December 2015
Quarterly Report
Schroder Wholesale Australian
Equity Fund
Total return %
8
Schroder Wholesale Australian Equity Fund (post-fee)
S&P / ASX 200 Accumulation Index
Relative performance (post-fee)
1 mth
3 mths
1 yr
2.80
2.73
0.07
3.66
6.48
-2.82
-4.25
2.56
-6.81
3 yrs p.a. 5 yrs p.a.
5.88
9.19
-3.31
5.80
6.97
-1.17
10 yrs p.a.
6.09
5.63
0.46
Please refer to www.schroders.com.au for post-tax returns
Past performance is not a reliable indicator of future performance
Inception Date: 01 Jul 2002, 13 years and 6 months.
Market cap
ASX 1 - 50
ASX 51 - 100
ASX 101 - 300
Non Index
Cash
Portfolio1
85.3%
7.1%
4.2%
1.0%
2.4%
Benchmark2
81.7%
11.5%
6.8%
Top ten holdings %
National Australia Bank Limited
Commonwealth Bank of Australia
BHP Billiton Limited
Westpac Banking Corporation
Woolworths Ltd
ANZ Banking Group Ltd.
Telstra Corporation Limited
Wesfarmers Limited
Rio Tinto Limited
Brambles Ltd
Total
Portfolio1
8.7%
6.4%
6.4%
6.1%
5.0%
4.8%
4.7%
4.4%
4.4%
3.8%
54.7%
Benchmark2
5.8%
10.6%
4.1%
8.1%
2.3%
5.9%
5.0%
3.4%
1.4%
1.3%
47.9%
Characteristics
No. of stocks
Portfolio turnover* (1 yr)
Sharpe Ratio (1 yr)
Volatility (5yr standard deviation)
Tracking error (3yr historic)
Portfolio
49
13.1%
-0.35
11.9%
2.7%
1
Benchmark
200
2
0.03
12.2%
Commentary
The S&P / ASX 200 Accumulation Index rose by 6.5%, while the Schroder Wholesale
Australian Equity Fund (post-fee) rose by 3.7%, underperforming by 2.8% for the quarter.
Much as we might prefer otherwise, the market price of every listed equity investment is an
amorphous blend of human behaviour, macroeconomic and corporate fundamentals. Share
prices do not conform to a precise mathematical theorem. Investment returns over any period
will comprise an element which reflects investors’ assessment of the short and longer term
earnings power of a business and an element which reflects the equity market popularity
contest. The separation of luck and skill in the process of investing will remain arbitrary, and
anyone suggesting luck does not play a significant part is either disingenuous or delusional. If
all securities moved by the change in book value per share plus dividends every year,
dispersion of returns would bear no resemblance to the scorecard which also incorporates
human behaviour. The gaps are often large. Blackmores grew book value plus dividends by
around $55m between June 2014 and June 2015, a strong result and a very solid return on
capital. Based on equity market capitalisation of a little under $500m at June 2014, this
represented a solid return of around 12%. Market capitalisation rose by $830m during the
same time frame. Between June and December this year it rose a further $2.4bn, with book
value growth and dividends probably accounting for another $50m. Chinese proclivity for
western vitamins aside (they liked iron ore for a while too), when market capitalisation shifts
by more than 50 times the change in book value, it is fair to say that human behaviour is
having a reasonable impact on the returns of investors. Even if book value growth doubles to
$110m annually, the return on the current equity market value ($3.75bn) is now below 3%.
Emotion (or share price momentum) can be extremely powerful in both directions. This will not
dissuade commentators, including us, from providing narratives which support their
prescience in cases of success and portray the path and quantum of returns as eminently
foreseeable. They are not. The assassination of Archduke Franz Ferdinand in Sarajevo has
become widely accepted as the trigger for the chain of events which incited World War I and
would feature in almost every retrospective. If one were to have conducted a survey on the
day of the assassination as to whether and why the event would trigger a World War, I
suspect things would not have been as obvious as historians now convey. Harry Hindsight
has always been a successful investor!
As always, we have sought to position the portfolio to take advantage of what we believe is
fundamental mispricing based on our expectation of the longer term earnings power of
businesses. This has been roundly unsuccessful of recent times. Rightly or wrongly, we
believe that returns in the longer run should remain driven by changes in economic value
through time, whilst behavioural elements will oscillate. Returns in the past year have been
disproportionately driven by behavioural factors, with momentum as powerful as almost any
time in history. Nearly all resource and energy stocks have seen large percentages of their
market capitalisation erode over recent years. Whilst there has been some economic value
erosion from poor investment, the vast bulk is behavioural. Reasons for this momentum will
always be debatable; however, it is almost certain that several factors are contributing
disproportionately. These factors are inter-related and represent a far from exhaustive list.
