Australian Small Cap Portfolio Quarterly Update June 2015

Transcription

1 Australian Small Cap Portfolio Quarterly Update June 2015 Adrian Atkins Senior Equity Analyst Portfolio Overview The Australian stock market fell in the June quarter on rising global bond yields, jitters from a potential Greek exit and a volatile Chinese stock market. The Australian Small Cap Equities Portfolio returned negative 6.6% in the March quarter, compared with negative 4.0% for the S&P/ASX Small Ordinaries Accumulation Index. The portfolio underperformed as some of its good-quality defensive companies gave back some gains, while the materials sector (which we are massively underweight) found a bid after years of poor performance. Longer-term performance of the portfolio remains excellent. Over one year, the portfolio returned 19.5%, well ahead of the benchmark's 0.4% return. Morningstar Style Box Value Blend Growth Large Mid Small Equity Style % Equity Style Value 41.5 Equity Style Core 21.7 Equity Style Growth 36.9 Despite the recent agreement for a third bailout, Greece is in a difficult position with debt to GDP of 175% (soon to be more than 200%) and a devastated economy with unemployment above 25%. While Greece is small and should be contained, any concessions to it would likely trigger demands from other financially challenged European countries. Debt-to-GDP ratios for Spain, Portugal, Italy, France and others are on an unsustainable path as high unemployment makes it hard to get government budgets under control without increasing taxes and further damaging fragile economies. A long work-out period is likely for Europe, with the European Central Bank keeping interest rates low and ongoing periods of quantitative easing. Perhaps the main risk is defaults spooking investors, and forcing bond yields higher for other heavily indebted nations as investors demand higher returns to compensate for growing risks. This would only bring defaults closer as some countries can barely cope despite current low interest rates. Small Cap Portfolio - Top 10 Holdings Portfolio Date: 30/06/2015 Hotel Property Investments CASH Platinum Asset Management Ltd isentia Group Ltd Pact Group Holdings Ltd Spark New Zealand Ltd Chorus Ltd Ainsworth Game Technology Ltd Abacus Property Group Veda Group Ltd Investment Growth of $10,000 Time Period: 1/02/2011 to 30/06/ , , , , ,000.0 Weighting % In China, the incredible stock market rally ended in June, and indices started to tank. At the June peak, the Shanghai market was up 150% over 12 months and the ChiNext composite index (the "Chinese Nasdaq") was up more than 200%. While Chinese stocks appeared cheap based on valuation multiples before the rally started, gains were supercharged by capital controls, which limit mainland investment options, and an army of unsophisticated retail investors chasing momentum, many using margin debt. Speculative stocks gained the most in the rally and unsurprisingly have the most to lose in the selloff. Perversely, these stocks have been allowed to halt trading in their shares to stop losses, which could lead to panicky retail investors dumping higher quality shares, many of which already appear reasonably priced. While this could hurt Platinum Asset Management (a portfolio holding) in the near term, Platinum has a keen eye for value and the turmoil should see the firm pick up bargains in preferred names. In Australia, conditions in resources states remain weak as Chinese fixed-asset investment continues slowing while commodities supply increases. Despite the challenging outlook, the price of oil and most commodities rose during the quarter, but have resumed their slides since quarter-end, dragging the Australian dollar lower. We remain wary of the materials and energy sectors because of the scarcity of quality in the small cap space and challenging outlooks. East-coast economies are performing better, particularly Sydney, which has been buoyed by a strong housing market and upswing in the building cycle. However, we remain cautious given affordability issues and high household debt levels. With a defensive stance and focus on good-quality companies, the small cap portfolio is well positioned for market volatility. Further, the portfolio owns many niche stocks pub landlords, health insurance, medical devices, currency exchange and data analytics to name a few not reliant on strong economies to grow earnings. 10, , , / / / / / / / / /2015 Aust Shares - Small Cap S&P/ASX Small Ordinaries TR AUD

