September, 2023
The K2 Australian Fund returned -1.35% for the month.
During the month the Australian Government released Its White Paper on Jobs and Opportunities. The goal is to create more employment prospects for more people in more places. However, to our mind, the more immediate challenge is addressing the erosion in productivity. Over the past year, unit labour cost growth has accelerated whereas the growth in earnings per hour worked has slowed. As a result, the measure of labour productivity has declined by 4% over the year and is now back levels last seen in 2015. So how does Australia pivot to producing more whilst using less? Rebalancing the labour market would surely help. In recent times, a number of bottlenecks have caused labour demand to outstrip supply. However, there are some signs that labour demand is starting to taper. The most recent SEEK Employment report showed that the volume of job advertisements were 20% lower than last year. In addition, the last ABS release revealed that the number of job vacancies were 15% below a year ago. There are also signs that labour supply is rising. The number of underemployed Australians has grown by 14% over the past year. It seems to us that the labour market rebalance is well under way and hence we would expect to see less interest rate hysteria in the future.
Towards the end of the month, the Fund established a position in Resmed (RMD). RMD produces Continuous Positive Airway Pressure (CPAP) devices for the treatment of Obstructive Sleep Apnea (OSA) and other respiratory conditions. Typically these respiratory conditions can be with obesity, gender or cranial facial problems. Hence, when Eli Lilly and Novo Nordisk announced that their Type 2 Diabetes (GLP-1) drugs were contributing to weight loss as well as reducing the risk of heart attacks, RMD's share price subsequently fell by 40% in just weeks. Clearly the market is concerned about the impact that these drugs will have on the demand for CPAP products. However, the cost of these GLP-1 drugs currently range from US$900-$1500/mth. As a result. a standard RMD CPAP device is competitive at an outright price of less than US$1.000. In addition, these GLP-1 drugs have exhibited side effects such as nausea, diarrhea, vomiting, constipation and abdominal pain. The global market of OSA is thought to be close to a billion people. so if the type 2 Diabetes drugs impact the market by 10-15%, there is still an enormous opportunity for RMD. A ten PE point de-rating in MD looks like an over-reaction to us.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/205414464.pdfAugust, 2023
The K2 Australian Fund returned 2.11% for the month.
In Australia, we are noticing that there is a growing divergence in management behaviour. One is actively investing for the future; management are taking an owner-like approach to operating the business and the customer is elevated above all else. The other is extracting from the future. Here, management act like short-term professional officers and the customer is an afterthought. Simply put, owner-like behaviour embraces a philosophy that compounds customer trust whereas the professional officer approach is to maximise short-term profits at the expense of the customer. Market share will cede from extractors-from-the-future to the investors-for-the-future. However, these Imarket dynamics do take time to gain momentum. Meanwhile, short-termism is causing Australia's inflation pulse to beat too fast. The price of bread, dairy and other food related products have, on average, risen more than 10% over the past year. Gas and electricity prices are, on average, 15% higher than a year ago, and insurance and travel prices have also been rising rapidly. The companies that have set these unchallenged prices have enjoyed inflated margins, but, the threat of competition is looming. Our investment process favours management teams that act like founders and are investing for the future. SVW Group Holdings (SVW) is a company that continually walks our talk.
SVW is your classic founder-led company. Back in 2010, the Stokes family enabled SVW to form. The WesTrac Group was merged with Seven Network to create SVW. At the conclusion of the merger, the Stokes family ended up owning 207 million shares of SVW or 68% of the company. On the first day of trading SVW was capitalised at $2.2 billion. Today SVW is a $10 billion company and, since the merger, has delivered shareholders a total return of 17% pa. The Stokes family continues to own 207 million shares but capital raising activities by SVW has seen their level of ownership dilute to 57%. Are SVW's best days behind it? We think not. We believe that SVW's model for capital allocation will be enduring and significant long-term shareholder value continues to be unrealised. SVW has empowered its decision makers to allocate capital as if it was their own and hence there is a healthy respect what equity capital can facilitate. As this ownership mentally S permeates through the company, the resultant flywheel of growth should gain sustainable momentum.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/204374967.pdfJuly, 2023
The K2 Australian Fund returned 3.82% for the month.
During the month the Treasurer appointed Michele Bullock as the 9th Governor of the Reserve Bank of Australia (RBA). She will commence in mid-September and will oversee the implementation of the recently announced Review of the RBA. The Treasurer has insisted that Australia should have the world's best and most effective central bank. He acknowledged that Australia is facing a complex and changing macro environment and monetary policy must be sufficiently equipped to make the right calls in the interests of the Australian people. So what could change? It seems unlikely that the RBA will suddenly embrace a more hawkish perspective. In fact, in a recent speech, Bullock stated that the RBA had been more willing to accept a more gradual return to the inflation target than peer developed central banks. This would help explain why Australia's cash rate is more than 1% lower than peer nations despite having an inflation pulse that is more than 2% faster. Furthermore, Australian mortgage holders are significantly more exposed to variable interest rates than developed peer nations. Fixed rate mortgages accounted for more than 30% of Australia's outstanding mortgages in 2022 and the RBA estimates that by 2024 more than 20% of these will have rolled into variable rates. This is one of the known knowns. An unknow known is, as disposable income squeezes, what will households determine to be non-negotiable expenses?
One non-negotiable expense that Australian households have historically prioritised is the servicing their mortgage. And, as was highlighted by Helia Group (HLI) during the month, this continues to be the case. HLI is Australia's leading provider of lenders mortgage insurance (LMI). HLI is at risk if a mortgage that has a LMI policy moves into the default phase. Problems occur when the outstanding loan is higher than the value of the property secured by the mortgage. Despite high mortgage servicing requirements, elevated living costs, and declining property prices, HLI continues to register a low level of claims and delinquencies. In fact, HLI is reducing the value of it prior liability claim reserves. This backdrop should be supportive for the forthcoming June half year earnings of the Funds holdings in Commonwealth Bank (CBA), Bendigo and Adelaide Bank (BEN) and to a lesser degree Kina Securities (KSL). We are underweight banks but believe that CBA, BEN and KSL are demonstrating that the lending business is sustainable.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/203797504.pdfJune, 2023
The K2 Australian Fund returned -0.37% for the month.
