Perth equity fund managers are having to look harder for value after generating very strong returns during the past year.
The past 12 months has been a good period for fund managers focused on Australian shares.
The market has been kind to them, with an overall gain of about 30 per cent, as measured by the ASX’s All Ordinaries Accumulation Index, which tracks share prices and dividends for the largest 500 stocks.
All the major Perth-based equity fund managers exceeded the index: some by a little, others by a lot.
The top performer was Argonaut’s AFM Perseus Fund: a long-running entity that was moribund for many years before being revived 18 months ago.
It is a small fund but has built a diverse portfolio of resources and mining services companies that delivered a gross return of 71.2 per cent for the year to June 30.
Argonaut’s Natural Resources Fund, established 18 months ago, was not far behind.
It had a gross return of 53.8 per cent for the year.
Westoz Investment Company (WIC) did not fare so well, returning 34 per cent.
Merchant Group merged two separate funds during the year to create the $188 million Merchant Opportunities Fund.
It was a mid-ranked fund, with a gross return of 46.7 per cent.
That put it ahead of Precision Funds Management’s Opportunities Fund, which returned 37.7 per cent.
The relative laggard this year was Katana Asset Management.
That won’t have pleased portfolio manager Romano Sala Tenna but, like all experienced fund managers, he knows you can’t be the top performer all the time.
“In the first half of the year, we were absolutely flying, we shot the lights out,” Mr Sala Tenna told Business News.
“In the second half, we were treading water largely.
“That’s part of the cycle you go through, as you build positions in a portfolio.
“The market is starting to recognise those positions now.”
Westoz executive director Dermot Woods has also learned to look past short-term volatility in his pursuit of consistent long-term returns.
For instance, WIC’s annual return was held back by its exposure to contractors such as Perenti Global, NRW Holdings, and Emeco Holdings.
Mr Woods noted that these stocks were up between 18 per cent and 25 per cent in the first two weeks of July.
“What a difference a fortnight makes,” he said.
Dermot Woods manages $220 million of investors' funds. Photo: Gabriel Oliveira
“Inflation is a known known, meaning we’ve all been talking about it for months so that isn’t a new threat,” Mr Chapman said.
“Political uncertainty is a constant, so I don’t think that one is too prevalent despite all the activity in the Pacific now.
“Interest rates will go up, but everyone knows this; the question really is how quickly and how high they go up?
“In my view the developed economies will manage the upward trajectory of interest rates accordingly, like post-GFC.”
Mr Chapman believes the largest macro risk is COVID-19 wave two or even wave three, although quantifying this is very difficult.
“Overall, equity markets look fully valued on most investment metrics and at risk if inflation proves to be more structural than transitory and flows through to higher interest rates,” Mr Franklyn told Business News.
Precision executive director Tim Weir is also cautiously optimistic after assessing global macro trends.
“Despite all the talk of inflation globally and central banks tapering stimulus and raising interest rates to counter, we are of the belief this will be in a very controlled manner,” Mr Weir said.
“We don’t expect to see rate rises until 2023 and tapering will be modest.
“Governments and central bank policy will still utilise stimulus to maintain GDP in the wake of the pandemic.
“Therefore, we expect markets to continue to perform robustly, albeit not at the same level of the last 12 to 18 months, and the prospect of a short-term correction is very real but will only be short term.
“We are also mindful we are at the mature end of the cycle, hence managing risk is a key consideration.”
Mr Sala Tenna is generally bullish about the prospects for equities, saying the investment gamebook has fundamentally changed.
“Central banks and governments are working in harmony to print money and do whatever it takes to avoid the next crisis,” he said.
With so much liquidity being pumped into the economy and interest rates so low, Mr Sala Tenna said there was little choice for investors wanting decent returns.
“Investing in cash is not sustainable,” he said.
“If I sat on the sidelines, I’d get a one per cent return rather than a 33 per cent return.”
That’s exactly what the investment team at Cottesloe-based Packer & Co have done.
After achieving outsized returns over many years by investing in international shares, they have been extremely bearish on global stock markets over the past two years.
“We are convinced we are facing one of the most dangerous points in stock market history and have no interest in risking your capital in the present environment,” the firm said in its June 2021 newsletter.
“Right now, we believe we are in a giant stock market bubble with asset prices at ridiculously high valuations, whilst economies run hot on government largesse.
“We have rarely seen a riskier cocktail.”
