Investor update for May 2022

Inflation must fall... or markets will (Part II)

With inflation punching new highs in the US on Friday and topping 8.6% annual growth, we thought it worth revisiting our chart from June last year which plots annual inflation levels in the US, versus the valuation of the S&P 500.

Fig 1. Ten year rolling stock market returns (US markets)

Since we last ran this chart nearly 12 months ago, inflation has ratcheted up to 8.6% from 5.4%, with the Russian invasion of Ukraine providing a surprise exogenous shock to global energy markets and compounding the already evident Global supply chain crisis. 

In turn, this elevated inflation (and the expected Fed response) is pulling valuations lower, with gravity difficult to fight when expected interest rates move higher. The valuation multiple has fallen from 21x to around 16x over this period, although fortunately for investors, earnings growth of over 10% has helped cushion the blow. As a result of earnings growth, the S&P500 is down only 11% over this period (despite the 22%  fall year to date).

So what does this mean? Despite the valuation de-rating to 16x, based on current levels of +8% inflation and the historic relationship with valuation multiples, in the US the multiple should be closer to 10x (!!). Therein lies the problem… inflation must fall, or markets will.

Base effect

Despite the recent inflation prints, there is a reasonable case to be made that inflation will fall in coming months, even if the main reason is simply that we will begin cycling higher prior year comparatives. Economists like to call this the ‘base effect’. 

Two-year inflation breakevens suggest a more moderate inflation expectation for the next 2-years, with 4.4% currently being priced as the difference between nominal and inflation linked bonds. 

If we refer to the historic relationship with valuation multiples, an inflation rate of 4.4% implies a PE of closer to 15x. So pretty much inline with where the market is currently trading, and much better than the 10x historic valuation should inflation remain above 8%! So perhaps at least from a valuation perspective, most is now in the price.

The other leg - Earnings

However this all assumes earnings forecasts remain unchanged, which seems increasingly unlikely. US CEO Confidence has recently taken a dive, which usually means corporate profits will follow. Furthermore, US Consumer sentiment has just posted its lowest ever recording, as higher oil prices and cost of living expenses sap disposable incomes. 

Fig 1. Ten year rolling stock market returns (US markets)

Downgrades to corporate earnings appear not be fully reflected in market estimates yet, although following US reporting season next month we believe they likely will start to be. Earnings downgrades will push PE multiples higher, again causing problems for current equity valuations.

Can we just hide out in commodities?

Commodities and energy exposure in particular have been the standout winners this year to date, and particularly since February 24th when Russia crossed the border into Ukraine. Whether it be agricultural commodities or mineral resources, most have rallied meaningfully the past 100 days. 

One outlier that’s worth flagging is copper, or ‘Doctor Copper’ to economists due to the metals ability to predict turning points in the global economy (economists say it has a PhD in economics). The relationship stems from coppers widespread use in all areas of the global industrial economy, with few other non-industrial applications. As a result, copper has proven a reliable leading indicator of economic activity in the broader economy.

Fig 1. Ten year rolling stock market returns (US markets)

The flipside of rocketing commodity prices is the eventual drag this has on economic growth, with the decline in copper over this period casting a shadow over the continued strength of all commodities. This is despite the higher copper intensity of electric cars and many other applications that may be considered to do well during an energy price spike. 

While the recent slowdown in China also has an impact on copper demand (China accounts for over half of the metals output), it seems hard to ignore the breakdown with other commodities and the potential signal this is flashing that concern may have tilted from coppers value as an inflation hedge, to coppers potential downside should economic conditions deteriorate. 

As the saying goes the best solution for higher oil prices is… higher oil prices, as energy users either curtail demand, or seek alternative power supplies. So while the flight for inflation havens seems robust for now, we’d caution that as every month the economy cools, a softening demand environment may catch up with supply side issues more rapidly than expected. Year to date, energy stocks in the US have had a fantastic run.

Fig 1. Ten year rolling stock market returns (US markets)

Outlook

From an investment perspective, the focus on inflation versus interest rates versus economic activity is dominating short-term share market returns as macro themes overpower stock specifics. As a result, correlations between individual securities have increased year-to-date, which means more shares are moving in the same direction on a given day (energy and resources have been the exceptions!). Higher correlations mean the market swings more like a pendulum, thus with higher volatility. 

Fig 1. Ten year rolling stock market returns (US markets)

This higher volatility can create opportunities for our strategies at Wheelhouse. Investors in our funds will know that we focus on systematic option selling strategies that both produce income and reduce risk. During these periods of heightened uncertainty, the income generation increases, as does the real return generation versus owning a portfolio comprised entirely of equities.

In the more recent past, one of the negatives of overlay strategies is that they are likely to relatively underperform in strong market recoveries. For the past ten years, spikes in volatility (and market corrections) were usually accompanied by a subsequent snap back in equity markets as the ‘Fed put’ sparked buy-the-dip investor responses. In this ‘snap-back’ environment, relative returns for overlays have suffered as the higher income generation has been outweighed by the aggressive market recovery.

However in today’s environment, minus the Fed put and with economic growth slowing, it seems likely to us that a lower growth, more volatile investment world awaits. In this environment, income generation is likely to remain elevated, but with far fewer of the ‘snap-back’ buy-the-dip type recoveries. With more of the positives (higher income) and fewer of the negatives (drag in strong markets), overlay strategies should be well placed to differentiate and add value in a generally lower-growth environment where returns from capital growth are likely far more challenged

Wheelhouse Global Equity Income Fund

7.9%

Income over 3 years (p.a.)

5.3%

Total over 3 years (p.a.)

 1 month1 year3 years (p.a.)Since inception^
Income0.00%7.76%7.90%7.23%
Growth(0.09%)(7.90%)(2.65%)(1.01%)
Total Return(0.09%)(0.14%)5.25%6.22%
Benchmark*(0.83%)2.64%11.44%10.56%
Risk (Beta)**n/a0.530.440.59

Performance figures are net of fees and expenses.
* Benchmark is the MSCI World Index (ex-Australia).

** Risk is defined as Beta and sourced from Morningstar Direct. Beta is represented vs the Benchmark and vs the S&P/ASX 200 Index. A Beta of 1.00 represents equivalent market risk to the comparison Index. A minimum of 12 months data is required for the calculation.

^ Inception date is 26/05/2017. Since inception figures are calculated on a p.a. basis. Past performance is not an indicator of future performance.

Click here to read the full performance report of the Wheelhouse Global Equity Income Fund.

Wheelhouse Australian Enhanced Income Fund

10.4%

Income over 3 years (p.a.)

11.6%

Total over 3 years (p.a.)

 

 1 month3 months12 monthsSince inception^
Income*1.46%3.36%11.83%10.41%
Growth(3.67%)0.18%(4.60%)1.19%
Total Return(2.21%)3.54%7.23%11.60%
Benchmark**(2.45%)3.54%6.34%10.64%
Excess return0.24%0.00%0.89%0.96%

Performance figures are net of fees and expenses.

* Income includes cash distributions and the value of franking credits and special dividends. Cash distributions are paid quarterly.

** Benchmark is the S&P/ASX 200 Franking Credit Adjusted Daily Total Return Index (Tax-Exempt).

^ Inception date is 9/03/2021. Since inception figures are calculated on a p.a. basis. Past performance is not an indicator of future performance.

Click here to read the full performance report of the Wheelhouse Australian Enhanced Income Fund.

News

Want to keep your fully-franked dividends but reduce risk?

As market returns trend lower, many investors are waking up to the underlying risk in their portfolios. In recent years as interest rates have marched steadily towards zero, investors who rely on income have been forced further out along the risk curve in order to generate sufficient yield.

Is there another way to capture full dividend yields, including franking, but with less risk? In this wire, we’ll introduce a systematic approach that for the past 18 years has captured the full dividend yield of the Australian market, and full equity returns, but has achieved this with around half the Beta (or risk) of the market. Later in the article we’ll also introduce our Australian fund that uses this source of superior risk-adjusted returns to target alpha, or outperformance.

View Article here

Wheelhouse Partners investor update for April 2022

Are we there yet?

As the market route continues from April into May, we’re often asked whether we feel the bottom is near… only for that question to be answered quite quickly with fresh lows being set! In this newsletter we take a step back and look at some high-level fundamentals.

