Markets continued their positive trajectory in April with strong returns generated across Australian and Global Equities, with listed Real Estate performing particularly well. Despite the strong returns, inflation concerns continue to dominate the market narrative. There are concerns that the so-called ‘reflation trade’, which has been supported by accommodative monetary policy and significant fiscal support, may have overshot as economies begin to open-up. As a result, we have seen commodity prices rise, with oil and base metal prices all appreciating.

The question is whether the rise in inflation is transitory, and that the current trend in prices is simply a function of economies making up for lost time due to COVID, or are we witnessing a structural trend in rising inflation. There is no question that there are supply and demand pressures pushing prices of certain goods and services up. However, Lonsec’s current view is that while we expect inflation to rise in the short-term, particularly in the US, our expectation is that the rise will be within range, and the risk of an out-of-control spike in inflation is not our base case.

Wage growth continues to be sluggish and broader structural deflationary pressures such as the continual technological developments impacting many industries will potentially suppress prices over the long-term. The main risk to this view is that central banks are behind the curve and allow inflation to run beyond manageable levels in their quest to stimulate growth.

From a portfolio perspective, modest inflation is generally positive for Equities. We have maintained our portfolios’ exposure to diversifying assets should inflation come through higher than expected, notably via our exposure to Gold and Inflation Linked Bonds.

IMPORTANT NOTICE: This document is published by Lonsec Investment Solutions Pty Ltd ACN 608 837 583, a Corporate Authorised Representative (CAR 1236821) (LIS) of Lonsec Research Pty Ltd ABN 11 151 658 561 AFSL 421 445 (Lonsec Research).  LIS creates the model portfolios it distributes using the investment research provided by Lonsec Research but LIS has not had any involvement in the investment research process for Lonsec Research. LIS and Lonsec Research are owned by Lonsec Holdings Pty Ltd ACN 151 235 406. Please read the following before making any investment decision about any financial product mentioned in this document.

DISCLOSURE AT THE DATE OF PUBLICATION: Lonsec Research receives a fee from the relevant fund manager or product issuer(s) for researching financial products (using objective criteria) which may be referred to in this document. Lonsec Research may also receive a fee from the fund manager or product issuer(s) for subscribing to research content and other Lonsec Research services.  LIS receives a fee for providing the model portfolios to financial services organisations and professionals. LIS’ and Lonsec Research’s fees are not linked to the financial product rating(s) outcome or the inclusion of the financial product(s) in model portfolios. LIS and Lonsec Research and their representatives and/or their associates may hold any financial product(s) referred to in this document, but details of these holdings are not known to the Lonsec Research analyst(s).

WARNINGS: Past performance is not a reliable indicator of future performance. Any express or implied rating or advice presented in this document is limited to general advice and based solely on consideration of the investment merits of the financial product(s) alone, without taking into account the investment objectives, financial situation and particular needs (“financial circumstances”) of any particular person. Before making an investment decision based on the rating or advice, the reader must consider whether it is personally appropriate in light of his or her financial circumstances or should seek independent financial advice on its appropriateness.  If the financial advice relates to the acquisition or possible acquisition of a particular financial product, the reader should obtain and consider the Investment Statement or the Product Disclosure Statement for each financial product before making any decision about whether to acquire the financial product.

DISCLAIMER: No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented in this document, which is drawn from public information not verified by LIS. The information contained in this document is current as at the date of publication. Financial conclusions, ratings and advice are reasonably held at the time of publication but subject to change without notice. LIS assumes no obligation to update this document following publication. Except for any liability which cannot be excluded, LIS and Lonsec Research, their directors, officers, employees and agents disclaim all liability for any error or inaccuracy in, misstatement or omission from, this document or any loss or damage suffered by the reader or any other person as a consequence of relying upon it.

Copyright © 2021 Lonsec Investment Solutions Pty Ltd ACN 608 837 583 (LIS). This document may also contain third party supplied material that is subject to copyright.  The same restrictions that apply to LIS copyrighted material, apply to such third-party content.

With the recovery in superannuation looking increasingly secure, the focus in May was on the federal budget and some of the new measures to strengthen the system, including additional support to boost women’s retirement savings.

This budget is the second pandemic budget, with the focus now shifting from temporary spending measures to building a more sustainable post-COVID economy.

Importantly for super members, it also reaffirms the increase in the Superannuation Guarantee (SG) to 12 per cent by July 2025 and introduces more flexibility to help Australians save more and enjoy better retirement outcomes.

“The federal budget has one eye on fighting the virus and the other looking to the future to determine what needs to be done to support households, improve our aged care system, and of course ensure superannuation is delivering for everyone,” said SuperRatings Executive Director Kirby Rappell.

“We’re pleased to see the government reaffirm its commitment to the legislated increase in the Superannuation Guarantee to 12 per cent, and take important steps towards ensuring everyone can retire with adequate savings, especially women and those who have been severely impacted by the pandemic.”

Supporting women and parents with more flexibility

Some additional measures announced in the budget to boost women’s retirement savings and increase flexibility include:

  • Abolishing the $450 per month earnings threshold for the payment of the SG.
  • The removal of the work test (for those aged 67-74) for superannuation contributions.
  • The expansion of the ‘downsizer scheme’ to those aged 60 and over.
  • Increasing the flexibility of the Pension Loans Scheme (PLS).

While the budget has taken some important steps to help close the savings gap, it is important to recognise those super funds that have already implemented their own initiatives to provide more flexibility for women and parents.

The table below provides a snapshot of some the key offers available through individual funds to provide targeted value for members.

Funds providing more flexibility for women and parents

Fund Initiative
CareSuper Members on employer approved parental leave can request a waiver of their insurance fees for death, TPD and income protection insurance for up to 12 months. This means, if you’re eligible, your insurance cover can continue while you’re on parental leave at no cost to you.
Cruelty Free Super Offers BabyBump – a refund of the weekly member fee for the time you’re on parental leave, up to a maximum of 12 months.
Future Super Future Super supports those on parental leave through a program called Baby Bump. Baby Bump is a refund of all or part of the annual dollar-based administration fee for the time you’re on parental leave, up to a maximum of 12 months ($93.60).
Grow Super GROW’s Fee Free Super removes fees for eligible new parents. Approved members who are primary carers will pay $0 superannuation fees for 6 months! Members can apply up to 12 months after the birth of their child.
HESTA Every HESTA member can get up to a 12-month break from paying insurance fees while they’re on parental leave.
Hostplus Hostplus members can enjoy Insurance cover without the cost for up to 12 months of parental leave.
Verve Super Verve members who take parental leave after the arrival of a new child, whether by birth or adoption, can apply for a rebate of the annual fixed administration fee for up to 12 months. Verve can also contact your employer, or support you, to ask them to keep paying your super during your parental leave.
Virgin Super Virgin Super Plus offers a Baby Break to members on maternity or paternity leave for up to 12 months. A Baby Break is a discounted asset-based administration fee for up 12 months for eligible members.

Source: SuperRatings estimates

Super fund recovery looks secure

April further solidified the recovery in superannuation with another month of strong performance figures, supported by an improving economic situation and confidence in state and federal vaccination plans.

According to SuperRatings’ data, the median balanced option rose an estimated 2.1% in April, while the median growth option rose an estimated 2.6% and the median capital stable option rose an estimated 1.0%. Over the 2020-21 financial year to date, the median balanced option has returned 14.5%, which captures the rebound in financial markets in the second half of 2020 and the continued momentum through the start of 2021 as the vaccine narrative takes hold.

