September 30, 2019

Economic and Investment Update - August 2019


Lonsec Research


With an increasing focus in the market on how we are all building our client portfolios, it is incredibly important to have a strong and defendable investment framework in place. This investment framework consists of, but is not limited to, how we structure our investment committee, what our APL looks like, and where we get our research from. 

Summary of Key Views

Building an effective investment value proposition

With an increasing focus in the market on how we are all building our client portfolios, it is incredibly important to have a strong and defendable investment framework in place. This investment framework consists of, but is not limited to, how we structure our investment committee, what our APL looks like, and where we get our research from. However, the foundation for this framework must lie with a clearly defined and articulated investment philosophy underpinning all our investment decisions.

At its essence an investment philosophy reflects a broad set of investment beliefs. It underpins our investment strategy and process and ultimately is our ‘source of truth’ as it gives a frame of reference around all investment decisions.

Your investment philosophy should provide transparency and ensure consistency in your decision making and help mitigate behavioural biases such as chasing last year’s winners. Typically, an investment philosophy will be underpinned by some sort of empirical evidence supporting the philosophy. An example of this may be a belief in active management or an investment approach based on a valuation discipline.

There are a number of different approaches that can be taken when articulating your investment philosophy, but for many with a diverse client base, keeping it simple is the best solution. Think broadly about what you are trying to achieve across your client base, irrespective of whether they are wealth accumulators, retirees or high net worth clients.

Do you believe in diversification? Do you believe that market beta is the primary driver of returns? How do you define risk? Do you believe markets are inefficient/ efficient? Answering questions such as this will help build the framework for what will become your investment philosophy. For anyone that has a more focused client base (for example; predominately retirees), you can start to ask questions around liquidity, income and timeframes.

Importantly, once you have established a set of principles that you believe in, ensure that you match this belief through your investment portfolios. For example, a philosophy based on protecting portfolios from downside risk and volatility, cannot be implemented via an index based solution.

It is always important to ensure that your investment philosophy does not remain a pretty plaque on the wall of your boardroom, but instead forms the basis for every conversation you have with your clients, as it should be clearly reflected in your recommended solutions. This is especially important in difficult market environments as a clearly articulated investment philosophy will be the reference point for your client education process.

Market developments during August 2019 included:

Australian Equities

Australian shares suffered a fall in August as global pressures weighed on sentiment while earnings season mostly delivered in line with expectations. The S&P/ASX 200 Index returned -2.4% over the month, with the Materials (-7.5%) and Energy (-5.6%) sectors the hardest hit. Australia’s largest building materials maker Boral (-17.6%) suffered a sharp fall after reporting a 7% drop in underlying net profit for FY19, with cost improvements in its US division failing to make up for the slump in construction activity in Australia. Oil and gas engineering group Worley Parsons (-23.9%) sold off heavily despite posting better-than-expected revenue and profit growth, but with management flagging “macroeconomic global uncertainty” and shying away from offering a forecast for FY20.

Bucking the trend was the Health Care sector (+3.6%), which saw solid gains from disinfectant innovator Nanosonics (+21.1%), which announced a 39% increase in revenue and installed base growth of 18%, while ResMed (+8.4%), the manufacturer of products treating sleep apnoea, continued to surprise investors on the upside with earnings growth of 10.6%, with the market upbeat about its expanding product portfolio. The Information Technology sector was flat in August but Afterpay Touch Group (+15.9%) was the standout performer, enjoying full-year underlying sales growth of 140% and growing its US customer base to 2.1 million only 15 months after launch.

Global Equities

Global equity markets could not withstand the pressure of renewed trade tension and a host of other geopolitical risks dominating the headlines in August. The MSCI World Ex Australia Index returned 0.3% in Australian dollar terms but fell 2.0% in local currency terms. The US S&P 500 Index fell 1.6%, with the Energy sector (- 8.7%) solidifying its position as the worst performer over 12 months, although its representation in the index has shrunk significantly since the oil market highs in mid-2008, while the higher yielding Utilities (+4.7%) and Consumer Staples (+1.6%) sectors were the only ones to finish the month in positive territory.

Steep selling occurred midway through the month, triggered by a brief inversion of the yield curve between 2-year and 10-year Treasuries. Volatility returned to the share market, with the CBOE Volatility Index rising from July’s low of 12.1 to 24.6 at the start of August and remaining at elevated levels. The STOXX Europe 600 Index fell 1.6% in August, with resources shares (-9.0%) and banks (-7.0%) the worst performing sectors. The ECB’s commitment to further stimulus has not helped Europe’s banking sector, with lower rates putting pressure on lending margins and hampering growth. In the UK, the Brexit issue remains a source of uncertainty despite a change in leadership, with the FTSE 100 Index falling 4.1% as further deadlock appeared to be the only visible outcome.

Fixed Interest

The bond rally continued unabated through August as markets foresaw further cuts to interest rates and investors sought safe-haven assets and jurisdictions to avoid fallout from the trade war and other geopolitical risks. Credit spreads have been steadily rising since January 2018 and are expected to continue to widen as the outlook for economic growth continues to deteriorate. The market value of negative-yielding bonds tracked by the Bloomberg Barclays Global Aggregate Index rose to US$17 trillion and now makes up around 30% of the index. European safe-havens like Germany and France make up the lion’s share (if you can call it that), with more than 80% of Germany’s federal and regional government bonds in the red.

Corporates have taken advantage of the steep fall in benchmark rates to raise debt, with big names like Apple, Deere and Disney issuing 30-year bonds with yields below 3.0%. US 10-year Treasury yields fell through August from 2.02% at the start of the month, hitting a low of 1.46% in early September before climbing back to 1.57% at the time of writing. Similarly, Australian 10-year Treasury yields fell from 1.19% to a low of 0.88% mid-month, recovering to 1.09% in early September.

REITs (listed property securities)

After a year and a half of continuous monthly declines, Australian house prices began to flatten in mid-2019 as interventions like interest rate cuts and relaxed lending rules lured buyers back to the market. It remains to be seen how lower interest rates filter through to the housing market and whether the availability of credit to the banks will help to produce a rebound. For listed property it was a tough month in August, but the sector managed to produce a small positive result, with the S&P/ASX 200 A-REIT Index returning 1.2%. The Charter Hall Long WALE REIT (+14.0%) was the top performer after reporting a 25% rise in EPS and a 6% rise in dividends.

Shopping Centres Australasia (+7.8%) and Scentre Group (+1.3%) had a positive month, while the Charter Hall Retail REIT (-3.5%) and Vicinity Centres (-0.8%) finished the month in the red. The sector continues to benefit from the hunt for yield, which is being exacerbated by the market’s expectations for lower interest rates, while rental and earnings growth appear relatively robust across most sectors. US REITs had a positive month, rising 3.3%, with gains from the self-storage (+8.9%) and single tenant (+7.6%) sectors, while regional malls (-8.3%) and hotels (-4.1%) were a drag on the index.

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