June 2021 Investment Report

July 23, 2021
Investment Updates

Our breadth of research means that the Fund participates in a more diverse range of investment opportunities than the overall market, with the index return concentrated around few major themes. There are two main benefits to our breadth of research; the first being around risk, with the Fund exposed to a more diverse range of economic factors with varying cycles; and secondly around returns, with the Fund not having to rely on a continuation of performance of the four major banks and three major iron ore companies to be able to generate competitive relative returns going forward, in our view. The Fund returns were also achieved during a strong year for the overall market and with the Fund carrying an underweight position in three strong sectors: Technology, Materials and Consumer Discretionary. Inflation expectations remain a key topic for markets but our focus remains on how the macro environment allows us to position the portfolio in individual companies that we like, at compelling valuations. So while we pay attention to news such as the June US CPI print and the Federal Reserve’s reaction to it, we keep our focus on individual stocks. We discuss what the current environment means for us, as a stockpicker below.

US CPI numbers were released mid-June and were slightly above expectations. While much of the ensuing debate centered around whether inflation is transitory or structural the important news for us is that the Fed confirmed that it will not step in to reign-in the economic and earnings recovery that is currently occurring.

What this means from a company bottom up point of view is that the demand growth that is driving the potential earnings upgrades at our chosen companies is more likely to occur, with continued assistance from Government fiscal policy and central bank liquidity. And while interest rates may not sharply increase, the ten year bond rate is unlikely to return to 2020 cycle lows in our view while the demand and the earnings recovery is taking place.

We observe two different cycles taking place at present.

One is a valuation cycle that arguably reached its peak somewhere in the last six months of 2020, driven by a decade of lower interest rates and exacerbated by excess liquidity, speculation on the future value of unprofitable companies and exacerbated further in 2020 by COVID lockdowns and short term spending habits of consumers. We see the long term drivers of this valuation cycle slowly unwinding and our view is that this cycle has now peaked.

The second cycle is about earnings growth from the depths of COVID and the emerging demand recovery and economic growth. We see this cycle as having just begun. The recent takeover activity (eg: Sydney Airports) highlights the market for private capital is starting to look through the earnings gap created by COVID and value companies on through-the-cycle earnings or recovered basis, while the listed market is still catching up. The equity of some listed companies where earnings recovery is likely is too cheap in our view. In addition, the earnings recovery cycle that is occurring is being intensified by high industrial capacity utilisation, cost savings initiated to survive during COVID and the long term underinvestment in the discovery and production of necessary commodities for an electrifying world.

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