Reflections on the past financial year
From a breathtaking downward spiral in sharemarkets to the sharpest rally in history, the 2019-20 financial year was a wild ride. But the news isn't all bad on super.
While we’re all a bit fed up seeing the word ‘unprecedented’, there’s really no better way to describe what happened during the past financial year. The collapse in economies brought about accommodation from central banks and governments which, by some measures, dwarfed the response to the GFC. Equally breathtaking was the downward spiral in sharemarkets followed by the sharpest rally in history.
Against this backdrop, to say that it’s pleasantly surprising that most of our members recorded flat to positive returns over the year, would be an understatement.
As one would expect in such volatile circumstances, the range in outcomes across investment strategies was extreme. Options with high exposure to global developed markets (particularly the US) and the booming technology sector performed best. Those with relatively high exposure to Australia, and the property and financial sectors, fared much worse.
Best and worst performers
The performance of all our key investment options continues to be very strong relative to our peers, with most of our diversified options ranking in the top quartile of returns over short and long terms. Relative performance is important because it demonstrates to our members that we are delivering on our core value proposition—competitive returns with low fees. But what matters most to members is actual (or absolute) returns because that’s what ends up in their accounts, so we’ll focus on absolute returns.
Best performing shares (of significance to UniSuper)
As we’re now around an $80 billion fund, our big investments are usually confined to large companies. While smaller companies typically have more downside and upside (and, by extension, are more likely to be the best- or worst-performing shares in the market) they don’t have a significant impact on our members’ returns. Therefore, in this article, we’ll just look at companies in which we have at least $500 million invested. Of those, here are our top three.
Apple was our standout performer, returning +86.5% (in US dollar terms) over the financial year. Given the leading role Apple has played in the smartphone revolution, nobody needs an introduction to the company. What may be under-appreciated, however, is the strength and growth of Apple’s services—e.g. the App Store, Apple Music and iCloud—that can be installed on 1.5 billion Apple devices. Concerns about over-inflated valuations in the tech sector are less relevant to a company like Apple. With annual revenues of US$268 billion and profits of US$57 billion—and net cash of US$83 billion—the US$1.6 trillion market value of Apple is supported by solid fundamentals.
Our next best was another tech darling, Microsoft, with +53.8% (in US dollar terms). As the dominant player in the enterprise software market, Microsoft doesn’t need any introduction either. Like many tech companies, it thrived during the latest crisis, with CEO Satya Nadella saying the company saw “two years’ worth of digital transformation in two months” as companies transitioned to remote working. Microsoft has seen a 60% increase in demand for its cloud platform (“Azure”) over the crisis. It’s another tech company whose lofty market value (US$1.6 trillion) is supported by strong revenues (US$139 billion p.a.), and profits ($US46 billion p.a.).
Built on home-grown scientific excellence, CSL (+35% over the year) could arguably lay claim to being Australia’s greatest company. It remains a leader in the use of plasma to treat autoimmune diseases, bleeding disorders and infections, as well as being one of the largest influenza vaccine producers. It is currently working on a treatment for COVID-19. CSL started as a government department (Commonwealth Serum Laboratories) and was listed in June 1994 at $2.30 (which equates to 0.76 cents after accounting for share splits). It’s currently trading at around $300 dollars, so it has been a spectacular investment for those who have been there for the duration.
Best performing investment option
With a return of +13.7%, our best performing investment option was Global Environmental Opportunities (GEO). Our in-house team manages GEO, so its performance is particularly pleasing. The GEO portfolio consists of companies deriving most of their revenues from addressing current and emerging environmental issues—renewable energy, water and waste treatment, energy efficiency and green buildings. The three best performers in the GEO portfolio were Tesla, SolarEdge and Citrix.
Given GEO doesn’t invest in companies directly involved in the exploration or production of fossil fuels, it managed to avoid the headwind of a crashing oil price. GEO is one of our three options themed on environmental, social and governance (ESG) issues—the other two being Sustainable Balanced (+5.5%) and Sustainable High Growth (+6.9%). Both sustainable options returned well in excess of their mainstream counterparts, also in part due to avoiding companies involved in fossil fuels.
