Welcome to the September edition of the Generate Member Newsletter. The solid gains in unit prices in July were eclipsed in August as global share markets continued to push higher. The advance was once again lead by US shares, with the Standard & Poors 500 setting new record highs in August. It appreciated 7.2% over the month when dividends are included.

The discovery of a new COVID-19 cluster and the subsequent lockdown of New Zealand’s largest city was not enough to drag the local bourse into negative territory. The key market benchmark, NZSE50 index, was up a very respectable 1.7% over the month of August. Later in this newsletter, we will detail how the strong lead from offshore markets and reassuring financial results released in the August reporting season provided a helpful distraction to economic concerns relating to the latest COVID outbreak in NZ. It is pleasing to note that these strong returns pushed two of the three KiwiSaver funds and the Unit Trust into positive territory for the calendar year to date. It is also worth noting that the returns displayed in the table below have reverted to more typical levels.

With our recent strong returns and low interest rates we are seeing record numbers of first home withdrawals. We are delighted to have been able to help so many members buy their first home.

Returns to 31 August 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.

Global share markets continued their relentless rally in August, with the MSCI World in NZ dollars gaining an impressive 4.8%. The investor optimism driving the US share market higher also pushed the NZ dollar higher in August, which acted as a drag on returns from offshore investments when converted back into NZ dollars. For instance, the Standard & Poors 500 index returned 7.2% when dividends are included in US dollars but only 5.3% in NZ dollars. A slightly less positive European share market also dragged down returns.

We were pleased with the performance of the two most equity orientated offerings: the (KiwiSaver) Focused Growth Fund and (non-KiwiSaver) Focused Growth Trust returning 4.5% and 4.4% respectively. These returns were close to the performance of global shares, which was a solid effort given the weaker performance of domestic shares. The Growth and Conservative Funds also put in commendable performances (given their lower allocation to global shares) gaining 3.5% and 1.6% respectively.

Turning to key contributors to performance, and starting with global equities, Facebook enjoyed an extremely strong month, up 15.6% in US dollars. While there were no key news announcements during the month the enthusiasm for some of FaceBook’s new offerings intensified. For instance, UBS did a ‘deep dive’ reviewing the upside opportunities from Facebook’s eCommerce initiative. They argued that Facebook was a key beneficiary of the significant step up in online activity driven by the COVID-19 pandemic and that eStore initiatives across Facebook and Instagram would drive strong growth revenue going forwards. Deutsche Bank also published late in the month. They highlighted the strong turnaround in Instagram Reels engagement arguing that Reels has stemmed user losses to TikTok and should make a contribution to future profit growth.

Chinese online behemoth Tencent was the only global equity holding to decline in value in August in local currency; its shares drifting back -0.7% in August. This soft performance should be put into context, Tencent has appreciated an impressive 41% in 2020. The rise of China-US tensions, more specifically suggestions that the usage of WeChat in the United States would be prohibited weighed on the company’s shares. Tencent reported its second-quarter results during the month which were better than analysts’ expectations driven by exceptionally strong mobile gaming growth, which was up 62% on the same quarter last year. Analysts were particularly pleased with the very modest deceleration on first-quarter growth (64%), as that quarter had the strong tailwinds of stringent COVID lock-downs in China.

The strongest property and infrastructure holding was the Australian real estate investment management company, Centuria, which was up 18.4% in NZ dollars. In our view, it was not the release of its results for the year ending June 2020 that drove the significant re-rate, as these were very much a ‘yawn fest’ (not a bad thing in these difficult times!). Instead, it was news that they had successfully taken over Augusta, a NZ based management company that has been hit hard by Covid-19 but has a number of future syndication and development opportunities. As these opportunities are realised Centuria will benefit from strong transactional fee income and then an attractive management fee annuity. In early August, Centuria also announced that its listed industrial fund was buying Telstra’s data centres for A$416m. This transaction extends the weighted average maturity of the Industrial Trust’s leases to over 7 years, which is attractive to investors. It also generates good transactional and management fee income.

Vector also put in a strong performance over the month - up 15.2%. Vector is the largest electricity and gas networks owner and operator in NZ. These networks generate the majority of Vector’s earnings. They have also driven earnings growth through smart electricity meters in NZ and Australia. These meters generate predictable levels of returns over long contracted periods. Vector released its results for its financial year 2020 in August. And as one could expect these were in line with expectations. The company highlighted growth opportunities via the continued rollout of smart meters in Australia and smart gas meters in NZ, which should drive growth in Vector’s earnings in future years.

The weakest performing Property and Infrastructure holding was Z Energy, which was down 4.6% in August. Z Energy was a victim of the increase in Covid-19 restrictions to Level 3 in Auckland and Level 2 in the rest of the country. These restrictions seek to reduce movement, which has a direct impact on the demand for Z energy’s products.

It is also worth noting that Spark, NZ’s largest telecommunications company, went from the strongest contributor in July to one of the softest in August. Spark declined 2% in August after releasing its results for the year ending June 2020. The results for 2020 were in line with expectations, but they provided limited future guidance deferring to an investor day scheduled in mid-September. The limited outlook commentary that the company provided was conservative. Spark signalled concerns over the impact of a significant decline in economic activity as a result of COVID-19, arguing that bad debt expense could step up this financial year if the virus drags the NZ economy into a deep recession. On the back of these concerns, the company guided to a 23-25 cent dividend per share in 2021 (2020 was 25 cents). We can understand why management chose to be conservative and note the exceptionally poor performance of Spark’s nearest comparable company, Telstra.

