Scottish Mortgage Investment : Inv Tst PLC - Annual Financial Report

Scottish Mortgage Investment Trust PLC

Annual Financial Report

A copy of the Annual Report and Financial Statements for the year ended 31 March 2015 of Scottish Mortgage Investment Trust PLC has been submitted electronically to the National Storage Mechanism and will shortly be available for inspection at http://www.morningstar.co.uk/uk/NSM

The Annual Report and Financial Statements for the year ended 31 March 2015 including the Notice of Annual General Meeting is also available on Scottish Mortgage's page of the Baillie Gifford website at: www.scottishmortgageit.com

The unedited full text of those parts of the Annual Report and Financial Statements for the year ended 31 March 2015 which require to be published by DTR 4.1 is set out on the following pages.

Neither the contents of the Managers' website nor the contents of any website accessible from hyperlinks on the Managers' website (or any other website) is incorporated into, or forms part of, this announcement.

Baillie Gifford & Co Limited

Company Secretaries

22 May 2015

Chairman's statement

I am pleased to report on another strong year for our shareholders. Scottish Mortgage's net asset value (NAV) total return (capital and income) for the year to the end of March 2015 was 27.7% and the share price total return was 29.6%; these returns were ahead of that of the broader global equities benchmark, the FTSE All-World Index, which produced a total return over the period of 19.2%.

Whilst this is more than satisfactory, I urge shareholders not to pay undue attention to short term numbers, no matter how good they may be. The Company is required to report these on an annual basis, but the investment approach adopted has a much longer-term philosophy and - as ever - I would encourage shareholders to think of their investment in Scottish Mortgage in this context. The five and ten year results, which are aligned with the investment thesis employed by the Managers, are the appropriate basis on which to judge performance and are the figures by which to assess the Managers' performance. I am happy to say these also remain excellent.

The table below shows the ten and five year total returns in percentage terms to 31 March 2015, alongside the Association of Investment Companies (AIC) Global Sector average for comparison.

Source: AIC/Morningstar (ten year NAV performance at par and five year NAV performance at fair).

The Board takes this opportunity to congratulate the Managers on their continued excellent performance. These figures support our belief that active management can provide very attractive returns for shareholders, both in absolute terms and relative to the returns from the broad global equity markets, when undertaken in a committed and patient long term manner. In January 2015, the Company announced Tom Slater's promotion to Joint Manager of the portfolio, in recognition of the contribution he has already made to Scottish Mortgage as Deputy Manager.

It was another landmark year for the Company: we bought back 6.6m shares near the start of the period and - with our shares trading at a premium - we subsequently issued 25.6m shares from treasury to meet market demand, resulting in net proceeds of around £49m. This is the first time that Scottish Mortgage has been in a position to issue shares in this way.

Looking ahead, the usual cautionary notes apply: past performance is no guarantee of future performance. I would emphasise that Scottish Mortgage is best suited to those who adopt a patient long term investment approach, as there may well be periods of under-performance in both absolute and relative terms.

This year, the Managers' report provides an exposition on the evolution of the broader ideas underpinning the selection of the individual stocks for the portfolio over the last decade and into the next, together with a paper on the Managers' approach to investment risk analysis; I encourage all present and prospective shareholders to read this. The Board continues to endorse wholeheartedly the Managers' committed long-term approach to investing by thorough research of individual companies which may have the potential to grow substantially.

Earnings and Dividends

Scottish Mortgage is clear in its focus as a growth investment trust. Our objective is to maximise total returns to shareholders, and the aim is to achieve this primarily through capital appreciation over the long term. The Board considers it important that the Managers are not constrained by having to acquire short term income for dividend payments, but be allowed to concentrate on finding the best growth companies in order to maximise the potential total returns to shareholders; indeed, this is where we feel their talent lies. A change was made at the AGM last year to the dividend policy to reflect this objective, removing the requirement for growth in dividend payments in real terms. The Board does recognise, however, that dividends are valued by many shareholders and the intention to grow the dividend remains.

This year's earnings per share were 2.24p, 7.8% lower than in 2013/14 (2.43p, adjusted for the 5:1 share split in June 2014). This is not unexpected. The companies in which Scottish Mortgage invests tend to retain their earnings and invest them for the future growth of their own businesses rather than paying them out as dividends. Whilst this is entirely consistent with the approach that the Managers seek in their investments and ought to be positive for the long term capital return prospects of these companies (and therefore of our own), the corollary is that we expect Scottish Mortgage's earnings to continue to fall in the foreseeable future.

In order to pay an increased dividend over last year, it will therefore be necessary to utilise some of the Company's revenue reserve. Bearing all this in mind, a final dividend of 1.55p is proposed, giving a total of 2.93p for the year, an increase of 1.0%. If approved, this will entail using 0.7p per share of the revenue reserves. In so doing, this will leave around 4p per share available to support future distributions. Shareholders will recognise that, while there is no immediate threat to the level of the dividend which your Company is paying, as revenue reserves deplete dividends may be constrained by prevailing earnings, subject to any future decisions on augmenting the resources from which dividends are paid with contributions from capital.

Gearing

Scottish Mortgage remains committed to the use of strategic gearing, in the belief that being geared into prospective long run equity market returns will benefit shareholders in the long term, especially with debt at historically cheap levels. No attempt is made to deploy short term tactical gearing shifts to capture the gyrations of markets, as we do not believe this to be one of our competitive advantages. The Board continues to monitor the level of strategic gearing.

Buybacks and Share Issuance

The proposition offered by Scottish Mortgage has been clearly articulated by the Board and Managers and has generated extensive press coverage which, along with marketing initiatives, has led to demand for shares from existing and new investors. It is particularly gratifying to see that there have been substantial inflows from direct investors through the Baillie Gifford Savings Schemes as well as through other share dealing platforms.

As mentioned earlier, the Company issued shares from treasury for the first time in its history, and was a net issuer of shares over the 12 month period. As per the intention expressed in last year's Annual Report, as the share price moved to a premium to the underlying net asset value the Company met market demand by issuing shares in this manner. Such market actions, whether in terms of share buybacks or share issuance, are undertaken with a long term purpose in mind of aiding an efficient market in the Company's shares in normal market conditions, rather than on a short term opportunistic basis. I would reiterate what has been said in previous years, that no discount limit or premium target is set, but the Board is aware that shareholders will expect the Company to continue to act to provide liquidity and buy back shares when supply exceeds demand.

