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3 things you must do before recommending a sustainable fund

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

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

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

1. Understand the product issuer’s frame of reference

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

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

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

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

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

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

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

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

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

Source: Lonsec

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

2. Determine what your client’s expectations are

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

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

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

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

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

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

3. Cut through the piles of data

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

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

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

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

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

Keep communicating the benefits

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

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

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

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

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

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

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

April 7, 2021/by Gordon Toy

Insights

COVID winners face higher expectations in 2021

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

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

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

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

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

Source: Lonsec / Financial Express

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

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

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.

April 7, 2021/by Gordon Toy

Insights, News & Insights

Market Overview, Portfolio Performance & Positioning Update

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.

March 23, 2021/by Lukasz de Pourbaix

Insights, News & Insights

As our values change, so does the investment product market

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.

March 23, 2021/by Lukasz de Pourbaix

Insights, News & Insights

Lonsec Investment Solutions – February 2021 Reporting Season Insights

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.

March 16, 2021/by Danial Moradi

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