Market falls

To put it in context, as of 12th May the year to date market declines look like this:

Source: Wheelhouse, Bloomberg

Clearly the higher materials and energy weightings in the Australian market are significantly pulling their weight. Sector heavyweights Materials and Financials are close to flat for the year, with Energy up 26%, As these sectors account for over 50% of the local market, it’s hardly surprising the ASX200 is outperforming… just don’t ask about Tech or Consumer Discretionary exposures.

These sector returns are broadly similar with markets everywhere else, it’s just that they account for significantly more of the local Index exposure than in other regions. As usual, getting the sector, or the factor right, will usually far outweigh the contribution to returns from individual stock selection. Commodities and Value were clearly the boats to be in so far this year. 

Valuations

So where are we now in terms of valuations? The chart below plots the forward Price/Earnings (P/E) ratio for Australia, the US and Europe. This provides a simplistic measure of where share prices are at, relative to the earnings they are expected to generate in the coming year.

On a pure valuation basis, and relative to history, equity markets look fairly priced. Perhaps even attractively priced at this point given the expected returns from many other asset classes are likely to be challenged.

This may provide some comfort that whether the bottom of this market correction is at hand or not, at least we’d be owning equities at a relatively attractive price.

Earnings

The other side of the P/E multiple is obviously earnings. According to Yardeni research, earnings thus far have remained relatively robust, with no downgrades to speak of in the US yet, and Australia even posting recent earnings upgrades on stronger commodity prices.

However, as always it’s the outlook that matters. The chart below aggregates verbal cues from the most recent reporting season in the US. The chart tallies when management refer to ‘weaker’ demand, or ‘lower’, ‘softer’ or ‘moderating’, to give an indication of managements expectations as communicated in their most recent earnings commentaries.

Should earnings decline on weaker demand, then the attractive P/E multiples currently screening above may prove a little illusory. If so, then the 14x multiple for the Australian market may be more likely 15 or 16x.. depending upon how bearish you expect earnings to be.

So, are we there yet?

As always in investing, it is usually only in hindsight that opportunities (and risks) become more obvious. Clearly there are risks with the current economic outlook and the ability of companies to grow earnings as expected, as there always is. While valuations are clearly pricing in a reasonable amount of gloom, it does seem more likely that an economic slowdown in the US and Australia, perhaps even a recession, is closer than it seemed even at the beginning of the year. 

The inflation genie, and how quickly it recedes, is looking like playing a pivotal role in future expected returns. This makes it very difficult to provide a definitive answer.

We believe there is a way to avoid having to be proven right, or wrong, on calling the bottom. When income forms the lions share of the investment return, the outcome is far less dependent upon whether the market is at its lows, or whether there is further to fall. This is more relevant for our Global strategy, which is lower risk, but the double dividends of the Australian strategy should serve it well should markets go sideways from here. 
So perhaps not a black and white answer to the question of ‘is this the bottom’, but at the same time it is a solution for investors who are aware that they need to take risk in order to generate acceptable returns, but also recognise they are uncertain what happens next with markets. 

With high income generation contributing a large component of our investment returns, we believe both strategies should do well regardless of the shorter-term market movements that lie ahead of us.  

Wheelhouse Global Equity Income Fund

7.9%

Income over 3 years (p.a.)

4.7%

Total return 3 years (p.a.)

 1 month1 year3 years (p.a.)Since inception^
Income0.00%7.88%7.86%7.36%
Growth1.00%(6.49%)(3.20%)(1.01%)
Total Return1.00%1.39%4.66%6.35%
Benchmark*(3.17%)4.73%10.07%10.94%
Risk (Beta)**n/a0.540.440.60

Performance figures are net of fees and expenses.

* Benchmark is the MSCI World Index (ex-Australia).
**Risk is defined as Beta and sourced from Morningstar Direct. A Beta of 1.00 represents equivalent market risk to the Benchmark. A minimum of 12 months data is required for the calculation.
^ Inception date is 26/05/2017. Since inception figures are calculated on a p.a. basis. Past performance is not an indicator of future performance.

Global fund commentary

During the month Global sharemarkets fell quite aggressively, with the Benchmark declining 8.4% in USD. On an equivalent basis (in USD) the Fund fell 4.4%, or a little over 53% downside capture. This is consistent with our risk targeting during drawdowns. With the Australan dollar resuming it’s defensive characteristics (refer February report for historical analysis of the AUD) the Fund was able to deliver a slight positive return to Australian investors for the month. This trade-off of around half the underlying risk (in USD) and an unhedged exposure (in AUD) has consistently achieved positive returns for Australian investors during most market drawdowns.

Click here to  read the full performance report of the Wheelhouse Global Equity Income Fund. 

Wheelhouse Australian Enhanced Income Fund

10.1%

Income over 3 years (p.a.)

14.7%

Total return 3 years (p.a.)

 1 month3 months12 monthsSince inception^
Income*0.03%3.83%11.19%10.08%
Growth(1.23%)6.37%1.36%4.65%
Total Return(1.20%)10.20%12.55%14.74%
Benchmark**(0.85%)8.84%11.74%13.93%
Excess return(0.35%)1.35%0.81%0.81%

Performance figures are net of fees and expenses. Since inception numbers include 30bps exit spread.

* Income includes cash distributions and the value of franking credits and special dividends. Cash distributions are paid quarterly.
** Benchmark is the S&P/ASX 200 Franking Credit Adjusted Daily Total Return Index (Tax-Exempt).
^ Inception date is 9/03/2021. Since inception figures are calculated on a p.a. basis. Past performance is not an indicator of future performance.

Click here to read the full performance report of the Wheelhouse Australian Enhanced Income Fund.

News

Zenith issues 'Recommended' rating on Wheelhouse Australian Fund

We are pleased to report that research house Zenith has issued a ‘Recommended’ rating on the Wheelhouse Australian Enhanced Income Fund after only 12 months of Fund performance.

In their report, Zenith notes that “Wheelhouse’s investment approach is differentiated and appealing for nil/low taxpaying investors who are income focused”. “Given the Fund’s return profile, Zenith is comfortable for it to be held as a core Australian equities exposure for income focused investors”

The report adds,” Overall, Zenith believes the Wheelhouse team has a wealth of experience relating to the options market and risk management, which ensures that the Fund’s risk management processes are strong”.

Please contact us for a copy of the Zenith report on the Wheelhouse Australian Enhanced Income Fund. 

Article

Zenith issues 'Recommended' rating on Wheelhouse Australian Fund

It’s no secret that Australian investors love their dividends. But recent Morningstar research has found that a portfolio of higher dividend-paying shares actually meaningfully outperforms over the long term. 

But by how much, you ask? Great question. 

Over a 45 year period, the research house found that Aussie dividend payers beat the S&P/ASX 200 benchmark by 3.7%, on average, every single year, delivering investors a return of 14.8% per annum. 

Unfortunately, getting the right exposure to these Aussie high yielders isn’t as easy as one may think. We reviewed the performance of the largest six “dividend” or “high yield” ETFs available locally, and all but one have underperformed the S&P/ASX 200. 

In this article, we outline a probable cause for this underperformance, as well as why an alternative strategy to target dividends may be investors’ best approach to taking advantage of this long-term opportunity.

Please click here to view the full article on Livewire or message us for a copy of the Morningstar Dividend report referenced.

Article

Ready to eat dividends?

Australian equities are likely to underperform the world market over the next five years, according to the Blackrock Investment Institute. Local market returns are expected to average 4.5% over these years, compared with 6% for US markets, and 9% for Europe.

If these forecasts are accurate, the reality for many Australian investors is that dividends will make up nearly 100% of expected total returns from equities over this period. Capital growth would likely prove negligible, as the positive effects from earnings growth are largely offset by falling valuations (as rates rise, valuations typically fall).

Please click here to view the full article on Livewire

Investor Update March 2022

Energy - the mouse that roared

For a ‘risk-off’ environment, returns from many traditionally defensive asset classes were left wanting this quarter. The interplay between geopolitical risk, globally diversified supply lines, and the resultant impact on inflation and interest rate expectations has clearly upended recent investment returns for many of the different asset classes illustrated below.

