Upload
others
View
2
Download
0
Embed Size (px)
Citation preview
Fund Manager
Commentary
December Quarter 2016
Contents
Australian Shares 3
International Shares 9
Australian Fixed Income 13
International Fixed Income 14
Credit 15
Cash 16
Australian Property 20
International Property 22
Active Balanced 23
Performance as at 31 December 2016 29
Fund Manager Commentary – December 2016 3
Australian Shares
BT Wholesale Core Australian Share Fund
Market review
Risk sentiment swung dramatically during the December quarter as pre-US election jitters were
squashed after investors quickly re-evaluated 'Trumponomics’ post the billionaire’s victory. This in turn
saw the S&P/ASX 300 gain a solid 4.9% into year end. Central bank activity including upbeat Fed
verbiage and an emphasis on QE flexibility from the ECB also offered investors guidance during the
period.
On global developments, a hawkish tone from Fed Committee members leading into its decision to
raise rates by 0.25% added fuel to a sell-off in bonds, which showed signs of fatigue into year-end.
Importantly, the FOMC raised both their growth and rate forecasts for 2017. This was against a
backdrop of significant improvements in key economic indicators like consumer confidence,
manufacturing and service activity surveys, as well as retail sales. Revisions to third quarter GDP were
also positive with the annualised metric eventually raised to 3.5%. While the number of jobs added
averaged below the 200,000 mark, wage growth was healthy.
Across the Atlantic, the ECB finally announced plans for its QE programme following months of
speculation. The central bank will reduce the size of purchases by 20 billion euros each month, but also
reduce the maturity of securities that qualify. With scope for adjustments if needed the outcome was
perceived as supportive for risk appetite. Investors in the region also felt relief after the Italian
referendum proved a non-event and concerns over the health of their banking system faded. Further
north, the wave of global optimism offset ‘Brexit’ implementation fears in the UK.
In Asia, the Bank of Japan appeared more optimistic on the outlook for the country’s economy in the
wake of USD/JPY’s 15.4% rally over the quarter. In neighbouring China, data was perceived as
reasonably strong with improvements in manufacturing survey data and decent reads from Industrial
Production and Profits. The Producer Price Index also ended 54 consecutive months of deflation.
However, concerns over continued capital outflows and the Yuan’s depreciation garnered increasing
press coverage heading into year end.
The forces highlighted above largely overshadowed the RBA’s first three meetings with Philip Lowe
presiding as Governor. The central banker noted improvements in Australia’s terms of trade from higher
commodity prices, but also a soft patch for economic growth and mixed labour market data. Importantly,
market pricing shifted from suggesting a cut to a hike as early as November 2017.
Data-wise, a number of quarterly domestic releases surprised the market. Third quarter wage growth
sunk to 1.9% year-on-year – the weakest since the series began in 1998. GDP over the same period
Fund Manager Commentary – December 2016 4
shrunk by 0.5% and the year-on-year reading dropped to its lowest since the GFC at 1.8%. Similarly,
headline CPI grew at a sluggish pace of 1.3% over the previous year.
Sector returns saw a fairly large dispersion in the final three months of the year. At the top of the league
tables were Financials (+12.5%) and Utilities (+9.3%). The former was a large beneficiary of
‘Trumponomics’ given expectations for significant deregulation in the industry. Energy (+7.4%) also
performed strongly as production cut commitments from oil producers sparked an 11.4% gain for crude
oil (WTI). At the other end of the spectrum, Health Care suffered an 8.8% drop. Trump’s election has
prompted uncertainty for parts of the Healthcare sector given the noise around the wind-back of
‘Obamacare’ and the little to no visibility of what might replace it. Telcos (-4.2%) were also hurt as more
domestically-orientated challenges – namely the NBN rollout – weighed on the sector.
Portfolio performance
The BT Wholesale Core Australian Share Fund returned 5.60% (post-fee, pre-tax) over the December
2016 quarter, outperforming its benchmark by 0.67%.
Contributors
Rio Tinto, RIO, OW, +16.1%
Another sizeable run for Rio Tinto’s key commodity exports pulled its share price higher by 16.1%
during the December quarter. Iron ore gained a staggering 41.2%, coal added 22.4% and copper
climbed an impressive 13.8%. Such an improvement in the pricing environment overshadowed news of
a bribery scandal that broke in November and deepened in December. The only other major company-
specific news was the launch of a debt reduction program valued at US$9 billion, which was received
positively by investors. We believe management’s sound balance sheet management and successful
cost reduction measures have made it a preferred play to leverage a brighter commodities outlook. It
also also a purer play than rival BHP on commodities like iron ore and has a more attractive valuation.
ANZ, ANZ, OW, +13.3%
Easing concerns regarding the health of the Australian banking sector helped lift shares in ANZ by
13.3% over the quarter. The release of its FY16 earnings report was the only major announcement
during the period. The result provided further evidence of its ongoing rationalisation as it reduces costs
and divests non-core businesses. The provision for bad debts remained flat and changes to mortgage
risk weight rules did not have the negative effect feared by the market. Overall, the update justified our
preference for ANZ over its peers. However, we acknowledge its strong outperformance has closed part
of the valuation gap relative to others in the space as well as industrials. This in turn may limit the
potential to repeat such a stellar run.
Fund Manager Commentary – December 2016 5
Incitec Pivot, IPL, OW, +29.5%
Shares in Incitec Pivot enjoyed a strong recovery during the quarter to finish higher by an impressive
29.5%. The fertiliser producer has been the beneficiary of ‘Trumponomics’ tailwinds. This is given
speculation of a resurgence for the US coal industry – a large customer of IPL’s explosives. Rumours of
Chinese fertiliser production cuts in December also aided IPL’s performance. Going forward, earnings
appear to be on a firmer footing and its greater exposure to a cyclical upswing than rival Orica (+18.2%)
supports a positive outlook for the stock.
Detractors
Caltex, CTX, OW, -11.1%
The loss of a key customer dragged shares in Caltex lower by 11.1% over the December quarter.
Woolworths announced it would sell its petrol station network to BP, who would in turn become the
preferred supplier. We believe the market’s reaction was exaggerated, given the earnings hit would be
smaller than suggested by the punishment of its share price. Caltex remains the only player with the
required infrastructure to continue supplying the network in certain geographies. More generally we
remain positive on CTX with a view there are still significant benefits to be realised from its greater
supply chain control.
Amcor, AMC, OW, -1.3%
Shares in Amcor lagged the broader index and slipped a marginal 1.3% over the period. Given a lack of
major negative announcements, its slight pullback was likely tied to profit-taking following a strong
performance in preceding months. During the quarter, the packaging giant announced the acquisition of
a Chinese flexibles providers for $36 million – the latest in a series of takeovers. Several new product
lines were also unveiled, which were met with a muted reaction from investors. Going forward, we
maintain a constructive outlook for the Melbourne-headquartered multinational, based on its positive
growth prospects both organically and via new business.
QBE Insurance, QBE, UW, +33.7%
QBE maintained a strong upward ascent from early November to finish higher by over 33%. The insurer
received a tailwind from Trump’s surprise election victory and ensuing bounce back in bond yields. This
is given the company’s earnings sensitivity to interest rates and its North American operations. While
we acknowledge its leverage to these positive macro developments it still faces overriding challenges.
Chief among these is pricing pressure as part of the current phase of the insurance cycle.
Strategy & Outlook
The portfolio outperformed the index over the quarter, helped by strong gains from Rio Tinto (our
preferred resources exposure) as well as ANZ and chemical company Incitec Pivot. The underweight in
Fund Manager Commentary – December 2016 6
bond sensitives, which weighed on performance over the first half of 2016, was also beneficial.
Infrastructure stocks such as Transurban and Sydney Airport continued to underperform given the
combination of previously high valuations and the view that bond yields will continue to rise in an
environment of higher inflation and interest rates.
We believe we remain in a low-market return environment, given a lack of strong, broad-based earnings
growth and limited scope for a sustained valuation re-rating, especially given that rating gains surprised
on the upside in H2 2016. That said, the market can continue to make steady gains, particularly if
underpinned by a moderate level of economic growth which does not accelerate to the point where
tightening is required – a scenario which appears reasonable at this stage.
Economic growth in the US appears underpinned by household balance sheets having healed to pre-
GFC levels, which could provide enough confidence to sustain an uptick. Meaningful tax reform under a
Trump presidency would also be stimulative, however it is too early to see if reality reflects rhetoric and
investors must be ready to react as events evolve in the US.
The major risks are geopolitical: elections loom throughout Europe, while the only certainty around
Trump foreign and trade policy is that there is no certainty as to what he will do. If there is a key lesson
to take from 2016 it is not to get too caught up in the headlines – the year that gave us the shock of
Brexit, a Trump victory, and repeated scares around Chinese growth also delivered an 11.8% total
return for the S&P/ASX 300. It is important to focus on the underlying trends of growth, which appear
reasonable at this point.
Our highest-conviction positions remain at the individual company level, where we have identified clear
triggers for outperformance as a result of our fundamental research. In this vein, we like Qantas, ANZ,
packing group Amcor, and wholesaler Metcash.