2 Small Cap Portfolio - Complete List of Holdings Portfolio Date: 30/06/2015 Hotel Property Investments CASH Platinum Asset Management Ltd isentia Group Ltd Pact Group Holdings Ltd Spark New Zealand Ltd Chorus Ltd Ainsworth Game Technology Ltd Abacus Property Group Veda Group Ltd Qube Holdings Ltd Automotive Holdings Group Ltd ALE Property Group NIB Holdings Ltd MYOB Group Ltd Sirtex Medical Ltd Ozforex Group ltd FlexiGroup Ltd Virtus Health Ltd Trade Me Group Ltd AWE Ltd New Hope Corp Ltd Code Style Box Economic Moat Fair Value Uncertainty Portfolio Weight % HPI Í None Medium PTM Ì Narrow Medium 6.8 ISD Ï Narrow Medium 5.8 PGH Ë None Medium 5.5 SPK Ê Narrow Medium 5.3 CNU Í None High 5.3 AGI Ï Narrow High 5.2 ABP Ê None Medium 5.2 VED Ì Wide Medium 5.0 QUB Ë Narrow Medium 5.0 AHG Í Narrow High 5.0 LEP Î None Medium 4.2 NHF Ë Narrow Medium 4.1 MYO Ì Narrow Medium 4.0 SRX Ì None Very High 3.7 OFX Ï None High 3.5 FXL Í None High 3.1 VRT Í None High 3.0 TME Í Wide Medium 2.3 AWE Í None High 1.8 NHC Ë None High 1.2 Note dividends for Chorus, Spark New Zealand and Trade Me are imputed for New Zealand residents. Australian residents receive unfranked dividends with a supplementary payment. Morningstar Investment Strategy Committee members own the following securities held by the portfolio: AGI Holdings-Based Style Map Holdings-Based Style Trail Time Period: 31/07/2012 to 30/06/2015 Micro Small Mid Large Giant Deep-Val Core-Val Core Core-Grth High-Grth Micro Small Mid Large Giant Deep-Val Core-Val Core Core-Grth High-Grth Small Cap Portfolio S&P/ASX Small Ordinaries TR AUD Small Cap Portfolio S&P/ASX Small Ordinaries TR AUD The above chart shows the portfolio and index style mix. The shaded area is the region in which 75% of the portfolio's holdings fall. The above chart shows the portfolio and index style mix over time, the smallest dot representing the earliest date.

3 Portfolio Fundamentals Display Benchmark 1: S&P/ASX Small Ordinaries TR AUD Inv Bmk1 Cat Avg Average Market Cap (mil) P/E Ratio (TTM) Debt to Capital % (TTM) ROA % (TTM) ROE % (TTM) , Transactions in the Quarter The Australian Small Cap Portfolio transacted several times during the quarter, selling Slater and Gordon, iinet and SMS Management and Technology. Proceeds were invested into MYOB Group, Automotive Holdings Group, Platinum Asset Management and Spark New Zealand. Cash ended the quarter at a relatively high level, and will be deployed as attractive opportunities arise. On 8 April, we sold our stake in iinet after it received an attractive takeover offer from competitor TPG Telecom. We sold on-market to reinvest the proceeds into Automotive Holdings Group, which owns a national network of car and truck dealerships, and a smaller division providing refrigerated logistics. We estimate the core dealership business earns a little over half its revenue from the sale of new and used vehicles, with the balance from servicing and the sale of parts. The servicing business is particularly attractive as sticky customers allow strong profit margins. Asset Allocation Portfolio Date: 30/06/2015 % Stock 92.8 Cash 7.2 Total On 28 April, we sold our small stake in SMS Management and Technology after reassessing its outlook and cutting our fair value estimate. We believe there is a structural increase in competition in SMS's typical hunting ground from global heavyweights and Indian technology firms using cheap foreign labour, resulting in ongoing downward pressure on profit margins. On 18 May, we took advantage of share price weakness to top up our relatively small positions in Platinum Asset Management and Spark New Zealand, funded from cash. Platinum is a highly regarded fund manager specialising in international shares, and benefits from a long-term tailwind from Australia's growing pool of superannuation savings. Spark is New Zealand's incumbent telco, with a dominant position affording cost advantages and economies of scale. Equity Country Exposure Portfolio Date: 30/06/2015 % Australia 92.8 Cash 7.2 Total On 16 June, we sold Slater and Gordon and bought a stake in MYOB Group. We sold Slater and Gordon as it entered the S&P/ASX 100 Index and no longer qualified for inclusion in the Small Cap Portfolio. Fortunately, we sold at a relatively good price. MYOB is the leading provider of accounting software to small and medium-sized enterprises in Australia. While we expect its market share to dwindle, it has attractive growth prospects from migrating users of its legacy desktop software to its more powerful cloud-based products. Most legacy software generates revenue from new sales with no recurring fees to MYOB, while the cloudbased products earn recurring revenue from annual subscriptions. Equity Sectors (GICS) Portfolio Date: 30/06/2015 % Financials 38.8 Telecom Services 11.9 Consumer Discretionary 14.2 Industrials 11.4 Energy 3.4 Materials 6.2 Healthcare 7.6 Information Technology 6.5 Total 100.0

