K2 Australian Absolute Return aims to deliver capital growth over the long term by seeking out opportunities in undervalued companies in all market cycles. The Fund also aims to deliver superior risk adjusted returns through the investment cycle.
The K2 Australian Fund returned -1.35% for the month.
During the month the Australian Government released Its White Paper on Jobs and Opportunities. The goal is to create more employment prospects for more people in more places. However, to our mind, the more immediate challenge is addressing the erosion in productivity. Over the past year, unit labour cost growth has accelerated whereas the growth in earnings per hour worked has slowed. As a result, the measure of labour productivity has declined by 4% over the year and is now back levels last seen in 2015. So how does Australia pivot to producing more whilst using less? Rebalancing the labour market would surely help. In recent times, a number of bottlenecks have caused labour demand to outstrip supply. However, there are some signs that labour demand is starting to taper. The most recent SEEK Employment report showed that the volume of job advertisements were 20% lower than last year. In addition, the last ABS release revealed that the number of job vacancies were 15% below a year ago. There are also signs that labour supply is rising. The number of underemployed Australians has grown by 14% over the past year. It seems to us that the labour market rebalance is well under way and hence we would expect to see less interest rate hysteria in the future.
Towards the end of the month, the Fund established a position in Resmed (RMD). RMD produces Continuous Positive Airway Pressure (CPAP) devices for the treatment of Obstructive Sleep Apnea (OSA) and other respiratory conditions. Typically these respiratory conditions can be with obesity, gender or cranial facial problems. Hence, when Eli Lilly and Novo Nordisk announced that their Type 2 Diabetes (GLP-1) drugs were contributing to weight loss as well as reducing the risk of heart attacks, RMD’s share price subsequently fell by 40% in just weeks. Clearly the market is concerned about the impact that these drugs will have on the demand for CPAP products. However, the cost of these GLP-1 drugs currently range from US$900-$1500/mth. As a result. a standard RMD CPAP device is competitive at an outright price of less than US$1.000. In addition, these GLP-1 drugs have exhibited side effects such as nausea, diarrhea, vomiting, constipation and abdominal pain. The global market of OSA is thought to be close to a billion people. so if the type 2 Diabetes drugs impact the market by 10-15%, there is still an enormous opportunity for RMD. A ten PE point de-rating in MD looks like an over-reaction to us.
What is K2 Australian Absolute Return K2 Australian Absolute Return is an Managed Funds investment product that is benchmarked against ASX Index 200 Index and sits inside the Domestic Equity - Long Short Index. Think of a benchmark as a standard where investment performance can be measured. Typically, market indices like the ASX200 and market-segment stock indexes are used for this purpose. The K2 Australian Absolute Return has Assets Under Management of 20.81 M with a management fee of 1.31%, a performance fee of 0.94% and a buy/sell spread fee of 0.5%.
How has the investment product performed recently?
The recent investment performance of the investment product shows that the K2 Australian Absolute Return has returned 7.57% in the last month. The previous three years have returned 3.98% annualised and 13.32% each year since inception, which is when the K2 Australian Absolute Return first started.
How is risk measured in this investment product?
There are many ways that the risk of an investment product can be measured, and each measurement provides a different insight into the risk present. They can be used on their own or together to perform a risk assessment before investing, but when comparing investments, it is common to compare like for like risk measurements to determine which investment holds the most risk. Since K2 Australian Absolute Return first started, the Sharpe ratio is 0.44 with an annualised volatility of 13.32%. The maximum drawdown of the investment product in the last 12 months is -5.25% and -33.15% since inception. The maximum drawdown is defined as the high-to-low decline of an investment during a particular time period.
What is the relative performance of the investment product?
Relative performance is what an asset achieves over a period of time compared to similar investments or its peers. Relative return is a measure of the asset's performance compared to the return to the other investment. The K2 Australian Absolute Return has a 12-month excess return when compared to the Domestic Equity - Long Short Index of 3.49% and -2.29% since inception.
Does the investment product produce Alpha over its Peers?
Alpha is an investing term used to measure an investment's outperformance relative to a market benchmark or peer investment. Alpha describes the excess return generated when compared to peer investment. K2 Australian Absolute Return has produced Alpha over the Domestic Equity - Long Short Index of 0.27% in the last 12 months and -0.1% since inception.
What are similar investment products?
For a full list of investment products in the Domestic Equity - Long Short Index category, you can click here for the Peer Investment Report.
What level of diversification will K2 Australian Absolute Return provide?
