Professional Selection Quarterly Review Fund Manager research trips - US and China June 2014

Two of the main drivers of financial markets in recent months have been uncertainty about the recovery in the United States (US), given the unexpectedly sharp slowdown in Q1 growth and concerns about the slowdown in China and the impact on the resource sector. Given the importance of the US and China in a global context and their influence on the Australian resource sector, two of Antares’ senior fund managers, Nick Pashias and Brett McNeill, embarked on research trips to these countries in the June quarter. This article outlines their findings and the implications for Antares share portfolios.

The information contained within this article is intended as factual information although we acknowledge that there is a reasonable likelihood of doubt and the information is not intended to imply any recommendation or opinion about a financial product.

US Q1 slowdown temporary but US Company visits in the US steel market suggested that the US currently has the highest steel prices on a global basis. In fact, the economy still operating well below capacity price premium in the US is so high that Chinese companies are Nick Pashias, Antares Co-head of equities and portfolio manager exporting steel into the US as they receive higher margins than in of the Antares Elite Opportunities Fund, visited the US on a their domestic market despite the freight charges associated with research trip. One of the current themes in the Antares Elite transporting the steel. This gives a clear insight into the relative Opportunities Fund is an overweight position in selected industrial weakness of the Chinese economy which we discuss in more cyclical stocks (including BlueScope Steel, Brambles, Sims detail below. Metal Management) that will benefit from stronger US growth and The key insights gained from Nick’s company visits to BlueScope are also experiencing significant structural changes that have Steel and are detailed in the following improved their fundamental valuations. Nick’s trip to the US was break-out boxes. primarily concerned with visiting some of these companies – particularly BlueScope Steel (BSL) and Sims Metal Management Key insights about BlueScope Steel (BSL) (SGM) – and getting a better understanding of the US economy, • Steel demand is improving – given the unexpected slowdown in Q1 growth. BlueScope Buildings The main message from this trip was that the US economy is (BBNA) has seen improved demand in definitely rebounding from the weakness in Q1. Most people Nick each of the past four years. Demand spoke to commented that April and May had seen much higher bottomed in 2010 at around 173 million volumes, with the point of debate shifting to whether this was just a tonnes (mt). Current demand is around catch up from the weak Q1, or a sign that some level of underlying 240-250mt, although this is still well below the 2008 peak of strength was returning to the economy. Many were still uncertain 390mt. on this point. Nick’s visits to Australian resource companies (more • Since the GFC, non-residential construction has been details below) also reinforced the view that growth is picking up dominated by government spending but more recently, private globally. Many of the companies he spoke to have seen signs of spending has returned. This is positive for BSL as it is more finished product drawdowns and lower inventories in the US that heavily exposed to the private sector. should result in increased resource demand as companies restock • Speculative builders have recently started to return to in coming months. Some companies also cited early signs of an the market. This suggests a more sustained recovery in improvement in demand from , although it was still patchy confidence. across the region. • Order backlogs have increased, although this is partly due to The other significant theme in the US is just how slow this recovery an inability to deliver product to customers during the extreme has been by historical standards. Most companies Nick visited Q1 weather. agreed that the US economy was still operating well below full • BSL has a competitive advantage in constructing large, capacity and this has clear implications for corporate profits. It is clear spans for light industrial buildings. The company has only when the economy approaches full capacity that companies just released a new product in this range that uses nuts and obtain pricing power. So in the current environment, profits can bolts rather than welding and this has been well received by only grow as volumes recover but the extra boost that is often customers (e.g. discount retailer Costco is using it in all new provided by higher prices is not yet evident. This is particularly facilities). BSL are the only company offering this product and it important for companies such as BlueScope Steel that are close is patent protected. to full capacity in some markets but do not yet have pricing power • The outlook for BSL’s US operations is mixed, partly due to as the industry in general still has significant spare capacity (see capacity constraints in some divisions. For example, BBNA break-out box on BlueScope Steel). management are confident of earnings growth as their business has plenty of scope to increase volumes without the need for significant capital expenditure. By contrast, North Star BlueScope is running at 100% capacity hence earnings growth is more reliant on pricing power which has not yet emerged as competitors still have spare capacity. 1 Fund Manager research trips - US and China

