Generate Newsletters

Welcome to the February edition of the Generate KiwiSaver Scheme Newsletter.

Generate KiwiSaver continues to deliver strong performances despite a volatile 2018.

In calendar year 2018, the Focused Growth Fund was 1st out of 10 aggressive funds, the Growth Fund was 3rd out of 27 growth funds and the Conservative Fund was 1st out of 19 moderate funds. Over five years the funds ranked 1st, 3rd and 2nd respectively. This strong performance indicates that the funds continue to deliver great value for money. See here for the Morningstar KiwiSaver Report: 31 December 2018

In other positive news share markets around the globe enjoyed a strong start to the year as macroeconomic fears receded. There were signs that the trade tensions between China and the US were easing and a deal might be struck. Commentary from the US Federal Reserve indicated that monetary policy was likely to be more accommodative, which further boosted the markets. On the flip side, and in contrast to previous months, company news was less positive.

Performance of Our Funds

Returns to 31 January 2019 (after fees* and before tax).

	One Year	Three Year (p.a.)	Since inception (p.a.)**
Focused Growth	-0.59%	9.92%	9.53%
Growth	1.68%	9.05%	8.87%
Conservative	4.69%	5.42%	5.64%

*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.

All three funds chalked up a positive month in January with the Focused Growth, Growth and Conservative Funds returning 4.46%, 2.97% and 1.00% respectively.

Facebook shares surged higher in January making it the strongest performing international equities holding. Nearing the end of the month the company delivered a strong fourth quarter earnings report. The stock was up 12% in after-hours trading and ended January up 27.2%! The highlight of the result was robust revenue growth, which was up 30% on 4Q 2017, comfortably outpacing the most optimistic sell side analysts. This strength and the growth in users reinforced the strength of Facebook’s platforms: the much publicised privacy issues are not causing users to shift away. In the December newsletter we mentioned that we thought Facebook was an attractive investment despite all the negative developments in 2018. It was nice to see our faith rewarded so soon.

The strong performance of the international holdings is probably best summed up by the weakest performer, Berkshire Hathaway, which was up 0.7% during the month. Berkshire’s largest listed investment, Apple, wrote to investors in early January warning that they would not meet previously issued guidance. The key driver of the downgrade was iPhone sales, which were weak in both developed markets and China. Speculation had been rife that sales of the recently introduced models had failed to meet the market’s and company’s expectations, fuelled by news from suppliers that Apple had cut order volumes, but on the day this letter was published Apple’s share price declined 10% and Berkshire’s share price was off 5%. When Apple reported its results, the market was encouraged by the strong services revenues and margins and as a result the stock rebounded, but Berkshire’s share price reaction was muted.

Z Energy was the strongest performing property and infrastructure holding generating a 9.3% return over the month. The market seems to be slowly coming to terms with the impact of the oil price on earnings. A high oil price acts as a headwind for the company because it takes them time to pass on the increase to commercial customers and as the petrol price rises customers reduce demand and at the margin shift away from Z Energy’s premium offering. It is worth noting that the bulk of this impact is transitory because commercial pricing catches up with the increased oil price.

In early January the company took the opportunity to upgrade earnings guidance when it released its third quarter volumes. The upgrade should not have been a surprise as oil prices have weakened considerably since the last set of guidance provided by the company at the time of its first half results. In our view, this implied that the headwind the company had incorporated into guidance had reversed into a tailwind. For a lower risk holding, Z Energy has a relatively volatile share price. The funds have taken the opportunity of this volatility: adding to our investment on weakness and then trimming the holding into strength.

The aged care sector stocks again featured as the weakest performing property and infrastructure holdings. This time Metlifecare and Summerset both achieved the dubious honour of the largest performance detractor with share price declines of 4.1%. The market has become increasingly concerned with the Auckland housing market and the headwind this could create for the retirement operators.

The funds’ holdings in this sector are currently concentrated in two companies: Arvida, because of its higher proportion of aged care bed earnings (that are not exposed to fluctuations in the housing market), and; Metlifecare, because in our view the 25% discount to its net asset value that it currently trades at is compelling. At worst it should limit further downside.

