Australian Equities High Conviction Portfolio Performance Report – May 2020
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Australian Equities High Conviction Portfolio Performance Report – May 2020 Market overview and portfolio performance Portfolio overview Investment bias Style neutral Designed for Investors with a medium-term investment objective focused on achieving portfolio growth with less focus on generating excess income and is prepared to accept higher volatility in pursuit of higher Jamie Nicol Scott Bender growth Chief Investment Officer Portfolio Manager Benchmark S&P/ASX 200 Accumulation Index The DNR Capital Australian Equities High Conviction Investment objective To outperform the S&P/ASX 200 Accumulation Index by 4% p.a. Portfolio outperformed its benchmark for the period. (before fees) over a rolling three The S&P/ASX 200 Accumulation Index was up 4.36% year period during the period. Information Technology (+14.5%) was Investable universe ASX listed securities with a focus the best performing sector for the period. The move was on the S&P/ASX 200 predominantly on the back of Afterpay’s (APT) strong Number of stocks 15–30 performance, but also reflected the broader rally in non-defensives. Communication Services (+8.4%) also Asset allocation Australian equities 80–100% outperformed as the trio of online advertisers (REA Group Cash 0–20% (REA), SEEK (SEK) and Carsales.Com (CAR)) reacted Stock limit 15% maximum weighting strongly to the reopening of the economy. Minimum suggested 5 years Health Care (-5.34%) lagged the index as investors investment timeframe lightened their defensive exposures in names like CSL (CSL). These trades had become crowded in the depth of the lockdowns, a situation duplicated in Consumer Staples (-0.40%), where supermarket names Woolworths Group (WOW) and Wesfarmers (WES) sold off as we exit the worst of the pandemic. Gross active return 1mth 3mth 6mth 1yr 3yr 5yr 7yr 10yr Incep.* % % % % % % % % % High Conviction Portfolio 6.08 -9.17 -17.46 -5.66 3.29 5.53 8.83 9.83 11.38 S&P/ASX 200 Accumulation Index 4.36 -9.92 -14.59 -6.70 4.35 4.27 6.73 7.25 8.41 Excess Return 1.72 0.75 -2.87 1.04 -1.06 1.26 2.10 2.58 2.97 * Inception date—October 2002 Excess return (calendar year) Source: DNR Capital Performance data relates to the DNR Capital model portfolio. Performance of an investment in this model portfolio through a Portfolio Service may have different performance to the performance in this monthly update as a result of different policies and procedures at different Portfolio Service operators. Past performance is not an indication of future performance. No allowance has been made for taxation and fees are not taken into account. Page 1 of 7 Performance Report May 2020 Market review Over the past month equity markets continued to rally. attempted to price companies based on our expectations The health impact of COVID-19 was less than feared for earnings in 2022 and beyond. For those companies and the reopening of economies occurred earlier than with greater cyclical exposure, we have been more expected. The resultant positive news flow supported conservative with our forecasts. Over the past month we markets and encouraged a rotation into some value have become a little more optimistic (or more correctly, stocks in the market. This month we examine the news less pessimistic) than we were regarding the near-term flow for a range of companies before examining current earnings. In some instances, this translates to a better market positioning and valuations. We also review recent outlook in the longer term. However, the risks remain high economic data. regarding that outlook. In cases where stocks have run hard, reducing the attractiveness of the risk versus return News flow trade off, we have been looking to trim positions. A range of companies announced results in May and provided commentary regarding current economic Asset allocation conundrum conditions. Much of the data was better than feared. Here Supporting markets is the broader positioning of market are snapshots from a range of commentaries: participants. Cash levels remain high. In addition, alternative asset classes are not all that appealing. } In the six weeks to 15 May, James Hardie’s North Low interest rates, uncertainty regarding retail and American volumes were down 3% and Australian office property, some difficulties for high-yield credit and volumes were flat. This was substantially better than some hedge fund strategies means equities become expected, with housing activity remaining open more a necessary asset class for many investors if they are than other businesses. We do expect activity levels to looking to preserve purchasing power over the long term. deteriorate over the year. This is illustrated when we compare yields on equities to } In May 2020 total new car sales (59,984) were down the miserly yields on offer from the banks or bonds. 