Commentary

The Australian stock market had a reasonable quarter to September 2020, ending up 1.1%. In comparison, the Fund generated a 1.5% return for the same period.  For the month of September, the Fund was down 2.0% compared to the market that yielded a negative 3.4%. For comparison purposes, the RBA cash rate yielded 0.1% for the quarter.

The main event of the September quarter was the August reporting season which had some specific characteristics. As expected COVID played havoc with FY20 earnings and in particular with forward-looking profit statements.  More importantly, businesses that were beneficiaries of lockdowns/Jobkeeper payments (WFH, online retailer, or essential services) benefitted disproportionately to others that had to cease or curtail trading. The pertinent question has become the sustainability of future earnings or, more importantly, the sustainability of future cash flows – “what is the new normal?”

Added to that, a darkening global macro horizon (US election, US fiscal cliff, geopolitical tensions between US/China, Brexit, and the second wave of COVID in particular in Europe) made for a challenging investment environment. Conversely, during the latter part of the quarter, there seemed to be a glimmer of light emerging in Australia – a marked improvement in the Victorian COVID case rate, substantial fiscal stimulus announced in the Federal Budget, travel bubbles with NZ, progressive state bordering re-openings and the Big Four banks reporting better than expected outcomes on provisions and hardship metrics – underpinning a positive shift going forward.

At a Fund level our holdings in Super Retail, Aristocrat, Credit Corp, and Accent Group were the main contributors to performance whilst Telstra, Ampol, Resmed, and Medibank Private impacted negatively. During the quarter we added to Mirvac, Flexigroup, and EBOS whilst we trimmed our positions in Westpac and Credit Corp. We also sold our JB Hifi positions due to valuation.

We remain cautiously optimistic that volatility continues to provide sufficient opportunities to achieve our investment objectives. As such we are comfortable holding some powder dry, ready for deployment – the Fund’s cash holding was 14% at end of September.

We remain focused on maintaining and growing the purchasing power of the funds entrusted to our stewardship. As indicated in our webcast (attached to this newsletter), there are several large conundrums that will have a medium to longer-term impact on investing:

1^st Conundrum – What is a Dollar (in any currency) worth when the global government/central bank “printing presses” continue to operate at these high levels?
A simplistic yet accurate definition of inflation remains when more money chases the same or smaller amount of goods and services.  In addition, investors are barely being rewarded for holding cash given record low-interest rates. Stimulus-induced liquidity appears to be driving asset prices ever higher, further eroding the purchasing power of cash. In addition to financial assets, we note that used car prices, domestic holiday costs, and even dry goods at the supermarket are experiencing significantly higher price moves.

2^nd Conundrum – What is the cost of money?
Valuations are typically derived by calculations based on three factors: the cost of money, the quantum and the certainty of future cash flows. Until recently, using the 10-year government bond yields as a proxy for the cost of money made this calculation trivial. Our time was focused on quantum and certainty factors.  However, with central banks around the world crushing the yield curve, price discovery is impossible. Furthermore, central banks are executing a massive heist on investors around the world by forcing them up the risk curve – more risk for less return.  Given the prevailing uncertainties, it is difficult to see how filling portfolios with long-duration assets (equities, property, and bonds) at these levels of interest rates will not end in tears.

3^rd  Conundrum – Can the government build a stimulus bridge across the lockdown valley AND THEN unwind all the debt without derailing the economy?
In our view, the Australian government has done an excellent job of extending a bridge across the COVID induced economic “lockdown” valley. Decisive and courageous action combined with robust demand for Australian commodities (hard and soft) has boosted our confidence that we may achieve a reasonable outcome, albeit landing us safely on the other side remains an enormous challenge.  However, it does appear that equity markets (based on valuations) are already anticipating success… and then some.

Our Strategy – Retain our investment methodology, discipline and focus on reasonably priced “Hard Assets”
Essentially we continue to focus on companies that have resilient business models, robust balance sheets, competent management, and are available at a reasonable price. Importantly we seek to own those businesses that have demonstrated a track record of “having the power” in their various stakeholder relationships. Typically these are represented by characteristics that include: long term contractual arrangements at favourable terms with strong counterparties (WPR), owning unique or scarce assets (BIN, RIO), being the lowest cost producer (CSL), and owning superior non-trivial intellectual property (Resmed).