The June quarter saw the continuation of the recent downward trajectory in equity markets, the ASX300 down 12.2%, with the Fund falling 16.1%, an underperformance of 3.9% in the quarter. An underweight position in Materials and Energy, and an Overweight position in Small Cap Industrials were the key detractors over the June 2022 quarter. The June quarter saw an escalation of the global Central Bank response to inflation, culminating in the RBA initiating the first hiking cycle in almost 12 years as broad levels of support continue to be unwound from the global economy. There was heightened volatility from equities, bonds and commodities, spilling into the most speculative of investments including various so called “stablecoin” crypto currencies.
How has the Fund responded to market volatility?
It is widely postured that over longer run time horizons, investor wealth creation is closely linked to how investment managers not only steer capital through times of market stress, but take advantage of market gyrations when and if they occur. Our investment process, with a focus on cash flow, strong balance sheets and management quality, coupled with the application of our in house EPORA based sustainability framework, lends itself to a deep focus on valuation discipline. As such, for much of the last few years we have not participated in the “high growth, high quality, high PE” game, seeing the risk reward backdrop as unattractive.
To illustrate how we have managed the portfolio as these valuations have changed, we have assessed the portfolio in the below buckets, benchmarked from December 31st 2021 to end of June 2022. This simple illustration about how we are thinking about our positioning is inspired by the famed money manager and author Peter Lynch (One up on Wall Street, 1989), who coined the categories we have highlighted below. In the attached PDF we go through each segment and our activity in more detail.
Looking forward, are weak balance sheets the last shoe to drop?
We note that unlike the last 3 cycles when bond yields have moved sharply higher akin to the current move (1994, 1999-2000, 2008), we have seen a period to date where the market has rewarded weaker balance sheets. As an example, we note businesses like Transurban (not held), with rock solid revenue streams, have significantly outperformed over the last quarter. Excluding demerged entities, no stock contributed more positively to the ASX300 index return over the last 3 months. However, we believe that as the market increases its focus on balance sheet and gearing we may see more focus on a company’s debt burden, noting Transurban is one of the more leveraged businesses on the ASX at over 9x ND/EBITDA (consensus data).
Our Investment process has a strict discipline on balance sheet strength and we have been cognisant to ensure the Fund is well positioned when the market inevitably turns its attention to debt serviceability. To this end we continue to monitor the balance sheets of our portfolio companies, buoyed by the fact that almost 40% of the portfolio currently is invested in companies with net cash positions and as per our process, on balance the portfolio enjoys strong assets and low debt burdens. Mark Twain once posited that “a banker is someone who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain”. In our view, our disciplined investment process ensures we will have a poncho in the top pocket to keep us dry if the weather turns.
Download report below
