Quarterly investment update – January to March 2015

New emerging market equity manager

In March 2015, VicSuper awarded AllianceBernstein a mandate of A$100 million for its Emerging Consumer strategy as a means to diversify VicSuper’s emerging market equities portfolio. Consumption growth in emerging markets represents one of the biggest investment opportunities in the world, with McKinsey Consulting estimating that emerging-market consumers will be spending US$30 trillion a year by 2025.^

According to AllianceBernstein, "this approach offers diversification from traditional emerging market equity strategies in two ways – by focusing on emerging market consumers and by being benchmark-unaware”. The Emerging Consumer strategy uses 'grassroots' research to explore themes identified by top-down analysis. This involves visiting emerging market countries and talking to business owners on their premises and consumers in their homes. Through this approach AllianceBernstein 's research team has visited and conducted research in over 13 emerging market regions since 2011, including Mexico, Peru, Chile, West and South Africa, India, Indonesia, Thailand, the Philippines and China.

AllianceBernstein also manages an Emerging Markets Value mandate and Australian Value mandate for VicSuper.

Key themes underlying financial markets in the next 12 months

  • World GDP growth will likely be moderate, led by the US and China. Australia’s GDP will also grow, albeit below the long term average trend.
  • Bond yields will likely rise in 2015. The trigger is likely to be the US Federal Reserve starting to raise interest rates.
  • Implications for the VicSuper fund:

    » From an asset allocation perspective, Equities are moderately attractive relative to bonds;
    » Alternatives are attractive as a means to diversify risk and to enhance total returns.

Table 1: Summary of VicSuper's asset class views Summary of VicSuper's asset class views

Source: VicSuper

VicSuper's investment option returns for the March quarter

The Australian shares option was the best performing option in the March quarter. Note this not only reflects the strength of the Australian equity market but also the benefit of franking credits.

Table 2: VicSuper's Investment Option returns

VicSuper FutureSaver

Accumulation (%)

VicSuper Flexible Income (%)

Quarter 1-year 5-year 10-year Quarter 1-year 5-year 10-year
Cash 0.6% 2.2% 3.2% 4.1% 0.7% 2.7% 3.8% 4.8%
Capital Secure 2.6% 7.7% 6.3% 5.5% 3.0% 8.4% 7.2% 6.4%
Capital Stable 4.2% 11.3% 7.9% 6.2% 4.8% 12.2% 8.9% 7.2%
Balanced 5.4% 13.5% 8.9% 6.8% 6.0% 14.8% 10.1% 7.8%
Growth 6.1% 14.9% 9.4% 6.9% 6.8% 16.3% 10.7% 7.8%
Equity Growth 7.6% 17.0% 10.6% 7.5% 8.3% 18.3% 11.9% 8.4%
Equity Growth Sustainability 7.5% 15.7% 10.1% 8.0% 8.3% 16.6% 11.3% 8.9%
Australian Shares* 9.2% 12.3% N/A N/A 10.7% 14.2% N/A N/A

Source: VicSuper

Note: Past performance is not a reliable indicator of future performance. The 5 and 10-year return is annualised.

* The Australian Shares investment option was introduced on 4 February 2013 for VicSuper FutureSaver and on 5 February 2013 for VicSuper Flexible Income.

See the current Term Deposit rates.

Asset class performance for the March quarter

Over the 12 months, all of VicSuper’s asset class benchmarks finished higher, except for Emerging Markets which were impacted by a strong USD (which contributed to losses in many markets whose currencies weakened against the dollar) and continued geopolitical tensions. In the March quarter, Australian Equities was the top-performing benchmark.

Chart 1: Major Index Returns (VicSuper’s Asset Class Benchmarks)

Source: IRESS, Bloomberg, Barclays, MSCI

Australian Equities

After a muted December quarter, the ASX 300 accumulation index gained 10% in the March quarter – Its largest first quarter return ever. A solid performance from sectors including consumer discretionary, banks, utilities and healthcare was more than enough to offset continued weakness in resources and energy companies.

The AUD/USD ended the March quarter at $US0.761, down 18% over the 12 months to March. However, key indicators including commodity prices, the terms of trade and the trade-weighted index point to further potential downside to the AUD. A lower AUD is crucial to rebalance the economy – i.e. increase the competitiveness of Australia’s non-mining exports and provide a boost to retail, tourism and home building.

Developed Market Equities (excluding Australia)

The MSCI World (excluding Australia) lifted by 2% in the March quarter amid rising mergers and acquisitions and signs of economic growth in Europe and Japan. Health care stocks rallied strongly on the back of several large acquisitions while the energy companies underperformed as oil prices continued to fall.

