SUMMARY
The Fund generated a +0.5% return in September, continuing to build on a solid start to the year. By way of comparison, the Australian stock market rose +3.5%, whilst the return of the RBA cash rate plus 6% equated to approximately +0.8% for the month. For the September quarter, the fund achieved a return of +5.5%, comfortably ahead of the cash plus 6% benchmark of +2.5% over the same period, whilst the broader market returned +7.9%.
Initial market momentum in September arose from a much anticipated but nonetheless outsized easing by the US Federal Reserve, reducing the targeted Federal Funds rate by 50bps. Equity market focus has been on central bank policy for some time, to some extent diverting attention from mounting macro economic pressures in China. Domestically, these pressures have manifested themselves in softer commodity markets and a steady rotation away from the miners (towards the banks). The perceived policy inertia in China was countered in the second half of September, with policy makers “unleashing” a series of monetary stimulus measures to resuscitate the struggling economy. As a result, commodities once again rallied and domestic mining stocks gained 12%, with the Materials sector alone delivering over 80% of the market’s return during the month. Notwithstanding the September rally, we continue to hold concerns about what appear to be more structural challenges to the Chinese economy, and question the sustainability of the more immediate and possibly shorter term stimulatory activity.
The rotation to the miners was funded mainly by the banks, who in aggregate fell by 1.5% in September. With aggregate consensus earnings forecasts continuing to modestly decline across the month, the market multiple has once again lifted, to 18.3x forward earnings (vs 17.7x in August).
We are pleased with the solid start to the financial year for the Fund, and to be tracking comfortably ahead of our cash plus 6% benchmark. In particular given the defensive positioning of the Fund (cash levels around 14%), and the relatively lower reliance on the resource sector (BHP for example was outside of the top 5 contributors), which as highlighted was the primary driver of broader market strength over the same period.
CIO and Senior Fund Manager Rhett Kessler recently provided a portfolio update and insights from the reporting season, which is available below for your review. CPD points are applicable for Australian Financial Planners HERE.
COMMENTARY
Resmed was the largest positive contributor to the Fund across the September quarter, with strong results in August followed by news flow out of an industry conference highlighting the positive impact GLP1 drugs could have on demand for its products. The discretionary retail holdings continued their run of positive contributions, with ongoing resilient operating results and cash flows, in particular from Super Retail Group and Accent Group. Both businesses continue to benefit from strong balance sheets with Super Retail announcing further cash returns to investors via special dividends in the period. Other strong contributors included Evolution Mining (ongoing strength in Gold prices), Stockland Group (strong fundamentals supported by a rotation to REITs following a more dovish rate outlook globally), and Telstra whose solid underlying cash flow profile continues to steadily assert itself on the share price.
Detractors in the September quarter were primarily focused on SG Fleet and NIB Insurance. NIB surprised the market in August with what appears to be conservative provisioning for future claims, limiting more immediate realisation of earnings upside from the structural step down in claims over the COVID period. SG Fleet reported solid operational results, including substantial cash returns via a special dividend, however a conservative outlook impacted by higher finance costs saw the stock weaken post results. We continue to see value in both names, in particular after their recent share price weakness.
From a trading perspective, we took the opportunity to add to positions across a number of names over the quarter, in particular Light n Wonder, Metcash, and Kelsian Group. A rebasing of its share price year to date provided an attractive opportunity for us to re-establish a position in Ampol in September. Whilst we continue to see strong operating momentum for JB Hi Fi, the August rally drove valuation to its limit for our process resulting in the sell down of our entire stake during that month. Our holding in CSR was sold to St Gobain as part of their takeover early in the quarter, other profit taking took place in NAB, Woolworths, and CSL.
As highlighted above, much of the share market’s performance this Financial Year has been driven by a multiple re-rating, as opposed to an improved earnings outlook. That is to say, stocks have simply become more expensive in the period. We have previously expressed our view that the negative impacts from central bank experiments with quantitative easing, deeply negative real interest rates and ever-expanding fiscal deficits are still to play out, and the reaction to data points continues to swing from fear to excitement in a matter of weeks. Amidst this period of increasing volatility, we believe that a focus on strong business models, backed by healthy cash generation and stewarded by competent management comes to the fore.
We continue to believe that the Fund is well positioned to navigate the existing volatility and deliver on our objectives of cash plus 6% in the medium term, given its defensive positioning, with solid balance sheets, and focus on businesses generating cash now. At month end the portfolio was generating an after tax cash earnings yield of ~6% for FY25 – underpinning our focus on fundamental value. Our expectation of these earnings, combined with further earnings growth, capital returns, and potential for valuation multiple uplifts provide comfort in achieving our return objectives.
We remain as focused as ever on our primary objectives of capital preservation and generating a reasonable real return for our investors. We continue to believe this is best served by a disciplined approach and consistent investment methodology. A variety of good businesses run by honest and competent management teams at the right price will create a well-diversified portfolio of ever-growing cash earnings streams.