The Lonsec Board of Directors is very pleased to announce the appointment of Mike Wright as CEO of Lonsec effective 5th July 2021.

Lonsec Chairman Mark Spiers said, “Mike’s unique blend of leading teams to develop and implement client-oriented growth and service initiatives along with his strong industry relationships and knowledge were exactly the leadership attributes that we were seeking.”

“By continuing to stay close to our clients Lonsec has enjoyed significant growth across all its business units and I am excited to be able to work with the great team at Lonsec to continue to build on this,” said Mike.

Mike was most recently the CEO of Xplore Wealth, an ASX listed company specialising in providing managed account investment solutions to financial advisers. Xplore Wealth was successfully acquired by Hub24 via a Scheme of Arrangement, completed 2nd March 2021.

Prior to this, Mike had a long and successful career in the Westpac/BT Group, where he held senior executive roles with Westpac’s Retail & Business Banking, and was State General Manager of Queensland before leading the Advice business at BT.

Release ends

For more information, contact:

Rob Hardy
robert.hardy@lonsec.com.au
+61 2 8651 6744

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. 

Market Overview, Portfolio Performance & Positioning Update

Given the recent market conditions – increased volatility, fear of inflation, rotation away from growth and quality stocks towards cyclical and value stocks – we asked Lonsec’s Chief Investment Officer Lukasz de Pourbaix to give us an update on his views of the market and how Lonsec’s portfolios are positioned for the environment ahead. In this video, Lukasz provides an overview of Lonsec’s current asset allocation positions following the most recent Asset Allocation Investment Committee meeting, and explains how Lonsec’s portfolios are positioned to manage risk and recovery.


Transcript:

Hello, my name is Lukasz de Pourbaix, I’m the Executive Director and CIO of Lonsec Investment Solutions. Today, I wanted to give you an interim performance update on our managed account portfolios, and specifically in relation to market events, which has certainly caused increased volatility in markets.

What has occurred in markets during the last 12 months?

So what have we been seeing in markets over the course of this year? And I guess the one thing I’d point to is, we’ve seen US 10-Year Treasuries go up from about 0.9% at the end of last year to above 1.6%. So what does that mean? It means that, on the positive side, signals that the economy is recovering, and our view would be that we are seeing signs of economic recovery, we’re seeing improved payroll data, we’re seeing improved productivity numbers. So there’s a lot of things that are pointing to the right direction in terms of economic recovery. But at the same time, what the market has been factoring in is the prospect of inflation. So with all the stimulus, we’ve just seen the US approve $1.9 trillion worth of stimulus coupled with all the other stimulus we’ve seen over the course of the last 12 months, the market is worried that all of this stimulus and the accelerated recovery, will cause inflation. So from a market perspective, we’ve seen, and it started probably in November last year, a big rotation away from those parts of the market that are more growth focus, towards more of your value, your cyclical type of exposures, and the rotation has been very sharp and very pronounced. So if you think about the Australian market, for example, resources, and banks were up about 30% over the course of November last year. Conversely, sectors such as healthcare were down over that same period. So we’ve seen a very abrupt rotation. And if you sort of step back and think that for the last 10 years or so those cyclical and, in particular, value stocks have really struggled.

How have our Lonsec portfolios been positioned?

So from a portfolio perspective, if we look across the board, so the Listed diversified portfolios, certainly did have a bias towards that quality end of the market. So in terms of stocks, those stocks that have had solid balance sheets, have navigated the COVID environment very strongly. So if you think about some of those stocks, we actually had no stocks in the portfolio that needed to raise capital over that period, which goes to point out how strong some of those companies are. But what has performed well since November are some of those stocks that arguably are not in that quality part of the market, as well as some of your cyclical exposures. So the portfolios all in all have had underperformance notably, I’d say over the last three months. Now, we’re very well aware of this underperformance. And we recently had our investment selection committee, along with our asset allocation committee. And from a broad portfolio positioning perspective, so if you think back in terms of from an asset allocation perspective, how we’ve been positioned, we continue to think that risk asset, so equities, are where you want to be at this point in time, relative to bonds. And that equities still provide a reasonable risk premium to bond assets. So we’ve been underweight bonds, and we’ve been overweight risk assets. And we continue to believe that, over the medium term, that’s where you want to be positioned and the portfolios remain positioned in that way.

