Scottish Mortgage shares face headwinds amid market turbulence and Chinese economic concerns

Scottish Mortgage Investment Trust (LSE: SMT) shares are currently trading at a fraction of their pandemic highs, leaving investors pondering the investment faith's future prospects. The growth-focused trust has experienced a significant share price decline, plummeting from nearly £15 to just £6.80 over the past two years.

While catching a falling stock is never easy, it might be worthwhile to examine the underlying factors affecting Scottish Mortgage's performance.

In August alone, Scottish Mortgage shares witnessed a sharp seven per cent decline, with a momentary drop of 10 per cent. Several factors have contributed to this downward trajectory, stemming from both broad market trends and the distinctive structure of Scottish Mortgage's growth-oriented portfolio.

A significant portion of Scottish Mortgage's assets, approximately 13 per cent, is still invested in China, including listed holdings in food delivery giants Meituan and e-commerce firm PDD Holdings, along with well-known companies like Tencent and NIO. Furthermore, the trust maintains an unlisted stake in ByteDance, the parent company of the popular social media platform TikTok.

August's descent in Chinese shares was partially ignited by concerns over the health of the Chinese economy, exacerbated by the default of Rustic Garden, which missed interest payments on bond holdings early in the month.

This has led to investor sentiment regarding the Chinese economy sinking to multi-decade lows, coupled with a pullback in Nasdaq stocks, making it a challenging month for Scottish Mortgage.

Nevertheless, Scottish Mortgage's investment portfolio emphasises the potential value of the companies it holds shares in. Given the high failure rate among growth companies, the trust offers investors exposure to this high-potential sector with a relatively low-risk profile.

The inclusion of a diverse range of growth companies allows investors to enter sectors characterised by innovation, transformative technologies, and promising business models.

When analysing the top 10 holdings of Scottish Mortgage, several intriguing changes have occurred since the beginning of the year. Notably, Nvidia's significant weighting reflects the company's strong performance in 2023.

Additionally, the impressive growth of Ferrari's stock has propelled it into the top 10 holdings, with a 53 per cent increase in share price over the past 12 months.

Despite the fact that Scottish Mortgage currently trades at a discount compared to a year ago, it is also trading at a notable 19.3 per cent discount to its net asset value (NAV). Net asset value represents the per-share value of a company's total assets minus its liabilities, divided by the total number of shares outstanding.

The trust did exhibit a modest recovery heading into August, reaching 735p on July 31st after a 10 per cent rise in a month. However, as of August 25th, shares have retreated by 10 per cent, now priced at 657p. This signifies that the stock remains down by a substantial 51 per cent over the past two years.

Scottish Mortgage's portfolio, still heavily invested in Chinese stocks, exposes it to the Chinese consumer market, which is facing a rapidly deteriorating economic outlook. Additionally, the trust has more than half of its assets in stocks listed on the tech-driven Nasdaq index, further contributing to its recent struggles.

A glimmer of hope for investors lies in the trust's discount to net asset value (NAV), which has recently narrowed slightly to 18.8 per cent, down from 22 per cent just a few weeks ago when many Nasdaq shares were rallying. The trust's board has also signalled a commitment to continue buying back shares in an effort to close the discount.

In 2022, Scottish Mortgage repurchased 36.5 million shares at a total cost of £283.3 million, representing 2.5 per cent of the share capital at the start of the year. However, the effectiveness of buybacks remains uncertain, as indicated by Baillie Gifford US Growth Trust's decision to abandon such efforts.

One of the key challenges faced by growth trusts like Scottish Mortgage is their substantial exposure to unlisted stocks. Market scepticism regarding the stated valuations of private companies held in Scottish Mortgage's portfolio, accounting for nearly 30 per cent of assets, remains a persistent concern.

Despite a collective write-down of 28 per cent across this portion of the portfolio in the previous year, this valuation gap continues to trouble investors.