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Sunday, 30 September 2012

ATI Equity Portfolio September 2012

Information as at 30 September 2012

Fund 1 Mth (%) 3 Mth (%) 1 Yr (%)   3 Yr (%pa) 5 yr (%pa) Inception (%pa)

ATI Portfolio Return








S&P/ASX 300 (Accum)








Outperformance (Alpha

1.0 0.8 0.2   (0.2) 2.6  2.1

*Past performance is not a guarantee of future results and may not be indicative of them. The gross returns are calculated using the Portfolios net asset value of a model mandate within the Share Invest SMA product. Performance assumes reinvestment of all income. Inception date is 23 December 2005.

Portfolio Objective

The ATI Australian Equity Portfolio seeks to achieve total returns (includes income and capital appreciation and before the deduction of fees and taxes) that exceed those on the S&P/ASX 300 Accumulation Index by 3% per annum over rolling three-year periods.

Portfolio Details as at 30 September 2012

  Fund S&P/ASX300     Fund S&P/ASX300
Largest Holdings Weight (%) Weight (%)   Sector Allocation Weight (%) Weight (%)

BHP Billiton







National Aust Bank







ANZ Bank




Consumer Staples



Westpac Bank




Consumer Discretionary










Rio Tinto














Commonwealth Bank







Newcrest Mining














Selected Portfolio Statistics as at 30 September 2012 

Inception Date 23-Dec-05   MER (est.) 0.90% p.a.
Number of Stocks 32   Tracking error (forward estimate) ~ 5% p.a.
ATI Funds Under Management ~$400m      

Relative Portfolio Performance

The ATI Equity Portfolio rose 3.2% in September compared with a rise of 2.2% in the S&P/ASX300 Accumulation Index. Against this benchmark, ATI is producing excess returns on a monthly, quarterly, 1 year, 5 year and since inception (Dec’05) basis.

The Best and Worst Performing Sectors

The best performing sectors for the month were Materials (+7.3%), Health Care (+2.1%) and Property Trusts (+1.3%); while the worst were Consumer Staples (-1.5%), Consumer Discretionary (-1.5%) and Energy (-0.9%).

Attribution of Stocks

The portfolio performance during September was assisted by overweight positions in Lynas Corp (LYC), Newcrest Mining (NCM) and PanAust (PNA); and by not holding Origin Energy (ORG), QBE Insurance (QBE) and GPT Group (GPT). Stocks in the portfolio that contributed most to its relative performance during the month included:

Lynas Corp (LYC) (+23.4%) outperformed the market in September despite a volatile month of share price performance. The main influence on the LYC share price continues to be developments in the conflict between Malaysian regulators, who are generally supportive of the company's ambitions of producing Rare Earth oxides from the Lynas Advanced Materials Plant (LAMP) in Kuantan, Malaysia, and opposition agitators who are seemingly intent on pursuing vexatious litigation for the dual purposes of self promotion and restraining Lynas from operating the LAMP. On 5 September 2012 LYC achieved a long-awaited milestone with the issuance of the Temporary Operating Licence, which had been approved way back on 1 February 2012, a decision which was subsequently affirmed by the Minister of Innovation, Science and Technology in June 2012. Accordingly in early September it appeared that the company would finally be clear of legal impediments, and would commence the import of concentrate into Malaysia prior to the ramp up of the LAMP in October 2012. However late in the month a group opposed to the LAMP convinced the Kuantan High Court to hear an application for an injunction against the June 2012 decision. The hearing will take place on 4 October 2012. During September the portfolio weighting of LYC was reduced following periods of significant outperformance (+41% on 6 September 2012 alone). This active portfolio management sell discipline was evident again late in September when the stock had been a relative out-performer.

Newcrest Mining (NCM) (+18.2%) outperformed during September, as the impact of the rising gold price managed to outweigh the company's ongoing issues at its major operations. Following months of media speculation, a variety of Quantitative Easing policies were released in the US, Japan, and Eurozone, which created the appearance of a co-ordinated approach to providing economic stimulus through asset purchasing programs and further debasing of currencies. The gold price subsequently appreciated by ~5% over the month, to ~US$1,770/oz, and precious metals stocks generally outperformed the market. Notwithstanding the attractive commodity outlook, NCM continues to struggle to deliver operating reliability despite its position as the most diversified gold mine operator on the ASX. During September the company reported two major operating interruptions, with the failure of a conveyor at the high margin Ridgeway operation in NSW, and an electical outage at the notoriously unreliable Lihir operation in PNG. Whilst the company maintained production guidance for FY2013 of 2.3-2.5moz of gold, these two incidents are likely to erode much of the operating contingency which had been factored in, with the company even more reliant on a strong second half to meet guidance. Whilst NCM remains a portfolio holding, the portfolio weighting was actively reduced during September following sustained periods of out-performance that meant the stock had become relatively less attractive.