Whilst the provision of liquidity in our shares remains the most important factor behind such share issuance, the Board also believes there to be a clear benefit to both new and existing shareholders from increasing the scale of the Company, such that the burden of costs is shared across a wider base.

Following the end of this financial year, the Company has seen continued investor demand and the shares have again traded at a premium to the underlying NAV, leading to further share issuance. Permission is therefore again being sought to sell treasury shares at a premium to NAV and also to issue new shares. As per the permission sought and granted in the previous year, the premium is specified as that reached when net asset value is calculated on the basis of the Company's debt at fair value. The Board believes these powers to be essential to aiding a liquid market in the Company's shares and determining the relationship between the price paid by shareholders and the underlying assets in which they are investing.

Low Cost

The Board strongly believes low operating costs to be an important competitive advantage of the Company, given the corrosive impact of high costs on compounded returns to shareholders. I am therefore very pleased to report that for the year to 31 March 2015, Scottish Mortgage's 'Ongoing Charges Ratio' (as defined by the AIC) again fell and now stands at 0.48% (2014: 0.50%), which remains one of the lowest figures reported in the investment trust sector. This reflects, in the main, the competitive management fee charged by our Managers - currently 0.3% on gross assets.

AIFMD

As of July 2014, the Company is required to comply with the EU-wide Alternative Investment Fund Managers Directive (AIFMD). As a result, Baillie Gifford & Co Limited was appointed as the AIFM. BNY Mellon Trust & Depositary has now been engaged to act as depositary, the additional costs of which are included in the ongoing charges ratio. I am pleased to note that this transition was implemented smoothly in the course of business as usual.

Board and AGM

The Annual General Meeting will be held in Edinburgh at The Balmoral Hotel at 4.30pm on 23 June 2015. The Joint Managers of the portfolio, James Anderson and Tom Slater, will make a presentation to shareholders on the investments and take questions. I do hope you will be able to attend.

Senior Independent Director

I would like to take this opportunity to thank Mr. Michael Gray for his many years of service on the Board of Scottish Mortgage. He has decided that after more than ten years as a non executive director it is not his intention to stand for re-election at the forthcoming AGM. We will miss his considerable contribution to the Board but we wish him all the very best in his future endeavours. He will be succeeded in his role as senior independent director by Professor John Kay.

Investment Strategy

The Statement of the Managers' core investment beliefs is again set out in an unchanged form in the Annual Report and Financial Statements.

The consistency of the investment philosophy underpinning Scottish Mortgage over the last decade has been one of its greatest strengths. The Managers are stock pickers, searching for those extraordinary businesses which have the potential to grow their earnings much faster than the broader market over a sustained period. Rather than speculating on short term market gyrations, they focus on analysing individual businesses, their opportunities and the calibre of the minds and the motivations of those controlling them. This philosophy is based on the premise that a company's worth is driven by what it can earn from its assets, and in the long run that its share price will move to reflect the growth in the underlying earnings.

Both the Managers and the Board believe that the true investment risk for our shareholders is in the permanent loss of capital in our investments over the long term, not in short term share price movements relative to an index. In fact short term market swings may even present Scottish Mortgage, as a long term investor, with opportunities.

Outlook

This is perhaps an appropriate moment to take stock and reflect on what has been achieved by your Company in the past decade. The first point to make is that Scottish Mortgage decided to pursue a fundamentally different investment strategy as compared with those employed by many of its competitors in the global growth sector; a higher conviction, much more concentrated portfolio emerged with, to use one of the indicators employed in the industry, one of the highest 'Active Shares' in the business - this being a measure of how far the portfolio deviates from its benchmark.

Secondly, the performance has been remarkable and, looking back, I notice that the theme of my recent statements has been along the lines of "we have had another good year, but don't rely on this continuing…". Not very long ago there was considerable debate as to whether our shares would ever exceed the supposedly magic barrier of £10, which they indeed passed some 18 months ago. We have since done a 5:1 split, which adjusts the currency of this argument, so it is worth pointing out that our shares on their new basis were at £2.67 as at 31 March 2015, this would have been £13.36 per share in 'old money'. By way of comparison our share price (in pre share split terms) was £3.33 on 31 March 2005.

I am acutely aware that there are serious issues for the world to address, whether these be Russian foreign policy, Chinese social shifts, tensions in the South China Sea or terrorism in all its guises across the world, which from time to time may have a dramatic impact on investment markets. Yet at such points it is important to stand at one step removed and ask: what might the longer term impact be on the individual companies in which Scottish Mortgage invests?

Meanwhile, I hope that the investment proposition from Scottish Mortgage remains clear. We aim to manage our investors' money, with a long term view, in an active and effective manner and to do so at a cost level which is below that of almost all our competitors. It is to be expected that we will encounter more volatility than some in our short term performance, both absolute and relative, as indeed we have experienced in the recent past. But in a world which is changing faster every year, our strategy gives rise to enormous opportunities for growth and I therefore remain excited by the prospects for Scottish Mortgage well into the future.

John Scott

Chairman

May 2015

Past performance is not a guide to future performance.

Managers' review

There has been little change in the essentials of the portfolio. Twenty seven of the last year's top 30 holdings are still owned. The top 5 holdings are in the same companies. Our aim continues to be to identify and then faithfully support outstanding and differentiated companies with open-ended growth opportunities for as long as their virtues remain intact and their advantages underestimated. The time horizons of these processes are long and beyond the patience of most investors.

Over the last ten years, Scottish Mortgage has steadily moved towards being a true global growth portfolio rather than a collection of individual regional mandates managed with reference to local indices. As this process has developed we have been driven by our core investment beliefs (once again set out on page 14 of the Annual Report and Financial Statements) but we have also been guided by three observations that have remained intact over this decade. We thought that a market scarred by the memory of the apparent bubble of the late 1990's was structurally unable to grasp the power of technological change. We believed that China was transforming the global economy (and increasingly that it was profoundly different from other emerging markets). We feared that the flaws of the Western financial system threatened much that was encouraging in the global economy and markets. We were disconcerted by quite how right this anxiety turned out to be in 2008-09. So these themes have served us well.