During the month there were a number of important data releases in Australia. Firstly, the CPI for May was 0.4% lower than April or 5.6% higher than a year ago; this was better than expected. Secondly, the number of Australian underemployed workers in May were 12% more than this time last year. Finally, the number of job vacancies in May were 10% lower than last year. Furthermore, we are mindful that a number of Australian companies are over-earning and are, therefore, enabling a new source of competitive threats. A number of younger companies have been able to utilise the latest iterations of technology and now have the potential to compete with scale. It therefore seems likely that tradable and non-tradable inflationary pressures are peaking. All up, these outcomes should provide the Reserve Bank of Australia (RBA) with some flexibility towards tightening monetary policy. Eventually, the RBA will be comfortable moving to the sidelines, and this should signal that Australia's economic activity is broadening. This would be very favourable for Seven Holdings (SVW).
SVW is one of Australia's leading industrial companies with operations spanning industrial services, energy and media. Over the past few years SVW has also demonstrated a disciplined approach to allocating capital. Between 2013 and 2016, SVW conducted an on-market buyback where it acquired 27 million shares at an average price of $5.82. Then in 2017, SVW issued $375 million of equity at $11.20 to acquire 53% of Coates Hire. Again in 2021. SVW placed $500 million of equity to institutions at $22.50 following its initial acquisition of 23% of Boral. This activity has enabled SVW to build exposure to a number of Australia's strategic growth avenues such as the infrastructure rollout, mining production and transitional energy.
The Fund is well positioned for a cyclical improvement in economic activity. There are some green shoots sprouting within the residential property market, housing prices are stabilising, auction clearance rates are improving and population growth has resumed. Dwelling construction activity is still subdued but a less volatile phase of monetary policy would surely cause some uplift in approvals for dwelling activity. The best lows performing holdings for the Fund this month were BHP Group (BHP) SVW and Macquarie Group (MOG), Detractors to performance were MAAS Group (MGH) and Peopleln (PPE).
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/202772064.pdfMay, 2023
The K2 Australian Fund returned -1.94% for the month. There are a few indicators that are sending mixed signals about the prospects for Australia. Firstly, global commodity prices have been edging lower. Secondly, China's economic activity appears to be losing momentum. Thirdly, Australia's inflation pulse is not receding as quickly as peers nations. And finally, Australia's key political figures have lost sight of the need to drive productivity and are instead tilting their narrative and actions towards growth in real wages. Higher real wages without productivity gains would no doubt cause the Reserve Bank of Australia (RBA) to become more hawkish at the worst possible time. More than 800,000 Australian mortgages are in the process of swinging from low fixed interest rates to substantially higher variable rates. The RBA has already tightened monetary policy twelve times this cycle. Any further upward movements will obviously have a bearing on household spending.
We are also beginning to see some signs that businesses are becoming less courageous with hiring intentions and it seems inevitable that Australia's unemployment rate will rise into 2024. The key question is whether the softening in consumer spending will coincide with an eventual rebalancing of the labour market and allow the RBA to stay on the sidelines. During the month a number of US listed companies indicated that strong demand for generative artificial intelligence and language models was underpinning future revenue prospects.
As a result, share prices of the 100 largest Nasdaq listed companies rose 8% for the month. Australia's Technology sector was also strong rising 4% for the month. It is important to note that the largest 100 Nasdaq listed companies trade on 25x next years' expected earnings.
The Australian Technology sector on the other hand trades on more than 40x earnings yet delivers less than half the ROE of the US peers. The best performing holdings for the Fund this month were Ryman Healthcare (RYM), MAAS Group (MGH) and News Corp (NWS). Detractors to performance were Macquarie Group (MQG), BHP Group (BHP) and Nick Scali (NCK). During the month the Fund acquired a new position in Lynas Rare Earths (LYC). The median holding of the Fund has a market capitalisation of $7.3 billion and, using expectations for the year ahead, has a PE of 13.4x, an ROE of 15.4% and a dividend yield of 3.8%.
File:April, 2023
The K2 Australian Fund returned 1.38% for the month.
The Australian economy is expected to deliver meagre economic advancement over the coming year; consensus estimates are that Australia's GDP growth will be just 1.7%. It is also likely that these estimates will continue to fade. The last time economists were so bearish about Australia's economic fortunes, excluding the COVID phase, was during the Global Financial Crisis. It is also worth noting that today Australia's 2 year bond yield is 3.16% whereas the official cash rate is 3.85%.
The last time the inversion was so extreme was back in September 2012. Inflation expectations back in 2012 were moderate so unsurprisingly, the Reserve Bank of Australia (RBA) started easing monetary policy. Unfortunately, today we are not so lucky. The inflation rate for the year ahead is expected to be 4.7%. Hence, although economic conditions are sanguine, the RBA is unlikely to aggressively reduce interest rates. That said, we also believe that the RBA will not be in a rush to tighten monetary policy much further.
The labour market is finally showing some early signs of rebalancing; the number job advertisements are now well below last years' level and this is typically a precursor to a lift in the unemployment rate. It would appear to us that a soft landing is still probable in Australia. We are also starting to see some contraction in the PE dispersion for the ASX 200. The PE of the cheapest top quartile company is currently 26x whereas during the COVID phase it averaged 30x and pre COVID the average was 17x. The PE of the cheapest top quartile company is currently 15 points higher than the most expensive bottom quartile company. During COVID, this dispersion averaged 17 points whereas pre-COVID the average had been 10 points. There is finally competition for growth so the dispersion in valuation metrics should continue to contract.
File:February, 2023
The K2 Australian Fund returned -2.66% for the month. During the month, the Governor of the Reserve Bank of Australia (RBA), Philip Lowe, had to make two appearances before government committees.
