How did your portfolio perform?

The Trans-Tasman Equities Fund (Fund) delivered a gross return of -0.54% during September, underperforming the Fund’s benchmark return of -0.40% by -0.14%.

The Fund’s launch date was 14 May this year, consequently there are no 12-month returns.
 
Two strong contributors to performance in September were our overweights in Tower and Tourism Holdings. Tower announced a reduction in its reinsurance expense, which should aid future profitability and lower risk. Tourism Holdings confirmed the two parties looking to acquire the company were still actively involved in due diligence.

Against that, our overweight in Australian stock Next DC and underweight in Fonterra hurt relative performance. Next DC announced material new contract wins, but the capex, debt and equity raisings required to fund the growth weighed on the share price. Fonterra reported strong earnings and guidance at its results announcement; we have held a key overweight in the Fund for some years, but over the last twelve months we have exited the stock, given our assessment of a reduction in valuation.

Australian positions made up around 12.5% of the Fund composition and contributed negatively to the Fund's relative performance over the month. The Australian dollar exposure of the Fund is hedged to the New Zealand dollar, between a range of 95% to 105%.

What happened in the markets you invest in?

September includes a small reporting season, generally covering the retail sector and agricultural producers. The bigger news for financial markets was the sharp increase in longer-term interest rates. This month's increase was primarily driven by relativities in global rates, and particularly US interest rates. Large financing requirements for both the Artificial Intelligence build-out and to fund rising US government deficits saw bond investors demand a higher interest rate. While the New Zealand government debt position is materially different to the US, we still need to compete for bond investors on the global stage.

Higher interest rates are particularly difficult for companies with low pricing power or those priced for high long-term growth. The first set of companies face a profit squeeze, while for the second group, the market requires a higher return (i.e. a lower price today) to take on the risk that distant earnings will be delivered.

The mini reporting season was once again solid, with Fonterra the standout on the back of strong market demand and continued cost control, in our view. Hallenstein Glassons bucked the cautious trading comments of the other retailers, with a strong performance driven by store roll-out in Australia.

What are we thinking about the future?

Higher interest rates have hurt returns for the property sector, along with regulated utilities such as Chorus and Vector. With ten-year interest rates above 5%, these defensive sectors look more appropriately priced to us and we are gently adding to our positions in those sectors.

The domestic cycle remains in a slow but positive uptrend. We will get an update from the reporting companies at their annual shareholder meetings this month, and then another mini reporting season in November. In our opinion, our three largest overweights are either not directly exposed to the domestic cycle (Tower) or are undertaking significant self-help initiatives (Sky City and Heartland Bank).

The Australian economic and interest rate outlook deteriorated over the month, and we are modestly lowering our exposure to Australian stocks, particularly those exposed to a weaker consumer and high oil prices.