Lonsec Australian

Market Outlook

November 2009William Keenan

Snr Equity Strategist

IMPORTANT NOTICE: The following relates to this presentation prepared by Lonsec Limited ABN 56 061 751

102, AFSL No 246842 ("Lonsec") and should be read before making any investment decision about the product(s).

Warning (General Advice Only): Today’s presentations will provide information about investment process, economic

conditions and outlooks for investment markets.

The views, opinions and recommendations included in the information today are all “General Advice”. That is, they do

not take into account the question of their personal suitability for any particular attendee and where a specific financial

product is referred to, attendees should not act on the advice without first consulting their financial planner or advisor

about its appropriateness to their investment objectives, financial circumstances and needs.

Past performance is not reliable indicator of future performance.

Disclaimer: No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of

the information being presented, which is based solely on public information that has not been verified by Lonsec. The

conclusions and recommendations contained in this presentation are reasonably held at the time of completion but are

subject to change without notice. Except for any liability which cannot be excluded, Lonsec, its directors, employees and

agents disclaim all liability (whether in negligence or otherwise) for any error or inaccuracy in, or omission from, the

information contained in this presentation or any loss or damage suffered by the recipient or any other person directly or

indirectly through relying upon the information.

Disclosure:Lonsec’s directors, officers, representatives, and their associates, may hold the securities referred to in this

presentation, which may change from time to time, but none receives or gains any other benefit as a consequence of the

recommendation or advice presented in this presentation. Lonsec considers such holdings not to be sufficiently material

to compromise the recommendations or advice, and the Analysts at the time of preparing this presentation are not aware

of any holdings. Lonsec receives brokerage or other benefits (e.g. application fees) for dealing in financial products and

its associated companies or introducers of business may directly share in the brokerage or benefits.

Disclaimer

1. Australian economic outlook

- Positives

- Negatives

2. Australian share market outlook

3. Market conclusion

4. Lonsec Core Model Portfolio

Agenda

Australian economic outlook

Positives

The Banking system is stable and credit is flowing

Financial markets are on the mend and volatility has eased

Monetary policy has been effective in lowering interest rates

The Gov’t is in a relatively strong financial position to provide fiscal stimulus

House prices have proven resilient

Net Exports have held up well

China (our main export partner) is still growing

Retail sales have been robust over 2009

Employment has also been surprisingly resilient (unemployment rate 5.7%)

Consumer and Business sentiment has experienced a V shaped recovery

The rising AUD is deflationary in the short term

Negatives

The GFC has induced a Global recession in the developed world

Global Private sector looking to deleverage

Global Public sector is re-leveraging as a result of fiscal stimulus

Global demand and trade has fallen sharply but now seems to be gradually

recovering

Australian sharemarket down ~ 35% ($500bn in wealth lost)

Aust. Export income declining in the short term due to lower coal and iron ore prices

Aust. Private sector debt levels high (170% of GDP) with A$678bn borrowed offshore

Underlying inflation is proving resilient at 3.5%

Interest rates are on the rise

A rising AUD will hurt our export competiveness in the medium to long term

Australian economic outlook

Australian sharemarket outlook

The Australian market is up 40% since 2001 whereas the US market is still under water

Resource and Energy stocks have outperformed because of demand from Asia and weak USD

Australian sharemarket outlook

The 07/08 bear market was similar to 1973 in severity but note that after each fall, the market has recovered all losses within 3-6 years

Daily share market volatility peaked in 2008 but is settling down in 2009 to <1.0% again

Australian sharemarket outlook

The recent market rally has increased the trailing PER to > 20x which looks expensive

However, the market expects earnings to recover by at least 20% over the next year

Australian sharemarket outlook

The market dividend yield is around 4.2% - closer to 4.8% if excluding low yielding resource stocks

Secondary market capital raisings increased markedly to $90bn or about 9% of total market cap over FY09