After a tough last quarter, share markets around the world started the year off on a more positive note: strong returns with minimal volatility. The key change was a more accommodative stance assumed by the Federal Reserve. The chances of a thawing in trade tensions also rose with both the United States and China making a number of encouraging statements about progress and the importance of reaching a deal. Interestingly, the growing possibility of a disorderly Brexit from the EU in late March was not enough to derail sentiment.

One less positive development has been the earnings season in the US. As of early February, 66% of S&P 500 companies had reported their earnings. Although earnings have beaten estimates they have not beaten the estimate by as much as the five year average. It is worth noting that analysts are predicting a decline in earnings for the first quarter of 2019 and only low single-digit growth in earnings for the second and third quarters of 2019.

Recap of market movements in January

Global share markets managed a very positive start to 2019 with the MSCI World Index returning an impressive 7.1% (in local currencies).

US shares were a key driver of the strong returns from global share markets. The S&P500 was up 8% when dividends were included. The key driver of this robust result was the swift reversal in rhetoric from the US Federal Reserve and of course the sell-off in share markets at the end of 2018.

The FOMC raised rates four times in 2018. While this was in line with the market’s expectations the forward-looking commentary at the December meeting was more hawkish than expected. The dot plots indicated that the Fed’s Committee expected two more rate rises in 2019 and the unwind of the Federal Reserve’s balance sheet was said to be on ‘autopilot’.

It is of limited surprise that a number of commentators argued that Federal Reserve Governor Jay Powell backed down to market pressure when a couple of weeks later in a speech to the America Economic Association, he raised the possibility of a pause and indicated that the unwind of the balance sheet would not occur irrespective of economic conditions.

The reversal was completed at the FOMC meeting at the end of January where the dots plots indicated Committee members did not expect further rate rises in 2019 and Powell stated that the raising cycle was on hold until data confirmed further raises were required.

One interpretation of the Federal Reserve’s commentary over the past few months is that stronger financial markets will see more hawkish language and weaker markets will see more dovish language. This strengthens the argument that the market is likely to be range bound in 2019, barring any shocks to the up or down-side.

Eurozone equities also contributed to the strong performance of global share markets. The Bloomberg European 500 Index was up 6.5%. This performance was particularly impressive given the lack of progress made to resolve the Brexit impasse. In mid-January, the UK parliament rejected Theresa May’s deal with the Europeans with a majority that had not been seen in 8 decades (432 to 202). This result was more extreme than even the most pessimistic projections and rumours.

A few weeks later a modest majority (317 vs 301) supported an amendment that May should return to Europe and negotiate a new backstop agreement. The only other successful amendment was that the UK should not leave the EU without a deal. While this amendment was advisory and has no legislative force, it provided the markets with some tangible evidence that the UK politicians were keen to avoid a no-deal Brexit.

The modest majority and comments made by British MP’s that had apparently supported the amendment, raised doubts whether Theresa May would be able to get an amended deal through parliament if the Europeans altered the backstop.
The Europeans were clearly unimpressed. Rhetoric was at best not encouraging, with the Europeans arguing that the deal was good, that it was designed by Britain and that they would not reopen negotiations with May. With little more than two months before Britain was scheduled to leave the EU any workable compromise looks to be a long way off. Forget about actually implementing it. All this while the drums beat louder for a second referendum…

The strength in the sterling and FTSE 100 share market index suggests that the market does not expect a no-deal Brexit. A delay looks more likely given the time required to agree a compromise and then implement the deal. The uncertainty is starting to have a real impact on the UK economy, with recently released data showing the UK grew at its slowest pace in six years in 2018.

Emerging Markets (EM) equities also enjoyed a strong start to 2019 with the MSCI EM Index returning 7.1% in January in local currencies. These share markets are exposed to US monetary policy, because of the propensity for individuals, companies and even governments to have US dollar-denominated debt. Consequently, the change of tact by the US Federal Reserve Chairman Jerome Powell, and hopes that the tightening cycle may have concluded was particularly welcome news for emerging markets investors.

