Kirby Rappell (Executive Director, SuperRatings) reveals insights into the superannuation landscape, based on SuperRatings’ latest benchmark report. It incorporates comments on the current market conditions, as well as the initiative to permit the early release of superannuation and the fund merger environment. A consistent theme of this year’s report is the state of flux being observed, coupled with pressures from regulatory and compliance initiatives, as well as COVID-19 impacts. Thoughts around the future outlook and key areas of focus for providers as they navigate the current environment are also provided.

 


Any advice that SuperRatings provides is of a general nature and does not take into account an individual’s financial situation, objectives or needs. Because the information that SuperRatings receives about superannuation and pension financial products is from a number of sources, it is not guaranteed to be completely accurate. Because of this, individuals should, before acting on the information, consider its appropriateness having regard to their own financial objectives, situation and needs and if appropriate, obtain personal financial advice on the matter from a financial adviser. Before making a decision regarding any financial product, individuals should obtain and consider a copy of the relevant Product Disclosure Statement from the financial product issuer. © 2020 SuperRatings Pty Ltd ABN 95 100 192 283 AFSL 311880

The A-REIT sector had a torrid March as the COVID-19 virus hit Australian shores. Local investors are now familiar with both the devastating health consequences of the virus as well the unprecedented social distancing measures that governments have been forced to implement to curb its spread.

These measures have hit the A-REIT sector hard, with retail assets being particularly impacted by the mandated closure of non-essential businesses, and the decision by some large national retail groups to temporarily reduce their bricks and mortar footprints. However, as the economic fall-out from C-19 grows wider, the other key sectors – office and industrial – will increasingly feel the impacts of falling business confidence and GDP.

There is a silver lining for investors, though. A-REITs have entered the C-19 market with a more defensive financial profile due to the GFC learnings. Hence, while the C-19 impacts will squeeze liquidity, raising the risks of capital raisings and distribution deferrals, investors should avoid the insolvencies or deeply dilutive rights issues that plagued the sector in 2008-2009.

The scale of the A-REIT sell-off can best be ascertained by a review of the 31 March 2020 performance data for its headline index, the S&P/ASX 200 A-REIT Index (XPJ). The XPJ provided investors with an abysmal -35.2% total return for the month of March – a negative monthly return which even eclipsed the worst of the GFC period. This calamitous result has also skewed the longer-term track record for investors, with the three- and five-year total returns now also falling into negative territory (-6.4% p.a. and -1.2% p.a. respectively).

This was despite the A-REIT sector having performed strongly in the calendar year 2019 due both to the bottom-up success of the Goodman Group in rolling out its specialist logistics business plans, and strong asset performance for the office and industrial sectors. After such a large price move, S&P noted in its March index update that the sector was trading at 0.56x book value and an indicative forward yield of 6.8%, which at face value would appear an attractive valuation entry point. But first we need to better understand why the index was sold off so heavily.

Where the retail sector goes, so goes the index

The A-REIT sector is highly concentrated, with a handful of names accounting for the majority of the market cap. For example, we have provided some analysis on the current price action for individual REITs with a market cap above $3 billion (see table below). This group of eight REITs currently accounts for approximately 80% of the XPJ’s market cap. What this also means is that some bottom-up issues for a large REIT or sector can have a similarly large impact on the index.

When comparing the drawdown of these REITs from mid-February to their March lows, we can see that this sector was the retail-only REITs such as Scentre Group and Vicinity Centres, which had significantly worse drawdowns of 62 to 64%. Further, while Scentre, for instance, has clawed back some of the drawdown, it is still much further off its mid-February peak compared to the broader sector. Given this, a greater understanding of the dynamics at play in the retail sector will go a long way to gaining a better understanding the current A-REIT dynamics.

Large-cap A-REITs have suffered large drawdowns since COVID-19 hit

ASX Code Name Last  15’Apr Mkt Cap $’b % of Index Sector Mid’Feb Price Mar’20 Low Draw down Recovery % off Feb
GMG Goodman 13.22 24.7 25% IND 16.62 9.60 -42% 38% 20%
SCG Scentre 2.13 10.7 11% RET 3.70 1.35 -64% 58% 42%
DXS Dexus 9.47 10.2 11% DIV 13.41 8.03 -40% 18% 29%
MGR Mirvac 2.24 9.0 9% DIV 3.32 1.65 -50% 36% 33%
GPT GPT 4.00 8.0 8% DIV 6.27 2.82 -55% 42% 36%
SGP Stockland 2.95 6.9 7% DIV 5.19 1.72 -67% 72% 43%
VCX Vicinity 1.40 5.1 5% RET 2.36 0.91 -62% 55% 41%
CHC Charter Hall 7.71 3.5 4% DIV 14.03 4.93 -65% 56% 45%

Source: Lonsec, IRESS

Retail REITs globally have been facing long-term structural headwinds due to strong competition being placed on certain segments, such as apparel and department stores, by the advent of online shopping. Retail REITs have been seeking to negate this challenge by changing their leasing mix to more ‘experienced-based’ tenancies offering services such as dining, cinemas, gymnasiums and healthcare.

If consumers are going online to shop for some of these disrupted categories, then landlords need to pull the services lever to restore foot traffic. Scentre is a good example of this dynamic, having been particularly successful in executing this strategy with 43% of the stores across its platform categorised as ‘experience-based’ at the end of 2019. The combined impact of a softer department store and specialty rental sector, along with the additional leasing and fit out costs of the forced conversion, has also impacted the operating cash performance and balance sheet metrics of the retail REIT sector versus office and industrial. This saw retail specialist REITs enter 2020 with reduced liquidity and more stretched balance sheets.

