During April 2019 the Ethical Partners Australian Share Fund returned 3.38% versus the S&P/ASX 300 Accumulation Index of 2.46%, an outperformance of 0.92% (after fees). Over the last quarter the Fund has returned 9.44% (after fees) versus the S&P/ASX 300 Accumulation Index of 9.41% performing broadly in line with a strongly rallying market. Since inception on 9 August 2018 the Fund has returned 1.29% versus the S&P/ASX 300 Accumulation Index of 4.51%, an underperformance of -3.22% (after fees). During April the Fund benefitted from overweight positions in Nick Scali, NIB Holdings, CSR Limited and Bega Cheese and holding no position in BHP Group benefitted the relative performance of the Fund. Key detractors for the month included Suncorp, Graincorp, Beacon Lighting and TPG Telecom.
Across the market it was banks, consumer staples, food and healthcare that contributed while miners, property trusts and other interest rate sensitive names detracted from market performance. Interest rates expectations generally came down which helped sentiment towards consumer and financial sectors with the market starting to expect the RBA to cut rates in May (which did not eventuate). After performing strongly in the first quarter of this calendar year, yield sensitive sectors were poor performers in April, with real estate and utilities underperforming. Within the S&P/ASX 100, three of the ten worst performing stocks were REITs. Firmer bond yields and the expectations for low global rates is now well known and it appears that the market priced in a lower rate environment very quickly in March, in some stocks, leaving little room for a further valuation re-rate. The Portfolio maintains exposure to the banks, Telstra and Vicinity all of which have some elements of interest rate sensitivity however all are well priced relative to peers and the market.
April also saw financials outperform with the major banks doing well leading into the May results of National Australia Bank, ANZ and Westpac. Our view is that the market is too pessimistic about the outlook for the banks and that investors are being paid a healthy yield to stay invested. There is also evidence that the housing market is now becoming “less worse” which we believe will be one indicator that relative performance for the sector will continue to improve. We note CSR Limited and GWA Limited, two building and construction related stocks, were strong outperformers for the month. The Portfolio remains overweight banks and Suncorp.
The portfolio remains overweight some of the more traditional sectors of the market while deliberately being underweight some of the newer technology related names. We believe that a two tier market has developed in Australia with a huge dichotomy existing between new and traditional sectors. While no-one uses terms like new economy anymore (today it is “disruption”) and tech arguably has more commercial business models today than in 2000, what is consistent is that stocks with any solid growth characteristics (and particularly those with a technology basis) have been bid up to extraordinary levels. Likewise, other companies displaying more pedestrian growth or those going through a cyclical downturn have been ignored. At present there are twenty three companies listed on the ASX with price to revenue multiples over 10x, compared to the start of the year 2000, when there were only fifteen such Australian listed companies with valuations around those levels.
Our view is that traditional sectors still have reasonable valuations and hence potential upside versus new sectors that we believe are exhibiting high risk characteristics. At present however the market may be showing signs of valuation fatigue and April’s performance may have reflected this. There are further signs this could be continuing with the largest tech listing on the New York Stock Exchange in years, Uber, ending its first day down more than 7% (Friday 10 May) as there were simply not enough investors left willing to further value the forward promise. It closed with a market cap of US $75bn for a company that on its pro forma income statement lost over US $2bn in CY18. It still has a market cap larger than Westpac which makes over USD $5bn profit per annum.
Locally, for property trusts there will also be a limit to what the market will ultimately pay over and above book value and for iron ore related companies, whilst enjoying the current effect of South American related volume restrictions of late, there is only so much “shortage” value the market should be willing to capitalise into the future. Since CVRD’s Córrego do Feijão mine shut down in January 2019, US $24bn of net market capitalisation (ie: the increase in the market cap of BHP, Rio Tinto and Fortescue less the decline in CVRD) has been created. The decline in the value of CVRD has been offset roughly three times by the value in the increase of its peers which we do not believe is sustainable or long term in nature.
Hot growth stocks and perceived long term commodity shortages can tend to focus market participants on a small number of “exciting” opportunities, often leading to outsized valuations and depressed valuations in other areas as capital withdraws. Our contention is that this is currently occurring in the Australian market. Many companies exposed to building or housing credit, retail or domestic drought conditions have to date been left out of the market rally. The result is that valuations in these sectors remain reasonably modest and some attractive individual company characteristics are being skipped over due to the general lack of interest.
We believe the two tier nature of our market means that some stocks from here have medium term downside (tech, mining, property and infrastructure names) and some still have medium term upside (agriculture, financial and some building related names) or will at least be more defensive. Our positioning has caused the Fund to lag during the strong market performance since the start of the calendar year with the Fund up 11.04%, calendar year to date, versus the market up 13.65% over the same period. We believe however the gains in the Fund have been achieved at lower than average risk (ie less potential downside) and that our positioning coupled with reasonable valuations in our stocks will hold our investors in good stead going forward.
In continuing our advocacy with Australian listed companies we have recently written to 23 companies regarding their sustainability, social and environmental policy and practice. Our ESG/SRI screen, called the Ethical Partners Operational Risk Assessment (EPORA) directly assists in selecting stocks for our investible universe and we use company feedback to complete our assessment and identify company specific risks. An important part of this process is advocating for stronger and more appropriate policies in the areas in which our EPORA is focused upon. Our correspondence has so far been centred around asking for specifics surrounding general statements made by companies in their sustainability reporting or their operating Code of Conduct.
We have been interested in the specific outcomes from managements’ supply chain assessments and independent audits and how they are preparing for pending Modern Slavery legislation. We like to hear about what went wrong and what is being improved. We like to see companies having a clearly communicated plan to improve in the future even if their practices are less than ideal today. We have also asked about water, waste, and energy saving initiatives, including carbon emission reduction targets and requested reasons as to why reporting metrics had changed in some instances. We will share some of the responses in future reports.
