Market Overview, Portfolio Performance & Positioning Update

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


Transcript:

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

What has occurred in markets during the last 12 months?

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

How have our Lonsec portfolios been positioned?

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

How are we diversifying our portfolios by investment strategy?

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

Are we making changes to our asset allocation positions?

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

We are here to support you.

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


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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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


Transcript:

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

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

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

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

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


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

This video is provided by Lonsec Investment Solutions Pty Ltd ACN 608 837 583, a Corporate Authorised Representative (CAR 1236821) (LIS) of Lonsec Research Pty Ltd ABN 11 151 658 561 AFSL 421 445 (Lonsec Research). LIS creates the model portfolios it distributes using the investment research provided by Lonsec Research but LIS has not had any involvement in the investment research process for Lonsec Research. LIS and Lonsec Research are owned by Lonsec Holdings Pty Ltd ACN 151 235 406.

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

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

Everyone has a view on cryptocurrency, and in most cases it’s a tale of extremes. On one side sit the sceptics, who believe that cryptocurrencies are one big Ponzi scheme that will self-implode like the ‘tulip mania’ of the 17th century Dutch Golden Age, which saw the price of tulip bulbs reach incredible highs and then dramatically collapse. On the other side are the ‘true believers’, who believe cryptocurrencies such as Bitcoin are not just a new form of currency but a symbol of decentralisation and freedom from central banks and governments.

I am by no means an expert on cryptocurrency and blockchain technology, however it is worth noting the growing interest by various institutions in cryptocurrency. Probably the highest profile announcement was Tesla’s decision to buy US $1.5 billion in bitcoin and its announcement that it would start accepting bitcoin as a payment method for its products.

The sceptics would say, yeah but it’s Elon Musk, the guy who sends rockets into Mars and wants to insert computer chips into people’s brains. However, we have seen institutions such as Mastercard indicate that it would bring cryptocurrencies onto their network, and recently JPMorgan Chase & Co strategists have been floating the idea of investors using cryptocurrencies such as bitcoin as a way of diversifying portfolios. According to a survey released by specialty insurer Hartford Steam Boiler Inspection and Insurance Company, 36% of small- to mid-sized businesses in the US accept digital currency for payments for goods and services.

From an investment perspective, proponents of cryptocurrencies such as bitcoin have considered the digital currency from two main perspectives. Firstly, bitcoin can be viewed as a store of value akin to gold. This view has been amplified in a world where central banks have been flooding economies with money via their quantitative easing programs since the time of the global financial crisis. The decentralised nature of bitcoin means that the price is not influenced by central banks, which is the case with traditional fiat currencies. Interestingly the uptake of cryptocurrencies has been strongest in some emerging economies where arguably they are more prone to government instability, and in some instances they have experienced the effects of hyperinflation, which has rendered traditional currency worthless.

Secondly, bitcoin offers ‘frictionless’ transacting, whereby the blockchain technology underpinning the digital currency uses a public ledger system to validate transactions, effectively cutting out the ‘middleman’, hence increasing the speed of transactions and reducing costs. The potential applications of blockchain technology beyond cryptocurrencies are far reaching and many institutions are actively exploring its application in areas such as property transfer, execution of contracts and identity management.

However, there are fundamental questions that need to be addressed before cryptocurrencies can become mainstream. From an investment perspective, how do you value crypto assets? What are you valuing and what metrics do you use to value it? These are valid questions and, in my view, we are yet to address them adequately as an industry. Questions around the secure storing of cryptocurrencies and the associated risks with the different methods, ranging from holding assets on an exchange through to storing assets via a digital wallet using web-based or hardware solutions, all have their pros and cons in terms of security, and need to be considered when allocating assets to crypto. For large institutional investors such as super funds, how they hold investments is very important, and having a custodial structure supporting crypto assets will be imperative for the asset class to gain traction in that market.

