September 2018 Investment Report

October 18, 2018
Investment Updates


Ethical Partners Australian Share Fund:         APIRCode EPF9951AU

                                                                       Investor class unit price 30 Sept $1.0184

                                                                       ClassB unit price 30 Sept $1.0185

Performance since inception:                          +1.8%(after fees) vs S&P/ASX300 Accum


To the clients of Ethical Partners and their advisors:

During September the Ethical Partners Australian Share Fund returned -1.7% versus the S&P/ASX 300 Accumulation Index of -1.2%, an underperformance of -0.5% (after fees). Since inception on 9 August 2018 the Fund has returned 2.2%versus the S&P/ASX 300 Accumulation Index of 0.4%, an outperformance of 1.8%(after fees). During the month the Fund benefitted from overweight positions Ingham’s, GWA Group, Telstra, Monadelphous and from not holding CSL. Key detractors for the month included holdings in NIB, CSR, Suncorp and having no position in BHP Billiton, RIO Tinto or South 32 detracted from the Fund’s relative performance.

The Fund used the market weakness during the month to selectively add to a number of existing positions and we introduced two new company holdings to the portfolio where valuation had previously been unattractive. The Fund reduced holdings in three existing positions in order to shift the Fund’s capital to better opportunities.

During September commodity and energy related stocks performed well,leading the contribution to Australian market returns as oil prices rose during the month, while industrials, financials, building related stocks and property trusts all under performed. Resource companies, many of whom are excluded under our investment process due to high country risk, outperformed the weaker market. In contrast to the weakness in certain housing and retail related stocks Australian economic activity generally continues to be stable with domestic fundamentals including credit growth, building approvals, employment, interest rates and retail sales continuing to be steady. Markets however are already pricing in an anticipated slowdown. Ethical Partners’ team is finding a number of opportunities in this area.

We also continued to research and further our understanding of company supply chains and operations. In addition to the supply chain experts we have had in our offices in recent months we recently hosted the supply chain manager of an unlisted consumer products company. This business has done extensive work on the life cycle of their products and the sustainable and ethical sourcing of inputs. On manufacturing, they concentrate on various stages such as the carbon it takes to make the product and packaging, the water usage and the ultimate waste at the end of the product’s life. On suppliers, they concentrate on visibility of the source of all inputs and the social aspects of workers who are involved in the manufacturing. This business has achieved visibility in over 90% of its inputs back to source and are in good shape to comply with the Modern Slavery legislation that may soon be introduced nationally (already in NSW). It was instructive to our team the extent that business can trace inputs where a real effort has been made, and the lower risk that will achieve, and we look forward to further conversations with listed companies, with this knowledge in hand.

On a wider look at equity markets, with global central banks still unwinding the QE related build-up of positions, volatility continues to climb. On one hand this is likely to give rise to investor impulsiveness, whilst on the other hand it gives the patient investor the opportunity to build positions based on long term fundamentals at attractive prices.

The chart below exhibits some major effects of the various QE programs that were implemented to stabilise markets following the financial crisis and had the effect of lifting all boats. Since the GFC valuation (PE expansion) has been the predominate driver of returns (54% of total), whereas the major driver in market expansions since 1975 has been sales growth (64%). In our view a major area of risk lies in this shift because with the liquidity being taken away,multiple expansion should no longer be the major driver of market returns and businesses will need to generate sales growth and higher margins in order for investors to benefit from here.

Indeed part of that multiple expansion also came from high capital flows being channelled into those relatively few companies that could achieve some growth(because growth was not widely spread) hence seeing those companies’ price relative to earnings increase dramatically. Due to this phenomenon we now have an equity market where PE dispersion is the highest in a decade.

With PE dispersion now at extreme levels the current day investor is left with the choice to either buy:

  1. slower growing companies (with market expectations of earnings growing at less than 5% pa) at lower than the average market multiple or;
  2. cyclicals that are way off their low points (from early 2016) or;
  3. growing businesses (with market expectations of earnings growing at more than 5%-10% pa) at prices more than double the average market multiple,in the hope they keep delivering and/or that they remain the select few that can still grow.

Given that choice we would take the former stocks (i) any day, with expectations still low and fundamentals remaining better than what is being reflected in the daily press and by market commentators.

The Fund is generally exposed to companies where balance sheets and cash flows are strong, earnings growth expectations are low (but on our research, could do better than that), there is perceived bad news ahead and valuations are still relatively attractive.

Until last week equity markets had held up relatively well but with the recent rise in US 10 year bond yields to levels that have not been seen for seven years and with the Fed and ECB no longer standing behind markets with an influx of buying, our view is that investors will be better off knowing their companies well and as such be in a position to take advantage of further volatility and build positions at attractive prices which can be beneficial to future returns.



Nathan Parkin                                     Matt Nacard
Investment Director                            Chief Executive Officer


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