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Pendal Monthly Commentary Pendal Australian Shares Portfolio September 2020

Market commentary Portfolio overview The S&P/ASX 300 lost momentum in September, falling - Australian Shares Portfolio 3.6%, and leaving returns just about flat (-0.1%) for the Investment The strategy employs a bottom up, quarter. strategy fundamental approach to build a diversified portfolio of Australian shares where the While the market was content to look through an August majority of active risk and outperformance reporting season which demonstrated the heavy impact of is driven by stock selection. Covid-19 across a number of sectors, concern over rising cases in the northern hemisphere and a delayed US fiscal Investment The objective of the Model Portfolio is to package weighed on sentiment in September. objective outperform the S&P/ASX 300 (TR) Index on a rolling 3 year period by 3% per annum. Technology (+13.0%) was the best performing index over the Benchmark S&P/ASX 300 (TR) Index quarter, helped by further indications of a prolonged period of low rates and yields which have helped boost valuations. Number of stocks 15-35 (35 as at 30 September 2020) That said, it gave back some gains and was among the Sector limits A-REITS 0-30% weakest sectors in September (-6.4%), in part due to Cash 2-10% Paypal’s decision to move into buy-now-pay-later dragging Dividend Yield 3.17%# on the stocks focused on that space. Income target No target There is a sense that some of the domestic industries

hardest hit by Covid may have seen the worst. Some domestic cyclicals have been rallying as a result, helping Top 10 holdings Consumer Discretionary (+10.1%) outperform over the Code Name Weight quarter. It fell -2.4% in September, but still held up better BHP BHP Billiton Limited 9.25% than the index. CSL CSL Limited 9.25% Energy was the worst performing sector over both the month CBA of Ltd 5.05% (-10.7%) and the quarter (-13.5%) as fresh concerns over the trajectory of economic rebound weighed on the oil price. WBC Banking Corporation 4.47% TLS Corporation Limited 4.44% Financials were also major underperformers over the month (-6.1%) and the quarter (-5.8%). The outlook for bad and XRO Limited 4.16% doubtful debts is tracking towards the more benign end of EVN Limited 4.12% expectations for the banks. However the low rate ANZ ANZ Banking Group Limited 3.91% environment remains a structural headwind for margins. That said, there appears to be some valuation upside from current JHX Plc 3.68% levels for the banks, which should be supported by the STO Santos Limited 3.38% resumption of dividends. Source: Pendal as at 30 September 2020

Top 5 overweights versus S&P/ASX 300 Code Name Weight EVN Evolution Mining Limited 3.53% XRO Xero Limited 3.46% BHP BHP Billiton Limited 2.99% MTS Trading Limited 2.88% NEC Co Ltd 2.87%

Top 5 underweights versus S&P/ASX 300 Code Name Weight WES Limited (not held) -3.01% WOW Woolworths Group Limited (not held) -2.75% NAB Limited -2.36% RIO Limited (not held) -2.09% GMG AE (not held) -1.78% Source: Pendal as at 30 September 2020

#The Portfolio’s dividend yield represents the weighted average 12-month forward-looking dividend yield of the portfolio holdings (excluding cash), as at the date of the Factsheet. Each individual security’s dividend yield is calculated using market consensus Dividend Per Share (DPS) before tax and franking credits, collated by Pendal and divided by the closing market price of the security as at the date of the Factsheet. The portfolio dividend yield therefore is only an estimate, and does not reflect the actual returns of the Fund, which will be affected by market movements in the price of individual securities, the returns on other assets such as cash holdings and variances of individual security's actual dividends from the forecasted DPS.

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Performance

Since 1 month 3 month 6 month 1 year 3 Year 5 Year Inception*

Pendal Australian Shares Portfolio -2.73% 0.52% 16.83% -6.59% 5.20% 8.14% 6.94%

S&P/ASX 300 (TR) Index -3.59% -0.06% 16.73% -9.96% 4.94% 7.41% 5.36%

Active return 0.87% 0.58% 0.11% 3.38% 0.26% 0.73% 1.58%

Source: Pendal as at 30 September 2020 *Since Inception – 15 June 2015 Performance returns are pre-fee. Investors should contact their platform provider for applicable fee rates. 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 JHX James Hardie Industries Plc 0.28% STO Santos Limited -0.33% NEC Nine Entertainment Co Ltd 0.26% QBE QBE Insurance Group Limited -0.20% EVN Evolution Mining Limited 0.24% TCL Group -0.09% QAN Airways Limited 0.16% SHL Limited (not held) -0.08% ALL Limited 0.15% NAB National Australia Bank Limited -0.07%

