Advance Wholesale Defensive Multi-Blend Fund (ADV0049AU) Report & Performance

In July, global equity markets maintained current upward momentum with most regions delivering solid, positive returns. On the other hand, fixed income performance was mixed, although in this “risk on” phase of the cycle, riskier parts of the sector fared better.

A combination of further declines in headline inflation, resilient economic data, particularly from the US, and market expectations that the current interest rate hiking cycle is nearing an end, led to positive investor sentiment throughout the month.

The advanced Q2 2023 US GDP growth figure was reported late month, coming in at 2.4% and surprising market economist estimates of 1.8%. On the flipside, UK and Eurozone growth was close to flat. Benefitting from the base effects of emerging from its extensive 2022 Covid lockdown, China’s GDP growth rate was measured at an annualised 6.3%, though a little below 7.3% expectations. Forward-looking composite purchasing manager indices (PMI) kept falling across the globe in July, with Japan the only region holding steady. PMIs for the services sector continue to outpace manufacturing though are easing towards 50, an important level that is considered the line between expansion and contraction.

Inflation data continued to decline, somewhat aided by the impact of last year’s energy price surge rolling off. US headline Consumer Price Index (CPI) fell to 3.0% p.a and is at the lowest level since early 2021. Similarly, CPI data across the UK, Eurozone and Australia, continues to show easing inflationary conditions, albeit at higher levels than the US. CPI has flatlined at near zero in China. Japan was the only major country that recorded a marginal increase in its inflation rate during Q2 2023. Central banks continued to err on the side of caution, increasing rates by 25bps in the US and Eurozone and 50bps in the UK, where inflation remains the highest among major developed economies. Central banks continued to emphasise a data-driven approach to future rate adjustments. In the US, which is furthest ahead in the inflation cycle, markets are now pricing in a greater than 50% chance that the Fed’s policy rate has peaked and interest rate cuts maybe forthcoming in 2024.

Over July, Hedged Developed Markets Overseas Shares delivered a 2.8% return. US indices were broadly in line with international developed markets, however, Emerging Markets (unhedged) outperformed with a positive 4.9% return. Value modestly outperformed growth over the period, although when looking on a year-to-date basis, mega-cap tech stocks still dominate returns and has led to increased market concentration within that segment of global markets. In the US, with roughly half of S&P500 companies having reported their Q2 2023 earnings, FactSet currently projects a 7% quarter over quarter (QoQ) earnings decline, which would be the softest quarterly outcome since the height of Covid’s impact. That said, to date the majority of companies have reported better than expected earnings results.

Hedged Overseas Government Bonds returned -0.4% over the month, as bond yields across most regions increased in July. Yields on both key long bonds in the US (10-year and 30-year) rose by approximately 15bps over the month. Outside the US, Japan’s 10-year yield rose by around 19bps, which is noteworthy following the Bank of Japan’s announcement that it will further increase the upper tolerance range for the 10-year yield (now 1.0% vs 0.5% previously). The UK was the only major economy where the 10-year yield fell, albeit modestly.

Australian Shares returned 2.9%, marginally outperforming their overseas counterparts in July. Financials (4.9%) and Energy (8.4%) were the strongest sectors of the market, while Healthcare (-1.5%), and Materials (1.4%) detracted.

Significant developments

• Australian seasonally adjusted employment increased by 75,900 in May, well ahead of expectations for an increase of 17,500 and significantly above the prior month’s decrease of 4,300. Unemployment rate decreased to 3.6%, below expectations of 3.7%, with the participation rate increasing to 66.9% (above expectations of 66.7%). Full time jobs increased by 61,700 and part-time jobs +14,200.
• Australian building approvals increased by 20.6% monthon-month to May, compared to the decrease of -6.8% (revised) for April.
• The Institute for Supply Management (ISM) Manufacturing Index (US) recorded 46 in June, below consensus for 47.1 and below the 46.9 recorded in May. Of the four manufacturing industries that reported growth in May, the top performers were Printing & Related Support Activities; and Nonmetallic Mineral Products. There were 11 industries that recorded contraction in June compared to May. The ISM Services Index recorded 53.9 in June, above consensus for 51.2 and above the 50.3 recorded in May. Of the 15 services industries that reported growth, the top performers were Accommodation & Food Services; and Arts, Entertainment & Recreation. There were three industries that reported a decrease in the month of June.
• US Non-Farm Payrolls increased by 209,000 in June, below the 339,000 increase recorded for May. The unemployment rate decreased to 3.6% over June and in line with expectations.
• The third estimate of US GDP for Q1 2023 was 2% quarter on quarter (annualised), above expectations of 1.4%.
• China’s Caixin Manufacturing PMI recorded 50.5 in June, above expectations of 50, as there was a modest rise in manufacturing production over the month.
• The preliminary estimate of the European Core CPI was 5.4% (year to June), marginally below expectations of 5.5%.
• The Eurozone composite PMI increased to 49.9 in June, below expectations for 50.3, showing slightly contractionary conditions.
• Eurozone seasonally adjusted GDP (first estimate for Q1 2023) was -0.1% QoQ and 1% YoY.