Key insights about Sims Metal Management (SGM) • Capacity is being taken out of the recycling industry by competitors and this is positive for SGM over the medium term • A recovery in the US once volumes improve. market represents the • Visits to SGM’s competitors confirmed Nick’s view of just how greatest opportunity for poorly the company was managed in the past. Hence there is Sims Metal Management a huge opportunity for the new CEO, Galdino Claro (instated in (SGM) to achieve November 2013), to change the way that investors perceive the earnings growth in the company. next few years. The US generated 58% of SGM’s earnings • SGM has implemented significant cost cutting in its US (before interest and tax) in 2008 but only 10% in 1H14. For a operations in the past 6-9 months in an effort to improve turnaround to be achieved, US volumes need to increase by margins. This is expected to continue. around 10% and the mix of scrap (see below) will need to revert • Nick believes the company will announce a strategic review in to historical norms. Volumes were very depressed in Q1 (partly Q3 which should contain further cost reduction initiatives. There due to bad weather) but have improved substantially in Q2. It is also a chance that SGM will announce some form of joint remains unclear how much of this is a catch up from Q1 versus venture with its main competitor, Schnitzer, which would be very an underlying demand improvement. positive for the stock. SGM tried but failed to achieve this joint • Since the GFC, the mix of scrap has changed as there has venture in 2008. been a significant fall in the number of cars and household appliances being scrapped (see Chart 1). This has hurt SGM’s Australian resource stocks and iron ore earnings as these are high margin scrap products due to their large content of non-ferrous material. Looking forward, we prices expect an improvement in scrap from these sources as the US Nick also spent time in Perth towards the end of June, recovery becomes more durable, although there is no evidence visiting ’s major mining companies to obtain a better of this to date. Given the age of cars and appliances in the US understanding of the recent weakness in the iron ore price (down has risen sharply (see Chart 2), stronger growth should prompt 19.7% in the June quarter) and how the slowdown in China replacement demand for these products. SGM is well placed to is impacting the industry. This ties in with another significant benefit from this trend once it commences. investment theme in the Antares Elite Opportunities Fund – an overweight position in some of Australia’s large capitalisation Chart 1: Significantly less cars and appliances being resource stocks such as , BHP Billiton, scrapped and OZ Minerals. Vehicles & Appliances ferrous scrap metal generation

65 kg per capita 2008-09 recession had significant impact on the The iron ore market consumer goods replacement cycle Continued low consumer confidence Whilst Antares had forecast some weakness in the iron ore price High unemployment, low labour participation, and in the second half of 2014 in response to new supply coming on 60 weak mortgage lending, relative to past levels, is keeping aging consumer goods in the scrap reservoir line, the price move came 3-5 months earlier than expected. It also coincided with unexpected strength in the Australian dollar, 55 a slowdown in the Chinese property sector, which is a very large Long-Term Avg source of steel demand, and tight liquidity conditions in China’s Return to long-term auto financial system. These factors all conspired to exacerbate the & appliance per capita 50 scrapping would boost impact of the weak iron ore price on resource stocks. shredder feedstock by at least 10% One of the main conclusions from Nick’s company visits was

45 the huge disparity in the impact of the weaker iron ore price on the small and large producers. The smaller Australian iron ore producers are really struggling to make a profit with the iron ore 40 price down at current levels as their cost bases are relatively high. These companies are searching for ways to reduce costs and Source: Polk, AHAM, USGS, Conference Board, Sims Metal Mangement most have put expansion and growth plans firmly on hold due to a lack of capital. By contrast, the large iron ore companies are Chart 2: Rising age of vehicles much lower on the cost curve hence they are still making healthy Rising age of vehicles margins at current price levels. These companies are continuing to 130 55% expand production and follow through on growth opportunities. Number of vehicles 120 over 11 years old up 50% 21% since 2008 Chart 3 shows an indicative cost curve for the iron ore market,

110 with Australia generally being one of the lowest cost producers % of total vehicles in use and the Chinese being relatively high cost producers. NIck’s 45% 100 recent company visits suggest that some of the high cost Chinese producers have pulled out of the market in the wake of 90 40% the recent price falls. This is positive for the market, particularly if

US vehicles in use (millions) 80 these withdrawals prove to be permanent. It also appears that a Over 120 million vehicles over 11 years old 35% 74% of all vehicles scrapped are between small amount of the seaborne iron ore market has been closed 70 11 and 23 years old1 down due to the price weakness. Whilst this is relatively small in Increasing vehicle age, cited by auto insurance consultant CCC, as a leading volume terms (only tens of millions of tonnes) it is still a significant 60 30% cause of higher ‘total loss frequency’ claims Low development for the market overall. # vehicles over 11 years % vehicles over 11 years (RHS)

Source: Sims Metal Management

Quarterly Review - June 2014 2 Fund Manager research trips - US and China

Chart 3: Iron ore cost curve However, this is not necessarily bad news for the large, low cost Australian producers who are the ones bringing on much of the 200 DomesticSupply cur vChinesee to Chin eOrese market for iron ore fines new capacity and are still very profitable at current iron ore price Australia 170 Vale Rio Tinto BHP Billiton FMG 165 levels. Since new supply is concentrated at the lower end of 160 Other AustraBrazillia Other Brazil India Africa 155 150150 the cost curve, it is flattening the cost curve, driving higher cost 145 China India Other 140 135 South Africa producers out of the market and diverting profits to companies 130 125 120 Other 115 with low cost bases (i.e. the large, low cost Australian producers).