Accumulation returns to end of April 2021

  FYTD 1 yr 3 yrs (p.a.) 5 yrs (p.a.) 7 yrs (p.a.) 10 yrs (p.a)
SR50 Growth (77-90) Index 18.3% 22.6% 8.5% 9.5% 8.6% 8.7%
SR50 Balanced (60-76) Index 14.5% 18.1% 7.3% 8.3% 7.8% 7.9%
SR50 Capital Stable (20-40) Index 6.2% 7.8% 4.3% 4.6% 4.7% 5.0%

Source: SuperRatings estimates

Pension returns were also positive in April. The median balanced pension option returned an estimated 2.3% over the month and 15.7% over the financial year to date. The median pension growth option returned an estimated 2.7% and the median capital stable option gained an estimated 1.1% through the month.

Pension returns to end of April 2021

  FYTD 1 yr 3 yrs (p.a.) 5 yrs (p.a.) 7 yrs (p.a.) 10 yrs (p.a)
SRP50 Growth (77-90) Index 19.2% 24.1% 9.1% 10.3% 9.5% 9.6%
SRP50 Balanced (60-76) Index 15.7% 19.8% 7.9% 9.0% 8.3% 8.6%
SRP50 Capital Stable (20-40) Index 6.8% 8.7% 4.9% 5.2% 5.1% 5.7%

Source: SuperRatings estimates  

“Confidence is back, and consumers have so far shrugged off the unwinding of the JobKeeper program, but the pandemic is still with us, which means super members should expect markets to remain volatile,” said Mr Rappell.

“The federal government has doubled down on its expansionary fiscal strategy, which will continue supporting the economy as some of the temporary spending measures come to an end. Our relative success in managing the pandemic has meant we can stay open and prevent longer-term scarring to businesses and the labour market.”

Release ends

Warnings: Past performance is not a reliable indicator of future performance. Any express or implied rating or advice presented in this document is limited to “General Advice” (as defined in the Corporations Act 2001(Cth)) and based solely on consideration of the merits of the superannuation or pension financial product(s) alone, without taking into account the objectives, financial situation or particular needs (‘financial circumstances’) of any particular person. Before making an investment decision based on the rating(s) or advice, the reader must consider whether it is personally appropriate in light of his or her financial circumstances, or should seek independent financial advice on its appropriateness. If SuperRatings advice relates to the acquisition or possible acquisition of particular financial product(s), the reader should obtain and consider the Product Disclosure Statement for each superannuation or pension financial product before making any decision about whether to acquire a financial product. SuperRatings research process relies upon the participation of the superannuation fund or product issuer(s). Should the superannuation fund or product issuer(s) no longer be an active participant in SuperRatings research process, SuperRatings reserves the right to withdraw the rating and document at any time and discontinue future coverage of the superannuation and pension financial product(s).
Copyright © 2021 SuperRatings Pty Ltd (ABN 95 100 192 283 AFSL No. 311880 (SuperRatings)). This media release is subject to the copyright of SuperRatings. Except for the temporary copy held in a computer’s cache and a single permanent copy for your personal reference or other than as permitted under the Copyright Act 1968 (Cth.), no part of this media release may, in any form or by any means (electronic, mechanical, micro-copying, photocopying, recording or otherwise), be reproduced, stored or transmitted without the prior written permission of SuperRatings. This media release may also contain third party supplied material that is subject to copyright. Any such material is the intellectual property of that third party or its content providers. The same restrictions applying above to SuperRatings copyrighted material, applies to such third party content.

Federal government doubles down on expansionary budget

It’s been only seven months since the last federal budget in October 2020, which was delayed in order to give the government maximum flexibility to respond to the COVID-19 pandemic. This budget is the second pandemic budget, with the focus now shifting from temporary spending measures to keep the economy afloat to building a more sustainable post-COVID economy and beginning the long journey of budget repair.

What’s clear is that—unlike many of the job saving initiatives employed during the pandemic—the impact on Australia’s fiscal position will be much less temporary, with mounting deficits through the forward estimates set to accumulate a net debt of just under $1 trillion by 2024-25. The consolation is that, with interest rates at record lows and the Reserve Bank of Australia intent on keeping them that way, there has never been a better time for the government to borrow to support households and add to Australia’s infrastructure pipeline.

The government has not taken any chances with this budget. While the economic recovery has been strong—reflected most notably in employment growth—and consumers have so far shrugged off the unwinding of the JobKeeper program, the pandemic is still with us and there are plenty of potential risks that could derail or forestall growth. Instead of taking the opportunity to go harder on budget repair, the government is keen to secure the recovery with a very expansionary budget that doubles down on the 2020-21 fiscal strategy.

Still fighting the virus

Australia’s management of the pandemic has been the envy of the world, but now the test of the Morrison government will be how effectively it can support the roll out of vaccines while providing the necessary fiscal support to businesses, households, and the healthcare system. To address the immediate challenge of the vaccine rollout, the government is providing $1.9 billion through the COVID-19 Vaccination Strategy plus an additional $1.5 billion to extend a range of COVID-19 health response measures.

While Australia is emerging from the COVID-19 shock with a strong recovery in activity and employment, the outlook for the global economy remains highly uncertain. With 800,000 COVID-19 cases diagnosed daily across the world, new strains of the virus emerging and international travel restrictions yet to be lifted, the effects of COVID-19 may not dissipate for some time yet.

Tax relief and targeted support for vulnerable sectors

Aside from the direct COVID-related measures, the real centrepiece of the budget is the tax relief measures, which will provide more dry powder for households, which are now more confident about the direction of the recovery and hopefully willing to spend down the savings they accumulated during the pandemic.

The government will retain the low and middle income tax offset (LMITO) in 2021-22 to provide $7.8 billion in targeted support to around 10.2 million low- and middle-income earners. This is on top of the $25.1 billion in tax cuts flowing to households in 2021-22 that have been announced in previous budgets.

The other key item is the extension of full expensing of depreciable assets for businesses with turnover below $5 billion, which was introduced as a temporary measure in the 2020-21 budget. This budget extends full expensing for another 12 months until 30 June 2023 to encourage additional investment and allow businesses embarking on projects with longer lead times to capture more of the benefits of this measure.

Other initiatives to provide more targeted support include an additional $1.2 billion for the aviation and tourism sectors, the Small and Medium Enterprise (SME) Recovery Loan Scheme, which builds on the SME Guarantee scheme, and an additional $500 million to expand the JobTrainer Fund, subject to matched funding by state and territory governments.

Another infrastructure budget

Infrastructure has become a budget staple regardless of who is in power, and the Morrison government has not missed their opportunity this time around. This budget provides an additional $15.2 billion over ten years for road, rail and community infrastructure projects, which the government claims will support over 30,000 direct and indirect jobs.

The highlights of the infrastructure spend include $2 billion to support delivery of the Melbourne Intermodal Terminal to increase national rail freight network capacity, $2.6 billion for the North-South Corridor (Darlington to Anzac Highway in South Australia) and $2.0 billion for the Great Western Highway Upgrade (Katoomba to Lithgow in New South Wales). This package also includes an additional $1 billion to extend the Local Roads and Community Infrastructure Program.

Improving aged care

Although it took a back seat through the pandemic, aged care reform has been the big issue on the government’s radar following the Royal Commission into Aged Care Quality and Safety. The government has committed an additional $17.7 billion over five years to improve the system, including $6.5 billion for the release of 80,000 additional Home Care Packages over the next two years. The Aged Care Quality and Safety Commission will also receive additional resources to manage compliance and ensure quality care services and the introduction of new star ratings.
An additional $13.2 billion has been provided for the National Disability Insurance Scheme, while a key political focus for the budget has been on the $3.4 billion to support women, including programs to improve women’s safety and economic security.

The elephant in the room: debt and deficits

None of the spending initiatives in this year’s budget would be possible without upending Australia’s fiscal norms. While debt-to-GDP remains low compared to Australia’s peers, the two pandemic budgets will test the political restraints that have traditionally governed the nation’s fiscal settings, even in the wake of the GFC. Government outlays are expected to hit 32.1% of GDP in 2020-21 and, while that is the peak, such a figure would have been unthinkable a decade ago.

