Balanced Fund
The Balanced Fund (Retail) (the ‘Fund’) returned 9.6% gross of fees in the financial year ended 30 June 2023, compared to its benchmark which rose 11.1%. The Balanced Fund (Wholesale) returned 10.4%..
Absolute returns were driven by the equities portfolios, with the International equities portfolio rising 20.6% and Domestic equities up 15.7%. Despite persistent high levels of inflation, rapid increases in interest rates, and a “minor” banking crisis, the economy remained resilient. GDP growth has remained positive and unemployment remains near all-time lows in much of the developed world, with the resulting positive sentiment in equities driving a continued recovery in the MSCI World Index post its 18% decline in the first half of 2021. The artificial intelligence excitement following the introduction of ChatGPT provided a further boon to equity markets, particularly technology stocks, with companies such as NVIDIA returning 179.3% over FY23.
Sentiment in fixed income markets did not match equity markets, with the MOVE index, a measure of volatility expectations on US Treasury bonds, reaching its highest levels since the 2008 global financial crisis. The Australian government bond yield fluctuated significantly between its starting point of 3.48% and end point of 4.02%, as the market pendulated between concerns of further rate hikes, or a recession.
Balanced (Wholesale) Fund Performance
As at 30 June 2023*
| fund | benchmark^ | |
|---|---|---|
| 3 months | 2.6% | 1.5% |
| 1 year p.a. | 10.4% | 11.1% |
| 3 years p.a. | 7.0% | 7.1% |
| 5 years p.a. | 6.9% | 6.3% |
| since inception p.a. | 7.1% | 6.9% |
^Benchmark: Australian Ethical Balanced Composite. Past performance is not a reliable indicator of future performance.
Inception date: 28/03/2018. Source: FE fund info.
Balanced (Retail) Fund Performance
As at 30 June 2023*
| fund | benchmark^ | |
|---|---|---|
| 3 months | 2.5% | 1.5% |
| 1 year p.a. | 9.6% | 11.1% |
| 3 years p.a. | 6.2% | 7.1% |
| 5 years p.a. | 6.0% | 6.3% |
| 10 years p.a. | 7.0% | 7.7% |
| since inception p.a. | 6.6% | 7.3% |
^Benchmark: Australian Ethical Balanced Composite. Past performance is not a reliable indicator of future performance.
Inception date: 16/10/1989. Source: FE fund info.
Contributors and detractors
Top 3 contributors to fund return
+51.0%
Domestic Equities - Materials
+36.2%
International Equities - Information Technology
+21.5%
International Equities - Financials
Top detractors to fund return
-2.6%
International Equities - Real Estate
Contributors
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The Information Technology sector, both domestically and internationally, was one of the top performing sectors over the period contributing 10.3ppts of the 20.1% international equities performance. Our overweight position in the sector, particularly within our domestic equities portfolio, was one of the key contributors to relative performance. Having been one of the hardest hit sectors as the rate hiking cycle got underway, the sector rallied significantly in the last 6-month of FY23. Being a highly rate sensitive sector, its performance was emblematic of the disconnect between equity markets and bond markets, with equity markets pricing in expectations of declining rates despite a rise in bond yields across the short and middle parts of the yield curve. The emergence of ChatGPT and the ensuing excitement on the promise of AI further bolstered the performance of technology stocks, with names like NVIDIA (+188.4%) and Microsoft (+37.9%) making the largest contribution to the international equities portfolios absolute performance.
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Our exposure in the Materials sector was the best performing sector in our Domestic equities portfolio, led by our lithium holdings in Pilbara (+119%) and Allkem (+55.4%). Along with IGO, which produces and processes copper, nickel and cobalt, critical minerals, our lithium holdings benefited from higher demand expectations arising from the adoption of electric vehicles and the energy transition. More broadly, the Materials sector, including our holdings in Boral (+55.6%) and CSR (+37.8%), also benefited from elevated prices in building and construction materials and commodities (excluding energy).
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Our global Financials sector names rose 21.5% against the benchmarks return of 16.7% and added a further 4.6ppts to our international equities performance. In addition to stock selection, our overweight position in the sector relative to the benchmark further contributed to our relative performance. The Financials sector has benefited from margin expansion in the current rate rising environment, while the portfolio was largely able to avoid the banking crisis, not holding a number of the banks caught up in the crisis, including SVB, First Republic and Credit Suisse.