With most of its money in cash, Packer & Co’s Investigator Trust returned just 1.8 per cent in the past financial year.
Mr Sala Tenna acknowledges the global financial system will probably implode under the weight of high debt and high liquidity but expects that is a long way off.
“Is it sustainable? No,” he said.
“Is it financially responsible? No.
“I can sit here and say it shouldn’t be happening, but I play the cards that I see before me.
“I need to form a view on the next one, two, three, four years.”
That means keeping a close eye on inflation, which he expects to increase because of the increased money supply.
“What is the number one thing I’m looking for at the moment?” Mr Sala Tenna asked rhetorically.
“It’s bond yields based on inflation.
“Bond yields are the number one driver of every aspect of share prices.”
Mr Sala Tenna said his funds management team backed their judgement calls with their own money, saying about 30 per cent of the $80 million Katana managed was the team’s money.
He said Katana did a lot to manage risk, holding zero debt, using no derivatives, and having no offshore exposure.
Across its portfolio of about 60 stocks, it also has a bias toward ‘liquid’ stocks that can easily be bought and sold.
This includes the likes of Mineral Resources, Uniti Group, Seven Group Holdings, South32, and Westpac Bank.
Whenever the stock market does correct, Mr Sala Tenna believes Katana will recover fast because of the quality of its stocks and its diversified holdings.
He can point to the long-term performance of both listed investment company Katana Capital and the Katana Australian Equity Fund to back up his assertions.
Since inception 15 years ago, they have delivered an average annual return of 10 per cent, compared to 7.5 per cent by the All Ordinaries Accumulation Index.
“Whilst we are in very challenging times, the central governments around the world have essentially underpinned the rally we have seen,” Mr Chapman told Business News.
“The real question for investors is that what does this look like in a vaccinated world with super cheap money?”
Mr Chapman believes fund managers will need to be very selective in their stock holdings in future.
“I don’t think we will see the outsized returns from the major indices we saw in 2020-21, where the rising tide really floated all boats,” he said.
“It will be all about stock picking and being in the right industries and companies; this will dictate your returns for the next few years, in my view.”
Merchant’s merged fund has an unusually diverse portfolio, ranging from very large companies such as BHP, Fortescue Metals Group and JB-Hi Fi, through to small plays such as Race Oncology and Auscann.
“We remain positive of the long-term thematic around decarbonisation and electrification, and expect that companies aligned with this trend will continue to perform strongly in FY2022,” Mr Franklyn said.
Argonaut positioned its portfolio last year to capitalise on resources that are expected to benefit from the electrification of the transport sector and decarbonisation of power generation, namely copper, nickel, and lithium.
Each of these commodities rose strongly in value over the financial year, driving companies exposed to these commodities higher.
Mr Franklyn has also spotted opportunities in the gold sector, which he described as the big underperformer in 2021.
“We have increased our exposure to the gold sector to over 20 per cent, as major producers represent compelling value, and emerging producers look appealing as potential takeover targets,” he said.
“Further, gold’s position as a store of value in times of uncertainty offers portfolio protection.”
Westoz’s Mr Woods has also focused on the gold sector.
He said a standout was gold development company Emerald Resources, which defied all the challenges associated with COVID-19 to build a new mine in Cambodia.
“Gold development companies performed very well in what was a very tough market for gold stocks,” Mr Woods said.
He said the Westoz team – which had about $220 million in funds under management – was comfortable investing in companies with offshore projects.
“We are not afraid to go offshore because a lot of the risk tends to be priced in,” he said.
“A lot of people feel uncomfortable with offshore stocks, but we’ve made good money on them, especially gold stocks.”
In keeping with this assessment, Westoz is also a big investor in Orecorp, which is developing a gold project in Tanzania.
Mr Woods said there were always pockets of undervaluation and overvaluation in the market, but he saw the balance tilting.
“I do think we are in a period where there are a lot of pockets of overvaluation,” he said.
“Things like cryptocurrencies are very obvious bubbles.”
Mr Woods also believes there are selective opportunities in the battery metals sector.
“That sector is incredibly exciting but there are some totally ridiculous valuations,” he said, adding the best way to get exposure to battery metals was via nickel stocks, such as Brazil-focused Centaurus Metals.
Like Katana, Westoz has a 15-year track record of outperforming the market.
WIC has returned $185 million of dividends and franking credits to its shareholders since 2005, while the smaller Ozgrowth has returned $99 million over the same period.
