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The Patersons Australian Core Portfolio is designed for investors looking for a Core Equities Portfolio exposure to high quality ASX listed securities, seeking both capital growth and dividend income, selected on quality, value and momentum factors.
The Patersons Australian Income Portfolio is designed for investors looking for an Income Portfolio exposure to high quality ASX listed securities paying a high, sustainable dividend yield.
The following changes were made to the portfolios this month.
- Core Portfolio: We rebalanced the portfolio in June, reducing some of our large overweight positions, specifically CSL Limited (CSL) and Charter Hall Group (CHC). We also decided to exit our positions in Challenger Limited (CGF) and Janus Henderson (JHG). We used the funds from the rebalance and sales to add new positions in Atlas Arteria (ALX), Ansell Limited (ANN) and Cleanaway Waste (CWY). Later in the month, we also exited our position in Dulux Group (DLX), as the stock had gone ex dividend, ahead of the takeover by Nippon Paints. The proceeds of sale of DLX was added to our cash position.
- Income Portfolio: We rebalanced the portfolio in June, reducing some of our large overweight positions, specifically Magellan Financial Group Limited (MFG) and Charter Hall Group (CHC). We utilised the proceeds from the rebalancing to add a new position in Stockland (SGP). We decided to exit our small position in Coles Group (COL), rolling those funds over into a more appropriate position in Wesfarmers (WES). We also added new positions in three major bank hybrids, in order to enhance the yield of the portfolio, while limiting equity volatility. Positions were added in CBAPG, NABPF and WBCPH.
- The following dividends were accrued this month. Income Portfolio: ARF (3.38cps), CHC (17.2cps) and SGP (14.1cps). Core Portfolio: SYD (19.5cps) and CHC (17.2cps).
- The forecast net yield on the Income Portfolio is 4.6% (68% franked), while the Core Portfolio has a forecast net yield of 3.5% (60% franked), inclusive of the respective cash positions.
- Our current cash position in the Core Portfolio is 22.5% and in the Income Portfolio is 8.5% (20.4% when our fixed interest exposure is included).
* Inception 31st Dec 2010
Overview of Markets
International Equity Market Performance
In June, the central banks came to the rescue. Confronted by weaker economic data, risks to the trade outlook and still low inflation, the Federal Reserve (the Fed) and the European Central Bank (ECB) indicated that the cavalry is coming in the form of further monetary stimulus. So bad economic news was good news for markets.
Risk assets, such as equities and credit, rallied along with traditional safe haven assets, such as developed market government bonds, gold and the yen. Reversing the weakness in risk assets in May, June’s strong performance has made it a good quarter and certainly a good start to the year. Developed market equities were up nearly 4% over the quarter and 17% year to date. Credit has also had a good quarter and start to the year. Most government bond indices are also up about 5% year to date, having rallied this quarter.
It may seem counterintuitive for risk assets and safe haven assets to rally at the same time. However, markets have been pricing in Fed and ECB rate cuts and the potential for further ECB quantitative easing (QE), all of which is supportive of developed market government bonds. Rate cuts and further QE can also be supportive for risk assets if they are successful in preventing the current slowdown from turning into an economic downturn. So current market pricing reflects expectations that central bank stimulus will keep the economic expansion going.
Manufacturing surveys have weakened around the world, with a notable decline in the US business surveys and continued weakness in China, Japan and Europe. Germany’s manufacturing sector in particular, looks to be struggling.
In short, the market has been willing to ignore the bad economic data in the hope that central bank stimulus will help avoid a recession. If the data remains weak, delivery of the hoped for stimulus seems highly likely. Whether the stimulus will be enough to extend what is now the longest economic expansion in history, only time will tell.
Data in early June also showed a slowdown in the pace of hiring in the US and the conference board’s measure of US consumer confidence declined. It is this rising risk to the employment and consumer outlook that has probably been a key driver of the shift towards further stimulus from the Fed and ECB. The market’s attention is therefore likely to be focused even more sharply than usual on the labour market data in the coming weeks and months.
Faced with greater downside risks to the economic outlook and falling long-term inflation expectations, the Fed backed up the dovish rhetoric that has been emanating from various members in recent months by indicating that eight out of seventeen members think rate cuts are warranted this year. Helped along by Fed chair Jerome Powell’s comment that “an ounce of prevention is worth a pound of cure”, the market now expects more than 0.5% worth of rate cuts by the end of this year, in sharp contrast to the 0.5% increase in interest rates it was expecting for 2019 back in of September. US 10 year yields have fallen to about 2%.
