Scottish American Investment Company: March 2021 Update

• James Dow and Toby Ross hunt around the globe for companies with sustainable growth prospects and resilient dividends
• The managers are supported by a well-resourced and diverse team at Baillie Gifford
• The trust has a track record of year-on-year dividend growth, having increased its pay-out for 41 consecutive years, although there are no guarantees this will continue

How it fits in a portfolio

Founded in 1873, The Scottish American Investment Company (SAINTS) is one of the oldest investment trusts around. The managers search globally for companies with the potential of sustainable growth and a reliable dividend. The aim is to grow income and capital over the long term by primarily investing in company shares, but they also invest in other assets such as property and bonds. Given its growth bias it could work well alongside ‘value’ funds investing in unloved companies to form part of an income focused portfolio.

Manager

James Dow and Toby Ross have been joint lead managers of the trust since August 2017, having served as deputy managers since July 2016. Both have spent their entire investment careers at Baillie Gifford after joining its graduate scheme. Prior to their current positions, Dow spent time covering US companies while Ross focused on the UK.

Together they lead the Global Income Growth Team and manage the Baillie Gifford Global Income Growth fund, an open-ended fund that invests in a similar way to this trust but doesn’t have the ability to invest in unquoted companies or borrow to invest, known as ‘gearing’. Dow is also co-manager of the Baillie Gifford Multi-Asset Income fund and Ross forms part of the International Alpha Portfolio Construction Group. Given the overlap in their process and approach, we think they can comfortably handle these responsibilities.

The managers are supported by a team of four analysts alongside dedicated ESG (Environmental, Social and Governance) and China specialists. They also benefit from the wider resource available at Baillie Gifford which consists of over 100 investment professionals.

Process

SAINTS has all the hallmarks of a Baillie Gifford portfolio, unconstrained with a focus on growth over the longer term. Dow and Ross require companies to demonstrate two key traits; a dependable income stream and the potential for above inflation profit growth. These companies need to demonstrate resilience through the economic cycle. This leads them to be very selective and only those companies they consider to be ‘exceptional’ make the cut.

To identify opportunities, they focus on bottom-up analysis (looking at individual company prospects) using a combination of quantitative and qualitative factors. Each company must pass their nine-question framework which focuses on understanding the drivers of growth and the reliability of the dividend. Meeting with company management is a crucial part of this process and it allows them to gauge the attitude towards paying a dividend to shareholders. If a company cuts its dividend, the managers review the investment, but this doesn’t necessarily mean it will be sold. Each company is assessed on a case-by-case basis and the managers acknowledge that dividend cuts can be prudent for long-term growth, for example to pay to acquire another business.

This analysis whittles a universe of around 4,500 into a portfolio of between 50-100 companies. The trust is split into four areas looking for different drivers of free cash flow - cash available to the business after expenses have been paid.

‘Compounding machines’ form the bedrock of the trust and consists of quality companies with strong balance sheets, barriers to entry from competition and experienced management teams. Companies like McDonald’s and Microsoft fit in this bucket. The managers like companies with an ‘exceptional revenue opportunity’, these tend to be market leaders with pricing power (the ability to raise prices without affecting demand) offering the potential for quicker growth. The remaining areas focus on longer-term free cash flow growth, looking for companies with a catalyst for positive change. Companies that possess these qualities can be hard to find, but by investing globally the managers give themselves the best opportunity to seek them out.

The managers keep the trust diversified by investing across different regions. The largest investments are in developed markets like the US and Europe but exposure to Asia has increased as new opportunities arise. The managers also invest in emerging markets which adds risk.

The trust also invests in a portfolio of UK commercial property managed by OLIM Property Limited and some global bonds, which includes riskier high yield and emerging market bonds. These investments are made with borrowed money with the intention of increasing returns (sometimes known as gearing), but this could magnify losses in a falling market and increases risk. The managers can also use derivatives, which if used adds risk. They can also invest in unlisted companies which adds risk, but they do not anticipate doing so for the foreseeable future.

Recent additions to the trust include Chinese online gaming company, NetEase, and Fever-Tree, a premium drinks company whose success in the UK has excited the team for its expansion into the US market. On the other hand, Swedish engineering company Sandvik and insurer Prudential have been sold due to a change in their dividend policies which now makes them unsuitable for the trust.

Culture

This trust is managed by Baillie Gifford, an independent private partnership founded in 1908. It's owned by its partners, who work full time at the firm. This ownership structure means senior managers have a vested interest in the company, and its funds and investment trusts, performing well. We think this has helped cultivate a culture with a long-term focus, where investors' interests are at the centre of decision making. We also like that fund managers are incentivised in a way that aligns their interests with those of long-term investors and should retain talented managers.

Baillie Gifford recognises the risks posed by Environmental, Social and Governance (ESG) issues and uses its position to encourage companies to act in a sustainable way. The company has a dedicated Governance and Sustainability Team, which is responsible for producing ESG research that challenges and contributes to the investment decision-making process. They also monitor companies' progress, engaging with them on ESG matters where appropriate.

Cost

The ongoing annual charge over the trust’s financial year to 31 December 2020 was 0.7%. Investors should refer to the latest annual reports and accounts, and Key Information Document for details of the risks and charging structure. If held in a SIPP or ISA the HL platform charge of 0.45% (capped at £200 per annum for a SIPP and £45 for an ISA) per annum also applies. The platform charge doesn’t apply if the trust is held in a Fund and Share Account.

Performance

Over the past five years (to 28 February) the trust’s net asset value (NAV) has increased by 107.4 % vs 98.6% for the FTSE All-World. The share price has increased by 109% over the same period. Much of this performance can be attributed to Dow and Ross since they have been named deputy managers since July 2016. Remember that past performance is not a guide to the future.

The past year has been a tough one for some investors, especially those hunting for income. Over this time the trust’s NAV increased by *17.5% vs 19.4% for the FTSE All-World benchmark, whilst the share price rose 20.8%. Asia was home to some of the biggest contributors to performance, a region where economic activity bounced back faster than the western world. Notable performers include semiconductor manufacturer TSMC, Chinese furniture maker Man Wah and sportswear company, Anta Sports.

The managers’ efforts to find resilient companies paid off with only a small number of dividend suspensions or cuts. Many of their companies held and even grew their dividend in 2020 such as the Brazilian stock exchange B3 and industrial distribution company Fastenal. While growth-style investing has done well in recent years compared to value investing, we think a well-diversified and robust portfolio should include a variety of styles, as different investment styles come in and out of favour, as well as different asset classes and geographies.

Last year the property portfolio returned 6.8%, most of which was from rental income - a good result given the challenging backdrop. However, the bond portfolio saw a negative return of -10.4% with currency fluctuation hindering returns.

SAINTS has increased its dividend every year for 41 years and the trust currently yields 2.7%. Remember yields are variable and not a reliable indicator of future income. At the time of writing it trades on a 3.5% premium to NAV. All investments can fall as well as rise in value so you could get back less than you invest.

Past performance is not a guide to the future. Source: *Lipper IM to 28/02/2021.

More about Scottish American Investment Company, including charges

Scottish American Investment Company Key Investor Information

The trust has a holding in Hargreaves Lansdown PLC.