Fund Manager Commentary Quarter ended 31 March 2019 pendalgroup.com 2 Table of Contents Australian Shares ............................................................................................................................... 3 International Shares ........................................................................................................................... 8 Australian Fixed Income ................................................................................................................... 11 International Fixed Income ............................................................................................................... 13 Credit ................................................................................................................................................ 14 Cash ................................................................................................................................................. 15 Australian Property ........................................................................................................................... 18 International Property ....................................................................................................................... 19 Active Balanced ................................................................................................................................ 20 Performance as at 31 March 2019 ................................................................................................... 24 3 Australian Shares Pendal Australian Share Fund Market Review The Australian equity market orchestrated a meaningful turnaround in the first quarter of CY2019, despite a somewhat less sanguine reporting season in February. A few factors contributed to the general improvement of investor sentiment: In the US there has been a material shift in rhetoric from the Fed. Comments now indicate a more dovish stance suggesting the board is not as deaf to market feedback as many feared. While we are still facing an environment of reduced liquidity, investors are now less concerned that a sharp liquidity crunch could drive a more sustained correction. Domestically, the implications of Vale’s tailings dam tragedy provided the iron ore miners with a tailwind. The Brazilian miner’s new 2019 volume estimates take into account the effect of mine closures and disruptions from the review into the safety of its tailings dams. New guidance suggests that, even with some deployment of existing inventory, the cut in volumes will be at the upper end of the market’s range of expectations. Overall, the S&P/ASX 300 index capped its strongest quarter since September 2009, with a gain of 10.9%. Large cap Resources (+16.5%) outperformed strongly; whereas large cap Industrials (+7.8%) were the laggard. Most of the 11 GICS sectors recorded double-digit gains over the March quarter, with limited exceptions being Health Care (+6.7%), Financials (+5.9%), and Consumer Staples (+5.0%). Information Technology (+20.0%), Materials (+17.7%) and Communication Service (+16.6%) had the largest absolute gains. Beneath the underwhelming headline return for Financials, performance was divergent amongst all: Diversified Financials (+13.6%) and Insurance (+14.2%) both recorded strong gains over the quarter; however they were more than offset by disappointing performance from heavyweight Banks (+3.0%). While the wrap-up of the Royal Commission gave the banks a boost in February, it was proven short-lived. The operating environment remains challenging for the whole sector, as the downward trend of the domestic property market is putting great pressure on banks’ loan books. In addition, the Reserve Bank of New Zealand has proposed to raise the minimum core tier one capital requirement for NZ banks from 8.5% to 16% - versus 10.5% in Australia, which will affect all the Kiwi subsidiaries of the ‘Big Four’, potentially forcing the parents to raise additional capital at some stage. Turning to Consumer Staples (+5.0%), the strong performance of infant manufacturers continued, including A2 Milk (A2M, +32.0%) and Bellamy’s (BAL, +51.8%). The latter’s recently-launched new formula has helped to raise BAL’s brand awareness and management is also hopeful of receiving approval from China's State Administration for Market Regulation during this year. Despite this cohort’s strength, the underperformance of supermarket duo, Woolworths (WOW, +5.0%) and Coles (COL, +0.9%) weighed on the sector’s relative performance. Coming out of reporting season, it was evident that the domestic operators are facing issues from higher costs coming through and the top line not moving as much as required to offset margin pressure. On the more positive side, the strong gains by oil and gas explorers, including Woodside Petroleum (WPL, +14.5%), Santos (STO, +26.2%) and Origin Energy (ORG, +12.8%) were largely attributable to the recovery of the oil price, as OPEC production cuts begin to take effect and fears of a major global slowdown recede. Oil companies form a significant part of global corporate credit markets and an improvement in the oil price has relieved some pressure here and seen corporate credit spreads narrow, signalling more confidence. 4 Finally, the decline of long-term bond yield over the quarter, from 2.68% to 2.42% for the US 10- year, and from 2.32% to 1.77% for the Australia counterpart, benefited the Real Estate (+14.0%) sector in general, as well as some bond-proxy infrastructure companies, such as Transurban (TCL, +13.3%) and Atlas Arteria (ALX, +17.8%). Sydney Airport (SYD, +10.4%) on the other hand underperformed slightly. Portfolio performance The Pendal Australian Share Fund returned 10.99% (post-fee, pre-tax) for the quarter, outperforming its benchmark by 0.07%. Contributors Overweight Santos January saw a marked bounce in oil prices as OPEC production cuts moderated supply and fears of a sharp slump in global growth receded. The West Texas Intermediate (WTI) crude oil price rose 19.2% and Brent Crude gained 20.4% in US dollar terms for the month. Santos (STO, +26.2%) has the greatest leverage to the oil price among the Australian energy names and performed accordingly. Its oil price tailwind was enhanced by a well-received production report for CY-2018, with revenue of US$3.7b well ahead of the US$3.5b expected by the market. Management production guidance for CY-2019 also came in ahead of expectations. The stock did pare some of the gains in March, as the price divergence between oil and gas weighed on sentiment. Overweight Viva Energy Viva Energy (VEA, +38.8%), which distributes Shell fuel in Australia, soared in February on the back of a deal which saw it purchase the right to set the retail fuel margin at the Coles-operated petrol stations, which had been previously set by Coles management. This will result in a meaningful earnings uplift for VEA, as well as allowing it to drop the fuel price – currently at a material premium to the market – in order to win back some market share. VEA has recently battled with the headwind of low refining margins, which should see some seasonal improvement as northern hemisphere refiners shut down for maintenance as they move into Spring. Overweight Fortescue Metal Group The iron ore miners continued to rise in response to an operations update from Vale. The Brazilian miner’s new 2019 volume estimates take into account the effect of mine closures and disruptions from the review into the safety of its tailings dams. New guidance suggests that, even with some deployment of existing inventory, the cut in volumes will be at the upper end of the market’s range of expectations. Given the view that FY19 iron ore prices will be higher than previously thought by many, Fortescue (FMG, +78.1%) outperformed alongside its peers. The closing of the price discount between high-grade iron ore, and the low-grade one that FMG mainly produces also contributed to the company’s strong gains over the quarter. Detractors Overweight Qantas While a stronger oil price weighed on Qantas (QAN, -0.1%) over the quarter, its poor performance in January was primarily a function of the market's response to a large earnings downgrade from fellow airliner, Air New Zealand. In our view, it is important to focus on the essential driver of QAN’s turnaround: the industry discipline which has seen no material domestic capacity added for the last 3-4 years, has resulted in less need for ticket discounting. By contrast, the New Zealand domestic market has been growing capacity at around 5% per annum, while demand has not kept pace. Beyond this, the kiwi carrier had headwinds from a strong New Zealand dollar and engine issues 5 on some planes which led to groundings. Neither of these issues are relevant to QAN and we retain our conviction, despite the short-term drag on our portfolios. Overweight ResMed Despite a strong second quarter bottom-line result, ResMed (RMD, -9.2%) sold off in January after the company missed their revenue target, driven by weaker rest of the world (ROW) flow-generator (FG) growth and a slight miss on revenues from its recent acquisition, Brightree. The mask business globally continues to do well and is supported by recent product launches. Issues around FG growth in the ROW segment are likely to persist over the next two to three quarters, in addition to concerns surrounding the growth rate declines at Brightree. That said, positives from other recent acquisitions are expected to feed through in coming halves. Overweight CSL Our