NEWS
29 Sep 2021 - Reduce your risk and pick outstanding companies
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Reduce your risk and pick outstanding companies Emma Fisher, Airlie Funds Management September 2021 Despite the record reporting season past and the major wall of cash returned to investors this year, we at Airlie can't help but feel things in markets are a little gloomy. We believe that this is due to two sources of dismay.
In cutting through this doom and gloom we think it is important to talk about uncertainty and risk. It may seem obvious, but it is worth pointing out that uncertainty and risk are different concepts. We think the market is pretty bad at distinguishing between the two and punishes both evenly. Uncertainty is not knowing what is going to happen in the future. Put this way, you realise uncertainty is a fact of investing and ultimately a fact of life. In our view, uncertainty in markets creates opportunity. We're always looking for the uncertainty that may create a mispriced asset. What we don't like is risk. Risk is the chance of a permanent loss of capital and in our view, often comes down to two reasons:
At Airlie, we use a four-stage investment process tailored specifically to take advantage of uncertainty while minimising risk. #1 Focus on financial strengthStrong balance sheets The first place we always start is with a focus on the balance sheet. Making sure that the financial position of our companies is rock-solid is the first way that we limit the permanent loss of capital. These businesses can weather the storm of whatever markets throw at them and help portfolios perform through all cycles. When we consider the share market as a whole, it's important to note that balance sheet risk is much lower than it has been historically. Over the last few decades, net debt to EBITDA has had a median of 2.5 times. Right now it's much lower at about 1.9 times. This is a good sign. While we believe valuation risk is highly elevated right now, the lowered level of balance sheet risk is in essence telling us to proceed with caution at the moment. Heading into the GFC, both measures of risk were highly elevated. If you were to consider it as two signals - we had both lights showing red. Right now we see one showing orange and one showing green.
Self-funding businesses The other element of financial strength we like to consider is whether the business is self-funding its operations. This is simply because it has been proven that over the long term that these businesses outperform. They are able to fund their own growth profile through earnings and do not dilute shareholder capital. Alternatively, the businesses that are constantly tapping the market for equity to sell investors the dream and fund the business growth underperform, as seen below. #2 Don't overpayWhen investors reflect on the 2001 tech bubble, it is important to remember that it wasn't only tech stocks caught up in the hype. If you bought Disney, Coca-Cola or Walmart at their peak during that period, you would have had to wait 11 to 16 years to get your money back. Investing during peak periods is a real risk to a permanent loss of capital. Now we don't believe that we are at similar levels in the Australian market but we do see pockets of extremely optimistic valuations. As the risk-free rate falls, the multiples you have to pay for future cash flows increases. Right now markets have never been more expensive since yields have never been this low. In our view, if you're investing in the most expensive parts of the market, you're taking a bet against bond yields. And that's not a risk we are comfortable taking. #3 Buy quality businessesAt Airlie, we see quality businesses as those with a high return on capital. This is because, for every dollar that is earned by a business, a greater portion will be returned to shareholders and not lost in capital expenditures. The issue that unfortunately presents itself here, is that high-quality businesses can often be the most expensive. Therein lies the greatest challenge of this current market and what we look for in our investments - which are the quality businesses available at good prices. We believe there are three main reasons why a high-quality business may not trading at high valuations.
The best example of a past "jewel in the crown" business is Wesfarmers (ASX: WES). It was not until the demerger of Coles that Bunnings was able to shine as one of the best businesses in Australia. Bunnings generates a return on capital of more than 70%, so when Bunnings went from a third of WES' earnings to 70%, Wesfarmers re-rated. We believe a similar unlocking of value is happening with Tabcorp (ASX: TAH). We believe Tabcorp's lottery business deserves a very high valuation. This business has proven to be a resilient growth story over time. Their growth is underpinned by state monopoly licenses that run for decades in most states and an ever-increasing spend on lottery tickets online, meaning they no longer have to pay a commission to the newsagent. The issue is that the wagering division of the business proves to be somewhat of a problem child. The wagering arm doesn't offer the same attractive low cost of capital, and many investors who would be interested in the lotteries business do not want exposure to the gaming division. So the answer the company is pursuing here is a de-merger. We think in about a year's time Tabcorp will be worthy of a significant re-rate. #4 Find good managementThe final factor of focus in reducing risk is finding businesses with good management teams and founder-led businesses. We like these companies because it often means that management tends to focus on the long term, their interests are aligned with shareholders, and they are passionate about the business. An example of one of these businesses we are really excited about is PWR Holdings (ASX: PWH). PWR is also an example of a company we think is currently flying under investor's radar. Most of the company's revenue comes from selling cooling systems to motorsports companies. The founder and CEO, Kees Weel, started his business as a mechanic in the 70s. After a while, he decided he would give making radiators a try. Now, 40 years later, he's making the best radiators in the world and is the radiator supplier of every Formula One team. But it's not only the motorsports arm that excites us. In our view, the most exciting reason to own PWR is the growth happening in the emerging technologies division.
