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5 May 2023 - Hedge Clippings | 12 May 2023



Hedge Clippings | 12 May 2023

Treasurer Jim Chalmers was understandably pleased to be able to hand down a budget forecasting a surprise surplus, but according to more than a few economists the real surprise will be whether it eventuates or not. As has been widely questioned, the risk is that the selected spending initiatives will be inflationary, leaving the RBA with no alternative but to either increase interest rates further or keep them higher for longer. Meanwhile, on the revenue side, there is still no appetite from either the government nor the opposition to fix or address the reliance on personal income tax. The opportunity has been lost for another year, as it has every year since the Henry Tax Review in 2010, and no doubt will be put in the too hard basket again next year as well.

Hedge Clippings is not going to dwell on the budget too long - it is covered more than enough elsewhere. However, it was interesting, if not alarming, that a research paper out of the RBA this week estimates the chance of a recession next year at 80%. If inflation does continue at an elevated level as many believe it will, and the RBA sticks to its determination to address it, a recession, whether with a "hard" or "soft" landing, is likely to be the outcome. It's going to be a delicate balance, or as Philip Lowe describes it, a "narrow road".

Turning to markets and managed funds. Market shocks, such as the '87 crash, the tech wreck of 2000, or the GFC, tend to create opportunity - particularly for the brave - after extended periods of investor exuberance, which when coupled with excessive leverage lead to stretched valuations. The past two to three years however have been different, but according to many managers we have spoken to, could be considered one of the most challenging periods in recent memory. Certainly there were stretched valuations, particularly in the tech and growth sectors, post GFC thanks to QE and central bank intervention, but little could have prepared markets for the combined effects of COVID, Russia's invasion of Ukraine, and the resultant outbreak of global inflation.

The small cap sector always takes the brunt when investors switch from risk on to risk off - having paved the way and outperformed in the first place. Over the year to December 2022, the average performance of the 86 funds which make up the Australian Mid and Small Cap Peer Group fell by 19% compared with the Australian Large Cap Peer Group, which fell on average only 4%. By contrast they topped the performance tables three years before. This cycle is not unusual given the lack of liquidity often accompanying stocks outside the ASX200 (and sometimes within it) but there's little doubt that as a result the lack of interest, or appetite for risk accentuates the losses, and in turn creates opportunity.

The key of course comes in the timing, so earlier this week we hosted a webinar discussion with three "small cap" fund managers, namely Dean Fergie from Cyan Investment Management, Steven Johnson from Forager Funds Management, and Gary Rollo from Montgomery Investment Management, to ask them the sometimes difficult question about their experiences over the past two years or so, but more importantly, if the worst of the current market was behind them?

You can watch a recording of the discussion below, but there were some key take-aways from each of them. None of them shied away from the difficult questions but were all consistent in their view that trying to time the bottom or turning point in the market was an impossible exercise. Each gave examples of oversold companies or markets, and each reiterated that holding profitable, successful businesses, with strong balance sheets (sometimes trading at or below asset, or even cash backing) will provide outsized future returns, rather than selling them at current depressed valuations.

Of interest is the fact that while the small cap sector has still underperformed the ASX200 in the six months to the end of April (+3.83% to +8.71%) at least it is positive, while over the past three months while marginally negative, the small cap peer group has just outperformed (-0.70% to the ASX200 at -0.80%).

Maybe the tide is about to turn?

News & Insights

New Funds on

The Future for Small Caps Webinar Recording

Magellan Global Fund Update | Magellan Asset Management

A once in a generation opportunity | Insync Fund Managers

April 2023 Performance News

Bennelong Australian Equities Fund

4D Global Infrastructure Fund (Unhedged)

Skerryvore Global Emerging Markets All-Cap Equity Fund

Delft Partners Global High Conviction Strategy

Bennelong Twenty20 Australian Equities Fund

Bennelong Kardinia Absolute Return Fund

Quay Global Real Estate Fund (Unhedged)

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