In this extract from our June 2021 Quarterly Commentary, Julian Morrison, CFA, our Head of Research Relationships and National Key Accounts, reviews the performance of the Allan Gray Australia Funds. Click here to read the full Quarterly Commentary.
Allan Gray Australia Equity Fund
The Australian sharemarket had a strong quarter to June, with the S&P/ASX 300 Accumulation Index up 8.5% for the quarter. The Allan Gray Australia Equity Fund returned 0.5% during the same period, underperforming its S&P/ASX 300 benchmark by 8%.
The June quarter saw investor preferences return to the extremes of recent years, after a brief hiatus, pushing various market darlings to even more overpriced levels. At the same time, out-of-favour companies (many of them cyclically-exposed) are being shunned and remain amongst the most attractive opportunities, in our opinion.
After contributing strongly in the previous two quarters, the Fund’s overweight positions in the Materials and Energy sectors were the largest detractors from relative returns from a sector perspective during the June quarter. Within Materials, the Fund’s exposure remains very different from the benchmark. Incitec Pivot, Alumina and Newcrest Mining were amongst the largest detractors. We added to these positions over the quarter as lower prices presented buying opportunities. Elsewhere in the Materials sector, recycling company Sims bucked this trend and we lightened our holding on its recent strength.
Energy companies such as Woodside Petroleum, Oil Search and Origin Energy have remained undervalued and, therefore, appealing in our opinion. We have also added to some of these on recent underperformance.
The Financials sector also detracted from performance overall for the quarter. Among the underperformers were AMP and ANZ, which we continue to view as offering good value. QBE was one of the Fund’s larger financial holdings that performed very strongly. We took advantage of higher prices in QBE and other strong performers, and the successful takeover of hygiene company Asaleo Care, to fund opportunities in more depressed names.
We believe recent years have seen extremes in both investor behaviour and dispersion between loved and unloved shares. This remains the case today and presents unusually significant risk, and opportunity, of a shift in future outcomes versus current expectations – the risk of overpaying and the opportunity to underpay. To paraphrase the late economist Rüdiger Dornbusch:
“The [shift] takes a much longer time coming than you think, and then it happens much faster than you would have thought.”
We acknowledge that we reiterate our focus on valuation and patience at the risk of sounding boring to our investors. But we find that immeasurably preferable to the alternative – capitulating on that discipline and risking permanent loss of capital. We see significant latent unrealised value in the Fund versus the market, and thus remain optimistic regarding future long-term prospects.
Allan Gray Australia Balanced Fund
The Allan Gray Australia Balanced Fund returned 2.3% for the quarter, underperforming its composite benchmark by 3.9%.
While the overall allocation to shares contributed positively to absolute performance, stock selection in both Australian and global shares detracted from relative returns.
The Fund had 68% in shares at quarter-end. This is after accounting for about 7% of the global share exposure being reduced through the use of exchange-traded derivatives, which allows for some protection in those periods where market indices fall.
The Fund held around 20% in fixed income securities and a 5% exposure to gold through an exchange-traded fund at quarter-end. The fixed income allocation has remained significantly shorter in duration than the benchmark – at below two years versus almost eight years for the benchmark. This means the fixed income holdings will not perform as well as the benchmark when government bond yields fall – and this was the case in the June quarter.
However, it also means that the fixed income portion of the Fund remains more defensively positioned than the benchmark (in terms of both relative and absolute returns), in the event that interest rates rise from current historically low levels.
As with the Equity Fund, we believe potential portfolio value relative to the market is significant and we continue to manage for risk with a long-term, valuation-driven perspective.
Allan Gray Australia Stable Fund
The Allan Gray Australia Stable Fund returned -0.1% for the quarter, underperforming its RBA cash rate benchmark by 0.1%.
The performance of the Stable Fund is driven by the performance of our favoured Australian share holdings and the decision on how much is invested in shares versus cash. The broad Australian sharemarket has risen strongly for three consecutive quarters now and reached all-time highs in June. The Fund took advantage of the recent strength to lighten some of our stronger-performing positions.
At the end of June, the Fund had around 29% invested in ASX-listed securities, versus around 35% at the end of the previous quarter. The remainder is held in cash and money market investments. This can be seen in the graph below, which shows our allocation between cash and shares over time.
The extreme strength in the sharemarket during the June quarter fails to highlight the significant divergence that has built up over time between different categories of shares. Some popular shares and sectors are priced at levels that in our view are far too optimistic. We therefore remain focused on avoiding those areas and the risks that come with excessive valuation. Instead, the shares held in the Fund will be those we have assessed as most attractively priced, where we see the risk of permanent capital loss to be lower.
Stable Fund share weighting – share allocation rises where we see value in shares
Source: Allan Gray, Bloomberg, as at 30 June 2021.
Julian Morrison holds a Bachelor of Arts (Honours – University of Sheffield) and the Chartered Financial Analyst designation.