Quarterly Investment Update Antares Australian Equities Fund – December 2019

For adviser use only

Highlights for the quarter Performance: The Fund returned 0.3% (net of fees) for the December quarter, underperforming its benchmark by 0.4%.

Contributors to performance: Positive contributors – Caltex, BlueScope Steel, and ; Negative contributors – Bank of , and CSL (underweight)

Stock activity: Buys/additions – GPT, Northern Star Resources, South 32, ; Sells/reductions – ANZ, Coles, BlueScope Steel, CBA, Link Administration, NAB, , .

Fund snapshot

Inception date 3 July 1995

Benchmark S&P/ASX 200 Total Return Index

To outperform the benchmark (after fees) over Investment objective rolling 5-year periods

Investment returns as at 31 December 20191

Since Period 3 months 1 year 3 years pa 5 years pa 10 years pa inception pa Net return2 % 0.3 20.0 7.8 7.9 7.3 9.4

Gross return3 % 0.5 20.7 8.6 8.8 8.2 10.4

Benchmark return % 0.7 23.4 10.3 9.0 7.9 9.5

Net excess return % -0.4 -3.4 -2.5 -1.1 -0.6 -0.1

Gross excess return % -0.2 -2.7 -1.7 -0.2 0.3 0.9 1 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. 2 Investment returns are based on exit prices, and are net of management fees and assume reinvestment of all distributions.

Contributors to performance Positive  Caltex (CTX) - We have discussed Caltex in the ESG section of the report. In short both management action to extract value, and subsequent news of a potential takeover bid from Canadian convenience store retailer Alimentation Couche Tarde created a strong share price rally.  BlueScope Steel (BSL) – BSL was a big beneficiary of both the cooling down of trade tensions with China, but also of other US trade action to protect US steel production.

 Amcor (AMC) – We were somewhat surprised by the Amcor sell off in the September quarter. The rebound in the December quarter seemed more about a recovery from the previous sell-off, which occurred on little news.

1

Chart 1: Fund attribution – December quarter

Source: Antares, December 2019

Negative  CSL Limited (CSL) - The Fund’s underweight position in CSL detracted from performance over the quarter as CSL rallied strongly in line with a strong rally in US pharmaceuticals. We note the rally in the S & P 500 pharmaceutical index leaves it trading on a forward PE of 15.8 times and the US Healthcare index trades on 22 times, according to Bloomberg data, whereas on the same methodology CSL trades on a forward PE of 41 times.  Bank of Queensland (BOQ) - BOQ reported a poor result and announced a capital raising. Of equal importance to the share price performance was the announcement of a strategy update early in 2020, which the market interpreted would bring more bad news. We note BOQ is now trading around book value, which theoretically should result in limited downside.

 Nine Entertainment (NEC) - After reporting a reasonable full year result, NEC subsequently updated the market of weakness in the advertising market, which saw the share price sold off.

Stock activity NB: commentary may not be provided on smaller trades or some positions where we have an imminent intention of buying or selling.

Stock activity – December 2019

 General Property Trust (GPT) - We further added to the position for the reasons discussed last quarter. Buys/additions  Northern Star Resources (NST) - Northern Star is our preferred gold stock. Its share price had weakened over the quarter, not only because the gold price had fallen, but because concerns remained around the quantum of production from its Pogo asset. Late in the quarter, NST announced, what we believe will be

Antares Australian Equities Fund Quarterly Investment Update – December 2019 2 another transformational acquisition, being 50% of the KCGM (ie the Kalgoorlie Super Pit) interest, including operator ship, from Newmont Goldcorp. The announcement also included an operational update showing the Pogo mine is now producing to expectations. We not only added to our position in the placement to fund the KCGM acquisition, but also bought on market.

(S32) - We again added to our position in what is one of our preferred mining companies, as per the commentary in the last quarterly report.  Worley (WOR) - We added to the position for the reasons mentioned in the last quarterly report.

 ANZ Banking Group (ANZ) - We reduced our holding in ANZ. We had become concerned that cost cutting was becoming more difficult, as ANZ went hard on costs well before the three other major banks, meaning that the low hanging fruit has already been picked. It was also clear they were experiencing operational difficulties in Australia. What we hadn’t expected, was the drop in dividend franking from 100% to 70%, with the expectation this level of franking will continue. The other major banks frank to 100% which means that ANZ stands at a grossed yield disadvantage. On top of this, the actual FY19 result was compositionally weak with poor revenue growth in the consumer segment, and a re-risking of the Commercial book. For the next six months the bright spot appears to be that ANZ have been able to reaccelerate growth in the mortgage market.

