Blue Whale’s Yiu: ‘Ban diversified portfolios’

For Blue Whale Capital’s lead fund manager and chief investment officer Stephen Yiu, the ambition is as large as the namesake mammal.

I join Stephen Yiu in a cramped meeting room surrounded by glass walls that look out into the office space where four analysts are busy typing away, staring intently at the Bloomberg terminals illuminated on their screens.

Yiu sits across from me, and beside him is a giant portfolio with charts and performance data spilling out of it. Behind him is a wall papered with watercolour whales and jellyfish.

Though Yiu’s domain is humble in appearance, this little boutique has something that not many do – the backing of one of Britain’s richest moguls, Hargreaves Lansdown co-founder Peter Hargreaves. The billionaire agreed to help get Yiu’s business off its feet, investing £25m in the venture to start.

Billionaire backing

Blue Whale Capital officially opened its doors nine months ago, launching its flagship global growth fund, which has now grown to £50m.

Yiu and Hargreaves say they had been discussing going into business together for years. The two met when Yiu landed his first job as an analyst at Hargreaves Lansdown in 2002 and stayed in contact as he took on roles at New Star (now Janus Henderson), Artemis and, most recently, hedge fund Nevsky Capital.

Asked why he decided to back his former employee, Hargreaves says he was keen to find a new home for the family money and trusted the bright and meticulous Yiu to run it for him.

“I’ve known him for 20 years. He’s very thorough and professional, and has huge amounts of experience in this field,” he says in a separate phone interview days later.

Now Hargreaves says he’s thinking of putting a lot more money in. The exact amount he’ll decide in due course.

“I’d rather trust my money here more than anywhere else, not because I have a stake in the business but because these guys are really connected and passionate about what they do,” he says.

Yiu is not your typical fund manager. For one thing he’s much younger than most lead managers you’ll meet in and around the City. The average age on the team is 35; Yiu himself will be 40 this year.

“We are probably the youngest contender in this massively competitive world,” admits Yiu. “We’re competing with all these giants who are better resourced than us, but the one thing they probably don’t have is our energy or competitiveness.”

The significance of the moniker ‘Blue Whale’, which Yiu registered over five years ago, is a testament to this drive and ambition.

“The blue whale is the largest animal known to have ever existed and we want the outperformance of Blue Whale’s funds to become as significant.”

Focused selection

Yiu runs a highly concentrated portfolio of 25-35 stocks. His top 10 holdings, including Paypal, Facebook and Unilever, make up 57% of the Blue Whale Growth Fund.

Having more than 35 stocks in the fund would water down the performance, in Yiu’s view. Both he and his 77-year-old co-founder believe fund managers are typically over-diversified and more concerned with asset gathering than outperformance.

The duo says many active funds in the market are really quasi-trackers and, like these types of passive products, will never underperform or outperform massively.

“One thing we do quite differently, which we want to demonstrate to the industry, is that running a highly concentrated portfolio is the best set-up to generate outperformance,” Yiu explains.

“If we do well we will outperform massively and deliver the outperformance to our investor for the fees they pay us. If we don’t do well, we will be out of business quite quickly because we will be underperforming.”

If he were the chairman of the Investment Association, Yiu says he would ban people from running diversified portfolios.

“Everyone would just need to pick 25 stocks and come up with a fund. Within the first year, I bet, one-third of the fund managers will underperform the market massively. They’re probably down, relative to the market, by 15-20%. Then after two or three years, at least two-thirds of the funds will underperform massively.”

Yiu asks me why investors, not least of all someone as formidable as Hargreaves, would put money in Blue Whale Growth if it was just in line with the market. Similarly, he believes there is no reason why an investor would stick with him other than for a competitive return.

“Performance is the ultimate judge,” he says. “Our performance of alpha is all we focus on internally, that’s how we measure ourselves. If we do not manage to generate enough alpha relative to our peers on a similar scale, there is no need for the existence of Blue Whale. Otherwise, why would you need our global fund when there’s already 220- odd funds out there?”

Making trades

Despite Yiu’s view that the industry is full of asset gatherers, he says his fund can hold a very large level of AUM due to the plethora of large liquid stocks that meet his investment criteria.

“We don’t believe that the fund has any capacity constraints,” Hargreaves insists. “If someone gave us a billion pounds tomorrow, we feel we can invest it in the fund we’re in.”

Yiu says he would be “very comfortable” with up to £5bn in the fund.

