To the clients of Ethical Partners and their advisors:
During March 2019 the Ethical Partners Australian Share Fund returned -1.34% versus the S&P/ASX 300 Accumulation Index of 0.73%, an underperformance of -2.07% (after fees). Since inception on 9 August 2018 the Fund has returned -2.03% versus the S&P/ASX 300 Accumulation Index of 2.00%, an underperformance of -4.03% (after fees). During March the Fund benefited from overweight positions in AUB Group, oOh Media and Telstra and holding no position in Woodside Petroleum benefited the relative performance of the Fund. Key detractors for the month included NIB Holdings, Kathmandu, Orora and having no holding in BHP Limited detracted from relative performance. The overall benchmark was boosted by miners and interest rate sensitive stocks such as property trusts and infrastructure while banks gave up some of the prior month’s advances.
Though the unit price of the Fund today does not look like it has moved far from where it started in August 2018 there has been a period of remarkable market volatility in stock and bond markets in the intervening period. From the high in August 2018 the Australian stock market fell approximately 14% and has since climbed back to within 1% of where it began. Broadly our response has been to look through the volatility to the underlying value of businesses and through this period we remained of the belief that there were some excellent investment opportunities being created for the medium term. We have been able to navigate the volatility having done our homework on stocks beforehand and stay invested in those stocks that we believe will ultimately contribute meaningfully to the medium and longer term performance of the Fund.
Looking at broader trends there is a prevailing view by commentators that the market is expensive and that the yield curve inversion is signaling a recession. We believe however, that there are still areas of significant value in the Australian stock market. We agree that some areas of the market are extreme in their valuations like the technology sector that is trading close to its all-time highs (Wisetech, Pro Medicus and Altium are examples) as well as other companies with a market capitalisation of over $5bn that haven’t yet made a profit. Some of the more interest rate sensitive stocks (GMG Group, Transurban, Charter Hall and GPT Group) are indeed at five year highs. But it is not pervasive and not everything is trading at record valuations. In fact many of the stocks in the Fund are trading significantly below what the market had decided they were worth at various times over the past five years. Our top 15 largest holdings are trading, on average, 31% below their individual highest points over the last five years. That is, the market was prepared to pay 31% more on average, for our stocks at a point in time over the last 60 months. But that alone does not make them cheap today. In our view, our holdings are relatively cheap fundamentally as we believe their collective quality of earnings, barriers to entry, economies of scale and market positions are better than what their current share price would imply. Indeed in some cases they are better businesses today than what they were when their share prices were higher. As current share prices are a function of what is currently happening and also the future perceived promise inherent in the business, stocks will usually rally when the forward visibility that the market craves is obvious to all. While it is hard to see the very high PE stocks continuing to re-rate upwards in terms of valuation we own a portfolio of stocks that, in our view, have a better future than what the market is envisaging for them and that should lead to our stocks doing better than stocks where a rosy future is already imagined and captured in the current value of the company.
Since early January the market has recovered and last month we questioned what would sustain the rally that began with the US Federal Reserve putting their interest rate tightening schedule on hold. On 20 March we got that answer and saw where the next phase of the rally might come from. Not only did the Fed reiterate that interest rates were on hold, it also flagged a halving of the rate at which they would sell down the existing store of US Treasuries. The Fed also announced they would reinvest principal payments back into Treasuries, thus turning the Fed into a net buyer (from a net seller). Importantly this means that instead of pushing interest rates up and removing liquidity, the Fed is now pushing rates back down and adding liquidity back into the monetary system. The market reacted swiftly by pushing down longer term bond yields with the US ten year bond yield falling from 2.52% to 2.29% through March. By signaling lower expected inflation and a pause in short term rate hikes, the reaction was similar to when the Fed put in place Operation Twist from late 2011 into 2012. For better or worse this had a very stimulatory effect on markets and in yield stocks in particular.
We view the recent moves by the Fed and other global central banks as likely to be supportive of markets but as a stock picker we will always focus on the inherent value in the companies we own. There is no doubt that domestic cyclicals and financials have been under pressure as the market concerns itself about an impending recession and the moves in bond yields certainly may help domestic confidence if the RBA follows suit. This could benefit many of our cyclical exposures. Additionally lower bond yields also make the large proportion of the Fund that is exposed to companies with a reasonably high (and growing) dividend yield look relatively better value and they could find support as the market applies this beyond property and infrastructure stocks.
Nathan Parkin Matt Nacard
Investment Director Chief Executive Officer