How are we diversifying our portfolios by investment strategy?

From a bottom-up perspective, in terms of investment selection, as I noted, we have been hurt over the last three months because of that bias towards some of the quality and defensive positions. And those positions have been there, from the perspective that while we think that markets and risk assets, in particular, are going to do well, we also note that there is the risk that the recovery may not be as strong, and we may see some stumbling blocks. So we do still want some of the defensiveness within the portfolios. Having said that, we are reviewing the portfolios at the moment and if you look at the Listed portfolios, where we’re focusing on is – do we add some more cyclical type of exposures just to balance some of the risks within the portfolio. So that is an area that we are exploring, particularly on the global equity side. We have already incrementally been doing that on the Australian equity part of the portfolio. And the other key area we’re focusing on is the bond part of that portfolio, which does have significant exposure to the duration or be it, we are underweight fixed interest. And we are looking at ways to further diversify the portfolios away from duration or interest rate risk within that defensive part of the portfolio. So, you recall, we did add Ardea back in January of this year, and that has proven to be a really good diversifier in this market environment. And we’re looking to further broaden that out. One of the challenges is obviously just identifying products because, in that bond space, the non-duration type of exposure is a little bit more limited. But we will be looking to adjust that part of the portfolio as well.

Are we making changes to our asset allocation positions?

So from a Listed portfolio perspective, overall, we’re relatively comfortable where we’re positioned. If you think about beyond these last three months, longer-term we still think that we will be in a lower rate environment. While we think inflation will go up marginally over the coming months, our base case is that we’re not going to see out-of-control inflation. So if you think about an environment where all things being equal, rates are still low, inflation is under control, and central banks are continuing to support markets, whether it be through monetary policy or fiscal policy, that type of dynamic is still conducive to having that long term quality exposure within the portfolios. So we are cognizant of the recent performance. Over the long term, though, we do think the portfolios are well-positioned in terms of the market environment we’re heading into. And we are making some adjustments just to limit some of those risks within the portfolios. If I just touch on very briefly in the other portfolios, our Multi-Asset portfolios, just by nature of the construct, and the ability to use different types of funds, have had a little bit more of that cyclical exposure, that value exposure, notably, managers like Allan Gray, for example, we have had less duration risk within those portfolios. One of the things we are looking at also in those portfolios is again reducing some of those more defensive exposures, keeping some in there because that is part of our process, as part of managing risk. But also just adjusting that given that our view on equities has become more constructive. And certainly, as I said before, we think that relative to bonds, equities will continue to look attractive.

We are here to support you.

So thank you for taking the time today to listen to this video. We will be coming out with more material to help you with your conversations with your clients relating to the portfolios. We’re working on a frequently asked questions document, which will delve a little bit deeper into some of the things I spoke about. And as always, we’ll do our quarterly update on our portfolios which again will provide an update on the performance and positioning. And with that, I hope you found today’s video useful and I want to thank you again for your support for the portfolios, and if there are any questions, please get in contact with our BDM team.


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 investment product market has evolved over the decades to cater to a wide range of investor needs and objectives. Now, as more and more investors wish to see their portfolio align with their values, the product market is evolving once again to deliver a range of responsible investment solutions.

Lonsec has observed a significant increase in demand for responsible investment solutions over the past two years. Combined with this we have seen a proliferation of investment products adopting ESG, sustainable or impact investing principles within their investment processes. This product evolution has extended beyond equities and now covers most key asset classes, including fixed interest and infrastructure.

We expect the range of products across asset classes and investment structures (i.e. managed funds and ETFs) to continue to grow. The increased demand and subsequent growth in available products have allowed portfolio professionals like Lonsec to construct a diversified investment solution to cater to this market, which was not possible even two years ago when most products were focused primarily on equities.

We believe that the increasing demand has been driven by two key factors that have been instrumental in shifting responsible investing from a niche market to one where there are clear structural tailwinds supporting the adoption of responsible investment solutions.

