Scottish Mortgage Investment Trust — Annual Report 2021

Statement from the Board — Justin Dowley, Senior Independent Director; Business Review (year ended 31 March 2021)

Context. The strongest annual return in the trust’s history: NAV +111.2%, market capitalisation closing above £18 billion. The pandemic "supercharged the prospects of several portfolio companies" — Illumina and Moderna sequencing the virus and producing a candidate vaccine in four days between them. The statement also announces James Anderson’s planned retirement (30 April 2022), Lawrence Burns’s appointment as Deputy Manager, and the succession plan for the next decade.

Note on scope. The source extract for this year preserves the Chairman’s Statement and Business Review; the Managers’ Review (James Anderson / Tom Slater, referenced on the pages indicated below) is not included in the available raw material.

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Corporate Strategy

The year to 31 March 2021 was clearly overshadowed by the Covid-19 pandemic. Quite apart from the devastating human cost, it has also created enormous social, economic and business disruption. However, this has also been a period that has supercharged the prospects of several portfolio companies, faster than many might have expected. We could point to Illumina and Moderna who, between them, took only four days to sequence the virus and make a candidate vaccine; online platforms such as Amazon that provided goods to our doors; or Zoom, the video conferencing service that turned into a verb overnight.

As an externally managed investment trust, the Company has been fortunate in not having to contend with so many of the difficulties faced by many operating businesses. But there have been some temporary challenges such as online Board meetings and restrictions on holding physical General Meetings.

In response to the obvious challenges of a virtual environment, Baillie Gifford made full use of the digital tools at its disposal to provide a full service that progressed uninterrupted. As one would expect, joint Managers James Anderson and Tom Slater remained resolutely focused on patient investment on behalf of shareholders and their time horizons reach far beyond the pandemic and its immediate after effects. Despite largely being confined to their own homes, they continued to engage with portfolio companies, as well as exploring new investment opportunities. It is worth noting that the portfolio turnover increased over the year in both monetary and number terms as Scottish Mortgage became owners of several new companies which the Managers believe can drive returns over the coming years.

Performance

For the financial year to 31 March 2021, shareholders saw the strongest ever return produced by the Company, surpassing the returns delivered during the Company's expansion post the Great Depression and, more recently, in the aftermath of the Global Financial Crisis. As a result, the Company reached new market capitalisation highs during the year, closing at just over £18 billion.

Source: AIC/Refinitiv/Baillie Gifford. NAV after deducting borrowings at fair value.

When the Managers judge performance, they focus on long term returns and the impact of compounding over time. Following a period of outperformance, they remain patient and only trim holdings when they believe the upside has reduced. As we have learnt, over long time periods, a small number of companies generate most of the total return.

Source: AIC/Refinitiv/Baillie Gifford. NAV after deducting borrowings at fair value.

Value for Money

It is pleasing that the continued growth in Scottish Mortgage's assets has meant that costs as a proportion of net asset value have again reduced as the Company shares the benefits of scale with its owners. Ongoing charges for the year were 0.34%.

Value for money is moving up the agenda across the asset management industry. Net outperformance lies at the heart of this issue, which is comprised of two factors: relative investment performance to passives and peers, and cost.

On cost, it is difficult to find fair comparison as very few other investment companies provide access to both public and private companies in one portfolio. However, the Company's ongoing charges are less than most actively managed funds invested in public equities and significantly less than private equity funds. This leads to the conclusion that Scottish Mortgage is not only low cost, but, once relative performance has been incorporated, outstanding value for money for shareholders. This will continue to be a central tenet for both the Board and Managers.

Financial Position

The Board remains committed to the strategic use of borrowing, which is one of the principal advantages of the investment trust structure. The extent and range of equity gearing was discussed by the Board and Managers at each Board meeting throughout the period. The absolute level of borrowing increased to remain within an appropriate range against a rapidly growing net asset value. All new borrowing was secured at very competitive rates (details provided on pages 69 and 70) and at the end of the year the overall value of the borrowing represented approximately 7% of the Company's net asset value.

Earnings and Dividend

The Managers seek to maximise total return by providing growth capital to a global portfolio of transformational public and private companies. One common characteristic across these companies is that many choose to retain and reinvest most of their earnings to support future growth. This results in a relatively low level of dividend income for your Company that represents a small and diminishing part of the overall return generated. The revenue earnings per share for Scottish Mortgage over the period were 0.62 pence — this represents a reduction on last year (1.55 pence in 2020), following a decline in income received from portfolio companies.

As a Board we acknowledge the importance of providing a predictable and growing level of dividend income, to help shareholders plan for their own overall portfolio income needs.

The Directors are, therefore, recommending that this year the total dividend be increased by 5.2% to 3.42 pence.

The Company's revenue earnings for the year are insufficient to cover the dividend and the majority will be paid from realised capital reserves. Collectively, we believe this to be appropriate, given the relatively immaterial size of the element paid from capital compared with the scale of the distributable capital gains achieved over the long term.

Liquidity

Over the period, the Company continued to operate its liquidity policy to meet, in normal market conditions, imbalances in supply and demand of its own shares over the short term. In total, the Company issued 24.7 million shares and bought back 56.4 million, resulting in a net buyback totalling around £420 million.

Portfolio Manager Update

In March of this year we informed shareholders that James Anderson will retire as a partner from Baillie Gifford and stand down as joint manager of Scottish Mortgage on 30 April 2022.

