Investing idea: Tapping the growth of video games 

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on January 22, 2018 - January 28, 2018.

If we include the sale of personal computers, software and consoles, the industry is probably worth more than US$150 billion — more if we include government and military simulation and educational software. > Pollak

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As niche as it may seem, video games are a rapidly rising sector of the technology industry. It is seeing explosive growth due to factors such as the expansion of mobile and online gaming and the shift from physical to digital distribution of software. 

The video game market, which is estimated to be worth well over US$100 billion globally, will be on an upward trend over the next 5 to 10 years, says Ted Pollak, president and portfolio manager at EE Fund Management, a US-based investment management firm. 

“The industry is a lot larger than most people think. The estimated size of the video game industry varies among different analysts, partially because of the different definitions. If we include the sale of personal computers, software and consoles, the industry is probably worth more than US$150 billion — more if we include government and military simulation and educational software.”

According to a Nov 28 industry report by international market intelligence provider NewZoo, the growth of the global gaming market will see a compound annual growth rate of 8.2% and revenues will reach US$143.5 billion by 2020.

The past few years have been very good for the video game industry. Most of the companies, which are engaged in producing either hardware or software for the industry, have beaten the broader market by a wide margin, says Pollak.

For example, Nvidia Corp — the creator of the graphics processing unit responsible for improving video game graphics — saw its share price surge 80.72% over the 12 months ended Dec 27, 2017, recording an astounding return of 1,358.18% over a five-year period. 

Meanwhile, the share price of video game developer Nintendo is up 76.42% over a one-year period. Analysts are predicting that the strong performance will continue following the high demand for the new Switch console. 

To capture and leverage these well-performing stocks in the video game and digital entertainment industry, Pollak founded the EEFund Video Game Tech Index. It is designed to reflect the performance of the companies in this sector. 

The index is tracked by the world’s first exchange-traded fund (ETF) to focus on the video game industry — the ETFMG Video Game Tech ETF (GAMR), formerly known as the PureFunds Video Game Tech ETF. The fund, incepted in March 2016, allows investors to participate and gain alpha from the strong performances of video game companies by investing in three baskets, namely “pure play”, “non-pure play” and “conglomerates”. 

The “pure play” basket comprises software developers or hardware providers for the entertainment, educational and virtual reality segments of the video game industry. The “non-pure play” basket consists of those that provide intellectual property in support of the industry while the “conglomerate” basket comprises large, broad-based companies with business models involving the industry. 

According to GAMR ETF’s investor materials (as at Nov 30), the fund delivered returns of 15.43% and 52.91% over six months and one year respectively, resulting in a total return of 90.16% since its inception. According to Harold Janecek, director of sales at ETF Managers Group (the investment adviser to the fund), GAMR ETF is one of the top-performing tech funds globally.

Nevertheless, GAMR ETF carries an expense ratio of 0.75%, which is higher than the industry average. Janecek explains that this is due to several factors including the complexity of the fund. 

“I believe the average ETF in the US is around 0.25%, but it does vary. We do not have the scale to offer what Vanguard, for example, is offering. We have lowered the fees of our other tech funds, but not yet for GAMR ETF,” he says.

“What investors need to understand is that GAMR ETF is [investing in] something very specific. It is not something with a simple, cut-and-dried strategy that most of the other ETFs have. It is not a mid-cap growth fund that 

anyone with access to a computer can construct. A lot of expertise has gone into assigning the baskets of companies in the industry.”

Positive prospects

As at Dec 26, GAMR ETF’s top five holdings were mobile and online game developers G5 Entertainment, Webzen Inc, Gravity Co Ltd, Gumi Inc and Netmarble Games Co. According to Pollak, one of the most exciting spaces in the video game industry is eSports, or organised multiplayer video game competitions. 

The eSports market is currently valued at about US$900 million and is expected to grow with higher value prices and rising viewership, as reported by Business Insider on Nov 28, 2017. Pollak says eSports is an interesting area for its potential to reach gamers and non-gamers and tap both types of consumers at the same time. 

“Typically, gamers would want to own a specific brand or types of devices and hardware that winning eSports teams are using, similar to how race car enthusiasts would want to buy Pirelli tyres after a racer who drives using them wins,” he says.

“But what is more interesting is the ability of eSports to reach even non-gamers, especially with celebrity endorsements, which happens a lot. For example, if prominent basketball players LeBron James and Steph Curry played a grudge match in the off-season using a video game and streaming it on social media, the advertising potential is very interesting. Of course, this is just one of the reasons why eSports can generate a lot of revenue for the industry.”

Although eSports is popular in Asia (especially South Korea), it is rapidly being adopted in the Western market, says Pollak. “I just attended a tournament in Oakland, California, where there were about 6,000 attendees. A similar tournament in Asia — a League of Legends competition, for example — is attended by tens of thousands. This goes to show that there is a huge opportunity for organisers to get more people into stadiums as eSports gains more recognition in the US and the UK.” 

Pollak says there are many segments in the video game industry that will drive its growth and benefit the index that the GAMR ETF tracks. The first is interactive technology, which will be increasingly used to serve the changes in consumer behaviour, where there is growing demand for simulative products. 

“I also believe that gamification is the most superior way to educate — at least for rule-based subjects such as physics, trigonometry and geometry — because it is a proven fact that people learn better by doing. It can also be used in skills training such as how to operate a cash register,” he says.

“Typically, a manager would have to stand over the shoulder of a new employee for a few hours at least to teach him how to use the point-of-sales system. But I believe that in the future, there will be no need for this as it will be possible for employees to show up on their first day as an expert on the system.”

Video games also deliver compelling cost-per-hour entertainment value, which will continue to provide attractive margin opportunities for software developers on the index, says Pollak. “The cost of a computer gaming system or console can appear expensive at first glance. The Nintendo Switch, for example, costs US$300 while a copy of a game is US$60 on average. 

“Recently, I finished a game that took me 200 hours to complete. That means the game cost me about US$1.80 per hour. And this cost gets cheaper the more times you play and utilise the device as the initial investment amortises. 

“By comparison, watching a blockbuster movie at the cinema may cost a consumer US$10 per hour. This means video games are one of the most economically frugal electronic entertainment choices while also providing fantastic margins for the creators and developers. 

“There are mobile games that took only US$50,000 to develop, but brought in revenue of US$20 million. Even the major video game releases rarely ever cost more than US$100 million, including marketing.”

There are other trends supporting the video game industry. Apart from the development of virtual and augmented reality devices, there has been a shift towards better screen resolution, which indirectly invigorates the video game industry and most of its components, says Pollak. 

“The global standard for screen resolution is currently 1080p. But we are moving into a new era of 4k resolution, which will require new televisions, newer and better consoles and better software. So, all this will lead to better returns for the companies in the index,” he adds.