With Australia now emerging from its first recession in 29 years as a result of the slowing economy caused by the COVID-19 restrictions in 2020, it is timely to compare the historical performance of the Australian & New Zealand Private Equity market across all time frames, to the performance of those Private Equity funds that were established during, or otherwise invested across, previous recessionary periods.

Summary statistics provided by AVCAL & Cambridge Associates reveal that the median and upper quartile net returns from Private Equity funds formed in Australia and New Zealand, between 1997 and 2018, focused on the later expansion and buyout financing stage, in which Vantage funds invest, was 11.1% p.a. and 20.3% p.a. respectively. These robust returns demonstrate Private Equity's ability to consistently outperform public markets as the return on the S&P ASX 200 Accumulation Index over the corresponding period was only 8.4% p.a.1.

However, during periods of economic contraction, the performance of Private Equity was even more pronounced. Utilising data provided by Preqin (2020) 2, Vantage conducted an analysis of the investment returns delivered by Private Equity Funds during the recessionary periods following the "dot-com crash" in 2000 and the Global Financial Crisis (GFC) of 2008 to 2010. Australian and New Zealand Private Equity funds, focused on investing in the lower to mid-market segment, investing during and up to 2 years following these events generated median and upper quartile net returns of 19.6% p.a. and 45.0% p.a. respectively, significantly outperforming the public market comparables during these periods.

WEIGHTED AVERAGE NET IRR % PERFORMANCE OF AUSTRALIAN & NEW ZEALAND PRIVATE EQUITY FUNDS

The reason for this outperformance is due to a number of factors which include an increase in opportunities, less competition from listed and  trade purchasers and an ultimate decrease in purchase multiples. Vantage's underlying managers' report that purchase multiples have followed a similar downward trajectory to that seen following the dot-com crash and the GFC, providing an increase in the number of attractive investment opportunities. As a result, it is likely that Private Equity funds investing during and following this recessionary period of 2020 - 2023 will more likely outperform historical returns, due to lower purchase multiples combined with the low interest rate environment and ample deployable capital available to be invested.

A number of academic papers have analysed and reported on Private Equity's resilience versus non-Private Equity backed peers during past economic downturns. Research conducted by Wilson et la. (2012) 3, from a data set of 14 million financial records, found that Private Equity backed businesses in the United Kingdom during the period 1995 - 2010, experienced significantly positive growth, relative to peers that were non-Private Equity backed throughout the 2008 crisis. Further highlighting Private Equity's resilience during the GFC period, A recent Stanford Business School study, titled "Private Equity and Financial Fragility During the Crisis" by Bernstein, Lerner & Mezzanotti (2017) 4, confirmed that Private Equity backed companies are significantly more resilient and can act as an economic stabiliser during a recession. In the study, Private Equity lead companies were found to be less likely to face financial constraints during an economic downturn such as the GFC, allowing them to grow and increase market share versus their peers throughout the same period.

Arguably the current economic contraction has signified the beginning of a new cycle in financial markets and the end of a prolonged period of asset inflation and increasing acquisition multiples. As a result, there will be an increase in attractive investment opportunities for Vantage's underlying Private Equity managers to invest capital at lower than historical valuation multiples, throughout the second half of the calendar year 2020 and into 2021. This re-rating of asset prices and Private Equity's ability to consistently outperform during and following recessionary periods, will ultimately deliver Vantage Fund investors with superior risk adjusted returns over the term of each Vantage Fund.

References

1. Private Equity data source; Australia Private Equity Summary Statistics, AVCAL & Cambridge Associates 30 September 2018. Measured across 72 private equity funds formed between 1997 & 2018, net to investor returns as at 30 September 2018. S&P ASX 200 Accumulation index data from September 1997 to September 2018, source www.rba.gov.au/statistics/tables/pdf/f07.pdf.
2. Preqin - Alternative Assets Data and Intelligence - Databases, Publications and Research. (2020). Retrieved 25 June 2020, from https://pro.preqin.com/dashboard/watchList
3. Wilson, N., Wright, M., Siegel, D., & Scholes, L. (2012). Private equity portfolio company performance during the global recession. Journal Of Corporate Finance, 18(1), 193-205. doi: 10.1016/j.jcorpfin.2011.11.008
4. Bernstein, S., Lerner, J., & Mezzanotti, F. (2017). Private Equity and Financial Fragility During the Crisis. SSRN Electronic Journal. doi: 10.2139/ssrn.3004594

Past performance is not necessarily indicative of future performance.