There was active debate around the merits of RBA's meaningfully tighter stance of monetary policy. Governor Lowe continually reiterated the dangers of inflation becoming ingrained in the public's psyche. Lowe also reinforced that the RBA was highly attuned to the fact that 880,000 fixed rate loan facilities, with an average balance of $400,000, would mature this year. Offsetting this to some degree would be the additional $300 billion that households had saved since the onset of the pandemic. However, the RBA is concerned that demand side factors continue to play a role in the elevated level of inflation and tighter monetary policy could assist in the rebalancing of the economy. Australia's December half reporting season was a little disappointing.
Nearly half of the companies in the ASX 200 saw downward revisions to next years' EPS projections. However, the magnitude of the downgrades were minor; the median revision was just -0.5%. Some of the key takeaways from the reporting season were the intense competition within the mortgage lending industry, the margin protection strategies of the grocers and petrol retailers, and the costs escalation for the major resource companies. Despite a few headwinds, the valuation metrics for the ASX 200 are still relatively attractive; on next years' projections the PE is 14.4x and the dividend yield is 4.5%. The major resource companies continue to trade on 10x forward earnings whereas the PE of the larger industrials is closer to 17x next years' earnings.
File:January, 2023
The K2 Australian Fund returned 6.95% for the month. For the past 75 years Australia has measured inflation on a quarterly basis. Last year the Australian Bureau of Statistics finally moved to a monthly CPI measure. Unfortunately, the monthly CPI reading for December was 8.4% stronger than a year ago. The Reserve Bank of Australia (RBA) has been highlighting that Australian business leaders have indicated that costs of doing business have risen and that prices would need to follow.
As a result, it would appear that some industries are now aggressively focussed on margin accretion to the detriment of their customers. Airlines, grocers and petrol retailers look to be the main culprits and their actions are having a meaningful impact on inflation gauges. We would prefer that business leaders counter short term input cost increases with long term productivity solutions. Supply chains have decongested, "just in case" inventories are no longer needed, and worker mobility is recommencing. Accordingly, a number of industries will increasingly be exposed to an improved level of competition and market share will ultimately cede from the complacent to the focussed.
Macquarie Group (MQG) is a company that typifies this opportunity. MQG is a specialist provider of financial services; two thirds of the activities have an annuity bias and a third are more market facing. The annuity style activities are mainly asset management and banking and have both displayed strong growth attributes in recent years. Over the past decade MQG has more than doubled its assets under management to nearly $800b. Despite this, MQG is still a relatively small player in the US$100t+ industry.
MQG's banking activities are also relatively small; MQG's Australian mortgage book has been growing by 20%pa and is now over $100b but is still less 4% of the market. MQG's market facing operations employ around 4,000 staff whereas global peers like Goldman Sachs and JP Morgan have 48,000 and 290,000 have employees respectively. Hence, we envisage that MQG, despite is recent success, can continue to grow quicker than its largest competitors and do so without disturbing the balance of the market. The best performance contributors for the Fund this month were Macquarie Group (MQG), BHP Group (BHP) and Seven Group (SVW). During the month the Fund acquired a position in Westpac Bank (WBC). Dexus (DXS) was sold. The median holding for the Fund has a market capitalisation of $12.1 billion.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/196410354.pdfDecember, 2022
The K2 Australian Fund returned -3.51% for the month.
During 2022, COVID related supply chain dislocations blended with Russia's invasion of the Ukraine to create an inflation cocktail that was difficult for the market to digest. Risk free rates and risk premiums concurrently increased resulting in lower valuation metrics for most asset classes. As we move into 2023 the inflation cocktail is starting to lose some of its potency. Supply chain bottlenecks are gradually decongesting, and this is coinciding with a reduced level of economic activity. Hence, there is less imperative for businesses to carry "just-in-case" levels of surplus inventory. The resulting downward shift in inventory levels should ensure that goods inflation continues to subside. However, the immediate inflation driver that needs to be resolved is the labour market imbalance.
Despite tighter financial conditions, labour demand continues to outstrip supply. Subdued economic activity is leading to an increased number of announced job cuts, however, many businesses continue to sight hiring as a meaningful challenge. Ultimately, corporate profitability will diminish, the pace of interest rate hikes should fade, and, in time, an appetite for risk will return. Over the past 12 months Australian Real Estate Investment Trusts (A-REIT) have delivered a total return of -22%. The weakness in the sector was associated with interest rate hedging programs that exposed cash flow projections to higher financing costs. A number of the large A-REITs are now trading at 25%+ discounts to book value and this could solicit some takeover interest from entities such as private equity funds. Hence, the Fund has recently acquired positions in property fund managers Goodman Group (GMG) and Charter Hall Group (CHC). We have prioritised investments in GMG and CHC since they both have conservative balance sheets, flexible dividend payout ratios and superior growth prospects.
The best performance contributors for the Fund this month were Rio Tinto Holdings (RIO), Maas Group (MGH) and QBE Insurance Group (QBE). Kina Securities (KSL) and Macquarie Group (MQG) were detractors. During the month the Fund bought Charter Hall Group (CHC) and ANZ Bank (ANZ). Bendigo Bank (BEN) was sold. The median holding for the Fund has a market capitalisation of $9.8 billion and, using next years' estimates, trades on a PE of 12.1x.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/195527545.pdfNovember, 2022
The K2 Australian Fund returned 5.05% for the month. During the month the ASX 200 Resource and Industrial indices delivered total returns of 14.6% and 4.0% respectively. The Fund has more than 20% exposure to resource companies and has been steady all year. We anticipate that resource companies will continue to deliver strong returns well into 2023. The Fund's resource exposure should benefit from a global trend where commodity producers have generally spent years preserving capital. As a result, the supply of a number of commodities has been constrained. China's eventual roll-back in its zero-COVID policy may be the catalyst that drives commodity demand beyond supply thus leading to upward pressure on prices. Industrial companies should also continue to perform well.
