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  • NZ Funds Monthly Review – March 2021

    22nd April, 2021
  • New Zealand Economic Update

     New Zealand’s COVID-19 elimination strategy has been spectacularly successful and has enabled a quick return to normal life. However, the flipside is that New Zealanders now expect our streets to be COVID-19 free. The challenge for New Zealand over the rest of 2021 is how to transition from the current closed border situation to a world of vaccines and open borders. Managing the competing risks will not be easy. We now have the initial steps with the announcement of the trans-Tasman bubble; however, at some point, borders need to be opened wider which can increase the risk that COVID-19 will return to the wider community. Once vaccination uptake is sufficiently high, this risk will be less but will remain a factor which we need to get used to. The other risk is that if borders remain closed, New Zealand’s economic activity may begin to level off just as the rest of the world begins to pick up speed. This will see local assets fall out of favour. The New Zealand share market finished the first quarter of 2021 with a -4.61% return (March, 2.73%). Our neighbours Australia significantly outperformed over the period with an increase of 6.77% for the quarter (March, 2.70%). The differing fortunes reflect the different makeup of the two markets. New Zealand is dominated by mature slower-growth companies that pay consistent dividends. These companies are closer to bonds and, as a result, their valuations have been weighed down by the general rise in longer-term interest rates. Australia, on the other hand, has a number of very large cyclical businesses and a heavy weighting to the major banks. Both of these sectors tend to perform well during periods of economic recovery and rising longer-term interest rates.

    International Economic Update

    The speed of vaccine roll-outs are now a focal point for markets as this will determine how quickly economies can move towards a post-COVID-19 world. Currently leading the vaccine charge are Israel (61%), United Kingdom (46%), Chile (37%) and the United States (32%). As vaccination uptake levels rise, so will general activity levels leading in turn to increased economic activity. This can already be seen in airport passenger numbers in the United States which have increased from around 600,000 passengers per day in late January to the current level of around 1,400,000, an increase of more than 100% and almost 65% of the pre-COVID-19 level. There is a high likelihood that this increased activity will unleash a significant spending boom. A key difference this time around is that, in general, the consumer is exiting the pandemic in a vastly better position than in past recessions. In the United States, household wealth and personal savings are not only back above their pre-pandemic levels but have expanded further and faster than any post-crisis period. This is thanks to swift government support via stimulus cheques and enhanced unemployment benefits. To put this in perspective, following the Global Financial Crisis it took a full five years for household net worth in the United States to return to 2007 levels. The speed of the current recovery is a key factor in our positive view for investment markets going forward. Global share markets finished the first quarter of 2021 with positive returns. Developed market equities ended the quarter up 8.65% (March, 4.27%) while emerging markets underperformed, ending the quarter up 4.04% (March, -1.5%).

    Income Generator

    Income Generator added four New Zealand companies in March – Fletcher Building, Summerset Group, Chorus and Meridian Energy. In total, the Fund now holds nine New Zealand dividend-paying companies and seven Australian dividend paying companies. The average dividend yield of the companies held is 3.93% (including imputation credits). Fund performance was flat in March, down -0.02%. Returns for the Fund’s share positions were generally in line with the performance of the New Zealand and Australian share markets which were up 2.73% and 2.70% respectively. However, the overall return for March was dragged down by Rio Tinto, and by interest rates which pulled back from their recent highs. Rio Tinto, the star performer in February, was the largest detractor during March. The decline reflected a decision in China to restrict steel production to meet environmental targets. With China comprising 50% of global steel demand and consumption, this action is likely to limit the demand for iron ore, Rio Tinto’s key product, so the position was exited. We continue to have a position to protect the Fund against rising interest rates. At the same time, we have a significant allocation to Australian banks which will benefit from improving economic conditions. Income Generator has returned 7.46% to 31 March 2021 from its 22 October 2020 inception.

    Income Category

    What a difference a year makes! It is now a full year since New Zealand entered its first lock-down and a full year since financial markets experienced the precipitous falls of late March 2020. This provides us an opportunity to review how the Income Category has performed throughout a year of rapid change. The Category experienced a difficult March 2020 as bond prices dropped significantly with the onset of the pandemic. However, at the time, we wrote that corporate bonds across all rating grades had priced in an exceptionally negative economic scenario, and that investors were being rewarded for taking on corporate credit risk. Moving forward a year, investors have certainly been rewarded as corporate bonds have increased significantly in price and spreads are once again at close to record tight levels. The Category has benefited from this move in several ways – through the bonds it purchased back in April and May and from long positions in both investment grade and high-yield credit default swaps (CDS). Over the last six months, the theme has shifted from the early stages of economic recovery toward optimism and the prospect of higher interest rates. As we have discussed a number of times, we have benefited by being based in New Zealand and experiencing how quickly life can return to normal. This has meant that the Category has been positioned to not only mitigate the negative impact of longer-term interest rates moving higher, but actively profit from this move. As a result the Category has recorded a record 12-month return for the year ended 31 March.

    Inflation Category

    The Inflation Category had a positive month in March which capped off a strong 12 months of returns for investors. March returns were once again driven by the continued increase in United States government bond yields, as well as positive share market performance. The yield on 10-year United States government bonds increased from 1.40% to 1.74%. NZ Funds’ clients profited from this move as the yield increased. Global share markets were strong in March as optimism continued, driven by the re-opening economy supporting economic growth. Inflation Category investors were positioned to benefit from this through positions in various global companies and share indices, as well as a tilt towards cyclical companies that typically perform better in a strong economic growth environment. March’s portfolio positioning reflects a continuation of the strategy that has driven the returns for Inflation Category investors over the past 12 months. The first half of the year to 31 March 2021 was characterised by a large ‘bounce’ in share markets following the March 2020 COVID-19 sell-off. NZ Funds were quick to add back share exposure following the market sell-off, which contributed to client’s outperformance throughout this period. Following this, the second half of the year was primarily characterised by optimism on the economic recovery and outlook as the economy reopened. While investors still benefited from their share exposure, a key additional driver of returns became the United States interest rate position which performed well as investors became increasingly confident of the outlook for the economic recovery. Further returns came from other investment strategies, including merger arbitrage and positions in commodities and cryptocurrency.

    Growth Category

    The Growth Category had a positive March which completes a record 12 months for clients. Results for March were driven by strong returns in shares as well as increases in United States interest rates. Global share markets continued to perform well driven by the re-opening economy supporting strong economic growth. Additionally, clients benefitted from United States government bond interest rates continuing to rise following increased inflation expectation. Returns over the past 12 months were generated across multiple asset classes, with the key driver being core positions held in shares. Share markets bounced back following the COVID-19 sell-off at the end of March 2020. NZ Funds were quick to add back share exposure, which contributed to outperformance in the first half of the year. Shares continued to drive significant returns through the second half as investors became increasingly positive about the speed of economic recovery. Rideshare remained a core position for the Category. Uber performed very well due to its dual offering in ride sharing and food delivery which complemented each other throughout the COVID-19 crisis. Strong returns were also generated across other investment strategies, such as United States interest rates, cryptocurrency and commodities. Many of these positions remained in clients’ portfolios for the majority of the year and continue to drive returns as we head into the new financial year. Our outlook remains positive on share markets which are still benefiting from large government stimulus packages and an economy that is rebounding at almost unprecedented speeds from the disruption caused by COVID-19.

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