K2 Australian Absolute Return has a correlation coefficient of 0.89 and a beta of 1.03 when compared to the Domestic Equity - Long Short Index. Correlation measures how similarly two investments move in relation to one another. This establishes a 'correlation coefficient', which has a value between -1.0 and +1.0. A 100% correlation between two investments means that the correlation coefficient is +1. Beta in investments measures how much the price moves relative to the broader market over a period of time. If the investment moves more than the broader market, it has a beta above 1.0. If it moves less than the broader market, then the beta is less than 1.0. Investments with a high beta tend to carry more risk but have the potential to deliver higher returns.
How do I compare the investment product with its peers?
For a full quantitative report on K2 Australian Absolute Return and its peer investments, you can click here for the Peer Investment Report.
How do I compare the K2 Australian Absolute Return with the ASX Index 200 Index?
For a full quantitative report on K2 Australian Absolute Return compared to the ASX Index 200 Index, you can click here.
Can I sort and compare the K2 Australian Absolute Return to do my own analysis?
To sort and compare the K2 Australian Absolute Return financial metrics, please refer to the table above.
Has the K2 Australian Absolute Return been independently verified by SMSF Mate?
This investment product is in the process of being independently verified by SMSF Mate. Once we have verified the investment product, you will be able to find more information here.
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Comments from SMSF Mates
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Performance Commentary - August 31, 2023 The K2 Australian Fund returned 2.11% for the month.
In Australia, we are noticing that there is a growing divergence in management behaviour. One is actively investing for the future; management are taking an owner-like approach to operating the business and the customer is elevated above all else. The other is extracting from the future. Here, management act like short-term professional officers and the customer is an afterthought. Simply put, owner-like behaviour embraces a philosophy that compounds customer trust whereas the professional officer approach is to maximise short-term profits at the expense of the customer. Market share will cede from extractors-from-the-future to the investors-for-the-future. However, these Imarket dynamics do take time to gain momentum. Meanwhile, short-termism is causing Australia’s inflation pulse to beat too fast. The price of bread, dairy and other food related products have, on average, risen more than 10% over the past year. Gas and electricity prices are, on average, 15% higher than a year ago, and insurance and travel prices have also been rising rapidly. The companies that have set these unchallenged prices have enjoyed inflated margins, but, the threat of competition is looming. Our investment process favours management teams that act like founders and are investing for the future. SVW Group Holdings (SVW) is a company that continually walks our talk.
SVW is your classic founder-led company. Back in 2010, the Stokes family enabled SVW to form. The WesTrac Group was merged with Seven Network to create SVW. At the conclusion of the merger, the Stokes family ended up owning 207 million shares of SVW or 68% of the company. On the first day of trading SVW was capitalised at $2.2 billion. Today SVW is a $10 billion company and, since the merger, has delivered shareholders a total return of 17% pa. The Stokes family continues to own 207 million shares but capital raising activities by SVW has seen their level of ownership dilute to 57%. Are SVW’s best days behind it? We think not. We believe that SVW’s model for capital allocation will be enduring and significant long-term shareholder value continues to be unrealised. SVW has empowered its decision makers to allocate capital as if it was their own and hence there is a healthy respect what equity capital can facilitate. As this ownership mentally S permeates through the company, the resultant flywheel of growth should gain sustainable momentum.
Performance Commentary - July 31, 2023 The K2 Australian Fund returned 3.82% for the month.
During the month the Treasurer appointed Michele Bullock as the 9th Governor of the Reserve Bank of Australia (RBA). She will commence in mid-September and will oversee the implementation of the recently announced Review of the RBA. The Treasurer has insisted that Australia should have the world’s best and most effective central bank. He acknowledged that Australia is facing a complex and changing macro environment and monetary policy must be sufficiently equipped to make the right calls in the interests of the Australian people. So what could change? It seems unlikely that the RBA will suddenly embrace a more hawkish perspective. In fact, in a recent speech, Bullock stated that the RBA had been more willing to accept a more gradual return to the inflation target than peer developed central banks. This would help explain why Australia’s cash rate is more than 1% lower than peer nations despite having an inflation pulse that is more than 2% faster. Furthermore, Australian mortgage holders are significantly more exposed to variable interest rates than developed peer nations. Fixed rate mortgages accounted for more than 30% of Australia’s outstanding mortgages in 2022 and the RBA estimates that by 2024 more than 20% of these will have rolled into variable rates. This is one of the known knowns. An unknow known is, as disposable income squeezes, what will households determine to be non-negotiable expenses?
One non-negotiable expense that Australian households have historically prioritised is the servicing their mortgage. And, as was highlighted by Helia Group (HLI) during the month, this continues to be the case. HLI is Australia’s leading provider of lenders mortgage insurance (LMI). HLI is at risk if a mortgage that has a LMI policy moves into the default phase. Problems occur when the outstanding loan is higher than the value of the property secured by the mortgage. Despite high mortgage servicing requirements, elevated living costs, and declining property prices, HLI continues to register a low level of claims and delinquencies. In fact, HLI is reducing the value of it prior liability claim reserves. This backdrop should be supportive for the forthcoming June half year earnings of the Funds holdings in Commonwealth Bank (CBA), Bendigo and Adelaide Bank (BEN) and to a lesser degree Kina Securities (KSL). We are underweight banks but believe that CBA, BEN and KSL are demonstrating that the lending business is sustainable.
