Interim management report

Our portfolio of growth investments is in robust health. Financial conditions have pushed companies to focus and prioritise profitable growth. Declines in stock prices have made valuations more attractive. This combination provides a strong underpinning for the long-term outlook.

We will have periods when we underperform the market, and the six months in question was one. Since the end of March, our net asset value per share, with debt at fair value (‘NAV’), fell by 2.7 per cent compared with a rise of 4.3 per cent for the FTSE All-World Index (both in total return terms). The longer-term performance record remains good. Over five years, the NAV has gained 59.6 per cent versus 49.6 per cent, and over 10 years it has increased by 358.1 per cent against 189.5 per cent (both against the index).

Although our focus remains on long-term capital appreciation, we know that a small and consistent dividend is of value to many shareholders. The Board is therefore recommending an interim dividend of 1.60p per share, no increase over last year’s payment.

Our objective is to find companies with the potential for exceptional growth and then own them patiently as they deliver. There are times when stock markets reward this approach and times, as now, when they do not. We constantly revisit the case for our investments and expect that we will sometimes find our optimism misplaced. However, we do not revisit the underlying investment philosophy that has served us well for many years. The value created by the innovation and dedication of exceptional companies will deliver returns for our fellow shareholders. In turn, Scottish Mortgage’s patient ownership and support can increase the likelihood of entrepreneurial success.

Not all large companies capable of outsized growth are listed on public stock markets. Accessing such opportunities at a reasonable cost is a distinctive part of our role for shareholders. The operational performance of our major private businesses has been strong despite the difficult prevailing conditions. The average revenue growth rate of the top ten private holdings was 38 per cent in 2022. Market scepticism around the performance and valuation of our private assets is misplaced, and we believe they will be a significant source of value creation for the Trust in the coming years. We deployed approximately £74mn into six private companies in the half year, and one of our private holdings, the beauty company ODDITY, went public.

Divining much that is useful from stock markets over a six-month period is challenging. The market’s positive return has been driven by a handful of large technology companies that would seem to be the early beneficiaries of developments in Artificial Intelligence (AI). The capabilities of today’s AI systems are sufficient for widespread commercial deployment. Their ability to communicate in natural language based on an ‘understanding’ of the relevant concepts lends itself to many different use cases. Building a foundational AI model can cost billions of dollars, so only those with the deepest pockets can compete. Giant consumer technology companies have those resources and vast user bases to whom they can deploy the resulting applications.

Chipmaker NVIDIA, whose shares we bought in 2016, has been the key provider of the necessary computing infrastructure for AI, or as CEO Jensen Huang put it, ‘if you don’t build it, they won’t show up’. The acceleration in its business has been breath-taking. Revenue guidance for the third quarter is $16bn, which compares to less than $6bn a year ago. The step change that we have seen in AI’s capabilities would have been impossible without NVIDIA’s silicon. The pace of progress has exceeded our expectations and has been well ahead of what Moore’s Law would have dictated for traditional computing. Instead of seeing the end of an aberrant growth era, we may be entering a period of even faster development. If so, the consequences will be yet more profound.

We are mindful that the pioneers may be the easiest to identify when seismic shifts occur in the technology landscape, but they are not always the biggest beneficiaries. Often, nimble new entrants emerge and arrogate opportunities before a dominant incumbent can react. This creates dramatic and long-lasting investment opportunities, as we saw in the PC, Internet and Mobile transformations.

We do not claim to be able to predict macroeconomic developments and are often bemused by the level of coverage given to the future course of interest rates. We can, though, observe the changes we have seen at the companies we own. Unable to assume that markets will provide capital, they are generating their own supply. They are trimming costs and focusing on the most promising projects. We are encouraged that they continue to spend heavily on research and development but believe a higher cost of capital introduces a healthy dose of prioritisation. The free cash flow from our listed portfolio more than doubled in the twelve months to the end of June.

Rising rates have little impact on our company. During the years of exceptionally low interest rates we proactively extended the term of our debt. The majority of our borrowings do not come due until after 2036 and our interest cost is below 3 per cent.

Progress is being made across a broad swathe of technologies. What makes this so exciting for growth investors is that the number of ways companies can combine these technologies grows exponentially. Accelerated computing drives artificial intelligence, which can be applied to vast datasets in the Cloud, enabling breakthroughs in healthcare and so on. Our companies are fitter for the future, and the opportunity they address grows at an accelerating pace. Economic news is usually dreary, and geopolitics rarely reassuring, but entrepreneurs’ collective creativity and productivity are a source of great confidence and optimism.

Past performance is not a guide to future returns.

Risk factors

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 can borrow money to make further investments (sometimes known as “gearing” or “leverage”). The risk is that when this money is repaid by the trust, the value of the investments may not be enough to cover the borrowing and interest costs, and the trust will make a loss. If the trust's investments fall in value, any invested borrowings will increase the amount of this loss.

The trust can buy back its own shares. The risks from borrowing, referred to above, are increased when a trust buys back its own shares.

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