They are currently working on the development of cooling systems for electric vehicles. This is likely to be a huge secular growth area for the company over the next few decades. Additionally, the team is working with a number of exciting companies to develop cooling systems in aerospace and defence applications. The passion their CEO Kees Weel has for the business and his staff is why we love founder-led businesses. Earlier this year we had a chance to visit the PWR headquarters in the Gold Coast and at the first stop of our site tour, Kees presented us all with a copy of the company's yearly cookbook. Kees showed us the on-site cafeteria that had been built so that the welders and engineers could have healthy, freshly cooked meals for free. That sort of passion for the culture and experience of the team is really infectious and something we love to see in the companies we invest in. Summing it all upIn conclusion, we want to highlight the importance of the difference between uncertainty and risk. While we love uncertainty, like the doom and gloom we see in markets, we hate risk. In our view, these four factors are the key to reducing risk and creating long term wealth. Invest where fair value exceeds market price We identify Australian companies based on their financial strength, attractive durable business characteristics and the quality of their management teams. The above article is a summary of the recent webinar hosted by Matt Williams and I. |
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Funds operated by this manager: Airlie Australian Share Fund |
28 Sep 2021 - Global small caps: From unrecognised growth to future global titans
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Global small caps: From unrecognised growth to future global titans Tobias Bucks and Simon Wood, Ausbil Investment Management September 2021 |
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Small companies offer the potential for growth that can exceed their larger peers over the long term, an assertion supported by the data. Small Companies offer investors early stage entry into names destined to become future global titans. Tobias Bucks and Simon Wood from Ausbil's global small-cap team answer some key questions on how to access such unrecognised opportunities. Q: Can you give us the elevator pitch for what you do? TB: We find global companies that are early in their stages of development, are not actively covered yet by the market, and have latent, unrecognised growth prospects with the potential for major rerates and sustainable unrecognised earnings growth. Finding uncovered 'gems', the names that offer what we call 'unrecognised growth' is where an active global investment manager like Ausbil can help investors take advantage of smallcap idiosyncrasies, while helping to reduce the typical level of risk that come with early-stage small-cap investing. We like global small caps because over the long-term, smaller companies consistently show outperformance against their larger peers, as evidenced in Chart 1 Chart 1: Small is beautiful: The compelling performance of smaller companies From Chart 1, since the inception of the MSCI indices in 2000, small companies have compounded well in advance of mid and large-cap peers. Over this twenty-plus years, small caps have risen by a factor of almost 6-times, mid caps buy almost 4-times, and large caps by the best part of 2.5-times. The outperformance of small companies has been shown consistently in the empirical long-term evidence provided by esteemed researchers such as Siegel (2015). Banz (1981) and Fama and French (1992), and in the market data. Q: Can you explain the term, 'unrecognised growth'? SW: Unrecognised growth is where a company exhibits the signs and potential for future earnings growth that is conceptually ahead of peers or the market in general, but for which there is no consensus as the company is not yet covered by a bevvy of institutional analysts. The company is 'unrecognised' because, due to size, it is yet to become large enough to warrant broad institutional coverage. Chart 2 illustrates how analyst coverage changes as companies become bigger. Global small caps operate in a 'sweet spot' of opportunity that has yet to be noticed or acknowledged by the institutional equity research machine. Chart 2: What 'unrecognised' looks like Ausbil's global small-cap team seeks the opportunities in the 231 developed markets in which we invest before any reliable institutional consensus has been established. In the case of some companies, there might be a consensus based on the views of a handful of analysts, as illustrated in Chart 1, but there is typically a significant divergence in views on valuation, opportunity and risk. The essential idea is that we focus on companies where growth will surprise, in companies that are attractively valued, and which we believe demonstrate relatively less risk in proportion to the opportunity. Combined with a lack of analyst coverage, forward surprise potential at attractive valuations reveals companies with unrecognised growth, which ultimately drives share prices. Q: Why do these companies go 'unrecognised' for a period of time? TB: Fast growing smaller companies are proving their business models, their sales and earnings can be volatile, and their businesses can be undiversified in terms of steady-state earnings. Institutions, like insurance companies which are not specialist small-cap investors, typically look for larger-cap equities with steady historical earnings, and more mature business models. However, large super and pension funds often carry significant allocations to small cap equities for the superior long-term returns they can offer in equity portfolios. Small companies, when the fundamentals are sound, the management is strong, and the business model is relatively unassailable, can offer upside potential for investors who are comfortable with riding-out shorter term bursts of volatility. From the sell-side perspective, small companies are often supported by specialist financiers, angel investors, cornerstone investors, large insider holdings and small broking houses in their early years, before they graduate into the bigger leagues and into larger capital raisings with larger investment banks. This creates significantly more opportunity for astute smallcap investors to participate in funding rounds for businesses that are on a trajectory for major growth, ownership transition events and other ongoing capital raisings and block trades that offer the potential to steadily build positions in companies with the potential to become the next global titans. Q: In your experience, what are the features of a good unrecognised opportunity? SW: Our fundamental and quantitative research seeks to unearth the unrecognised winners that have a high probability of earnings upgrades. Chart 3 illustrates how, to date, we have been able to consistently track ahead of the market on capturing earnings upgrades. Chart 3: Beating the consensus on identifying quality and upgrades There is no exact template for finding companies with significant unrecognised growth that are also in the process