There's nothing like a big round number to concentrate the mind. Investors, in particular, have a tendency to get excited about arbitrary price points with an abundance of zeroes. Think the 1999 best-seller 'Dow 36,000' (we're still waiting but not for long, I suspect).

Last week's big round number was 10,000 - the price in (US) dollars for a tonne of copper. It was the first time the metal, which is used in everything from kettles to electric vehicles and wind turbines, had fetched that price since the peak of the last industrial metals upswing in 2011.

When you consider that you could have bought a tonne of copper for US$4,300 a year ago, the recent rise is quite something. It is hardly surprising that talk of a commodities boom is picking up. And not just any old rally; what's getting investors excited is the prospect of a commodities supercycle.

Most industries are cyclical to an extent, but commodities are more so than most because the price of metals, crops and energy are closely tied to real day to day supply and demand. The price of a share can be sustained by hopes for future growth in earnings, but the cost of a tonne of copper reflects the balance of buyers and sellers today.

This means that commodities are always moving in mini bull and bear markets. Rising demand and constrained supply pushes prices higher and that, in turn, creates the oversupply that brings the market back into balance.

A supercycle is different. It is always driven by some kind of structural change in which demand is transformed over a period of many years, and usually all around the world at the same time. The mass production of motor cars in the early part of the last century, and then the growth of aviation, fundamentally changed the supply/demand dynamic for oil, for example.

Commodity supercycles are not that common, but when they kick in they last for years. There have probably only been four proper ones in the past 150 years. The first was triggered by American industrialisation and urbanisation, fuelled by the US's railway boom and accelerated by the First World War's demand for armaments.

The causes of the other three are well-known: the post-war recovery in Europe and Japan; the 1970s oil shock, boosted by Lyndon Johnson's Wars on Poverty and in Vietnam, and the space race; and China's rapid growth after it joined the World Trade Organisation in 2000.

So, the big question today is whether the recent price signals, from copper (which has doubled in a year), iron ore, nickel, zinc and other metals, indicate a temporary upswing as the world emerges from the Covid pandemic or the start of something more substantial. The answer to that question may well be one of the most important for investors today.

It's easy to make the case for a short-term bull market in commodities. The economic data around the world in recent weeks has surprised economists if not stock market investors who identified the possibility of a V-shaped recovery in activity a year ago. Coupled with short-term supply interruptions due to the pandemic, and longer-term constraints thanks to a decade of falling prices, it's no surprise that prices should have bolted in recent months.

What's more interesting, however, is the potential for that all-important multi-decade shift in demand. And for that you need look no further than the twin drivers of Joe Biden's transformational spending programme and the energy transition that has the potential to absorb however many trillions of dollars the world's big-spending governments want to print.

A third of Biden's so-called American Jobs Plan is earmarked for transport infrastructure and electric vehicles. China, too, has decided that electric vehicles will be the mainstream option within 15 years. Here in Europe, time has already been called on the internal combustion engine over the next decade or so. By 2040, Wood Mackenzie forecasts, there could be 300 million electric vehicles on the world's roads. In 2019 there were 5 million.

And that is just cars. Factor in green energy generation, let alone the once in a hundred years rebuilding of crumbling infrastructure on both sides of the Atlantic, and the demand for green metals like copper, nickel, aluminium and platinum is likely to soar. Glencore, the commodities trader and mining company, thinks demand for copper could double in 30 years.

Importantly, capital investment in new capacity is well below what is needed to meet that growth in demand. Of the more than 200 big copper deposits to have been found in the past three decades, only a handful have come in the last 10 years. Only 80 or so are now in production or have been closed. It takes years to develop a copper mine and in recent years shareholders have encouraged the payment of dividends over preparing for a future boom.

So, how might investors position themselves for the supercycle ahead? The simplest and cheapest way is via a commodities-focused exchange traded fund. There are plenty of different flavours but a broad-based exposure to metals and energy makes sense. To turbo-charge returns in the event of a prolonged upswing, investing directly in commodity producers is a better idea. With relatively fixed costs, miners' and oil companies' earnings will rise more quickly than the price of their underlying resources.