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s 80 for the market on a longer term view as it reduces capacity again. o 75 in above our LR C 70 F I 65

C incentive price in 2012 6500 55 50 45 Chinese economy - growth slowing but

US$/dry tonne CFR equivalent 40 35 30 25 20 150 restructuring needs to continue 10 5 0 100 200 300 400 500 600 700 800 900 1000 -

0 0 Brett McNeill, portfolio manager of the Antares Listed Property 5

10 0 15 0 20 0 25 0 30 0 35 0 40 0 45 0 50 0 Cumulative55 0 60 0 65 0 70 0 75 0 mt80 0 85 0 (wet,90 0 95 0 as00 0 05 0 delivered)10 0 15 0 20 0 25 0 30 0 35 0 40 0 45 0 1 1 1 1 1 1 1 1 1 1 Volume (mt) Fund and deputy portfolio manager of Antares Dividend Source: Metalytics Builder, attended CLSA’s 19th China Forum in Beijing during the quarter. The most significant findings from his trip relate to the Cost cutting and capital management recent slowdown in growth and the challenges associated with restructuring such a large economy. Brett also did some company Cost cutting remains a major focus of the large mining companies, visits in the property sector and some research on Chinese with some looking at automation as a way of reducing costs outbound tourism, with a focus on the potential benefits for further. This includes driver-less trains, driver-less trucks and Australian companies. drill rigs with no human operators! This is likely to result in a polarisation of the cost curve as companies need capital to Chinese GDP growth has slowed significantly in recent years (see implement such automation and only the large mining companies Chart 4) as the Chinese authorities have tightened monetary policy currently have excess capital. This will result in the large mining in an attempt to slow the overheating property sector. The Chinese companies pulling further ahead of their smaller competitors. government’s task of managing the slowdown has also become more complicated due to a sharp drop in the margin for error in At present, shareholders are demanding dividends, higher hitting its growth targets. For example, back in 2010-11, Chinese dividend payout ratios and share buy-backs and this is preventing growth was running between 2-4% above the official target, hence companies from implementing capital expenditure plans. the chance of a policy decision causing growth to undershoot its NIck believes the recent cuts in capital expenditure across the target was very low. More recently, actual GDP growth has been industry will ultimately sow the seeds of the next bull market as much closer to target growth (and almost fallen below target), once demand starts to pick up, capacity utilisation will rise and hence policy risk has increased. In the current environment, eventually so will prices. Currently there is a good example of this a small policy error could easily cause growth to undershoot in the nickel market where a lack of investment in new capacity in significantly. recent years has resulted in the nickel price moving sharply higher (+19.7% in the June quarter and +38.9% over the past year). Chart 4: China’s actual and target GDP growth

Implications for Antares’ portfolios Difficult GDP target with small margin for error 15 Nick reduced the large cap mining overweight in the Antares Elite 14 Opportunities Fund early in the quarter as he expected some 13 12 iron ore price weakness in 2H14. With the market having adjusted 11 more quickly than expected to increased iron ore supply, Nick has (%) 10 Small margin recently started to reweight back into some stocks at lower prices. 9 of error 8 If anything, Nick’s recent company visits reinforced the current 7 positioning in the large cap mining stocks and strengthened Nick’s 6 view that we have no risk appetite for the smaller producers as 5 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 they are higher up the cost curve and have relatively weak balance sheets. Actual quarterly Actual target Looking forward, incremental demand growth in the iron ore Source: CEIC, Wind, CLSA market is around 60 million tonnes annualised whilst incremental The capital-output ratio has also deteriorated (see Chart 5), which supply growth is around 140 million tonnes as there is more new is concerning. The capital output ratio measures the incremental supply due to come on stream in 2H14 and 2015. So the market amount of capital that is required to produce an incremental will continue to have an unfavourable demand / supply balance for increase in output (growth). The higher the capital output ratio, the some time. more inefficient the economy. A rising capital output ratio suggests the Chinese government needs to set a lower growth target if future economic growth is to be sustainable.

