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."