Fig 1: Major Asset Class Returns - Q1 2022

The rally in energy was truly breathtaking during the quarter, highlighting the fragility of reliable energy sources that we often take for granted. Unfortunately for investors, the energy sector accounts for only 4% of global sharemarket indices so had a difficult job moving broader indices higher on its own. 

While the energy sector is small from a market capitalisation perspective, the spike in oil prices has far wider ramifications for the economy and thus for all asset classes. The outperformance of commodity related currencies (AUD vs JPY) and markets (ASX 200), plus movement in interest rates and government bonds, helps explain the unusual moves in what are considered traditionally defensive assets.

Evidence of this dramatic change in outlook can be observed in how traders have changed their oil price expectations in future years. The chart below illustrates the most recent forward curve for Brent oil (the orange line), and how it has changed from 6 months ago (pre Ukrainian crisis, green line) and 5 years ago (blue line). 

Fig 2: Brent oil futures (12/4/22, 12/10/21, 12/4/17)

The current Brent oil future is showing oil being priced for delivery at around $70/bbl in 5-years, up from around $57 only 6 months ago. This is a similar price to that expected 5 years ago (the blue line). 

Interestingly, the oil market (as with most other commodities) is currently in backwardation, meaning forward prices are expected to be lower than current spot prices. Usually when backwardation is as acutely steep as the current curve it can suggest that the market believes geopolitical and supply side issues will be resolved shortly, and prices will fall. This may prove true in coming months. The fact that longer-term expectations are materially higher also signals that expectations have broadly changed for longer term energy prices which in turn will likely keep inflation supported.

This change in expectations for inflation and markets is also evident in other signposts.  Inflation breakevens have steadily climbed the past two months, which is helping to push the short end of the yield curve to inversion. As has been well covered elsewhere, an inverted yield curve is often a harbinger for impending recession and it seems clear that albeit still a low probability in the short-term, this risk is far more elevated than it was only three months prior.  

All up, since the failure of brinkmanship in Ukraine, we feel that the sense of change in the market is palpable. Regardless of whether we have a recession this year or next, the ingredients for slower growth in both economies and markets appear to be evident. Income will almost certainly prove an increasingly important source of real return should this scenario materialise. 

Wheelhouse Global Equity Income Fund

7.9%

Income over 3 years (p.a.)

5.2%

Total return over 3 years (p.a.)

 1 month1 year3 years (p.a.)Since inception^
Income1.81%7.91%7.90%7.47%
Growth(5.35%)(6.20%)(2.66%)(1.23%)
Total Return(3.54%)1.71%5.25%6.24%
Benchmark*(0.89%)11.60%12.93%11.87%
Risk (Beta)**n/a0.630.470.60

Performance figures are net of fees and expenses.
* Benchmark is the MSCI World Index (ex-Australia).

** Risk is defined as Beta and sourced from Morningstar Direct. Beta is represented vs the Benchmark and vs the S&P/ASX 200 Index. A Beta of 1.00 represents equivalent market risk to the comparison Index. A minimum of 12 months data is required for the calculation.

^ Inception date is 26/05/2017. Since inception figures are calculated on a p.a. basis. Past performance is not an indicator of future performance.

Global fund commentary

The Global fund suffered from uncharacteristic strength in the Australian dollar during what was a weaker quarter for equity markets.  The currency impact on returns for February and March combined was negative 6.1% versus the total drawdown of 7.4% for the Fund over the same period. While painful, we don’t believe the Australian dollar has lost its underlying defensive characteristics for either a slowing growth environment, or for a more acute geopolitical event in our region, both of which would affect the Australian economy (and investors) more directly. Rather, we see the recent AUD strength as a short-lived reaction to the spike in commodity prices which already appears to be waning.

Leaving currency aside, the defensive benefits of the Fund were clearly evident during the lows in early March with the fund only falling a little over half the equity market decline from peak to trough in USD (the trough so far, that is).

Given the exceptional rebound into month-end which saw cyclicals solidly outperform there was some underperformance in the equity portfolio. We should highlight that for the past 12 months the equity portfolio has trailed the benchmark by 3.7%, as quality has in general lagged more cyclical exposures, including energy. Similar to currency, we remain comfortable that quality businesses with pricing power (or Wide Moat, in Morningstar language) will serve us well as we transition to a lower-growth investing climate with higher inflation and volatility. 

Looking forward, we believe there is an increasing opportunity for the underlying income generation of the fund to prove its worth in a lower growth world. Combined with a portfolio of high-quality equities, we believe this differentiated approach will serve us well in fully funding our income objectives of 7-8% annually, even if broader equity returns are lower.

Click here to  read the full performance report of the Wheelhouse Global Equity Income Fund. 

Wheelhouse Australian Enhanced Income Fund

7.9%

Income over 3 years (p.a.)

5.2%

Total return over 3 years (p.a.)

 1 month3 months12 monthsSince inception^
Income*1.87%3.51%11.72%11.04%
Growth5.29%(1.61%)6.35%6.26%
Total Return7.17%1.91%18.07%17.29%
Benchmark**7.05%2.81%16.62%16.02%
Excess return0.12%(0.90%)1.45%1.27%

Performance figures are net of fees and expenses.

* Income includes cash distributions and the value of franking credits and special dividends. Cash distributions are paid quarterly.

** Benchmark is the S&P/ASX 200 Franking Credit Adjusted Daily Total Return Index (Tax-Exempt).

^ Inception date is 9/03/2021. Since inception figures are calculated on a p.a. basis. Past performance is not an indicator of future performance.

Australian fund commentary

The Australian fund celebrated its first birthday this month and is close to meeting all our targeted objectives. 

  • Outperformance – Total return was 18.1% for the year which made for 1.5% outperformance after fees.
  • Twice the yield of the market – Total income was 11.7%, or close to double the fully-franked dividend yield of the Australian market.
  • Tracking error was amongst lowest of peer group at 2.5%, with zero value or growth tilts. 

With the 12-month hurdle behind us and key objectives being met, we are pleased the Fund returns are coming together as expected.

Click here to read the full performance report of the Wheelhouse Australian Enhanced Income Fund.

Investor Update February 2022

Australian Dollar: Friend or foe?

For Australian-based investors in unhedged Global share portfolios, the Australian dollar is usually our friend during a crisis.

Over the past 30 years, corrections (greater than 10% declines) in Global markets have consistently coincided with declines in the Australian dollar which in turn has protected Australian investors to some extent during times of crisis.

However, during the most recent crisis, the Australian dollar has proven a little ‘unfriendly’ for Australian investors in Global shares. Year to date (and particularly in February), the Australian dollar strengthened despite the worsening geopolitical and stock market developments. This strengthening adds to losses in Australian dollars on a Global share portfolio.

Why has the AUD proven defensive for Global equity portfolios in the past?

Source: Wheelhouse

Historically the Australian dollar has been perceived as a ‘risk’ currency, in part due to our high exposure to commodity exports to China and sensitivity to global growth. When the outlook is rosy, the AUD typically rallies (risk-on) and when clouds appear, the AUD typically falls (risk-off). During a crisis there is usually a ‘flight to safety’ whereby investors buy USD and sell AUD, as they seek protection in the world’s number one reserve currency.

In fact, the relationship is so strong that the AUD is often used as an alternative hedge to protect equity portfolios from share market declines. This is partly evidenced when looking at global foreign exchange volumes. The AUD/USD cross accounts for 6% of global foreign currency transactions which seems disproportionate when compared to the Australian economy and share market which are less than 2% of Global totals. Many hedge funds and institutions have reported using the AUD as both a hedge and speculatively when volatility is attractive relative to buying protective equity puts outright.

How reliable is the AUD as a hedge?

As the chart above illustrates, over more acute drawdowns the Australian dollar has historically proven highly reliable in terms of offering protection during market corrections. However over shorter periods, (such as month by month) the protection is not always as reliably evident.

The left-hand chart below plots monthly movements of the S&P500 Index vs the move in the AUD/USD exchange rate, for all monthly market declines of -3% or greater (since 1990). For monthly movements the AUD is usually defensive, but not always. From a frequency perspective, 75% of data points are above zero (AUD our ‘friend’), with the magnitude of these beats far greater than losses. 

