ASF Research Book - Mar 2012 - Institutional

7/31/2019 ASF Research Book - Mar 2012 - Institutional

1/17

Aus t r a l i an Shar e

Fund

Compos i te

Research Book

March 201 2

PM CAPITAL Limited

ABN 69 083 644 731

AFSL 230222

Level 24, 400 George Street, SydneyNSW 2000

P: 02 8243 0888 F: 8243 0880

E: [email protected]

www.pmcapital.com.au

ABN 69 083 644 731

AFSL No 230222


2/17

Disc la imer

This information has been provided by PM CAPITAL Limited (ABN 69 083 644 731) (AFSL 230222). Thisreport is intended solely for the information of the person to whom it was provided by PM CAPITAL Limitedand is ONLY intended for wholesale and institutional investors and under no circumstance should be suppliedto retail clients. Past performance is not necessarily a guide for future performance. Please note that allreturn figures reported are after all fees and before taxes. While the information contained in thispresentation has been prepared with all reasonable care, PM CAPITAL Limited accepts no responsibility orliability for any errors or omissions or misstatements however caused. Except insofar as liability under any

statute cannot be excluded, PM CAPITAL Limited and its directors, employees and consultants do not acceptany liability (whether arising in contract, in tort or negligence or otherwise) for any error or omission in thispresentation or for any resulting loss or damage (whether direct, indirect, consequential or otherwise)suffered by the recipient of this presentation or any other person.


3/17


4/17

4

Gro ss p er f o rm a n ce su mm a ry t o 3 1 Ma rch 2 0 1 2

Annu a l i sed Return s Aust r a l ian Share Fund * ASX 200 Excess Return s

1 Year -4.4% -6.1% 1.7%

2 Year 1.3% -1.4% 2.7%

3 Year 14.8% 11.3% 3.5%

5 Year -1.1% -2.0% 0.9%

10 Year 8.7% 6.9% 1.8%

Si n ce I n c ep t i o n 1 0 . 2 % 7 . 7 % 2 . 5 %

Ret u rn Sum m ar y Aus t ra l i an Sha re Fund * ASX 200 Excess Ret u r ns

2012 Financial year -1.7% -2.1% 0.4%

2011 Financial year 17.3% 11.7% 5.6%

2010 Financial year 16.4% 13.1% 3.3%

**2009 Financial year -6.1% -20.1% 14.0%

2008 Financial year -27.9% -13.4% -14.5%

2007 Financial year 25.9% 28.7% -2.8%

2006 Financial year 29.2% 23.9% 5.3%

2005 Financial year 17.8% 26.4% -8.6%

2004 Financial year 43.9% 21.6% 22.3%

2003 Financial year -3.0% -1.7% -1.3%

2002 Financial year -3.1% -4.7% 1.6%

2001 Financial year 14.5% 9.1% 5.4%

2000 Financial year 23.5% 17.3% 6.2%

Since I ncep t i on Tota l Retur n(30 . 11 . 99 )

2 3 2 .9 % 1 5 1 .1 % 8 1 .8 %

* Returns for the PM Capital Australian Share Composite listed above are gross of all fees and pre tax.

** In March 2009 the PM CAPITAL Australian Share Portfolio Manager was replaced, initially by PaulMoore (CIO) and 3 months after by Paul Frost (current Australian share portfolio manager). Alsoduring 2009 PM CAPITAL added to its investment team with three senior investment personnel, JohnWhelan, Tim McGowen and Dane Roberts. In 2009 PM CAPITAL had 75 years of experience it now hasover 140 years of investment experience in its team.


5/17

5

Por t fo l i o Manager upda te - Aust ra l i an Share Com pos i te March 2012

Despite the underperformance of resource stocks, the ASX200 was dragged higher through the quarterposting gains of 8.4% whilst the PM CAPITAL Australian Share Portfolio returned 11.3%. Part of theperformance differential is explained by PM CAPITALs cautious outlook on commodities. Interestingly, inMarch, China's National People's Congress guided to a GDP growth target of 7.5% in 2012 - the first timesince 2004 that this annual target has been set below 8%. Strong performance of core holdings such asEcho, Austar and QBE Insurance made strong contributions.

