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Australian Shares Core PortfolioQuarterly Update December 2015
The Core Portfolio returned 6.2% in December quarter, slightly trailing S&P/ASX 200 Accumulation Index's 6.5%. It was a tumultuous year which saw the portfolio post a negative 1.8% return compared to positive 2.6% for the benchmark. Our underweight to energy was the largest industry contributor in the quarter while underweight to banks was the largest detractor, although the latter have retraced materially in January's chaotic first few weeks. Still 2015 was a challenging year for the Core strategy.
There is no shortage of phenomena to worry about at present. Plummeting commodity prices, weakeninghome prices, one of the worst starts to a year for equity markets, smouldering currency wars, and a planet that is literally the hottest it has ever been. Anyone not at least mildly uncomfortable is blissfully unaware. This uncertainty is typically an environment where value is discovered, but the pain has been concentrated in lower quality sectors while many of the companies we'd like to own remain stubbornly expensive.
Commodity prices are an important part of Australia’s well-being. The positives of this are relatively well-known — expanded employment, capital inflows, asset price appreciation, and economic growth to name a few. What a difference a year or two can make, as we now experience the other side of the coin. Expanding commodity production at any cost turns out to have been an egregious and permanent destruction of capital for many firms. Seemingly limitless demand from China for raw materials has actually started to decline in spots, turning the commodity industry, and countries dependent on it, upside down to varying degrees. It is no surprise to us that the resources sector is volatile and lacking in competitive advantages (economic moats), but the sheer voracity of the demise has surprised even our generally sceptical view of the space.
With the Australian equity market down a fair amount, we are doing what we should given our long-term valuation-driven approach — looking for mispriced opportunities. Unfortunately, less attractive businesses have driven much of the decline supplemented in no small part by the big four banks which are still uncomfortably large index constituents and facing problems of their own, such as regulation, rising bad debts, and a tenuous housing market. Meanwhile, the more defensive quality companies have held or even gained ground. Healthcare, property, and industrials with foreign currency earnings, for example, seem to have gone from loved to uncomfortably crowded trades in some instances. Nonetheless, we stay the course and search for value hoping for uncertainty to put sales tags on our watch list companies.
The upcoming earnings season could be one of the more interesting compared to the last few years, given the dislocations that have already occurred and others that seem on our doorstep. A few issues we are watching closely that might stir value in the not-to-distant future are tangential impacts of the resources collapse, a potential disorderly weakening in home prices, and disruptive currency fluctuations.
Currency is likely to be a critical factor in Australia during the next couple of years. Recent inflation figures suggest wages are stagnating while overall inflation rises, partly due to the things we import becoming more expensive as a result of Aussie dollar weakness. A lower Aussie dollar is often seen as a panacea fix, but going from currency strength to weakness and its myriad implications can rarely be smooth, not to mention there isn't much left of Australia's manufacturing base to be restarted.
Tourism from China has no doubt grown, but devaluation of the yuan seems a reasonable stimulus to the slowing Chinese economy. This could not only slow the flow of sightseers but could also compound theslowing Australian housing market, particularly in light of stricter Chinese capital controls. The old adage "May we live in interesting times" has been granted in spades as a belated gift. We look forward to new investment opportunities in the year ahead.