Australia’s net debt will hit nearly $1 trillion by 2024-25

 

Source: Budget papers

Net debt is expected to be 34.2% cent of GDP in 2021-22 and peak at 40.9% of GDP in 2024-25. Net debt is then projected to fall over the medium term to 37.0% of GDP in 2031-32. In other words, Australia will be managing the fiscal impact of the pandemic for a decade or more.

While gross debt has increased significantly since the onset of the pandemic, the cost of servicing that debt is lower in 2021-22 than it was in 2018-19 as a result of historically low interest rates. The government’s management of the yield curve has helped reduce refinancing risk and has made repayments less sensitive to short-term yield moves. However, while low yields will be doing much of the heavy lifting, the government must still work to reduce the economy’s dependence on government spending and ensure there is enough room to move when the next crisis hits—hopefully far off down the road!

 

IMPORTANT NOTICE: This document is published by Lonsec Investment Solutions Pty Ltd ACN: 608 837 583 (LIS), a Corporate Authorised Representative (CAR number: 1236821) of Lonsec Research Pty Ltd ABN: 11 151 658 561 AFSL: 421 445 (Lonsec Research). LIS creates the model portfolios it distributes using the investment research provided by Lonsec Research but LIS has not had any involvement in the investment research process for Lonsec Research. LIS and Lonsec Research are owned by Lonsec Fiscal Holdings Pty Ltd ACN: 151 235 406. Please read the following before making any investment decision about any financial product mentioned in this document.

Disclosure at the date of publication: Lonsec Research receives a fee from the relevant fund manager or product issuer(s) for researching financial products (using objective criteria) which may be referred to in this document. Lonsec Research may also receive a fee from the fund manager or product issuer(s) for subscribing to research content and other Lonsec Research services. LIS receives a fee for providing the model portfolios to financial services organisations and professionals. LIS’ and Lonsec Research’s fees are not linked to the financial product rating(s) outcome or the inclusion of the financial product(s) in model portfolios. LIS and Lonsec Research may hold any financial product(s) referred to in this document. LIS and Lonsec Research’s representatives and/or their associates may hold any financial product(s) referred to in this document, but details of these holdings are not known to the Lonsec Research analyst(s).

Warnings: Past performance is not a reliable indicator of future performance. Any express or implied rating or advice presented in this document is limited to “general advice” (as defined in the Corporations Act 2001 (Cth)) and based solely on consideration of the investment merits of the financial product(s) alone, without taking into account the investment objectives, financial situation and particular needs (“financial circumstances”) of any particular person. Before making an investment decision based on the rating or advice, the reader must consider whether it is personally appropriate in light of his or her financial circumstances or should seek independent financial advice on its appropriateness. If the financial advice relates to the acquisition or possible acquisition of a particular financial product, the reader should obtain and consider the Investment Statement or the Product Disclosure Statement for each financial product before making any decision about whether to acquire the financial product.

Disclaimer: This document is not intended for use by a retail client or a member of the public and should not be used or relied upon by any other person. No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented in this document, which is drawn from public information not verified by LIS. Financial conclusions, ratings and advice are reasonably held at the time of completion (refer to the date of this document) but subject to change without notice. LIS assumes no obligation to update this document following publication.

Except for any liability which cannot be excluded, LIS and Lonsec Research, their directors, officers, employees and agents disclaim all liability for any error or inaccuracy in, misstatement or omission from, this document or any loss or damage suffered by the reader or any other person as a consequence of relying upon it.

Copyright © 2021 Lonsec Investment Solutions Pty Ltd ACN: 608 837 583

While the use of a value approach or value (factor) bias is often associated with equity portfolios, the extraordinary events in early 2020 served as a reminder of the value bias inherent in many multi asset solutions. This bias results from the valuation factors inherent in both asset allocation and security selection decisions.

The emphasis managers place on ‘value’ in their asset allocation and security selection processes has impacted portfolio performance over the past several years given the headwinds ‘value’ as a factor has faced. Lonsec’s recent review of multi-asset funds emphasised the need for adequate risk management systems to ensure any ‘bets’ in the portfolio are intended and in line with managers’ strategic decisions. Moreover, Lonsec was interested to discuss the role of ‘value’ in asset allocation decisions alongside other factors including liquidity, sentiment and policy, and the timeframe in which managers frame their decisions.

In this thought piece Lonsec aims to answer why the last five years has been a challenge for asset allocators, the role the ‘value’ factor has played and why Lonsec believes it is vital that asset allocators and their investors understand the drivers and extent of any bias’s present in portfolios and the likely effect this will have on portfolio performance at different points in the cycle.

Asset allocation

Investment managers who build diversified portfolios of assets with allocations to an array of asset classes (i.e., multi asset portfolios) often use an asset allocation approach as the core building block of their portfolio construction process.

While there are numerous asset allocation approaches, the most recognised are long term ‘strategic asset allocation’ (SAA), medium term ‘dynamic asset allocation’ (DAA) and short term ‘tactical asset allocation’ (TAA). While some managers have defined their own asset allocation approach and associated acronym, their approaches invariably sit somewhere between long term SAA and short term TAA.

For managers who build portfolios based on a clearly defined asset allocation approach, capital market assumptions (i.e., forecasts for asset class returns, asset class risks and cross-asset correlations) are key inputs into the setting of portfolio asset allocation, regardless of the approach used.

When defining capital market assumptions for the forecast period, asset allocators commonly use expected returns, expected risk and correlations as the essential inputs into the asset allocation process. For SAA decisions, expected returns are heavily reliant on current valuations. DAA processes by contrast focus on medium term horizons of circa 18 months to 3 years and can focus on broader factors in determining the under and overweights to particular asset classes. In Lonsec’s experience, valuation will still play a role, and in some cases a heavy role, in determining positioning over these periods. For example, if equity markets are deemed to be trading at high valuations relative to long term averages (e.g., on metrics such as price to earnings multiples), asset allocators may choose to down-weight equities in their current asset allocation. This decision may be driven by the assumption valuation multiples will normalise in the ensuing period towards the long-term average (e.g., where a compression in earnings multiples drives a fall in share prices). Likewise, in the fixed income sphere, low yields and narrow spreads have meant allocating to these sectors has been a challenge. The difficulty with this approach is that valuations can overshoot for an extended period of time, especially when liquidity is higher than average and central bank policy has been supportive. The use of valuation metrics as inputs in asset allocation approaches is likely to create a bias towards asset classes offering attractive valuations and in turn creating value biases in multi asset portfolios.

The dominance of macro factors in overshadowing asset specific factors has continued to be a discussion point between Lonsec and multi-asset managers. Lonsec has found those using a framework to assess the economic and market cycle to have a more holistic DAA framework when compared to others using more simple methodologies.

Security selection

Alongside asset allocation, another dominant driver of positioning for multi asset managers is security selection. Having identified the desired portfolio asset class exposures, in order to select the securities for inclusion in each asset class managers will often analyse the prevailing valuation levels of securities or sectors. This analysis can involve drilling down to the sub asset class level, geographical location level, and the sector/industry level to find the best opportunities within an asset class.

While some managers may seek to build portfolios with diversified factor exposures, many managers tilt security selection away from seemingly expensive areas of securities markets and towards undervalued areas of securities markets.

As Figure 1 shows, entering 2020 the valuation gap between growth equites and value equities had moved to highs not seen since the early 2000’s bubble:

Figure 1

While increasing exposure to cheaper areas of securities markets makes sense intuitively, where multi asset managers apply this approach across many of or all the underlying asset classes utilised, it may create a large value factor bias within portfolios. Lonsec believes managers need to be aware of these biases and ensure exposures are intended rather than unintended positions.

