Alphinity Concentrated Australian Share (HOW0026AU) Report & Performance

The Fund underperformed somewhat in July. The best contributors were energy company AGL, packaging company Orora and not owning Macquarie Group; worst were lithium play IGO, pallet pooler Brambles, mineral sands/rare earth miner Iluka, and supermarket Woolworths; not owning ANZ Bank also hurt.

The Fund remains skewed to stocks which are going into reporting season with positive earnings momentum: i.e. the Fund’s holdings on average have had more positive changes to earnings expectations than the market over the last several months. This is typically a good lead indicator that there will be further earnings changes in the same direction. Our quantitative insights back up our fundamental research which also suggests the portfolio has solid prospects for ongoing positive earnings surprises. Of course, given the prevailing economic environment, this could actually mean they have less risk of disappointing earnings than the overall market.

We have taken the opportunity to further increase our underweight to Resource companies as many of their share prices – temporarily in our view – strengthened on the back of sentiment in China that so far looks to us to be overly optimistic. This sector could present us with some interesting opportunities later in the year as medium-term price expectations, especially for iron ore-producing companies, currently look undemanding. The near-term outlook, however, is more uncertain.

Increased supply, combined with the likely reintroduction of steel production caps by the Chinese Government in order to support steel prices and reduce the risk of over-supply, risks further iron ore price weakness in coming months.

As always, the August reporting season will bring new insights and possibly new investment opportunities. We look forward to reporting on them next month.

The Fund performed in line with the market in June, and lagged slightly over the June quarter. The best contributors were global insurer QBE, pallet hirer Brambles, lithium play IGO, advertising platform carsales.com; not owning resource giants South32 or Rio Tinto also helped. Offsetting these however were holdings in resource giant BHP and medical device maker Fisher & Paykel Health; being underweight ANZ Bank and not owning high tech companies Xero and Wisetech also detracted from returns.

The Fund lagged the market a little in May, with a holding in respiratory products maker Fisher & Paykel and not holding accounting software provider Xero both detracting from returns. The portfolio benefitted from no exposure to Wesfarmers and gold miner Newcrest, while overweight holdings in CSL and Lynas Rare Earths also contributed to returns.

respiratory products maker Fisher & Paykel and not holding accounting software provider Xero both detracting from returns. The portfolio benefitted from no exposure to Wesfarmers and gold miner Newcrest, while overweight holdings in CSL and Lynas Rare Earths also contributed to returns.

Portfolio outlook

In a market with limited overall earnings growth and earnings revisions that, despite some stabilisation more recently, appears to have more risk to the downside than upside, companies which can deliver growth, and especially growth ahead of market expectations, should be well rewarded. The Fund remains well exposed to these types of companies overall and we look forward to confirmation of this as we approach the August reporting season.

During May we further reduced our Bank exposure as increased mortgage competition and higher funding costs will be a challenging combination for the Banks’ net interest margins, especially in a low credit growth environment. We remain less concerned about large credit losses for the banking sector as a whole given large unused provisions that were raised during the Covid period. A moderate underweight to the sector is appropriate, in our view. We have also reduced our exposure to the Resources sector in face of weaker economic data out of China. We remain firmly underweight that sector in aggregate with a maintained preference for iron ore exposure, albeit at lower levels.

We have however built positions in James Hardie and Cochlear during the past months. We previously had concerns with Hardie’s ability to manage margins and continue taking market share in a soft US house siding market that is increasingly competitive. While the overall market environment remains challenging, housing starts have stabilised at lower levels in recent months. More importantly however, James Hardie has managed the weak environment well from a cost and sales perspective resulting in a better than expected margin outlook and likely further earnings upgrades.

The Fund performed essentially in line with the market in April, and there were few companies of note on either side of the ledger. The only meaningful positive contributor was not owning diversified miner Rio Tinto; the only meaningful detractors were owning resource giant BHP and not owning big bank ANZ.

Despite ongoing macro uncertainty, the portfolio has continued to exhibit better earnings revisions than its benchmark with March quarter updates from Brambles, Viva Energy, Medibank Private and Woolworths some of the highlights. Indications of stronger-than-anticipated increases in mobile pricing plans across the telecom sector has also benefitted Telstra.