We have seen BNY Mellon, the world’s largest custodian bank, announce that it will roll out a new digital custody unit later this year to assist clients in dealing with digital assets. Furthermore, we have already seen crypto ETFs launched in Canada and we will no doubt see managed fund and ETF structures reach our shores at some stage, which will alleviate some of the issues associated with storing crypto.

Another area which has come under the spotlight regarding crypto currencies is ESG (environmental, social, and governance) concerns over the energy required to mine cryptocurrencies. According to the Cambridge Center for Alternative Finance, coal accounts for over 38% of energy consumption by miners. Given ESG is a growing part of people’s investment considerations and processes, this will be a relevant aspect of crypto which will need to be explored further.

Finally, we expect the sector to become more regulated as cryptocurrencies gain greater acceptance. While this does create uncertainty, it is also an important step for digital currencies to become accepted more broadly.

Cryptocurrencies and the associated implications of blockchain protocols and their applications are arguably still in their infancy and will dramatically evolve over time. While we don’t expect cryptocurrencies to suddenly appear within your standard diversified portfolio in the near future, to simply dismiss the sector without trying to understand it would be a mistake. At a minimum, clients are increasingly likely to ask questions about cryptocurrencies, particularly as we see product structures such as ETFs and managed funds make the sector more accessible for investors. The more we learn, the more we will be able to provide an informed response to our clients.

 

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. 

Traditionally value managers used the book-to-price ratio (B/P) as their standard value metric. The B/P ratio served value managers well back when economies were largely industrial. However, as the developed world shifts to a service- and knowledge-based economy—thanks in part to the catalysing effect of COVID-19—the B/P ratio has become a less meaningful metric and used on its own fails to capture some important information.

As more and more companies invest in the creation of intangibles such as R&D, patents, and other intellectual property, the book value of these companies can be greatly understated by an investor relying solely on the B/P ratio. Because the book value of a company does not reflect the value of intangible assets, managers tend to use price/earnings (P/E) and similar ratios in conjunction with traditional value metrics like the B/P ratio in order to get a better understanding of a company’s fundamentals and prospects.

A recent study in the Financial Analysts Journal showed that, due to this trend of using a broader set of metrics, many value managers now have portfolios filled with stocks that would previously have been categorised as growth stocks. This raises interesting questions about how we define value and growth, and the extent to which the lines can become blurred.

There was a sigh of relief for many investors incorporating value strategies in their portfolios when in Q4 2020 we saw a long-awaited rally in value stocks. Unfortunately, for many ‘value’ managers, the rally did not seem to extend to their own portfolios. On closer inspection, it appears that value with a quality bias generally did not join in the rally, but that it was predominately cyclicals that performed strongly as the market gained more confidence in the COVID-19 vaccine rollout.

What does this mean for value managers?

Firstly, it means that those traditional value strategies that stuck to their knitting (or as some may now argue, stuck to a very narrow definition of value) and built portfolios comprised of quality companies trading at a discount to their perceived value underperformed the market. Secondly, it means that managers who were less focused on quality—or were less narrow in their definition of value—may have been rewarded.

So why would quality value not rally with the rest of value? Quality is typically referred to as a factor using a collection of metrics indicating robust financial health within a company. While there is no standard definition of quality, according to a recent article, it is typically a combination of broad categories including profitability, earnings stability, capital structure, growth, and other such metrics.

Why did these types of quality companies not participate in the rally? When will the market finally recognise their value? These are questions baffling today’s investors, and it may be some time before we ever find satisfactory answers. For now, we can only be aware of the challenge and respond to it by maintaining exposure across a broad selection of styles and strategies, and by understanding the nuances of each investment and how it may or may not react in certain market conditions.

Ultimately what matters to investors is not the relative returns over the past decade or century, but the relative returns over an investor’s time horizon. On that basis, predicting the winning style is impossible. But making sure we are diversified across a range of styles is not only possible but prudent.

