Sydney Travel Blog Part 1– December 2016
After the clear skies in Hong Kong it was good to arrive in Sydney when three days of rain were clearing. Sydney in December allows travellers from the Northern Hemisphere to become reacquainted with summer, with humidity levels at this time of year still relatively low. Much of Australia has suffered a cool, wet spring but summer has now kicked in with temperatures ranging from the mid 20s to low 30s. Whilst States such as Queensland and WA have suffered from the slowdown in the resources sector, Sydney remains buoyant, although there are now some signs that its rampant property market is coming off the highest levels. Sydney property has attracted a large number of Chinese buyers, both attracted by the quality of life available in a bolthole location, and also perhaps a protection against fears of controls on the movement of capital in China and further RMB depreciation. The Australian exchange rate is no longer as strong as it was, although unsurprisingly in Sterling terms prices are higher than 12 months ago when Brexit was not regarded as a likely outcome of the EU Referendum. The impact of the fall in Sterling is noticeable as there appear to be less UK tourists around, but this is being made up, not only by Chinese visitors, but also a lot more visitors from the States who are enjoying the spending power of the resurgent US currency.
Walking to meetings in Sydney is always a pleasure as the sandstone buildings make a great site. The State Library of New South Wales is worth a visit for those interested in seeing some of Sydney’s original historic manuscripts.
First State Investments, or Colonial First State as they are known in Australia, operate a number of different boutiques within their core asset management subsidiary which no longer of course includes the Stewart funds. Each of these different investment teams are responsible for their own investment process with no ‘House View’ dictating investment strategy.
I met up with Stephen Hayes, who is Head of Global Property Securities at First State. Australian institutions and pension funds have typically favoured using property equities for their overseas real estate exposure, as even the largest local institutions are not really big enough to invest directly into overseas property markets and achieve diversification. The property equity team at First State have a number of offices within the different regions including Australia, the US and UK.
Since my last meeting with Stephen the US team has been further strengthened, meaning there are now three portfolio managers and two analysts in the States, which is an important market for property equity funds as it accounts for over 50% of the global benchmark. One point to note about this fund is that it is not a holder of bricks and mortar property, so unlike some direct property funds based in the UK it did not have to close to meet redemption requests. All the securities held are daily traded listed stocks with the result that this type of fund can be more volatile than traditional direct investment. A positive for investors over the last 12 months has been that the international exposure has benefitted from the depreciation of the UK currency post Brexit. First State have not seen much change to UK direct property valuations post Brexit, especially in terms of prime London property.
In 2016 the fund has been defensively positioned, and after a more difficult period has outperformed since the start of the Fed interest rate rises. US Reits are now having to contend with steepening yield curves, which has never been a positive for the sector. Fund manager Stephen Hayes takes a conservative approach to investment and will avoid sectors he believes are overvalued such as in Japan JReits, which have benefitted from buying by the Bank of Japan under its QE programme, but trade at a significant premium to net asset value. General property developers in Japan are favoured over the JReits with names such as Mitsubishi Fudosan and Sumitomo Realty favoured.
In the US, where rising interest rates and bond yields are likely to impact negatively on the overall sector, there is a focus on niche areas such as data centres which account for 10% of the fund. Other US exposure includes West Coast offices in Los Angeles, San Francisco and Seattle. The US Reit market is relatively sophisticated with investors able to choose what type of sectors they wish to invest in. In Hong Kong exposure is concentrated on holders of prime Central locations such as Hong Kong Land which has exposure to Exchange Squares 1, 2 and 3 and Jardine House. The fund is more positive on the UK than Continental Europe despite Brexit. Three names are held: Hammerson, Unite Group the student accommodation business and Land Securities. London offices, which could be vulnerable to moves by investment institutions offshore after the Brexit vote, only account for 1% of the fund on a look through basis. Exposure to Australia has been increased with National Storage still a key holding in the fund. After the setback to the property equity market post the Trump election victory, in-house forecasts for the portfolio show double digit upside as valuations are now more attractive than 12 months ago.
I met up with the First State Global Resources team headed by Jo Warner and also met energy specialist Mark Hume. This year has seen a huge commodity price rally which started in February, after the sustained selloff which occurred in the latter part of 2015 and January 2016. The catalyst for the rally was the Chinese stimulus package, or at least the expectation of this. As well as slightly improved demand, mainly driven by the Chinese infrastructure stimulus package, there has also been Chinese money chasing a hot investment sector. On the fundamental side there have been closures of high cost producers, so genuine supply side reduction is underway. The next Chinese electoral cycle is in October/November 2017 and historically the economy has been kept firm and on track ahead of these changes. Thus, Chinese commodity demand is likely to remain relatively strong leading up to this. However, it is unlikely that the amount of fixed asset investment, and hence commodity demand, will accelerate from here.