The strong gains in global share markets in August were detailed earlier in this newsletter. The sell-off in the first quarter was one of the sharpest on record and the recovery has matched that impressive pace. The S&P 500 index reached a new record high in mid-August eclipsing the previous record set early in the year before the COVID-19 sell-off. The chart below shows that this recovery is the fastest on record. More specifically, the chart below summarises all of the bear markets (a greater than 20% pullback) in the last 100 years using the S&P 500 index. The recent bear market took only 190 days to recover.

Early in the month, the US share market was propelled higher on the back of increased optimism that the Republicans and Democrats could agree to a new stimulus package by the end of August. This would replace the first stimulus package that ended 31 July.

The terms of the deal are still being negotiated as we pen this newsletter, but assuming they successfully reach an agreement, a new stimulus package will provide a much-needed demand boost mitigating some of the COVID-19 damage and aiding the economic recovery.

There was also growing optimism that a vaccine would be developed sooner rather than later. This boosted share markets because the headwinds form COVID-19 will largely be a thing of the past when a significant percentage of the population can get vaccinated.

Later in the month, the Fed Chairman Jerome Powell clarified that the 2% inflation target should be thought of as the middle of a range i.e. he was happy for inflation to rise above the target for periods of time, which further cemented the market’s view that rates would stay lower for longer. Not only does this provide fuel for the “There Is No Alternative” or TINA argument for why the share market will continue to appreciate, but lower interest rates also put upwards pressure on analyst valuations because a lower discount rate increases the present value of future cash flows.

The performance of European share markets was a little more patchy in August. There was a strong start to the month as European governments made it clear that there would not be a second lockdown to stem the COVID-19 resurgence in Europe. Instead, different approaches would be used to manage the COVID-19 flare-ups going forwards. Late in the month, European share markets also benefited from the Fed Chairman’s dovish argument that people should expect the US central bank to allow inflation to exceed the 2% target for periods of time.

The local bourse followed the strong lead set by offshore share markets in early August, but this optimism was reversed by the revelation that NZ was no longer COVID-19 free. A shift to level 3 restrictions in NZ’s largest city and level 2 restrictions in the rest of NZ dragged down local shares as investors factored in a slower economic rebound. The key reporting season for companies with a June year-end was encouraging. While companies did not smash expectations there were also no significant disappointments. Finally, news that the US is likely to have an accommodative monetary policy for a longer period of time was enough to secure a positive month for local shares.

Knowledge Builder: Green Bonds

This month we take a break from investor biases and review a relatively recent development in capital markets - the issuance of green bonds.

For those not familiar with bonds, they are best thought of as a term deposit. They will typically have both a fixed term (say 5 years) and a fixed rate of return. Bonds are often issued by companies and governments rather than just banks and the other key difference is that they can be sold on a secondary market if the investor needs the money.

The first green bond was issued by the World Bank in 2008. They are bonds that are issued to fund investments that reduce carbon emissions or have other environmental benefits. Investors that want to improve the Environmental, Social and Governance (ESG) credentials of their portfolios can invest in these bonds.

The push towards the incorporation of ESG into investment consideration has seen the size of the green bond market expand dramatically. Robeco estimated that the total size of the market was 700 billion euros earlier this year.

This trend has not escaped NZ. Electricity generators and property trusts have issued green bonds taking advantage of the lower interest rates that investors require for these bonds.

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Investore Property

Investore Property (IPL) is a listed property company with a focus on large format retail properties. It listed on the share market in 2016 with 25 properties from IPL’s manager, Stride, and then added a further 14 properties from ASX-listed Shopping Centres Australasia. In total, these properties were valued at just over $640 million. 

Stride has continued to expand the size of IPL’s portfolio and at the time of its last financial year-end, it had 43 properties valued at just under $900m.

The key attraction of IPL is the predictable rental incomes generated by its properties. This is because the tenants are well-positioned to pay the rent. Just over two-thirds of IPL’s rental income was paid by the two main supermarket chains (Countdown and Foodstuffs) and a sixth of rental income was paid by the two leading hardware chains (Mitre 10 and Bunnings).

IPL has also signed long lease contracts with its tenants locking them in for an average of just over 10 years, which provides investors with confidence that IPL will receive strong rental income from its assets for an extended period of time.

It is also worth noting that a number of IPL’s assets are well located, and so should the retailer tenants decide they do not want to roll the lease at the end of their term IPL can redevelop the site for either industrial or residential uses.

The uncertainty created by the COVID-19 pandemic and low-interest rates offered by term deposits makes the predictable income paid by IPL attractive. Consequently, IPL has been one of the portfolio’s star performers this year. Even at $2.20, IPL still pays a tax paid yield of 3.5%, which equates to an equivalent pre-tax yield of 5.2% for investors on the top marginal tax rate. Should Labour win the next election IPL tax paid dividends will become even more attractive to those on the highest marginal tax rate, increasing the equivalent pre-tax yield to 5.7%.

Next month: T Rowe Price Global Equity

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