Australian Shares Core Portfolio Quarterly Update December 2015
Core Portfolio - Complete List of Holdings
Portfolio Date: 31/12/2015
CodeStyle Box
EconomicMoat
FairValue
Uncertainty
PortfolioWeight
%
Australia and New Zealand Banking Group LtdWestpac Banking CorpVeda Group LtdNational Australia Bank LtdResMed Inc DRCash AccountBHP Billiton LtdQBE Insurance Group LtdPlatinum Asset Management LtdWesfarmers LtdWestfield CorpWoolworths LtdCSL LtdBrambles LtdCrown Resorts LtdTelstra Corp LtdComputershare LtdGoodman GroupTrade Me Group LtdAnsell LtdAlumina LtdIluka Resources LtdQube Holdings Ltd
ANZ Ç Wide Medium 8.2WBC Ç Wide Medium 7.6VED Ì Wide Medium 6.7NAB Ç Wide Medium 5.6RMD Ë Narrow Medium 5.6
5.4BHP È None High 5.2QBE È Narrow High 5.1PTM Ì Narrow Medium 4.6WES È Narrow Medium 4.5WFD É Narrow Medium 4.5
WOW Ç Narrow Medium 4.3CSL É Narrow Medium 3.7BXB É Wide Medium 3.3
CWN É Narrow High 3.3TLS È Narrow Medium 3.3CPU Ë Narrow Medium 3.2
GMG É Narrow Medium 3.1TME Ê Wide Medium 3.1ANN Ë Narrow Medium 2.7AWC Ì None Very High 2.6
Aust Shares - Core 31/12/2015 S&P/ASX 200 TR 31/12/2015
Note dividends for Trade Me are imputed for New Zealand residents. Australian residents receive unfranked dividends with a supplementary payment.Morningstar Investment Committee members own the following securities held by the portfolio: AWC, BHP, NAB, QBE, STO, TLS, WES
The above chart shows the portfolio and index style mix. The shaded area is the region in which 75% of the portfolio's holdings fall.
The above chart shows the portfolio and index style mix over time, the smallest dot representing the earliest date.
Australian Shares Core Portfolio Quarterly Update December 2015
Transactions in the Quarter
During the December quarter, there were three transactions in the Core Equity Portfolio. Qube Holdings was purchased, while Santos and our Westpac entitlements were sold. The net impact was a small reduction of our resources exposure and overall positive contribution to performance, particularly with Santos halving in price since.
Sold Westpac Banking Corporation entitlement rightsWestpac Banking Corporation raised equity to meet capital requirements related to various APRA requirements, including increased residential mortgage risk weights. Similar to peers, Westpac is working toward achieving "unquestionably strong" status to help ensure Australian financial system stability through the economic cycle. While the Westpac business was generally performing well and was undervalued according to Morningstar, we sold our rights on-market as we already have material exposure to the big four banks in our strategies.
Exited 3.1% position in SantosAs severe intrinsic value dilution either via discounted equity raisings or asset sales became probable, our analyst moved the Santos moat rating to none, increased the uncertainty rating to very high, and sharply reduced the fair value estimate, revealing a stock that has no place in the portfolio. Thus far the downside risks we feared when exiting the position have played out. Santos has limited control over its balance sheet at this stage and potential requirements for additional dilution are worrisome given its already leveraged position as oil prices have plummeted.
Initiated Qube Holdings position at 2%Later in the quarter, we used part of our cash balance to initiate a position in Qube Holdings. Qube has a narrow moat, medium uncertainty, and was trading at about a 20% discount to intrinsic value according to the Morningstar Equity Research analyst. We see great long-term potential for this company although also expect short-term pain in the next year or two as its resources facing earnings come under heavy pressure.
Qube's share price has fallen largely due to mining exposure, primarily via its Ports & Bulk division. While this business segment is generally more exposed to commodity volumes rather than prices, the particularlyacute and deep decline in iron ore, oil, and gas prices mean that marginal producers are no longer profitable, causing them to shutter production or negotiate lower transport costs, regardless eating into Qube's future cash flow. It's hard to say whether the resources bloodbath is complete. We suspect it isn’t but believe the downside is sufficiently priced into Qube's shares to take an initial stake.
More importantly, we buy into the long-term opportunity that Chairman Chris Corrigan has been pursuing for decades which is to improve the logistics of international trade with Australia. There are several projects in the pipeline but the largest is Moorebank which once completed will become Australia’s largest inland intermodal terminal. As long as international trade continues to rise (on average) over time, which seems a sure bet to us, then the services and infrastructure Qube offers, owns, or controls, will rise in value.