The first has been a clear change in investor values. Investors are increasingly incorporating their own views on issues such as the environment within their investment decision-making process. While this is not a new phenomenon, it has taken on a new life over the past two years as we see more millennials enter the investment landscape. This is a generation that has been acutely aware of environmental and social issues throughout their lives and believe everyone has a role to play in improving the world, including through their individual investment decisions.

In a 2018 survey of high-net-worth millennials published in US Trust’s Insights on Wealth and Worth, 87% of respondents considered a company’s ESG track record an important consideration in their decision about whether to invest or not. Then you have natural disasters like bushfires—still fresh in Australians’ minds—which have prompted us to become more aware of the type of investments we want exposure to and which we want to avoid. Of course, it’s not just millennials driving this shift. Investors of all ages—from those entering the workforce to those nearing or in retirement—are proactively seeking investments that they believe will benefit future generations.

The second driver for increased demand has been changes in financial adviser behaviour as a result of the Future of Financial Advice reforms of 2012 (FOFA) and subsequently the Royal Commission into the financial services industry, which delivered its final report in 2019.

Focus on best interest duties and the need for advisers to be able to provide advice specific to investors’ needs has been instrumental in focusing adviser attention to responsible investing. In a June 2020 paper ‘Building Stronger Client Relationships with Responsible Investing’, Franklin Templeton noted that 88% of advisers see responsible investing as a meaningful way to evaluate investments. They also found that 84% of Australian advisers cite at least some level of fiduciary concern related to selecting responsible investments, compared to 61% of advisers globally. Remarkably, 88% of surveyed advisers expect to increase allocation to responsible investing strategies over the next two years.

Lonsec recently conducted a telephone survey of several advice practices, and the consensus view was that between 20% and 30% of clients actively communicate preference regarding responsible investing. For example, they may have a view on the environment and climate change, or views on industries such as gambling and alcohol.

Looking further afield we believe that responsible investing will become more mainstream with ESG and sustainable investment principles becoming an expectation rather than a nice-to-have. There is precedent for this within the institutional investment market. In Europe, fund managers will generally not be awarded investment mandates if they have not integrated ESG and increasingly sustainable elements within their investment processes.

We have already witnessed this in the wholesale space whereby fund managers who do not actively market themselves as ‘responsible’ managers will nevertheless exclude certain harmful industries such as tobacco. It’s clear that the trend towards responsible investing is heading in a positive direction, with all participants actively engaging in the sector. In the future, responsible investment will not be merely another option for investors to select from, but rather a core part of our investment toolkit.

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.

A year on from the start of the COVID-19 pandemic, super funds continue to enjoy in the market recovery as vaccine rollouts and the return to more normal economic conditions lift confidence.

Members have welcomed the return to a more stable footing, but markets are still more volatile compared to the pre-COVID-19 situation. Much also depends on the speed and efficacy of vaccination programs globally, with some regions facing delays and logistical challenges.

According to SuperRatings data, the median balanced option rose an estimated 0.7% in February and the median growth option rose an estimated 1.1%, while the median capital stable option fell an estimated 0.1%. Over the 2021 financial year to date, the median balanced option returned 9.7%, reflecting the strength and speed of the post-pandemic recovery, which has been extended through the start of 2021.

The federal government said Australian health professionals will soon be delivering over 500,000 vaccinations a week, with general practitioners set to assist in the COVID-19 vaccine rollout in coming weeks. Australia will keep its international borders shut for at least another three months.
“Super has notched up another positive month, thanks to the vaccine narrative and the relative strength of Australia’s economic recovery, which has exceeded expectations,” said SuperRatings Executive Director Kirby Rappell.

“Markets are still bumpy and members should not be surprised to see the value of their super fluctuate over the course of 2021. With the severe shock of the pandemic now behind us, the challenge will be gradually transitioning away from government support programs and getting households and businesses back on a sustainable footing.”

Accumulation returns to end of February 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 12.0% 7.4% 7.0% 9.2% 7.9% 8.2%
SR50 Balanced (60-76) Index 9.7% 5.9% 6.1% 8.0% 7.1% 7.6%
SR50 Capital Stable (20-40) Index 4.1% 2.0% 3.7% 4.5% 4.4% 4.8%

Source: SuperRatings estimates

Pension returns were also positive in February. The median balanced pension option returned an estimated 0.6% over the month and 10.3% over the financial year to date. The median pension growth option returned an estimated 1.1%, whereas the median capital stable option was down an estimated 0.2% through the month.

