State Street Australian Equity Fund January 2017

State Street Australian Equity Fund January 2017 | Strategy Highlights

unprecedented loose monetary policy and fiscal restraint, a concomitant suppression of yields, and a desperate search for returns from risk assets. This healing process continued in 2016. In a year characterized by volatile economic data, the rise of populism, Brexit and an almost unbelievable result in the US election, equity markets rallied strongly from an initial swoon in January to close by Toby Warburton, CFA, Ph.D — Senior Portfolio Manager around their highs. and Olivia Engel, CFA — Head of Active Quantitative Equity, Asia Pacific From July onwards there was an even broader sea-change in market leadership. Previous winners, especially those in Every Loser Wins higher-yielding sectors, such as utilities, telecoms and real estate, by contrast fell over the second half of the year.

Figure 2: Earnings Expectations Summary • The Australian equity market posted another double- 12m Forward EPS, Index to 100 on 1st January 2012 digit gain in 2016, the third in the past 5 years 200 • Previous winners, especially those in higher-yielding sectors, such as utilities, telecoms and real estate, by 150 contrast fell over the second half of the year. 100 • This course of events was exacerbated in November following the US election. 50

0 Jan Aug Apr Dec 2012 2013 2015 2016 How did that happen? The Australian equity market posted — Healthcare — Telecoms — Real Estate — Utilities another double-digit gain in 2016, the third in the past 5 years and marked the sixth calendar year of positive market total — Financials — Cons Disc — Industrials — S&P/ASX 300 return in the past seven, since we started managing the State — Cons Staples — Energy — Materials Street Australian Equity Fund. Source: SSGA, S&P/ASX, Bloomberg Finance L.P. As at 31 December 2016. Over these years, the global economy has been slowly and painfully recovering from a deep crisis, through an era of

Figure 1: 2016 in One Chart: S&P/ASX 300 Index Returns (%)

% 15 US data improves Yield Trumphoria Weakness in US trade falters Reversal 10 Oil price collapses economic data within equity market Fears over Chinese Weakness in 5 economy Weakness Aus banks Bond Yields rise in US Commodities rise 0 Chinese stimulus Underwhelming Equities rise China Commodities surge Aus reporting improves Fed hikes -5 RBA cuts Brexit blip season RBA cuts again Materials & Energy rebound US election -10 Central Banks ease Positive Australian economic surprises -15 Dec Apr Aug Dec Jan 2015 2016 2016 2016 2017

Source: State Street Global Advisors (SSGA), Bloomberg Finance L.P. As at 31 December 2016. State Street Australian Equity Fund

Figure 3: S&P/ASX 300 Sector Returns Figure 5: S&P/ASX 300 Sectors — Total Return

Growth of A$100 Energy 300 Financials Materials 250 Telco 200 Staples IT 150 Industrials Discretionary 100 Health Care 50 Real Estate Utilities 0 Jan Aug Apr Dec -20 -10 0 10 20 30 2012 2013 2015 2016 Total Return (%)

— Healthcare — Telecoms — Real Estate — Utilities  31-Jul to 31-Dec  7 Months to 31-Jul

— Financials — Cons Disc — Industrials — S&P/ASX 300 Source: Factset. — Cons Staples — Energy — Materials