There has been extensive press on Qube's aggressive pursuit of Asciano's assets, namely the former Patrick Corporation that Corrigan and team built years ago. We're not overly fussed about the outcome as long as Qube management keep prudence in front of legacy and avoid an all-out bidding war. Depending on how this and other projects proceed, or how deep the commodities rout ultimately becomes, we can't rule out a discounted capital raise at some point. However, if the long-term outlook remains intact, we'll be happy to increase our stake, all else equal.
For more information about these companies or any portfolio holding, please read the Morningstar Equity Research reports.
Australian Shares Core Portfolio Quarterly Update December 2015
Quarter Performance
The Core Portfolio rose 6.2% in the December quarter compared with a 6.5% increase for the benchmark, underperforming by 0.1%. Platinum, Crown, and Trade Me were the largest contributors while CBA, BHP,and Westfield were the largest detractors. From an industry perspective an underweight to energy contributed while an underweight to banks detracted.
Contributors:Platinum (overweight) outperformed nicely in the quarter. Capital requirements in the business are virtually nil with nearly all earnings paid as dividends leading to an attractive dividend yield. The stock has retreated in early 2016 with equity markets and probably due to its China exposure, but we're still fans of this business long term, particularly given that management smartly put on yuan hedges as devaluation becomes probable.
Crown (overweight) moved from detractor to contributor with increasing signs that James Packer, majority owner of the company, is likely to make a bid for some or all of its assets. This information helped to partly reverse what has been a tough year for the shares as the Macau business struggles with rapid declines in turnover following China corruption crackdowns. Lapping tough comparables in Macau or additional information regarding Packer's intentions could be near-term catalysts.
Trade Me (overweight) recovered from undue pessimism in the quarter, as a strong franchise, reasonable valuation and attractive yield brought demand for its shares. Now trading slightly above fair value, there's less upside potential remaining, but it is a good company that we're happy to hold.
Detractors:Commonwealth Bank of Australia (underweight) bounced in the quarter dragging up the market given its very large weight. We don't own Commonwealth Bank in the Core Equity Portfolio because of concerns that it is being priced at an abnormally large premium to peers, regulatory headwinds, mounting home price pressures, and because of our desire to demonstrate greater diversification than the benchmark which holds about 10% in Commonwealth Bank. We readily acknowledge Commonwealth Bank is the highest quality of the big four banks but its valuation seems to more than reflect this characteristic.
BHP Billiton (overweight) shares were hammered in the quarter. Falling commodity prices across the board, uncertainty around China growth and demand going forward, and the unfortunate Samarco disaster were a perfect storm for this former stalwart. While there is likely value in the shares, we're substantially less enthused given the material downgrades to fair value and moat ratings put through by the MorningstarEquity Research team.
Westfield (overweight) shares fell about 12% in the quarter. We continue to like the shares as a result of high quality properties and the diversification benefits for the portfolio from its offshore earnings.
Risk-Reward
Time Period: 1/08/2004 to 31/12/2015
Std Dev
0.0 3.0 6.0 9.0 12.0 15.0 18.0
0.0
2.0
4.0
6.0
8.0
10.0 Aust Shares - Core
S&P/ASX 200 TR
Retu
rn
Aust Shares - Core - Market Performance
Time Period: 1/08/2004 to 31/12/2015
Inv Bmk1
Up Period Percent
Down Period Percent
Best Month
Worst Month
Best Quarter
Worst Quarter
Up Capture Ratio
Down Capture Ratio
62.04 63.50
37.96 36.50
9.19 7.98
-12.66 -12.61
23.45
-15.94
21.50
-18.25
100.00
97.21
96.64
100.00
Risk
Time Period: 1/08/2004 to 31/12/2015
Inv Bmk1
Return % pa
Std Dev
Downside Deviation
Alpha
Beta
R2
Sharpe Ratio (arith)
Tracking Error
8.30
13.74
8.18
13.95
0.00
0.00
3.68
5.08
1.00
0.00
100.00
0.26
0.15
0.95
87.01
0.25
Performance Relative to Peer Group (one month lag)
Peer Group (5-95%): All Managed Investments - Australia - Equity Australia Large Blend
Top Quartile 2nd Quartile 3rd Quartile Bottom Quartile
Australian Shares Core Portfolio Quarterly Update December 2015
Sector and Industry Weightings Analysis
Our transactions in the quarter leave the portfolio with no direct energy exposure (exited Santos) and a mildly larger industrials allocation (added Qube).