Pension returns to end of February 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 13.1% 7.9% 7.5% 10.1% 8.7% 9.1%
SRP50 Balanced (60-76) Index 10.3% 6.2% 6.7% 8.8% 7.8% 8.3%
SRP50 Capital Stable (20-40) Index 4.4% 2.3% 4.2% 5.2% 4.9% 5.6%

Source: SuperRatings estimates

The pace of Australia’s economic recovery was reflected in the recently released GDP figures for the December 2020 quarter, which showed growth of 3.1%, taking the yearly rate from -3.7% to -1.1%. The result marked the second straight strong quarter of growth, helped by high levels of monetary and fiscal stimulus.

The February and March earnings season revealed a corporate environment still impacted by COVID-19, with earnings down in aggregate and companies opting to hold more cash, although the lift in dividends has been a key positive development for Australian investors.
According to SuperRatings, the pandemic has been a critical case study for super funds and will inform the way they manage risks and respond to member needs into the future.

“A lot is happening in super at the moment, from regulatory change to further consolidation,” said Mr Rappell.
“Funds have shown they are able to adapt to rapid changes on these fronts, while also managing risks and attending to the needs of members through a challenging market. The pandemic period will serve as a masterclass in change management for superannuation that will lead to a more robust and agile industry in the long run.”

Release ends
We welcome media enquiries regarding our research or information held in our database. We are also able to provide commentary and customised tables or charts for your use.

For more information contact:

Kirby Rappell
Executive Director
Tel: 1300 826 395
Mob: +61 408 250 725
E: Kirby.Rappell@superratings.com.au

In this video, Dan Moradi, Portfolio Manager for Listed Products, provides an update on the Australian equity market following a very interesting reporting season and takes an in-depth look at how various sectors and companies performed.

The February reporting season results were better than initially expected, particularly if we look at the middle of last year when earnings expectations were experiencing significant downgrades in the midst of the COVID-19 related lockdowns. Since then, the downturn has not been as severe as expected, and we’ve seen estimates for FY21 being upgraded, indicating relatively strong balance sheets across the market and to some extent, improved confidence of corporate boards in setting up payout dividend ratios.

Overall, we seem to be turning a corner with the majority of the companies expected to return to growth over FY21 and 22. Although despite these earnings rebound, some companies aren’t out of the woods yet.


Transcript:

I hope everyone is safe and well. Today I’ll be providing an update on the Australian equity markets following a very interesting profit reporting season, which was much better than initial expectations, particularly if we look at the middle of last year when earnings expectations were experiencing significant downgrades in the midst of the COVID related lockdowns around the globe. Obviously, since then the downturn has not been as severe as expected, and we’ve seen estimates for FY21 getting upgraded, particularly over the latter part of 2020 and heading into the reporting season this year. At the market level, overall EPS for 2021 grew by around 5% over the month of the upgrades while the dividend expectations grew by around 10%. However, despite the upgrades, market gains during the month were modest as the positive conditions were most likely priced into the lead-up of the reporting season. At the sector level, this was really driven by upgrades within the financials and resources sectors, while the technology and industrials saw the largest EPS downgrades. Aside from the more upbeat outlook statements dividends surprised to the upside, indicating relatively strong balance sheets across the market and to some extent, improving the confidence of boards in setting up their dividend payout ratios. Once again, this was driven by the banks and resources which saw dividend expectations upgraded by 12% to 15%, obviously driven by high commodity prices within the resources and the removal of the restrictions on banks. At the stock level, within the ASX200 universe we had the likes of James Hardie, Seek, Cochlear, and Commonwealth Bank reports stronger than expected performances, whilst Challenger, Ampol, Center Group, and Appen delivered relatively weaker results.