 

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

The performance of the Lonsec Alternatives universe generally performed well in the December 2020 quarter and into January 2021. The vaccine breakthroughs played a significant role in buoying investor sentiment, and while there have been logistical hiccups in some countries that have delayed the rollout, overall developments are positive for markets.

A key catalyst for stronger performance outcomes has been the return of the value risk premia after a long period of headwinds. Value has benefited from the vaccine narrative and the return to more normal operating conditions, while fiscal and monetary measures helped to plug the liquidity gap, patch up balance sheets, and prevent a complete collapse in confidence.

Risk premia strategies have benefitted from the factor rotation in the market, with risk premia such as value, carry, trend and volatility becoming more favourable, and to a lesser extent equity long/short.

Private equity and debt markets were up in the December quarter, underpinned by the risk-on mood, strong returns, excess liquidity and the chase for yield. However, given the strong rally and sentiment in public markets, stress and forced selling hasn’t yet materialised across the sectors, with the exception being real estate. Managers with excess capital are well placed to buy attractively priced businesses if forced selling becomes more widespread.

Managed Futures strategies performed relatively well over the December quarter as buoyant market conditions and improving market sentiment reversed trends seen in the previous quarter. US dollar weakness trends underpinned the advance, with continued strength in all major currencies against the US dollar, and a continuation of the upwards momentum in stock markets. Additionally, strong trends across agricultural and energy markets aided commodities indices.

Equity market neutral strategies have been mixed. Factor rotation leadership and the buoyant sentiment driven by vaccine developments, political changes, and fiscal stimulus led to a decrease in stock dispersion, which tends to be unfavourable for these strategies. Notably, factor correlations have risen to the highest level in two decades, and equity issuance slowed further within the Australian market over the quarter. Equity issuance had allowed for strong alpha capture in previous quarters as many offers were priced at attractive discounts to market prices.

Global macro strategies performed well through the quarter, buoyed by the positive market sentiment, with discretionary managers finding attractive trading opportunities around political events, as well as significant policy changes being made by monetary and fiscal authorities. Lonsec continues to believe the qualitatively driven strategies appear better placed to adapt and react to changing market conditions and significant central bank intervention compared to their systematic global macro peers.

These strategies tend to be better placed to balance the portfolio across asset classes using a combination of directional and spread trades in addition to dedicated hedges. Nonetheless, quantitative macro strategies were favourably positioned for the December quarter, most notably benefiting from a return to fundamentals and the value risk premia.

Within private debt, despite risk appetite continuing to return, the market is still less favourable for debt exposed to leisure, retail and energy sectors. Nonetheless, newly priced issues tend to require a greater level of asset security and financial covenants, which are favourable for the lender.

The Australian equity market experienced a very strong end to 2020, delivering an outsized 13.8% return as measured by the S&P/ASX 300 Accumulation Index in the December quarter. The recent advances contributed to the 2020 calendar year generating a surprising positive absolute return of 1.7% despite heightened volatility.

The impressive quarterly return was led by the largest index weighted sector financials with increasing optimism of a broad economic recovery predicated on recent positive developments from some of the front-running Covid-19 vaccine candidates, particularly Pfizer/BionTech and Moderna. Additional tailwinds were the federal government’s decision to ease lending restrictions, APRA’s removing a cap on listed companies paying out dividends, and an uptick in long-term bond yields, which in aggregate should lift profitability for the sector.

Over the December quarter, the four major banks recovered well from their lows earlier in the year, with ANZ gaining 32%, CBA jumping 29%, NAB up 27%, and Westpac rising 15%. The energy sector produced the largest sector gain of 26% supported by a stronger oil price and depreciating US dollar, while being highly leveraged to the re-opening of the economy.

A significant jump in the iron ore price was the principal catalyst for a re-rating of the three largest local miners, with Fortescue surging 44% higher, Rio Tinto climbing 21% and BHP rising 19%. The price of the key steel-making ingredient hit multi-year highs amid Brazilian miner Vale cutting production guidance and improved demand conditions in China as the government has undertaken a substantial infrastructure spending program to reignite their economy.

