Blue Whale’s Stephen Yiu is well-known for his love of quality tech companies. While LF Blue Whale Growth is not a tech fund as such, the sector accounts for 62.8% of his portfolio, with the manager a fan of its low input costs. When combined with pricing power, these allow companies in the sector to maintain high margins.
Yet while tech showcases the cutting edge of human ingenuity, allowing it to quickly overpower legacy business models across a swathe of industries, Yiu’s head has been turned by a sector that was itself disrupted more than 100 years ago – rail. The manager added North American operators Canadian National Railway and Union Pacific to his portfolio this year.
“We like monopolies,” he explained. “With high margins and strong cash generation, these companies offer a defensive play given the spectre of recession.”
Putting aside what a business does today, Yiu’s definition of a quality company also includes the ability to “derive significant profitability in an industry benefiting from a global secular trend”.
Rail may not be the first thing that comes to mind when you think of a growth industry – especially compared with former tech holdings Meta and PayPal, which he recently ditched – but Yiu claimed it is set to benefit from a powerful medium-term tailwind that has surged in importance this year.
“The big thesis we have is that deglobalisation and reshoring is part of the New World Order, and I can't see anything that will change the trajectory of that,” he said.
“Of course, we could go back to the good old days where every country is a friend of one another. But I don't think it will be like that anytime soon – certainly not for the next five to 10 years.
He added: “Something that comes out of that is that countries want to be self-sufficient in terms of what they produce and manufacture. They don't want to be overly dependent on other places. And the US railroads would be the connectors to facilitate that.”
Yiu claimed that rail could also be a beneficiary of rising inflation. Consumer spending currently makes up about two-thirds of GDP, but the manager said this could fall as disposable incomes are squeezed – with industrial activity picking up the slack.
“The government is funding a lot of this development,” he explained. “This New World Order is all about infrastructure spending, such as building facilities and giving companies tax breaks.”
One example of this is the Chips Act, which would provide about $50bn in subsidies to strengthen the US semiconductor industry and reduce dependence on manufacturers overseas. The bill has just advanced through the Senate, but has yet to pass through the House of Representatives.
Yiu’s quality-growth style has led him away from commodities, which is one of the reasons why he has underperformed the market this year – his fund is down by 26.9%, compared with losses of 6.8% from the MSCI World index and 10.8% from its IA Global sector.
Performance of fund vs sector and index in 2022
Source: FE Analytics
However, the manager said that rail is one area of his portfolio that could benefit if the oil price remains high.
“With high oil prices, the railroads would give you another option as they’re a lot cheaper if you don't need the goods straightaway,” he added.
“And the rail operators can directly pass on energy costs. They might get affected for one quarter, but they can pass higher prices on with a few months’ lag.
“In addition, they offer an interesting [environmental, social and governance] ESG angle given the sustainability and efficiency of utilising railroad transport over that of truck haulage and air delivery.”
The sector currently represents a small position in Yiu’s portfolio, with both Canadian National Railway and Union Pacific outside his top-10, as he said it may take five to 10 years for the deglobalisation theme to fully play out.
“But when they get bigger, we can say we’re not just tech,” he finished.
Yiu’s move into railway operators probably shouldn’t have come as too much of a surprise, given his quality-growth strategy. The pioneer of this approach, Berkshire Hathaway chairman Warren Buffett, referred to Burlington North Santa Fe Railway as “the number one artery of American commerce”, making it an “indispensable asset for America as well as for Berkshire”.
“I’ll venture a rare prediction: Burlington North Santa Fe Railway will be a key asset for Berkshire and our country a century from now,” he said in his annual letter to shareholders earlier this year.