In terms of the themes that we saw, unsurprisingly COVID-19 and its impact on the corporate sector as a whole was the main discussion point again during the reporting season. However, there was a much more improved tone in the company’s communications to the market in comparison to what we saw in August last year. In absolute terms, the pandemic has had and continues to have a material impact both positive and negative on various segments of the market, the extent to which still remains unclear. Companies within the retail, e-commerce, technology, and metals and mining sectors have benefited greatly from the shifting consumer behavior experienced over the past year. While obviously the supply chain disruptions and the potential inflationary impacts of the pandemic have been a positive tailwind for commodities and the metals and mining sector as a whole. On the other side of the spectrum, the tourism, infrastructure, retail landlords, insurance, bank, and the energy sectors took the brunt of the earnings in FY20. But all seem to be turning the corner with the majority of the companies expected to return to growth over FY21 and FY22. But despite these earnings rebound, some of these companies are not really out of the woods yet. And it may take a few years for conditions to normalise. And this is likely to be reflected in a high degree of ongoing volatility for these companies.

Some of the other key themes that we saw during the reporting season was the ongoing impact of COVID-19 on supply chains, which as an example is impacting inventories in a number of sectors and this is likely to have an inflationary impact on these companies and sectors until these issues are resolved. We’ve also seen a significant move in bond yields. So with the 10-year bond yields almost doubling since December. Whilst this doesn’t have an immediate impact on company earnings, the market is really reassessing the sustainability of rising bond yields and its impact on the valuation of the high-duration growth companies like technology and healthcare businesses and also the lower Beta defensive companies in infrastructure and staple sectors. This concern has been a major driver of the underperformance of these sectors since December last year and probably going to continue in the short term.

Lastly, the strength of the companies in the resources sector was another theme evident during the reporting season. The strengthened commodity prices and the very strong balance sheet in the sector. So the likes of BHP, Rio, Tinto, and Fortescue all beat dividend expectations. This trend does look like it can continue over the short term, obviously subject to the underlying commodity price movements, but we do see upside risk to earnings within the resources segment with the attractive yields on offer, probably set to continue over 2021.

Looking ahead, at this stage consensus estimates are expecting a 33% rebound in earnings in FY21 as a whole, and this has improved from around 10% after the August reporting season last year. Now if this was to eventuate this means that the market earnings have gone back to pre COVID levels, which is a remarkable development and one of the sharpest earnings recoveries in history. From a dividend perspective, the pace of the recovery has improved, but expectations so far in play will take a slightly longer period to return to pre-COVID levels. But I think there is an upside risk to that scenario, particularly if the worst of COVID is already behind this and commodity prices remain strong. So this does imply that from a valuation perspective, the market is currently trading at a PE ratio of around 18 times with a dividend yield of 3.8%. And I’d say both would be expected to improve in 2022. In terms of what’s in store for the rest of the year, obviously, the path of the pandemic will play a large part in the outcome, but the momentum has definitely turned positive. On the earnings front, consumer confidence remains solid. The tapering of the government stimulus at the end of March this year will provide further insight into the shape of the recovery. And the RBA stance on being on hold until 2024 is still a very positive tailwind for risk assets. In terms of risks, this is a very uneven recession and recovery and over a very short period of time, the after-effects of such could result in some unintended consequences which can potentially result in periods of elevated volatility potentially over the remainder of the year. Thank you


This information is provided by Lonsec Investment Solutions as a corporate authorised representative of Lonsec Research Pty Ltd who hold an AFSL number 421445. This is general advice, which doesn’t consider your personal circumstances. Consider these and always read the product disclosure statement or seek professional advice prior to making any decision about a financial product. You can access a copy of our financial services guide at lonsec.com.au

This video is provided 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.

Past performance is not a reliable indicator of future performance. This is general advice, which doesn’t consider your personal circumstances. Consider these and always read the product disclosure statement or seek professional advice prior to making any decision about a financial product. While care has been taken to prepare the content of this video, LIS makes no representation or warranty to the accuracy or completeness of the information presented, which is drawn from public information not verified by LIS. The information contained in this video is current as at the date of publication.

Copyright © 2020 Lonsec Investment Solutions Pty Ltd ACN 608 837 583

Important information: Any express or implied rating or advice is limited to general advice, it doesn’t consider any personal needs, goals or objectives.  Before making any decision about financial products, consider whether it is personally appropriate for you in light of your personal circumstances. Obtain and consider the Product Disclosure Statement for each financial product and seek professional personal advice before making any decisions regarding a financial product.