Japan quietly led developed market equities for the quarter. Despite economic growth remaining sluggish, deflation fears have subsided indicating Abenomics policy initiatives are working. Abenomics is Prime Minister Shinzo Abe’s three-arrowed approach to reviving the economy after more than a decade of deflation and no growth. Corporate reforms, including encouraging higher return on equity and greater independence in corporate governance, should continue to support the Japanese equity market.

The European Central Bank's (ECB) quantitative easing (QE) program of €1.1 trillion began in March and boosted equity markets. The ECB expanded its asset purchases to include bonds of Eurozone governments, agencies and European institutions. The ECB will buy €60 billion of bonds per month through at least September 2016. Stocks in Europe advanced almost 12% in local currency terms for the quarter.

Emerging Market Equities

Emerging markets lifted by 2% in the March quarter as investors’ risk appetite was boosted by the US Federal Reserve's reassurance that it was in no rush to raise interest rates and by news of the European Central Bank's highly anticipated large-scale quantitative easing program. Within the MSCI Emerging Markets Index, the Information technology sector was the best performer while utilities fared the worst.

Australian and International Fixed Interest

​​As reflected by the UBSA Composite Bond Index (proxy for Australian fixed interest) and the Barclay’s Global Aggregate Index (proxy for international fixed interest), Australian and international fixed interest markets finished the quarter up 3%. US bonds rallied in the quarter as investors’ appetite for them grew given their appealing relative value as yields in Europe and Japan touched record lows. Extremely low bond yields been a key driver of price/earnings (P/E) multiples expanding to elevated levels (see charts 2 & 3). However, high valuations in equity markets are not overly concerning given earnings yield remain well above 10-year bond yields. This is one of the main reasons why equities remain moderately attractive relative to bonds from an asset allocation perspective.

Charts 2 and 3: Falling bond yields as price/earnings multiples expand

Source: Bloomberg

Cash

The RBA cut the official cash rate to 2.25% in February, as a means to boost business and consumer confidence and also to put further downward pressure on the AUD. Additional monetary policy stimulus may be on the cards given the economy remains soft .The RBA faces a dilemma however, given household debt is already at record levels and further cuts could fuel increased leverage and fears of house price inflation.

^ http://www.mckinsey.com/features/30_trillion_decathlon

New emerging market equity manager

In March 2015, VicSuper awarded AllianceBernstein a mandate of A$100 million for its Emerging Consumer strategy as a means to diversify VicSuper’s emerging market equities portfolio. Consumption growth in emerging markets represents one of the biggest investment opportunities in the world, with McKinsey Consulting estimating that emerging-market consumers will be spending US$30 trillion a year by 2025.^

According to AllianceBernstein, "this approach offers diversification from traditional emerging market equity strategies in two ways – by focusing on emerging market consumers and by being benchmark-unaware”. The Emerging Consumer strategy uses 'grassroots' research to explore themes identified by top-down analysis. This involves visiting emerging market countries and talking to business owners on their premises and consumers in their homes. Through this approach AllianceBernstein 's research team has visited and conducted research in over 13 emerging market regions since 2011, including Mexico, Peru, Chile, West and South Africa, India, Indonesia, Thailand, the Philippines and China.

AllianceBernstein also manages an Emerging Markets Value mandate and Australian Value mandate for VicSuper.

Key themes underlying financial markets in the next 12 months

  • World GDP growth will likely be moderate, led by the US and China. Australia’s GDP will also grow, albeit below the long term average trend.
  • Bond yields will likely rise in 2015. The trigger is likely to be the US Federal Reserve starting to raise interest rates.
  • Implications for the VicSuper fund:

    » From an asset allocation perspective, Equities are moderately attractive relative to bonds;
    » Alternatives are attractive as a means to diversify risk and to enhance total returns.

Table 1: Summary of VicSuper's asset class views Summary of VicSuper's asset class views

Source: VicSuper

VicSuper's investment option returns for the March quarter

The Australian shares option was the best performing option in the March quarter. Note this not only reflects the strength of the Australian equity market but also the benefit of franking credits.