While resources are unlikely to repeat 2016’s strong outperformance, given investor exposure is more
balanced today than was the case twelve months ago, we remain broadly positive. Resources are the
only major segment of the market likely to see earnings upgrades, as most sell-side model expectations
are based on commodity prices significantly below today’s levels. We do believe analyst earnings
upgrades are probably less influential upon resource stock performance than for other parts of the
market. Nevertheless, earnings momentum is likely to provide a tailwind in 2017.
Chinese policy remains the key factor for resource stock performance. Having buoyed the sector in
2016, the possibility of a change provides the largest risk in 2017. There are clear signs that Beijing is
tightening policy at the margin. However the positive side, a significant number of infrastructure projects
will hit their sweet spot in terms of spending this year. The upshot is that Chinese economic growth
remains reasonable; unlikely to surprise on the upside, but strong enough to support decent commodity
prices. Our exposure is primarily through well-diversified, less-leveraged stocks such as BHP and RIO,
mindful that Chinese policy can change quickly and with little warning.
Fund Manager Commentary – December 2016 7
Australian Shares
BT Wholesale Smaller Companies Fund
Market review
Risk sentiment swung dramatically during the December quarter as pre-US election jitters were
squashed after investors quickly re-evaluated 'Trumponomics’ post the billionaire’s victory. This in turn
saw the S&P/ASX 300 gain a solid 4.9% into year end. Central bank activity including upbeat Fed
verbiage and an emphasis on QE flexibility from the ECB also offered investors guidance during the
period.
On global developments, a hawkish tone from Fed Committee members leading into its decision to
raise rates by 0.25% added fuel to a sell-off in bonds, which showed signs of fatigue into year-end.
Importantly, the FOMC raised both their growth and rate forecasts for 2017. This was against a
backdrop of significant improvements in key economic indicators like consumer confidence,
manufacturing and service activity surveys, as well as retail sales. Revisions to third quarter GDP were
also positive with the annualised metric eventually raised to 3.5%. While the number of jobs added
averaged below the 200,000 mark, wage growth was healthy.
Across the Atlantic, the ECB finally announced plans for its QE programme following months of
speculation. The central bank will reduce the size of purchases by 20 billion euros each month, but also
reduce the maturity of securities that qualify. With scope for adjustments if needed the outcome was
perceived as supportive for risk appetite. Investors in the region also felt relief after the Italian
referendum proved a non-event and concerns over the health of their banking system faded. Further
north, the wave of global optimism offset ‘Brexit’ implementation fears in the UK.
In Asia, the Bank of Japan appeared more optimistic on the outlook for the country’s economy in the
wake of USD/JPY’s 15.4% rally over the quarter. In neighbouring China, data was perceived as
reasonably strong with improvements in manufacturing survey data and decent reads from Industrial
Production and Profits. The Producer Price Index also ended 54 consecutive months of deflation.
However, concerns over continued capital outflows and the Yuan’s depreciation garnered increasing
press coverage heading into year end.
The forces highlighted above largely overshadowed the RBA’s first three meetings with Philip Lowe
presiding as Governor. The central banker noted improvements in Australia’s terms of trade from higher
commodity prices, but also a soft patch for economic growth and mixed labour market data. Importantly,
market pricing shifted from suggesting a cut to a hike as early as November 2017.
Data-wise, a number of quarterly domestic releases surprised the market. Third quarter wage growth
sunk to 1.9% year-on-year – the weakest since the series began in 1998. GDP over the same period
Fund Manager Commentary – December 2016 8
shrunk by 0.5% and the year-on-year reading dropped to its lowest since the GFC at 1.8%. Similarly,
headline CPI grew at a sluggish pace of 1.3% over the previous year.
Sector returns saw a fairly large dispersion in the final three months of the year. At the top of the league
tables were Financials (+12.5%) and Utilities (+9.3%). The former was a large beneficiary of
‘Trumponomics’ given expectations for significant deregulation in the industry. Energy (+7.4%) also
performed strongly as production cut commitments from oil producers sparked an 11.4% gain for crude
oil (WTI). At the other end of the spectrum, Health Care suffered an 8.8% drop. Trump’s election has
prompted uncertainty for parts of the Healthcare sector given the noise around the wind-back of
‘Obamacare’ and the little to no visibility of what might replace it. Telcos (-4.2%) were also hurt as more
domestically-orientated challenges – namely the NBN rollout – weighed on the sector.
Portfolio performance
The BT Wholesale Smaller Companies Fund returned -2.32% (post-fee, pre-tax) over the December
2016 quarter, outperforming the S&P/ASX Small Ordinaries Accumulation Index by 0.13%.
Contributors
Fantastic Holdings, FAN, OW, +45.7%
Fantastic Holdings is the company behind Fantastic Furniture, Australia’s third largest furniture retailer
by sales volume, and the owner of several other furniture and bedding franchises. It was subject to a
cash takeover offer in October from Dutch company Steinhoff at a 43% premium to its price at the time,
which was recommended by the board. The proposal was cleared by the Federal Court of Australia in
mid-December and the shares were acquired later in the month.
Cover More Group, CVO, OW, +33.1%
Cover More is an insurance company, primarily focused on travel insurance, which has expanded from
Australia to operations in the UK, NZ, Asia and the US. It surged over 47% in December following a
cash takeover offer from Swiss giant Zurich Insurance. While the offer is subject to regulatory approval,
its hefty premium was enough to secure board approval, and the takeover is expected to be
implemented towards the start of Q2 2017.
Detractors
Mayne Pharma Group, MYX, -32.8%
Mayne Pharma manufactures and distributes both branded and generic pharmaceuticals, with around
85% of its revenues sourced from the United States. It has done well in recent years on the back of a
pipeline of rights to several drugs, including portfolios from larger peers. It fell in December on the news
that it is one of six companies subject to legal proceedings brought by a collection of US states, who are
Fund Manager Commentary – December 2016 9
accusing the drug companies of artificially inflating the price of a specific drug. At this point, the lawsuit
has just been filed, and there is no certainty around the timing or any possible effect on earnings. The
stock price of the other companies named did not react to the news and MYX’s initial fall appears to
have been an over-reaction.
Sims Metal Management, SGM, UW, +39.8%
The persistence of strong iron ore and coking coal prices has seen a surge in the price of scrap metal
as an alternative, to the benefit of scrap metal dealer Sims Metal management. We do not hold the
stock, which dragged on performance as a result.
Strategy & Outlook
Strong performance from several of the portfolio’s larger positions – such as Cover More, Japara
Healthcare and Cleanaway Waste Management – as well as the lack of exposure to many of the small
cap gold miners, saw it outperform the index in Q4.
The small cap sector has seen several savage responses to earnings disappointments over the past six
months, with the sharp falls in Estia Health, Bellamy’s Australia and Asaleo Care providing pertinent
examples. This is a factor of the hefty valuations to which many small cap stocks have been driven as
investors seek the kind of growth which is not widely available at the large-cap end of the market. There
is in some sense an asymmetric risk at the moment, as those companies which delivered good news
during the AGM season generally only saw modest share price appreciation. This demonstrates that
stock selection is critical in small caps at this juncture – and it is as much about avoiding the more
egregiously over-valued stocks which are vulnerable to earnings disappointment, as it is about
identifying the opportunity for growth and long-term alpha.
The latter opportunity persists. Whilst only the resource sector looks set to benefit from earnings growth
momentum in 2017 among large caps, the small cap sector continues to offer profitable pockets of
growth in areas such as tourism and travel, technology, agriculture, and in niche services or retail. As
always, we maintain our bias to quality and earnings stability and visibility. At the moment, this
approach leads to our largest positions including auto-parts distributor Bapcor, accommodation provider
Mantra, Super Retail Group (which includes franchises such as BCF and Rebel) and in enterprise
software provider Technology One.
The steady pipeline of IPOs which has helped refresh the small cap universe in recent years, removing
the previous resource-related dominance, appears to have dried up. This is at least partly due to
investor exhaustion following a series of over-hyped listings. At the same time, there has been an uptick
in M&A activity in the sector, such as construction company CIMIC’s (previously Leighton) takeover bid
for small cap UGL. This provides opportunities among the cheaper stocks, or those undertaking a
turnaround.
Fund Manager Commentary – December 2016 10
Broadly speaking, we believe we remain in a low-market return environment, given a lack of strong,
broad-based earnings growth and limited scope for a sustained valuation re-rating, especially given that
rating gains surprised on the upside in H2 2016. That said, the market can continue to make steady
gains, particularly if underpinned by a moderate level of economic growth which does not accelerate to
the point where tightening is required – a scenario which appears reasonable at this stage.
International Shares
BT Concentrated Global Share Fund
Market review
Global developed equity markets had a strong quarter shrugging off another quarter of political
uncertainty and market volatility with the MSCI World ex Australia returning 7.68%. US markets were
positive with the S&P 500 up 3.3% driven by a post Trump election win rally to end the year
optimistically on the outlook for fiscal stimulus to continue to drive growth and stimulate the economy.
The US Federal Reserve increased rates as expected, however the language was still very dovish
which saw markets react positively. Key sectors that outperformed for the quarter were Telcos, Utilities
and REITs.