Unfortunately for retail REITs, a tenancy portfolio heavily weighted towards ‘experience-based’ tenancies rapidly morphed into a portfolio full of ‘non-essential’ services in the C-19 pandemic. Forced closures have also occurred at the same time as foot traffic has declined due to both isolation directives for the general public and the drop-off in international travel, which in turn has led retailers with large national ‘bricks and mortar’ store networks temporarily closing their shops.

The end result has been a perfect storm for retail REITs faced with the prospect of a large decline in Funds form Operations (FFO) due to reduced variable rents, rent relief support for impacted tenants, and ultimately increased spreads on lease renegotiations and higher vacancies.

A-REIT balance sheets are holding up in face of the COVID-19 crisis

Despite the headwinds of C-19, balance sheet conservatism means it is still unlikely that larger trusts will need to resort to the deeply dilutive recapitalisations witnessed during the GFC. As the table below shows, balance sheet metrics for the top five A-REITs by market cap as at 31 December 2019 indicate that debt remains manageable. Outside of Scentre Group, the other large REITs all have conservative metrics, with gearing ratios well below 30% and Interest Coverage Ratios (ICRs) above 5x. Further, the composition of their loan books are demarcated by a much greater exposure to bond markets, longer-dated terms to maturity, and ample liquidity.

Balance sheet metrics for top five large A-REITs remain relatively healthy

ASX Code Name Gearing ratio ICR   (x) Liquid. $’b Bonds Term Mat. (Yrs) Current Refis $’b Int. Costs
GMG Goodman 10% 18.5 2.4 100% 6.3 0.3 2.9%
SCG Scentre 33% 3.6 1.8 64% 4.2 2.5 4.2%
DXS Dexus 26% 5.7 1.3 65% 7.4 0.4 3.5%
MGR Mirvac 21% 6.1 0.9 94% 7.7 0.2 4.5%
GPT GPT 22% 6.7 1.3 86% 7.7 0.1 3.6%

Source: Lonsec, Company Financial Reports

The outlier here, however, is Scentre Group, with the longer-term retail sector headwinds meaning it entered the C-19 period with both a higher gearing ratio of 33%, a lower ICR of 3.6x, and the need to refinance over $2.5 billion in debt expiring in the short term. This, along with the more acute impacts on its operations from C-19, is a key reason for its recent underperformance versus peers. However, even Scentre’s metrics are well below the GFC, when the average gearing ratio was closer to 40% and the ethos of financing long-term assets with short-term bank debt was in the ascendancy.

There is still a great deal of uncertainty and many moving parts to the C-19 pandemic, including government policy responses, and likely many months before the economy returns to normal (or as close to normal as we can expect). Overall, however, the major A-REITs appear in good shape and are well positioned to weather the storm without the scale of the recapitalisations we saw in 2008-09.

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. ©2020 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. 


Lonsec’s experts look at four key themes we believe every financial adviser needs to understand to help their clients weather the storm and be in the best position possible to take advantage of future market conditions.

Bonds

Lukasz de Pourbaix, Executive Director & Chief Investment Officer

Providing insight into current market dynamics and performance-driven by historically high levels of volatility and tight liquidity conditions

Equities

Danial Moradi, Portfolio Manager Listed-Products

An overall update on the banking sector, focusing on the future of dividends in the current environment and a look into what the future may hold.

Performance of portfolios

David Wilson, Senior Investment Consultant

A summary of the overall performance of Lonsec’s managed accounts, including a deeper dive into the underlying strategies used and drivers of returns at the security selection level.

Dynamic Asset Allocation

Brook Sweeney, Senior Investment Consultant

Insight into Lonsec’s dynamic asset allocation process and the valuation, cycle, policy, and momentum factors that drive decision making.

 


This information is provided by Lonsec Investment Solutions as a corporate authorised representative of Lonsec Research Pty Ltd who holds 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

There is a powerful maxim best suited to the current predicament faced by markets, and that is, there are decades where nothing happens, and there are weeks where decades happen. The advent of 2020 has brought with it unprecedented volatility, with markets whipsawing erratically and appearing to have detached completely from the underlying fundamentals. No sooner had investors been beaten into submission from depression era plunges in equity markets, were they then riding a jubilant wave of euphoria on a spectacular relief rally. Unfortunately, there is no investing rule book which outlines how to effectively manoeuvre your portfolio while the global economy is placed in suspended animation and a deadly viral pathogen wreaks havoc. However, if there was ever an opportunity for active investing to shine, this is it.

In the midst of a lethal pandemic gripping markets, investors have also been dealt a one-two punch of a brutal collapse in oil prices amid a price war between Saudi Arabia and Russian. As such, the price of West Texas Intermediate (WTI) has plummeted from US$62/bbl to a low of US$20/bbl, and now seriously threatens the viability of a highly leveraged global energy industry. While lower oil prices translate into lower transportation costs, this is less relevant given large swathes of the globe are in lockdown and the airline industry has drastically curbed output.

Source: Bloomberg

Importantly, with the price of oil well below break-even, exploration and production will come to a standstill and untold numbers of jobs will be lost. Bizarrely however, in a market gripped by panic, the mindset has inexplicably shifted from selling anything (barring safe-haven currencies and US Treasuries) to a dramatic reversal bordering on irrational exuberance. This is perfectly exemplified by the FOMO (fear-of-missing-out) driven bull market rally, where investors are piling in despite the IMF now predicting the deepest economic downturn since the Great Depression of the 1930s. Astoundingly, the S&P 500 has now notched a 25% return from the depths of the recent bear-market low.

