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Monthly Report December 2019


Returns


Return  volatility

All returns are in NZ$ 31 Dec 19 3 months 12 months Since
inception pai

Since
inception pai

Aspiring Fund

-0.18% 4.96%  21.19%   11.25%
    8.30%

New Zealand Equitiesii

1.55% 5.18% 30.42%     9.26%
    11.14%

Australian Equitiesiii

-2.99% -2.41%  23.12%     6.43%
    15.32%

World Equitiesiv

-1.81% 0.90%  26.49%    6.53%
    12.53%
i February 2006, ii NZX50 Gross, iii ASX All Ordinaries Accumulated, iv MSCI World Equities Total Return

Unit Price

$4.1242


Asset Allocation

New Zealand Equities

37.5%

Australian Equities

16.7%

International Equities

32.5%

Bonds

2.6%

Total Cash

10.7%

Short Equities

-0.9%
Net Fund Value $449.6m


The Fund's main direct currency exposures at month end were - NZD 48% , AUD 19% , USD 23%


The Fund returned -0.18% in December as the impact of the rising NZ$ on our unhedged currency positions offset a solid return from the Fund’s equities investments.

Our Equities Portfolio was up over 1.5% in local currency, with particular strength from our International component which was up in excess of 5%. However the overall Fund return was materially impacted by unhedged currency positions, with the 4.8% and 2.4% strengthening of the Kiwi against the US Dollar and British Pound respectively. Excluding unfavourable currency movements, the Fund would have posted a ~1.3% positive return for December.

Unhedged currency has been a drag on Fund performance in the 4th quarter of 2019 but we believe the cost of this had some internal offsets as US dollar weakness, in particular, helped fuel the rally in our international portfolio holdings. We expect the reverse would likely occur in a risk-off selloff, providing the Fund with downside protection. At the time of writing we have seen some evidence of this following Trump’s military strike on Iran.

The Fund achieved a 21% calendar year return in 2019, a performance we are pleased with considering our average Equities allocation of 76% over the year, and the, still sore, scars of the late 2018 market sell-off.

Rising valuation (price/earnings (PE)) multiples were again the driving force behind returns in 2019, with investors happy to accept lower returns (higher share prices) as the returns on alternative investments (cash and bonds) declined with lower interest rates. This was particularly noticeable in the bond yield sensitive New Zealand share market, where the NZ10yr bond yield fell from 2.4% to a 1.06% low (a negative yield ex-inflation) in 2019, seeing the average PE ratio for NZ Equities climb from 16x to a record 20x.

Against this 23% rise in multiples, the average NZ stock delivered a capital return of ~19% in 2019. The difference is the impact of forward earnings going backwards. Deteriorating earnings momentum and the recent pick up in the NZ10 year yield are two negative return drivers that make us cautious on the outlook for local shares in 2020.

The 2019 valuation story offshore was not as pronounced. World Equities started the year at 14x, a discount to its historical average of ~15.5x, and finished the year marginally above at 17x. Excluding US equities, valuations offshore are broadly at their long-run averages.

The other key feature of 2019 was the influence politics had on market sentiment dominated by the US / China trade war, the constantly tedious Brexit situation and, closer to home, the Labour Party’s unexpected defeat in the Australian election. The magnitude of the Conservative’s win in the UK election fuelled a sharp rally in domestic equities but market euphoria has unwound a bit and sterling has given ground as the magnitude of the Brexit challenge has swamped relief that Corbyn’s hard left agenda was so decisively rejected.

While ink hasn’t seen paper (signing expected mid Jan), the announced agreement of a phase 1 trade deal between the US and China was well received by the market. However nothing is ever certain with Trump’s style of government and political uncertainty will continue to build into the US election in November.

What does seem certain is a continuation still of very low interest rates by historical standards, and this should act as a continued draw-card for risk assets. However, this is a late cycle bull market and, on balance, we expect the higher level of optimism priced into US equities to cause increased market volatility this year.

Our NZ portfolio had a decent month, with Metlifecare (+17%) being the standout following a takeover offer, and EBOS (+6.4%) and Napier Port (+23%) climbing on no material news flow. These tailwinds were offset by Z Energy (-14%), Spark (-4.6%) and Sky TV (-16.5%).

Metlifecare (MET) received a takeover offer in December which was a shallow victory for its shareholders, with the $7.00 offer price only fractionally above the company’s last reported book equity value (its net tangible asset value or NTA) of $6.96 per share. The takeover offer, recommended by the MET Board, provides a useful insight against valuations across the sector. 

In our view, Retirement company valuations can be simplified into two parts. 1) the net sale value of the existing properties, and 2) the future value gain of properties that are yet to be built (the present value of the future development pipeline). The investment thesis for retirement stocks is more akin to property development than healthcare.