Quarterly Review - June 2014 3 Fund Manager research trips - US and China

Chart 5: China’s capital-output ratio deteriorating China - the challenges of restructuring China’s incremental capital output ratio (ICOR) Escalating debt 7 (x) 6 One of the main issues affecting sentiment towards China in recent months has been the huge increase in debt, mainly in the 5 1993-98 Asian Financial Crisis corporate sector (see Chart 7). Total outstanding debt is now 4 2001-08 WTO boom 234% of GDP, sharply higher than the 150% of GDP recorded in 2008. CLSA forecasts suggest debt will continue to grow, reaching 3 1970-93, Deng’s reform approximately 260% of GDP by 2016. 2 Chart 7: China’s debt crisis 1 GFC + 2009 stimulus Outstanding debt as % of GDP, by destination Outstanding debt as % of GDP, by instrument (% of GDP) 0 300 (% of GDP) 300 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 External debt Corporate sector Domestic informal lending 258 258 Household sector 246 Domestic shadow lending 246 Note: ICOR is defined as the ratio between gross capital formation in the 250 250 Domestic corporate bonds Public sector 234 234 previous year and the change in nominal GDP in the subsequent year. 219 Domestic bank lending 219 Sovereign bonds Source: NBS, CLSA 199 200 199 200 200 187 200 186

153 Some economic commentators believe that the official GDP data 152 150 149 150 150 151 149 150 139 150 are overstating the actual level of growth in China and that growth is already below the government’s official target. This view is 100 100 supported by other measures of growth such as the Li Keqiang 50 50 Index (see Chart 6) which uses electricity consumption and cargo

0 0 rates as proxies for actual growth in the economy. According to this 2007 2008 2009 2010 2011 2012 2013 14CL 15CL 14CL 15CL index, Chinese growth is currently around 6.5%, well below the 7.4% 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 year-on-year growth rate that was released in the Q1 GDP data. Source: CLSA Chart 6: Li Keqiang growth proxy index The other significant point to make about Chart 7 is that it confirms (YoY%) that most of the recent increase in debt in China has come from 18 GDP reported shadow financing and informal lending to companies whilst 16 Proxy-GDP household debt remains quite low. Shadow financing and informal lending ring alarm bells as they are not well understood or easy to 14 regulate. This makes them difficult for the government to monitor 12 and control from a prudential perspective.

10 We believe instability in the financial sector remains a key risk to Chinese growth in the future. It also has the potential to impact 8 financial markets as evidenced by the response of bond and 6 sharemarkets to the news that Shanghai Chaori Solar Energy was defaulting on its domestically issued bonds in Q1. 4 2 Very high pollution 0 Pollution and the environment are major concerns of the Chinese 2007 2008 2009 2010 2011 2012 2013 2014 people according to CLSA’s China Reality Research. Protests Proxy GDP of electricity consumption and all cargo carried. Source: CEIC, CLSA about these issues are becoming more common as the negative impacts of widespread pollution and poor air quality are being Looking forward, we believe the government definitely needs to recognised by the local population. continue with economic reform if China is to maintain a strong growth path and overcome its major challenges. In particular, On the basis of the global PM 2.5 air pollution measure, Beijing escalating debt, excessive pollution, negative demographic trends has a meagre 1% of days that rate as “good”. Coal fired power and cost pressures are all constraining growth at present (see generation is responsible for 25-50% of air pollution. Whilst the details below). share of new power generation capacity that is coal fired has fallen from 60% to 35% between 2010 and 2013, the share of overall Investors also need to remember that reforming an economy is capacity that comes from coal is still forecast by CLSA to be 66% rarely positive for growth in the first year. China’s restructuring is by 2020 vs 77% in 2010. A goal of the Government’s new pollution risky because the economy is already over geared. Even though policy is for coal consumption to be below 65%, with renewable investment and credit growth are slowing gradually, risks remain and nuclear to increase from 9% to 13%. This is ambitious and will in the financial sector given the huge amount of “shadow banking” take years to achieve. that takes place in China. Shadow banking refers to non-bank financial intermediaries that provide services similar to traditional Negative demographic trends commercial banks but operate outside normal bank regulation. In China, this sector has grown significantly (see Chart 7) hence it is China’s demographic story gets tougher in the next few years as difficult to tell just how much leverage there is in the economy. population growth for the group aged 25-29 peaks in 2015 and is then forecast to decline sharply (see Chart 8). This trend towards Interestingly, the Chinese leadership don’t appear to be in an aging population makes it harder to restructure the economy denial about the current problems in the economy and this is away from investment and towards consumer demand driven very different to the situation that prevailed in the US and Japan growth as older people tend to have higher levels of saving and before their bubbles burst. Whilst acknowledging the problems lower consumption. It also means the tax base starts to shrink and doesn’t guarantee that they will fix them, at least they have a better this negatively affects government revenues. chance.

