When Amar Bhidé joined the board of Baillie Gifford’s flagship Scottish Mortgage Investment Trust three years ago, an insider complimented the academic as a “world-class brain and a world-class bastard” who would take to task the £13.4bn company’s investment managers.
Bhidé, a professor of business at Tufts University in Massachusetts, departed in acrimony this week, chastising colleagues for a “natural avoidance of difficult questions after things have gone so well for so long”, as the FTSE 100-listed company announced a boardroom shake-up.
Fiona McBain, chair of Scottish Mortgage since 2017 and a director since 2009, will stand down after this year’s annual meeting, to be succeeded as chair by senior independent director Justin Dowley, on the board since 2015. Professor Paola Subacchi will retire from the board after nine years.
Bhidé’s criticisms and the nature of his exit have sent ripples through the cosy world of investment trusts, a £268bn industry that forms a bedrock of pension portfolios. It also highlighted tensions over the direction of one of the UK’s most popular investment vehicles whose share price has halved over the past 18 months.
In a blistering attack, Bhidé went public with concerns about the length of McBain’s tenure; the board’s lack of investment expertise; its communications with shareholders; and the trust’s investments in unlisted companies that for most of the past decade produced exceptional investment returns. Bhidé argues those gains were an aberration rather than a new normal. “The world has not changed, it just went mad temporarily,” he told the Financial Times.
McBain told the FT she had consistently offered to stand down since 2020, “but I was asked to stay on to keep continuity during the [coronavirus] pandemic, James Anderson’s retirement and the recent period of market volatility”.
Anderson, the driving force behind Baillie Gifford’s investment strategy, made a well-timed exit last year and was replaced by his co-manager Tom Slater, and Lawrence Burns. The trust’s tumbling share price has reversed a decade of stellar profits from early bets on the likes of Tesla, Amazon and Alibaba, and the tailwind of loose monetary policy in the wake of the financial crisis.
“Since James retired, there has been an unjustified self-confidence in the continuation of a strategy that worked very well during the great tech boom,” said one veteran investment company director.
Surging inflation, rising interest rates and Sino-US geopolitical tensions have taken their toll on the fast-growing companies that are Scottish Mortgage and Baillie Gifford’s bread and butter. Last year group assets under management dropped a third to £223bn, its worst-ever annual fall.
The Edinburgh-based private partnership now finds itself at the centre of an embarrassing episode that spotlights the question of whether asset managers live up to the standards they demand of others.
“The failure here is much more one of governance than of investment,” said the chair of a rival trust. “It’s bad for the overall investment trust industry.”
Industry outlier
More than a century after it was founded to finance Malayan plantations in British imperial territories, Scottish Mortgage is the largest of the UK’s 377 investment trusts.
It also stands out for more controversial reasons, including its use of debt to increase the size of its investment portfolio. Falling asset values mean leverage has risen to a 10-year high of 17 per cent of total assets, up from a low of 6 per cent at the end of 2021.
“Gearing always works on the way up and it’s more problematic on the way down,” said the rival investment trust chair. “When markets are rising and debt is cheap, it is worth borrowing money to magnify positions. But when the cycle turns, markets fall and the cost of servicing the debt increases.”
Another issue relates to investments in about 50 illiquid, unquoted securities. A strategy pioneered by Anderson over a decade ago, it is credited with giving ordinary investors low-cost access to private companies such as TikTok owner ByteDance, Swedish battery maker Northvolt and Elon Musk’s SpaceX.
The trust can invest up to 30 per cent of its total assets in unlisted securities — typically late-stage private businesses — measured at the time of purchase. The fall in prices for its listed investments has pushed the proportion to 29.9 per cent of total assets at of the end of February.
Pushing up at the threshold limits Scottish Mortgage’s ability to make new investments, meaning it cannot partake in new funding rounds by its portfolio of private companies.
Selling such private holdings is difficult, and would risk setting price benchmarks that further depress valuations and hit the trust’s asset-to-debt ratio. In a worst-case scenario, Scottish Mortgage could find itself in a downward spiral: if markets sell off further it could breach its leverage limit and be forced to sell down listed positions, which in turn could force it to breach the thresholds for private assets and precipitate a fire sale at the worst possible time.
Private markets reckoning
For now, a question mark is hanging over the fair value of the unquoted assets. Baillie Gifford’s own head of private markets, Peter Singlehurst, has warned that investors in private markets face a reckoning this summer.
Alan Brierley, analyst at Investec, said: “A feature of last year was the disconnect between late-stage venture capital valuations and listed companies. Ultimately, though, we expect price discovery, and for many [private] companies this could be brutal.”