Significant developments

• Australian March CPI rose 1.4% for the first quarter of 2023 taking the one year figure to 7.0%. The quarterly rise has been the lowest since December 2021.
• The Institute for Supply Management (ISM) Manufacturing Index recorded 47.1 in April, above consensus for 46.8 and above the 46.3 recorded in March. Of the five manufacturing industries that reported growth in March, the top performers were Printing & Related Support Activities and Apparel, Leather & Allied Products. There were 11 industries that recorded contraction in April compared to March. The ISM Services Index recorded 51.9 in April, above consensus for 51.8 and above the 51.2 recorded in March. Of the 14 services industries that reported growth, the top performers were Arts, Entertainment & Recreation and Other Services. There were three industries that reported a decrease in the month of April.
• US Non-Farm Payrolls increased by 253,000 in April, above the 236,000 increase recorded for March. The unemployment rate decreased to 3.4% over April, below expectations of 3.6%.
• US GDP first estimate for Q1 2023 is 1.1% quarter on quarter (QoQ) annualised, below expectations of 1.9%.
• The Caixin Manufacturing PMI in China recorded 49.5 in April, below expectations of 50, as business conditions moderated slightly over the month.
• The preliminary estimate of the European Core CPI recorded 5.6% over the year to April, in line with expectations.
• The Eurozone composite PMI increased to 54.4 in April, above expectations for 53.7.
• The first estimate recorded for Q1 2021 Eurozone seasonally adjusted GDP is 0.1% QoQ and 1.3% YoY.

The Advance Defensive Yield Multi Blend underperformed the benchmark by 47bps during the month of February. Relative manager performance was mixed over the month, with TwentyFour and TCW underperforming versus the benchmark whilst Kapstream outperformed. TwentyFour underperformed over the month as broader spread widening in financials as well as non-financial corporates, led to some weakness in underlying returns. The ABS positions however contributed positively as the sector continues to recover from its LDI squeeze and it’s floating rate nature provided a natural hedge against rising rates. TCW also underperformed with duration being the primary detractor as Treasury yields rose over concerns of persistent inflation data that drove expectations for more restrictive Fed policy. Against this backdrop, the allocation to credit and securitized sectors contributed to relative performance. Kapstream fared well during February with its conservative approach to duration positioning allowing the portfolio to mitigate against rising government bond yields.

Australian physical credit spreads also compressed domestically, which allowed for some capital appreciation withing the portfolio. The fixed income markets traded with mixed results for the month of February as government bond yields generally rose and credit markets struggled to make an impact, with relatively limited moves in credit spreads. Overall, risk markets moved little in February after higher volatility in previous months. Most major central banks raised interest rates early in the month, all of which were expected. Inflations continued to slacken, led by softer energy prices. However, certain upward influences such as higher food prices continue to retain the attention of policymakers who remain concerned for the potential of a renewed uptick in inflation data.

In Europe, the European Central Bank (ECB) increased interest rates by 50bp in early February taking the benchmark rate to 3.0%, a 15-year high. ECB President Christine Lagarde reiterated the hawkish stance of eurozone policymakers by saying a further 50bp increase is planned for the March meeting. Headline inflation fell back in January, though the core measure edged higher. The Bank of England also hiked rates by 50 basis points and accompanied by a dovish statement. In the US, the Federal Reserve increased official rates once more, as was widely expected, but policymakers opted to hike by just 25bp, which might signal a deceleration in monetary tightening. While recent improvements in inflation may pave the way for a softer approach, meeting minutes showed the Federal Open Market Committee believes risks to inflation remain skewed to the upside and that it would not consider lowering rates “until inflation is clearly on a path to 2%.” Feb members, including Chair Powell, pushed a potential “higher for longer” narrative following strong US economic data. Economic data out of the US was generally stronger than expected, which saw the market reprice terminal cash rates higher as the expectation is that central banks will need to continue to hike rates to slow economies to bring inflation down. The labour market remained tight and the unemployment rate moved down from 3.6% to 3.4%, the lowest level in more than 50 years, and average hourly earnings rose 0.3% in January resulting in an annual increase of 4.4%, while consumer sentiment continued to improve. January inflation data was in line with consensus. Headline inflation rose 0.4% for the month and resulting in an annual increase of 6.4%, whilst core inflation was 0.4% and 5.6% for the same periods.

