High Conviction Fund
The High Conviction Fund (Wholesale) (the ‘Fund’) performed strongly in the September 2024 quarter, increasing 13.5% net of fees and outperforming the benchmark ASX 300 Accumulation Index’s return of +7.8%.
Renewed enthusiasm for equity markets pushed the broader market index to a record high, with the S&PASX 300 notching up its strongest quarterly start to a financial year since 2010. News of the first interest rate cut in the US in four years and economic stimulus measures in China helped sentiment, triggering some sector rotation out of defensive names and into economic sensitive sectors.
During the September quarter, Australian investors digested reporting season, which led to aggregate earnings downgrades across the market and a subdued outlook for FY25. Expectations for an interest rate cut in Australia have now been pushed out to early next calendar year and consensus forecasts are poised for an earnings recovery in FY26.
Stock selection was a key contributor to Fund outperformance during the September quarter, with a number of positive developments across the portfolio. While reporting season was particularly volatile for the market, the portfolio’s focus on attractively valued companies delivered a strong return with the number of companies reporting favourable results outweighing those that missed market expectations. A takeover approach and asset sale for Orora reignited investor sentiment in a forgotten name, while index inclusions for a number of our smaller cap names (Immutep, Opthea, Australian Clinical Labs, Nuix) also boosted investor interest.
At a sector level, Information Technology and Healthcare were the two biggest contributors to performance during the September quarter. Within Information Technology, Nuix was the standout performer for the portfolio, more than doubling over the quarter as the market digested a strong FY24 result and positive outlook, combined with inclusion into the ASX 300 index. A recent addition to the portfolio, SiteMinder, also had a strong quarter, with investor sentiment improving as a result of free cash flow generation, new products coming to market in FY25, and management incentives being aligned with the ‘Rule of 40’ going forward.
Within the Healthcare sector the Fund had a number of strong performers, with Resmed, Fisher & Paykel Healthcare, and Australian Clinical Labs all reporting positive earnings results. The negative sentiment that surrounded Resmed relating to the potential for obesity drugs to negatively impact demand for Resmed products appears to have largely dissipated now, in line with our investment view that the issue was overblown initially.
The Materials sector also contributed positively to performance, despite the headwind from a resurgent Resources sector (which the portfolio has a material underweight position in) after stimulus measures were announced in China late in the quarter. The strong performance of Orora offset this impact, with a takeover approach reminding investors of the value within the business, followed by an earnings result that beat market expectations, and the announced sale of its US Distribution business that allays balance sheet concerns.
The Utilities and Consumer Discretionary sectors were the two key detractors from performance during the September quarter. The New Zealand Gen-tailers faced difficult operating conditions due to a particularly dry period and gas supply issues in the market, while Contact Energy’s proposed acquisition of Manawa Energy during the quarter was met with a muted response from the market. Within Consumer Discretionary, WEB Travel Group indicated it was facing some short-term demand disruption, however the demerger of its B2C business towards the end of the quarter leaves it focused on its B2B operations that we believe can grow strongly in years to come.
During the quarter, the Fund participated in capital raisings for IPH and Fletcher Building, with both share prices trading comfortably above the raising price at the end of the quarter. The Fund divested its position in Medibank Private and replaced it with NIB Holdings due to the significant differential in Price-Earnings multiple that has opened up between the two companies. The Fund also added to its positions in CAR Group, Siteminder, IPH and WEB Travel Group.
Outlook for the Fund
The High Conviction Fund is a concentrated portfolio of typically larger cap stocks with active stock selection across our Ethical universe. Our process focuses on fundamental research and we seek opportunities to invest in attractive companies, where the share price materially undervalues the long-term valuation. Reflecting this, we exited our position in Medibank Private during the quarter and replaced it with NIB Holdings, where we see significant valuation upside.
Market valuations remain elevated, with the All Industrials index trading at a 20% P/E premium to its long-term average of 17x. In this environment we continue to focus on companies where we see fundamental valuation attractiveness. At a sector level, the Fund is positioned with an underweight to the Financials sector given that a number of Banks and Insurers are trading on elevated P/E multiples above their long-term averages.
Macro will continue to play a role in the broader volatility of markets, with continued focus on inflation and interest rate trajectory. With central banks beginning a rate reduction cycle, the current environment suggests growth sectors like healthcare and technology should be supported. We believe the portfolio is well positioned to benefit from this thematic, with these sectors accounting for a ~30% weighting in the portfolio, compared to less than 15% in the ASX 300 index.