The other advantage of investing in commodity-related shares is that they can also deliver a high and sustainable dividend income. The combination of price gains and re-invested dividends over the duration of a typical supercycle might point you towards your own big round number.

By now most investors are tiring of their inboxes being filled by sell-side economists and strategists talking about reflation, how much more optimistic they are relative to consensus, and for how much longer the reflation trade will persist.

To be clear, there were very few people talking about a strong V-shaped recovery this time last year. Indeed, a scan of the forecasts of leading sell side economists in April 2020 shows consensus* forecasts of 3% for the CY21 for Australia and 3.8% for the USA.

Indeed, peak pessimism was not reached until September 2020, when economic growth downgrades ceased and modest upgrades commenced. Currently, consensus for CY21 has risen to 5.7% in the USA and 4.4% for Australia.

By contrast, our forecasts for the US in 2021 - which we published in mid-April 2020 - was 6.5% (represented by the cross in Chart 1). For Australia (Chart 2) we were even more optimistic, forecasting 7.0% economic growth. As we moved through 2020, it was clear the expected contraction in economic growth in 2020 was going to be less than expected and hence we reduced our forecast rebound in Australia's economic growth in 2021 to a still sizeable 6.0%.

Much of our more upbeat analysis was based on: (i) the nature of the shock being more akin to a natural disaster; (ii) the quantum of the fiscal packages; (iii) excess credit growth; (iv) the outlook for vaccine development; (v) and the prospect of pent up demand.

One year on, the clambering to upgrade growth estimates has only intensified. Over the past two months, consensus forecasts for Australian economic growth in 2021 have been upgraded a further 0.7%. In the USA the revision over the past 2 months is a remarkable 1.6%.

In other words, consensus economic growth forecasts are now more realistic, but the upward revisions are not yet complete and there is still scope for consensus to upgrade economic growth further in coming months to nearer our long held forecasts.

Indeed, when we compare our forecasts for economic growth to consensus there are now examples of economic growth forecasts for the US that exceed our forecast. The most notable is the Bank of Canada's recent upgrade of 2021 US economic growth from 5.0% to 7.0%. Given the US is Canada's largest trading partner, the Bank of Canada has a strong incentive to get its US outlook near the mark! The Bank of Canada also lifted its global growth forecast in 2021 to 6.8%, which is 1.25% higher than any global growth year since IMF data commenced (1980) and 0.8% above the IMF's April forecasts!

However, one of the largest gaps between consensus and our own 2021 forecasts is for Australia. We remain 1.5% above the consensus forecast and around 1% above the most optimistic forecaster. Given there remains an appreciable gap between our forecasts and other forecasters, it's reasonable to ask what supports our optimism?

1. Australia's data continues to consistently beat economic forecasters

Charts 3 and 4 show our calculation of economic data surprises for economic activity and inflation relative to consensus forecasts (US vs Australia). A positive reading represents economic data beating consensus expectations weighted by data importance and time decay. Clearly, Australia's economic activity data is not only continuing to beat increasingly upbeat economic forecasts, the positive data surprises are larger in Australia.

2. Real economic growth is expanding at pace

Secondly, our nowcasting techniques (Chart 5) for gauging in real-time how fast the economy is expanding already suggest that real economic growth is expanding at 4%yoy by the end of 1Q2021. That is, we are about to see a very solid 1Q GDP print for Australia that we expect will be the catalyst for a further upgrade of the consensus view.[1]

Clear trends and themes have emerged in investment markets as a result of the pandemic and its effect on discretionary and non-discretionary spending and where we live. Exploring these themes was the focus of Sage Capital's recent webinar, which delved into how these dynamics are playing out in Australia and around the world.

Bricks and mortar drives markets

The webinar provided perspectives on the nature of the current housing boom and how long it can continue. It explored a related theme of consumer spending and how it has shifted one year after the first COVID lockdowns.

The housing market cycle was the main theme during the session, given low interest rates the world-over have stimulated a boom in residential property markets. Detached dwellings in particular have benefitted, as people seek more space at home when they are prevented from travelling too far from their homes due to stay-at-home orders and border closures.

As a result, apartment prices have not experienced the same gains as stand-alone homes. Flagging demand for inner-city properties is also the result of many people embracing the opportunity to move out of the city given the widespread adoption of the work-from-home way of working.