PanAust (PNA) (+15.9%) outperformed during September, supported by the resilient performance of its underlying commodity exposures; copper, gold, and silver. PNA delivered a solid interim FY2012 result in late August, with attributable NPAT of US$67.6m exceeeding the market's expectations, and in addition the company declared a maiden dividend of A3¢/share. Speculation, and subsequent delivery, of further Quantitative Easing policies in the US, Japan, and Eurozone supported commodity prices during September, and precious metals in particular, with the gold price appreciating by ~5% over the month to ~US$1,770/oz. Meanwhile the copper price was further supported by the acceleration of previously announced infrastructure programs in China, appreciating by ~9% to ~US$3.75/lb. Even with its recent share price performance, PNA remains relatively attractive and a portfolio holding.

Positions that detracted most from the portfolio’s performance during the month were from being overweight Lend Lease (LLC), Emeco Holdings (EHL) and Metcash (MTS); and from not holding Macquarie Group (MQG), Worley Parsons (WOR) and Iluka Resources (ILU). Stocks in the portfolio that detracted most from performance during the month included:

Lend lease (LLC) (-7.5%) underperformed in September following news that two projects in the Australian Abigroup construction division had profit outlooks which were different to that reported at the August FY12 results. The projects in question were the Peninsula Link roadway in Victoria and the Ipswich Motorway in Queensland with the errors involved the overstating of profits on the former project and understating of profits on the latter. While LLC said that the net impact of the reporting irregularities was neutral, the four senior executives involved were asked to step aside until a full audit has been completed. As we are yet to receive clarity on the extent of this reporting problem within the Group, the weighting of portfolio position was reduced as the stock fell during the month. LLC remains relatively attractive and a portfolio holding in the absence of any new information regarding the reporting issues referred to above.

Emeco Holdings (EHL) (-6.4%) underperformed during September despite the absence of company specific news. We do note that macro concerns over a slowdown in commodity markets and announcements of delays or cancellation of capex and expansion plans from major mining companies, impacted earnings visibility and sentiment in the mining services sector generally. We note that the key risk short term risk for EHL is in the coal sector (50% of Australian revenue) where a number of contracts (4-5) with coal customers are concluding in the middle of FY13, and the company is yet to commence discussions on contract extensions. Pending the outcome of these discussions it is possible some fleets will need to be transitioned to new projects in 2H13 (impacting utilisation and incurring costs), but we feel this is already reflected in the current stock price. EHL remains a portfolio holding, with the share buyback (10% complete), strong balance sheet and diversified earnings base (both geographically and sector exposures) underpinning its relative attractiveness within its sector.

Metcash (MTS) (-3.3%) underperformed in September after the company updated its FY13 guidance at its AGM (30 August 2012) “to a range of 1% - 3% EPS dilution compared to FY12 underlying EPS, with the dilution heavily weighted to the first half”. This followed a series of announcements including the purchase of the remaining 49.9% of Mitre 10, the purchase of Automotive Brands Group and the signing of a distribution agreement with Liquor marketing Group. MTS also announced in September that the current CEO, Mr Andrew Reitzer would step down as CEO on 30 June 2013 (but would remain as a consultant to the board for 3 years during which he will be subject to a non-compete restriction). MTS said it expected to make an announcement regarding Mr Reitzer’s successor in February 2013. MTS remains a portfolio holding and its growth profile is expected to improve in FY14 following a full year contribution from the above mentioned transactions, which the company stated were “all EPS accretive”.


Portfolio Construction

The ATI portfolio, with regard to the market capitalisation exposures, remains similar to the benchmark index with ~83% of the portfolio (excluding cash) in the top 50 stocks (compared to 83% of the benchmark index), ~13% in the next 100 (~13% of the benchmark index), and ~4% in the last 150 stocks (~4% of the benchmark index).

Whilst the portfolio’s market cap bias is similar to the benchmark index, its underlying sector positioning is not. ATI has maintained the portfolio position of being overweight the materials and underweight financial sectors, even though we expect there to be ongoing market volatility driven by the unresolved European debt issues, a slower Chinese growth profile and a sluggish US economy. We remain comfortable holding a number of smaller resource stocks with iron ore and copper exposure that have become sufficiently attractive for their relatively high expected return profile to justify some additional portfolio risk. The current forecast tracking error of ~4.5% is slightly lower than the level of last month due to some slight weighting reductions in the month.

The main portfolio weighting changes during September included top-up purchases for Commonwealth Bank (CBA) and Rio Tinto (RIO); disposal of our holding in Kingsgate Consolidated (KCN); and some slight weighting reductions for Atlas Iron (AGO), Fortescue Metals Group (FMG), PNA and Sandfire Resources (SFR).

Portfolio Risk 

The current forecast tracking error of ~4.5% (range of 2% to 8%) for the ATI portfolio is unlikely to change in coming months unless we feel that the risk/return benefit of taking on some relatively oversold material stocks requires some amendment with particular reference to a greater than expected deterioration in the global economic outlook. At present the main sources of portfolio risk are from overweight positions in Sandfire Resources (SFR), Pacific Brands [PBG], LYC, PNA, AGO, FMG, EHL and Flight Centre (FLT); and an underweight position in CBA.

