INVESTMENTS | FUND COMMENTARY
Balanced Fund
The Balanced Fund (Wholesale) (the ‘Fund’) returned –7.6% for the quarter ended 30 June 2022, underperforming its benchmark which fell 6.7%. The Fund returned -7.1% for the 2022 financial year, also underperforming its benchmark which fell 5.0%.
25 July 2022
Fund commentary
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The recent market environment has proven a difficult period of performance for the Fund, returning –7.6% over the quarter ended 30 June 2022. With all the major liquid asset classes declining, it was only the cash exposure that could preserve value. Our screening out of fossil fuel companies and bias to small cap growth sectors such as IT, healthcare and renewables saw the Fund underperforming its SAA-weighted benchmark by 90bps.
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Both the negative absolute and relative underperformance were primarily driven by the domestic equities portfolio, which declined 14.7% against its S&P/ASX 200 benchmark return of -11.9%. While international share markets saw similar declines, our unhedged currency exposure demonstrated its defensiveness as the AUD fell from US$0.75 to US$0.69, leading to a net of currency return for international equities of -8.35%, against the MSCI World ex AU index return of -8.42%.
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Our fixed income portfolio also continued to decline over the quarter as inflation fears drove bond yields higher. The Australian 10yr Government bond yield rose from 2.83% to a high of 4.19% in mid-June before pulling back considerably to end the quarter at 3.66% as markets became increasingly concerned with the prospect of a recession triggered by the aggressive rate rising cycle anticipated to continue by central banks globally.
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Our unlisted investments in property and alternatives have so far remained resilient, with two of our venture capital fund investments delivering solid performance over the quarter. However, while we are pleased with the performance, we anticipate the volatility seen in equity market is likely to begin impacting our unlisted exposures as we continue to move through valuation cycles.
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FY22 was a difficult year for Balanced Fund (Wholesale) investors. Listed growth assets performed poorly, and the rise in yields across bond markets only added to losses rather than preserving capital. Only the decline in the Australian dollar reprised its defensive role, helping offset losses in the international equities portfolio, but that too was challenged during the period – climbing initially with commodity prices before falling sharply late in the year. Our unlisted property assets have also remained resilient so far.
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The Balanced Fund (Wholesale) returned -7.1% through FY22 against its SAA-weighted benchmark return of -5.0%. The negative performance occurred entirely in the second half of the financial year, returning -12.0% over the 6-month period, more than offsetting the prior 6-months return of 5.6%.
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The largest driver of negative absolute and relative performance came from our domestic equities portfolio, which was down -12% over the 12-months against the benchmark, the S&P ASX 200 index, return of -6.5%. Our Australian equities portfolios, in line with our Ethical Charter and sustainability focus, hold no fossil fuel companies, have a significantly lower than benchmark materials allocation, and have a sizeable allocation to small companies. All these positions were negative contributors in the first-half of calendar 2022 given heightened inflation and concerns around energy supply, plus rising interest rates which impact smaller growth-oriented companies. During challenging markets we do not waiver from our Charter, but rather seek to manage volatile periods through active management.
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Our international equities portfolio returned -7.6% against the benchmark, the MSCI World Ex-AU return of -6.5%. While in local currency the global equity market fell -12.5%, as measured by the MSCI World Ex-AU index, our unhedged international equities exposure demonstrated its defensive characteristics with the AUD falling significantly in the last 3-months of the year to US$0.69, having started the year at US$0.75, partially offsetting the negative share market performance.
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Fixed income’s defensive characteristics however were not evident through the 12-month period, declining 10.6% as bond yields rose rapidly as central banks showed signs of aggressively tightening policy to tackle increasingly high rates of inflation. Having started the 12-month period at 1.53%, the Australian Government bond yield briefly fell to a low of 1.08% as large parts of the economy went into a prolonged locked down, before starting its rapid rise to reach a peak of 4.19% in mid-June. Yields subsequently fell 53bps to finish off the year at 3.66% as the market’s concerns of a rate rise induced recession grew.
Outlook for the Fund
Increasing volatility has been a persistent feature of the past year, and this quarter has been no different with the Ukraine war and Covid restrictions in China driving volatile commodity prices and markets oscillate between growth and inflation fears. The VIX (Volatility Index) has remained elevated in the mid-20s, a level on par with 2020 when we grappled with a very uncertain Covid future, but also the late 1990s and early 2000s in the wake of the dotcom bubble.