Source: Bloomberg

So, this leaves the pundits questioning, has a technical bottom been found in the markets, or are we witnessing a textbook bear-market rally? In the case of the former, perhaps it’s the invisible hand of the market looking through to a solid economic and corporate upturn. Conversely however, the rally could simply be driven by over-optimism around global governments and central banks being ‘all-in’ amid past condition to ‘buy-the-dip’. Given the magnitude of the uncertainties we’re faced with, intuition favours the latter. This has tended to be the consensus view held among Australian equity portfolio managers when posing the same question during meetings as part of Lonsec’s annual review process over the course of the first two weeks of April. Moreover, some Managers are bearishly predicting a re-test of the lows experienced in March.

Historically, downward trending bear markets have frequently been plagued with sharp relief rallies, only to run out of steam and reverse course. Logic likely dictates that given the magnitude of the deteriorating fundamentals and economic data, a sustained recovery from here is likely over-optimistic. This was evidenced throughout the latter stages of 2008 where the S&P 500 was in the grips of a death-spiral despite numerous surges ranging from 10-25%, to ultimately bottom in March 2009. Furthermore, if using weekly jobless claims in the US as a proxy for the health of the global economy, the outlook appears dire. Jobless claims continue to skyrocket and take the cumulative total number of people who have lost their job since March 2020 to almost 17 million. In the singular month of March these jobless claims have already far outstripped the devastation witnessed during the Great Recession of 2008.

The dislocation in the credit markets has likewise been pronounced, and counterintuitively, this has spread to sovereign bonds which are typically immune from indiscriminate selling. Perversely, the US Federal Reserve has resorted to not only purchasing sovereign debt, but also sub-investment grade bonds through high-yield credit ETFs. In a sign of how distorted capital markets have come, the Fed is now extending credit to cash-starved corporates in attempts to stymie a systemic economic contagion in which credit markets freeze and liquidity evaporates. Once again, this type of intervention is without precedent and has significantly stabilised markets through keeping these companies on life-support whilst the ‘risk-off’ sentiment remains heightened. However, both credit spreads and trading in credit default swaps (CDS) remain elevated which suggests a marked disconnect between the ‘blue-sky’ scenario priced into equity markets, and fixed income securities languishing in the doldrums. Consequently, in the face of such ghastly economic data, one would imagine that the ‘Fed-Put’ is starting to weaken. Alternatively, perhaps we’re witnessing the last vestiges of blood being wringed from the retail investors with quantitative trading driving momentum higher before a swift ‘pump and dump’ ensues. So, for those telling themselves that this time is different, a word of caution, as history does not repeat itself, but it does rhyme.

Source: Bloomberg

The global economy is now likely wrestling with a complete paradigm shift in how globalisation is viewed. The longer we remain in lockdown limbo, the greater the push will be for a secular and structural de-globalisation of the world economy in the post-crisis landscape. Not only has the world been devastated through the effects of a global health catastrophe, but Orwellian impositions on our personal liberties have been thrust upon us that would have been utterly inconceivable barely months ago. Moreover, the chasm between the ‘haves’ and the ‘have-nots’ has radically deepened as a wider dispersion between the working class and the inner-city elites has been exposed. Given the increasing social unrest we’ve already witnessed unravelling in supermarkets, it’s not a stretch to see this playing out on a broader scale. Likewise, the America First mantra now appears less xenophobic as countless other countries have adopted even more radical shifts to protectionism in a fight to survive. A likely consequence of this would be the return of innovation and manufacturing to many countries, where previously this function had been outsourced to China. Case in point being the world’s reliance on China for life-saving pharmaceuticals. Australia imports approximately 90% of medicines, where an outsized reliance is placed on China to meet these needs. As such, given the supply chain vulnerabilities exposed by COVID-19, a re-assessment of Australia’s sovereign capability to meet our domestic pharmaceutical consumption is warranted. Secondly, corporate vanity and window dressing will likely take the back seat as companies are forced to re-focus on their core stakeholders when staring down the barrel of economic ruin.

The exogenous COVID-19 shock has exposed significant vulnerabilities in the financial system yet has also created potentially lucrative investment opportunities for rational investors. Whilst it might be difficult to maintain a dispassionate outlook at this juncture, remember that it isn’t the end, and that markets will bottom well in advance of a positive shift in investor sentiment. If history is anything to go by, you should never let a good crisis go to waste and use this opportunity to dollar-cost-average, as this could be our March 2009 moment. With that said however, the market always delights in humbling the masses, so proceed with caution.

When the COVID-19 crisis hit financial markets, we decided to hold more frequent Investment Committee meetings and provide you with regular updates on our thoughts and discussions from a portfolio perspective.

The following is a summary of the discussion and actions taken at our most recent meeting held on 7 April.

As you know, Lonsec’s Investment Committees are now meeting at least monthly, with additional meetings held as required. Our Investment Committees are comprised of our portfolio managers, heads of research, and external macro-economic experts. Our team utilises a combination of top-down and bottom-up analysis to establish our dynamic asset allocation positions.

Positioning leading into our Investment Committee meeting

Leading into the meeting our overall active asset allocation positioning had a defensive bias with a below-target allocation to developed market equities, a positive tilt to emerging markets equities, real assets and alternatives, and a largely neutral allocation to fixed income assets. We had held this positioning prior to the COVID-19 pandemic, which has served us well in limiting some of the downside associated with the market pull back, particularly in March.

