LEGG MASON MARTIN CURRIE REAL INCOME FUND

Transcription

1 LEGG MASON MARTIN CURRIE REAL INCOME FUND TRUE TO LABEL DELIVERING IN A VOLATILE MARKET JANUARY heralded the return of volatility to investment markets as growth accelerated and central banks, especially the US Federal Reserve (Fed), started to remove excess liquidity by raising interest rates and reversing quantitative easing. As a defensive, income focused strategy, the Legg Mason Martin Currie Real Income Fund (Fund) is positioned to perform relatively well in such environments and that is exactly what the Fund has done. The Fund generated a total return of 1.55% (net of fees) over the calendar year, outperforming the broader share market (S&P/ASX 200 Accumulation Index: -2.8%) and the majority of its peers, whilst delivering a distribution yield of 4.7%. The Fund was also the only Australian equity fund to experience positive performance in the December 2018 quarter 1, delivering a total return of 0.5% (net of fees) versus a broader share market fall of over 8%. Legg Mason Martin Currie Real Income Fund - Performance as at 31 December 2018 (net of fees) 3mth 1-year 3-years (pa) 5-years (pa) 7-years (pa) Since Incep.* (pa) Fund (%) *November 2010 The Fund s investment strategy Low risk, low beta, low volatility stocks tend to perform well in times of uncertainty and market uncertainty has clearly increased. The Fund s resilience in 2018 is related to the types of stocks in which it invests. The Fund holds a portfolio of listed companies that own hard physical assets, like property, utilities and infrastructure (e.g. A-REITs, airports, toll roads, electricity and gas grids). Real asset companies like these are an integral part of everyday life and are often monopolistic in nature. Their demand profile is therefore relatively inelastic and not pegged to the business cycle, hence these companies have more predictable free cash flow and dividends. The typically long-term nature of their cash flows (underpinned by long term contracts and favourable regulatory structures) also offers protection during market downturns, as well as upside growth potential from population growth. This means real asset companies typically have a low beta versus the broader equity market and can provide a low-volatility regular income stream. Due to their strong market positions, and the growing demand driven by population growth, real asset companies have the ability to raise prices, in some cases above inflation, irrespective of the business cycle. In other words, real assets generally have the ability to protect future income from inflation. This makes them relatively defensive investments. Very few investment funds in Australia offer this combination of assets. 1 Mercer investment performance survey of Australian shares to 31 December

2 Highly liquid and transparent alternative to A-REITS We consider the Fund to be a much better solution to real assets than a traditional standalone investment in the A-REIT Index. Compared to owning just A-REITs, the Fund has several advantages: Lower concentration risk The Fund s investment universe is more diversified as it includes infrastructure and utilities, so it avoids the concentration issues associated with the A-REIT Index. Lower single stock concentration The Fund is actively managed and seeks to deliver high, sustainable and growing income, so the portfolio managers focus on building a diversified portfolio that is not over-exposed to any one company or thematic. For example, Scentre Group has a 19% weight in the A-REIT Index but its exposure in the Fund is only 5.4% 2. The Fund also has a 9% maximum stock limit, ensuring that it constantly remains well diversified across individual stocks and real asset sub-sectors. Stock positions that performed well over the year 3 The most significant positions contributing positively to performance over the year included: Holdings in several New Zealand energy companies, such as Meridian Energy (MEZ), Contact Energy (CEN) and Genesis Energy (GNE) and Mercury New Zealand (MCY) that benefited from a more favourable weather pattern and rainfall in late 2018, as well as New Zealand dollar strength and the market s rotation into less risky sectors. Charter Hall Group (CHC) benefited from falling bond yields and an announced change in distribution policy, reducing payouts from 85-95% of operating earnings per share (OEPS) to 70-95%. This will allow the residential property management company to reinvest in growing its business. SCA Property Group (SCP) performed well after it announced the acquisition of 10 assets from Vicinity Centres for $573m on a 7.5% yield. The portfolio comprised three Sub Regional and seven Neighbourhood centres. Stocks that detracted from performance over the year 3 The following stocks detracted from performance over the year although their impact was more than offset by other stocks that performed well: Stockland (SGP) has been weak in recent months due to market nervousness around softer residential house prices, however we believe the market has oversold Stockland given its volumes are supported by urban sprawl and population growth. Aveo Group (AOG), an Australian property and investment group, was weaker due to continued slow clearance rates in the established housing market, which may impact on occupancy in its established retirement villages, and the announcement of a royal commission (RC) into the aged 2 As at 31 December The information provided should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of the security transactions discussed here were, or will prove to be, profitable. 3 The information provided should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of the security transactions discussed here were, or will prove to be, profitable. 2

