FE fundinfo Alpha Manager Stephen Yiu has added a new top-10 position in Nintendo to his £686m Blue Whale Growth fund, in keeping with a long-running interest in the video game sector.
The global equity strategy’s concentrated approach means any new top-10 position in its 30-stock portfolio can often make a meaningful impact on the fund. The top-10 companies account for more than half (56.6 per cent) of its total portfolio.
The latest addition to the fund is Nintendo, the Japanese multi-national consumer electronics and video game company that owns gaming names that include Mario, Zelda and Pokémon. It replaced PayPal in the top-10.
“The company has been able to update its games franchises to stay with the zeitgeist over the last four decades and has been relentlessly adding to its roster of best-loved games over time,” Yiu said.
“Nintendo is an innovative company and we believe the Nintendo Switch represents a game-changing (pardon the pun) way of keeping fans engaged and updated beyond the traditional console cycle.”
He added that the video game sector is an area the team covers very closely. When the fund first launched three-and-a-half years ago, it had positions in Electronic Arts and Activision Blizzard. Indeed Microsoft, one of the fund’s largest holdings, derives 10 to 15 per cent of its business from Xbox Live and its gaming division.
Yiu explained his reasoning for the new position: “There’s two transitions going on within Nintendo that could put the business model in much more competitive position over the medium term, compared to historically.”
He drew a comparison to where Apple was five to six years ago when there were concerns that the growth of new iPhone sales was going to stagnate.
The company eventually beat expectations and continued to deliver growth via new iterations of the iPhone with various models, screen sizes and faster processors. Yiu believes Nintendo is at the same stage where Apple was five to six years ago.
Nintendo has been a video game staple for many decades with iconic devices such as the Nintendo 64 to more recently the Nintendo Wii. The company’s latest device is the Nintendo Switch, which released in 2017.
Yiu has taken the view that the Nintendo Switch is going to be the company’s standard device for years to come – much like the iPhone was Apple’s standard device for years.
“Whatever comes in the next five to 10 years is going to be iteration of the Switch,” he said.
“If that's the case, then it means that they would be able to capture a lot of the economics in the model that they have now, which is switch, rather than let's say three years from today if they launch another device.”
Share price of Nintendo over the 1 year
Source: Google Finance
Yiu continued: “If you take the view that they can repeat the success of iPhone in the Switch, that changes the business model completely.”
Indeed, Samsung has recently announced a partnership with Nintendo to release a new Switch with a larger screen, which Yiu believes underscores what he believes what is going to happen with Nintendo.
“The second transition that they're making, which is not new and not unique to them, is the digital download of the games,” he said.
The Japanese company is rather late to the digital transition when compared to the likes of EA and Activision, which made the transition about five years ago.
“Now the share of digital downloads for EA and Activision make up about two-thirds of the sales of the games,” Yiu said. “If you look at Nintendo, less than a third of their sales are from digital downloads.”
He believes their transition to digital downloads is still at its early innings and has much more room to continue.
“The beauty of that transition is they will make higher margins and they will be able to engage with the customer rather than through a third-party distributor,” he explained.
“Put those two together: the Switch being the perpetual iPhone equivalent, plus the digital transition that they're making, it will give them higher margins.
“Yet if you look at the valuation of the company it is trading at what I would suggest is quite similar to what Apple was trading at about five, six years ago.”
Yiu asserted the stock is not pricing in the two changes happening at the company: “If you believe that it's going to be another console cycle, they're going to make a lot of money with the Switch in a few years’ time.”
Blue Whale Growth has seen a lot of activity with several stocks moving in and out of the top-10 holdings over the past year.
“I think the market sometimes is overly concerned about whether there's too much turnover in the fund,” Yiu said.
“I think it is quite misunderstood because if the market gives you opportunity, then you should want to capture it as much as you can.
“And if the valuation become less attractive, or overly priced for what it is, or it has a lot more macro uncertainties, then you might want to avoid it.”
Amazon was a top 10 position in the fund during the second quarter of last year, but after it rallied more than 100 per cent Yiu started to build a position in luxury fashion brand Moncler.
He asked: “What do we do? Do we just sit back and do nothing with Amazon?
“We were looking at Moncler, it was much more attractively valued with less uncertainty, so we switched some of our investment in Amazon into Moncler.”
Since late summer of 2020, shares in Amazon have traded sideways and shares in Moncler have rallied almost 50 per cent.
“We want to keep the keep the portfolio at all times quite competitively positioned for the next 12 to 18 months, and we try to do as much as we can,” Yiu finished.
Coincidently, the popular £22bn Fundsmith Equity fund also took the chance to invest in a luxury goods company sometime in late 2020.
Manager Terry Smith, who prides himself in having a low turnover within the fund, revealed earlier this year he took a position in Moët Hennessy Louis Vuitton, otherwise known as LVMH.
Performance of fund versus sector & benchmark since launch
Source: FE Analytics
Since launch, Blue Whale Growth has a delivered a total return of 70.89 per cent compared to 37.77 per cent from the average fund in the IA Global sector and 39.69 per cent from the MSCI World index. It has an ongoing charges figure (OCF) of 0.89 per cent.