For adviser use only This report is intended only for financial advisers. It must not be distributed or communicated to any third party and must be kept confidential. The Model Portfolio performance information in this report is based on Antares’ construction of the notional model portfolio which is not available for direct investment. It is not a guarantee or an indication of the actual performance of a client’s portfolio. Advisers need consider the relevant disclosure documents of providers or platforms that offer the Model Portfolio for investment before recommending the Model Portfolio to their client.

Highlights for the quarter Performance: The Model Portfolio returned 2.5% (gross of fees) for the December quarter, outperforming its Benchmark by 0.6%.* Contributors to performance: Positive contributors – Caltex, , Mineral Resources; Negative contributors – , , .

Stock activity: Buys/additions – Atlas Arterial, Metcash, Cochlear; Sales/reductions – BlueScope Steel, Fortescue Metals.

Portfolio snapshot

Inception date 27 May 2015

S&P/ASX 200 Total Return Index excluding the Benchmark S&P/ASX 20 Total Return Index The Model Portfolio’s objective is to outperform the Investment objective Benchmark over rolling 5 year periods.

Investment returns* as at 31 December 2019

Since Period 3 months 1 year 3 years pa 5 years pa 7 years pa inception pa Gross return % 2.5 35.1 14.8 - - 13.7 Benchmark return % 1.9 26.8 12.2 - - 11.1 Gross excess return % 0.6 8.3 2.6 - - 2.6

**Past performance is not a reliable indicator of future performance. Returns are not guaranteed and actual returns may vary from any target returns described in this document. The value of an investment may rise or fall with the changes in the market. Investment returns for the Model Portfolio are based on a notional model portfolio constructed by Antares and are gross of administration (platform) and investment management fees, net of estimated transaction costs, and assume all dividends remain in the Model Portfolio. *Performance is based on the income and market value of the notional model portfolio.

Performance and market update The strategy delivered a return of 2.5% (gross of fees) in the December quarter, which compared favourably to our benchmark’s 1.9%. It was pleasing to generate a positive return in absolute terms as well as one that was ahead of our benchmark. It caps a very strong 2019 for both the Australian market and our strategy.

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Outlook and Positioning

Noting the strong rally in markets, we are cautious at present about the near term. As the following chart shows, global economic data continues to disappoint expectations, despite a period of weakness. Such weakness usually lowers expectations sufficiently to correct overly bullish expectations but as yet, this has not materialized.

Chart 1: Citi Global Surprise Indicator

Source: Bloomberg; December 2019

Likewise, global markets are expecting the revenue line of the world’s listed equities to decline moderately, emphasising the lack of topline growth at present.

Chart 2: Global Revenue Expectations as measured by the MSCI Global Index

Source: Bloomberg; December 2019

Why have markets been so strong over calendar year 2019? In our opinion, the starting point was important as the S&P/ ASX 200 fell 9% in the December 2018 quarter on fears of a global recession. These fears proved groundless, as central banks provided increased liquidity – the US Fed not only stopped reducing its balance sheet which had grown with quantitative easing (QE), but actually cut rates. Meanwhile, the ECB announced another round of quantitative easing, while others, like our own RBA, aggressively cut interest rates.

The lack of recession, coupled with a surge in liquidity, buoyed markets from a low starting point in 2019.

This explains our caution at present – with such a strong rally premised on a lack of fundamental earnings support we believe it prudent to be cautious. This is not to be risk-averse, however, as there are some signs that the global economy has bottomed and growth maybe returning.

For instance, the OECD Lead Indicator of global growth looks to be turning. As the following chart shows, this series has been in decline since late 2017, tracking the perceived weakness in global economies. Interestingly, when this is broken down into its constituent parts, it is Europe which seems to be showing the greatest rebound.

Quarterly Report – Ex-20 Australian Equities – December 2019 2 Chart 3: OECD Lead Indicator

Source: Bloomberg; December 2019

Looking at manufacturing, conditions also seem to have at least stabilised, if not actually begun to improve. Manufacturing is cyclical and can often lead a recovery in the general economy as inventory that has been drawn down needs to be replaced.

Chart 4: Major Global Manufacturing Indices

Source: Bloomberg; December 2019

While we are cautious given recent strength, it is also apparent that the liquidity provided by central banks has created a number of interesting anomalies in the market, not least of which has been to drive bond rates ever lower.

