SUMMARY
- The Fund declined 0.2% in September, proving more resilient than the MSCI ACWI SMID Cap Index (net, AUD), which fell 0.9%, as stock selection led by International Seaways more than offset weakness in technology. Over the third quarter, the Fund declined 1.53%, against a 2.61% fall in the index.
- Global equity markets fell as bond yields climbed and most major central banks raised interest rates. Smaller companies lagged larger peers by a wide margin, while technology was among the few sectors to rise.
- No new positions were initiated, and the sale of Cury Construtora was the only change, following slower sales and tighter credit for its buyers.
COMMENTARY
Market review
Equity markets declined in September as bond yields moved higher. Smaller companies fell considerably further than large companies, with US small-caps recording their steepest monthly decline in more than a year. European and Chinese equities also lost ground, while Taiwan and Korea advanced.
In the US, technology and communication services were the only sectors to rise, while financials, materials and real estate fell most. A sell-off in AI infrastructure shares in mid-September, after industry leaders called for slower AI development, reversed quickly for the wider technology sector, though data centre equipment makers were slower to recover. Size was the dominant style influence over the quarter, with US small-caps trailing large-caps by one of the widest third-quarter margins on record.
The Federal Reserve raised rates by 25 basis points to 4.00%, its first increase since July 2023, and the European Central Bank, Bank of Japan and Reserve Bank of Australia each lifted rates by the same amount, while the Bank of England held. The US 10-year Treasury yield reached its highest level since 2007, and Brent crude rose about 14% as talks to reopen the Strait of Hormuz stalled. The Australian dollar fell 3.1% against a broadly stronger US dollar, reducing losses for Australian-based investors.
The month underlined how sensitive smaller companies remain to the direction of interest rates.
Portfolio Commentary
The Fund held up better than the benchmark in September, with stock selection the main driver of relative returns. Energy was the largest sector contributor, and materials, financials and real estate added value. Technology was the main offset, detracting through both our holdings and an underweight position, as did a low weight in Asia. Over the third quarter the Fund was ahead of the index in July and September and behind in August, with financials and energy adding most.
International Seaways, the US tanker owner, was the leading contributor as shipping rates reached record levels. The benchmark rate for the largest crude tankers exceeded $1 million a day for the first time in mid-September, with attacks in the Strait of Hormuz keeping many owners away. The company paid its largest ever dividend of $5.05 per share, and the shares rose 20.7%.
Gates Industrial, the US maker of industrial belts and hoses, recovered about half of its August decline. There was no single catalyst, though US factory activity expanded for an eighth consecutive month and the company completed its acquisition of the Timken belts business on 28 September.
Fagron, a supplier of customised medicines to hospitals and pharmacies, rose without operating news. The gain was a partial recovery from the fall that followed its first-half results in July, when organic growth slowed to 3.1%, and the shares finished the quarter lower.
Munters, the Swedish data centre cooling specialist, was the largest detractor, falling 21.3%. The company brought forward its chief executive handover on 14 September, the same day AI infrastructure shares weakened, and three brokers then cut price targets on supply and margin concerns. Demand is not in question, with the order backlog more than doubling over the past year. We regard the 23 October results as the test of delivery.
Max Stock, Israel’s leading discount retailer, detracted despite no adverse developments in the business, where second-quarter revenue rose 12.7%. The decline extended a de-rating through the second half that followed an exceptional two-year run. With earnings still growing, we consider the valuation reasonable and retained the position.
We sold Cury Construtora, the Brazilian homebuilder, in the second week of September. The pace of sales had slowed markedly from a year earlier, unsold inventory was building, and the state bank that finances its buyers was tightening credit, leaving the growth case we owned it for no longer intact. No new positions were initiated, and the exit removed the portfolio’s only South American holding.
Industrials remain the largest sector weight, followed by consumer discretionary and financials, and Western Europe is held at more than double its index weight. We continue to favour a concentrated portfolio of high-quality smaller companies and to act only when the evidence on a business changes.