Milford Australian Absolute Growth Fd 1 (ETL8155AU) Report & Performance

Moderating inflation numbers and robust economic growth in July saw the markets doubling down on the “goldilocks” narrative of low inflation and a soft landing. This saw equity markets globally and in Australia push higher. The Fund continued to gain ground and finished up 1.7% for the month.

Within the equity market, robust global economic data saw a rotation away from crowded defensive equities and back into unloved cyclical equities, as equity investors unwound bets on an imminent recession. This was something we had been waiting for after selling our fully valued defensive positions, such as supermarkets and Telstra, in recent months and adding to beaten up and unloved banks and cyclicals. The Australian banks were up 6 to 8% while Telstra and Woolworths Supermarket fell modestly. As this rotation plays out (which typically takes a couple of months) we will reduce bank holdings and add back to defensive equities. We have begun to take profits on banks and add back to defensive equities in moderate size already.

Other stocks that were strong over the month were our small positions in Universal Store (+20.1%), Neuren Pharmaceuticals (+6.4%) and Monadelphous Group (+16.2%). We had added to Universal Store in June as it fell following a poor trading update. The decision to buy was based on our positive medium outlook for the business and we appear to have been rewarded earlier than expected on this investment. Neuren rose after signing a new distribution deal with Acadia Pharmaceuticals for its in-development NNZ-2591 drug for Rett and Fragile X syndromes.

Markets are pricing in optimistic outcomes in the near term for inflation and economic growth. This is probably correct in the near term but becomes a more dangerous prediction as we look into 2024, where we may see broader economic weakness or another inflationary impulse in the US. We are pleased with the Fund’s upside participation as markets move higher, while still taking relatively low levels of absolute risk. In August we look forward to Australian company results, as this tends to always throw up a few opportunities to buy companies that we believe are priced incorrectly following results.

June saw a lot of economic developments globally, while share markets continued to be led by US equities and tech-related stocks. The Australian market rallied 1.7% and the Fund returned 0.6%.

Over the month we saw a wave of Australian-listed retailer downgrades indicating stress is developing with certain cohorts of consumers. Thus far the weakness seems contained to durable goods retailers such as clothing and furniture while spending on restaurants or travel remains robust. This may be the case for a while as durable goods spending is easily deferred post the Covid lockdown binge, while many cohorts still wish (and are able) to travel and eat out. Chinese economic growth continued to disappoint, and stimulus measures so far have been minor and targeted at consumers. The share prices of miners rebounded from recent weakness on hopes of further stimulus, but the market will need to see delivery of larger stimulus or will be disappointed.

It was a relatively quiet month on the stock picking front for the Fund, with little in the way of news flow for our companies. CSL declined 9.5% following an earnings downgrade. Smartpay was strong once again and our insurance companies and miners performed well.

We increased our equity exposure modestly, as the ASX fell sharply later in the month, picking up some unloved banks and a few Real Estate Investment Trusts (REITs) given the reasonable value on offer. We also purchased some call options which worked well as the market recovered into month end. As we approach earnings reports in August, we anticipate further earnings weakness but also opportunities over this period.

The share market recovery continued in November following on from a strong October. The rally was spurred on by more signs that inflation is peaking and central bankers in both the US and Australia are moving towards a “wait and see approach” to gauge the impact of rate hikes already done. This has seen bond yields back off recent highs as economic growth slows but remains reasonably resilient – a good scenario for equities. The Reserve Bank of New Zealand remains one of the few still pushing ahead with large interest rate hikes. The Australian Absolute Growth Fund returned 3.0% in November compared to 6.6% by the ASX 200 Accumulation index. Over the past year the Fund is up 2.8%.

Our best performer for the month was Origin Energy which rallied 41.1% on the back of a takeover offer from a consortium at $9.00 a share. At the time of writing, Origin remains at a significant discount to that price, trading at near $8.00 a share as it is subject to due diligence and various approvals. We have maintained our position in the company.

Other strong performers included Smartpay (+25.9%) and Virgin Money (+25.6%) which were both up after reporting good results. Resources companies also rallied strongly in the month with gold miners reacting to lower bond yields and iron ore miners buoyed by China walking back restrictions on property and its Covid-zero policies. As this news was priced into BHP’s share price, we significantly reduced our position in the mining company.

Our worst performer for the month was Collins Foods (-18.6%) which declined after guiding to weaker margins at its result. We had fortunately reduced our investment in the business over the past couple of months.

After tactically reducing cash levels during the month, we did take the opportunity to sell equities and raise cash again later in the month. Markets have had a good recovery but, as we look forward to 2023, we see increasing economy and earnings risk for companies and as such we continue to focus on capital preservation until these risks are more fully priced into markets.