The last five years, and heading into 2020

In the years after the GFC, having taken official cash rates to record lows, the modus operandi of central banks has been to pump liquidity into economies and investment markets at any and every sign of trouble. This has helped to drive down bond yields and expected returns across all asset classes. The challenge of where to invest in this environment has been one impacting all asset allocators.

While managers have stuck to their investment and portfolio construction processes over this time, Lonsec notes there has been a disconnect between portfolio positioning and financial market performance. The challenge for managers over this period was to correctly form a view on the business cycle. With interest rates rising (albeit slowly) from late 2015 to 2018 and contrasting views on the emergence of inflation, there were divergent views on how portfolios should be positioned (over this period Lonsec has noted funds in its Variable Growth Assets > Real Return sector have been positioned at both ends of the risk spectrum). Likewise, views on the market cycle becoming later stage were predicated on valuations becoming more expensive across the board. Many of the managers we rate had been conservatively positioned due to this, and underperformed passive benchmarks which benefitted from the continued and increasing richness of valuations (particularly in geographies like the US, and sectors like Technology and Healthcare).

While there were signs of a pick-up in economic growth and a corresponding response from value and cyclical assets in late 2019 and some managers became more constructive on market outcomes, the three-year period leading into January 2020 undoubtably favoured strategies that invested in growth assets over value assets, as shown in Figure 2:

Figure 2

The 2020 experience – the bear market

The COVID induced sell off that began in February 2020 saw value stocks fall faster and further than growth stocks through late March 2020. Value orientated strategies have at times underperformed at the beginning of equity bear markets, arguably as investors throw in the towel and finally pull the sell trigger on their worst performing stocks, and this was the case in 2020. Figure 3 shows that from 1 Jan 2020 to 20 May 2020, the performance of value stocks materially lagged that of growth stocks.

Figure 3

Figure 4 shows that the valuation gap between growth equities and value equites continued to reach new multi-year highs during and coming out of the COVID induced bear market:

Figure 4

The 2020/21 experience (so far) – multi asset managers

The chart in Figure 5 shows the experience of a sample of managers in the Variable Growth Assets – Real Return sub-sector. While some multi asset managers suffered smaller drawdowns relative to peers by entering February 2020 defensively positioned based on valuations (and had been conservatively positioned for much of the prior two to three year period), other multi asset managers nimbly reduced risk exposures by reducing equity exposures or adding downside protection through derivatives.

Among the managers that suffered larger drawdowns relative to peers, many had pronounced value biases through their asset allocation and security selection approaches, in some cases adding significantly to cheap, cyclicals as the market sold off. These managers were impacted when growth styles started to recover more quickly. Lonsec notes, however, that those managers with value biases have bounced back (in some cases sharply) as the value rotation has taken hold since late 2020, though Lonsec notes it is too early to suggest how sustained this will be and may be somewhat dependent on the path of the economic recovery from here.

Lonsec believes articulation of the manager’s strategy to be important given it is likely to provide a greater understanding of how the manager and their fund is equipped to perform in different environments. Nonetheless, it is important to recognise that Lonsec’s ratings encompass a ‘through the cycle’ view on managers we assess.

Figure 5

Key takeaways

Whilst portfolios may be diversified at the asset class level, this may not be indicative of the inherent level of diversification overall within portfolios. As Lonsec has seen in its recent multi-asset review, biases towards the value factor have, in some cases, been high and exacerbated by biases coming from both asset allocation and security selection effects. Lonsec prefers to see diversification across not only style, but also strategy, geography, sector and factor. Value biases have been pronounced in some portfolios in recent years given high valuations and the belief in some quarters that the cycle was maturing. This positioning has proved a performance headwind against passively managed SAA weighted benchmarks in recent years and in recent months led to significant performance dispersion among different strategies.

Going forward, while it is difficult to time decisions over shorter periods, Lonsec expects greater levels of dispersion in markets which should provide greater opportunities for active asset allocators to extract alpha from markets. Lonsec continues to discuss the foundations for any active bets in portfolios and the framework behind such decisions. Moderately leaning into certain style or factor bets can be challenging but possible at points in the cycle when supported by a strong asset allocation framework.

When the value bias in an investment manager’s approach is compounded in the security selection process, Lonsec believes asset allocators must be cognisant of the degree of value bias in their portfolios to ensure this is in line with their strategy (or any factors for that matter). All bets must be intended with unexpected performance resulting for those unaware of their true exposures. As valuations have been shown to have stronger explanatory power on returns over longer term horizons, Lonsec also continues to progress conversations on the time horizon of manager’s decision making processes. Overall, Lonsec believes that asset allocators making shorter to medium term decisions should include value as one factor among others that may have increased forecasting power over the medium term.

Authors

Darrell Clark, Manager, Multi-Asset

Sebastian Lander, Senior Investment Analyst

Issued by Lonsec Research Pty Ltd ABN 11 151 658 561 AFSL 421 445 (Lonsec). Warning: Past performance is not a reliable indicator of future performance. Any advice is General Advice without considering the objectives, financial situation and needs of any person. Before making a decision read the PDS and consider your financial circumstances or seek personal advice. Disclaimer: Lonsec gives no warranty of accuracy or completeness of information in this document, which is compiled from information from public and third-party sources. Opinions are reasonably held by Lonsec at compilation. Lonsec assumes no obligation to update this document after publication. Except for liability which can’t be excluded, Lonsec, its directors, officers, employees and agents disclaim all liability for any error, inaccuracy, misstatement or omission, or any loss suffered through relying on the document or any information. ©2021 Lonsec. All rights reserved. This report may also contain third party material that is subject to copyright. To the extent that copyright subsists in a third party it remains with the original owner and permission may be required to reuse the material. Any unauthorised reproduction of this information is prohibited. 

The Australian equity market experienced another positive quarter of performance to the end of March, delivering a 4.1% return as measured by the S&P/ASX 300 Accumulation Index. The recent gains have contributed to a significant 38.3% return over the past 12 months, when the local market touched its cycle lows on 23 of March 2020.

The quarterly return was led by the telecommunications, financials and consumer discretionary sectors, with key companies producing stronger than expected results primarily driven by cost control and margin expansion. The banks reinstated larger dividend payouts and material writebacks of their COVID-related bad debt provisions, signaling to investors increased confidence in their earnings outlook. Long-term bond yields were up 77 basis points in response to stronger economic activity flowing through to a re-pricing of higher inflation expectations. In this environment, banks should benefit with improved earnings growth. Very low levels of community transmission and the rollout of the COVID-19 vaccine program have delivered a boost of optimism for investors, particularly sectors directly linked to the re-opening of the economy, in particular consumer discretionary, industrial and resources. A cautionary note: companies that have benefited from COVID-19 (e.g. Coles and JB Hi-Fi) will have significantly higher comparable sales to meet or exceed in upcoming result periods to maintain their share price gains.

The telecommunication sector gained 13.9% courtesy of merger and acquisition activity with Macquarie Infrastructure Group and Aware Super launching an indicative bid for Vocus, and further details on Telstra’s proposal to restructure its business model. Telstra’s restructure would split the company into four business segments, seeking to realise the value of the company’s infrastructure assets, which the market has responded to positively with some brokers upgrading their target prices.

Resources maintained their positive momentum with the global economic recovery continuing to gather pace. Miners including BHP (+9.6%) were driven by a resilient iron ore price and announcements of larger dividends at their recent February results. Within the Energy sector, Santos (+14.2%) and Oil Search (+10.7%) were also stronger performers as the Brent Crude price increased to US$64 per barrel.

S&P/ASX 300 TR Index three-year rolling returns (% p.a.) to 31 March 2021

SOURCE: LONSEC, FINANCIAL EXPRESS

The value rotation has been in full swing since October 2020

SOURCE: ABS

Australian share index performance to 31 March 2021

SOURCE: FINANCIAL EXPRESS

Information Technology was the laggard sector delivering -10% in the March quarter, with several companies not matching their high expectations (e.g. Appen in the recent results period). Investors are pivoting away from COVID beneficiary sectors IT and Healthcare, while shifting investor attention to cyclically exposed stocks and higher bond yields detract from the value of their long-term cash flows.

