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Is Scottish Mortgage too exposed to volatility?

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Scottish Mortgage Investment Trust (LSE: SMT) has performed terrifically recently. At 1,446p today, its share price is up 171% since a low of 533p at the end of March 2020. But I’m always cautious when a trust delivers high returns in a short time frame. So what’s going on?

What is an investment trust?

Investment trusts invest in shares of companies, as well as other assets, such as cash or bonds. The value of the trust’s shares depends on the underlying value of all assets owned, as well as demand for the fixed number of shares in the trust. One advantage is that the investment is spread across multiple companies, which reduces the amount of time I have to spend researching individual stocks. And Scottish Mortgage can hold up to 30% of the trust in private companies that are difficult for retail investors like me to access.

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However, investment trusts charge management fees, annual charges, and sometimes even performance fees. But Scottish Mortgage’s ongoing charge of 0.34% is low compared to competitors. And in defence of the charge, the trust has increased its dividend for the last 39 years in a row. 

Net asset value

Net asset value (NAV) is the value of the trust per share. This figure is reached by adding up the value of all the trust’s shares and assets, and then subtracting any debts. This total is then divided by the total number of shares in the trust. Scottish Mortgage currently has a NAV of 1,383p, against a share price of 1,446p. That means that its trading at a 4.3% premium, indicating high demand. 

Scottish Mortgage says, “we look to add value over five year time frames, preferably much longer“. This long-term investment philosophy aligns strongly with my own investment strategy. But it’s also a warning to investors — don’t buy its shares if you might need the money in the short term. That’s because while it has put on a great performance recently, there’s been bumps in the road. 

Scottish Mortgage volatility risks

An advantage of most investment trusts is that they are less volatile than individual shares. But that’s not been the case for Scottish Mortgage recently. It was at 1,415p on 15 February, before falling to 1,017p on 5 March. After recovering, it fell from 1,277p on 29 April to 1,077p on 12 May. Having now reached 1,446p, I think this pattern could repeat itself. And trust co-manager James Anderson has recently left, which is another concern for me.

But my biggest issue is that its top 10 holdings, 43.6% of the total, are in tech stocks. Tech share prices can soar rapidly, but they can also fall just as fast. Two days ago the tech-heavy NASDAQ saw its biggest fall since March, as investors grow increasingly concerned that rising interest rates will limit their ability to borrow to grow. 

Its Chinese tech stocks include Alibaba, NIO, and Tencent, which are all vulnerable to the ongoing regulatory crackdown. And it has large holdings in Moderna and Tesla. Their price-to-earnings (P/E) ratios are sky-high, so falling consumer confidence might soon hit these shares hard.

I think Scottish Mortgage has delivered high returns on the surging technology sector. But as I think tech stocks might be falling soon, I won’t be adding it to my portfolio.

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Charles Archer owns shares of Tesla. The Motley Fool UK owns shares of and has recommended Alibaba Group Holding Ltd., NIO Inc., and Tesla. The Motley Fool UK has recommended Moderna Inc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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