Perpetual : Q&A with James Rutledge

Perpetual Portfolio Manager James Rutledge recently moved from co-managing the Pure Value Share Fund with Head of Equities Paul Skamvougeras, to running it single-handedly. We asked him about the day-to-day management of the fund, some of the stocks in the portfolio and his thoughts on reporting season.

Can you give us an idea of your background prior to joining Perpetual as an Equities Analyst in 2017 and your path to becoming sole Portfolio Manager of the Pure Value Share Fund from 1 July 2022?

I spent about 10 years on the sell side covering various sectors prior to joining Perpetual in 2017. I started at Perpetual as an analyst covering sectors like building materials and healthcare that I was already very familiar with. I then built out my coverage across a number of consumer staple stocks (such as Treasury Wine and Wesfarmers) and started working on the Pure Value Share Fund with Paul Skamvougeras in 2019. On the three-year anniversary of working on the fund I took over as sole Portfolio Manager. Perpetual has a great track record of progressing people through the investment team. In the Perpetual style, this had been a long-planned transition and a natural progression after three years of working alongside Paul on the fund.

Talk us through the Pure Value Share Fund's performance over the three years you managed it with Paul?

Since managing the fund with Paul over the last three years, the Pure Value Share Fund has delivered 11.9%* return per annum net of fees. That's an 8.5%* per annum above the per annum return of the ASX300, which has been a really pleasing outcome.

A full performance table for the fund as at 31 August 2022 is included for reference below.

	Fund	ASX300	Excess
1 month	5.88	1.18	+4.71
3 months	-3.72	-2.41	-1.31
FYTD	8.19	7.20	+0.99
1 year p.a.	4.25	-3.67	+7.91
2 year p.a.	22.01	11.30	+10.72
3 year p.a.	14.65	5.64	+9.01
4 year p.a.	8.03	6.51	+1.53
5 year p.a.	8.02	8.24	-0.22
7 year p.a.	9.73	8.63	+1.10
10 year p.a.	11.01	9.32	+1.69
since incep.	14.45	6.51	+7.93

^{Source: Perpetual Asset Management. Past performance is not indicative of future performance.}

Pure Value is more of an absolute return-focussed product than our other long-only funds but utilises the best ideas from our large and experienced investment team. It is a highly concentrated fund with 10 to 20 stocks. As a result, we typically look to include our highest conviction holdings (usually about five positions) at ~7.5-8%, our core holdings at ~5% and others coming into or out of the portfolio below this. This is the structure we adopted when taking on the fund three years ago and it remains in place. The fund can hold up to 25% cash and can hold up to 20% in offshore positions.

Recession concerns dominated the June quarter and macro factors continue to cloud the outlook for 2022. As a bottom-up stock-picker, how do you operate in this environment?

The June quarter was a difficult quarter as the market focussed on the risk of recession as a result of higher interest rates. For now, we are yet to see any material pull back in consumer spending, though I would emphasise "for now". Although we are seeing evidence that inflation rates have peaked, central banks will want to keep inflation expectations under control and return to a more benign level in future. The challenge that central banks have is the strength of the labour market, in part compounded by the shift in demand towards more labour-intensive services, which in turn is putting pressure on wages globally.

We see the potential for central banks needing to continue to raise rates, which is likely to put continued pressure on equities. Having said that, we are mindful that upside risks in the market may come from a larger-than-expected pull back in oil (though we see this as unlikely), further government support, or significant stimulus out of China. The macro has been a big driver of returns in recent months, which is a challenge. As we structure the portfolio, we need to be mindful of these macro influences (which drives our limited holdings across banks and consumer sectors, for example), but we remain fundamental bottom-up stock pickers. The style of market we are currently in should favour active fund management and we remain alert to the opportunities that will present.

What did you make of the August / September reporting season and are there some fund highlights you can take us through?

Our portfolio enjoyed a solid reporting season, with the fund delivering 5.9% absolute returns net of fees in August compared with the ASX300 at 1.2%. Qantas and A2 Milk were the highlights for the fund. For Qantas, a $3b improvement in operating cashflow was the highlight, largely due to a $2.7b improvement in unavailed passenger revenue (ie. revenue paid in advance of a flight). This allowed the company to announce a surprise $400m on-market share buyback. Notwithstanding our views around the consumer, travel intentions remain elevated across both domestic and international, which sets up the business well for FY23. A2 Milk appears to be through the channel issues it has experienced in China over the last 12-18 months, and we are seeing improved freshness of product and pricing through the channel. A number of A2's peers are now facing similar channel issues. The Shanghai lockdown was actually a positive for the company - and not the negative the market had feared. Distribution points in China are now up 16% and China label sales continue to grow well, especially in lower tier cities. English label sales have now stabilised while the company also announced a $150m buyback.

Can you take us through the investment thesis for Qantas in more detail?

While recession concerns and continued, high oil prices were headwinds for Qantas over the June quarter, we continued establishing a position in the stock. We acknowledge the discretionary element of airline travel, but it is interesting to look at the data on passenger trends over the last 35 years. For domestic services, prior to Covid, there have only been three years where domestic passenger growth has been negative: FY90 due to a pilot strike, which materially impacted the industry; FY02 where the aftermath of the 9/11 attacks saw the collapse of Ansett and hurt the industry globally; and FY15 where stronger East Coast leisure market numbers couldn't quite offset the weakness in the resources sector. On the international side, prior to Covid, there have been just two years where passenger growth has been negative: both FY02 and FY03 in the wake of 9/11.

As the initial spike in demand post Covid subsides, higher real prices (as a result of higher oil prices) are likely to have a meaningful impact on passenger volumes. Simplistically, if we were to assume that a reversal in real pricing that occurred over the 2000s had a similar ~300bp impact on demand, we see the airline competitive dynamics such that an implied -1% passenger volume rate can still see profit growth through higher load factors. Clearly a tougher macro-economic environment would lead to an even softer demand environment, however, a favourable industry structure means that Qantas should be able to navigate this tougher demand backdrop well if and when it arrives.

How would you describe your personal investment philosophy and influences that have shaped your career?

I've had a passion for investing since a young age. I remember closely following the IPO of Commonwealth Bank back in 1991, and my interest in markets has remained ever since. My early years in broking, however, made me highly alert to both the ups and downs of the market. My career in equities started in June 2007 when I joined a sell side broker. The market subsequently peaked in November 2007 before the GFC delivered a terrible 2008. I was responsible for putting together the morning note through that period and writing up what had happened overnight made me very aware of how significant downside risks can be in the market.

When running a product that is more absolute return focussed, this early experience constantly reminds me that markets aren't on a one-way track. These are hard fundamental lessons but fortunately for me, they were acquired at the very beginning of my working life and have left a lasting impression. Having said that, in such a flexible portfolio like Pure Value, it is important to be a cautious optimist, and restrain from holding too much cash, which can significantly eat away at performance returns. I feel personally aligned with Perpetual's investing philosophy and am enthused by the challenge of running the Pure Value concentrated mandate.

^{*Performance for the period 1/7/19 - 30/6/22, net of fees.}