Quarterly Review - June 2014 4 Fund Manager research trips - US and China

Chart 8: Sharp demographic changes ahead Chart 10: Primary residential sales – developed market comparisons Population aged between 25 and 29; number of marriages and divorces US primary residential sale % of GDP Hong Kong primary residential sale % of GDP 14,000 ('000 couples) ('000) 140,000 7 (%) 10 (HK$bn) 12,000 120,000 9 6 10,000 100,000 8 5 7 8,000 80,000 6 4 No. of marriages (China) 6,000 No. of divorces (China) 60,000 5 Population aged 25-29 (RHS) 3 4,000 40,000 4 2,000 20,000 2 3 2 0 0 1 1

0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2015F 2020F 2025F 2030F 2035F 2040F 2045F 2050F

Source: CLSA 1929 1932 1935 1938 1941 1944 1947 1950 1953 1956 1959 1962 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: CEIC, US Statistical Bureau, Case Shiller Price Index, Midland, CLSA Cost pressures CLSA are estimating a huge drop in supply post 2013, particularly in Tier 3 cities (also known as county level cities) which is where Many Chinese companies are experiencing cost pressures in the most of the vacancy is likely to be concentrated given the recent Chinese market with wages having risen significantly in recent over-building. A lot of the apartments built in these cities will stay years. As a result, there is an emerging trend towards companies vacant for a long time. shifting some of their manufacturing from China to other lower cost Asian countries such as the Philippines and Thailand. One of the major problems with the Chinese property market is that there is too much property being developed in the wrong China’s property market - over-building a places. For example, development has been widespread in Tier 3 cities but all the population growth has been in Tier 1 and Tier 2 cause for concern cities (see Chart 11). China’s property market is crucial for the health of the overall Chart 11: Population growth by city type (2004-2012) economy. One of the main reasons for this is that property is widely used by banks as collateral for loans. Data from Citi Big cities see rapid population growth . . .

Research suggests that 44% of loans from banks they analysed 35 (%) 33.2 on China’s H-share market are secured by mortgages, which is 30 extremely high. In addition, this probably understates the true 25 20.9 dominance of property collateral in China as the shadow banking 20 system also relies heavily on property for loan backing. This 15 situation is fine when property prices are rising but if property 10 prices start to fall, the value of the loan collateral falls whilst 5 3.9 3.4 the loan size does not. This triggers a potentially dangerous 0 downward spiral in which banks are forced to demand additional Tier 1 Tier 2 Tier 3 Tier 4-5 (2004-2011) collateral from borrowers in a falling asset price environment. Source: CLSA In 2013, China’s new residential sales were 12% of GDP (see A significant driver of the over building in Tier 3 cities is the current chart 9). This is the highest ever for China and well above other tax arrangements. Local cities are heavily reliant on land sale tax developed markets (see Chart 10). For example, the US has not for revenue and this results in the approval of more and more land even experienced new residential sales of 6% of GDP since 1929 developments regardless of whether there is sufficient demand. and in Hong Kong, the peak over the past 18 years was 9%. In this environment, we expect to see more bankruptcies amongst ChartChina’s 9: China’s primary primary residential residential sale as sales% of GDP (% (p12)GDP) smaller developers in these areas.

Volumes of new residential sales have already started to fall 14 (Primary residential sales as % of GDP ) 12 according to anecdotal data. For example, one company we met with referred to a 40% fall in the listing of new homes for sale in 10 Beijing. We heard similar figures from other real estate companies. 8 Chart 12 (overleaf) shows that property price growth also slowed

significantly in 2013 and prices have now started to fall.

6 11 . 9

11 . 3

11 . 0 11 . 0

10 . 5 10 . 3

10 . 2

10 . 0 9 . 6 9 . 5 9 . 0

8 . 5

8 . 0 8 . 0 4 7 . 9 6 . 7

6 . 5

4 . 8 4 . 1

2 3 . 7 3 . 0 14CL 15CL 16CL 17CL 18CL 19CL 20CL 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: CLSA

Quarterly Review - June 2014 5 Fund Manager research trips - US and China

Chart 12: China property prices and sales growth • One of GMG’s current developments is Goodman Pudong

