In this extract from the September 2020 Quarterly Commentary, Julian Morrison, CFA, 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 rose in July and August, but was notably weaker in September, giving back the earlier gains. The Fund’s benchmark, the S&P/ASX 300 Accumulation Index, was down 0.1% for the quarter. The Allan Gray Australia Equity Fund (Class A) underperformed its benchmark by 4.6% during the period.
In a reversal from the prior quarter, our overweight position in the Energy sector was the largest detractor from returns. This includes stocks such as Woodside Petroleum and Oil Search. Performance from the Materials sector was also negative overall, with Alumina and Sims detracting from relative performance. We continue to view companies such as these as offering particularly attractive value relative to the market, strong balance sheets and sustainable businesses.
Elsewhere, exposure to Financials was negative for relative performance, with the sector generally weaker than the market during the quarter, including holdings such as National Australia Bank and AMP.
The strongest positive contributor to returns during the quarter was residential land developer Peet. Also amongst the top positive contributors were stocks within the otherwise unloved Energy and Materials sectors – Worley and Incitec Pivot.
While the shorter-term underperformance is challenging, we firmly believe that now it is as important as ever to remain focused on valuation discipline. History shows that getting drawn into popular trends for short-term comfort is more likely to result in overpaying and long-term disappointment. As such, we continue to avoid areas we see as particularly overvalued (for example many of the staples, utilities, healthcare and technology names). Instead, we continue to hold positions in companies that are less favoured by the consensus, but that we believe have sustainable business models and that offer great value in a distorted market.
Allan Gray Australia Balanced Fund
The Allan Gray Australia Balanced Fund underperformed its composite benchmark by 2.4% for the September quarter.
The Fund had 69% in shares at quarter end, though about 7% of the global share exposure is reduced through the use of exchange-traded derivatives, which allows for some protection in those periods where market indices fall. The Fund has been overweight global shares versus global fixed income. This detracted from relative performance for the quarter, as global shares underperformed fixed income. In addition, stock selection in both the Australian and global shares detracted from relative returns. This follows a continuation of the trends mentioned above, which we believe results in extreme dispersion in valuations. In turn, we believe the current portfolio is particularly attractive versus the benchmark in terms of both prospective return and risk.
The Fund held around 22% in fixed income securities and 6% in gold (via an ETF) at quarter end. The fixed income allocation has remained significantly shorter in duration than the benchmark – at below one year versus almost eight for the benchmark. This had limited impact on the Fund for the September quarter, with government bond yields generally flat during the quarter. The Fund remains more defensively positioned than the benchmark in terms of both relative and absolute returns, in the event interest rates rise. The exposure to gold contributed positively to performance for the quarter and provides some diversification to the overall portfolio.
Allan Gray Australia Stable Fund
The Allan Gray Australia Stable Fund underperformed its cash rate benchmark by 1.7% for the September quarter.
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. Having added to share exposure earlier in the year, the Fund took advantage of weakness during the September quarter to add selectively to shares assessed as offering great value.
As at the end of September, the Fund had around 31% invested in shares, with the remainder in cash and money market investments. This can be seen in the graph below, which shows the Fund’s allocation to shares over time.
The broad Australian sharemarket remains some way from its previous high. However, the market average fails to highlight that 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 that we have assessed as most attractively priced and where risk of permanent capital loss is low.
Graph: Stable Fund share weighting – share allocation rises where we see value in shares
Source: Allan Gray, Bloomberg, as at 30 September 2020.
Julian Morrison holds a Bachelor of Arts (Honours – University of Sheffield) and the Chartered Financial Analyst designation.