WAM Leaders Investment Update and Q&A
WAM Leaders (ASX: WLE) marked its fifth anniversary with strong investment portfolio outperformance and a record profit for FY2021. The WAM Leaders investment team shared their insight into the strategies that drove their success and how they are positioning for continued performance in FY2022 on behalf of shareholders.
Below is summary information only. For full details on the Entitlement Offer, please refer to the Entitlement Offer Booklet.
Shareholders are giving you an additional $241.2 million to manage on their behalf, what is your plan for this investment?
Our approach will be very much along the lines of sticking with our investment process of positioning for inflection points, which we have proven over the years.
This extra capital will allow us a bit more flexibility to participate in changes in the market – we can at our current size, but the extra capital allows us to jump forward. We think this will be a real benefit for the WAM Leaders shareholders.
The Entitlement Offer is one-fifth of the existing WAM Leaders shares, correct?
Yes. For every five shares you own, you are offered one more share. If you own 5,000 shares, then you are offered the opportunity to pay $1.44 for another 1,000 shares.
Is the Top-Up facility only for shares not taken up under the Entitlement Offer?
Any New Shares not applied for by WAM Leaders shareholders will be included in the Top-Up Facility, under which shareholders who take up their Entitlement Offer in full may also apply for Additional New Shares in excess of their Entitlement. Applications for Additional New Shares under the Top-Up Facility will be allocated at the sole discretion of the WAM Leaders Board of Directors and will be subject to scale back (where applicable).
If everyone takes their entitlement up then there will be no Top-Up facility.
When do you need to be a WAM Leaders shareholder to participate?
It is only open to WAM Leaders shareholders on the record date of 19 July 2021.
The WAM Leaders portfolio outperformed over 9% last year, following an exceptional 2020. How was this achieved?
We will begin with why FY2021 was such a strong year for equities first, which will help frame how the team achieved this result.
For equities to go up, you need three things: growth rates to be high, interest rates to be low and risk premiums for equities to be low. Last financial year, we experienced each of these at extreme levels, making the equity market a great place to be.
We positioned in the first quarter for a change in the market narrative. At the time, the narrative was centred on very low interest rates and a lot of growth companies had extreme valuations. For us, this was something we thought would change. We positioned the portfolio ahead of the inflection point, which happened in November of 2020. We were very heavily invested in cyclical companies, particularly financials, as we thought they were oversold.
Positioning for inflection points is something we have found over the years to be very important. In November of last year, there was one day where we gained over 150 basis points, or 1.5% of our performance on a single day. That shows you how important it is to be ahead of the curve.
This year, we think there are quite a few inflection points to play out, as the market narrative changes again. Growth will start to decelerate, interest rates should creep up and equity risk premiums should increase. We are excited about this year and think we are well positioned to capture outperformance.
Looking forward to FY2022, can you share in more detail how the WAM Leaders portfolio is positioned?
We continue to think that the portfolio should be positioned towards quality cashflow generative companies.
We focus on four ‘buckets’, with the first one being financials. We want to remain overweight to the financial sector, with the stocks we would call out being QBE (ASX: QBE) and NAB (ASX: NAB.) We continue to think they are the standouts in the sector and should continue to outperform in the short run and over the next one-to-three years.
We remain positive on commodities broadly. The stocks that we’ll call out there are South32 (ASX: S32), BHP (ASX: BHP) and Oil Search (ASX: OSH), as they are significant lagging the spot price for oil.
Our top 25 holdings have a quality skew. Some of these quality growth companies include Woolworths (ASX: WOW), Goodman Group (ASX: GMG) and Telstra (ASX: TLS). After years of turmoil, we think there is potential for positive cash flow and earnings surprises coming out of Telstra.
Then, there is a large area in the portfolio we think still has a lot of pent-up performance. Given the topsy-turvy nature of coronavirus and the markets, we think stocks like Ramsay Healthcare (ASX: RHC), Qantas (ASX: QAN), Treasury Wine (ASX: TWE), Star Entertainment (ASX: SGR) and Crown Resorts (ASX: CWN) have a lot of latent potential to be drivers of the portfolio particularly for the next 12 months. Moreover, we still think there is going to be a lot of volatility in the market particularly over the next six months. We are not through coronavirus yet. We think this volatility presents opportunity.
In the August reporting season, for example, many people will be fixated very much on the short-term results, forgetting the long-term structural advantages, the repositioning and the heavy lifting that companies have done, particularly over the last six months. We think there is going to be a lot of opportunities shaken out over the next six-to-12 weeks and we are quite positive around that.
