March 2016
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
4.76
4.73
0.03
-2.77
-2.75
-0.02
-14.74
-9.59
-5.15
3 yrs p.a. 5 yrs p.a.
2.13
5.40
-3.27
4.56
5.70
-1.14
10 yrs p.a.
4.82
4.43
0.39
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 9 months.
1
2
Market cap
ASX 1 - 50
ASX 51 - 100
ASX 101 - 300
Non Index
Cash
Portfolio
82.6%
8.9%
4.6%
1.6%
2.2%
Benchmark
80.7%
12.0%
7.4%
Top ten holdings %
National Australia Bank Limited
BHP Billiton Limited
Commonwealth Bank of Australia
Westpac Banking Corporation
Woolworths Ltd
ANZ Banking Group Ltd.
Telstra Corporation Limited
Wesfarmers Limited
Rio Tinto Limited
Brambles Limited
Total
Portfolio1
7.9%
6.5%
5.9%
5.8%
4.7%
4.7%
4.7%
4.6%
4.5%
3.8%
53.1%
Benchmark2
5.2%
4.1%
9.6%
7.6%
2.1%
5.1%
4.9%
3.5%
1.4%
1.4%
44.9%
Characteristics
No. of stocks
Portfolio turnover* (1 yr)
Sharpe Ratio (1 yr)
Volatility (5yr standard deviation)
Tracking error (3yr historic)
Portfolio1
52
14.2%
-1.05
12.4%
2.9%
Benchmark2
200
-0.80
12.6%
Commentary
The S&P / ASX 200 Accumulation Index fell by 2.75%, while the Schroder Wholesale
Australian Equity Fund (post-fee) fell by 2.77%, underperforming by 0.02% for the quarter.
At last, some diversity. The March quarter for the ASX saw a myriad of stocks and sectors
lead and lag in performance. A motley lot – South32, Medibank Private, Newcrest, Vicinity,
Santos and Transurban – were the best performers, whereas Macquarie, Incitec, the major
banks, Computershare, Woolworths and Caltex were among the worst. Even though bonds
still rallied through the quarter, it was a marginal move and the path was wild, and equity
markets followed accordingly. It continues to be intellectually vacuous to believe that Bonds
are expensive whilst maintaining that the best performing stocks on the ASX through the past
few years, which are almost wholly Bond sensitives, continue to have the best prospects.
Of these broad themes, one stood out. Banks wobbled, mostly after ANZ disclosed bad debts
had risen by $100m because of a few, large exposures, and after Westpac confirmed net
interest margins are flat this half even after two repricings. Australian Banks have enjoyed a
generational “stronger for longer” run that dwarfs anything the resources market enjoyed
before the consequent fall. To wit, BHP this year will make the same ebit it made a decade
ago; CBA made $5b pre tax a decade ago and will make $13b this year. The driver for this
increased profitability is simple; flat margins, and other revenues and costs growing in line
with revenues, have meant that volume growth has been the game, set and match for bank
earnings through this time. A little more than a decade ago, monthly housing finance
approvals were $10b, and today they are in excess of $30b. No products innovated nor
exported, no global competitive advantage, no efficiency in production, but some lessons
were learnt from abroad as ASIC is now making public. It can be rightly argued that the banks
have been rational in maintaining pricing through this strong volume environment, but BHP
moved to a market linked price for iron ore as demand increased as well.
If management for the Banks is as subject to human frailty as us all, and volume growth drove
the great generation of performance, what has caused market nervousness through the
quarter as to the prospects for the sector? Forecasts were too optimistic, on every line, but
especially credit. Of course bad debts had to rise from all time lows relative to the like asset
base. The issue now becomes what is a sustainable credit loss rate? We continue to assume
a level above this year’s experience. We also model a “recessionary hit”, material bad debt
charge, which we deduct from book value in our valuation. Valued on this basis, major banks
on a lower price to net tangible asset basis now look good value relative to the market; the
higher multiples attaching to CBA and Westpac continue to be world leading for banks, and
subject to ongoing pressure as regulatory forces continue to crimp the extraordinarily high
return on equity that have accrued to Australian mortgage portfolios in recent years.
Apart from pressures on the banks, the dispersion in drivers in return across the Australian
equity market through the quarter followed the scrip written by Larry Summers in “The Age of
Secular Stagnation”. On quantitative easing, he wrote “… More important, these policies are
running into diminishing returns and giving rise to increasingly toxic side effects. Sustained
low rates tend to promote excess leverage, risk taking and asset bubbles …” All four factors
have impacted upon Australian market performance.
Sustained low rates have promoted “yield” stocks and bond sensitives, notably infrastructure
and property, to the point where the dispersion between them and materials stocks is as wide
as it ever has been. If the forces for low rates abate, we would expect at least some of this
outperformance to unwind. And thus it went through the quarter.
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 March 2016
Please note numbers may not total 100 due to rounding
*Turnover = ½(Purchases + Sales - ∑Cashinflows + ∑Cashoutflows) / ½(Market
Value(T0)+ Market Value(T1) - ∑Cashflows)
Further, excess leverage is the financial drug of choice for corporate manic depressives.
Nothing propels the highs, higher, nor the lows, lower. Consider the oil sensitives - Qantas as
a winner and Origin Energy as a loser. Woodside has of course underperformed because it
shares a reliance upon the oil price for its economics, but its underperformance has been half
of Origin’s. Part of this is due to lesser operational leverage, but much more is due to lesser
financial leverage. In 2013, Origin produced $1.1b in operating ebit and had $6.8b in net debt.