1 The 'Portfolio' is the Schroder Wholesale Australian Equity Fund
2 Benchmark is the S&P / ASX 200 Accumulation Index
Unless otherwise stated all figures are as at the end of December 2015
Please note numbers may not total 100 due to rounding
*Turnover = ½(Purchases + Sales - ∑Cashinflows + ∑Cashoutflows) / ½(Market
Value(T0)+ Market Value(T1) - ∑Cashflows)
Economic growth – acceptance of the inevitability of low levels of economic growth moving
forward has become almost universal. If central bankers, the IMF and politicians reinforce it
with sufficient regularity, it becomes the accepted wisdom. The reasons for low growth get
less attention. The ability of individuals and businesses to harness resources to improve
productivity and improve quality of life is unlikely to have changed significantly. The
slowdown in reported growth is almost solely the result of an extended period of borrowing
from the future through aggressive credit growth. Pulling forward consumption, encouraging
population growth and deferring repayment has been the global recipe. They are the problem
and they have a cost.
Interest rates – Albert Edwards, Global Strategist at Societe Generale dubbed Alan
Greenspan and his central banker successors Ben Bernanke and Janet Yellen “economic war
criminals”. Whilst obvious hyperbole, his point is correct.
Schroder Wholesale Australian Equity Fund
Quarterly contributors %
Position *
Brambles Ltd
Chorus Limited
Westfield Corporation
Aurizon Holdings Ltd.
Spotless Group Holdings Ltd
Overweight
Overweight
Underweight
Underweight
Underweight
Quarterly detractors %
BHP Billiton Limited
Rio Tinto Limited
Commonwealth Bank of Australia
South32 Ltd.
Woolworths Ltd
Position *
Attribution
0.26
0.18
0.15
0.15
0.10
Attribution
Overweight
Overweight
Underweight
Overweight
Overweight
-0.54
-0.43
-0.41
-0.21
-0.21
* Portfolio weights versus benchmark are average weights over the quarter
Distribution details for the financial year ended 30 June
Total CPU (i)
Capital gains (ii)
Discount capital
gains
Non discount
capital gains
Franking % (iii)
Growth
component (iv)
Distribution
component (v)
Return
(post-fee)
Benchmark (vi)
2013
2014
2015
3.44
3.57
4.24
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
90.37
95.25
102.00
21.29%
12.47%
-1.04%
4.34%
3.58%
3.82%
25.63%
16.05%
2.78%
22.75%
17.43%
5.68%
i) CPU: Cents Per Unit.
ii) Annual cash distribution represented by capital gains.
iii) Franking for financial year ending 30 June. Franking Levels Per
FSC calculation being franking credits as % of cash distribution
multiplied by (1-tax rate) divided by the tax rate.
iv) Growth return is the price to price return excluding distributions.
v) Distribution return includes both income and realised capital
gains where applicable.
(vi) Benchmark is the S&P / ASX 200 Accumulation Index
Quarterly Report
December 2015
Commentary continued
What began as the ‘Greenspan put’, an expectation by financial market participants that any
corrections in asset prices which threatened the inexorable rise in credit would always be
met with further accommodation, has proven correct. It has permeated behaviour globally
to a desperately unhealthy degree and has significantly altered the apportionment of
economic value throughout the economy. The one thing financial markets are good at is
arbitrage. If you bail them out every time they cry wolf, they’ll call your bluff. Buybacks,
merger and acquisition activity and real estate bubbles are behavioural outcomes of an
ingrained expectation of bail outs. On no planet is it rational to suggest that those with the
discipline to save should have these savings forcibly removed through negative interest
rates such that the more profligate should be permitted to bring forward yet more
consumption. Things are surreal.
Relative size of financial assets versus the real economy – the obvious corollary of low
interest rates is that assets and liabilities have become far larger relative to revenues and
incomes. This creates the mathematical certainty of hypersensitivity. The race to zero
interest rates and the exorbitant asset revaluations thereby induced has seen wealth
transfers of stratospheric proportions. The theoretically infinite valuations which become
justifiable at negligible discount rates can dwarf history. We could halve mortgage rates
again and justify another doubling in Sydney house prices. An average home might sell for
$2m. The gain triggered would be more in absolute terms than over the rest of history. You
wouldn’t even need any more income as long as credit is made freely available. These are
the maths currently permeating equity markets, making those invested in the market
darlings look like geniuses and the contrarians (us) look like dunces.