4 Performance Relative to Peer Group (one month lag) Peer Group (5-95%): All Managed Investments - Australia - Equity Australia Mid/Small Blend Return Risk-Reward Time Period: 1/02/2011 to 30/06/ Aust Shares - Small Cap Top Quartile 2nd Quartile 3rd Quartile Bottom Quartile Aust Shares - Small Cap YTD 1 year 3 years Since inception S&P/ASX Small Ordinaries TR AUD S&P/ASX Small Ordinaries TR AUD Quarter Performance The Australian Small Cap Portfolio returned negative 6.6% in the three months ended 30 June 2015, underperforming the benchmark S&P/ASX Small Ordinaries Accumulation Index which returned negative 4.0%. Longer-term performance remains excellent. The portfolio's returns of 19.5% over one year and 19.0% per annum over three years are well ahead of the benchmark. The Small Cap portfolio has delivered vastly superior returns with less volatility than the benchmark thanks to our focus on high-quality businesses with sustainable earnings. Since inception in February 2011, the portfolio has outperformed the S&P/ASX Small Ordinaries Index by 18% per annum, on average. It has achieved this with 30% less volatility than the index, with a standard deviation of 11.1% versus 15.6% for the index. Contributors The largest contributor to performance in the quarter was Sirtex Medical, which recovered much of last quarter's collapse as secondary data from its recent SIRFLOX medical trial (in liver cancer that metastasised from the bowel) appears positive. For patients with liver-only metastases, the liver tumours were stunted for an average of 21.1 months with a combination of Sirtex's treatment and the standard chemotherapy, compared with just 12.4 months with the chemotherapy alone. We think this and other secondary data support Sirtex growing beyond a salvage therapy, despite missing the primary endpoint of slowing the progression of cancer through the rest of the body. Good results in the SARAH clinical trial next year are vital to promote Sirtex's therapy to a first-line treatment. SARAH is a study into primary liver cancer, giving Sirtex's therapy the best chance of working as it is a targeted therapy aimed at liver tumours. Further, the primary endpoint of the study is overall survivability - the most important factor for cancer patients. We think the company has an attractive outlook, though uncertainty is very high. Return Pact Group's share price recovered to near-record highs as the company continues to expand in a profitable manner, while isentia continued its strong run following its good half-year result. Avoiding struggling media stocks such as Nine Entertainment and Seven West Media also helped relative performance. Std Dev Aust Shares - Small Cap - Market Performance Time Period: 1/02/2011 to 30/06/2015 Inv Bmk1 Up Period Percent Down Period Percent Best Month Worst Month Best Quarter Worst Quarter Up Capture Ratio Down Capture Ratio Detractors Virtus was the largest detractor from performance after it downgraded guidance by about 10%, though it still expects net profit growth of a few percent. While much of the downgrade related to non-recurring factors, the company also cited a negative mix-shift of its low-cost offering, intensifying competition from new entrants and the increasing use of frozen embryo transfers versus fresh. We trimmed our fair value estimate, but consider the sell-off overdone. Qube Holdings also detracted from performance after downgrading earnings guidance because of very tough operating conditions for its Western Australia business which services small miners. We had expected weakness in Western Australia and believe more bad news is likely, but this division has little to do with our investment thesis and we're happy to ride out the bumps. We rate Qube and its management very highly, and believe it has a favourable long-term outlook as it creates a vertically integrated logistics company. The big Moorebank intermodal development in Sydney's west and intermodal terminals in other states are key components of this strategy, and should drive strong growth for the company when completed. Risk Time Period: 1/02/2011 to 30/06/2015 Return % pa Std Dev Downside Deviation Alpha Beta R2 Sharpe Ratio (arith) Tracking Error Inv Bmk

