Welcome to the April edition of the Generate Member Newsletter. We hope this newsletter finds you and your loved ones safe and healthy and that you are getting through the lockdown well.

As an “essential service” Generate’s staff have seamlessly transitioned to working from their homes and our investment team are working as closely as ever – despite the physical distance!

The last seven weeks have been some of the most turbulent for financial markets in modern history. Many share markets hit record highs in mid to late February. But from February 19 to March 23, the S&P 500 in the US suffered the most rapid tumble in history, for a loss of 34%. It then bounced vigorously making for the best three day run since the 1930’s.

The following quote was one that resonated with the writer of this newsletter during the GFC and it held him and his co-investors in good stead – in the long run. Although we don’t know what short term gyrations lie ahead for us we believe it will hold our members in good stead - in the long run - this time around too:

‘In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.’ - Warren Buffett

Returns to 31 March 2020 (after fees** and before tax)
 

**except the $3 per member per month fee.
***the funds opened on 16 April 2013
Note: Past performance is not necessarily an indicator of future performance.

During the month of March the three Generate KiwiSaver Scheme funds and the new Generate Focused Growth Trust fell in sympathy with global and local markets. The Focused Growth Fund, the Growth Fund and the Conservative Fund were down -11.77%, -12.19% and -6.22%, whilst the Focused Growth Trust was also down -11.77%.  The reason the Growth Fund underperformed the Focused Growth Fund, notwithstanding its lower exposure to growth assets, was primarily due to the fund having the largest exposure to property and aged care stocks – both of which underperformed over the month. As a comparison point for the funds’ returns in March, the S&P500, the ASX 200 and NZX50G fell -12.35%, -20.47% and -13.00% respectively (in local currencies).

It is worth noting that at the time of writing all four funds are up month to date (FGF: 1.43%, GF: 1.08%, CF: 0.27% and FGT 1.67%) as signs of COVID-19 containment are giving the markets hope that economies will be able to get out of lockdown before too long.

In the month of March positive returns were few and far between with only 3 international holdings ending in the green (on an NZD basis) and only 1 local market equity investment contributing positively.

China’s share market materially outperformed over the month which contributed to Chinese internet behemoth Tencent being the funds’ top performer on an NZD basis. When China was in full lockdown mode some of Tencent’s business units such as online gaming, cloud infrastructure and remote working software actually prospered. Businesses that are resilient even when the company’s entire nation is in lockdown are rare indeed – hence Tencent’s strong relative performance. A lower NZD against the Chinese Yuan also boosted the stock’s performance in NZD.

Another international equities’ positive contribution came from Worldwide Healthcare Trust Plc (WWH). March was a wild ride for WWH with its shares trading -23.9% lower mid-way through the month. At this point fear in the markets was at its highest and as a result the shares traded at a 15.9% discount to underlying net asset value (NAV). As sentiment began to turn the other way the discount narrowed to such an extent that the shares were actually trading at a premium by the end of the month and closed the month up 0.5%.

Microsoft also made a positive contribution to returns in March in NZD terms. Microsoft is one of the most highly regarded companies in the US with a highly respected management team. This coupled with its pristine balance sheet and resilient business model meant the stock outperformed the S&P500 by 9.7% in the month of March. The NZD fell -4.5% against the USD in March which boosted the NZD return.

Notable negative returns came from European Opportunities Trust Plc (JEO) and Siemens with falls of -14.9% and -14.1% respectively in NZD in March.

For much of February JEO’s shares were trading at a premium to their NAV. However, when the sell-off began in earnest in late February JEO began trading at an ever-widening discount so that at the trough in markets in mid to late March the shares were trading at a 17.1% discount to NAV. The discount did narrow by month’s end but given the 12.6% fall in NAV over the month it was still a disappointing performance.

Long awaited turn-around story Siemens had another tough month alongside the entire European industrials sector. Bloomberg Intelligence analysts think the sector could be in for a similar experience to 2009 when demand dived and adjusted earnings fell ~30% year on year. One bright spot for the company is that medical devices made up 17% of Siemens’ revenue – and this percentage is likely to grow in this COVID-19 interrupted world. We remain comfortable with our position in Siemens as we look to its €140 billion pipeline of work which is largely supported by advance payments and its strong balance sheet. Restructuring over the next couple of years should also result in a cleaner, more capital efficient entity.

As you know we have the ability to hold some non-property and infrastructure stocks within that part of our portfolio. And it is a good thing we do as A2 Milk (ATM) was the star performer out of our Australasian investments. ATM delivered a 5.5% return in March as investors gained comfort from upward pricing trends and the understanding that the company was benefiting from a shift to online sales during the COVID-19 outbreak in China.

The most notable negative returns during the month came from Aventus (-47.1% AUD return) and Metlifecare (-44.8%).

Aventus – the Australian ‘big box’ retail property owner – suffered a share price that fell almost in a straight line from AUD2.68 on March 11 to AUD1.42 on March 23. The stock has recovered a portion of its losses as market sentiment improved. As the virus spread in Australia many investors figured a lockdown was inevitable which is particularly painful for a retail property owner who we understand to have only ~20% of its income base classified as “essential” services. Rental abatements are inevitable.

Although Aventus has gearing higher than the average of its peers - with a loan to value ratio of 37.4% - this is well below its covenant of <55%. We take further comfort that Aventus has no debt expiring prior to May 2022 and > AUD100m in cash and undrawn facilities available to it.