The MET offer price at 1.01x NTA, like the share price itself over many years, essentially only factors in the value of its existing properties. NTA is a good proxy for the value of the existing properties, as the assets are revalued annually by independent experts and cross-checked against each villages’ own and neighbouring sales evidence. In stark contrast, the share prices of Ryman (RYM) and Summerset (SUM) currently trade at 3.8x and 1.9x their respective NTA’s.

What’s more telling than share-price/NTA ratios is comparing the three companies in terms of the dollar value of their premiums to book value. The MET offer values the company only $9m above its current book equity value. Summerset’s share price values the company $930m above book value, and Ryman’s share price implies $6.2 billion above book value. Put another way, the MET offer factors in virtually no value gain from any yet to be developed future properties, versus ~$1bln from Summerset and ~$6bln for Ryman.

While we think the amount of future development factored into Ryman’s current share price is excessive, our view is irrelevant if the marginal investor is happy to pay for more years of development success. However, what is relevant is these high expectations (large dollar premiums above book value) create very challenging math for investors seeking compounding annual returns.

For simplicity, assume investors want a 9% annual return from Ryman and Summerset shares. Ryman with a $8.5bln market capitalisation requires a $750m annual return in the year ahead. Assuming the 1.5% dividend yield is funded by operating cashflow (net of overheads, interest costs, and tax), this leaves $630m of required capital gain from asset appreciation. If it’s $7bln existing property portfolio has price inflation of 3% ($220m) this leaves roughly $400m of capital gain to be generated by the change in value of its future development pipeline. If we roll forward ten years, to maintain a 9% annual return for shareholders, with a then market cap of ~$17bln, the value of the properties not owned today would have to increase by $1bln in the year 2030 alone!

Using the same approach, for Summerset to achieve a 9% total return, the value attributed to its future development pipeline would have to increase by $60m this year, and increase by around $200m in the year 2030. Why would Summerset developments in the year 2030 (or 2040) be so materially less value adding than Ryman, under likely different management teams and different contracted construction teams (their people) than today?

We acknowledge Ryman as one of the most successful business’s in New Zealand. However, high embedded expectations and the law of large numbers has seen the Fund own Summerset (from mid last year when our outlook for house prices changed) and hold no shares in Ryman. For Metlifecare, we are happy but not ecstatic receivers of essentially a takeover offer at book value.
 
Z Energy fell after yet another downgrade (its 5th in 2 years) as the sustained severity of a challenging retail environment seems to consistently surprise its management. While management’s forecasting credibility has taken a hit from the slew of downgrades, we estimate the share price roughly prices in the dividend never exceeding 40 cents (its downgraded guidance level for 2020) and declines to less than 6cps by 2050. While this appears extreme given emerging signs of a bottoming out of retail margins, the downgrade cycle has been so severe we think the market will require management to consistently deliver on their targets before any rerate is likely. Meanwhile the gross dividend yield pretty much meets our required expected return.

SPK (-4.6%) was dragged down by its key share price driver, the performance of Aussie Telco Telstra which was down 8.3% giving back the majority of its gains in November. The chart below shows how close Spark's share price trades relative to what the Spark share price would be if it traded at Telstra’s dividend yield. Spark is a key income holding for Fund with a 7.5% dividend yield and a conservative level of debt compared to the industry globally.

 

 




Our Australian portfolio had a soft month after a particularly strong year, as the ASX200 fell 2.2%, making it the only major developed market index to fall in local currency terms. We had a couple of decent wins in smaller positions, however these were outweighed by Treasury Wines (-13%) and Cleanaway (-5%) which both fell on no particular news. Our Aussie portfolio posted a 40% return in 2019, a very pleasing result following a tough 2018. However we continue to tread relatively lightly in Aussie (~16.5% of Fund value), given the Aussie market can be prone to wild swings at the individual stock level, and like NZ, trades at historically high earnings multiples.

Our International portfolio had another very good month as global markets rallied, with a bunch of strong performers and no material headwinds. Value based positions Freeport-McMoRan (+15%) and Imperial Brands (+12%) led the way, and we also had decent wins in Alibaba (+13%) and Tencent (+6%), in addition to our UK positions. We noted in November our ~7% exposure to UK domestic stocks in anticipation of the Conservative party retaining power in December’s election, thereby closing in on an end to the Brexit uncertainty. Pleasingly this outcome played out in convincing fashion, and our UK investments rallied sharply.

In our December 2018 monthly commentary we noted we were more encouraged in the Fund’s medium term outlook than we had been for a good while. While 2019 share price moves, largely in the absence of earnings growth, have tempered the risk/return equation, the Fund’s relatively small size and large investment universe continues to provide us with the opportunity to find meaningful new global investment opportunities. Our appetite for risk concentration is unchanged with the majority of our individual company positions below 2% of Fund value.


Top 10 Holdings


TILT Renewables

4.1%

Spark

3.9%

a2 Milk

3.2%

Amazon

3.0%

Contact

3.0%

Alibaba

2.8%

EBOS

2.6%

Infratil

2.4%

Cleanaway

2.4%

Google

2.2%



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..