of exceeding market expectations on earnings growth, however there are some key elements that appear in the excellent examples we have found in the past. A great, unrecognised growth company often starts as a niche leader, that has global ambitions and products that are capable of contesting position in the global market place. Unrecognised growth companies often invest capital into their own expansion, as opposed to paying higher dividends, as they are able to earn a greater return on capital for investors through reinvestment. Quality unrecognised growth companies seek expansion, but not at the expense of strong ESG characteristics, which ensure critical elements are in place for successful expansion: strong corporate governance; and low environmental and social risks. An attractive company that exhibits unrecognised growth offers the potential for earnings surprise in future years, which ultimately draws the attention of the institutional market and eventually catalyses significant re-ratings. It may be an oft-repeated cliché, but what holds all together, from the development of great strategy to the execution of a successful local and global business strategy, is the quality of leadership. Great unrecognised growth companies invariably boast great management. People matter in successful companies, and as active investors, we are well positioned to meet with, review, question and assess management as part of our due-diligence process. Q: What about risk? Aren't small caps riskier investments than larger companies? SW: In theory, small caps should be riskier than larger companies when compared on crude measures of diversified income and size, however, when adjusted for risk, small caps can be surprisingly rewarding. As illustrated in Charts 1 and 4, using the Sharpe Ratio measure of risk adjusted returns, global small caps typically demonstrate a superior risk-adjusted returns (higher Sharpe ratios), than both mid and large-cap stocks. Moreover, an active investment approach can increase this Sharpe ratio through concentration in high-quality unrecognised growth companies, and the active avoidance of low quality small caps that do not match the criteria we apply. Chart 4: The risk-return profile of small caps in perspective
In taking a wider range of risks into consideration with the application of additional ESG risk filters, it is possible to further improve the risk-return outcome for small caps. ESG considerations can help reduce many tangible and intangible, un-quantifiable risks that help select winners and deselect losers in the risk-return equation. 5 Contactus@ ausbil.com.au Finally, liquidity management is key to success in global small-cap investing. Unlike mid and large-cap stocks that typically have deep order books in the marketplace, global small caps can display shallower order books, to the point of illiquidity. A company needs market trade flow in order for the execution of a clean investment thesis through the clean entry and exit of positions. In an illiquid stock, news can hamper the ability of investors to trade or exit. Ausbil manages exposure to liquidity risk very closely, and we will not enter positions that we cannot exit at any time, and within a reasonable timeframe. Relative to all small caps, this further improves the riskreward positioning of our approach, and can also materially improve our Sharpe ratio. In today's volatile markets, large companies are not a guaranteed mitigation for risk. The market has rapidly sold down many large caps regardless of size, and institutional share registers can be brutal to large caps, as much as they can to smaller companies. Q: So can you give us some examples of what a great, unrecognised growth story looks like? TB: Australia is only 2% of the world market. There is a lot of potential on offer in the other 98% of markets, and a lot of companies and sectors that are just not available in Australia. Moreover, small caps in larger markets have a natural advantage in being 'small fish in very large ponds'. One such company is theTradeDesk (TTD). The Global SmallCap Fund invested in TTD in June 2018. At the time, TTD was marketing online banner ads and content that rivalled Google Ads, but protected the identity of advertisers. TTD was a small fish in a very large pond, but it offered a compelling challenger solution to the dominant player in one of the world's most profitable spaces. TTD displayed many of the crucial characteristics we look for as a sign of quality, unrecognised growth. It was a niche leader in digital advertising, with global expansion ambitions for developed and emerging markets. It offered new and unique products, especially in universal IDs that was not being offered by Google. The management team were already proven, and reinvesting a growing earnings stream back into expansion of the business. With strong ESG credentials and a focus on improved data privacy, a competitive edge in the market, TTD was able to build and expand, and generate earnings surprises that were not recognised by the market. The result is that from the $87 entry price in June 2018, earnings surprises drove the stock price to $900 by January 2021, at which time the Fund exited, with TTD graduating 'with honours' as an emerging global titan, moving from the Fund's benchmark into the mid-cap benchmarks. Another example from the Fund's portfolio is Generac, a world leader in generators, based in the United States. Generac (GNRC) is another company that demonstrates the features of an emerging global titan, similar to our experience with TTD. Generac started as a niche leader in generators and smart energy. Growth ambition has since seen it expand globally, into South America and Europe. GNRC has expanded its product offering into inverters and smart grid tech, further investing through accretive mergers and acquisitions that expand both its capabilities and its footprint. GNRC has strong ESG credentials, especially with its link to future sustainable energy demand, and like TTD, it has a highly regarded management team. The Fund has seen its investment to date rise to over $280, from an entry point of $50 in May 2018, with the stock a key holding for future earnings surprise. Q: Can you summarise the benefits of adding global small caps to a portfolio? SW: We think the proposition for investors is simple. Global small caps offers a superior riskadjusted return from a global opportunity set of companies, many of which are not represented in Australian equity sectors. The opportunity to invest early in the next theTradeDesk, Google or even Tesla are waiting to be discovered in these 23 developed markets. They are not common, but with the criteria we apply in selecting companies demonstrating superior unrecognised growth potential, we believe the odds are significantly shortened for investors capturing the growth of future global titans. |
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Funds operated by this manager: Ausbil 130/30 Focus Fund, Ausbil Australian Active Equity Fund, Ausbil Global SmallCap Fund, Ausbil MicroCap Fund |