To compare this with an example of active risk targeting, the chart on the right-hand side highlights capital preservation of the Wheelhouse Global fund during negative returning days, since inception. The datapoints represent every negative returning day for Global equities greater than -1% since May 2017.

Source: Wheelhouse

Clearly, while the AUD has generally provided monthly protection, when compared to active risk targeting in the chart at the right, the difference in efficacy is dramatic. Within the Global fund we use a combination of income producing overlay, integrated with ‘always-on’ tail hedging, to produce a largely mechanical and hence highly reliable downside risk profile, despite the fund being near fully invested at all times. 

The hidden difference between the two profiles is cost. We expect our tail hedging programme to cost around 1.5% a year in returns, on average.  When we compare this with the equity returns we expect to mostly capture, we are willing to accept this insurance-like cost. 

However, the exposure to an unhedged Australian dollar is expected to be zero cost, over time. The reason for this is major currencies are generally mean reverting, meaning they will trade up, and down, but likely to cross fair value many times in the years ahead. In this sense, the AUD offers an element of free protection during a drawdown, which is then paid for in better times when markets recover and the AUD appreciates again.

Why is it different this time?

The surprising near-term strength in the AUD given the risk off environment, perhaps isn’t so surprising when the current conditions are considered:

  • The bull run in commodities driven both by supply side issues from Russia, and inflation protection demand from everywhere else. For example, Russia provides Europe with 67% of its metallurgical coal (steel making), along with providing Germany half of its thermal coal (power generation)*. Hence Europe’s move to sever economic ties with Russia is helping push coal prices higher, one of our key exports.   
  • Potentially a soon to be pivoting RBA from dovish to hawkish is also likely to provide some tailwind for the AUD.
  • The conflict in Europe can make faraway Australia feel a whole lot safer than the rest of the world.

In fact, ‘safe-haven’ has started being used loosely in the same sentence as the Australian dollar, which is a new thing. If this proved true, then looking forward it would likely upend all the historic defensive characteristics that have been evident over the past 30 years. We think this is extremely unlikely.

While we understand the recent bid for AUD, if anything the events of recent weeks underscore why we believe the AUD is the oppositive of a safe haven currency. All of the key ingredients of the current crisis in Europe are, in our opinion, right at our doorstep in Asia. 

  • Economic sanctions are increasingly being weaponized by nations seeking to avoid outright conflict. It seems highly likely that should the geopolitical environment deteriorate in our own region, aggressive/retaliatory sanctions are likely to escalate. 
  • While iron ore is the dominant export and it remains questionable whether China could locate alternate supply (we’ll leave that to resource analysts), what can get missed is that our economy is also far more heavily reliant on Chinese imports to key industries than any of our security partners in the Five Eyes (UK, US, Canada, NZ).  
  • Taken together, while Russia supplies roughly 30% of energy needs to Europe, China accounts for over 30% of our total trade. Hence the economic impact on our economy (and balance of payments) would likely to be far more acutely felt and damaging. 

The risk of conflict in Asia is what we would call a known unknown, in Rumsfeld speak. The risk is in plain sight, however the likelihood or timing of it materialising is impossible to know. Like most tail events however, we believe the risk (and potential damage) is likely vastly underestimated by most investors, particularly those with extensive Australian equity portfolios. 

While the Australian dollar may be proving an unreliable friend more recently, should a genuine black swan scenario materialise we believe the Australian dollar would quickly revert to historical norms and prove incredibly valuable, just when our domestic investments may be faring their worst. Like skew on a put option after Black Monday in 1987, one could argue the AUD should trade with a perennial discount to fair value, in order to incorporate this risk. 

For these reasons, we continue to take comfort from the protective benefits of our friend, the Australian dollar, even if over shorter periods we may have to endure a little pain.

(NB, the strengthening AUD impacted our Global fund returns by -2.9% in February)
*Source: Orbex

Wheelhouse Global Equity Income Fund

7.8%

Income over 3 years (p.a.)

6.6%

Total return 3 years (p.a.)

 1 month1 year3 years (p.a.)Since inception^
Income0.00%8.51%7.68%7.27%
Growth(4.04%)1.20%(1.30%)(0.11%)
Total Return(4.04%)9.72%6.55%7.16%
Benchmark*(5.52%)18.33%13.82%12.31%
Risk (Beta)**n/a0.620.450.60

Performance figures are net of fees and expenses.
* Benchmark is the MSCI World Index (ex-Australia).

** Risk is defined as Beta and sourced from Morningstar Direct. Beta is represented vs the Benchmark and vs the S&P/ASX 200 Index. A Beta of 1.00 represents equivalent market risk to the comparison Index. A minimum of 12 months data is required for the calculation.

^ Inception date is 26/05/2017. Since inception figures are calculated on a p.a. basis. Past performance is not an indicator of future performance.

Click here to read the full performance report of the Wheelhouse Global Equity Income Fund.

Wheelhouse Australian Enhanced Income Fund

9.2%

Income over 3 years (p.a.)

10.5%

Total return since inception

 

 1 month3 months6 monthsSince inception^
Income*1.80%2.58%4.39%9.22%
Growth2.28%(4.76%)(7.38%)1.28%
Total Return4.08%(2.18%)2.99%10.50%
Benchmark**2.55%(1.32%)(3.30%)9.34%
Excess return1.53%(0.86%)0.31%1.16%

Performance numbers below are based on exit prices. Since inception returns include the 30bps exit spread.

* Income includes cash distributions and the value of franking credits and special dividends. Cash distributions are paid quarterly.

** Benchmark is the S&P/ASX 200 Franking Credit Adjusted Daily Total Return Index (Tax-Exempt).

^ Inception date is 9/03/2021. Since inception figures are calculated on a p.a. basis. Past performance is not an indicator of future performance.

Click here to read the full performance report of the Wheelhouse Australian Enhanced Income Fund.

Investor Update for January 2022

Why inflation will cool in coming months

Right now it feels like inflation is everywhere. At the petrol pump, in the supermarket, at the butcher especially. Indeed, inflation prints particularly in the US are running hot and expected to touch 7.3% for January. As a result, brokers have been rushing to forecast 4 or even 5 hikes to interest rates during 2022 in the US, as they try to predict what it will take for the Federal Reserve to get back in front of the curve when it comes to dealing with inflation.

However, longer-term market expectations for inflation appear to be cooling. TIPs Breakevens, which measure the spread between nominal and inflation protected bonds (and hence, provide an excellent market-based estimate of future inflation), have fallen from their peak the past few months. This is despite the continued spike in short-term inflation.

We believe the primary reason for this divergence is the market looking forward and recognising that supply chain issues are likely to ease in future months. Until now, supply chain issues have proven to be the key exogenous shock driving higher inflation, whether this be Covid-driven labour shortages at the wharves, abattoirs or driving trucks, or 5x higher container shipping costs. It seems natural that as these roadblocks are removed, inflation will likely fall.  

In fact in recent months, shipping costs have already started to fall. Particularly for bulk commodities (refer Baltic Dry Index down 70% from peak), but also for containers, costs look to be falling across all routes. While container shipping prices remain very elevated relative to history inferring more short-term pain, pricing looks to have peaked in October around the same time inflation expectations rolled over. 

Contributing to the expected future decline in shipping costs will likely be the massive increase in capacity expected to arrive later this year and into 2023.

  • In 2021, the number of container vessels ordered surpassed 2017, 2018, 2019 and 2020 combined as reported by VesselsValue, and was driven by “unprecedented box demand”.
  • Clarkson Research estimate there are currently orders for 5.7m TEU, which represents a quarter of the total global containership capacity.

Furthermore, on the demand side of the equation, with continued re-opening we believe the demand pressure points will also cool, as global economies reposition for increased spending on services such as travel, restaurants and entertainment. Since the onset of the pandemic the nature of spending on durable goods (stay at home) has been particularly elevated, which should reverse as economies reopen. This in turn should partially reduce the acute demand for shipping containers and durable goods coming out of Asia and thus help ease prices.

Wage pressures remain a risk to the scenario of moderating inflation, although pressures to date have been mild and the low participation rate suggests to us that there is some latent capacity in labour markets should higher wages materialise, attracting workers back into the market.