3 care sector. We do not see any significant implications for AOG as it is predominately a retirement home provider, similar to Stockland and their retirement home villages. We also note that all the listed companies with varying exposure to Aged Care have been heavily de-rated because of the RC announcement and we do not as yet know the terms of the RC. AGL Energy (AGL) weak earlier in the year following the release of the ACCC s report on Australian electricity prices, which contained a large variety of recommendations. Investors were concerned that some of the recommendations could disrupt the natural operation of the retail market in the short term. We see smaller non-integrated competitors at most risk, which may potentially help AGL s retail market share in the long term. The change in the Prime Minister and uncertainty around the government s energy policies were also an impact throughout the year, however the opposition Labour party s energy policy is more accommodative to AGL s business than the current Liberal policy. The effect of bond yields on the Real Income Fund s unit price Whilst bond yields rose in early 2018 in response to strong global economic growth and higher inflation expectations that caused central banks, especially the US Federal Reserve, to commence monetary policy tightening and unwind quantitative easing policies, the top in yields was around June. As the year progressed, signs of US growth moderation and heightened risks including US-China trade tensions, Brexit uncertainty and geopolitical tensions fuelled investor uncertainty and this caused bond yields to fall again. The Fund s underlying investments include listed real assets such as A-REITs, utilities and infrastructure, and their pricing is inversely influenced by the prevailing bond yield. If bond yields rise, the price that the market is prepared to pay for real assets may come under downward pressure because a higher bond yield means a higher discount rate for a future income stream, reducing the market price of real asset companies. The opposite is also true as bond yields fall, the share prices of real asset companies tend to perform well as it implies a lower discount rate for future income streams. This is what happened in the second half of 2018, underpinning Fund performance. Australian 10-year bond yield Source: RBA as at 31 December

4 Real Asset market outlook For the real asset sector, and in particular Australian real estate investment trusts (A-REITs), the outlook is robust from an earnings perspective and this should support an attractive dividend yield for the Fund: Retail sales look to have bottomed late in 2018, signalling a better outlook for retail real estate investment trusts (REITs). With a better wage environment and healthy employment levels, this trend should continue. Office demand remains strong, in-line with robust GDP. Office capitalisation rates look to have bottomed for this cycle, but there is no pressure yet for these to start rising. We expect more affordable suburban markets to mirror the strength in the CBDs. Residential credit tightening is still affecting the forward order books of developers, but this seems to be more about future volumes than settlements of past sales. A reduction in existing dwelling prices is playing out as expected, and we are seeing some pressure on both selling prices for new product developed by residential developers and retirement-village operator rents. However, population growth is ultimately supportive, especially in Victoria and Queensland where affordability is better. In utility markets, policy uncertainty is seeing investment capital sit on the sidelines but Renewable investment impacts are still to play out in energy markets, as some older less efficient coal-fired electricity generation exits the market over time. Asset base growth for gas and electricity grids and networks pipes, distribution and transmission will be slower, but volumes continue to be bolstered by material population growth. For the infrastructure sector, strong volume growth in toll-road traffic, airport passengers and child-care patronage is expected. Toll-road regime optimisation remains an important driver, especially as truck tolls rebase upwards. Foreign capital is still eyeing Australia s attractive internal rate of return (IRR) for yield and growth, with supportive appeal from our high levels of disclosure and transparency in real asset markets. What is the outlook for the Fund? We remain positive on the prospects for high-quality real assets, with conservative balance sheets and cash flows and distributions. On a forward-looking basis, the Fund is expected to provide a dividend yield of 6.2% (grossed up for franking credits) over the next 12 months to December The Fund's cashflows that support its income stream of 6.2% look very solid and we are confident in the outlook. The key drivers of this income stream - population growth and real assets ability to increase pricing in line with inflation (think utility company and toll road increases) - remain strong. We believe the Fund is uniquely positioned in an asset class that can provide a growing and sustainable income stream. Many real assets such as shopping centres, ports, toll roads and airports are considered essential assets for the economy and are well positioned to grow their business as the Australian population increases. This provides a long-term income opportunity that few other asset classes can match. Some of the top holdings in the Fund include Transurban, Stockland, Vicinity Centres and AGL Energy 5. 4 Past performance is not guide to future returns Source: Martin Currie Australia, FactSet; as at 31 December Data calculated gross of fees for the Legg Mason Martin Currie Australia Real Income Fund. Next 12 Months (NTM) Income yield is calculated using the weighted average of broker consensus forecasts of each portfolio holding because of this, the returns quoted are estimated figures and are therefore not guaranteed. Assumes zero percent tax rate and full franking benefits realised in tax return. 5 The information provided should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of the security transactions discussed here were, or will prove to be, profitable. 4