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References Banz, R. W. (1981). The Relationship between Return and Market Value of Common Stocks. Journal of Financial Economics, 9(1), 3-18. Fama, E.F. & French. K.R. (1992). The Cross-Section of Expected Stock Returns. The Journal of Finance, 47(2), 427. Siegel, J. J. (2013). Stocks for the long run: The definitive guide to financial market returns and long-term investment strategies. New York: McGraw-Hill. DISCLAIMER Important Information: Australia, Canada, Denmark, Kuwait, Netherlands, Sweden, United Arab Emirates, USA, United Kingdom. General Research provided to a client may vary depending upon various factors such as a client's individual preferences as to the frequency and manner of receiving communications, a client's risk profile and investment focus and perspective (e.g., market wide, sector specific, long-term, short-term, etc.), the size and legal and regulatory constraints. This information is for distribution only as may be permitted by law. 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Investors should be aware that they may be required to bear the financial risks of an investment in the Interests for an indefinite period of time because the Interests (i) cannot be sold unless they are subsequently registered under any and all applicable securities laws in the United States, or an exemption from registration exists and (ii) are subject to the restrictions on transfer contained in the offering document or limited partnership agreement of the Fund. The reader must comply with all applicable laws and regulations in any jurisdiction in which it subscribes for an investment; and the reader, by its acceptance of this report, agrees that the Firm and the Fund will not have any responsibility for the reader's compliance with such laws and regulations. The Firm is registered as an investment adviser with the U.S. Securities & Exchange Commission. Certain information contained in this Report constitutes "forward-looking statements," which can be identified by the use of forward-looking terminology such as "may," "will," "should," "expect," "anticipate," "target," "project," "estimate," "intend," "continue" or "believe," or the negatives thereof or other variations thereon or comparable terminology. Due to various uncertainties and risks, actual results and performance of the Fund may differ materially from those reflected or contemplated in such forward-looking statements A short notice on the COVID-19 public health event, and how it can impact investments Given the currently evolving issues around the Coronavirus (or Covid-19) globally, which has officially been designated a pandemic by the World Health Organisation, we wish to notify that, as with many firms, business may be disrupted. A public health crisis, pandemic, epidemic or outbreak of a contagious disease, such as the recent outbreak of Coronavirus (or Covid-19) in Australia, Italy, China, South Korea, the United States and other countries, could have an adverse impact on global, national and local economies, which in turn could negatively impact investment returns in any of Ausbil Investment Management Limited's registered managed investment schemes (the Funds). Disruptions to commercial activity relating to the imposition of quarantines or travel restrictions (or more generally, an inability on behalf of authorities to contain this pandemic) may adversely impact any investment, including by delaying or causing supply chain disruptions or by causing staffing shortages. The outbreak of Coronavirus has contributed to, and may continue to contribute to, volatility in financial markets. The impact of a public health crisis such as the Coronavirus (or any future pandemic, epidemic or outbreak of a contagious disease) is difficult to predict, which presents material uncertainty and risk with respect to any investment or fund performance. |
27 Sep 2021 - The Rate Debate - Episode 20
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The Rate Debate - Episode 20 Yarra Capital Management September 2021 The RBA expects a material slowdown in economic growth in September, but is forecasting a bounce-back in December that will stretch into the first half of 2022. Given market uncertainties, is the RBA's confidence justified, and could it mean higher interest rates are coming? Darren and Chris answer this question and more in episode 20 of The Rate Debate. |
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Funds operated by this manager: Yarra Australian Equities Fund, Yarra Emerging Leaders Fund, Yarra Enhanced Income Fund, Yarra Income Plus Fund |
24 Sep 2021 - What is a Life Settlements Investment?
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What is a Life Settlements investment? Tony Bremness, Laureola Advisors September 2021 The sale in the USA of a life insurance policy to a 3rd party
Imagine having the ability to benefit from the diligent financial habits of middle America. Like most residents of advanced countries, Americans have a tradition of establishing a life insurance policy as they start a family, take on a mortgage or build their own business. Over a period of responsible financial discipline, the children become independent, and debt is paid off. The need for insurance cover diminished. Some policyholders realise that their life policy is a financial asset and would seek to cash in its value. Unfortunately, there is a low level of understanding of the options available to cash in life insurance policies. This resulted in over 90% of life policies being terminated in the US without paying a death benefit in 2018. To provide a better outcome, the life settlements market was formed to match policyholders wishing to sell their unwanted cover to investors looking for a non-correlated asset class with the potential for stable returns. A life settlement market will give policyholders additional options in obtaining a higher value of their policies. A life settlement transaction starts with a policyholder selling their life insurance policies to an investor (usually a fund). The life settlement investor buys the life insurance policy from the policyholder and commits to paying future insurance premiums until the insured person dies. The investor then collects the death benefit payout from the insurance company as the concluding repayment of the life settlement transaction. The path of an illustrative policy is shown below. Illustrative example - assume a life settlement transaction backed by a policy with a death benefit of $100k Hence, a life settlement transaction is clearly win-win transaction for the seller and for the investor. The returns to the investor are embedded in the benefit payout collected upon the maturity of the policy. Most market observers estimate a long-term range of 6-12% p.a. as potential returns going forward as long as the portfolio is managed properly. Funds operated by this manager: |
23 Sep 2021 - Is Evergrande Contagious?
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Is Evergrande Contagious? Jonathan Wu, Premium China Funds Management September 2021
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23 Sep 2021 - What are the Benefits of Life Settlements for Society?