(COL) - We reduced our Coles holding after the stock’s strong sharemarket performance left little upside on our valuation. Although low volatility earnings has been the market sweet spot for some investors, we expect COL’s earnings growth to be 4% pa or below for the next three years. The stock is priced on a 2020 PE multiple of 23 times, a Price to Book ratio of six times and a yield of 3.8%. Although the payout ratio is not extreme, it is unlikely to be increased in the short term due to the very large capital investments required to remain competitive with peers. There is also a risk of further competition coming into the market from Kaufland, and possibly Lidl. We also note thus far Amazon’s entrance into Australia has been somewhat benign, but this may not always be the case. A positive for Coles is the abatement of Sales/reductions price deflation in grocery, and possibly even nascent signs of small inflation re- emerging, which if sustained would increase profitability. However, on balance at such high valuation multiples the risk return trade - off is turning down in our view.  BlueScope Steel (BSL) – We trimmed the position after a very strong price run left little margin for any negatives.  (CBA) - CBA does not report its full year result at the same time as the other big three banks, so when ANZ and WBC reported weakly, followed by capital requirements from WBC and NAB, CBA benefitted by default. Further, when Austrac made the horrific Westpac accusations, CBA benefited from having already been called out by Austrac. In a sense, the market is pricing CBA as having already suffered its regulatory issues, and therefore it trades at a massive PE premium to the three other major banks. Also in its favour was its 1Q trading results which looked much better than ANZ and WBC, particularly with regard to revenue growth, so that became a sector differentiator. However, as in so many ASX sectors currently, the sector leaders are enjoying huge premiums over peers, which in this case has led to what we believe is an overvalued share price.  Link Administration Holdings (LNK)-We trimmed after the size of the position had expanded after a strong share price rebound.  – We sold down to index weighting. Although the FY19 result was ok, uncertainty remains around the possibility of the new MD

Antares Australian Equities Fund Quarterly Investment Update – December 2019 3 rebasing earnings and regulatory fine risk around Austrac and ASIC, which may pressure NAB’s’ capital position and dividend.  Westpac Banking Corporation (WBC) -We reduced our position considerably early in the quarter, after the strong share price run had taken away much of the potential valuation upside. This was before the bank reported on 4 November, Unfortunately for our remaining position, Westpac produced a poor result, conducted a capital raising, cut its dividend, and shortly thereafter was served with the horror of the Austrac claims, resulting in the MD resigning, one board member not seeking re-election and the Chairman announcing his intention to step down. While we believe the huge price fall now looks to be a bit overdone to the downside, given all that has occurred we don’t expect the market will re- rate the stock in the short term.

Strategy and Outlook

Economic Overview

International

The quarter has elicited strong debate about the state of the global economy.

On the bullish side, proponents point to

 possibly expanding credit conditions in China,

 a very strong consumer in the US with robust wages growth and high levels of employment (The US consumer is arguably the best area to be exposed from a corporate perspective at present.),

 signs that leading indicators and global PMIs have bottomed and are now rebounding. Chart 1: OECD Leading indicators (6 month moving average rate of change %)

Source: Macquarie Australian Equity Strategy; 18 November 2019

Chart 2: Manufacturing PMIs – Global, USA and Euro Area

Source: Macquarie Australian Equity Strategy; 18 November 2019

Antares Australian Equities Fund Quarterly Investment Update – December 2019 4  the UK election outcome has removed substantial uncertainty and tail risk,

 the supposed agreement of phase one trade talks between the US and China,

 economic data from Europe showed steady improvement over the quarter,

 corporate bond spreads remain low, which is a healthy sign for credit markets, and the price of copper is starting to bounce, which is often regarded by the market as a bellwether for growth,

 wages growth is reasonable, consistent with “ok” levels of demand and growth, Chart 3: Global wages growth

Source: Deutsche bank FX Special Report; 3 December2019

 The US Federal Reserve (Fed) will inject a massive $500b in liquidity to help the repo (collateralised short term loan) market over December. Such huge boosts to liquidity have historically been associated with strong asset price performance,and

 The Australian Mid-Year and Economic Fiscal Outlook (MYEFO) showed the budget remains in good shape, which probably means more tax cuts or government spending programs in 2020. Bears would argue

 growth in China continues to slow,

 US corporate profits have been quite flat suggesting underlying weakness, which is in line with the Citi economic surprise composite weakening throughout the quarter,

 globally, company earnings revisions remain negative,

 The money market problem in the US in September which saw repo rates rise to 10% represents an underlying structural problem in the banking system,

 it could be argued the phase one US China trade talks are a side show and “fake news”, as history suggests China cannot possibly buy the amounts of agricultural products they have agreed to buy, and that because the overall agreement touches such a small part of both the US and Chinese economies, it is immaterial,

 Australia in particular seems to be going through a particularly weak period, with the Reserve Bank expected to cut rates again at their next meeting in February, and

 In particular, Australian Industrials are extremely expensive relative to history. Chart 4: Australian equity market PE Ratio (x) Industrials (ie Market ex Resources)

Antares Australian Equities Fund Quarterly Investment Update – December 2019 5 Source: Macquarie Australian Equity Strategy; 18 November 2019.

