Outperform Magazine

Runaway inflation, the war in Ukraine, soaring interest rates, skyrocketing energy prices, out-ofcontrol carbon emissions… maybe even Trump 2024? If 2022 proved anything, it’s that anything can happen, any time.

With that behind us, and a new year nearly upon us, the case for engaging experts to manage our nest egg seems stronger than ever.

Welcome to Outperform. Our purpose is simple: to introduce retail investors to the best and brightest investment managers across a range of asset classes and investment styles.

Today’s investment management industry provides more choice for retail investors than ever before. Fixed interest, domestic equities, international equities, small cap equities, sector funds, digital

assets, the boom wave of ETFsthis isn’t the investing world your grandparents, or even your parents grew up in. And if there’s one sure bet in markets today, it’s that it won’t be anything like what your children will face either.

More choice is always a good thing. The ability to tailor your investments to your income, your lifestyle, even your ethical considerations means you are able to make a personalised, meaningful impact beyond the workplace on your own financial future.

But with it comes noise. A lot more noise.

In this – our first edition – we are proud to introduce you to some of the most respected large-scale and boutique money managers around to help you navigate your way through the hawkers, sales pitches

and shills. We’ll also aim to include commentary and advice from other relevant specialists such as tax advisors and wealth managers so that you can be properly informed and ready to make the choices that suit your financial situation, your future, and your family best.

We’ll start by offering Outperform to you monthly, for free. You’re already winning.

It’s almost Christmas. Let us help you end 2022 with many happy returns, and more to come in 2023 and beyond.

Disclaimer

“Today’s investment management industry provides more choice for retail investors than ever before.”

Barry Fitzgerald

"...an energy system

energy technologies differs profoundly from one fuelled by carbon-emitting sources."

Decarbonisation to ward off global warming through the adoption of clean energy sources has brought a suite of metals and minerals that have previously played second fiddle to iron ore and coal into the spotlight.

It is why BHP has turned away from thermal coal and checked any future investment in iron ore to concentrate new investments into what it calls the ‘future-facing metals’ of copper and nickel.

In a clean energy driven world in which decarbonisation is underpinned by electrification from renewable sources, BHP expects copper demand could double over the next 30 years compared with the last 30. For nickel it could be four-fold.

They are but two of the ‘critical metals’ the world needs for the clean energy technologies potentially capable of delivering the dream of Net Zero emissions in the global energy system by 2050.

As explained by the International Energy Agency (IEA), an energy system powered by clean energy technologies “differs profoundly’’ from one fuelled by carbon-emitting sources.

“The types of mineral resources used vary by technology. Lithium, nickel, cobalt, manganese and graphite are crucial to battery performance, longevity and energy density.’’

That’s a lot of metals, and a lot of technologies for your average investor to get across, especially in a sector dominated at the moment by explorers and where consolidation is yet to become a feature.

Net Zeroa once in a generation investment opportunity

The accelerating global decarbonisation push is having a telling effect on the shape of the Australian mining industry. And this reshaping is full of implications for investors.

BARRY FITZGERALD

But the opportunity to invest in and be a part of a once in several generations shift - and a permanent one at that - is beyond doubt.

Rare earth elements are essential for permanent magnets that are vital for wind turbines and EV motors. Electricity networks need a huge amount of copper and aluminium, with copper being the cornerstone for all electricityrelated technologies.’’ the IEA says.

“(So) the shift to a clean energy system is set to drive a huge increase in the requirements for these minerals.

There are doubts the global industry is up to the challenge if left to its own devices.

There is also an added layer of concern around security of supply in critical metals because of China’s grip on supplies and more recently, the supply dislocation caused by COVID and Russia’s war with Ukraine.

It is why governments around the world, including Canberra, have reached a compact of sorts to encourage new investment in critical metals.

The twin imperatives of decarbonisation and security of supply were behind the Biden Administration recently awarding US$2.8 billion in grants to battery material companies, including three from Australia.

Europe is going down the same pathway, and in Canberra, the Albanese government is working on a new National Critical Minerals Strategy which is to include $1 billion in funding for value-adding initiatives in the critical metals space on top of the $2 billion

Critical Minerals fund established by the Morrison government.

Because Australia ranks highly in reserves of most of the critical metals, the local industry will be front and centre in meeting the global supply challenge. Australia also enjoys preferred supplier status on sovereign risk and ESG performance measures.

All of those factors have come together to fuel the remarkable growth of the Australian lithium industry from one valued on the ASX at $8 billion four years ago, to one now valued at $45 billion, and growing.

Other critical metals are also expected to benefit. So which one grabs your eye?

Fortunately, it doesn’t have to be one. Like the mining industry itself, investors need to be alert to the opportunities coming from the decarbonisation push, a modern day mega-trend. But they must also be alert to the pitfalls from single company/project investing.

Investing in the mega-trend via specialist exchange traded funds or specialist institutional resources funds with strong ESG screening protocols in place will be a safer option for most.

