Blue Whale Update: Three new pitfalls for investors in a post-Covid world

Stephen Yiu - Blue Whale Fund Manager Stephen Yiu is the Chief Investment Officer at Blue Whale Capital and Lead Manager of the Blue Whale Growth Fund.
Stephen co-founded Blue Whale Capital with Peter Hargreaves, co-founder of Hargreaves Lansdown, in 2016. The Blue Whale Growth Fund was launched in September 2017 and is a long-only global equity fund focusing on developed markets.
Stephen adopts a high conviction, active approach based on bottom-up, fundamental research.

Stephen shared his views in a short article below:

Blue Whale Growth Fund – Three new pitfalls for investors in a post-Covid world – beyond just “high leverage”

Around the world, many companies suffered heavy losses as the full effect of a global lockdown became apparent. Many are speculating that these companies, now at bargain basement prices, should recover to their pre-Covid levels and therefore represent extraordinary value for investors.

While this may be the case for some companies, at Blue Whale we do not think this is as prevalent as others would have you believe. In fact, we see many reasons why a lot of companies should be avoided as they are unlikely to deliver either growth or income for investors.

One commonly expressed view is that, provided an investor steers clear of highly indebted companies they should be alright. While we agree that these companies present risks that are best avoided at this time, we think it should go further than this. Below we outline three types of companies that we think are best left alone for the time being.

1.       Low Quality “Bargains”

Obvious examples of low-quality bargains are aplenty among cyclical companies with levered balance sheets and poor pricing power – the likes of miners and energy companies. These companies tend to perform poorly in any downturn, so are not directly tied to the specifics of this global pandemic.

However, a more insidious species of low-quality companies is those that we believe have “Old World” business models. We define these as companies that have failed to adapt to changing customer expectations and whose growth and profitability are structurally challenged – high street retailers and banks are key examples here. Often their branding can trap investors into thinking they are valuable companies, but they end up delivering, at best, stagnant returns over the long term.

In both cases (cyclical companies and structurally challenged “Old World” incumbents), Covid-19 was simply a catalyst to accelerate their inevitable decline.

2.       Post-Covid Quality Traps

These are companies which, prior to the outbreak, would have been considered as having high-quality business models, but have since been rocked by the new-normal of social distancing and government mandated lockdown.

Falling under this category, we include coffee chains, hotels and children’s themed holiday parks. These sectors are seeing longer term revenue growth coming into question with social distancing protocols reducing their ability to operate at full capacity. In addition, compliance with more stringent public health standards means that margins become squeezed for the foreseeable future. All of this signifies poor returns for investors – regardless of their perceived brand value.

3.       Bubble stocks

With the new-normal setting in, many of us have taken to video conferencing, increased streaming of entertainment and exercising from home. In return, a number of companies which cater specifically to these examples have seen their share prices rocket as they are perceived as beneficiaries of the post-Covid world.

While home exercise machines and streaming services have certainly had their moment in the sun during this pandemic, quite often their business models simply do not hold up to the great expectations heaped upon them, with little to no ability to turn a profit over and above cash needs.

In the three examples above of the types of businesses we are avoiding, we need to be clear on one thing – we’re not forecasting that they disappear into oblivion. We are simply sharing our view that we see little chance of outperformance from these types of businesses, where underperformance is the more likely outcome.

LF Blue Whale Growth Fund is manufactured by Blue Whale Capital LLP and represented in Malta by MeDirect Bank (Malta) plc.


Blue Whale Key Risks & Disclaimers: 

The opinions, data, and analyses presented herein is issued for information only by Blue Whale Capital LLP (“Blue Whale”) which is a limited liability partnership incorporated in England and Wales under number OC414255. Blue Whale is authorised and regulated by the Financial Conduct Authority (“FCA”).

The contents presented herein are based upon sources of information believed to be reliable, however, save to the extent required by applicable law or regulations, no guarantee, warranty or representation (express or implied) is given as to its accuracy or completeness and, Blue Whale, its members, officers and employees do not accept any liability or responsibility in respect of the information or any views expressed herein. All data is sourced from Blue Whale unless otherwise stated.

The contents herein may include or may refer to documents that include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements. The views we express on holdings do not constitute Investment Recommendations and must not be viewed as such.

