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And while the whole finance community (including us) focuses on the the impacts of 2019-nCoV (the Coronavirus) on global supply chains, there is another deadly virus in China changing the way the Chinese eat, that is impacting protein prices, and offers tailwinds to select ASX names.

Background

The Chinese consume a lot of pork. Per capita consumption in 2018 was ~40kg and represented approximately 2/3 of meat consumption with poultry 11kg and beef 6kg per person p.a. It is further estimated that China consumes almost double the global average when it comes to fish/seafood at 41kg/person p.a.

Source: Australian Government Department of Agriculture

And the country (at least in 2018) was largely self-sufficient, producing ~54 Million tonnes, approximately half the world’s pork (only importing close to 1Mt).

Source: Statista

But this is all changing, at least temporarily as the country grapples with African Swine Fever.

China’s pork supplies decimated

African Swine Fever (ASF), despite the name was rumoured to have originated from Russia and was first detected in China in August 2018, in Liaoning Province. Shortly after it was reported to have spread to Inner Mongolia and by December 2018 reached Guandong. By April 2019 ASF was detected in Tibet and Xinjiang in Western China. Within a year ASF had covered most of China and spread to neighbouring pork producing countries, including Vietnam, Cambodia, Korea and the Philippines.

Within China the Ministry of Agriculture and Rural Affairs responded immediately, enacting legislation to fight the disease. Once detected on a farm all pigs within a 3km radius were to be culled and disposed of, with farmers to receive compensation of RMB1200/pig.

The impacts of this were huge, with the World Organisation for Animal Health estimating 200 million pigs to be culled in China ~40%(1) of China’s 2018 production levels, or ~20Mt. The effects of which are likely to be experienced over several years. Experts suggest the market won’t be close to rebalancing until at least 2025.

General Impacts

• China pork price: At the start of the ASF epidemic Chinese pork prices were ~RMB20/kg. By June 2019 prices had crept to ~RMB24/kg before rocketing by September to be up >80% at ~RMB38/kg. In October it spiked to ~RMB50/kg before settling to ~RMB45/kg in December.

• International pork prices: China increased imports of pork by ~80% in 2019 to 2.1Mt, Brazil and Australia being 2 key beneficiaries of the volume which has led to rising global prices. The Australian pig industry is focused primarily on domestic production with only ~10% of production (pre 2019) exported. In some areas over the hook pig prices have increased ~50% from ~AUD2.50/kg to >AUD3.50/kg. European prices are also up about 30% over 2019 with increased exports.

Source: Eurostat

• Other protein demand and prices: Without completing a China wide survey of protein intentions we can’t be precise about the exact substitution occurring however price increases of chicken, beef and other proteins provide strong evidence of substitution. This may also be creating an additional factor in balancing global markets for beef and poultry. Within China the prices of chicken, beef and mutton were all up ~20% by September 2019. Outside China Brazilian beef prices are up ~40%. China buys ~40% of Brazil’s beef exports and that number is increasing. US 90CL (Chemical Lean) imported beef indicator, a benchmark for frozen manufacturing beef into the US, measured by Meat and Livestock Australia (MLA) shows the impact on the US with the indicator reaching AUD8.40/kg in November from ~AUD6.00/kg a year earlier.

Source: Beef Magazine

• Pig Feed Demand: Chinese pig feed rations on average contain ~5% fishmeal, 20% soymeal and 70-75% corn. ~65% of global fish oil/fishmeal is used in aquaculturewith~25% used in pig feed.Hence the drop in pig production could lead to a decrease in near term fish oil/fishmeal demand, easing its cost. In 2018 Chinese consumption accounted for 25% of global corn consumption with production almost solely within country at 260Mt of production. It is estimated that ASF could wipe out ~40Mt of Chinese corn consumption (15%). China also accounts for ~30% of global oilseed consumption and 50% of imports. Demand for oilseeds and soybeans have been materially reduced by ASF with world prices expected to remain low until a supply response occurs, at a time when China is also increasing domestic soybean production.

Chinese Soybean imports January to June 2019

Source: UN Comtrade

• Inflation: With China pork prices more than doubling and pork’s significance in Chinese diets, it’s no surprise to see food inflation at ~20% and CPI hit 4.5% in November. This is the first time since 2012 CPI has been >4%. With benign inflation globally it is interesting to note CPI at 8-year highs in the world’s second largest economy.

Source: Zerohedge

ASX Agribusiness Impacts – Chester Investable Universe

With no ASX listed pork producer we can’t get direct exposure to the pig price increase in Australia however below we revisit our universe of Agribusiness opportunities and discuss likely impacts.

Additional Impacts

• WH Group (0288.HK): Given the Chester High Conviction Fund has the ability to invest in select names within Asia, Hong Kong listed WH Group is worth mentioning. It is a previous holding of CHCF. WH Group is the largest pork company in the world and produces 3.4Mt of meat (2018 level) from facilities in China, US and Europe. Although ASF has impacted near term profitability in China (with benefits to global operations) longer term ASF is expected to be extremely lucrative for corporate producers like WH Group. This is because despite compensation payments, many small producers simply can’t afford the increased investment required in cleaning facilities, general pig hygiene, and other biosecurity measures to deal with ASF longer term. Hence market share over time shifting to larger corporate players.

• Wellard (WLD.ASX): Has experienced a disastrous 5 years as a listed entity and is only now cleaning up its balance sheet after switching CEOs mid-2019. Despite being too small for the fund, as a large cattle exporter, it may be an interesting company for micro-cap managers to review.

• Woolworths and Coles (WOW & COL ASX): ASF, coupled with the tragic impacts of the bushfires could see the supermarkets experiencing food inflation.

Food for thought

 

Source: https://www.livewiremarkets.com/wires/pork-pulled-protein-price-pressure

DISCLAIMER

Past performance is not a reliable indicator of future performance. Positive returns, which the Chester High Conviction Fund (the Fund) is designed to provide, are different regarding risk and investment profile to index returns. This document is for general information purposes only and does not take into account the specific investment objectives, financial situation or particular needs of any specific individual. As such, before acting on any information contained in this document, individuals should consider whether the information is suitable for their needs. This may involve seeking advice from a qualified financial adviser. Copia Investment Partners Ltd (AFSL 229316, ABN 22 092 872 056) (Copia) is the issuer of the Chester High Conviction Fund. A current PDS is available from Copia located at Level 25, 360 Collins Street, Melbourne Vic 3000, by visiting vertium.com.au or by calling 1800 442 129 (free call). A person should consider the PDS before deciding whether to acquire or continue to hold an interest in the Fund. Any opinions or recommendations contained in this document are subject to change without notice and Copia is under no obligation to update or keep any information contained in this document current

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Like many local technology trailblazers before it, Catapult (CAT) has endured a turbulent first 5 years as a listed company on the ASX. One only has to view its historic share price to be reminded that the journey from emerging technology upstart to profitable global category leader is rarely straightforward. The saying “Things are never as bad or as good as they seem” certainly springs to mind…

Source: IRESS

To reflect on CAT’s history since listing in December 2014 is to note several familiar features that have become something of a rite of passage for many formative local tech companies.