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What are the Benefits of Life Settlements for Society? Tony Bremness, Laureola Advisors September 2021 Alignment with ESG principles is becoming imperative in investment management. A majority of Australians expect their super or other investments to be invested responsibly and ethically. In addition to the expectation of returns not being compromised, investors also expect these investments to have a real environmental, societal or governance impact, not just "ethics washing." Due to slow-changing legacies, popular investments such as equity and bonds, funds usually start their ESG journey through implementing negative screening to exclude investments whose activities are considered harmful. However, it is still difficult to directly link the remaining assets to having actual positive ESG impact. These assets might just be less harmful. Positive ESG impact assets are not immediately obvious because most investors are not used to the idea that assets that service a societal need can be profitable. The opportunity in life settlements shows how helping others can be profitable too. How can an investment in life settlements, where returns are made when the insured dies, be a social good? The positive impact that can arise from an investment in life settlements is improved physical and financial wellbeing of senior citizens in the US (where the most active life settlements transactions market operates). An investment in a life settlements fund can help vulnerable retirees and tackle three ESG-related issues in the US: There is a shortfall of retirement savings in the US The National Institute of Retirement Security estimates that approximately 44% of people born between 1944 and 1979 are at risk of having insufficient income to meet basic day-to-day expenses in retirement. Due to the savings shortfall, seniors cannot access long-term care The average middle-class senior citizen does not have sufficient savings to cover the cost of long-term care. When accounting for long-term care costs, 69% of households are at risk of being unable to maintain their standard of living in retirement. Instead of helping to ease this shortfall, life insurance policies add to the burden with regular ongoing demands for insurance premiums while the senior is alive. Every year since 2009, over 33 million life insurance policies terminate prematurely which means the policyholder does not realise a benefit from the policy despite paying premiums for decades. The American Council of Life Insurer reported over 90% of life policies terminate without paying a death benefit in 2018. Life settlements provide a solution to these issues by providing a cash payout to the seniors and by shifting the burden of the insurance premium to life settlements investors. By investing in this asset class there is potential for:
Researchers from London Business School estimated in 2013 that the value unlocked by the life settlement market is on average about four times greater than that of the surrender value offered by insurance companies. While life settlements might not look like a candidate as a force for ESG- aligned investing, its fundamental raison d'etre is to address a societal need for better retirement provision. In return for such social good, life settlement investors can obtain stable, uncorrelated returns which has historically been in the teens. Tomorrow, we continue this release with a follow-up article 'What is a Life Settlements Investment?". Funds operated by this manager: |
22 Sep 2021 - Crispin Murray: What's driving ASX stocks this week
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Crispin Murray: What's driving ASX stocks this week Crispin Murray, Pendal 20 September 2021 |
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Here are the main factors driving Australian equities this week according to our head of equities Crispin Murray. Reported by quantitative analyst Lee Ma GLOBAL EQUITY markets remained soft last week. The S&P500 fell 0.5%, bringing month-to-date performance to -1.9%. In Australia the S&P/ASX 300 was flat, though there was some meaningful sector divergence. Metals and Mining came off 4.4% while Energy was up 3.5%. There were two key drivers of this performance:
Covid and vaccines Domestic news has been generally positive. NSW Covid cases peaked at a lower level than feared and vaccine penetration has continued to grow solidly. Take-up rate for the first dose has risen to 82.2% — up 3.7% compared to last week. This rate has been holding up well. That's important since a higher rate will help relieve potential strain on hospital systems in future outbreaks and reduce the likelihood of future lockdowns. The seven-day moving average for second-dose vaccinations is close to 61,000 this week — up from about 50,000 last week. If this trend continues we might get to 80% full vaccinated — and further relief from lockdowns — before October 18. Globally case numbers continue to improve, albeit marginally in the UK and the US. Return-to-school impact can be seen in the higher ratio of kids in case numbers. Though this is tending to sustain case numbers rather than increase them. Hospitalisation numbers have been slowly improving in both counties. This is leading to some evidence of improved sentiment in the US. Economics and policy Tension has been building for weeks around Evergrande, China's (and the world's) most indebted property developer. Evergrande's bond interest payments are due on September 23. The question is whether the market will see a bankruptcy or some form of debt restructure. More importantly, people are contemplating whether this will have a cascading effect on China's other property developers and the economy more broadly. Weakened sentiment contributed to the precipitous drop in iron ore over the week. We see great uncertainties around how this will eventually play out. There is a good chance a default is possible with the Chinese government choosing to send a strong message on property speculation. But we think the outcome will be something the government can manage, since Evergrande is not a state-owned enterprise and is not as systemically important. That said, we will reach a crescendo of concern over the next couple of weeks. Outside China, the focus has been on renewed concerns that inflation is set to be persist for longer, leading to faster tapering and potentially an earlier move in rates. Inflation fears in the US have come mainly from a combination of labour shortages and unemployment insurance (UI) payments coming to an end. The next few weeks will be an important test of the durability of labour tightness. Recent