There are significant risks associated with investment in the Fund referred to herein. Investment in the Fund is intended for investors who understand and can accept the risks associated with such an investment including potentially a substantial or complete loss of their investment.

Past performance is not a guide to future performance. The value of investments and any income derived from them can go down as well as up and the value of your investment may be volatile and be subject to sudden and substantial falls.

Investment in a Fund with exposure to emerging markets involves risk factors and special considerations which may not be typically associated with investing in more developed markets. Political or economic change and instability may be more likely to occur and have a greater effect on the economies and markets of emerging countries. Adverse government policies, taxation, restrictions on foreign investment and on currency convertibility and repatriation, currency fluctuations and other developments in the laws and regulations of emerging countries in which investment may be made, including expropriation, nationalisation or other confiscation could result in loss to the Fund.

Income from investments may fluctuate. Changes in rates of exchange may have an adverse effect on the value, price or income of investments. Fund charges may be applied in whole or part to capital, which may result in capital erosion. The Authorised Corporate Director may apply a dilution adjustment as detailed in the Prospectus. The Fund is not traded on an exchange or recognised market.

The foregoing list of risk factors is not complete, and reference should be made to the Fund’s Prospectus, KIID and application form.


MeDirect Disclaimers:

This information has been accurately reproduced, as received from Blue Whale Capital LLP. No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment and may be deducted from the invested amount therefore lowering the size of your investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

Exploring Mutual Funds – Understanding the Risks Involved

Ray Calleja

An article written by Ray Calleja: Head – Private Clients, MeDirect

In the previous article we discussed benchmarks to evaluate your fund’s returns. Comparing your fund’s performances with indices and with other funds, which track and invest in the same way as yours, respectively, will put such results into context.

In this article we will start discussing the risks involved when investing. The very act of investing always involves an element of risk. After all, you’re choosing to trust your money with a fund manager rather than putting it away in a relatively much safer savings account with your local bank.

Generally, the greater the return of an investment, the greater the risk—and therefore the greater potential for loss. Investors who take on a lot of risk expect a greater return from their investments, but they don’t always get it. Other investors are willing to give up the potential for large gains in return for a more probable return and not taking on too much risk.

Many big gains are won only through tremendous risk taking, which often means many ups and downs in short-term returns and that is called volatility. As an investor you have to consider a fund’s volatility in conjunction with the returns it produces.

There are a number of ways to measure how volatile a fund is. There are four main risk measurements that appear in mutual fund shareholder reports, in the financial media, and on Morningstar.com. These include standard deviation and beta, which we will discuss here today.

The following is an example of a Risk table which can be found in a Morningstar fund factsheet, which are accessible from the MeDirect website for each and every fund that we have available for trading on our online platform:

Article Image - Risks
In this article we will be discussing the Standard Deviation, Beta, R-squared and will also have a look the 3-Yr, 5-Yr and 10-Yr risks – collectively referred to as the Morningstar risk rating.

Standard deviation is probably the most commonly used measurement for a fund’s past volatility and it provides quick comparison among funds. It shows how much a fund’s returns have fluctuated during a particular time period. Our partners, Morningstar calculate standard deviations every month, based on a fund’s monthly returns for the preceding 3, 5 and 10-year periods. Standard deviation represents the degree to which a fund’s returns have varied from its 3, 5 or 10-year average annual return, known as the mean (or the average). Theoretically and for most funds, a fund’s returns have historically fallen within one standard deviation of its mean 68% of the time and within two standard deviations 95% of the time.

Let’s take an example, where you have a fund, which has a standard deviation of 4 and an average return of 10% per year. Most of the time (or, more precisely, 68% of the time), we can expect the fund’s future returns to range between 6% and 14%. Almost all of the time (95% of the time), its returns will fall between 2% and 18%, or within two standard deviations of its mean.

As investors we are interested in the likelihood of loss in the future. Variance (from the mean) and standard deviation give you a picture about past volatility of a fund. You therefore need to examine the circumstances whether the future will be like the past. It is not uncommon that a measure of volatility calculated two or three years ago puts a fund in the low-risk category but one calculated last month can put it into the high-risk category or vice-versa.

Another relative risk measurement is Beta which provides insight into a fund’s volatility against a benchmark.

Beta measures the extent to which a fund has, historically, gone up when the market as a whole rose, and gone down when the market went down. It is a fund’s sensitivity to the market movements.