And leveraging this once in a generation decarbonisation opportunity in Australia means you’re spoilt for choice on that front. As you’re about to find out in

this launch edition of Outperform, a dazzling array of diversified funds, sector funds, sector ETFs, direct equities and the like are available to expose you to the upside, and protect you from the pitfalls as we move inevitably toward Net Zero.

powered by clean

Safety in numbers: It’s the risk reduction strategy for all

It seems counter-intuitive, but an ever more regulated investment environment actually creates barriers for investors starting with less than $500,000.

PETER STRACHAN

Increasingly, compliance costs exclude smaller investors from seeking professional investment advice from stockbrokers, who in turn are less willing to support the compliance cost and risk-profile associated with smaller investors.

So we find new entrants inevitably shunted towards chatroom share forums and online broking services where as little as $1,000 can find a useful home with which to begin constructing a portfolio.

But consistently achieving outperformance of any market over time is a difficult task.

As more options come online though, increasing numbers of investors of all sizes are starting to see the benefit of pooling funds to achieve more diversity while reducing risk, as well as gaining access to commodities, bonds and private or overseas investments and other asset classes that are not easily accessed by an individualespecially those with small amounts to invest.

Unlisted managed funds can offer a set-and-forget, pooled investment option for a longerterm investment where a team of fund managers and analysts do the legwork selecting stocks or assets with characteristics outlined in their mandate. This option holds potential to outperform over time through the investment cycle, but comes with higher fees, typically

of 1.2% and up to 2% pa and often shared outperformance against the benchmark with the investment manager, thus limiting upside potential for an investor.

Purchase and redemptions of unlisted funds are dealt from the manager at a price based on net underlying value less a fee, calculated daily.

While offering better liquidity, listed investment companies (LICs) are subject to a risk that the fund trades at a discount to its underlying net value. LICs are closed, so that buyers acquire an investment from sellers, who must match selling with a buyer, which often leads to a persistent value discount on the market.

At last count there were 223 exchange traded funds (ETFs) on the ASX covering seven asset classes. ETFs have become popular with investors applying as little as $1,000 to seek exposure to equities. An ETF trades like any ordinary listed share on the market but offers a market price on any day that always closely reflects the underlying asset value of the fund.

These products are designed to track investment in a certain market index, commodity, or geography. They are very low cost, with fees of typically less than 0.1% pa and are managed via computer driven algorithms to hold a certain weighted portfolio of stocks that mirror a desired target asset subclass.

In contrast to a value driven managed fund that seeks opportunities when markets fall and sells when markets rise, ETFs buy into a rising market and sell into a falling market, which might extend bull or bear runs on the underlying asset classes.

ETFs can provide low-cost exposure to specific commodities via underlying physical exposure and/or exposure to listed producers and developers of mining projects.

ETFs can also offer a top-down thematic that might not be appropriate for a set-and-forget style, such as gaining exposure to petroleum or battery metals where an exit can be made if value in that sector becomes overstretched.

LICs generally rely on the skill of management to offer broad market exposure, as do unlisted managed funds that can also offer a specific geographic or industry focus.

ETFs generally mirror a selected or manufactured index of stocks, adjusting exposure as funds flow in and out.

Whichever is your preference, all of the above achieve a common goal - giving everyone access to a shared investing experience. Sharing risk, success, wisdom and experience.

And the best part of it all is that the valuable knowledge you’re accessing in such products is - like this edition of Outperform - free.

Peter Strachan

"...investors of all sizes are starting to see the benefit of pooling funds to achieve more diversity while reducing risk."

According to the Responsible Investment Association Australasia’s latest annual benchmark report, in calendar 2021 responsiblytinged investments accounted for $1.54 trillion of the $3.60 trillion of Australia’s professionally managed funds.

This included $30 billion of ‘impact’ investments, “those made with the explicit intention of generating positive social and/or environmental impact alongside a financial return.”

According to LGT Crestone head of sustainability Amanda MacDonald, the earlier ethical investing approach hinged on exclusion policies, “taking the investible universe and excluding a range of companies considered to be sin stocks.”

Locally, LGT Crestone provides

How to make money, with change

Australian investors are taking the ‘ethical’ mantra a step further and are adopting the approach of actively promoting enterprises that engage in suitable sustainable practices – and demanding change if they don’t.

BOREHAM

private wealth advice to high-networth individuals, family offices and ‘for purpose’ organisations such as university endowments.

The firm was formed from the purchase of Crestone (formerly Potter Partners and UBS Wealth Management) by LGT, the 80-yearold private wealth advisory house owned by the Princely House of Liechtenstein.

The brother of the principality’s current reigning prince HansAdam, Prince Max von und zu Liechtenstein, is LGT’s chairman and is keen to maintain the firm’s age-old commitment to responsible investing.

MacDonald says tech entrepreneur Mike Cannon-Brookes’ tilt at AGL Energy is a “great example” of impact investing creating

meaningful change.

While the Atlassian founder’s takeover attempt came to nought, his advocacy resulted in the utility scuppering its contentious planned demerger of its coal-fired generators.

MacDonald says investors concerned about climate change simply could have excluded a stock such as AGL from their portfolio.

