Lonsec Australian
Market Outlook
November 2009
William Keenan
Snr Equity Strategist
Disclaimer
IMPORTANT NOTICE: The following relates to this presentation prepared by Lonsec Limited ABN 56 061 751
102, AFSL No 246842 ("Lonsec") and should be read before making any investment decision about the product(s).
Warning (General Advice Only): Today’s presentations will provide information about investment process, economic
conditions and outlooks for investment markets.
The views, opinions and recommendations included in the information today are all “General Advice”. That is, they do
not take into account the question of their personal suitability for any particular attendee and where a specific financial
product is referred to, attendees should not act on the advice without first consulting their financial planner or advisor
about its appropriateness to their investment objectives, financial circumstances and needs.
Past performance is not reliable indicator of future performance.
Disclaimer: No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of
the information being presented, which is based solely on public information that has not been verified by Lonsec. The
conclusions and recommendations contained in this presentation are reasonably held at the time of completion but are
subject to change without notice. Except for any liability which cannot be excluded, Lonsec, its directors, employees and
agents disclaim all liability (whether in negligence or otherwise) for any error or inaccuracy in, or omission from, the
information contained in this presentation or any loss or damage suffered by the recipient or any other person directly or
indirectly through relying upon the information.
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presentation, which may change from time to time, but none receives or gains any other benefit as a consequence of the
recommendation or advice presented in this presentation. Lonsec considers such holdings not to be sufficiently material
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its associated companies or introducers of business may directly share in the brokerage or benefits.
Agenda
1. Australian economic outlook
- Positives
- Negatives
2. Australian share market outlook
3. Market conclusion
4. Lonsec Core Model Portfolio
Australian economic outlook
Positives

The Banking system is stable and credit is flowing

Financial markets are on the mend and volatility has eased

Monetary policy has been effective in lowering interest rates

The Gov’t is in a relatively strong financial position to provide fiscal stimulus

House prices have proven resilient

Net Exports have held up well

China (our main export partner) is still growing

Retail sales have been robust over 2009

Employment has also been surprisingly resilient (unemployment rate 5.7%)

Consumer and Business sentiment has experienced a V shaped recovery

The rising AUD is deflationary in the short term
Australian economic outlook
Negatives

The GFC has induced a Global recession in the developed world

Global Private sector looking to deleverage

Global Public sector is re-leveraging as a result of fiscal stimulus

Global demand and trade has fallen sharply but now seems to be gradually
recovering

Australian sharemarket down ~ 35% ($500bn in wealth lost)

Aust. Export income declining in the short term due to lower coal and iron ore prices

Aust. Private sector debt levels high (170% of GDP) with A$678bn borrowed offshore

Underlying inflation is proving resilient at 3.5%

Interest rates are on the rise

A rising AUD will hurt our export competiveness in the medium to long term
Australian sharemarket outlook
 The Australian market is
up 40% since 2001
whereas the US market is
still under water
 Resource and Energy
stocks have outperformed
because of demand from
Asia and weak USD
Australian sharemarket outlook
 The 07/08 bear market
was similar to 1973 in
severity but note that after
each fall, the market has
recovered all losses within
3-6 years
 Daily share market
volatility peaked in 2008
but is settling down in
2009 to <1.0% again
Australian sharemarket outlook
 The recent market rally has
increased the trailing PER to
> 20x which looks expensive
 However, the market
expects earnings to
recover by at least 20%
over the next year
Australian sharemarket outlook
 The market dividend yield
is around 4.2% - closer to
4.8% if excluding low
yielding resource stocks
 Secondary market capital
raisings increased
markedly to $90bn or
about 9% of total market
cap over FY09
 This is significantly larger
than the 1995-2008
average of 3.8% of market
cap
 Investors will need to keep
an eye on EPS growth
rather than NPAT growth
Australian sharemarket outlook
 The cash rate has been
slashed but is on the way
back to more “neutral”
levels
 Bond yields are also on
the rise
 Rising bond yields
increase the cost of debt
and in turn equity capital
 Investors need to keep an
eye on this trend
Conclusion
 The Global economy seems to be stabilising and gradually recovering
 The Australian economy has proven remarkably resilient over FY09
 Consumer and Business sentiment has recovered
 Financial markets have improved
 The Australian market has rallied 45% from its March 09 lows but is still
down 35% from its 2007 peak
 There are encouraging signs that the worst has past
 Nonetheless, significant challenges lie ahead for the developed world with
growth likely to remain subdued for some time due to the deleveraging
process that has now begun, post credit crisis
 Asia looks to have much cleaner prospects for growth
 Lonsec expects the Australian market to move towards 5,000 over FY10,
as investors rediscover their appetite for risk
 Lonsec recently increased its Australian Equity weighting to overweight
Lonsec Direct Equity
Model Portfolios
The Lonsec approach to direct investing

Construct and manage virtual model portfolios

Focus on absolute returns over the medium to long term

High conviction, low turn-over, active portfolios

Four-step investment process

Strong focus on “top-down” macro-economic and
industry themes

Risk mitigation at the portfolio and individual stock level
Lonsec investment process
Step
1
Investment
Objectives
Step
2
Portfolio
Construction
Return
Income v Capital
Client Risk Profile
Timeframe
Risk Controls –
Min. no. of Industries
Macro-economic view Min. no. of Stocks
Stock universe restriction
Sector view - Growth,
Stock weighting limits
Cyclical, Defensive, Value
Portfolio turnover rules
ICVR x 4 Stock Filters
Step
3
Stock
Selection
Industry Ratings
Company
Valuation
Company Quality
Company
Risk Rating
Daily monitoring
Step
4
Portfolio
Management
Monthly performance
measurement
Attention to Corporate
Actions
Quarterly Investment
Committee Review
Implement any changes
Regular Reporting
Lonsec stock selection filters

Each of our stocks is selected after a rigorous qualitative and
quantitative analysis involving four stock filters – Industry,
Company Quality, Valuation and Risk

A Lonsec model portfolio stock will rank highly in each
category (ICVR) based on our analysis and experienced
judgement.