5 GICS Sector Weights Relative to Benchmark Financials Consumer Discretionary Telecom Services Industrials Technology Healthcare Materials Energy Consumer Staples Utilities Sector and Industry Weightings Analysis The Small Cap portfolio remains heavily overweight the financials and telecommunication services sectors. It is heavily underweight the consumer discretionary and materials sectors. The large divergence in sector exposures between our portfolio and the benchmark index reflects which sectors have the better-quality, lower-risk businesses, and the more attractive outlooks and valuations. The portfolio's industry positioning worked against it in the quarter, particularly the overweighting to diversified financials and underweighting to materials. The best weighting was avoidance of the struggling media industry. The large overweight position in the financials sector reflects stakes in diversified financials and Australian REITs. REITs total 17% of the portfolio, and have highly defensive earnings, particularly Hotel Property Investments and ALE Property Group, which benefit from long leases to strong tenants. Despite the potential for interest rates to rise in the medium term, they will likely remain low compared with historic averages, underpinning the attractiveness of property and other high-yielding investments. These core holdings have been major contributors to the portfolio's long-term outperformance and stability. In diversified financials, NIB Holdings offers highly defensive earnings while others have attractive long-term growth outlooks unrestrained by soft real economies Small Cap Portfolio S&P/ASX Small Ordinaries TR AUD GICS Industry Group Weights Relative to Benchmark Diversified Financials 10.0 Telecommunication Services Real Estate Transportation Insurance Pharmaceuticals and Biotechnology Software and Services Retailing Technology Hardware and Equipment Household and Personal Products Utilities Automobiles and Components Consumer Durables and Apparel Banks Energy Health Care Equipment and Services Food, Beverage and Tobacco Consumer Services Commercial Services and Supplies Capital Goods Media Materials The portfolio has a large overweight position in the telecommunication services sector. These firms have defensive earnings and relatively attractive long-term tailwinds. The portfolio holds Spark New Zealand and Chorus. iinet was sold after it received a generous takeover offer from competitor TPG Telecom. We believe telecommunications companies have favourable outlooks given the trend to increasingly incorporate the Internet into everyday life. The portfolio's largest underweight position is in the materials sector. This positioning hurt performance during the quarter as the small cap materials sector performed relatively well, for the first time in a while. Our only exposure to the materials sector is Pact Group, a manufacturer of rigid plastic packaging for a wide range of drink, food, household and cosmetic products. We continue to have no exposure to resources, except our energy stocks. We find it difficult to justify investment in most small-cap resources stocks because of the challenging outlook and scarcity of high-quality assets. The consumer discretionary sector was our largest underweight position early in the quarter, but we increased our exposure with the acquisition of a stake in Automotive Holdings Group. Despite the acquisition, we remain heavily underweight consumer discretionary companies, and this positioning worked well as the sector performed poorly in the quarter. Traditional retailers are struggling with weak consumer sentiment caused by the soft economy, combined with longer-term headwinds from online competition and the powerful shopping-centre owners. The portfolio is also underweight the industrial sector, which is mainly due to the avoidance of companies servicing the mining and oil and gas industries. Avoiding these stocks has been a major contributor to our outperformance of the benchmark in recent years. We remain wary of these low-quality firms despite huge stock price falls as resources capital expenditure will remain weak for some time, presenting a major risk to their profitability and perhaps survivability.

