Investment Outlook

Investment Outlook third quarter 2019



World economy

The market rally that started in January this year came to an abrupt end on May 6, after the US president announced that the import duties on USD 300 billion worth of Chinese goods would be raised to 25%. This announcement was in stark contrast with positive signals emerging earlier regarding US-China trade talks. In response, China introduced import duties on mainly agricultural goods from the US. The US went on to blacklist Huawei, an important Chinese telecom company. New negotiations were  announced at the G20 summit in Japan last June, but it remains to be seen whether both countries can reach an agreement. In addition, political developments in the United Kingdom appear to be heading towards a "hard Brexit" on 31 October 2019, the current deadline. The Conservatives are in the midst of choosing a new Prime Minister who can continue negotiations with the EU. The financial markets are expected to remain sensitive in the coming months to both of the aforementioned negotiations. However, financial markets at the moment seem to be even more focused on monetary policy. Whereas last year two interest rate hikes were expected in the US for 2019, the market now expects at least two interest rate cuts. The US 10-year interest rate has fallen from 3.23% in November to 2.01% today. In Europe, the ECB has also hinted at a longer-term hawkish monetary policy. In the same period, the interest rate in Germany fell from 0.45% to -0.33%. Inflation expectations have also been adjusted downwards. This has led us to revise our asset allocation to the interest-sensitive real estate and financial sectors. As macro statistics are still predominantly positive and consensus expectations for economic growth in 2019 and 2020 remain around 3.3%, it remains to be seen whether central bankers will consider increasing expansionary monetary policy necessary.

Persistently low interest rates support strong valuations for growth companies. Especially within technology, many listed companies are expected to continue making significant losses for the next several years and/or are highly dependent on future growth for their market valuation. Companies such as Uber, Pinterest and Slack come to mind. These companies will most likely need many more years of investment to grow. The existence of such companies has a direct impact on the rest of the economy. In long-term loss-making companies, the shareholder subsidizes the consumer. This reduces pricing pressure in the economy as a whole and makes more traditional companies reluctant to invest. Although we are not invested in these companies, we are keeping a close eye on developments for this reason.

Bonds and cash - The average maturity of fixed income was slightly increased during the quarter, partly to correct for the passing of time and partly due to reduced interest rate expectations. Despite the expectation of a low interest rate for longer, we remain cautious about taking interest rate risk as real interest rates are still significantly negative. Due to the flat or inverse interest rate curve, holding longer-term bonds is furthermore not rewarded. For this reason, we are underweight interest rate sensitivity. Due to the low interest rate risk reimbursement, the high allocation to cash is maintained.

Equities - The neutral allocation to equities remains more or less unchanged. Despite the +17.5% movement in the MSCI World index this year, equities, especially compared to bonds, are still an attractive investment category in which we expect a good return over the medium-long term. The portfolio has been adjusted by reducing allocation to cyclically sensitive companies with a relatively large debt-load. Examples are the sale of Siemens Gamesa, the second largest producer of wind turbines and Fanuc, a manufacturer of factory robots that are mainly used in the production of smartphones and cars. Liberty Media Formula 1 was sold, due to limited management progression, stock price appreciation and the very high debt burden. We also took profit on part of the position in ASML. Although ASML remains a unique company in which we are keen to remain invested, the demand for semiconductors seems to have been declining since the end of 2018. Nintendo and Hyatt have been added to the portfolio. Nintendo has a strong balance sheet with no debt, and is discussed in detail on the next page. Hyatt is a leader in the hospitality industry. This is a cyclically sensitive sector, but we think that the current valuation more than compensates us for that risk.

In earlier Investment Outlooks, we mentioned the disconnection between growth and value stocks, where growth stocks trade at hard-to-explain high valuations and value stocks are notably cheap. This observation remains up to date.

Listed private equity - Private Equity investors have abundant opportunities to add value in an environment of low interest rates and economic growth. The overweight allocation to this asset class is maintained.

Real estate - Real estate remains vulnerable to potential interest rate normalization, but together with infrastructure and listed private equity, this investment category may benefit most from lower interest rates for longer. For this reason, Capitaland Commercial Trust, a so-called SREIT with investments in office buildings in the Central Business District of Singapore, was added to the portfolio in the second quarter. Our positions in Unibail Rodamco Westfield and Brookfield Asset Management have also been increased.