Global equity markets experienced a decent rebound over the March quarter, with the MSCI index posting itsbest first quarter performance since 1998. Growing confidence in a sustained US economic recovery hasbeen a key driver with unemployment and leading business indicators continuing to trend positively. Furtheraiding sentiment, the European Central Bank (ECB) completed its second colossal injection of liquidity intothe European banking sector through the Long Term Refinancing Organisation (LTRO) program which will atleast buy some time for governments and central banks to implement a longer term solution.

Fund act i v i t y

Activity in the Fund stepped up during the quarter, via corporate activity and value realisation with most of

the capital release being recycled into existing holdings. We exited the Funds holding in News Corporation asthe stock reached our assessed valuation. We reduced the Funds holding in CSL after a strong share pricerally following its interim result. The major sale for the Fund was Austar. During the quarter, we used priceweakness to add to the Funds holdings in Tabcorp, Sky City Entertainment, Brambles, Westpac, AMP andInsurance Australia Group (pre-result). We have also executed options strategies around core holdings inBrambles, Suncorp, QBE and CSL. These options strategies have generated incremental premium incomeequivalent to, or exceeding, interim dividends declared by the respective companies in the recent reportingseason.

Aus t a r late in the quarter, we exited the Funds holding at a price slightly below Foxtels merger offer of$1.52. We sold the holding following release of the ACCCs announcement of commercial undertakingsprovided by Foxtel to enable the merger with Austar to proceed. Despite this good final outcome, it is fair tosay that this transaction has been a long, drawn out process with an extended period of negotiation betweenthe ACCC and the merger parties. Interestingly, many market analysts viewed the merger as unlikely to

proceed based on the ACCCs definition of the TV market and some isolated competition concerns raised byit on the monopoly-like attributes of the merged pay TV entity. Since release of the ACCCs Statement ofIssues in July 2011, we have held a firm view that the TV market, as defined by the competition regulator,was too narrow and not truly representative of the commercial environment in which Foxtel and Austaroperate. In the ensuing share price weakness following release of this Statement of Issues, we increased theFunds holding in Austar (below $1.10). This was based on our strong conviction that a rational outcomewould eventually be forthcoming, and that the merger would be approved. In addition, a recent legalprecedent in the Metcash/Franklins case gave us some confidence that the ACCC would more likely go downthe negotiation path rather than endure a protracted, expensive court battle with Foxtel. The end result is apleasing one for Austar shareholders.

Despite the increased activity noted above, there was little change to the Funds overall sector positioning.We continue to maintain strong weightings in select Major Banks and more defensive, less economically-sensitive sectors such as Gaming, General Insurance and Healthcare. We remain cautious on the Industrialsspace, particularly cyclical companies, following sanguine company outlook statements during the Decemberreporting season.

In our view, domestic market valuations remain compelling relative to bond yields and cash. Many of theFunds holdings continue to deliver ungeared pre-tax earnings yields in the mid-high teens. At current prices,many holdings are also providing sustainable, above average dividend yields, including major banks, generalinsurers, Tabcorp and AMP. These dividends are often double-digit when grossed up for franking credits.


6/17

6

The Aust ra l i an Share Fund com pos i t i on as a t 31 M arch 201 2 w as as fo l l ows :

Portfolio composition for this Fund is very different to the ASX200 Index. Most Australian fund managers tendto deviate only marginally from the ASX benchmark index when constructing investment portfolios. As astock picker, PM Cap i ta l i s benchm ark agn ost i c . We are not compelled to invest in any particular sector,or company, simply because of its representation in an index. We prefer to focus on building concentratedinvestment portfolios (20-30 holdings) in companies that we view as fundamentally undervalued and wherewe believe we can deliver above average returns for clients over time in a tax effective manner. For example,we currently have no Fund exposure to several sectors - Telco, REITs, utilities, energy, mining services andconsumer staples.

The Fund also has holdings in companies that are not represented in the benchmark index, or are dual-listed,such as Sky City Entertainment and Rio Tinto PLC. Lastly, our mandate gives us flexibility to hold higherlevels of cash in the absence of compelling value in equities.

