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Unit Prices as at 31 January 2018 ($)

Focused Growth 1.6789
Growth 1.5816
Conservative 1.2955

Funds under Management as at 31 January 2018:

$689.4 million

In other news

Understanding the highs and lows of KiwiSaver investing
Generate #1 performance in two categories for 2017

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The Generate Team

Disclaimer

The Generate KiwiSaver Scheme Member Newsletter has been prepared by Generate Investment Management Limited. It is based on information believed to be accurate and reliable although no guarantee can be given that this is the case. Clients, directors or employees of Generate Investment Management Limited may have an interest or holding in companies and securities mentioned in the newsletter. No part of the newsletter is intended as financial advice. For more information about the Scheme please refer to the Generate KiwiSaver Scheme Product Disclosure Statement.

Newsflash - Generate led the pack in 2017!

We are delighted to inform you that the Generate Focused Growth Fund and the Generate Growth Fund were the top performing KiwiSaver funds in their respective categories for 2017! We are very proud of this achievement and will be working hard to try to stay ahead of the pack in 2018.

As you know the Newsletter took a break last month so there is plenty to cover in this edition. 2018 got off to a cracking start with share markets notching up strong gains in January only to give them up month to date in February. More on this later.

Performance of Our Funds

Returns to 31 January 2018 (after fees* and before tax).

	One Month	One Year	Three Year (p.a.)
Focused Growth	3.15%	26.71%	11.39%
Growth	2.08%	20.28%	10.12%
Conservative	-0.05%	6.84%	5.81%

*except the $3 per member per month fee.

Note: Past performance is not necessarily an indicator of future performance.

The Focused Growth, Growth and Conservative Funds returned 3.15%, 2.08% and -0.05% respectively over the month of January (all returns after fees and before tax).

The IEM or large cap international stock with the highest return was Alibaba Group (BABA), which returned 18.5% (in USD terms) in January. During the month investors eagerly awaited BABA’s quarterly earnings results which were released on 1 February. The company posted 56% growth in year over year revenues, which was 8% above consensus. Of interest the company also announced that it has an incredible 515 million annual active consumers on its China retail market places.

The IEM or large cap international stock (in which we hold a material position) with the lowest return for the month was Worldwide Healthcare Trust (WWH) with a return of -1.1% (in GBP). The U.S. healthcare sector (to which WWH is primarily exposed) actually performed positively in January. The primary reason why WWH fell during the month was because the pound rallied strongly against the US dollar.

The top performing Australasian stock for the funds in January was retirement village and aged care operator Summerset Group (SUM) with a return of 4.6%. During the month SUM released its fourth quarter 2017 sales statistics. The company achieved a record of 204 sales of both new and previously occupied units. Initially some investors seemed disappointed by SUM’s new sales figures. However, when it became apparent that the underwhelming new sales figures would be made up for in the first quarter of 2018 the stock rallied higher.

On the other side of the ledger was Refining New Zealand (NZR) with a -5.7% return. Mid-way through the month NZR reported a slightly disappointing gross refining margin (GRM) for the November and December 2017 period.

Volatility Strikes Back!

2017 was a year that delivered stellar share market returns marked by a remarkable lack of volatility (market ups and downs). In our December newsletter we highlighted that “we certainly are not expecting 2018 to enjoy the same extraordinary returns of 2017.” When the market zoomed higher over the first few weeks of January we were second guessing ourselves - only for the market to turn and (as we write) wipe out most of January’s gains.

During 2017 the S&P500 VIX Index (otherwise known as the fear index) was happily bumbling along in what could be termed the “complacent zone” but came back with a vengeance early in February as you can see in the chart below.

S&P500 VIX Index

Source: Bloomberg

So what caused the VIX Index to awaken from its slumber and US equities (in particular) to enter a correction (whereby the share market falls by 10% or more).

S&P500 Index

Source: Bloomberg

The event that seemed to trigger the dramatic move was a higher than expected wages number released in the US as it raised concern that the inflation genie may finally have escaped from the bottle. Higher inflation means higher interest rates, which - among other things - tends to dent company profit margins and tighten financial conditions. Some in the market also focused on the future inflationary effects of Trump’s tax cuts amid concerns that he might be “pouring petrol on the fire.” These concerns are justified and given the strength of the US economy we would argue for fiscal consolidation - not largesse. But it is fair to say that Trump never shied away from taking on large debts during his business career – despite the fact that in the past six of his companies have had to file for bankruptcy protection…

So where to from here? We think the era of low volatility is behind us and that it will return to more historically normal levels. This is because inflation will probably continue to spook the market for some time yet.

We do not believe that we are at the start of a bear market. We think a touch of euphoria entered the market in January. This is not healthy as over-optimism leads to excessive risk taking which inflates asset price bubbles until they go ‘pop’. So we view the recent pull-back as a healthy correction and a painful dose of reality for some investors.

We continue to believe that share markets globally will have a positive year in 2018 due to strong underlying fundamentals and our belief that interest rates will stay at historically low rates (albeit they are likely to finish the year higher than where they are now). We added to our holdings during this pull back as we believe the fall in prices presented some good buying opportunities.

As an aside it was interesting to see the wild ride in bitcoin has continued. In our December newsletter we said that we were firmly of the opinion the bitcoin was a bubble and that when the music stops it won’t be pretty. Well the music did stop (for the time being at least) a mere 2 days after we sent out the newsletter, with bitcoin reaching its highs on December 16. Since then the price of bitcoin has fallen almost 50% as at the time of writing.