Over the last two decades James has led the transformation of the Company, from a largely UK-focused trust to one that is now global, long term and index indifferent. He also pioneered Scottish Mortgage's investments in private companies, one of its most important strategic initiatives to date. There is a lot more to say about the huge contribution that James has made, but it would be premature to do so now, as he remains focused on jointly managing the portfolio over the coming year.

During this year, the investment team increases to three, with the addition of Lawrence Burns as Deputy Manager. Lawrence's name may be new to many shareholders but he is philosophically aligned with the current Managers. He has a particular focus on transformative growth companies and has also co-managed some of Baillie Gifford's largest strategies alongside James and others. Lawrence's arrival marks the next step in a long term succession plan that has been agreed between the Board and Managers and will ensure that we have a strong team in place to manage the portfolio for the next decade or more. The Board would like to take this opportunity to welcome Lawrence to his Scottish Mortgage role.

Environmental, Social and Governance (ESG)

We recognise the importance of considering ESG factors when making investments and in acting as a responsible steward of capital. We consider that Board oversight of such matters is an important part of our responsibility to shareholders.

Governance also needs to be considered in the context of the philosophy that underpins the management of the portfolio.

The Managers take a very selective approach, with a focus on companies that can grow to many multiples of their current size. More often than not, the companies with the most exciting prospects are those that seek to tap into technological and cultural progress to find newer and better ways of producing the goods and services that society will need over the course of the next decade. In this context, the Managers' approach to governance and sustainability is based on five core beliefs that are detailed in the recently published document, 'Our Approach to Governance'. We recommend this as valuable reading to all shareholders and it can be accessed on the Company's website scottishmortageit.com.

Shareholder Engagement

The Annual General Meeting will be held on 24 June 2021 at Baillie Gifford's offices at Calton Square, 1 Greenside Row, Edinburgh. In view of the continuing Covid-19 related restrictions, attendance will be kept to the minimum permitted by the Company's Articles of Association and shareholders will not be able to attend. We would, though, remind shareholders that they are able to submit proxy voting forms before the applicable deadline and also to direct any questions or comments for the Board in advance of the meeting through the Company's Managers, either by emailing scottishmortgage@bailliegifford.com or calling 0800 917 2112 (Baillie Gifford may record your call).

As always, the details of the outcomes of the AGM business will subsequently be available on the website, as will a filmed Managers' update.

More generally, we would encourage shareholders to engage with the Company throughout the year, not solely via the AGM. The Managers provide information and 'Insight' pieces on the portfolio on the Company's website scottishmortgageit.com.

Now more than ever these digital resources allow shareholders to stay well informed, by hearing directly from those managing their money. Over the year, webinar presentations have been extremely well attended and more are planned in future. Details of these will be put on the website.

It is hoped that the Managers will be able to proceed with a shareholder forum in Edinburgh in September 2021, as well as other live events later in the year. If such events can take place, Board members will look to attend a number of these to provide opportunities for face to face engagement with shareholders.

Directors’ Share Qualification

Following a review, the Board is proposing that the Articles of Association be amended at the forthcoming AGM to remove the so-called 'Directors' share qualification' provisions. The formal requirement for each Director to hold a particular number of shares is somewhat historical and would now involve a substantial financial commitment from any proposed Director, which is not considered by the Directors to be conducive going forwards to attracting a diverse range of candidates to the Board. Further information on this proposal is set out on page 37.

Outlook

It might perhaps seem insensitive to look forward when the world remains in the grip of the pandemic. Nonetheless, it is incumbent on us to be optimistic and look beyond the current crisis. If the last year has taught us anything, it is that the world is uncertain but that we can endure and businesses can flourish in the most challenging of circumstances.

Investment opportunities are likely to remain plentiful as companies increasingly use digital tools to revolutionise industries and build a sustainable future. Scottish Mortgage is well placed to give you access to these transformational growth companies. The Managers are known as patient investors with time horizons well aligned to company founders, which is particularly attractive to private company owners who carefully select who they wish to see on their ownership registers.

We remain confident that Scottish Mortgage merits a place in all portfolios. Shareholders benefit from high quality managers, with a clearly defined investment philosophy and process, together with independent board oversight. All of this is provided at a cost that the Board believes represents genuine value for money.

Justin Dowley, Senior Independent Director (in the temporary absence of the Chair) — 12 May 2021

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Business Review (excerpt)

The Company aims to achieve a greater return than the FTSE All-World Index (in sterling terms) over a five year rolling period or longer. This benchmark is a reference point for considering performance and emphatically is not a portfolio construction tool. The portfolio does not set out to reproduce the index and there will be periods when performance diverges significantly from the benchmark.

Borrowings are invested in equity markets when it is believed that long term investment considerations merit the Company taking a geared position. Apart from in exceptional market conditions the Company will not take out additional borrowings if, at the time of borrowing, this takes the level of gearing beyond 30% calculated in accordance with the Association of Investment Companies (AIC) guidelines. In any event, the Company will not exceed the limit on borrowings set out in its Articles of Association, which provide that the amount of all the Company's borrowings shall not, without the previous sanction of an ordinary resolution of shareholders, exceed one half of the aggregate issued and fully paid share capital and capital reserves of the Company and, in addition, that the Company may from time to time borrow for temporary purposes sums not exceeding 20% of the Company's issued and fully paid share capital.

The Managers' Core Investment Beliefs with respect to the Company are set out on page 19.

Details of investment strategy and activity this year can be found in the Statement from the Board on pages 2 to 4 and in the Managers' Review on pages 13 to 18. A detailed analysis of the Company's investment portfolio is set out on pages 22 to 31.