October 2018 Investment Report

November 14, 2018
Investment Updates

Ethical Partners Australian Share Fund - As at 31 Oct, 2018. Unit price, Investor Class $0.9589, APIR code EPF9951AU

During October the Ethical Partners Australian Share Fund returned -5.84% versus the S&P/ASX 300 Accumulation Index of -6.16%, an out performance of 0.32% (after fees). This was one of the worst monthly Australian equity market performances over the last twenty years with around two thirds of stocks in the ASX300, by number,under performing the benchmark. Additionally there was significant divergence among small and large cap stocks during the month with the ASX100 Accumulation Index down -5.7% versus the Small Ordinaries Accumulation Index down -9.6%.With the Fund having a large overweight position in small and mid-cap stocks(we are underweight large caps by approximately 30%), our selected positions did better than average in that sector and we were pleased with our portfolio companies’ fundamental performance at their various AGM updates.

While we were not pleased with the large negative Fund return over the month we note that our earnings growth and forward income estimates for our portfolio did not change,meaning the portfolio is now fundamentally cheaper. Since inception on 9 August 2018 the Fund has returned -3.76% versus the S&P/ASX 300 Accumulation Index of -5.78%, an out performance of 2.02% (after fees). During October the Fund benefitted from overweight positions in Graincorp, Ramsay Health Care, Orora and Link Administration Holdings. Key detractors for the month included Nick Scali, TPG Telecom, Kathmandu and GWA Group and having no position in Woolworths and Transurban Group detracted from the Fund’s relative performance. The Fund used the period of market weakness to selectively add to a number of existing positions where excess liquidity was present amidst the sell-off.

Our Investment Process that focuses on balance sheet,operational cash flow and quality management as well as our EPORA and a strict valuation discipline has held the portfolio in good stead through the recent market volatility. Benefits of our process include: firstly that we retain our conviction in the fundamentals of our companies even when market volatility is present; secondly our focus on a strong balance sheet means that companies in our portfolio are less likely to undertake a dilutive capital raising at times of market weakness and thirdly holding businesses that generate solid cashflows makes a good income stream possible for our clients even when capital gains are hard to come by.

Since we started the Fund we have maintained a focus on companies that we feel we know well. In equity markets there are always new things coming along that are made to look like opportunities and since we started the fund there have been 137 capital raisings by companies, raising a total of over $14bn. Since we started the Fund we have not participated in one new deal or IPO, instead choosing to focus on companies we know well and that generally have long operating histories and have been through a number of cycles. The market volatility has presented a number of solid companies at more attractive valuations and while we have been patient with new opportunities, we are considering more now than before.

As mentioned above, our estimate for one year forward earnings growth for the portfolio remained at 4.5% (this did not change through October - as our companies did not suffer any earnings downgrades) with a prospective dividend yield of approximately 5%. Generally, as high PE growth companies are less highly sought after in a stock market where capital gains are harder to come by, we believe that balance sheet, modest valuation metrics,cash flow generation and shareholder income will become relatively more important to future returns. We believe we are well positioned for this scenario.

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