This is significantly larger than the 1995-2008 average of 3.8% of market cap

Investors will need to keep an eye on EPS growth rather than NPAT growth

Australian sharemarket outlook

The cash rate has been slashed but is on the way back to more “neutral” levels

Bond yields are also on the rise

Rising bond yields increase the cost of debt and in turn equity capital

Investors need to keep an eye on this trend

Conclusion

The Global economy seems to be stabilising and gradually recovering

The Australian economy has proven remarkably resilient over FY09

Consumer and Business sentiment has recovered

Financial markets have improved

The Australian market has rallied 45% from its March 09 lows but is still

down 35% from its 2007 peak

There are encouraging signs that the worst has past

Nonetheless, significant challenges lie ahead for the developed world with

growth likely to remain subdued for some time due to the deleveraging

process that has now begun, post credit crisis

Asia looks to have much cleaner prospects for growth

Lonsec expects the Australian market to move towards 5,000 over FY10,

as investors rediscover their appetite for risk

Lonsec recently increased its Australian Equity weighting to overweight

Lonsec Direct Equity

Model Portfolios

Construct and manage virtual model portfolios

Focus on absolute returns over the medium to long term

High conviction, low turn-over, active portfolios

Four-step investment process

Strong focus on “top-down” macro-economic and industry themes

Risk mitigation at the portfolio and individual stock level

The Lonsec approach to direct investing

Step 1

InvestmentObjectives

ReturnIncome v Capital

Client Risk Profile

Timeframe

Step 3

StockSelection

ICVR x 4 Stock Filters

Industry Ratings

Company Quality

Company Valuation

Company Risk Rating

Step 4

PortfolioManagement

Daily monitoring

Monthly performance measurement

Attention to Corporate Actions

Quarterly Investment Committee Review

Implement any changes

Regular Reporting

Step 2

Risk Controls – Min. no. of IndustriesMin. no. of StocksStock universe restrictionStock weighting limitsPortfolio turnover rules

Macro-economic view

Sector view - Growth, Cyclical, Defensive, ValuePortfolio

Construction

Lonsec investment process

Each of our stocks is selected after a rigorous qualitative and

quantitative analysis involving four stock filters – Industry,

Company Quality, Valuation and Risk

A Lonsec model portfolio stock will rank highly in each category (ICVR) based on our analysis and experienced judgement.

Not necessarily looking to find the best stocks in the best industries but the best value stocks in the best industries.

The Valuation and Risk filters are there to minimise our downside.

Examples: HSP and PRY instead of SHL and RHC, CBA and WBC instead of ANZ and MQG, ORG instead of AGL (major decision at the time), BHP instead of RIO

Lonsec stock selection filters

A closer look at Step 3 – ICVR stock filters

IIndustryRating

INDUSTRY

ProductsSupply & DemandKey Macro-economic variablesGrowth RateStructure

Barriers to entryReturn on CapitalGovernment interventionSustainability

CCompanyQuality

COMPANY QUALITY

Industry positioningBarriers to entryRecurring- revenueGrowth ratesMarginsReturn on Equity

Free Cash FlowDividend historyManagement- experience and track recordManagement- incentives and stake in equityCorporate StrategyCorporate- GovernanceBalance sheet- strength

VCompanyValuation

VALUATION

Enterprise Value / EBITDA

Market Cap. / Free Cash Flow

Stock Price / Cash EPS

Stock Price / Dividend PS

Market Cap. / Book Value

RCompany

Risk Rating

RISK RATING

Key macro-economic & weather- sensitivitiesKey customers and suppliersGovernment influenceLevel of recurring- revenue Barriers to entry

Balance sheet- strengthFree Cash FlowCorporate StrategyCorporate -GovernanceMarket –CapitalisationShare liquidityMajor shareholders

Core Model Portfolio

Objective

To deliver strong absolute returns, over the medium to long term,

through a diversified “blue-chip” portfolio invested across a number

of industries.

