Mai Platts:
Hello and welcome to our podcast for December. My name is Mai Platts, I'm the account director at Bennelong Funds Management. And today I'm joined by the BAEP investment team including Mark East, CIO, Neale Goldston-Morris Senior Analyst Economics and Market Strategy. Brad Clibborn, portfolio manager and Doug Macphillamy, portfolio manager. Gents, thanks for joining us here today. Neale I might start with you for an update on your global macro view. Throughout 2024 you focused on the backdrop of strong economic growth out of the US and slowly moderating inflation. If you could please give us some brief comments on how the macro backdrop has evolved through 2024 and what we can expect in 2025.
Neale Goldston-Morris:
If we go back to the beginning of this calendar year, the consensus was that the US economy would slow significantly, that corporates would struggle for EPS growth and that the Fed would do lots of rate cuts because inflation would fall rapidly. Our view was that US growth would remain strong because of a confident consumer, a strong labor market and strong productivity growth. And that whilst there would be some rate cuts, they would be limited. And broadly, if you look at this year as it unfolded, it basically followed our thoughts. US growth has been strong and is strengthening. The Fed has started some moderate rate cuts and we have a bull market inequities centered on the US. And we believe that will continue into the next year because with the new administration they are firmly pro-growth, deregulation, tax cuts, more oil production to keep oil prices low. And all that resulting in strong ongoing productivity growth which drops straight through to the bottom line as far as corporates are concerned.
So that's a real positive. When you look at the rest of the world, they have lagged and lagged badly because they have the opposite policies, more regulation, more government control, falling productivity growth. Europe in particular saddled with that, Australia to some degree, so we're somewhere in the middle but it still means in Australia the cake is not growing. So limited exposures are necessary there and China is starting a stimulus process, but it's very different to what we saw in the last two decades. Back then the stimulus was focused on construction and this time around, China's faced with excess capacity in housing, factories, infrastructure, all that area. They need to stimulate the consumer and that's what they're starting to do. There'll be some runoff on commodities but very limited compared to past cycles, we believe. So there's a diverse outcome around the world. It's overall positive, but the fundamental rule number one in markets is you never fight the Fed.
If the Fed has got the green light on with the rate cuts, you go with the flow, you invest and you stay fully invested and you target growth. And that's the incline that we have at the moment and that should continue for quite a while yet. There is one risk on the horizon in the US and that's tariffs. But again, even there we regard those tariffs as a negotiating technique. In other words, I'll put tariffs on you unless you do a quid pro quo and give me something. So in the case of Mexico, it is control your borders as far as immigration and drugs are concerned. Similar for Canada for that matter. And in China it's stimulate your consumer, don't add more industrial capacity, just stay. You can export to us and break our car industry, things like that. China is time to make moves in those directions. So yes, tariffs will go up, but it looks like there'll be a lot less than people expect and there's going to be lots of trade-offs. In other words, be able the deal.
Mai Platts:
Given the themes and the macro factors you've just mentioned there, Neale, how does that then flow through to your top-down view on portfolio construction?
Neale Goldston-Morris:
Basically, let's call it long and strong US exposures. Our portfolio is very overweight the US and growth within the US, that is stocks that not just benefit from a strong economy but are taking market share within their niches as well because they have a better product or service. And the list is long now, Goodman, James Hardie, Aristocrat, Breville, WiseTech, Block, Reece, et cetera. Just some of the names we have in our portfolios. That's been in place for a while and if anything, we've increased those exposures in some cases over the last six months as well and Brad will detail those. Bringing it back to Australia, we don't have broad-based economic exposures because Australia is not growing the cake. Canberra is in conflict with the private sector and hitting the private sector wherever it can and as often as possible. Where we do have exposures is in stocks that are exploiting niches, taking market share again because they have a better product or service. Examples are HUB24 REA and Carsales, so not the broad, large market cap exposures. And we have very little exposure to either China or Europe.
Mai Platts:
Thanks, Neale. If I can ask you one final question, BAEP are very focused on earnings growth, but there is some concern that valuations may be elevated. Keen to get your thoughts on that.
Neale Goldston-Morris:
Yes, valuations are elevated. That's normal when liquidity is expanding when the Fed is cutting rates. I go back to my earlier comment, you don't fight the Fed. When the Fed has got the green light on, valuations are a secondary issue. It's the EPS growth and the revisions to EPS growth. Markets green light remain expensive for long periods of time. If you sit on the sidelines, you can miss an awful lot of action whilst that is occurring. Yes, once the Fed starts to turn the red light on, in other words break rises, then you do the opposite. That maybe will be a year's time. I don't know at this stage, but at the moment the green light's on. So yes, there's always a trade-off between price and growth. And we're not in those stocks that have no growth and look cheap because they're cheap for a reason. Got no growth.