Some of the less economically sensitive sectors (i.e. Health Care and Utilities) delivered negative returns for the quarter. Key utility companies announced earnings downgrades (e.g. AGL, dragged down by lower wholesale electricity prices). Large index weight CSL led the healthcare sector down, with the company announcing the cessation of its Covid-19 vaccine, which was triggering false positives for HIV.

Value outperformed growth stocks by a staggering 18% in the December quarter

A rotation out of some expensive growth pockets into value sectors was clearly evident over the December quarter with further RBA stimulatory measures, including the cutting the official cash rate by 15 basis points in November and an additional $100 billion of bond purchases as part of its QE program. On top of the vaccine breakthroughs, additional stimulus was a trigger for a rally in many beaten-up cyclical-oriented sectors.

The small cap segment of the market experienced an almost identical return in the December quarter compared to its broad cap counterparts, returning 13.8% as measured by the S&P/ASX Small Ordinaries Index, with the small resources index delivering an even stronger return of 20.3%. The performance of the broad commodities complex—principally iron ore, copper and oil—all rallied strongly.

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

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

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

 The Lonsec Sustainable Managed Portfolios were launched on HUB24 on 8 December 2020 and investor capital was put to work immediately in improving societal and environmental outcomes. The Sustainable portfolios have been well supported to date, with an increasing number of investors looking to invest in not only a way that delivers solid returns, but also aligns to their values.

While we don’t yet have a full month of performance to report on, the portfolios have performed in line with our expectations over the first few weeks, generating positive returns for investors.

And looking forward, there couldn’t be a better time to invest sustainably.

Momentum on climate action is gathering pace as governments, companies and communities seek to move out of this COVID-19 induced haze and look towards a greener and more equitable recovery.  Europe and the UK have committed billions towards what some are terming a ‘Green Industrial Revolution’, encouraging innovation and private investment in clean technologies, creating hundreds of thousands of jobs, while at the same time protecting the environment. China too, has backed a ‘green recovery’, setting ambitious targets for reducing carbon emissions, re-forestation and increasing renewable energy sources including wind and solar. With the US re-joining the Paris agreement on 20 January 2021, two thirds of global polluters have now committed to carbon neutrality, or net-zero emissions by 2060 at the latest. These recent developments provide strong regulatory tailwinds for those wanting to invest sustainably.

And while some governments have been dragging their heels on the climate action front (Australia is looking increasingly isolated in its stance), locally companies are forging ahead with their own commitments to reaching net zero. According to Climate Action 100+, 43% of the world’s largest emitters (including Qantas, BHP and Woodside Energy) have now adopted some form of net zero emissions target. While the nature of those targets varies, we view this as an important step and highlights the positive impact capital owners can have through direct shareholder engagement.

Shareholders are voicing their concerns on a range of ESG issues from modern slavery to gender diversity as well as climate related issues. Public awareness of sustainability issues has never been higher.  As the Boards of AMP and Rio Tinto are now acutely aware, listening to and responding to broader stakeholder concerns is becoming increasingly important.

But for all this optimism, there is still much work to do, not only on the climate front, but across a range of other Sustainable Development Goals (SDGs) to which these portfolios aim to align themselves.  COVID-19 has exacerbated inequality around the world, health outcomes have diverged significantly, and poverty is on the rise particularly in some of the hardest hit developing nations. It is important that as we move into 2021, governments, companies and investment managers alike look to maintain that positive momentum and ensure no-one gets left behind as we build back better.

Now, let’s get to work!