“But the argument is that if you are not investing, you are simply selling to someone who doesn’t necessarily care about those ESG factors,” she says.

LGT Crestone has identified five key sustainability challenges: climate change, social wellbeing, access to healthcare, financial inclusion and the circular economy (recycling).

While climate change features predominantly in clients’ thinking,

many of them argue that large wads of capital have already been devoted to that space and they prefer to focus on gender diversity, improving access to healthcare or addressing financial exclusion.

“It really is an individual thing,” she says.

MacDonald says LGT Crestone can leverage the impact strategies of some of the largest overseas private market managers, “who are far more progressed in this space than in Australia.”

But are they walking the ESG walk, rather than just making grand pronouncements about their sustainable investing credentials?

MacDonald says the firm has diligent processes to ensure these parties aren’t engaging in greenwashing or indeed ‘rainbow washing’ (using Pride colours to indicate support for LGBTQI causes with minimal effort or actual results).

“We conduct unbelievably deep due diligence because the devil really is in the detail on these third party funds,” she says. “You really have to look under the bonnet to see that they are doing what they say.”

MacDonald admits that the energy sector’s substantial outperformance over the last 12 months has led to some investors querying the financial worth of renewable energy investments.

But over the last three years, energy stocks have underperformed.

“We argue companies that don’t take ESG considerations into account are unlikely to have sustainable futures,” she says.

Driving home the point, the UN Principles for Responsible Investment cite the value of global financial assets at risk from climate change at a disturbing $US2.5 trillion.

“The net zero transition is happening whether you like it or not,” MacDonald says.

Tim Boreham

"...companies that don’t take ESG considerations into account are unlikely to have sustainable futures."

TIM

Epsilon Direct Lending is an Australian private markets investment manager focused on lending to middle sized companies, having identified that this section of the private credit market offers relatively better returns compared to other private credit strategies, according to Mick WrightSmith, founding partner of Epsilon.

Direct lending to middle market companies has emerged in Australia as traditional bank lenders have reduced lending activities to these companies, due to regulatory, capital and cost pressures. Epsilon has entered the space to meet corporate borrowers’ demands for loans and says the returns are attractive.

“We like mid-market corporate lending because the market is still dominated by the Big Four banks and the availability of capital is limited. So, from a lender's perspective, there is an opportunity to access loans which offer good relative value, that is, loans with relatively higher returns and lower risks compared to other private credit strategies such as larger broadly syndicated corporate loans, for example,” says Wright-Smith.

The corporate loan market (excluding bonds) in Australia is worth over $1 trillion. Unlike bonds, private credit is not issued or traded in public markets. Wright-Smith defines mid-market loans as those sized between $10 million and $100 million. Above that level, larger loans become broadly syndicated and there are many lenders (including domestic and offshore banks and credit funds) who participate in this segment.

“The market for large corporate loans is crowded with lenders; there are many lenders chasing the same deals and so there is an oversupply of capital. But in the mid-market, borrowers don't have much choice of lenders other than the Big Four banks.”

INCOME FOCUS

Corporate loans deliver a regular income stream for lenders, and it often comes with a hedge against inflation. Corporate loans typically have floating rate coupons, which are linked to the bank bill swap rate and reset regularly, often every 90 days. The interest rates on loans have a wide range of

Private credit offers opportunities for smart investors

between 4 per cent through to 15 per cent depending on the borrowers’ risk profiles, which also varies widely.

Overall returns from mid-market direct lending are typically in the high single digits, whereas large syndicated loans are a little lower than that as lenders compete on price. Interestingly, long term rating agency statistics suggest that the risk of suffering losses are lower when lending to medium sized companies than larger companies.

defensive characteristics. In an inflationary environment where interest rates are rising, the loan interest rates that borrowers commit to increase because of the floating rate coupons,” says Wright-Smith.

“Corporate borrowers can deliver consistent cash yields, capital preservation and low volatility. An increasing interest in direct lending globally suggests that borrowers are happy to compensate lenders for the illiquidity risk and credit risk involved.”

FUND MANAGER EXPERTISE KEY TO GOOD RETURNS

Middle market corporate loans are predominantly bilateral in nature – that is, there is one borrower and one lender as party to the loan agreement. Lenders need broad industry contacts to access the most compelling lending opportunities.

THE PRIVATE CREDIT MARKET AND DIRECT LENDING – THE LOW DOWN

The Australian private credit market encompasses a broad range of strategies, including direct lending. It provides lenders and investors with exposure to companies, mostly private, and the risk/ return profiles are very diverse depending on the risk of the borrower and loan.

There are many drivers of these statistics and one is because direct lenders tend to have greater influence over terms and conditions and also have greater control when company performance doesn’t go to plan. Syndicated lenders generally adopt loan structures created by intermediaries, and they must negotiate amongst themselves initially when company performance is off track.

“Middle market borrowers have

Loan terms and pricing are often idiosyncratic, so private credit managers with expertise and experience are best placed to lend to borrowers; the asset selection process is key to creating a solution for borrowers that combines a good return with managed credit risks.

