Australian equities 2019 in review

The Australian Equities market moved significantly higher (+23.8%) over the 2019 calendar year, which provide stark contrast to the weakness that preceded the period when the benchmark fell 8.4% in the December 2018 quarter. The strong return for the year was driven to a large extent by macro factors which drove multiple expansion (c90% of returns), as shown below.

Valuation multiples expanded significantly to around 18x P/E at 2019 year end (compared to a longer term average of c14.5x) despite weakening fundamentals as earnings growth turned negative for the market as the year progressed. The primary drivers of expanding equity market valuations were macro factors, most notably the interest rate cuts of global central banks, including the Federal Reserve and the Reserve Bank of Australia. These factors significantly impacted the trajectory of bond yields which raised all boats but especially benefited long duration growth stocks and yield sensitive sectors.

Other key domestic events to impact the market included the unexpected re-election of the Coalition Government (with policies widely believed to be more friendly to banking, insurance and building sectors, resulting in a relief rally); and supply disruptions in the iron ore market sending prices significantly higher, benefiting large cap miners.

Performance was particularly strong for the market in Q1 and Q2 2019 (as represented by the orange and grey bars below) with a much more muted return of 3.3% in the second half of the calendar year.

Overall, this proved to be a challenging backdrop for active management, particularly in the first half of 2019.

Market Leadership

Market leadership through the year was narrow, with the return of the ASX 300 Index being largely provided by a small group of stocks. From a contribution to benchmark performance perspective, (chart below left) the top 10 stocks provided ~45% of the Index return for the year of 23.8%. The large cap iron ore miners BHP, Rio Tinto and Fortescue Metals were three of the top ten stocks, while the top five stocks contributed circa 30% of the benchmark return. Active positioning in these stocks was accordingly very important, particularly in relation to CSL. From a sector contribution perspective (below right), the Materials, Financial and Healthcare sectors combined accounted for 54% of the return for the Index for the year.

Key outliers for the market in terms of returns were Healthcare (+39%) and IT (+35%). The former is primarily comprised of CSL, while the latter has been led by the ‘WAAAX’ (WiseTech Global, Appen, Altium, Afterpay Touch and Xero) stocks, which are Australia’s less well-known equivalent of the ‘FAANGs’. These sectors performed spectacularly well despite very expensive valuations, as part of the ‘long duration growth’ thematic as bond yields compressed over the year. Exposure to these stocks was largely limited to growth biased managers given elevated valuations. Exposure to the IT sector had a large impact on performance fortunes for the small cap manager universe.

Manager Performance

Most of the strong returns for the Australian Equities market played out through the first six months of 2019 given the factors outlined above, with more muted market returns in the September and December quarters. While the first half of the calendar year was generally poor for active managers, the second half was generally strong. Accordingly, the performance of the Australian Equities manager universe over the year in aggregate was mixed relati0076e to history, driven by the aforementioned themes.

The chart shows the excess return over the one-year period to 31 December for a universe of 119 long only / Broad cap managers in the Australian market, from the eVestment database. It shows that around 55% of managers outperformed for the calendar year period, with the median manager 0.5% ahead of the benchmark. While this is a modest outcome, the number of outperformers actually improved significantly in the second half of the year. It is noteworthy that the same data at 30 June 2019 showed underperformance by 80% of managers for the rolling one year period, with around 30% of the universe underperforming the S&P/ASX300 Index by more than 5%. The median manager had underperformed by 2.8%. It is also noteworthy that realised performance outcomes were in many cases outsized compared to tracking error expectations.

Investment managers found the less thematically driven market environment of the last two quarters of 2019 to be more conducive to stock picking with a number citing a ‘return to fundamentals’ during the period. The stabilisation of global bond yields is likely to have contributed to this.

How the 2018/19 Financial Year Compares to History

The past year of active manager returns in Australian Equities remain tainted by the very poor 2018/19 financial year period. In JANA’s experience, the realised performance outcomes were largely unprecedented for the Australian Equities manager universe, and we note that the average outperformance of the median manager since 2007 remains at 1.8% p.a. despite the very poor relative performance for the period (JANA notes a level of survivorship bias in the sample).
The chart below highlights the extent of the unusual period in which even the best active managers in JANA’s view struggled with dynamics of the market.

JANA has confidence that this was a transient period for poor active performance and have faith that quality investment capabilities will be to recoup the underperformance delivered for the 2018/19 FY. Indeed, as noted, the second half of 2019 calendar year showed a promising turnaround in this regard.