Portfolio update

From a portfolio perspective, one of the ways we work to align the portfolio with SDG 13: Climate Action is through our investment in BNP Paribas Environmental Equity Trust.  The strategy is managed by Impax Asset Management, a London based manager who invests globally in companies that are active in the resource efficiency and environmental markets.  The top holding in the Trust is Linde Plc, a global leader in industrial gases.  In January 2021, Linde announced it would build and operate the world’s largest PEM Electrolyzer for Green Hydrogen. Once built the total green hydrogen being produced will be able to fuel approximately six hundred fuel cell buses, driving 40 million kilometres and saving up to 40,000 tons of carbon dioxide tailpipe emissions per year. This investment also aligns well to SDG 7: Affordable and Clean Energy.

On the fixed income side, the Pendal Sustainable Australian Fixed Interest Fund invested in the Australian dollar KfW Green Bond. KfW is a development bank owned by the German government Projects supported by this bond include the construction of a wind park, solar farm and energy efficient housing in Germany. This bond aligns well to a number of SDGs including SDG 7: Affordable and Clean Energy, SDG 11: Sustainable Cities and Communities and SDG 13: Climate Action.

With initiatives such as the Net Zero Asset Managers initiative, launched in December 2020, global fund managers are also committing to net zero. This initiative aims to secure further backing among asset managers to eliminate greenhouse gas (GHG) emissions from their portfolios. Three managers we are invested with have joined as founding members of this initiative; AXA Investment Management, Wheb and Atlas Infrastructure.

From 1 January 2021, Ausbil announced that it was removing fossil fuel exposure from the investment universe for the Ausbil Active Sustainable Fund.  This includes the exploration, mining and/or distribution of fossil fuels, such as oil, gas, oil sands and coal.  70% of the equity managers in the Lonsec Sustainable portfolios now exclude all forms of fossil fuel investments, the remaining 30% exclude at least thermal coal.

Role Role
Australian Equities Real Assets
Australian Ethical Australian Shares Fund ESG / Sustainable / Impact Resolution Global Property (Hdgd) ESG
Alphinity Sustainable Share Fund ESG / Sustainable ATLAS Infrastructure Australian Feeder Fund AUD Heged ESG
Ausbil Active Sustainable Equity ESG / Sustainable VanEck Vectors Australian Property ETF Passive
BetaShares Australian Sustainability Leaders ETF ESG / Sustainable
Global Equities Fixed Income
AXA IM Sustainable Equity Fund ESG / Sustainable Pendal Sustainable Australian Fixed Interest Fund ESG / Sustainable / Impact
BNP Paribas Environmental Equity Trust ESG / Sustainable / Impact Altius Sustainable Bond Fund ESG / Sustainable / Impact
Pengana WHEB Sustainable Impact Fund ESG / Sustainable / Impact PIMCO ESG Global Bond Fund ESG / Sustainable / Impact
BetaShares Global Sustainability Leaders ETF ESG / Sustainable Vanguard International Fixed Interest Index ETF Heged Passive

Outlook

The last quarter has seen a sharp rotation into some of the more cyclical and value orientated sectors of the market. We expect this rotation to be relatively short lived. Longer term, we see the thematics that have underpinned the strong performance of the ESG/Sustainability sector over the last 18 months to remain intact.  Companies that are focused on delivering solutions to the challenges facing society and the environment are particularly well placed in a low-growth world and one boosted by a green recovery. Regulatory tailwinds and green fiscal policy initiatives are now providing good support. Companies that perform well on ESG metrics, that is companies that understand and factor in the risk of climate change, companies that are well-governed and maintain their social license to operate by meeting stakeholder expectations, should also outperform. Opportunities abound as we emerge from COVID-19 pandemic with the chance to ‘rebuild better’.

Efficient portfolio implementation is sometimes overlooked as a ‘nice-to-have’ rather than something that adds value to the investment process. This attitude is far less viable today given recent market volatility and product rationalisation, which have made the ability to implement timely portfolio changes essential for advisers and their clients.

The market downturn in March prompted many of us to reassess our investment strategies. We tried to understand where the pockets of risk were in our portfolios and identify opportunities presented by the market dislocation. Most of the key platforms in the market recorded a significant increase in portfolio changes during this period as managers of managed portfolios repositioned their allocations, taking into account their revised view of the world.

