Pendal Monthly Commentary Pendal Australian Tax Effective Income Portfolio October 2019

Market commentary Portfolio overview Australian Tax Effective Portfolio Australian equities gave back some of their recent gains in Investment Dual focus: Deliver tax-effective capital & October, with the S&P/ASX 300 Accumulation index ending strategy grossed-up income. down -0.4%. Broad hunting ground: Core approach, drawing ideas from across the market cap There are some signs of the global rotation from growth to spectrum. value stocks apparent in the Australian markets, although Income focus: Greater exposure to stocks the trend is clouded by the lack of bank participation. The with high grossed-up yield & dividend Financial sector fell -2.9% for the month, dragged down by sustainability. the banks as headwinds on revenue, margins and capital Investment The objective of the Model Portfolio is to make for a muted outlook as they move through reporting objective outperform the S&P/ASX300 (TR) Index on a rolling 3 year period by 3% per annum, season. while delivering a higher gross yield than Information technology (-3.2%) also underperformed on the market. sharp reversals in Touch (APT, -19.5%) and Benchmark S&P/ASX 300 (TR) Index Wisetech Global (WTC-19.5%). While a short-seller attack Number of stocks 15-35 (28 as at 31 October 2019) contributed to WTC’s reversal, there is also a sense that Sector limits A-REITS 0-30%, Cash 2-10% both companies have been at valuations which do not fully reflect the risks to outlook. Top 10 holdings Consumer Staples (-2.2%) were weaker. Index heavyweight Code Name Weight Woolworths (WOW, +0.1%) held up, but Coles (COL, - CBA of Ltd 9.19% 2.7%), Treasury Wines (TWE, -5.4%) and (MTS, - CSL CSL Limited 8.49% 5.7%) combined to drag the sector down. There were also BHP BHP Billiton Limited 8.21% downgrades from some drought-affected stocks. TLS Corporation Limited 5.91% The iron ore majors, BHP (-2.1%) and (RIO, - ANZ ANZ Banking Group Limited 5.87% 1.9%) underperformed alongside the gold miners Newcrest QAN Airways Limited 5.17% Mining (NCM, -9.9%), Norther Star Resources (NST, - WBC Banking Corporation 4.86% 10.6%) and (EVN, -8.8%). Whilst there was no clear catalyst for the diversified miners' pullback, the poor STO 4.77% performance from gold stocks may reflect better risk appetite MQG Limited 4.36% amongst investors. TCL Group 4.03% Source: Pendal as at 31 October 2019 Health Care (+7.3%) was the best performing sector over the month, as CSL (+9.6%), (RHC, Top 5 overweights versus S&P/ASX 300 +5.6%) and ResMed (RMD, +7.2%) outperformed. ResMed Code Name Weight delivered yet another decent quarter with a slowdown in price deflation underpinning good revenue momentum. QAN Qantas Airways Limited 4.61% STO Santos Limited 3.98% Industrials (+2.9%) finished in the black, driven by TLS Telstra Corporation Limited 3.65% Airport (SYD, +9.3%) and Brambles (BXB, +7.7%). Utilities NEC Co Ltd 3.15% (+1.23%) and Real Estate (+1.8%) also outperformed. MTS Metcash Trading Limited 2.86%

Top 5 underweights versus S&P/ASX 300 Code Name Weight WOW Woolworths Group Limited (not held) -2.68% WES Limited (not held) -2.46% WPL Limited (not held) -1.65% NCM Limited (not held) -1.31% GMG AE (not held) -1.26% Source: Pendal as at 31 October 2019

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Performance

Since 1 month 3 month 6 month 1 year 2 Year 3 Year Inception*

Pendal Australian Tax Effective Income Portfolio -0.21% -0.71% 7.72% 17.30% 8.49% 11.54% 10.49%

S&P/ASX 300 (TR) Index -0.38% -0.78% 7.73% 19.50% 10.88% 12.53% 11.50%

Active return 0.17% 0.08% -0.02% -2.20% -2.39% -0.99% -1.01%

Source: Pendal as at 31 October 2019 *Since Inception – 14 September 2015 Past performance is not a reliable indicator of future performance Top 5 contributors – monthly Top 5 detractors – monthly