6 Returns Relative to Benchmark As of Date: 30/06/ Return month YTD 1 year 3 years Since Inception* (28/01/2011) Aust Shares - Small Cap S&P/ASX Small Ordinaries TR AUD Performance measures are expressed before fees, costs and taxes are deducted. Dividends are reinvested in the portfolio. The performance displayed is for the Morningstar Small Cap Equities Portfolio and represents modelled performance only. This performance will differ from actual performance depending on factors such as transaction timing and any divergence from constituent weightings. * Where inception date is not the beginning of a month, returns are calculated using a start date which is the first day of the month following inception. Selection Effects Time Period: 1/04/2015 to 30/06/2015 Underperform Outperform Relative Weight Overweight Underweight Relative Return Best Selections Investment Type Weight +/- Return +/- Effect 1 Sirtex Medical Ltd Stock Pact Group Holdings Ltd Stock isentia Group Ltd Stock Nine Entertainment Co. Hol... Stock Seven West Media Ltd Stock APN News and Media Ltd Stock Abacus Property Group Stock Independence Group NL Stock Greencross Ltd Stock Retail Food Group Ltd Stock Fletcher Building Ltd Stock Paladin Energy Ltd Stock Energy Resources of Austra... Stock ALE Property Group Stock GWA Group Ltd Stock Worst Selections Investment Type Weight +/- Return +/- Effect 1 Virtus Health Ltd Stock Qube Holdings Ltd Stock Spark New Zealand Ltd Stock Trade Me Group Ltd Stock FlexiGroup Ltd Stock Ainsworth Game Technolog... Stock Slater & Gordon Ltd Stock Liquefied Natural Gas Ltd Stock Chorus Ltd Stock PanAust Ltd Stock New Hope Corp Ltd Stock Select Harvests Ltd Stock Evolution Mining Ltd Stock Sandfire Resources NL Stock NIB Holdings Ltd Stock

7 Allocation Effects Time Period: 1/04/2015 to 30/06/2015 Relative Weight Underperform Outperform Overweight Underweight Relative Return Best Weighting Weight +/- Return +/- Effect 1 Media Telecommunication Services Real Estate Health Care Equipment and Services Capital Goods Worst Weighting Weight +/- Return +/- Effect 1 Diversified Financials Materials Transportation Food, Beverage and Tobacco Consumer Services Cumulative Attribution Effects Time Period: 1/07/2014 to 30/06/2015 GICS Industry GroupCumulative Attribution Effects Cumulative Allocation Effect Cumulative Selection Effect Cumulative Active Return Attribution Effect % Attribution Effects Allocation Effect Selection Effect Active Return

8 Equity Sectors (GICS) Time Period: 1/07/2012 to 30/06/ / / / / / /2015 Energy % Materials % Industrials % Consumer Discretionary % Consumer Staples % Healthcare % Financials % Information Technology % Telecom Services % Utilities % Equity Style Valuation Time Period: 1/07/2012 to 30/06/ / / / / / /2015 Value % Core % Growth % Equity Market Capitalization Time Period: 1/07/2012 to 30/06/ / / / / / /2015 Giant % Large % Mid % Small % Micro %

9 Investment Methodology and Process Portfolio Mandate and Typical Positioning Small Cap Portfolio Strategy The Australian Small Cap Equities Portfolio is an actively managed concentrated portfolio consisting of our best small cap ideas outside of the S&P/ASX 100 with liquidity restraints. The portfolio is constructed with a focus on long term fundamental value and bias toward businesses with sustainable competitive advantages (economic moats) and predictable cash flows. Total return from the Small Cap Portfolio will tend to be driven by both capital appreciation and dividend yield with the mix dependent on the opportunities available. The Small Cap Portfolio will tend to hold a few more positions than the other Morningstar portfolios to allow sufficient diversification. High quality companies are less common in the small cap universe, causing this portfolio to holder fewer companies with an economic moat than is preferred, but it will still generally have a quality bias relative to its benchmark. Similarly, the Small Cap Portfolio may on average have higher uncertainty ratings than other Morningstar portfolios which allows pursuit of greater reward opportunities, with likely greater volatility. Investment Strategy Committee Process Morningstar s equity portfolios are managed by their portfolio managers and Morningstar's eight-person investment strategy committee which comprises selected members of the equities research team. Committee meetings reinforce rigor and consistency of research methodology through collaborative debate on proposed and existing holdings. A constant feedback loop between Morningstar s research team and investment committee members leverages team strengths in vetting stock calls and portfolio holdings. This constant cycle strengthens team culture, expertise and ratings, minimising key-person risk and common behavioural pitfalls. The committee is experienced and well-resourced, ensuring stability and succession planning. Representation from each sector team ensures cross-market expertise. Committee members have average industry experience of 17 years and average tenure with Morningstar of 10 years. We are not averse to an occasional portfolio manager change, as the driving forces behind our portfolio construction process are our bottoms-up research and investment committee overlay. In-depth research by our large, global, and experienced analyst team is the bedrock of our portfolio management process and facilitates our high conviction investments. We have over 100 equity and credit analysts globally, covering around 1,700 stocks and 700 debt issuers, making us one of the largest independent research teams in the world. Our 20 Australian and New Zealand-based analysts cover about 230 Australian and New Zealand stocks which includes extensive research reports, timely event analysis, actionable special reports, and deep discounted cash flow modelling on every company. This is complimented by our local credit research to help us assess the complete capital structure and preserve capital while pursing upside opportunities. Investment Committee Feedback Loop