The Australian economy could be one the strongest performers in the developed world over the coming year. The Reserve Bank of Australia (RBA) is less willing to subject the country to unnecessary pain; a self-sustaining economy seems to take precedence ahead of near term inflation readings. Our industrial exposure is directed towards companies that have operational tail winds and are coupled with attractive valuation metrics. In November, the Reserve Bank of New Zealand (RBNZ) delivered an early Christmas gift to the country's borrowers; the highest cash rate in the developed world. Despite the fact that other central banks are embracing a more moderate pace of rate rises, the RBNZ actually considered accelerating its speed of rate hikes. The RBNZ appears to have a myopic view that inflation expectations are destined to spiral higher and that a recession is the only solution. To our mind, the RBNZ has historically demonstrated limited capacity in anticipating inflationary trends. Hence, we have had the Fund positioned for a more lenient approach to monetary policy.
This year the Fund has averaged around 5% exposure to New Zealand based companies. It is likely that the RBNZ will be the first central bank to cut rates in 2023 and this should result in strong performance from the Fund's New Zealand holdings. The best performing holdings for the Fund this month were BHP Group (BHP), Rio Tinto (RIO) and Seven Group Holdings (SVW) which rose 21%, 24% and 14% respectively. Ryman Healthcare (RYM) and Healthia (HLA) and were the largest detractors. During the month the Fund increased it holdings in National Australia Bank (NAB) and Northern Star Resources (NST). Reliance Worldwide (RWC) was sold.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/193188142.pdfOctober, 2022
The K2 Australian Fund returned 2.47% for the month.
The Reserve Bank of Australia (RBA) continues to demonstrate a pragmatic approach to monetary policy. It has motioned towards more gradual rate rises of 25 basis points whereas the US Federal Reserve (FED) and the Reserve Bank of New Zealand (RBNZ) have been opting for aggressive 75 basis point hikes. As a result, we believe that the RBA is moving towards a period of interest rate inaction. These phases are embraced by market participants and strong equity returns typically follow. On the other hand, we envisage that if the FED and the RBNZ continue with a more heavy handed approach, economic consequences will be more amplified. Accordingly, we believe that Australia will be able to sustain a stronger and more prolonged phase of economic activity than peer nations. Macquarie Group (MQG) is the largest holding for the Fund. MQG operates both annuity style and market facing businesses. Despite the uncertain trading conditions globally, MQG is positioning itself for growth. Over the past year MQG has expanded its workforce by 12% and built up surplus capital of more than $12 billion. We would expect MQG to redeploy capital aggressively as interest rate peak and volatility subsides. Seven Group Holding (SVW) is another large holding for the Fund and heavily leveraged to construction and mining related activity in Australia. An extensive pipeline of infrastructure projects is underpinning construction activity.
In addition, despite slower global activity, demand for Australian resources remains solid. As a result, SVW is well positioned to continue to deliver profit growth and is attractively priced at a PE of 10x next years' earnings. The Fund also has a meaningful position in Woodside Energy Group (WDS). WDS has an advantageous position in a world that is seeking energy security; the balance-sheet is strong, profitability is high, and the PE is low. The best performing holdings for the Fund this month were Woodside Energy Group (WDS), Macquarie Group (MQG) and Judo Capital (JDO) which rose 16%, 9% and 17% respectively. Maas Group (MGH) and Winton Land (WIN) were the largest detractors. During the month the Fund added Goodman Group (GMG) and JB Hi-Fi (JBH). MA Financial (MAF) was sold. The median holding for the Fund has a market capitalisation of $6 billion and, using next years' estimates, trades on a PE of 11.1x and generates an ROE of 15%.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/192319556.pdfSeptember, 2022
The K2 Australian Fund returned -6.77% for the month. Australia appears to be in the cross hairs of global macro traders.
At present the consensus trade seems to be sell long bonds, buy VIX, buy US dollars and sell Australian assets. As a result, the Australian dollar is trading like an emerging market currency. However, Australia is performing better than the currency suggests. Australian households have built up over $3 trillion of superannuation assets and this now accounts for almost 20% of their total assets.
In addition, the Australian household debt to assets ratio is just 17% whilst interest payments on housing debt remains manageable at 4.7% of household disposable income. Interest payments will rise in-line with higher rates over the coming year but the impact is softened by the embracement of fixed rate loans during the COVID pandemic.
Additionally, the global economy is losing momentum. Hence, the Reserve Bank of Australia (RBA) should be able to be more pragmatic with monetary policy over the coming months. Back in the early 1990's, the RBA accepted that an appropriate target for monetary policy would be to achieve an inflation rate of 2-3%, on average, over time. Since then, the RBA has changed the official cash rate on 70 occasions. Importantly, the RBA has kept rates unchanged 80% of the time. Given that global oil and food prices have retreated 27% and 13% respectively since mid-year, and the impact of monetary policy typically occurs with a lag, we feel that the RBA must getting more comfortable that its target inflation rate is within reach. Therefore, we believe that the RBA is getting closer to a period of inaction.
The ASX 300 has historically responded well when the RBA is sedentary. Since 1992, during the quarters when the cash rate was unchanged, the ASX 300 delivered an average total return of +2.8%. As a result, the Fund is optimistically positioned in financials (ex the major banks) and industrials.
The best performance contributors for the Fund this month were Pilbara Minerals (PLS), Winton Land (WIN) and BHP Group (MPL). Macquarie Group (MQG), Maas Group (MGH) and Bendigo and Adelaide Bank (BEN) were detractors. During the month the Fund bought ASX Ltd (ASX) and Dexus (DXS). Medibank Private (MPL) was sold. The median holding for the Fund, using next years' estimates, trades on a PE of 10.9x, generates an ROE of 14.0% and offers a dividend yield of 4.3%.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/191324266.pdfAugust, 2022
The K2 Australian Fund returned 0.89% for the month. The Reserve Bank of Australia (RBA) has lifted interest rates for the 5th time this year.
