No part of the market was spared during the sell-off sparked by the spread of Covid-19, but high-quality businesses have rebounded quicker than others and will continue to do so, according to Blue Whale Capital chief investment officer Stephen Yiu.
Before coronavirus crisis struck the market in mid-February, Yiu’s £263m LF Blue Whale Growth fund had 11 per cent in cash. However, the manager was buying throughout the sell-off and by the end of March the quality-growth fund’s cash level had fallen to 3 per cent.
“With the cash level that we had, we seized opportunities to reinvest the cash into new interesting names and existing names at an attractive valuation,” Yiu said.
“For most investors it is probably quite scary when you see stocks that are down 10-15 per cent intraday. Maybe some investors will panic and need to sell and raise cash. However, we follow companies very closely and we exercised our confidence to go in, taking a medium-term view.”
One of the names LF Blue Whale Growth deployed “quite a lot” of cash into was Amazon. “Amazon is actually a net beneficiary on both fronts, on the commerce front and Amazon Web Services [AWS] front,” the manager said.
“A lot of people who haven’t shopped online before are now Amazon customers and if you are an existing customer, you will be shopping more frequently.
“But the second part of the business, which is even more exciting, is Amazon Web Services, which powers Netflix and Ocado, as well as other applications. Much like Azure in Microsoft, you would expect an exponential upsurge in demand for AWS and for the cloud.”
Performance of fund vs sector and index in 2020
Source: FE Analytics
Another name the fund deployed a lot of cash into was Microsoft, which is now the biggest holding in the fund.
“Originally Microsoft were expecting to grow about 12-13 per cent revenue for this year and an earnings per share [EPS] of close to 20 per cent.” Yiu said. “They downgraded that number by a small margin, now expecting 11-12 per cent revenue growth, and EPS is expected to grow 15 per cent this year.
“You have the world collapsing and you have this company that can actually grow their earnings per share by 15 per cent. Not many companies can do that; a lot of companies are going into negative territory in terms of their earnings.”
Yiu went so far as to say Microsoft’s actual earnings number could experience no downgrade and perhaps have an earnings upgrade for the year: “Everyone is using Teams, everyone is signed up to Office 365 licenses, and the demand for the cloud, Microsoft Azure, is going through the roof.
“If you look at the share price, over the last few weeks, Microsoft has already outperformed the S&P 500.”
Another area where LF Blue Whale Growth deployed cash was the medical technology space. Yiu highlighted names such as Stryker and Boston Scientific, which are both in the funds’ top 10.
“We see med-tech companies recovering quite strongly. When we increased our holdings they were being punished much more. It's not structural,” he explained.
“All the hospitals are occupied with Covid-19 patients, a lot of elective surgeries have been postponed, there is no capacity to do these operations,” he said. “As soon as the hospital can free up the capacity from Covid-19, we expect these procedures to get back to normal as quickly as anything, even quicker than your next luxury handbag, or your next holiday.”
But the fund wasn’t restricted to buying during the sell-off. One holding it sold out of was Louis Vuitton, or LVMH.
“The stores are shut, fewer people are buying and luxury spending is dependent on Chinese consumer spending. You cannot make a sensible forecast for this year or next,” Yiu said.
The fund also sold out of various hotel names, including Intercontinental Hotels Group (IHG), citing the fact that they make a lot of money from events and conferences. Yiu believes there is going to be some permanent change of behaviour on the back of Covid-19.
“There are implications for some companies who depend on revenue from items that are no longer the new status quo,” he said. “Companies are going to be less willing to spend on hosting events and conferences in a hotel if they had a choice to do it remotely or less frequently.”
Terry Smith, who manages the £17.3bn Fundsmith Equity fund and holds a stake in IHG, said he would only see a 5 per cent loss if the holdings in Intercontinental Hotels Group, and travel technology company Amadeus, were completely “vaporised”.
Commenting on why he opted to sell his holdings, Yiu said: “We like certainty, in terms of underlying dynamics of the company, and if we don’t feel we have enough certainty in terms of the earnings profile or revenue profile, then we would rather redeploy the cash into companies that we have more certainties. With Intercontinental Hotels Group, there is no certainty”
He added: “At Blue Whale we care more about outperformance than turnover in the fund. Ultimately, IHG is not going to go bust, it is not going to disappear, but it doesn’t mean it will outperform. There is a big difference.”
Yiu believes that during the upcoming earnings season there will be a clear segmentation in the market between companies who will have taken a big hit to earnings and those who have not.
“What’s going to happen is that a number of companies would come out as clear winners on the back of this crisis, such as Microsoft. When earnings come out, investors might suddenly realise that they are probably a net beneficiary on the back of Covid-19,” he said.
“As soon as Covid-19 dissipates, companies who have already differentiated themselves in terms of earnings, these companies could fly and do even better. Companies whose earnings depend on how prolonged Covid-19 will be, cannot come up with any assurances, in which case, investors will assume the worst.”
Asset allocators who looked to portfolio rebalancing may have looked to the defensiveness of funds with value strategies, in the hopes they would mitigate downside risks. However, Yiu questioned whether value strategies are a better strategy because they buy cheaper companies.
“Investors argue value strategies are a better strategy because they buy cheaper companies. In our view, it's not cheaper, it's actually more expensive because most of these companies have no future” he said. “Low quality businesses typically trade at low PE multiples. It's as simple as that.”
Performance of fund vs sector and index since launch
Source: FE Analytics
Since launch in September 2017, LF Blue Whale Growth has made a 35.35 per cent total return – which ranks it in fifth place out of the 293 funds in the IA Global sector. It has also outperformed the MSCI World index (although the fund does not have a benchmark) by a significant margin.
The fund has an ongoing charges figure (OCF) of 0.89 per cent.