Generate Newsletters

Welcome to the June edition of the Generate Member Newsletter.

Recently we attended the opening ceremonies of two of the Salvation Army's new social housing developments. The openings were attended by Prime Minister Jacinda Ardern, Minister of Housing Megan Woods, and Auckland Mayor Phil Goff.

In order for these housing developments to come to life they required the collaboration of several different parties including The Salvation Army, the Government and investors. Generate KiwiSaver members can feel proud of the part you played with the Scheme being the cornerstone investor in the bonds that financed these social housing developments. This is delivering members a sound investment return whilst having a significant positive social impact by helping scores of families and individuals to have a safe, warm and dry house they can call home.

Performance of the Generate Funds

Returns to 31 May 2021 (after fees* and before tax).

* Except the $3 per member per month administration expense that is charged to KiwiSaver members.
** The Generate KiwiSaver Scheme funds opened on 16 April 2013. The Generate Focused Growth Trust opened on 1 November 2019.
Note: Past performance is not necessarily an indicator of future performance. Generate's fund updates can be found here.

Global sharemarkets enjoyed another positive month appreciating 1.2% in May (when measured by the MSCI World Index in local currencies). As is often the case, good performance from sharemarkets is accompanied by a strong performance from the NZ dollar. In May this currency headwind dragged the returns NZ investors received on their global share investments into negative territory (-0.1%). However, this was still ahead of the returns provided by our local share market, which declined -3.2% over the month (when measured using the NZX50 index). The weak performance of the local share market can be attributed to a couple of large companies which provided disappointing updates during the month. We'll dig into this in the market update section.

Given this backdrop, we are very pleased with the performance of the funds over the past month as all of the funds generated positive returns. Interestingly, the fund with the largest allocation to NZ shares, the Growth Fund, led the charge, up 0.73%. The Focused Growth Fund and similarly managed Focused Growth Trust returned 0.50% and 0.48% respectively, and the more cautiously positioned Conservative Fund returned 0.22%.

Berkshire Hathaway, the insurance and investment behemoth led by Warren Buffet and Charlie Munger, was the strongest performing global holding in May. The company's share price was up 5.3% (in US dollars) over the month after the company held its highly anticipated AGM and released its first quarter results. The results were ahead of expectations, with a number of divisions positively surprising including Insurance, Energy and the Manufacturing, Services & Retail business. The railway and net investment income were the only areas of weakness. Buffet also stated that "we can't buy companies/stock as cheap as we can buy our own", confirming that they consider their stock undervalued and would therefore continue to use their vast cash reserves to buy it back.

Alibaba was the weakest performing global holding, declining -7.4% in May. This weakness was catalysed by the release of the company's fourth quarter financial results. While the company generated stronger than expected sales growth in the final quarter, this growth was driven by higher-than-expected expense growth. As a result, profit fell short of the market's expectations. On the conference call management explained that this theme would continue for the next few years, i.e. revenue growth would take priority over profit growth. A good example of the company's ambition is the target of being the first Chinese company with more than 1 billion active consumers. Arguably, this makes sense for those with a long-term focus, but the market tends to have a short-term focus, particularly when a company has disappointed versus expectations.

Given the weak performance of NZ shares over the month, it is pleasing to report that a number of the domestic shares in your portfolio appreciated during the month. In fact, almost twice as many domestic shares increased in value as those that decreased.

The best performing domestic holding was EBOS. EBOS primarily distributes medical supplies and equipment to hospitals, medical clinics and pharmacies in NZ and Australia. The company has built a track record of solid but not spectacular growth, which could well have been attractive to investors that were disappointed by the market updates provided by Fisher & Paykel Healthcare and A2 Milk. It is also worth noting that Pfizer announced that it was transitioning back from its internal distribution model to using external distributors (like EBOS). This serves to reconfirm the value of distributors, and should modestly boost EBOS's earnings growth next year.

The largest holding in this part of the portfolio, Infratil, continued its strong run in May, appreciating 7% over the month. The company released its financial results for the year ending March 2021 and provided earnings guidance for the year ahead. The highlight of Infratil's results was Vodafone, which generated profits near the top end of guidance in 2021 and guided to 10% growth in 2022. Vodafone is a turnaround story, and this early evidence that the company is successfully growing earnings is encouraging.

A2 Milk was the weakest performing domestic holding declining -23% in May after warning the market that guidance provided in late February was not going to be met. After three downgrades in the past six months, it is fair to say that we and the rest of the market were not surprised that the company was struggling, but the magnitude of the company's problems was far worse than feared. A2 Milk confirmed that the recovery they were hoping for in the final quarter would not occur. Quite the opposite in fact. The company announced that it had identified excess inventory in its channels to market and that this would require inventory write-downs and a significant reduction in near term supply into those channels. It is encouraging to see the new CEO take charge of the situation and make some decisions that are painful in the short term but seek to protect the brand. The hope is that this will position the company to recommence its growth path once they are through the inventory clearance.

In a number of respects, the most interesting financial news in the past month was a developing theme that central banks were alert to the risks of runaway inflation and were prepared to react should persistent inflationary pressures emerge. Three central banks provided commentary (including our own) that is best described as showing the first signs of hawkishness (aka controlling inflation). More specifically, the tone of their commentary had started to shift back to how they would control inflation instead of managing risks to the economy. While the commentary by the US central bank (the Fed) remained dovish (aka stimulating the economy) speeches by some of its governors suggested that discussions around the timing of reducing quantitative easing had begun i.e. behind closed doors they are focused on when they should reduce monetary stimulus. Arguably this is reassuring because runaway inflation is not constructive.

The local sharemarket declined by -3.2% when measured by the NZX50 index. This disappointing performance was not widespread. The poor performance was largely a result of a couple of the key growth companies, which in turn represent a large proportion of the index, providing disappointing updates during the month.

The key culprit was Fisher and Paykel Healthcare (FPH), which declined -17% during the month. Fisher & Paykel Healthcare has by far the largest weighting in the NZX 50 index and so this dip had a disproportionately severe impact on the overall index. We are happy to report that this company is not held by our funds, but given the magnitude of its decline, it's worth providing a brief overview of what happened to it during May.

FPH released its financial year results during the month. Profits were up a staggering 82% over the last financial year. So why did its shares suffer a major dip after reporting such strong growth? Fisher & Paykel Healthcare's products are used in hospitals when patients are provided respiratory support. At the risk of stating the obvious, demand for these products soared with Covid-19 hospitalisations. In market lingo, FPH is a Covid-19 beneficiary. After a strong half year result, confident commentary from the company, and an explosion in Covid-19 cases in the Northern Hemisphere winter, the share market became overly optimistic about its prospects. Too optimistic as it turns out. The company didn't meet their high expectations, and this disappointment was compounded by sobering commentary from the company on its results call. Management stressed that the last financial year was very unusual, and the company would not produce the same level of profitability for a number of years. We are now taking another look at this company, and its outlook. Fisher & Paykel Healthcare is one of NZ's highest quality companies with strong positions in large addressable markets and a strong culture. Uncertainty over near-term results may provide an opportunity for Generate to buy into the company.

The other key detractor was the serial underperformer A2 Milk. This company makes up a very small part of the Generate portfolios and given we covered its most recent troubles above, we won't revisit them here.

Top Holdings as of 31 May 2021

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Knowledge Builder - 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.