Quarterly Fund review – September 2021
In this extract from our September 2021 Quarterly Commentary, Julian Morrison, CFA, our Investment Specialist, 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 positive quarter to September, with the S&P/ASX 300 Accumulation Index up 1.8%. The Allan Gray Australia Equity Fund returned 5.5% during the same period, outperforming its benchmark by 3.7%.
On a monthly basis, the S&P/ASX 300 Accumulation Index fell 1.9% in September. This was the first negative calendar month performance for the broad market in 12 months! In contrast, the Fund rose in this falling market. Undervaluation can be a powerful force as recognition spreads and imbalances are uncovered.
When markets correct imbalances, the pace of adjustment may vary widely. Timing investment decisions in this environment is a challenging game. That is why the closest we get to investment timing is to ask “which stocks look particularly good value, at this particular time”? Sometimes we have to wait very patiently for our decisions to play out. While we may have seen a positive shift in September, we believe this is a small start, and tremendous opportunity remains as the market adjusts from a position of extreme imbalance.
During the quarter, positioning in the Materials sector was the biggest positive contributor. This is remarkable given Materials was by far the worst performing sector overall. Notably, the Fund held zero exposure to the large iron ore miners, which fell heavily. Meanwhile, positions in Alumina, Incitec Pivot and South32 all contributed strongly to relative performance for the quarter. Newcrest Mining and Sims, on the other hand, detracted and we added to those positions on weakness.
Within the Energy sector, Woodside Petroleum, Oil Search and Origin Energy all contributed positively for the quarter. However, we believe these remained significantly underappreciated by the market, and so the Fund continues to hold meaningful positions here. We also added further to engineering services company Worley, which underperformed for the quarter.
The Financials sector was mixed, with outperformance from QBE and NAB offsetting underperformance from stocks such as ANZ and AMP. Within Financials, the banks have performed strongly over the last year. With the rise in share prices, we believe the prospective appeal has reduced versus the potential risk. During the quarter, we therefore reduced positions in the banks, reallocating to more attractive opportunities. These have included other Financials such as QBE and Challenger, as well as stocks in other sectors.
The last quarter may have hinted at a much larger adjustment to come, for a market that we believe is still woefully unbalanced. Risk in investing is deceptive, and may eventuate in places where it appeared to be absent. Today those places are a wide array of very popular, very expensive stocks, which seem to be viewed as incapable of disappointing. But disappointment doesn’t require things to go bad – just a little less great than expected.
The focus on valuation and patience is critical at a time when many are capitulating on that discipline. The risk of piling into today’s winners is, in our opinion, much greater than seems to be appreciated. Counter to this, we have positioned the Fund where we see significant latent unrealised value, and thus we remain optimistic regarding future long-term prospects for outperformance.
Allan Gray Australia Balanced Fund
The Allan Gray Australia Balanced Fund returned 2.4% for the quarter, outperforming its composite benchmark by 0.3%.
The allocation to shares contributed positively to absolute performance, with stock selection in Australian shares contributing positively, while stock selection in global shares detracted slightly 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 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 interest rates rise from current historically low levels. Longer-term interest rates did indeed rise during the quarter, and we believe this position continues to be prudent.
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 2.2% for the quarter, strongly outperforming its RBA cash rate benchmark by 2.2%.
The performance of the Stable Fund is driven by the performance of our favoured Australian security holdings and the decision on how much is invested in these listed securities versus cash. The broad Australian sharemarket has risen strongly for four consecutive quarters now, and remains not far from all-time highs in June. The Fund took advantage of the recent strength to lighten some of the positions that have risen to around fair value or beyond. We have also maintained positions in some stocks which have risen, but which are still significantly below fair value.
As at the end of September, the Fund had around 35% invested in ASX-listed securities (of which around 32% was shares and almost 3% selected hybrid securities). The remaining 65% is held in cash and money market investments. This can be seen in Graph 1, which shows our allocation between cash and ASX-listed securities over time.
The extreme strength in the sharemarket during the last year fails to highlight the significant divergence that has built up over time between different categories of stocks. Some popular stocks 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 and where we believe the risk of permanent capital loss is low.
Graph 1: Stable Fund listed security weighting – allocation rises where we see value in listed securities
Source: Allan Gray, Bloomberg, as at 30 September 2021.
Julian Morrison holds a Bachelor of Arts (Honours – University of Sheffield) and the Chartered Financial Analyst designation.