Mai Platts:
Thanks, Neale. So that we might now focus on how that macro view translates to the portfolio. Brad, perhaps we should start with how you changed the portfolio throughout this year.
Brad Clibborn:
Thanks, Mai. In broad terms, we look at stocks like Fisher and Paykel where we increased them earlier in the year. And where we saw accelerating earnings growth from new product releases and we are overweight the healthcare sector across the portfolios. We continue to hold that high level exposure to stocks that leverage to the strong US economy that Neale has spoken about. Names we've mentioned many times in the podcast like Breville, James Hardie, Aristocrat, ARB and Carsales. More recently we've taken some opportunities to add to some positions in tech at attractive levels. The important point with all of those is each of those decisions are very much bottom-up driven. And I might take this opportunity just to talk about how we do leverage Neale's views and incorporate the macro into our process. So we do use Neale's work to highlight areas of risk and opportunity across the portfolio.
We'll never just add a stock or a collection of stocks to give us a sector or geographic exposure even if Neale's work is suggesting it's attractive. We're always very much focused on that bottom-up fundamental work and Neale's work will help identify where those opportunities or risks might be. And a good example this year is going back to Neale's view around inflation and interest rates at the start of the year and the expectation that there would be fewer rate cuts. And obviously we had a meaningful position in James Hardie and that highlighted an area of risk around James Hardie with the potential for mortgage rates to remain elevated through the year when the market had started to price in quite a few cuts. It definitely put us on alert for James Hardie and as we went through the early part of this year, customer feedback remained very strong in those early months. But as we got through to late March and into April and the expectation had started to change around rate cuts and elevated inflation, we started to get feedback from customers that the sell-through in home builders and repair and remodel was softening.
We did a number of calls and that's proved to be pretty consistent feedback. And we down-weighted the stock quite materially and that was ahead of a revision downwards to earnings expectations for Hardie that came through at the may result. And it kind of flows into my second point as well. You might hear us talk about certain stocks on a repeated basis and there's good reason for that. The average holding period across the large funds at BAEP is around five years. What that doesn't highlight however, is just how we do optimized position sizing to take advantage of those opportunities and risks around earnings in the shorter term. Again using that James Hardie example, we continue to like the long-term story and we did earlier in the year when we reduced that position. They only have around 20% market share in the US and have a long runway for growth. And all of the customer feedback continued to confirm that structural opportunity, but given that shorter-term macro risk, we took the view to reduce the position and protect performance given some of those downside risks to earnings.
So the point there is really just highlighting that we are really focused on the bottom up and leverage that macro work for the areas of opportunity and risk across the portfolio.
Mai Platts:
Thanks, Brad. So as Neale said earlier, we have Trump's inauguration in January, then we have the Australian election in May, so both of those events could lead to major policy announcements. How are you positioning the portfolio to deal with the uncertainty and potential for volatility?
Brad Clibborn:
I guess part of financial markets you're always dealing with uncertainty, so there's really no change in our approach. First and foremost, we always stick with quality companies. That's the first box we need to tick when we're looking at our companies to potentially go into the portfolio. That's companies that have all the usual things you'd expect, high ROE, low gearing, trustworthy managements. We also want companies to have a track record of earnings delivery and earnings growth. We're not into concept stocks. But one of the less obvious characteristics we look for when we're defining quality is those companies that have consistently reinvested at a higher level back into their business over time into R&D new products and marketing. And that sets them up to become leaders in their niche, enjoying sustained market share gains over time and pricing power. And that's what helps them to continue to grow earnings and be less reliant on the underlying cycle and macro conditions.
Looking at sort where we see some of the feedback coming through from our industry work at the moment, we've been to the US back in September and we continue to do our regular industry contact work. Recent feedback's been that retail spending over the Black Friday period was generally pretty solid for the retail exposed companies. We're seeing some green shoots around US housing activity post the election and similarly in the gaming space, speaking to US casinos recently, volumes appear to be remaining pretty solid post the election as well. So there's some insights into some of the current trends. But really around that question on focusing on the volatility, it's really sticking to quality is the way we approach that.