Sentiment already shifting

Many investors are already voting with their feet in terms of changing their inflation expectations. In recent weeks the iShare TIPS Bond ETF has seen record outflows as investors revaluate the need for specialised inflation protection within their portfolios.

Implications for markets

One major concern of markets, particularly during January, is that the Federal Reserve has been boxed into a position of having to aggressively raise rates to counter the surge in inflation, regardless of the health of the underlying economy. This is exactly what happened in 2008 when the ECB was forced to hike to address rising inflation only to have to aggressively slash rates three months later as the GFC unfolded. Should supply chain issues subside a little sooner than expected, and inflation expectations wane, the risk of policy error in our view diminishes.

Assuming the Fed manages to thread the needle and avoid policy error, this may potentially provide support to equity markets in the short-term as quite often markets do well in the initial stages of the hiking cycle. Particularly in the current environment as real interest rates remain negative (very accommodative), and the economy continues to remain strong and re-open.

Further out however, the facts remain that we are entering a tightening cycle which should subdue equity market gains (from a valuation perspective), plus at some point cool the economy (and slow earnings growth). Neither of these are positive for equity markets, and as inflation subsides and real interest rates continue to rally, we could get to this point relatively swiftly.

As we transition to this genuine tightening cycle we expect a roller coaster ride for equity markets, which despite the higher volatility should still be able to deliver acceptable, although more muted, returns than previous years. Particularly relative to other asset classes which may be more challenged in a rising rate environment, defensive equities look a good place to be.

January performance

Wheelhouse Global

During previous times of market stress we have often highlighted how our Global fund has performed as the defensive characteristics come to the fore. The Global fund delivered positive returns for the month and was never worse than 2% down at any point, despite near double digit declines at times for the S&P 500. The chart below highlights the daily movements in January of the fund with the light blue line illustrating the AUD unit price.

Drawdown was consistently less than 50% of the market in USD, inline with our risk targeting of only assuming half the market risk. This performance is entirely consistent with the performance of the fund during other peak to trough drawdowns, where on all previous market corrections was able to preserve wealth and deliver a positive return in AUD when markets were free falling.

Wheelhouse Australian

Our Australian fund has an entirely different objective to Global, targeting relative outperformance through the cycle while assuming full market risk to do this. We do expect higher returns over time, albeit with a bumpier ride. During market corrections of 5-7% we do expect a little underperformance which came through, however we expect this to be more than offset with outperformance in most other months (February numbers are on track to evidence this).

Importantly, should markets have continued to fall the portfolio risk is designed to fall at a faster rate than the market providing some protection in more acute falls.  

Wheelhouse Global Equity Income Fund

8.1%

Income over 3 years (p.a.)

9.8%

Income over 3 years (p.a.)

 1 month1 year3 years (p.a.)Since inception^
Income0.00%8.85%8.09%7.46%
Growth0.46%5.26%1.68%0.77%
Total Return0.46%14.12%9.77%8.23%
Benchmark*(2.20%)27.30%18.11%13.89%
Risk (Beta)**n/a0.690.450.60

Performance figures are net of fees and expenses.
* Benchmark is the MSCI World Index (ex-Australia).

** Risk is defined as Beta and sourced from Morningstar Direct. Beta is represented vs the Benchmark and vs the S&P/ASX 200 Index. A Beta of 1.00 represents equivalent market risk to the comparison Index. A minimum of 12 months data is required for the calculation.

^ Inception date is 26/05/2017. Since inception figures are calculated on a p.a. basis. Past performance is not an indicator of future performance.

Click here to read the full performance report of the Wheelhouse Global Equity Income Fund.

Wheelhouse Australian Enhanced Income Fund

Performance numbers below are based on exit prices. Since inception returns include the 30bps exit spread.

 1 month3 months6 monthsSince inception^
Income*0.00%1.15%3.17%7.15%
Growth(8.64%)(6.94%)(7.06%)(0.98%)
Total Return(8.64%)(5.78%)(3.89%)6.17%
Benchmark**(6.35%)(4.15%)(3.13%)6.63%
Excess return(2.29%)(1.63%)(0.79%)(0.46%)

Performance figures are net of fees and expenses.

* Income includes cash distributions and the value of franking credits and special dividends. Cash distributions are paid quarterly.

** Benchmark is the S&P/ASX 200 Franking Credit Adjusted Daily Total Return Index (Tax-Exempt).

^ Inception date is 9/03/2021. Since inception figures are calculated on a p.a. basis. Past performance is not an indicator of future performance.

Click here to read the full performance report of the Wheelhouse Australian Enhanced Income Fund.

Investor update for December 2021

The most important driver for markets in 2022?

Astrology followers would know that January is the time for market experts to give their view on sharemarket returns for the next 12 months. The table below summarises market forecasts for the Australian and US markets, although a table format robs investors of the colourful storylines for how we will get there.

Mid-single digit returns may appear fairly ordinary in the light of recent sharemarket gains, with the US market averaging 26% per year the past three years and the ASX 200 averaging 14% (dividends included). However, as flagged in our October report, institutions have been forecasting for some time to prepare for lower growth equity returns ahead, in order to bring returns closer to their longer-term averages of 9-10%.

The critical ingredient for equity growth

All bull cases for equities that we have seen share a central theme – that continued robust earnings growth will outweigh headwinds from rising bond yields and more hawkish central banks. 

Indeed, earnings growth powered the market during 2021, with corporate earnings jumping 47% for the S&P 500 off pandemic lows. This time last year the market was only expecting 20% growth for 2021 in the US, thus delivering an environment this past 12 months of continual earnings beats every reporting season. Market strategists expect this growth to continue into 2022, with 8% growth for the S&P 500 and nearer 13% growth for the ASX 200, with Australian growth assisted by the reopening of lockdown affected Sydney and Melbourne. 

Embedded in these robust earnings forecasts is a continued boom in profit margins. Despite supply chain issues dominating the headlines, corporate profitability soared on post pandemic revenue growth coupled with lean cost bases. Profits in the US are now at their highest levels ever when compared with underlying GDP. 

Looking forward, the underlying premise for further earnings growth appears to be continued re-opening of global economies, which translates into continued margin expansion and profit growth. One concern with this assumption might be that the lean cost bases that have helped generate outsized profitability are unlikely to last forever. The same forces that help propel re-opening and reflation, are also likely to drive more material cost inflation than that witnessed in 2021. 

Indeed, profitability in the US looks to have stabilised the past few months. According to Goldman Sachs research, margins for every sector except energy and chemicals have either stabilised or fallen during this recent period. While profit forecasts may still be achieved, we’d argue the ‘beat and raise’ environment of 2021 is largely behind us.

This change in environment may be where market forecasts come unstuck, as earnings represent only one side of expected future returns. The other side is the price, or what the market is willing to pay for robust earnings growth. Should ‘market beating’ earnings growth prove a little harder to deliver, then perhaps the scales might tip a little in favour of concern about rising bond yields and the unwind of unconventional monetary policy. At 21x valuation multiples in the US for 2022, and 18x in Australia, there seems a lot riding on robust earnings growth being delivered.

Not all doom and gloom – three areas of opportunity

Not all stocks and sectors were swept along with the beat and raise euphoria, and one unloved segment of the market has seen this movie before. ‘Defensive equity’, defined as Healthcare, Staples and Utilities, has not been cheaper relative to the broader market with the exception of the period immediate before the year 2000 tech correction.

Looking specifically at large pharmaceutical companies, this cheapness is reflected in the valuation multiples of many of these stocks which are trading for around half the price of the broader market but with generally stable margins through all historical market conditions. While Healthcare has underperformed materially during the post pandemic low-quality rally (and our Global fund has a consistent overweight to Healthcare), looking forward we believe the prospects are far brighter.

In a similar vein to Defensive equity, we would again highlight the prospects for the UK market. We have discussed in our October monthly but at 4% yield, a 12x PE, and effectively zero technology exposure, the FTSE-100 index screens as a highly contrarian and unloved defensive corner of the market, or at the very least a happy hunting ground for bargain seeking investors.

