Why has my portfolio underperformed the All Ords for the March Quarter?

We have had a few calls recently about this last quarter and what is happening in portfolios.  I just wanted to walk you through some of the ‘behind the scenes’ machinations that drive portfolio construction and why despite a solid twelve months, we can still have a bad quarter.

First off, our active International and Australian equity managers were pretty well placed for rising inflation, increasing interest rates, some wages growth and softening world growth.

Due to the huge fiscal stimulus we have seen during the pandemic, bank accounts are healthy and there is a solid argument that discretionary spending will continue to push company earnings up on increased revenues. This should lead to share price growth which will be reflected in your portfolios. Yes, in the second half of calendar year, 2022, there was an argument that this would soften but January was too early to make that call.

Our active managers look for opportunities over a one to three year cycle.  Day traders will try and anticipate the direction of a stock and think in 24 hour time allocations.  This can work for the individual but can have major tax implications and not many are successful at it.

Crypto currency is a day traders dream as it can move quickly up and down and there is no fundamental reason for the directions.  Its value arguably is ‘scarcity’ so even though it peaked at $63,000 US a coin on 12 April 2021 and today (13 April 2022) sits at $39,526, -38% down, traders could have made money on it due to big daily swings.  No we do not advise on Crypto and the main reason is we have no basis for why it will or won’t increase in value. 

A portfolio manager will have a team of analysts that are usually assigned a sector and will have to argue their stocks against other analysts and the potential for theirs to outperform verses the general market. The portfolio manager might make the final decision but these are all professionals that are tasked with knowing as much as they can about a company, from its board, management, financials, products and future opportunities and all done with the backdrop of what is happening in the broader global and local economy and expected consumer behaviours.

Every now and then something very left field will throw all these carefully reviewed strategies out.  We saw it in March 2020 when the world realised there was a dangerous new coronavirus circulating, and we saw it again this year with rising tensions in Russia and Ukraine and the eventual invasion of Ukraine on the 24^th of February.

Now if you are sitting in a passive or index fund (we do hold a portion of these in our growth assets) you reflect the whole market so shares that might have been out of favour on the anticipated scenario might suddenly become far more valuable.

A good example is Woodside Petroleum (WPL).  Back on the 14 Feb 2022 its price was $27.31 and despite being a very well-run company, given the anti-fossil fuel sentiment, did not have a great growth profile and is less diversified than a stock like BHP. Over the last two months its price has risen as high as $34.36 (5^th March 2022) and is sitting at $32.06 today (13 April 2022).  Even at todays’ price that is a 17% rise over two months.  WPL is Australia’s 15^th largest company by market capitalisation. You would have benefited from this in our passive strategies but our active Australian equity managers were not holding it.

Energy stocks, gold stocks and armaments are all seeing a bounce and yes there is an argument that our active managers should pivot to this new scenario but they would then be buying shares that are even more expensive than when they didn’t want them and their longer term profile hasn’t changed.

They would argue, and we would agree, that we are moving into a rising interest rate environment, ongoing supply chain issues, inflation, increased trade barriers and deglobalisation.

Banks have done well in this quarter but rising interest rates would not usually support earnings growth as they are very reliant on mortgages.  Defaults and a consequential softening of property markets won’t help them and solid dividends might be offset by capital losses in the underlying share price in the medium term

An active manager, like Hyperion, would argue healthcare, technology, communications and consumer cyclicals are more resilient and have better earnings potential in a slowing economy along with reduced government stimulus.

I know this all sounds a bit like ‘trust us’ and yes it is. 

The reason you had strong outperformance over the last seven years is that we find best of breed managers to include in the various sectors within your portfolio. We do question and challenge them and will change them if we believe their style is not appropriate in the next cycle.  These mangers have been here before and have very strong convictions about their holdings and their positioning for the coming cycle.

On March 31^st 2022 we added a ‘Top Twenty’ portfolio option to our Australian Equity managers to increase our exposure to large stocks but this is more to smooth the volatility than a vote of no confidence in our active managers.

The below is our AAN Core portfolio relative to the S&P/ASX All Ordinaries Index (All Ords). In theory, the All Ords should have outperformed our Core which is only 65% growth assets but the underlying managers and balance of assets has delivered stronger performance and less volatility, other than this last four months.

The next ten years will not be the same as the last.

The GFC started in 2007 and really hit in 2008. We saw massive government stimulus and very low interest rates that have fuelled asset prices even before the increased stimulus we saw through the pandemic.

• Interest rates are on the rise, here and overseas.
• Inflation will be a driver and while supply chains are part of the inflationary mix, wages growth – no matter which government we have – will start having an impact.  Unemployment rates at lower than 4.0% is great but that puts pressure on wages as the fight for talent increases (don’t tell our staff).  This is basically full employment in economic terms as it includes people who are eligible to work but are studying or upskilling and those that simply can’t work.

There is a fair to good chance that the Eurozone will have a technical recession over the first two quarters of calendar year 2022 and they are forecasting inflation rates of 8% annually with some months having double digit inflation during this conflict.

German inflation hit 7.6% for March (expected was 6.7%) and Spain had a March Quarter inflation rate of 9.8%.

The US unemployment rate is 3.6% and their March Quarter inflation rate was just announced as 8.5%.

The annual inflation rate in Australia at 31 March 2022 was 3.5% but it is increasing.

This is reflected locally in our government bond yields.  The government issues a bond to fund its excess spending or debt – basically you lend the government money and they pay you an interest rate (yield) and then when that bond matures you get your capital back.  If the government issues a bond with a yield that the market thinks is too low they simply won’t buy it as they can get better yields off other debt instruments like corporate bonds.

• Six months ago, Australian 5 Year Government Bonds were being issued with a yield of 0.77%. If you invested in one today (13 April 2022) the yield is 2.756%.
• The RBA may have the cash rate at 0.10% but that is not indicative of what is happening in Mortgage rates. 

In markets like this you want companies with strong cash flow, recession proof products and low debt.

Yes we are sticking to our knitting but we have definitely not taken our eye off the ball.

As always, if you have any concerns please do not hesitate to contact us.