The first half of 2022 saw inflation fears of late 2021 come to a head. Accordingly, global equity markets saw increased volatility, with a mark down across the board. Traditional value stocks, which had fared well in 2021, also saw their share prices coming off, with a few exceptions, largely in the oil and gas sector.
An area that was particularly hit was the tech sector, in which Blue Whale has a significant portion of the Fund invested. While lower quality businesses thrived under pandemic conditions (Peloton, Deliveroo for example), inflated share prices not backed by company fundamentals saw investors flee as the world emerged from lockdowns. However, investor nerves led not only to lower quality businesses seeing a price downgrade, but also contagion spreading to higher quality tech stocks as an indiscriminate sell-off materialised.
In the first half, the Fund fell 30.3% (based on the I Accumulation Sterling class unit as at 30.06.2022) compared to the IA Global Average which fell 14.1%. This underperformance over the period was largely due to the higher technology exposure in the portfolio versus the Global sector as a whole.
Two of the larger individual detractors to performance fall into this sector – Nvidia (maker of high-capability processors) and Atlassian (collaborative working tools). The share price decline of these two companies can be attributed to a valuation reset based on higher interest rates – with no material adverse news or change to company fundamentals we remain confident in our investment thesis. The other main detractor was Sartorius (biomedicine). Again, the investment thesis remains intact, and we view the share price decline primarily as a symptom of macro-economic malaise.
Leading contributors to fund performance were Nintendo (video games) and Mastercard and Visa (payment networks and systems). With the release of a raft of new games and sales of the popular Switch console continuing apace, the Nintendo share price recovered some lost ground in the first few months of the year. Mastercard and Visa, whilst decidedly volatile during H1 2022, benefitted from the return of cross-border travel. The two payment titans also offer what we believe to be the purest available inflation hedge as they continue to take their percentage on the inflated price of goods and services bought using their ubiquitous payments systems.
New additions to the portfolio were North American railroad operators Canadian National Railway and Union Pacific. With high margins and strong cash generation and a secular move towards repatriating supply chains, these companies offer a defensive play given the uncertainty of inflation and the spectre of recession. In addition, they offer an interesting ESG angle given the sustainability and efficiency of utilising railroad transport over that of truck haulage and air delivery.
Key disposals were PayPal and Meta (Facebook). In the case of PayPal, concerns over company strategy relating to acquisitions and increased competition in the sector encouraged us to sell our position. Meta, having changed its name from Facebook, showed their hand when it came to investment in the metaverse, subsequently leading to concerns over a deterioration in its business quality due to an apparent significant investment in this area. Following the disposal of Amazon at the end of 2021, the only FAANG still standing in the portfolio is a small holding in Alphabet (Google).
Looking forward, whilst the first half of the year has been characterised by inflation and interest rate risk, we anticipate that the inflation narrative will taper off whilst we head towards greater recession risk. As the cost of capital is likely to remain high, the Blue Whale portfolio of companies maintains a net-cash balance sheet, with high gross margins and strong pricing power. The relative valuation of high-quality tech businesses in the portfolio is attractive when compared to those sectors which have done comparatively well in the first half – sectors such as consumer staples which now trade at a significant premium to the market. We therefore hope to see a return to outperformance on a relative basis at least in the coming months.
Please note that the information provided in this article is not to be construed as advice and any views we express on holdings or other assets 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.