Lessons from the 2011 - 2012 correction International Airport Logistics where we went for a site visit. 2.0 (%) (%) 80 Phase 1 and 2 of this development were finished in 2013, with 1.5 60 a total GLA of 100,000 sqm, of which approximately 75% is 40 leased. Phase 3 (95,000 sqm) is expected to be a 17 month 1.0 20 build starting in June 2014. The completion date is late 2015 0.5 0 and it is currently being leased. Leasehold of 50 years is 0.0 (20) grandfathered as it starts from when GMG bought the land. (40) (0.5) (60) (1.0) Beijing stepped in (80) Jul 11 Jul 12 Jul 13 Oct 11 Oct 12 Oct 13 Jan 11 Jan 12 Jan 14 Jan 13 Apr 11 Apr 12 Apr 14 Apr 13 Jun 11 Jun 12 Jun 13 Feb 11 Feb 12 Feb 14 Feb 13 Sep 11 Sep 12 Sep 13 Dec 10 Dec 11 Dec 13 Dec 12 Mar 11 Mar 12 Mar 14 Mar 13 Nov 11 Nov 10 Nov 12 Nov 13 Aug 11 Aug 12 Aug 13 May 11 May 12 May 13 MoM price change (LHS) Sales growth on the same month of previous three years Note: In this chart we use sales data in 12 large cities and ASP among the 120 for sale projects CRR tracks. Source: CRR Antares portfolios - logistics & tourism From a portfolio perspective, the China trip also involved some company visits with a particular focus on the logistics and tourism sectors. In logistics, we visited Goodman Group (GMG) China as the Antares Listed Property Fund is overweight Goodman Group and we wanted to meet the local management team and learn about their China business. GMG’s China operations incorporate 18 established properties, with total assets under management (AUM) in Mainland China valued at US$1.1 billion. In terms of land, the company has 1.1 million square metres (sqm) of gross lettable area (GLA), 592,000 sqm land under development and over 2.5 million sqm GFA development pipeline. The main insights we gained from this GMG company visit are as follows: Source: Antares • GMG is targeting a development run rate of 600-800,000 sqm Our interest in travel and the tourism sector stems from the theme per annum in Mainland China. This suggests its current land that the growth of Chinese outbound tourists is set to continue for bank amounts to about 3 years’ supply. some time and this represents a huge opportunity for Australian • VIPshop, China’s largest online discount brand retailer, is companies. CLSA’s analysis shows that foreign travel has become GMG’s biggest customer in China. However, VIP also does a bit of a luxury good for the Chinese middle class. Huge interest its own developments so GMG does not get all VIPshop’s in overseas travel is also seen in China Reality Research data. The business. most popular destinations according to experienced travellers are • Around 30% of lettings over the past 12 months were Thailand, Taiwan, Hong Kong, South Korea, Japan, Singapore, e-commerce companies. United States and Macau, with Australia being 12th on the list. • Obtaining land is the toughest part of GMG’s business. Land CLSA expects overseas travellers to grow from 80 million presently allocations for industrial property are very competitive. This is to 200 million by 2020 (see Chart 13 below). partly due to the fact that the Chinese government receives less tax dollars for industrial land than it does for residential, office Chart 13: China’s outbound departures – 200m expected by and retail land. So whilst the government knows it needs to 2020 have sufficient industrial land, new tracts of industrial land are China: Number of outbound tourists granted more grudgingly. • GMG does not believe it is at a disadvantage at land allocations 220 (no.) No. of outbound tourist % YoY (RHS) (%) 25 200 due to its lack of a local partner. GMG also does not believe 180 20 that having Bank of China and COFCO as partners will help 160 Cagr : 11% their main competitor, Global Logistic Properties (GLP) which 140 15 120 has much larger development aspirations than GMG. 100 • GMG does a mixture of pre-committed and speculative 80 10 development, but most of it is speculative. The company is 60 Cagr : 15% 5 somewhat concerned about supply as it believes there are 40 20 pockets of over supply ahead in certain areas. 0 0 • We remain confident in the long term story but tenant demand 05A 06A 07A 08A 09A 10A 11A 12A

is much less consistent at present. 13CL 14CL 15CL 16CL 17CL 18CL 19CL 20CL Source: CLSA We think this growing market represents a huge opportunity for any Australian companies that can successfully capitalise on this theme. In particular, Airport (SYD) should be a major beneficiary and we are overweight this stock in some of our equity funds.

Quarterly Review - June 2014 6 Antares market & Fund updates Below is a brief review of how the Australian sharemarket performed during the quarter as well as short commentaries on each Antares Fund, outlining their net performance and the main contributors to performance.#

