The High Conviction Fund (Wholesale) (the ‘Fund’) returned 9.6% net of fees in the financial year ended 30 June 2023, underperforming its benchmark, the ASX 300 Accumulation Index, which rose 14.4%.

The FY23 year was a tale of two halves, with a number of headwinds in the first half contributing to underperformance relative to the benchmark by the end of December, followed by a good recovery in the second-half as these headwinds subsided. The carbon-intensive Materials and Energy sectors (which the portfolio has minimal exposure to under the Ethical Charter), were a material headwind in the first-half as the China re-opening thematic buoyed the major iron-ore producers. While this headwind dissipated somewhat in the second-half, the two sectors still detracted from performance over the year given the portfolio’s material underweight position (6% vs. 30% for the benchmark).

Financials was the Fund’s best performing sector in FY23, with stock selection a key driver of performance. The Fund is overweight insurers and underweight banks. It was a strong year for insurance stocks with general insurers successfully implementing price increases to offset a high claims environment, while health insurers benefited from a low claims environment that is yet to normalise post-Covid. Banks, on the other hand, faced a challenging year dealing with heightened competition and declining net interest margins.

The Fund’s underweight position in the Real Estate sector contributed positively, while stock selection contributed positively in two of the Fund’s overweight sectors - Utilities and Industrials. Contact Energy, one of the large NZ ‘Gen-tailers’ powered by ~90% renewable generation, had a good year as the energy market outlook in NZ improved, while Brambles and Fletcher Building were two strong performers in the Industrials sector.

The Materials sector was the Fund’s largest detractor from performance. This was largely due to the Fund’s material underweight position. Healthcare and Information Technology were also detractors from performance as the significant increase in cash rates from the RBA weighed on some of the growth sectors in the market. Healius and Ramsay Health Care drove the underperformance in the Healthcare sector despite positive performance from Ansell and the decision not to hold CSL (which underperformed). The negative impact in the Information Technology sector was largely due to the Fund’s positioning in smaller cap companies, with large caps outperforming small caps in FY23 despite much higher relative valuations. In both the Healthcare and Information Technology sectors, we think there are valuation opportunities emerging that will lead to improved performance in these sectors in FY24.

High Conviction (Wholesale) Fund Performance

As at 30 June 2023^*

Benchmark: S&P/ASX 300 Accumulation Index. Past performance is not a reliable indicator of future performance.

Inception date: 01/10/2021.

Contributors and detractors

Contributors

• QBE Insurance Group (QBE) returned 33% for the year. QBE is one of the top 20 insurance and reinsurance companies globally with the potential for material earnings increases in the medium term if its North American operations improve. A significant reinsurance transaction was undertaken in February that should reduce earnings volatility going forward.

• Suncorp (SUN) returned 28% for the year, demonstrating strong operating metrics by delivering a 10% underlying insurance margin at the 1H23 result. Management recently reiterated its 10-12% insurance margin target and a sole focus on the general insurance business is expected to result in better returns if the sale of the bank to ANZ proceeds.

• Ansell (ANN) returned 24% for the year. ANN saw some early weakness in the year driven by destocking and a strong USD. However, wider market support positively shifted to ANN’s future outlook, with more focus on the recovery of its sales volumes and margin profile.

Detractors

• Ramsay Health Care (RHC) declined 22% over the year with weakness primarily off the back of KKR pulling its $88 per share bid in August 2022. Balance sheet concerns and a slower recovery in patient volumes have also contributed. However, we believe focusing on the recovery and the strategic nature of RHC’s assets offers valuation upside from current levels.

• TPG Telecom (TPG) declined 15% over the year with the ACCC and then the Australian Competition Tribunal knocking back TPG’s proposal for a network sharing arrangement with Telstra. Despite this, the telco market is operating more rationally than it has in the past, with mobile operators focused on getting price increases through to capture an adequate return on 5G network investments. TPG has a number of growth opportunities across mobile, fixed wireless, and Enterprise, which we’ll be looking for progress on over the next 12 months.

• Healius (HLS) declined 12% over the year. HLS focused too intently on COVID-19 testing, which, combined with its weaker than anticipated recent acquisition performance, has meant a decline in its share price. However, we see a pathway forward and anticipate growth in FY24 and FY25 as GP volumes improve and the full impact of the cost-out benefits HLS.

QBE is one of the top 20 insurance and reinsurance companies globally with the potential for material earnings increases in the medium term if its North American operations improve.

Portfolio changes

Additions to the Fund

• Downer EDI (DOW) – DOW is an integrated services business operating in the sectors of Transport, Utilities, Facilities, Engineering, Construction, Maintenance and Mining, across Australia and New Zealand. DOW faced a challenging year reflected in a disappointing 1H result, but with a change of management, refined strategy targeting $100m pa of earnings benefits, and an attractive valuation, we added to our position over the course of the year.
• Suncorp (SUN) – SUN is a provider of general insurance, life insurance and retail and business banking services. We are attracted to SUN as it has hit its underlying insurance margin targets and expect investment income to increase substantially in the near term.
• Orora (ORA) – ORA is a manufacturer of packaging solutions for consumable and beverage products, operating mainly in Australia, NZ and the US. We are attracted to ORA for its market leading position in its core products, consistent cash generation, and strong balance sheet. While possessing a number of defensive style characteristics, ORA also has opportunities for growth across its business.

Selldowns from the Fund

• Helia (HLI) – HLI is a major provider of lenders mortgage insurance in Australia and successfully renewed its key contract with CBA during the year. After a period of strong performance we decided to take some profits to reinvest into other opportunities.

• Perpetual (PPT) – PPT is an Australian based investment fund manager and the Fund’s holding was divested following the acquisition of Pendal.

• GrainCorp (GNC) – GNC is the leading bulk grain handling company in Australia, with a network of high-quality infrastructure assets utilised to store, handle, and connect grain to customers domestically and worldwide. After a highly favourable period of weather conditions that drove record earnings, the outlook for changing weather conditions suggests earnings will also normalise and we therefore decided to take profits at this point in the cycle.
  
  
  
  

TPG Telecom (TPG) declined 15% over the year with the ACCC and then the Australian Competition Tribunal knocking back TPG’s proposal for a network sharing arrangement with Telstra.

Heading into FY24, we believe the portfolio is well positioned to continue delivering on the strong performance recorded over the second half of FY23.

Sector allocation

Sector overweights
Communication Services, Healthcare, Industrials, Utilities (Renewables)

Sector underweights
Consumer Discretionary, Energy, Materials