European markets ended the year on a high note, with a strong December quarter supported by gains
in the price of crude oil, movements in the US dollar and central bank actions. At central bank policy
meetings, the European Central Bank held interest rates steady, whilst extending its Quantitative
Easing programme until December 2017, but will reduce purchases from €80 billion to €60 billion from
April 2017.The French CAC index was strongest returning 9.3%, the German DAX was up 9.2% and
the UK FTSE 100 was up 3.5%. Asian markets were mixed with the Japanese Nikkei returning a strong
16.2% with the large fall in the Yen saw optimism that Trump may be able to help with increasing
growth in Japan. The rest of Asia was more negative with the Hang Seng Index dropping 5.6%.
Currency markets were dominated by a continuation of a stronger US dollar as expectations around
Fed tightening in 2017 increased as the markets started to price in increasing inflation expectations for
2017 and beyond. Emerging market currencies and the Yen were the big casualties against the USD,
with the dollar/yen rallying 15.4% for the quarter. The AUD continued to decline, falling 5.9% to
US$0.72, although it fared much better on a trade-weighted basis.
Portfolio performance
The BT Concentrated Global Share Fund returned 8.82% (post fee, pre-tax) over the December 2016
quarter, outperforming its benchmark by 1.14%.
The December 2016 quarter marks the first full calendar quarter for the Fund. The quarter started with
global markets still grappling with the uncertainty that the Brexit vote back in June delivered, and ended
Fund Manager Commentary – December 2016 11
with the unknown outcome of a Trump Presidency and an Italian referendum which has resulted in the
reformist Prime Minister Renzi’s resignation. Amid the volatility and uncertainty we have focused on
investing in companies that we view are trading below their intrinsic value. It was pleasing to that end,
that two of the stocks we held in our portfolio - Janus and Time Warner - received take-over offers
during the quarter.
Our 10%+ holding in regional banks contributed 3.9% to our performance over the quarter. Our
investment in regional banks was predicated on a belief that earnings are cyclically depressed and
valuations are appealing, with companies trading below book value. Each of the banks we own have
the dominant market share in the region that they operate. Balance sheets have strengthened
considerably since the global financial crisis and arguably we have passed the regulatory peak for the
sector. Macro events such as the Brexit vote, speculation as to the outcome of the US election and the
Italian referendum in our view created opportunities to buy these businesses below what we consider to
be their intrinsic value.
US railways were another significant contributor of approximately 1% to the portfolio performance in the
quarter. We added to our holdings over the quarter as we saw the weakness as an opportunity to add to
our position. The businesses have strong balance sheets, declining capital expenditure and are
favourably exposed to a normalisaton of economic growth in the US.
MGM Resorts contributed 0.63% to the Fund’s performance this quarter. MGM Resorts is the dominant
integrated resort operator on the Las Vegas Strip, with 14 properties. They also have a 55% stake in
MGM China. MGM China has one property on the Peninsula in Macau, whilst the other is due to open
in Cotai, Macau in the first quarter of 2017. On December 8th MGM also opened their US$1.4bn
National Harbour property in the Washington DC area. The property is situated within an hour’s drive of
four of the country’s five riches counties by median household income. The company has excess
capacity to deploy as demand normalizes and also becomes ex capital expenditure in 2017, targeting
all free cash flow back to shareholders.
Detracting 0.51% from performance in the quarter was our holding in consumer staple companies. A
general sector rotation into more interest sensitive companies resulted from the Trump election win. We
do not view the consumer staples in our portfolio as bond proxies and instead focus on strong and
growing free cash flows, high margins and growing dividends.
Strategy & Outlook
We continue to be of the view that unlike the last five years equity markets are best suited to stock-
picking than broader market exposure. We remain cognisant of macro and geo-political risks, however
are comfortable that the companies we invest in have dominant positions in their respective industries
and have balance sheets to withstand economic downturns. We also believe that despite the macro
risks our portfolio of companies are well positioned to prosper and reward shareholders.
Fund Manager Commentary – December 2016 12
International Shares
BT Wholesale Core Global Share Fund, managed by AQR
Market review
Global developed equity markets had a strong quarter shrugging off another quarter of political
uncertainty and market volatility with the MSCI World ex Australia returning 7.68%. US markets were
positive with the S&P 500 up 3.3% driven by a post Trump election win rally to end the year
optimistically on the outlook for fiscal stimulus to continue to drive growth and stimulate the economy.
The US Federal Reserve increased rates as expected, however the language was still very dovish
which saw markets react positively. Key sectors that outperformed for the quarter were Telcos, Utilities
and REITs.
European markets ended the year on a high note, with a strong December quarter supported by gains
in the price of crude oil, movements in the US dollar and central bank actions. At central bank policy
meetings, the European Central Bank held interest rates steady, whilst extending its Quantitative
Easing programme until December 2017, but will reduce purchases from €80 billion to €60 billion from
April 2017.The French CAC index was strongest returning 9.3%, the German DAX was up 9.2% and
the UK FTSE 100 was up 3.5%. Asian markets were mixed with the Japanese Nikkei returning a strong
16.2% with the large fall in the Yen saw optimism that Trump may be able to help with increasing
growth in Japan. The rest of Asia was more negative with the Hang Seng Index dropping 5.6%.
Currency markets were dominated by a continuation of a stronger US dollar as expectations around
Fed tightening in 2017 increased as the markets started to price in increasing inflation expectations for
2017 and beyond. Emerging market currencies and the Yen were the big casualties against the USD,
with the dollar/yen rallying 15.4% for the quarter. The AUD continued to decline, falling 5.9% to
US$0.72, although it fared much better on a trade-weighted basis.
Portfolio performance
The BT Wholesale Core Global Share Fund returned 7.97% (post-fee, pre-tax) over the December
2016 quarter, outperforming its benchmark by 0.29%.
The Fund outperformed its benchmark over the fourth quarter of 2016. Outperformance was sourced
from each of the North American, European and developed Asian regions.
In terms of notable thematic performance drivers, the outperformance over the quarter was largely
driven by relative value and investor sentiment themes, which drove positive returns in all regions.
Offsetting somewhat was weakness in momentum measures, again in all regions. Business quality
orientated measures had mixed performance from region to region, with minimal net influence on active
returns at the portfolio level.
Fund Manager Commentary – December 2016 13
Active industry/sector positioning was a source of underperformance over the quarter, largely due to an
underweight position in Financials (which outperformed the broader market) though the underweight in
Energy and overweight in Utilities also contributed negatively. Outperformance at the Fund level was
due to stock selection within Industry groups, with strong results within each of the Industrials, Utilities
and Information Technology sectors all contributing notably over the quarter.
At a stock level, strongest positive contributions came from overweight positions in: PNC Financial
Service Group Inc, an American financial services corporation; United Continental Holdings Inc, the
holding company for United Airlines; and Southwest Airlines Co, a major US low-cost carrier. Largest
detractors were: underweight positions in Bank of America Corp and JPMorgan Chase & Co, both of
which are multinational banking and financial services holding companies headquartered in the US; and
Tyson Foods Inc, a US headquartered multinational operating in the food industry.
Strategy & Outlook
Entering January, the largest active sector positions are overweights in Information Technology and
Utilities and underweights in Health Care and Consumer Discretionary. Relative to long-term
allocations, we remain mildly tilted towards higher quality companies with positive momentum and away
from cheaper industry peers in Europe, while mildly tilted towards relative value considerations in Japan
and the US.
Australian Fixed Income
BT Wholesale Fixed Interest Fund
Market review
During the quarter Australian 3 year bond yields leapt higher by 46 basis points to 1.94% from 1.48%
and 10 year yields climbed a sizeable 83 basis points from 1.94% to 2.77%. This saw the 3-10s yield
curve steepen to 83 basis points. The solid increases were largely attributable to expectations of pro-
growth, pro-inflation Trump policies. This overshadowed to a degree the RBA’s first three meetings with
Philip Lowe as Governor. The central banker noted an improvement in Australia’s terms of trade, but a
soft patch for economic growth and mixed labour market data. Indeed, a motley set of employment
figures over the period revealed no clear trend and left the unemployment rate 0.1% higher at 5.7%.
Leading indicators like business and consumer confidence witnessed a clearer deterioration.
Meanwhile, lagging metrics were weak with third quarter GDP at 1.8% year-on-year (the lowest since
the GFC), wage growth over the same period at 1.9% and a mediocre 1.3% increase in headline CPI.
However, these developments left little lasting impact amid broader global optimism which ultimately
saw markets shift from pricing a cut by the RBA to a hike as early as November 2017.
Fund Manager Commentary – December 2016 14
Portfolio performance
The BT Wholesale Fixed Interest Fund returned -3.57% over the December 2016 quarter (post-fees,
pre-tax), underperforming its benchmark by 0.71%.
The Fund underperformed its benchmark over the quarter. The Cross-Market and Duration strategies
were the largest detractors from performance in the alpha overlay, while the other strategies were
largely flat. The Government bond component underperformed its benchmark with the Yield Curve and
Cross-Market strategies being the main detractors. The Duration strategy was flat over the quarter.
The Credit component outperformed its benchmark with positive performance coming from an
overweight in infrastructure, utilities and subordinated bank paper.