The final opportunity we believe will likely deliver healthy returns even should earnings disappoint, are highly income generative strategies. Should the experts be proven correct and growth is indeed lower than average the next few years, then the merit of income strategies that rely far less on capital growth to generate equity like returns, should become increasingly valuable to investors. 

Wheelhouse Global Equity Income Fund

8.1%

Income over 3 years (p.a.)

9.7%

Income over 3 years (p.a.)

 1 month1 year3 years (p.a.)Since inception^
Income1.72%8.83%8.09%7.60%
Growth(1.35%)5.03%1.64%0.69%
Total Return0.37%13.87%9.73%8.28%
Benchmark*1.68%29.58%20.58%14.72%
Risk (Beta)**n/a0.690.450.60

Performance figures are net of fees and expenses.
* Benchmark is the MSCI World Index (ex-Australia).

** Risk is defined as Beta and sourced from Morningstar Direct. Beta is represented vs the Benchmark and vs the S&P/ASX 200 Index. A Beta of 1.00 represents equivalent market risk to the comparison Index. A minimum of 12 months data is required for the calculation.

^ Inception date is 26/05/2017. Since inception figures are calculated on a p.a. basis. Past performance is not an indicator of future performance.

Click here to read the full performance report of the Wheelhouse Global Equity Income Fund.

Wheelhouse Australian Enhanced Income Fund

Performance numbers below are based on exit prices. Since inception returns include the 30bps exit spread.

 1 month3 months6 monthsSince inception^
Income*0.95%1.27%3.52%7.82%
Growth1.92%1.62%3.09%8.38%
Total Return2.87%2.90%6.61%16.20%
Benchmark**2.76%2.26%4.58%13.86%
Excess return0.11%0.64%2.03%2.34%

Performance figures are net of fees and expenses.

* Income includes cash distributions and the value of franking credits and special dividends. Cash distributions are paid quarterly.

** Benchmark is the S&P/ASX 200 Franking Credit Adjusted Daily Total Return Index (Tax-Exempt).

^ Inception date is 9/03/2021. Since inception figures are calculated on a p.a. basis. Past performance is not an indicator of future performance.

Click here to read the full performance report of the Wheelhouse Australian Enhanced Income Fund.

Investor Update for November 2021

Rolling returns point to slower growth ahead

As markets continue to push new boundaries in terms of price and valuation metrics, it’s worth a glance back to see where we are relative to history. While the past is never prologue, the rhythm of historical rolling returns in the chart below (credit Kailesh Concepts) is quite compelling. Despite delivering an average long-term return of 9-10%, equity returns are rarely delivered linearly.

Fig 1. Ten year rolling stock market returns (US markets)

Overlaid on the rolling return profile is the Schiller PE multiple, which not surprisingly has a high correlation to market peaks and troughs. After 10 years of near 15% average growth in US equity markets, both rolling returns and valuation multiples are currently close to touching their historic peaks. These metrics are entirely consistent with an environment of high corporate profits, low interest rates and a favourable taxation regime.

However as the chart also highlights, the growth pendulum historically reverts, suggesting future sharemarket gains are likely to be far more challenging than what we have come to experience as ‘normal’ the past ten years. This outlook is entirely consistent with the views outlined in our October monthly report.

Of note, markets don’t need to actually fall for the slope of the ten year growth line to turn negative. A trending sideways market would also have the effect of reducing growth and valuation multiples. While there are plenty of reasons why markets may fall, a lower return environment may simply be the least painful path for these multiples to normalise.

Given the predominantly systematic nature of our investment process we never try to predict precisely when these return profiles will roll over. Market timing calls are notoriously difficult to get right, we would argue near impossible. We do however have a great deal of confidence in one of our core beliefs – that income has the capacity to smooth returns and by doing so reduces the significance of market timing. Through generating most of our returns via income, our funds are less reliant on the movements in capital to deliver on our objectives.

We believe this approach will be rewarded should the historical rhythm return in coming years.

Wheelhouse Global Equity Income Fund

8.0%

Income over 3 years (p.a.)

9.1%

Income over 3 years (p.a.)

 1 month1 year3 years (p.a.)Since inception^
Income0.00%8.75%7.97%7.35%
Growth2.35%1.64%1.08%1.01%
Total Return2.35%10.39%9.05%8.36%
Benchmark*3.70%26.81%18.19%14.59%
Risk (Beta)**n/a0.760.450.60

Performance figures are net of fees and expenses.
* Benchmark is the MSCI World Index (ex-Australia).

** Risk is defined as Beta and sourced from Morningstar Direct. Beta is represented vs the Benchmark and vs the S&P/ASX 200 Index. A Beta of 1.00 represents equivalent market risk to the comparison Index. A minimum of 12 months data is required for the calculation.

^ Inception date is 26/05/2017. Since inception figures are calculated on a p.a. basis. Past performance is not an indicator of future performance.

Click here to read the full performance report of the Wheelhouse Global Equity Income Fund.

Wheelhouse Australian Enhanced Income Fund

Performance numbers below are based on exit prices. Since inception returns include the 30bps exit spread.

 1 month3 months6 monthsSince inception^
Income*0.30%1.92%5.88%6.62%
Growth(0.06%)(2.75%)(0.01%)6.34%
Total Return(0.24%)(0.83%)5.87%12.96%
Benchmark**(0.40%)2.01%4.08%10.80%
Excess return0.64%1.18%1.79%2.16%

Performance figures are net of fees and expenses.

* Income includes cash distributions and the value of franking credits and special dividends. Cash distributions are paid quarterly.

** Benchmark is the S&P/ASX 200 Franking Credit Adjusted Daily Total Return Index (Tax-Exempt).

^ Inception date is 9/03/2021. Since inception figures are calculated on a p.a. basis. Past performance is not an indicator of future performance.

Click here to read the full performance report of the Wheelhouse Australian Enhanced Income Fund.

Investor Update for October 2021

Peak shipping?

“One swallow does not a summer make”… but with shipments for the Black Friday sales (in the US) and Christmas shopping now largely in transit on ocean shipping lines, we may have seen the highs for shipping costs. Or at the very least, they may have stopped going up as quickly as they were earlier this year. As we outlined in August, while we believe shipping costs will remain above average for some months until supply issues abate, it does seem the heat is starting to come out of more recent extreme pricing.

The trend is similar for the Baltic Dry Index (bulk shipping, eg grains and metals), plus a number of other commodity prices which look to have peaked in the last few weeks.

Should freight rates continue to moderate, Central Banks globally may rightly feel vindicated in their views that inflation was indeed temporal, or transitory, or at least short term in nature. To be sure, inflation may well still print higher for many months as these higher shipping costs are passed onto consumers – but with a moderation in freight costs, one of the root causes of higher inflation may have already peaked.

In turn, this should be supportive for markets, as the risk of policy error subsides and an accommodative monetary environment may persist for longer.

While the market breathes a sigh of relief (what we seem to be observing this past week) and reduces the risk of a stagflation-type environment (interest rates pushed higher to head off inflation, despite soft labour market), we would caveat that this may only be a temporary reprieve from a generally tightening cycle.

Interest rates are still likely to go up given their low absolute levels, plus we’re still technically in an ‘emergency stimulus’ period post covid. However, it may simply be that the pace of rate hikes proves a little less aggressive than what was expected a month or two back. This subtle change may be all that is required to spark a little relief rally into year end.

Lower growth ahead

Longer-term however, the elephant in the room remains sky-high valuations across all asset classes. Within equities for example, the US, Australian and European markets are currently trading 30-40% above their 15-year averages (from a forward PE multiple perspective). This presents major headwinds for further capital appreciation across all asset classes.

This viewpoint is reflected in the latest 10-year expected returns from Morgan Stanley, which shows slower growth expected ahead, particularly for US equities and Fixed Income. While Australia is not separately broken out in the chart below, other institutional estimates are looking for 4.5% nominal growth for Australian equities over this period, or around 3.8% real after inflation and franking credits are included. 

Clearly lower growth in anyone’s language, but especially relative to the massive gains enjoyed the last few years.

Income as a source of real return

Faced with lower expected returns from asset growth, we believe income is likely to be a far more meaningful contributor to investor returns than it has been the previous 10 years. 