Chief amongst these:

– Executive turnover

– Capital raisings

– Acquisitions

– Concerns around organic growth rates

– Difficulty managing investor expectations

– Challenges balancing growth and market leadership ambitions with the path to profitability

Market Leadership

Despite the challenges what’s clear is that CAT has continued to be a leader in its field. Specifically, wearable technology and accompanying analytical software, including video. From its origins in the early 2000’s as a partly Commonwealth funded research project developed in conjunction with the Australian Institute of Sport, CAT now enjoys presence in over 130 countries with a customer base that exceeds 3000 and use in more sports (40) than its nearest competitors comfortably.

Having followed the progress of CAT since its IPO the Chester High Conviction Fund took a position in the company shortly after it delivered its F19 result in August last year. The result delivered the company’s maiden positive EBITDA result, in line with guidance issued in October 2018.

Ahead of investing in CAT, Chester had continued to follow the progress of CAT for a pretty simple reason. In short, it is a company that remains exposed to favourable industry tailwinds. Investment in top level sport continues to rise globally as broadcasting (both traditional and non-traditional mediums), advertising, sponsorship and apparel deals rise. The flow on effect has been the adoption and integration of technology into these elite sporting programs globally as teams and athletes have sought an edge over competitors. There’s little doubt that CAT has been at the forefront of this push and a long list of championship winning CAT adopters across numerous sports is a strong endorsement of the technology.

Despite only entering international markets a little over 10 years ago, CAT maintain several customers that are amongst their longest tenured in offshore markets and significantly, are amongst their highest spending. In fact, of CAT’s largest 15 clients (by revenue) 11 are US based. With churn rates (customers not renewing their elite wearables software subscriptions) continuing to fall (5.2% at the end of F19), it’s apparent that the CAT product is becoming more entrenched in sports programs globally and teams are continuing to derive considerable value from their investments. This is an important point that should not be understated. CAT have a product that customers stand to gain more value from over time as the accumulated athlete data becomes a more comprehensive database for benchmarking. At risk of using just a little creative licence, Chester sees Catapult and their powerful athlete data as fast becoming the ‘Bloomberg’ of the sports industry.

In addition to the 3000+ teams that in one form or another now utilise the CAT suite of products it’s significant that CAT has continued to have success signing ‘League-wide’ deals with various sporting organisations. Numbering in excess of 10, these deals which typically see all league teams gain access to the CAT wearable units and accompanying software platform are significant because they represent a further level of validation for the product. On top of all teams gaining access to the technology designed to optimise athlete performance and welfare monitoring league’s too can gain from having access to a considerable centralised database of athlete data. It’s very likely that we remain at the early stages of the commercialisation of league-wide athlete data and its integration with broadcasters and the like.

In the past 12 months it’s significant that CAT has extended existing contracts with both the Australian Rugby Union (ARU) and National Rugby League (NRL) despite the ambitions of northern hemisphere rival STATSports to establish a customer beachhead in CAT’s home market. With further league-wide deals up for renewal over the coming 12-24 months it will be important to watch the success CAT has on this front.

A Leading Sports Technology Portfolio

Looking ahead, recently appointed CEO Will Lopes joins the business at an exciting time. Joining as CAT’s first US based CEO and with considerable experience as a senior executive with Audible, Amazon’s global audio content business, Lopes assumes control of a portfolio of sports technology assets that are becoming increasingly integrated with each other. This is significant because increasingly, CAT’s future growth should be driven by existing customers adopting other products from the CAT portfolio.

Source: Catapult

Having acquired XOS Technologies in mid-2016 as a leading product in the digital and video software segment and representing about 500 of CAT’s current customer teams, we’d anticipate the fruits of a number of years of investment and development will increasingly see this product sold beyond the product’s traditional markets, football and ice hockey in North America. CAT’s recent announcement of a league-wide deal with the Colombian Premier Football League that includes implementing both wearable technology and video analysis products supports our belief that CAT’s video products will have wider use than traditional high-speed, stop-start sports such as US football.

Rounding out the CAT portfolio are some less established products, albeit with considerable potential. CAT’s ‘Athlete Management System’ (AMS) product has been developed to complement the wearables and video analysis products as a platform that can consolidate athlete data and allow for greater interaction by athletes for monitoring not only performance but also health and wellbeing which are considered increasingly important by sporting teams. Complimenting CAT’s ‘Elite’ wearables technology solutions are some products and solutions designed to meet the needs of the tier of athletes that sit just below the top echelon of professional athletes – termed ‘Prosumers’ by CAT.

Opportunities Abound

In the near term, we anticipate Lopes will prioritise sales to elite customers and seek to build on the momentum CAT has enjoyed with their latest wearables device, Vector, which was released in mid-2019 and has been very well received. Favouring elite customer sales over the larger but less developed prosumer market should deliver a number of benefits to CAT.

Firstly, by focusing largely on penetrating the top professional sports should allow CAT to continue to control their operating costs better than they have in the past. By narrowing the focus of their sales staff we anticipate current staffing at around 360 people can be broadly maintained in the near term. With staff representing about ~65% of the groups operating costs (after COGS) improved cost control should see investors gain greater confidence in the prospect of margin expansion and a more predictable earnings profile. On the expectation that product development capex should be maintained at similar levels to F19 in the next couple of years, the prospect of free cash delivery by F21 looks readily achievable, if not sooner.

Source: Chester Asset Management

By prioritising elite customers the likelihood that more sales will be contracted on a subscription basis, consistent with history, should see subscription, or recurring revenues (as a percentage of total revenue) rise once more from current levels of ~70%. Again, we’d expect this would be well received by investors who continue to show a strong appetite for high recurring revenue business models. The fact that CAT trades at an enterprise value (~AUD340m) little more than 3 times its consensus F20 sales currently, a significant discount to many domestic technology peers (with global operations), suggests there is strong re-rate potential for the share price if this strategy is well executed.

Source: IRESS (Consensus F20 forecasts) – at 15/1/20. All figures quoted are AUDm

An additional outcome of higher elite sales is the prospect that the recent declines in the group’s gross margin should slow as a greater percentage of higher value units are contracted over the next couple of years. Together with the potential to grow Average Revenue Per User (ARPU) above the AUD108/month (per elite wearable subscription) it has averaged over the last couple of years as existing customers transition to the latest generation Vector product, these developments would likely be viewed as incrementally positive.

The US Opportunity – A long way to go

Chester expect the US to remain a key driver of CAT’s growth in the near term. Despite counting over 1000 teams as customers in this market already, we believe that the market continues to underappreciate the sheer size of this opportunity. Beyond the globally recognised four major US sports bodies (Football (NFL), Basketball (NBA), MLB (Baseball), Ice Hockey (NHL)) which together with the English Premier League (Soccer) are the five highest turnover sports in the world, huge opportunities exist for CAT.

