There have been marked fluctuations and significant comparative divergence in regional equities markets in the 12 months to 30 September 2018. Australian and US equities experienced an unusually long bull run, while the UK faced into an uncertain future as it contemplates its impending exit from the European Union. Europe also experienced its own geopolitical turmoil, which read through to sentiment in specific markets. It was a difficult period for Asian and Japanese markets, however, such turmoil may yield interesting future opportunities for investors. We're well-positioned and well-resourced to manage these transitionary periods in all markets and have outlined our respective regional investment strategies below.
April 2018 was the 15th anniversary since the establishment of our current Australian equity team and process under its head, Crispin Murray, which makes it one of the most enduring and stable investment teams by any comparison. During that period there has been, and continues to be, significant change in both the investment and commercial landscape for Australian equity managers. Our team’s approach has truly stood the test of time, demonstrating time and again that research-led, fundamental, active management can lead to persistent outperformance. The team’s stability, resources, skill and experience of working together through many cycles has created an investment culture that rewards tenacity and curiosity and is focused steadfastly on anticipating change in companies’ earnings ahead of the market through knowing those companies better than other market participants.
The flows for the boutique this year have been very encouraging. In the Wholesale Adviser channel, the Pendal Australian Focus Fund and the Pendal MidCap Fund have continued to enjoy strong inflows. In the institutional market, we have seen the strongest momentum for several years, winning several new mandates among our broad cap capabilities, which has gone a long way to replace the FUM that left us as part of BTFG’s MySuper fund restructure that was also completed during the year.
Separately managed accounts (SMAs) continue to gain traction in the market as some investors are drawn to the greater degree of visibility on stock ownership and the individual tax treatment these structures provide. The Australian equity models that we provide for SMAs remain popular and have been added to several platforms over the year. Our flagship Australian Shares Portfolio model achieved its three-year anniversary in June 2018 and since its inception it has delivered +2.85 per cent annualised outperformance before fees, as at 30 September 2018. We also run several income-focused variants of model and SMA models, which continue to provide a source of growth for the boutique.
With regard to performance, we have followed up last year’s strong performance with another solid year. Most of the broad cap funds finished the 12 months ahead of their benchmark before fees. The flagship Pendal Focus Australian Share Fund gained 17.38 per cent, 3.35 per cent ahead of its index before fees. Other key broad cap strategies, such as the Pendal Australian Share Fund, Pendal Imputation Fund and Pendal Ethical Share Fund, all finished ahead of their benchmarks before fees.
The Pendal Smaller Companies and Pendal MidCap Funds also outperformed their indices. The strong gains in technology and healthcare provided a challenge in these parts of the market and provided something of a headwind to performance, given our strong valuation discipline precluded ownership of many of these growth stocks. Nevertheless, selective investment in more attractively valued growth stocks and good stock selection in other parts of the market overcame this challenge.
The disruptive effect of new technology, competition, and political intervention across the Australian economy continues to provide challenges for investors. However, there are winners and losers in this environment; a fact reflected in the large degree of dispersion in performance across and within sectors. Given the breadth and depth of our research coverage and demonstrable insight at a company level, we believe this is a good market for active investors – and one which plays to our strengths. Coupled with the team’s stability, experience, our proven and repeatable process, and momentum in fund flows, we believe the boutique is in strong health and remains well set to continue delivering on our strong and long track record of performance for investors.
|FUND NAME||FUND FACT SHEET|
|Pendal Australian Share Fund||View the latest fact sheet|
|Pendal Focus Australian Share Fund||View the latest fact sheet|
|Pendal MidCap Fund||View the latest fact sheet|
|Pendal MicroCap Opportunities Fund||View the latest fact sheet|
|Pendal Imputation Fund||View the latest fact sheet|
|Pendal Australian Long/Short Fund||View the latest fact sheet|
|Pendal Ethical Share Fund||View the latest fact sheet|
|Pendal Smaller Companies Fund||View the latest fact sheet|
|Pendal Property Securities Fund||View the latest fact sheet|
Our four UK Equities strategies are each managed by a different team, each applying their own distinctive approach to investing. The four strategies experienced mixed fortunes over the period.
Positive momentum continued with our £2.0 billion UK Dynamic strategy, which has enjoyed major asset growth in recent years – net flows into the strategy in FY2018 were £579 million – and a growing profile among professional fund buyers. The strategy seeks opportunities in mispriced or undervalued companies making positive changes to transform their businesses, usually either in the form of new management teams, new business strategies, or both. The strategy celebrated its 10th anniversary during the year and experienced another year of outperformance, which has bolstered its already excellent long-term performance record. Unusually for this stock-picking strategy, outperformance was attributable to positive sector exposure effects rather than stock selection. Individual stocks that did add material value over the year included electrical component distributor Electrocomponents, an example of a company whose fortunes have been turned around by a new management team imposing a new strategy.