Strategy & Outlook
Fourth quarter inflation data is the key domestic economic data release due in January, however would
need to be much weaker than expected to see the Reserve Bank ease monetary policy in the near
term. The labour market remains weak and household balance sheets remain stretched. The risks to
financial stability have increased and the hurdle for any further monetary policy easing is very high.
Currency moves will be key. The Reserve Bank would become concerned if currency appreciation
occurred without an accompanying increase in either commodity prices or global economic growth
prospects. The market is now looking for further policy tightening from the Federal Reserve in the
United States, which should be supportive for US dollar strength. It is likely that external developments
drive market pricing and expectations more than domestic events in the nearer term.
International Fixed Income
BT Wholesale Global Fixed Interest Fund
Market review
Risk sentiment swung dramatically during the December quarter as pre US election jitters were
squashed after investors quickly re-evaluated ‘Trumponomics’ post the billionaire’s victory. The heavy
sell-off in bond markets that ensued was fanned to some extent by hawkish FOMC verbiage. Ultimately,
the central bank delivered its second rate hike in as many years and issued a more upbeat growth and
rate forecast than anticipated. This was against a backdrop of improving US economic data. This
spurred a sizeable 43 basis point increase in US 2 year yields, from 0.76% to 1.19%. Longer-dated 10
year yields jumped an outsized 85 basis points from 1.59% to 2.44%. Outside the US, investors in
Europe were relieved as the Italian constitutional reform referendum proved a non-event and the ECB
announced the extension of its QE program. While in Asia, the BOJ offered upbeat commentary in the
wake of USD/JPY’s 15.4% rally over the quarter. Japanese 10 year yields rose a modest 14 basis
Fund Manager Commentary – December 2016 15
points to remain near the central bank’s 0% target at 0.05%. At home, the Australian dollar pulled back
by 5.9% against the US dollar as the reserve currency regained its upward momentum. Finally,
developed market equities and commodities enjoyed strong gains.
Portfolio performance
The BT Wholesale Global Fixed Interest Fund returned -3.34% over the December 2016 quarter (post-
fees, pre-tax), underperforming its benchmark by 0.52%.
The Cross-Market, Yield Curve and Duration strategies detracted while FX and Macro strategies were
largely flat. The Cross-market strategy was the largest detractor over the quarter with losses mainly
from long New Zealand vs Australia in the front-end and Australia vs the US in the long end. The
majority of the losses in the Yield Curve strategy were from our Australian front end bill flatteners and
European curve flatteners, although the losses were partially offset by curve steepeners in the front end
of the US curve. Losses in the Duration strategy were from long positions in the Australian and Swedish
front-end earlier in the quarter, and from long positions in the New Zealand front-end in December. The
FX strategy was flat and gains from long USD, short emerging market currencies were offset by losses
in long AUD against a basket of currencies. Our protection positions in Australian iTraxx were largely
flat over the quarter.
Strategy & Outlook
The market is expecting further monetary policy tightening in the US. The FOMC factored in some
expectation of Trump’s fiscal expansion and raised its expected interest rates in the ‘dot plot’. Inflation
has bottomed out in the past few months and is returning to Fed’s target level. Other elements of
Trumponomics include the heightened probability of trade conflicts between the US and its trade
partners. As a result, there are downside risks for emerging markets. They will be impacted via the
exchange rate and international trade channels.
Credit
BT Wholesale Enhanced Credit Fund
Market review
Over the quarter ending December physical cash credit spreads continued to tighten. The positive
performance in credit spreads was helped by perceived market risks largely not materialising and lower
supply of new corporate credit in the domestic market. During the quarter commodity market pricing
remained stable and fears that China would not be able to manage its economic transition to a more
inward focused economy appeared premature. Over the period concerns that the Brexit vote and US
election could induce adverse credit market volatility did not eventuate. Expectations of future US Fed
Fund Manager Commentary – December 2016 16
raising rates and a potentially strengthening US economy saw underlying government yields globally
and domestically increasing, resulting in the Bloomberg Non-Government Index recording a negative
total return for the quarter.
The US Fed rate increase in December was fully priced in by the market before the announcement. In
anticipation of the rate rise, and expectations of increased growth, the US government 10 year bond’s
yield increased nearly one percent from the start of the quarter. This rise in rates impacted the domestic
market with Australian government bond yields increasing upwards of 86 basis points by quarter end.
Whilst global economic data over the period did not exhibit significant changes, expectations of
potential economic and political changes covered the headlines. Event risks included: elections in the
US; anticipated fallout from Brexit; and, the Italian referendum. Fears were that any of these could have
adversely impacted risk markets. The potential of any of these events causing significant market
volatility combined with smaller intermediaries’ inventory, amongst other factors, resulted in lower
secondary market liquidity for corporate credit.
Issuance of corporate credit was approximately 20% lower than the prior comparative period. The
lower issuance helped support secondary market pricing of credit. Over the quarter, consistent with a
strong rebound in commodity pricing the resources sector was the strongest performer on a spread to
swap basis. In addition, the defensive sectors of infrastructure and utilities were strong performers.
Over the quarter physical credit and CDS tightened.
Portfolio performance
The BT Wholesale Enhanced Credit Fund returned -1.57% over the December 2016 quarter (post-fees,
pre-tax), outperforming the benchmark by 0.05%.
Positive performance came from an overweight in infrastructure, utilities and subordinate bank paper.
Negative performance came from swap spread movements.
Activity over the quarter included acquiring utility, infrastructure and finance company bonds.
Strategy & Outlook
Our macro credit view remains neutral. Going into 2017 there is the potential for significant event risk
and associated volatility. Early in 2017 the new US President will be inaugurated and it’s unclear what
mix of policies will be enacted and their impact. We expect continued monetary policy action from
central banks such as the US Federal Reserve and ECB to impact risk appetite. In Europe and the UK
we will have the start of Brexit and elections in France and Germany which could influence investor
sentiment.
Fund Manager Commentary – December 2016 17
We continue to have ongoing concerns over solvency of some European banks that could be a
headwind in 2017 without new capital injections. Going forward it will be the impact of new banking
regulations that could be the catalyst for improving solvency. Given the potential headline risks and
associated contagion concerns we continue to remain underweight European financials.
Whilst we maintain a more sanguine longer term view we believe near term volatility could erupt to
negatively impact credit performance. Risk markets will continue to suffer from uncertainty and
unexpected consequences from events mentioned above. In addition, shifting expectations on central
bank interventions will feed volatility.
Global growth appears to be tracking around 2.8% going into 2017 with corporate capital spending
expected to increase given improved global business sentiment. Underpinning this is the expectation of
China maintaining it balancing act of stimulus, credit easing and currency depreciation. China’s growth
story underpins commodity price stability. That said, iron ore, whilst performing strongly in the fourth
quarter of 2016, appears likely to weaken with increases to Vale’s iron ore production and high China
port inventories. This could represent a vulnerability to commodity price stability.
Accordingly whilst near term market tone is positive we remain cautious with many unknowns going into
2017. Domestically we see weak growth persisting and improvement largely dependent on commodity
price stability and housing. As such we continue to recommend a defensive approach with any
overweights in operationally resilient sectors such as utilities and infrastructure that provide a higher
yield to index returns.
Cash
BT Wholesale Managed Cash and BT Wholesale Enhanced Cash Funds
Market review
Risk sentiment swung dramatically during the December quarter as pre-US election jitters were
squashed after investors quickly re-evaluated ‘Trumponomics’ post the billionaire’s victory. This largely
overshadowed the RBA’s first three meetings with Philip Lowe presiding as Governor. The central
banker noted improvements in Australia’s terms of trade from higher commodity prices, but also a soft
patch for economic growth and mixed labour market data. Importantly, market pricing shifted from
suggesting a cut to a hike as early as November 2017.
Data-wise, a number of quarterly domestic releases surprised the market. Third quarter wage growth
sunk to 1.9% year-on-year – the weakest since the series began in 1998. GDP over the same period
shrunk by 0.5% and the year-on-year reading dropped to its lowest since the GFC at 1.8%. Similarly,
headline CPI over the previous year grew at a slow pace of 1.3%, despite the quarter-on-quarter print of
0.7% beating the consensus forecast.
Fund Manager Commentary – December 2016 18
Most major leading indicators of economic growth also deteriorated. This included business confidence
and consumer confidence. However, retail sales were actually reasonably resilient over the period.
Meanwhile, a motley set of employment figures revealed no clear trend and left the unemployment rate
0.1% higher at 5.7%.
On global developments, aside from the US election the other major development in the world’s largest
economy was the Fed’s rate rise in December. A hawkish tone from Committee members leading into
the decision added fuel to the sell-off in bonds, which lost some momentum into year-end. Alongside
more upbeat verbiage from the central bank, the FOMC raised both their growth and rate forecasts for
2017. This was against a backdrop of significant improvements in key economic indicators like
consumer confidence, manufacturing and service activity surveys, as well as retail sales. Revisions to
third quarter GDP were also positive with the annualised metric eventually raised to 3.5%. While the
number of jobs added averaged below the 200,000 mark, wage growth was healthy.