Investment committee discussion

The key question we asked ourselves during the committee meeting was: when is the right time to take a more positive tilt towards risk assets given the material market pull-back we have experienced? When we assessed our Dynamic Asset Allocation (DAA) models, it was clear that valuations across most risk assets had improved materially over recent months. The biggest unknowN was to what extent the market had priced in the impact on company earnings.

In terms of policy, liquidity conditions improved over the month as central banks and governments reacted quickly via monetary and fiscal backstop initiatives. Most notable was the US Federal Reserve’s decision to extend their bond purchasing program to investment grade credit, which significantly improved liquidity conditions in global credit markets. From a cyclical perspective, our expectation is that economic news will be negative as it tends to be lagging in nature, and from an overall sentiment/risk perspective our indicators showed an improvement (decline in risk), although risk indicators such as the VIX remain at elevated levels.

While many uncertainties remain, our base case is that we may be in for a ‘U’-style recovery in markets, with the bottom of the ‘U’ potentially being elongated. However, if we take an 18-month to three-year view, and we are prepared to handle some volatility, a consideration to increasing our exposure to risk asset is warranted.

Asset allocation decision

The committee decided to increase our exposure to Australian and global equities from a slightly underweight exposure to a neutral position. The allocation was funded from our alternative exposure, which has played its role in the market pull-back as expected, providing some downside protection relative to equity markets. For our asset allocation without alternatives, the allocation was funded from excess cash positions in the portfolios. While we remain cautious on markets and expect volatility to continue, we believe that if we take a three-year view, risk asset prices will appreciate over this time.

What next

As part of our committee discussion we also flagged a review of our fixed interest exposure, particularly around the exposure to duration assets (government bonds) and credit. We have held a relatively neutral exposure to duration risk which has performed well relative to higher risk segments of the fixed income sector such as high-yield, emerging market debt and hybrids. We believe that central banks may continue to drive bond yields lower, however given the significant widening of credit spreads there may be an opportunity to increase the weighting to credit away from duration risk.

For more information on the Investment Committee work that we do for the Lonsec Model and Managed Portfolios, as well as other external consulting clients, please contact us on 1300 826 395 or info@lonsec.com.au.

In the wake of the most challenging quarter for financial markets in living memory, super members are scrambling to check their account balances to see what effect the sell-off is having on their retirement savings.

While members are undoubtedly nervous and wondering what the market has in store for them next, leading research house SuperRatings cautioned members against making investment decisions based on an emotional reaction to the current environment.

“Our message for super members, especially those further from retirement, is stay invested if you can,” said SuperRatings Executive Director Kirby Rappell.

“Knee-jerk changes to your portfolio could have a negative effect on your retirement. Switching to cash will lock in losses and mean you miss out on the upside when the market eventually recovers. We suggest members talk to their fund or financial adviser to help ensure any decision is aligned with a long-term strategy.”

Superannuation has been hit hard by the coronavirus and the market’s reaction to extreme measures such as social distancing, lockdowns, and travel bans.

According to estimates from leading research house SuperRatings, the median balanced option fell 8.9% in March and is down 10.0% over the quarter.

The median growth option, which generally has a higher exposure to shares, fell 12.5% in March and 14.1% over the quarter. The median capital stable option fared relatively well amid the market turmoil, falling only 4.1% in March and 3.8% over the quarter.

Accumulation returns to end of March 2020

  CYTD 1 yr 3 yrs (p.a.) 5 yrs (p.a.) 7 yrs (p.a.) 10 yrs (p.a)
SR50 Growth (77-90) Index -14.1% -6.4% 3.1% 3.7% 6.8% 6.5%
SR50 Balanced (60-76) Index -10.0% -3.1% 3.7% 4.3% 6.7% 6.5%
SR50 Capital Stable (20-40) Index -3.8% 0.4% 3.1% 3.2% 4.5% 4.9%

Source: SuperRatings estimates

Pension returns have also been buffeted by the wave of selling. The median balanced pension option fell an estimated 10.2% over the March quarter, while the median growth option fell 14.4%. In contrast, the median capital stable option was down 3.8%.

Pension returns to end of March 2020

  CYTD 1 yr 3 yrs (p.a.) 5 yrs (p.a.) 7 yrs (p.a.) 10 yrs (p.a)
SRP50 Growth (77-90) Index -14.4% -5.9% 3.7% 4.4% 7.8% 7.3%
SRP50 Balanced (60-76) Index -10.2% -2.5% 4.2% 4.6% 7.3% 7.2%
SRP50 Capital Stable (20-40) Index -3.8% 1.0% 3.8% 3.7% 5.1% 5.6%

Source: SuperRatings estimates

The only good news in March seemed to be signs of a relief rally as markets priced in the government’s fiscal stimulus packages and the Reserve Bank of Australia’s bond-buying program, along with similar efforts from governments globally.

While more pain is expected, markets have already sold off heavily in response to the coronavirus and the measures taken to contain it.

How is your super option exposed to market moves?

According to SuperRatings, times of severe market stress can make investors second-guess their long-term investment strategy. For super members, switching to a more conservative investment option in the middle of a crisis can lock in significant losses and mean missing out on the upside when markets inevitably recover.

Older members nearing retirement are likely to be in conservative balanced or capital stable options which have higher allocations to defensive assets, providing protection from share market movements.