Health care is still our largest sector overweight position, driven by ResMed, CSL, and Ansell. The health-care weighting is meant to leverage the themes of increasing wealth, standards of living, and longevity, as well as the steadily ageing population.
The consumer staples sector is another overweight position due to Woolworths and Wesfarmers. We have high confidence in the competitive advantages of Wesfarmers. The unfortunate state Woolworths finds itself in can partly be attributed to its own severe missteps but Wesfarmers management deserves a good chunk of credit for its exceptional execution. We're not expecting a turnaround in the short term at Woolworth’s, but given valuation, we think it's worth holding on a long-term view.
Our largest sector underweight position is to financials, reflecting an underweight in banks, although our exposure to the "big four" is still large in absolute terms. In the last year or so, we increased the diversification of our financials holding, away from banks, with the addition of Platinum Asset Management and an increased weighting to Veda Group, the latter set to be acquired shortly. These complement holdings in Westfield Corporation, Goodman Group and QBE Insurance Group. Our property exposures of WestfieldCorporation and Goodman Group are more growth-orientated and global facing. Both bring internationalexposure and benefit from a falling Australian dollar.
14 Insurance Australia Group Ltd Stock -0.98 7.90 -0.07
15 Macquarie Group Ltd Stock -2.04 3.51 -0.07
Returns Relative to Benchmark
As of Date: 31/12/2015
3 month YTD 1 year 3 years 5 years Since inception (29/07/2004)-4.0
-2.0
0.0
2.0
4.0
6.0
8.0
10.0
6.2
-1.8 -1.8
5.8 6.17.5
6.5
2.6 2.6
9.2
7.08.3
Aust Shares - Core S&P/ASX 200 TR
Retu
rn
Performance measures are expressed net of fees, gross of costs and taxes are deducted. Dividends are reinvested in the portfolio. The performance displayed is for the Australian Shares Core Portfolio and represents modelled performance only. This performance will differ from actual performance depending on factors such as transaction timing and any divergence from constituent weightings.* Where inception date is not the beginning of a month, returns are calculated using a start date which is the first day of the month following inception.
Australian Shares Core Portfolio Quarterly Update December 2015
Portfolio Mandate and Typical PositioningInvestment Methodology and Process
Core Portfolio StrategyThe Australian Shares Core Portfolio is an actively managed concentrated portfolio consisting of our best ideas in the S&P/ASX 200 Index. The portfolio is constructed with a focus on long-term fundamental value and bias toward businesses with sustainable competitive advantages (economic moats) and predictable cashflows.
Total return from the Core Portfolio will tend to be driven by both capital appreciation and dividend yield with the mix dependent on the opportunities available. Core holdings may overlap with our Income, Growth, and Sustainable Portfolios with the style bias driven by the relative value offered by market prices. Investors in the Core Portfolio simplify their investment decision process by outsourcing the style tilt to Morningstar. Relative value is largely determined by comparing prevailing stock prices to our research team’s price/fair value estimates. The Core Portfolio has a strong bias toward companies with an economic moat and more predictable cash flows (lower uncertainty). This approach helps ensure preservation of capital, low turnover, and reduced volatility while pursuing excess returns.
Investment Strategy Committee ProcessThe equity portfolios are managed by their portfolio managers and our eight-person investment strategy committee which comprises selected members of the equities research team. Committee meetings reinforce rigor and consistency of research methodology through collaborative debate on proposed and existing holdings. A constant feedback loop between Morningstar’s research team and investment committee members leverages team strengths in vetting stock calls and portfolio holdings. This constant cycle strengthens team culture, expertise and ratings, minimising key-person risk and common behavioural pitfalls.
