Antares June 2021 Australian Equities Fund Quarterly Investment Update
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Quarterly Investment Update Antares Australian Equities Fund – June 2021 For adviser use only Highlights for the quarter Performance: The Fund returned 7.3% (net of fees) for the June quarter compared to its benchmark return of 8.3%. Contributors to performance: Positive contributors – Aristocrat Leisure, Iluka, Woodside (not owned); Negative contributors – Incitec Pivot, Amcor, CBA (underweight). Stock activity: Buys/additions – Computershare, Downer EDI, Endeavour Group, IGO Limited, Northern Star, Qantas, Ramsay Healthcare, Treasury Wine Estates ; Sells/reductions – BlueScope Steel, Scentre Group, Tabcorp . Fund snapshot Inception date 3 July 1995 Benchmark S&P/ASX 200 Total Return Index To outperform the benchmark (after fees) over Investment objective rolling 5-year periods Investment returns as at 30 June 20211 Period 3 months 1 year 3 years pa 5 years pa 7 years pa Since inception pa Net return2 % 7.3 35.0 7.2 9.6 7.5 9.3 Gross return3 % 7.5 35.8 7.8 10.4 8.3 10.2 Benchmark return % 8.3 27.8 9.6 11.2 8.8 9.5 Net excess return % -1.0 7.2 -2.4 -1.6 -1.3 -0.2 Gross excess return % -0.8 8.0 -1.8 -0.8 -0.5 0.7 1 Past performance is not a reliable indicator of future performance. Returns are not guaranteed and actual returns may vary from any target returns described in this document. 2 Investment returns are based on exit prices, and are net of management fees and assume reinvestment of all distributions. Contributors to performance Positive • Aristocrat Leisure (ALL, overweight): The business continues to go from strength to strength and there were more positive earnings revisions over the quarter. Aristocrat is seen as a growth stock and has also benefited from the strong thematic pivot away from “value” into “growth” over the quarter. • Woodside Petroleum (WPL, not owned): Woodside, in our view, has suffered issues with growth projects and the expected return on invested capital for some time. These issues came to the fore on reports that Woodside faces significant cost increases for its Scarborough gas project. • Iluka Resources (ILU, overweight): The mineral sands market has been improving, leading to significant earnings upgrades for ILU. The company’s price started to move strongly in early May when it appeared that the Australian government supports Iluka’s potential rare earths refinery project in Western Australia. The feasibility study is expected to be completed during the first half of 2022. 1 Figure 1: Fund attribution – June quarter Source: Antares, June 2021 Negative • Incitec Pivot (IPL, overweight): Please refer to the comments in the trading activity section. We believe the market took a short term view and overreacted to the downgrade. We can understand why, this has been a disappointing stock, however, the underlying fundamentals are improving rapidly, which should eventually impact performance positively. • Commonwealth Bank (CBA, underweight): CBA rallied after the other three major banks went ex- dividend last quarter. We often see this type of dividend hunting rotation in the bank sector. CBA continues to perform strongly in both deposits and housing lending, however, the valuation seems to be an outlier in a global context • Amcor (AMC, overweight): AMC’s share price moved up and down over the quarter and finished largely unchanged on no material news.. Overview and Portfolio activity Markets are largely reacting to changing opinions around a multitude of factors including economic activity, inflation expectations, central bank policies and valuations: • Economic recovery and consequences for earnings. Have growth expectations already peaked? Are we moving into the mature lower growth stage of the recovery? • Inflation and inflationary expectations. One of the most important economic issues outside of growth, remains that of the outlook for inflation and inflationary expectations. Central banks maintain their view that the uptick is transitory. We are not so sure, but at the time of writing, the market is suggesting the reflation trade is unravelling. Part of this debate now centres around rates of change of monetary and fiscal stimulus. Although fiscal deficits in the larger economies may remain well above historic levels, there is an argument that relative to the past 12 months, they will be much lower. Therefore, the lower stock of credit growth will be the important determinant in slowing down inflation. For example, it could be argued that a US fiscal deficit of 10% of GDP is very loose, however, coming off a 15% deficit last year implies tighter conditions this year than last. • Central banks’ monetary accommodation and the outlook for both interest rates and asset purchases. During the June quarter, both the Fed and the RBA seemed to slightly wind back expectations as to when asset purchases will taper. When the Fed surprised the market with a more hawkish attitude, the equity market took this as a sign that the cyclical trade had peaked, and that a less accommodating