Inner city apartments notwithstanding, the booming housing market isn't just good news for property, it also has flow-on effects to other sectors. The strong residential real estate market has translated to high demand for mortgages, which is good news for lenders and also service providers such as mortgage insurers.

It's worth noting the lending sector is strong for another reason. At the start of the pandemic, many lenders made very large bad debt provisions, assuming borrowers would be stretched as a result of the pandemic leading to shut downs in many areas of the economy. These provisions, at least in Australia, have proven to be too generous, largely due to government stimulus programs helping borrowers to meet their obligations and taking the pressure off lenders.

While this has been good news for financial institutions and also the housing market, concerns are emerging about whether the market is running too hot. Governments and regulators are also worried about housing affordability. As a result, some countries are taking action to moderate house price growth.

As examples, New Zealand has taken steps to cool its housing market and Canada has recently tapered its bond-buying program. The Reserve Bank of Australia has not given any indication it's going to steer away from its lower for longer approach to interest rates. But that does not mean investors should not be informed by actions in other jurisdictions. It's a trend of which our portfolio managers should be aware, as these same trends could play out in other markets.

What's happening at the checkout?

Turning to consumer spending patterns, one of the fundamentals we're always curious about is the connection between housing market movements and consumer spending, and how this may play out across the investments in our portfolios.

Retail spending is highly correlated with house prices. So when house prices are strong, we're much more likely to buy a new car, renovate and buy furniture and appliances. But this trend often reverses as interest rates and home loan repayments rise, and people are less inclined to spend money on non-discretionary items.

We are also closely watching shifts in consumer spending as a result of the pandemic, investigating whether and when these shifts normalise and who the winners are in the short- medium- and long-term.

When it comes to discretionary and non-discretionary spending, consumers will look for alternate ways to spend their money if recreational travel remains off the table. Which is why Sage Capital has been scouring the market for retailers with a real digital capability that may have been so far largely overlooked by investors.

Retailers that are strong omni-channel marketers that have a demonstrated ability to do online fulfilment are well placed, especially those with strong national store networks, so they can easily deliver orders on the same day they are placed.

This is a real advantage over online competitors that rely on big fulfilment centres for retail distribution. Achieving same day delivery is going to be very difficult for these operators and require significant capital expenditure to maintain their competitive position.

Our ability to add value

At Sage Capital, we understand these trends and aim to position the portfolio accordingly. These insights help us form a view on when to rotate in and out of stocks exposed to the housing market and the retail sector.

As for the future, there are still many unknowns. These include the COVID-19 vaccination rollout in Australia and around the world and how that may affect international border openings and the future of international travel. The way these themes play out has implications for any investments exposed to the movement of people and goods across borders.

These are just some of the themes we have been investigating at Sage Capital and that inform our approach to portfolio management. We look forward to sharing further insights form our webinars in the future.

As a long short manager, the investment team is able to use its shorting powers to benefit from a falling market. At the same time, it can go long stocks when markets rise. This investment style, and the diversified nature of the portfolio, helps mitigate risks and provides protection when markets correct.

Sage Capital is an Australian long-short equities manager with two investment strategies, the CC Sage Capital Equity Plus Fund and the CC Sage Capital Absolute Return Fund. Long-short strategies are often popular with investors when traditional asset classes are challenged. It's a strategy that aims to provide consistent returns through market cycles.

Both Funds have performed well for investors over the one year to 31 March 2021. The CC Sage Capital Equity Plus Fund delivered a net return of 43.59%* and the CC Sage Capital Absolute Return Fund delivered a net return of 9.98%*, outperforming their respective benchmarks for the same period by 6.12% and 9.89%.

*Past performance is not indicative of future performance.