Central banks worldwide are now talking about changing their policies, what changes are you making in the portfolio to address that?
A big debate at the moment is around how quick the central banks taper. We have done event cycle studies over the past three tapering cycles, we went through stock performance post tapering events. Unfortunately, there was no clear direction of winners for stocks, but the way we are positioning for it is very much through some of the financials. We think they will benefit in the short-term from tapering.
At the moment, there is a debate on the market interpretation of tapering – that it is either going to help growth with some of this liquidity being drained, or it is going to be a hindrance. It is a matter of timing, but we think with so much excess liquidity in the market there will not be a huge impact on some of the financial stocks.
At the moment, it is really a case of holding the portfolio as it is and looking for signs of interpretation. We are very much holding the course with the portfolio and positioned very well for it.
Out of the big miners, are there any that have upside potential?
Our preference out of the big miners, which we classify as BHP (ASX: BHP) and Rio Tinto (ASX: RIO), is BHP today. The main reason for this is around the diversity of the BHP portfolio. We think the upcoming result will demonstrate positive cash generation. Secondly, the operating performance of BHP should be superior to Rio Tinto.
At the next level down, between Fortescue (ASX: FMG), South32 and others, the market has significantly discounted the spot commodity price relative to the share prices. From that standpoint, we think there is plenty of upside even if there is some sort of retracement in commodity prices.
How confident are you that QBE has sufficiently provisioned for potential claims regarding COVID-19, do you have any concerns for the share price?
That is front of mind at the moment. Of all the general insurers, QBE is actually the one that we are most comfortable with at the moment for a couple of reasons. First, it has very comprehensive re-insurance programs which will pay for a significant proportion of their business interruption claims. Secondly, QBE did update the market about a week ago, noting that it was satisfied that its reserving remains robust.
Thinking about it from a broader Australian perspective, test cases are going through the courts later this year. We probably will not have an outcome until the end of this year at the earliest and then the first time we might hear from the insurers in terms of how they are feeling about the reserving is going to be at the February results.
When we are thinking about how comfortable we are holding the insurers, it becomes a case of whether it is in the price. We are of the belief that any business interruption risk is well and truly factored into the share prices, and is very much a known overhang by the market.
What are you monitoring for in terms of inflationary risk, how are you positioning the portfolio as a result?
As we have explained in the past, what we are looking for is really job creation. In the US, we think that will start happening in the next few months. What does that mean for portfolio positioning? Higher inflation generally leads to a policy response. If we look at the US Federal Reserve, it said it was going to look through the inflation because it’s transitory. We think if job creation is high, then their policy will change. That will mean uplift in interest rate curves and a steepening potentially if the market takes it that way.
Interestingly, the last few takes of the market have been when higher inflation has come through, the short end has moved up and the long has moved down, because the market is betting on a policy mistake. In that instance the market is looking at it negatively. However, we think it is going to be a positive event – inflation will come through and it will lead to outperformance of financials. For us, it really gets back to outperformance on financials.
Can you make any comments on Telstra and the telecommunications industry?
We think the telco sector overall is entering a really exciting stage, following years of headwinds. The outlook now is for strong revenue and earnings growth over the next two or three years at least.
Telstra is in our top 10 holdings and there are a number of reasons why we are high conviction on the name. Firstly, and most importantly, the mobile market is in repair. Telstra increased pricing last year and Optus (SGX: ST) and Vodafone (LON: VOD) have since followed this year. This is a really positive indicator that the market is acting rationally and everyone is lifting their prices to try and improve industry returns. We expect to see this through average revenue per unit (ARPU) growth over the coming year.
Second, Telstra recently sold its mobile towers business. It was sold earlier and at a higher valuation than the market expected and we think this implies further upside for Telstra’s other infrastructure assets. Third, when international borders reopen, we think Telstra will be put in that bucket of winners, as international roaming is a very high margin business. Fourth, it has a very solid dividend yield and we think dividends will make up a larger proportion of returns this year than they have in previous.
Finally, something that we look at for all our holdings, is upcoming catalysts. For Telstra, it is the result in August, and then later in the year it has its annual general meeting where we are expecting a refresh of its T22 strategy.
Why are you holding Qantas?
