July 2012

Monthly Report

Schroder Wholesale Australian

Equity Fund
Total return %
8
Schroder Wholesale Australian Equity Fund (post-fee)
S&P / ASX 200 Accumulation Index
Relative performance (post-fee)

1 mth

3 mths

1 yr

4.7
4.3
+0.4

-0.6
-2.0
+1.4

4.0
1.3
+2.7

3 yrs p.a. 5 yrs p.a.

6.8
4.6
+2.2

0.0
-2.8
+2.8

10 yrs p.a.
9.0
7.9
+1.1

Please refer to www.schroders.com.au for post-tax returns

Past performance is not a reliable indicator of future performance

Inception Date: 01 Jul 2002, 10 years and 1 month.

Portfolio1
86.9%
8.0%
2.5%
1.1%
1.4%

Benchmark2
84.4%
9.6%
6.1%

Top ten holdings %

Portfolio1
BHP Billiton Ltd.
11.2%
National Australia Bank Ltd.
7.3%
Westpac Banking Corp.
7.2%
Commonwealth Bank of Australia
7.1%
Australia & New Zealand Banking Group Ltd. 6.5%
Woolworths Ltd.
5.8%
Telstra Corp. Ltd.
4.8%
Wesfarmers Ltd.
3.7%
Brambles Ltd.
3.4%
Rio Tinto Ltd.
2.7%
Total
59.7%

Benchmark2
10.0%
5.5%
7.0%
8.9%
6.2%
3.4%
4.8%
3.7%
0.9%
2.3%
52.7%

Our fundamental views havent changed much. Six principles of this line of thought are;

Portfolio1
49
15.9%
16.5%
3.0%

Benchmark2
200

the political capital invested in bond holders being kept whole (and the consequent
ongoing rally in sovereigns to unprecedented levels, and the knock on effect in equity
markets);
the ongoing robustness of the Australian dollar in the face of falling commodity prices
(albeit we think the correction in bulks to date is mild relative to our long run assumption);
and,
the readiness of corporates to regear and add capacity, in the face of ongoing tumult in
debt markets and broad based declines in demand, respectively.

Market cap
ASX 1 - 50
ASX 51 - 100
ASX 101 - 300
Non Index
Cash

Characteristics
No. of stocks
Portfolio turnover* (1 yr)
Volatility (5yr standard deviation)
Tracking error (3yr historic)

Commentary
The S&P / ASX 200 Accumulation Index rose by 4.3%, while the Schroder Wholesale
Australian Equity Fund (post-fee) rose by 4.7%, outperforming by 0.4% for the month.
July followed Junes gains, led by the major banks, Telstra and the supermarket stocks
(Woolworths and Wesfarmers) which combined made up 2/3rds of the index gain for the
month. Yield stocks led the rally, whilst resource stocks continue to be beset by concerns of
slower global growth, finishing July at close to four year lows.

16.6%

lower (global growth) for longer, driven by overcapacity and demographics;

an ongoing need for deleveraging by the government, financial and household sectors,
albeit deferred (but ultimately exacerbated) by political realities;
there is no long term monetary solution to indebtedness;
in line with unemployment rates, the Australian economy is far above mid cycle whereas
most other developed world economies are below;
business plans extrapolating prior cycles are folly; and,
the two golden rules for corporate success in this low volume environment remain the
ability to exert pricing power, and a productivity focus.
To the contrary, three thematics which have provoked us through the past year, and caused
us to question our embedded beliefs, include;

Surprises, though, can sometimes be helpful in prompting us to rethink paradigms and

stress test our assumptions; just as the Queen jumping from a helicopter with James Bond
did!
If our fundamental views havent changed much, equity prices have. CBA ($90b market
capitalisation) has outperformed BHP ($100b market capitalisation) by 40% through the
past year. Think about that, in dollars you can buy any of the domestic energy, insurance
or listed property sectors with that amount of market cap. The treatment of miners is, we
feel, somewhat indiscriminate, with the majors being treated just as harshly as some
second and third tier stocks, despite being significantly better placed in terms of both
operating and financial leverage than many of these smaller peers. We can hardly be
accused of being cheerleaders for resource stocks through the past cycle but rather than
becoming more vocal as prices correct, we have increased our weighting to the majors as
they trade ever further below fair value, even with our mid cycle commodity prices
remaining below spot (especially in the case of bulk commodities).The sensitivity of
resource equities to pro cyclical (and dilutionary) capital allocation, however, can best be
calibrated by the fact that EPS for the resources sector will end F12 lower than it was five
years ago, even with commodity prices at higher levels.

