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Monthly Report February 2020


Returns


Return  volatility

All returns are in NZ$ 29 Feb 20 3 months 12 months Since
inception pai

Since
inception pai

Aspiring Fund

-4.22% -2.78%  12.67%   10.90%
    8.37%

New Zealand Equitiesii

-3.89% -0.49% 20.76%     8.99%
   11.15%

Australian Equitiesiii

-7.63% -6.87%  7.78%     6.04%
    15.41%

World Equitiesiv

-4.48% -2.82%  14.60%    6.38%
    12.55%
i February 2006, ii NZX50 Gross, iii ASX All Ordinaries Accumulated, iv MSCI World Equities Total Return

Unit Price

$4.0168


Asset Allocation

New Zealand Equities

35.2%

Australian Equities

14.2%

International Equities

33.4%

Bonds

2.2%

Total Cash

15.0%

Short Equities

-1.3%
Net Fund Value $437.0m


The Fund's main direct currency exposures at month end were - NZD 46% , AUD 19% , USD 25%


After posting very strong performance in the first three weeks of the month, the Fund ended February down 4.22%. This was a disappointing result but it occurred in the midst of a sharp global sell-off occasioned by the global spread of the coronavirus.

Like many, we had interpreted the lack of market response to the initial news of this outbreak as further evidence that interest rates trump everything when they are this low. The initial stories about supply chain disruption etc from companies like Apple were concerning but market reaction was very muted suggesting market confidence that the effects were likely to be short term.

As the political responses to the global spread became more extreme, the market was jolted out of its complacency and we saw one of the sharpest global one week sell-offs ever with the MSCI world index falling 11.9% for a total month return of -8.5%. This was remarkably consistent across major markets with Australia, the UK, Germany, Japan, France and the USA all recording falls for the month between 7.7 and 9.0%.

Notable exceptions to this were China and New Zealand where the markets fell less than 4% (China in fact produced a positive return, with political intervention a potential explanation).

Once again, the performance of New Zealand’s benchmark NZ50 index masked the true underlying condition of the broader share market. Excluding a2 Milk and Fisher & Paykel Healthcare, the index would have instead recorded a -7.4% return, and across the index the average stock return was -7%. Outside the 50 large companies that make up the NZ50 index, the NZ Small Company index (a universe where the Fund has reduced its exposure) experienced a genuine liquidity drought and was down 10.3% in February.

Unsurprisingly, in such an environment bond yields also plummeted with the US 10-year yield falling from 1.7 to 1.0% and the New Zealand 10-year yield falling below 1.0% for the first time ever. Commodity prices also suffered with the oil price experiencing its biggest weekly drop (-5%) since the dark days of 2008.

Tourism stocks were hardest hit, with airlines leading the fall across the globe. US airlines were down ~30% from January highs, and at home Air New Zealand fell 31%. After selling out of Air NZ in November, and with a zero holding in Auckland Airport, the Fund has a small (~2.5%) direct exposure to Tourism. We continue to see NZ Tourism growth as a highly investable enduring theme, and believe our holdings, which include Sky City, Skyline, Tourism Holdings and Wellington Airport (via Infratil) provide very favourable medium-term return potential.

In addition, the Fund also has limited exposure to Financials (~4%) which are hit by the double whammy of lower net interest margins from the fall in interest rates and a likely pick up in non-performing loans.

Regular readers of our monthly commentary would be well aware of the importance we have attributed to the direction of long bond yields as the key driver of equities returns.

The combination of falling equity prices and bond yields has seen the risk premium in equities pricing (the margin between the earnings yield of shares and the yield on long bonds) widen to 5-year highs (refer below chart).



This is a very supportive 'Buy Equities' signal for investors who believe low interest rates will likely remain a supportive influence on valuations long term.

Interestingly, the sharp increase in the equities risk premium has seen the dividend yield of NZ defensive stocks rise despite interest rate falls. A partial explanation for this in the case of the Gentailers is the pending announcement from Rio Tinto on its decision to continue to run or exit the Tiwai Aluminium Smelter. While most analysts continue to think the latter outcome is unlikely, we regard it as a non-trivial binary risk. Hence despite the much increased appeal of the Gentailers at current prices we have only added modestly to our existing holdings.

February reporting season (for the 6 months to Dec-19) was overshadowed by the coronavirus which was a significant factor in outlook statements and a recurring theme in company meetings and presentations. The uncertainty about the spread of the virus and the possible political responses and their effect on end demand and supply chains has created enormous short term uncertainty for many companies.

NZ companies showed mild revenue growth of +3% (median of companies covered by Forsyth Barr), but increasing competitive and cost pressures (including wages) saw earnings decline (-0.4%).

In Australia earnings were particularly weak, with Goldman Sachs reporting that ASX200 Industrial firms delivered their weakest profit growth since the GFC, with the median company seeing earnings per share fall 8% on the prior year.