Not wanting to be left out and also concerned about the downside risks to the economic outlook, the ECB also came out with fighting talk. ECB president Mario Draghi said that monetary policy would be loosened unless the economy improves, tried to convince markets that the ECB still has plenty of ammunition left if further QE is required and that interest rates could fall even further into negative territory if needed.
In the UK, the news has been dominated by the Conservative Party leadership race. The polls and odds suggest that Boris Johnson is a strong favourite to be the next prime minister. Whoever is prime minister, parliament is still likely to prevent a no deal Brexit, unless a general election or referendum takes place and provides a strong mandate from the population for such an outcome. At the moment, polls suggest only about 30% of UK voters want to leave the European Union without a deal. How the new prime minister hopes to unite the Conservative Party and solve the Brexit impasse remains to be seen.
The Bank of England (BoE) has been less dovish than the Fed and ECB, given concerns around the limited spare capacity in the UK economy and wage growth that has accelerated significantly over the last couple of years. After the BoE meeting, the Confederation of British Industry’s reported retail sales measure for June came in at the weakest level since the financial crisis. If a broader swathe of economic data deteriorates, the BoE could well join in the easing party by cutting interest rates.
The G20 meeting resulted in the US and China agreeing to keep talking about trade, with no escalation in tariffs but also no significant signs of progress in addressing the key sticking points in the negotiations. While the lack of further escalation avoids the worst case scenario for now, the ongoing uncertainty and potential for a further breakdown in negotiations could continue to weigh on business sentiment.
Australia’s ASX200 Accumulation Index (including dividends) was up 3.7% for the month of June underperforming global markets. For the quarter ended 30 June 2019 the accumulation index was up 8.0% while for the 12 months ending 30 June 2019 the index was up 11.5%, well ahead of the MSCI Global Accumulation Index and the US markets.
Australian economic data continued to be a mixed bag. Building approvals are continuing to trend down and point to ongoing weakness in housing construction, retail sales and car sales remain weak and point to a soft June quarter for consumer spending and now falling job vacancies are in line with other labour market indicators in warning of rising unemployment. Against this, house price data for June adds to other indicators in suggesting they are at or close to the bottom and a new record trade surplus for May points to a positive contribution to growth from trade and to national income. Finally, the Melbourne Institute’s Inflation Gauge was weak in June and points to ongoing weak inflation. All of which suggests that growth is weak but not negative and inflation remains weak consistent with expectations for further RBA rate cuts later this year.
The RBA cut rates for the second consecutive month, but remains upbeat on growth but cites a desire to see lower unemployment and underemployment. While it doesn’t admit it, the downturn in growth over the last year and emerging signs of an uptrend in unemployment have likely played a big role in its decision to cut rates. Rate cuts may not provide the same boost they did in times past, but this is not because they are low but rather because household debt ratios are much higher, and Australians won’t be rushing out to take on even more debt and the banks are less inclined to provide it. But rate cuts will still help.
The Parliament passed the Governments tax cut. Stages 2 and 3 of the tax cuts don’t kick off into 2022 and 2024 so are a bit academic in the short term but do at least provide confidence that bracket creep will be constrained and income tax payments will not continue to grow more quickly than household income. However, the stage 1 payment of a $1,080 tax refund to those earning between $48,000 and $90,000 will be a welcome relief and the total $7.5 billion payment being around 0.6% of household disposable income is equivalent to around two RBA rate cuts. Based on the GFC “stimulus payments” some of it will be spent and this will help consumer spending in the next few months with a spike likely in retail sales around September/October. However, the $7.5 billion boost to households is much smaller than the $19 billion in GFC stimulus payments (around one quarter the size in real terms) and is likely to only add around 0.2% to GDP over a year.
The Communications, Info Tech and Materials sectors have had the best returns (capital gains plus dividends) in the 12 months to 30 June 2019. The Energy sector continues to record a negative return over the past 12 months.
ASX200 Best and Worst
Nanosonics Limited (NAN), Ausdrill Limited (ASL) and Pact Group Holdings (PGH) were the three best performing stocks in the ASX200 for June. Vocus Group (VOC), Pilbara Minerals (PLS) and Galaxy Resources (GXY) were the three worst performing stocks in the ASX200 for June.
