The portfolio recorded a gross return of -12.4% for the year ended 31 December 2022, underperforming the benchmark ASX 200 Accumulation Index’s return of -1.1%.

2022 was a challenging year for the portfolio. Our style of investing naturally lends itself to being underweight carbon-intensive sectors like Materials and Energy (which performed well over the year) and to being overweight in future growth sectors like Information Technology and Healthcare (which were negatively impacted by broad market sell-offs in high growth stocks as central banks moved interest rates higher to combat inflation).

Despite this, we have not wavered from our view that our ethical investment approach delivers attractive returns over the long-term, and we have therefore maintained a consistent approach to portfolio construction during this time. We continue to look for attractively valued stocks with good management teams, strong balance sheets, and recurring revenue models that deliver growing cash flows over time.

At a sector level, Financials was the strongest performing sector for the portfolio over the 12 months. The portfolio’s slightly overweight position relative to the benchmark was positive as the Financials sector was one of the best performing sectors in the non-Resources space. However, stock selection was the biggest driver of performance, with overweight positions in insurance stocks (SUN, IAG, NHF) performing well and Helia (HLI) buoyed by a contract renewal with CBA and strong financial results. The portfolio’s Bank exposures were broadly neutral through the year.

A significant headwind for the portfolio came from the strong performance of the Materials (+13%) and Energy (+50%) sectors, which together accounted for approximately half of the portfolio’s underperformance relative to the ASX 200. In line with our ethical screening approach, the portfolio’s weighting in these two sectors is just 5%, well below the 30% combined index weighting. Strong gains were made in these sectors as investors looked for inflation protection, while the war in Ukraine contributed to energy price spikes. The portfolio’s exposure to lithium provided some benefit to the portfolio over the year as lithium raw material prices spiked to record highs, however, sentiment began to turn towards the end of the year, offsetting some of this benefit.

The Information Technology sector (-34%) had a difficult 12 months, as interest rate increases to combat growing inflation drove equity investors away from high growth stocks with longer-dated cash flows. The portfolio’s exposures in this sector tend to be some of the smaller cap names where we see the biggest long-term potential. This segment of the market was hit even harder as the market looked for relative safety in larger cap stocks. As a result, the IT sector was the portfolio’s biggest detractor from performance in 2022.

Australian Shares SMA Portfolio Performance

As at 31 December 2022^*

^Benchmark: S&P/ASX 200 Accumulation Index. Past performance is not a reliable indicator of future performance.

Inception date: 16/04/2020. Source: Praemium portal.

Contributors and detractors

Contributors

• Helia Group (HLI), a major provider of lenders mortgage insurance, produced strong results during 2022. Despite rising interest rates, the company continues to experience low levels of claims. The strong capital position of the company has allowed it to return capital to shareholders via attractive dividends and buybacks.

• Meridian Energy (MEZ) was the second-best contributor to the portfolio’s performance, returning 15.1% over the year. MEZ is one of the largest ‘Gen-tailers’ in New Zealand, with 100% renewable electricity generation in the form of hydro and wind power. MEZ started the new financial year well with strong hydro inflows and South Island storage at 138% of average levels in early December. As a result, MEZ is on track for record 1H earnings. The medium-term outlook also appears favourable for MEZ as it appears likely that the NZ Aluminium Smelter owned by Rio Tinto will stay beyond the current 2024 end date of the contract. Combined with the NZ Government’s focus on decarbonising the economy and MEZ’s efforts in stimulating additional sources of demand, it appears that MEZ has a long-term pathway of earnings growth ahead of it.

Detractors

• EML Payments (EML), a fintech company offering a broad range of global payment solutions, was the largest detractor. Its problems intensified with their UK regulator now restricting new business while compliance issues are investigated.

• Domain (DHG) was the second biggest detractor from portfolio performance during the year, declining 52.4% over the 12 months. DHG is the #2 online real estate portal in Australia, serving the residential and commercial sectors, with primary exposure to the Sydney and Melbourne markets. Driven by a sharp increase in interest rates over the course of 2022, residential listing volumes have declined as buyers and sellers wait for house prices to stabilise. In December, DHG indicated that Q2 listing volumes will be down ~20%, albeit from a comparatively high period last year. While this will result in depressed first-half earnings, cost reductions have been implemented as a result and imply that second-half earnings will likely be a record. Although the timing of a listings recovery is uncertain, history indicates that property transactions will inevitably recover, giving us confidence that the current share price sell-off is overdone.

• Healius (HLS) is a significant provider of diagnostic services across pathology and imaging, which benefited initially from the significant increase in work associated with COVID-19. However with COVID-19 pathology volumes now falling, the company has experienced negative operating leverage and near term earnings expectations have been reduced.

Helia Group (HLI), a major provider of lenders mortgage insurance, produced strong results during 2022.

Portfolio changes

Additions to the portfolio

• Pexa Group (PXA) – PXA is the leading digital property settlements platform in Australia with more than 90% market share in NSW/Victoria and has largely replaced the previous title transfer system which was paper based. We are attracted to PXA because of its high margins, strong free cashflows, high level of predictability of property transaction volumes each year, and growth options in the UK market.

• Reliance Worldwide (RWC) – RWC manufactures and distributes behind the wall plumbing and heating products for a global customer base. It has new innovative products that replace more expensive copper products. We are attracted to RWC because of its strong management team, healthy cash flow and solid balance sheet.

Reductions from the portfolio

• Bravura Solutions (BVS) – BVS is a leading global provider of software to the financial services industry in EMEA and ANZ, offering solutions designed to streamline and automate administration and reporting processes. BVS failed to maintain the internal liquidity and holding requirements required in order to remain in the portfolio.

• Nitro Software (NTO) – NTO is a global SaaS company providing document productivity tools and e-signing solutions to business customers. NTO failed to maintain the internal liquidity and holding requirements required in order to remain in the portfolio.

• G8 Education (GEM) – GEM owns and operates more than 440 childcare centres around Australia. GEM failed to maintain the internal liquidity and holding requirements required in order to remain in the portfolio.

• EML Payments (EML) – EML is a fintech company offering a broad range of global payment solutions. EML was removed from the portfolio following the emergence of a second regulator, the UK’s Financial Conduct Authority, raising concerns with EML’s processes and governance practices in one of its divisions. The timeline for EML satisfying all regulatory concerns has now been extended for an uncertain length of time.

• Link Administration (LNK) – LNK provides outsourced administration services to super funds, listed companies and others in Australia and the UK, while also holding an equity stake in the leading digital property settlements platform in Australia, Pexa Group (PXA). Disappointingly, the takeover proposal by Dye & Durham failed to succeed due to regulatory intervention and the earnings outlook now appears uncertain.
  
  
  

Reliance Worldwide (RWC) manufactures and distributes behind the wall plumbing and heating products for a global customer base.

In the short-term, inflation concerns may remain a headwind in certain sectors, however we believe the portfolio has the right exposures to deliver strong returns over the long-term and we see appealing valuations in these sectors.

Sector allocation

Sector overweights
Utilities (Renewables), Healthcare, Industrials

Sector underweights
Materials, Energy, Consumer Discretionary