Markets recovered in October as once again investors prepared for central banks to back off interest rate hikes. This saw the ASX 200 increase 6.0% for the month. The Australian Absolute Growth Fund returned 1.7% as we had very little in banking shares, which drove much of the ASX rally, and our overall cautious positioning. The cautious positioning has served the Fund well this year with the Fund only down 1.9% year to date in difficult markets, and we believe this remains the correct approach for the uncertain near term.

Our best performers for the month were Smartpay (+15.6%) which reported a strong quarter, Suncorp (+13.8%) which rallied on better bank margins and Santos (+8.6%) on the back of higher energy prices. Our worst performer was Ampol which fell 5.3% after reporting a disappointing earnings update on some surprise logistic cost issues. These issues are relatively short term in nature and Ampol has very attractive cash flows looking forward. Energy companies remain a key exposure in the Fund due to their high cashflow yields and the positive outlook for energy prices on a five-year view. While we may see temporary declines in the oil price, these declines are unlikely to be long lasting as OPEC+ is now cutting supply to manage oil prices. The rest of the Fund is concentrated in defensive businesses, USD earners and select small and mid-cap stock picks we have a positive view on.

Economies have been robust for 2022 but are beginning to slow and company earnings are just starting to falter. This is due to high inflation and interest rates hurting the financial position of both households and businesses. We are approaching the point where central banks will reduce the size of their interest rate hikes but continue to raise rates as the job market remains tight and inflation has not slowed enough. Markets tend to bottom before earnings hit their lows, but we are very early in the earnings downgrade cycle and intend to remain cautious until earnings declines are further progressed, and interest rates are closer to being cut. We had invested some of our cash earlier in the month but took the opportunity to sell some equities back out as the market rallied into month end.

Equity markets sold-off sharply in September on the back of inflation data that remained too hot resulting in a large sell-off in bonds. With inflation remaining stubbornly high there is limited scope for central banks to ease back from interest rate hikes and bond yields repriced higher as investors digested this reality. This ultimately drove equities to also reprice lower given interest rates are the yard stick used to determine the valuation on equities. It is our belief that we will need to see weakness in job markets before core inflation returns to reasonable levels below 3%. While job market weakness will likely eventuate at some point next year, there is limited sign of it occurring now which is keeping the pressure on central banks to continue tightening. What we may see however is more serious fractures in the financial system that could cause a temporary turnaround in monetary policy which would be positive for markets. That by definition requires more bad news before the good news on policy pivot.

Our cautious positioning meant that as expected the Fund’s decline in September was much less than the market at 3.3% compared to the ASX 200 decline of 6.2%. We did add back some equities into this weakness but only in moderate size as we retain a cautious medium-term view.

Our winner for the month was once again Neuren Pharmaceutical which was up 13.3% in a tough month. Losers were some of our energy names including Santos which was down 10.1%.

As this equity weakness continues, we will begin to establish longer term buy and hold opportunities at attractive prices. Growth and technology stocks have now come off a long way and some of them are approaching reasonable levels (if not yet highly discounted levels). As economic weakness sets in more broadly in 2023 the time will come to buy homebuilders, retailers and other early-stage cyclicals. Until then, we anticipate more volatility both up and down which we intend to navigate with caution and selective buying on weakness.

The Australian Absolute Growth Fund produced a small 0.3% gain in August and is up 0.9% for the calendar year. Equity markets were strong earlier in the month before pulling back sharply late in the month following Fed Reserve Chairman Jerome Powell’s speech at the Jackson Hole central bankers’ symposium. His comments were clear and concise with the message that the Fed must keep monetary policy tight until they are sure inflation is under control and will sacrifice economic growth and jobs if necessary. This removed the markets view that rate cuts would begin early next year and increased the fear that central banks may continue raising rates into slowing economic growth and falling company profits. Similar messages have been made by the Bank of England and the European Central Bank. Inflation data is now an even more important driver of future monetary policy and markets as central banks have made it clear weak economic data won’t change their policy course while inflation remains too high.

Most of our holdings reported their full year results over the month with most reporting reasonable earnings and some having strong gains such as IPH (+11.7%) and Webjet (+7.2%). Energy companies also performed strongly as they reported strong cash flows and energy prices rallied again. TPG declined 15.6% after a poor result but it was fortunately a small position in the Fund. We sold nearly our entire positions in supermarkets Woolworths and Coles as they become overvalued which was fortunate as the companies pulled back sharply after reporting a more uncertain outlook than the market expected. As their share prices declined, we began to buy back into these companies again with a focus on Woolworths rather than Coles due to its better cost outlook.