Australian sharemarket review Entertainment Group and WorleyParsons. The main detractors from performance over the quarter were overweight positions in The Australian sharemarket experienced subdued performance Coca-Cola Amatil and QBE Insurance Group. despite strength in global sharemarkets. The S&P/ASX 200 Accumulation Index rose just 0.9% in the quarter but returned a High Growth Shares Fund solid 17.4% for the financial year. The best performing sectors The Antares High Growth Shares Fund returned 1.7% (net of were REITs (+9.3%) and utilities (+7.9%) that were supported by fees) for the quarter, outperforming the benchmark S&P/ASX 200 falling bond yields. The 4.6% rise in the oil price underpinned the Accumulation Index return of 0.9% by 0.8%. Contributing positively energy sector (+5.2%). The materials sector (-3.1%) was negatively to performance during the June quarter were an overweight affected by the higher Australian dollar and a sharp fall in the position in Echo Entertainment Group and an underweight position iron ore price (-19.7%). The consumer discretionary sector also in . The main detractors from performance underperformed, as several retailers warned that sales had been were an underweight position in and an affected by the fall in consumer confidence following the Federal overweight position in Iluka Resources. budget. Merger and acquisition activity continued to be a focus, with Small Companies Fund over $5 billion in takeover announcements involving high profile The Antares Small Companies Fund delivered a return of -4.9% companies such as David Jones and Goodman Fielder. The major (net of fees) for the quarter, underperforming the benchmark deals included: S&P/ASX Small Ordinaries Accumulation Index return of -2.3% • South African based Woolworths Holdings made a bid for by 2.6%. The main contributors to performance for the portfolio David Jones, offering to pay $4.00 cash per share. David were overweight positions in Western Areas and Slater & Gordon. Jones’ Board advised shareholders to accept the offer “in the Detracting from performance were overweight positions in BC Iron absence of a superior proposal” and subject to an independent and . experts report. Australian Shares Fund* • Wilmar/First Pacific made a non-binding, conditional bid for Goodman Fielder at $0.70 per share. The Antares Australian Shares Fund delivered a return of 2.1% • Holdings and Baosteel (Chinese steelmaker) offered to (net of fees) for the quarter, underperforming the benchmark S&P/ buy Aquila Resources for $1.42 billion. ASX 200 Accumulation Index return of 0.9% by 1.2%. The main • Private equity firm, Kohlberg Kravis Roberts (KKR), made contributors to performance for the portfolio over the quarter were a $4.70 per share bid for which was overweight positions in Echo Entertainment Group and rejected. Airways. Being overweight Coca-Cola Amatil and QBE Insurance Group detracted from performance. Australian Equities Fund Listed Property Fund The Antares Australian Equities Fund returned 2.1% (net of fees) The Antares Listed Property Fund delivered a return of 8.7% (net for the June quarter, outperforming the benchmark S&P/ASX 200 of fees) for the quarter, underperforming the benchmark S&P/ASX Accumulation Index return of 0.9% by 1.2%. The main contributors 200 A-REIT Accumulation Index return of 9.3% by 0.6%. Positively to performance for the portfolio over the quarter were overweight contributing to performance during the quarter were overweight positions in Echo Entertainment Group and Qantas Airways. Being positions in Charter Hall Retail REIT and Westfield Corporation. overweight Coca-Cola Amatil and QBE Insurance Group detracted The Fund’s performance was negatively impacted by overweight from performance. positions in Peet and Pacific Data Centre Group. Dividend Builder Premier Fixed Income Fund Antares Dividend Builder delivered a return of 2.9% (net of fees) for The Antares Premier Fixed Income Fund delivered a return of 3.0% the quarter, outperforming the benchmark S&P/ASX 200 Industrials (net of fees) for the quarter, performing in line with the benchmark1 Accumulation Index return of 1.3% by 1.6%. The main contributors return of 3.0%. The Fund benefited from its positions in Australian to performance for the portfolio over the quarter were overweight semi-government and supranational bonds and overweight positions in DUET Group and Tatts Group. The main detractors from positions in higher yielding European bonds against comparable performance were overweight positions in Coca-Cola Amatil and German bonds. The main detractors from performance were a . yield curve steepening position in Australian government bonds and a negative view on inflation-linked government bonds in Elite Opportunities Fund France. The Antares Elite Opportunities Fund returned 1.5% (net of fees) for the quarter, outperforming the benchmark S&P/ASX 200 Accumulation Index return of 0.9% by 0.6%. The main contributors to performance for the portfolio were overweight positions in Echo

# All returns are net of fees. Please refer to page 7 of the Quarterly Review for a summary of returns which are gross of fees. * Closed to new investments 1 Benchmark is 75% UBS Australia Composite Bond Index and 25% Barclays Capital Global Aggregate Bond Index (hedged into A$)

Quarterly Review - June 2014 7 Quarterly Review Antares Investment Returns Performance to 30 June 2014