Mai Platts:
Thanks, Brad. Appreciate those insights. Mark, we've had Neale talk about the macro and how the funds are positioned. Perhaps if you could just talk about some of the performance over 2024 and any of your thoughts for 2025.
Mark East:
Yeah, thanks, Mai. Yeah, we entered 2024 confident that economic growth would remain strong and good companies that executed well could generate strong earnings growth. Where we ended up is that the portfolios have generated good absolute returns, but the relative returns versus a benchmark are not where we wanted them. We've had good returns from stocks like Fisher and Paykel Healthcare, Breville, Hub Carsales and Goodman Group, but we've had a few key detractors which I'll run through. Firstly, IDP education, IDP places international students into unis in Australia, Canada, the UK and the US. It's faced a number of industry headwinds in its key destination markets of Australia, the UK and Canada as governments have tightened up their immigration policies. These changes in government policy have resulted in uncertainty for potential students, which is unhelpful for their ability to commit to international education. Our work, talking to key players in the industry suggests that IDP's position in the industry and its market share have strengthened, suggesting it'll be well positioned when conditions do improve.
Another detractor from performance was Corporate Travel Management, the company underperformed over the year due to a number of factors. Firstly, a large UK government contract the one didn't eventuate and other UK government work rolled off. Also, the company took longer to integrate acquisitions that had made in Australia and the US, and these issues drove earnings downgrades which led to share price underperformance. We believe these issues are largely behind the company and we've added to the position in periods of weakness. Another detractor from the Concentrated and Core portfolios was our underweight position in banks, which performed strongly over the year. This cost the funds over 400 basis points in performance. And we think banks are expensive, have little earnings growth and so we're happy to stick with our underweight position here. Looking forward to 2025, we're confident in our approach and process. We'll continue to look for high quality companies with strong earnings growth and think this will hold us in good stead over the coming 12 months. Team's working as hard as ever and we're totally focused on generating strong returns for our investors.
Mai Platts:
Thanks, Mark. Before we wrap up today, we have Doug Macphillamy to provide us a brief update on the emerging companies fund. Doug, the fund is up more than 40% this year. Perhaps if you could share with us what has driven such strong performance.
Doug Macphilamy:
Thanks, Mai. Before we kick off, worth mentioning a new joiner at BAEP, Kurt Gelsomino. He's been with us since early July and has hit the ground running. Great to have some extra horsepower in the emerging companies fund, and we're already seeing the benefits in terms of making headway with new ideas. It's been a pretty active period in the last six months for the fund. While stock numbers in the portfolio have stayed at around that 21 to 22 level. Since the end of June, we've added nine new ideas, exited seven positions and had one takeover. Looking at performance, if we take a step back and focus on the cumulative alpha for the 12 months to the end of November, the total contribution from top five positive attributors was close to 27% while the total drag from the bottom five detractors was around negative 4%. So the portfolio is really doing what it should be doing in terms of maximizing the winners and limiting the damage from those stocks that don't go to plan.
We continue to disclose our top five holdings each month. As at the end of November in no particular order, Paragon Care, Pinnacle, Superloop, Supply Network and Temple and Webster are in there. While they are all in very different industries, they do exhibit a lot of the characteristics we like to see when we look at investments. They're founder led or have experienced management who've been in the company in most cases for over 10 years. They're profitable and cash generative and can self-fund their own growth. This generally goes hand in hand with high return on equity and return on invested capital. They have conservative balance sheets and in most cases a net cash. And they've got sensible valuations when measured against the earnings growth.
Mai Platts:
Doug, I've noticed a new name in that top five list, Paragon Care, if you can share some insights on that company.
Doug Macphilamy:
Yes, Paragon is a newer position. We initiated it back in July. It's the fourth-largest player in Australian pharmaceutical wholesaling behind the likes of Sigma, EBOS and API. Paragon's gone from a standing start to 7% share of the market with ambitions to double this over the next five years, along with some chunky synergies from a merger earlier this year. We expect strong earnings growth from here for the business. They're founder led. There's attractive industry dynamics at play. We see multiple growth levers and a sensible valuation for the growth on offer, so continue to like that one.
Mai Platts:
Great. Appreciate those insights there, Doug. Thank you. And thank you to Mark, Neale and Brad for your thoughts today. Some really good insights. The team have provided a lot of information on this podcast, but if you do want more details on stocks, investors can go to our recent investor letter. It does include further commentary on markets and portfolio outlook. Thank you everyone for listening in today and thank you to our investors for your support this year. Have a great day.
