|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 2020 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.
A unique inflationary environment
As the world emerged from lockdown earlier this year, people started to enjoy themselves again leading to global demand increasing rapidly. By itself, a rise in demand normally would lead to price increases – this is known as “demand-pull” inflation. However, where this inflationary environment is different is the exacerbating circumstance of drastically limited supply. Whilst the global economy ground to a halt in 2020, governments (through the furlough scheme) and some companies, continued to pay their workforce not to be at work – people were still getting paid whilst the global economy was producing far less. Consequently, what we have seen is a surge in demand with supply drastically depleted.
In simple economic terms, raising the demand curve and lowering the supply curve drives prices higher, leading to inflation.
What can investors do about inflation?
At the moment, both cash and bonds offer an interest rate far below that of inflation. Bonds have the added problem of leaving the owner at the mercy of the market when they come to sell – in a rising interest rate environment, they may get back less should they not hold the bond to maturity. Precious metals had more relevance as a hedge against inflation when global central banks were devaluing currencies with their quantitative easing strategies. Property is also an area of interest, however the costs of upkeep rise significantly with inflation, as anyone who has attempted home renovations in the last 18 months will attest to.
It will not surprise you to hear it is our belief that equities offer the greatest protection against inflation. But not all equity investments are created equal. There is a particular combination of attributes we look for in a company that we believe gives the greatest protection from inflation and can even benefit the company.
Companies with superior pricing power are great to hold during inflationary periods. This means they can raise their prices in line with (or even beyond) inflation, without losing too many customers in the process.
Our favourite example is Microsoft. Earlier this year Microsoft announced they will be raising the price of their key office products by 15-20%. I imagine many of you will be reading this on your Microsoft Windows operating system, you may have received the email notifying you of this article through Microsoft Outlook, and I drafted this article in Microsoft Word. All these products are key both in your everyday and working life. If the price of Microsoft’s services goes up, you are likely to pay it.
But pricing power is only part of the story. When choosing our investee companies for the Blue Whale Growth Fund, we also pay close attention to gross margin.
We specifically look for companies with a high gross margin – this means that the uncontrollable external costs of running the business is comparatively low when compared to the revenue.
As an example, the Blue Whale Growth Fund has a weighted average gross margin across its investee companies of c.70%. This means that, of the companies’ total revenue, there are external costs associated with running the business of 30%. With external costs increasing due to inflation, this high gross margin is favourable over, for example, UK Blue Chip companies, which have a gross margin of c.30%, i.e. UK Blue Chips are paying the external costs of inflation on roughly 70% of their total revenues.
In short, inflation has a higher impact on businesses with a lower gross margin.
Why not have both?
It is our opinion that the “Holy Grail” of inflation-busting companies is a company that can combine a high gross margin with superior pricing power – a “double whammy” that means they are less affected by rising costs, whilst also being able to increase their prices to outpace inflation. What an investor wants to avoid, are those companies that have a low gross margin, with little or no pricing power.
At Blue Whale, our focus is on beautiful companies – companies that combine both key attributes. It is these companies that should benefit in an inflationary environment. We therefore believe inflation should be seen not as a headwind to investment performance, but potentially as a boon to the performance of those companies that can prove their mettle during inflationary times.
There is one more thing to consider – the merits of investing in great companies stand up even outside of an inflationary environment. Should this inflationary period prove to be transitory, as an investor in the Blue Whale Growth Fund you will still hold a portfolio of what we believe to be the most beautiful companies in the world. We hope this portfolio will outperform the wider market regardless of the macro-economic environment.
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 Blue Whale Growth Fund was launched in September 2020. All references to actions before this date relate to the LF Blue Whale Growth Fund. Information on the LF Blue Whale Growth Fund is provided for comparison purposes only; it is a UK UCITS which is not registered for sale in nor is it promoted to investors in the EEA. Whilst the investment objectives and charges are not identical, both funds are run on the same investment process.
Please note that the information provided in this article is not to be construed as advice and any views we express on holdings 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.Blue Whale Capital LLP is authorised and regulated by the UK Financial Conduct Authority.
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.
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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.
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