Fridays can be challenging for all sorts of reasons: Sadly, but probably sensibly, the long lunch is a thing of the past. Nowadays a fair proportion of my Fridays are spent trawling through an assortment of manager's monthly performance reports seeking inspiration for the current week's edition of Hedge Clippings.
Sometimes we are assailed by the antics of a politician of one particular persuasion or another, and at other times the economic or industry landscape provides the necessary spark. This week is different again and we have been gifted by the monthly performance report from George Colman of Optimal Australia. Normally we might borrow a few ideas from such a report, but in this case George encapsulates such an excellent summary of the Australian market and the challenges it is facing that there seems little point in trying to do so.
Therefore, we unashamedly, and I might add with full permission from George, have reproduced in full his commentary below; it is longer than our normal clippings, and considerably more cerebral. Take it away George:
We continue to hold our net risk exposure at close to zero. From this point, it seems madness to us to try to replace fixed income or deposit coupon yield through equity securities at these extended valuations without some form of insurance in place.
The Fed continues to 'taper' its QE program. Why take away the punch bowl at this point? To suggest that this is because QE policies have worked is drawing a pretty long bow in view of 1Q US GDP growth at negative 1%, although the narrative has it that this was only due to bad weather. It seems more likely that even the Fed recognises, belatedly, that they've taken QE too far: "...keeping rates very low - will continue to incentivise investors to reach for yield." (the Fed's Esther George, in classic understatement mode).
With the ECB likely to force a residual element of excess European bank liquidity (the major part has already traded on the signalling, most likely in US Treasuries) into the markets and not, sadly, into the real economy, through negative deposit rates, conditions will likely remain distorted and volatile for some time yet. The warning signs are growing, and it looks like pre-2008 history is repeating itself in several key respects:
In the credit markets, the average quarterly volume of US high-yield debt issuance in 2013 was US$90bn, with 65% of that sold on a covenant-light basis, compared with a quarterly average of US$40bn in 2007 with an average of 28% cov-light. Typical debt to EBITDA leverage in private equity deals has reached similar levels to 2007, at up to 7x, but the junior debt in 2007 was priced at up to 12%, compared to today's 7%.
In Australia, the IPO pipeline has turned into a veritable gusher, with private equity and other sponsors seeking to sell every position not nailed down. Even the deals that failed in late 2013 are now getting done, with no obvious price adjustment, and just prior to large wads of escrowed vendor stock becoming tradeable following June 2014 earnings results.
Finally, the M&A cycle continues to heat up, with KKR launching a conditional offer for the hapless Treasury Wine Estates at $4.70/share, and a counter-bid for developer ALZ, at a 25% premium to NTA.
This is all occurring against a slow deterioration in the economy. As expected, the Coalition Government forecast a $30bn F15 budget deficit, and with the exception of a tax levy on high earners, the budget focused on spending cuts. Having barely noticed the effect of the 2008 global crisis, Australians do not much like the concept of budget austerity, much less the removal of their middle-class welfare entitlements.
Post-budget economic data points are limited, but May's Westpac-MI consumer confidence index declined 7% MoM, with the outlook for family finances and the economy over the next 12 months the hardest hit, plunging 23% and 14%, respectively. Anecdotally, the consumer has been very weak since the budget.1Q's impressive 3.5% YoY GDP growth did not capture the budget effect, and was driven by 4.8% growth in exports, just before bulk commodity pricing fell apart.
As for economic rebalancing in Australia away from mining, a study by UBS showed that since June 2012, 95% of all Australian credit growth has gone into property, and 76% of all business lending has gone into commercial property. This still strikes us as a structurally challenged economy with a richly-valued stock market and currency, both driven by carry money.
For the record the Optimal Australia Absolute Trust has a track record of almost 6 years, having launched the day that Lehman's failed in September 2008. In that time the Fund has returned an annualised 10% and has never suffered a drawdown of more than 1.38%, has an annual standard deviation of 3.49%, and a Sharpe ratio of 1.78.
We think George's opinion is worth listening to.
Specific results received this week include the following PERFORMANCE and NEWS UPDATES:
The Optimal Australia Absolute Trust returned 1.40% over May with an annual return of 4.81% achieved with volatility of 1.70%.
May returned 0.36% for the Bennelong Kardinia Absolute Return Fund and over the previous twelve months, low volatility of 4.27% and returns of 7.49% .
The Paragon Fund had a strong month, returning 3.2% and bringing it's twelve month return to 26.19%.
Taking advantage of stronger global markets, Morphic Global Opportunities Fund also had a strong month with performance for May at 3.91% and 21.73% for the prior twelve months.
18 June in Sydney: MAX: the Marketing, Advertising and Sales Excellence Forum and Awards. Forum 8am - 4:30pm; Awards dinner 7-10pm.
14-15 August in Sydney: Alternative Investments Conference - Investigating the rise and rise of non-traditional high yield and low risk investment products, strategies and allocation in an era of prolonged volatility and low returns.
If you would like your Event listed in our calendar, please contact us.
And now for something completely different this week, sad but true, the latest generation of children can usually play Angry Birds better than they can spell.
On that note, I hope you have a safe and happy weekend.
Best wishes,
Chris
CEO, AUSTRALIAN FUND MONITORS
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Australian Fund Monitors are helping to raise awareness to support research into prevention and cure for cerebral palsy. For more information visit www.cpresearch.org.au or contact me by email.