Our £3.7 billion UK Equity Income Fund remains soft-closed although received net inflows of £328 million from existing investors in FY2018. It performed broadly in line with its benchmark over the year as positive sector effects were cancelled out by modestly negative stock selection. The team continues to find value in companies with UK domestic economic exposure, particularly as Brexit worries have fuelled investor antipathy towards companies focused solely on the UK economy. The team’s strict yield discipline helped ensure another year of growth in the fund dividend, while the market dividend environment was boosted by sterling’s weakness versus the US dollar. The fund’s status as one of the leaders in its sector received industry recognition during the year, with the fund winning the UK Equity Income category at the Investment Week Fund Manager of the Year Awards, the most prestigious awards in the UK investment management industry.
Our UK Opportunities strategy experienced a challenging 12 months after the retirement of the former lead manager in September 2017 after a number of years at the strategy’s helm. Despite a well-managed communication programme with clients and clear succession plan, his retirement led to the loss of a large segregated mandate and substantial fund outflows, culminating in net outflows for the overall strategy of £1.6 billion. Net flows have now stabilised and the strategy’s co-managers are focused on building upon the fund’s strong long-term performance.
The UK Opportunities portfolio remains defensively positioned, based upon the team’s longstanding concerns over the artificial inflation of asset prices by central bank policies. A focus on absolute rather than relative valuations has led the team to hold a large cash balance, reflecting their philosophy of putting capital preservation first. This high cash balance and an overweight exposure to the utilities sector contributed to the portfolio’s underperformance over the period.
Our UK Growth strategy aims to identify mispriced or undiscovered growth stocks, focusing on stocks which have a high margin of safety but significant upside potential. The strategy experienced positive net flows over the year while relative performance was modestly positive.
A clear portfolio theme in recent years has been backing innovative companies investing in disruptive technologies and market-leading technological solutions. A good example is NCC Group, currently one of the largest active positions within the portfolio. It is one of the largest independent cyber security consultants in the world. Cyber security has gone from being an IT decision to a boardroom decision and is exhibiting enormous underlying growth. NCC has world-class capabilities in ethical hacking, threat detection and analytics, not to mention an enviable position in automotive cyber security, where it works with many global car manufacturers.
|FUND NAME||FUND FACT SHEET|
|JOHCM UK Equity Income Fund||View the latest fact sheet|
|JOHCM UK Dynamic Fund||View the latest fact sheet|
|JOHCM UK Opportunities Fund||View the latest fact sheet|
|JOHCM UK Growth Fund||View the latest fact sheet|
Politics remained on many investors’ radars. In Italy, a presidential veto over the proposed appointment of Eurosceptic Paolo Savona as Economy Minister initially halted the formation of the populist Five Star/League coalition government. This convulsed financial markets as concern spread over the putative government’s European credentials. Whilst the new government was ultimately formed, markets took fright as to what may lie ahead as regards future standoffs with the European Commission over budgets and the implications for Italy’s credit rating. In Germany, the SPD finally voted in favour of forming a new coalition government with Angela Merkel’s Christian Democrats. In Spain, Prime Minister Rajoy was ousted at the start of June after the findings of a slush fund investigation.
Our Continental European Fund and our large cap European Concentrated Value Fund both marginally outperformed their respective benchmarks over the period. Our Continental European Fund, which takes a more top-down, sector-based approach combined with bottom-up stock-picking, was boosted by our energy overweight as oil companies benefited from a rising oil price and stock selection in the utilities and materials sectors. The main negative came from owning Bayer within the healthcare sector and being overweight the financials sector.
European Concentrated Value is a large cap stock-picking fund, which combines traditional ‘value’ and ‘quality’ characteristics and targets companies generating high rates of return on capital employed. It benefited from favourable sector exposure effects over the period, most notably our continued avoidance of the financials sector, as well as being overweight information technology. However, this tailwind was negated by weakness in our materials and healthcare holdings, although the industrials sector was a bright spot from stock selection perspective.
European Select Values, our all cap sister strategy to European Concentrated Value, lagged its benchmark materially, although it retains a market-leading long-term track record. Relative performance in the latter was weighed down by its consumer names, with Technicolor, Aryzta and Metro Wholesale & Foods being the main stock laggards. The latter sold off heavily in April following a profit warning related to its Russian operation. The share price later recovered somewhat on reported quarterly results that showed the first signs of an operational turnaround in Russia. Its share price subsequently received a further boost from the news that a new and core shareholder is planning to increase further its shareholding, which triggered takeover speculation. This is a long-term turnaround story and we maintain our position. Stock picking in energy and materials was also unhelpful, but the portfolio’s structural lack of exposure to the financials boosted relative performance.