Value outperformed growth by 9.6% in the March quarter

The rotation out of growth into value sectors continued over the March quarter with the economic recovery starting to materialise with a lower unemployment rate contributing to stronger growth. Unless some unforeseen tail risk event occurs, it is expected that business and consumer confidence will rise, providing a clear indication of ‘normal’ conditions returning in the not-too-distant future.

The small cap segment of the market experienced a softer return outcome in the March quarter compared to its broad-cap counterparts returning 2.1% as measured by the S&P/ASX Small Ordinaries Index, with mixed performances from the small resources index delivering -2.8% and the small industrials index gained 3.3%.

The Australian equity market is trading on a one-year P/E ratio of nearly 20 times, which is circa 30% above the long-term average of 14.5 times and prima facie looks stretched relative to history. However, based on the current environment, with policy and liquidity support underwriting economic activity for the foreseeable future, the market appears to be moderately expensive.

Outlook

Presently, the Australian equity market is profoundly influenced by macro factors surrounding the management of Covid-19, with company specific fundamentals taking some form of a back seat. The unprecedented fiscal and monetary stimulus measures implemented over the past 12 months should continue over the medium term but gradually taper off on the basis that Covid-19 is well contained, and economic re-opening becomes a sustainable state of affairs.

While it is not expected to be smooth sailing, as the economy moves towards a solid recovery phase, the reflation trade is likely to occur with cyclicals benefitting on relative basis over long-duration growth companies.

Issued by Lonsec Research Pty Ltd ABN 11 151 658 561 AFSL 421 445 (Lonsec). Warning: Past performance is not a reliable indicator of future performance. Any advice is General Advice without considering the objectives, financial situation and needs of any person. Before making a decision read the PDS and consider your financial circumstances or seek personal advice. Disclaimer: Lonsec gives no warranty of accuracy or completeness of information in this document, which is compiled from information from public and third-party sources. Opinions are reasonably held by Lonsec at compilation. Lonsec assumes no obligation to update this document after publication. Except for liability which can’t be excluded, Lonsec, its directors, officers, employees and agents disclaim all liability for any error, inaccuracy, misstatement or omission, or any loss suffered through relying on the document or any information. ©2021 Lonsec. All rights reserved. This report may also contain third party material that is subject to copyright. To the extent that copyright subsists in a third party it remains with the original owner and permission may be required to reuse the material. Any unauthorised reproduction of this information is prohibited. 

Generating a meaningful level of income within the risk constraints of a retirement portfolio has certainly had its challenges over the last 12 months.

When the full effects of the COVID-19 pandemic hit in March 2020, a number of usually very reliable income sources—such as the banks, REITs, and infrastructure—either reduced, suspended or cancelled their dividends altogether as the global economy came to an abrupt halt. Bond yields, which have been grinding lower for the better part of 30 years, plummeted further, reaching record lows. In fact, yields across an entire diversified portfolio came under enormous pressure and remained that way for the better part of a year.

At Lonsec we were able to generate in excess of the targeted 4.0% p.a. yield (before franking) across our Lonsec Retirement Managed Portfolios despite the difficult market conditions—a great outcome for our clients who rely on this income to fund their retirement needs.

Lonsec’s portfolios have generated income in excess of the 4.0% target
(12 months to end March 2021)


Source: Lonsec

The importance of active strategies and diversification

So how did we get here?

For us, the single most important factor was active management. Being active at all stages of the investment process—from asset allocation through to manager selection and security selection—was critical in helping deliver income objectives for our clients. With the potential for default rates to skyrocket and dividend traps around every corner, we wanted both our equity and credit managers to really test the balance sheets of companies and ensure the robustness of the businesses we were investing in or lending to.

Wide dispersion in outcomes also played out at the sector level, where the “stay at home” tech sectors, for example, did well out of COVID, while the travel sector was heavily impacted. In an environment where uncertainty is high and there is a large dispersion between the likely winners and losers, active management was key.

Secondly, diversification was, and will remain, very important in terms of how we construct retirement portfolios. COVID-19 has made that excruciatingly clear. If you were relying on the dividends of a few bank stocks to meet your living expenses in retirement, then you took an enormous hit to your income over the last 12 months. We aim to diversify income sources broadly across not only asset classes – but also across the underlying drivers of that income—whether that be dividends from equities, option premia, bond coupons, rental income from real estate and other sources.

Over the course of the year, we also broadened out the types and sources of income we were accessing in the portfolio. We invested in relative value strategies in the fixed income space that didn’t rely on credit or duration to generate returns as well as shorter duration credit strategies that had the ability to rotate across fixed income sectors to source income.

We also accessed some more idiosyncratic or alternative sources of income (via multi-asset income strategies), which allowed us to gain exposure to assets such as litigation finance, catastrophe bonds, healthcare and music royalties. Importantly, these additional sources of income were largely unrelated to what was going on in the broader economy and uncorrelated to existing income sources in the portfolio.

Crisis equals opportunity

It is often in times of crisis that the best opportunities emerge. We believe it is important to be opportunistic and have enough nimbleness in your process to take advantage of those opportunities as they arise. Shortly after the market sell-off in March 2020, good opportunities opened up in some of the higher yielding credit markets as spreads blew out. We entered a position in syndicated loans given the spread widening in that sector, funded by reducing our exposure to a traditional global equity dividend yield strategy which was facing headwinds from the COVID-induced shutdown.

We also tilted towards strategies where there was an obvious tailwind. For example, we increased our weighting to strategies employing option strategies which we felt were well positioned to take advantage of the increased volatility in markets. Key to being able to take advantage of these opportunities is having a robust decision-making framework in place that allows you to respond quickly.

Looking forward now, and with the worst effects of the COVID-19 shutdown largely behind us, we have adopted what we would consider to be a more ‘normal’ portfolio position in that we are now close to benchmark weights across the major asset classes. Yields have begun to normalise, not only in equities where companies are feeling more confident about paying distributions, but also in bond markets where higher bond yields underpin our more optimistic outlook for income across the remainder of the year.

 

IMPORTANT NOTICE: This document is published by Lonsec Investment Solutions Pty Ltd ACN 608 837 583, a Corporate Authorised Representative (CAR 1236821) (LIS) of Lonsec Research Pty Ltd ABN 11 151 658 561 AFSL 421 445 (Lonsec Research).  LIS creates the model portfolios it distributes using the investment research provided by Lonsec Research but LIS has not had any involvement in the investment research process for Lonsec Research. LIS and Lonsec Research are owned by Lonsec Holdings Pty Ltd ACN 151 235 406. Please read the following before making any investment decision about any financial product mentioned in this document.

DISCLOSURE AT THE DATE OF PUBLICATION: Lonsec Research receives a fee from the relevant fund manager or product issuer(s) for researching financial products (using objective criteria) which may be referred to in this document. Lonsec Research may also receive a fee from the fund manager or product issuer(s) for subscribing to research content and other Lonsec Research services.  LIS receives a fee for providing the model portfolios to financial services organisations and professionals. LIS’ and Lonsec Research’s fees are not linked to the financial product rating(s) outcome or the inclusion of the financial product(s) in model portfolios. LIS and Lonsec Research and their representatives and/or their associates may hold any financial product(s) referred to in this document, but details of these holdings are not known to the Lonsec Research analyst(s).

WARNINGS: Past performance is not a reliable indicator of future performance. Any express or implied rating or advice presented in this document is limited to general advice and based solely on consideration of the investment merits of the financial product(s) alone, without taking into account the investment objectives, financial situation and particular needs (“financial circumstances”) of any particular person. Before making an investment decision based on the rating or advice, the reader must consider whether it is personally appropriate in light of his or her financial circumstances or should seek independent financial advice on its appropriateness.  If the financial advice relates to the acquisition or possible acquisition of a particular financial product, the reader should obtain and consider the Investment Statement or the Product Disclosure Statement for each financial product before making any decision about whether to acquire the financial product.