This information is for Wholesale and Professional Investors only and is provided by the Investment Manager, Sage Capital Pty Ltd ACN 632 839 877 AR No. 001276472 ('Sage Capital'). Channel Investment Management Limited ACN 163 234 240 AFSL 439007 ('CIML') is the responsible entity and issuer of units in the CC Sage Capital Equity Plus Fund ARSN 634 148 913 and the CC Sage Capital Absolute Return Fund ARSN 634 149 287 (collectively 'the Funds'). Channel Capital Pty Ltd ACN 162 591 568 AR No. 001274413 ('Channel') provides investment infrastructure services for Sage Capital and is the holding company of CIML. This information is supplied on the following conditions which are expressly accepted and agreed to by each interested party ('Recipient'). This information does not purport to contain all of the information that may be required to evaluate Sage Capital or the Funds and the Recipient should conduct their own independent review, investigations and analysis of Sage Capital and of the information contained or referred to in this document. This email (including attachments) is subject to copyright, is only intended for the addressee/s, and may contain confidential information. Unauthorised use, copying, or distribution of any part of this email is prohibited. Any use by unintended recipients is expressly prohibited. To the extent permitted, all liability is disclaimed for any loss or damage incurred by any person relying on the information in this email. This communication has been prepared for the purposes of providing general advice, without taking into account your particular investment objectives, financial situation or needs. Past performance is not indicative of future performance. All investments contain risk. An investor should, before making any investment decisions, consider the appropriateness of the information in this communication, and seek professional advice having regard to these matters, any relevant offer document and in particular, you should seek independent financial advice. For further information and before investing, please read the Product Disclosure Statement available from www.sagecap.com.au and www.channelcapital.com.au.

In our Investment Strategy Note we discuss how even the best long-term performing fund managers always have shorter term periods of underperformance - it's not a bug, it's a feature of the best.

Summary:

• The goal of equity fund investors is generally to be with the top performing managers over the long term (5-10+ years).
• Data shows that virtually all long-term top performing managers have shorter term periods (1-3 years) where they underperform their benchmark.
• Ditching long term top performing managers at the first sign of underperformance is likely to be a suboptimal strategy.
• To be with long term top performing managers you should expect you will have to endure short term periods of underperformance.

The financial media love to laud or lament short-term investment performance, both good and bad. As an investor, it's easy to get drawn in, as you mentally extrapolate out recent trends across your portfolio.

But to capture superior long-term results, which is what most of us ultimately aim for, we must first be willing to tolerate periods of short-term pain.

These short-term swings can be difficult to stomach and will often tempt investors to bail out of the market. However, without being able to accept periods of underperformance, investors may miss out on the market's inevitable rebound and fail to harvest the long-term superior returns of equities.

If investors can develop a deeper understanding of how top funds perform over time, they will more confidently weather the inevitable periods of short-term volatility in performance, and be more likely to reach their long-term investment goals.

Don't be alarmed

The evidence is clear: virtually every top-performing fund has instances where it underperforms its benchmark and its peers, particularly over time periods of three years or less.

A study by independent US investment bank, Baird, looked at a group of more than 1,500 funds with 10-year track records. They then narrowed the list to 600 funds that outperformed their respective benchmarks by one percentage point or more, on an annualized basis, over the 10-year period. The list was further narrowed to include only those funds that both outperformed and exhibited less volatility than the market benchmark.

Despite their impressive long-term performance, 85% of these top managers had at least one three-year period in which they underperformed their benchmark by one percentage point or more. About half of them lagged their benchmarks by three percentage points, and one-quarter of them fell five or more percentage points below the benchmark for at least one three-year period.

Depending on which of the three-year periods investors looked at, they could have been highly alarmed by these periods of underperformance. Yet in the long-run investors profited: all these managers were top performers over the full 10-year time span.

It pays to be patient

When looking at shorter periods, the results were even more telling. All the top managers dropped below their benchmark at least once. Moreover, one-quarter of them went through at least one 12-month period where they underperformed their benchmark by 15 percentage points or more.

By these measures, it looks as though all fund managers, including even the best ones, will go through periods of underperformance. For investors, it can be particularly challenging knowing what to do when your fund is in the midst of one of these tough periods.

The evidence suggests that rather than leaving a top-performing manager during difficult times, it pays to be patient through periods of underperformance. Indeed, the longer an investor can wait, the better their funds' chances of beating its benchmark become.

Time diversification

One of the major factors affecting fund performance is the cyclical relationship between asset prices and the business cycle. In the short term, investments can fluctuate in value for a number of reasons, including changes in the economy, volatility, political uncertainty, business failures, interest rate changes, fluctuations in currency values, and company earnings. In an economic downturn, GDP growth slows, and business earnings decline, which leads to less optimistic outlooks for companies and lower stock prices. In an economic expansion, the reverse tends to happen.

