Total return % 8
Schroder Wholesale Australian Equity Fund (post-fee)
S&P / ASX 200 Accumulation Index
Relative performance (post-fee)
1 mth
-0.52
-1.76
1.24
3 mths
-4.60
-4.61
0.01
1 yr
-19.05
-13.73
-5.32
3 yrs p.a. 5 yrs p.a.
-0.30
3.70
3.01
-3.31
4.87
-1.17
10 yrs p.a.
4.85
4.43
0.42
Inception Date: 01 Jul 2002, 13 years and 8 months.
Market cap
ASX 1 - 50
ASX 51 - 100
ASX 101 - 300
Non Index
Cash
Top ten holdings %
National Australia Bank Limited
BHP Billiton Limited
Commonwealth Bank of Australia
Westpac Banking Corporation
Woolworths Ltd
Telstra Corporation Limited
ANZ Banking Group Ltd.
Wesfarmers Limited
Rio Tinto Limited
Brambles Ltd
Total
Characteristics
No. of stocks
Portfolio turnover* (1 yr)
Sharpe Ratio (1 yr)
Volatility (5yr standard deviation)
Tracking error (3yr historic)
Portfolio
1
83.1%
8.9%
4.6%
0.9%
2.5%
Portfolio
1
7.6%
6.3%
5.8%
5.7%
5.1%
4.8%
4.7%
4.5%
4.5%
4.1%
53.1%
Benchmark
2
80.6%
12.4%
7.0%
Benchmark
2
1 The 'Portfolio' is the Schroder Wholesale Australian Equity Fund
2 Benchmark is the S&P / ASX 200 Accumulation Index
Unless otherwise stated all figures are as at the end of February 2016
Please note numbers may not total 100 due to rounding
*Turnover = ½(Purchases + Sales - ∑Cashinflows + ∑Cashoutflows) / ½(Market
Value(T0)+ Market Value(T1) - ∑Cashflows)
5.0%
3.9%
9.4%
7.5%
2.3%
5.0%
5.1%
3.4%
1.3%
1.5%
44.4%
Portfolio
1
52
15.2%
-1.47
12.3%
2.9%
Benchmark
2
200
-1.18
12.5%
Please refer to www.schroders.com.au for post-tax returns
Past performance is not a reliable indicator of future performance
Commentary
The S&P / ASX 200 Accumulation Index fell by 1.8%, while the Schroder Wholesale Australian
Equity Fund (post-fee) fell by 0.5%, outperforming by 1.2% for the month.
Investment strategy of recent years has been somewhat monotonous. The sequence can be roughly described as follows: 1) Buy every safe haven asset one can think of; 2) Wait for another piece of disappointing economic news; 3) Cue another promise of further monetary stimulus; 4) Await further elevation in the value of aforementioned safe haven assets driven by ever lower discount rates; 5) Repeat. Like all well learned routines, behaviour becomes ingrained. Investors have grown accustomed to risk assets underperforming regardless of valuation, and vice versa in the case of defensive assets. Incentives to invest in long dated capital investments subject to free market pressures have all but disappeared. When no-one is underwriting the returns on these investments and on the other side of the ledger, financial assets are providing assured gains underwritten by central banks and offering vastly superior liquidity, one should probably not be surprised as to where the money has gone. In this environment, it is equally unsurprising that one of the most frequently asked questions we face is: What is the catalyst for these trends to change? Our answer: We don’t know.
Nevertheless, we remain convinced the monotony will break. The fact that something has happened does not always improve the probability of it continuing to happen. We are more inclined to side with Isaac Newton in believing “For every action, there is an equal and opposite reaction” than believing in the existence of a ‘free lunch’ and the magical ability of economists to create prosperity out of thin air. The massive imbalances in the size of the financial economy relative to the real economy to which we have referred in previous months are the outcome of many repetitions of the above sequence. Every action has been at the expense of the real economy and in particular, those investing tangible capital, and in support of the financial. As investors are forced to contemplate the implications of the latest chapter in the policymaker handbook for global distortion; negative interest rates, assessing a development able to detrimentally impact financial profits rather than augment them, doubtless came as a shock. The share prices of banks globally suffered as their ability to pass on the costs of these nonsensical policies to the real economy was questioned. When hiding money under the mattress starts to deliver better returns than your cash management account and regulators are countenancing ways of reducing and removing physical cash, it’s fairly clear they are getting desperate. Little wonder the gold bugs saw more than a few rays of light in the past month or so.