Other studies have highlighted this from a dividend perspective, where in lower growth decades (for eg the 1940s, 1950s and 1970s), returns from dividends contributed over 60% of total shareholder return. In the most recent decade this fell to only 17%, due in part to much stronger capital appreciation (which diluted the contribution from dividend income), plus less generous payout policies from companies. 

Since the introduction of systematic income producing overlays on the S&P 500 in the 1980’s, the same income generating characteristic has also proven reliable in delivering real returns, even when markets failed to deliver capital growth. Should we be entering a genuine lower growth period, income may well prove once again a valuable source of real return, with far less reliance on shares having to go up.

Post Script

As the valuation chart above illustrates, one of the few markets trading at a discount to history, at least slightly, is the FTSE 100 Index in the UK. Couple of points on this:

  • The UK market (the FTSE) has underperformed global equity markets for 6 straight years now. The current dividend yield is 4.0%, more than 3x the US.
  • The composition of the FTSE is a value investors playground. Technology accounts for only 1% of the index, versus 5% in Australia and 28% in the US. The largest sectors include Energy, Materials, Consumer Staples, Healthcare (Pharma) and Financials. All of these are generally shorter duration and typically well disposed, at least relatively, to a tightening monetary cycle.
  • Even excluding the typically lower multiple Energy and Financial sectors, the UK is still trading at the largest discount to Global equity markets for many years. 
  • While Brexit is a concern for the UK economy and the GBP, the FTSE is a genuinely Global market, with around 70% of revenues generated outside the UK. While the pound may rise and fall on Brexit developments, typically the value of the Index will rebase depending upon the foreign currency earnings. This explains why the FTSE often increases when the GBP falls. 
Contrarian or Value-minded investors may find it worthwhile reviewing these characteristics, particularly should we enter a lower growth environment where income generation becomes more important in terms of generating returns, and PE multiples look more vulnerable in a rising rate environment.

Wheelhouse Global Equity Income Fund

7.9%

Income over 3 years (p.a.)

7.9%

Income over 3 years (p.a.)

1 month 1 year 3 years (p.a.) Since inception^
Income 0.00% 8.77% 7.88% 7.46%
Growth (1.89%) (1.78%) 0.01% 0.50%
Total Return 1.89% 10.54% 7.90% 7.95%
Benchmark* 1.65% 31.36% 16.05% 13.94%
Risk (Beta)** n/a 0.62 0.44 0.59

Performance figures are net of fees and expenses.
* Benchmark is the MSCI World Index (ex-Australia).

** Risk is defined as Beta and sourced from Morningstar Direct. Beta is represented vs the Benchmark and vs the S&P/ASX 200 Index. A Beta of 1.00 represents equivalent market risk to the comparison Index. A minimum of 12 months data is required for the calculation.

^ Inception date is 26/05/2017. Since inception figures are calculated on a p.a. basis. Past performance is not an indicator of future performance.

Performance comment

While income generation and risk have been on target, performance for the past 12 months has been less than our targeted objective of roughly 55% capture in strong markets. We expect to underperform in higher growth environments (and outperform in lower growth and negative markets), but we felt this greater deviation was worth some explanation.  

The reason for the less than target return has been the 5.4% underperformance of the Morningstar Index during the past year, which our equity exposures reflect. Most of this ‘negative alpha’ is reflected in our returns and has caused the deviation from target capture. 

We constantly monitor returns of the Morningstar Index, which over the past ten years has delivered over 3% in annual outperformance (which we seek to capture). Most of the recent underperformance has been due to an overweight to large Healthcare names during the year (Roche, AstraZeneca et al), which trailed the market.

The current Healthcare exposure is now more consistent with the longer-term history of the Index, and we see no reason why the underperformance will continue (November returns to date have already seen some evidence of this).  

Click here to read the full performance report of the Wheelhouse Global Equity Income Fund. 

Wheelhouse Australian Enhanced Income Fund

Performance numbers below are based on exit prices and include the 30bps exit spread. The fund has passed the six-month hurdle and is outperforming as expected, with a very low tracking error of 0.65 for this period.

 1 month3 months6 monthsSince inception^
Income*0.01%2.14%6.01%6.28%
Growth(0.23%)(0.13%)2.39%6.40%
Total Return(0.22%)2.01%8.40%12.68%
Benchmark**(0.09%)1.07%7.11%11.24%
Excess return(0.13%)0.94%1.29%1.44%

Performance figures are net of fees and expenses.

* Income includes cash distributions and the value of franking credits and special dividends. Cash distributions are paid quarterly.

** Benchmark is the S&P/ASX 200 Franking Credit Adjusted Daily Total Return Index (Tax-Exempt).

^ Inception date is 9/03/2021. Since inception figures are calculated on a p.a. basis. Past performance is not an indicator of future performance.

Click here to read the full performance report of the Wheelhouse Australian Enhanced Income Fund.

Investor update for September 2021

Value correlations to bonds yet another dislocation in a shaky market.

Given the relatively minor drawdown in equity markets recently, there seems to be a surprisingly large number of dislocations appearing in global financial markets.

We have written previously about why we believe inflation is likely to run higher for longer and the burgeoning energy crisis we’re witnessing globally seems almost certain to support this view. Central banks and global bond markets are also growing increasingly concerned, with longer-term interest rates well bid in recent weeks.

One such dislocation is the continued divergence of Growth and Value equities. Chart of the month is attributed to Goldman Sachs and highlights the correlations of global Growth & Value shares versus bonds.

From a correlation perspective, it has been difficult to discern between Value and Growth stocks for most of the past 20 years. Over this period the relationship has been firmly negative, although if we were to extend this chart back a further 40 years this negative relationship would appear as an outlier.

However, in recent months there has been a breakdown between the correlations of Value and Growth shares versus bonds. The dark blue line shows that Growth equities have more recently delivered a positive correlation to bonds, meaning that as interest rates have risen and bonds fallen, these shares have also mostly fallen. Conversely, the light blue line is showing a continued negative correlation for Value equities, meaning they have been generally appreciating during the recent interest rate spike. 

This represents a meaningful divergence from the 20 year trend, where typically the market made little distinction between Value or Growth, they were just ‘equities’. 

This has proven a boon for Value investors during the most recent mini-drawdown. The reason can be attributed to the increasing duration, or interest rate sensitivity of Growth stocks in recent years. As valuation multiples expanded for future earnings that were not expected to be delivered until much further into the future, even slight upward movements in interest rates can have a large impact on valuations. Value stocks have much less of this issue, as typically the multiples are lower, and profits are expected to be realised much sooner.

The extreme valuations of the tech and Growth sector has been well documented elsewhere, but one way to look at it is to compare current P/E multiples with their 20-year average. While Growth has always traded at a premium to the market and to Value, it remains at extreme levels.

Interestingly, the chart also shows that Value is similarly trading at a valuation premium, relative to its own history. It’s only relative to Growth that it looks a much safer bet, but for more absolute return minded investors this does raise questions regarding capital at risk.

Can Value's negative correlation to Bonds be sustained?

In the short term, with valuation levels as they are, it is certainly possible. However, with valuations for Value also at record levels, we believe this relationship has a limited horizon. It would be unusual to see value shares continue to appreciate should rates continue to march higher.

A look back to the tech bubble deflation in year 2000 highlights this point. While Growth stocks started falling in March 2000, Value stocks actually kept appreciating through to December. It was only then that Value also succumbed to gravity and started falling (although at this point a recession had also emerged, which is a risk that may also materialise this time around should rates keep climbing).

In our view this makes all equities risky, whether they be Value or Growth in colour. For investors that seek access to the longer-term returns of equities, it seems obvious from the valuations of all equities that risks are clearly higher in the current environment.

A more reliable alternative

One solution for investors looking to introduce negative correlations into their portfolios is to consider derivative strategies. Whether this be tail hedging or systematic option selling overlays, both can deliver negative correlations of far higher magnitude and with far more reliability, as they have zero reliance on Value/Growth tilts or other idiosyncratic relationships. This is our speciality at Wheelhouse, and helps explain why the risk in our Global fund is so low.