Performance Commentary - June 30, 2023 The K2 Australian Fund returned -0.37% for the month.
During the month there were a number of important data releases in Australia. Firstly, the CPI for May was 0.4% lower than April or 5.6% higher than a year ago; this was better than expected. Secondly, the number of Australian underemployed workers in May were 12% more than this time last year. Finally, the number of job vacancies in May were 10% lower than last year. Furthermore, we are mindful that a number of Australian companies are over-earning and are, therefore, enabling a new source of competitive threats. A number of younger companies have been able to utilise the latest iterations of technology and now have the potential to compete with scale. It therefore seems likely that tradable and non-tradable inflationary pressures are peaking. All up, these outcomes should provide the Reserve Bank of Australia (RBA) with some flexibility towards tightening monetary policy. Eventually, the RBA will be comfortable moving to the sidelines, and this should signal that Australia’s economic activity is broadening. This would be very favourable for Seven Holdings (SVW).
SVW is one of Australia’s leading industrial companies with operations spanning industrial services, energy and media. Over the past few years SVW has also demonstrated a disciplined approach to allocating capital. Between 2013 and 2016, SVW conducted an on-market buyback where it acquired 27 million shares at an average price of $5.82. Then in 2017, SVW issued $375 million of equity at $11.20 to acquire 53% of Coates Hire. Again in 2021. SVW placed $500 million of equity to institutions at $22.50 following its initial acquisition of 23% of Boral. This activity has enabled SVW to build exposure to a number of Australia’s strategic growth avenues such as the infrastructure rollout, mining production and transitional energy.
The Fund is well positioned for a cyclical improvement in economic activity. There are some green shoots sprouting within the residential property market, housing prices are stabilising, auction clearance rates are improving and population growth has resumed. Dwelling construction activity is still subdued but a less volatile phase of monetary policy would surely cause some uplift in approvals for dwelling activity. The best lows performing holdings for the Fund this month were BHP Group (BHP) SVW and Macquarie Group (MOG), Detractors to performance were MAAS Group (MGH) and Peopleln (PPE).
Performance Commentary - May 31, 2023 The K2 Australian Fund returned -1.94% for the month. There are a few indicators that are sending mixed signals about the prospects for Australia. Firstly, global commodity prices have been edging lower. Secondly, China’s economic activity appears to be losing momentum. Thirdly, Australia’s inflation pulse is not receding as quickly as peers nations. And finally, Australia’s key political figures have lost sight of the need to drive productivity and are instead tilting their narrative and actions towards growth in real wages. Higher real wages without productivity gains would no doubt cause the Reserve Bank of Australia (RBA) to become more hawkish at the worst possible time. More than 800,000 Australian mortgages are in the process of swinging from low fixed interest rates to substantially higher variable rates. The RBA has already tightened monetary policy twelve times this cycle. Any further upward movements will obviously have a bearing on household spending.
We are also beginning to see some signs that businesses are becoming less courageous with hiring intentions and it seems inevitable that Australia’s unemployment rate will rise into 2024. The key question is whether the softening in consumer spending will coincide with an eventual rebalancing of the labour market and allow the RBA to stay on the sidelines. During the month a number of US listed companies indicated that strong demand for generative artificial intelligence and language models was underpinning future revenue prospects.
As a result, share prices of the 100 largest Nasdaq listed companies rose 8% for the month. Australia’s Technology sector was also strong rising 4% for the month. It is important to note that the largest 100 Nasdaq listed companies trade on 25x next years’ expected earnings.
The Australian Technology sector on the other hand trades on more than 40x earnings yet delivers less than half the ROE of the US peers. The best performing holdings for the Fund this month were Ryman Healthcare (RYM), MAAS Group (MGH) and News Corp (NWS). Detractors to performance were Macquarie Group (MQG), BHP Group (BHP) and Nick Scali (NCK). During the month the Fund acquired a new position in Lynas Rare Earths (LYC). The median holding of the Fund has a market capitalisation of $7.3 billion and, using expectations for the year ahead, has a PE of 13.4x, an ROE of 15.4% and a dividend yield of 3.8%.
Performance Commentary - April 30, 2023 The K2 Australian Fund returned 1.38% for the month.
The Australian economy is expected to deliver meagre economic advancement over the coming year; consensus estimates are that Australia’s GDP growth will be just 1.7%. It is also likely that these estimates will continue to fade. The last time economists were so bearish about Australia’s economic fortunes, excluding the COVID phase, was during the Global Financial Crisis. It is also worth noting that today Australia’s 2 year bond yield is 3.16% whereas the official cash rate is 3.85%.
