Scottish Mortgage Investment Trust (SMT) has built a formidable reputation, with a unique investment philosophy and an enviable performance track record. The investment company, managed by Baillie Gifford & Co. made early investments in Amazon and Tesla, which propelled massive gains. In financial year 2021, the net asset value (NAV) increased by 111%. The rockstar mantle rested comfortably on the shoulders of SMT. In FY 2022, however, the NAV fell 13.1% and by another 18% in FY 2023. The share price fell even harder, dropping in FY 2023 by 33.5%.

Sharply rising interest rates have been particularly testing for SMT’s global portfolio of high growth stocks. Companies promising returns many years in advance are especially susceptible to rising interest rates that are used to discount long duration income flows. Financial markets have been especially hard on unquoted private equity investments, which comprise 30% of SMT’s NAV. There is a good deal of scepticism over the valuations ascribed to unquoted investments.

SMT has one of the most rigorous valuation processes for its unquoted investments in the industry. Valuations are reviewed on a rolling three-month basis. A third of the assets are reviewed each month by the Baillie Gifford valuation group and the independent third-party valuer, S&P Global. Beyond the regular cycle for the valuations, an ad hoc valuation is conducted if there is a trigger event such as a change in company fundamentals or changes to valuations in publicly listed comparator companies. During FY 2023, there were 532 revaluations performed on the 87 unquoted line items, resulting in an aggregate write down of 28% across the unquoted portfolio. Seven unquoted companies were revalued upwards during the year.

The unquoted holdings are not venture capital or start-up companies. They are late stage with a global footprint at an average value of $10 billion. Some of the unquoted holdings have already grown into household names. SpaceX is launching more satellites into space with its reusable rockets than the rest of the world combined. Northvolt has already made history by making the first ever lithium-ion battery cell using 100% recycled nickel, cobalt, and manganese. It has $55 billion in contracts to supply major auto manufacturers. Bytedance, which owns TikTok amongst other apps, uses artificial intelligence to target content and advertising distribution to users. These three unquoted investments have enjoyed steady upward valuations and together comprise 9.4% of SMT’s NAV.

SMT’s investment philosophy has always been based on the belief that technological improvements will drive innovation and that even picking a small number of these successful future companies and holding on to them long enough to let the magic of compounding work, will lead to exceptional returns for clients. There have been some mistakes along the way, such as the exposure to Chinese tech stocks but the approach has never been about trying to get everything right, nor timing short-term market moves, but rather seeking to benefit from a few outsized winners over the long-term. According to management, the “greatest investment mistakes come not from those investments which fail, but from the opportunities missed.”

Management has a bottom-up approach in its search for the best growth companies, but this is framed by four key long-term structural growth trends. (1) Digitalisation, which has revolutionised retail, media and advertising and is now broadening into food, finance, and enterprise. (2) Healthcare innovations, which are expected to take a great leap forward with the growing adoption of technology. (3) Decarbonisation. (4) “And beyond,” which includes space exploration and timeless luxury goods. SMT’s largest holding is ASML with a weighting of 7.8%. It is the dominant world manufacturer of the lithography equipment used to make microchips. Chief technology officer, Martin van den Brink is a visionary who has been described as the “main driver of our generation’s Moore’s Law,” the idea that computing power doubles every two years. ASML is not just at the forefront of the next big thing, rather the next several big things. Another microchip manufacturer in SMT’s portfolio is Nvidia, which through its Graphics Processing Units plays a systemically crucial role in artificial intelligence. Moderna is the second largest portfolio holding, a biotech company developing medicine based on messenger RNA (mRNA) technology, which has transformational potential in pioneering a new class of medicines. Talking about Moderna as simply a Covid-19 vaccine provider is akin to pigeonholing Amazon as just a bookshop in the early 2000s.

The time to buy the share is probably now. The share price has dropped nearly 50% from its late 2021 peak, the largest decline since the 2008/09 Global Financial Crisis, when the shares fell over 60%. Despite this, the shares are still up a remarkable 325% over the past 10 years, well above the 179% return in the FTSE All-World Index. Right now, management believes novel technologies can be acquired “on the cheap” and highlights that “the biggest winners are built in bear markets.” Given its exceptional long-term track record, the share regularly trades at a slight premium to NAV, but the performance over the past 18 months has led to an unravelling of that premium and the share is now trading at a discount to NAV. A recent board room spat, which was aired publicly, caused the NAV discount to widen to 22%, creating an exceptional opportunity to buy the shares on the cheap.

Overberg Asset Management purchased the share for its global private client portfolios in late March 2020, when the Covid pandemic selloff created a good buying opportunity. A narrowing in the discount to NAV and simultaneous recovery in underlying investments led to a sharp rally in the share price, which doubled in less than a year from the 533p purchase price. When the share price hit 1393p in February 2021 we banked profits by rebalancing the share back to model portfolio weightings. The share continued to rise, reaching a peak of 1528p in November 2021 but has since slumped, plumbing a recent low of 612p earlier this month. The share is now at almost half our model weightings. A further rebalancing exercise makes a lot of sense, this time involving a reweighting rather than a trimming of profits. The share has a market capitalisation of just under £10 billion and is a constituent of the FTSE 100 index. If one values the quoted investments at NAV, which is reasonable given their liquidity, the 20% discount to NAV of the share price means investors get the unquoted portfolio at a 66% discount to NAV. If one also values the unquoted rising stars, SpaceX, Northvolt and Bytedance at NAV, which is reasonable given their listing prospects, investors are getting the remainder of the unquoted portfolio for free. This is too good an opportunity to ignore.