College sport in the US, regulated by the powerful National Collegiate Athletic Association (NCAA) is extremely big business and the distinction between professional sports and college sports continues to narrow – albeit with one key distinction. College athletes still cannot be paid. Therefore, as the money from broadcast and sporting apparel deals continues to flow into college sports programs at record levels the pressure on these colleges to invest in their student athletes across all sports builds. Considering that there are >9000 teams that compete in NCAA sporting competitions across the US it’s clear this remains a large opportunity.

To highlight this point, we see the recently announced partnership CAT has with the University of Louisville as a useful reference. Possessing the largest sporting apparel contract with global brand Adidas in the US College ranks¹, the University of Louisville’s implementation of CAT’s AMS product across all 23 sporting teams and adoption of CAT’s wearable technologies² offers an insight to the types of opportunities that exist in this market.

In Summary

Chester consider CAT a strong investment opportunity at current prices. Trading at a healthy discount to our current DCF derived valuation of AUD2.50 (WACC 9%, TGR 3%), with upside potential should CAT achieve some price inflation over the medium term, we think CAT is well placed to capitalise on favourable industry conditions and its category leadership. With a unique portfolio of products that extends its sales opportunity well beyond its key competitors, we see CAT as extremely well positioned as it enters its next 5 years on the ASX.

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1: https://www.forbes.com/sites/danielkleinman/2019/09/13/ucla-most-valuable-college-apparel-deals/#4cd159296762

2:  https://gocards.com/news/2019/8/13/general-louisville-athletics-partners-with-catapult.aspx

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DISCLOSURE

Past performance is not a reliable indicator of future performance. This document is for general information purposes only and does not take into account the specific investment objectives, financial situation or particular needs of any specific reader. As such, before acting on any information contained in this document, readers should consider whether the investment is suitable for their needs. This may involve seeking advice from a qualified financial adviser.

The post Catapult – A global technology leader that won’t cost the world appeared first on Copia Partners.

Copia will provide exclusive retail distribution and marketing support for the Sydney-based fund manager’s Listed Investment Company ECP Emerging Growth Limited (formerly Barrack St Investments Ltd). It will also act as Responsible Entity for the ECP Growth Companies Fund, a soon to be launched unit trust which will provide retail investors access to the strategy that to date has only been available to institutional clients.

ECP is a high conviction Australian equities specialist investment manager established in 2013. The investment team includes six investment professionals and the business has built a successful well-rated institutional business with $1.7 billion under management.

The partnership with Copia is aimed at building ECP’s retail footprint and follows a period of significant investment by Copia to bolster its retail sales and marketing resources.

Manny Pohl, Chief Investment Officer of ECP said “We are excited to join forces with Copia as we take our institutional investment capability to the retail market. Copia has a proven track record in raising assets in the financial advice channel and we view our partnership as a good strategic and cultural fit.”

Sam Baillieu, Chief Executive Officer of Copia said “We’re delighted to have an investment partner with the calibre of ECP. ECP brings to Copia a highly respected and experienced institutional grade investment proposition that we are excited to take to the retail market.”

The “ECP AM All Cap” portfolio managed by ECP has performed in the top quartile over one and three years in the Mercer Investment Performance Survey Australian Shares (Long Only) Sub Universe as at September 2019*.

Copia has five investment partners under its distribution umbrella: OC Funds Management (Australian small companies), Ralton Asset Management (SMA specialist in Australian equities), Vertium Asset Management (Australian equity income), Chester Asset Management (High conviction Australian and Asian equities) and ECP Asset Management (High conviction growth Australian equities).

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About Copia Investment Partners
Copia Investment Partners is an independent multi-boutique investment management group.
www.copiapartners.com.au

*Source: MercerInsight®”.
Past performance is not a reliable indicator of future performance. You should not rely on past performance to make investment decisions.
Information contained herein has been obtained from a range of third party sources. While the information is believed to be reliable, Mercer has not sought to verify it independently. As such, Mercer makes no representations or warranties as to the accuracy of the information presented and takes no responsibility or liability (including for indirect, consequential or incidental damages), for any error, omission or inaccuracy in the data supplied by any third party.

Copia Investment Partners Ltd (AFSL 229316, ABN 22 092 872 056) (Copia). The partner fund managers are representatives of Copia, except for ECP Asset Management who is a representative of EC Pohl & Co Pty Ltd (AFSL 421704). This document is for general information purposes only and does not take into account the specific investment objectives, financial situation or particular needs of any specific reader. Any opinions or recommendations contained in this document are subject to change without notice and Copia is under no obligation to update or keep any information in this document current.

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As Tony Montana taught us “first you get the money, then you get the power, then you get the woman (or man[2])” Which generally requires a place to live. The problem however, as highlighted in the 2hr Google commercial, the Internship, is that Silicon Valley housing is expensive and in short supply leading some employees to secretly live in motor homes behind their workplaces[3]. It is estimated that despite the 750,000 new jobs created within the Bay Area of California (San Jose, San Francisco and Oakland) from 2010 to 2018 only 100,000 new homes had been built[4].

In June 2019 Google pledged USD1bn to help fix this crisis and one month later announced it had entered an agreement with Lend Lease (LLC) to develop 3 major areas in the San Francisco Bay Area into mixed use communities (San Jose, Sunnyvale and Mountain View). It is our understanding that Google had tendered the 3 district developments as separate contracts and LLC had bid on and won all 3. LLC estimates that it will develop ~1.4 million sqm of residential, retail, hospitality and associated community uses (Google will develop the commercial) with an estimated end development value of USD15bn, AUD20bn. The work would commence as early as 2021 and include at least 15,000 (to 20,000) new homes on Google land over a 10 to 15-year period. It appears the median house price in San Francisco is currently USD1.3m. Based on the contract value and reported details the apartment prices would need to be below that (USD700k-1.0m) but it supports as much as AUD2bn of gross revenue to LLC per annum from this contract alone.

We further note “In recent years, urbanisation development activity has averaged AUD4bn per annum. There is scope for activity to accelerate materially over the medium term given the significant growth in the pipeline”. With the addition of Google, we take this to mean >AUD6bn gross Development revenue per annum.  LLC has historically targeted between 15-25% margin on cost for apartment developments. We would expect the Google contract to be at the lower to mid-point of this range (15-20%). Below we assess what the expanded pipeline could mean for future earnings of LLC and how we believe the sell-side is yet to fully factor this in.

Increased Development Pipeline = Increased Development Earnings

Although obviously material it is more than just Google that has elevated LLC’s Development pipeline to ~AUD100bn. Google, combined with other projects, has taken the  build to rent pipeline  to ~AUD20bn by June 30, 2019, providing significant scope for growth.