As the chart below shows, Australian and international shares generally make up just over half of the portfolio for a balanced option, with the rest invested in bonds, property, alternative assets, and cash. For growth options, shares typically make up around 67% of the portfolio, meaning members are more exposed to movements in share markets.

In contrast, members in a capital stable option will typically have only a 20% allocation to shares, with much higher allocations to bonds and cash, providing more stability and protection against share market swings.

Over time we have seen funds investing more in Alternative assets such as unlisted property, infrastructure and private equity, with these assets representing around 20% of the average balanced fund’s portfolio in 2019, up from 15% in 2008.

Asset allocation by investment option


Source: SuperRatings indices

Members need to keep the current market conditions in context. For most members, while there may be a fall on paper, the loss only becomes crystallised when members sell out. If you’re in the 20 to 40 age bracket, you have another 30 to 50 years to go before you need to start drawing down on your super. Even members in their 50s will need to rely on their super for drawdowns over the next 20 to 30 years.

The performance of the Alternatives universe during the recent market downturn has been widely dispersed, albeit skewed to the downside. Systematic Risk Premia strategies have been an area of poor performance with long running statistical relationships breaking down in current market conditions. Sharp spikes in volatility and the speed of asset price reversals have tested many strategies.

Exposure to risk premia such as value and carry, specifically short volatility, have been key points of pain. Momentum or trend following within Systematic Risk Premia strategies were positioned largely risk-on going into February this year, and during the initial market sell-off, signals were slow to react and re-position the portfolio or reduce risk. Meanwhile, dedicated trend followers with shorter trend horizons and faster twitch signals have generally fared well through the period.

Systematic Risk Premia products encompass a wide range of investment styles and strategies, although they are largely designed to offer liquid, transparent and cost-effective solutions for accessing hedge fund-like return streams.

The rise of Systematic Risk Premia strategies shares similarities with the shift towards passive investing in more traditional asset classes, spurred in part by the general underperformance of higher-fee fundamental investment managers.

These strategies are generally rules-based, multi-asset, and utilise a long-short approach with leverage and derivatives forming a key part of portfolio construction. Fund managers within Lonsec’s Systematic Risk Premia sector seek to provide long-term absolute returns through a variety of replication techniques or by employing other commonly used (or ‘classic’) trading strategies used by active hedge funds (this may also include exposures to more commonly recognised ‘factors’).

Performance of Systematic Risk Premia strategies during the COVID-19 pandemic

In February and March 2020, as the COVID-19 outbreak worsened and many major growth asset classes suffered severe losses, many Systemic Risk Premia strategies came under pressure. Underperformance within Lonsec’s universe of rated funds has largely been driven by carry factors such as short volatility, although value also detracted across many asset classes, as did momentum/trend.

Portfolio construction and risk management processes for many Systematic Risk Premia strategies rely on the back-tested assumptions that risk premia are uncorrelated, or at least lowly correlated. That said, recent performance in down-markets has suggested that this may not always be the case, which is when these relationships are needed most.

It is well known that trend factors often suffer losses during sudden inflection points and risk-off events like the current COVID-19 outbreak. Depending on prior signal direction and positioning, this is also the case for merger arbitrage and carry factors. For example, the Lonsec Systematic Risk Premia peer group underperformed in 2018 and most notably in Q4 2018 when most financial markets, including equity markets, experienced a relatively rapid drawdown of greater than 10%.

Overall, this has led to disappointing results in recent down markets. We believe more scrutiny regarding portfolio construction approaches is required, including the reliance on longer-dated statistical relationships that can deteriorate as market regimes shift. This remains a key area of focus for Lonsec during research reviews.

Performance of Systematic Risk Premia strategies (growth of $10,000 since January 2018)

Source: Lonsec

Using Systematic Risk Premia strategies in a portfolio

Lonsec believes that these products, especially those with more conservative risk-return targets, should generally suit moderate risk profile investors with specific liquidity requirements. Investors should also expect limited or no exposure to less liquid hedge fund strategies, such as Event Driven strategies.

That said, some fund managers like GAM have researched and established products with allocations to replicate less-liquid strategies, such as Merger Arbitrage, in a more liquid and lower cost offering. While increased liquidity is ordinarily a good thing for investors, the question also needs to be asked if the push towards more liquid underlying assets comes at the cost of lower returns. Hedge funds have historically benefitted from investing in illiquid assets, where the freedom to leverage into assets holding an illiquidity premium has delivered strong returns.

These types of strategies are not generally possible in a daily liquid vehicle due to the potential for a redemption freeze. Much like the discovery of over 400 factors, the efficacy of the risk premia employed by Lonsec’s peer group are subject to back-test bias. This makes it difficult to assess the performance and diversification benefits of these strategies given limited track records.

While live data is limited, these strategies have so far demonstrated medium-to-low correlation to major asset classes. However, without experiencing many sustained market downturns, through-the-cycle expectations are sceptically reliant on back-tested data. The current market environment will offer further evidence of how these strategies behave.

Correlations between Alternatives strategies

Source: Lonsec

As the chart above shows the correlation between common Alternative strategies including Systematic Risk Premia (SRP) and traditional asset classes based on monthly data from August 2011 to August 2019 (in Australian dollar terms). As can be seen, the reasonably high correlation between SRP, Managed Futures and CTA strategies is not unexpected given the inclusion of trend and momentum factors within SRP strategies. This is the case for a number of SRP managers in the Lonsec peer group, who have a heritage in trend following, meaning this premium can often dominate a strategy’s risk allocation.