But time is an investor's best ally.

As investor holding periods lengthen, short-term risks tend to become less relevant, partly because many short-term price movements tend to offset each other over a complete business cycle. This means that, as an investment's holding period increases (e.g., 20 years vs. 5 years), investment risk due to market volatility (i.e., ups and downs of prices) will decrease.  Because of this relationship, both the frequency and magnitude of underperformance become less dramatic over more extended periods.

A more wholistic view

Investors who buy into an equity fund based solely on a few quarters of strong returns are quite likely to reverse course and sell out of the fund when returns fall short. In our opinion, this churn benefits no one, and hence at Ophir we seek investors who agree with our investment philosophy and appreciate our process. We expect our portfolios to have negative years or underperform their benchmarks on occasions and understand that investors can start feeling nervous and uncomfortable through these periods. As seen below, our Ophir Opportunities Fund, which has the longest track record of any Ophir fund at nearly 9 years, has had two periods of 1-year underperformance and one period of 3-year underperformance (albeit briefly), yet is ranked no.1* over the long term, generating 24.6% p.a. (net) since its inception in August 2012.

We strongly believe investors should remain focused on their long-term financial plan and avoid knee-jerk reactions during times of negative absolute or relative performance. All equity fund managers have short term periods of underperformance. A more wholistic view of managers needs to be taken. This includes factors such as long-term track record (if it exists), people, investment process, levels of alignment and adherence to capacity constraints, amongst others. In this way, investors who take a more wholistic view are more likely to set themselves up for long-term success.

Source: Ophir Asset Management. *FE fundinfo data, Australian Small/Mid Caps, Aug 2012- March 2021

One year on from the 'fastest bear market in history' we can see the benefits in keeping calm and staying invested in the Australian stock market.

Prime Value Emerging Opportunities Fund portfolio manager, Richard Ivers, shares his views below on where the market is currently at. But first, let's rewind 12 months:

During February and March 2020 markets plummeted. In the USA, the S&P 500 fell 30 per cent in just 22 trading days after reaching a record high on 19 February 2020 - the fastest drop of its magnitude ever.

Likewise, the ASX 200 entered its fastest bear market, shedding 20.5% in just 14 days.

As economies globally shut down, the question seemed to be how far could markets fall?

What happened next surprised many investing experts and emphasised the virtues of the words: DON'T PANIC.

The fastest bear market in history turned out to be the shortest bear market. One year on, the recovery has been remarkable.

Prime Value Asset Management's Australian equities funds show the benefits in keeping a steady hand.

Looking through the market

As Prime Value fund managers Richard Ivers and ST Wong often say, their job is to "look through" short-term market fluctuations when making investment decisions.

When markets were spiralling one year ago, Richard and ST sought to turn crisis into opportunity.

The savage sell-off meant many good quality companies were suddenly available at better value, in line with Prime Value's 'Growth at a Reasonable Price' approach.

For the Prime Value Emerging Opportunities Fund, the volatility among small cap stocks has provided many opportunities during the shutdowns and on through the recovery.

Investing during this uncertainty - always with an eye on 'protecting the downside' - allowed the Prime Value Emerging Opportunities Fund to be the best performing Australian small caps fund for the year to 30 June 2020, the second best performing Australian equities fund in any category for the calendar year to 31 December 2020 (Morningstar), and currently the best among funds who blend value and growth styles for the year to 31 March 2021 (Morningstar).

Current state of play

Richard Ivers, portfolio manager for the fund, says the market continues to create opportunities. "The small caps market is still choppy, there is more takeover activity, and there are some good buying opportunities at present.

"The volatility has created the opportunity to buy some quality companies relatively cheaply."

He says looking through the COVID-19 market recovery continues to be key. "We see some big fluctuations in stocks which may be perceived as winners or losers from the recovery. By looking through the short-term issues and analysing the strength of the business we can find some real gems.

"But the economy is changing, and investors need to look through the market swings. A key current question is how will the COVID winners and losers from last year fare during 2021

"Many people are trying to trade the re-opening, but it always has to come back to growth at a reasonable price.

"For example, some of the travel stocks are now over-priced. But there are other ways to benefit from economies re-opening which are less obvious, via really good businesses."