Now we need to make several assumptions but if we assume:

• The lifespan of Development projects hasn’t differed too much over the past 5 years, and will remain similar into the future
  • As can be seen below in the past 4 years LLC has delivered ~8% gross urbanisation pipeline Revenue per annum (implies 12.5 years run rate)
• The margin profile doesn’t differ too much going forward to history
  • As can be seen in our table below however we have assumed 100bpts lower margin to account for increased 3^rd party funding of projects
• The market continuing valuing Development consistently to history
• ~AUD17bn of UK projects where LLC is currently preferred convert
• Work secured approximates work completed in FY20 and FY21
• Completions represent a reasonable proxy for gross revenue
  • (Commercial) completions don’t equal revenue in a given year however should approximate over the longer term

We see a case on these assumptions for projected Development EBITDA for FY22 onwards (once Google contract kicks in) being as high as AUD1,200m p.a.

Lend Lease Development Division Summary – Historic and projected FY22

Source: Lend Lease Annual Reports and Chester Asset Management

As evidenced below this is considerably higher than that assumed by the sell-side and would lead to a materially higher assessment of value. Most analysts value LLC using a SOTP methodology. We present a survey of these below (but have chosen to keep the analysts surveyed anonymous).

Lend Lease Development Division Summary – Historic and projected FY22

Source: Various unspecified analysts and Chester Asset Management

Obviously, there are several reasons why this may not transpire to be the case including:

• The pipeline having a longer gestation period than the past
  • However, the Google contract is reported as “10 to 15 years” which is in line with our 12.5-year assumption
• The Google Contract/ pipeline ramp-up taking longer than 24 months
  • Whether it is FY22 or FY23 the point of the analysis doesn’t change; i.e. we have reviewed sell side estimates beyond FY22 (where available) and don’t see a discernible increase in FY23 projections
  • The Google announcement comments that development work could start as early as 2021
• Margins being lower than history
  • We believe the Google contract is 15-20% on cost vs Management historically targeting 15-25% of cost on projects
  • Fixed Development overheads may increase due to increased geographic reach, but we would assume that operating leverage would provide some support to the assumption of 14% on gross revenue
• Analysts changing valuation methodologies i.e. reducing the multiple applied to Development earnings
  • This could occur but we would contend that a large part of the uplift in Development earnings comes from this Google contract which is arguably lower risk than other Development contracts[5]
• Our survey misrepresenting consensus
  • We have chosen 4 brokers (at random) that cover the stock[6]
  • In IRESS we note 7 analysts covering the company
  • The other 3 analysts could potentially have higher Development earnings than those included within our sample
• Completions being a poor proxy for Gross revenue

Engineering and Services Issues still linger

In November 2018 management took a provision of AUD500m on 3 projects  excluding the likely cost to exit the business (another AUD500m at the mid-point in estimated exit costs). We provide the summarised update on these 3 projects from 30 June below.

• Gateway Upgrade North: Operational Since March 2019
• Kingsford Smith Drive: >85% complete – expected completion CY20
• North Connex M1/M2 Tunnel: >85% completed – expected completion CY20

At the 30 June 2019 LLC had chosen to present the Engineering and Services subsegment of Construction as non-Core. Despite being presented as non-core and the provisions raised LLC has continued to operate the segment as a going concern (as divestment is progressed). This has included commencing new contracts including:

• Melbourne Metro Tunnel Project: <20% complete
• WestConnex 3A M4-M5 Link Tunnels: <20% complete

There remain no guarantees  we won’t see further provisions, particularly against these 2 projects so continue to see this as the biggest risk investing in LLC.  As evident in the table below, ex the Engineering and Services businesses, Construction earnings have remained relatively steady over the past 5 years.

Construction 5 year historic earnings

Source: Lend Lease Annual reports

Going forward we aren’t projecting any material changes from history.

We note LLC are said to be making good progress on the exit of Engineering and Services. We expect to have some clarity in the December Quarter.

Investments Earnings will also benefit from the Development Pipeline

Funds Under Management has doubled over the past 5 years and with the increase seen in the Development pipeline it is likely that it will double again in the medium term, as LLC take more developments on balance sheet including Residential (apartments) for Rent.

Although not explicitly disclosed how much LLC earns from each of the subsegments we estimate the following amounts in FY2019.

Lend Lease Investments Division Summary – FY19 Chester Estimates

Source: Chester Asset Management and Lend Lease Annual Results Material

Most of the Funds Management business is in Australia (71% year end FY19) where FUM typically has minimal  performance fees. We see Investment Management as the key growth driver of the segment with in our minds other subsegments not expected to materially differ from their FY19 levels in the near term. We assume it takes 5 years for the FUM to double again from current levels so by FY22 we expect Investment Management Fees to be ~50% higher than current levels.

Potential for a Re-rate

Although a previous holding of Chester we had chosen to exit in August 2018 at ~AUD20.00/share on valuation and earnings insight grounds. We chose to re-enter the position in August 2019 at ~AUD15.00/share on valuation and earnings insight grounds. Now trading on ~12x consensus FY21 earnings with a 4% dividend and potential material upward analyst revisions in FY22 and beyond we feel the stock could rerate, particularly with the exit of the Engineering and Services business and some guidance by Management on the medium-term earnings trajectory.

LLC Sum of the Parts Valuation Analysis

Source: Chester Asset Management

[1] Source: https://siliconvalleyindicators.org/data/economy/employment/job-growth/relative-job-growth/

[2] Or whatever is more politically correct to insert here

[3] https://www.independent.co.uk/extras/lifestyle/silicon-valley-google-rv-housing-crisis-us-workforce-motor-homes-a8928936.html

[4] By Metropolitan Transportation Commission

[5] being a Land Management style deal among other things

[6] that we have relationships with

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In a move that’s likely to change the way retirement portfolios are designed, the Federal Government is introducing a retirement income covenant that will require superannuation trustees to seek to maximise a retiree’s income for remaining life, not just life expectancy.

That change of wording will have a big impact, as it recognises that those fortunate to live longer than expectancy (84 for males and 87 for females) simply need a longer lasting portfolio. That will potentially require planning for a 35-year portfolio duration (rather than 22 for life expectancy) because under a remaining life principle, you need to provision for the chance you’ll live to 100, even if you don’t.

From a public policy perspective – you can see the merit in the covenant. Having a burgeoning post-retirement population with portfolios designed for expectancy isn’t going to be entirely useful if half of the folk live beyond it.

But bear in mind there’s no extra dollars to help retirees increase their portfolio mileage. The same dollars will simply need to last a third longer – and remember that’s in a world where rates not expected to tip above 1% anytime soon.

You don’t need to be Einstein to see a looming challenge ahead.

As there is an implementation period before the covenant commences in July 2020, action can be taken now. A possible first step may be to reassess how the portfolio is invested and whether it can last 13 more years on the same tank of fuel.

This is where expert personalised financial advice or consulting can really prove its value, because the change will probably force a change in portfolio design and drawdown profile.

The change in the investment mix could be profound, because chances are a 35-year portfolio will need more in higher income generating or capital growth assets than a 22-year portfolio, for a given drawdown sequence. And with that, higher risk.

But here is one of the greatest paradoxes in retirement portfolio construction.

