REPORT TO THE UNIT HOLDERS IN THE ASPIRING FUND FOR THE QUARTER ENDED 30 JUNE 2007
PERFORMANCE
Over the June quarter the Aspiring Fund returned 1.41% after fees and tax. This was below the 3.4% return posted by the NZX50 Gross and the 2.5% New Zealand dollar return from the ASX All Ords. However, since inception the Fund's return is 27.94% after fees and tax which compares more favourably with the 26.37% return from the NZX50 Gross for the same period
COMMENTARY
There were three big stories in this quarter.
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The strength of the New Zealand dollar which appreciated by 7.4% on a TWI basis.
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| 2 |
The strength of global equity markets. The MSCI - the most widely followed global equity index - was up 5.*% in US terms.
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| 3 |
Global bond market weakness. The yield on US 10 year treasuries rose from 4.65% to 5.03% while the yield on 10 year NZ Government bonds rose from 5.93% to 6.71%.
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The global economy continued to grow strongly over the quarter with strength in China, India and Europe compensating for slower growth in the USA. The world is definitely reducing its historic reliance on the US consumer to maintain this momentum. Given the parlous state of the average household’s finances in the US and the likelihood of further deterioration as the fallout from the housing bust continues, this is a good thing. This strength and a general trend towards tighter monetary policy globally was behind the bond market selloff which was even more pronounced before a flight to quality (a direct consequence of the subprime fiasco) caused a late rally in US treasuries.
Equity markets rallied as confidence about the outlook for earnings coupled with continued hype about private equity buying and merger and acquisition activity was enough to offset the negative effects of rising bond yields.
Unfortunately for New Zealand investors the strength of the New Zealand dollar swamped these global returns so that unhedged global assets generally produced negative returns for the quarter. While the MSCI was up 5.8% in US$ it was down by 2.1% in NZ$ thanks to the 8.1% appreciation in the Kiwi against the US$. The Australian sharemarket was up 5.5% in Australian dollars for the quarter but in NZ$ it was up only 2.5%.The Kiwi’s strength has had the effect of negating returns across all offshore assets over the duration of the Aspiring Fund’s short life. At some point this will reverse but, as long as there is a tightening bias in monetary policy, betting against the Kiwi offers a lot of risk for little reward as Alan Bollard has already discovered.
In fact, we remain as resolutely uncertain about the future as we were at the end of the last quarter.
Globally, the indifference of equity markets to higher bond rates is unusual, inflationary pressures and geopolitical risks seem to be on the increase, valuations in developed markets are very full and appetite for credit risk in bond markets is clearly diminishing.
Domestically, the Reserve Bank has finally recognized that asset price inflation is at least as damaging to the economy as consumer price inflation. After sleepwalking their way though 2006, they now seem determined to deliver a cure which will have profoundly negative short term consequences for the patient. Strong employment numbers and the inflationary consequences of Government spending still tilt the odds in favour of further rate increases. This is unlikely to make life any easier for domestically focused businesses in competitive industries and most of our domestic exposure is concentrated in businesses with utility characteristics.
Fortunately the New Zealand equity market also offers many investment options which are relatively unaffected by both Reserve Bank and Government actions. Our biggest holding, Mainfreight, has a first class domestic business but its real investment appeal lies in its rapidly growing international business. Cavotec has no New Zealand business to speak of but a global distribution network through which they market an expanding portfolio of top quality products to a wide variety of international customers in growth industries like shipping, mining and aviation. Michael Hill is a much bigger business in Australia than New Zealand with a significant growth option being developed in Canada. Fletcher Building has a dominant footprint in New Zealand but a huge presence in Australia and, with its latest acquisition a profitable beachhead in the USA.
However, overall we have seen little to change the cautious outlook we had last quarter.
Earnings growth among the companies which reported in the quarter was marginally better than expected but interest rates, wage increases and raw material cost increases all raise the risk of downside risk to future earnings.
The fact that our cash weighting was down to 13% at the end of June does not signal a change to that cautious stance. We view property stocks as a proxy for cash, buying them when we think they are oversold and selling them when they rally. So far, this has consistently added value to the fund and our 5.1% weighting in MGP at the end of June was an example of this. If this is added to the fund inflow we knew was coming at the end of June our effective cash weighting in July bounced straight back up to 23%.
The portfolio experienced no nasty surprises in the form of news flow from the constituent companies. In part, this can be attributed to our aversion to exporters while they are priced for a currency decline which shows no signs of materializing. Most of the earnings downgrades were concentrated in that sector. Unfortunately our aversion to expensive stocks meant that we owned no Auckland Airports which contributed 59% of the market’s performance during the quarter. Their performance accentuated a marked divergence between small and large cap stocks with the NZX small cap index up a paltry 0.6% against the NZX Top Ten’s 4.8% rise. Over the long run small caps have consistently outperformed large cap stocks so we remain comfortable with this bias in the portfolio.
Australia proved problematic for the fund in the latest quarter. Our largest holding, Iress Market Technology fell 4.79% in $NZ terms but we remain committed to this story and it has been a significant win for the fund since purchase. Our preference for growth companies over more traditional stocks such as banks and major resource companies has also worked against us in the short term, and we will be looking for better from these holdings in the coming period.
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TOP 10 HOLDINGS |
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| Cash |
13.0% |
| Mainfreight |
10.1% |
| Cavotec |
5.3% |
| Goodman Property |
5.1% |
| Michael Hill |
5.0% |
| Fletcher Building |
4.9% |
| Infratil |
4.4% |
| IRESS |
3.8% |
| Contact Energy |
3.6% |
| Turners and Growers |
3.3% |
| Energy Developments |
3.3% |