Welcome to the May edition of the Generate newsletter. As we recount the experiences of April, we acknowledge the phenomenon that was the nation being in total lockdown for the month’s entirety under Alert Level Four as truly remarkable. We applaud the dedication of the population to cooperate in tackling COVID-19, and have the deepest sympathies for those that have suffered loss as a result. Businesses and people alike have responded commendably, and in some cases transformed in ways that would have seemed unfathomable just a few months ago. Generate’s staff continued to perform their full range of job duties throughout Level Four and into Level Three without skipping a beat.

Also not skipping a beat was the performance of your funds. We are delighted to announce that for the sixth consecutive quarter, all Generate KiwiSaver funds have ranked either 1st, 2nd or 3rd in their respective Morningstar categories over the past five years*.

Local and international markets were strong in April. In an economic environment where some industries such as tourism and retail have almost entirely ceased, it is in some ways extraordinary that as at the end of April the S&P 500 is down just -9.3% for the year. Perhaps though, the most extraordinary thing witnessed in April was the contract for May delivery of West Texas Intermediate (WTI) oil which reached a negative price of- $40 per barrel! In the sections below we hope to provide some context around the market movements, and commentary on how some of our key investments have performed.

The investment team continue to actively manage investments in the portfolios by stress testing company financials, talking to company management teams, and the fund managers that we invest in. Alongside engaging with industry experts and market analysts we are working tirelessly to distil this information into considered investments on your behalf.

Returns to 30 April 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.

In what were considerably different market conditions relative to March, the three Generate KiwiSaver Scheme funds and the new Generate Focused Growth Trust produced strong performance in April. As could be expected given their larger exposure to international equity markets, the Focused Growth Trust and Focused Growth Fund led the charge returning 6.88% and 6.44% respectively. The Growth Fund returned 5.88% for the month, while the Conservative Fund with its much lower exposure to international equities returned a positive 2.83%.

We will illustrate our view as to what we believe has been driving markets later in this newsletter, but first let’s highlight some of the key contributors and detractors to performance.

Beginning with our international holdings, Facebook was a standout performer over April returning 22.7% in local currency terms. Facebook found favour with investors over the month as varying forms of lockdown policies around the world drove higher social media usage amidst a surge towards online gatherings and communications. Alongside this, sat a counter view Facebook’s advertising revenue may come under pressure as companies reduced marketing budgets. Facebook released their 1Q20 result on the last day of April, which revealed this concern had potentially been overstated. The result detail showed revenue growth of 22% to the end of March, but what really excited the markets were comments that the first three weeks of April was flat compared to the same period in April 2019. This allayed fears that Facebook may be facing a sharp downturn in revenue growth. In aftermarket trading hours Facebook’s share price rose more than 10%, highlighting the extent of shareholder relief.

Reflecting similar sentiment to that shown towards Facebook was Alphabet, the parent company of Google which returned +15.9% in local terms last month. There had been concern throughout April around Google’s advertising revenues, however 1Q20 reported numbers were a positive surprise to the market. While Google’s advertising revenues are not immune to the current economic environment, it appears that Google may offset some of the decline by taking share from traditional forms of advertising, such as billboards and print. Coupled with  management’s commentary around disciplined spending including a slowdown in the pace of hiring, a focus on efficiencies, as well as lower capital expenditure, investors gained confidence that profit margins will benefit when advertising spending returns to normal rates of growth.

Other notable mentions were Microsoft which was up 13.6% and Siemens AG which returned 11% in April. Berkshire Hathaway was somewhat off the pace as they carry more direct exposure to cyclical aspects of the economy, but still returned a positive 2.5%. We continue to think Berkshire is being undervalued by the market.

In last month’s newsletter we highlighted that Jupiter Opportunities Trust was a meaningful negative contributor to performance and traded as low as a 17% discount to net asset value. It was pleasing to see this recover somewhat in April, returning 12.5%. Our investment in Worldwide Healthcare Trust also performed strongly, up 11.6%. More than two-thirds of Worldwide’s portfolio exposure is in the biotechnology and pharmaceutical sectors, which are proving very appealing under pandemic conditions. 

Turning to Property and Infrastructure, and after an uncomfortable month in March there was a strong bounce back in share prices. Auckland Airport (AIA) returned 22% over the month, which included the successful equity capital raise of $1.2bn at a price of $4.66 per share. To put this price in context, we need to go back to early 2015 to find the last time that AIA traded at that level. After extensive scrutiny of cashflows and the balance sheet, the three Generate KiwiSaver Scheme Funds and the Focused Growth Trust participated meaningfully in the raise. Notwithstanding the fact that travel will face difficult months to come, purchasing a recapitalised AIA at a steep discount to recent valuations proved attractive. Post the raise, AIA’s share price performed strongly, rallying 28% to $6 per share, at which point we decided to take profits. To put this in context, New Zealand’s S&P/NZX50G rose 7.5% over the month.

A second standout was our long-held position in Infratil (IFT) which returned 17.6%. During the month Infratil provided an update to the market which provided comfort that Infratil’s capital structure and assets were handling the impacts of COVID-19. The core asset base of Infratil is comprised of Canberra Data Centres (CDC), Trustpower, Tilt and Vodafone. In the case of CDC there is little near-term volume or profitability impact expected as their core rental revenues are underpinned by long-term lease agreements with high creditworthy counterparties such as the Australian Government. IFT’s most recent acquisition, Vodafone, is also a defensive business. While there will be a negative earnings impact from the reduction in roaming charges associated with travel restrictions, Vodafone is expected to be a beneficiary from increased data usage and communication resilience that business and individuals have sought during, are likely to seek post lockdown.