”To build a sustainable private credit business, we’ve made a conscious decision to focus on lending to companies in defensive sectors such as healthcare, food staples and telecommunications. We think this will serve us well as we head into potential economic headwinds.

“It also serves companies in Australia well, because historically the major banks and established private credit funds have tended to focus more on real estate lending and consumer discretionary sectors such as hospitality."

Epsilon is a non-bank lender and private market asset manager specialising in middle market direct lending, providing bespoke financing to high quality, resilient Australian and New Zealand middle market companies. Epsilon was established in 2019, by Mick Wright-Smith, Joe Millward and Paul Nagy.

The corporate or business private credit market is worth about $1 trillion in Australia, with middle market growth loans comprising a $70 billion segment of this. Middle market companies in Australia have annual revenues between $25 million and $500 million. In the middle market most loans are provided directly, hence the term “direct lending”, which means the lender doesn’t have to work through intermediaries in order to evaluate, structure and document a loan.

Private credit can take different forms, including direct lending, real estate loans and many other loan types.

The non-bank corporate loan market has been difficult for middle market borrowers to access in Australia, with lenders focussed on real estate and larger corporate borrowers, where lending opportunities are largely arranged and structured by banks, investment banks and brokers.

Middle market companies have less influence over loan structure, terms and conditions than larger borrowers. That is because there are fewer lenders in the middle market, with more competition between borrowers for loans.

"The non-bank corporate loan market has been difficult for middle market borrowers to access in Australia."

Mick Wright-Smith

The link between responsible housing and higher returns

Hayes

KEY

"In real estate

high correlation between responsible investing considerations and investor returns."

While the carbon abatement narrative centres on electric vehicles and the phasing out of coal-fired power, the property sector is a bigger culprit than transport when it comes to emissions.

According to the World Green Building Council, constructing and operating buildings produce 39 per cent of greenhouse gases globally, of which 11 per cent is attributed to “embodied carbon” (mainly the use of steel and cement in construction).

These numbers are not lost on the custodians of First Sentier Investors Global Property Securities team which manages more than $1.78 billion invested in many of the world’s best listed property landlords (known as real estate

investment trusts, or REITs).

First Sentier is also a sector trailblazer in responsible investing practices.

First Sentier Investors’ global head of property securities Stephen Hayes says the sector has “much heavy lifting to do” on emissions reductions, “but we have seen some really good gains in the sector over the last five years, especially in regard to operational carbon.”

He adds that enabling more efficient buildings is not just about helping the planet.

“In real estate there’s a very high correlation between responsible investing considerations and investor returns. We have seen that over a long period of time.”

Hayes says the fund is constantly encouraging landlords to modernise their assets and measure and mitigate carbon outputs in the process.

“We have a heap of in-house proprietary methodologies and a whole range of benchmarking tools,” he says. “We [undertake] full due diligence of carbon analysis on any investment before we take a position.”

The fund’s role is made easier because its investee companies are

among the most sophisticated in the $US2 trillion investable universe.

“They are large and publicly traded, which means liquidity is easily available,” Hayes says. “The great majority of the world’s best buildings are controlled by these landlords and it would be nigh on impossible to replicate these assets.”

Currently, the US accounts for more than 60 per cent of the funds’ assets by value, with a further 7.5 per cent located in Canada.

Hayes also cites supportive “long-dated structural themes” such as e-commerce adoption, data consumption, falling home ownership rates, decentralisation and ageing populations.

Reflecting this, one of the fund’s biggest holdings is the $US11 billion market cap American Homes 4 Rent, a specialist owner of freestanding residences, with a skew towards the fast-growing Sunbelt (southern) states.

The fund also has a stake in the $US29 billion Digital Realty Trust, which owns a network of data centres as well as the $US9bn selfstorage operator Life Storage.

ABOUT US

First Sentier Investors is a global asset management group focused on providing high quality, long-term investment capabilities to clients. We bring together independent teams of active, specialist investors who share a common commitment to responsible investment principles.

Global Property Securities’ investment style is active, concentrated, focussed on stock fundamentals and ESG considerations. We have the flexibility to take a conviction-based approach where we see valuation anomalies. The investment time horizon is over the medium to long term. Valuation methodologies include a strong ESG bias.

QUESTIONS FOR FIRST SENTIER INVESTORS

Tell us about your strategy and how you invest

• Specialist real estate investor focusing on active management/responsible investing

• Invest in world's largest landlords

• Assets are cash-flow stable, excellent inflationary hedge

• Capital intensive, high barriers to entry.

Why invest in global property securities?

• Diversity and place in new and evolving economies

• Exposure to trends in eCommerce, data consumption, aging, falling home ownership and new post-COVID themes like decentralisation

• High-quality assets that are well placed as energy efficiency and environmental considerations increase.

Why is responsible investing so important?

• Reduces risk, generates higher returns

• Strong governance and stewardship of capital plus focus on energy and water efficiency means better investor outcomes

• Developed own proprietary carbon analysis to consider energy efficiency and carbon risk.

Why should real estate investors be interested in carbon measurement and ESG?