Yet we are concerned that we need to renew our thinking. It seems to us that all three themes have been sufficiently important that they have in turn altered the investment world. In doing so their own meaning has changed irrevocably. We would like to explore this topic by topic.

Accelerating Change and the Redundancy of Technology as a Sector

Our original contentions surrounding the attractions of technology investing are close to exhaustion. Most of those who vowed never again to invest in technology have retired or forgotten their promises. Others simply sulk in their tents. In a world in which the youthful and controversial Uber can be valued at over $40bn as a private company it is hard to contend that animal spirits are still entirely repressed.

Yet still it appears to us that seemingly shocking exponential change is actually more predictable than most market commentators accept. From Moore's Law in semiconductors to Carlson's Curve projecting genomic improvements the pattern of price and performance gains are well-established but much ignored by static financial modelling. Moreover, by the time we tend to have large holdings in companies creating and exploiting these improvements, the underlying trends have normally been securely established. We are not gamblers on speculative conjunctures but respectful observers of the powers of foundational technologies and the application of time and capital.

We believe it to be of paramount importance for investors to recognise that the scale of the changes driven by Moore's Law, sophisticated software, mobile communications and the internet are just too all encompassing to be defined and confined as a discrete sector. This is the way of successful technologies. Electricity went through the same process once upon a time. What we now have is almost every business exploiting foundational electronics technologies to develop - and often revolutionise their industries. It seems misguided to classify the companies leading such surges of productivity and improvement as a separate technology sector. Thinking in such terms all too often unduly narrows the perception of the opportunities on offer to the beneficiaries and the dangers to the incumbents. The potential revolutions we see looming in healthcare as genomic science and gene therapies drive towards personalising medicine, improving clinical outcomes and even cutting costs are securely based on deep scientific and technological progress. So too is the strength of Tesla's challenge to the automobile and utility sectors. For retailers it makes no sense to ignore Amazon and Alibaba just because their challenges are driven by Moore's Law. Any temptation for newspaper and advertising executives to dismiss Google, Tencent and Facebook because they are internet technology companies has proven deeply dangerous. Yet investors indulge in such mental tangles through their preoccupation with index definitions.

China, Emerging Markets and Corporate Success

Five years ago we argued that China was profoundly different from other emerging markets in its ability to sustain fundamental economic improvements. From education to life expectancy improvements to a huge middle class, it displays an unparalleled scale and significance. The Trust once offered a fairly broad exposure to emerging markets but subsequently moved to a concentration on China's most promising domestic companies. Five years later, it is very striking that it has been China's mobile communications, advertising and e-commerce companies that have built imposing businesses and enjoyed exceptional share price performance whilst much else has fallen shy of initial promises. Tencent, for example, now enjoys a market value higher than HSBC or IBM and a multiple of that of its erstwhile emerging market peers such as Petrobras and Gazprom. The success of Tencent, Alibaba and Baidu has only been equalled by the global giants of the West Coast of the USA. This is a remarkable achievement. Our concern at this point is that these forces of modernity and voices of vibrant communication are increasingly discordant with the conservative and repressive tenor of the government.

Whilst the fall from economic and investment grace of Russia and Brazil has been dramatic and terrible to behold, the Indian stock market has suffered no such setback. The election of the questionable Mr. Modi has been greeted with prolonged acclaim. In order to check whether my scepticism is justified our colleague Peter Singlehurst has recently spent several months in Delhi, Mumbai and Bangalore. In general Peter's trip has not dispelled my concerns. But we have been persuaded that a younger generation of business leaders carries evidence of a more dynamic and enlightened model of capitalism. We bought a holding in Flipkart, the Indian unquoted e-commerce leader, which we think exemplifies the improvement but which will also ultimately require a broader creation and distribution of wealth to succeed.

Reinventing the Financial System

There is still precious little evidence that the financial system has meaningfully reformed itself. Indeed the saga of corrupted incentives and unjustified greed continues apace. Banks that once had some claim to relative moral authority and practical leadership such as HSBC and JPMorgan have shown themselves to be as out of control as their presumed inferiors. What may have changed is that traditional banks and investment banks may be becoming less central to the economic system. This is partly the result of regulatory pressures that may have been too limited but have demanded sufficient new equity to make previous methods unprofitable even in normal times. But it is also that the banks are rapidly being undercut by new methods. Finance itself is being attacked by innovation of a rather more profound and promising nature than it has itself supplied. An example of this is Lending Club which is the world's largest online marketplace for consumer credit. We participated in the IPO in late 2014. We believe that it can provide a better system with lower credit spreads than traditional models. With Alibaba and Tencent making significant progress in their own financial services efforts we think this is a global trend.

Emergent Themes of the Future

We can only conclude that we need to abandon our previous themes. We would suggest that three new sets of issues will be crucial in the next five years.

¾ Will major and accelerating improvements in core technologies lead to progress in healthcare, energy and transportation analogous to those in information technology in recent years? Or will secular stagnation and limited productivity gains dominate? These questions are already inherent in our thoughts above. Our current answers are markedly more optimistic than those espoused by most practitioners and commentators.

¾ Which companies will prove to have the greatest profitability resilience and longevity? There has long been a presumption in markets that some industries are the epitome of steady earnings and cash flow growth whilst also offering the prospect of enduring as businesses for decades if not centuries. The allure of such stocks has been particularly great since 2008-09 as investors have sought low volatility so determinedly. There has been an equal and opposite horror of companies that historically and industrially have been perceived to be volatile, cyclical or subject to competitive boom and bust.

Our hypothesis is that the years ahead may prove to be very different. It seems to us that several industries, such as healthcare, oil majors and utilities, which have been havens of stability may face dramatic change. Global brands may follow national grocers into a margin storm. At the same time all too many traditional quoted companies have failed to reinvest in their businesses in order to produce earnings to the satisfaction of the financial industry. As aggressive unquoted enterprises and founder run competitors with less pressure to generate immediate earnings become ever more prominent, the complacent incumbents will be under serious pressure. Equally we believe that the long-term ambitions and visions, network strengths, low capital requirements, technological strength and sheer intelligence of the aggressors may mean that their longevity is more akin to that of General Electric than that of Socks.com. Future vulnerabilities will have little in common with the dictates of risk models.