If history is a guide, while we could be encountering turbulence for a protracted period yet, volatility didn’t start to decline until the real economy entered into and started to recover from a recession a few years after the dotcom bust – but the opportunities provided to patient investors then could be the same now. Those with a longer time horizon stand to benefit if they can identify those companies with brightest opportunity amongst the selling by those who are shaken out by the volatility. Already we are starting to find very attractively valued smaller companies.
In the immediate term, we continue to focus on deploying capital into diversifying growth exposures, like venture capital and private equity where we believe there is significant prospect for individual outcomes to be more significant than the market. We are encouraged to move a little faster now that we are getting feedback that valuations in those markets are becoming more competitive again. Further, following the rapid increase of bond yields over recent months it now leaves fixed income assets in a much better position to resume their historical role of offering income and the potential to appreciate during economic uncertainty.
From a broader sustainability perspective, we see long term trends continue to favour the portfolio. The recent federal election has put in place increased ambition in our pathway to net zero, which will see companies preferred by our approach and charter with a stronger growth profile. Additionally, our focus on sustainable commodities, continues to be an area of long-term support.
Balanced (Wholesale) Fund Performance
As at 30 June 2022*
| fund | benchmark | |
|---|---|---|
| 3 months | -7.6% | -6.7% |
| 1 year p.a. | -7.1% | -5.0% |
| 3 years p.a. | 4.3% | 3.7% |
| since inception p.a. | 6.4% | 5.9% |
*Source: FE fundinfo. Benchmark: Australian Ethical Balanced Composite. Past performance is not a reliable indicator of future performance.
Inception date: 28/03/2018.
Balanced (Retail) Fund Performance
As at 30 June 2022*
| fund | benchmark | |
|---|---|---|
| 3 months | -7.7% | -6.7% |
| 1 year p.a. | -7.7% | -5.0% |
| 3 years p.a. | 3.5% | 3.7% |
| 5 years p.a. | 5.4% | 5.9% |
| 10 years p.a. | 7.5% | 8.5% |
| since inception p.a. | 6.5% | 7.2% |
*Source: FE fundinfo. Benchmark: Australian Ethical Balanced Composite. Past performance is not a reliable indicator of future performance.
Inception date: 16/10/1989.
Our investments in global healthcare names was the only sector within our equity portfolios to perform positively over the quarter ending 30 June 2022.
Contributors
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Our property portfolio was the greatest contributor to performance, with valuations remaining resilient despite the volatility in equity and bond markets. Our healthcare property exposure was the main driver of performance, returning 3.7%, partially reflecting positive valuation gains in the March valuation cycle. However, we are conscious that valuations may be adversely impacted in future valuation cycles as the spread between healthcare property cap rates and government bond yields continued to compress through the most recent quarter.
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Our venture capital fund investments also performed well through the quarter. In particular, our investment in the Artesian Clean Energy Seed Fund appreciated significantly. This largely reflected significant valuation uplifts in March for companies like:
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5B - a clean technology innovation company who build solutions to deploy low-cost, safely deployed, gigawatt-scale solar energy, and
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Swoop Aero - a drone logistics company that employ their own drone technology to deliver critical supplies such as vaccines and medication to inaccessible locations.
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Global healthcare holdings performed positively over the quarter, returning 4.5% against the benchmark return of 1.4%. The largest contributors included:
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Amgen - which produces medicines for the treatment of cancer, kidney disease, bone disease and other serious illnesses, and appreciated 10.5% over the quarter, and
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Covetrus - global animal-health company that provides products, services, and technology to support veterinary practices, and appreciated 35.0%.
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Our property portfolio was the greatest contributor to performance, with valuations remaining resilient despite the volatility in equity and bond markets. Our Healthcare property exposure was the main driver of performance, returning 3.7%, partially reflecting positive valuation gains in the March valuation cycle. However, we are conscious that valuations may be adversely impacted in future valuation cycles as the spread between healthcare property cap rates and government bond yields continued to compress through the most recent quarter.
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Our alternatives portfolio also performed well over the year, returning 21.5%. The performance was led by our venture capital investments; however, we also saw strong performance from our infrastructure investments. Our investment in the Artesian Clean Energy Seed Fund had a particularly strong year, due to significant valuation uplifts for companies like 5B and Swoop Aero.