Financia ls we have a significant sector position comprising core holdings in select banks, life insurance,general insurance, and other stocks leveraged to capital markets activity. Many of these companies havestrong leverage to rising investment yields, a softening AUD and rising US bond yields, including MacquarieGroup, QBE Insurance, ANZ, NAB, AMP, Suncorp and IAG.

Major banks share prices performed solidly over the quarter as the global rotation out of resources into thefinancial sector finally found its way to Australia. We expect the major banks to deliver mid-single digitearnings growth in 2012 - a reasonable outcome given a sustained two-speed domestic economy. The capitalposition of the major banks continues to steadily improve with each reporting period, and the sector is well

advanced to meet regulatory capital/liquidity thresholds demanded by APRA under the Basel III regime. Thecurrent industry dynamic encompassing higher capital standards, more disciplined risk pricing, moresustainable rates of lending growth, corporate & household deleveraging and the exit of foreign bankcompetition leaves the Australian major banks and larger financial services providers well positioned.

Macquar ie Grou p s share price had a strong rally in the quarter after hitting cyclical lows in the Decemberquarter. Activity in its capital markets divisions remains well below mid-cycle levels, a function of weak retailinvestor confidence and ongoing caution by corporate boards. Nevertheless, activity across its globaloperations is showing signs of improvement and revenue growth is expected to rebound as global investorrisk appetite reverts to more normal levels. Despite this rally, Macquaries share price remains well belowreported book value and our assessed valuation. The company has recently flagged a 10% buyback, subjectto regulatory approval. Macquarie remains a compelling investment and a core holding.

I n s u r e r s QBEs share price experienced a significant rebound over the quarter after the market receivedgreater clarity on its 2011 full year result and the company completed an equity raising (at $11 per share) to

Sector

Banks 29.1%

Gaming 13.1%

Insurance 12.8%

Resources 8.4%

Healthcare 6.7%

Media 5.6%

Listed Property Trusts 3.7%

Consumer Discretionary 3.2%

Wealth Management 3.2%

Other 7.5%

Net Exposure 93.3%

Cash 6.7%

Tota l Exposu re 100 %


7/17

7

replace a convertible hybrid security. The Fund participated in this raising. Investor sentiment also changedmore favourably following a rebound in US bond yields and release of improved US economic data. Despitethe recent share price rally, QBE is trading well below our assessed valuation. We expect the companysshare price to continue to re-rate as the recent catastrophe event experience reverts to more normal levelsand global investment yields continue to normalise over time. Recent AGM commentary suggests that this

process is underway.

I n d u s t r i al s the Fund has core weightings in more economically-resilient Industrial sectors such as Gaming(Sky City Entertainment, Echo, Tabcorp) Healthcare (CSL, Sonic) and Logistics (Brambles, Qube Logistics).

We believe many industrial companies will still struggle to meet market expectations for earnings growth in2012. In our view, latest (downgraded) market forecasts for earnings growth in 2013 also remain toooptimistic, a view based on current activity levels in domestic/offshore markets and feedback garnered fromour contact with many companies across industry. Our cautious stance is based around three key issues - anabsence of meaningful top line revenue growth, higher costs of debt funding in tight credit markets, andlimited scope for management to pursue further major cost cutting programs without risking long termdamage to company franchises. Nonetheless, we have identified a small number of holdings and prospects inwhich we would be happy to invest at our target price.

Resources we remain cautious on the resources sector with Chinas rate of growth slowing, albeit still

robust. The rate of China growth remains a key risk to current supply/demand dynamics, commodity pricesand resource company earnings growth. As such we hold no second tier resources companies. We havemaintained the Funds positions in the PLC stock of Rio Tinto and BHP Billiton over the quarter. The valuationdiscount of PLC stock (relative to ASX-listed stock) remains compelling and increasingly attractive relative toassessed company valuation. More recently, Rio Tinto and BHP Billiton have been facing increasing pressureto return surplus capital to shareholders rather than pursue aggressive expansion via large acquisitions ornew greenfield mining projects. In an environment where the rate of growth in China is less certain, wesupport a balanced capital management program by these companies in the near term that focuses onexisting operations (brownfield expansion) supplemented by the return of surplus capital to shareholders.We expect future buyback activity to remain focused on the London-listed PLC stock, and for the spread tonarrow.

