This podcast may contain general advice, but does not take into account your personal circumstances, needs or objectives. Any scenarios and stocks mentioned during this podcast are for illustrative purposes only, and do not constitute a recommendation to buy, hold, or sell any financial products. The opinions expressed in this podcast are the personal views of the speakers, and do not represent Colonial First State's views.
Scott Tully: (00:29)
Hello and welcome to another edition of Colonial First State's Investor Digest. I'm Scott Tully; I'm the Executive Director of Investments. And today I'm joined by Ben Lam. Ben's the Senior Investment Manager at Colonial First State. Ben looks after Australian equity portfolios. Welcome, Ben.
Ben lam: (00:45)
Thanks, Scott. Great to be here.
Scott Tully: (00:47)
So Australian equities have long been, let's say, the poor cousin of global equities. We saw global equities perform exceptionally well up until, say about, the middle of last year but since then there's been quite a dramatic turnaround.
Ben lam: (01:04)
Yes. We've definitely seen a dramatic turnaround in the performance of Australian shares relative to global. A key driver of that is the difference in sector positioning. So in global, one of the largest sectors is your IT or technology sector, which also incorporates communication services. That is a relatively small component of the Australian market, which is dominated by financials and resources.
Scott Tully: (01:31)
Yeah. So let's recap some of the numbers. So I've got some performance figures here at the end of April. These are for the index over one year, the Australian share market was represented by the 300 Index has actually generated a positive return of 10%, whereas the MSCI World Hedged, so taking out the effect of the Australian dollar, actually lost value over one year. So, even been more dramatic over the last four months to the end of April, where the 300 is down about 1%, I think, Ben? That sounds about right. But the global market is down 12% over that period. So we've seen this big shift, as you say, that change in sectors has been pretty impactful.
Ben lam: (02:15)
Yeah. And more specifically to the Australian market, we've seen some strong performance in the resource sector and the energy sector, which are much larger components within the Australian Index.
Scott Tully: (02:25)
Yeah. What's been the impact on tech stocks in the Australian market? I mean, tech and that sort of space, have they been impacted as much as globally?
Ben lam: (02:39)
They have been impacted to a similar manner to global stocks, so seeing very sharp selloffs. But their influence on the overall index is much more muted given their smaller allocation and weight.
Scott Tully: (02:51)
Yeah, absolutely. So who have been the strong performers? Is it just the large-cap Australian stocks or has it a bit more broader than that?
Ben lam: (03:03)
Yeah, you'd probably say a lot of it has been driven by resource oriented stocks. So we have seen strong performance in the iron ore sector with a strong iron ore price. The energy sector with oil prices rising significantly in recent periods and as well as... Sorry. As well as coal, which has been a significant beneficiary of recent rise in energy prices. And on the flip side of that, still resources related, has been strong performance of lithium stocks. So they're the beneficiaries of a move to a lower carbon world.
Scott Tully: (03:46)
Yeah. So quite a few things going on in there. So let's look at the biggest company in on the Australian market now, which is BHP. Just for the listeners to benefit, do you want to do a quick recap of what's happened to BHP in terms of corporate structure this year? And then we'll talk about what that's meant.
Ben lam: (04:05)
Yes, Scott. There definitely has been a lot of activity with BHP. So what occurred late last year was a decision by BHP's board and shareholders to collapse their dual listing structure. So effectively a number of years ago, BHP and Billiton merged and created two boards and entities, one based in Australia and one based in the UK. So whilst the revenues and everything were from the one entity, they actually had two separate corporate structures and a decision was made to collapse that. So that actually had a significant impact on the Australian Index and the Australian market. And effectively at the end of January, BHP's position in the 300 Index moved from roughly a bit over 8% to almost 12%.
Scott Tully: (05:02)
Yeah. So let's just recap on exactly how that works. So BHP as a company had two parts to it. The component that was listed on the UK Stock Exchange wasn't included in the ASX market capitalisation. And then as you say, in January, they brought those two parts of the company together and the company is now effectively listed solely on the Australian market or primarily on the Australian market. Is that how you describe it?
Ben lam: (05:33)
So, yes. The primary listing is on the Australian market but is still available to be bought and sold in the UK market and the US markets as secondary listings, which does make things quite confusing.
Scott Tully: (05:46)
Yes, it does. And it is very important to note the company actually hasn't changed, although they're about to make some changes, they haven't changed what they do. The size of the company in terms of revenue and the like are the same, it's just where it's listed has changed.
Ben lam: (06:02)
Yeah. So it's almost that interesting dynamic. So if you looked at global markets, you would've captured the entire BHP in a global index, so both the Australian listing and UK listing previously. Whereas in Australia, you only captured the Australian portion of that.
Scott Tully: (06:20)
Which means if you're an index investor or you're investing in an index fund, you've had an increase in the amount of that index fund allocated to BHP as a company?
Ben lam: (06:33)
Yes, that's right. So there's a bit of nuance to that. So if you are in a pure index fund, almost $12 out of every $100 would now be invested in BHP. And similarly, if your active manager is a benchmark relative manager, they would be adjusting their BHP allocation because they're looking at the risks they're taking relative to benchmark.