The mixed news out of China, especially the suggestion that there might be a Government-mandated cap on steel production, has seen weakness across the commodity price complex. The portfolio remains underweight this sector and we trimmed our iron ore exposure somewhat as near term earnings upside has become more limited.

The Fund has for a long time been underweight gold mining stocks, preferring to invest in companies with more sustainable growth prospects. Despite sharply higher interest rates around the world, which has increased the opportunity cost of investing in assets such as gold with no income stream, the gold price has been strong thus far in FY23, and this has detracted from the Fund’s relative performance. The strength has been largely due to gold’s status as a “safe haven” in times of trouble, and this appeal has more than offset its lack of income. In addition, the weakness of the $US against major currencies has bolstered the price of gold, which is traded in $US. We will continue to monitor the situation but at this stage we are not convinced that the current strength in the gold price will be sustained.

We trimmed the Fund’s exposure to the Bank sector earlier in the year to close to a neutral position as mortgage pricing competition intensified. This trend appears to have continued and we trimmed our exposure further, even though strong balance sheets and attractive dividend yields should cushion the fallout from a faster than expected normalisation of net interest margins.

We remain confident in our ability to identify companies with stronger earnings prospects than forecast by market participants. We believe this will ultimately be rewarded by investors, notwithstanding continued volatility in market sentiment.

The Fund performed a little better than the market over the March Quarter. The material contributors were a diverse mix: gaming company Aristocrat Leisure, health insurer Medibank Private, petrol distributor Viva Energy and pallet pool provider Brambles, and also not owning ANZ Bank. These were partially offset by our positions in National Australia and Commonwealth Banks and not owning gold miner Newcrest.

Following a brief period of individual company earnings focus, macro factors are again dominating the headlines. And following an even briefer period of market nervousness investors appear to have decided, for now at least, that the main upshot from the US regional banking calamity is further arguments for the US Federal Reserve and other central banks to end the current rate hiking cycle. The rationale behind this view is that reduced credit availability will now do some of the work higher interest rates would otherwise have had to do. Our own central ban ’s decision to not raise interest rates further in April is likely to have been at least partly influenced by this thinking.

As rising interest rates have been the main headwind for global equity markets a peak in interest rates is, everything else being equal, clearly positive. However, things are seldom equal. As we have argued for some months now the focus for equity investors should move from whether rates have peaked, or are close to peaking, to how long they will stay around current levels and how significant the impact on the economy, and in consequence, corporate earnings, will be from the sharp hikes we have already had.

While central bankers have shown they can change policy direction swiftly if the economic data surprises them, positively or negatively, they have also shown that they are concerned about repeating past mistakes of taking the foot off the brake too early. In Australia, this concern is likely to have been reinforced by the support from Federal and some State governments for CPI-equivalent minimum wage increases, which will likely flow on to substantially higher awards wages as well.

The Fund outperformed the market nicely in February, helped by strong returns from some of our key positions. The best contributors to overall performance came from health insurer Medibank Private, global insurer QBE, packaging company Orora, pallet company Brambles Industries, gaming machine maker Aristocrat Leisure and insurance broker Steadfast. The only detractors of note were our positions in BHP and Commonwealth Bank.

The February reporting season was a welcome break from the many macro factors that had been dominating individual share price performances. The Fund had a good month with most portfolio holdings which reported delivering strong results, positive outlook statements and, as a consequence, strong share price performance. Some of the highlights were pallets pool company Brambles, global insurer QBE, retailer Super Retail Group, packaging/distribution company Orora, logistics specialist Qube, airline Qantas and asset manager Macquarie Group, in addition to The Lottery Corporation, Medibank Private and Woolworths. While the earnings drivers naturally varied amongst this very diverse group of companies, common features were strong operational performance, the ability to manage cost pressure from higher input costs through a combination of operational efficiency and pricing power. We added to our positions in both Woolworths and Medibank Private after their 1H results with increased confidence in their renewed operational momentum with diminishing challenges from Covid disruptions and November’s cyberattack respectively.

In the banking sector, only CBA reported first half earnings while the others released 1st quarter updates. CBA delivered a strong set of numbers but also indicated that increased competition and a gradual rise in funding costs will start to impact margins in the second half. We continue to like the banks for their positive margin leverage from higher interest rates and strong balance sheets. However, we have trimmed the sector to a more neutral sector weight while monitoring for further evidence of their earnings resilience.