• Carbon regulation is coming. Companies with carbon reduction programs can deal with that risk

• Real estate sector responsible for some 40% of greenhouse gas emissions

• Sector currently in very early stages but will move quickly Advice for investors?

• Listed real estate includes companies with stable, long term cash flows caught in broader market sell off

• You’re exposed to big, enduring structural and societal trends

• Tenants and markets want high quality, well managed assets with focus on energy efficiency and carbon measurement

Stephen

there’s a very

Get real - the link between responsible housing and higher returns.

The local ETF filling green gaps for younger investors

QUESTIONS FOR GLOBAL X

KEY POINTS

◾ A provider of thematic, commodity, income and digital asset ETFs

◾ Products backed by industry-leading research

◾ Offering investors a ‘Beyond Ordinary’ approach to ETFs

"We

Under its new shingle, exchange traded fund provider Global X ETFs Australia plans an “aggressive” rollout of ‘thematic’ local offerings to tap burgeoning investor interest in the sector.

“Global X Australia is uniquely positioned in the market because we are backed by an exceptional international team as well as having almost two decades of local industry expertise,” says Global X head of investment strategy Blair Hannon.

Global X was known here as ETF Securities, before being acquired by the New York based Global X (a subsidiary of South Korea’s Mirae Asset Management).

The ETF provider now has 24 funds on offer to Aussie investors

after the Global X Green Metal Miners ETF (ASX:GMTL) hit trading boards in October, as the first launch under the new brand.

“We plan to launch another two or three before the end of the year, including one based around carbon credits,” Hannon says.

Global X’s approach reflects the sector’s transition from plain-vanilla funds that track a broad market index, to more niche exposures to flesh out a portfolio.

“We’re not competing with the Vanguards and iShares with passive index ETFs, we want to give investors broader choice in this evolving market,” Hannon says.

“Traditionally ETF Securities had a [thematic] focus and so too did Global X, so it has been a good integration of two providers with a similar vision.”

Despite hundreds of ETFs being available locally, Global X learned of key product gaps when it sought feedback from investors and advisers – and ‘green’ metals featured prominently.

“Decarbonisation is a high level thematic and it’s very pertinent for younger investors who also heavily use ETFs,” Hannon says. “It’s also a play on the Australian market because of its familiarity with commodities, so the green miners fund is a good combo.”

He adds the green metals fund has strategic allocations to a range of critical minerals including lithium, copper, nickel, cobalt and rare earths which are all vital in powering clean energy infrastructure and technology, from electric vehicles to wind turbines and solar arrays.

The planned carbon credit ETF will track futures contracts in the US and Europe, where pricing carbon pollution is a more mature discipline than here.

“We know education will be key to help investors and advisers see where such a unique asset class fits in a portfolio,” he says.

Global X is also eyeing a locally-

traded version of its $US6.4 billion Nasdaq 100 Covered Call ETF. Covered calls involve the use of options to generate additional (premium) income, albeit at the expense of capital gains (which are capped).

Hannon believes the demand for such “alternative” income is just as strong here as in the US, where dividend yields traditionally are much lower than here.

“We know the market is large and hopefully this can fill a hole for many investors.”

Hannon says it would have been difficult to launch such a fund 15 years ago, with investors becoming far more educated about ETFs since then.

“They saw that ETFs did what they said they were going to do: follow the index for a fee,” he says.

“Now that they’re comfortable, they’re willing to allocate to more targeted exposures, such as thematic ETFs.”

He notes that while ETF valuations have tapered in line with the underlying indices or assets, inflows into the sector remain strong.

ABOUT US

For the past two decades, ETF Securities has been a pioneer in the ETF industry with a focus on bringing intelligent alternatives to the market including the world’s first physical gold ETF and Australia’s first cryptocurrency funds.

Now, as Global X ETFs, we are leveraging a global network and new capabilities to maximise value for Australian investors. While retaining our existing products and local expertise, we are entering a new phase with the promise and global capability to deliver ETFs that are beyond ordinary.

Who are you?

Global X ETFs Australia is one of the country’s leading ETF providers. We are dedicated to providing our clients with bestin-breed investment solutions backed by industry-leading research. Our deep, international resources paired with our ground roots expertise in the local market – thanks to almost two decades of operating under the ETF Securities brand – gives us a unique opportunity to explore innovative opportunities across a diverse range of sectors, geographies and investment outcomes. In doing so, our team is creating an ETF powerhouse with an ever-growing suite of products which are accessible and cost-effective for all kinds of investors and portfolios.

What are you known for?

Global X ETFs Australia is a leading provider of thematic, income, commodity and digital asset ETFs. We burst onto the local scene in 2003 under our previous brand, ETF Securities with the world’s first physical gold ETF (ASX: GOLD) and have since brought a wide selection of innovative funds to market which meet the needs of local investors. Our commodities range has grown to include a selection of physically backed products and future-focused metal producers, while our thematic range offers extensively researched exposure to a variety of megatrends from tech giants and semiconductors to battery technology. Global X also helps investors generate income with high yield, US bonds and long and short Nasdaq funds. Moving forward, Global X will continue to launch undiscovered investment solutions which live up to our moto of being truly ‘Beyond Ordinary’.