If we look at the current situation, what we think – hopefully – is this is the last lockdown we are facing in Sydney. We also think the lockdown in Sydney could be a catalyst to stir on higher vaccine take-up and supply. We think that means we have an ‘end’ and that is what we have been lacking. The market has been lacking a definitive end to when lockdowns would stop hurting companies, and from that perspective, we feel comfortable trying to forecast what cash flows and earnings are going to look like for the foreseeable future.
Qantas is going through a lot of challenges and heartache. It had to make some difficult decisions at the start of the coronavirus period last year, which has permanently reduced its cost base. Now, if we look at the long-term, we do know that when travel returns, it returns quickly. The US is a great example of this, it is already back to 80% of pre-coronavirus levels.
We remain confident on the long-term, but there will obviously be some short-term headwinds with these lockdowns.
Do you think the lockdowns in Sydney, and the spread of the Delta variant, will have an impact on equity markets going forward?
It definitely will have an impact on the economic growth, which is already happening now. However, you have to look through some of this, because it is temporary. The pain in New South Wales will be quite high for some people, but we will get through this. It will have an impact, but it will not change the way we manage the portfolio.
What are your thoughts on mergers and acquisitions (M&A) going forward, in light of the Sydney Airport takeover bid?
We have started to see a lot of M&A percolate through the Australian market. A lot of it is being driven by opportunistic, global private equity firms. What is driving this is their access to cheap debt, and they are going to try and make hay while the sun is shining. We would expect that M&A will continue in a significant way for the next six months.
From a portfolio perspective, we have to consider that and we are constantly screening stocks which have been laggards and have potential for some sort of break up or valuation uplift from strategic investment.
What we would like to see is less conditional bids and more unconditional bids. That is, the acquirer putting their money where their mouth is as opposed to trying to get a ‘free look’ and we have seen that recently with Sydney Airport.
We would like to see more of it, but from a portfolio perspective, we have to be very conscious of it and protect the portfolio, and try to screen out some opportunities that may be there.
You mentioned previously you were positive on the healthcare sector, namely CSL Limited (ASX: CSL). Can you comment on your view on healthcare now and if there are any companies you are positive on?
The main issue that CSL faced during coronavirus, which was widely publicised, is it was struggling to attract donors to plasma collection centres in the US. We tracked foot traffic data into the centres very closely and in April, we saw that the foot traffic had turned and was improving. We went tactically overweight CSL and we thought that would be a momentum trade. That paid off and we rode that for a couple of months. Valuations started to get a little bit toppy and with a few concerns around August guidance we have since neutralised our position, and we are market weight CSL at the moment.
More recent news includes legislation has passed that Mexicans cannot cross into the US to donate plasma and this impacts around 5% of CSL’s donor pool. We do expect it will be resolved but there is no time frame on this. At the moment we are in a bit of a holding pattern until the August result.
We are slightly overweight the healthcare sector as a whole. Our top pick at the moment is Ramsay (ASX: RHC), which is leveraged to the reopening of UK and Europe, as it conducts elective surgeries in private hospitals those areas. We estimate the backlog will be significant and there will be elevated volumes for at least 12 months. With these elevated volumes come operating leverage and higher earnings, particularly when you compare it to FY2020 where electives ceased and earnings were significantly impacted.
What is your view on growth and income for the banks over the next six months?
On the banks, you would expect the majority of returns to be through income. They are all over-provisioned. They will be paying back capital progressively over the rest of this year and next. Very much most of the growth will be coming through income on the banks. We expect a little bit of capital appreciation, but it is very much going to be an income-driven story from the banks from here.
What is your view on the prospect of capital management initiatives from the major banks after this current earnings reporting cycle?
Capital management is at the forefront. Speaking with management of the banks, it is very much on the agenda. When it happens, and how large, is the question.
Commonwealth Bank (ASX: CBA) has massive excess capital at the moment. We are predicting it may happen in August with a large off-market buyback. CBA has excess franking and wants to return that to shareholders. We think CBA will kick off the capital management programs, then NAB will be next, which we think will be more of a progressive on-market buyback.
All the banks are in great capital positions. The recent outbreak of the Delta virus in New South Wales may cause some uncertainty if it goes for a bit longer, which may halt some of the release of capital for CBA, but we think capital management for the Australian banking sector will be very much a story over the next couple of years, as they have huge amounts of excess capital.
Do you have any final messages you would like to deliver to shareholders?
We would like to thank the shareholders of WAM Leaders. We have reached our fifth year anniversary and it has been a great journey. The last few years have been great from a performance perspective. We would like to thank our shareholders for being supporters, and we look forward to serving you in the future.