June 2022 Investment report

July 18, 2022
Investment Updates

Over the last quarter the market has been particularly volatile but we have used the opportunity to buy into and increase our holdings into several high quality companies at levels significantly below recent peaks. Such companies include Pinnacle Investment Management, Breville and Reece. These and others that have been added to in the portfolio are all highly profitable, have excellent management teams we know well, have strong balance sheets and good ESG credentials. Recent market weakness has provided the rare opportunity to own these companies at reasonable valuations.

Newly established portfolio positions fall primarily into two categories. The first being stocks where consensus earnings expectations have already fallen and taken the stock price with it to attractive valuation levels, considering the outlook. The second category is where the stock price has already well and truly priced in the likely earnings downgrades to come. In August, at the next opportunity for companies to update the market at their full year financial results, we believe that for our positions, the outlook will either not be as bad as consensus now expects or if the stock has reached a valuation level that is attractive enough (even with consideration to a worse outlook) these positions have the potential to significantly outperform.

Good investment opportunities occur during poor market sentiment. And while buying into weakness can have a short term cost it can also maximise the medium term return potential for any investment. In one example of how poor market sentiment is currently, in recent weeks one of Australia’s largest retail brokerages did a survey of share advisors. 86% of respondents are currently bearish to neutral on the market and their favourite stock to own in this environment? BHP Limited. 72% of advisors were predominantly investing in Australian Large Caps with only 12% currently liking Australian Small Caps. BHP is actually down -8.7% since the survey while the Small Ords is up +1.5% over the same time, showing that crowded trades aren’t the ones you want to have a major exposure to. The portfolio has sold all of its major Transition Commodity and Resources positions into share price strength in the last few months so recent commodity and resources weakness is not affecting the portfolio. Our view is that the uncrowded (but quality) areas of the market have the most promise from here.

Another thing that might help market sentiment in coming months is the run rate of inflation. Despite the predominance of inflation talk and the resultant central bank rate hike fears across markets it is difficult to see any hard or soft commodity that is actually going up right now. And we know that inflation is a lagging indicator. Additionally, the UBS Supply Chain Stress Indicator is also showing an improvement, indicating lower order backlog, better shipping and airfreight costs, improving empty/full container ratios and order/inventory data. This might also just be a reflection of a slowing global economy. As supply chain pressures ease this will also help the backward looking inflation numbers that are due to be released. As these measures stabilize we believe it will help confidence to be restored to markets even as economic growth potentially slows.

ESG AND ENGAGEMENT COMMENTARY (more detail attached)

Ethical Partners travelled to New Zealand to visit the assets of one of our portfolio companies and ESG leaders, Meridian to gain a better understanding of their important role in the New Zealand renewable energy generation. We were able to tour their wind farms and their hydro-electric assets across the country. This was a valuable experience in order to better understand their operations on the ground, and the passionate commitment of their entire team, from the operational staff right through to the chairman towards clean energy, their own footprint, their potential role in green hydrogen, and their policy engagement regarding country wide decarbonisation planning. It was also a good chance to better understand and discuss their policies and practices involving cultural heritage and their consultation, consenting and collaboration with the Maori Iwi People.

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