Fed would see the economy slow down, thereby pushing longer term Antares Australian Equities Fund Quarterly Investment Update – June 2021 2 interest rates lower. The reaction of equity markets to this scenario was the outperformance of the market factor of “growth” compared to “value”. • How to generate returns in a very low interest rate environment. We continue to see strong speculative fervour in a number of asset classes and other areas. Equity markets continue to reflect valuations that are derived from very low interest rates and abundant global liquidity. Valuations are at elevated levels around the globe, which is unsurprising given the relative unattractiveness of cash and bonds. US valuations seem more extreme than Australian valuations, which raises the possibility, that similar to after the tech bubble burst, Australia may experience a few years of better returns than US equities. A recovery from covid is seemingly fully factored into equity markets. Australia’s stance of eradication, closed borders and lockdowns looks to be at odds with re-openings in the US and Europe. From a market perspective, if this continues for the rest of the year, investors may start to differentiate more between Australian and international cyclical sectors. Australian Equities Australian equities are trading at a very high multiple relative to history. What does this mean for future returns? Normally one would expect that paying an above market multiple would lead to somewhat lower than average returns going forward. As the Australian market is made up of several very diverse industry groups, we will look at valuations in various industries. Figure 2: ASX historic valuations Source: Goldman Sachs, Factset; June 2021 The Resource Sector Mining - The sector looks to be trading at below average multiples at a PE ratio of around 12 times. The complicating factor is that the largest profit pool in the resource sector is iron ore, and we expect over the next few years there will be much greater supply coming on-stream which implies that the current iron ore price is likely unsustainable. We have spoken previously about credit growth in China, which tends to lead global manufacturing orders. At present this is slowing and flashing a major warning signal for commodities. Antares Australian Equities Fund Quarterly Investment Update – June 2021 3 Figure 3: China credit impulse Source: Bloomberg, June 2021 Energy - Carbon related energy such as oil, and now gas, has become somewhat of an ESG pariah. In the US we have seen Exxon Mobil lose a proxy fight with green investors meaning it will take on two ’green’ directors, whose agenda is for the oil company to reduce its carbon footprint. In Europe we have seen Royal Dutch Shell ordered by a court ruling from The Hague to reduce their carbon emissions by 45% from 2019 levels by 2030. These types of issues have seen the energy sector de-rate. Currently the energy sector is trading historically cheap at a sector multiple of 15.7x. We discuss the outlook for energy later in this report. Figure 4: ASX 200 Energy Sector relative valuation Source Goldman Sachs, June 2021 Industrials The industrial sector in aggregate looks to be trading way above historic norms. But an analysis of individual sectors reveals stark divergences. Cheaper industrial sectors Banks (16 times FY22 forecast earnings). The sector is cheap relative to the market, but quite fully priced based on historic sector multiples. Insurers (15 times). The sector has suffered some large covid claims, so it is somewhat difficult to measure these businesses based on historic claims. But based on current multiples it appears reasonably priced relative to the market. Antares Australian Equities Fund Quarterly Investment Update – June 2021 4 Expensive industrial sectors Healthcare (40 times) The sector is trading at historically high multiples, partly due to the market favouring stable growth businesses when interest rates are low. Information Technology (114 times) The sector looks hugely expensive, but the difficulty is that because these are very high growth businesses, using PE multiples is notoriously risky and can produce poor results. Perhaps the most important issue for these companies is the continuation of low interest rates and abundant liquidity, which would allow sustained high multiples if their growth continues. Infrastructure. The sector always trades on high multiples. We believe DCF valuations are the only appropriate measure to value infrastructure businesses. Consumer staples (25 times) This sector is mainly supermarkets, which have performed well during covid and maintained historically high multiples. From an investment perspective, the current investment conundrum is that the very highly rated sectors are those that can be considered high growth and or defensive, and in some cases quality, and are therefore desirable businesses outside of valuations, whereas the cheaper sectors are financials and cyclicals, which are more exposed to the economy, and are therefore the most volatile should the market receive a setback.