Several of the anchors carrying the weight of the monotonous routine referred to above are increasingly weakening in our view, throwing into question an investment strategy entirely premised on buying bonds, REITs or equities that look as much like bonds as possible. While the simple questions of deteriorating central banker credibility, collapsing global trade in the face of increasingly protectionist behaviours and ever ballooning debts are important, the dysfunction and its manifestation is perhaps better examined by looking at a range of earnings results across market sectors.
The resource and energy sectors, amongst the largest investors of fixed capital in the economy, were perhaps the least surprising. Returns for shareholders are almost universally low to mid single digit or totally non-existent. The majority featured write-downs of both ill-considered merger and acquisition activity and/or over capitalisation of projects now face a dire outlook. Whilst reactions ranged from the self-help of redoubled efforts to further reduce costs and control industry overcapacity to the reduction of dividends to both preserve cash and optimise the ability to take advantage of acquisition opportunities, share price reactions were telling. Alumina (+30.0%), South32 (+28.2%) and Iluka Resources (+23.9%) were firmly in the self-help camp. Rio Tinto (+6.7%) is perhaps trying to keep a foot in both camps, with a strong focus on costs yet a determination to keep the dinosaurs focused on production growth
(despite having no relationship with economic value growth) placated, whilst BHP Billiton
(+1.4%) opted for the savage dividend cut, relatively weaker cost focus and sought support for preserving firepower to pursue acquisition activity. Forgive our cynicism, but having extinguished sufficient value over the years in deals such as the Billiton merger and US shale investments to bankrupt virtually any other Australian company, we would prefer to be leaving
Donald Trump in charge of US immigration policy than leave the BHP board in charge of capital allocation.

To outperform the S&P/ASX 200 Accumulation Index after fees over the medium to long term by investing in a broad range of companies from
Australia and New Zealand.
Schroders is a bottom-up, fundamental, active growth manager of
Australian equities, with an emphasis on stocks that are able to grow shareholder value in the long term.
APIR code
Fund size (AUD)
Redemption unit price
Fund inception date
Buy / sell spread
Minimum investment
Distribution frequency
Management costs (p.a.)
SCH0101AU
$1,781,999,267
$0.9486
July 2002
0.25%/0.25%
$25,000
Normally twice yearly - June and Dec
0.92%
Energy
Chemicals
Construction Materials
Containers & Packaging
Metals & Mining
Paper & Forest Products
Industrials
Consumer Discretionary
Consumer Staples
Health Care
Information Technology
Telecommunication Services
Utilities
Capital Markets
Consumer banks
Diversified Fin Services
Insurance
Real Estate Mgmt & Dev
Property Trusts
-8.0
-6.0
-4.0
-2.0
0.0
2.0
4.0
6.0
8.0
10.0
-4.7
-5.5
-3.5
-3.2
-1.6
-1.4
-0.3
-0.6
-1.5
0.3
0.0
0.3
1.0
1.2
0.4
1.4
2.6
3.5
Unless otherwise stated all figures are as at the end of February 2016
Benchmark is the S&P / ASX 200 Accumulation Index
9.1
The energy sector displayed similar dynamics. Origin Energy (+10.5%) and Santos (+6.4%) remain buried under the weights of excessive debts supporting projects now likely to deliver abysmal returns, with share price gains merely reflecting the derisory amounts of market capitalisation now left supporting these massive projects, leaving investors necessarily subject to extreme sensitivities in the value of residual equity. In connecting these results back to expectations of an ongoing deflationary environment supporting negligible interest rates indefinitely, we would suggest there is very limited scope for significant further price falls in these areas. As losses or unacceptably low returns permeate almost the entire industry and capital expenditure continues to be savaged, sustained further price falls
(removing further value from the real economy) are not becoming increasingly likely.
Additionally, if further deterioration occurs, it will inevitably require pain to be shared by debtholders, as equity buffers are negligible. We believe the vast majority of deflation is in the rear vision mirror, not through the windscreen.