¾ Corporations, states and citizens. Who wins? Since the late 1970's capital has enjoyed ideological and practical dominance over labour. Almost everywhere and almost regardless of political labels the state has encouraged and endorsed this situation. It is unclear whether this pattern will remain intact in the coming decade. Many strains are already apparent. From concern over marked inequality in the developed world to rising wages in China the compact seems under threat. At the same time relations between most states and many corporations has been frayed by battles over tax versus globalisation, and security versus freedom of expression. It is unclear to us where the arguments and economics will settle or whether the populaces of the world prefer the offerings of consumer and electronic capitalism to the paternalism and resources of the state. This is not just an issue for the West. Iran's future will be a fascinating if unusual example of such evolving controversies whilst a revolution in China might prove the most important possibility of all.

Concluding Comments

In the course of the year I was delighted that the Board promoted Tom Slater to Joint Manager. Tom has contributed hugely to our investment record in recent years. His involvement provides an excellent justification for confidence that we can investigate and navigate the emergent themes in the years to come.

Plainly we have much to think about in the decade to follow (and beyond). But the challenges and uncertainties should not be allowed to obscure the excitement and opportunities that the current investment world offers us. We are lucky enough to meet remarkable companies, both quoted and unquoted, often with extraordinary leaders and frequently offering almost unimaginable opportunities and rewards. It is an extraordinary era for growth investors.

James Anderson

Scottish Mortgage's Approach to Investment Risk

This paper outlines the approach used by the Managers and Board to identify and mitigate the risks that we take for Scottish Mortgage in pursuit of long-term returns. Unfortunately, those looking for a straightforward answer or a single number to summarise this multifaceted topic will be disappointed.

The primary risk is the potential for permanent loss of capital. There are many other definitions but our objective is to generate long term capital growth for our shareholders. To achieve this objective we must assume risk and accept the possibility that this may lead to a reduction rather than growth in the Trust's capital base. This may sound obvious. The investment management industry and academic community have found many ways of describing and measuring risk that have little to do with this fundamental aim. One part of the explanation for this is that risk is incredibly difficult to perceive or quantify. The fortunes of individual companies are tied up in the complex system of the global economy over which is layered the self-referential voting machine of the stock market. Consequently, many choose to view volatility as an easily quantifiable heuristic for risk. We do not think that this is a good substitution.

Stock price volatility reflects many factors which have little to do with the profitability and outlook for a company in five or ten years' time. This is where we believe real investment risk resides, not in the daily fluctuations of the market. The focus on volatility is damaging. It increases the pressure to listen to the overwhelming clamour of stock markets and act on the associated newsflow. Avoiding this temptation is difficult. More difficult though is to answer the real question: what are the risks we are taking and how can we understand and manage them?

Effective Number of Stocks

Central to our view of how to manage risk is the requirement to have a diverse portfolio. In pursuit of attractive returns we want to assume a number of different risks and not several versions of the same one. This means owning a collection of assets that have different fundamental drivers. We are frequently wrong about the opportunities we are presented with. Acknowledging this, we want to try to understand the effect of misjudgments and ensure that they don't unintentionally undermine a broad range of holdings simultaneously.

The first step in doing this is to ensure there are a sufficient number of positions in the portfolio. This is more complex than simply counting the number of holdings. We need to consider the effectivenumber of holdings. To understand this, consider a portfolio with two holdings. One accounts for 99.9% of the assets and the other for 0.1%. Whilst this portfolio has two holdings it is essentially a one-stock portfolio (it has an effective number of holdings which is very close to one) whereas a portfolio with 50% in each holding is a genuine two-stock portfolio (it has an effective number of holdings of two). So, the effective number of holdings in the portfolio can be thought of as the number of holdings the portfolio would have if each of the positions were equally sized. The Board looks at the effective number of holdings on a regular basis as a guide to the degree of concentration in position sizing.

It is necessary to consider the effective number of holdings because the portfolio is a long way from being equally weighted. There is good reason for this. The structure of returns over the past ten years exhibits a clear pattern. We have made mistakes and losses in individual holdings. We have also had some very successful investments. Thankfully the maximum we have been able to lose is the capital that we have invested. The returns from the winners have been several times our investment and it is this asymmetry which has been crucial.

This outcome is not unique to Scottish Mortgage. The structure of returns is also present in the broader market. Looking at the rolling five-year returns for each stock in the S&P 500 in the thirty years between 1984 and 2013 gives around eighteen thousand investment opportunities. This data set doesn't follow a normal distribution. The best 1% of stocks returned 13-fold over five years, the top 5% returned just over 5-fold and the top 20% returned just over 2.5-fold. Investing in about one quarter of the opportunities resulted in a loss.

To benefit from this return structure, we have to maximise the chances of identifying stocks with the potential to return a multiple of the initial investment. We then have to maximise the chances of owning the shares for long enough for the Trust to benefit from this return. This shines a different light on the task of managing risk. Most investments are mediocre, some will destroy capital and losses are almost inevitable. Consequently one of the significant risks is failing to identify big winners. Equally, we must guard against fear of concentration and volatility prompting us to reduce or sell those winners prematurely. Not owning, or aggressively reducing, our holding in Amazon would have significantly lowered the returns we would have generated for shareholders over the past ten years. This is the tension we work with on a day-to-day basis as we seek to maintain diversity but also continue to back the great management teams that run the Trust's successful holdings.

Concentrations in the Portfolio

Having established a practical way of quantifying the number of positions we then consider how these positions relate to one another. We do not attempt to do this by crunching the data on the relative movements of stock prices. Observing that a pair of share prices has been correlated in the past does not, in our view, tell us a great deal about the risks of owning them. Instead, we assess the business models of the companies in the portfolio, the environment in which they operate and the drivers of growth. We do not separate the process of evaluating risks from the process of making investments. Whilst we appreciate the views and advice from our colleagues in Baillie Gifford's risk team, we strongly believe that, as managers, we must challenge ourselves to think critically about risk. We also benefit greatly from having a board with a broad range of experience that can offer different perspectives on the issues and help us to refine our approach.