Flows into our European strategies were mixed. European Concentrated Value enjoyed strong flows of £481 million, taking assets into the strategy beyond the £1 billion mark. European Select Values and Continental Europe both experienced net outflows over the period.
|FUND NAME||FUND FACT SHEET|
|JOHCM Continental European Fund||View the latest fact sheet|
|JOHCM European Concentrated Value Fund||View the latest fact sheet|
|JOHCM European Select Values Fund||View the latest fact sheet|
It was a highly challenging period for our two Asia ex Japan strategies (Asia ex Japan and Asia ex Japan Small and Mid Cap) from both a performance and fund flows perspective.
For the all cap strategy, our process dictates a maximum of 25 per cent in cyclicals versus the index composition which is around 55-60 per cent cyclicals. This means that whilst we should typically broadly keep pace, we are unlikely to significantly outperform during a strong cyclical rally, which was the case towards the end of 2017 and the beginning of 2018. The portfolio was also hurt by several idiosyncratic stock-specific issues, which weighed heavily on relative returns.
The largest stock laggard was Largan Precision, a Taiwanese lens-maker which supplies lenses for all iPhone models. Its share price sold off dramatically (along with other key Apple suppliers) towards the end of 2017 when Apple scaled back orders for the iPhone X.
AKR Corporation was another notable underperformer. This is an Indonesian firm involved in fuel distribution logistics which has been plagued by political uncertainty. Freeport, the largest mining firm in Indonesia, is in negotiations with the Indonesian Government to sell down its stake, extend its licence period and build a copper smelter in Indonesia. The industrial estate of AKR is one of the likely sites for the project but the decision has been delayed as the negotiations on the value of the stake sell down is still not agreed upon. This looks like a timing issue and we maintain our holding.
In light of the portfolio’s disappointing performance, we have made significant changes, reducing the cyclicality as the risk of trade tensions escalating and US dollar strength continue to provide headwinds. In the face of what appear to be challenging conditions for Asian economies, recent portfolio additions all broadly share the same characteristics: a strong balance sheet; high cash flow-generating abilities; a domestic business orientation; and, finally and importantly, signs of a turnaround from the effects of idiosyncratic slowdowns that each of them has had to deal with.
For the Asia Small and Mid Cap strategy, weakness came predominantly from our Taiwanese consumer discretionary names. Weak investor sentiment amid concerns of a greater than expected slowdown in China and rising trade tensions exacerbated the sell-off of several of our holdings. Against this backdrop, even companies that reported earnings that met or beat expectations were marked down sharply.
At a country level, our large overweight position in Indonesia was unhelpful. Our optimism over Indonesia was based on a stabilising economic environment but also improving corporate fundamentals. However, returns have been hampered by a number of factors. In 2017, concerns rose over a religious feud surrounding Jakarta’s then governor, which culminated in him losing his bid for re-election and receiving a two-year prison sentence. Investors were also disappointed by the sluggish economic recovery and the slow pace of government infrastructure spending. More recently, concerns that the weakness of the rupiah will force the central bank to tighten monetary policy have provided a headwind.
|FUND NAME||FUND FACT SHEET|
|JOHCM Asia ex Japan Fund||View the latest fact sheet|
|JOHCM Asia ex Japan Small and Mid Cap Fund||View the latest fact sheet|
The JOHCM Japan Fund, which is soft-closed to new investors, aims to identify undervalued small and mid cap stocks, an area of the market where a lack of analyst coverage helps create opportunities for experienced active investors. In contrast, although still embracing a ‘value’ philosophy, the JOHCM Japan Dividend Growth Fund is a large cap fund that targets Japan’s growing dividend culture and offers a blend of dividend growth and dividend yield.
With buyers of Japanese equities continuing to favour ‘growth’ stocks over the types of ‘value’ names in which we invest, performance has been challenging for both funds in recent years, including in FY2018. However, the pronounced underperformance of value stocks versus growth stocks in Japan since 2010 has left the valuation gap between the two styles at a 40-year high. Any form of mean reversion that saw this extreme market anomaly start to unwind would have a powerfully positive effect upon our portfolios.
The stocks held within the funds represent our best investment ideas, rather than a particular outlook or economic standpoint. However, for some time now, both funds have been aggressively positioned, given the compelling value in the Japanese market. Never in our investment careers has the backdrop to the Japanese market been more favourable. Beside low valuations, corporate earnings growth is spectacular, the economy is strong, fiscal and monetary policy are supportive, shareholder returns are improving and there is political stability.