Detractors
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Within International equities, an overweight exposure to the global real estate sector was the major detractor, being one of the few sectors that delivered a negative return over the financial year. There were significant sell-offs in real estate stocks, with steep discounts to NAVs, as the market anticipated large de-valuations as the spread between cap rates and benchmark rates narrowed following the rate rises. The office sector in particular has faced significant headwinds following the work-from-home disruption post-COVID, resulting in significant vacancy levels across many parts of North America, while increased interest costs put further pressure on margins.
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Our Domestic fixed interest portfolio, while outperforming the benchmark, was the largest drag on performance among the asset classes, returning 1.5%, though outperforming the benchmarks return of 1.2%. Bond markets continued on another year of volatility, with the MOVE index, a measure of volatility expectations for US Treasuries, reaching its highest level since the 2008 global financial crisis. The Australian 10-year government bond moved through a 50bps point range multiple times over the year, fluctuating between a low of 2.98% and a high of 4.20%. The year finished 36bps higher at 4.02% as near-term fears of a recession abetted as inflation proved to be stickier, and the economy more resilient than markets had expected.
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Our Cash holdings further detracted from our relative performance due to a combination of a slightly overweight position, and the strong performance of equities over the period. Given the majority of the RBA rate hikes occurred after 30 June 2022, the asset class did not attract the 3.5-4% returns currently being generated over the whole period.
The Information Technology sector, both domestically and internationally, was one of the top performing sectors over the period contributing 10.3ppts of the 20.1% international equities performance.
Portfolio changes
Additions to the Fund
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Global fixed income – We added both a global credit and global sovereign bond strategy to the portfolio, providing significant diversification to the defensive component of the Fund’s asset allocation, with this diversification offsetting the higher risk and return derived from the credit strategy.
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Alternatives – We significantly broadened the base of our growth alternative unlisted investments, diversifying the alternatives portfolio across asset class sub-types and geographically, importantly adding a meaningful emerging markets exposure to the portfolio for the first time. We have also added a new ‘Defensive Alternatives’ asset class to the portfolio, further diversifying the defensive assets within the portfolio, including insurance linked bonds, private credit and micro-finance.
Selldowns from the Fund
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Domestic fixed income – We reduced our allocation to domestic fixed income, trading the allocation for global fixed income as we sought to improve the diversification of the defensive allocation of the Fund.
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Domestic Real Estate – Where we have been able to source liquidity and current valuations, we have reduced our unlisted domestic real estate exposure.
Within International equities, an overweight exposure to the global real estate sector was the major detractor, being one of the few sectors that delivered a negative return over the financial year.
While risks are abundant, if the volatility of the recent quarter has taught us anything, it’s that markets can be resilient.
Outlook for the Fund
In recent months, volatility of financial assets has declined and market measures of volatility such as the VIX have receded to levels similar to pre-Covid levels. While recent inflation and growth data points to an increasing possibility of a “soft landing” and has supported a rebound in asset prices, we are cognizant that risks remain - particularly the outlook for inflation.
Energy commodities, a key component of inflation, reached unprecedented highs following the Russian invasion of the Ukraine. They have now receded, but we believe the global energy complex remains fragile with benign weather, demand and near optimal outcome on the transition required to maintain current levels. Closer to home, Australian electricity prices continue to rise reflecting potential shortages following a prolonged period of underinvestment in energy infrastructure.
Energy is not the only latent risk, but also: the lagged impact of the monetary tightening cycle complicated by the disrupted spending patterns of COVID; changing demographics (including a declining population in China) and falling levels of productivity domestically – not to mention that people are still catching COVID!
While risks are abundant, if the volatility of the recent quarter has taught us anything, it’s that markets can be resilient – indeed our strategic asset allocation processes reflects this, with an explicit acknowledgment that by surmounting known risks, financial returns are more likely to remain positive; and by being well-diversified, you may reduce the impacts of being exposed to those parts of the market that can’t surmount the risk (like US regional banks in recent history). Tactically, we don’t believe market measures of volatility adequately reflect the risks that lie ahead – particularly at current valuations - so we have added protection to our equity holdings and continue to favour assets with more capital protection in their structure, such as credit to drive returns.
*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.
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