Table 2: VicSuper's Investment Option returns

VicSuper FutureSaver

Accumulation (%)

VicSuper Flexible Income (%)

Quarter 1-year 5-year 10-year Quarter 1-year 5-year 10-year
Cash 0.6% 2.2% 3.2% 4.1% 0.7% 2.7% 3.8% 4.8%
Capital Secure 2.6% 7.7% 6.3% 5.5% 3.0% 8.4% 7.2% 6.4%
Capital Stable 4.2% 11.3% 7.9% 6.2% 4.8% 12.2% 8.9% 7.2%
Balanced 5.4% 13.5% 8.9% 6.8% 6.0% 14.8% 10.1% 7.8%
Growth 6.1% 14.9% 9.4% 6.9% 6.8% 16.3% 10.7% 7.8%
Equity Growth 7.6% 17.0% 10.6% 7.5% 8.3% 18.3% 11.9% 8.4%
Equity Growth Sustainability 7.5% 15.7% 10.1% 8.0% 8.3% 16.6% 11.3% 8.9%
Australian Shares* 9.2% 12.3% N/A N/A 10.7% 14.2% N/A N/A

Source: VicSuper

Note: Past performance is not a reliable indicator of future performance. The 5 and 10-year return is annualised.

* The Australian Shares investment option was introduced on 4 February 2013 for VicSuper FutureSaver and on 5 February 2013 for VicSuper Flexible Income.

See the current Term Deposit rates.

Asset class performance for the March quarter

Over the 12 months, all of VicSuper’s asset class benchmarks finished higher, except for Emerging Markets which were impacted by a strong USD (which contributed to losses in many markets whose currencies weakened against the dollar) and continued geopolitical tensions. In the March quarter, Australian Equities was the top-performing benchmark.

Chart 1: Major Index Returns (VicSuper’s Asset Class Benchmarks)

Source: IRESS, Bloomberg, Barclays, MSCI

Australian Equities

After a muted December quarter, the ASX 300 accumulation index gained 10% in the March quarter – Its largest first quarter return ever. A solid performance from sectors including consumer discretionary, banks, utilities and healthcare was more than enough to offset continued weakness in resources and energy companies.

The AUD/USD ended the March quarter at $US0.761, down 18% over the 12 months to March. However, key indicators including commodity prices, the terms of trade and the trade-weighted index point to further potential downside to the AUD. A lower AUD is crucial to rebalance the economy – i.e. increase the competitiveness of Australia’s non-mining exports and provide a boost to retail, tourism and home building.

Developed Market Equities (excluding Australia)

The MSCI World (excluding Australia) lifted by 2% in the March quarter amid rising mergers and acquisitions and signs of economic growth in Europe and Japan. Health care stocks rallied strongly on the back of several large acquisitions while the energy companies underperformed as oil prices continued to fall.

Japan quietly led developed market equities for the quarter. Despite economic growth remaining sluggish, deflation fears have subsided indicating Abenomics policy initiatives are working. Abenomics is Prime Minister Shinzo Abe’s three-arrowed approach to reviving the economy after more than a decade of deflation and no growth. Corporate reforms, including encouraging higher return on equity and greater independence in corporate governance, should continue to support the Japanese equity market.

The European Central Bank's (ECB) quantitative easing (QE) program of €1.1 trillion began in March and boosted equity markets. The ECB expanded its asset purchases to include bonds of Eurozone governments, agencies and European institutions. The ECB will buy €60 billion of bonds per month through at least September 2016. Stocks in Europe advanced almost 12% in local currency terms for the quarter.

Emerging Market Equities

Emerging markets lifted by 2% in the March quarter as investors’ risk appetite was boosted by the US Federal Reserve's reassurance that it was in no rush to raise interest rates and by news of the European Central Bank's highly anticipated large-scale quantitative easing program. Within the MSCI Emerging Markets Index, the Information technology sector was the best performer while utilities fared the worst.

Australian and International Fixed Interest

​​As reflected by the UBSA Composite Bond Index (proxy for Australian fixed interest) and the Barclay’s Global Aggregate Index (proxy for international fixed interest), Australian and international fixed interest markets finished the quarter up 3%. US bonds rallied in the quarter as investors’ appetite for them grew given their appealing relative value as yields in Europe and Japan touched record lows. Extremely low bond yields been a key driver of price/earnings (P/E) multiples expanding to elevated levels (see charts 2 & 3). However, high valuations in equity markets are not overly concerning given earnings yield remain well above 10-year bond yields. This is one of the main reasons why equities remain moderately attractive relative to bonds from an asset allocation perspective.

Charts 2 and 3: Falling bond yields as price/earnings multiples expand

Source: Bloomberg

Cash

The RBA cut the official cash rate to 2.25% in February, as a means to boost business and consumer confidence and also to put further downward pressure on the AUD. Additional monetary policy stimulus may be on the cards given the economy remains soft .The RBA faces a dilemma however, given household debt is already at record levels and further cuts could fuel increased leverage and fears of house price inflation.

^ http://www.mckinsey.com/features/30_trillion_decathlon

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