Across the Atlantic, the ECB finally announced plans for its QE programme following months of
speculation. The central bank will reduce the size of purchases by 20 billion each month, but also
reduce the maturity of securities that qualify. With an added emphasis on flexibility for adjustments if
needed the outcome was perceived as supportive for risk appetite. Investors in the region also felt relief
after the Italian referendum proved a non-event and concerns over the health of their banking system
seemingly became a smaller blip on the radar. Further north, the wave of global optimism offset ‘Brexit’
implementation fears in the UK.
In Asia, the Bank of Japan appeared more upbeat on the outlook for the country’s economy in the wake
of USD/JPY’s +15% rally over the quarter. In neighbouring China, data was perceived as reasonably
strong with improvements in manufacturing survey data and decent reads from Industrial Production
and Profits. The Producer Price Index also ended 54 consecutive months of deflation. However,
concerns over continued capital outflows and the Yuan’s depreciation garnered increasing press
coverage heading into year end.
Regarding rates, the heavy global bond sell-off pushed Australian 3 year yields higher by 46 basis
points to 1.94%, while their 10 year counterparts rose 83 basis points to 2.77%. At the front end, BBSW
rose 8 basis points to 1.82%. In the US, 2 year rates climbed 43 basis points to 1.19% and further out
the curve 10 year yields rose 85 basis points to 2.44%. The excitement regarding prospective Trump
policies was also felt strongly in FX markets with the AUD/USD dropping -5.9% to finish the quarter at
0.7208.
Credit markets performed well in the face of significant events over the December quarter. These
events included an unexpected result in the US elections, concerns around the outcomes of FOMC and
ECB meetings and the Italian constitutional reform referendum. Strengthening commodity prices were
supportive for risk assets.
Fund Manager Commentary – December 2016 19
Delving deeper on a month-by-month basis, credit spreads finished October relatively unchanged with
accruals driving total returns. The market held up well given concerns around ECB tapering. Bloomberg
reports emerged citing unnamed eurozone central bank officials, reporting that the ECB is likely to
gradually wind down bond purchases before the scheduled March 2017 conclusion of its quantitative-
easing program. However, later both the ECB President and Vice President denied the reports which
saw risk assets recover. Soft Chinese and US payrolls data weakened sentiment. However, supporting
markets was a dovish Yellen statement suggesting the US economy could be allowed to overheat as
the current recovery has not been strong enough, as well as firm US manufacturing and GDP data. A
better-than-expected US earnings season also helped risk appetite; 77% of companies beat
expectations while both revenue and earnings increased by 2% and 3% respectively versus the prior
corresponding period.
In November, credit markets performed reasonably given significant event risks. An unexpected Trump
win in the US elections saw a sharp rise in global bond yields on the back of an increase in future
inflation expectations as well as more government debt supply to help fund the potential new policies.
This sharp rise in yields would normally see a widening of credit spreads. Trump policies are expected
to be pro US growth through fiscal spend on infrastructure, manufacturing and tax cuts for corporates
and individuals. Also, policies around reducing banking regulation were taken positively by markets.
However, there were concerns around his protectionist stance on international trade due to his
comments on raising tariffs on imported goods. This sparked fears of a trade war with China that could
result in a reduction in global GDP growth. The markets had also been grappling with the Italian
constitutional reform referendum and implications for the country’s troubled banks. Italy is grappling with
slowing growth, high unemployment and distress in its banking system. Italian banks have been under
pressure because of the high number of nonperforming loans they are holding and worries about
whether the banks can recapitalize. Physical credit spreads were actually a little tighter in November on
the back of a rally in commodity prices. The strength in crude oil (+5.5%), iron ore and coking coal
prices over the month on the back of the expected Trump infrastructure spend and supply constraints
has supported credit market spreads.
Finally in December, credit spreads performed well. Supporting the market was a continuation of
positive sentiment around Trump’s pro US growth policies, the European Central Bank extending its
asset-purchase program, oil producing nations agreeing on production cuts, the FOMC showing greater
confidence in the US economy going forward, whilst the Italian referendum “no” vote had minimal
impact on markets.
The ECB’s announcement of a nine-month extension to their asset purchase program at a reduced rate
of €60billion month from March onward, a reduction of €20 billion a month compared with market
expectations of a six-month extension at an unchanged pace. In a positive move, the minimum maturity
of the purchases was reduced from 2 years to 1 year and the yield on security purchases no longer
constrained by the ECB’s deposit floor of -0.4%, i.e. they can be bought at a lower yield. This is bullish
for shorter dated bonds and acts as a curve steepening policy which is supportive for banks. Draghi
Fund Manager Commentary – December 2016 20
said the ECB decision didn’t constitute a move to taper and tapering had not been discussed and the
presence of the ECB on the markets will be there for a long time. The dovish tone of the press
conference suggest that the high level of monetary accommodation in the Euro area remains in place.
The Australian iTraxx index (Series 26 contract) traded in a 14 basis point (bp) range finishing the
quarter 1bp tighter to +104bps. Physical credit spreads also strengthened, tightening 2bps on average.
The best performing sectors were resources, RMBS, infrastructure and telecoms narrowing 17, 8, 7 and
6bps respectively, whilst domestic banks underperformed, finishing the quarter 3bps wider. Semi-
government bonds narrowed 1bp to government bonds.
Portfolio performance
Managed Cash
The BT Wholesale Managed Cash Fund returned 0.47% over the December 2016 quarter (post-fee,
pre-tax), outperforming its benchmark by 0.03%.
The Fund returned 52 basis points for the quarter, outperforming its benchmark by 9 basis points and
26 basis points for the year. With a higher running yield than the index the Fund remains well positioned
to outperform. Themes and credit exposure remain consistent with prior months, with excess spread
from A-1 rated issuers likely to be the main driver of outperformance. The Fund ended the quarter with
a weighted average maturity of 65 days (maximum limit of 70 days). Yields further out the curve
continue to offer better relative value and the weighted average maturity has consistently been longer
than benchmark due to this. With longer dated yields offering better value and with Reserve Bank
monetary policy tightening a distant prospect we will remain longer than benchmark.
Enhanced Cash
The BT Wholesale Enhanced Cash Fund returned 0.67% over the December 2016 quarter (post-fee,
pre-tax), outperforming its benchmark by 0.23%.
The Fund had a strong quarter of performance. Positive performance came from infrastructure,
financials, industrials and RMBS sectors. Activity during the quarter included investing in financials,
infrastructure and RMBS sectors funded out of cash.
As at the end of the quarter, the Fund had a credit spread of 83basis points over bank bills, interest rate
duration of 0.12 years and credit spread duration of 1.50 years.
Strategy & Outlook
Fourth quarter inflation data is the key domestic economic data release due in January, however would
need to be much weaker than expected to see the Reserve Bank ease monetary policy in the near
term. The labour market remains weak, with wage inflation at record low levels and employment growth
Fund Manager Commentary – December 2016 21
concentrated in part time jobs over the past 12 months. Household balance sheets remain stretched:
the ratio of household debt to disposable income is elevated and has continued to rise. The risks to
financial stability have increased and the hurdle for any further monetary policy easing is very high.
Currency moves will be key. Lower interest rates and the fall in the currency have helped support the
economy as it transitions away from the mining investment boom. The Reserve Bank would become
concerned if currency appreciation occurred without an accompanying increase in either commodity
prices or global economic growth prospects. The market is now looking for further policy tightening from
the Federal Reserve in the United States, which should be supportive for US dollar strength if it occurs.
It is likely that external developments drive market pricing and expectations more than domestic events
in the nearer term.
Australian Property
BT Wholesale Property Securities Fund
Market review
The REIT sector generated a total return of -0.73% for the December quarter, underperforming the
broader market which was up 4.9%. Year rolling AREITs have returned 13.2%, outperforming the
broader market by 1.4%. In global REITS, Australia was the best performing (+15% in USD terms) in
2016, while UK (-22%) was the worst performing market.
The best performing stocks over the quarter were Dexus (+7.5%), Cromwell (+7.0%) and Viva Energy
(+6.2%). The worst performing stocks were mostly large caps and Generation Healthcare REIT -9.1%.
It was another volatile quarter for global capital markets, with the US equity market surging almost 9%
after a pre election slump. The surge reflects confidence about the buoyant US economy with payrolls
and unemployment pointing to a recovery in the US economy. The Australian share market performed
particularly well (+4.9% over the quarter) despite a weak GDP print. The Australian economy
unexpectedly contracted 0.5% in the third quarter of 2016, compared to an upwardly revised 0.6%
growth in the June quarter and missing market consensus of a 0.3% expansion. It was the first
contraction since the March quarter 2011. Through the year, the economy grew by 1.8%, slowing
sharply from a 3.3% annualised expansion in the June quarter.
REIT news for the quarter included GPT selling its stake in Woden Shopping centre at an 11% premium
to book value and Investa office reporting an 8-9% uplift in office values. This sale and valuation
increase bodes well for the asset rich AREIT sector. Over the quarter we also saw a new AREIT debut
Charter Hall Long WALE, a diversified REIT with 66 properties, managed by Charter Hall Group with a
lease expiry of 12.5 years. In total there have been three new REITS (Charter Hall long WALE, Viva
Energy and Propertylink) debut this year increasing choice in the sector.