DISCLAIMER: No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented in this document, which is drawn from public information not verified by LIS. The information contained in this document is current as at the date of publication. Financial conclusions, ratings and advice are reasonably held at the time of publication but subject to change without notice. LIS assumes no obligation to update this document following publication. Except for any liability which cannot be excluded, LIS and Lonsec Research, their directors, officers, employees and agents disclaim all liability for any error or inaccuracy in, misstatement or omission from, this document or any loss or damage suffered by the reader or any other person as a consequence of relying upon it.

Copyright © 2021 Lonsec Investment Solutions Pty Ltd ACN 608 837 583 (LIS). This document may also contain third party supplied material that is subject to copyright.  The same restrictions that apply to LIS copyrighted material, apply to such third-party content.

By Lukasz de Pourbaix, Executive Director & CIO – Lonsec Investment Solutions

Markets have been buoyed as signs of an economic recovery continue to be reflected in economic data. The IMF (International Monetary Fund) has revised their projections upwards on global GDP growth with the US expected to grow by 6.4% in 2021 and China by 8.4% over the same period. Domestically, we have seen a similar trend with manufacturing and non-manufacturing sectors as measured by the PMI (Purchasing Managers’ Index) lifting in March and consumer sentiment also on the rise.

The rotation into cyclical and contrarian value stocks continued for the first two months of the quarter as the market digested the prospect of an economic recovery and the potential for an uptick in inflation. Lonsec’s base case is that we may see a modest rise in inflation over the next 12 months, but that over the medium-term inflation will remain under control as broader structural deflationary pressures such as the continual impact of technology in society and the aging population continue to weigh down on most developed economies.

From an asset allocation perspective, we continue to favour risk assets over bonds despite bond yields rising over the quarter. Over the medium term we believe that cash rates and bond yields will remain relatively low which will continue to be conducive for risk assets. From a dynamic asset allocation perspective, we are favouring Australian Equities and Emerging Markets and within Fixed Income we are seeking to diversify away from duration risk.

IMPORTANT NOTICE: This document is published by Lonsec Investment Solutions Pty Ltd ACN 608 837 583, a Corporate Authorised Representative (CAR 1236821) (LIS) of Lonsec Research Pty Ltd ABN 11 151 658 561 AFSL 421 445 (Lonsec Research).  LIS creates the model portfolios it distributes using the investment research provided by Lonsec Research but LIS has not had any involvement in the investment research process for Lonsec Research. LIS and Lonsec Research are owned by Lonsec Holdings Pty Ltd ACN 151 235 406. Please read the following before making any investment decision about any financial product mentioned in this document.

DISCLOSURE AT THE DATE OF PUBLICATION: Lonsec Research receives a fee from the relevant fund manager or product issuer(s) for researching financial products (using objective criteria) which may be referred to in this document. Lonsec Research may also receive a fee from the fund manager or product issuer(s) for subscribing to research content and other Lonsec Research services.  LIS receives a fee for providing the model portfolios to financial services organisations and professionals. LIS’ and Lonsec Research’s fees are not linked to the financial product rating(s) outcome or the inclusion of the financial product(s) in model portfolios. LIS and Lonsec Research and their representatives and/or their associates may hold any financial product(s) referred to in this document, but details of these holdings are not known to the Lonsec Research analyst(s).

WARNINGS: Past performance is not a reliable indicator of future performance. Any express or implied rating or advice presented in this document is limited to general advice and based solely on consideration of the investment merits of the financial product(s) alone, without taking into account the investment objectives, financial situation and particular needs (“financial circumstances”) of any particular person. Before making an investment decision based on the rating or advice, the reader must consider whether it is personally appropriate in light of his or her financial circumstances or should seek independent financial advice on its appropriateness.  If the financial advice relates to the acquisition or possible acquisition of a particular financial product, the reader should obtain and consider the Investment Statement or the Product Disclosure Statement for each financial product before making any decision about whether to acquire the financial product.

DISCLAIMER: No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented in this document, which is drawn from public information not verified by LIS. The information contained in this document is current as at the date of publication. Financial conclusions, ratings and advice are reasonably held at the time of publication but subject to change without notice. LIS assumes no obligation to update this document following publication. Except for any liability which cannot be excluded, LIS and Lonsec Research, their directors, officers, employees and agents disclaim all liability for any error or inaccuracy in, misstatement or omission from, this document or any loss or damage suffered by the reader or any other person as a consequence of relying upon it.

Copyright © 2021 Lonsec Investment Solutions Pty Ltd ACN 608 837 583 (LIS). This document may also contain third party supplied material that is subject to copyright.  The same restrictions that apply to LIS copyrighted material, apply to such third-party content.

Debate in global property markets is now focused on office markets and how the global pandemic may have changed demand for office space on a permanent basis. In Australia, the immediate impact has seen CBD office vacancy levels rise in Sydney and Melbourne from 3.0–4.0% to around 8.0–9.0% over the year to January 2021.

Net absorption for Australia overall has reduced from +50,000 sqm in the six months to January 2020 to -90,000 sqm in the latest six months to January 2021. Sub-leasing levels have spiked as tenants with longer leases look to offload spare capacity. While face rents have remained largely unchanged, incentives have jumped to over 35% compared to around 25% pre-pandemic, dampening net effective rents.

The return to work in CBDs is progressive, but there is a growing realisation that more flexibility to allow working from home arrangements is both possible and desired. As corporates plan ahead and leases come to an end, already there is demand for core space plus an option for a flexible amount. Landlords will also need to ensure that buildings provide good quality space (including high environmental ratings) with facilities being upgraded in line with social distancing requirements.

While there will be some requirement for more space per person, it is likely that the trend for more flexible space and working from home arrangements will drag on demand while the world works its way through this pandemic. Given there is the possibility of more pandemics in the future, the outlook for office space will have a higher degree of uncertainty. A bright spot is medical and life sciences office space, where demand has been boosted by pandemic conditions.

Property sector will keep evolving

In the March quarter 2021 Australian property securities lost ground (S&P/ASX 300 A-REIT Index -0.5%) to the broader Australian equities index (+4.3%), although a stronger March almost made up for a poor first two months of the new year. Conversely, global property securities – AUD hedged (+7.3%) outperformed global equities – AUD hedged (+6.1%) during the first quarter of 2021.

Healthcare property continues to evolve with limited listed opportunities in Australia but increasing activity in unlisted funds. The highlight during the last quarter was the bid for Australian Unity Healthcare Property Trust by Canadian-based NorthWest Healthcare, with two conditional bids being rejected by Australian Unity as significantly undervaluing the patiently accumulated portfolio (December 2020 value was $2.4 billion) plus the ongoing development potential.

Heavily sold off early in 2020, retail property REITs have had bursts of recovery during the last six months as investors reacted to a vaccine-led recovery. Food and necessity-based shopping centres have continued to trade well and remain in demand by investors. Shopping strips and malls with a high proportion of discretionary spending have been hard hit, and owners face a period of readjustment in tenant mix and rentals. Nevertheless, in countries where lockdowns have lifted, foot traffic has rapidly returned to the ‘fortress’ shopping centres.

Secondary market for residential property expected to stabilise

A surprising area of strength is the residential market in Australia and some other parts of the globe where the COVID-19 response has been well handled (e.g. New Zealand). The combination of the RBA announcing that interest rates would stay low for a number of years and a shortage of supply in the secondary market has seen prices escalate quickly. This seems at odds with the underlying economic conditions in Australia where government income support (i.e. JobKeeper) has now ended and banks require mortgages to be serviced after a brief hiatus for those in need.