1 The 'Portfolio' is the Schroder Wholesale Australian Equity Fund

2 Benchmark is the S&P / ASX 200 Accumulation Index
Unless otherwise stated all figures are as at the end of July 2012
Please note numbers may not total 100 due to rounding
*Turnover = (Purchases + Sales - Cashinflows + Cashoutflows) / (Market
Value(T0)+ Market Value(T1) - Cashflows)

Whilst it has been an uncomfortable year for resource names, being caught in a (corporate)
rip can sometimes be a good experience. Through the past quarter, the banks have
belatedly been picked up by the market and repriced on the back of their yield, which had
got to record premiums over bonds. This may have run its course, however, unless they
accelerate nascent and to date fumbling attempts at (real) productivity gain. With its gigantic
market capitalisation, CBA is now the seventh biggest bank in the world, and $35b larger
than NAB, which has the lowest market capitalisation of the major Australian banks and the
biggest asset base. In fact, its discount to the peer group is now close to the largest it has
been in twenty years, following NAB being the worst performer of the majors through the
past year whilst CBA has led the way; despite NAB winning most market share, and CBA
shedding the most share, through that period. The message is clear; in a low growth
environment, value is most enhanced through harvesting the existing book (ie leading
repricing) rather than discounting to win share. The NAB break up campaign may have
won gold medals in the advertising community, but they have been more than offset by
brickbats from the stock market.

Schroder Wholesale Australian Equity Fund

Fund objective

Monthly Report
July 2012

Commentary Continued

To outperform the S&P/ASX 200 Accumulation Index after fees over the
medium to long term by investing in a broad range of companies from
Australia and New Zealand.

Investment style
Schroders is a bottom-up, fundamental, active growth manager of
Australian equities, with an emphasis on stocks that are able to grow
shareholder value in the long term.

Fund details
APIR code
Fund size (AUD)
Redemption unit price
Fund inception date
Buy / sell spread
Minimum investment
Distribution frequency
Management costs (p.a.)

SCH0101AU
$1,392,600,475
$0.8701
July 2002
0.30%/0.30%
$50,000
Normally twice yearly - June and Dec
0.92%

Sector exposure versus the benchmark %

-8.0
Energy

-6.0

-4.0

-2.0

0.0

2.0

4.0

-2.0

Chemicals

1.9

Materials

Construction Materials

3.7

Containers & Packaging

0.4

Metals & Mining

0.4

Paper & Forest Products

0.1

Industrials

-0.8

Consumer Discretionary

-0.9

Consumer Staples

1.8

Health Care

1.5

Information Technology

0.7

Telecommunication Services

0.3

Utilities
Capital Markets

Financials

-0.1

Diversified Fin Services

-0.1

Insurance

The high Australian dollar is hurting only some of those we would have anticipated, in an
investment sense. Domestic manufacturing is predictably hurting Caltex closed their
Kurnell oil refinery (330 jobs lost) and Ford (44), Accolade Wines (175), Public Transport
Australia (367) and LTQ Engineering (164) all saw jobs lost. CSR spent $1b acquiring a
glass business through the past five years and are now equivocating over whether to spend
another $150m in CAPEX for the acquired plants; or cease (currently loss making) local
manufacturing. Being an importer for marginal commodity product has given an immense
cost advantage over local manufacturing production through recent years, as Adelaide
Brighton (to its gain) and Boral (to its cost) have found out in cement, and Arrium and
Bluescope have endured in steel. Some foreign earners, though, have escaped relatively
unscathed, as the US economy, and especially housing in that market, gradually improves.
James Hardie, for example, is now one of the best market performers through the past
year, even with US housing starts at very low levels. The fact that it makes the price in its
markets putting prices up through the past few years of depressed volumes and is
ruthlessly focused on productivity, resulting in a margin above 20% through this time, and it
has no net debt, highlights the ingredients of strong equity market performance even with a
poor macro backdrop. Newscorp has been an even stronger performer, driven by the
cessation of dilutive M&A transactions finally joining good operational performance. Both of
these stocks, dominated by US dollar earnings, have prospered even in the face of a strong
Australian dollar.
Finally, the Kay Review of UK equity markets and long-term decision making was released
during the month. We agree with the conclusion the core purpose of equity markets is to
enhance the performance of companies, and to provide returns to savers. It suggests
short-termism is an underlying problem in equity markets, principally caused by a
misalignment of incentives within the investment chain and the displacement of trust
relationships by a culture based on transactions and trading. In our case, turnover has long
been such that our average holding period is four years or more; and last year we voted
against almost 15% of resolutions put to us for consideration, based upon relatively
objective criteria tied to our investment philosophy, in an attempt to encourage better
performance from our investee companies and better align shareholder returns with
executive reward. We also wrote a detailed paper to Treasury last year on executive
remuneration, expressing the view that incentives should be payable on growth in net
tangible assets per share, and fully paid in shares, which vest progressively through five
years. Only active management can meet both of Professor Kays objectives; we are failing
in our duty as active managers if we do not use our vote prudently. A gold medal for
Professor Kay!

