Scottish Mortgage (SMT), the FTSE 100 global investment trust, underlined its reputation as the UK’s biggest growth fund today with annual results showing an impressive 40.9% total return to shareholders for the year to 31 March.
Interest in the trust’s big investments in technology-inspired ‘disrupters’ such as Amazon (AMZN.O), Tesla Motors (TSLA.O) and Illumina (ILMN.O) – the US gene sequencing giant – paid off, with the shareholder return exceeding the growth of the portfolio whose net asset value (NAV) leaped 38.1%.
Both the share price and NAV returns beat the 33.1% gain in the FTSE All-World index, according to the trust's latest annual results.
The gains for 2016/17 lift total shareholder returns over the ten years to 302.2%, more than double the 148.7% achieved by the FTSE benchmark.
It’s a great performance – second only to Lindsell Train (LTI) in the AIC’s Global sector – but presents a bit of a challenge on the dividend front.
Although SMT’s fund manager Baillie Gifford is focused on generating good long-term capital returns for investors, its board knows shareholders like their half-year dividends and that growing the payments is part of the trust’s formal investment objective, even though the shares yield just 0.8%.
The issue, which the board flagged up last year, is that investment income has steadily declined as fund managers James Anderson and Tom Slater have increased their positions in growth stocks such as Amazon (AMZN.O), Google (or Alphabet GOOGL.O) and Alibaba (BABA.K). These don't pay dividends but prefer to reinvest their cash in their businesses.
The dearth of investment income has been compounded by the rising level of unquoted 'unicorns', which also don’t pay dividends, to nearly 12% of the £5.3 billion portfolio.
The duo continue to be busy in this part of the portfolio, in March adding a £60 million investment in Grail, the cancer detection startup spun off from Illumina last year, making it SMT's largest unquoted holding.
As a result in the latest year earnings per share fell 36% to 1.07p, forcing the board to use up nearly all its remaining revenue reserve, which is the pot of undistributed investment income it has earned over the years, in order to declare a final dividend of 1.61p per share up from 1.58p a year ago.
On top of the interim dividend paid in December this raises the total to be paid to shareholders for 2016/17 to 3p per share, up from 2.96p last year.
However, it leaves SMT with revenue reserves of just 0.5p per share, requiring chairman John Scott to say that unless there is an unexpected leap in income from the portfolio the board will either have to cut the dividend next year or use its powers to take some money out of its capital reserves to make the shareholder payouts.
Although a growing number of investment trusts are using the flexibility they were given five years ago to pay dividends from their capital profits, the practice has raised concerns - recently expressed on this website by Ian Cowie - that it could expose shareholders to greater losses in periods of tumbling stock markets.
‘In view of the explicit growth component of the company’s investment objective, the board wishes to make clear to shareholders that it would be willing to make such distributions from capital profits, in order to sustain or modestly increase our dividend, provided that the board is of the view that the total returns being earned by the company over the long run justify this,’ Scott said.
Scottish Mortgage's impressive long-term returns clearly give it plenty of historic gains to tap into. Nevertheless, the running theme of how to pay the dividend highlights a fundamental tension with its ambition to deliver both growth and income.
Scottish Mortgage will publish its annual report later this month. It will contain an update from Anderson and Slater. The shares have gained 21% this year and at 398.8p trade at a premium of just over 3% to Morningstar's estimate of their 376p NAV per share.