In this next phase of our journey, we will provide Australian investors with unique ETFs across Thematic Growth, Income, Commodities and Digital Asset categories.

Blair Hannon

know the market is large and hopefully this can fill a hole for many investors."

Finding the future leaders of tomorrow

Small to mid-cap investing is not for the faint of heart, but even moderate risk can bring massive reward, says Fidelity’s James Abela.

co-manager James Abela.

KEY POINTS

To most Australian investors, small to mid-sized stocks are synonymous with subscale and speculative ventures with inadequate balance sheets or a weak market position.

But for the portfolio managers of the Fidelity Global Future Leaders Fund, the global small to mid cap sector is a different beast altogether – and more attractive than the usual blue-chip giants.

In short, they’re the equivalent of Goldilocks’ porridge: not so well loved enough to be overvalued, but well established with market leading positions.

“They do come with more volatility … but the additional return you get from investing in that asset class has shown to more than compensate for that,” says fund

Co-manager Maroun Younes adds there are “structural advantages” to pursuing such stocks, including less analyst coverage which increases the opportunity for mispricing.

While there are no hard and fast rules in defining the global small/mid cap sector, the fund targets stocks outside the top 10 or 20 on the major bourses.

From an ‘investible universe’ of 4000 stocks, Fidelity’s managers whittle down the potential selections to 100 or so, using a core ‘bottom up’ approach of assessing the company’s fundamentals.

Filters include return on capital, earnings consistency and reliability, the structure of the market and –increasingly – compliance with good environmental, social and governance (ESG) practices.

The fund also seeks companies with structural tailwinds, either because of the industry itself or because the individual company is gaining market share.

The fund currently holds 40 to 70 investee companies at any one time, ranging in market cap from $US3 billion to $US50bn ($5-80bn), with a median valuation of $US20bn.

“We are not talking about concept stocks,” Younes says. “By and large we are talking about well-established businesses that in many cases have been around for 10 years or more.”

Around two-thirds of the fund’s circa $300 million of holdings are US based, which is not deliberate but no accident either.

“US companies tend to do well in their own market and then go global,” Younes says. “They generally have higher returns on equity and returns on capital and are more investor friendly.”

The fund’s biggest investment is the New York Stock Exchange-listed Cheniere Energy, which exports LNG to a gas-hungry world.

“The company owns the infrastructure, but it doesn’t own the gas itself, sourcing it from third party suppliers. It has access to enormous

volumes of low-cost gas from the Permian basin in Western Texas,” Younes says.

Another key holding is the mid-tier US insurance broker Arthur J Gallagher, which ‘owns’ its customer while not bearing the underwriting risk of an insurer.

Ultimately, proof lies in performance and the small/mid sector has comfortably outshone the global large caps over the last three to four decades, as measured by annualised returns.

The fund’s benchmark, the MSCI World Mid Cap Index NR, returned 8.74 per cent per annum between 1994 and 2021, compared with 7.96 per cent for the large caps index.

The fund itself has delivered an annual return of 10.80 per cent since it was established in September 2020, compared with the benchmark of 8.84 per cent.

“We are looking for companies that will double in value over the next decade,” Maroun says. “That’s really the core of what we are looking to invest in.”

He says the managers are able to tap Fidelity’s global network of hundreds of analysts, who have direct access to the senior management of prospective investments.

“That makes the job easier for us located here in Australia to cover the entire world.”

ABOUT US

James joined Fidelity in 2003 and has 25 years’ investment experience. He’s been portfolio manager of the Australian Future Leaders Fund since 2013, which was awarded the 2018, 2019 and 2020 Morningstar Fund Manager of the Year award for the Domestic Equities Small Cap Category under his stewardship.

Maroun joined Fidelity in 2012 as an investment analyst and has 16 years’ investment experience in sectors covering telecommunications, media and technology.

QUESTIONS FOR FIDELITY INTERNATIONAL

Who are you?

Investing on behalf of our clients for more than 50 years, Fidelity International offers world class investment solutions and retirement expertise. As a privately owned, independent company, we are driven by the needs of our clients, not by shareholders.

What are you known for?

Fidelity is an active fund manager. With more than 400 investment professionals worldwide, we’re known for the breadth and depth of our global research. We believe better research delivers better investment ideas and better long-term performance for our clients.

What's new?

This September we celebrated the Fund’s 2-year anniversary. The Fund was recently nominated for International Small Cap Fund Manager of the Year by Zenith Investment Partners. We’re proud to be recognised for the risk/return profile and performance of the Fund during this volatile period.

Do you support ESG?

Our focus is on delivering sustainable investment returns for our clients, while managing our impact on society and the environment. To achieve this, we incorporate sustainability considerations into our investment processes and our business operations, and we work closely with investee companies to encourage them to operate more sustainably.

Any advice for investors?

Maroun says “Now is the time to prioritise businesses with resilient revenue streams, as well as those with strong balance sheets. Stock picking, as ever, will be key to surviving market volatility. Success over the next six months may well be defined by dodging bullets, as opposed to striving to hit home runs.”