35% yoy … but had bounced 54% mom from 38,926 Cash as % of equity market capitalisation in April 2020. } Retail sales transacted online grew 59% yoy in April reflecting a lack of mobility in the month. Total retail sales year to date are up on last year with strong food and pharmacy sales offsetting the drop in discretionary spend. Consumer spending has held up for those retailers able to sell their goods thanks to JobKeeper and JobSeeker. } SkyCity Casino reopened and reported pokie revenues down only 20% despite distancing restrictions, reflecting pent-up demand and easing of fears of socialising. } New jobs on SEEK’s site in the two weeks to 31 May are up 49% from the April average, although are still less than half the level of February. In China, job ads are down in the mid-teen levels from being 35% down in February. Source: Alpine Macro } The ANZ loan-assistance scheme showed that more customers were seeking assistance. From late April to late May there was a 24% increase in those seeking Grossed up yield on equities versus bonds and cash assistance, with a worrying 18% of those being commercial entities. } Hospitals were able to increase elective surgeries but are not yet at full capacity. } REA Group saw listing volumes return. At its lowest, it was down a better-than-expected 20%. } Some companies have benefited, particularly those supporting people staying at home. Breville enjoyed strong sales of coffee machines and Domino’s continued to see strong growth in some markets (offset by softness in those areas where there was a harsher lockdown). Clearly COVID-19 is having a significant impact on the broader economy and this is impacting the earnings outlook for many companies. We have not been overly Source: DNR Capital concerned about near-term downgrades, but rather have Page 2 of 7 Performance Report May 2020 Valuations An earlier than anticipated reopening of the economy The forward PE chart highlights the market at the and flattening of the COVID-19 curve, combined with upper end of its range. We are mindful that one-year unprecedented government stimulus, helps explain a forward earnings is impacted by the lockdown and not large part of the momentum reversal. Nonetheless, the necessarily reflective of future value. The difficult task valuation dispersion remains at extremes. is to consider what earnings will look like beyond this High PE firms trade at a 85% premium to the market, period. How long-lasting will the impact of COVID-19 which is 31% above the 20-yr average be? How effective will the stimulus be? Will it drive inflation and eat into the purchasing power of money at low interest rates? If interest rates stay low, then equities don’t look all that expensive and should we be willing to pay more, especially for growth stocks? The range of possible answers to these questions suggest significant opportunities will emerge for stock pickers. Rolling forward PE looking expensive Source: FactSet, Goldman Sachs Global Investment Research Low PE firms trade at a 53% discount to the market, which is 8% below the 20-yr average Source: DNR Capital … but cheap relative to bonds (earnings yield versus bonds yield) Source: FactSet, Goldman Sachs Global Investment Research Since the financial crisis, there has been a particularly strong trend of defensive and growth outperformance over value, driven, for the most part, by growth scarcity and very low interest rates. Most periods of cyclical and value outperformance typically coincide with rising bond yields. Bond yields remain extremely low, albeit there has been a modest shift higher recently and there remains the possibility of further steepening of yield curves. This Source: DNR Capital remains a key catalyst. Value rotation Growth has outperformed value since the GFC One of the interesting characteristics of the first phase of the rally was the leadership of growth and defensive companies. This reflected the impact of policy support in reducing tail risks for investors, but there was still lingering uncertainty about when economies would trough and infection rates slow. Over the past couple of weeks markets have moved into a second phase, with a further rally in equities being driven by a sharp rotation of leadership: 1. Cyclicals outperformed defensives 2. Value outperformed growth 3. Small caps outperformed large caps Source: Datastream, Goldman Sachs Global Investment 4. Weak balance-sheet stocks outperformed strong. Research Page 3 of 7 Performance Report May 2020 While value/cheap/low-PE/cyclical stocks continue to look The US has seen a large increase in unemployment and appealing on valuation, a sustained economic recovery is a collapse in labour participation, but this has coincided more likely required to deliver sustained outperformance with a large pickup in the savings rate. Consumers are of these stocks. Until this occurs, it is likely that: in pretty good shape. They have de-geared while they are locked up at home.