The RBA's Cash Rate now stands at 2.35% and this has driven a 50% lift in the standard variable home loan rate (SVHLR) over the past 12 months. That said, it is worth noting that the SVHLR is still 35% lower than what was experienced during the 30 years prior to the GFC. The RBA did stated that it "...expects to increase interest rates further over the months ahead, but it is not on a pre-set path". We believe that this pragmatic approach to monetary policy will hold the Australian economy in good stead. Inflation hysteria is fading; supply chain congestion is gradually alleviating and surge prices are starting to run off. However, the demand side of the labour market is still robust. We believe that tighter financial conditions will address this in time. Hence, we believe that a soft landing for the Australian economy is probable. The Australian equity market continues to offer attractive opportunities. The ROE of the ASX200 is expected to be over 15% next year yet the PE ratio is just 13.5x. Granted a meaningful driver of the equity productivity is resource led, however Australia's leading miners are demonstrating an improved level capital allocation discipline. As a result, we believe that Australian equities will provide investors with a steady stream of dividends and capital management proceeds over the years ahead. In addition, the resource companies are consistently adapting to the lower carbon footprint expectations from global citizens.
The best performing holdings for the Fund this month were Medibank Private (MPL) and Pilbara Minerals (PLS) which rose 9% and 32% and 6% respectively. MPL continued to deliver growth in its number of policyholders during FY'22 and this helped drive a 10% lift in its Health Insurance profit. PLS is a lithium company that generated a profit of $561 million in FY'22. PLS trades on less than 7x next years' expected earnings and has an attractive production profile over the coming years. The largest detractor to performance for the month was Bendigo Bank (BEN). Despite a 9% lift in profits for FY'22, BEN complicated the net interest margin outlook with a new hedging strategy. Despite this, we were pleased to see BEN commit to driving the ROE higher with a renewed focus on productive growth. We believe that BEN offers more compelling return prospects than the four major banks.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/190428281.pdfJuly, 2022
The K2 Australian Fund returned 4.88% for the month.
The Reserve Bank of Australia (RBA) continues to tighten monetary policy. The cash rate now stands at 1.85% and this has driven a 2.25% lift in the average standard variable home loan rate over the past 12 months. This annual elevation in mortgage servicing costs is one of the most aggressive moves in more than forty years. The most obvious casualty will be the residential property market. The RBA hiked interest rates quickly in 1982, 1985, 1989 and 1994. During these cycles the subsequent average move in the median house price was down 4%. Clearly house price valuations are more than double what they were forty years ago but mortgage serviceability metrics are 30% lower than the long run average. Hence, we expect the weakness in house prices to continue but we are not anticipating double digit declines.
Australia's rate of inflation is still elevated and the next reading is not until mid-October. So, given the brisk decline in global commodity prices of late, inflation pressures may already be easing. In addition, the supply side of the labour market continues to remain tight. This is a global phenomenon so central bankers around the world are creating tighter financial conditions in an effort to curtail the demand side of the labour market. To our mind this is working. We would expect indicators like job advertisements and job vacancies to start turning down soon. As a result, long bond yields should drift towards official cash rates. Ultimately this would be supportive for equity markets. Valuation metrics would gravitate higher particularly if sustainable earnings growth is evident. The median company in the ASX 200 is attractively priced at 13.7x forward earnings, which is 3.6 PE points lower than last year.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/189904623.pdfJune, 2022
The K2 Australian Fund returned -10.94% for the month. The Reserve Bank of Australia (RBA) is well and truly in tightening mode thanks to some exogenous factors; the Fair Work Commission concluded that the National Minimum Wage would rise by 5.2% in FY2023 and this coincided with volatile energy prices resulting from strains on the structure of the nation's distribution network. It would also appear that the RBA has picked up signals that some business leaders have stepped away from the prior disciplined cost culture. As a result, the RBA probably feels that it needs to help anchor inflationary pressures before they become too embedded into everyday life. Fortunately, despite elevated headline inflation, the number of Australian industrial disputes at present is 90% lower than in 1985 when the annual CPI reading was at a similar level. Higher wages should reflect productivity gains as opposed to preserving the level of real purchasing power.
Global food and oil prices are on average 30% higher than last year and this has contributed to global inflation expectations rising 1.5%. Historically, a prolonged elevation in food and oil prices has led to a supply response that typically comes online well after prices have peaked. We have also noted that when food and oil prices move 30% quickly, global measures of risk move sharply higher and mis-priced assets are subsequently exposed. From an equity market perceptive, the risks have clearly shifted away from valuations and towards earnings. Australia's mining industry is contending with higher operating costs; a number of gold companies have already guided to lower profits for the June half. In addition, debt hedging strategies of REIT's have been explored and a number of downward revisions have followed. Hence, during June, sell-side analysts downgraded EPS forecasts for 40% of the companies in the ASX200.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/189001694.pdfMay, 2022
The K2 Australian Fund returned -3.68% for the month. During the month a number of central banks lifted their official cash rate. Most central bankers appear to be placing significant weight on survey results that amplify the difficulties in finding labour. However, to our mind, the tightness in labour markets could be on the verge of becoming a lagging indicator; the persistent poor performance of share prices, the contraction in business confidence and the flattening yield curve is probably suggesting that job openings could be on the cusp of a meaningful down turn. By way of example, over the past six months, the value of the average US listed software company has declined by 30%. Given this dramatic move, it is reasonable to assume that the demand for software engineers should taper. This is why central bankers closely monitor financial conditions; sharp downward moves in asset prices can allow central banks to be less hawkish in their application of monetary policy.
Earlier this year, the RBA indicated that Australia has had an advantageous inflationary bearing thanks to multi-year enterprise wage agreements, a strong corporate cost culture and a more balanced supply of domestic energy. However, it would appear that the RBA's business liaison program has identified a softening in the cost culture. In addition, energy supply constraints have led to elevated wholesale electricity and gas prices. As a result, inflation is emerging quicker than the RBA expected. Coincidently, the Australian Labour Party (ALP) won the recent election. The ALP campaign was focussed on climate action, real wages and employment opportunities. The ALP believes that a 5% increase in the minimum wage is needed and that renewable energy can create jobs, reduced emissions and provide a cheaper source of power. It will be interesting to see how the Reserve Bank of Australia (RBA) interprets the ALP's strategies
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/187912177.pdfApril, 2022
K2 Australian Fund returned -1.70% for the month.
