Financial Keys Quarterly Update
Below is a summary of market movements this quarter and major changes to some of the key asset classes:
The Australian equity market (as measured by the S&P/ASX 200) continued to slowly recover in July and August (off the back of a better than feared reporting season). The market traded sideways and struggled to gain much momentum. However as September drew to a close, heightening volatility, mainly due to lack of US fiscal stimulus and second wave virus concerns, caused the market to fall away significantly, resulting in the quarter finishing down (-0.44%).
Quarterly returns, both losses and gains, were evenly spread across all sectors with cyclical sectors again being impacted the most (Energy -14%, Financials -6%). Information technology continued its northward trajectory (+13%), whilst Consumer Discretionary was up (+8.7%).
With the large cap sector potentially running out of steam, the more volatile, yet greater potential small and mid-cap sectors continue to outperform posting (+5.7%) and (+5.4%) respectively for the quarter.
All major developed and emerging markets outperformed the Australian market finishing the quarter strongly in AUD terms, albeit not helped by a rise in the Aussie dollar. In the US, second waves of COVID-19 across the country and increasing uncertainty surrounding the upcoming election did not stop the local indices gaining further ground; the S&P 500 returning (+4.5%).
Emerging Markets (as measured by the MSCI EM index) returned a robust (+5.2%) aided by optimism towards a COVID-19 vaccine and improving economic conditions. Europe (as measured by the STOXX Europe 600 index) was fairly flat over the quarter returning a mild (+0.5%) whilst Asia, excluding Japan (as measured by the MSCI AC Asia Ex Japan index) recorded a strong return of (+6.3%) which was aided by double digit returns across Taiwan, India and Korea. Information Technology and Consumer Discretionary lead the way.
Property & Infrastructure
The Australian listed property sector showed some resilience returning (+7.0%) however the sector will remain structurally challenged (divergence in performance across sub-sectors even more pronounced) due to the pandemic and slowing economy. Global listed property (+0.6%) and global listed infrastructure (+1.0%) performed fairly flat on a currency hedged basis, but a rise in the Aussie dollar saw unhedged returns fall into negative territory, (-2.4%) and (-1.8%) respectively.
Bonds and Cash
The RBA and central banks globally continued their significant stimulus programs to support bond markets. Bond returns were again muted in the September quarter. Australian bonds (Bloomberg AusBond Govn 0+Yr) were up (+0.95%) whilst global bonds (BBgBarc Global Aggregate TR Hedged) were also slightly positive (+0.68%). Corporate bonds outperformed government bonds as spreads continue to tighten albeit at lesser levels than the June quarter. Riskier bond assets were broadly buoyant with monetary policy helping anchor yields at low levels thus forcing investors out the risk spectrum to chase yield. Cash yields remained anchored low with the RBA leaving the official rate (+0.25%) untouched throughout the quarter.
The September quarter was mixed all around with markets, economics, and politics all ebbing and flowing throughout the quarter.
Markets broadly finished up for the quarter, but it was an unusual ride through as virus concerns rose as did political risks, particularly in the US. Second wave virus fears were proven correct as Europe saw a large rise in new daily infections as many Europeans travelled for the summer holidays, possibly buoyed by European political leaders vowing no second lockdown. New daily US infections also rose as the US economy began to re-open as businesses and households tried their best to get back to some level of normal. This resulted in some increases in restrictions within Europe and the US, and even parts of Asia.
Pleasingly, the increase in new daily infections didn’t coincide with an increased daily death rate. The reasons: better testing, contact tracing, hospital and healthcare preparedness, and increased use of widely available treatments. However, the increases in some restrictions meant concerns regarding the pace of the economic recovery ahead. Closer to home, Victoria went into stage 4 lockdown again, with increased restrictions regarding curfews and distance from home, whilst states kept their borders closed longer than previously expected.
Prior to the second wave fears, economic data both locally and globally had begun to improve. Employment data, particularly in the US, saw strong improvements whilst local employment data came in much better than previously expected. The Australian economy contracted in the June quarter, but came in much better than previously expected and much better than most other developed nations. Manufacturing data also improved globally as demand for goods and services increased, whilst US housing data continued to show strength. Oil prices also rose, confirming the increase in economic activity and improving economic outlook.
The Australian economy eagerly awaited the Federal Budget which was to be handed down in the first week of October, whilst income support packages in JobKeeper and JobSeeker saw their first tapering at the end of the quarter which concerned some parts of the market and economy particularly the household and consumer discretionary spending.
Outside of virus concerns, political concerns were the next biggest driver of markets in the quarter. The run into the US election heated up as we saw the first of the televised debates between President Trump and Joe Biden, which ended in a hard to watch stalemate. News broke that US President Trump had contracted the virus which saw markets react negatively. Markets recovered some of those loses at the end of the quarter as it became apparent that a range of drug treatments had seen the President recover much quicker than expected. However, markets fell again soon after as the President announced that he was calling off all fiscal stimulus negotiations between both parties as they increasingly failed to agree to a fresh round of much needed measures.