10

11

12

13 Portfolio Overview An actively managed portfolio of Australian equities outside of the S&P/ASX 100, focusing on companies with sufficient liquidity trading at relatively attractive valuations. Sector Specialist Managed Accounts Asset Allocation Return Objective Time Horizon Risk Profile Growth Assets % Defensive Assets % Australian Shares Core S&P/ASX 200 Accumulation Index 7 years High Australian Shares High Yield S&P/ASX 200 Accumulation Index 7 years High Australian Shares Small Cap S&P/ASX Small Ordinaries Accumulation Index 7 years Very high Property S&P/ASX 200 REITs Accumulation Index 5 years High Global Shares MSCI ACWI Accumulation Index (Net Dividends Reinvested) 7 years High Cash Bloomberg Australian Bond Bill Index 2 years Very low This document is issued by Ibbotson Associates Australia Limited (ABN , AFS Licence No ) ( Ibbotson ). Ibbotson is a member of the Morningstar group of companies ( Morningstar ) Morningstar, Inc. All rights reserved. In compiling this document, Ibbotson has relied on information and data supplied by Morningstar and other third party information providers. Whilst all reasonable care has been taken to ensure the accuracy of information provided, neither Ibbotson, Morningstar nor their third party information providers accept responsibility for any inaccuracy or for investment decisions or any other actions taken by any person on the basis or context of the information included. Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar or your adviser. Past performance is not a reliable indicator of future performance. Neither Ibbotson nor Morningstar guarantees the performance of any investment or the return of capital. The information provided is general advice only has been prepared without reference to an individual person s objectives, financial situation or particular needs. You should consider the advice in light of these matters and if applicable the relevant disclosure document before making any decision to invest. To obtain advice tailored to your situation, individuals should contact a professional financial adviser. For a copy of the relevant disclosure document, please contact our Distribution Team on Some material is copyright and published under licence from ASX Operations Pty Ltd ACN

14 Diversified Managed Accounts Asset Allocation Return Objective Time Horizon Risk Profile Growth Assets % Defensive CPI+ 0.75% Rolling 1 year Low Defensive Assets % Conservative CPI+ 1.0% Rolling 3 years Low to Medium Balanced CPI+ 2.5% Rolling 5 years Medium Growth CPI+ 3.5% Rolling 7 years Medium to High High Growth CPI+ 4.5% Rolling 9 years High High Growth Plus CPI+ 5.0% Rolling 10 years High 95 5 Diversified Income CPI+ 2.0% Rolling 4 years Medium This document is issued by Ibbotson Associates Australia Limited (ABN , AFS Licence No ) ( Ibbotson ). Ibbotson is a member of the Morningstar group of companies ( Morningstar ) Morningstar, Inc. All rights reserved. In compiling this document, Ibbotson has relied on information and data supplied by Morningstar and other third party information providers. Whilst all reasonable care has been taken to ensure the accuracy of information provided, neither Ibbotson, Morningstar nor their third party information providers accept responsibility for any inaccuracy or for investment decisions or any other actions taken by any person on the basis or context of the information included. Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar or your adviser. Past performance is not a reliable indicator of future performance. Neither Ibbotson nor Morningstar guarantees the performance of any investment or the return of capital. The information provided is general advice only has been prepared without reference to an individual person s objectives, financial situation or particular needs. You should consider the advice in light of these matters and if applicable the relevant disclosure document before making any decision to invest. To obtain advice tailored to your situation, individuals should contact a professional financial adviser. For a copy of the relevant disclosure document, please contact our Distribution Team on Some material is copyright and published under licence from ASX Operations Pty Ltd ACN