The past year saw an accelerating trend of funds flowing into ESG-themed investment products and this has boosted the share prices of the companies that qualify for inclusion in such strategies. By many measures, valuations look quite stretched relative to the general market. Tesla is the classic case in point. With a market value of US$224 billion, Tesla is now the most valuable car company in the world. It’s on target to manufacture about 436,000 vehicles this year and make a profit of about US$631 million. The second most valuable car company is Toyota, which will manufacture about 9 million vehicles and make over US$10 billion. Of course, it’s much more fashionable to be seen in a Tesla, and the company’s growth prospects are far greater than Toyota’s. But its lofty valuation can’t be sustained without rapidly increasing profits. And rapidly increasing profits will be harder to come by as the competition heats up. Then again, we’ve said this before and the share price has continued its ascent.
Worst performer (of significance to UniSuper)
Our hardest hit shares were two property companies, Scentre Group (-40.1%) and GPT (-30.6%). The impact of lockdowns on shopping centres has been self-evident. Scentre and GPT are landlords, and tenants have contractual obligations to pay rent. But if the tenants are in danger of going out of business, compromises have to be made. Accordingly, expectations of rental growth (and ultimately dividends) have been slashed, at least for the short term. Adding to the industry woes is the long-term threat posed by internet shopping, and the potential for changing work practices to permanently lower the demand for office space (impacting GPT).
It therefore won’t surprise that our worst performing investment option was Listed Property (-16.1%).
Valuations are now pricing in a very pessimistic outlook. While it looks tempting to buy after prices have fallen so far, it’s hard to see a catalyst that will underpin significant price appreciation, over and above the general market. There look to be better ways of playing a post-COVID recovery, such as Sydney Airport (SYD) which ranks as our third worst performer (-27.9%). Air travel has obviously been decimated by COVID-19, but it will return, and SYD doesn’t have the same structural challenges as shopping centres.
The Defined Benefit Division (DBD)
We use two key measures to monitor our DBD’s financial health—the Vested Benefits Index (VBI) and the Accrued Benefits Index (ABI). As at 30 June 2020, we estimate the VBI to be around 114 and the ABI to be around 123. While this is a material decline from recent peaks, the DBD remains in a healthy surplus, which is in stark contrast to most defined benefit plans around the world. The underlying portfolio certainly took a hit but at no time during the crisis did we get into a funding level below 100%. In short, the DBD provided the peace of mind—as it was designed to do—when it was most needed.
The overarching highlight
Given the enormity of what has transpired, we feel generally satisfied with how the 2019-20 financial year’s results panned out. Our overarching highlight was the way our conservative approach to liquidity enabled us to handle the crisis without being forced into selling assets at low prices. The impact on performance relative to our peers was best captured by a recent article in the Australian Financial Review, entitled ‘Darling funds will become duds in volatility, and vice versa’. The article, dated 23 June, included the following table showing how the 10 top-ranking super funds in 2019 navigated March and April 2020 (when the market crashed and then sharply recovered).
|First State Super||9||15.8|
|First State Super||8||-8.8|
|First State Super||43||2.3|
Source: Frontier advisors
Of the top ranked funds in 2019, only two remained in the top 10 after the sharemarket’s crash and partial recovery. At the heat of the crisis, our high levels of cash and bonds meant we easily dealt with the drain on liquidity caused by members switching into cash, foreign currency settlements, and early redemptions. Furthermore, on top of not being a forced seller, we were actually able to participate in many capital raisings at attractive prices. By the end of June, we had invested over $600 million in support of capital raisings. It demonstrated not just our own strength, but also the important role that superannuation plays in funding corporate Australia at critical times. Hopefully policymakers have taken note.
Past performance isn’t an indicator of future performance. This information is of a general nature only and may include general advice. It has been prepared without taking into account your individual objectives, financial situation or needs. Our investment strategies won’t necessarily be appropriate for other investors. Before making any decision in relation to your UniSuper membership, you should consider your circumstances, the relevant product disclosure statement for your membership category and whether to consult a licensed financial adviser. This information is current as at 4 July 2019. This is not intended to be an endorsement of any of the listed securities named above for inclusion in personal portfolios. The above material reflects our view at a point in time, having regard to factors specific to us and our overall investment objectives and strategies.