General Market Commentary 

World equity markets rallied in September as central banks in the US, Europe and Japan all announced new asset re-purchasing initiatives with the aim of providing additional liquidity to try and reinvigorate growth in their respective economies. With policymakers coming to the rescue in advance of the global economic backdrop showing any signs of improvement, the short term risks to the global growth outlook seem to have been put on the ‘back burner’ for now. While the outpouring of central bank liquidity should provide a boost to depressed global business confidence, it would appear that the current equity market strength is in part being driven by PE multiple expansion as the fundamental metrics of improved economic and earnings growth are yet to eventuate. Despite no central bank action of our own, but a recovery in commodity prices, the outcome was similar in Australia as our equity market was up for a fourth consecutive month with the ASX300 Accumulation Index rising +2.2%.

With most developed economies now having very low to zero interest rate settings, the need to find returns seems to be pushing investors back to risk assets and this may also help explain why the equity markets continue to be supported despite weak economic data and lowered earnings expectations post the recent reporting season. With Australian interest rates still one of the highest in the developed world, there is still some form of investment alternative for income generation outside of equity markets and this would seem to be part of the story as to why our market has not rallied to the same extent as those seen in the US and Europe during calendar 2012. The chase for yield in our equity market was not sufficient in September to counter the rush for materials stocks and the bank sector had its worst relative performance since February. Other defensive yield-heavy sectors including utilities, telco’s and property trusts also lagged the broader market as the rotation into more cyclical resource stocks played out.

The mining-heavy materials sector broke a seven month losing streak versus the broader market to post strong gains in September as the asset repurchase initiatives of global central banks and Chinese announcements of further infrastructure spending prompted a recovery in sentiment towards many commodity prices and resource stocks. The recovery in iron ore prices was accompanied by the strong monthly performance of portfolio holdings such as AGO, FMG and RIO whilst an improved copper price provided some underlying support for other holdings such as PNA and Sandfire Resources (SFR). Regarding the iron ore price outlook, we still expect cost-curve support to remain a market focus in 2H12 and feel that the iron ore price should be supported around current levels as the fundamentals prevail and a large volume of unprofitable high cost production is withdrawn from the market. Any improvement in the global economic backdrop would only further improve the prospects for increased demand and provide more support for the underlying commodity price.

Local economic data releases in September were mixed, with retail sales for July were down -0.8% in the month while employment continued to soften with the participation rate down to 65.0%, albeit the unemployment rate was slightly down from the previous month at 5.1%. The RBA left cash rates unchanged at 3.5%, in line with market consensus, but brought forward its expectations for the peak in mining investment to occur as early as mid-2013. The meeting minutes also revealed that the RBA still had an easing bias as it was noted that the low level of inflation provided “scope to adjust policy in response to any significant deterioration in the outlook for growth”. The possibility of further rate cuts in 2012 would now seem to depend on some further deterioration in the domestic and/or offshore economic growth outlooks. With no move from the RBA on rates during September, the A$ remained at similar levels to the previous month and closed at US$1.046 (+1.4c).

The benchmark spot iron ore contract, Tianjin 62% fines, rebounded sharply from an early-September low to gain 16.6% for the month. However this still left it below the level at which it began August. The rally closed the discount at which imported products had traded relative to Chinese domestic; this had been attributed to domestic supply having shorter delivery times and sometimes better credit terms. Despite the support to sentiment given by central back activism during the month, spot Brent crude oil (-2.2%)
gave back some of its June-August rally as Saudi Arabia flagged a willingness to increase output to dampen prices. The LME index of base metal prices spiked 10.0% in September with zinc (+13.7%), aluminium (+13.3%) and copper (+8.0%) all making solid gains. The LME index is now up 7.4% for the year to date despite market concerns over the level Chinese demand growth. Spot gold (+4.7%) built on the gains of the three previous months as central bank policy activism underpinned its appeal as an inflation hedge. Gold ended the month just 6.4% shy of its record close achieved on 6th September 2011.


With global equity markets rising on the prospects of what increased liquidity from global central banks may do, it now seems that lower global growth forecasts are just one part of the puzzle. We would expect that this euphoria will wear off by early 2013 if the economic and company earnings data continues to weaken in spite of the central banks throwing everything they have at their respective economies by pumping them with liquidity. Other unresolved issues regarding European debt bailouts, US elections and Chinese growth initiatives will remain a part of the story but have been moved to the sidelines as equity markets seem to have taken the view that things surely must get better from here.

The combined global stimulus efforts have certainly proved capable of providing some short term respite for equity market investors. However, only a sustained improvement in the global growth outlook, including the contribution from the resource-intensive growth of China, can provide a reliable foundation for equity markets to maintain the current momentum. The fate of the Australian equity market is clearly linked to these outcomes, and even more so now, as consensus forecasts for domestic growth in FY13 continue to fall as the growth engine in the ‘dual-speed’ economy looks to be losing some of its “steam”. For the domestic earnings outlook to improve and help drive the market higher, we need the global backdrop to show some improvement sooner rather than later.

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