This shift in the way we viewed the world resulted in changes to the overall asset allocation positioning of portfolios, as well as changes to underlying investments. Lonsec was no different. From an asset allocation perspective, we increased our exposure to risk assets such as equities and identified a window of opportunity to gain exposure to assets that in our view were mispriced by the market, such as parts of the credit markets.

An example of this was the syndicated loan and high yield market, which experienced a significant blowout in credit spreads as the market priced in a significant uptick in defaults in these assets. We believe the market over anticipated a rise in defaults and that a pricing opportunity presented itself. Lonsec acted on this view by adding the Bentham Syndicated Loan Fund to the Lonsec Multi-Asset portfolio in late May. We have subsequently reduced our allocation to the fund given the strong return the fund has generated as we have seen credit spreads narrow.

The addition of Bentham offers an excellent example of how timely implementation affects return. As at 30 November 2020, Bentham added 7.38% for the five months since the fund was added to the portfolios. If implementation was delayed by a month, the return would have been only 5.70%, and if a two-month implementation delay was experienced, the return would have been even less, at 3.52%.


Source: Lonsec iRate Bentham Syndicated Loan Fund

A one- or two-month implementation delay is not uncommon outside of a managed account structure, where advisers may be following a model portfolio and having to issue ROAs to clients to implement changes.

Efficient implementation can also be additive where a product issuer decides to close a product. Such occurrences can be difficult to predict, but there are times when the risk of a product being wound up increases, particularly where a fund may be in significant outflow.

A recent example has been the winding up of the CFM IS Diversified Trust. The trust was held in the Lonsec Multi-Asset portfolios before being removed earlier in the year. The rationale to remove the trust was primarily driven by the inconsistent nature of fund returns and a recognition of the challenges faced by systematic risk premia strategies, which generally struggled to perform in a market distorted by central bank policy.

Recently, the product issuer made the decision to wind up the trust. In contrast to a traditional model portfolio approach, whereby clients may still be invested in the trust because the portfolio change has not yet been implemented, the managed account structure ensured that—in the case of Lonsec’s Multi-Asset portfolios—all clients invested in the managed portfolio were exited from the trust.

There are numerous ways to measure value. We believe that one of the key value propositions of managed accounts is the ability to implement portfolio changes in a timely manner, allowing clients to capture portfolio exposure as intended by the model manager. We believe that platform technology will continue to evolve to allow model managers to increasingly finesse portfolio implementation with a view of adding value to end clients.

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 © 2020 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.

Watch the video.

Markets seem to have taken a sigh of relief post the US election result with risk assets seemingly returning to their upward trajectory. Lukasz de Pourbaix ED, CIO Lonsec Investment Solutions will discuss the latest insights for our recently held asset allocation investment committee. Specifically, Lukasz will discuss the rotation into value style stocks, a discussion of the key economic and market indicators and risks investors should look out for.



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

This video is provided by Lonsec Investment Solutions Pty Ltd ACN 608 837 583, a Corporate Authorised Representative (CAR 1236821) (LIS) of Lonsec Research Pty Ltd ABN 11 151 658 561 AFSL 421 445 (Lonsec Research). LIS creates the model portfolios it distributes using the investment research provided by Lonsec Research but LIS has not had any involvement in the investment research process for Lonsec Research. LIS and Lonsec Research are owned by Lonsec Holdings Pty Ltd ACN 151 235 406. Past performance is not a reliable indicator of future performance. This is general advice, which doesn’t consider your personal circumstances. Consider these and always read the product disclosure statement or seek professional advice prior to making any decision about a financial product. While care has been taken to prepare the content of this video, LIS makes no representation or warranty to the accuracy or completeness of the information presented, which is drawn from public information not verified by LIS. The information contained in this video is current as at the date of publication. Copyright © 2020 Lonsec Investment Solutions Pty Ltd ACN 608 837 583

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