Over the course of the second quarter of 2019, we became more cautious. The most recent economic data show that most major economies are experiencing a slowdown. While we believe that the U.S. and China will ultimately manage to negotiate a deal, the ongoing uncertainty and tit-for-tat imposition of tariffs has already had an impact on economic growth. As a result, we increased our exposure to high-quality lower-beta companies, reflecting our more cautious stance on markets.

We remain overweight to companies with good structural growth prospects and to those that have direct exposure to stronger economic environments, particularly the U.S. We also maintain our significant underweight to the banking and domestic cyclical sectors where we remain concerned about the strength of the domestic economy and earnings growth in the near term.

As of the end of June 2019, our largest relative sector overweights were in health care, industrials and business services, consumer staples, and consumer discretionary. Our key underweights were financials, real estate, and materials.

Raised Exposure to Utilities

As previously noted, over the quarter we increased our exposure to companies with more defensive revenue streams. We raised the weighting to the utilities sector, moving from a modest underweight to a small overweight. We did this through initiating a position in APA, a large energy infrastructure business. APA operates 15,000 km of gas transmission and distribution pipelines, gas storage, renewable assets, and power stations. The company has long-term contracts, mostly on a fixed charge basis, providing it with stable, predictable cash flows.

Moved Further Underweight Financials

As the June quarter began, the portfolio was significantly underweight financials. Over the course of the past three months, we further reduced our exposure by cutting our positions in Macquarie Group, NAB, Westpac, and ANZ.

We also continued to reduce the portfolio's exposure to the insurance industry, continuing to trim the position in Insurance Australia. Although the non-life insurers are benefiting from a backdrop of rising premiums, there are some concerns as to the prospects of improving insurance margins, as well as by rising regulatory costs. We believe there are more compelling opportunities in other sectors.

Reduced Industrials and Business Services but Remain Overweight

Over the course of the quarter ended in June, we reduced the size of our industrials and business services position, although we remain overweight. In particular, we eliminated ALS Queensland. ALS is a testing and inspection business, with a heavy weighting toward commodities testing. Our investment thesis has been based on our view that the stock is a way to leverage a recovery in the exploration cycle, particularly gold, driving strong earnings growth due to operation leverage that is underappreciated by the market. However, following the release of its latest results in May, we were dedicated to reducing the size of our position.

Switched Holdings Within IT Space

The portfolio retains its modest overweight to the IT sector. However, over the course of the second quarter of 2019, we made a number of changes to our holdings. We initiated a position in Xero, funding this through reducing the size of our holding in Link Administration.

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• Xero: This company provides cloud accounting software to small and medium businesses. Xero is focused on growing its UK and U.S. operations as well as extending its non-accounting software as a service (SaaS) products. Recent results demonstrate strong offshore execution. The UK is the key driver of near-term growth as accounting software is becoming mandatory.

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• Link Administration: We made a decision to reduce the size of our holding in this provider of fund administration services. As previously outlined, Brexit concerns are affecting Link's asset services division in the UK, leading the company to issue a significant profit downgrade.

Easing by Regulator Led Us to Seek Out Opportunity in Property Listings

Following the supportive moves by both the APRA and the RBA, we have been looking for opportunities in housing-related names. To this end, we initiated a position in online property listings business REA Group. Its share price has struggled in recent months due to the decline in domestic housing transactions. However, we are of the view that some of the tail risks around housing-related names have been taken out.

Reduced Exposure to Consumer Names

Over the course of the quarter, we reduced our consumer staples position, although we remain overweight. We trimmed a number of positions including Treasury Wine Estates, a2 Milk, and Woolworths. In the case of infant milk manufacturer a2 Milk, this was a new addition to the portfolio in late 2018. The company is a pioneer in the A2 milk segment and the leading player in the premium infant formula marketplace. It has already moved into the U.S. in fresh milk, and the strategy in that market is to invest heavily and grow distribution, with the aim of eventually launching infant formula in the U.S. market. However, our local industry feedback suggested that demand for A2 milk in China, a key market, slowed early in the quarter in large part due to the enforcement of regulatory changes regarding daigous. Daigous, which purchase goods overseas for resale in China, account for a significant proportion of a2 Milk's distribution in the country.

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Despite this reduction in the consumer staples weighting, we continued to find some opportunities in the consumer discretionary space. Over the course of the review period, we opened a position in Wesfarmers, the Australian conglomerate, following weakness in its share price. We believe Wesfarmers' diversified portfolio is less exposed to domestic cyclical sectors, where we see rising risks to the economy. The vast majority of Wesfarmers' earnings are consumer-related, more specifically to hardware retailing in the Bunnings chain, and in Coles, the leading supermarket in Australia.