The US 10-year and 2-year yields increased by 41 bps and 61 bps to 3.92% and 4.82% respectively. Global credit bonds underperformed duration-equivalent government bonds as spreads widened. Higher yields and the prospect of “higher for longer” interest rate regimes weighed on fixed income assets. Investment grade corporates were down the most (-3.2%), lagging Treasuries by over 50 bps on a duration-adjusted basis, while agency MBS also posted negative excess returns. Despite slipping 1.3%, high yield corporates finished ahead of durationadjusted Treasuries by 39 bps, as did securitized credit with ABS and CMBS ahead of Treasuries by 26 and 24 bps, respectively.

The Advance Defensive Yield Multi Blend outperformed the benchmark by 96bps during the month of January. TwentyFour rebounded strongly over the month as the fixed income rally continued. The portfolio made its largest gains in the higher beta areas, corporate hybrids and subordinated financials but made gains across the board as government bonds also rallied. TCW also delivered strong returns in January.

The portfolio’s positive duration profile benefitted relative performance given the move lower in rates throughout the month, with the corporate credit allocation also key to outperformance as both investment grade and high yield corporates finished ahead of duration-matched Treasuries. Meanwhile, the impact from securitized products was an additional tailwind as all securitized sectors posted positive excess returns, with non-agency MBS providing the largest benefit as yield spreads tightened throughout the month, carrying over momentum from December.

Kapstream posted a monthly gain of +0.57% in January, taking the three month return to 1.10% as the higher yield environment which developed over 2022 continued to add to returns as anticipated. Australian physical credit spreads compressed in the month, further supporting the portfolio’s returns given the modest but positive credit exposures.

Government bonds strengthened as yields declined in most major markets in January. Most larger central banks did not hold rate-setting meetings during the month, resulting in no changes to interest rate policy. Inflation, which remained the primary concern of most central banks, generally fell back slightly, though markets continued to anticipate more interest rate increases despite the fragile global economic outlook. Warmer weather in Europe, lower natural gas prices, and China’s reopening added to the optimism. In Europe, headline eurozone inflation fell back more than expected in January, declining to 9.2% from 10.1%, but core inflation continued to increase.

There was no rate-setting meeting of the European Central Bank (ECB) in January but ECB policymakers continued with hawkish rhetoric, calling for rate increases to be continued and for some time. Minutes from the December meeting showed some members called for a third successive 75bp increase, but the consensus agreed on 50bp. In the UK, the Bank of England (BoE) noted that labour market indicators were loosening, and data indicated sluggish economic activity. In the US, continued hawkish rhetoric emanating from the Federal Reserve (Fed) led the market to anticipate another, albeit smaller, rate hike in early February. Inflation continued to decline and initial data for GDP growth for Q4 2022 was a little better than had been expected at 2.9%, but still weaker than in Q3. Forward-looking indicators of economic activity seemed to confirm a softer tone, suggesting that the effects of higher interest rates is being reflected in the real economy.

In Federal Open Market Committee’s (FOMC) meeting minutes released earlier in the month, the Fed reiterated their resolve to bring down inflation. The Fed commented that the move from 75 to 50 basis points “was not an indication of any weakening of the committee’s resolve to achieve its pricestability goal”. Fed officials’ median projections for the appropriate path of interest rates also revealed that none of the Fed officials expect that it will be appropriate to cut interest rates in 2023.

This is at odds with market pricing. The US 10-year and 2-year yields decreased by 37 bps and 22 bps to 3.51% and 4.2% respectively. Global credit bonds outperformed in January as spreads tightened, with all sectors outpacing treasuries on a duration-equivalent basis. Corporate credit posted a strong month, led by the high yield cohort with 218 bps of positive excess returns, while investment grade corporates bested duration-matched Treasuries by 120 bps. Securitized sectors were also positive, led by agency MBS given a reduction in rate volatility, followed by CMBS and ABS.

The Advance International Equities Multi-Blend Fund declined 3.87% in December, outperforming the MSCI World ex-Australia Index by 1.62%. Global equities sold off in December as recession fears and expectations of earnings downgrades weighed on investor sentiment. A persistently hawkish tone from the US Federal Reserve Chair Powell compounded these concerns over the month. Against this background, Wellington Global Opportunistic Value was the top contributor to relative performance. The strategy invests in companies that have sold off due to increased uncertainty.

Strong stock selection in the US consumer discretionary sector drove outperformance over the month. Conversely, Ardevora was the largest detractor from performance. The manager applies a framework based on cognitive psychology to identify risky management behaviour and errors made by investors and analysts. Negative stock selection, particularly in financials and industrials detracted over the month. From a country perspective, strong stock selection in the United States was the top contributor to relative performance, while the fund’s overweight to Korea was the top detractor from relative performance. On a sector level, effective stock selection in consumer discretionary names was the top contributor to relative performance, whereas the overweight to utilities was the largest detractor. The fund’s underweight to Tesla was the top driver of relative performance whereas the overweight to the London Stock Exchange Group was the heaviest detractor.