Still, isn’t that degree of concentration kind of risky, I ask Hargreaves. He concedes that it is but adds that most investors will buy Yiu’s fund as part of a portfolio, which will “counterbalance any risk”.

“To me, the risk of having a less-than-average return is a bigger risk than having a concentrated portfolio,” he says.

Yiu believes his fund is in the mould of global funds run by two industry giants – Nick Train and Terry Smith. However, one crucial difference between Yiu and many of his contemporaries is that he is not big on buy-and-hold. This approach, which he describes as “very active”, is one of Blue Whale’s unique selling points, he says.

Yiu’s fund is only nine months old and yet already he admits he has done “quite a bit of trading” because of the different set of macro conditions in 2017 versus 2018.

Blue Whale Growth charges retail investors 1.17%, which is higher than FundSmith Equity’s ongoing charges figure of 1.05% and Lindsell Train Global Equity’s 0.75%. But both Train’s and Smith’s funds have relatively low transaction costs due to their long-term buy-and-hold styles. Fundsmith Equity racked up transaction costs of 0.05% in 2017, while the Lindsell Train Global Equity Fund disclosed extra charges of just 0.01%, though many were sceptical of how low these figures were.

Yiu declines to provide further statistics on turnover, which he feels are not particularly meaningful at this stage.

“What we can say is that for the top 10, once we bought an initial position then the stock has always remained in the portfolio,” he comments. “We anticipate the level of trading to be relatively low in a market with more normal levels of volatility.”

Hargreaves denies Yiu is anti buy-and-hold for the sake of it or that he has a highly active approach.

I ask him if investors might feel uneasy about the prospect of potentially higher transaction costs. “The stocks we hold in Blue Whale are not expensive to deal in; the bid and offer spread is quite low.

“Would you rather stay in a company that has achieved more or less what it set out to achieve or would you prefer to pay 0.5% of the value of that share to get something with considerably more potential?”

Knowledge pays

One of Yiu and Hargreaves’ big goals in setting up Blue Whale Capital was increasing transparency around the investment process and enhancing investor education.

Yiu has published several pieces of research from the Blue Whale team to the website thus far and plans to make more reports publicly available.

The reports are not meant to serve as stock recommendations and are not laden with industry jargon about share price or EPS targets. Instead, Blue Whale’s research highlights information on the business model, the competitive landscape and barriers to entry, etc.

“A lot of fund managers usually start off with valuations,” says Yiu. “They say, ‘I want that company because it’s cheaper.’ I think that’s the wrong starting point; you should start with the business. ‘Is it a good company? Is the business model right?’”

By making research publicly available, Yiu hopes he will arm DIY investors with a standard template so they can perform their own company analysis.

Right now, 69.3% of the Blue Whale Growth Fund is invested in US stocks. According to Hargreaves, this is unusual for a global fund. “I’ve always felt almost every UK investor has been considerably underweight US,” he says.

“There is a tremendous culture of entrepreneurship in America, more than in any other country in the world, but you’ve got to be selective.”

The remainder of the portfolio is in the UK (19.4%) and Europe (4.8%).

Hargreaves has been very vocal about his pro-Brexit stance ahead of and post-EU referendum. He donated more than £3m to the Leave campaign. But Yiu says politics play no part of his investment process.

“We never invest in a stock due to a macro view. We focus on fundamentals and if a company meets our investment criteria. Before and after the Brexit vote, there were few UK-listed domestically focused businesses that met our criteria and so we don’t spend much time analysing the UK economy.”

Fund selector view: Darius McDermott, managing director, Chelsea Financial Services

“The Blue Whale Growth Fund has thrived since its launch in September last year, having more than doubled its average peer in the IA Global sector with a total return of 18.62% in sterling terms, according to FE.

“It has a concentrated, benchmark-agnostic portfolio of about 25 holdings and hunts for high-quality growth companies: a style not too dissimilar to that of Lindsell Train Global Equity and Fundsmith Equity.

“What sets it apart, however, is its bias towards technology companies. It has a 42% allocation to the sector and has sizeable positions in the likes of Adobe Systems, Microsoft, Facebook, Alphabet and Paypal.

“As the fund is rather stylistic I fear it will struggle if tech firms fall out of favour. The sector has been doing well and so the fund has outperformed but, in times of difficulty, a lot of its stocks are susceptible to falling at once, meaning it could have a steep drawdown.

“For long-term investors with a stronger stomach for risk, this could present  good option as part of a diversified portfolio.”

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