what does it mean for shareholders?

These are eventful times for Scottish Mortgage, the giant investment trust. First the £12bn portfolio announced plans to shrink by buying back £1bn worth of its own shares; then it emerged that an American hedge fund had taken a 5% stake in the trust, which is Britain’s largest listed fund.

All this happened just two years after the fund lost its long-standing co-manager James Anderson, who had been at the trust since 2000. His departure was followed by a period of poor performance for the fund, previously a favourite of investors thanks to its early backing of companies such as Amazon and Tesla. In 2022 the fund’s net asset value fell by 39% and the share price by 45.7%.

What do the latest developments mean for individual shareholders? We take you through it step by step.

The background

Scottish Mortgage thrived when low interest rates encouraged investors to put their money into stocks that seemed to promise strong growth as opposed to income – and the fund specialises in seeking “exceptional growth companies”. When interest rates rose, this trend went into reverse and the share prices of the fund’s holdings started to suffer. This prompted some investors to sell shares in the trust itself, and about two years ago its shares started to trade at a discount, which means they were worth less than the assets they represented.

The discount before the announcement of the share buyback and the hedge fund’s stake was about 15%. In other words, the stock market was valuing the trust at 15% less than the combined value of its holdings (after accounting for its debts). It was this relatively wide discount, on a trust that in the past had tended to trade in line with the value of its assets, that prompted both the trust’s decision to buy some of its own shares and the interest from the hedge fund.

The share buyback

When an investment trust trades at a discount, one of the steps its board can take is to buy some of its own shares. This increases demand for the shares and should therefore, all else being equal, boost the share price. Often just the announcement of a plan to buy back shares will boost the share price and narrow the discount.

This is what happened in the case of Scottish Mortgage earlier this month. At 7am on 15 March the trust announced that it would make available at least £1bn to buy back its own shares over the next two years and by the time the stock market closed that day the share price had risen by 5.5% to 824.2p. This narrowed the discount from 15.1% to 9.8%.

Even if a share buyback does not increase the share price – share prices are, after all, always at the mercy of market sentiment – it will, as a matter of simple mathematics, increase the trust’s net asset value per share if the shares are bought back when they are trading at a discount. This is explained here:

 – Ask the expert: what is a share buyback?

The hedge fund’s intervention

In the evening of 21 March, after the stock market had closed, Scottish Mortgage announced that Elliott Investment Management, an American hedge fund, had a stake in the trust of more than 5%, the threshold for disclosure. Elliott said the threshold had been crossed two days earlier.

At the close of trading the following day the shares had risen further to 878.8p, 12.5% higher than before the announcement of the buybacks. At that point the discount stood at 6.8%, less than half the figure before the buyback announcement.

What could happen next

Much depends on the hedge fund’s intentions, which we don’t know (other than it wants to make money!). Its options include simply seeking to sell its Scottish Mortgage shares for more than it paid or seeking to use its stake in the trust to influence how it is run.

If the first is the case, it is off to a good start, thanks to the rise in the share price. Elliott may also have hedged its position so that its profits are determined solely by the narrowing of the discount, in which case it should also be strongly in the black.

But it could instead agitate for more change, such as a reduction in Scottish Mortgage’s unlisted holdings. Because valuing these holdings is subjective (there is no share price), their valuations are less reliable than those of the trust’s quoted holdings, and investors may compensate for this by making the shares trade at a discount. Reducing the percentage of the trust’s money in private companies from the current 26% or so could therefore help to reduce the discount.

While the board of Scottish Mortgage received many plaudits for the introduction of the largest buyback in investment trust history, in what appeared to be a very “shareholder-friendly” move, given subsequent developments City analysts said the more cynical observer might now question whether this was more driven by Elliott building up a stake.

As a result of the drastic narrowing in the discount over the past two weeks, it’s likely that Elliott has already made a large paper profit. If it is satisfied with that, it may now concentrate on selling its holding in the trust – which would be likely to take some time given that its stake is worth hundreds of millions of pounds. Alternatively, it may contemplate increasing its stake so that it can put more pressure on the trust to take further action to address the discount.

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