The Fund’s best Australasian performers were a2 Milk (+8.7%) and Cleanaway (+11.3%).

A2 produced a strong half year result with continued revenue and earnings momentum. Pleasingly the company has broadened its sales channels by growing its direct sales into China and, in an effort to mitigate its supply risk, it is also evaluating opportunities to participate in manufacturing. This did nothing to help the heavily Australian-investor owned Synlait Milk (not held by the Fund) whose share price fell 32% in February and is now 56% off 2018 highs. 

Cleanaway shook investors’ confidence last year as the slowing Australian economy drove a soft 2019 result followed by a downgrade at its AGM. This put heightened importance on a clean half year result, and the company delivered, beating expectations. Cleanaway’s reliable long-duration cashflow characteristics and impressive management team make it a core fund holding.

Pleasingly, Chorus, a key NZ holding for the Fund, also posted a positive return for the month. Our investment thesis is playing out, with the company now valued marginally above the cost of its Fibre network. Chorus provided first time guidance for a new dividend policy to payout a high ratio of its substantial future free cashflow as unimputed dividends. We are disappointed with this decision. We cannot see how significant dividend tax leakage maximises long-term shareholder value. Instead we believe investors would be better served by investment (72 cents in the dollar is a low investment hurdle to beat). 

Core Fund holding Alibaba was a good example of a strong result tempered by coronavirus commentary with the share price only up 0.7% in the month. It posted 3rd quarter revenue growth of 38% and earnings growth of 56%. On the result call, management guided to negative earnings growth in the March quarter with lower activity, and also significant fee concessions provided to their customers.

It is clear the coronavirus will have a material short term impact on economic activity across the globe, as fear impacts consumer behaviour, and manufacturing and supply chain disruptions will significantly impact trade and related service industries. 

At the time of writing, we continue to see a Fiscal and Monetary policy response, including rate cuts from the Reserve Bank of Australia (-0.25%) and the US Federal Reserve and Bank of Canada (-0.5%).

While the Fund’s globally diversified business holdings will be impacted, we see this as a more favourable position to be in rather than concentrated exposure to one market/country or industry. We continue to like companies with rock solid balance sheets, strong cash flows and enduring business models, which should be well placed to traverse short-term economic shocks. While there is clearly uncertainty about their near term earnings outlook, there is no doubt about their ability to remain profitable throughout a recession of any length. This is not to say we expect a long lasting recession but we would not want to own a portfolio of heavily indebted companies if it occurs.

When investor uncertainty abruptly increases, the prices for risk assets typically fall. We are seeing this playing out again. It is worth noting comments from UBS Chef Economist Paul Donovan, “forecasters nearly always underestimate human resilience, and thus economic recovery from big shocks. The initial damage is correctly assessed, but the bounce back tends to come earlier and stronger than consensus expects”. 

It is encouraging that some commentators have reported China virus cases falling. There are also signs of a recovery in China activity, evidenced by Deutsche Post noting on their result call that DHL’s China Express freight business has rebounded close to 90% of pre-virus levels.

We have deliberately refrained from making any predictions about the spread and duration of the coronavirus in the immediate term as this is best left to experts and we are conscious of adding to the noise. However our central case scenario is the coronavirus outbreak is extremely unlikely to have an enduring influence on how equities will be valued. The Fund’s risk setting, ~15% cash, provides us a good opportunity to increase allocation to equities. We are now selectively buying shares at what we see as very compelling discounted prices.

While equities overall are still not at extreme cheap levels on an absolute basis, we suspect T.I.N.A (there is no alternative to equities) is not dead. In our view, equities continue to provide the best opportunity for long-term returns in a low interest rate world.


Top 10 Holdings


TILT Renewables

4.0%

Google

3.7%

Amazon

3.5%

Contact

3.1%

Spark

3.1%

Alibaba

3.1%

Infratil

2.9%

Cleanaway

2.8%

a2 Milk

2.4%

Grifols

2.4%



Disclaimer :  The information contained in this newsletter reflects the views and opinions of the issuer of the Aspiring Fund, Aspiring Asset Management Limited.  The content of this newsletter is not intended as a substitute for specific professional advice on investments, financial planning or any other matter, and does not take into account any particular investor’s objectives, financial situation or needs.  Investors should seek the advice of an authorised financial adviser before making any investment decisions. Although the information provided in the newsletter is, to the best of our knowledge and belief correct, Aspiring Asset Management, its directors, employees and related parties accept no liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result of reliance on the information provided and opinions expressed in this newsletter, except as required by law.  Please also note that past performance is not necessarily an indication of future returns.

For further information please read/request a copy of the Product Disclosure Statement for the Aspiring Fund (available at www.aaml.co.nz) or contact Aspiring Asset Management..