Investment update with John Pearce – July 2024

Hi, I'm John Pearce, Chief Investment Officer. Welcome to this investment update.

Over the past couple of weeks, I've been on a roadshow and I know that many of you have actually attended that roadshow so I'm going to try to not repeat myself too much. What I would like to do is briefly recap the last financial year and the returns over the range of our investment options. Also, I'd like to address some of the frequently asked questions that you asked me in the course of that roadshow.

First—option returns. Here's a list of all our accumulation option returns over the financial year ‘24. A big range there, not enough time to go through all of them.

Chart 1: Table showing the accumulation returns of UniSuper investment options for the 12 months to 30 June 2024. At the top of the list is International Shares (17.33%) followed by Global Companies in Asia (16.52%). Also shown are Sustainable Balanced (12.24%), Balanced (9.24%) and at the bottom, Global Environmental Opportunities (-15.96%).

A few key ones. Firstly, our Balanced option. This is our default option, pretty solid return. Our Sustainable Balanced option, 3% higher. Therein lies the first question—can that outperformance of the Sustainable Balanced, or Sustainable High Growth for that matter, last?

Members love asking me for predictions and I always try to avoid them because they’re difficult. What I will do, however, is talk about the drivers of that outperformance.

Let's have a look at the Sustainable Balanced option and its restrictions. We know that Sustainable Balanced and Sustainable High Growth cannot invest in fossil fuel companies¹ so you see them underweight the energy and materials sector, and they were underperforming sectors last year. To counter that underweight, they're overweight in other sectors such as technology and communications, and those sectors outperformed. The tech sector was on a tear. And that explains the difference.

If you think about the dynamics of those sectors, can we expect to see a persistent outperformance? Well, not if history is any guide. Have a look at the past few years. In financial year ‘22, it was actually the Balanced option that outperformed by about 4%—both of them down, but the Balanced option less so. In financial year ‘23, about square, not much between the two. Then of course last year we had a 3% outperformance of the sustainable option. What about over a longer period, what about over ten years? Guess what—identical. Of course this is history, what about the future? Well, in the short term, what you find is the difference in those sectors will drive the difference in performance. Over the long term, our best guess is that performances will tend to converge.

Chart 2 : Chart showing the relative performance of Balanced and Sustainable Balanced over FY22, FY23, FY24 and the 10 years to 30 June 2024. The relative returns of the two options are less correlated over short timeframes, but over 10 years, the returns are similar.

Let's have a look at the best and the worst. International shares, heavily weighted towards tech. Those big six tech darlings drove about 50% of the performance of that option. Right down the bottom, a laggard by over 30%—Global Environmental Opportunities. Of course, the inevitable question—what is the outlook for Global Environmental Opportunities, or GEO as we call it for short?

First point to mention here is that the returns are very volatile. We go back to financial year ‘21, GEO returned about 50%. So the past three years we've actually seen a give-back of about half of that performance. But what about the prospects going forward? Let's have a look at a couple of the positive drivers.

Firstly, the secular growth themes remain intact. What do I mean by that? GEO is looking to invest in companies that earn at least 40% of their revenues from environmental themes, be that electronic vehicles, renewable energy, batteries, etc. This theme is still strong. In ‘23, there was a 50% increase in renewable capacity in the world. There was a tripling of storage. The theme’s intact. Most importantly, we're not having to pay as high a price to access those themes.

You think about a company like Tesla. Over the last three years, Tesla's almost halved in price. Generally, if you look at the portfolio in total, you look at something like the price earnings ratio. This is just a valuation metric where we're comparing the price of the company to its profitability. What we're seeing now is that PE ratio for the portfolio is about where the market average is. In the heady days of ‘21, it was about double the market average. So here we have a situation with a portfolio with much better growth prospects than the broader market, trading on similar valuations.

What about risks? Of course, there are risks. Politics. Trump's attitude towards energy is ‘drill baby, drill’. That's actually his motto. That would not be good for the sector.

China is still flooding the market with EVs, with solar panels, etc. There are Chinese companies that are that are selling at prices below cost, which is not healthy. However, that cannot last forever. On balance, GEO is certainly on a more solid footing than it was during the heady days of ‘21. But there are risks. The concentrated nature of this portfolio means that it is going to be more volatile, so it really is only for those with a very long-term investment horizon.