0.3

Portfolio outlook & strategy

-1.2

Consumer banks

Real Estate Mgmt & Dev

6.0

Finally, sins of omission are often as culpable as sins of commission, even if less overt.
NAB has spent twenty years building up a presence in the UK market, only to watch during
the month as The Co-operative group acquired five million customers, and a fully funded
balance sheet, from Lloyds for 350m, or A$500m. We are often critical of prices paid in
M&A transactions the two exceptions to this rule through the past cycle were Amcors
US$2b purchase of Alcan packaging from RIO and CBAs $2.1b purchase of Bankwest,
both counter cyclical and at low multiples (as opposed to the typical transaction which is
pro cyclical and at high multiples). The Co-op transaction, though, is in another league
again in Olympic parlance, if this was a gold medal acquisition by Co-op, Amcor and CBA
tied for the silver, but a long way behind. NAB shareholders have paid a high price over two
decades waiting for a credible business in the UK; for it to reverse tack months before this
transaction occurred, given a low transaction price was predictable given the parlous
financial state of all other potential acquirers, leaves NABs strategy as the corporate
equivalent to Mr Bean playing Vangelis.

-0.9
0.7

Property Trusts -7.1

Unless otherwise stated all figures are as at the end of July 2012
Benchmark is the S&P / ASX 200 Accumulation Index

The six principles we spoke to in setting the scene for our market outlook at the beginning
of this commentary are prima facie headwinds for both multiples and earnings. They ignore
two, critical, issues; the price paid for the equity purchased, and the management intent to
generate good returns on investment even in the face of challenging conditions. As equity
markets underperformed, these risks did not become larger; and hence we have
increasingly assumed more cyclical assets in the Portfolio, albeit those which generally are
exposed to offshore cycles and feature lower levels of financial; leverage. Finally, the tide
has gone out good (and bad) management is being laid bare, and the better performers
have laid a path to how equity holders can be well rewarded even in low growth
environments.
Andrew Fleming

Contact
www.schroders.com.au
E-mail: simal@schroders.com
Schroder Investment Management Australia Limited
ABN 22 000 443 274 Australian Financial Services Licence 226473
Level 20 Angel Place, 123 Pitt Street, Sydney NSW 2000
Phone: 1300 136 471 Fax: (02) 9231 1119

Investment in the Schroder Wholesale Australian Equity Fund ('the Fund') may be made on an application form in the Product Disclosure Statement dated 1 February 2011, available from
the Manager, Schroder Investment Management Australia Limited (ABN 22 000 443 274 AFSL 226473) (Schroders).
This Report is intended solely for the information of the person to whom it is provided by Schroders. It should not be relied on by any person for the purposes of making investment
decisions. Total returns are calculated using exit price to exit price, after fees and expenses, and assuming reinvestment of income. Gross returns are calculated using exit price to exit
price and are gross of fees and expenses. The repayment of capital and performance of the Fund is not guaranteed by Schroders or any company in the Schroders Group. Past
performance is not a reliable indicator of future performance. Unless otherwise stated the source for all graphs and tables contained in this report is Schroders. Opinions constitute our
judgment at the time of issue and are subject to change. This report does not contain and is not to be taken as containing any financial product advice or financial product
recommendation. For security reasons telephone calls may be recorded.