April was an extraordinary month. Russia continued with its invasion of the Ukraine. The CRB Food Index and the oil price both rose 4% and global inflation expectations for the year ahead subsequently moved 1% higher. Despite wide ranging sanctions, the Russian Ruble surged 15% against the US dollar. China continued with its pursuit to contain COVID outbreaks, which, when combined with some relaxed foreign exchange reserve requirements, saw the renminbi decline 4% against the US dollar. The CBOE Volatility Index (VIX) spiked 20 points to hit 33 by month end. The US 10-year bond yield rose 60 basis points to 2.93% taking it back to the same level as late 2018 when the Federal Reserve ceased its rate hike cycle. In response, central bankers around the world now feel compelled to tighten monetary policy, including the Reserve Bank of Australia (RBA). The RBA has tightened sooner than previously expected; business contacts now suggest that they are passing on higher costs of doing business to customers. In addition, there are a growing number of businesses that are alluding to larger wages increases. Ultimately the inflation pulse has quickened and financial conditions have tightened meaningfully.
One of the consequences of tighter financial conditions is that valuation metrics typically decline. We have noticed that companies in the US that have exhibited historically superior levels of revenue growth have lost 7 PE points this year. These growth companies today are trading on PE's of 16-17x next years expected earnings. In Australia, similar growth oriented companies have lost 12 PE points but still look relatively expensive at 27x. More broadly, the ASX 200 has lost 5 PE points this year and is now trading below 15x next years' earnings. We estimate that the weighted average cost of capital for Australian equities has risen by around 1.5% this year and equates to about 2 PE points. Hence, we can only assume that market participants expect interest rates to rise significantly higher or that future profits will be jeopardised by tighter financial conditions. Our feeling is that supply bottlenecks will subside, surge pricing will taper and cash rates will not sky rocket
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/186940188.pdfMarch, 2022
The K2 Australian Fund returned 3.79% for the month. During the month Russia continued with its invasion of the Ukraine. Many of the world's nations have condemned Russia's hostilities and meaningful sanctions have been imposed. Russia's ability to export oil, gas and fertilizer has been constricted and this has resulted in elevated commodity prices. Despite this, market participants have embraced risk assets and hence the developed equity markets of the US , Europe, Japan and Australia on average gained 4.4% for the month. Most central banks around the world are now in rate tightening mode. Equity markets have a tendency to look through higher debt costs and typically deliver positive returns during rate hike cycles. In addition, bond yield curves are flattening. Normally this indicates that tougher economic conditions are on the horizon. However, equity market have also tended to outperform despite recessionary fears.
The Reserve Bank of Australia (RBA) has been vocal that the conflict in the Ukraine will lead to economic uncertainty and therefore a patient approach towards monetary policy should be warranted. Fortunately, higher commodity prices are a net benefit to the Australian economy and listed companies are now experiencing better returns on employed capital. Importantly, within this year's Budget, the Australian Government responded to higher global energy prices by halving the fuel excise tax for the next 6 months. This should help taper inflationary expectations and ensure that household consumption is supported.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/186102190.pdfJanuary, 2022
The K2 Australian Fund returned -5.82% for the month of January which was +0.74% ahead of the index in a volatile month. Over the long term the fund has delivered an above benchmark (BM) +9.84% p.a. return over 22 years (after all fees).
Global equity markets were incredibly volatile during the month. Market participants reacted nervously to minutes from the US Federal Reserve's (FED) meeting in December 2021. Broadly the FED explained that the Omicron variant had caused its baseline economic activity projections to be skewed to the downside whereas its inflation projections were skewed to the upside. The FED also disclosed that it had begun discussions about the appropriate conditions and timing for the commencement of the balance sheet run off. Almost all members of the FED concluded that the balance sheet run-off should be initiated after the first increase in the federal funds rate. Three weeks later the FED announced, given inflation was well above 2% and the labour market was strong, it would soon be appropriate to raise rates. Market participants have rapidly priced in 4 rate hikes by the FED this year and equity prices around the world experienced a sharp retraction. The Reserve Bank of Australia (RBA) is taking a more patient approach to monetary policy than the FED. Australia has demonstrated that it has an advantageous inflationary setting and as a result CPI forecasts for the year ahead are 2% lower than the US. This means that the RBA can allow the economy to expand without the immediate risk of breaching 3% wage growth. We envisage that the Australian economy will be one of the best performers this year which should support corporate profits and equity market values
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/183130835.pdfDecember, 2021
The K2 Australian Fund returned 2.58% for the month.
The Reserve Bank of Australia (RBA) is taking a pragmatic approach to monetary and banking policy. The RBA has made it quite clear that it does not target housing prices. In addition, the RBA has consistently stated that there is little chance that it will need to lift interest rates in 2022. Given that Australian households are now sitting on more than $200 billion of cash, we would expect to see economic activity tilt towards the services sector over the year ahead. This would be jobs accretive and should ensure that the Australian economy delivers more than 4% GDP growth in 2022. We are optimistic about the EPS growth projections for Australian equities over the coming year and share prices should at least match the improved level of profitability. This will be important as we feel that the cheap beta cycle that has been with us for the past decade is starting to fade. We believe that Quantitative Easing (QE) has served its purpose in reviving risk taking activities. However, it has enabled a large congregation of market participants who are ultimately momentum chasers. As QE inevitably transitions towards Quantitative Tightening (QT), prospective investment returns will require a greater appreciation of the interaction between valuation and growth.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/182071787.pdfNovember, 2021
The K2 Australian Fund returned -1.43% for the month. The fund has delivered an above benchmark (BM) +10.09% p.a. return over 22 years without excess market volatility (after all fees).