Increasing the exposure to a riskier asset class like shares, can lower portfolio risk long term – we’ll get to the reason later. And that exposure to riskier shares can be moderated by investing in low-risk equity strategy. Like a lot of things, it’s the execution of the principal that matters.

That’s because the level of risk of investing in Australian shares is not homogenous – it depends on the equity strategy employed. For example, holding a traditional equity fund aiming to maximise capital growth is a whole different ball game than investing in an equity income fund focusing on capital preservation. Both are equity investments – granted – but are chalk and cheese when it comes to risk levels.

Can lower equity risk extend portfolio life?

It can be shown, at least in theory, that extending the longevity of a retirement portfolio may be possible by switching exposure towards low risk equities – particularly if it’s low risk against the equity market.

Because we are comparing risk against a sharemarket index, an effective measurement tool is Beta, which compares the volatility of a fund to the volatility of the sharemarket. It tells you the degree to which a fund is sensitive to sharemarket movements.

For example, a low Beta of 0.5 means the fund has half the sensitivity of the market. A Beta of 1 implies the fund has the same sensitivity – just as volatile.

Beta casts no judgement on whether the volatility leads to better or worse performance – it just measures relative volatility.

The chart below shows how long a nest egg is expected to last under two different approaches in lowing risk for retirees. A common strategy called the bucket approach (grey line) blends 50% cash and 50% equities (either an index fund or possibly more akin to an equity accumulation fund). An alternative approach is to invest in an equity income fund with a beta of 0.5.

Both portfolios start with $614,000, with an assumed 10% per annum return on shares over the long term, cash return of 1.5%, annual living costs of $43,255 (based on ASFA comfortable retirement), and CPI of 2%. Given where markets are poised, we have also assumed equity markets suffer a 20% decline in year one of retirement.

Given that both retirement portfolios have a beta of 0.5, it minimises the impact of the equity market correction in year one. Big tick. However, the retiree investing in the Beta 0.5 equity income portfolio (gold line) will in theory, have a 35-year portfolio that includes income earned on the equity portfolio, plus a gradual drawdown on the capital base, until all funds are exhausted at age 100.

But look what happens to the lifespan of the bucket approach. It is halved, and only lasts 17 years, to age 82.

So to put it another way, switching to a low-risk (low Beta) may double the theoretical lifespan of a retirement income portfolio.

How does this happen?

While the cash/equities blend will reduce risk, over the long term the very low returns from cash will result in running out of money faster. You can blame low rates for this. It simply forces the retiree to draw down on other assets that would otherwise generate higher income.

It’s ironic that the very thing that many retirees have relied on for safety – cash – may do the exact opposite when rates are low and more years are needed.

Of course, if rates rise, then the outcomes will change, but the basic principle still applies.

The key point here is that lowering equity Beta may extend the lifespan of a retirement portfolio, without needing more money upfront.  And we’re not talking just a few extra years. In this scenario the lifespan is doubled. That’s a massive difference in a retiree’s living standards.

It’s worth considering a low Beta fund, if you want to reduce the risk sensitivity of your retirement portfolio.

At the end of the day, you can’t go back in time and increase a retirement nest egg. But you can act today and change the way it’s invested and potentially the extra distance it now needs to go.

So how can you lower portfolio Beta?

If you are seeking to reduce portfolio Beta, the first consideration is to look beyond the marketing of equity income funds and compare the Beta results.

Our research indicates the Vertium Equity Income Fund has the lowest level of Beta compared to other equity income funds in the Australian market, when assessed from its inception in April 2017. Lower beta means lower volatility of returns and hence less chance of negative surprises. The chart below compares the results.

Vertium seeks to deliver a low-risk experience for equity income investors by its focus on low portfolio risk first, stock selection, and deployment of cash as a key risk management tool. A low Beta is not specifically targeted, but proof of the process.

Speak to Copia today (Vertium’s distribution partner) to discuss how Vertium may lower your market risk exposure and potentially expend the life of a retirement portfolio.

DISCLAIMER

Past performance is not a reliable indicator of future performance. This document is for general information purposes only and does not take into account the specific investment objectives, financial situation or particular needs of any specific reader. As such, before acting on any information contained in this document, readers should consider whether the investment is suitable for their needs. This may involve seeking advice from a qualified financial adviser.

Copia Investment Partners Ltd (AFSL 229316, ABN 22 092 872 056) (Copia) is the issuer of Vertium Equity Income Fund. To invest, contact Copia on 1800 442 129 or email clientservices@copiapartners.com.au or visit vertium.com.au. Any opinions or recommendations contained in this document are subject to change without notice and Copia is under no obligation to update or keep any information in this video current.

The post Need a longer lasting retirement portfolio? Lowering ‘Beta’ may be key appeared first on Copia Partners.

In its June quarter research paper, the equity income fund manager compared the past seven share market corrections during global slowdowns since 1990 to the most recent correction in December 2018. For each correction the average decline in the share market index was 19% and the recovery time (from low to high) was 1.4 years.

But the most recent December 2018 equity market dip has been different, recording only half of the historical decline (11%) and one third of the recovery duration (5 months). The question is then will the market continue its unusually quick recovery, or will it follow the more common scenario of protracted recovery with possibly even another downward correction.

Vertium Chief Investment Officer Jason Teh said “one effective way retirement portfolios can be better shielded from a correction is lowering the sensitivity to equity market movements. An efficient way to achieve this is to allocate more to funds with low correlation to the market, so if the market declines, that portfolio is not fully tethered to the decline in capital values.”

For example, the Vertium Equity Income Fund has one of the lowest sensitivities with the share market among equity income funds in its peer group. Vertium has calculated its volatility risk measure is half that of the S&P/ASX 300 Index, with a Beta measure of 0.5. When the share market dipped in the December 2018 quarter, the low sensitivity was put into practice and the Fund’s capital value was cushioned by about 50%.

John Clothier, General Manager of Distribution for Copia said “our financial adviser clients are increasingly expressing concerns about of a lack of attractive income options for retirees, as well as the likelihood of a pull-back in equity markets. We have had increased interest in the Vertium Equity Income Fund due to its very low equity market sensitivity that can help protect capital, without denting any of the income potential for investors.”

The Vertium Equity Income Fund is currently expected to deliver 6% income over the next twelve months. The Vertium Equity Income Fund is currently expected to deliver 6% income over the next twelve months. Lonsec also recently reaffirmed the Fund’s rating as “Recommended” in its July Fund Report.

About Copia Investment Partners

Copia Investment Partners is an independent multi-boutique investment management group.

Copia provides distribution and business support for four partner fund managers: OC Funds Management (Australian Small Caps), Ralton Asset Management (Managed Accounts), Vertium Asset Management (Equity Income) and Chester Asset Management (High Conviction Australian Equities).

Copia forms partnerships with select investment managers to establish, grow and support their boutique businesses. At the same time, partners have the opportunity to access and broaden their reach within Australia’s highly competitive investment market.