The Fund currently has minimal exposure to the Reta i l sec tor given well publicised trading headwinds facingthe sector (cautious consumers, high AUD, online competition, non-discretionary cost inflation). Our view, asconveyed in recent quarterly reports, remains unchanged near term.

Rising USD/ fa l l i ng AUD in recent quarterly reports, we stated our view that the AUD was overvaluedrelative to its long term average, with global interest rate differentials and sustainability of growth in Chinaexpected to dictate the pace of an AUD unwind. During the quarter, the AUD came under selling pressurefollowing outlook comments forecasting a lower rate of growth in China in 2012. US bond yields also ralliedon encouraging US economic data and a more positive outlook for a sustained US recovery. We are seeingsome signs of investor rotation into companies with leverage to foreign currency-denominated income &offshore earnings. The Fund is already well positioned for this dynamic to play out with core holdings in CSL,Sonic Healthcare, Brambles, Macquarie Group, QBE and ANZ companies with meaningful offshoreoperations/earnings that are steadily growing.

PM CAPITAL Aust ra l ian Share Por t fo l io Man ager Pau l Frost


8/17

8

Stock s to r y Echo En te r t a inm ent Group

Echo Entertainment Group (Echo) was conceived in July 2011 from the demerger of Tabcorp into two listedentities: 1) wagering & Victorian gaming - Tabcorp, and 2) casino operations - Echo.

Echo comprises four casino assets - The Star in Sydney, Treasury Brisbane, Jupiters Gold Coast and

Townsville. Each casino is, in effect, a regional monopoly operating under a long term license regulated bycasino authorities under respective State Government law. Sydney casino is a regulated monopoly in NewSouth Wales with a license to operate exclusively in NSW until 2019.

Until recently, the Sydney casino had languished due to an extended period of underinvestment. As a result,operating performance significantly lagged domestic peers; most notably, Crown Melbourne. Following itsdemerger from Tabcorp and appointment of an experienced casino management team, Echo has undertakena major upgrade of its core Sydney asset & since rebadged The Star. This $870 million investment, combinedwith additional gaming license concessions approved by NSW Government, has transformed the propertyfrom a tired, RSL-style gaming hall to a more competitive, integrated gaming and entertainment destination.

Since September 2011, Echo management has progressively re-opened new and upgraded facilities at TheStar. The PM Capital investment team has made several site tours to The Star during the re-constructionphase, as well as attended opening functions to assess the new facilities and patrons response. Overall, wehave been impressed with the project execution, improvements to the main gaming floor layout and qualityof fit-out in new/upgraded facilities. To date, the level of public interest and patronage across the precincthas been encouraging, albeit still early days.

On completion of this major project, The Star will have integrated gaming and entertainment facilities thatshould enable it to more effectively compete on a level playing field with domestic peers such as CrownMelbourne. The Star should have greater appeal to local gaming patrons (particularly, local VIP market),domestic/international tourists as a destination for gaming/non-gaming facilities, and a more appealing offerto compete with other Asian casino operators for international VIP commission play; a segment of the globalmarket that continues to grow rapidly.

Echo is targeting an after-tax IRR (return on capital) in excess of 14% on its project spend. If achieved, TheStar should deliver significant earnings growth for Echo over the next few years. A key success factor ingenerating an acceptable return on this investment will be the ability to drive: 1) increased patronage, 2)improved spends per patron, and 3) increased utilisation of the expanded gaming infrastructure. Successful

execution of this strategy should enable Echo management to deliver a positive outcome on its first majorinvestment undertaking and improve returns to shareholders over time.

In the year to date, financial outcomes from capital investment at The Star have been difficult to measuregiven the progressive ramp up of new/upgraded facilities in the September and December quarters.Pleasingly, December quarter operating performance improved significantly - a function of reducedconstruction disruption, rollout of new gaming product and initial benefits from expanded gaming facilities.Revenue growth of 27% in the quarter was impressive.

