Core Equity Portfolio update

Today’s topics

  • Portfolio positioning
  • TPG

Portfolio positioning

Valuation

Our direct equity portfolio is similar to peers and the benchmark on many factors. For example, Price to Book and Price to Earnings of our portfolios are similar to that of the ASX 200, and to the Morningstar average for the category.

Price to earnings ratioPrice to book ratio
Core Equity Portfolio24.722.31
Benchmark23.332.23
Morningstar peer group22.772.14

Size / market cap

However we have quite a bit fewer of the mega caps, relative to the others (here the number is describing exposure, smaller numbers meaning less exposure).

Market cap (giant)
Core Equity Portfolio28.7
Benchmark42.6
Morningstar peer group36.5

Cyclicals

We are also much less cyclically exposed. Comparatively, this means we are long lower volatility, more stable businesses.

Super sector (cyclical)
Core Equity Portfolio44.8
Benchmark63.1
Morningstar peer group59.8

Defensives

This equates to a much more defensive portfolio.

Super sector (defensive)
Core Equity Portfolio27.8
Benchmark17.2
Morningstar peer group17.0

Sector exposure

This is particularly evident when viewed on a sectoral basis, with our portfolios overweighting Healthcare, Utilities, Staples and Telecos, and underweighting Banks and Metals and Mining stocks.

UtilitiesHealthcareStaplesTelecosBanksMetals and Mining
Core Equity Portfolio4.9716.386.536.3114.9214.79
Benchmark1.3010.055.642.6521.4219.71
Active+3.67+6.33+0.89+3.66-6.50-4.92

Quality companies

Our search for Quality companies often results in a bias to offshore dollar earners. After all, a quality company is one likely to have taken a successful business model and replicated it elsewhere. They also tend to be in sectors where profitability is more concretely in the hands of management (i.e. pricing power) and less vulnerable to the ebbs and flows of more cyclical pricing structures (like that of commodity prices, where all you can really control are your costs).

Factor loadings

As such, the portfolio tends to be a) lower beta, meaning a correlation to movements in the broader market and b) comparatively short (underweight) the Aussie dollar, meaning our portfolio tends to underperform when the AUD is strong.

Quality companies also tend to be longer duration, because more of their value is derived from earnings streams 10 years out, than it is for say Value based stocks where it is more about a) near term earnings and b) near term earnings that don’t collapse quite as badly as the market expects. That sort of earnings trajectory does not particularly care whether the discount rate is 2%, or 4%.

As such, the portfolio tends to be underweight changes in the level of the interest rate, with rising rates tending to result in our portfolios underperforming.

Macro market movements

As such, the recent rise in bond yields, strong Aussie dollar, strong cyclicals, and in particular strong Value sectors (commodity producers, and Banks) have made for a more generally challenging environment.

Positioning: conclusion

However, we remain very comfortable with our exposures, believing that whilst bond yields might have some further cyclical upside pressure to them (from COVID related recoveries to growth and inflation expectations) and from US fiscal stimulus (which has positive spill over effects to other countries), in the longer run they should remain broadly capped not far from present levels, given the pervasive effects of demographics (real supply side factors that ultimately determine the equilibrium for rates).

Given our views that a) commodity prices are unsustainable, driven by short term dislocations in supply chains (COVID related, and now, a large trapped cargo vessel in the Suez Canal) and b) that Australia’s level of high household debt and weak wages growth will inevitably constrain lending growth (the Banks major source of revenue) we see little reason to position more aggressively in these cyclical sectors.

More broadly, we continue to see the market as somewhat expensive, and, vulnerable to the expiry/windup of Job keeper, noting that the transition between government supported GDP and private sector led recovery poses risks to those presently elevated equity market valuations.

TPG

The TPG share price is trading down today, driven by the resignation of David Teoh, the enigmatic chair and founder of TPG.

The press describes it as a “shock exit” which evokes unpleasant memories of the period shortly after the Vocus merger of MTU and VOC, in which the founders stepped down after differences in vision for the strategic direction of the then newly merged entity. That set of circumstances is well echoed here, and we are mindful of such parallels.

Against that, David Teoh has been talking about his eventual retirement for 2 years, and had already stepped down as CEO of TPG, and into the position of Chair, to facilitate the eventual exit.

So it is perhaps not quite a “shock”. Further, the letter accompanying the resignation is among the more collegiate and amicable of such letters.

Unlike the VOC/MTU comparison, TPG is a much stronger, more financially secure business, and as such we have much less concern about the management departure than we perhaps otherwise might. We also noticed that whilst Mr Teoh, and his son are stepping down, another son is in fact stepping into the newly vacated position.

That helps reduce some of the markets anxiety about the negative connotations, at the margin, however we’d emphasise that the “stronger and more financially secure” argument is of much greater importance to the thesis.

It bears comparison with the AMP letter, also released today, and first heralded by a trading pause, about the potential exit of their CEO.

Which was hurriedly followed up with another trading halt and a subsequent “additional” statement on matter.

Reading the additional statement, it was perhaps even more ominous.

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