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Consumer staples was one of the strongest contributing sectors to both relative and absolute performance within our domestic equities portfolio. Our investment in Graincorp accounted for almost all of the performance, appreciating 90.0% (including dividends) over the 12-month period. The company demonstrated resilience through FY22, with earnings outperformance driven by strong Australian east coast wheat volumes, and strong global pricing arising from the North American drought and the conflict in Ukraine.
Detractors
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The information technology sector was the greatest detractor within our domestic and international equities portfolios. In particular, our overweight position to the sector led to it being the largest detractor within the Fund’s domestic equities portfolio.
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Energy stocks continued to detract from relative performance across our domestic and international equities portfolios. The sector, which is largely ethically screened out of our universe, delivered further positive performance over the quarter, with the continued conflict between Russia and Ukraine keeping global oil and gas prices elevated, though considerably down from their peaks.
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Domestic healthcare holdings were a significant detractor from both relative and absolute performance. While there were a number of negative performers over the quarter, our underweight position in CSL that was the most significant detractor to our relative performance, with the stock comprising 6.1% of the benchmark against our portfolio weighting of 1.8%.
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Fixed income was one of the surprising big detractors from absolute performance. The allocation fell -10.6% over the financial year as bond yields pushed higher with inflation globally continuing to rise to troubling levels on the back of over stimulus, supply chain and labour market distortions due to COVID-19, and the conflict in Ukraine impacting the availability of oil, gas and grain supplies. The aggressive response that continues to be anticipated from the RBA pushed the Australian Government bond yield up 210bps from where it started in July 2021 to finish the year at 3.66%.
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The information technology sector was the greatest detractor within our domestic equities portfolios. While stock selection did lead to a small outperformance against the S&P/ASX 200 benchmark, our overweight position to the sector, which declined 35.7%, accounted for -5% of the total -12% absolute performance of the domestic equities portfolio, and -3% of the total -5.6% of relative performance.
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The information technology sector was the greatest detractor within our domestic equities portfolios. While stock selection did lead to a small outperformance against the S&P/ASX 200 benchmark, our overweight position to the sector, which declined 35.7%, accounted for -5% of the total -12% absolute performance of the domestic equities portfolio, and -3% of the total -5.6% of relative performance.
Portfolio changes
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In December, we finalised an investment into Generation Investment Management’s Sustainable Solutions Fund IV. Generation is a well-established and well-aligned growth stage private equity manager with an excellent track record across its growth equity strategies. Our investment provides an exciting opportunity as the portfolio’s first entry into the private equity market. The fund primarily targets growth stage private businesses in North America and Europe across three thematics:
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People health
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Planetary health
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Financial inclusion
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In our domestic equities portfolio, we directed flows towards larger cap stocks through our investment in the High Conviction Fund from October 2021. The High Conviction Fund’s greater allocation to large caps and financials, and lower allocation to information technology complemented the tech and small cap bias of our other active exposures. The re-positioning towards this fund helped to partially offset the underperformance of our domestic equities portfolio through the volatility of the last 6-months, with the High Conviction Fund outperforming its benchmark by 2.4% over the 6-month period.
Fund strategy
Australian Ethical offers investors the opportunity to invest in a diversified portfolio of asset types and markets to reduce the volatility of returns. Asset classes include Australian and international equities, property, fixed income securities and cash. The Balanced Fund is built around long-term benchmark asset allocations which are regularly reviewed and as otherwise required to adapt to significant changes in market conditions. We determine the asset allocation with the potential to consistently deliver outperformance across the investment horizon.
*Total returns are calculated using the sell (exit) price, net of management fees and gross of tax as if distributions of income have been reinvested at the actual distribution reinvestment price. The actual returns received by an investor will depend on the timing, buy and exit prices of individual transactions. Return of capital and the performance of your investment in the fund are not guaranteed. Past performance is not a reliable indicator of future performance. Figures showing a period of less than one year have not been adjusted to show an annual total return. Figures for periods of greater than one year are on a per annum compound basis. The current benchmark may not have been the benchmark over all periods shown in the above chart and tables. The calculation of the benchmark performance links the performance of previous benchmarks and the current benchmark over the relevant time periods.
This commentary may contain material provided by third parties derived from sources believed to be accurate at its issue date. While such material is published with necessary permission, Australian Ethical accepts no responsibility for the accuracy or completeness of, nor does it endorse any such third party material. To the maximum extent permitted by law, we intend by this notice to exclude liability for this third party material.