James Abela

Maroun

Younes

Seeks to invest in tomorrow’s global leaders, today

A proven small to mid-cap manager

Aims to deliver more consistent returns through different market cycles

"We are looking for companies that will double in value over the next decade."

KEY POINTS

◾

Green and social bonds are growing in popularity

◾ Provide regular income and positive environmental and social benefits ◾ Can perform better than conventional bonds

"...directly helping disadvantaged individuals is an incredibly powerful way to deploy capital."

Green and social bonds are a fast-growing asset class issued by governments and corporations to finance projects that benefit the environment and the disadvantaged.

They combine the best features of a regular bond like capital protection and stable income while providing direct finance to solve some of society’s biggest problems, says Pendal’s George Bishay.

“You're getting the best of both worlds. These bonds not only give you the financial return that any vanilla bond gives you, but they go one step further in that they provide a positive impact on either the environment or society,” says Bishay, who heads credit and

Investing with impact

A powerful form of fixed income investing is gaining traction by combining stable returns with delivering important projects like social housing, renewable energy and education for disadvantaged kids.

sustainable strategies for Pendal’s Fixed Interest team.

Despite poor performance in fixed income markets this year, partly due to rising inflation and sharp interest rate hikes, fixed income remains an important part of many people’s investment portfolios. With high quality bonds there is the regularity of interest payments as well as the return of capital at maturity, offering protection from the swings of the sharemarket.

As an investment, green and social bonds are similar to traditional government and corporate bonds in terms of income and capital repayments, but also provide additional benefits of proceeds going towards better social and environmental outcomes.

“The positive for these bonds is the fact that demand tends to be stronger than vanilla bonds from the same issuer, which means the bonds can perform very well in the secondary market,” says Bishay.

But it’s more than performance attracting investors.

Green and social bonds finance renewable projects like wind farms, solar and hydroelectricity and the proceeds can be used for social housing or education for the underprivileged.

“It’s very powerful. Our clients love this concept. These funds have been so popular because not only is the performance very good, but also, they love what we're doing on the impact side.

“Getting involved in these types of projects where we're directly helping disadvantaged individuals is an incredibly powerful way to deploy capital.”

Bishay tells the story of a social housing project in western Sydney that has been backed by Pendal’s Sustainable Australian Fixed Interest Fund.

“I get chills down the spine thinking about it,” he says.

“One of the women we met wanted us to hear her story — an abusive relationship, a one-year-old child, living in her car.

“And now, she’s in this secure one-bedroom unit and her life has completely turned around.

“To be able to support the disadvantaged in society is something special.

“And to do it in a way that is not to the detriment of investment performance is even better.”

Importantly, green and social bonds are structured so that investors are not taking risk on the underlying projects but instead rely on the credit quality of the issuer, usually a government, bank or big corporation.

“Your link is to the issuer’s credit quality, not the project's credit quality,” says Bishay.

“Because of that, the credit quality is quite high, and this means the bonds are generally liquid — you can buy them and sell them in the secondary market in most market conditions.”

Bishay says investors in the Pendal Sustainable Australian Fixed Interest Fund can measure their impact on the fund’s website with a calculator that uses holding dates and investment amounts to create a bespoke report on exactly how an individual’s investments have had an impact on making the world a better place.

ABOUT US

Pendal has a proud heritage in responsible investment leadership.

We offer a range of innovative solutions and embed our sustainable investing practices across all our active management strategies.

And we seek positive change. Last year we undertook 479 meetings with investee companies to influence positive change on important environmental, social and governance (ESG) issues.

Pendal was recognised as the sustainable and responsible investments fund manager of the year in the 2021 Zenith awards, and this year we won the sustainable award in the income category.

QUESTIONS FOR PENDAL GROUP

Who are you?

Pendal is one of Australia’s largest investment managers with a heritage that goes back 51 years, managing $104.5 billion in funds around the world. Our brands include J O Hambro (UK and Europe), TSW (US) and Regnan (responsible investing).

What are you known for?

Pendal is best known for our flagship Australian equities strategy, Pendal Focus Australia Share fund, which has been managed by Crispin Murray for more than 20 years. We’re also known for our income and fixed interest boutique which manages more than $20 billion in funds.

Do you support ESG?

Yes we are a pioneer in ESG. Pendal’s Regnan business traces its roots to Monash University where it helped establish ethical investing in the 1980s. Regnan is now a fully-fledged investor focused on impact investing strategies. More info at regnan.com

Any advice for investors?

Our head of government bonds Tim Hext says; “It’s a challenging time for everyone –especially central banks trying to bring down inflation without a recession. However it does mean bonds are back – and their role as insurance in these highly uncertain times should not be underestimated.”

George Bishay

KEY POINTS

A contrarian take on a classic equity tale

For APSEC Funds Management’s Nicolas Bryon, a crowd is just a chance to swim against the tide, and win.

In essence, Bryon says, APSEC takes a highly contrarian approach –underpinned by the age-old ‘buy low, sell high’ principle.