Geopolitical risk. Members came up to me and said, “John, you didn't talk about geopolitical risk, yet it seems to be very elevated in our view.” Well, I've mentioned about this before. I've been investing for over three decades, and I've never been in a situation where the world was totally at peace. Is the world a riskier place now? That's quite subjective. The reality is that we've had weapons of mass destruction for decades, so I question whether the world is actually riskier now. Interestingly, what we find with geopolitical events is that the market tends to shrug them off.

Have a look at this list. Here we have all the geopolitical events back to about World War II. And those bars are showing the Australian stock market performance 12 months after that event. Green bars, positive returns—and green bars dominate this graph. So markets tend to bounce back pretty quickly. What's the bottom line? We do not take geopolitical events or the probability of one happening into account when we're looking at forming our investment strategy.

Chart 3: Table showing the returns of the Australian share market one year after geopolitical events from World War II onwards. The majority of one-year returns are positive.

Turning now to our Defined Benefit Division. It's a subject matter that I didn't have time to cover, and some people say “Why not?” And it’s a fair question because we do have about $35 billion in the DBD so it is worth mentioning. Maybe it's complacency, but the reality is that we are in such a healthy surplus that I always say you've got nothing to worry about.

A measure of the surplus is the accrued benefit index, the ABI. The latest estimate is 133%. So that’s a very healthy surplus. Now, the more insightful line of questioning I've been getting is, “Alright, given the size of that surplus, are you changing your investment strategy?” And the answer to that is yes, we are. In fact, we are de-risking our portfolio.

And how are we doing that? We're selling down some of our listed shares, the more volatile listed shares; we're adding to our exposure of unlisted property and infrastructure; and importantly, we're also buying bonds. You might ask the question, “The ABI was actually around this level four or five years ago, why didn't you start de-risking then?”

Here's the answer. Back in 2020, shares were actually cheaper, and bonds were more expensive. In fact, bonds—the return on bonds—were actually not meeting our hurdle return. Today, they are. The implication of this is actually much more far reaching than just the DBD. Any investor now can achieve a desired level of return by taking less risk. This is a profound development.

Chart 4: Table comparing the relative attractiveness in 2020 and 2024 of investing in the ASX 200 (higher risk) versus investment grade bonds (lower risk) for the Defined Benefit Division.

And finally, people came up to me and asked me, “What about the recent market jitters, what's causing all of this?” Bear in mind this happened after the US recorded its worst three-day consecutive performance this year. And there are various explanations. There are the technicians that say, “Well, the September quarter’s traditionally a weaker quarter so there's seasonal patterns involved here.” There's a more novel explanation—have a look at this graph, did you know, that in a US election year markets are weaker if the sitting president is a lame duck president? It just shows you there's a stat for every occasion. Are you buying that? No. Neither am I.

Chart 5: Line chart showing the returns of US shares in the fourth year of a ‘lame duck’ US President versus the fourth year of a new President.

I think the answer is far more simple. The reality is that the market’s had a fantastic run. The US market—over the last 38 weeks, 28 were positive. To get that sort of result, you've got to go back to 1989, so it's been a fantastic run. And when the market has had a run like that, it becomes susceptible to any negative news, no matter how small, and we have had some negative news.

There is the US election uncertainty. Trump came out and said that Taiwan has stolen the American chip industry, and hinted that the Americans would not defend Taiwan. Not good for tech stocks. And of course, we had the global IT outage, CrowdStrike, causing major disruptions.

But most importantly, there's not been any change to the fundamentals, and the biggest fundamental of all is inflation. And if indeed inflation can continue on its downward path, I'm very confident that the market can maintain the solid gains that we saw last year.

Thank you very much for watching.

¹The reference to fossil fuel companies in relation to our Sustainable High Growth and Sustainable Balanced options is to companies with material reported revenues from the exploration and production of fossil fuels. For these options, we apply a negative screen to companies with greater than 10% of their reported revenues from fossil fuel exploration and production.

This video provides general information and may include general advice. It doesn’t take into account your financial situation, needs or objectives. Consider your situation before making financial decisions, because we haven’t, as well as the PDS and TMD relevant to you at unisuper.com.au/pds, and whether to consult a qualified financial adviser. Past performance isn’t an indicator of future performance. Information is current as at 24 July 2024. Comments on the companies we invest in aren’t intended as a recommendation of those companies for inclusion in personal portfolios. Holdings are current as at 30 June 2024 and are subject to change without notice. Prepared by UniSuper Management Pty Ltd (ABN 91 006 961 799, AFSL No. 235907) on behalf of UniSuper Limited (ABN 54 006 027 121) the trustee of UniSuper (ABN 91 385 943 850, AFSL No.492806) the fund.