Mercer tables: Tech boom powers resurgence in growth funds

These Australian growth funds have pole-vaulted back up Mercer’s coveted investment leaderboard, with annual returns of more than 25 per cent.

Hyperion’s top US stock holdings as of September included Tesla, Service­Now, Amazon, Microsoft, Spotify, Workday, Intuit, Block, Visa, Airbnb, Palintir, Mastercard, Costco, Alphabet and Meta. Picture: Getty Images

Australian growth funds rose from the ashes with impressive investment returns for the past year, buoyed by the prospect of interest rate cuts, a soft landing for the global economy and a boom in artificial intelligence stocks.

Whereas in 2022 some of Australia’s best-known growth funds lost 20-30 per cent as central banks clamped down on inflation with massive interest rate hikes that sparked recession fears, the same funds have pole-vaulted back up the leaderboard with gains of a similar magnitude.

Growth funds have rebounded strongly, taking out the top 10 spots in Mercer’s coveted investment performance tables for the year to December.

The top-performing fund was Hyperion Australian Growth with a 25.1 per cent annual return, more than double the 12.1 per cent return from the S&P/ASX 200 index.

Hyperion lost 25.4 per cent in 2022 after outstanding success with Afterpay in recent years.

But it has been the best performing fund over five years, returning 15.1 per cent per annum. In their most recent letter to investors, Brisbane-based Hyperion portfolio managers Mark Arnold and Jason Orthman said the “paradigm shift” to artificial intelligence and machine learning “is real and may have the potential to create a rarely seen opportunity to increase equity values”.

Top US stock holdings as of September included Tesla, Service­Now, Amazon, Microsoft, Spotify, Workday, Intuit, Block, Visa, Airbnb, Palintir, Mastercard, Costco, Alphabet and Meta.

In second place was Manny Pohl’s ECP Asset Management All Cap fund which returned 23.6 per cent for the year.

ECP ranked sixth for five years with an annual return of 15 per cent.

ECP Asset Management ECP executive director and portfolio manager Jared Pohl said that from the perspective of his portfolio, the past few years were “tough” for growth managers.

“While earnings growth continued to provide a positive contribution to performance over the past few years, we faced severe headwinds in the form of multiple compression as discount rates rose,” Mr Pohl said.

“From an outlook perspective, discount rates are more likely to be flat to down.

‘‘If this is true, then the headwinds we faced should become tailwinds for the portfolio.”

The largest contributors to ECP AM’s active returns for the 12 months to December were Block, Megaport and GQG Partners. All of these positions were counter-consensus calls.

“The market was initially concerned about Block’s slowing growth and lack of profitability, which the company has since taken steps to resolve,” Mr Pohl said.

“Similarly, Megaport put to rest concerns surrounding the need to raise capital and weakening operating metrics. GQG continues to build the scale of its franchise through continued AUM growth and performance, but the market has yet to give it the premium multiple that it ­deserves.”

ECP is a quality growth manager building its portfolio bottom-up by focusing exclusively on finding the best businesses it can and then allocating capital to them based on its expected returns.

Rounding out the top 10 for the one-year period are Smallco Broadcap, Selector High Conviction, Platypus Australian Equities, First Sentier Concentrated Growth, Bennelong Core Equities, First Sentier Large Cap Growth, Bennelong Concentrated Equities and Greencape High Conviction.

First Sentier head of Australian equities growth, Dushko Bajic, looks for companies that can deliver strong growth in revenue, earnings and cash flow, with returns above their cost of capital.

Mr Bajic also finds it “very important to be very open minded”.

His team models 200 companies and invests in 20-30 stocks with a particular focus on changes in the return on invested capital as a potential share price catalyst.

Structural growers helping First Sentier included Pro Medicus, WiseTech, Xero and REA Group.

“That sort of keeps you on your toes and also gives you a good reason to look at other parts of the market, because industry structure can change – competitive intensity can increase or decrease, as can capex requirements and that can fundamentally change rates within industries and companies,” Mr Bajic said.

“So that gives us a good reason to look at all parts of the market.”

His team is “trying to pick the eyes out” of companies that can grow faster, while using a disciplined valuation process.

“You’ve always got to be careful what you pay for these wonderful attributes of earnings growth, cash flow generation and higher return on investment capital,” he said.

“We put it through our modelling process, come up with a valuation, and if we think the company’s prospects are better than the market is currently pricing, it’s a good catalyst to put in the portfolio.”

He counters the idea that his fund got a tailwind from rate cut expectations based on his observation that the US 10-year bond yield started and ended the year close to 4 per cent. More important, in his view, was his fund’s expectation of a soft economic landing.

“We were pretty strongly of the view that neither Australia nor the US would go into a recession,” Mr Bajic recalled.

“We had a differentiated view, based on the strength of the labour markets in the US and Australia, and the fact that consumers had built up a heap of excess savings.

“So we had a view of stronger-for-longer and that informed our view of how Australia and the US played out last year, but we also focused on our structural growers (companies).”

Structural growers helping First Sentier included Pro Medicus, WiseTech, Xero and REA Group as their earnings were better than expected, while James Hardie and Megaport did better than feared.

Goodman Group also did well for the fund, as its focus on very high quality properties meant it was resilient to rising interest rates and less activity post-pandemic.

At the start of 2023, Mr Bajic asked his team what stocks could double in value.

They said Xero and WiseTech.

“It was almost so contrarian to think that a stock could double,” he said. “Coming out of the last quarter of 2022 it was almost a heresy to think of growth stock could do well ever again.

He thinks 2024 will be a “steadier year” without the depressed base there was before 2023.

“It will be a year of stocks making the market, but I think you’ll still be able to get decent returns.”