pricing power surveys clearly indicate that US companies are pushing through pricing increases in a number of sectors. This reflects input price pressures, constrained availability of product and higher labour costs. Also, gas prices continue to remain far higher than we have seen for years in the US and Europe. Inventories are low heading into winter. There is a 70% probability of a La Nina weather event, which may lead to a colder winter. There are concerns elevated gas prices will persist, which has already led to higher electricity prices in the US and UK. All eyes are on the Fed's September meeting this week. The market will closely watch how they signal the pacing of tapering and their quarterly update on the dot plots. The dots are expected to have shifted forward again towards the median rate rise around the turn of 2023. The other focus will be on the number of rate rises through to the end of 2024. Similarly, there was media attention on unpublished forecasts by the ECB, which could see inflation rising 2% by 2025. This may lead to rates rising in 2023. All this has added to the market's wariness on the inflation impact on central bank policies. Markets The market saw a continued drop in iron ore price. The seaborne benchmark fell 22% last week and is now down 37% for the calendar year-to-date. In contrast the oil price was up by 3% and 45% in the same periods. The main reason for this disconnect was iron ore's reliance on Chinse demand, compared to oil's link to global demand. The fall in iron ore has been driven by a number of factors. It had an over-extended starting point, driven by surging steel production in China in 1H21. The production surge was then met by a dramatic slowdown starting from 2H21: steel production was down 18% in July and a further 10% in August. The Chinese government has an aggressive rhetoric around holding down steel production through 2H21 for environmental reasons and trying to keep production growth flat for the full year. These restrictions are expected to continue limiting steel production through to the end of the winter Olympics in late February next year. At the same time the Chinese government has introduced policies to maintain controls of the property sector, which is a key driver of steel demand. Fears for the overall sector have been exacerbated by the Evergrande situation. Also weighing on demand, the Chinese economy has been generally softer recently due to rolling COVID lockdowns. More stimulatory policies on local government bond issuance that funds infrastructure spend are unlikely to kick in until 2022. Lastly, the deteriorating relationship between China and Australia may have led to other measures impacting on the commodity price. Where to from here? The debate is not so much whether iron ore bounces much, but rather whether it can hold in the US$100s or if it continues to move towards a longer term price of US$70. The Evergrande final resolution may mark a sentiment low in China and its property sector. Consequently, some measures to support the economy may be introduced such as the RRR cut. We should still expect relatively subdued demand from China, but the real-time indicators on the economy look to be near their lows. Global demand for steel remains strong, as evident from the very high global steel spreads, suggesting there are still cyclical tail winds. Supply disruption also continues to emerge, with Vale announcing this week its iron ore production next year will be lower than expected. Overall, this week could be the crescendo in negative sentiment before investors start to rebuilding confidence slowly. Against this backdrop, equity markets overall are re-testing support levels. There could be support in early evidence that the US economy is experiencing a re-acceleration as Covid cases start to stabilise and fall. And liquidity from Central Banks remains abundant. Lastly, we note the rotation of value to growth has been mirrored by fund flows. Inflows to tech and outflows from cyclicals look to be at extremes. As such, we continue to see cyclicals holding better from here. |
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Funds operated by this manager: Pendal Total Return Fund |
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This article has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and the information contained within is current as at August 11, 2021. It is not to be published, or otherwise made available to any person other than the party to whom it is provided. This article is for general information purposes only, should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient's personal objectives, financial situation or needs. Because of this, recipients should, before acting on this information, consider its appropriateness having regard to their individual objectives, financial situation and needs. This information is not to be regarded as a securities recommendation. The information in this article may contain material provided by third parties, is given in good faith and has been derived from sources believed to be accurate as at its issue date. While such material is published with necessary permission, and while all reasonable care has been taken to ensure that the information in this article is complete and correct, to the maximum extent permitted by law neither PFSL nor any company in the Pendal group accepts any responsibility or liability for the accuracy or completeness of this information. Performance figures are calculated in accordance with the Financial Services Council (FSC) standards. Performance data (post-fee) assumes reinvestment of distributions and is calculated using exit prices, net of management costs. Performance data (pre-fee) is calculated by adding back management costs to the post-fee performance. Past performance is not a reliable indicator of future performance. Any projections contained in this article are predictive and should not be relied upon when making an investment decision or recommendation. While we have used every effort to ensure that the assumptions on which the projections are based are reasonable, the projections may be based on incorrect assumptions or may not take into account known or unknown risks and uncertainties. The actual results may differ materially from these projections. |
21 Sep 2021 - Jamieson Coote Bonds - August 2021 Market and Performance Review
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Jamieson Coote Bonds - August 2021 Market and Performance Review Channel Capital August 2021 Charlie Jamieson, Chief Investment Officer at Jamieson Coote Bonds discusses the market and performance of high grade bonds in August 2021.
