Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Quirks and opportunities from reporting season
Australia is doing comparatively very well fighting the spread of COVID-19 and also comparatively well fighting its impact on the broad sharemarket. But there have been several quirks in sharemarket behaviour which have become evident in the latest reporting season, which may present opportunities for investors.
All-in-all the season demonstrated resilience through the population’s “civil obedience” and through the understanding shown in market sentiment. In its wrap up of the ASX’s company reporting season, active equities manager Martin Currie noted that Australian stocks, especially the top 200 by market cap, suffered their largest lead-in downgrades prior to their results since the GFC in 2008. But the market response to the actuals was interesting. What was evident compared with history was that there was a lack of negative price reaction when there was a downgrade to earnings or dividends.
Reece Birtles, the CIO for Australian equities, said: “This really suggests that the market understands that we are looking at low cycle earnings. The market wasn’t punishing companies that had further downgrades, but it also wasn’t really rewarding upgrades.”
But what Martin Currie gleaned from about 100 company interactions during and after the reporting season, Birtles says in his report to investors, and what concerned the manager was: “The consensus approach appears to have taken the low-cycle results for impacted industries (such as real assets, tourism etc.) and used them as the new base – they have not built in any expectations of bounce back. Conversely, areas that have really seen strength in earnings, consensus is seeing this high as the new base – they have not considered what will happen heading into next year when the stimulus measures are removed.”
Overall, Martin Currie is buoyed by the resilience shown by both consumers and companies. While the impact has been more damaging in certain industries, Martin Currie noted that its engagements with companies have highlighted Australia’s ‘civil obedience’ to follow the rules to stay at home, and to spend the government stimulus they have been given, as the key theme coming out of reporting season. Underpinning the ‘civil obedience’ theme is:
- the strength of Australian consumers’ ability to spend on consumer goods when they haven’t been able to spend on services;
- the extent the JobKeeper and early super withdrawal benefits from the Government; has transferred readily through to the economy;
- how companies have continually adapted their business models to deliver what consumers wanted and needed during social distancing; and
- the shift in company behaviour toward staff and customers, through delays in redundancies, or loan & rental relief and insurance premium discounts.
It was widely regarded that dividends would play an important part in reaction to the latest reporting season. Earlier in the year, Martin Currie wrote to the boards of 40 quality companies about the issue. The firm pointed out that COVID-19 had exacerbated the already downward trend in dividends to record lows. The letter said: “For retirees, foundations and charities who depend on income from their investments. We stated that the need for companies to pay out their dividends for these investors has never been greater and if a company has reasonable cashflow and a sound financial position, dividends should be paid, even if they must be reduced.”
Payout ratios fell across the board, particularly in financials due to APRA guidance to cap dividends. Birtles said: “However, what we found was that dividend surprise was positive for high quality companies, whereas low quality companies had more dividend disappointment. This is not surprising for us. Empirically, we have found that quality is a very good indicator of a company’s sustainable dividend payment ability.”
In terms of the best and worst performers, Martin Currie ranks each by taking the average of the company’s actual results, the surprise versus consensus, revisions of future forecasts, as well as the price reaction to those announcements, and generates a reporting score card for each stock and sector. The standout performer was the consumer discretionary general merchandise space, followed by environmental facilities services, iron ore, auto parts and equipment and diversified real estate activities. The worst performers were coal and consumable fuels, followed by oil and gas refining and marketing, airlines, diversified capital markets and life and health insurance.
In terms of the future and looking at the broader picture, there are many ways to look at the current state of the economy and the size of the investment opportunity, Birtles says. “However, depending on which lens you look at it through, you will get a divergent view as to whether COVID-19 still has a significant impact to go, or if we are on the mend.” The Martin Currie philosophy, especially in uncertain times, is to focus on fundamentals.
“Based on our top-down analysis, fundamental views from our company engagements, and our big picture work, we expect that the full COVID-19 impacts will have been felt in Australia during 2020, and we should expect a recovery in company earnings and dividends into 2021 and 2022. The timing of economic recovery does remain somewhat uncertain, but as the market shifts its focus from the recession to the recovery, we expect the Value style to swiftly come back into favour,” the manager says.
“Today’s situation of very wide value spreads at GFC-like levels, and an expensive market, offers longer-term investors attractive opportunities at once-in-a-life-time valuations. In order to take advantage of this shift, investors will need to ensure that they are positioned in value- exposed opportunities well ahead of the inflection point, to fully capitalise on future narrowing spreads. Now is the truly the time to position for value.”
– G.B.
Note: Martin Currie is a sponsor of Investor Strategy News. The views expressed are those of the author and not necessarily those of Martin Currie.