The last time the inversion was so extreme was back in September 2012. Inflation expectations back in 2012 were moderate so unsurprisingly, the Reserve Bank of Australia (RBA) started easing monetary policy. Unfortunately, today we are not so lucky. The inflation rate for the year ahead is expected to be 4.7%. Hence, although economic conditions are sanguine, the RBA is unlikely to aggressively reduce interest rates. That said, we also believe that the RBA will not be in a rush to tighten monetary policy much further.
The labour market is finally showing some early signs of rebalancing; the number job advertisements are now well below last years’ level and this is typically a precursor to a lift in the unemployment rate. It would appear to us that a soft landing is still probable in Australia. We are also starting to see some contraction in the PE dispersion for the ASX 200. The PE of the cheapest top quartile company is currently 26x whereas during the COVID phase it averaged 30x and pre COVID the average was 17x. The PE of the cheapest top quartile company is currently 15 points higher than the most expensive bottom quartile company. During COVID, this dispersion averaged 17 points whereas pre-COVID the average had been 10 points. There is finally competition for growth so the dispersion in valuation metrics should continue to contract.
Performance Commentary - February 28, 2023 The K2 Australian Fund returned -2.66% for the month. During the month, the Governor of the Reserve Bank of Australia (RBA), Philip Lowe, had to make two appearances before government committees.
There was active debate around the merits of RBA’s meaningfully tighter stance of monetary policy. Governor Lowe continually reiterated the dangers of inflation becoming ingrained in the public’s psyche. Lowe also reinforced that the RBA was highly attuned to the fact that 880,000 fixed rate loan facilities, with an average balance of $400,000, would mature this year. Offsetting this to some degree would be the additional $300 billion that households had saved since the onset of the pandemic. However, the RBA is concerned that demand side factors continue to play a role in the elevated level of inflation and tighter monetary policy could assist in the rebalancing of the economy. Australia’s December half reporting season was a little disappointing.
Nearly half of the companies in the ASX 200 saw downward revisions to next years’ EPS projections. However, the magnitude of the downgrades were minor; the median revision was just -0.5%. Some of the key takeaways from the reporting season were the intense competition within the mortgage lending industry, the margin protection strategies of the grocers and petrol retailers, and the costs escalation for the major resource companies. Despite a few headwinds, the valuation metrics for the ASX 200 are still relatively attractive; on next years’ projections the PE is 14.4x and the dividend yield is 4.5%. The major resource companies continue to trade on 10x forward earnings whereas the PE of the larger industrials is closer to 17x next years’ earnings.
Performance Commentary - January 31, 2023 The K2 Australian Fund returned 6.95% for the month. For the past 75 years Australia has measured inflation on a quarterly basis. Last year the Australian Bureau of Statistics finally moved to a monthly CPI measure. Unfortunately, the monthly CPI reading for December was 8.4% stronger than a year ago. The Reserve Bank of Australia (RBA) has been highlighting that Australian business leaders have indicated that costs of doing business have risen and that prices would need to follow.
As a result, it would appear that some industries are now aggressively focussed on margin accretion to the detriment of their customers. Airlines, grocers and petrol retailers look to be the main culprits and their actions are having a meaningful impact on inflation gauges. We would prefer that business leaders counter short term input cost increases with long term productivity solutions. Supply chains have decongested, ”just in case” inventories are no longer needed, and worker mobility is recommencing. Accordingly, a number of industries will increasingly be exposed to an improved level of competition and market share will ultimately cede from the complacent to the focussed.
Macquarie Group (MQG) is a company that typifies this opportunity. MQG is a specialist provider of financial services; two thirds of the activities have an annuity bias and a third are more market facing. The annuity style activities are mainly asset management and banking and have both displayed strong growth attributes in recent years. Over the past decade MQG has more than doubled its assets under management to nearly $800b. Despite this, MQG is still a relatively small player in the US$100t+ industry.
MQG’s banking activities are also relatively small; MQG’s Australian mortgage book has been growing by 20%pa and is now over $100b but is still less 4% of the market. MQG’s market facing operations employ around 4,000 staff whereas global peers like Goldman Sachs and JP Morgan have 48,000 and 290,000 have employees respectively. Hence, we envisage that MQG, despite is recent success, can continue to grow quicker than its largest competitors and do so without disturbing the balance of the market. The best performance contributors for the Fund this month were Macquarie Group (MQG), BHP Group (BHP) and Seven Group (SVW). During the month the Fund acquired a position in Westpac Bank (WBC). Dexus (DXS) was sold. The median holding for the Fund has a market capitalisation of $12.1 billion.
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