Scott Tully: (06:57)
Yeah. That was an interesting period back when the change happened, wasn't it? We had all these fund managers having to take into account that shift and I think it happened almost overnight, didn't it? So there were forced sellers and forced buyers of BHP stock and having to manage that to make sure that the portfolios remained consistent and benchmark relative.
Ben lam: (07:24)
Yes, that's right. So yes, you had investors in the UK who would've been forced sellers, no longer being able to hold an Australian listed stock for a UK strategy or European strategy. And now your Australian Index, either index or index relative managers, all had to start shifting up their weight and effectively, as you highlighted, a one day event, which saw lots and lots of activity.
Scott Tully: (07:53)
Yeah. Surprisingly, the whole market didn't blow up but it did seem to get through and there wasn't any damage there. And then BHP, I think it was after that, they did the deal with Woodside Petroleum. I'm trying to remember the time.
Ben lam: (08:10)
Yeah, it was around the same time or kind of during that period, there was an intention to separate its oil and petroleum assets into Woodside. And that has just recently been approved by shareholders and will be occurring. So that's another significant change to the index. So the BHP weight will actually drop again as those oil and petroleum assets move over to Woodside. And so you'll see Woodside shifting up in weight. And that is the interesting and dynamic thing with share markets, that there is always change.
Scott Tully: (08:47)
Ben lam: (08:48)
And I guess with mergers and acquisitions, corporate activity, we've seen elevated levels of that over the past 12 to 18 months.
Scott Tully: (08:57)
Yeah. So if I'm a BHP shareholder I'll end up with some Woodside Petroleum shares as well, is that the way it works?
Ben lam: (09:05)
That's right. So roughly, maybe say 10% or thereabouts of your BHP holdings will convert into Woodside shares.
Scott Tully: (09:15)
Yeah. So why are they doing that? What's the driver of the BHP board and the Woodside board to come to that arrangement?
Ben lam: (09:25)
Yeah. There's probably kind of an interesting ESG or Environmental, Social and Governance aspect to both sides of that transaction. So a lot of investors are concerned about ESG, want to reduce their exposure to fossil fuels and would see a revenue threshold of companies that they see as investible. So someone like a BHP potentially would be uninvestible to a number of ESG oriented funds. Though on the flip side for someone like Woodside, scale becomes more important because financing of new projects or expansion projects for oil and gas is quite limited. So banks are pulling back from financing activities like that. So in essence, you have to be larger and be able to self-fund any initiatives you want to have and that will benefit Woodside by becoming a larger entity.
Scott Tully: (10:32)
Yeah. Okay. So BHP becomes a company that's ex-fossil fuel, that's the thinking?
Ben lam: (10:40)
Scott Tully: (10:41)
Yeah. So they won't have any exposure, they'll be sticking to their core businesses and Woodside Petroleum would become an oil and gas play ultimately? Yeah. And so that's been happening, I know that we won't probably go into detail but not the similar things happening with AGL potentially where they're splitting their assets subject to shareholder approval, which is obviously up in the air?
Ben lam: (11:05)
Yeah. So we've seen a few instances of that. So yeah, as you highlighted AGL is another example, basically splitting the company into two, a cleaner business and greener business and one that is seen as probably more brown. And then we've also seen something similar with Woolworths last year when they split off their liquor and gaming business into a group called Endeavor where I guess that's where they're gaming machines and alcohol and I guess with similar ESG considerations, they're not fossil fuel related, have seen them make that shift as well.
Scott Tully: (11:45)
Yeah. So an investor can now be more specific about what they're investing in, I suppose. They can avoid certain stocks or invest in certain industries if they choose, is the idea?
Ben lam: (12:00)
Scott Tully: (12:00)
Interesting, I suppose, with the divestment of energy stocks. Energy’s had a fairly strong run recently after a number of years of performing poorly. What sort of companies have been benefiting from that?
Ben lam: (12:19)
So probably the strongest beneficiaries of that have been the coal companies.
Scott Tully: (12:23)
Ben lam: (12:24)
So the likes of Whitehaven Coal and New Hope have performed extremely strongly over the past 12 months. And similarly with the energy sector has also been a strong performer, outperforming the index materially.
Scott Tully: (12:42)
And so how do you see that in terms of transition to net-zero by 2050 and other targets? Colonial First State has established targets to reduce our carbon footprint by 2030. How does that impact investors, Ben? What do you see as implications?
Ben lam: (13:05)
I think what we have to look at are, what are the key objectives of lowering carbon or decarbonisation? It is to address climate change and create a more sustainable economy for the world. And so with anything like that, there is unlikely to be a smooth ride in terms of how capital markets or economies transition. So we've seen that, I guess more specifically - with what's happening in Ukraine and Russia, that the reliance on fossil fuels is still real and it's still a core part of use of energy globally. And the positive thing for this is it's a realisation that there possibly needs to be an acceleration in terms of how we address the reliance on fossil fuels. But that also means that it creates challenges in the short term because the supply of those fossil fuels could become more challenging and you'll have these impacts in the short term that could see some of those oil and gas prices rise significantly. But I guess you always have to look at the bigger picture and what you're trying to achieve in order to get to the end outcome.
