The High Conviction Fund (Wholesale) (the ‘Fund’) increased 6.9% net of fees in the year ended 31 December 2023, underperforming its benchmark, the ASX 300 Accumulation Index’s return of +12.1%.

Equity markets fluctuated throughout the year, driven largely by changing sentiment around inflation and the outlook for interest rates. With inflation remaining sticky, the “stronger for longer” view on interest rates pervaded equity markets for much of the year, keeping a lid on returns. This changed towards the end of the year, with expectations for multiple rate cuts in 2024 signaled by the US Federal Reserve in mid-December providing a backdrop for a strong end of year rally for equity markets, with the ASX 300 benchmark index ending near record levels.

At a sector level, the Industrials sector was the strongest performer for the Fund in 2023, with the portfolio’s positions in Brambles (BXB) and Downer EDI (DOW) performing well in the first half the year. BXB delivered positive earnings growth in FY23 driven by pricing improvements, while DOW began a turnaround of the business with a refreshed management team following a challenging period. With fundamental valuations beginning to look stretched in our view, we divested both positions towards the end of the year and replaced them with Reliance Worldwide (RWC) and Qube (QUB). Both new positions also contributed positively to performance.

The Financials sector was another strong performer for the Fund in 2023, with the portfolio’s overweight position in insurance stocks contributing to the positive performance. The market environment for insurers was favourable during the year with solid premium growth across the sector and a low claims environment in certain categories. QBE (QBE) and Suncorp (SUN) were the standout performers for the Fund, but after a golden run for the insurers in 2023 we have trimmed our exposure to the sector going into 2024.

The key sector detracting from performance during 2023 was the Healthcare sector. While the Fund benefited from the portfolio’s underweight position in CSL, performance was negatively impacted by holdings in Healius (HLS), Ansell (ANN) and Ramsay Healthcare (RHC). HLS was impacted by a decline in testing volumes post the Covid period, but disappointingly brought additional pressure on themselves with a stretched balance sheet and as a result we divested the position and replaced it with peer Australian Clinical Labs (ACL). We are of the view that ACL is better placed to navigate the current market conditions and the share price performed well towards the end of the year. Resmed (RMD) was another addition to the portfolio later in the year. RMD’s share price came under significant pressure as sentiment turned negative on concerns that obesity drugs will reduce demand for RMD’s sleep apnea products. We think the potential impact is overstated and, with valuation looking attractive, we took the opportunity to establish a position in a quality global business.

Also detracting from performance during the year was the portfolio’s natural underweight position in the Materials and Consumer Discretionary sectors. The portfolio has minimal exposure to either sector under the Ethical screening process. Iron ore producers (not owned by the portfolio) performed strongly during the year, while Consumer Discretionary stocks held up better than expected despite the inflationary impacts across the economy.

High Conviction (Wholesale) Fund Performance

As at 31 December 2023^~

^ Benchmark: S&P/ASX 300 Accumulation Index. Past performance is not a reliable indicator of future performance.

Inception date: 01/10/2021.

Contributors and detractors

Contributors

• Nuix (NXL) share price strengthened after a positive update was provided at their annual general meeting. The technology company stated that it had a positive start to FY24 and re-iterated targets to grow annual contract value by around 10% in FY24. Management is expecting to be underlying cashflow positive for the full year. Under this management team, the business has seen significant transformation for the product offering and engagement with customers, which has yielded positive results.

• Brambles Limited (BXB) share price rose on the back of a strong operational performance period, underpinned by pricing growth and a focus on efficiencies. Improving cash flows have also been a highlight. Looking forward the company is further focused on enhancing network efficiencies and reduced capex. Current challenges facing the stock include progressive destocking impacting pallet availability, and the need for a turnaround in new business wins. With the stock trading up at our fundamental valuation level, we think additional returns will be hard to achieve and therefore divested our holding during the final quarter of the year.

• Suncorp (SUN) delivered a strong FY23 result and is forecast to continue to grow earnings in FY24. Double digit premium increases are expected to continue and insurance margins to hold or slightly increase. The Australian Competition Tribunal will announce the review of the sale of Suncorp Bank to ANZ by February 2024. If this is approved, we expect that SUN as a pure-play insurance company will be favourably viewed by the market. SUN recently announced that the East Coast weather events are expected to be within their budget allowance.