The modest correlation to Equities (as defined by the MSCI AC World Index) may mean that the diversification benefits in a balanced portfolio are muted, although this will be dependent on the observation period. As mentioned, there is significant variation in the strategies and risk premia within the Lonsec rated peer group. The correlation to US Treasuries – and to a lesser extent global bonds – may be more sample-dependent and attributed to the synchronised monetary easing exhibited by most global central banks. As such, over the period, persistent declines in global interest rates have benefitted fixed income–oriented premia strategies, in particular those seeking to extract carry, trend, and volatility premia within the fixed interest asset class.

The need for a holistic portfolio approach

Investors also need to consider how best to incorporate Systematic Risk Premia strategies in a holistic portfolio, whether it be as a hedge fund replacement or to complete a balanced Alternatives allocation. Consideration must also be given during the Manager selection stage, as risk premia exposures can vary significantly between strategies.

While not designed as a hedge, diversification is best provided during risk-off market environments, and the inclusion of particular carry risk premia such as short volatility, which potentially experience drawdowns during these risk-off events, may make them unsuitable within a strategy designed to simply provide diversification. Further, there is the potential for some risk premia to already be represented in other parts of an investor’s portfolio (e.g. a strong value bias within an equity allocation) and having a sizeable allocation to the value premia within a systematic risk premia strategy may further reduce diversification benefits.

As the COVID-19 pandemic sweeps across the globe, shutting down countries and closing borders, the Australian Government had to quickly come to terms with the severity of the health crisis and the inevitability of an economic recession.

A series of economic measures has been announced since early March to mitigate the impact on the local economy and people’s lives. The usual May federal budget was delayed to 6 October 2020, while the uncertainty makes formulating reliable economic and fiscal estimates an impossible task. We outline the fiscal measures announced by the government so far and attempt to assess their effectiveness in this highly uncertain world.

First package—12 March

Total: $17.6 billion (0.9% of GDP)

Measure Cost $m
Increase the instant asset write off threshold from $30,000 to $150,000 and expand access to include businesses with aggregated annual turnover of less than $500 million (up from $50 million) until 30 June 2020. 700
Back business investment by providing a time limited 15-month investment incentive (through to 30 June 2021) to support business investment and economic growth over the short term, by accelerating depreciation deductions. Businesses with a turnover of less than $500 million will be able to deduct an additional 50 per cent of the asset cost in the year of purchase. 3,200
Boost Cash Flow for Employers by up to $25,000 with a minimum payment of $2,000 for eligible small and medium-sized businesses. 6,700
Support small businesses to support the jobs of around 120,000 apprentices and trainees. 1,300
A one-off $750 stimulus payment to pensioners, social security, veteran and other income support recipients and eligible concession card holders. 4,800
Support those sectors, regions and communities that have been disproportionately affected by the economic impacts of the Coronavirus, including those heavily reliant on industries such as tourism, agriculture and education. 1,000

Second package—22 March

Total: $46 billion (2.3% of GDP)

Measure Cost $m
$550 per fortnight to both existing and new recipients of the JobSeeker Payment, Youth Allowance jobseeker, Parenting Payment, Farm Household Allowance and Special Benefit, paid for the next 6 months. 14,100
$750 payment to social security and veteran income support recipients and eligible concession card holders, except for those who will receive the Coronavirus supplement above. 4,000
Allow individuals in financial stress as a result of the Coronavirus to access up to $10,000 of their superannuation in 2019-20 and a further $10,000 in 2020-21. 1,200
Reducing superannuation minimum drawdown requirements for account-based pensions and similar products by 50 per cent for 2019-20 and 2020-21. N/A
Reducing social security deeming rates. 876
The Government is providing up to $100,000 to eligible small and medium sized businesses, and not‑for-profits (including charities) that employ people, with a minimum payment of $20,000. 25,200
Guarantee 50% of new loans issued by eligible lenders to SMEs. N/A
Support for the aviation industry. 715

Third package—30 March

Total: $130 billion (6.5% of GDP)

Measure Cost $m
Eligible employers (turnover<$1bn with reduction in revenue of 30% or more, turnover>$1bn with reduction in revenue of 50% or more) will receive payments of $1500 per fortnight per eligible employee for up to six months. 130,000
Temporarily relaxing the partner income test for JobSeeker Payment. N/A

Balance sheet support

Total: $125 billion

The Reserve Bank will provide a three-year funding facility to authorised deposit-taking institutions (ADIs) at a fixed rate of 0.25 per cent. This facility is for at least $90 billion or approximately 4.5% of GDP.

The AOFM’s $15 billion investment capacity to invest in wholesale funding markets used by small ADIs and non-ADI lenders (0.8% of GDP). The government will guarantee up to $20 billion to support $40 billion in SME loans, as part of the second package announced on 22 March (1.0% of GDP).

Keeping the economy alive

The stimulus measures have been designed and announced quickly to address the current economic crisis. The size of the stimulus is substantial, revealing the potential negative impacts the Government assesses as likely to be felt across the economy.

The majority of the measures are aimed at sustaining businesses, keeping people in jobs and protecting the financially vulnerable. Getting money into people’s hands (through measures like the JobKeeper Payment and increased benefits payment) will help people pay rent and keep food on the table. Measures including guaranteeing SME loans and instant asset write-offs will hopefully keep the businesses viable or be in a stable to bounce back once the lockdowns are lifted.

However, pumping more money into an already blocked economic plumbing might not be enough to solve the problems. Given normal production and distribution of goods and services are being disrupted by the extensive lockdowns, simply having money in people’s hands might not be enough to combat both the supply and demand shocks.