Further details on Copia Investment Partners and its strategies can be accessed via the website www.copiapartners.com.au

DISCLAIMER

Past performance is not a reliable indicator of future performance. Positive returns, which the Vertium Equity Income Fund (the Fund) is designed to provide, are different regarding risk and investment profile to index returns. This email is for general information purposes only and does not take into account the specific investment objectives, financial situation or particular needs of any specific individual. As such, before acting on any information contained in this email, individuals should consider whether the information is suitable for their needs. This may involve seeking advice from a qualified financial adviser.

Copia Investment Partners Ltd (AFSL 229316, ABN 22 092 872 056) (Copia) is the issuer of the Vertium Equity Income Fund. A current PDS is available from Copia located at Level 25, 360 Collins Street, Melbourne Vic 3000, by visiting vertium.com.au or by calling 1800 442 129 (free call in Australia). A person should consider the PDS before deciding whether to acquire or continue to hold an interest in the Fund. Any opinions or recommendations contained in this email are subject to change without notice and Copia is under no obligation to update or keep any information contained in this email current.

The Lonsec Rating (assigned 10 July 2019) presented in this document is published by Lonsec Research Pty Ltd ABN 11 151 658 561 AFSL 421 445. The Rating is limited to “General Advice” (as defined in the Corporations Act 2001 (Cth)) and based solely on consideration of the investment merits of the financial product(s). Past performance information is for illustrative purposes only and is not indicative of future performance. It is not a recommendation to purchase, sell or hold Vertium product(s), and you should seek independent financial advice before investing in this product(s). The Rating is subject to change without notice and Lonsec assumes no obligation to update the relevant document(s) following publication. Lonsec receives a fee from the Fund Manager for researching the product(s) using comprehensive and objective criteria. For further information regarding Lonsec’s Ratings methodology, please refer to our website at: http://www.lonsecresearch.com.au/research-solutions/our-ratings

The post Retirees may need to dial up their defensive equity allocations to help protect Capital, says Vertium appeared first on Copia Partners.

a) Have a long track record of performance.

b) Have an alignment of interest with other investors.

c) Show a high level of focus yet be flexible and diversified.

d) Have a strong repeatable process, yet be ever evolving.

e) Invest ahead of the curve in unloved or undiscovered opportunities.

In our minds Mineral Resources’ management display many of the traits of a successful portfolio manager, we see them as strong stewards of capital and are attracted to their approach to literally look at anything in the Pilbara (WA) that can make them money.

a) Since listing between FY2007 to FY2018 they have grown total investor returns at an impressive 29% p.a. (20% p.a. eps CAGR).

b) Management owns 15% of the business (MD Chris Ellison personally owns 11.6%).

c) They are resource focused but somewhat agnostic to how they make money and have services spanning: mining (iron ore, lithium, graphite, manganese, etc.), mining services (crush, drill and blast), transport (haulage and port logistics), infrastructure (bulk ore shuttle system “BOSS” and port), manufacturing (carbon fibre components, synthetic graphite, etc.) and energy.

d) From what was once a pure crushing business MIN is now a completely diversified mining service provider (and miner) for a mix of external and internal (profit share) projects.

e) MIN’s investments in loss making/early stage iron ore mines: Iron Valley, Koolyanobbing, Marillana and Kumina; and, pre-boom in lithium mines: Mt Marion and Wodgina, show an ability to identify early stage opportunities and their sell-down of Wodgina displays a high degree of capital discipline.

Below we detail why MIN remains a key holding of the Chester High Conviction Fund and we continue to invest alongside management as we see a combination of valuation support and earnings insight for what we perceive as a quality company.

Disclaimer: we are conscious preparing a sum of the parts valuation to espouse that MIN is undervalued isn’t original, but we felt it appropriate for the completeness of this note.

Mining Services
As discussed above since IPO, MIN has transformed from a pure crushing business to a diversified services operation across the full life cycle and supply chain of mining projects. The evolution and growth of the business model has also seen MIN shift from providing services purely to third parties to primarily internal, profit share projects.

Source: MIN 2018 AGM Presentation

This provides increased earnings certainty as MIN is somewhat guaranteed to retain the contract over a project’s economic life. Key contracts include:

· Wodgina – 30-year mine life: crushing, accommodation and maintenance, mine to port haulage, ship loading and shipping.

· Mt Marion – 20-year mine life: mining and haulage, crushing and beneficiation, remote power services, road haulage, port handling, ship loading.

· Yilgarn (Koolyanobbing) – five to six years plus extensions: accommodation, mining and haulage, crushing and screening, train load-out, rail rolling stock, remote power services.

Below are the earnings for the division over the past three years and our expectation for FY20.

MIN has provided 2H FY19 guidance of AUD151-171m and commented “earnings are expected to increase as mining services under life of mine (LOM) contracts continue to ramp up at three internal sites”. The midpoint of this is AUD161m and given management’s comments that “increase is expected to be sustainable in future periods” we assume this level holds for FY20 (per table above).

Given the uniqueness of MIN’s diversified offering the market has at times struggled finding companies to comp the business against. Below we table a conglomerate of peers but feel the earnings certainty and LOM contracts; capability of management; historic & projected growth; and, level of diversification of MIN could afford a higher multiple than some peers ie. in the table below MLD has a contract life of <4 years (order book/annualised revenue) vs MIN’s key LOM contracts.

Despite the averages of the above, for conservatism we assume an EBITDA multiple of 5x FY20 to value MIN’s Mining Services business.

Iron Ore
At times the market seems to ignore the optionality in MIN’s Iron Ore business. Since the tragic tailings dam collapse at Corrego do Feijao (late Jan 2019) the iron ore price (62% dmt CFR fines) has rocketed to ~USD120/t. Although debate about the long-term implications to supply continues, the share prices of iron ore miners, particularly FMG, implies a structural change in the long term (LT) price of iron ore which we feel hasn’t been reflected in MIN’s share price.

We have input consensus (FY20) prices and the implied LT FMG iron ore price into our model for each of MIN’s assets to determine an appropriate valuation. We summarise our findings below.

Iron Valley

MIN commenced operations at Iron Valley in August 2014 and the current production rate is 7-8Mtpa, with an ~10-year mine life (depending on price). The product is low grade (~59%) with high impurities, hence is heavily discounted. Even using a USD64/dmt 62% Fe LT price we arrive at a marginal long-term valuation (ex Mining Services) for Iron Valley but see material near term earnings (refer table below).

Koolyanobbing
The asset was acquired from Cliffs in August 2018 and has a project size of 6Mtpa, expanding to 8Mtpa. It currently has a five to six-year mine life which could expand with exploration success. The product is similar grade to Iron Valley (59%) but has a lower level of impurities hence has a much higher realised price. Within our DCF we value Koolyanobbing at ~AUD550m (AUD2.90/share).