In 2019 we forecast those same metrics at remarkably similar proportions - $2.2b and $11.5b.
And yet, Origin’s share price has more than halved from the $10 per share seen in 2013, due
to the need in the interim to raise $2.5b and issue a large number of shares in an endeavour
to address leverage woes arising from malinvestment. Qantas management have done a
stellar job since 2008.
Schroder Wholesale Australian Equity Fund
Quarterly contributors %
Alumina Limited
South32 Ltd.
Commonwealth Bank of Australia
Brambles Limited
Iluka Resources Limited
Quarterly detractors %
Newcrest Mining Limited
National Australia Bank Limited
Scentre Group
Woolworths Ltd
Amcor Ltd
Position *
Attribution
Overweight
Overweight
Underweight
Overweight
Overweight
Position *
0.41
0.32
0.31
0.21
0.21
Attribution
Underweight
Overweight
Underweight
Overweight
Underweight
-0.25
-0.25
-0.20
-0.15
-0.14
Quarterly Report
March 2016
Commentary continued
The equity performance, though, has been magnified by not just the oil price fall but also the
operational leverage embedded in all airlines and entities with large on and off balance
sheet lease liabilities (just ask any Woolworths shareholder).
In the Australian equity market context, we do not believe undue risk taking is rife among
Australian corporate management now. Leverage, though, is meaning that the penalty for
undue risk previously assumed, as in the Origin case, is now being called. The bigger area
of undue risk for investors continues to be in the multiples paid for income streams
perceived to be defensive; the gap in multiples between the highest and lowest rated
industrial stocks continues to be at record levels. If asset bubbles exist in Australia, this is
where they sit. Again, the quarter past was interesting in that for the first time in several
years, on days when the market was pressured, low cost resource companies with lower
levels of debt often performed better than infrastructure stocks. History would suggest that
resource names outperforming in down markets in Australia is common, which is counter
intuitive, but an essence of what is needed for our portfolio to continue to outperform.
* Portfolio weights versus benchmark are average weights over the quarter
Contributors
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
Alumina (o/w, +14.7%) Alumina performed strongly during the quarter following some
moderate strength in the alumina price, but also reflecting a low starting multiple which had
been crushed following several years of material underperformance by the company.
Alumina continues to bear negligible financial risk and is trading on a mid-cycle ebit multiple
of five times.
South32 (o/w, +37.6%) South32 has a high level of exposure to Alumina and hence
benefited from the same factors as those that drove Alumina’s performance. It also
released a result which highlighted the majority of the US$300m cost reduction target had
already been achieved, which is a material sum for a company we expect to make $900m
on a sustainable basis.
Commonwealth Bank (u/w, -10.0%) CBA underperformed, along with all banks, as the
market started to better appreciate the headwinds on volumes, margins, costs, bad debts
and capital confronting the sector. Many of these factors have been tailwinds for much of
the past two decades, and at 2.5 times net tangible assets downside exists to the CBA
multiple as these earnings pressures play out.
Detractors
Newcrest (u/w, +30.8%) All that glitters was Gold during the quarter, and as the largest and
most liquid gold stock Newcrest was a prime beneficiary. Management are optimising
production to a greater extent than had been the case in recent years but as has always
been the case, the prime factor that drive Newcrest’s performance remains exogenous,
being the gold price,
NAB (o/w, -9.9%) As with CBA, NAB felt the wrath of sectoral pressures through the
quarter. Our overweight position in turn hurt performance. NAB continues to trade at a
material discount on a net tangible asset multiple basis to its two more domestically focused
peers, and yet its return profile is now converging given the portfolio changes of the past
year.
Scentre (u/w, +8.5%) As with many bond sensitives, Scentre performed strongly through
the quarter. On our mid cycle earnings Scentre currently offers a 3% ebit yield on enterprise
value. In turn, we continue to believe the equity is materially (almost 30%) overvalued.
Schroder Wholesale Australian Equity Fund
Fund objective
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.
Outlook
Quarterly Report
March 2016
In previous commentaries we have highlighted the six principles driving our fundamental
views. They remain prima facie headwinds for earnings, and whilst multiples continue to
adjust they are not yet cheap, but better described as fair. These principles also ignore two,
critical, issues; the price paid for the equity purchased, and the management intent to
generate good returns on investment, even in the face of challenging conditions. We
continue to seek to increase our exposure to positions where we feel operational leverage –
evident across the breadth of the market, as discussed above by reference to the bank and
energy sectors, but equally applicable more broadly – is accommodated within current
valuations.
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.
Andrew Fleming
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
$1,838,142,450
$0.9938
July 2002
0.25%/0.25%
$25,000
Normally twice yearly - June and Dec
0.92%
Sector exposure versus the benchmark %
-8.0
-6.0
-4.0
-2.0
0.0
2.0
Energy
4.0
6.0
2.7
Materials
Construction Materials
0.2
Containers & Packaging
-1.5
Metals & Mining
9.0
Paper & Forest Products
0.0
Industrials
1.4
Consumer Discretionary
-1.4
Consumer Staples
3.3
-4.3
Information Technology
0.2
Telecommunication Services
-0.3
Utilities
-0.8
-1.4
Capital Markets
Financials
Consumer banks
-3.4
Diversified Fin Services
1.1
Insurance
-3.3
Real Estate Mgmt & Dev
Property Trusts
10.0
1.3
Chemicals
Health Care
8.0
0.7
-5.4
Unless otherwise stated all figures are as at the end of March 2016
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.