Chinese equities had a strong start to 2019 but lagged other markets. The Shanghai Composite ended the month up 3.6%. News of a more dovish US monetary policy and progress on trade talks was partially offset by mixed news from companies.
Over the ditch, Australia also lagged other markets. Arguably, this was to be expected because the “lucky country” avoided the pullback suffered by most share markets in December. The ASX 200 Accumulation Index increased by 3.9%. The move higher was very broad with the financial sector the only sector not to contribute positively. No doubt speculation on the upcoming final Royal Commission Review report weighed on the sector. A strong oil price ignited energy stocks which were up 11.5%.

Back home and the NZ50G Index notched up a 2.0% gain making it the weakest performing market that we follow. The performance was certainly not helped by a couple of domestic cyclical stocks (Air New Zealand and Kathmandu) downgrading earnings and some weak economic statistics raising question marks over future economic growth.

Warren Buffett wisdoms

After 50 years at the helm of Berkshire Hathaway (which is currently one of the largest growth investments for all three of our 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:

“In the 54 years (Charlie Munger and I) have worked together, we have never forgone an attractive purchase because of the macro or political environment, or the views of other people. In fact, these subjects never come up when we make decisions”

Here Buffett surmises that investments need to be taken on their own merits. Economic growth will peak and trough but when you are looking to hold an investment for the long term it is better not to get caught up in what the economy is doing in the short term and focus on the fundamentals of the investment opportunity.

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 original 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 2019

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

Conservative Fund	Growth Fund	Focused Growth Fund
International Equities
Berkshire Hathaway	Berkshire Hathaway	Platinum International Fund
Alphabet	Platinum International Fund	Berkshire Hathaway
Alibaba	T Rowe Price Global Equity Fund	Magellan Global Fund
Ping An Insurance	Magellan Global Fund	T Rowe Price Global Equity Fund
Facebook	Worldwide Healthcare Trust	Worldwide Healthcare Trust
Property and Infrastructure
Infratil	Infratil	Infratil
Z Energy	Mercury	Contact Energy
Arvida Group	Contact Energy	Mercury
Mercury	Z Energy	Z Energy
Metlifecare	Metlifecare	Arvida Group
Fixed Income and Cash
Term Deposits	Term Deposits	Cash & Cash Equivalents
Cash & Cash Equivalents	Cash & Cash Equivalents	Westpac Bank Term Deposits
Vector bonds	Vector bonds	Z Energy bonds
Kiwi Property bonds	Z Energy bonds	Contact Energy bonds
Chorus bonds	Chorus bonds	-

Stock Spotlight

Summerset Group Holdings

Summerset has undeniably been the turnaround success story of the aged care sector. The turnaround started when Quadrant took control of Summerset in 2009/10 and worked with management to put in place a plan that would see Summerset’s development rate step up significantly.

In simple terms, the plan was to replicate the success of Ryman, but the failure of other companies to successfully execute similar strategies underlines the difficulty of the task. Success is a testament to the quality of the management team at Summerset.

To understand how Summerset achieved this turnaround it is useful to review its business model. Like the other NZ retirement village developer/operators Summerset sells the right to occupy a unit to the resident. When they eventually vacate the unit Summerset pays them back this initial payment less a management fee. The payments made by residents to occupy their retirement units covers the total cost of developing the village, and as a result, the developer can then reuse this capital in the next development.

The key to this business model is that it is capital light (capital is only tied up in villages under development and new units that have not been sold). This has allowed Summerset to almost triple the size of its portfolio over the last eight years (1,352 units at the end of 2010 to 3,732 units at the end of 2018). It also makes development very attractive because residents pay management fees and the retirement village owner also gets the benefit of rising property prices without having any capital tied up in the village.

There is a risk that the slowing Auckland property market is a leading indicator for the rest of NZ, which would act as a headwind for the sector (and a number of other businesses exposed to the NZ economy for that matter!). It is worth remembering that this risk is transitory, but the ageing population thematic is structural.

Next month:
Precinct Property

Disclaimer

© 2019 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. Any general advice or ‘class service’ have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser.

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