Whilst industrial related commodities such as base metals and oils have seen a price rebound, gold has had a more difficult year, although gold miners overall have done ok. The backdrop today of rising US interest rates is not positive for precious metals. Coal, which was already benefitting from mine closures, has also rallied on the election of Trump who has promised to revitalise the US rust belt. Whilst there are hopes that US infrastructure spending will be positive for commodities, it is important to remember that US demand is only 8% of global commodity demand compared to China which accounts for 50%.
The strategy for miners going forward will be to continue to focus on dividend payments, rather than instigate large amounts of capex, but the downturn has shown that it is not possible for mining, which is a cyclical sector, to have a progressive dividend policy. Dividends will now be paid out as a percentage of earnings which is a lot more sustainable, but means dividend payments will vary.
The December Opec meeting resulted in an agreement for production cuts, but the exact effect on oversupply in the market is harder to call. Whilst Opec and some other countries are cutting back, US shale producers are forecasting 20% production growth next year. Furthermore, countries such as Nigeria, Libya and Venezuela may well come back to the market. Whilst there has been a lot of comment about Russian production cuts they were already in next year’s internal Russian forecasts, as certain projects have come to an end and new supply will not come on stream for a few years. US producers may get a boost from less red tape in terms of building new wells and access to infrastructure.
Within energy there is a focus on companies that can ramp production up and down with ease without negative impact on the assets held as prices fluctuate. There has been some increased exposure to US natural gas and after the Trump inspired selloff exposure to renewable energy names has been increased. Many companies in this space are now profitable, even without government incentives or help. Wind turbine company Vestas is a case in point and has net cash on the balance sheet and a good ROE. Within the oil majors Chevron is a favoured name with good leverage to rising oil prices and holding excellent assets in the Permian Basin. The large US integrated oil companies are much preferred in general to the European names. Whilst the team do not make explicit commodity price forecasts they expect Brent to trade over the next year at $45 - $65 with the market consensus currently around $55.
I also met up with the First State Global Listed Infrastructure team headed by Peter Meany. This fund aims to deliver inflation protected income and capital growth through a globally diversified portfolio of infrastructure securities. Some sectors such as transport infrastructure including roads, airports and ports, together with rail, are more economically sensitive, whilst utilities such as water, gas and electricity are more bond like. The portfolio can also invest in energy storage, pipelines and mobile communication towers. The fund manages its sector exposure between economically sensitive and defensive assets, but is always likely to have at least around 40% invested in utilities. The team travel a lot doing on the ground due diligence and the large number of anlalysts means individuals only need to cover 20-25 names, allowing them not only to know the company well at the micro level, but also understand the regulatory regime with overseas visits taking in meetings with regulators and assessing the political framework in the country.
At the back end of 2015 the fund was investing in US rail as the sector had been significantly de-rated. This sector has seen a strong recovery on the improvement in the US economy and expectations of increased levels of activity in US manufacturing and infrastructure spending programmes. The portfolio has also benefitted from a move to overweight pipeline stocks which have benefitted both from a rise in the energy price and increased levels of M&A activity such as Columbia/TransCanada and the Spectra/Enbridge takeovers.
The fund has been underweight in regulated utilities for a few years, as the team were expecting a backup in bond yields at some stage. Thus the fund has avoided in particular low growth bond proxies. There is however exposure to some renewable utility names such as PG&E, Eversource Energy and Dominion Resources.
Utilities have been hit in the bond induced selloff post the Trump election victory, but the portfolio has benefited from an underweight position in this sector. The team believe bond yields are the number one driver of utility performance. Whilst the portfolio remains underweight, some names that have been hard hit have been added to on a selective basis. Gas utilities are benefitting from the increased supply coming from the Marcellus shale gas field through building transmission pipelines and therefore growing the regulated asset base. Utilities exposed to wind farms, solar panels or battery cell storage are also favoured.
As discussed US rail has been a major beneficiary of a Trump election victory, but over the longer term certain of its markets are likely to remain in structural decline such as coal. The fund has now sold out of its position in CSX.
There have been fears that Trump’s climate change theories will end the roll out of renewable energy, but much of the demand is driven either at the local authority level by States such as California, or from private businesses such as Google and therefore not subject to the vagaries of Federal government policy.
Emerging market exposure was added to 12 months ago when stocks in China and Brazil looked oversold. Brazil in particular has done well over the last 12 months with the economy showing signs of stabilising. The fund has exposure to toll roads and a water utility.
Although the oil price has risen this has not been a good time to hold oil storage names as the price curve has flattened. As a result traders are no longer able to pick up a sufficient margin by buying on the spot curve and selling forward so storage companies are running at relatively low capacity usage levels.
When the portfolio was launched just before the Financial Crisis it was looking to deliver a total return of 10% p.a. with 4% yield and 6% growth. These returns have been broadly achieved and the team believe this fund can still deliver on a 3-5 year view high single digit returns benefiting from an initial starting yield on the portfolio of between 3% and 4%.
After a hectic period Christmas day and Boxing day was spent catching up with a friend in Sydney. Then it was further south on the journey to Tasmania for the New Year only stopping at South Cape Bay Australia’s most southerly point!