Scottish Investment Trust Review

One of my contacts has asked me to look at the Scottish Investment Trust (SCIN). This is a self-managed global investment trust which seems to have the same problems that Alliance Trust had before they had a revolution. Namely persistent under-performance. As a result, it is trading at a discount of 10.4% to the net asset value despite doing considerable share buy-backs in the last few months, presumably to try and control the discount. But as we saw at Alliance Trust, which was also self-managed prior to the revolution, share buy-backs rarely solve the discount problem if investors have become disillusioned with the company.

The AIC reported performance figures show a share price total return of -9.2% over one year and -3.1% over 3 years. That compares with global sector returns of +52.2% and +108.4% respectively. Only over 5 and 10 years do they match the sector figures. In other words, recent performance is the issue. This performance is surprising bearing in mind that 34% of their portfolio is in North America which should have been a recipe for success last year.

What’s their investment strategy? Their last interim report spells it out. They have a “High conviction, global contrarian investment approach”. In more detail they say:

“We are contrarian investors. We believe markets are driven by cycles of emotion rather than dispassionate calculation. This creates profitable investment opportunities. We take a different view from the crowd. We seek undervalued, unfashionable companies that are ripe for improvement. We are prepared to be patient. We back our judgement and run a portfolio of our best ideas, selected on a global basis. Our portfolio is unlike any benchmark or index and we fully expect to have differentiated performance. Our approach will not always be in fashion but we believe it delivers above-average returns over the longer term, by which we mean at least five years”.

This kind of comment makes me very sceptical. This looks like a “pick the cheap dogs because the fundamentals will eventually pay off” kind of approach. But I never found that worked. The dogs tend to remain dogs. Being a contrarian in the investment world can be very dangerous.

Terry Smith of Fundsmith has been attacking the concept of chasing “value stocks”, i.e. those that look cheap on fundamentals. I believe he is quite right. The stocks with a high return on capital, good cash generation and sales growth are the ones that are more successful even when a recession hits.

I have not looked at the SCIN investment portfolio in detail but I would certainly question some of their holdings. I would suggest investors need to tackle the board on this, and ask whether their investment managers are really making good investment decisions. Such substantial underperformance over as long as 3 years certainly raises doubts.

This is what the Chairman said in the last Annual Report:

“Global markets continued this year to be dominated by a momentum style of investing which seemingly pays scant regard to valuation, and is an anathema to our value-focused style of investing. To have kept pace with global markets this year, our portfolio would have required a proportionately large exposure to a very small number of companies that we believe are greatly overvalued and a lot less exposure to the names which we consider offer the best potential for long-term gains. This influence, unfortunately, has been a hallmark of markets during the five years since we adopted our contrarian approach and has become greater in more recent years. The result is an extreme divergence between the most and least expensive parts of the market. Such extremes have, historically, proved unsustainable and we believe that a new phase for markets is overdue, one that may favour those who, like us, do not follow the crowd.

Notwithstanding our lack of exposure to what we consider irrationally priced momentum driven investments, there were two particularly advantageous decisions made during the year. The first was our Manager’s decision to take pre-emptive action to preserve capital at the onset of the Covid-19 crisis by selling out of some of the companies we believed would be most impacted. The second was a large exposure to gold miners, which participated strongly in the recovery. Unfortunately, the benefits of these decisions were masked in the second half of the year as markets rewarded stocks deemed impervious to the challenges facing the real economy, such as information technology stocks. In contrast we invested in companies we believed would be less impacted by the travails of the real economy, but were considered dull in the feverish monetary environment created by central bank support, which has fueled momentum investing.

Our contrarian approach explicitly aims to take a different view from other managers and invest without regard to index composition in order to avoid the herding around popular investments that is an inherent trait of active management. We therefore expect our portfolio, and its returns, to be unlike any index”.

It would appear that they adopted the new investment style five years ago which might be identified as when under-performance took off. If an investment strategy does not work, how long should you persist with it? Not many years in my experience. It’s too easy to hold the dogs longer than you should.

Shares magazine have this week published a list of 15 global trusts and gave their 5-year share price total return performance. SCIN came bottom with a total return of 43% whereas the best was Scottish Mortgage at 476%. What a difference! Scottish Mortgage might be exceptional because of their big bets on technology companies, including some unlisted companies but Alliance achieved 106% and Witan 79%. Monks achieved 272% which reminds me that I used to hold it years ago but sold due to consistent poor performance – they had the same investment philosophy as SCIN but they changed it in 2015 after a change in individual fund managers and after I sold the shares. They have been on a roll every since. Does that suggest that patience can eventually be rewarded? No it suggests to me that less patience would have been preferable.

One problem with self-managed funds, even if it does enable a low charging structure, is that it can be difficult to fire the fund managers. A multi-manager approach now followed by Alliance and Witan is, I suggest, a better option.

The directors got an average of 18% against their re-election at the last AGM so clearly there is a strong demand for some change from investors.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

DISCLOSURE: The author does not hold shares in the Scottish Investment Trust

Response from the Scottish Investment Trust:

All the global trusts have similar long-term goals regarding performance but have adopted different approaches to achieve this. For our part, the contrarian strategy we have pursued for a little over 5 years aims for capital appreciation and has allowed us to pay a relatively high, growing dividend (3.3%) that is an important part of shareholder returns.

Being contrarian, we think the best balance between risk and reward is found where expectations are low. For example, our ‘ugly duckling’ holdings are fundamentally good companies that have obvious operational challenges and depressed valuations. However, the reason we like them is that we foresee an incremental improvement which will drive the share price. Plenty of oil names and banks fit that criteria currently.

It’s been a tough period to invest this way because, overall, the best performing stocks have been those where expectations are high. I understand it’s tempting to believe that ‘the winners will always keep winning’ but, having begun my career with such a mindset, it’s not the case. In reality, success breeds complacency and when the growth stops, the skeletons tumble out the closet.

The divergence of valuations within markets between the ‘winning’ areas and the unloved areas has reached new extremes. It’s almost reminiscent of the position 20 years ago as the unloved areas are those most exposed to the ‘real’ economy. It does seem unsustainable and with governments determined to reflate the ‘real’ economy there is major potential for a long-term reversal. It’s for this reason we continue to favour a contrarian approach.

Alasdair McKinnon
Manager