Value Value Code Name Code Name Added Added STO Santos Limited 0.20% NEC Nine Entertainment Co Ltd -0.18% CSL CSL Limited 0.19% MTS Metcash Trading Limited -0.16% NCM Newcrest Mining Limited (not held) 0.14% EVN Evolution Mining Limited -0.11% QAN Qantas Airways Limited 0.10% ANZ ANZ Banking Group Limited -0.10% RHC Ramsay Health Care Limited 0.10% SYD Sydney Airport (not held) -0.10% Top 5 contributors – 1 year Top 5 detractors – 1 year

Value Value Code Name Code Name Added Added

JBH JB Hi-Fi Limited 0.70% S32 Limited (not held) -0.81% CSL CSL Limited 0.41% WHC Whitehaven Coal Limited -0.69% WPL Woodside Petroleum Limited (not held) 0.41% CTX Caltex Australia Limited -0.58% JHX Plc 0.32% MTS Metcash Trading Limited -0.41% TCL Transurban Group 0.27% WOW Woolworths Group Limited (not held) -0.37% Source: Pendal as at 31 October 2019 Underweight positions are in italics.

Stock specific drivers of monthly performance relative to benchmark Three largest contributors Three largest detractors: Overweight Santos (STO, +5.0%) Overweight Nine Entertainment (NEC, -5.9%) STO announced plans to buy ConocoPhillips' north An earnings downgrade for Southern Cross Media (SXL) on Australian gas assets for just over $2 billion, which was tough advertising markets weighed on the broader media well received by the market. It reinforces our view of sector, including Nine Entertainment. While there is no doubt STO as the best LNG play in the Australian market that NEC is facing some cyclical headwinds, it is managing to right now, not least for its diversified, bite-sized growth offset some of this effect via larger market share. It recent options. acquisition of Fairfax Media has also diversified the business Overweight CSL (CSL, +9.6%) which, along with decent performance from divisions such as Stan, leaves it less vulnerable to the advertising market than CSL continues at a solid pace in the wake of its most was previously the case. recent update, which demonstrated that the company Overweight Metcash (MTS, -5.7%) continued to deliver strong performance in all its keys segments. There are also signs of a shortage in News that 7-Eleven was putting its fresh and dry food supply plasma products in the US, which will support pricing contract to tender, dragged on Metcash (MTS, -5.7%) which and margins for CSL. holds the current contract. Whilst the media compared this contract to MTS's loss of the Drake's contract in South Not held Newcrest Mining Limited (WPL, -9.9%) Australia, the 7-Eleven contract is a known quantity and at a Newcrest Mining released 1QFY20 production report in much lower margin. That aside, there is growing evidence October. Planned and unplanned maintenance at Cadia that we are seeing grocery inflation creeping back, to which and Lihir, and the 1.4 train strategy recently announced for MTS has the highest operating leverage. Telfer saw gold volume decline by -23% from last quarter, and copper volume down by -14%. All-in sustaining cost Overweight Evolution Mining (EVN, -8.8%) was also 25% higher for the quarter. Improved sentiment on the geopolitical front – with regard to Brexit and US-China trade – has seen the gold price sell off after as strong run. The position in EVN detracted as a result, although this was largely offset by the underweight position in Newcrest Mining (NCM, -9.9%) which is the largest gold stock in the index.

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Market outlook

• The last couple of months have seen a shift away from growth stocks and towards value by global equity investors. Growth stocks in the Australian market – which include the health care, technology, and some China-related food and beverages stocks – have outperformed the broader market by well over 100% since the GFC.

• We are mindful that while there is a sense of investors rebelling against the extreme valuations to which some growth stocks have been driven, we are nevertheless likely to remain in an environment of low rates for some time. This does support the technical valuations for growth stocks at higher levels than in the past.

• As always, our approach is to not try and time shifts in sentiment on thematic and style-based factors. Our edge lies in our access to and knowledge of companies – and we design our portfolios to be driven by that edge. As a result, we have both growth and value stocks in the portfolio. We monitor the degree to which portfolio risk is driven by these factors, to ensure that stock-driven risk remains dominant.

