AIC slams Morningstar for Scottish Mortgage move

Baillie Gifford's current Edinburgh HQ

The UK’s Association of Investment Companies (AIC) is taking on the mutual fund analyst giant Morningstar following its downgrade of Baillie Gifford’s Scottish Mortgage Investment Trust plc, the £14 billion flagship of the UK closed-end fund sector.

That’s according to a report in trade news platform Citywire, which added that the AIC is now worried about “a possible spate of trust downgrades.”

The report said the trade body for UK investment trusts has spoken out against changes that Morningstar has made to its ratings criteria — which it says “penalises trusts for the costs of gearing (borrowing) without accounting for its ability to enhance returns.”

In August, Morningstar analysts downgraded Baillie Gifford’s high-flying Scottish Mortgage — which has returned more than 60% so far this year — from a “gold” rating to a “silver” rating on cost grounds “following changes to the way that funds are rated.” 

The Citywide report said however that Scottish Mortgage’s ongoing charges, excluding borrowing costs, are the lowest in its AIC Global sector, where the average is 0.51%.

Scottish Mortgage is so big it is a member of the FTSE 100. It is the best-known fund of Edinburgh-based investment giant Baillie Gifford, which has assets under management and advice of more than £260 billion.

The report said the AIC has criticised Morningstar’s move to “lump in” borrowing costs with other fees as part of the analysis.

It said the trade body has expressed concerns about “inaccurate comparisons with open-ended funds, which generally cannot borrow money, and a possible spate of trust downgrades.”

AIC chief executive Ian Sayers told Citywire: “It’s absolutely legitimate to take into account in any recommendation or rating a trust’s gearing.

“There’s no debate about that.

“The question that it comes down to is how is it being taken into account.

“One of the concerns we’ve had about bringing the gearing costs into a one-off figure has been that, if you do that and you simply look at the headline figure, then you are essentially saying that whenever you gear, you will be marking a trust downwards.

“In the case of SMT, it’s a relatively low-cost trust with low-cost gearing.

“And you put those things together and you’re now saying it’s not so cheap.

“That doesn’t seem quite right to me.”

Sayers told Citywire it was ironic that ratings could be hurt by gearing costs under Morningstar’s new framework at a time when trusts could borrow at very low rates.

“Hands up anybody who thinks an equity portfolio isn’t going to return 2.3% over 20 years, on average?,” he said.

“It seems to me that that is probably not going to be a cost to shareholders over the long term.

“That is going to be a profit to shareholders over the long term, on average.”

The AIC has “begun to engage with Morningstar” on the issue, the report said.

Morningstar’s head of UK manager research, Jonathan Miller, told Citywire its approach was in line with regulatory changes.

Beginning in 2018, trusts have had to report borrowing costs as part of “ongoing costs” in key information documents, or KIDs.

“It’s just an evolution of where the regulation stands on what you report. We’re pretty adamant it’s a cost to the investor,” he said.

Over five years, Scottish Mortgage’s net asset value (NAV) total return grew 124.6% and its share price total return grew 123.5%, compared to the 41.5% of the FTSE All-World index, the 69.1% of the investment trust global sector average NAV total return, and the 68.4% of the investment trust global sector average in share price total return.

The investment trust’s top holding is Tesla, accounting for 11.1% of its portfolio, followed by Amazon, which accounts for 9.3% of assets, according to recent Morningstar data. 

Almost 17% of the portfolio is in Chinese stocks including internet giants Tencent and Alibaba. 

Among its unlisted holdings are Elon Musk’s aerospace business SpaceX and home-sharing app AirBnb. 

About the Author

Mark McSherry
Dalriada Media LLC sites are edited by veteran news journalist Mark McSherry, a former staff editor and reporter with Reuters, Bloomberg and major newspapers including the South China Morning Post, London's Sunday Times and The Scotsman. McSherry's journalism has also appeared in The Washington Post, The Guardian, The Independent, The New York Times, London's Evening Standard and Forbes. McSherry is also a professor of journalism and communication arts in universities and colleges in New York City. Scottish-born McSherry has an MBA from the University of Edinburgh and a Certificate in Global Affairs from New York University.