Top 5 contributors – 1 year Top 5 detractors – 1 year

Value Value Code Name Code Name Added Added XRO Xero Limited 1.28% QAN Qantas Airways Limited -1.04% EVN Evolution Mining Limited 1.27% STO Santos Limited -0.91% JHX James Hardie Industries Plc 0.80% WES Wesfarmers Limited (not held) -0.64% CSL CSL Limited 0.75% APT Limited (not held) -0.59% WPL Woodside Limited (not held) 0.55% IAG Insurance Group Australia -0.57% Source: Pendal as at 30 September 2020 Underweight positions are in italics.

Stock specific drivers of monthly performance relative to benchmark Three largest contributors Three largest detractors Overweight James Hardie (JHX, +7.5%) Overweight Santos (STO, -13.9%) JHX continues to benefit from strength in the US housing market, The second wave of coronavirus in the northern hemisphere, which is feeling the tailwind of both a cyclical rebound from Covid coupled with the ongoing impasse over a fiscal package from as well as the structural issue of under-construction in recent the US has led to concerns over the pace of the economic years. At the same time, JHX’s strategy to reclaim market share recovery. This has weighed in the price of oil and, in turn, on appears to be working. The current margin benefit from low pulp the domestic energy sector. We retain STO as part of the prices is likely to fade, however there appears to be enough recovery-lined part of the portfolio and see it as fundamentally additional factors to support its valuation. the best-placed of the Australian LNG stocks in the current Overweight Nine Entertainment (NEC, +6.4%) environment. NEC continued to do well on the back of improved sentiment on Overweight QBE Insurance (QBE, -19.9%) the outlook for advertising demand. The company has moved The UK High Court announced its decision in a test case on swiftly to reduce its cost base, helping offset this effect. Parts of the liability for QBE to cover for business interruption from its digital business such as Stan have seen improving trends Covid-19 under its policies. It found in QBE’s favour in two of through Covid. The net effect is that NEC’s outlook is much better the three policies under review. This means than QBE will than many feared. have some liability, which saw the stock reaction. However it Overweight Evolution Mining (EVN, +3.6%) is also likely to mean that total costs for this issue are less likely to exceed the amount that QBE had already Gold miners outperformed in September as broader sentiment provisioned. turned more negative. Gold continues to play an important role in the portfolio, protecting against a material market downturn – but Underweight Transurban Group (TCL, +4.8%) also serving as a hedge against the possibility of negative real The portfolio holds Transurban, but at less than index weight, rates that may result from current policy settings. Evolution preferring within the transport infrastructure continues to deliver the best free cash flow per ounce of sector. An increase in expectations of easing restrictions in production in the Australian gold mining sector. Victoria helped TCL in September, given the material impact that the lockdown is having on traffic volumes. 3

Market outlook The Australian Federal budget was stimulatory, as expected. On balance, the size of the total package was probably a touch larger than consensus was looking for. The scale of measures, which will drive the budget deficit close to 12%, demonstrates the willingness of policy makers to underpin the economy.

This is a material shift in mindset away from the fiscal prudence and balanced budgets that Western governments have generally adopted over the last three to four decades. It is an important factor at play in the determining the ultimate economic impact of Covid 19 and the speed of the recovery.

Both government and central bank rhetoric – in Australia and in many countries overseas – is emphasizing the determination to limit the structural economic and social damage from the virus and shutdowns. The outcome is likely to be loose monetary policy for some time – alongside large scale stimulus from the government.

At this point the constraint on fiscal stimulus is either rampant inflation of loss of confidence in government credit. Neither issue is in play at the moment. Over time, we think there is a chance of a period of negative real interest rates, as inflation expectations rise while nominal rates are kept low. This is one factor in the portfolio’s exposure to gold miners – as real assets such as gold, commodities and property tend to do well in period of negative real rates.

We remain mindful of the resurgence of Covid cases in the US and, more recently, in Europe. The second wave in the US has thus far not stalled the economic recovery and the hospitalization and mortality rates remain far below the levels of the first wave. Likewise, in Europe, there has not been any material impact on economic activity so far.