Source: SSGA, S&P/ASX, Bloomberg Finance L.P. As at 31 December 2016. These negative effects were somewhat tempered by our relative underweight to Financials, and the banks in particular, for whom regulation, high payout ratios, weaker earnings and Figure 4: 2016 in Halves — S&P/ASX 300 Relative concerns over the property market led to weaker returns. Sector Returns (%) Stock-selection over the year was strong within Consumer H1 2016 Discretionary stocks, aided by holdings in Bapcor, JB Hifi and 20 Materials Collins foods. However, we fared worse in Industrials through Utilities not holding the likes of Maca, Bradken and Mineral Resources, 10 Healthcare Industrials which looked too volatile for our process but prospered as Energy Telecoms Consumer resources rebounded. Our position in Transurban was also a 0 Discretionary detractor as it was caught up in the higher-yielding sell-off IT Financials post July. Consumer -10 Staples With many large-cap and resources stocks looking either expensive or very volatile, we increased our allocation to select -20 -25 -15 -5 5 15 25 smaller-capitalisation stocks within the portfolio during the H2 2016 year. Despite holding some winners, such as Collins Foods and Infigen Energy, overall these names detracted — largely due to Source: SSGA, S&P/ASX, Bloomberg Finance L.P. As at 31 December 2016. one-off shocks from erstwhile holdings such as Austal, Programmed Maintenance and Estia Health. This course of events was exacerbated in November following Over the course of the year we increased our position in the US election, when reflation-fever took hold of the market Financial stocks, although we still hold significantly less than and hope that president-elect Trump’s fiscal policies would lead a market-weight. We increased our weight in Materials stocks, the world back to growth engorged equity markets globally. although largely outside the volatile metals and mining names. Fund Return and Attribution These changes were funded through a sizeable reduction in our The State Street Australian Equity Fund ended 2016 with a holdings in the Healthcare sector. total return of 11.1% gross (10.2% net of fees), underperforming Outlook the S&P/ASX 300 Index return of 11.8%. The path to achieve In our outlook at the beginning of last year we were concerned those fund returns, however, was not as smooth as we would about the outlook for resources and energy stocks and were have liked. After an exceptionally strong first seven months more phlegmatic about the banks, but overall expected of the year, we underperformed significantly as market mediocre returns for the Australian market. We were right for risk appetite reversed and sizeable sector rotations gripped about a month and a half and then were spectacularly wrong. the market. This reminds us of the quote attributed to the great Danish At a sector-level by far and away the biggest negative physicist and Nobel laureate Niels Bohr “prediction is difficult, contributor for the fund relative to the market was the especially about the future”. Therefore, within our investment underweight position in resources — particularly detrimental process, rather than attempting to forecast and navigate every was not owning BHP Billiton, South32 or Fortescue Metals micro twist and turn of the markets, we aim to build a portfolio Group, whose share price more than tripled. seeking to maximize risk-adjusted total returns for our clients over the long-term.

State Street Global Advisors 2 State Street Australian Equity Fund

This year the only thing we can say with certainty is that there As a result, the S&P/ASX 300 Index is currently looking fully will be a lot of uncertainty. Uncertainty around the ability of valued, trading on a ratio of 27 times last year’s earnings, for the new US administration to effect its proposed changes, example. So, as we start 2017, we have positioned our portfolio uncertainty around the outcomes and implications of elections to be better value than the market on measures such as price in Europe, uncertainty around China and its ability to continue to earnings (both historical and forward-looking), on price to to stimulate the economy and uncertainty about what all this cashflow and on price to book. The dividend yield is also now means for the Australian economy and companies. slightly above that of the index. One concern is that equity markets are not even thinking At a sector level, we maintain our largest position in the about the probabilities of these outcomes, but rather are Financials, where we can find reasonable value in quality unequivocally assuming things will be fine. In the goldilocks stocks. We continue to like some of the consumer discretionary scenario the US economy continues its path back to growth, names and maintain a meaningful weight in transportation- fiscal policy from the incoming administration, such as tax related Industrials and Real Estate. Our expected returns, risks cuts and infrastructure investment, is implemented swiftly and some portfolio positions will evolve over the course of the and effectively, trade barriers do not unduly impact world year, but the fundamentals of our process will remain the same. trade, there are no shocks emanating from Europe and China continues serenely on its way. This may well come to pass, but other outcomes would be unpalatable for markets that seem to be pricing in the best.