High Conviction (Wholesale) Fund Performance
As at 30 September 2024~
| fund | benchmark^ | |
|---|---|---|
| 3 months | 13.4% | 7.8% |
| 6 months | 10.0% | 6.5% |
| 1 year p.a. | 22.7% | 21.7% |
| since inception p.a. | 5.3% | 8.1% |
^ 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
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Nuix (NXL) was a key positive contributor to returns. Under this management team, there has been transformation of the business, particularly in evolving the product offering and engaging with customers, which has yielded positive results. The company posted a strong FY24 result which highlighted the company’s solid underlying cash flow and balance sheet, with FY25 guided ACV growth ahead of expectations. Nuix was added to the S&P/ASX 300 index in September.
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Orora (ORA) performed strongly following a sequence of positive news flow. The company delivered a better-than-expected FY24 result, received a take-over offer (subsequently rejected), and announced the sale of the North American packaging solutions business for better-than-expected A$1.8B, providing scope for significant debt reduction, growth investment and capital management.
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Resmed (RMD) performed strongly following the release of its fourth quarter FY24 results and outlook commentary. The market was pleased with RMD’s top line growth and gross margin improvement, especially considering headwinds from shipping. Outlook commentary was also well received, with FY25 margin guidance implying upgrades to consensus. The stock continues to perform strongly amidst GLP-1 speculation and there remains valuation support.
Detractors
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Ramsay Health Care (RHC) underperformed following the release of its FY24 result. Limited guidance was provided, conference call feedback on a flat margin outlook driven by investment appeared below consensus expectations. We continue to hold a favourable long-term view in investing for the future and the long-term margin benefits. Ramsay’s market leading position and land holdings provide us with long-term strategic investment upside.
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Webjet (WEB) underwent a demerger in the September quarter, with Webjet separating the online travel agent to a separately listed entity (ASX code: WJL). Although the trading update provided by the company in August is tracking below expectations, we note temporary issues with delayed travel demand associated with the Olympics and the collapse of FTI Group. We believe there is a compelling valuation appeal in WebBeds.
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Contact Energy (CEN) underperformed during the period. In early July the company issued FY25 guidance, outlined its development plans and updated the dividend outlook over the next three years, which was below market expectations. However, if the proposed Manawa acquisition is successful, the dividend profile is expected to improve.
Orora delivered a better-than-expected FY24 result, received a take-over offer (subsequently rejected), and announced the sale of the North American packaging solutions business for better-than-expected A$1.8B.
Portfolio changes
Additions to the Fund
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NIB Holdings Ltd (NHF) – NHF is a predominantly a private health insurance company with 10% market share and growing. The Fund added the stock in the September quarter, as we see valuation appeal in NIB, with the stock now trading at a 30% discount to the ASX200, compared to its historical premium.
Divestments from the Fund
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G8 Education Limited (GEM) – The Fund’s small position was exited on share price strength, as the Group demonstrated a recovery in operational performance post Covid.
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Webject (WJL) – The Fund exited the small position in Webjet (WJL) following the demerger event from WEB. The Fund retained its position in WebBeds (WEB), as we believe there is strong valuation upside in WebBeds.
- Medibank Private Ltd. (MPL) – The Fund switched out of Medibank and into NHF in the September quarter as share price weakness made NHF a more attractive relative value proposition for a holding in the private health sector.
Contact Energy underperformed during the period after updating its dividend outlook over the next three years, which was below market expectations.
Our process focuses on fundamental research and we seek opportunities to invest in attractive companies, where the share price materially undervalues the long-term valuation.
Sector allocation
Sector overweights
Communication Services, Health Care, Industrials, Information Technology, Utilities (renewables)
Sector underweights
Consumer Discretionary, Energy, Financials, Materials, Real Estate
*Total returns are calculated using the sell (exit) price, net of management fees, transaction costs and performance fees where applicable and are calculated based on distributions being reinvested. The actual returns received by an investor will depend on the timing of the buy and exit prices of individual transactions. Distributions 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.
Disclaimer
Interests in the Australian Ethical Managed Funds are issued by Australian Ethical Investment Ltd (ABN 47 003 188 930, AFSL 229949), the Responsible Entity of the Australian Ethical Managed Funds.
The information in this summary is of a general nature and is not intended to provide you with financial advice or take into account your personal objectives, financial situation or needs. Before acting on the information, consider its appropriateness to your circumstances and read the Financial Services Guide, relevant product disclosure statement and Target Market Determination available on our website.
You may wish to seek financial advice from an authorised tax or financial adviser before making an investment decision. Past performance is not a reliable indicator of future performance.
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