Precious metals – The position in gold remains an insurance, in particular against the continuing geopolitical risks and a possible recession. Historically, gold performs well in an environment of lower real rates, i.e. low interest rates and higher inflation.


Because Japan is the third largest economy of the world and home to many leading and innovative multinationals, we are keen to invest in Japanese equities. At the same time, it can be difficult to find Japanese companies that meet our selection criteria. With our recent purchase of Nintendo, known for games such as Mario, Pokémon and Zelda, we believe we have added a Japanese company to our portfolio that meets our quality requirements.

The business model of Nintendo is as follows: Nintendo tries to sell as many gaming consoles as possible by selling them with a minimal margin. After a consumer has paid around EUR 300 for a console, Nintendo sells games for around EUR 60 per title. If Nintendo developed that game themselves, the company earns EUR 60 minus the store's fees. If an independent developer developed the game, Nintendo earns approximately EUR 10 in royalties.

Historically, Nintendo has been a volatile company. The life cycle of a successful console only lasted for a few years each time around, after which Nintendo had to develop a new hit console and rebuild the user base from scratch. The Nintendo Wii for example was sold between 2006 and 2013, and it wasn't until 2018 that their latest gaming console, the Nintendo Switch, came to the market.

In June 2018, Mr. Furukawa was appointed the new President of Nintendo. Under the new management, we see five reasons to be positive about the Nintendo’s business:

Digitization of the sale of games. Unlike the competitors PlayStation (Sony) and Xbox (Microsoft), most Nintendo games are still stored on a physical medium and sold in store. As Nintendo recently added the possibility to buy and download a game online, Nintendo can now keep the 30% that normally goes to the retailer. Together with the cost savings of not making and distributing physical discs, this adds up to circa 20 euros extra income per game. In addition, Nintendo launched Switch Online in December 2018. This is a subscription-service to play online with friends for $ 20 a year. Although Nintendo had only eight million members after four months, we see no reason why this cannot grow to the 59 million members that Xbox has or the 90 million members of PlayStation.

China. Until recently, sale of gaming consoles was not allowed in China. As a result, only a few consoles were sold on the black market and the majority of the Chinese instead play games on their PC or smartphone. In April 2019, the "Guangdong tourism and culture agency" approved the Nintendo Switch for sale. This is only a first step, and must be followed by approval from the central government plus the ratification of individual games. Nevertheless, with $ 30.8 billion a year, China is the largest market for computer games and the market has great potential.

Smartphones. In 2016, Pokémon Go was the most popular smartphone game worldwide for several months. However, after that huge hit, the company was slow to release new smartphone games. Current management has indicated that 2-3 games per year will be released. We think it is likely that a game like Mario Kart Tour, due for release this summer, has a lot of potential. Nintendo, unlike its competitors, in the past has been reluctant to charge money for "in-game purchases". Competitors were frequently criticized for these in-game charges. After observing this trend for a few years, Nintendo expects to be able to earn more from their games without damaging their reputation.

Other earning methods. Since the new management was appointed, plans have been made to build Mario attractions in Universal Studio theme parks. Nintendo is also working on movies with Nintendo lead characters and recently announced that they will open a flagship store in Tokyo. This seems to be indicative of the attention paid by the current management to Nintendo’s intellectual property (IP), and the monetization of this IP. Like Disney, Nintendo has a lot of IP to utilize, including Super Mario, Zelda and Pokémon.

An end to the hit-based Nintendo business model. The Nintendo Switch has a strong network effect. Because many people buy the game console, many developers are eager to make games for the Switch, in turn making the console even more attractive to buy. We think that gaming computers, just like smartphones, have reached a phase in which the graphic progress is minimal. For this reason, the Switch can be simply followed by a Switch 2.0, which can build on the same network of players and developers as the current Switch. The Switch Pro and the Switch Mini will be available in stores later this year. With only incremental improvements in the hardware, it should be possible to play older games on these consoles as well, ensuring that the network effect is not cancelled out every few years.

The risk to the investment case is that the Nintendo Switch will no longer be sold in two years' time and that Nintendo will not be able to abandon their hit-based model. Mr. Furukawa’s clearly different approach gives us the confidence to give Nintendo time to deliver on initiatives discussed above. We think that the current valuation of Nintendo is such that just a success in digitization or in the development of smartphone games can already lead to a good return on investment.