Since 3 mths % 1 yr % 3 yrs % 5 yrs % 10 yrs % Inception p.a. p.a. p.a. % p.a. Australian Equities Net return 2.1 15.1 9.5 10.8 9.1 9.9 Australian Equities Fund Benchmark Return 0.9 17.4 10.4 11.2 9.0 9.7 Inception date: 03/07/1995 Net Excess Return2 1.2 -2.3 -0.9 -0.4 0.1 0.2 Gross Return3 2.3 16.1 10.4 11.7 10.1 10.9 Net return 2.9 17.2 17.5 15.4 - 8.0 Dividend Builder Benchmark Return 1.3 17.4 17.4 15.2 - 7.4 Inception date: 06/09/2005 Net Excess Return2 1.6 -0.2 0.1 0.2 - 0.6 Gross Return3 3.0 17.9 18.2 16.1 - 8.7 Net return 1.5 16.1 8.2 11.2 10.2 11.7 Elite Opportunities Fund Benchmark Return 0.9 17.4 10.4 11.2 9.0 9.9 Inception date: 18/11/2002 Net Excess Return2 0.6 -1.3 -2.2 0.0 1.2 1.8 Gross Return3 1.6 16.9 9.0 12.0 11.0 12.6 Net return 1.7 13.9 9.2 10.8 9.8 11.3 High Growth Shares Fund Benchmark Return 0.9 17.4 10.4 11.2 9.0 8.3 Inception date: 07/12/1999 Net Excess Return2 0.8 -3.5 -1.2 -0.4 0.8 3.0 Gross Return3 2.0 15.1 10.4 12.0 11.1 13.0 Net return -4.9 17.6 2.0 11.3 11.0 10.5 Small Companies Fund Benchmark Return -2.3 13.1 -2.9 3.4 4.5 3.9 Inception date: 19/11/1999 Net Excess Return2 -2.6 4.5 4.9 7.9 6.5 6.6 Gross Return3 -4.6 18.7 3.0 12.4 12.1 11.5 Listed Property Net return 8.7 9.3 14.8 13.6 4.3 7.6 Listed Property Fund Benchmark Return 9.3 11.1 15.3 14.3 2.3 6.9 Inception date: 28/02/1994 Net Excess Return2 -0.6 -1.8 -0.5 -0.7 2.0 0.7 Gross Return3 8.9 10.1 15.6 14.4 5.1 8.4 Fixed Income Net return 3.0 6.7 7.1 7.4 6.6 6.7 Premier Fixed Income Benchmark Return 3.0 6.5 7.2 7.3 6.9 6.9 Fund 2 Inception date: 31/05/2000 Net Excess Return 0.0 0.2 -0.1 0.1 -0.3 -0.2 Gross Return3 3.1 7.2 7.6 7.9 7.0 7.1

Disclaimer: 1 All net returns are based on exit to exit unit prices for Professional Selection units, are net of fees and assume the reinvestment of income. 2 Gross returns are provided to show performance against the investment objective. Past performance is not a guide to or indication of future performance. At Antares’ discretion, the management and/or performance fee may be partly rebated to professional, sophisticated or wholesale investors. The above information is of a general nature and has been prepared without taking account of your individual investment objectives, financial situation or particular investment needs. It is not intended as financial advice to retail clients. Before making an investment decision, you should consider the appropriateness of the information, having regard to your objectives, financial situation and needs. We recommend you consult with your financial adviser, who can help you determine how best to achieve your financial goals and whether investing in a fund is appropriate for you. Investment in the Antares Investment Funds will only be made upon receipt of a completed application form from the current PDS, a copy of which can be obtained from Antares. Antares Capital Partners Limited ABN 85 066 081 114. AFS Licence No 234483. Level 20 8 Exhibition Street Melbourne VIC 3000 GPO Box 2007, Melbourne 3001 Telephone: (03) 9220 0300 Facsimile: (03) 9220 0333 Email: [email protected] Website: www.antarescapital.com.au

Quarterly Review - June 2014 8 NOTES NOTES NOTES Get in contact Toll free: 1800 671 849 antarescapital.com.au Email: [email protected] Mail: GPO Box 2007 Melbourne VIC 3001

The above information is of a general nature and has been prepared without taking account of your individual investment objectives, financial situation or particular investment needs. It is not intended as financial advice to retail clients. Before making an investment decision, you should consider the appropriateness of the information, having regard to your objectives, financial situation and needs. We recommend you consult with your financial adviser, who can help you determine how best to achieve your financial goals and whether investing in a fund is appropriate for you. Antares Capital Partners Limited ABN 85 066 081 114. AFS Licence No. 234483. Level 20 8 Exhibition Street Melbourne VIC 3000 GPO Box 2007, Melbourne VIC 3001 Telephone: (03) 9220 0300 Facsimile: (03) 9220 0333. Email: [email protected] Website: antarescapital.com.au.