In early March Metlifecare (MET) outperformed its peers as the market was confident that the takeover of MET by private equity vehicle Asia Pacific Village Group (APVG) would go ahead at $7.00. As COVID-19 swept around the world and share markets began tanking investors began to wonder whether APVG would try to wriggle out of the deal. As a result the share price began a precipitous drop.

On 16 March the Board of MET tried to reassure investors that the takeover would go ahead by stating “Metlifecare… has no reason to believe that the conditions of the Scheme Implementation Agreement (SIA) will not be satisfied to enable the scheme to be implemented in late May 2020.”

Unfortunately, on the evening of 7 April MET received notice of an intention to terminate the takeover from APVG as they see COVID-19 triggering the “Material Adverse Change” clause in the Agreement. MET believes APVG’s assertions are without substance and are currently taking legal advice on the matter.

Fortunately, we sold the vast majority of our holding in MET at prices close to the takeover offer of $7 as we believed the risk of the deal falling over outweighed the minimal upside from hanging on to the shares and waiting for the takeover deal to close. At the time of writing the shares were trading at $3.50.

In the month of March, the U.S. experienced a full bear market, down 20% or more, and a full bull market, up 20% or more. Bull and bear markets can often take months or even years to play out so for them both to occur in one month is nothing less than extraordinary. These dramatic swings are evidence of the huge degree of uncertainty as to how big a toll COVID-19 and its associated lockdowns will take on economies around the world.

In the last several weeks dire headlines almost became the norm:

“US Jobless Claims Hit 6.6 million as Virus Spreads.”

“Unprepared America Wakes Up to Coronavirus…”

“With Record Daily Deaths. Italy’s toll crosses 9,000.”

But thankfully the trend in headlines is currently on the improve:

“Europe Looks for Lockdown Exit Strategy as Rate of New Coronavirus Cases and Deaths Slows.”

“New York Leaders are Hopeful Coronavirus Crisis is Peaking…”

“New Zealand isn’t Just Flattening its Coronavirus Curve. It’s squashing it.”

These positive developments have breathed some confidence into share markets around the world. If these trends continue there is hope we may have seen the bottom. However, if it becomes apparent that economies are going to have to endure rolling lockdowns for some time - and government finances are going to be stretched even further as they seek to assist businesses and the general public alike - new lows may be tested.

We would note that even if the virus is not brought under control completely that full lockdowns cannot go on indefinitely as governments in developed countries do not have bottomless wells of cash to draw on. There is also a social cost for being in lockdown: whether it be mental health issues from isolation, chronic stress and its associated health issues from having a failing business or little or no income, and increased incidents of domestic abuse. In addition, the more governments borrow now, the more fiscal austerity that is likely to be required in the future which would dampen growth prospects.

As the headline above alluded to New Zealand is in an enviable position and many around the world are looking at the way we have handled this crisis with admiration. It is conceivable that our domestic economy will be for the most part up and running again within 2 weeks – albeit with some restrictions in place including the likelihood of localised lockdowns if COVID-19 flare-ups were to occur. So, as we approach the Easter break let’s all continue to do our bit so that we can get back to a way of life whereby people can hug their family and friends, return to their workplaces and get their kids back to school sooner rather than later.

Knowledge Builder: Investor Biases

We firmly believe that in order to be a successful investor over the long term, it is vital to understand, and hopefully overcome, common human biases that often lead to poor decision making when investing. These biases are ‘hard-wired’ which means we are all liable to take shortcuts, oversimplify complex decisions and be overconfident in our decision-making process. Understanding our biases can lead to better decision making which is crucial to improving investment returns over time. Over the coming months, we will look into some of these in-built biases with the goal being to help you recognise them when they occur and therefore be able to overcome them.

This month: The bandwagon effect

The bandwagon effect, or groupthink, describes how people often gain comfort in something because many other people are doing (or believing in) the same thing.

In our view, to be a successful investor, you must be able to think independently. Speculative bubbles are typically the result of herd mentality whereby investors hear about the gains their neighbours or taxi drivers are enjoying and then get FOMO (fear of missing out) notwithstanding market valuations being at eye watering heights.

We derive no comfort from what other people are doing. We make decisions based on our own analysis and know that whether we are right or wrong in the long term depends on how good our analysis is.

Although we do not seek to be contrarian we are more than happy to take the path less travelled if that’s where our analysis firmly points us.

Please log in to your account to see your full portfolio breakdown.

Spark

Spark is a relatively new holding in the portfolios. It was first added in mid-January and has quickly become one of the largest property and infrastructure holdings.

In 1987, the telecommunications activities of the New Zealand Post Office were spun out and Telecom NZ was formed. A few years later Telecom NZ was privatised and listed on the NZX. Telecom NZ went through an operational separation process in 2008 creating three operating businesses: Retail, Wholesale and Networks. In 2011 Telecom NZ demerged - with Telecom and Chorus (the network division) becoming separate listed companies. Telecom NZ subsequently changed its name to Spark.

In the last decade, the composition of Spark has changed significantly. Spark now generates three-quarters of its earnings from “new” business lines (mobile, broadband and cloud services). It is arguably best thought of as a mobile and data business, whilst the legacy voice business, once its core revenue stream, now only makes up 16% of gross profit.

Initially, a key attraction of Spark was valuation. Spark was trading on an attractive yield when compared to both the NZX50 Index and other incumbent telecommunications companies (for instance, Telstra in Australia). As it became more evident that COVID-19 would have a greater impact on New Zealand the defensive nature of Spark’s earnings to a lockdown was also a key attraction.

Next month: Vector

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