Mr Weir said Precision had recently sold some stocks and increased its cash holdings because of continued economic strength and some signs the market cycle had peaked.
“We have also looked to increase our quality and more liquid holdings by switching from more speculative illiquid companies,” he said.
This meant switching out of junior explorers with a market cap below $50 million into companies that were in production or near production.
Its $55 million investment portfolio includes a big holding in copper play Venturex Resources, which is chaired by Precision director Biill Beament.
Other companies favoured by Precision include Orecorp, gold developer Capricorn Metals, and PYC Therapeutics.
Mr Weir said commodity markets continued to be driven by Chinese demand and credit growth.
“Any hiccup will be met with further stimulus, so we expect to see further upside in metal prices over the next 12 months, but again, not at the same rate we have enjoyed in the previous period,” he said.
Mr Weir said the lack of new investment and sustained global growth would help the oil price continue to gain traction.
However, the sector was not attractive from an investment perspective because of the increased focus on environmental, social and governance factors.
Mr Weir said he expected gold to remain robust in the wake of inflation fears and the US dollar to soften.
A broader perspective
Financial planners like Michael Matthews have a very different slant on investment markets.
As an executive director at Capital Partners Private Wealth Advisers, Mr Matthews helps clients keep some perspective on investment returns.
This includes the ‘COVID crash’ of March 2020 and the recovery since then.
“The stock market had a spectacular recovery from a spectacular decline over a very short period of time, but if you draw a line from January 2020 to now, it’s not that spectacular,” Mr Matthews told Business News.
“Three-year average returns of about 12 per cent are strong but not crazy.”
Mr Matthews doesn’t try to predict future stock market returns; if he, or anybody else, was able to predict market returns consistently and accurately, shares would not have a risk premium.
Instead, his focus is on helping clients structure their portfolio according to their risk tolerance.
“We make sure the client has the capacity to be exposed to the risk,” Mr Matthews said.
“We are very deliberate in making sure people don’t need to have a knee-jerk reaction.”
AMP Capital’s head of investment strategy and chief economist, Shane Oliver, is another who constantly works to educate investors.
He quotes long-term returns to provide perspective.
Since 1900, Australian shares have returned 11.8 per cent per year and US shares 10 per cent per year (including capital growth and dividends).
Drawing on this track record, Mr Oliver encourages investors to look past short-term volatility.
“Investors need to recognise that shares return more than cash in the long term because they can lose money in the short term,” he said.
“Share market volatility driven by worries, bad news, and bouts of recovery and investor euphoria is normal.
“It’s the price investors pay for higher longer-term returns.”
However, for every statistic Mr Oliver can quote, the team at Packer & Co have some contrary figures.
Their June newsletter noted that the continuous fall in global interest rates over the past 40 years had boosted asset prices at every downward move.
“Consequently, the US stock market index has returned 1,080 per cent when adjusted for inflation,” it stated.
“Compared to previous 40-year periods, nothing has come close.
“From 1941 to 1981, the US market rose just 130 per cent, despite all the benefits of the post-war boom.
“In the 40-year period from 1901 to 1941, the stock market lost 43 per cent of its value.
“The effects of World War I, the Depression, and the start of World War II made it a brutal period for stockholders.”
On a more positive note, the latest annual returns from Australia’s superannuation funds illustrates the benefits of maintaining a diversified portfolio exposed to shares (equities).
Australia’s super funds have just delivered their best annual financial year returns in 34 years, according to research from Rainmaker Information.
Its default superannuation index posted FY21 returns of 18 per cent, after all fees and taxes.
The only time superannuation annual returns have beaten this was just before the October 1987 stock market crash.
Returns in the year to June 1987 hit 19 per cent, marginally ahead of this year’s results.
Driving the high returns were the 33 per cent gain from the listed property sector, followed by 28 per cent gains from both Australian and international shares (see table).
These were offset by lacklustre financial year returns from unlisted direct property, bonds, and cash.
Rainmaker director of research and compliance Alex Dunnin said Australian and international shares and listed property were asset classes more favoured by retail super funds compared to not-for-profit super funds.
Mr Dunnin said this explained why the retail superannuation segment was now outperforming.
“Reinforcing this, unlisted and direct property, being an asset class that has generally been the backbone of why NFP funds have performed so strongly over the long-term, has delivered only meagre returns this financial year,” he said.