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Funds operated by this manager: CC Jamieson Coote Bonds Active Bond Fund (Class A), CC Jamieson Coote Bonds Dynamic Alpha Fund, CC Jamieson Coote Bonds Global Bond Fund (Class A - Hedged), CC Jamieson Coote Bonds Global Bond Fund (Class B - Unhedged) |
20 Sep 2021 - Opportunities and risks for investors in the latest UN climate change report
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Opportunities and risks for investors in the latest UN climate change report Edwina Matthew, Pendal 11 August 2021 |
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Key points
THE UN's latest Climate Change report made headlines this week with predictions of irreversible global warming, rising sea levels and climate change affecting every corner of the planet. But it also provides evidence-based information to help investors better understand portfolio risks and identify investment opportunities such as carbon capture and methane-reduction technologies. The 3900-page report from the UN's Intergovernmental Panel on Climate Change (IPCC) -- the United Nations body for assessing the science related to climate change -- is the gold standard for research on the science of climate change and options for adaption and mitigation. Government and corporate decision-makers worldwide rely on the IPCC's findings to inform their climate risk assessments and emissions reduction strategies The report -- which was unanimously endorsed by the governments of all 195 country members including Australia -- is based on a three-year analysis of 14,000 peer-reviewed scientific studies. It will be the central terms of reference later this year at COP26 -- the upcoming United Nations climate conference in Glasgow. The report shows unequivocally that human activities are responsible for the warming world. This warming is increasing the frequency and severity of extreme weather events such as heatwaves, droughts, cyclones and heavy rain. Global temperature rises of between 1.5 and 2 degrees Celsius are expected unless deep reductions in greenhouse gas emissions occur in the next few decades. Regardless of action, changes already occurring due to past emissions are now likely to be irreversible for thousands of years. Low likelihood, high-impact events such as ice sheet collapses, ocean current changes or Amazon dieback cannot be ruled out. "It's a sobering read," says Edwina Matthew, Head of Responsible Investments at Pendal. "And remember that these are averages - different regions, different countries, even different states will be impacted to a greater or lesser degree than this average. "For example, the report finds that average global warming is 1.09 degrees Celsius above pre-industrial temperatures. Australian land areas are already 1.4 degrees Celsius above pre-industrial averages. "This is going to increase the probability of extreme weather events, heatwaves, sea surges and drought." Risks and opportunities for investorsWhat should investors take out of the IPCC report? What does it mean for portfolio construction? And how can investors ensure they understand the risks and opportunities posed by global warming? Matthew identifies three headline risks and opportunities for investors to consider:
The most high-profile litigation so far has been a Dutch court ruling that the multinational oil giant Royal Dutch Shell must reduce its emissions because its contribution to global warming violates human rights. Previous IPCC reports were referenced in the court case and this latest one will likely be used in the appeal hearing. A number of Australian cases have also referenced IPCC findings. Sharma v Minister for the Environment [2021] found the federal environment minister owed a duty of care to children who might suffer potential "catastrophic harm" from the climate change implications of approving a NSW coal mine extension. Investors also need to watch for governments being the target of litigation which could affect regulatory approvals and business permissions in their investments. 2. The report's heightened focus on methane is of interest for investors A "strong, rapid and sustained' reduction in methane emissions is required to help reduce greenhouse gas emissions and hopefully avoid the catastrophic impacts of climate change, the report finds. Methane is not only a vastly more potent greenhouse gas than carbon dioxide, but its concentration in the atmosphere has been increasing rapidly. Importantly, it is short-lived in the atmosphere meaning controls on methane can rapidly reduce atmospheric concentrations. Governments are already acting on methane. The EU is proposing curbs on methane emissions while the US is planning tighter emission rules. But it's a tricky problem to solve. Some gas production emits methane. Raising livestock for meat and nitrogen-based fertilisers are major sources. Rotting waste in landfill also emits methane. "All of these are important challenges that investors can play a part in," says Matthew. "Investors can engage with companies to better understand how they're thinking about these issues, what they're doing to mitigate the risks and how they're transitioning to thrive in a low-carbon economy. "Investors can also direct funds to solutions. For example, CSIRO is working with the private sector to commercialise a livestock feed additive made from seaweed, which has been shown to reduce methane emissions in cattle by up to 80 per cent." 3. Carbon removal solutions can also play a role in investor portfolios "Carbon removal is a vital net zero tool which has a place alongside absolute emissions reductions," says Matthew. "It covers a range of investable methods, from afforestation to wetland restoration to carbon capture and storage (CCS) and ocean fertilisation." However carbon removal technologies such as CCS need more development to work at the scale required. We need more co-ordinated efforts to advance these sorts of emissions reduction solutions in sectors with harder-to-abate industrial processes such as cement and steel production. Future climate scenarios are becoming clearer We now know more than ever how possible climate futures could play out. The report is very clear that without "immediate, rapid and large-scale reductions" in emissions, curbing global warming to below 2 degrees Celsius -- the Paris Agreement goal -- will be "beyond reach". These findings call on us all to accept and act on the reality of the situation, including policymakers, investors, businesses and consumers. In the words of the UN Secretary-General Antonio Guterres the report is a "code red for humanity". |
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Funds operated by this manager: Pendal Total Return Fund |