The Core portfolio underperformed the ASX200 Accumulation index for the month of June by 2.0%, while the Income portfolio underperformed by 0.8%. The Core portfolio was 3.8% behind the benchmark for the rolling quarter to June, while the Income portfolio was 1.6% behind the benchmark.
The Core portfolio has underperformed the benchmark ASX200 Accumulation Index for the 12 months to 30 June 2019 by 0.2%, while the Income portfolio has outperformed by 8.0%. Both portfolios continue to outperform the benchmark on two, three and five year timeframes, on both absolute and risk adjusted measures.
NB: Prior to March 2013, the performance of the portfolios was calculated assuming an equal weighting to each stock.
Note that it is not unusual for the Income portfolio, which is defensive in nature, to outperform the market during bear markets and underperform during bull markets. On the other hand, the Model portfolio is expected to outperform its benchmark in all market conditions over the long term.
Both portfolios have significantly outperformed the benchmark on two, three and five year timeframes, on both absolute and risk adjusted measures.
Patersons Australian Core Portfolio
The Core Portfolio underperformed the benchmark ASX200 Accumulation Index for the month of June primarily as a result of our exposure to Challenger Limited (CGF). Our underperformance was also driven by our exposures to South32 (S32) and Amcor (AMC), as well as our large cash position.
CGF hosted an investor day which came with a guidance revision of “the lower end of previous guidance” for normalized net profit of $545m to $565m. The downgrade relates in part to poor investment returns across the business as the shift to selling more annuity products has created a longer term earnings model, which has forced Challenger to change its investment mix, moving down the risk curve in more conservative but less lucrative investments. The company also started to lower expectations for FY20 which concerns us as investors; the forecast for next year was based on expected lower equity returns, product and marketing cost, lower interest rates and a lower return on equity. CGF are now targeting an ROE of RBA + 14%, down from a flat 18% target which CGF had fallen short of over the past few years. We decided to exit our position in CGF as the business won’t be helped by lower interest rates and higher costs.
We also decided to exit our position in Janus Henderson (JHG) during the month. JHG reported a disappointing March quarter update, which included news that it had lost the presence of famed bond market investor Bill Gross, while also suffering outflows because its team of emerging markets investment specialists has left or is in the process of leaving. The March quarter report highlighted that JHG had improved its overall investment performance with now 69% of all assets under management (AUM) outperforming the benchmark on a three-year horizon, a noticeable improvement from the 61% comparable number at December 31. However, back in 2017 JHG was able to advertise close to 90% of its assets were outperforming benchmarks on a 5-year comparison, while for a 3-year horizon the number peaked above 75% in Q3 2017. Equally important is that the weaker, underperforming strategies, including fixed interest (bonds) and Intech, are seemingly being punished harshly, with sizable funds shifting elsewhere.
During the month we also rebalanced the portfolio, reducing some of our large overweight positions, specifically CSL Limited (CSL) and Charter Hall Group (CHC).
We used the funds from the rebalance and sales to add new positions in Atlas Arteria (ALX), Ansell Limited (ANN) and Cleanaway Waste (CWY).
Later in the month, we also exited our position in Dulux Group (DLX), as the stock had gone ex dividend, ahead of the takeover by Nippon Paints. The proceeds of sale of DLX was added to our cash position.
The Income Portfolio underperformed the benchmark ASX200 Accumulation Index for the month of June as a result of our exposure to AGL Energy (AGL), Alumina (AWC) and Wesfarmers (WES).
We rebalanced the portfolio in June, reducing some of our large overweight positions, specifically Magellan Financial Group Limited (MFG) and Charter Hall Group (CHC).
We utilised the proceeds from the rebalancing to add a new position in Stockland (SGP).
We decided to exit our small position in Coles Group (COL), rolling those funds over into a more appropriate position in Wesfarmers (WES).
We also added new positions in three major bank hybrids, in order to enhance the yield of the portfolio, while limiting equity volatility. Positions were added in CBAPG, NABPF and WBCPH.
In the charts below, we have distinguished the Miners separately from the Materials GICs sector and the Banks from the Financials GICs sector. We remain underweight Banks in both portfolios.
Warning: This report is intended to provide general securities advice, and does not purport to make any recommendation that any securities transaction is appropriate to your particular investment objectives, financial situtation or particular needs. Prior to making any investment decision, you should assess, or seek advice from your adviser, on whether any relevant part of this report is appropriate to your financial circumstances and investment objectives.