Marillana
On 22^ndJanuary 2019 MIN fortuitously entered a JV with Brockman for 50% of Marillana. The project has a resource of >1bn tonnes, with the ability to produce a 60-61% product at over 20Mtpa. Hence the project has a long >20-year mine life. We note, per Brockman’s 1H FY19 report independent experts had valued 50% of the project (pre Corrego do Feijao incident) at NPV10 AUD543m, however, given the market cap of Brockman ~AUD300m as its primary asset we ascribe AUD200m to MIN’s share of the JV in our valuation (AUD1.05/share).

Kumina
In October 2018 MIN acquired the Kumina project from BC Iron for AUD27m with up to AUD8m owing in additional payments. The project has a resource of 78Mt at 59.1% Fe. We ascribe only purchase price in our valuation but believe valuation could be materially higher.

Iron Ore Earnings
Detailed below is our outlook for MIN’s Iron Ore earnings for FY19 and FY20 using historic (Q4 FY19) and consensus (FY20) iron ore prices.

Lithium

Mt Marion
On 21^st December 2018 MIN announced it would outlay AUD51.9m for 6.9% of the project from Neometals (NMT), taking its equity position to 50%. This outlay implies AUD376m for MIN’s 50% of the project. Although this is below our DCF valuation of the project, for conservatism we use the lower value in our sum of the parts below. We further note that there has been a material reduction in quoted spodumene pricing, which we factor into our forward earnings projections.

Mt Marion Earnings

Wodinga
MIN executed an agreement last year with Albemarle to sell-down 50% of the Wodgina project for USD1.15bn. The deal is expected to complete Q4 2019 at which time MIN will receive USD1.15bn (AUD1,640m) minus tax. This supports MIN’s remaining 50% interest (DCF validated) being worth ~AUD1,640m.

Furthermore, the deal gives Albemarle the responsibility for selling and marketing all the spodumene concentrate produced. Hence, with an eye to CEO Luke Kissam’s comments “if demand is not there, we won’t run the plant”, and uncertainty around full ramp-up, we see Wodgina spodumene sales as the biggest unknown in projecting MIN’s FY20 earnings. We see a downside case that Wodgina is constructed but no tonnes produced in FY20.

Valuation and Projected Earnings

Sum of the Parts

* Refer disclaimer above

Projected Earnings

Refer above for projections by division/asset. Further note that we have assumed corporate costs revert to a more normalised level ~AUD30m p.a. in FY20 vs 1H FY19 which included three material corporate transactions, including Wodgina sell-down.

Conclusion

MIN for us remains undervalued on a sum of the parts basis, with a margin of safety in earnings vs consensus even if Wodgina earnings in FY20 are immaterial (our projections imply ~3.5x EV/EBITDA in FY20).

Author: Anthony Kavanagh – Chester Asset Management

The post A different kind of Portfolio Manager appeared first on Copia Partners.

The usual definition of a bear market is based on an arbitrary level of negative returns, such as -20%. While there can be flash crashes during bull markets (for example, 1987 or 2010), in our opinion, proper bear markets occur when global growth slows. Over the last thirty years, there have been eight global slowdowns, which have coincided with significant share market corrections. The anatomy of these bear markets and recovery (peak to trough return, peak to trough duration, trough to peak duration, peak to peak duration) are displayed in the table below:

*Not yet complete
Source: Iress

During an economic slowdown, the average peak to trough return was about -19% and the average bear market and recovery duration (peak to peak) was about 30 months (excluding the 2008 GFC period which is yet to complete).

Bear markets do not end abruptly. They tend to be drawn out processes with lots of volatility. Hence, something is very peculiar about the recent share market correction. The All Ords index collapsed in the fourth quarter of 2018 which reflected global growth concerns. Despite no sign of a global recovery, the market formed a V-shaped recovery and recorded its strongest half year return (20%) since 1991. If December 2018 was the market low, then this correction would be one of the most benign in terms of magnitude (-11%) and peak to peak duration (9 months). The correction to date happened so fast that there are not many wounds to lick, unlike previous global slowdowns.

This strange bear market behaviour is driven by a divergence from historical precedents in both the All Resources and the All Industrials indices.

What is driving the resource divergence?

Resource stock earnings are highly sensitive to the global environment because of their operating leverage to commodity prices. Typically, during global slowdowns the earnings of resource stocks collapse and the All Resources index records negative annual returns. However, for the first time in twenty years the performance of the resource sector has diverged during a global slowdown. The rolling annual return for the All Resources Accumulation Index has amazingly remained positive (even prior to the Vale dam disaster in January 2019). This once in a lifetime divergence is due to the Chinese supply side reform implemented in 2016. By cutting supply for certain commodities, the Chinese have engineered high prices to help some of their heavily indebted industries pay off debt.

Source: Iress

What is driving the industrial divergence?

However, resource stocks account for about 20% of the market. The majority of the All Ords is driven by industrial stocks, which have rallied so hard that current market valuations are on par with the technology boom peak. This is the fourth time in the last twenty years that the All Industrials has hit its 16.5x PE multiple ceiling. The high valuation multiple is more akin to market tops, which is in direct contrast to previous global slowdowns where PE multiples contract.

Source: UBS

While the WAAAX (Wisetech, Appen, Altium, Afterpay, Xero) stocks get a lot of attention about their exhilarating growth, it is the large companies with slower growth prospects that have pushed the market to its highs. For example, Commonwealth Bank (CBA) and Woolworths’ (WOW) PE multiples have expanded despite their earnings being revised down over the last few months. Like the market, their PE multiples have also hit their historical extreme PE ceilings. In contrast, during previous global slowdowns both CBA and WOW had contracting PE multiples. Contrary to popular opinion, WOW was not so defensive in the past.

Source: Factset

During economic slowdowns, interest rates fall and valuations compress

Many pundits attempt to justify rising stock valuations by pointing to falling interest rates. This is only partially correct because valuations are not a one factor model based on interest rates – growth is a more important factor. In periods of economic slowdowns, valuation multiples typically compress because the impact of lower growth expectations outweigh the impact of lower interest rates. This is the same reason why PE multiples generally expand when economic growth is robust.

Source: UBS, Iress

Can Central Banks engineer a shallow slowdown?

The divergence between rising PE multiples and negative earnings revisions (which coincide with falling bond yields) stems from excessive risk seeking sentiment – more so than in previous global downturns. Alternatively, maybe the worst is over, and an economic recovery is shortly underway as Central banks will save the day.

Indeed, the Reserve Bank of Australia has consecutively cut rates twice in June and July 2019. And the US treasury market is expecting the Federal Reserve to cut rates at the end of July 2019. Over the last forty years, when the short-term yield curve (2-year treasury yield minus Federal Funds target rate) inverted, it preceded the Federal Reserve cutting interest rates.

Source: Refinitiv

Before the current inversion, there were five instances since the late 1980s when the short-term yield curve inverted. Two of them coincided with shallow market corrections (1994 and 1997) and the other three (1990, 2002, and 2008) were deeper corrections that coincided with US recessions. From a pure statistical basis, two versus three is not favourable odds for the Federal Reserve to engineer a shallow slowdown. Putting one’s faith in a recovery based on the first rate cut by the Federal Reserve is not a great strategy to aggressively buy stocks.