We also saw rising Brexit risks as the UK and the EU wrangled over trade agreements, with the UK threatening to re-write the Brexit agreement, all whilst PM Boris Johnson came under pressure for his handling of the virus. Closer to home, PM Scott Morrison and Treasurer Josh Frydenberg became more vocal in calling for state borders to be opened and for restrictions to be relaxed so that the economy can begin to recover.
The outlook remains mixed in light of the virus second wave, pending US election, phase 3 vaccine trial results which are expected in the quarter, all whilst governments contend with balancing the economic recovery with potentially increased restrictions on households and businesses. Positively, governments and central banks remain committed in doing whatever it takes to patch any holes and get the economic recovery going. That stimulus will continue to support asset prices in the short to medium term, but we will not be surprised by increased volatility in the quarter ahead.
Key High Growth Model – Portfolio Update
Returns were quite mixed across asset classes, whilst a rising Australian dollar took some gloss off unhedged global equity returns. The strongest returns came from riskier parts of the equity market including Australian small companies and Asian and Emerging Market equities. Sharp falls right at the end of the quarter resulted in large cap Australian equities finishing down for the period whilst global equities performed strongly, particularly Growth stocks and sectors (in contrast to Value). Global listed property and infrastructure actually finished up for the quarter on a hedged basis, but a rising Australian dollar saw unhedged returns fall as concerns rose regarding a second virus wave.
From an asset allocation perspective, we saw positive contributors across the portfolio on an absolute basis. On a relative basis, our overweight to Global vs Australian equities helped boost returns, whilst the portfolios strong allocation to Australian small companies and Global Emerging Markets also assisted. Allocations to Property & Infrastructure detracted from returns, however our underweight exposure to these asset classes provided a buffer here.
From an investment selection perspective, we were pleased to see strong absolute and relative return performers across the portfolios.
Within Australian Equities, we saw mixed results across the portfolio. Greencape continued to perform strongly, outperforming the benchmark, assisted by their Growth style bias and strong stock selection. Allan Gray and Solaris underperformed the benchmark, largely due to their cyclically and economically exposed portfolio holdings. Allan Gray was particularly weak due to their strong Value style bias which came under pressure in the quarter. In contrast, Flinders Emerging Companies produced an exceptional result for the quarter, up more than 10% in absolute terms and almost more than 5% ahead of the benchmark. Strong stock selection is the key here. We added Flinders Emerging Companies into the portfolio at the back end of July. The basis for the move was to increase portfolio exposure to small and micro-cap companies in the Australian market through a specialist manager. This part of the Australian market segment is better diversified by sector and stock, versus the large-cap segment, and contains plenty of strong growth opportunities.
Within Global Equities, we saw mixed results across the portfolio for the quarter. Anything overweight to the US and Technology, with a Growth style bias, performed strongly against the index. That meant strong outperformance from T. Rowe Price Global Equity (+7.03%), Insync Global (+9.19%), and Magellan High Conviction (+5.71%), all benefiting from their exposures to US equities and the technology sector. Whilst Insync produced the largest absolute return, Magellan High Conviction impressed the most with strong returns whilst holding more than 20% in Cash. In contrast, fund managers with a greater valuation focus, or bias right now, saw returns lag. Orbis and AB both produced positive returns but were lower than the benchmark. Both portfolios contain plenty of embedded value which we expect to provide a boost in the medium term.
Rounding out Global Equities was the portfolios Emerging Market exposure, where we saw very strong returns from both an asset class and a manager perspective in the Fidelity Global Emerging Markets Fund (+9.03%), benefiting from a weaker US dollar, reasonable technology exposure, and a growth style bias.
Within Property & Infrastructure, both asset classes produced better results benefiting from better economic data as more countries relaxed virus restrictions, but only on a currency hedged basis as the Australian dollar rose in the quarter. Both managers used in the portfolio (Quay Global Real Estate and Magellan Infrastructure) are currency unhedged, given our medium term outlook for the Australian dollar and the diversification and risk benefits of a portfolio being less exposed to the Australian dollar. Both managers remain well positioned within their respective asset classes, with both having strong track records in playing both offense and defence as needed, and both having absolute return mindsets in managing their portfolios. There remains plenty of value to extract from both asset classes, but both need a catalyst (e.g. a vaccine, economic recovery).
As outlined above, the different asset classes and then the individual investments within them, have varying returns over all timeframes. This is the outcome of diversification across not only asset class but the types of investments held for example, those businesses that have done well during a lockdown environment such as those in technology, compared to the more ‘cyclical’ businesses that will do better in an environment of re-opening, economic recovery and one in which a vaccine is created and widely used. We aim to ensure portfolios hold investments which can perform well in a range of market environments and an outcome of this is that they do not all move in unison. What all of the investments can do though, is provide a positive return over time, despite going through periods of volatility.