Echo management has also announced a proposed investment of $625m to expand and upgrade itsQueensland casinos. This investment is underpinned by a package of additional gaming license concessions,the bulk of which have already been approved by the Queensland Government. Gold Coast and TreasuryBrisbane properties are expected to install additional EGMs by the fourth quarter of 2012 calendar year(front loaded concessions relative to the timing of capital spend).

I n l a t e Feb rua ry 201 2 , Crow n L im i t ed announced i t had t aken a 10% i n t e res t i n Echo and has

m ade an app l i ca t i on t o NSW and Queens land gam ing au t ho r i t i es t o i nc rease i t s s t ake beyond1 0% . A decision by the relevant gaming authorities in each State is expected to take a few months. We viewCrowns move on the Echo register as a prelude to corporate activity. The timing of Crowns move isintriguing. Most of Echos major capital spend on The Star is now largely behind it, free cash flow shouldgrow strongly hereafter and Echo management has flagged a much improved second half result in 2012 - thefirst half year without major disruption and a full period contribution from its expanded operations.

The Echo Boards rejection of Crowns request for a board seat (should regulatory approval be given forCrown to increase its stake beyond 10%) has seen battlelines drawn between Crowns chairman, JamesPacker and Echos chairman, John Story all of which could lead to a protracted takeover battle. However,Crown reasons for acquiring Echo are compelling. The operational synergies (revenue and cost) from amerger of the two entities are numerous and material.

The medium term risk to Crowns earnings growth profile from a rejuvenated Echo operation is also veryreal. Key risks include: 1) Echo recapturing market share lost to Crown in past years in the local VIP /


9/17

9

international VIP space, 2) a more competitive tax regime under Echo will now operate, and 3) increasedinterest in Echos assets from local/international tourism markets.

We view the recent media publicity on Crowns interest in constructing a new high rise boutique hotel (withinternational VIP facilities) in Barangaroo Central as a smokescreen for Crowns long term objective to

own Echo outright. Crowns domestic casino operations have a lot to lose from a rejuvenated Echo operationin NSW and Queensland.

Casino gaming expenditure (i.e. player loss) in Australia is ~$3.5bn, with growth trending at mid- to high-single digits. Of this expenditure, 85% is attributable to six casinos operated by Crown and Echo - CrownMelbourne, The Star, Crown Burswood, Jupiters Gold Coast, Treasury Brisbane and Townsville. Almost 70%of this expenditure is spent in the two largest casinos, Crown Melbourne and The Star. Burswood casino inPerth is the only significant operation outside of NSW, Victoria and Queensland. An acquisition of Echo wouldgive Crown an impressive network of upgraded regional monopoly assets covering all major Australian citiesunder long duration licenses.

Should a full takeover be forthcoming from Crown, we expect a bid well in excess of $5.00 would be requiredto: 1) provide an acceptable takeover premium to, and ensure adequate sharing of synergy benefits with,Echo shareholders, and 2) receive the support of Echos board of directors.

We increased the Funds holding in Echo during the December quarter (below $3.60), based on more positiveobservations made during our recent site visits. We have maintained the Funds position following Crownsannouncement of its increased stake as we await regulatory approval on whether Crown can lift itsshareholding, and pending potential corporate activity. Should a takeover bid from Crown not be forthcomingin the short term, we still expect the Echo share price to continue to re-rate in line with earnings growthdelivered from The Star project and, over time, from the proposed Queensland casino upgrades. Either way,we see meaningful valuation uplift in Echo over the next few years as the companys major capitalinvestment programs deliver improving returns to shareholders and our investment thesis plays out.


10/17

10

Due Diligence


11/17

11

I n ve s tme n t o bj e c t i ve s

The objective of the Australian Share Fund is to provide returns in excess of the benchmark over a two tothree year period by investing in a concentrated portfolio of undervalued Australian equities. The benchmark

of the Fund is the S&P/ASX 200 Accumulation Index however the goal of the Fund is not to replicate theIndex and it is likely that the Fund will have varied outcomes to the benchmark.