As a postscript, we’d highlight that during the tech deflationary period in year 2000-2003, systematic overlays meaningfully outperformed both Value and the market by preserving capital better and delivering regular cashflow in lieu of capital growth. Should growth have peaked, and rates continue a more normalised ascent, one could argue we may be entering a very similar environment.

Wheelhouse Global Equity Income Fund

7.8%

Income over 3 years (p.a.)

7.0%

Total return 3 years (p.a.)

 1 month1 year3 years (p.a.)Since inception^
Income1.66%8.91%7.82%7.64%
Growth1.66%3.45%(0.85%)0.95%
Total Return(2.03%)12.35%6.97%8.59%
Benchmark*(3.05%)27.76%13.30%13.81%
Risk (Beta)**n/a0.580.480.60

Performance figures are net of fees and expenses.
* Benchmark is the MSCI World Index (ex-Australia).

** Risk is defined as Beta and sourced from Morningstar Direct. Beta is represented vs the Benchmark and vs the S&P/ASX 200 Index. A Beta of 1.00 represents equivalent market risk to the comparison Index. A minimum of 12 months data is required for the calculation.

^ Inception date is 26/05/2017. Since inception figures are calculated on a p.a. basis. Past performance is not an indicator of future performance.

Click here to read the full performance report of the Wheelhouse Global Equity Income Fund.

Wheelhouse Australian Enhanced Income Fund

Performance numbers below are based on exit prices and include the 30bps exit spread. The fund has passed the six-month hurdle and is outperforming as expected, with a very low tracking error of 0.55 for this period.

 1 month3 months6 monthsSince inception^
Income*1.62%2.17%6.24%6.28%
Growth(2.47%)1.45%6.36%6.65%
Total Return(0.85%)3.61%12.60%12.93%
Benchmark**(1.53%)2.28%10.93%11.34%
Excess return0.68%1.34%1.67%1.59%

Performance figures are net of fees and expenses.

* Income includes cash distributions and the value of franking credits and special dividends. Cash distributions are paid quarterly.

** Benchmark is the S&P/ASX 200 Franking Credit Adjusted Daily Total Return Index (Tax-Exempt).

^ Inception date is 9/03/2021. Since inception figures are calculated on a p.a. basis. Past performance is not an indicator of future performance.

Click here to read the full performance report of the Wheelhouse Australian Enhanced Income Fund.

New Insight: Risk Efficient Income

Recently the Wheelhouse income funds were added to leading online investment marketplace Australian Money Market. As part of the platform launch we penned a short piece on how investors can build ‘risk-efficient’ income portfolios with higher yields and minimal increases in risk.

Please click here to view the Risk Efficient income flyer.

Investor Update for August 2021

What’s with all these 'Global Supply Chain Issues'? Do they matter?

Supply chain issues were cited by company management numerous times during the recent reporting season and were attributed as one of the key reasons behind operational cost increases, logistical breakdowns and inventory increases.

For example, Resmed CEO Mick Farrell said: “Global supply chain limitations, including a shortage of electronic components, as well as ongoing freight constraints and costs, are impacting our ability to respond to the unprecedented increase in demand for ResMed products,”. There were many other companies also commenting with similar views.

While newswires have focused on the shortage in semiconductors and the resultant 30% decrease in US Auto manufacturing volumes, the global supply chain issue is much broader when the interconnected global network of shipping is considered.
The chart below illustrates the price of shipping a container from China to various major Western ports. The trend is similar for the Baltic Dry Index, which measures bulk shipping rates (eg grains and metals).

Source: Bloomberg, Drewry

Cargo shipping is typically a very inelastic industry on the supply side, as ships take around two years to build and are expensive to remove from service for short intervals. Hence when demand shifts, the price can move materially. 

There are two reasons behind the massive price spike witnessed in 2021:

1. The stop-start (lockdown vs stimulus) affected global recovery.

While usually shipping rates can be a good leading indicator for global growth, the ‘pop’ in pricing during 2021 is also reflective of supply side issues. Historically the global supply chain, and the shipping industry that underpins it, operates in an orderly market with a relatively smooth flow of containers and ships around the world. However, due to the stop-start nature of the current economy, this orderly flow has been majorly impacted. Some recent incidents include:

… all of these ‘isolated’ events are happening at all points of the supply network. When ships are delayed at port, the containers waiting patiently on those ships are meant to be ferrying goods elsewhere. This delay then in turn creates bottlenecks at trucking and rail hubs, and means containers are far less likely to be where they are meant to be at the right time.

Source: Freightwaves

Hence the global nature of the pandemic and the de-synchronised growth that has resulted, has been a major contributor to supply chain issues. 

2. Demand spike for durable goods

Consumer demand has also materially changed. The table below illustrates demand for Durable goods and consumer products, versus demand for services. 

Once again, the pandemic has created a major disruption but this time on the demand side. Consumers are spending their money on cars and consumer goods, and far less on services like travel and restaurants. This is creating huge demand for exported goods out of Asia and creates a major capacity imbalance relative to the traditional flow of goods that operated pre pandemic.  

How long before this is resolved?

Shipping companies have placed record orders with ship-builders to improve the supply of ships, however given the time lag it is unlikely these will have major impact for another 18-24 months. 

Meanwhile demand for consumer and durable goods appears likely to remain elevated, with the stop-start economy and travel restrictions continuing to impact the speed of re-openings. 

When combined, it is difficult to see Supply Chain issues and the elevated costs that accompany them, as being addressed in the next 12 months. Indeed, shipping index provider Drewry suggests rates are likely to go higher in the near-term during the run into black Friday sales and Christmas.

What is the impact?

Supply chain issues are likely to be with us for some time to come. While the impact is difficult to quantify and will vary across companies and industries, what seems clear is that cost inflation and the impact on corporate profitability is likely to keep prices well supported for the foreseeable future.

This leads us to believe that the definition of inflation as ‘transitory’ is likely to be extended, and it’s usage may end up being very ‘un-transitory’ in and of itself!! In any case, the timeline certainly seems beyond what was originally envisaged by the Federal Reserve when the Chairman Powell raised the term around the March 2021 FOMC meeting.

While we remain of the view that we are unlikely to see the inflation shocks of the 1970’s, even a modest level of underlying inflation – that proves more enduring – may well move interest rates a little quicker than the market is expecting. 

As always, plan for the best, but prepare for the worst. For further insights regarding the impact of inflation on equity market valuations and the defensiveness of bonds in a balanced portfolio please refer to our previous newsletters or reach out to discuss.

Wheelhouse Global Equity Income Fund

7.8%

Income over 3 years (p.a.)

8.0%

Income over 3 years (p.a.)

 1 month1 year3 years (p.a.)Since inception^
Income0.00%9.57%7.78%7.42%
Growth1.66%7.68%0.19%1.86%
Total Return1.66%17.25%7.98%9.29%
Benchmark*3.10%31.37%14.68%14.92%
Risk (Beta)**n/a0.480.470.60

Performance figures are net of fees and expenses.
* Benchmark is the MSCI World Index (ex-Australia).

** Risk is defined as Beta and sourced from Morningstar Direct. Beta is represented vs the Benchmark and vs the S&P/ASX 200 Index. A Beta of 1.00 represents equivalent market risk to the comparison Index. A minimum of 12 months data is required for the calculation.

^ Inception date is 26/05/2017. Since inception figures are calculated on a p.a. basis. Past performance is not an indicator of future performance.

Click here to read the full performance report of the Wheelhouse Global Equity Income Fund.

Wheelhouse Australian Enhanced Income Fund

Performance numbers below are based on exit prices and include the 30bps exit spread.

 1 month3 monthSince inception^
Income*0.48%3.93%4.55%
Growth2.64%2.82%9.35%
Total Return3.11%6.76%13.90%
Benchmark**2.73%6.22%13.07%
Excess return0.38%0.54%0.83%

Performance figures are net of fees and expenses.

* Income includes cash distributions and the value of franking credits and special dividends. Cash distributions are paid quarterly.

** Benchmark is the S&P/ASX 200 Franking Credit Adjusted Daily Total Return Index (Tax-Exempt).

^ Inception date is 9/03/2021. Since inception figures are calculated on a p.a. basis. Past performance is not an indicator of future performance.

Click here to read the full performance report of the Wheelhouse Australian Enhanced Income Fund.