As the coronavirus outbreak began to spread across the world earlier this year, many investors adopted a cautious approach. But Stephen Yiu, lead manager of LF Blue Whale Growth Fund (GB00BD6PG563), was busy topping up positions in big US tech stocks. At the start of the year, the fund had a cash position of 13 per cent because Mr Yiu was wary of high market valuations. But by the end of March this had fallen to 3 per cent. “We couldn’t have foreseen coronavirus, but were quite prepared for it,” says Mr Yiu.
The fund's largest holding is Microsoft (US:MSFT), which Mr Yiu topped up in March. “Microsoft was down 25 per cent from peak to trough, in line with the S&P 500 index,” he says. “That was when we redeployed a lot of cash into it, based on the attractiveness of the valuation.”
Mr Yiu believed that the expected earnings downgrade for Microsoft this year was significantly less than the market was pricing in at the time he invested in it. And despite its share price recovering nearly all of its fall since February highs, following strong results in April, he thinks its valuation is still attractive on a relative basis.
Mr Yiu also topped up Amazon (US:AMZN) in March on the basis that more people are buying their groceries online and demand for the company's cloud computing service continues to grow. However, he says its share price looks less attractive now so he may reduce the fund's holding in it and allocate more capital to other opportunities. Amazon’s share price rose 45 per cent between its lowest point in March and its highest point in April.
Software company Adobe (US:ADBE), meanwhile, has been one of the fund's largest holdings since its launch in 2017 and remains one of Mr Yiu’s favourite stocks. “The valuation has always been attractive,” he explains. “We like this company a lot, but the valuation is the most important part.”
Part of the reason why Mr Yiu and his colleagues place such great importance on the valuation of companies, and invest in ones that they think look well placed to outperform in the near term, is because they aim for LF Blue Whale Growth to outperform over every 12-month period. And this has certainly been the case recently, with the fund making a total return of 10.92 per cent over the year to 7 May, well ahead of the Investment Association Global sector average return of -0.49 per cent.
Valuation is also the reason why Mr Yiu recently sold LVMH Moet Hennessy Louis Vuitton (Fr:MC) and InterContinental Hotels (IHG) out of the fund. He thinks they are good businesses that will succeed in the long term. But he is concerned that in the short term there is too much uncertainty over how quickly people will start going on holiday again or spend a lot of money on nonessential items such as luxury goods. He and his team have built conservative earnings forecast models which suggest that these companies' earnings will fall short of the market consensus.
“I don’t think they will outperform the market and that could cost us relative performance," adds Mr Yiu.
Due to the amount of time that Mr Yiu and his team spend on building earnings forecasting models to spot undervalued companies, and researching potential investments, they invest in stocks with a view to holding them for a number of years. So Mr Yiu only expects to sell around five holdings a year and add a similar number of new investments. “We don’t want to make too many changes because it can be time consuming and expensive,” he explains.
The fund is also very concentrated, with only 25 holdings. These are typically large-cap equities listed in the US, where 74 per cent of the fund's assets were invested at the end of March. And relative to global indices such as MSCI World, the fund is very overweight technology companies, in which it had 62.3 per cent of its assets at the end of March. Other sector exposures include healthcare, consumer staples and consumer discretionary companies, which accounted for 12.3, 10.4 and 5.5 per cent of the fund's assets, respectively.
Mr Yiu does not consider some industry sectors such as banking because he thinks it is not transparent enough. And he does not invest in certain areas of digital transformation. For example, he would “never be interested” in Netflix (US:NFLX) because, although its top-line growth is strong, he does not see how the company will generate high returns over the long term. “In the video streaming world content is expensive to create or buy, and it is competing with likes of Amazon, Disney (US:DIS) and HBO, which are all spending a lot of money," he explains.
And he doesn't think that Zoom Video Communications (US:ZM), which has soared in popularity since the start of the coronavirus pandemic, is a high-quality business model as it could easily be replicated by the likes of Microsoft, Google (US:GOOGL) or WhatsApp.
Mr Yiu and his team are also currently avoiding cyclical companies such as those in the oil and gas, mining and chemicals sectors, on the grounds that the economic cycle is at a late stage. They don't invest the fund in pharmaceutical or biotechnology companies, meanwhile, because they don't think that they have sufficient expertise in this area and prefer to keep research in house. "Doing research yourself is very important if you want to do much better than your peer group,” explains Mr Yiu.
Stephen Yiu CV
Stephen Yiu is lead manger of LF Blue Whale Growth Fund and chief investment officer of Blue Whale Capital, which he co-founded with Peter Hargreaves in 2016. Before this he worked at Nevsky Capital, a global long-short equity hedge fund, and has also run funds at Artemis and New Star.
Mr Yiu started his career at Hargreaves Lansdown where he worked until 2007.