We consider carefully where companies are benefiting from the same underlying trends in order to identify concentrations within the portfolio. For example, we believe the largest concentration in the portfolio at present is in companies that are benefiting from advertising moving from traditional forms of media to the Internet. The scale and pace of this change reflects a massive shift in consumer behaviour which is throwing up some of the most exciting investment opportunities. Given the returns we think can be achieved, this is a risk we want to take acknowledging that if consumer behaviour changes or advertising budgets stop making this transition, it will have a deleterious effect on several of our holdings. We will continue to think carefully about the size of this exposure relative to our expectations for returns. Other concentrations we have identified include those companies benefiting from increasing use of computers and mobile devices for commerce, those whose business is driven by consumption in what we believe are structurally growing economies, those western brands with appeal in developing markets and companies whose prospects are tied closely to global industrial growth.

We regularly discuss the applicability of these groupings and they also feed our research agenda. Companies that bring new growth-drivers and associated risks are welcome as they increase our diversity. Equally, having identified the powerful underlying dynamics that are driving the portfolio, finding stocks which benefit from more than one of these drivers and therefore sit at the intersection of our risk groupings is also appealing.

The Index is Risky

We believe that our limited overlap with the index is an important component of reducing risk. In his report, James Anderson highlights the issues we think will be crucial over the next five years. He raises the question of whether progress in important core technologies will lead to changes in healthcare, energy and transportation. Similarly he touches on the growing threat of new entrants in the financial services industry. Taken together these industries represent a large proportion of indices and will be an important determinant of market returns.

Companies with new business models underpinned by technology and run by founder-owners are investing aggressively at a time when many listed entities are diverting their cashflows to dividends and share buybacks. There is a good chance that the newcomers will reshape much of what is currently considered to be safe. We think this is a significant risk for investors and not one that we wish to take.

We believe it is very important for an actively-managed portfolio to offer a very different exposure to that provided by investing in the market index. Whilst it is appropriate to measure the performance of the fund over longer periods of time by comparing it to a proxy for the overall market, we find it unhelpful to consult an index when building the portfolio. We don't decide upon our exposure to countries, sectors or companies by considering how they are categorised or ranked by index-makers.

One way to measure the degree of difference from the index is to look at active share. The active share of a portfolio is the proportion of the portfolio that differs from the benchmark index. As a simple example, if the index contained only a single stock then the active share of any portfolio would be the proportion of the portfolio that was not in that one stock. Generally, the less overlap a portfolio has with its benchmark, the higher its active share will be. Scottish Mortgage's active share is over 90%. In practice this means that the returns we deliver are likely to be very different from the index and academic studies would suggest that high active share has a positive association with investment performance.

Summary

The risk we seek to minimise is the loss of our shareholders' capital. The structure of market returns is such that losses in individual stocks are inevitable so we must also ensure we find and hold on to stocks that can return us a multiple of our investment. We do this whilst trying to maintain diversity through having a sufficient number of effective holdings and employing a qualitative process to review continually the concentrations of underlying business drivers. A high level of active share means that the risks inherent in the portfolio are likely to be very different from those present in a broad market portfolio. In pursuing this approach we hope to deliver attractive returns over the long term for our shareholders.

Tom Slater

The Managers' core investment beliefs

Whilst fund managers claim to spend much of their careers assessing the competitive advantage of companies they are notoriously reluctant to perform any such analysis on themselves. The tendency is to cite recent performance as evidence of skill despite the luck, randomness and mean-reverting characteristics of most such data. If this does not suffice then attention turns to a discussion of the high educational qualifications, hard work and exotic remuneration packages that the fund manager enjoys. Sometimes the procedural details of the investment process are outlined with heavy emphasis on risk controls. Little attention is given to either the distinctiveness of the approach or the strategic advantages the manager might enjoy in order to make imitation improbable. We think we should try to do better than this.

¾ We are long term in our investment decisions. It is only over periods of at least five years that the competitive advantages and managerial excellence of companies becomes apparent. It is these characteristics that we want to identify and support. We own companies rather than rent shares. We do not regard ourselves as experts in forecasting the oscillations of economies or the mood swings of markets. Indeed we think that it is hard to excel in such areas as this is where so many market participants focus and where so little of the value of companies lies. Equally Baillie Gifford is more likely to possess competitive advantages for the good of shareholders when it adopts a long term perspective. We are a 100 year old Scottish partnership. We think about our own business over decades not quarters. Such stability may not be exciting but it does encourage patience in this most impatient of industries. We only judge our investment performance over five year plus time horizons. In truth it takes at least a decade to provide adequate evidence of investment skill.

¾ The investment management industry is ill-equipped to deal with the behavioural and emotional challenges inherent in today's capital markets. Our time frame and ownership structure help us to fight these dangers. We are besieged by news, data and opinion. The bulk of this information is of little significance but it implores you to rapid and usually futile action. This can be particularly damaging at times of stress. Academic research argues that most individuals dislike financial losses twice as much as they take pleasure in gains. We fear that for fund managers this relationship is close to tenfold. Internal and external pressures make the avoidance of loss dominant. This is damaging in a portfolio context. We need to be willing to accept loss if there is an equal or greater chance of (almost) unlimited gain.

¾ We are very dubious about the value of routine information. We have little confidence in quarterly earnings and none in the views of investment banks. We try to screen out rather than incorporate their noise. In contrast we think that the world offers joyous opportunities to hear views, perspectives and visions that are barely noticed by the markets. There is more in the investment world than the Financial Times or Wall Street Journal describe.

¾ We are global in stock selection, asset allocation and attribution. We are active not passive - or far worse - index plus in stock selection. Holding sizes reflect the potential upside and its probability (or otherwise) rather than the combination of the market capitalisation and geographical location of the company and its headquarters. We do not have sufficient confidence in our top-down asset allocation skills to wish to override stock selection. We do not have enough confidence in our market timing abilities to wish to add or remove gearing at frequent intervals. We do, however, have strong conviction that our portfolio should be comparatively concentrated, and that it is of little use to shareholders to tinker around the edges of indices. We think this produces better investment results and it certainly makes us more committed shareholders in companies. We suspect that selecting stocks on the basis of the past (their current market capitalisation) is a policy designed to protect the security of tenure of asset managers rather than to build the wealth of shareholders. Companies that are large and established tend to be internally complacent and inflexible. They are often vulnerable to assault by more ambitious and vibrant newcomers.