Detractors

• Healius (HLS) shares fell throughout the period as diminishing Covid-19 testing revenues combined with solvency concerns around its balance sheet. Towards period end, these factors resulted in a capital raise required by lenders to pay down debt. The raise was accompanied by full-year guidance that implied a material 1H vs 2H skew at the midpoint and was priced at a 30% discount, further impacting the share price..

• Ramsay Health Care Limited (RHC) suffered inordinately during the COVID-19 pandemic as government intervention saw elective surgery halted and treatment focused on COVID-19. The significance of these decisions resulted in a slower earnings and margin recovery in CY23 but also highlighted the risk in RHC’s large debt balance. Late in CY23, RHC was forced into a sale of its Sime-Darby JV to improve its leverage ratios.

• Ansell Limited (ANN) shares fell following its Jul-23 trading update whereby pricing declines and destocking trends were the key drivers of the weaker outlook. In our view, the FY24 guidance range implied minimal valuation upside when considering the risks associated with the manufacturing rightsizing and IT investment programs. As a result, we divested our position following this update.

Nuix stated that it had a positive start to FY24 and re-iterated targets to grow annual contract value in FY24.

Portfolio changes

Additions to the Fund

• ResMed (RMD) – RMD is a leading global MedTech player in the sleep and respiratory care markets, providing Continuous Positive Airway Pressure (CPAP) machines for treating obstructive sleep apnea (OSA). RMD is the market leader in a large addressable market, with devices growing high single digit growth annually. We saw the weakness in share price from concerns around weight loss drugs provided an opportunity to add the name.

• Fisher & Paykel Healthcare (FPH) – FPH designs and manufactures medical devices for use in respiratory care, acute care, and the treatment of obstructive sleep apnea.

• Webjet (WEB) – Webjet is a digital technology travel business, with a strong balance sheet and trading at an attractive valuation considering the growth profile in the hotel marketplace division.

• Challenger (CGF) – Challenger is a leading provider of annuity products in Australia and manages a multi-boutique asset strategy in the Fidante division. With the stock trading at an attractive valuation and offering double digit earnings growth in FY24, we thought it was opportunistic to add the stock to the portfolio.

• Mercury (MCY) – MCY is one of the largest ‘Gen-tailers’ in New Zealand, with 100% renewable electricity generation in the form of geothermal, hydro and wind power. With a positive long-term demand outlook as NZ moves to decarbonise its economy, MCY is well placed to grow earnings and dividends over time.

Divestments from the Fund

• Healius (HLS) – We divested our Healius shareholding as whilst we fundamentally like the pathology sector, we view Healius as the expensive opportunity with higher risk given its FY24 guidance skew. It currently also trades at a material premium to SHL and ACL, which is difficult to justify in light of the continued risks.

• QBE Insurance Group (QBE) – QBE shares performed well in 2023 in line with other insurance peers and with the stock trading up around decade highs we decided to reduce portfolio exposure to the insurance sector and took profits in the name.
  

• Brambles Limited (BXB) – While BXB was one of the Fund’s top performers in 2023, with the stock trading up at our fundamental valuation level, we think additional returns will be hard to achieve and therefore divested our holding during the final quarter of the year.
  

• Ansell (ANN) – Shares fell following ANN’s Jul-23 trading update whereby pricing declines and destocking trends were the key drivers of the weaker outlook. In our view, the FY24 guidance range implied minimal valuation upside when considering the risks associated with the manufacturing rightsizing and IT investment programs. As a result, we divested our position following this update.

• Blackmores (BKL) – BKL was acquired by Japanese conglomerate Kirin for $95/share, with shareholders voting to approve the takeover and receiving the final proceeds on August 10th.
  
  
  

Healius shares fell throughout the period as diminishing Covid-19 testing revenues combined with solvency concerns around its balance sheet.

The portfolio maintains significant exposure to key growth sectors in Information Technology, Healthcare, and Renewables that we expect will outperform the rest of the market over the long-term

Sector allocation

Sector overweights
Healthcare, Information Technology, Utilities (Renewables), Industrials

Sector underweights
Materials, Energy, Consumer Discretionary