Market volatility rose during the month. The World Health Organisation named omicron as the latest COVID-19 variant of concern and this coincided with a more pragmatic inflation narrative from the US Federal Reserve Bank (FED). It is too early to have an expectation for omicron's transmission and severity, and it is also unclear how effective current vaccines will be. Australia is suitably prepared given that 88% of the adult population are fully vaccinated and 15% of the elderly have already received the vaccine booster. FED Chairman Powell commented that US inflation is more elevated than expected, employment indicators are stronger than anticipated and, despite this, there has been no increase in the supply of labour. As result, the US economy is strengthening so the FED will taper asset purchases sooner than expected. We believe that Australia will follow the US lead. Although Australia's Household Savings Rate (HSR) for the September quarter was 19.8% and was the 5th highest quarterly print in 60 years, we believe that the HSR will decline below 5% throughout 2022 and beyond. Assuming that the omicron variant is not too severe, we anticipate that Australia's economy has the potential to sustain around 3%pa growth over the years ahead. The Fund continues to be optimistically positioned.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/181306106.pdfOctober, 2021
The K2 Australian Fund returned -0.48% for the month and +30.0% over the past year. The fund has delivered an above BM and consistent +10.20% p.a. return over 22 years without excess market volatility. Australia is moving into an environment where the majority of the economic pistons will be firing in unison. At present Australia's Household Savings Rate (HSR) is twice as high as the average rate over the past 30 years. An elevated HSR typically co-exists with low levels of confidence and adverse business trading conditions. It is our expectation that Australia's HSR will decline below 5% throughout 2022 and beyond, driving economic growth expectations to around 3%pa. Typically, when trading conditions are robust, confidence is high and growth opportunities are embraced by management teams. We believe that economic leading indicators are an insightful tool for gauging the mood of business leaders. It is our expectation that 2022 will be a year of more economic stability and we anticipate that leading indicators in Australia will stay stronger for longer. The Fund has more than 65% exposure to companies that prosper when economic activity improves.
The Fund is significantly under-weight the 4 major banks. Positions in ANZ Bank (ANZ) and National Australia Bank (NAB) have been increased during the month whereas Commonwealth Bank (CBA) and Westpac Bank (WBC) continue to be avoided. The Fund's banking exposure is more tilted towards the long-standing position in Macquarie Group (MQG). MQG continues to invest with confidence and is pursuing growth in large market segments like Australian mortgages and green energy projects
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/180763909.pdfSeptember, 2021
The K2 Australian Fund returned -1.35% for the month and +32.83% over the past year, outperforming the benchmark (BM)by +0.2% and +1.4% respectively). The fund has delivered an above BM and consistent +10.27% p.a. return over 22 years without excess market volatility.
During the month economists reduced next years' GDP growth estimate for Australia by 0.2% thus bringing the aggregate downgrade to 0.6% for the quarter. This is hardly surprising given that 57% of Australian's adult population reside in NSW and Victoria and both states are largely in COVID-19 lockdowns. However, we believe that over the coming months significant economic activity will be released as movement liberations evolve. Australia's saving rate is elevated at present and this should provide households with meaningful spending power next year. Business confidence has contracted over the past few months and is now as low as it was back during the GFC. We would expect business leaders to regain their courage by year end and we envisage that a new cycle of growth capital expenditure is forming. The Fund currently has 65% exposure to financials, industrials and discretionary retailers; these are typically the more economically cyclical segments of the market. We are mindful that regulators are concerned about emerging risks in the housing market. Loan serviceability thresholds have been increased but we are comforted by the fact that Australia's household debt to income has been stable for 5 years. It is also worth noting that Australia’s household interest payments as a share of income is now at its lowest level in over 30 years
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/179509592.pdfJuly, 2021
The K2 Australian Fund returned +0.5% for the month and has now returned +32.6% over the past year to be +2.2% ahead of the benchmark (BM). The fund has delivered a consistent excess return vs BM over the long run over many different economic cycles. Importantly, the fund has delivered an above BM and consistent 10.3% p.a. return over 21 years without excess market volatility.
Companies within the ASX 200 Index have now experienced 11 consecutive monthly EPS upgrades with an average uplift of +3.3%. This has been the strongest upgrade cycle in a decade. The last time we saw a similar phase of positive earnings revisions was after the Global Financial Crisis when, between July 2009 and June 2010, there were 12 consecutive monthly EPS upgrades of +2.8% per month. Unfortunately, during those 12 months, the Reserve Bank of Australia (RBA) lifted interest rates on 6 occasions and the earnings momentum for the ASX 200 faded during the following year.
We believe that the RBA will not make the same mistake this cycle. The prevalence of the Delta strain of the COVID-19 virus has spread quickly through certain parts of Australia and a significant section of Sydney has now been put into lock-down. As a result, it is likely that temporary fiscal assistance and monetary latitude will be required. Importantly, during the last week of July more than 600,000 Australian adults received their 2nd vaccine.
That weekly vaccination rate should improve over the coming months and hence it is likely that 70% of Australia's adult population will be fully vaccinated before Christmas. This should mean that by 2022 the need for lock downs will diminish. As a result we are optimistic about the prospects for improved economic activity next year and believe that earnings momentum will be sustained.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/175631949.pdfJune, 2021
The K2 Australian Fund returned +1.01% for the month and has returned +36.1% over the past fiscal year to be +5.5% ahead of the benchmark (BM). The fund has delivered a consistent excess return vs the BM over the long run and since the severe March 2020 pandemic induced correction. Importantly, the fund has delivered an above BM and consistent 10.3%p.a. return over 21 years without excess volatility.
As of the end of June, about 30% of Australia's adult population had received a COVID vaccine. This is well below the US and the UK where around 70% of their adult population have been vaccinated. Importantly, 70% of Australians over the age of 70 have received their first vaccine dose and 17% are already fully vaccinated. One of the consequences of Australia's relatively slow vaccine rollout is that projections for GDP growth over the year ahead are more than 1% lower than those for the US and the UK. This is understandable; however, we believe that by year end Australia will be displaying superior growth attributes. The rollout of Australia's COVID vaccine will ramp-up following the recent National Cabinet meeting. On the current run-rate it is likely that by September, 70% of Australia's adult population will have received a vaccine. It is also probable that economic destabilising lockdowns will become less frequent. Hence, we envisage that as we head into 2022, the domestic economy will be performing with more consistency, international students and economic visa holders will gradually re-emerge and GDP growth forecasts will surpass 5%. This backdrop should support earnings momentum for Australian companies for at least the next 12 months
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/174342138.pdfMay, 2021
The K2 Australian Fund returned +1.05% for the month and has now returned +37.61% over the past year this financial year to be +7.7% ahead of the benchmark (BM).
