘The board’s guidance on the maximum level of 15%, is defined as being “at time of purchase.” For example, were there to be a dramatic fall (or rise) in the public equity markets or in one of the large listed equity positions, the relative weighting in the unlisted holdings in the portfolio would clearly rise (or fall) without the company taking any action and therefore could go beyond 15%.

‘The portfolio is reviewed and discussed at every board meeting with the managers,’ it added.

Scottish Mortgage Trust's unlisted holdings

Company Business Market value £m (31/10/15) % total assets (31/10/15)
Palantir Technologies Inc US data analysis 38.6 1
Thumbtack US trades directory 32.4 0.9
You & Mr Jones US online branding company 32.4 0.9
Flipkart Indian e-commerce 33.3 0.9
Dropbox Inc US online file storage 26.9 0.7
ZocDoc Inc US online medical booking 25.9 0.7
HelloFresh Food subscription service 17.9 0.5
CureVac German biotechnology 17.9 0.5
Airbnb Inc US online travel & accommodation 16.2 0.4
Essence Healthcare US cloud-based health provider 15.5 0.4
Funding Circle Ltd US peer-to-peer lender 15.8 0.4
Home24 AG German online furniture retailer 16.5 0.4
Innovation Works Development Fund and III LP Chinese investment company 16.2 0.4
JAND Inc (Warby Parker) A common and D prefeerred shares US eyewear company 16.2 0.4
Souq Group Ltd Middle East e-commerce 16.2 0.4
Spotify Ltd Swedish online music streaming 16.2 0.4
SurveyMonkey Online survey provider 16.2 0.4
WI Harper Funds VII & VIII QP LP US venture capital fund 13.2 0.3
Total 38.3 10.01
China Internet Plus Local services provider n/a n/a
Udacity Online education provider n/a n/a

Source: Baillie Gifford. The four holdings in italics are the most recent and were not included in our table on 6 November, 2015

Woodford comparison

The investments in China Internet Plus and Udacity have taken the proportion of unlisted stocks in SMT to over 10% although it is not clear by how much.

Based on SMT’s current total assets a 10% weighting would equate to £380 million in unquoted stocks, up from £350 million at the end of last September. This is bigger than all but four of the 18 existing trusts investing in smaller companies and nearly half of those in private equity.

The off-market activities of Anderson and Slater also draws comparison with Neil Woodford, another leading fund manager who has expanded into unquoted stocks to pursue investments in early stage healthcare and biotech companies.

His £8.1 billion Woodford Equity Income fund has 7.5%, or £570 million, in unlisted stocks. Meanwhile, the £800 million Woodford Patient Capital Trust (WPCT ) has nearly 35% or £280 million in unquoteds. It is considering raising more money from investors so this figure is likely to rise.

Shareholder expectations

As Patient Capital demonstrates, investment trusts are not restricted from holding more than 10% in unquoted companies in the way that unit trusts and open-ended investment companies are.

As ‘closed-ended’ funds with limited shares in issue, investment trusts are not forced to sell investments in order to give cash to investors who want to sell their holdings. This stability can make them attractive investors and providers of long-term capital to companies.

Despite this structural advantage, SMT will be wary of straying too far from shareholders’ expectations of it being a fund that invests mainly in public markets.

While there are plenty of private equity investment trusts that invest successfully in unlisted investments and indeed rival global trusts such as Caledonia (CLDN ) and RIT Capital Partners (RCP ) which include private equity in their ‘multi-asset’ portfolios, problems in recent years at Artemis Alpha (ATS ) show the disadvantages of venturing too far into private markets.

Originally billed as a ‘best ideas’ fund for Edinburgh-based Artemis, ATS at one point had around 30% in unquoted holdings. Its performance suffered as many of these companies delayed flotations on the stock market, depriving manager John Dodd of making a profit on the investments. Recently, performance has improved as Dodd has cut the level of unquoteds in the fund.

Risk, work, reward

Speaking last week, Slater sought to reassure investors about the scope of the trust’s holdings in privately owned companies. Explaining that they were essential for the fund to capture some of the world’s fastest growing businesses, which don’t need stock market capital to progress, SMT’s co-manager said: ‘We’re not trying to be venture capitalists – we’re not after two men in a garage. These are significant business that have gone through several rounds of funding.’

However, he acknowledged that they required him and Anderson to do a lot more due diligence before investing as the companies hadn’t had to pass the listing rules that businesses must meet before joining the stock market.

‘You take on more risk and there’s more work to do,’ he said.

However, he hit out at media reports of a ‘bubble’ in unquoted internet stocks pointing out that while valuations appeared high, the revenue and profit forecasts of these companies were confidential and not disclosed.

‘The risk and rewards are more attractive than that price narrative would have you believe,’ Slater said.

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