As an example of the remarkable value present in the Japanese market, during the year we established a position in Ahresty, a maker of aluminium die cast components. Despite being profitable, it traded on a price-to-book multiple of just 0.4 at the time of purchase. Aluminium die-casting is a growth industry, benefiting from automakers’ push to make their cars lighter. Companies such as Ahresty, along with other portfolio names such as Maeda, are available on single-digit P/E multiples. These extraordinarily cheap stocks may have been left behind recently, but they offer substantial upside potential for very little risk, in our view.
Although continued earnings growth helped Japanese equities to record a double-digit gain in yen terms over the 12-month period, the market has struggled in 2018, in part amid worries over rising global trade tensions and its impact upon Japan’s large export sector. It is important to note, however, that we are underweight exporters. In both funds we have very limited exposure to the auto sector and none to consumer electronics.
Secondly, whilst we have exposure to the chemicals, textiles and industrial electronics sectors, our exposure is to niche players. In areas such as electronics, we own components companies such as Alps and industrial electronics firms such as Hitachi, which is combining its expertise in manufacturing, software and telecoms to become a leader in artificial intelligence, big data and the internet of things. We have significant weightings in construction, retail, real estate, railways and regional banks. These are sectors which are relatively immune to the global economic cycle and unlikely to be impacted by the policies of the Trump administration.
Thirdly, our stocks are so cheap, that we believe they have relatively limited downside. If there is risk to Japanese equities, it probably lies with some of the expensive cosmetics companies, biotech or robotics names which global equity funds have been so busy buying for the past couple of years.
We continue to believe that the long-term opportunity in Japan lies in proper, fundamental analysis of such undervalued companies, not in taking refuge in expensive growth names. We are not ignoring economic or geopolitical risks, but we believe that our companies are cheap enough and their businesses sound enough to withstand them.
|FUND NAME||FUND FACT SHEET|
|JOHCM Japan Fund||View the latest fact sheet|
|JOHCM Japan Dividend Growth Fund||View the latest fact sheet|
The portfolio enjoyed excellent performance over FY2018, outperforming its benchmark, the Russell 2500 Index, by a wide margin. Returns were mainly driven by stock selection as our technology names surged. Here, one of the team’s highest conviction ideas, Rapid7, is centred around cyber security. Network attacks have become increasingly sophisticated and prevalent over the past decade, with more involvement from large governments and organised crime. Both governments and commercial enterprises have been upgrading their networks to prevent and fight these attacks, driving the need for more investment in network security. Rapid7 is well-positioned in this space and was one of the portfolio’s top performers over the period.
Infrastructure is another opportunity set that currently interests us. President Trump’s mooted infrastructure plan has dropped off the radar in recent months, but with mid-term elections ahead, the team see this as a prime opportunity for the infrastructure conversation to be restarted. The project will be funded by a combination of private, public and state partnership over the next decade and could add US$100-150 billion to GDP. Projects are likely to emphasise transportation infrastructure but will include a broad range of needs including water, energy, telecommunications and hospitals. While we do not expect immediate passage, the plan will likely get bipartisan support in Congress and has a higher probability of passage later this year. Beneficiaries within the portfolio include industrial infrastructure names Terex, Martin Marietta and HD Supply. They could gain a significant earnings boost from the projects over the next several years.
When it comes to President Trump, it is important to separate the rhetoric from the reality. The pro-growth economic policies of the Trump administration have been a resounding success. A combination of regulatory relief and the landmark tax reforms passed in December 2017 have accelerated growth, improved corporate revenues and boosted earnings. Consumer and corporate confidence levels remain high and the labour market is buoyant. Whilst the lurch towards protectionism is unwelcome, there is method to President Trump’s tough talk on trade. “America First” does not mean America alone. His aggressive public posturing is aimed at renegotiating more balanced deals between the US and its major trading partners.
With capital expenditure poised to surge over the next 12-18 months, the regulatory environment becoming more business-friendly, potential for fiscal stimulus through Trump’s promised infrastructure bill a possibility for 2019 and US consumers in an ebullient mood, the outlook for US earnings growth, the factor that drives share prices over the long term, remains highly positive.
US small and mid caps are currently sitting in a sweet spot. For investors worried about trade tensions, the greater domesticity of small and mid caps versus US large caps gives comfort. Over 80 per cent of the revenues of the 47 companies held in our fund at 30 June were generated in the US, for example. This domestic bias also mutes the negative translation effects from a strengthening dollar. Meanwhile, helped by vibrant capital markets, smaller companies should also be beneficiaries of M&A activity. Small and mid-sized firms make enticing targets: bulky enough to move the revenue dial for any acquirer and providing plenty of synergies, but not so large as to induce corporate indigestion.
|FUND NAME||FUND FACT SHEET|
|JOHCM US Small Mid Cap Equity Fund||View the latest fact sheet|