The committee is experienced and well-resourced, ensuring stability and succession planning. Representation from each sector team ensures cross-market expertise. Committee members have average industry experience of 17 years and average tenure with Morningstar of 10 years. We are not averse to an occasional portfolio manager change, as the driving forces behind our portfolio construction process are our bottom-up research and investment committee overlay.
In-depth research by our large, global, and experienced analyst team is the bedrock of our portfolio management process and facilitates our high conviction investments. We have more than 100 equity andcredit analysts globally, covering around 1,700 stocks and 700 debt issuers, making us one of the largest independent research teams in the world. Our 20 Australian and New Zealand-based analysts cover about 230 Australian and New Zealand stocks which includes extensive research reports, timely event analysis, actionable special reports, and deep discounted cash flow modelling on every company. This is complimented by our local credit research to help us assess the complete capital structure and preserve capital while pursing upside opportunities.
This document is issued by Ibbotson Associates Australia Limited (ABN 54 071 808 501, AFS Licence No. 228986) (‘Ibbotson’). Ibbotson is a member of the Morningstar group of
third party information providers. Whilst all reasonable care has been taken to ensure the accuracy of information provided, neither Ibbotson, Morningstar nor their third party
information providers accept responsibility for any inaccuracy or for investment decisions or any other actions taken by any person on the basis or context of the information included.
Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar or your adviser. Past performance is not a reliable
indicator of future performance. Neither Ibbotson nor Morningstar guarantees the performance of any investment or the return of capital. The information provided is general advice only
has been prepared without reference to an individual person’s objectives, financial situation or particular needs. You should consider the advice in light of these matters and if
applicable the relevant disclosure document before making any decision to invest. To obtain advice tailored to your situation, individuals should contact a professional financial adviser.
For a copy of the relevant disclosure document, please contact our Distribution Team on 02 9276 4550. Some material is copyright and published under licence from ASX Operations
Pty Ltd ACN 004 523 782.
Portfolio Overview An actively managed portfolio of Australian equities, with a focus on companies with economic moats that are trading at
relatively attractive valuations.
Sector Specialist Managed Accounts
Asset Allocation Return Objective Time Horizon Risk Profile
Growth
Assets %
Defensive
Assets %
Australian Shares
Core
S&P/ASX 200 Accumulation Index 7 years High 100 0
Australian Shares
High Yield
S&P/ASX 200 Accumulation Index 7 years High 100 0
Australian Shares
Small Cap
S&P/ASX Small Ordinaries Accumulation Index 7 years Very high 100 0
Property
S&P/ASX 200 REITs Accumulation Index 5 years High 100 0
Global Shares MSCI ACWI Accumulation Index
(Net Dividends Reinvested)
7 years High 100 0
Cash
Bloomberg Australian Bond Bill Index 2 years Very low 0 100
This document is issued by Ibbotson Associates Australia Limited (ABN 54 071 808 501, AFS Licence No. 228986) (‘Ibbotson’). Ibbotson is a member of the Morningstar group of
third party information providers. Whilst all reasonable care has been taken to ensure the accuracy of information provided, neither Ibbotson, Morningstar nor their third party
information providers accept responsibility for any inaccuracy or for investment decisions or any other actions taken by any person on the basis or context of the information included.
Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar or your adviser. Past performance is not a reliable
indicator of future performance. Neither Ibbotson nor Morningstar guarantees the performance of any investment or the return of capital. The information provided is general advice only
has been prepared without reference to an individual person’s objectives, financial situation or particular needs. You should consider the advice in light of these matters and if
applicable the relevant disclosure document before making any decision to invest. To obtain advice tailored to your situation, individuals should contact a professional financial adviser.
For a copy of the relevant disclosure document, please contact our Distribution Team on 02 9276 4550. Some material is copyright and published under licence from ASX Operations
Pty Ltd ACN 004 523 782.
Diversified Managed Accounts
Asset Allocation Return Objective Time Horizon Risk Profile