Fund Manager Commentary – December 2016 22
Portfolio performance
The BT Wholesale Property Securities Fund returned -0.85% over the December 2016 quarter (post-
fee, pre-tax), underperforming its benchmark by 0.12%.
The Fund performed close to benchmark for the December quarter. Overweight positions including
Propertylink, Lifestyle Communities and Investa Office and underweight positions in Iron Mountain and
BWP added to performance. The main detractors were from our underweight positions in Cromwell
Dexus and Charter Hall Retail. An overweight to Charter Long WALE also detracted.
Strategy & Outlook
The sector is now priced on an FY17 dividend yield of 4.7%, 28% premium to NTA and a PE ratio of 18
times.. However, earnings and balance sheets are stable with sector gearing at 30% and falling slowly
as asset prices continue to rise. Falling bond and cash yields continue to be supportive. The better
managed REITs continue to use the buoyant direct market as an opportunity to divest non-core assets.
International Property
BT Wholesale Global Property Securities Fund, managed by AEW
Market Review (In USD)
For the quarter ended 31 December 2016, performance of the global property securities market (on an
ex-Australia basis) as measured by the FTSE EPRA/NAREIT Developed Index declined, posting a total
return of -5.4%. Europe (down 8.9%) was the weakest performing region, followed by Asia Pacific
(down 8.0%) and North America (down 3.4%). In Asia Pacific all countries were in negative territory for
the quarter. Hong Kong (down 12.1%) posted the largest decline, followed by Singapore (down 12.0%),
New Zealand (down 9.1%) and Japan (down 4.2%). Similarly, results in Europe were negative in all
countries. Germany (down 13.5%) was the weakest performer, followed by Sweden (down 11.9%) and
France (down 11.5%). Within North America, the US and Canada returned -3.5% and -2.1%,
respectively.
Portfolio performance
The BT Wholesale Global Property Securities Fund returned -2.23% over the December 2016 quarter
(post-fee, pre-tax) outperforming its benchmark by 0.22%.
Fund Manager Commentary – December 2016 23
North America
For the quarter ended 31 December 2016, BT’s North America portfolio returned -2.60% before fees
and taxes, beating the FTSE EPRA/NAREIT North America Index by 79 basis points. Outperformance
relative to the benchmark was driven by positive sector allocation results and, to a lesser extent,
positive stock selection results. Regarding sector allocation, positive results were attributable to the
portfolio’s underweight to the underperforming triple net lease and health care sectors. The portfolio’s
small cash position was also a positive contributor given the REIT sector’s negative absolute
performance for the quarter. In terms of stock selection, results were strongest in the triple net lease,
data centre, and health care sectors and were weakest in the office, apartment, and manufactured
home sectors. Among the portfolio’s holdings, top individual contributors to relative performance
included overweight positions in outperforming Host Hotels & Resorts (HST) and DuPont Fabros
Technology (DFT), and a lack of exposure to underperforming HCP, Inc. (HCP). Detractors most
notably included overweight positions in underperforming Simon Property Group (SPG) and Welltower
(HCN), and a lack of exposure to outperforming Essex Property Trust (ESS).
Europe
For the quarter ended 31 December 2016, BT’s European portfolio returned -9.52% before fees and
taxes, lagging the FTSE EPRA/NAREIT Developed Europe Index by 55 basis points.
Underperformance relative to the benchmark was attributable to both negative country allocation results
and negative stock selection results. Regarding country allocation, negative results were driven by the
portfolio’s overweight to the underperforming Sweden and France, as well as an underweight to the
outperforming Switzerland. In terms of stock selection, results were weakest in France, Germany, and
Switzerland and were strongest in the United Kingdom, Netherlands, and Sweden. Among the
portfolio’s holdings, top positive contributors to relative performance included overweight positions in
outperforming Workspace Group Plc. (United Kingdom) and Segro Plc. (United Kingdom), and a lack of
exposure to underperforming Fastighets Balder AB Class B (Sweden). Detractors most notably
included overweight positions in underperforming Deutsche Wohnen AG (Germany) and Gecina SA
(France), and a lack of exposure to outperforming Derwent London Plc. (United Kingdom).
Asia
For the quarter ended 31 December 2016, BT’s Asia portfolio returned -7.80% before fees and taxes,
outperforming the regional EPRA benchmark return by 18 basis points. Outperformance relative to the
benchmark was attributable to both positive stock selection results and positive country allocation
results. In terms of stock selection, positive results in Japan were partially offset by negative results in
Singapore and Hong Kong. Positive country allocation results were largely driven by the portfolio’s
underweight to the underperforming Singapore. Among the portfolio’s holdings, top contributors to
relative performance included a lack of exposure to underperforming New World Development (Hong
Kong) and overweight positions in outperforming Tokyo Tatemono (Japan) and Mitsui Fudosan (Japan).
Detractors most notably included an underweight position in outperforming Sumitomo Realty &
Fund Manager Commentary – December 2016 24
Development (Japan) and overweight positions in underperforming Cheung Kong Property Holdings
(Hong Kong) and Japan Retail Fund Investment (Japan).
Strategy & Outlook
North America
Looking ahead, while higher interest rates could put some upward pressure on cap rates, real estate
fundamentals are strong. Demand growth was a bit slower than prior years in 2016, though still
generally enough to offset new supply. On a national level, supply risk is limited outside of apartments
and seniors housing. A few select office, industrial and hotel markets are seeing meaningful
construction, though in most cases it is being built to fill strong demand in these same markets.
Construction costs would likely rise if increased infrastructure spending becomes a reality and should
help keep new supply under control. At the end of 2016, REITs continued to trade within fair value
range versus other asset classes. With interest rates moving up, we expect investors to pay increased
attention to the factors that differentiate REIT returns from bond returns, most notably that REIT
incomes rise faster in a more rapidly growing economy and that rising rents and property values help
offset inflation. Some investors will inevitably lump REITs in with bonds and react negatively to
increases in interest rates, but it is important to be mindful that interest rate increases will likely only be
sustained if the economy is growing. A more sophisticated view will factor in the higher earnings growth
that will likely accompany any meaningful improvement in the economy. Overall, for the sector, we
expect average cash flow growth for REITs to be roughly 7% per share in 2017.
Europe
During the quarter, interest rates moved up from their all-time lows by a range of 30 basis points
(Germany) and 50 basis points (United Kingdom and Spain). It is likely that the continued trend will be
upwards as world economic growth is on a solid recovery path and central banks have begun to
recognize the negative effects of very low interest rates. The Bank of England is done cutting interest
rates to protect the value of the British pound as import inflation could become a problem. The
European Central Bank (ECB) extended quantitative easing during the quarter from March through
December 2017, but the amount of its monthly purchases will be scaled back. Other measures from the
ECB, such as the ability to buy shorter-dated debt, are signs that the central bank is targeting a steeper
yield curve but also that quantitative easing will wind down in the future, though at a slow pace. During
the fourth quarter, the worst performing real estate sector in Europe was German residential. These
stocks are seen as the most interest rate sensitive sector by investors as leases are long, risk of
vacancy is limited, and rents are moving up. The best performing sector in the fourth quarter were the
London office REITs, which underwent a significant correction following the Brexit vote in June 2016
and were trading at greater than 20% discounts to their net asset values. The London office market has
been reasonably resilient in the second half of the year. Demand for space has continued to be fairly
good, and the investment market has been buoyant due to strong demand from foreign investors, who
wanted to take advantage of the fall of the British Pound. London office REITs bounced back on this
Fund Manager Commentary – December 2016 25
news but were still trading at double digit discounts to net asset values at year-end. Looking ahead,
although rising interest rates could be a headwind for property equities, it is expected that interest rates
will stay reasonably low in historical terms. Moreover, the spread between interest rates and property
yields will continue to be relatively attractive. A more solid economic environment will lead to increased
demand for space and, thus, rising rents in the better locations. Higher inflation is a positive for the
REIT sector as Continental European rents are contractually indexed to inflation. Still, a significant or
rapid increase in interest rates would be a risk to property valuations and the European property sector
(as well as other asset classes). Overall, after the relatively disappointing performance of 2016, the
sector no longer traded at a premium and stocks had no growth priced in. At year-end, European REITs
were trading at a 3% discount to net asset values with an earnings yield of 5.4% and a dividend yield of
3.7%.