Despite the occasional COVID flare-up, Australian households are generally in good shape. Consumer sentiment is at a two decade high, house prices are five times household disposable income and the household savings ratio has almost halved during the past three quarters. Household net worth is subsequently rising steadily. Business confidence is also strong; capacity utilisation is at a thirty year high and borrowing rates have never been lower. Despite this, business loan growth over the past year is negative and business investment as a share of nominal GDP is today as low as it was back in the recession of the early 1990's. Given that Australian corporates are running extraordinarily conservative balance sheets and fiscal stimulus measures are plentiful, we have been surprised that corporate animal spirits are still sombre. We can only hope that Australian business leaders will eventually recognise that the pursuit of growth will be applauded. We believe that over the next decade a number of industries will experience a rotation in sizable chunks of market share. Progressive businesses that have invested heavily during the pandemic will ultimately prevail. Two such holdings for the Fund are Macquarie Group and Ryman Healthcare.
The best performing holdings for the Fund this month were Maas Group (MGH), Pendal Group (PDL) and Commonwealth Bank (CBA) which rose 15%, 6% and 10% respectively. MGH listed late last year and is a construction materials, equipment, and services provider with diversified exposures across the civil, infrastructure, mining, and property markets. During the month, the Australian Budget outlined an additional $15.2 billion over ten years to fund infrastructure commitments. MGH is extremely well positioned to benefit from this. PDL announced the highly accretive acquisition of US based fund manager TSW for $413 million. The acquisition will increase FUM to over $130 billion and should add more than 10% to next years' EPS. During the month CBA announced that its 3Q profit was 24% high than the average of the first 2 quarters of the year. Loan growth is strong and bad debt provisions are declining.
The Fund's net exposure for the month averaged 97.2%. The median holding for the Fund has attractive characteristics; using consensus forecasts for the year ahead the PE is 15.6x, ROE is 12.7%, and the dividend yield is 3.1%. The market capitalisation of the median holding for the Fund is $8.5 billion and EPS growth is expected to be +10.8% over the next 12 months.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/172920378-1.pdfApril, 2021
The K2 Australian Fund returned +4.35% for the month and has now returned +33.3% this financial year to be +8.7% ahead of the benchmark (BM). The fund has also performed strongly over the past year to be +44% outperforming the BM by +10.1%. Importantly, the fund has delivered an above BM and consistent 10.3% p.a. return over 21 years without excess market volatility.
The Australian economy is expected to expand by more than 4% over the year ahead and the state of the jobs market has been a significant contributor. Australia's unemployment rate has improved by nearly 2% in less than a year and further gains look probable. The removal of the JobKeeper subsidy on March 31 will be a crucial obstacle that the economy will need to contend with however early indicators are promising. ANZ Job Advertisements for April were 4.7% stronger than March and are now almost 8% higher than the pre-COVID peak level.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/171227107.pdfDecember, 2020
The very strong returns continued in December. The K2 Australian Fund returned +2.4% for the month to be +0.6% ahead of the benchmark (BM). The fund has now returned +22.9% this financial year to be +7.2% ahead of the BM. Since the lows of the March correction the fund is up +70.3% outperforming the BM by +17.7%. The combination of good stock selection and investing cash early in the recovery have contributed to the strong performance vs benchmark since the severe March correction.
Importantly, the fund has delivered a consistent 10% p.a. return over 21 years without excess market volatility. Back in March 2020 we commented that: "Today the world is in hibernation. The banking system has had a decade to prepare for these very conditions and fiscal support has been widespread. We believe that today's investment opportunities are as attractive as those that were presented to the Fund during the 1st quarter of 2009. The Fund subsequently delivered a 35% return over the following 12 months." Pleasingly since the end of March 2020 the Fund has delivered a +47% return.
The Fund's net exposure has averaged 95.5% over the past 3 quarters and is still optimistically positioned. Despite relatively high valuation multiples (the PE of the ASX200 is now over 20x next year's expected earnings) we believe that conditions continue to favour equities. Central Bankers around the world are determined to keep interest rates low for the foreseeable future. Inflation pulses are rising however this should not disturb the Quantitative Easing commitment that Central banks have made. The 3 largest Central Banks (US Fed, ECB and BOJ) have collectively increased their balance-sheets by more than US$7 trillion this year and an unwinding of these positions is unlikely to be considered until the world has effectively eradicated the COVID-19 virus.
In a zero-bound investing world, Australian equities continue to offer a compelling yield with a dividend stream that will escalate over the years ahead. The best performing holdings for the Fund this month were resource heavy weights BHP Group (BHP), Rio Tinto Ltd (RIO) and Fortescue Metals Group (FMG) which rose 11%, 12% and 28% respectively. The price of iron-ore rose more than 30% for the month and this triggered a double digit increase in profit forecasts for our major resource holdings. Detractors to performance for the month included Corporate Travel Management (CTD), Austal Ltd (ASB) and a short on Afterpay Ltd (APT) which was closed out during the month.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/163368898.pdfticker: KAM0101AU
release_schedule: Monthly
commentary_block: Array
factsheet_url:
https://investmentcentre.moneymanagement.com.au/factsheets/mi/n8y5/k2-australian-absolute-return
Provider’s own factsheet
asset_class: Domestic Equity
asset_category: Australian Long Short
peer_benchmark: Domestic Equity - Long Short Index
broad_market_index: ASX Index 200 Index
structure: Managed Fund
manager_contact_details: Array
fund_features:
K2 Australian Absolute Return aims to deliver capital growth over the long term by seeking out opportunities in undervalued companies in all market cycles. The Fund also aims to deliver superior risk adjusted returns through the investment cycle.
- Target return is 10+% p.a. over the long term.
- The strategy invests in listed equities in Australia and New Zealand, typically holding up to 80 different stocks in a range of sectors, but may also hold up to 100% cash depending on market conditions to help protect clients’ invested capital.