In the US the rate of the rebound is slowing as household income falls. However at this point it seems that accrued savings from the previous months – when the savings rate spiked – is helping offset the effect of previous support rolling off.

The impasse over the next stimulus package remains and it appears increasingly unlikely that an agreement will be reached prior to the Presidential election, with Senate Republicans focused instead on nomination of a new Supreme Court Justice. At this point the notion of a Democrat sweep of the White House and Senate – supported by current bookmaker odds – and therefore a larger package post-election is doing enough to calm market fears on this front.

We maintain the portfolio’s balanced construction. While policy support is rendering the possibility of a double dip recession less likely, there is still the risk of a market downturn and hence we retain the portfolio’s protection in the form of companies with defensive earnings and the exposure to gold.

At the same time, there is a sense that perhaps the worst has passed for some domestic cyclicals – we have seen the portfolio’s positions in Qantas and Nine Entertainment start performing over the last two months. There are still stocks that are trading well below pre-Covid highs and are in decent shape and aligned with the recovery. We have been adding here selectively in recent weeks.

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

Buy new position in Coca Cola Amatil (CCL). The portfolio is adding a new position in CCL, a stock which has seen sales hit by the impact of Covid-19 but which our research suggests is more resilient that the market expects and is positioned to do well as economic momentum improves. CCL bottles and distributes a broad range of alcoholic and non-alcoholic beverages in Australia, New Zealand, , PNG and Fiji. By division in 2019, Australian beverages was just under 58% of earnings, the rest of Asia Pacific ~35% and Alcohol & Coffee the remainder. Within Australia, volumes are split evenly between supermarket sales and “on-the-go” which includes restaurants (both licenced premises and quick-service restaurants), convenience stores and petrol stations. However margins in on-the-go are almost twice that in supermarkets, which means it ultimately drives about two thirds of the Group’s earnings. Historically, CCL has been considered a relatively defensive stock, albeit one facing revenue headwinds in Australia and questions over its ability to deliver on the promise of growth in Indonesia. However CCL was not defensive in the face of the idiosyncratic effect of Covid-19. Travel restrictions, work-from-home, restaurant and event closures and ongoing social distancing have had a severe impact on CCL’s high margin on-the-go segment. Indonesia, which was 7.5% of Group earnings in 2019 has also seen a severe impact. The net impact has been a -19.4% fall in EBITDA for the first half of 2020. The stock’s performance reflects this as well as a valuation de-rating; it is still down -30% from its pre-Covid highs and has not participated in the market’s rebound. However recent trends are more encouraging. Loosening restrictions meant that total Australian volumes in July were 4% higher than the previous year. In New Zealand, they were 8% higher. The resumption of lockdown in Victoria has had an impact on August numbers, but overall volume growth is still trending flat year-on-year.

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There is likely to be a mix-shift effect that remains in the near term, given the larger hit to the on-the-go segment. We expect that volumes in this channel will still be below CY19 levels in CY21. However our research suggests that the degree of recovery will be better than the market’s valuation is currently implying. There are several aspects which need to be watched. We need to see the interplay between the effect of work-from- home versus the trend towards more private transport – and hence traffic through petrol stations. We also need to see the impact of fewer international tourists balanced against perhaps more domestic tourists. However we do not see any structural changes which would ultimately impede on-the-go volumes to near previous levels – an outcome not currently priced into the stock. We continue to emphasise the heightened uncertainty over how quickly the economy can recover. The return of restrictions in Victoria – and more cautious consumer behaviour in NSW in recent weeks – emphasises this. As a result, we retain our balanced portfolio construction, with several defensive positions to protect it in the case of economic deterioration. Nevertheless we are also looking to benefit from stocks which have fallen out of favour, but where sentiment can turn quickly as circumstances change. There has been steady news flow on vaccines and confidence in this area is growing. In the meantime, it looks as though economies will need to cope with a degree of restriction. Better understanding of the virus, methods of treatment and testing can help manage a certain base load of Covid cases, without returning to the scale of lockdowns seen earlier in the year. Under this scenario – and especially if we see developments on a vaccine - we see material upside to the current valuation, which we believe will be reflected once the market gains confidence in the gradual normalisation of economic activity.

For more information contact your key account manager or visit pendalgroup.com

This monthly commentary has been prepared by Pendal Institutional Limited ABN 17 126 390 627, AFSL 316455 (Pendal) and the information contained within is current as at the date of this monthly commentary. 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 Shares 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.