5 Overall, we think the recent market volatility is providing tactical opportunities to invest in an attractive asset class, with solid fundamental growth leveraged to Australia s world-leading population growth. While the uncertainty over the macro environment and the direction of long bond yields could create further market volatility in coming months, we remain positive on the prospects for the Real Income Fund's underlying share holdings, which tend to have conservative balance sheets and sustainable distributions. Leading its peers The Real Income Fund has been a consistently strong performer over the long term. The Fund returned 13.9% pa over 5 years making it the strongest performer in its Morningstar category 6 over this time frame. The Fund is also a top quartile performer over 1, 3 and 5 years. 7 These strong returns have also been generated with lower risk than peer funds. This is clearly shown in Table 1 (next page) that details the 5-year return versus standard deviation (a common measure of fund risk) for the Fund and its peer group of Lonsec rated Property and Infrastructure funds (excluding funds with significant allocations to direct property). The Legg Mason Martin Currie Real Income Fund has delivered top two performance in this Lonsec peer group over the five years to 31 December 2018 but with the lowest level of risk of any fund (as measured by standard deviation). With this track record, the Fund represents a very powerful risk/return proposition for investors. 6 Source: Morningstar Direct. Ranked first in its category among 19 funds respectively within Morningstar Equity Australia Other category as at 31 December Source: Morningstar Direct. Ranked in the top quartile among 15 funds respectively within Morningstar Equity Australia Other category as at 31 December

6 Table 1: Property and infrastructure fund 5-year performance and standard deviation Fund 5-yr pa return Standard deviation (%) Charter Hall Maxim Property Securities Legg Mason Martin Currie Real Income Cromwell Phoenix Property Securities ishares Australian Listed Property Index Vanguard Australian Property Securities Index UBS Property Securities Fund Pendal Property Securities Zurich Investments Australian Property Securities FirstChoice WS Property Securities CFS Wholesale Indexed Property Securities MLC Wholesale Property Securities Freehold AREITs & Listed Infrastructure CFS Wholesale Property Securities APN Property for Income No Optimix WS-Property Trust APN Property for Income APN AREIT SGH Property Income Antares Prof Listed Property SG Hiscock Property Legg Mason Martin Currie Property Securities OnePath WS-Property Securities Trust SG Hiscock Property Opportunities Yarra Australian Real Assets Securities Fund S&P/ASX 300 A-REIT Index (total return) Source: Morningstar Direct as at 31 December

7 Legg Mason Asset Management Australia Ltd (ABN AFSL ) is part of the Global Legg Mason Inc. group. Any reference to Legg Mason Australia is a reference to Legg Mason Asset Management Australia Limited. Legg Mason Australia is the responsible entity of the Legg Mason Martin Currie Real Income Fund (ARSN ) and appointed Martin Currie as the fund manager. Before making an investment decision you should read the relevant Product Disclosure Statement (PDS) carefully and you need to consider, with or without the assistance of a financial advisor, whether such an investment is appropriate in light of your particular investment needs, objectives and financial circumstances. The PDS is available and can be obtained by contacting Legg Mason Australia on or at The information in this article is of a general nature only and is not intended to be, and is not, a complete or definitive statement of the matters described in it. The information does not constitute specific investment advice and does not include recommendations on any particular securities. Legg Mason Australia nor any of its related parties, guarantee the repayment of capital or performance of any of the Legg Mason trusts referred to in this document Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. Any general advice or class service have been prepared by Morningstar Australasia Pty Ltd (ABN: , AFSL: ) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Refer to our Financial Services Guide (FSG) for more information at You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. The Lonsec Rating (assigned as follows: Legg Mason Martin Currie Real Income Fund - March 2018) presented in this document are published by Lonsec Research Pty Ltd ABN AFSL The Ratings are limited to General Advice (as defined in the Corporations Act 2001 (Cth)) and based solely on consideration of the investment merits of the financial products. Past performance information is for illustrative purposes only and is not indicative of future performance. They are not a recommendation to purchase, sell or hold Legg Mason Asset Management Australia Limited products, and you should seek independent financial advice before investing in these products. The Ratings are subject to change without notice and Lonsec assumes no obligation to update the relevant documents following publication. Lonsec receives a fee from the Fund Manager for researching the products using comprehensive and objective criteria. For further information regarding Lonsec s Ratings methodology, please refer to our website at: 7