Also worthy of a mention is A2 Milk, which we discussed in last month’s newsletter. A2 continued its strong performance from March into April returning 14.2%. Additionally, our recently established position in Vector rose 11.4%, and Aventus bounced following March’s difficulties, rising 15%. We discuss Vector more fulsomely in our Stock Spotlight section below.

A key detractor from P&I performance was Precinct (-6.7%). Precinct owns office assets in Wellington and Auckland including the soon to be completed Commercial Bay tower and retail precinct. The office sector has come under the spotlight as cities across the globe entered various forms of lockdown and work from home situations. As a result, some market participants, including the investment team at Generate, are pondering what office demand may look like in the future and whether there may be a structural shift in work methods resulting in lower demand for office space. There are some interesting counter arguments, one of which is whether office density (people per square metre) may reduce to allow for social distancing. Notwithstanding the emergence of this theme, we are cognisant that office as a sector has always exhibited cyclicality and the size of our Precinct position across the funds reflects this.

Having written last month that March extraordinarily contained both a full bull and bear market, April saw the bull run rampant and in fact produced the strongest month of returns since January 1987. In the US, the S&P 500 returned 12.8%, the MSCI World Index 10.6% (in local currency terms), New Zealand’s S&P/NZ50G returned 7.5% and the S&P/ASX200 13.7%. Global 10-year bond yields continued to bounce along the bottom with the US 10-year bond yield at 0.61%, while the New Zealand equivalent ended April at a yield of 0.72%.

The moves in April have polarised the market with some arguing that the stimulus injected into economies and markets from governments and central banks alike are enough to bridge economies, and in turn markets, into recovery. Elsewhere a view sits that what we have witnessed is a bear market rally, and that the market is likely to retest lows as incrementally negative economic data comes to the fore. Looking back through history, most bear markets have experienced at least one “relief” period where stocks rally, only to then go on to retest lows. Additional to this, there is still a concern that some countries may experience a “second wave” of the coronavirus. For this to occur in a world where we do not yet have a confirmed vaccine, would be unsettling.

The market is currently trying to reconcile fiscal and monetary stimulus with the eventual economic realities of massive unemployment and business failures. In contrast to what was witnessed in the Global Financial Crisis of 2008/09, the response of central banks and governments has been swift, determined, and meaningful. It has been pleasing to see lessons of the Global Financial Crisis learned where central banks have not allowed credit conditions to tighten to critical levels. Additionally, governments have kept many hundreds of thousands employed through wage subsidies such as those seen in New Zealand, and closely mimicked in Australia and the United Kingdom.

One thing we know for sure, is that news flow will continue to come at a rapid pace and have the ability to change the mood of markets at any time. We are continually testing our views and asking if we are comfortable with our current positioning and while we can’t control the direction of the winds, we can adjust our sails to suit.

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: Hindsight Bias

With many market participants and commentators referencing the Global Financial Crisis of 2008/09 during this current coronavirus situation, we thought that the hindsight bias was a particularly relevant subject to revisit. 

Hindsight bias is a phenomenon in which we are prone to revising probabilities after the fact, or to exaggerate the extent to which past events could have been predicted beforehand. This can be a dangerous state of mind and create “decision traps” as it may cause overconfidence in one’s ability to predict, or how to act during events.

Financial “bubbles” are a case in point. After the dotcom “bubble” and the GFC many market commentators were quick to point out how obvious it was that a “crash” was coming. Of course, some do correctly make this prediction, but if it were as easy as hindsight suggests then perhaps the “inevitable” crash wouldn’t occur in the first place.

A good way to avoid hindsight bias is to keep a record of what is influencing your decision making so it can be revisited at a later date and updated for any change in beliefs. Additionally, considering things that might have happened but didn’t helps gain a more balanced view of the associated probabilities.

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Vector

Vector’s core business is the ownership and operation of regulated electricity and gas networks in Auckland. Regulated network revenue represents approximately two thirds of Group revenues. Key revenue drivers are the number of gas and electricity connections, consumption per connection, and the tariff per connection. This tariff principally is based on Vector’s “allowable” revenue which is in turn set by the Commerce Commission using Vector’s estimated cost of capital as a key input. Vector’s regulated earnings are reset on 5-year intervals providing long periods of earnings stability.

Outside of the core regulated business, Vector operates a gas trading business and a technology business. The gas trading business includes the sale of natural gas and 9kg gas bottles. Vector also used to own and operate Kapuni Field gas assets. However, in February the company completed the sale of these assets to Todd Energy.

In the same month Vector’s management and Board drew a “line in the sand” with respect to dividend levels. While the positive incremental diividend policy has been removed, we expect Vector’s revenue and earnings profile to be robust. Further we expect that as the metering business grows that dividends too, will be able to continue to grow.

At the current share price ($3.60) Vector is trading on a 4.60% net dividend yield. Further attraction is Vector’s relative immunity from the impacts of coronavirus, and the long term view that Vector is well placed to benefit from the electrification of New Zealand as electrical vehicles, and electrified heat processes become more common place.

Next month: Worlldwide Healthcare Trust

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