The rise of the machines – the days of equity markets functioning primarily to facilitate
exchange of ownership between investors are long gone. It is now a database of
microsecond price histories, earnings revisions and correlation matrices. There is little
doubt that behaviour of fundamental investors with more malleable belief sets can become
reflexive in response. The correlation of price moves with changes in earnings per share is
heightening and in 2015 was alarming. Upgrades are good; downgrades are bad.
Importantly, in combination with the above issue on financial market size, share prices are
set at the margin. Volatility is heightened, market efficiency and reliability of valuations, not
so much!
Given the above dynamics, the winners and losers over the final quarter looked like a copy
of the past year, 2 years and 3 years. Blackmores (+49.4%), Domino’s Pizza (+43.5%),
Magellan Financial (43.4%) and Fisher & Paykel Healthcare (+29.6%) were near the top,
Sims Metal (-23.7%), South32 (-22.0%), Worley Parsons (-21.7%) and BHP Billiton (19.6%) were near the bottom. Moves are becoming more extreme. South32’s balance
sheet shows $US11bn of equity value supporting its $A5.7bn market capitalisation.
Blackmores shows $A133m supporting its $A3.75bn. We have no issue with the ability to
create highly valuable businesses without the need for tangible capital, however, the
frequency and extent to which this polarisation is becoming commonplace is alarming.
Strange days indeed.
Contributors
Chorus (o/w, +56.4%) Seemingly interminable interactions with the NZ Commerce
Commission to determine the fair price for retail service providers to access the Chorus
network saw prices finalised at a level above the interim determination and at a level far
more likely to provide an adequate return for Chorus shareholders. Significant financial
leverage has heightened the reaction of the stock to these regulatory fluctuations.
Crown Resorts (o/w, +26.3%) A major shareholder seemingly determined to pursue
significant incremental investment despite signs of excessive capacity addition in most
markets outside Australia, has created a significant conundrum. A valuation which has
increasingly reflected expected value destruction offers shareholders significant scope for
gains should this destruction not eventuate, however, indications of either the Board or
management listening or acquiescing to views other than those of the major shareholder
are indiscernible.
Brambles (o/w, +18.8%) Although value creation at Brambles remains solid and business
quality strong, share price gains are undoubtedly reflective of an ongoing exodus from
materials and energy stocks rather than evidence of any change in the longer term potential
of the business. Additionally, as a beneficiary of lower fuel prices, the current environment
should assist short term earnings.
Navitas (o/w, +17.6%) As a lower currency restores Australia’s competitive position in
offering education services in a global environment, Navitas remains well positioned to
assist universities in maximising the opportunity. Evidence remains overwhelmingly
supportive of partnerships between universities and Navitas delivering far superior
outcomes to universities in their own right.
Detractors
BHP Billiton (o/w, -19.6%) The Samarco disaster combined with further commodity price
declines to provide fuel for investors to imagine ever more bearish scenarios for BHP
Billiton. Reductions in equity value over the quarter were multiples of the entire book value
of the Samarco JV. Despite remaining profitable at commodity prices where most producers
are struggling for oxygen, momentum in commodity markets continues to overwhelm
valuation. If the company were to halve the dividend it would still leave the company
offering a fully franked yield of close to 5%.
Schroder Wholesale Australian Equity Fund
Fund objective
Quarterly Report
December 2015
Commentary Continued
To outperform the S&P/ASX 200 Accumulation Index after fees over the
medium to long term by investing in a broad range of companies from
Australia and New Zealand.
Primary Healthcare (o/w, -38.3%) Significant financial leverage has amplified the pain for
shareholders as the freezing of Medicare indexation for GP’s and further efforts to stem
government outlays in pathology and radiology pressure earnings. Although portfolio
exposure is small, we feel this pricing paradigm may become a greater issue for the
healthcare sector in the future as constrained government budgets call into question the
sustainability of assured price and volume growth for businesses delivering little in the way
of productivity gain.
Investment style
Schroders is a bottom-up, fundamental, active growth manager of
Australian equities, with an emphasis on stocks that are able to grow
shareholder value in the long term.
Fund details
APIR code
Fund size (AUD)
Redemption unit price
Fund inception date
Buy / sell spread
Minimum investment
Distribution frequency
Management costs (p.a.)