He described Scottish Mortgage’s approach to private valuations as “genuinely more proactive and dynamic than the industry norm” but said “there is no real visibility on the actual valuation multiples”. Scottish Mortgage said the average writedown of the trust’s private companies last year was 45 per cent.
Dowley told the Financial Times the board had lengthy discussions about the portfolio and that “Baillie Gifford’s valuation process is as rigorous as you can get”.
Uncertainty about valuations is seen by some, including Bhidé, as the reason Scottish Mortgage’s shares trade at a 20 per cent discount to its net asset value, the widest in a decade.
In Bhidé’s analysis, periods when valuations are highly uncertain are an inherent aspect of investment in illiquid securities, a conclusion that drove some of his strongest criticisms of the trust.
He said the trust’s explanation of its buyback policy was “incoherent”, and that “simply calling it a liquidity policy seems to be, and I said this in meetings, smoke and mirrors”.
“If you plan to hold a large portion of your assets in illiquid, you then cannot be following a policy of buying back stock to narrow the NAV discount, because it simply cannot be done,” he said, calling for clearer communication: “This is what we do. Do not count on being able to sell at NAV.”
Scottish Mortgage has also invested in a series of promissory notes, a way for private companies to access capital without having to raise equity through a dreaded “down round” — accepting funding at a lower valuation than previously secured.
The trust first invested in Intarcia Therapeutics, a US biopharma firm, through a promissory note. However, the company went bankrupt in 2020 and wiped out Scottish Mortgages’ $15mn investment.
It has also lent, through promissory notes, £73.2mn to Northvolt, £20.1mn to US artificial intelligence software company Uptake Technologies, about £16mn to luggage company Away and roughly £4mn to Blockchain.com.
Singlehurst warned last year of the potential for these structured funding rounds to create a “misalignment of incentives”. New investors are coming in with “drastically different” terms from existing ones, he said: “How that all unravels when companies come to the public markets [or] if those companies do eventually need to do a down round . . . is not well understood.”
Governance and oversight questions
The issues facing the trust set the stage for the battle over the skills needed to govern it. Bhidé wanted the board to recruit new directors with direct trading or fund management experience. Instead, he said, McBain and Dowley ran a process designed to recruit macroeconomic experts.
McBain, a chartered accountant and former chief executive of Scottish Friendly Assurance who is a director at three other companies, said “we have entirely appropriate skill sets”.
Someone who has worked with her said: “Fiona is straightforward and honourable, even if mistakes have been made . . . she can get somewhat rattled by disagreement.”
Several people characterised Dowley as a highly capable and well-connected City figure with a thick skin. A former investment banker, he used to chair alternative asset manager Intermediate Capital Group and heads the board at FTSE 100 conglomerate Melrose Industries.
Dowley told the FT the lack of hands-on investment management expertise was deliberate. “We don’t want people second-guessing Baillie Gifford. We want them to challenge the investment managers to examine the risk exposures whether it’s country, sector or individual positions.”
McBain said it was “a long-held fundamental point of principle . . . Our role is to oversee and challenge the managers and make sure that they stick to the investment strategy that our shareholders have approved.”
Bhidé wanted to debate the strategy itself. Relations had reached breaking point during a board meeting at the end of last week at Baillie Gifford’s Edinburgh offices, according to several people who attended.
The final straw was disagreement about a recruitment process to appoint two new board members. In November the board of Scottish Mortgage appointed Nurole, an online recruiter positioned as a disrupter to industry for boardroom appointments, following a competitive tender.
Nurole was founded in 2014 by Susie Cummings, a longtime friend of Dowley with whom she co-owns a chalet in the Swiss ski resort of Klosters. The relationship was disclosed to the Scottish Mortgage board before Nurole’s appointment. Nurole has placed about 2,500 board directors since it was set up, including 146 on investment trusts in the past five years.
One experienced investment manager who applied received a rejection email from Nurole that described the trust’s ideal candidate for one of the positions: “strong academic credentials in leading thought and research on macroeconomics, and a proven ability of successfully working within commercial organisations to advise and lead regarding economic policy and decisions”. The other specified a financially qualified director.
Bhidé, unhappy with the process, was asked to resign. Refusing, he said he would have to be fired — and thought he had been. “Unambiguously I had been removed at the end of the meeting,” he said. After the FT reported his exit on March 17, Scottish Mortgage said the following day he remained on the board, before announcing his departure on March 21. Now the trust is “well advanced” in appointing two new directors who must help it navigate the challenges ahead.
Scottish Mortgage’s long-term vision for how a handful of growth companies will change the world “may well be correct”, said the rival investment trust chair. “But the journey to that being correct could be bumpy and if the governance is not appropriate it creates potentially bad outcomes.”