The Fund is managed from an Australian investors perspective with tax being an important consideration inthe daily management of the Fund.

I n v e st m e n t s t r a t e gy

The investment process is built around the simple principle that the best way to preserve and enhance yourwealth over the longer term is to buy a good business at a good price. The portfolio is a focused portfoliowith approximately 20-40 stock specific ideas purchased in the Australian equity market. Typically our timehorizon for assessing stocks is at least two to three years and all portfolio positions are subject to intensiveresearch and peer group review. The Australian Share Fund's risk and return philosophy differs from thestandard relative fund manager. Risk is regarded as the potential loss of invested capital as opposed todeviation from a benchmark.

I n v e st m e n t t e am

Pau l Moore

CIO

Pau l F ros t

Head of Australian EquitiesFinancials

UdayCheruvu

Financials /Credit

Kev in

Ber to l i

Asia

DaneRober ts

Industrials

ClementTseung

Transport

John

Wh e l a n

Credit/Currency/

Property Trusts

Jarod

Dawson

Credit/Currency/Infrastructure

Ash leyP i t t a r d

Commodities

T i m Mc G o w e n

Options and Protection Strategist

Thomas R ice

Industrials/Consumer

Pau l Gyenge

Property/Healthcare

The Australian Share Fund utilises the resources of 11 analysts with a combined experience of 130 years.The team operates on a globally integrated sector basis. PM CAPITAL believes that generally 80% of stocksare fairly valued over the short term and therefore the investment team spends its time looking at a narrowsubset of anomalies that are viewed as mispriced over the long term. That being said, PM CAPITAL feels it is

very well resourced to research in depth the opportunity subset for its focused portfolios.


12/17

12

Por t fo l i o const r uc t ion : 20 to 40 Aust ra l i an equ i ty pos i t i ons

Typically the Fund will hold between 20 and 40 Australian equity positions. This may include stocksthat are dual listed on other stock exchanges. The Fund may also invest in hybrid / quasi-equitysecurities.

The Fund will not purchase individual positions greater than 15% of the portfolio or 1.5 times theindex weighting, whichever is the greatest.

To control short-term volatility risk we generally initiate a 2-3% position in a stock with the objectiveof moving towards a 5% core position. For stocks that we have an extremely strong view on andwhich exhibit compelling valuation we can hold up to a 10% position or 1.5 times its weighting in theASX 200.

The Fund may employ exchange-traded option strategies to reduce market risk.

Derivatives may be used for hedging purposes or to replicate underlying positions.

If the fund cannot find attractive equity investments it will not be afraid to let the cash build up to20% however it would be common for the cash weighting to be significantly less than this. Inaddition, the net effective exposure of the Fund can be reduced to 50% through the use ofderivatives.

From a risk control perspective we monitor our stock positions and industry concentrations on a daily basis.We also monitor the Funds overall market exposure and if deemed excessive we either sell stock or employoption strategies to reduce risk. In the long run, the best way to control risk is by owning a number of goodbusinesses purchased at good prices i.e. true diversification.

Cash

Economic FactorIndividual

Company Factors Industry Factors

Bottom up fundamental company analysis

THE PORTFOLIO IS CONSTRUCTED FROM THE BOTTOM UP

Focused

portfolio

Option overlay

Zero WeightOverweight

Undervalued Fair Value /

Overvalued

Maximum 10%or

1.5 times index

>50% in S&P ASX100 Index


13/17

13

Va lua t ion

At PM CAPITAL we believe the best way to preserve and enhance wealth is to buy a good business at a goodprice. What does this mean?

Good business

A good business is one where:

It is simple to understand;

Its cash-flows and capital requirements are transparent

Managements interests are aligned with shareholders

The business model is sustainable and there are barriers to entry

Good price

Our research focuses on how the company generates and uses its cash. The key focus is on the cashflowstatement and how it matches with the income statement, with the objective being to understand the cashgeneration from the core business relative to its price. When looking at the price, we are interested in howmuch we would have to pay to privatise the business, meaning how much it would cost to buy the businessin its entirety (i.e. the equity and the debt). This causes us to look at a business in the same way as abusiness owner would do, which is also why we tend to have an above average number of takeovers withinour funds. If we are looking at price in the way that we say we are, we should see a number of our stocks bidfor. This has indeed been the case over time (refer to Investment Philosophy and Style to see thecorporate actions we have experienced in our Funds over time).