Chart 5: US and German 10 Year Bond Rates (%)

Source: Bloomberg; December 2019

While this is well-known, perhaps what has not been such a focus is that on at least one traditional metric, the spread between earnings-yield and bond-yields, equities look cheap. This metric examines the spread between equities’ earnings yield, which is

Quarterly Report – Ex-20 Australian Equities – December 2019 3 the price earnings ratio inverted (put another way, how many cents of earnings does $1 invested buy) and the 10-year bond rate.

This is particularly apparent in .

Chart 6: ASX 200 Earnings Yield to Bond Yield Spread (%)

Source: Bloomberg; December 2019

This chart is very interesting as it suggests that equities might be cheap compared to the other major asset class, fixed interest. Or it might also show that interest rates are unsustainably low. While rates have been low by historical standards since 2008, as Chart 5 highlights, they have continued to go lower. This is indicative of low growth expectations.

What does all this mean?

Equities do not look overvalued in some respects, but it may be that some pockets of the market are susceptible to a sell-off should interest rates rise on the back of improving economic data. This would suggest that equities which exhibit a longer than average duration (typically higher PE) may come under pressure if rates rise. Some of those businesses may benefit from improving economic conditions, and it is our role to identify these. On the other hand, as Chart 5 reminds us, there have been expectations of a rise in bond rates for a decade or more now, and so far they have continued to go down. Hence we believe it is important to be diversified and prudent in any stock selection at this point.

Stock attribution

Chart 7: Portfolio attribution – December quarter

Source: Antares, December 2019

Quarterly Report – Ex-20 Australian Equities – December 2019 4 Positive Contributors

Caltex Australia (CTX) was the best contributor for the quarter, driven by a series of positive announcements. The first of these was issuing upgraded guidance for its retail business, followed by a proposal to place most of its property assets in a listed real estate investment trust and thus free up capital to return to shareholders. Immediately following these announcements came news of a bid for the entire company from Canadian convenience retailer, Alimentation Couch-Tarde at a 15% premium to the previous close.

Xero (XRO) also posted a solid quarter on the back of a very strong 1H20 result. The key driver was the acceleration in subscriber numbers to over 2m in the period, while average revenue per user remained flat. This added around NZ$175m in annualised monthly recurring revenues in the period. While the business continues to scale, the platform for future profitability is becoming larger, as can be seen from operating profit nearly doubling in the period and as such we remain comfortable with our investment thesis.

Mineral Resources (MIN) enjoyed a strong quarter on the back of receiving FIRB approval for its deal to sell approximately 50% of its Wodgina lithium mine to Chilean based company Albemarle. This was a very good deal for MIN when announced but the market had been awaiting the FIRB approval to reflect its value in the MIN share price. While lithium prices remain depressed as the market deals with increasing near term supply growth, we remain committed to MIN for its longer term exposure to lithium and its role in the decarbonisation of the global economy.

Negative Contributors

AfterPay (APT) detracted from the portfolio for the quarter. While there was no company specific news, we note that APT has had a very strong run and some profit taking was inevitable. Indeed, we reduced our own position at the beginning of the quarter given its success had led it to become outsized relative to our process. We note that peer technology company, Wisetech, suffered some turbulence on the back of a short selling report. While this had nothing to do with APT, nor were the concepts at all related, the report did have an impact on the sector overall.

Vocus Group (VOC) was weaker during the quarter. While there was no specific company news, the market is focusing on the encroachment into the enterprise market by the National Broadband Network, traditionally a strong market for VOC. The legality of the NBN’s move is open to debate, given its core mandate is to be a wholesaler of fibre cable, rather than a provider of direct services.

Metcash (MTS) experienced a poor quarter after releasing its 1H20 results. While the result itself was in line with market expectations, the market did not like the commentary around some major contracts that MTS was looking to re-sign in the period. We believe these concerns are over-done, as the recent loss of the 7-Eleven contract was for very specific reasons attributable only to the changing 7-Eleven business model. We were encouraged by the underlying trends in its IGA Distribution business which saw a return to positive growth for the first time in many years. This growth, coupled with MTS’ valuation leaves us committed to the position.

Stock activity

Buys / additions.

We added Atlas Arterial (ALX) to the portfolio during the month for three reasons: firstly, we took advantage of an attractive entry point given its recent equity placement. The second reason was that the equity placement was partially used to fund the purchase of the management agreements of the ALX business from Macquarie Bank. We view this transaction favourably, as it gives ALX better alignment to shareholders given management can now make decisions independently, rather than at the behest of Macquarie. Thirdly, ALX has been trading at a material discount to other higher quality infrastructure businesses, in part because of the Macquarie management rights. With those management rights removed, we now believe that the business should now be valued by the market in line with its peers.