While employees may maintain a level of safety net income, their spending will suffer, both as a result of weaker consumer confidence (e.g. not replacing a white good while fearing for job security) as well as an unavailability of what they would normally consume (e.g. movies, eating out).

While the economy remains in lockdown, people are only likely to consume the bare essentials: rent and mortgage payments, food and drinks, toilet paper (possibly in unreasonable quantities), keeping the kids occupied, and maintaining one’s sanity. The businesses and those employed by them in these sectors will do well during this time (e.g. supermarkets, pharmacists), as well as essential services such as healthcare, police and council services including garbage collection. But those outside these ‘essential’ services will continue to struggle for as long as the lockdown remains, and possibly even longer.

Maybe it’s also time the government acted more as a central planner and channelled the idle productive capacity in the economy towards projects that will employ and pay people. This would allow them to keep the lights on and use their collective expertise to increase the economy’s productive capacity in the long term.

Some examples I can think of include: constructing temporary hospitals to care for the potentially higher number of patients, re-purposing manufacturing facilities to make medical protective equipment or ventilators, investing in better communication infrastructure so more people can work from home effectively, rebuilding drought and bushfire-affected communities, providing online training to small town tourism operators and pub owners, and modernising the curriculum to prepare a future-ready workforce. Finally, what better time to think about diversifying the economy from mining and residential construction?

We can’t rely on China to save the day this time

Many Australians born in the 90s and later have never experienced a recession. In fact, we beat the Netherlands and hold the record of the longest economic expansion in the developed world. The last recession to hit our shores was the “recession we had to have” in 1990. Twenty years on, a recession now seems almost inevitable.

Call us the lucky country, but there is unlikely to be another massive infrastructure spending in China this time around, which on previous occasions has driven up demand for our coal and iron ore (like during the GFC). If anything, our reliance on China has meant the tourism and education sectors are taking a harder hit than many other countries. Those affected range from lobster farmers in WA, to luxury shops in Sydney and Melbourne, to struggling higher education providers.

As global borders are closed and trade and tourism take a massive hit, countries are also in a mad scramble to get their hands on surgical masks and other protective equipment, some re-engineering production lines to make masks instead of clothing. It’s looking increasingly likely the last few decades of globalisation might start to unwind once we come out of this health crisis. Maybe it’s time to implement some long overdue structural reforms and set the economy up for the future.

For detailed measures and eligibility, see Treasury’s updated document on the economic response to the coronavirus.

 

Introduction

Listed Investment Vehicles such as Listed Investment Companies and Trusts were under much scrutiny prior to the eruption of the current crisis to engulf markets. Casting our minds back only two months, the issue dominating this corner of the investment world revolved around stamping fees. While Treasury has been tasked to formulate a response, it arguably has more pressing matters such as devising strategies to keep the Australian economy from imploding from the COVID-19 shutdown and direction may be some time coming.

The vehicles themselves have endured a torrid time during the market turmoil with planned capital raisings cancelled and the usual performance issues that inevitably crop up. The correction has, however, exposed other fundamental issues with LIVs ranging from underlying portfolio valuations to how these products themselves should be used in a client context.

From frying pan to the fire

Financial markets tend to resolve issues by themselves—for good or for bad. Stamping fees are otherwise known as commissions associated with a capital raising for a LIV. With the ASX having cratered 36% in short order (Feb. 20 to March 23), and investors nursing losses it seems likely that interest in new product would be severely curtailed for the medium term at least.

This is probably even more so for the yield orientated strategies which had been crowding the ASX boards of late. The thirst for yield, and the hitherto relative calmness in markets, had emboldened investors to reach out across the fixed income risk curve into highly sophisticated territory like private debt. While uncertainty surrounding stamping fees may have given issuers of new products cold feet, the ensuing COVID-19 induced market correction has more than likely forced a re-evaluation of timelines—from 2021 if at all.

These assets had been the preserve of institutional investors given the underlying risks and the need to have a genuine long-term view in order to prosper. The LIV closed-end structures are well suited to these types of assets protecting value from any investor panic and forced redemptions. However, while the assets themselves are sheltered (setting aside any potential issues relating to their prospective quality and resilience) the LIV trades daily on the market and concerns/reduced conviction will be impounded. There is always the ever-present issue of misuse although not dissimilar to illiquid or volatile micro and small cap equities.

Lonsec researches 25 LIVs across Australian Equities, Global Equities, Fixed Income, Alternatives and Infrastructure (see Appendix 1 for the full list). All vehicles experienced steep drawdowns in traded value in excess of 10% during the window of February 20 to March 23 as seen in the following chart.

Source: Lonsec Research, Iress & Bloomberg | Stock Codes = See Appendix 1 | AEQ = S&P/ASX 200 TR Index AUD; GEQ = MSCI World ex Australia NR Index AUD; EMEQ = MSCI Emerging Markets NR Index AUD; AFI = Bloomberg AusBond Composite 0+ Year Index AUD; GHY = Bloomberg Barclays US Corporate High Yield (Unhedged)

Observations:

  • Most LIV prices have fallen in line with the broader Australian share market rather than proxies which more closely match the underlying assets within their portfolios. For instance, the Magellan Global Trust (MGG) price fell 38% while the benchmark global equities index only fell 23%—this represents a significant 15 percentage point difference. A common criticism of listed infrastructure and property is that these assets will tend to trade more like stocks (Australian stocks at that) and this chart suggests that this criticism may be extended to non-AEQ LIVs. This can have serious consequences for client portfolio management and rebalancing decisions.
  • Nine of the 25 LIVs fell less than the Australian market’s 36% of which six were Australian Equities focused vehicles.
  • Platinum Asia Investments Limited (PAI) stands out with only a -16% fall. This would seem counterintuitive given its heavy China focus (net 42.9% as at 29 Feb. 2020 to China and related) and a healthy dollop of Korean exposure (net 9.4% as at 29 Feb. 2020). However, China’s stocks have so far proven resilient to the economic fallout with the CSI300 down only 12% for the same period (following an earlier period of volatility in January/February 2020).
  • The only other LIV to have experienced such a cushioned fall (-18%) was Global Value Fund Limited (GVF). GVF uses a sophisticated strategy investing across a range of assets (including LIVs) as well as derivatives.
  • The most eyebrow raising moves have been seen with the Fixed Income LIVs although this would seem reasonable after digging a bit deeper. Fixed Income more generally has a safe haven status during period of stress albeit with well understood limitations. Sovereign bonds tend to be the safest (hence their general risk-free asset status) followed by highly rated corporate bonds. All the Fixed Income products under coverage (including PGG) invest across a range of riskier debt with mixed liquidity and quality in order to generate their high yields.
  • NB Global Corporate Income Trust (NBI) has the unenviable title of the worst price performer (-54%) of all listed products researched by Lonsec. Partners Group Global Income Fund (PGG) takes third spot (-47%) behind Forager Australian Shares Fund (-53%). NBI invests in global high yield bonds (GHY) which have been at the centre of concerns during this current crisis. GHY is also be considered as relatively more liquid than some of the other higher risk Fixed Income strategies in this space (e.g. private debt). NBI was also forced to cancel a c. A$340mn capital raising as a result of the market volatility. PE1 (withdrew ahead of close) and MXT (c. A$344mn) also cancelled capital raisings. Australian players MXT (-37%) and GCI (-36%) cannot escape the ignominy either.
  • The investors need to be mindful of however is that unlike equities, bonds/loans (in Fixed Income products) have a finite period and strategies should receive a return of their capital barring any significant wave of defaults (then the recovery rate becomes another factor, generally higher than equities). Moreover, while traded prices may fluctuate as investors react to news affecting the underlying investments, the closed-end nature of these vehicles supports the integrity of the investment vehicle as these LIVs are immune from redemption pressure. Then again, they may simply trade at deep discounts to NTA for an extended period.

Stale NTAs Blight Sector

Listed markets are great for price transparency and particularly well suited to forming views on industrial companies. Maybe less so when it comes to LIVs judging by the propensity of these vehicles to trade away from their NTA—sometimes significantly.

LIVs may have actively quoted prices but the frequency with which the value of their underlying investments is published can vary widely from daily, weekly, monthly or potentially longer. Clearly increased costs could be a limiting factor to increasing the frequency of audited values but producing daily estimates is not expected to be a material cost especially as this information should already be readily available within portfolio management systems.

Sadly, most Australian Equities LIVs report their NTA on a monthly basis and this stands in stark contrast to their Global Equities peers updating the market weekly. ARG has responded to the recent market turmoil by publishing weekly estimates. CIE, AMH, AFI, MIR and DJW have provided intra-month March updates. FOR and PIC meanwhile have been providing daily estimates for a long time and this should conceivably be the default model for all equities based LIVs.

Equity-based strategies are quite straightforward and typically uncomplicated with readily available asset prices. NTA updates on a monthly basis should no longer be accepted as general practice and these vehicles should improve their communications to investors. That vehicles with arguably less price transparent debt assets can confidently provide daily NTA estimates should give most of their peers cause for reflection on their own practices.

Source: Lonsec Research, Iress & Bloomberg | NTA = Pre-Tax NTA; Period = End of Month

The above chart highlights the premiums / discounts as at the end of January and February 2020. Clearly these values are very dated given the widespread price action post the 20th of February but nonetheless provide a useful discussion point. For instance, given the distress which has befallen credit markets globally and the significant price corrections experienced by the vehicles themselves, the very narrow discounts are expected to have noticeably widened. Using NBI as an example, this was trading at a 16% discount based on the March 26 NTA and March 27 closing price.

NBI observation also provides another lesson. Complicated strategies, or those with which the market has less familiarity or comfort, may nevertheless trade away materially from the underlying portfolio value. This is irrespective of the frequency with which NTA updates are provided. Moreover, not all assets can be valued more frequently either (e.g. direct property). Traded prices reflect future expectations and factors which impinge on an investor’s ability to derive these can weigh on market performance. In times of crisis, investors tend to flock not only to safety but simplicity too.

Conclusion

The treatment of stamping fees had been consuming the industry for many months before the Treasurer announced a review into the issue in January. This was before the world changed with COVID-19 and exposing some other deep-seated issues within the industry. For instance, why should a portfolio of liquid daily traded securities only provide NTA updates on a monthly basis? By comparison managed funds can strike prices daily on similar pools of assets. Moreover, debt focused LIVs are already confidently providing daily NTA estimates. Stale NTAs are expected to have a material impact on investor psychology and into the trading performance of these vehicles.

The other more pernicious issue relates to portfolio construction. A client portfolio built of non-equities based LIVs is likely to miss out on immediate and normally expected correlation benefits as many Lonsec researched ASX-listed LIVs traded in-line with the ASX and not with their underlying assets. Perhaps this issue should get at least equal attention than whether stamping fees should persist.

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.