Lonsec expects some stabilisation to occur in pricing for the secondary housing market as these factors take hold and supply increases. Developers of primary housing stock will reap the benefits in the near term, although the apartment market is softer as demand is weak (no international buyers or renters) and rentals are about 20% lower than the pre-pandemic level. While values in regional and coastal areas have reacted to the work from home trend, this is also a reflection of relative value compared to the capital cities.

The residential rental and manufactured housing sectors are well developed internationally and have shown their resilience with a high proportion of recurring income from a multitude of tenants, although these sectors are not immune from some impact of a pandemic. Student housing is a good example, where travel restrictions have seen international student occupancy at very low levels. Longer-term trends of demand for high quality education should see these businesses recover in due course.

Property subsector winners include the Industrial and logistics and data centre sectors as growth continues off the back of accelerating trends towards e-commerce. However, pricing of assets in this area has become historically expensive and investors need to tread carefully to ensure the properties have tenants that are tied in not only by long leases, but by specialised fit-outs (preferably tenant funded). Similarly, hotels and lodging earnings are set to benefit as intra-national travel restrictions are eased and are dependent on how international travel patterns pan out.

A key positive that remains in place is low interest rates globally, which are having the impact of maintaining investor demand and underpinning tight market capitalisation rates (apart from discretionary retail assets). Lonsec maintains the view that these policy settings are artificially low, and as inflation resurfaces, bond rates and borrowing costs will rise (the US 10-year rate rose from 0.72% in October 2020 to 1.85% at the end of March 2021).

At this stage, REITs remain reasonably geared and investors should steer away from companies starting to push these boundaries. At the same time, highly priced property groups with components of funds management and development earnings can be vulnerable to a reversal of asset values.

Issued by Lonsec Research Pty Ltd ABN 11 151 658 561 AFSL 421 445 (Lonsec). Warning: Past performance is not a reliable indicator of future performance. Any advice is General Advice without considering the objectives, financial situation and needs of any person. Before making a decision read the PDS and consider your financial circumstances or seek personal advice. Disclaimer: Lonsec gives no warranty of accuracy or completeness of information in this document, which is compiled from information from public and third-party sources. Opinions are reasonably held by Lonsec at compilation. Lonsec assumes no obligation to update this document after publication. Except for liability which can’t be excluded, Lonsec, its directors, officers, employees and agents disclaim all liability for any error, inaccuracy, misstatement or omission, or any loss suffered through relying on the document or any information. ©2021 Lonsec. All rights reserved. This report may also contain third party material that is subject to copyright. To the extent that copyright subsists in a third party it remains with the original owner and permission may be required to reuse the material. Any unauthorised reproduction of this information is prohibited. 

It sounds simple enough: invest in things that are good for the planet and society. Investing sustainably should be that simple, but in practice things are a lot less straightforward.

Confusion quickly sets in when we try to navigate the different approaches to sustainable investing. Much of this confusion stems from the plethora of industry terminology and definitions, and a general lack of understanding about how different product issuers approach questions around sustainability. Advisers with clients serious about taking an ethical and sustainable approach to their investment decisions are often left to un-muddy the waters.

Sustainable investing is a simple concept, but it’s not always simple to implement. The following three steps will help you clarify the sustainability issue and find an investment solution that genuinely meets your needs and expectations.

1. Understand the product issuer’s frame of reference

Not everyone thinks of sustainability in the same way. Some may think of it as actively avoiding certain industries, while others may see it as a way of mitigating the risk of out-dated industrial processes, bad PR, or the threat of disruption.

This can lead to a number of misunderstandings that can be detrimental to your objectives. Before we begin comparing different sustainable investment offerings, it’s necessary to nail down some terms:

ESG (environmental, social and governance) investing: The ESG approach to investing involves taking into account ESG factors (i.e. impact on climate change, board composition, or relations with employees, suppliers and the community) as they relate to a particular business, using a systematic research process. ESG factors are used to enhance traditional financial analysis by assessing the risk these factors pose to a company’s business model and using this information to optimise their portfolio.

Impact investing: The aim of impact of investing is to make a positive difference by investing specifically in businesses, non-profits or other organisations that are seeking to improve the world through the development of new technologies (e.g. clean energy or sustainable agricultural practices), the provision of essential community services (e.g. open banking, micro-finance, medical services), or the construction of critical infrastructure. The bulk of impact investing is done at scale by institutional investors and major philanthropic organisations.

Sustainable investing: The sustainable investing approach specifically targets sustainable themes (e.g. low carbon industries, Paris or UN SDG-aligned outcomes) and avoids certain harmful businesses and industries (e.g. tobacco, fossil fuels, gambling, weapons manufacturing). Sustainable investing may incorporate elements of ESG and even impact investing, but with the goal of achieving investment goals while considering the activities and practices of the underlying companies in the portfolio.

Each of these types of investing fall under the broader rubric of ‘Responsible Investment’ (RI). While these definitions are similar, they also differ in some important ways. For example, ESG, in contrast to sustainable investing, tends to be more focused on process than outcomes. While investment decisions may be informed by a sustainable overlay, an ESG fund manager may invest in unsustainable companies if it makes sense from a risk and return perspective.

ESG is a perfectly valid process, but it is important to understand the framework used by individual fund managers and how it aligns with your own values and expectations.

In Lonsec’s experience, ESG is interpreted and implemented in different ways. A survey of Lonsec’s financial advisers revealed a wide variety of responses when it comes to defining ESG. Half of advisers surveyed believed that a strong ESG framework means using a range of filters or screens on the portfolio. While this might seem like a reasonable assumption, for most fund managers, what really defines an ESG product is simply whether ESG risks are considered when making investment decisions. It doesn’t speak to the actual outcome, i.e. the companies and activities the product invests in.

Lonsec’s adviser survey revealed some confusion about the meaning of ESG


Source: Lonsec

This highlights the importance of digging deeper to find out what the product issuer means when they label a product ‘responsible’, ‘ethical’, ‘ESG’, or ‘sustainable’. It might not mean what you think it means, and it may be something different from what your client is looking for.

2. Determine what your client’s expectations are

We all have different values, priorities, and objectives. When we aim to invest sustainably, we will naturally be forced to make trade-offs. Investing in financial markets means accepting that we’ll end up with some exposure to things we don’t like. Even a company with impeccable green credentials will leave some carbon footprint. And environmental considerations may be only part of the equation. Some companies might be investing in green energy but still be lagging on gender equality and other social indicators. There is no perfect company, and likewise no perfect portfolio.

This is where individual, subjective values come into play. It’s up to the adviser to work with the client to determine their investment objectives—including risk and return preferences—while thinking about the types of exposures they are comfortable with from a sustainability perspective.

For this reason, not all self-described ESG or sustainable investment products will suit. For example, an ESG product may still invest in industries like tobacco and coal if it makes sense from a pure risk and return perspective. While this would suit some investors, it would not be appropriate for someone who is looking specifically to avoid investing in these industries.

When Lonsec assesses an investment product’s sustainability, it considers both sustainability and ESG. We seek to understand the effectiveness of the fund manager’s ESG process, but ultimately we’re interested in the product’s underlying portfolio: the companies, industries, and activities the product invests in.

If your clients are serious about investing sustainably, you should have a full discussion about exactly what it is they’re looking for so you know which products can best meet their needs. As regulations and standards become more stringent, we also need to be more cognisant of our obligations. The FASEA Code of Ethics Standard requires advisers to act in the best interests of their clients, which means product recommendations must be appropriate to meet the client’s objectives while considering their broader, long-term interests. This includes any social or ethical preferences the client might have.

The Financial Planning Association (FPA) guidelines on the FASEA Code of Ethics states: “Financial advisers should ask their clients if there are any environmental, social or ethical considerations that are important to them”. This involves having the sustainability conversation, determining the approach that works for you as the client, and recommending a solution that meets your needs and expectations.