¾ We are Growth stock investors. Such has been the preference for Value and the search to arbitrage away minor rating differentials that investors find it very hard to acknowledge the extraordinary growth rates and returns that can be found today. The growth that we are particularly interested in is of an explosive nature and often requires minimal fixed assets or indeed capital. We think of it as 'Growth at Unreasonable Prices' rather than the traditional discipline of 'Growth at a Reasonable Price'. We need to be willing to pay high multiples of immediate earnings because the scale of future potential and returns can be so dramatic. On the stocks that flourish the valuation will have turned out to be derisorily low. On the others we will lose money.

¾ We believe that it is our first duty to shareholders to limit fees. Both the investment management fee (0.30%) and ongoing charges ratio (0.48% as at 31 March 2015) are low by comparative standards but at least adequate in absolute terms. We think that the malign impact of high fees is frequently underestimated. The difference between an ongoing charges ratio of 0.48% and one of 1.5% may not appear great but if the perspective is altered to think of costs as a percentage of expected annual returns then the contrast becomes obvious. If annual returns average 10% then this is the difference between removing approximately 5% or 15% of your returns each year. Nor do we believe in a performance fee. Usually it undermines investment performance. It increases pressure and narrows perspective.

Thirty largest holdings and twelve month performance at 31 March 2015

† Absolute performance (in sterling terms) has been calculated on a total return basis over the period 1 April 2014 to 31 March 2015.

# Contribution to absolute performance (in sterling terms) has been calculated to illustrate how an individual stock has contributed to the overall return. It is influenced by both share price performance and the weighting of the stock in the portfolio, taking account of any purchases or sales in the period.

* Figures relate to part-period returns where the equity has been purchased during the period. Source: Baillie Gifford/StatPro.

Past performance is not a guide to future performance.

Distribution of assets

The Directors' fees for the year are detailed in the Directors' Remuneration Report on Page 32 of the Annual Report and Financial Statements.

No Director has a contract of service with the Company.

Management fee arrangements

Details of the Investment Management Agreement are disclosed on page 24 of the Annual Report and Financial Statements. Baillie Gifford & Co Limited's annual management fee is 0.30% of total assets less current liabilities (excluding short term borrowings for investment purposes). Prior to 1 April 2014 the fee was 0.32% per annum. The management fee is levied on all assets, including holdings in. The management fee is levied on all assets, including holdings in collective investment schemes (OEICs) managed by Baillie Gifford & Co; however the OEICs' share class held by the Company does not itself attract a management fee.

† From 1 April 2014, the investment management fee is charged 25% to revenue and 75% to capital (previously 50% to revenue and 50% to capital).

Principal risks and uncertainties

As an Investment Trust, the Company invests in equities and makes other investments so as to achieve its investment objective of maximising total return, whilst also generating dividend growth, from a focused and actively managed global portfolio. In pursuing its investment objective, the Company is exposed to various types of risk that are associated with the financial instruments and markets in which it invests.

These risks are categorised here as market risk (comprising currency risk, interest rate risk and other price risk), liquidity risk and credit risk. The Board monitors closely the Company's exposures to these risks but does so in order to reduce the likelihood of a permanent loss of capital rather than to minimise the short term volatility. Risk provides the potential for both losses and gains and in assessing risk, the Board encourages the Managers to exploit the opportunities that risk affords.

The risk management policies and procedures outlined in this note have not changed substantially from the previous accounting period.

Market Risk

The fair value of future cash flows of a financial instrument or other investment held by the Company may fluctuate because of changes in market prices. This market risk comprises three elements - currency risk, interest rate risk and other price risk. The Board reviews and agrees policies for managing these risks and the Company's Investment Managers both assess the exposure to market risk when making individual investment decisions and monitor the overall level of market risk across the investment portfolio on an ongoing basis. Details of the Company's investment portfolio are shown in note 9 and on pages 16 to 20 of the Annual Report and Financial Statements.

Currency Risk

Certain of the Company's assets, liabilities and income are denominated in currencies other than sterling (the Company's functional currency and that in which it reports its results). Consequently, movements in exchange rates may affect the sterling value of those items.

The Investment Managers monitor the Company's exposure to foreign currencies and report to the Board on a regular basis. The Investment Managers assess the risk to the Company of the foreign currency exposure by considering the effect on the Company's net asset value and income of a movement in the rates of exchange to which the Company's assets, liabilities, income and expenses are exposed. However, the country in which a company is listed is not necessarily where it earns its profits. The movement in exchange rates on earnings may have a more significant impact upon a company's valuation than a simple translation of the currency in which the company is quoted.

Foreign currency borrowings can limit the Company's exposure to anticipated future changes in exchange rates which might otherwise adversely affect the value of the portfolio of investments.

Exposure to currency risk through asset allocation, which is calculated by reference to the currency in which the asset or liability is quoted, is shown below.

*Includes net non-monetary assets of £12,000.

*Includes net non-monetary assets of £35,000.

Currency Risk Sensitivity

At 31 March 2015, if sterling had strengthened by 5% in relation to all currencies, with all other variables held constant, total net assets and total return on ordinary activities would have decreased by the amounts shown below. A 5% weakening of sterling against all currencies, with all other variables held constant, would have had an equal but opposite effect on the financial statement amounts.

The analysis is performed on the same basis for 2014.

Interest Rate Risk

Interest rate movements may affect directly:

¾ the fair value of the investments in fixed interest rate securities;

¾ the level of income receivable on cash deposits;

¾ the fair value of the Company's fixed-rate borrowings; and

¾ the interest payable on the Company's variable rate borrowings.

Interest rate movements may also impact upon the market value of the Company's investments outwith fixed income securities. The effect of interest rate movements upon the earnings of a company may have a significant impact upon the valuation of that company's equity.

The possible effects on fair value and cash flows that could arise as a result of changes in interest rates are taken into account when making investment decisions and when entering borrowing agreements.

