Scottish Mortgage Investment Trust (LSE: SMT) is the world’s most popular trust fund due to the size of its asset class and its incredible track record of generating high returns. Nonetheless, the Scottish Mortgage share price has seen a 25% drop since the start of the year. This is in part due to the decline of valuations in growth stocks.
Interest goes both ways
Scottish Mortgage was started as a mortgage-based fund, but has since transitioned to a heavily tech-based fund. This transition brought investors monumental returns from the tech boom during the pandemic. However, its share price has since fallen 40% from its all-time highs due to the underwhelming recent performance of those big tech names. This list includes the likes of Netflix, Zoom, Shopify, and many other growth stocks.
The reason for the heavy decline can be attributed to inflation and the rise of interest rates. The consensus is that when interest rates rise, growth stocks tend to suffer. This is because growth stocks have higher valuations based on future cash flows. High interest rates tend to slow economies down with the aim of suppressing consumer spending. As a result, growth companies are then expected to receive reduced cash flows which end up cutting their future valuations. This results in investors losing interest in those companies.
Upon assessing the Scottish Mortgage portfolio, it’s notable that the majority of its investments have seen monumental declines since the year began. Its biggest holding, Moderna, has seen its share price plunge 65% from its all-time high. The trust’s second-largest holding, Tesla, has also seen its share price suffer lately despite surpassing production estimates.
Locked down profits
The top holdings within Scottish Mortgage Trust include heavy investments in biotech, technology, and logistics. Within those names, the fund has a heavy allocation to China. As such, investors who want exposure to China can do so by investing in Scottish Mortgage as a close substitute. The FTSE 100 fund holds positions in Tencent, Alibaba, and even TikTok’s parent company, Bytedance.
As an emerging market, China’s growth is unprecedented, but its zero-Covid policy and authoritarian tendencies have seen many of its companies lose huge chunks of their valuations. The latest lockdowns in Shanghai and Beijing haven’t helped the Chinese investment case either. With three of Scottish Mortgage’s top holdings being Chinese-based companies I expect its share price to continue underperforming in the near term.
Trust in Scottish Mortgage Trust?
But has trust run dry in Scottish Mortgage Trust? I’d argue not. The flagship fund is managed by Baillie Gifford, one of Britain’s most popular fund managers. The firm has an excellent track record of producing stellar returns and I reckon that this is just a pit stop on a road to larger returns. For young investors like myself, the current bear market presents buying opportunities.
The current Scottish Mortgage share price is trading at a price-to-earnings (P/E) ratio of two. So, this could be a suitable entry point to buy the dip. Nonetheless, I feel the risks associated with investing heavily in Chinese stocks outweigh any potential returns. Therefore, I’m not planning to invest in Scottish Mortgage shares for the foreseeable future.