• In this vein, it is interesting to note that the rotation away from growth was not absolute in October. Two high profile tech companies, Afterpay Touch (APT, -19.5%) and Wisetech Global (WTC, -24.7%) gave up considerable ground. Not owning these companies made a positive contribution to the Fund’s relative performance. However our favoured growth company CSL (CSL, +9.6%) actually outperformed. In our view, it helps that there is greater certainty around earnings support for CSL.

• At the same time, the rotation into value was also not broad-based. Notably, the banks did not participate in the gains, as markets remained wary of persistent stiff headwinds on revenues, earnings, margins and capital heading into financials reporting season. This divergence within style-based cohorts suggests that investors are remaining mindful of fundamentals despite what could be a change in a multi-year investment trend.

• The domestic economy remains in a soft patch. House prices appear to have stabilised, although listings numbers have been light. We will be watching this figure closely as we move further into the warmer months. While housing is no longer deteriorating, there will nevertheless be a lag in construction activity picking up again, particularly given the long lead times around apartment development. In tandem with a delay in some infrastructure projects and weak consumer data, it paints an uninspiring picture of the economic outlook.

• In the absence of further fiscal stimulus, it appears that the outlook will remain soft. Cuts to tax and interest rates plus lower utility prices looks to have done enough to halt a slide into recession, but we do not expect a sharp pick-up in activity and demand in the near term.

• Nevertheless, it is important to note that there are companies who are doing a reasonable job of navigating a tough patch. Environments like this do help highlight the stronger management teams and companies and weak sentiment means they can sometimes be bought for an attractive price. This notion, coupled with the divergence in fortunes within both the growth and value cohorts, is driving a stock-picker’s market in our view. This plays to the strengths of our company-focused approach.

New stocks added and/or stocks sold to zero during the month

Sell to zero in (SGR). We are selling down the portfolio’s position in gaming company Star Entertainment (SGR). Our longer-term investment thesis for SGR remains intact. Main gaming floor revenue growth should be supported by ongoing cuts to interest rates and house price growth. Margins should be supported by cost out, capital discipline is improving and we would expect the stock’s valuation to improve as the risk of a second casino on the Gold Coast diminishes. That said, we believe there are signs that overseas-based VIP gaming revenues may be softer than the market expects, driven by a combination of ongoing Australian regulator investigations, heightened China-Australia tensions and vertical integration by junkets, particularly in SE Asia. Consensus expectations are for VIP revenues to be 3% less in FY20 than FY19 – however our research suggests that the reduction could be materially worse. VIP has now shrunk to 12% of the Group’s earnings (EBITDA). Nevertheless, if our re-based expectations of VIP revenue are met, it would leave very little valuation upside. Given our more positive medium term view, SGR is one we will continue to monitor and may look to take advantage if an attractive entry point presents itself. But in the interim, we are closing this position given the material near-term risk.

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This monthly commentary has been prepared by Pendal Institutional Limited ABN 17 126 390 627, AFSL 316455 (Pendal) for the exclusive use of advisers. It is not to be published, or otherwise made available to any person other than the party to whom it is provided. This monthly commentary relates to the Pendal Australian Tax Effective Income Portfolio, a portfolio developed by Pendal. The portfolio composition for any individual investor may vary and the performance information shown may differ from the performance of an investor portfolio due to differences in portfolio construction or fees. Performance figures are shown gross of fees and are calculated by tracking the value of a notional portfolio. Past performance is not a reliable indicator of future performance. This monthly commentary is for general information purposes only, should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient’s personal objectives, financial situation or needs. Because of this, recipients should, before acting on this information, consider its appropriateness having regard to their or their clients’ individual objectives, financial situation and needs. This information is not to be regarded as a securities recommendation. The information in this commentary may contain material provided by third parties, is given in good faith and has been derived from sources believed to be accurate as at its issue date. While such material is published with necessary permission, and while all reasonable care has been taken to ensure that the information in this commentary is complete and correct, to the maximum extent permitted by law neither Pendal nor any company in the Pendal group accepts any responsibility or liability for the accuracy or completeness of this information.