Portfolio Rules

Investment universe ASX TOP 150

Benchmark ASX TOP 100 Accumulation Index

Min. no. of stocks 10

Min. no. of industries 8

Individual stock limit 12.5%

Cash weighting 0%

LPT weighting 0% (refer Property Asset Allocation)

Targeted portfolio turnover 20-30% pa

Core Model Portfolio

Portfolio Profile

Current no. of stocks 12

Cash weighting 0%

Top 3 sector exposures Financials 31.25%

Energy 18.75%

Mining 12.5%

Top 50 exposure 87.5%

Ex Top 50 12.5%

Current forecast cash yield 3.9% (5.4% gross)

Inception date 17/04/2000

Core Model Portfolio Performance INVESTMENT PERFORMANCE 3 Years 5 Years 7 Years 9 Years Since Since

Period ending 30 September 2009 Month Qtr Year (pa) (pa) (pa) (pa)Inception1

(p.a.) Inception1

Lonsec Core Model Total Return2 7.0% 20.9% 19.3% 11.2% 17.2% 17.3% 16.5% 18.1% 382.7%

ASX TOP 100 Accumulation Index 6.6% 21.9% 9.3% 2.2% 10.3% 11.8% 8.9% 9.8% 142.4%

Out/Under Performance 0.4% -1.0% 10.0% 9.0% 6.9% 5.5% 7.6% 8.3% 240.3%

1 Inception date 17 April 20002 Investment Performance is calculated before fees, charges, brokerage and taxes. Dividends are reinvested at the end of each month.

The portfolio is reset at the end of each month back to the model portfolio weightings. This prevents portfolio weightings from skewing over time and ensures performance

figures remain relevant. The Lonsec Core Model portfolio is a fully-invested notional portfolio with no cash weighting. Physical portfolio results will differ depending on

cash levels, start date, fees, taxes and compliance with model weights. Past performance is not a reliable indicator of future performance.

Standard Deviation (volatility of quarterly returns)Lonsec Core 19.53% 19.45% 16.03% 14.13% 13.19% 13.63%ASX TOP 100 Acc. Index 22.17% 22.75% 18.54% 15.84% 15.06% 15.11%

Tracking error (correlation with the index) 6.19% 6.65% 5.91% 5.60% 7.22% 7.13%

0%

50%

100%

150%

200%

250%

300%

350%

400%

450%

Q2 00 Q4 00 Q2 01 Q4 01 Q2 02 Q402 Q203 Q403 Q204 Q404 Q205 Q405 Q206 Q406 Q207 Q407 Q208 Q408 Q209

Lonsec Core Model Portfolio Total Return since inception 17/04/00

ASX TOP 100 Accumulation Index since 17/04/00

383%

142%

Case Study – recent change to Core portfolio

Stock Filter TLS out PRY in

Industry Major change Defensive / attractive

Company Quality Good Very good

Valuation Attractive Attractive

Risk High Medium

While TLS looks attractive from a bottom up view (PER 10x, Div yield 8.8% ff) the top-down outlook is very uncertain

Govt plans for a National Broadband Network and the structural separation of TLS creates great uncertainty over TLS’ future earnings and capital structure

TLS does not pass the Industry and Risk filters

Private healthcare industry has strong fundamentals (ageing and rising population, rising participation rates, 4 major players)

PRY well positioned in Medical Centres and Pathology

PRY valuation is attractive (PER 13.4x, Div yield 5.7% ff)

Risk has been significantly reduced after recent capital raising

Lonsec Direct Model Portfolios

• Investment Philosophy - Active, focused on absolute returns, top-down process, high conviction portfolios

• Investment Process – Four-step, top-down process with four

stock filters (ICVR); risk mitigated at the portfolio and stock

selection level

• Two model portfolios – Core and Income

• Seeking strong absolute performance over the long-term

Summary

Lonsec Australian

Market Outlook

November 2009William Keenan

Snr Equity Strategist