Asia
Key events this year like Brexit and Trump’s victory in the US election resulted in changes in interest
rate expectations and currencies, driving the performance of property stocks. In Japan, following
Trump’s victory in the US, the Japanese yen weakened by 15%, and developers rallied strongly on
growth and inflation expectations. JREITs underperformed, however, as the 10 year Japanese
Government Bond yield crept up from -0.05% to 0.03%, reducing the attractiveness of JREITs. Demand
for property assets remained strong with both domestic investors such as pension funds and quasi-
government agencies (e.g. Japan Post) as well as overseas investors looking to deploy capital,
increasing the possibility of further cap rate compression as assets available for sale are limited. The
Hong Kong property market saw the greatest decline in the region during the quarter, led by
developers. The Hong Kong government announced in November that it will increase the Double Stamp
Duty for residential homes to a standardized rate of 15%. The new measures came on the back of a
12% rebound in property prices since the trough in March and increasing concerns that investment
activities were driving the market upwards. We believe this new measure is aimed at curbing
investment demand, especially in light of the recent run-up in prices, and could have a material impact
on transaction volumes. Singapore was the worst performing market in 2016, driven by a weak property
outlook and rising bond yields. Both CBD office and retail rents declined in 2016, and Singapore's 10
year Government Bond yield ended the year at 2.47%, inching closer towards the 2.6% level at which it
began 2016. Most of the Singapore REITs have been fixing their debt in the range of 70-80% and, thus,
the impact of higher interest costs remains fairly limited in the near term. Looking into 2017, we expect
Australia to have the best property fundamentals within the region, while the outlook for the rest of the
region is mixed. With the correction in the fourth quarter, value has emerged within the region. The
portfolio continues to seek the best relative value in the sub-property markets where we expect to see
improving property fundamentals, with potential earnings, dividend, and net asset value upside.
Fund Manager Commentary – December 2016 26
Active Balanced
BT Wholesale Active Balanced Fund
Market review
The S&P/ASX 200 index ended the year strongly delivering a 4.93% return for the December quarter.
The banks performed the strongest, rebounding 13.8% for the quarter after a tough few months
previously. A combination of rising bond yields and the Trump election win saw investors become more
confident of future earnings potential and less regulation headwinds for banks. The other strong sectors
were Utilities (9.2%), Resources (8.7%), Materials (7.9%) and Energy (7.5%) all enjoying a strong
rebound in underlying commodity prices over the last six months, but especially the December quarter.
Global developed equity markets also had a strong quarter shrugging off another quarter of political
uncertainty and market volatility with the MSCI World ex Australia returning 7.68%. US markets were
positive with the S&P 500 up 3.3% driven by a post Trump election win rally to end the year on
optimism on the outlook for fiscal stimulus to continue to drive growth and stimulate the economy. The
US Federal Reserve increased rates as expected, however the language was still very dovish which
saw markets react positively. Key sectors that outperformed for the quarter were Telcos, Utilities and
REITs.
European markets ended the year on a high note, with a strong December quarter supported by gains
in the price of Crude Oil, movements in the US dollar and central bank actions. At central bank policy
meetings the European Central Bank held interest rates steady, whilst extending its Quantitative Easing
programme until December 2017, but will reduce purchases from €80 billion, to €60billion from April
2017.The French CAC index was strongest returning 9.3%, the German DAX was up 9.2% and the UK
FTSE 100 was up 3.5%. Asian markets were mixed with the Japanese Nikkei returning a strong 16.2%.
Japan saw a large fall in the Yen on the back of optimism that Trump may be able to help with
increasing growth in Japan. The rest of Asia was more negative with the Hang Seng Index dropping
5.6%.
Currency markets were dominated by a continuation of a stronger US dollar as expectations around
Fed tightening in 2017 increased as the markets started to price in increasing inflation expectations for
2017 and beyond. Emerging market currencies and the Yen were the big casualties against the USD,
with the dollar/yen rallying 15.4% for the quarter. The AUD continued its decline, falling 5.9%% to
US$0.72, although it fared much better on a trade-weighted basis.
During the quarter Australian 3 year bond yields leapt higher by 46 basis points to 1.94% from 1.48%
and 10 year yields climbed a sizeable 83 basis points from 1.94% to 2.77%. This saw the 3-10s yield
curve steepen to 83 basis points. The solid increases were largely attributable to expectations of pro-
growth, pro-inflation Trump policies. This overshadowed to a degree the RBA’s first three meetings with
Philip Lowe as Governor. US bonds also moved higher: a sizeable 43 basis point increase in US 2 year
Fund Manager Commentary – December 2016 27
yields, from 0.76% to 1.19% and longer-dated 10 year yields jumped an outsized 85 basis points from
1.59% to 2.44%.
Australian bonds were negative with the Bloomberg Composite Bond Index down -2.86% and the JP
Morgan Global Bond Index also down -2.82%.
Portfolio performance
The BT Wholesale Active Balanced Fund returned 2.45% (post-fee, pre-tax) over the December 2016
quarter, underperforming its benchmark by 0.36%.
The key drivers of the positive absolute returns was stronger equity markets that continued their rally
post Trump’s election on renewed optimism of fiscal policy driving growth in the US and hopefully
globally. This was offset by negative bond markets where yields rose dramatically as markets started to
price in more rate rises due to increasing inflation.
The Australian equity component realised a reasonable outperformance relative to its benchmark over
the December quarter. The largest individual contributors were overweights in Rio Tinto and ANZ. The
former rallied alongside significant gains for its key commodity exports, while the latter strengthened on
fading domestic banking concerns and broader global deregulation speculation.
On the global equities front, a decent return above the benchmark was delivered over the quarter. This
was sourced from each of the North American, European and developed Asian regions. Relative value
and investor sentiment themes made contributions, while the momentum sub-strategies
underperformed. Sector-wise, an underweight in Financials detracted given the area’s strong run.
The alternatives component delivered a strong excess return over the period. Contributions were made
by all subcomponents barring Managed Futures and Pure Alpha Fixed Income, with the most value
added by the Equity Market Neutral, Global Macro and Event Driven strategies. The Tactical Asset
Allocation detracted -0.36% from returns. This stemmed largely from the alternatives bucket, which
includes commodities like copper, crude oil and gold. Meanwhile, positions in Australian and
International equities added value.
Strategy & Outlook
Equity markets ended the year on a positive note with all the recent political uncertainty taken a positive
and the uncertainty around the Trump presidency - for the time being - taken as less concerning.
Whilst bond markets seem to have consolidated from their recent rise in yields and despite the US
Federal Reserve raising rates for the second time this decade, there is less of a concern now about
bond yields rising too quickly.
Fund Manager Commentary – December 2016 28
China still remains a wildcard and growing debt is definitely a concern for both global markets and the
Australian share market, especially commodities that have enjoyed a nice recovery and continue to go
higher on the belief that growth in the US and China will continue to remain strong.
We remain cautious in our positioning relying on our active management of the underlying asset
classes to help offset volatility combined with our exposure to alternatives as well as tactically moving
the portfolio around. As always active management plays an important role in managing these risks and
taking advantage of market dislocations driven by sentiment rather than underlying fundamentals.
Fund Manager Commentary – December 2016 29
Performance as at 31 December 2016
F YT D 1 year 2 Years 3 Years 5 Years Since
(pa) (pa) (pa) (pa) Incp. (pa)
Australian Shares - All Cap
B T Who lesale C o re A ustralian Share F und A P IR - R F A 0818A U