Scott Tully: (14:37)
Yeah. So it's got to be something you need to navigate, understanding all the dynamics of the price of fossil fuels, the direction that the globe is taking, government policy and the like. There's a whole bunch of stuff to consider there as an investor.
Ben lam: (14:55)
Yeah, there's definitely a lot of nuance there. So ultimately the end use of fossil fuels, you think, if we get to our low carbon economy will be quite limited. But they still effectively play a role as we transition to more renewable sources.
Scott Tully: (15:16)
You mentioned before Ukraine, since February 24 when Russia invaded Ukraine, inflation has definitely been at the thinking of everyone, investors, what other elements of inflation? So we've seen, as you've said, fossil fuel inflation or energy inflation, we've seen it in other commodities like wheat and the like. But how do you see it impacting Australian companies?
Ben lam: (15:51)
Yeah. So that's an interesting dynamic with inflation. So I guess what you've highlighted are some of the key input costs associated with the provision of goods and services to people in the economy. Other aspects of inflation that we are seeing are related to labour and employment.
Scott Tully: (16:16)
Ben lam: (16:17)
So what we're seeing there is significant wage pressures in certain industries, starting in WA with the pandemic and spreading more broadly to the rest of the economy. So as wages increase, input costs increase, this leads to ultimate price inflation, which we're seeing. But the interesting dynamic for Australian companies and the ASX in particular is ultimately who has the pricing power to protect their margins and maintain their earnings? Because we know that prices will be going up but it is the companies with pricing power that will be able to retain their earnings and margins.
Scott Tully: (17:09)
And we saw some of that in the recent profit reporting season, there were some companies who have started to talk to their ability to price or to pass on cost increases. But was it significant in that period or is there still some uncertainty?
Ben lam: (17:28)
Yeah, I think we're in the early stages of that. And so we've had a period of very benign or low inflation and this ability to pass through is likely to be tested for a lot of companies. So I think a lot of companies would be of the belief and hope they have pricing power. But the real test point is to see who has the true pricing power and who is able to set the end price and ultimately protect their earnings.
Scott Tully: (18:01)
Presumably those companies are the ones whose share price will do better over time if you can maintain your margins?
Ben lam: (18:11)
That's right. And yeah, you'll see some challenges for other companies who may have thought they had pricing power and their earnings have struggled. So I guess with share prices and performance of companies, there are kind of two components almost to what you see as the final share price, their earnings and the multiple that investors are willing to pay for those earnings. And I guess some of the more recent performance impacts has probably seen a de-rating or a reduction in multiples that investors are willing to pay, but we haven't seen the true earnings impact as yet.
Scott Tully: (18:56)
Yeah. So you got those two levers and I suppose that's why you use a professional fund manager to make those assessments. Because the market does tend to price those changes in fairly quickly or least the perception of what those changes are going to be in the price of the market and a professional fund manager should be trying to do that analysis to work that out.
Ben lam: (19:29)
Yeah. So yes, when we use active managers, they're always making an assessment of the underlying earnings of companies and what they believe the value is. And as new information does come in, they're actively assessing - is my valuation for that company still appropriate? Do I still feel comfortable owning this company? And if not, they will make that decision to exit or on the flip side, find new opportunities to invest.
Scott Tully: (19:58)
So you do think the markets, I won't use the word efficient, but is that information being reflected in prices now or are we taking some of the bubble out of some of those stocks?
Ben lam: (20:11)
Yeah. There's probably a couple of things to that. The other component almost is what's happening with the rest of the market in terms of fixed income and cash. Because we were in this period of low interest rates where effectively for equities, it was almost seen as there is no alternative or the Teener kind of principle, given how low rates were, I'm happy to take on that additional risk with equities. But now you actually do have alternatives for a lot of multi-asset investors to actually invest in a fixed income fund and get a return. And then at the same time, this constant assessment of equity investors of what earnings will be, I don't think there is any consensus to what that might actually be. So you will see divergence and I guess it's the underlying fund manager's ability to assess earnings and make an accurate prediction will drive relative performance.
Scott Tully: (21:17)
Yeah. Well thank you, Ben. Thank you for your time. You've been listening to Ben Lam, who's the Senior Investment Manager in charge of our Australian equity portfolios here at Colonial First State. I'm Scott Tully, I'm the Executive Director of Investments at Colonial First State. Thank you for listening to Investor Digest Podcast. Please subscribe to the podcast and we look forward to you joining us next time. Thank you.
Just a reminder, the opinions expressed in this podcast are the personal views of the speakers and do not represent Colonial First State's views. You should read the PDSs available on our website, assess with it the information as appropriate for you and consider speaking to a financial advisor before making an investment decision. Past performance is no indication of future performance.