Pengana Australian Equities Income Fund Portfolio Manager, Mark Christensen, outlines the fund's approach to delivering consistent returns through all markets cycles with an absolute focus on capital preservation.
Jessica Amir: Hi I’m Jessica Amir for the Finance News Network. Joining me from Pengana Australian Equities Income Fund is Fund Manager, Mark Christensen. Hi Mark and welcome.
Mark Christensen: Hi Jessica, thank you.
Jessica Amir: First up, can you give us an introduction to the Fund?
Mark Christensen: With interest rates at or near all-time lows, investors are increasingly turning towards equities as an alternative source of income. Whilst it is true, equities do offer the opportunity for a premium yield over cash, the risk for an equity income investor is that capital is lost, in the search for additional yield. With the Pengana Australian Equities Income Fund, we aim to provide a common-sense approach to actively manage an investment portfolio, with a primary focus on capital preservation. And where a substantial component of the returns are delivered in the form of income. It’s a relatively new product from our established Australian Equity team, really in response to a lot of investor demand for that income type of product.
Jessica Amir: Before going into stock selection, maybe you can tell us about your investment philosophy?
Mark Christensen: The first point I think I’d like to make is that we are an absolute fund, not benchmarked to a particular index. So as a result of that, we don’t spend our time trying to match or track a moving target. We don’t think that’s consistent with our objective of preserving capital and achieving a reasonable rate of return for our investors. So that’s important point number one.
The second point is our portfolio. We would not expect it to look like a traditional yield portfolio with heavyweight positions across utilities and REITs. We think actually we’re more likely to look like a more balanced portfolio, including industrials and financials. Essentially good businesses run by competent management teams that happen to pay dividends out of their cash flows. We can hold 20 to 30 stocks in a portfolio at any one point in time, so it’s a reasonably concentrated fund and we are market cap agnostic so we can invest right across the spectrum.
The other thing is we can have up to 100 per cent of the fund in cash, if we think it’s appropriate. And simply, if we can’t find investments that justify that objective of capital preservation and offering us a reasonable return, we will stay in cash until such time as we can invest with those targets.
Jessica Amir: It is quite a unique income fund, but just tell us about your stock selection process?
Mark Christensen: Put simply, we just look to invest in good businesses run by competent management teams, at the right price. There are a lot of factors that go into deciding whether a business is good or otherwise. For us we look for transparent and predictable cash flows, we prefer economic insensitivity. And generally speaking, we like to invest in companies who hold the balance of power in their respective value chains. What makes a right price is far more specific and for us, it’s not a peer multiple, we are focused on cash yields.
We ask ourselves the question, how much cash can this business sustainably generate before going on to decide whether you either invest in future growth, retire debt or pay a dividend to shareholders. Essentially, we search for gifts that keep on giving, looking for companies that can generate strong cash flows year after year, and that can feed us and help us meet our objectives.
Jessica Amir: What is a reasonable return?
Mark Christensen: When we think about what a reasonable return is, we start off with what an investor could get in cash. At the moment call it 1.5 or 2 per cent. If an investor is going to take a leap and invest in equity markets, they deserve a risk premium to compensate for that risk. We think that’s about six per cent. So a reasonable return for investing in equity markets we think should be about eight per cent each year. And that’s not an official target if you like, because we don’t benchmark ourselves to a target, but that’s what we would hope to deliver over time year in year out.
Jessica Amir: Now to some of your largest positions Mark. Just tell us about these and what’s your outlook for each?
Mark Christensen: We do have substantial positions in the major banks. We absolutely acknowledge that the growth outlook for the banks might not be as strong now as it has been over the last number of years. But balance sheets on the other hand are arguably stronger than they ever have been. And in fact, we see increase in surplus capital across a lot of the majors. There are a lot of cost savings potential to help support income growth and valuation remains attractive. Our preferred payment space right now is probably ANZ (ASX:ANZ), but all the banks generally provide back those characteristics.
Another area that has been successful for us is actually in the retail space. It’s been a controversial space for us to have large positions in. Over the past 12 months, overhyping from anticipation of Amazon’s (NASDAQ:AMZN) entry in Australia, has really led to an indiscriminate selloff across the sector. And whilst it is certainly the case that these companies’ cash flows will be impacted from an entry to Amazon, the share price reactions have been far more severe, giving us we think the opportunity.
In that particular space, Super Retail Group (ASX:SUL) and JB Hi-Fi (ASX:JBH) we think are very good operators, in their respective categories. They have strong balance sheets, good sustainable cash flows and dividend streams, which we think will hold up well in a post-Amazon world.
Jessica Amir: With interest rates heading higher albeit slowly, what does it really mean for income funds such as yours?
Mark Christensen: It is an interesting time to be managing an income fund, an income portfolio. Over the last eight years or more, traditional income portfolios and in particular the heavyweight sectors such as utilities and REITs are really benefitting significantly, from a falling interest rate environment. These companies tend to have higher levels of debt, so benefit from lower cost of servicing that debt. But also the relative appeal of their dividends increases as the cash alternative decreases. So that being the case, in a rising interest rate environment, it would be our expectation that the same dynamic would work in reverse. And it’s for this reason that we would choose not to build a portfolio around heavyweight income sectors, such as utilities and REITs.
We think that in a rising interest rate environment, hopefully is coming about on the back of stronger economic data and occasion sentiment, would actually mean that building a portfolio around a more diversified mix of industrials, financials and perhaps a selection of those other income sectors, would be far better placed to deliver on capital preservation and generating a reasonable return. So that’s where our focus is in a potentially rising interest rate environment.
Jessica Amir: Last question now Mark. What can investors expect over the coming 12 months?
Mark Christensen: Our view over the last couple of months, markets have been very strong. We do find ourselves with relatively high levels of cash and we suspect we might get the opportunity to deploy that, if markets do actually find a correction sometime soon. So we’re looking forward to that opportunity. In the meantime, we remain focused on our strategy and our objectives. And having been part of and seeing that strategy work successfully for the core Australian Equity Fund at Pengana, which has delivered reasonable returns, consistent returns through all market conditions, gives us conviction that the strategy’s right. And confidence that if we still to our processes, we’ll get a good outcome for our investors.
Jessica Amir: Mark Christensen, thank you so much for the time.
Mark Christensen: Thank you.
Jessica Amir: And thank you for watching.
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