We added Metcash (MTS) to the portfolio in November based on valuation grounds, and what we believe is the looming improvement in the industry dynamics of its core IGA distribution business. MTS has faced headwinds for a number of years from price deflation in grocery, with the driver being the aggressive price-led strategy of competitors. With the change to ownership structure in a major competitor (Coles), the industry seems to be moving away from price-led strategies that have driven this deflationary pressure over recent years. This is particularly important for the MTS wholesale model, as it is no longer absorbing deflation-driven price-losses on goods moving through its warehouses. Hence, contrary to the market’s expectations, we see the potential for margins to improve and earnings to surprise to the upside.

We have added (COH) back to the portfolio. Recent product launches have helped our conviction in the earnings growth of COH. Further, the benefits of hearing assistance from products such as the cochlear implant are now extending to an aging population. This creates a much larger market than has previously been targeted, so we see a long trajectory of growth available to COH as it supplies this new market. Quarterly Report – Ex-20 Australian Equities – December 2019 5 Sells / reductions

We exited our position in Bluescope Steel Ltd (BSL) as we are concerned about the trajectory of steel spreads - this being the gap between the price of steel’s raw materials of iron ore and coking coal and the steel price realised by manufacturers like BSL. Steel prices have turned lower, but raw materials’ prices have remained around recent highs which hurts profitability at companies like BSL. With housing growth slowing in Australia, we note that BSL has late cycle exposure via its Colourbond product. Colourbond is high margin, and we feel the market might be underestimating the impact given its late use in building projects. The roof goes on last - hence we have sold BSL.

We have also exited our position in Limited (FMG) on similar concerns about steel maker profits. Weaker profits for steel makers can limit their ability to pay higher prices for raw materials, especially the iron ore from producers like FMG. While FMG has experienced stronger than expected demand in 2019, the iron ore market has also experienced significant supply disruptions. Our research suggests that supply is beginning to normalise, which may take iron ore prices lower. Hence we have taken our profits in FMG.

Quarterly Report – Ex-20 Australian Equities – December 2019 6 DISCLAIMER

This report has been prepared by Antares Capital Partners Ltd (ABN 85 066 081 114 ) (“Antares”), a member of the Limited (ABN 12 004 044 937) group of companies (“NAB Group”) in good faith, where applicable, using information from sources believed to be reliable and accurate as at the time of preparation. None of Antares, any other member or the NAB Group, or the employees or directors of the NAB Group are liable for any loss arising from any person relying on information provided by third parties.

This report is directed to and prepared for financial advisers only. This report and any information contained in it must not be distributed to any third party and must be kept confidential.

This communication contains general information and may constitute general financial product advice. It does not take account of an investor’s particular objectives, financial situation or needs. Advisers should therefore, before acting on information in this report, consider its appropriateness, having regard to the investor’s particular own objectives, financial situation or needs and consider the relevant disclosure documents of providers or platforms that offer the Model Portfolio for investment by advisers’ clients.

The Model Portfolio performance information in this report is based on Antares’ construction of the notional model portfolio which is not available for direct investment. It is not a guarantee or an indication of the actual performance of a client’s portfolio. Past performance is not a reliable indicator of future performance. Returns are not guaranteed and actual returns may vary from any target returns described in this document. Any projection or other forward looking statement (‘Projection’) in this report is provided for information purposes only. No representation is made as to the accuracy or reasonableness of any such Projection or that it will be met. Actual events may vary materially.

Antares does not provide and is not responsible for any financial product advice or other financial services an adviser may provider to their client or any financial services provided by providers or platforms with respect of offering of the Model Portfolio. Antares disclaims all responsibility and liability for any loss, claim or damage which any person may have and/or suffer as a result of any person’s reliance on any information, predictions, performance data and the like contained within this document.

Bloomberg Finance L.P. and its affiliates (collectively, ‘Bloomberg’) do not approve or endorse any information included in this publication and disclaim all liability for any loss or damage of any kind arising out of the use of all or any part of any such information.

Get in contact

antarescapital.com.au Toll free: 1800 671 849 Email: [email protected] Mail: GPO Box 2007 Melbourne VIC 3001

Quarterly Report – Ex-20 Australian Equities – December 2019 7