The interconnection with other segments of the economy was also evident. It transpires that
Aurizon (+13.4%) does actually require solvent coal and iron ore companies to support the value of its rail and rolling stock assets. Who would have thought! The dismal state of global trade and the shipping industry is beginning to impact the port business of Asciano (+1.1%), building materials businesses like Boral (+6.3%) and Fletcher Building (+4.6%) delivered modest returns despite a buoyant construction environment, and insurers such as QBE
(-2.9%) and the commercial insurance businesses within Suncorp ( -1.0%) and IAG (+2.5%) continued to struggle under the weight of surplus capital globally. All these observations cause us to question the expectation of ongoing deflation and its use in the justification of egregiously low interest rates. The intense pressure which these businesses are already under necessarily limits their ability to make ongoing future profit donations to support the financial asset Ponzi scheme and to contribute to the expectation of ongoing price deflation.
At the other end of the spectrum, companies enjoying the benefits of ‘capital light’ structures, which invariably means using the capital of others, are living the dream. It is ironic to say the least, to see infant formula producers making out like bandits while the producers of milk powder are being decimated by collapsing prices. Management of one company assured us that capital employed is no longer a relevant measure and that brand value and intangibles invalidate the relevance of measures such as price to book and support an acquisition based strategy with very healthy doses of intangible asset value.
Forgive us for thinking it may not be ‘different this time’.
Portfolio outlook & strategy
We do not pretend to understand where every risk lies, however, our sense is that the real economy is not positioned to be the perpetually disproportionate loser which current valuations suggest. There just isn’t enough profit left in it. Observations in results season only left us more convinced of the inability of ports, railroads, pipelines, shopping centres, airports and office towers to thrive without acceptable returns also accruing to those taking disproportionately greater risk. With a far greater percentage than normal of the world’s investment capital crammed into richly priced defensive assets and a pervasive belief in the inevitability of ongoing deflation in the real economy and underwritten stability in financial assets, the pool of candidates awaiting admission to this party may be dwindling. Should these conditions change slightly, the next tune playing at the party might be that of Martha and the Vandellas, introduced by Robin Williams in ‘Good Morning Vietnam’; “Nowhere to run to baby, nowhere to hide”.
The future path seems to us more likely to bifurcate. Either a methodology will be found to inject money into the real economy such that prices and activity begin to outpace the wild escalation in financial asset values, allowing egregious debt levels to ameliorate, or the financial asset values will need to retrace to match the ability of the real economy to pay.
The obvious signal in following policies such as negative interest rates is that the rubber band attaching the value of financial assets to the economy which actually does something to generate the income for these assets, is stretched very tightly. The problem with this bifurcation is that the paths go in very different directions. In the former case, the profits of the real economy could be expected to benefit disproportionately, whilst the latter raises the spectre of which financial asset owners are decimated to restore balance. Our attempts to look through cycles still suggest that many of the businesses across energy, materials, industrial and consumer sectors, offer attractive long term value. Given the risks associated with the above bifurcation, we far prefer those with very conservative financial leverage.
When we combine these with self-help efforts to lower costs and improve productivity, such is the case with aforementioned businesses like Alumina, Iluka Resources and South32, we are particularly comfortable.
www.schroders.com.au
E-mail: simal@schroders.com
Schroder Investment Management Australia Limited
Martin Conlon
ABN 22 000 443 274 Australian Financial Services Licence 226473
Level 20 Angel Place, 123 Pitt Street, Sydney NSW 2000
Phone: 1300 136 471 Fax: (02) 9231 1119
Investment in the Schroder Wholesale Australian Equity Fund ('the Fund') may be made on an application form accompanying the current Product Disclosure Statement available from the Manager, Schroder Investment Management Australia Limited (ABN 22 000 443 274 AFSL 226473) (“Schroders”).
This Report is intended solely for the information of the person to whom it is provided by Schroders. It should not be relied on by any person for the purposes of making investment decisions. Total returns are calculated using exit price to exit price, after fees and expenses, and assuming reinvestment of income. Gross returns are calculated using exit price to exit price and are gross of fees and expenses. The repayment of capital and performance of the Fund is not guaranteed by Schroders or any company in the Schroders Group. Past performance is not a reliable indicator of future performance. Unless otherwise stated the source for all graphs and tables contained in this report is Schroders. Opinions constitute our judgment at the time of issue and are subject to change. This report does not contain and is not to be taken as containing any financial product advice or financial product recommendation. For security reasons telephone calls may be recorded.