Tony Cousins, CEO of Pyrford International and Portfolio Manager of the Nedgroup Investments Global Cautious Fund, provides an overview of the Fund’s performance for the last quarter and its positioning going forward.
Q3 Market performance
The major asset performers this year were gold, returning 5.3% in US dollars for the period, and government bonds also delivering impressive returns of 2.9% in US Dollars, the latter being a key component of the Fund. Detractors over the quarter were Brent Crude and REIT markets.
Q3 Fund performance
The Fund delivered a gross return of 2.24%, which was above its cash benchmark. All contributions were positive with the exception of cash and currency hedging. The Fund’s significant non-US Dollar unhedged exposure (45%) was a contributor as the US Dollar weakened. The US and non-US equities positions contributed positively at 8.8% and 2.0% respectively. Our Australian Dollar currency hedge detracted over the period. Our policy is to manage overseas unhedged foreign exposure within a 0-45% of total funding risk parameter. Pyrford’s equity portfolio, US and overseas, both underperformed the market index, which continued to rally. Due to the strength of the market rally, we want an equity portfolio which is characterised by quality and value. The portfolio is currently very defensive, so when the market rallies as strongly as it did in Q3, the stocks will tend to lag. When markets go through turmoil as they did in Q1, our stocks preserved capital and are very defensive in that environment.
The Fund is constrained to a maximum equity weighting of 40%. We believe that equities will be the best performing asset class in the very long term. Our strategy it to lean more into equities as they get cheaper. In Q1 as equities fell very sharply in response to the crisis, we increased the equity weighting, putting the money into overseas equities as they offered significantly better value than US. As equities rallied strongly in early June, we reduced the equity weighting again. Equities had gone up 20%, but dividends on those equities had actually fallen by 22%, meaning that markets in that period had essentially became 40% more expensive. That is one of our concerns today. Equities have rallied strongly but the underlying earnings and dividend base have actually deteriorated.
Earnings on the World Index
The market and the price earnings ratio on the market fell in Q1. As the market has rallied back to where it was at the beginning of the year, the PE has obviously risen. But, what has happened during this time is that the earnings base has fallen significantly, resulting in a market which was valued at about 21 times earnings at the turn of the year and is now valued at 25 times earnings. The market is now significantly more expensive than it was when we started 2020.
The same is true for dividends. The world market started the year with dividend yields of 2.3%, which increased to 3% when the market fell. This has since fallen sharply because the market has gone up and also because dividends have been cut. Dividends have fallen precipitously around the world with the World Index dividends falling by 17% year to date. This has not been shared equally among the regions. Europe has been much harder hit with the Eurozone falling 25%, the UK 32% and the US 10%. By far the best place has been Asia, including and excluding Japan, with single digit declines.
In terms of the world market capitalisation to GDP, over the last 20 years we were only higher than where we are today in the dot-com boom. Markets are clearly discounting a strong recovery from COVID-19 and are being very optimistic about the future. The World Export Volume Index shows that the rebound has only been about one third of the fall, indicating that economic activity is still very suppressed, yet the market is anticipating a full recovery.
We saw a massive and coordinated fiscal and monetary stimulus in Q1 and Q2. Germany’s response was the highest at 18% of GDP followed by the US (13%) and the UK (12%). This has been necessary as governments have tried to build a bridge from the pre-COVID world to the post-COVID world and support economies, wages and employment until we emerge from this crisis. Eight months into the crisis the bridge is running out of road and what is needed is further fiscal stimulus, particularly in the US, which because of the political impasse is not happening.
We have 72% in bonds, 25% in equities and 3% in cash. We are favouring non-US dollar bonds in order to achieve overseas exposure. Similarly, we are favouring non-US equities because they are significantly cheaper. Within the non-US equity portion, we are favouring the economies in the markets of Asia, excluding Japan. These markets are cheaper in terms of simple valuations and economic growth and will outshine the US and European markets significantly. We maintain a cautious stance within this portfolio and do have some concerns looking forward for what equities can deliver.