I n d u s t r y e xa mp l e Co mm o d i t i e s

How PM CAPITALs valuation process is unique

We do not buy on macro prediction; in other words, we do not guess where the commodity prices will bein the future.

We look for commodity companies that will perform irrespective of the macro environment.

We base our long term valuations on trend pricing. We perceive the trend commodity price to be thatwhere 15% of the industry is losing money.

We look for the lowest cost producer / with long life assets.

We look at the cost curve to get a feel for the sustainability of the business model.

We ask - what are the cash costs of operating this business?

Why we bought commodities post 2000

Global growth expectations (and thus stock prices) were low

Commodity prices were well below long term trend prices and our expectations of a weaker $US wouldaccelerate their recovery

Assuming long term trend commodity prices stock valuations were very cheap

No new mines were being built, hence there was no new supply coming through

Post the Asia Crisis we expected industry consolidation

Australian producers were very cheap with the $A approaching 50 cents and experts expecting 40cents.

We built our commodity positions post 2000 with our exposure peaking at around 30%.

As a result of our commodity positioning the Fund experienced 8 corporate takeovers.

The following stocks have all been part of the Australian Share Fund at the time of the takeoverannouncement.

Eastern Aluminium

Comalco


14/17

14

Acacia Gold

Woodside (takeover blocked by ACCC)

MIM

Cominco Western Mining

Inco

Recent years

In mid- to late-2008, the Australian Share Fund held zero exposure to resources companies despite thesector having an approximate 30% weighting in the ASX200 index. Our view at the time was that recordcommodity prices were unsustainable in the face of the global economic downturn coupled with the levels ofcapital expenditure being undertaken by resource companies, implying a significant shift in both the demandand supply side of the equation.

During the last six months of 2008, stock prices of commodities businesses collapsed with Rio Tinto fallingfrom $120 to $25 and BHP Billiton fell from an all time high of $50 to $22. Global growth expectations had

collapsed, investment markets were questioning the sustainability of the China story and global industrialproduction fell to levels never seen before. While the market was pricing in an end to the commodity cycleand discounting these businesses accordingly, we saw an opportunity to look through this short sighted panicselling and focus on the long term fundamentals of the businesses in a normalised operating environment.

We spent significant time in late 2008 and early 2009 refreshing our background due diligence on the globalcommodity companies which led to us building our commodity exposure from 0% at the start of 2009 to23% by mid year in the Australian Share Fund. This intensified research effort was focused on thosecompanies that we viewed as higher quality, meaning businesses with long life reserves, low cost operations,diversified asset portfolios (by commodity and geography) and a track record of generating earnings throughall stages of the economic cycle.

The other interesting dynamic which occurred in the resources sector was that the dual-listed companieswhich trade on both the ASX and London stock exchanges were trading at significantly different valuations.Throughout history, BHP Billiton and Rio Tinto have, on average, traded at a small discount on the London

exchange compared to the ASX-listed stock. On face value, this would appear justified based on the smallvaluation difference implied by the fact that Australian shareholders receive additional franking credits (whichUK shareholders do not receive) and also partly reflecting the disproportionate weight of companies like BHPBilliton in the ASX 200 Index. In late 2008 and 2009, the valuation discount between the Londonlistedstocks and AAX-listed stock expanded to a range approaching 25-30%. This can be seen in the chart below,where the red line indicates the valuation gap for Rio Tinto over time.


15/17

15

Many Australian equity portfolios are restricted from investing in the London-listed stock. However, ourflexible mandate allows us to take advantage of this pricing anomaly. As a result, in late October 2009 we

made a wholesale shift for the Australian Share Fund and sold all of the ASX listed stock in both BHP Billitonand Rio Tinto and purchased the equivalent dollar amount in the London listed stock. We expect thisvaluation discrepancy to narrow over time, and this discount unwind is expected to add incrementally to thereturns achieved by the underlying businesses.