To summarise, the global economy currently appears ok - not great but not disastrous. However with regard to the outlook we find elements of both the bull and bear arguments to be valid, and therefore we keep an open mind and maintain a watching brief on developments. An unresolved market debate of importance surrounds inflation. Some analysts claim US inflation will fall substantially in 2020 due to the rent component falling, yet we can measure what the market expects for underlying inflation through the US breakevens, which have been rising for the last four months, up from 1.25% to 1.67%, ie heading towards the Fed’s inflationary target of 2%.

Historically, the levels of world growth and inflation we are experiencing would have resulted in interest rates hundreds of basis points higher than where they are at present. The easing by the Fed, and the negative interest rate policies in many economies seem totally out of sync with the economic backdrop, and raise the uncomfortable issue of whether central banks are becoming agents of politicians and financial markets. Over the medium to longer term, the results of these policies are uncertain.

Markets

Of note are the unusual efforts of the Federal Reserve to inject massive liquidity into the US short term money market over December and into January. The Fed announced on 13 December 2019, that an additional $500b would be injected on top of the $300b that had been required over the prior three months. To put these amounts of money into perspective, the Troubled Asset Relief Program (TARP) that was seen to have helped turn around the economy post GFC, was initially announced as $700b, but was subsequently scaled back to $475b. In other words, the vast amounts of money currently being injected suggest that there is either something structurally wrong with the US money market function, or that the Fed is concerned about a yet to be disclosed systemic issue. Either way we expect more news about their rationale in the March quarter of 2020.

Australian Equities

Chart 5: Australian industrial equities PE ratio rerating

Source: Goldman Sachs Kickstart 24 November;2019

It is unusual to report that virtually all of the Australian equity market returns up until November 2019 were driven by PE rerating, particularly as earnings estimates (as measured by Goldman Sachs Kickstart 9 December 2019) were 2% lower than they had been at the start of 2019.

Antares Australian Equities Fund Quarterly Investment Update – December 2019 6 Chart 6: Elevated forward PE ratios for Growth (high PE) stocks.

Source: Goldman Sachs Kickstar;t 24 November2019

The differential between “value” and “growth” that we have talked about extensively in previous reports remains at elevated levels.

Chart 7: Global PE differential between growth and value (six month moving average)

Source: JPMorgan - The Global Vantage Point; 15 November 2019

Chart 8: Australian equities - Value vs Growth

Source: JPMorgan - The Global Vantage Point; 15 Novemnbert2019

Resource Stocks

Resource stocks ex-iron ore are likely to experience downgrades throughout 2020 unless their underlying commodity prices improve. In contrast, the very large iron ore exposed stocks, ie BHP, RIO and Fortescue Metals (FMG), will likely experience upgrades based on spot iron ore prices, although based on our analysis of the fundamentals, we believe the current spot price for iron ore is unsustainable over the medium term.

Antares Australian Equities Fund Quarterly Investment Update – December 2019 7 Banks

Over the quarter we reduced our exposure to the banks, in the first instance after an early quarter rally prior to reporting their results. We also reduced exposure subsequent to their results reporting.

Issues facing the banking sector in 2020 include:

 Will the Productivity Commission review, -or could one of the banks themselves move to address- the front book - back book issue, whereby new mortgages are discounted relative to existing mortgages? This has the potential to see further downgrades across the sector.

 Will the expected regulatory fines be of a scale that requires more capital?

 If the RBA cuts rates further, it becomes harder for the banks to maintain profitability.

Bond Proxies

Much of the high valuation is driven by considerations that can be correlated to interest rate sensitivity, low volatility and the growth outlook. In the Australian context we have been reducing our exposure to bond proxies on the basis of valuation.

ESG Commentary

Our approach to ESG is to analyse factors on a company by company, issue by issue basis. The purpose of our ESG process is to identify ESG risks in companies, and to invest accordingly. We believe companies and management should be accountable, an ideal which must be balanced with the need to ensure the companies are in a position to function properly going forward.

There have been some high profile issues over the quarter that provide examples of our approach to ESG.

Caltex Australia (CTX) - We have engaged with management over several years to better extract value for shareholders. We were encouraged to see the company announce it would be divesting its retail property outlets. Also during the quarter Alimentation Couche Tarde announced a takeover bid for CTX. We agree with the CTX board’s recommendation not to accept the current bid, and also agree that the potential bidder, Alimentation Couche Tarde should be granted due diligence, but on a non-exclusive basis. We do not think it is wise to preclude other parties from due diligence.

Couche Tarde’s estimation of value in Caltex, appears to confirm that our engagement with the company over several years was indeed on the right track. Also we note that it can take some time before an argument gains traction, so many of these types of processes can burn very slowly.

