Stephen Yiu is confident the companies in which they have invested have the potential to deliver outperformance given at least a medium-term view.
2022 PERFORMANCE UPDATE
by Stephen Yiu
03 May 2022
As we approach the halfway point of 2022, we feel it is necessary to discuss the recent performance of the fund.
The fund has suffered over the first half of the year. We make a point to always present our performance relative to our comparator benchmark and therefore do not hide the fact the fund (LF Blue Whale Growth Fund I Acc) is down 22%, compared to the IA Global Sector average of -8% in 2022 (data for period 01/01/2022 – 30/04/2022). As a long-only fund dedicated to investment in our asset class, we will suffer when markets fall as they have in the last six months.
Here we review the performance in light of the Ukraine crisis and inflation woes which have weighed heavily on markets this year. In times of such macroeconomic headwinds, we often see a rotation into cyclical sectors such as oil and gas, utilities etc. It is therefore no surprise that the top performing companies in both the S&P 500 and FTSE 100 over the last 6 months have fallen into these categories. This brings me onto my first point – the LF Blue Whale Growth Fund is founded on a philosophy of investing in high quality businesses, at attractive valuations. The problem is that we would, in general, define businesses in the cyclical sectors as lower quality. It would be hard to argue that BT and Chevron offer the same level of quality that you would see from Microsoft and Alphabet, for example. We consequently do not sacrifice quality in the portfolio for short-term performance.
If we are invested in high-quality businesses, what has caused this underperformance year to date? Firstly, it is the rotation into cyclical stocks (miners, oil and gas in particular) which we shun. Secondly, whilst we have avoided the low-quality segment of the tech sector (Peloton, Netflix etc.), such companies are weighing on the sector as a whole. As their business models have come under greater scrutiny following the share price exuberance during the pandemic, the whole sector has taken a hit indiscriminately.
Short-term underperformance, whilst displeasing, is to be expected in any portfolio. Legendary investor Benjamin Graham famously said, “In the short run, the market is a voting machine, but in the long run, it is a weighing machine.” He was explaining that trends and fashions will drive short term prices, but eventually the share price will always be representative of the quality of the business.
Running a concentrated portfolio, whilst giving us the greatest chance for long-term outperformance (the LF Blue Whale Growth Fund is comfortably outperforming our benchmark (IA Global) since launch over 4 years ago), will exacerbate short-term underperformance. Each company in the portfolio was chosen for both its quality and its attributes. We consider they are particularly appropriate in mitigating against the key macro-risk factors of the moment – inflation and the Ukraine crisis. Put simply, the portfolio has negligible exposure to Russia, and has, what we believe to be the ultimate combination of high gross margin (70% on average across the current portfolio) and strong pricing power to combat inflation.
After thorough examination of the companies in the portfolio over the last few months, do we see any issues? In short, no, we only see opportunity. We define risk in the portfolio as potential for permanent loss of capital based on company fundamentals. It is hard to imagine a world in which the likes of Microsoft and Google do not play a key role in our day-to-day lives. The indicators show that such companies are only going to play a greater role in the global economy going forward. The portfolio invests in several companies that will see greater integration in a digitising world. The latest round of results for such companies, just last week, has vindicated this belief. The high-quality businesses in which we are invested are now offered at a discount to their price of six months ago, yet their prospects, if anything, look better. In the event of a deep recession (which we do not consider a likely outcome) stock markets and even the best long-only funds would doubtless suffer more pain. In those circumstances holding high quality companies would be even more important.
In summary, at Blue Whale we cannot promise consistent short-term returns, but we can promise to only invest in companies of the highest quality. The areas in which we invest, along with the market in general, have taken a hit over the last six months. This has allowed us to deploy cash into those businesses that we see offering the best opportunity for outperformance over the medium to long term. The macro challenges facing the world mean we have had to apply even greater scrutiny to our portfolio. A raft of key disposals in late 2021 and early this year, has mitigated some negative performance in the fund, whilst we have refined the portfolio with a view to defending against further disruption. We are confident that the portfolio is consequently positioned to benefit from secular trends, such as global digitisation, whilst defending against inflation and macro uncertainty.
It is you, our investors, that we value most highly. Many of you have been with us since the early days of Blue Whale, but we are also mindful there are a number of you who will have invested over the last couple of years. It is humbling that so many of you have continued to invest during this turbulent time, demonstrating your trust in our process, as the LF Blue Whale Growth Fund sees net inflows for the year so far. We all know that equity investments should be viewed over a five year period but we hope our medium to long-term record of outperformance, our regular updates, and the types of company in which we are invested continue to give you comfort during this disagreeable time for markets. Looking forward, we strongly believe the companies in which we are invested have the potential to deliver outperformance given at least a medium-term view.
Please note that the information provided in this article is not to be construed as advice and any views we express on holdings or other assets do not constitute investment recommendations and must not be viewed as such. If you are unsure as to the suitability of an investment for your circumstances, please seek independent financial advice. Investments can go down in value as well as up so you may get back less than you invested. Your capital is at risk. Past performance is not a guide to future performance.