The chart below shows the price action of the ASX200 Resources Index since January 2000 and the weightsof the Australian Share Fund at major inflexion points. The chart highlights the Australian Share Fundscontrarian weighting to resource companies.

Why invest i n ou r Aust ra l i an Share Fund?

The Fund offers different risk / return characteristics to those offered by more traditional investmentmanagers as a result of us paying little attention to the benchmark

The Fund is focused on after-tax returns as opposed to relative pre-tax returns

PM CAPITALs investment team is split on a global industry basis. The Australian equity view is supportedby global equity knowledge

The fund is not compelled to be fully invested or in every industry

The Fund is a concentrated portfolio of investments

The Fund may use derivatives to protect and enhance stock returns

PM CAPITAL are traditional investors as opposed to traders

Portfolio construction is an outcome of intensive research and peer group review.

We look through short term risk issues and concentrate on the long term value of a company

PM CAPITAL has a contrarian approach to investing, with stocks more likely to be purchased when theyare out of favour, resulting in a superior number of corporate actions


16/17

16

From a por t fo l i o const ruc t ion perspect i ve , w ha t a re your t y p ica l exposures and lim i ts i nthe Aust ra l i an Share Fund?

Long positions:

Initial position: 2% 3%

Core position: 5%

Maximum position: 10% or 1.5 times index weight, whichever is the greater.

Stocks outside the ASX 100 Leaders must not to exceed 50% of the total portfolio.

Do you have any res t r i c t i ons regard ing ex posures to sma l l compan ies and resourcestocks?

We do not have any formal restrictions as to the extent of exposure to small companies or resource stocks.Rather, we have a wide investable universe in the sense that we do not exclude stocks based on size orindustry. The exposure to small companies and resource stocks are monitored during the top-down review.

How does PM CAPI TAL incorp orat e ESG issues in to i t s investm ent pr ocess?

PM CAPITAL regards Responsible Investment as a commonsense consideration in terms of assessingexisting and prospective investments. ESG factors must be considered as part of an overall assessment of acompanys risk management framework to the extent that these may impact the value of the company overtime. In our quest for a portfolio of good quality businesses, sustainability issues are inherently analysed.

PM CAPITAL defines Responsible Investment as: an investment process that considers the governance, socialand environmental consequences of investments, both positive and negative, within the context of rigorousfinancial analysis.

PM CAPITAL has a policy of exclusion when we feel that a company or sector can not, as a result of itsprimary business activities, be considered to be a Responsible Investment. The exclusion of a stock or sectorhas a negligible effect on the size of the investable universe. PM CAPITAL is typically looking to hold 25-45investment positions in its portfolios at any time. Some examples of sectors that are screened from ourinvestable universe include tobacco manufacturers and weapons manufacturers.

PM CAPITAL acknowledges that the UNPRI is a voluntary, aspirational initiative that provides a framework forintegrating ESG considerations into investment decision-making. As such we have chosen to be a signatoryto the UNPRI.

How do you m anage cash in the Aust ra l i an Share Fund?

The Fund can hold up to 20% in cash (which can be increased to 50% through use of derivatives) butgenerally the cash weighting is less than this. In terms of cash, unlike most other managers we do not havea policy of buying a new position once we exit a stock in order to maintain a fully invested position. Onoccasions when we have not identified an appropriate investment to replace a former position, cash has beenallowed to accumulate until such time as we can identify a stock that meets our strict investment criteria.


17/17

17

Cont act Us

PM CAPI TAL Head Of f iceLevel 24, 400 George Street

Sydney NSW 2000

Ph: (02) 8243 0888Fax: (02) 8243 0880

Website: www.pmcapital.com.au

I ns t i t u t i ona l Sales Ch r i s DonohoeDirect: 02 8243 0806Mobile: 0413 315 631

Email: [email protected]

At PM CAPITAL we remind ourselves that the stock market is far more volatile than theunderlying businesses that it represents. Thus the key to successful investing is good

business judgement in combination with the ability to control your emotion.

19

Documents

ASF Research Book - Mar 2012 - Institutional