3. Cut through the piles of data

Once you’ve established what the client is looking for, the next step is to identify suitable investments that fit our criteria. If you’ve picked up an ESG research report lately, you’ll know these tend to be stuffed full of metrics, some of which may not even be directly relevant to us. It’s difficult to know who these reports are designed for, because most investors and many advisers would suffer a severe bout of MEGO (‘my eyes glaze over’) if they tried to read through it.

Data is central to sustainable investing. Without the right data—and without the right quality of data—we can’t make good investment decisions. But the key is bringing this data together in a way that’s clear and actionable. A data dump is next to useless, even if the data itself is perfectly good.

Effective sustainability research is able to look through an investment product’s portfolio to assess sustainability at the security level, taking account of each company’s production methods, their role in the supply chain, and any second- and even third-order effects resulting from their activities. It also needs to summarise this in a digestible format that can be read and understood by advice clients, providing a clear rationale for why the product was recommended for them.

As an example, Lonsec’s sustainability reports are only two pages long, but they bring together a vast array of data to enable better decision making. The reports show the product’s exposure to and alignment with the United Nation’s 17 Sustainability Development Goals (SGDs), as well as ten controversial industries like fossil fuels, gambling, and tobacco. The product’s overall sustainability is presented in a single Sustainability Score, measured between one and five bees (a widely recognised symbol of sustainability given the critical role they play in our ecosystem).

Good sustainability research goes beyond product labels to tell clients exactly what they are investing in. It should also make it easier for you as the adviser to demonstrate the value of your advice and recommendations in a tangible way, without a deluge of extraneous metrics that confuse your message and make it harder for investors to understand the real benefit of your investment solution.

Keep communicating the benefits

Regular communication is the key to client retention. We all know this, but in reality maintaining both the frequency and relevance of our communications can divert us from other necessary business operations, including winning new clients and growing our advice practice. Having a suite of managed portfolios can help scale not only your investment process but also your portfolio communications, making the task of portfolio reporting and the generation of individual client communications significantly easier.

Once we have the right investment solution in place, we need to be proactive in communicating the benefits. Again, the right research and reporting is crucial. The sustainability conversation doesn’t end once the client’s portfolio is place. It will need to evolve over time, just as community expectations and client preferences change. But if we can do this successfully, we can create even more value for our clients, and add a whole other dimension to the value of our advice offering.

IMPORTANT NOTICE: This document is published by Lonsec Investment Solutions Pty Ltd ACN 608 837 583, a Corporate Authorised Representative (CAR 1236821) (LIS) of Lonsec Research Pty Ltd ABN 11 151 658 561 AFSL 421 445 (Lonsec Research).  LIS creates the model portfolios it distributes using the investment research provided by Lonsec Research but LIS has not had any involvement in the investment research process for Lonsec Research. LIS and Lonsec Research are owned by Lonsec Holdings Pty Ltd ACN 151 235 406. Please read the following before making any investment decision about any financial product mentioned in this document.

DISCLOSURE AT THE DATE OF PUBLICATION: Lonsec Research receives a fee from the relevant fund manager or product issuer(s) for researching financial products (using objective criteria) which may be referred to in this document. Lonsec Research may also receive a fee from the fund manager or product issuer(s) for subscribing to research content and other Lonsec Research services.  LIS receives a fee for providing the model portfolios to financial services organisations and professionals. LIS’ and Lonsec Research’s fees are not linked to the financial product rating(s) outcome or the inclusion of the financial product(s) in model portfolios. LIS and Lonsec Research and their representatives and/or their associates may hold any financial product(s) referred to in this document, but details of these holdings are not known to the Lonsec Research analyst(s).

WARNINGS: Past performance is not a reliable indicator of future performance. Any express or implied rating or advice presented in this document is limited to general advice and based solely on consideration of the investment merits of the financial product(s) alone, without taking into account the investment objectives, financial situation and particular needs (“financial circumstances”) of any particular person. Before making an investment decision based on the rating or advice, the reader must consider whether it is personally appropriate in light of his or her financial circumstances or should seek independent financial advice on its appropriateness.  If the financial advice relates to the acquisition or possible acquisition of a particular financial product, the reader should obtain and consider the Investment Statement or the Product Disclosure Statement for each financial product before making any decision about whether to acquire the financial product.

DISCLAIMER: No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented in this document, which is drawn from public information not verified by LIS. The information contained in this document is current as at the date of publication. Financial conclusions, ratings and advice are reasonably held at the time of publication but subject to change without notice. LIS assumes no obligation to update this document following publication. Except for any liability which cannot be excluded, LIS and Lonsec Research, their directors, officers, employees and agents disclaim all liability for any error or inaccuracy in, misstatement or omission from, this document or any loss or damage suffered by the reader or any other person as a consequence of relying upon it.

Copyright © 2021 Lonsec Investment Solutions Pty Ltd ACN 608 837 583 (LIS). This document may also contain third party supplied material that is subject to copyright.  The same restrictions that apply to LIS copyrighted material, apply to such third-party content.

The rotation out of growth into value sectors continued over the March quarter as the economic recovery began to materialise with a lower unemployment rate contributing to stronger growth. Unless some unforeseen tail risk event occurs, it is expected that business and consumer confidence will rise, providing a clear indication of ‘normal’ conditions returning in the not-too-distant future.

The re-opening of state borders, very low levels of community transmission, and the rollout of the COVID-19 vaccine program has delivered a boost of optimism for investors, particularly sectors linked directly to the re-opening of the economy, in particular consumer discretionary, industrial and resources. However, companies that have been among the clear ‘winners’ from COVID-19 (e.g. Coles and JB Hi-Fi) will now have significantly higher comparable sales to meet or exceed in upcoming result periods to maintain their share price gains.

Looking back over the March quarter, returns were led by the telecommunications, financials and consumer discretionary sectors, with key companies producing stronger than expected results primarily driven by cost control and margin expansion. Notably, the banks reinstated larger dividend payouts and material writebacks of their COVID-19 related bad debt provisions, signaling to investors increased confidence in their earnings outlook. Long-term bond yields were up 77 basis points in response to stronger economic activity flowing through to the market, re-pricing higher inflation expectations. In this environment, banks should benefit with improved earnings growth.

Resources maintained their positive momentum with the global economic recovery continuing to gather pace. Miners including BHP (+9.6%) were driven by a resilient iron ore price and announcements of larger dividends at their recent February results. Energy sector Santos +14.2% and Oil Search +10.7% were also stronger performers as the Brent Crude price increased to US$64 per barrel.

Information Technology was the laggard sector, delivering around 10% in the March quarter, with several companies not matching their high expectations (e.g. Appen in the recent results period). Investors are pivoting away from COVID-beneficiary sectors like IT and Healthcare while shifting investor attention to cyclically exposed stocks and higher bond yields, which detract from the value of their long-term cash flows.


Source: Lonsec / Financial Express

The macroeconomic backdrop has not changed significantly over the March quarter and some key growth drivers have been strengthened. Australia is better positioned economically than most developed countries, the unemployment rate has not reached the peak that was initially expected, and fiscal and monetary stimulus is fueling an economic recovery, reflected in rising house prices. Terms of trade, especially rising commodity prices, have significantly boosted national income. Consumer sentiment is expected to remain resilient and wealth effects will encourage a normalisation in the savings rate, which should benefit consumer spending. Overall, stocks that are largely exposed to the economic cycle are expected to be well supported in this environment.

From a valuation perspective, the Australian equity market is trading on a one-year forward P/E ratio of nearly 19 times, which is circa 25% above the long-term average of 14.5 times and appears stretched relative to historical averages. The overall market appears to be moderately expensive and earnings growth needs to continue its upward trajectory over the next 12 months to support some of these elevated prices.

 

 

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