The beta for the overall market is taken to be 1.00. So, if, for example, the mutual fund beta is 1.2, this indicates that the fund has performed 20% better than its benchmark index in up markets and 20% below the index in down markets.

For example, if a fund’s benchmark index is the S&P 500 and the index has a return of 10% this year, the investor would expect the fund with a beta of 1.2 to have a return of 12%. Conversely, if the S&P 500 index fell 10% during the given year, the fund with a beta of 1.2 would be expected to fall 12% during that year.

You could have a beta, which is less than 1.0, which means that the fund is less volatile than the index. So, if you have a fund with a beta of 0.9, it should return 9% when the market goes up 10%, but it should lose only 9% when the market drops 10%.

The danger of relying on beta for future-orientated investment decisions is that you have to assume that the relationship with market returns will continue, which may not always be the case.

Conservative investors who wish to preserve capital would do well to focus on funds with betas lower than 1, while investors willing to take on more risk in search of higher returns are likely to look for high beta investments.

Another measuring tool for mutual funds is called R-squared.

R-squared is a statistical measure used for investment analysis and research that investors can use to determine a particular investment’s correlation with a given benchmark. It is shown in Morningstar reports for any fund that has more than three years of history.

In other words, the benchmark is an index, such as the S&P 500, that is given a value of 100. A particular fund’s R-squared can be considered a comparison that reveals how similarly the fund performs to the index. If, for example, the fund’s R-squared is 95, it means that movements in the index explain 95% of the fund’s movements (ups and downs in performance).

A low R-squared rating means the less reliable beta is as a measure of the fund’s volatility. The closer to 100 the R-squared is, the more meaningful the beta is. Unless a fund’s R-squared against the index is 75 or higher, beta is to be disregarded.

Morningstar-only measurements

Finally, we will look at Morningstar-only measurements to get more information of a fund’s risk. These tools help the investor get a much better picture of how a mutual fund should behave. These are all available in the Morningstar report, which are accessible from the MeDirect website for each and every fund that we have available for trading on our online platform.

Standard deviation and beta alone do not tell you whether the fund’s swings were gains or losses. As an investor you would want to know how successful a fund manager has been at generating good returns, but also how good he/she has been at protecting you and the other shareholders from losses.

This is where the Morningstar risk rating comes in. It looks at all variations in a fund’s returns (just like Standard Deviation) but also emphasises a fund’s losses relative to its category

Morningstar’s risk rating looks at funds’ performance over a variety of time periods. Funds with less than three years history are not rated because of insufficient data to be able to draw an adequate assessment.

Interestingly, Morningstar will base their risk rating of a fund 50% on its 10-year record while the 5-year and 3-year periods count for another 30% and 20% respectively. This applies for all funds which are 10 years old or more. For funds which are 5 years old or more, but less than 10 years, 60% of its risk rating is based on the past 5 years and 40% on the past 3 years. For funds which are 3 years old or more, but less than 5 years, its risk rating is based entirely on its 3-year performance.

Risk scores are assigned on a monthly basis. A fund’s risk is measured relative to other funds in the same category and so it is easy to compare funds that invest in a similar way.

In the risk rating process, 10% of a category’s funds with the lowest measured risk are rated as low risk. The next 22.5% are rated below average, the middle 35% are average, the next 22.5% above average, while the top 10% are rated as high risk. Morningstar measures risk for as many as three periods (three, five, and 10 years). These separate measures are then weighted and averaged to produce an overall measure for the fund. Funds with less than three years of performance history are not rated.

In the next article we will continue to explore more tools to measure returns after adjusting for risk through alpha and the Sharpe ratio as well as looking in detail at the Morningstar star and analyst ratings of funds.


The above is for informative purposes only and should not be construed as an offer to sell or solicitation of an offer to subscribe for or purchase any investment. The information provided is subject to change without notice and does not constitute investment advice. MeDirect Bank (Malta) plc has based this document on information obtained from sources it believes to be reliable but which have not been independently verified and therefore does not provide any guarantees, representations or warranties.

MeDirect Bank (Malta) plc, company registration number C34125, is licensed by the Malta Financial Services Authority under the Banking Act (Cap. 371) and the Investment Services Act (Cap. 370).

The financial instruments discussed may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in any of the products discussed you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment and may be deducted from the invested amount therefore lowering the size of your investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

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