SCH0101AU
$1,964,215,660
$1.0221
July 2002
0.25%/0.25%
$25,000
Normally twice yearly - June and Dec
0.92%
Sector exposure versus the benchmark %
-6.0
-4.0
-2.0
0.0
2.0
Energy
4.0
6.0
8.0
0.0
Materials
Chemicals
2.7
Construction Materials
Commonwealth Bank (u/w, +17.6%) Two and half decades of uninterrupted credit explosion
have provided the fuel for banks to become the engine of both the economy and the equity
market. As valuation levels return to around 3 times net tangible assets, the expectation of
banks continuing to provide a steady stream of ever growing dividends without hiccup is
clear. If ever there was clear evidence of the behavioural outcomes induced by an
expectation of central bank protection, this is it.
Outlook
None of the above is intended to distract attention from the poor results we have delivered
over the past year. It is intended as a reminder that risks remain elevated (an
understatement) and conditions are far from normal. Current corporate bond market
activity should heighten concerns. US corporate debt has risen significantly over the past
couple of years whereas ungeared earnings have barely moved. Widening spreads
indicate a degree of discomfort from debt investors not currently shared by equity
counterparts. The view that plummeting oil and commodity prices should be seen as boost
for economic activity seems a touch ironic in light of the rationale for low interest rates being
part of an ongoing battle against deflation. Obviously the falling prices central bankers are
worried about don’t include these. The complacency evident in financials (particularly in
Australia) rests significantly on the extremely benign bad debt experience of recent months
and quarters. This was also the case months before the global financial crisis and may not
be the data point on which to anchor a benign forecast.
0.3
Containers & Packaging
-1.4
Metals & Mining
8.5
Paper & Forest Products
0.0
Industrials
1.2
Consumer Discretionary
-1.5
Consumer Staples
3.4
Health Care -4.4
Information Technology
0.5
Telecommunication Services
-0.3
Our focus on economic value necessitates an acknowledgement that this process is most
commonly slow and steady, particularly when accompanied by sensible levels of financial
leverage. As behaviour continues to wildly overshadow fundamentals, the lure of outsized
gains causes investors to forget totally about a margin of safety. If the share price of BHP
Billiton or Rio Tinto continues to decline when the business is not making losses and asset
values are already reflecting an exceptionally tough operating environment, the margin of
safety is improving. When share price gains are wildly outpacing the rate of value creation,
margin of safety is declining sharply. These rules are simple, but behaviour is powerful.
FoMO (Fear of Missing Out) can, and has, overshadowed economic value for some time as
momentum has ruled. It will not always be this way.
0.1
Utilities
Capital Markets
-1.0
Financials
Martin Conlon
Consumer banks-5.0
Diversified Fin Services
Insurance
10.0
1.6
Building Products
Rio Tinto (o/w, -8.0%) As for BHP, downward earnings revisions from commodity price
declines continue to overwhelm all other valuation metrics as momentum investment
continues to rule. Strong cost reduction efforts allowing the company to maintain its
advantageous position on the cost curve count for little.
1.0
-3.3
Real Estate Mgmt & Dev
0.1
Property Trusts -4.9
Unless otherwise stated all figures are as at the end of December 2015
Benchmark is the S&P / ASX 200 Accumulation Index
Contact
www.schroders.com.au
E-mail: simal@schroders.com
Schroder Investment Management Australia Limited
ABN 22 000 443 274 Australian Financial Services Licence 226473
Level 20 Angel Place, 123 Pitt Street, Sydney NSW 2000
Phone: 1300 136 471 Fax: (02) 9231 1119
Investment in the Schroder Wholesale Australian Equity Fund ('the Fund') may be made on an application form accompanying the current Product Disclosure Statement available from
the Manager, Schroder Investment Management Australia Limited (ABN 22 000 443 274 AFSL 226473) (“Schroders”).
This Report is intended solely for the information of the person to whom it is provided by Schroders. It should not be relied on by any person for the purposes of making investment
decisions. Total returns are calculated using exit price to exit price, after fees and expenses, and assuming reinvestment of income. Gross returns are calculated using exit price to exit
price and are gross of fees and expenses. The repayment of capital and performance of the Fund is not guaranteed by Schroders or any company in the Schroders Group. Past
performance is not a reliable indicator of future performance. Unless otherwise stated the source for all graphs and tables contained in this report is Schroders. Opinions constitute our
judgment at the time of issue and are subject to change. This report does not contain and is not to be taken as containing any financial product advice or financial product
recommendation. For security reasons telephone calls may be recorded.