APSEC’s flagship Atlantic Pacific Australian Equity Fund will have a net ‘long’ position varying from nil to 100 per cent – and currently around 60 per cent.

also super normal.”

With valuations trimmed across the board, the fund is becoming comfortable with stocks that it was wary about a year or so ago.

QUESTIONS FOR APSEC

Who are you?

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Global earnings recession is coming next year ◾ Inflation will be around for a long time ◾ Focus on absolute returns in a low return/high inflation environment

To APSEC Funds Management’s Nicolas Bryon, generating decent outperformance is just as much about avoiding losses as making gains.

“We are very much trying to make money from year-to-year but also trying not to lose money,” says the cofounder of the highly active, Sydney based ‘long-short’ fund.

Bryon describes APSEC’s investment approach as “highly unusual” in terms of its flexible ‘style-neutral’ methodologies and risk mitigation techniques.

“I don’t think you will come across another manager in Australia who does things quite like we do,” he says.

“We don’t like crowded trades, we tend to take the opposite side,” he says.

“If someone is shorting a stock, we might see value and take the long side. Or if people are ramping a stock we will go tactically on the short side.”

For example, last year the fund had ‘shorts’ on healthcare stocks following their pandemic bull run.

“We saw a lack of value in some of the COVID names like Sonic Healthcare or Cochlear,” Bryon says. “There are many instances where we have picked the top [of the market] with our medium term ‘shorts’.”

The fund uses a hybrid technique called “quadruple alpha”, which aims to outperform overall market cycles by capturing the upside while minimising downside risk.

This involves a mix of fundamental analysis of an individual stock, appraising upcoming events and how they might influence valuations and assessing macroeconomic conditions.

The fund also hedges its position with ASX SPI 200 futures contracts, which have high accessibility and liquidity.

“We adapt to information and we adapt very quickly,” he says. “If we need to take off our SPI hedge, we will in minutes. If there’s an extraneous event offshore, we will put one on overnight.”

Contrary to its internationallyflavoured moniker, the Atlantic Pacific Australian Equity Fund invests in ASX-listed stocks, usually in the top 200. Typically, it has a long exposure to 20 to 30 stocks and ten or so ‘shorts’.

“In an environment when prices are moving very fast on the downside, it gives managers like us an ability to hedge out that market risk,” he says. “But when equities are ready to bounce, the returns in our case are

“There are certainly a lot more opportunities we are looking at nowadays, things we felt were overvalued previously when everyone else was trying to buy them.” Bryon says.

“On the long side, recent holdings include Karoon Energy and thermal coal producers including Whitehaven Coal and Terracom.

“We are long CSL and Telstra, but are shorting the banks because we believe their provisioning will change [erode] over the next six to 12 months.”

Bryon believes that inflation probably has peaked globally. “But we aren’t going to hang our hat on it,” he says. “We are just going to adapt to whatever comes.”

In the year to September 2022 the fund returned an impressive 25 per cent after fees and expenses, compared with the 7.7 per cent decline of the benchmark S&P/ ASX200 accumulation index.

In the decade since it was formed, the fund has returned a cumulative 141.5 per cent compared with the benchmark 94.2 per cent.

As Bryon puts it: “We create unusual return outcomes because of our style.”

ABOUT US

Nicolas Bryon has spent over 25 years analysing companies and managing portfolios within leading financial institutions, including numerous hedge funds investing in Australia and global markets.

Nicolas founded the Atlantic Pacific Australian Equity Fund (APAEF) based on his experience running a large Asian Hedge Fund through the GFC, which instilled the value of downside protection for superior long-term returns, the founding principle of the APAEF.

We are not prepared to accept large losses in the funds entrusted to us by our investors.

APSEC is an Australian owned Australian Equity long/short manager. Our flagship product, the APAEF, founded in June 2013, is a managed investment trust which buys or short sells Australian listed securities and S&P/ASX SPI 200 Futures contracts (Index Futures), with a core focus on downside protection.

What are you known for?

We are known for our trackrecord of protecting investor capital during market downturns. For example, during March 2020 the Fund generated a return of 17.2%, while the S&P/ASX 200 Accumulation index fell -20.6%. The Fund has also substantially outperformed through the current market downturn since the start of 2022.

What are your points of difference?

We employ a dynamic variable beta strategy that allows us to reduce net market exposure through our use of Index Futures or short-selling equities, creating a highly differentiated and uncorrelated risk/return profile. This provides significant equity portfolio diversification benefits. Our focus on downside protection means the largest loss the Fund has experienced since inception was -7.7% while the largest loss for the S&P/ASX 200 Accumulation index over the same period was -26.7%.

Any advice for investors? Despite pockets of enthusiasm in the short-term, we expect markets to trend downwards for the next 6-12 months, so we suggest focusing on absolute returns and managing downside portfolio risk. Market drawdown can, however, provide opportunities for profiting from oversold stocks, if you’re ready to trade nimbly and use the right investment research platform to help you make timely trades.

Nicolas Bryon

"We adapt very quickly. If we need to take off our SPI hedge, we will in minutes."