V-shaped recoveries occur infrequently

Historically, V-shaped recoveries are infrequent, occurring twice (1997 Asian crisis and 2001 Technology crash) out of seven prior slowdowns. They also tend to be fleeting as the initial market optimism eventually deflates and morphs into a W-shaped recovery. Volatility prevails when investor expectations are too out of sync with economic reality.

Source: Iress

The 1997 Asian crisis ended up being a shallow correction while the 2001 Tech crash was a deeper correction which coincided with a US recession. If the current market recovery maintains its course, it would set a record. Is this time different or will history rhyme?

Conclusion

If corrections are the market’s winter season, then the fourth quarter of 2018 saw a quick hail storm before becoming balmy with sunny skies. It saw half the average bear market return, one third the duration and the sharpest V-shaped recovery in history – all extraordinary.

Excessive optimism has pushed PE multiples to their historic highs. This is despite negative earnings revisions within the current global slowdown. Investors who adopted the same risk seeking behaviour in prior slowdowns would have been caught in a blizzard with no clothes.

While the current market recovery appears to have seen many firsts, perhaps there is another explanation. Maybe the correction process is still underway. With expectations extremely high, this sets the foundation for risk rather than the fantastic returns that is on offer at the bottom of bear markets.

Author: Jason Teh

The post The Anatomy of Bear Markets appeared first on Copia Partners.

For most advisers, the chance to present a tax effective investment solution to clients has strong appeal as part of the advice value proposition: the challenge is how do you explain those concepts in a simple way that clients understand. In this article we’ll take you through three ways in which tax optimisation can benefit your clients.

We’ve designed the examples to apply to clients transitioning into a Ralton Asset Management Separately Managed Account (SMA) such as the Dividend Builder, but the concepts can be applied more broadly.

First way a SMA is tax efficient: Avoid tax inheritance

For clients where tax management is a priority, avoiding the inheritance of a capital gains liability is a great first step, because it stops the client taking on a tax burden in the first place.

You can show your client what this means using chart above. It shows a hypothetical increase in a managed fund’s unit price over a period that begins when a fund manager buys a stock into that fund, and when it sells that same stock. In the middle of that period, the investor buys units in that fund. The price of that unit has inflated since the stock was bought, because it includes the accrued capital gain.

The investor has no choice but to buy into that gain, even though they were never invested during that initial period. They have inherited a capital gain liability. Of course, for the sake of simplicity we have made very simple assumptions, but the concept remains.

For completeness, it should also be noted the opposite is true. If a fund is carrying a capital loss, then the investor can inherit those losses and potentially reduce taxable income – but that is not typically the objective of investing.

In the next chart we’ll compare managed fund example to the Ralton SMA Dividend Builder.

Before explaining this chart, it’s important to highlight that in Ralton’s SMA, the investor has beneficial ownership of shares. And that makes all the difference in terms of what tax burden they are responsible for.

If we assume they invest the same day through the period as the previous example, the capital gain begins from when they invest, and not the start of the period like it was with the fund. That’s because they’re buying shares in their own name through the managed account structure, rather than units in a fund carrying capital gains. They will avoid inheriting a capital gains liability. All other things equal, you would expect their tax burden to be lower.

Second way a SMA is tax efficient: In specie transfer

Another way to optimise tax for clients is to transfer stock holdings into the SMA via in specie transfer. That will save selling down assets, and avoid a capital gains liability even before the new investing takes place.

In the example above, an investor holding ANZ moves their investment into the Ralton Dividend Builder SMA, which also holds ANZ alongside 24 other stocks, such as BHP, WOW and AMC. The key point here is through a transfer, the amount of selling is minimised through the transition into the SMA.

The opposite also works. An investor moving out of an SMA may decide to keep ANZ and sell out of the rest. That may reduce the tax burden on the way out.

Logistically, the ‘in specie’ stock transfer is typically nominated during the platform application process. The adviser will nominate where in specie transfers apply, saving the investor any avoidable capital gains.

And by avoiding the trade, the investor also saves on brokerage costs. It all adds up and gives more of the return to your client.

This is the advantage of having beneficial ownership of shares. The same outcome is generally not possible with managed funds.

Third way a SMA is tax efficient: Manage individual holdings

As a beneficial owner of stocks, SMAs also allow the client to manage their holdings in a way that optimises their personal tax position. A client can elect to hold or sell parcels of stock depending to benefit their overall tax position. For example, a gain on one parcel may be used to offset a loss on another, and so on. This technique of splicing of individual parcels is generally not available in a managed fund arrangement.

Managed funds have their benefits too

While the examples above highlight some examples of tax advantages of SMA over a managed fund, there are still plenty of reasons a fund arrangement may be suitable for other investors. Managed funds often have the advantage of being able to invest over longer periods, in less liquid stocks, that may provide a higher return potential.

There are also more investment options available in the managed fund space, especially if the investor has a specific portfolio need. For example, advisers seeking a seasoned smaller companies strategy from OC Funds Management, or a low-risk equity income strategy in this part of the cycle could consider the Vertium Equity Income Fund, or even the Chester High Conviction Fund for a highly active Australian equity strategy – these options are not available as SMAs, but as managed funds offered by Copia.

Ralton is an Australian Equity Income SMA Specialist

Established in 2005, Ralton offers three SMA portfolios including Concentrated Australian Equity, Dividend Builder and an Australian Equity Ex 50. The portfolios are externally rated, have all outperformed since inception (February 2008) after fees, and are available on major platforms, including Powerwrap.

Tools to explain, with your branding

Copia has developed a range of presentation charts to help advisers explain concepts about SMA the easy way.

If you would like to receive copies with your branding, please reach out to Copia’s Distribution team.

DISCLAIMER

Performance returns of the Ralton Dividend Builder Portfolio, Ralton Concentrated Australian Equity Portfolio and the Ralton Australian Equity Ex 50 Portfolio are based on a model portfolio and are gross of investment management and administration fees, but net of transaction costs. The total return performance references are historical and do not allow the effects of income tax or inflation. Total returns assume the reinvestment of all portfolio income. Past performance is not a reliable indicator of future performance.

This document is for general information only and does not take into account the specific investment objectives, financial situation or particular needs of any specific reader. As such, before acting on any information contained in this document, readers should consider whether the information is suitable for their needs. This may involve seeking advice from a qualified financial adviser. Ralton Asset Management (ABN 45 114 924 382) (Ralton) is the provider of the Ralton Dividend Builder Portfolio, Ralton Concentrated Australian Equity Portfolio and the Ralton Australian Equity Ex 50 Portfolio. For further information, contact Copia Investment Partners Ltd (AFSL 229316, ABN 22 092 872 056) (Copia) by calling 1800 442 129 or email clientservices@copiapartners.com.au. Any opinions or recommendations contained in this document are subject to change without notice. Ralton and Copia are under no obligation to update or keep information contained in this document current.

The post Top 3 ways an SMA helps clients optimise tax appeared first on Copia Partners.