The Board reviews on a regular basis the amount of investments in cash and fixed income securities and the income receivable on cash deposits, floating rate notes and other similar investments.

The Company finances part of its activities through borrowings at approved levels. The amount of such borrowings and the approved levels are monitored and reviewed regularly by the Board. Movements in interest rates, to the extent that they affect the market value of the Company's fixed rate borrowings, may also affect the amount by which the Company's share price is at a discount or a premium to the net asset value at fair value.

The interest rate risk profile of the Company's financial assets and liabilities at 31 March is shown below:

Financial Assets

* Based on expected maturity date.

The cash deposits generally comprise call or short term money market deposits of less than one month which are repayable on demand. The benchmark rate which determines the interest payments received on cash balances is the Interbank market rates.

Financial Liabilities

The interest rate risk profile of the Company's bank loans and debentures (at amortised cost) and the maturity profile of the undiscounted future cash flows in respect of the Company's contractual financial liabilities at 31 March are shown below.

Interest Rate Risk Profile

The interest rate risk profile of the Company's financial liabilities at 31 March was :

Maturity Profile

The maturity profile of the Company's financial liabilities at 31 March was:

* Includes £675,000 irredeemable debenture stock.

Interest Rate Risk Sensitivity

An increase of 100 basis points in bond yields as at 31 March 2015 would have decreased total net assets and total return on ordinary activities by £5,481,000 (2014 - £5,298,000) and would have increased the net asset value per share (with borrowings at fair value) by 0.94p (2014 - increased by 0.68p (restated for share split)). A decrease of 100 basis points would have had an equal but opposite effect.

Other Price Risk

Changes in market prices other than those arising from interest rate risk or currency risk may also affect the value of the Company's net assets.

The Board manages the market price risks inherent in the investment portfolio by ensuring full and timely access to relevant information from the Investment Managers. The Board meets regularly and at each meeting reviews investment performance, the investment portfolio and the rationale for the current investment positioning to ensure consistency with the Company's objectives and investment policies. The portfolio does not seek to reproduce the index, investments are selected based upon the merit of individual companies and therefore performance may well diverge from the short term fluctuations of the benchmark.

Other Price Risk Sensitivity

Fixed asset investments are valued at bid prices which equate to their fair value. A full list of the Company's investments is given on pages 18 to 20 of the Annual Report and Financial Statements. In addition, a geographical analysis of the portfolio, an analysis of the investment portfolio by broad industrial or commercial sector and a list of the 30 largest investments by their aggregate market value are contained in the Strategic Report.

106.8% (2014 - 108.8%) of the Company's net assets are invested in quoted equities. A 3% increase in quoted companies equity valuations at 31 March 2015 would have increased total assets and total return on ordinary activities by £106,608,000 (2014 - £84,774,000).

A decrease of 3% would have had an equal but opposite effect.

Liquidity Risk

This is the risk that the Company will encounter difficulty in meeting obligations associated with financial liabilities.

Liquidity risk is potentially significant but the majority of the Company's assets are investments in quoted securities that are believed to be readily realisable. The Board provides guidance to the Investment Managers as to the maximum exposure to any one holding and to the maximum aggregate exposure to substantial holdings.

The Company has the power to take out borrowings, which give it access to additional funding when required.

Credit Risk

This is the risk that a failure of a counterparty to a transaction to discharge its obligations under that transaction could result in the Company suffering a loss.

This risk is managed as follows:

¾ Where the Investment Managers make an investment in a bond or other security with credit risk, that credit risk is assessed and then compared to the prospective investment return of the security in question;

¾ The Board regularly receives information from the Investment Managers on the credit ratings of those bonds and other securities in which the Company has invested;

¾ the Depositary is liable for the loss of financial instruments held in custody. The Depositary will ensure that any delegate segregates the assets of the Company. The Depositary has delegated the custody function to Bank of New York Mellon SA/NV London Branch. Bankruptcy or insolvency of the custodian may cause the Company's rights with respect to securities held by the custodian to be delayed. The Investment Manager monitors the Company's risk by reviewing the custodian's internal control reports and reporting its findings to the Board;

¾ Investment transactions are carried out with a large number of brokers whose creditworthiness is reviewed by the Investment Managers. Transactions are ordinarily undertaken on a delivery versus payment basis whereby the Company's custodian bank ensures that the counterparty to any transaction entered into by the Company has delivered on its obligations at the same time as any transfer of cash or securities away from the Company is completed;

¾ Transactions involving derivatives, and other arrangements wherein the creditworthiness of the entity acting as broker or counterparty to the transaction is likely to be of sustained interest, are subject to rigorous assessment by the Investment Managers of the creditworthiness of that counterparty. The Company's aggregate exposure to each such counterparty is monitored regularly by the Board; and

¾ Cash is held only at banks that are regularly reviewed by the Managers.

Credit Risk Exposure

The maximum exposure to direct credit risk at 31 March was:

None of the Company's financial assets is past due or impaired.

Fair Value of Financial Assets and Financial Liabilities

The Directors are of the opinion that the financial assets and liabilities of the Company are stated at fair value in the balance sheet with the exception of long term borrowing. Long term borrowings in relation to debentures are included in the accounts at the amortised amount of net proceeds after issue, plus accrued finance costs in accordance with FRS26. The fair value of bank loans is calculated with reference to government bonds of comparable maturity and yield. A comparison with the fair value (closing offer value) is as follows:

All short term floating rate borrowings are stated at fair value, which is considered to be equal to their par value.

Deducting long term borrowings at fair value would have the effect of reducing the net asset value per share from 268.0p to 262.4p. Taking the market price of the ordinary shares at 31 March 2015 of 267.2p, this would have given a premium to net asset value of 1.8% as against a discount of 0.3% on a debt at par basis. At 31 March 2014 the effect would have been to reduce the net asset value from 212.2p to 208.0p (taking account of the five for one stock split in June 2014). Taking the market price of the ordinary shares at 31 March 2014 of 208.8p, this would have given a premium to net asset value of 0.4% as against a discount of 1.6% on a debt at par basis.

Investments

Investments in securities are financial assets designated at fair value through profit or loss on initial recognition. In accordance with Financial Reporting Standard 29 'Financial Instruments: Disclosures', the preceding tables provide an analysis of these investments based on the fair value hierarchy described below, which reflects the reliability and significance of the information used to measure their fair value.