Following is a recap of market movements in January

After a subdued December markets roared to life in January.

U.S. equities had a very strong month with the S&P500 rising 5.6%. This marked the 10th positive month in a row for the index or 15th if you include dividends.

Economic data was generally robust over the month and coupled with the prospect of a solid earnings season drove the market to border-line euphoria territory. After the release of some strong wage data the market began to consider the implication of higher interest rates, which ‘knocked the wind out of the market’s spinnaker’ and saw US share markets close the month off their record highs.

Eurozone equities registered gains in January with the Bloomberg European 500 Index gaining 1.8%. The region’s economic expansion gathered steam and cyclical (economically sensitive) stocks led the gains.

Minutes from the European Central Bank’s December meeting discussed the bloc’s “expansion” as opposed to “recovery”. The improvement in tone made some question whether the ECB might bring its ultra-loose monetary policy stance to an end sooner than what markets were pricing. This possibility saw bond yields rise and the euro strengthen.

In China, the Shanghai Stock Exchange Composite Index had a stellar month rising 5.3%. Tech companies and banks led the way. Better than expected economic data added a tail-wind.

Emerging equity markets as a whole continued on from 2017’s strong gains with the MSCI Emerging Markets (EM) Index storming higher by 6.7% in January (in local currencies). Continued strength in global growth and trade, accompanied by a weaker US dollar brought the planets into alignment for EM equities. As a result the sector enjoyed strong net capital inflows.

In Australia, the share market bucked the trend with the ASX200 Index falling 0.5% over the month. The higher bond yields and AUD weighed on stocks.

Back home and the NZ50 Gross Index nudged 0.5% higher in January. Although the Australasian share markets missed out on the stellar rallies enjoyed by some share markets in January they have outperformed in the sell off month to date in February.

Warren Buffett wisdoms

After 50 years at the helm of Berkshire Hathaway (which is currently one of the largest investments for both of our growth funds) Warren Buffett has become widely regarded as one of the world’s greatest investors. In his annual letters to shareholders, and in various interviews he has given, he has shared many of the lessons he has learned during his career. This month:

“The stock market is a wonderfully efficient mechanism for transferring wealth from the impatient to the patient.”

Given the recent pull back in marketswe thought this quote was particularly relevant. Probably the main reason why a lot of investors fall into the “impatient” camp is because they let their emotions control their investment decisions. And when it comes to financial markets the emotions that so often come to the fore are greed and fear. With share markets taking a dive in the second week of February, fear reigned supreme with many investors running for cover. The patient investor would not have sold shares and instead would have stayed in the market if the fundamentals justified it, or even added to his or her holdings.

Investing 101

Be prepared to walk away

Our inbuilt biases make it difficult for us to walk away from investment opportunities we have worked on or to sell investments when they go wrong.

If an investor has spent considerable time (or money) researching a potential opportunity it can become difficult to walk away even if the investment doesn’t quite stack up. But investors must be prepared to set the opportunity aside. In addition, people’s natural aversion to losses can lead to poor and irrational investment decisions, whereby investors refuse to sell loss making investments in the hope of making their money back at some later point in time.

We believe that the most successful investors pay little or no attention to the purchase price of an investment in deciding whether or not to sell, hold or buy more. The rational investor will estimate the likely return on the investment on a forward-looking basis and compare that return to other investment opportunities. This is something we are consistently doing in the management of your KiwiSaver investments.

Top Holdings as of 31 January 2018

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Conservative Fund	Growth Fund	Focused Growth Fund
International Equities Managers
N/A	Berkshire Hathaway	T Rowe Price Global Equity Fund
N/A	T Rowe Price Global Equity Fund	Platinum International Fund
N/A	Platinum International Fund	Berkshire Hathaway
N/A	Magellan Global Fund	Magellan Global Fund
N/A	Polar Capital Technology Trust	Polar Capital Technology Trust
Property and Infrastructure
Infratil	Infratil	Infratil
Arvida Group	Arvida Group	Arvida Group
Metlifecare	Metlifecare	Metlifecare
Contact Energy	Contact Energy	Contact Energy
Z Energy	Summerset Group	Summerset Group
Fixed Income and Cash
Term Deposits	Term Deposits	Cash & Cash Equivalents
Cash & Cash Equivalents	Cash & Cash Equivalents	N/A
Z Energy Nov 2021 Bonds	Fonterra Oct 2021 Bonds	N/A
Kiwi Property Aug 2021 Bonds	Precinct Property Aug 2021 bonds	N/A
ANZ Oct 2049 bonds	Kiwi Property Aug 2021 Bonds	N/A

Stock Spotlight

Arvida

Given Generate has recently become a substantial holder in Arvida Group (ARV) - meaning we currently own more than 5% the company’s shares - we thought it timely to make Arvida our spotlight stock this month.

ARV listed on the NZX in December 2014 following the roll-up of 18 aged care and retirement villages. Through acquisitions this number has now grown to 29 villages and means ARV is one of the largest corporate aged care providers in New Zealand. By having an investment in ARV, KiwiSaver members gain an exposure to the positive industry dynamics at play for aged care and retirement village operators. ARV has future growth prospects primarily centred on brownfield expansion, and via the acquisition of further care-focused retirement facilities. The company has a defensive earnings profile given its heavily ‘needs based’ portfolio. Therefore, ARV’s earnings should be more resilient versus some of its peers in the event of a significant fall in the housing market. Because of its reliable and growing earnings ARV pays an attractive dividend.

Next month: Tencent

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