Westpac Banking Corporation (WBC) - It is hard to remember such vitriolic media surrounding an MD and Chairman than that aimed at Westpac after the Austrac disclosures. We do not wish to discuss the issues in depth here.

When it came to voting at the Company’s AGM soon after the Austrac announcement, we took into account that the MD had resigned, one director who was up for re-election had declined to stand, and the Chairman has committed to leave. As such we thought enough blood had been spilled and the most important issue going forward is to ensure Westpac deals with the issues that have arisen. These will include a large fine, ensuring compliance with the legislation and implementing systems such that these breaches can not occur again. Not all of the information is yet known but it appears these breaches were not intentional, and the serious allegations of allowing child exploitation were only brought to the Westpac board’s attention five days before the Austrac action was announced. As such we did not vote for a full board spill.

We should disclose we had a confidential meeting with the Westpac Chairman after the Austrac action was announced.

Harvey Norman (HVN) - We viewed the lead up to the HVN AGM as one of the stranger governance situations, where some proxy advisers recommended voting out the high performing MD (who happens to be Gerry Harvey’s wife, and seems to attract unfair criticism probably because of it). This recommendation seemed to be based on issues regarding, among others, variable remuneration.

We voted for the Remuneration Report notwithstanding a number of concerns we initially had, particularly around the fixed remuneration of the CEO and directors and the lower weightings to variable incentives. We have engaged with the board on a number of these concerns. Whilst the fixed remuneration for the CEO and additional executive directors is above the peer group cited by some proxy advisors, we note that this is highly dependent on the peer group selected. Importantly, we observe that executive total remuneration at HVN is broadly in line with its closest peer, JB Hifi. We believe this is appropriate given that Harvey Norman has more complex operations than JB Hifi, operating across eight countries and also having an extensive property portfolio in addition to retail operations. In addition, we believe that the high levels of executive share ownership provides sufficient alignment with shareholders on a long term basis reducing the importance of the LTI incentive program in our view. Antares Australian Equities Fund Quarterly Investment Update – December 2019 8 We are also realists, noting that although there would be a board spill following a second failed remuneration report, all shareholders vote for a new board. Given Gerry Harvey speaks for the majority of shares, he would almost certainly vote back in all of the existing directors, so the whole exercise would have achieved nothing.

The proxy advisers also felt frustrated about the company not having enough independent directors, and as a protest saw fit to not recommend voting for a high performing MD, whilst recommending an unproven person with no requisite experience who has unsuccessfully stood for election to multiple Australian company boards. While our engagement with the company has encouraged board renewal at an appropriate time, we voted to re-elect the existing directors, on the basis of their significant experience and expertise, and voted against the non-board endorsed candidate.

Our view is that in the case of Harvey Norman, some of the proxy advisers recommendations were arguably fuelled by emotion, resulting in some recommendations that were not in the best interests of shareholders.

Newcrest Mining. We flag an emerging issue of water availability for the Cadia mine in NSW. This is more a medium term issue that requires monitoring at this stage, but is consistent with our ESG policy of attempting to identify and quantify risks.

Antares Australian Equities Fund Quarterly Investment Update – December 2019 9

LEGAL DISCLAIMER

Important information: Antares Capital Partners Ltd ABN 85 066 081 114, AFSL 234483 (‘ACP’), is the Responsible Entity of, and the issuer of units in, the Antares Australian Equities Fund ARSN 090 827 802 (‘the Fund’).

An investor should consider the current Product Disclosure Statement (‘PDS’) when deciding whether to acquire, or continue to hold, an investment in the Fund, whether an investment in the Fund is an appropriate investment for the investor and also consider the risks associated with any investment.

This report has been prepared in good faith, where applicable, using information from sources believed to be reliable and accurate as at the time of preparation. However, no representation or warranty (express or implied) is given as to its accuracy, reliability or completeness (which may change without notice). This communication contains general information and may constitute general advice. This report does not take account of an investor’s particular objectives, financial situation or needs. Investors 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.

We recommend investors obtain financial advice specific to their situation. 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.

Any opinions expressed by ACP constitute ACP’s judgement at the time of writing and may change without notice. ACP is a subsidiary of the National Australia Bank Limited group of companies. An investment in the Fund is not a deposit with or liability of National Australia Bank Limited (‘NAB’) or any other member of the NAB group of companies (‘NAB Group’) and is subject to investment risk, including possible delays in repayment and loss of income and capital invested.

Neither ACP nor any other member of the NAB Group guarantees the repayment of your capital, payment of income or the performance of your investment. NAB does not provide a guarantee or assurance in respect of the obligations of ACP.

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Antares Australian Equities Fund Quarterly Investment Update – December 2019 10 Get in contact

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

Antares Australian Equities Fund Quarterly Investment Update – December 2019 11