Figure 5: State Street Australian Equity Fund Performance As at 31 December 2016 2 Years 3 Years 5 Years Since 1 Month 3 Months 6 Months 1 Year (p.a.) (%) (p.a.) (%) (p.a.) (%) FYTD CYTD Inception (p.a.)† Performance State Street Australian Equity Fund (% Gross) 4.32 0.65 3.31 11.11 9.73 11.25 15.26 3.31 11.11 11.78 Benchmark + (%) 4.34 4.93 10.43 11.80 7.21 6.57 11.67 10.43 11.80 6.97 Value Added (% Gross)* -0.02 -4.28 -7.13 -0.69 2.53 4.68 3.59 -7.13 -0.69 4.82 State Street Australian Equity Fund (% Net) 4.26 0.45 2.90 10.24 8.88 10.38 13.68 2.90 10.24 9.67 Value Added (% Net)* -0.08 -4.48 -7.54 -1.56 1.67 3.82 2.00 -7.54 -1.56 2.70

Risk and Return Standard Deviation/Volatility of Fund^ (%) — — — 12.03 11.52 10.61 9.63 — 12.03 9.36 Standard Deviation/Volatility of Benchmark^ (%) — — — 12.05 13.22 12.48 11.90 — 12.05 12.30 Volatility Reduction (%) — — — -0.02 -1.70 -1.87 -2.27 — -0.02 -2.94 Tracking Error (%)# — — — 8.05 6.63 5.74 5.72 — 8.05 5.98 Risk Free Return (Bloomberg Bank Bill) (%) 0.15 0.44 0.92 2.06 2.21 2.37 2.78 0.92 2.06 3.37 Sharpe Ratio~ — — — 0.75 0.65 0.84 1.30 — 0.75 0.90

Income/Growth Income (including distributed gains) (%) 1.16 1.12 1.15 3.44 3.55 5.09 6.56 1.15 3.44 5.23 Growth (%) 3.09 -0.67 1.75 6.80 5.33 5.29 7.11 1.75 6.80 4.44

Source: S&P and SSGA. Differences in the gross and net returns prior to August 2013 are attributable to fluctuating MERs on the initial SSGA seed money. In August 2013, the MER on the fund was capped at 79bps p.a. Any net performance numbers stated here or in external materials prior to this date will reflect a larger MER that is not attributable to investors going forward. † Inception date is September 2009. Benchmark: S&P/ASX 300 Accumulation Index, S&P/ASX 200 All Australian Accumulation Index prior to February 2013. ^ Standard deviation is a historical measure of the degree to which a fund’s returns varied over a certain period of time. It is normally shown over a time period of 36 months, but the illustrations noted in this material reflect a shorter time. This may not depict a true historical measure, and shouldn’t be relied upon as an accurate assessment of volatility. The higher the standard deviation, the greater the likelihood (and risk) that a fund’s performance will fluctuate and have greater potential for volatility; a lower standard deviation indicates past returns have been less volatile. * The value added returns may show rounding differences. # Tracking error measures the volatility of the difference between the returns of a fund and its associated benchmark. A larger tracking error means that the fund’s return has historically deviated from the benchmark significantly, a smaller tracking error means the fund’s return has historically been closer to the benchmark. ~ Sharpe ratio is calculated by dividing the fund’s excess return over the risk-free rate by its standard deviation. The higher a fund’s sharpe ratio, the better its returns have been relative to the amount of investment risk it has taken. Past performance is not a reliable indicator of future performance. Performance returns for periods of less than one year are not annualized. Net returns are before taxes but after management and transaction costs. Gross returns are before management costs and taxes, but after transaction costs. Returns have been calculated assuming reinvestment of all distributions. Index returns reflect capital gains and losses, income, and the reinvestment of dividends. Index returns are unmanaged and do not reflect the deduction of any fees or expenses.

State Street Global Advisors 3 State Street Australian Equity Fund

Figure 7: Cumulative Growth of $100,000 Since Inception

Thousands 240

210

180

150

120

90 Sep Feb Jul Dec Jun Dec 2009 2011 2012 2013 2005 2016

— State Street Australian Equity Fund (Net) — Market

Source: SSGA. As at 31 December 2016. Past performance is not a reliable indicator of future performance. The performance figures contained herein are provided on a net of fees basis, before taxes but after management and transaction costs. Returns have been calculated assuming reinvestment of all distributions. The index returns are unmanaged and do not reflect the deduction of any fees or expenses. The index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income. Performance returns for periods of less than one year are not annualised.

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