Total Return (post-fee, pre-tax) 4.05 5.60 10.26 10.26 5.74 5.94 5.84 11.61 9.90
Total Return (pre-fee, pre-tax) 4.12 5.81 10.69 10.69 6.56 6.77 6.67 12.49 10.91
Benchmark 4.34 4.93 10.43 10.43 11.79 7.20 6.57 11.64 9.97
B T Who lesale Imputat io n F und A P IR - R F A 0103A U
Total Return (post-fee, pre-tax) 4.28 6.41 10.93 10.93 6.54 4.67 4.97 10.31 9.50
Total Return (pre-fee, pre-tax) 4.35 6.65 11.42 11.42 7.49 5.61 5.92 11.30 10.52
Benchmark 4.34 4.93 10.43 10.43 11.79 7.20 6.57 11.64 8.65
B T Who lesale F o cus A ustralian Share F und A P IR - R F A 0059A U
Total Return (post-fee, pre-tax) 4.16 6.85 12.30 12.30 7.98 7.96 7.93 12.77 8.88
Total Return (pre-fee, pre-tax) 4.20 7.13 12.80 12.80 8.23 8.95 8.87 13.70 9.95
Benchmark 4.34 4.93 10.43 10.43 11.79 7.20 6.57 11.64 7.28
B T Who lesale Ethical Share F und A P IR - R F A 0025A U
Total Return (post-fee, pre-tax) 4.26 6.44 10.55 10.55 6.05 6.32 6.64 11.45 8.35
Total Return (pre-fee, pre-tax) 4.34 6.69 11.07 11.07 7.05 7.33 7.66 12.51 9.41
Benchmark 4.34 4.93 10.43 10.43 11.79 7.20 6.57 11.64 7.95
Australian Shares - Mid Cap
B T Who lesale M idC ap F und A P IR - B T A 0313A U
Total Return (post-fee, pre-tax) 3.65 0.17 8.11 8.11 12.08 13.02 12.75 15.32 9.59
Total Return (pre-fee, pre-tax) 3.72 0.40 8.60 8.60 12.66 14.29 14.15 17.20 11.94
Benchmark 4.24 -0.08 6.93 6.93 16.48 13.28 12.12 12.50 4.45
Australian Shares - Small Cap
B T Who lesale Smaller C o mpanies F und A P IR - R F A 0819A U
Total Return (post-fee, pre-tax) 3.91 -2.32 4.73 4.73 3.41 13.85 8.44 13.18 13.24
Total Return (pre-fee, pre-tax) 4.03 -2.01 5.38 5.38 4.70 15.28 9.80 14.60 14.53
Benchmark 3.61 -2.45 5.84 5.84 13.18 11.66 6.24 4.87 7.49
Australian Shares - Micro Cap
B T Who lesale M icro C ap Oppo rtunit ies F und A P IR - R F A 0061A U
Total Return (post-fee, pre-tax) 1.21 -3.88 10.67 10.67 13.95 22.65 19.09 22.01 18.91
Total Return (pre-fee, pre-tax) 0.79 -3.50 12.56 12.56 15.49 26.87 23.86 28.13 24.56
Benchmark 3.61 -2.45 5.84 5.84 13.18 11.66 6.24 4.87 1.94
International Shares
B T Who lesale C o re Glo bal Share F und A P IR - R F A 0821A U
Total Return (post-fee, pre-tax) 4.32 7.97 10.90 10.90 4.96 8.73 10.97 18.34 5.53
Total Return (pre-fee, pre-tax) 4.40 8.24 11.43 11.43 5.95 9.77 12.04 19.48 6.70
Benchmark 4.48 7.68 9.78 9.78 7.92 9.84 11.53 18.58 7.05
B T Glo bal Emerging M arkets Oppo rtunit ies F und - Who lesale A P IR - B T A 0419A U
Total Return (post-fee, pre-tax) 1.77 -2.22 5.19 5.19 4.48 2.71 4.99 N/A 8.80
Total Return (pre-fee, pre-tax) 1.89 -1.87 5.93 5.93 5.95 4.14 6.61 N/A 11.29
Benchmark 2.26 1.28 7.44 7.44 11.72 3.40 4.56 N/A 8.62
B T C o ncentrated Glo bal Share F und A P IR - B T A 0503A U
Total Return (post-fee, pre-tax) 3.10 8.82 N/A N/A N/A N/A N/A N/A 8.25
Total Return (pre-fee, pre-tax) 3.20 9.16 N/A N/A N/A N/A N/A N/A 8.81
Benchmark 4.48 7.68 N/A N/A N/A N/A N/A N/A 7.63
Property
B T Who lesale P ro perty Securit ies F und A P IR - B T A 0061A U
Total Return (post-fee, pre-tax) 6.84 -0.85 -2.27 -2.27 13.01 13.11 17.32 18.02 7.70
Total Return (pre-fee, pre-tax) 6.90 -0.69 -1.94 -1.94 13.75 13.83 18.08 18.77 8.52
Benchmark 6.75 -0.73 -2.60 -2.60 13.18 13.78 17.96 18.51 7.56
B T Who lesale Glo bal P ro perty Securit ies F und A P IR - R F A 0051A U
Total Return (post-fee, pre-tax) 3.58 -2.23 -0.95 -0.95 4.71 4.26 11.39 12.97 9.54
Total Return (pre-fee, pre-tax) 3.66 -2.00 -0.49 -0.49 5.66 5.22 12.42 14.02 10.54
Benchmark 3.39 -2.45 -0.94 -0.94 5.59 4.72 12.09 13.48 9.25
Fixed Interest
B T Who lesale F ixed Interest F und A P IR - R F A 0813A U
Total Return (post-fee, pre-tax) -0.59 -3.57 -2.94 -2.94 1.42 1.49 4.67 4.39 6.58
Total Return (pre-fee, pre-tax) -0.55 -3.45 -2.69 -2.69 1.93 2.00 5.19 4.91 7.14
Benchmark -0.17 -2.86 -1.96 -1.96 2.92 2.75 5.05 4.95 6.80
B T Who lesale Glo bal F ixed Interest F und A P IR - R F A 0032A U
Total Return (post-fee, pre-tax) 0.01 -3.34 -3.30 -3.30 4.16 2.82 5.84 5.18 6.42
Total Return (pre-fee, pre-tax) 0.06 -3.21 -3.04 -3.04 4.71 3.37 6.40 5.73 7.00
Benchmark 0.29 -2.82 -2.61 -2.61 4.93 4.28 6.55 5.95 7.34
B T Who lesale Enhanced C redit F und A P IR - R F A 0100A U
Total Return (post-fee, pre-tax) -0.22 -1.57 -0.33 -0.33 3.32 3.01 4.81 5.50 5.86
Total Return (pre-fee, pre-tax) -0.18 -1.46 -0.11 -0.11 3.79 3.48 5.28 5.98 6.39
Benchmark -0.23 -1.62 -0.40 -0.40 3.40 3.14 4.82 5.53 5.98
Cash & Income
B T Who lesale Enhanced C ash F und A P IR - WF S0377A U
Total Return (post-fee, pre-tax) 0.23 0.67 1.43 1.43 2.68 2.48 2.80 3.59 5.05
Total Return (pre-fee, pre-tax) 0.25 0.73 1.55 1.55 2.94 2.74 3.06 3.84 5.40
Benchmark 0.15 0.44 0.92 0.92 2.07 2.20 2.37 2.78 5.06
B T Who lesale M anaged C ash F und A P IR - WF S0245A U
Total Return (post-fee, pre-tax) 0.15 0.47 0.97 0.97 2.11 2.20 2.33 2.75 6.66
Total Return (pre-fee, pre-tax) 0.17 0.52 1.08 1.08 2.33 2.42 2.55 2.98 6.96
Benchmark 0.15 0.44 0.92 0.92 2.07 2.20 2.37 2.78 6.73
B T Who lesale M o nthly Inco me P lus F und A P IR - B T A 0318A U
Total Return (post-fee, pre-tax) 0.17 -1.14 0.54 0.54 3.14 3.03 4.21 5.17 5.57
Total Return (pre-fee, pre-tax) 0.22 -0.98 0.87 0.87 3.81 3.71 4.89 5.86 6.23
Benchmark 0.13 0.38 0.78 0.78 1.75 1.94 2.14 2.59 3.18
Diversified
B T Who lesale A ct ive B alanced F und A P IR - R F A 0815A U
Total Return (post-fee, pre-tax) 2.83 2.45 5.07 5.07 4.13 4.99 6.79 9.91 7.61
Total Return (pre-fee, pre-tax) 2.92 2.70 5.57 5.57 5.12 5.99 7.81 10.95 8.69
Benchmark 2.85 2.81 5.62 5.62 8.49 6.71 7.51 10.23 7.49
(%)1 M o nth 3 M o nths 6 M o nths
For more information Please call 1800 813 886, contact your Business Development Representative or visit btim.com.au
All returns calculated by BT Investment Management (Fund Services) Limited, ABN 13 161 249 332, AFSL 431426 (BTIM). No part
of this Fund Manager Commentary (Commentary) is to be circulated without this page attached.
This Commentary is dated 17 January 2017 and has been prepared by BTIM. The information in this Commentary is for general
information only and should not be considered as a comprehensive statement on any of the matters described and should not be
relied upon as such. The information contained in this Commentary may contain material provided directly by third parties and is
believed to be accurate at its issue date. While such material is published with necessary permission, neither BTIM nor any
company in the BTIM Group of companies accepts any responsibility for the accuracy or completeness of this information or
otherwise endorses or accepts any responsibility for this information. Except where contrary to law, BTIM intends by this notice to
exclude liability for this material.
This Commentary has been prepared without taking into account your objectives, financial situation or needs. Furthermore, it is not
intended to be relied upon for the purpose of making investment decisions and is not a replacement of the requirement for individual
research or professional tax advice. Because of this, before acting on this information, you should seek independent financial and
taxation advice to determine its appropriateness having regard to your individual objectives, financial situation and needs.
BTIM does not give any warranty as to the accuracy, reliability or completeness of the information contained in this Commentary.
This Commentary is not to be published without the prior written consent of BTIM.
Performance data (post-fee) assumes reinvestment of distributions and is calculated using exit prices, net of management costs.
Performance data (pre-fee) is calculated by adding back management costs to the (post-fee) performance. Past performance is not
a reliable indicator of future performance. The term ‘benchmark’ refers to the index or measurements used by an investment
manager to assess the relative risk and the performance of an investment portfolio.
BTIM is the issuer of the following products:
BT Wholesale Core Australian Share Fund ARSN 089 935 964
BT Wholesale Smaller Companies Fund ARSN 089 939 328
BT Concentrated Global Share Fund ARSN 613 608 085
BT Wholesale Core Global Share Fund#
ARSN 089 938 492
BT Wholesale Global Fixed Interest Fund ARSN 099 567 558
BT Wholesale Enhanced Credit Fund ARSN 089 937 815
BT Wholesale Fixed Interest Fund ARSN 089 939 542
BT Wholesale Property Investment Fund ARSN 089 939 819
BT Wholesale Global Property Securities Fund ARSN 108 227 005
BT Wholesale Managed Cash Fund ARSN 088 832 491
BT Wholesale Enhanced Cash Fund ARSN 088 863 469
BT Wholesale Active Balanced Fund ARSN 088 251 496
A product disclosure statement (PDS) is available for each of the above products and can be obtained by contacting BTIM on
1800 813 886, or by visiting btim.com.au. You should consider the relevant PDS in deciding whether to acquire, or to continue to
hold, the product. BT® is a registered trade mark of BT Financial Group Pty Ltd and is used under licence.
# AQR began managing international equity for BT Financial Group in June 2006.