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This article has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and the information contained within is current as at August 11, 2021. It is not to be published, or otherwise made available to any person other than the party to whom it is provided. This article is for general information purposes only, should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient's personal objectives, financial situation or needs. Because of this, recipients should, before acting on this information, consider its appropriateness having regard to their individual objectives, financial situation and needs. This information is not to be regarded as a securities recommendation. The information in this article may contain material provided by third parties, is given in good faith and has been derived from sources believed to be accurate as at its issue date. While such material is published with necessary permission, and while all reasonable care has been taken to ensure that the information in this article is complete and correct, to the maximum extent permitted by law neither PFSL nor any company in the Pendal group accepts any responsibility or liability for the accuracy or completeness of this information. Performance figures are calculated in accordance with the Financial Services Council (FSC) standards. Performance data (post-fee) assumes reinvestment of distributions and is calculated using exit prices, net of management costs. Performance data (pre-fee) is calculated by adding back management costs to the post-fee performance. Past performance is not a reliable indicator of future performance. Any projections contained in this article are predictive and should not be relied upon when making an investment decision or recommendation. While we have used every effort to ensure that the assumptions on which the projections are based are reasonable, the projections may be based on incorrect assumptions or may not take into account known or unknown risks and uncertainties. The actual results may differ materially from these projections. |
17 Sep 2021 - Investment Perspectives: Thinking about office
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Investment Perspectives: Thinking about office Quay Global Investors September 2021 |
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Imagine you are an office manager for a medium sized firm of 20 employees. Under normal circumstances, you and the staff would occupy around 400 sqm of office accommodation located in the CBD. But these are not normal circumstances. Lockdown orders mean that all staff are currently working from home.
You are invited to a Zoom call by the CEO. In between regular interruptions of your 10-year-old requesting you to help print the Storm Boy quiz, it becomes clear the CEO has big changes in mind for the post-COVID world. You are informed that upon returning to the office, the new company policy will be to allow each staff member 1 day per week to work from home (WFH). You have been given the task of negotiating with the landlord the firm's new office space requirements. The maths is not as simple as it seems Assuming the WFH days are not rostered and are available on a random basis, there are potentially days when a large number of your 20 staff are in the office at the same time. You may even contemplate the possibility that all 20 are in the office on the same day. If so, the decision will be to either have no reduction in office space, or risk an uncomfortable and cramped office conditions on random days. To put some science around the problem, you decide to run a Monte Carlo simulation[1] to calculate the maximum number of employees on any given day over 100 days, and the chance (probability) of hitting that number. Again, assuming the days working from home are not rostered and generally random (for example, no preference for Friday or Monday), the probability of at least 1 day (from 100) of each 'number of staff in office' scenario can be estimated as below.
Source: Quay Global Investors What the above chart shows is that over 100 work days (approx 4 months), there is an 85% chance that at least 1 work day will have all 20 employees in the office. Conversely, there is a 15% probability that at most 19 employees will be in. To be clear, there will be other days when there are less - but this analysis is calculating the maximum workers in the office on any particular day over 100 days, since this is the basis for the required office accommodation. As office manager, depending on how un/comfortable an environment you want for your staff, the overall space reduced will be between 0-5%. Running similar analysis for 2, 3 and 4 days WFH scenarios results in less needed space (obviously), but the relationship is far from linear.
Source: Quay Global Investors So even under the scenario where employees are allowed 4 (out of 5 days) to randomly work from home, there is at least 1 day in 100 where 50% of staff will be in on the same day. So office usage is only reduced by 50% despite 80% days worked from home. How realistic are our assumptions? To us, the idea of a rostered WFH day for staff seems unlikely. It seems to fly in the face of 'flexible work days', which is the main attraction of WFH. We think it is more likely there will be biases for preferred days, which suggests our analysis above is too bearish on overall long-term office demand. The above analysis also assumes every employee will want to WFH 1 day per week. As the lockdowns across Australia drag on (6th time in Melbourne), it is reasonable to think this is an unrealistic assumption. This would again mean our analysis above is too pessimistic. Other considerations? Investment considerations So, when considering office property as an investment we simply ask ourselves two questions:
The purpose of this article is to consider the second question. If the answer to both questions is 'yes', an attractive investment opportunity may well exist. What we don't know is whether office tenants will 'experiment' with WFH scenarios, which will temper short-term tenant demand - at least for the foreseeable future. In other words, it could take a long time for values to recover, and the next development cycle to emerge. But for long-term investors, this shouldn't matter. Whether the recovery is quick or slow, so long as the entry point is below cost, then the capital appreciation from the purchase will exceed a rise in building costs (which should roughly match inflation). If an adequate return on capital is generated in the meantime, then our investment objective (CPI + 5%) total return is achievable.
Source: Quay Global Investors Concluding thoughts Yet, as we have highlighted in previous Investment Perspectives, this is certainly not the case for retail; and we think we have illustrated it is not likely to be the case for office. Investing is about finding opportunities or investments priced for a pessimistic outcome that may not happen. These types of investments can sometimes offer a skewed bet - not much loss if the market was right, but big gains if wrong. The office sector may harbour such opportunities. |
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Funds operated by this manager: Quay Global Real Estate Fund |