Fair Value Hierarchy

The fair value hierarchy used to analyse the fair values of financial assets is described below. The levels are determined by the lowest (that is the least reliable or least independently observable) level of input that is significant to the fair value measurement for the individual investment in its entirety as follows:

Level 1 - investments with quoted prices in an active market;

Level 2 - investments whose fair value is based directly on observable current market prices or is

indirectly being derived from market prices; and

Level 3 - investments whose fair value is determined using a valuation technique based on assumptions

that are not supported by observable current market prices or are not based on observable

market data.

Other Risks

Other risks faced by the Company include the following:

Regulatory Risk - failure to comply with applicable legal and regulatory requirements such as the tax rules for investment companies, the UKLA Listing Rules and the Companies Act could lead to suspension of the Company's Stock Exchange Listing, financial penalties, a qualified audit report or the Company being subject to tax on capital gains. Baillie Gifford's Business Risk, Internal Audit and Compliance Departments provide regular reports to the Audit Committee on Baillie Gifford's monitoring programmes.

Major regulatory change could impose disproportionate compliance burdens on the Company. In such circumstances representation is made to ensure that the special circumstances of investment trusts are recognised.

Operational/Risk - failure of Baillie Gifford's accounting systems or those of other third party service providers could lead to an inability to provide accurate reporting and monitoring or a misappropriation of assets. Baillie Gifford have a comprehensive business continuity plan which facilitates continued operation of the business in the event of a service disruption or major disaster. The Board reviews the Managers' Report on Internal Controls and the reports by other key third party providers are reviewed by the Managers on behalf of the Board.

Premium/Discount Volatility - the premium/discount at which the Company's shares trade can change. The Board monitors the level of premium/discount and the Company has authority to sell shares held in treasury and buy back its own shares.

Leverage Risk - the Company may borrow money for investment purposes. If the investments fall in value, any borrowings will magnify the extent of this loss. If borrowing facilities are not renewed, the Company may have to sell investments to repay borrowings.

All borrowings require the prior approval of the Board and leverage levels are discussed by the Board and Managers at every meeting. The majority of the Company's investments are in quoted securities that are readily realisable. Further information on leverage can be found in note 22 on page 55 of the Annual Report and Financial Statements and the Glossary of Terms on page 63 of the Annual Report and Financial Statements.

Capital Management

The capital of the Company is its share capital and reserves as set out in notes 13 and 14 of the Annual Report and Financial Statements together with its borrowings (see notes 11 and 12 of the Annual Report and Financial Statements). The objective of the Company is to maximise total return, whilst also generating dividend growth, from a focused and actively managed global portfolio. The Company's investment policy is set out on page 7 of the Annual Report and Financial Statements. In pursuit of the Company's objective, the Board has a responsibility for ensuring the Company's ability to continue as a going concern and details of the related risks and how they are managed are set out on pages 28 and 29 of the Annual Report and Financial Statements. The Company has the authority to issue and buy back its shares (see pages 25 and 26 of the Annual Report and Financial Statements) and changes to the share capital during the year are set out in notes 13 and 14 of the Annual Report and Financial Statements. The Company does not have any externally imposed capital requirements other than the covenants on its loans which are detailed in notes 11 and 12 of the Annual Report and Financial Statements.

Statement of directors' responsibilities in respect of the annual report and the financial statements

The Directors are responsible for preparing the Annual Report, the Directors' Remuneration Report and the financial statements in accordance with applicable law and regulations.

Company law requires the Directors to prepare financial statements for each financial year. Under that law they have elected to prepare the financial statements in accordance with applicable law and UK Accounting Standards (UK Generally Accepted Accounting Practice). Under company law the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Company and of the profit or loss of the Company for that period. In preparing these financial statements, the Directors are required to:

¾ select suitable accounting policies and then apply them consistently;

¾ make judgements and accounting estimates that are reasonable and prudent;

¾ state whether applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the financial statements; and

¾ prepare the financial statements on the going concern basis unless it is inappropriate to presume that the Company will continue in business.

The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company's transactions and disclose with reasonable accuracy at any time the financial position of the Company and enable them to ensure that the financial statements and the Directors' Remuneration Report comply with the Companies Act 2006. They are also responsible for safeguarding the assets of the Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.

Under applicable law and regulations, the Directors are also responsible for preparing a Strategic Report, Directors' Report, Directors' Remuneration Report and Corporate Governance Statement that complies with that law and those regulations. The Directors have delegated responsibility to the Managers for the maintenance and integrity of the Company's pages on the Managers' website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.

Each of the Directors, whose names and functions are listed within the Directors and Managers section of the Annual Report and Financial Statements, confirms that, to the best of their knowledge:

¾ the financial statements, which have been prepared in accordance with applicable law and UK Accounting Standards (UK Generally Accepted Accounting Practice), give a true and fair view of the assets, liabilities, financial position and net return of the Company;

¾ the Annual Report and Financial Statements taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company's performance, business model and strategy; and

¾ the Strategic Report includes a fair review of the development and performance of the business and the position of the Company, together with a description of the principal risks and uncertainties that it faces.

By order of the Board

John Scott

11 May 2015

Income statement

* From 1 April 2014, the investment management fee and finance costs are charged 25% to revenue and 75% to capital (previously 50% to revenue and 50% to capital).

† Prior year figures restated for the five for one share split on 30 June 2014.

The total column of this statement is the profit and loss account of the Company.

All revenue and capital items in this statement derive from continuing operations.

A Statement of Total Recognised Gains and Losses is not required as all gains and losses of the Company have been reflected in the above statement.

Balance sheet

† Prior year figures restated for the five for one share split on 30 June 2014.

Reconciliation of movements in shareholders' funds

For the year ended 31 March 2015

For the year ended 31 March 2014

* The Capital Reserve balance at 31 March 2015 includes investment holding gains of £1,776,507,000 (31 March 2014 - gains of £1,213,115,000).

Cash flow statement

Notes to the financial statements

† Prior year figures restated for the five for one share split on 30 June 2014.

None of the views expressed in this document should be construed as advice to buy or sell a particular investment.

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