Not necessarily looking to find the best stocks in the best
industries but the best value stocks in the best industries.

The Valuation and Risk filters are there to minimise our
downside.

Examples: HSP and PRY instead of SHL and RHC, CBA and
WBC instead of ANZ and MQG, ORG instead of AGL (major
decision at the time), BHP instead of RIO
A closer look at Step 3 – ICVR stock filters
INDUSTRY
I
Industr
y
Rating
Products
Supply & Demand
Key Macro-economic
variables
Growth Rate
Structure
COMPANY QUALITY
C
Company
Quality
Industry positioning
Barriers to entry
Recurring- revenue
Growth rates
Margins
Return on Equity
VALUATION
V
Company
Valuation
R
Company
Risk
Rating
Barriers to entry
Return on Capital
Government
intervention
Sustainability
Free Cash Flow
Dividend history
Management- experience and track
record
Management- incentives and stake in
equity
Corporate Strategy
Corporate- Governance
Balance sheet- strength
Enterprise Value / EBITDA
Stock Price / Cash EPS
Market Cap. / Free Cash
Flow
Stock Price / Dividend PS
Market Cap. / Book Value
RISK RATING
Key macro-economic & weathersensitivities
Key customers and suppliers
Government influence
Level of recurring- revenue
Barriers to entry
Balance sheet- strength
Free Cash Flow
Corporate Strategy
Corporate -Governance
Market –Capitalisation
Share liquidity
Major shareholders
Core Model Portfolio
Objective
To deliver strong absolute returns, over the medium to long term,
through a diversified “blue-chip” portfolio invested across a number
of industries.
Portfolio Rules
Investment universe
ASX TOP 150
Benchmark
ASX TOP 100 Accumulation Index
Min. no. of stocks
10
Min. no. of industries
8
Individual stock limit
12.5%
Cash weighting
0%
LPT weighting
0% (refer Property Asset Allocation)
Targeted portfolio turnover 20-30% pa
Core Model Portfolio
Portfolio Profile
Current no. of stocks
12
Cash weighting
0%
Top 3 sector exposures
Financials 31.25%
Energy 18.75%
Mining 12.5%
Top 50 exposure
87.5%
Ex Top 50
12.5%
Current forecast cash yield 3.9% (5.4% gross)
Inception date
17/04/2000
Core Model Portfolio Performance
INVESTMENT PERFORMANCE
Period ending
30 September 2009
3 Years
5 Years
7 Years
9 Years
(pa)
(pa)
(pa)
Month
Qtr
Year
(pa)
Lonsec Core Model Total Return2
7.0%
20.9%
19.3%
11.2%
17.2%
17.3%
ASX TOP 100 Accumulation Index
6.6%
21.9%
9.3%
2.2%
10.3%
11.8%
Out/Under Performance
0.4%
-1.0%
10.0%
9.0%
6.9%
5.5%
1
Inception date 17 April 2000
2
Investment Performance is calculated before fees, charges, brokerage and taxes. Dividends are reinvested at the end of each month.
Since
Inception1
Since
(p.a.)
Inception1
16.5%
18.1%
382.7%
8.9%
9.8%
142.4%
7.6%
8.3%
240.3%
The portfolio is reset at the end of each month back to the model portfolio weightings. This prevents portfolio weightings from skewing over time and ensures performance
figures remain relevant. The Lonsec Core Model portfolio is a fully-invested notional portfolio with no cash weighting. Physical portfolio results will differ depending on
cash levels, start date, fees, taxes and compliance with model weights. Past performance is not a reliable indicator of future performance.
Standard Deviation (volatility of quarterly returns)
Lonsec Core
ASX TOP 100 Acc. Index
Tracking error (correlation with the index)
19.53%
22.17%
6.19%
19.45%
22.75%
6.65%
16.03%
18.54%
5.91%
14.13%
15.84%
5.60%
450%
400%
Lonsec Core Model Portfolio Total Return since inception 17/04/00
383%
350%
ASX TOP 100 Accumulation Index since 17/04/00
300%
250%
200%
150%
142%
100%
50%
0%
Q2 00 Q4 00 Q2 01 Q4 01 Q2 02
Q402
Q203
Q403
Q204
Q404
Q205
Q405
Q206
Q406
Q207
Q407
Q208
Q408
Q209
13.19%
15.06%
7.22%
13.63%
15.11%
7.13%
Case Study – recent change to Core portfolio
Stock Filter
Industry
Company Quality
Valuation
Risk
TLS out
PRY in
Major change
Defensive / attractive
Good
Very good
Attractive
Attractive
High
Medium
 While TLS looks attractive from a bottom up view (PER 10x, Div
yield 8.8% ff) the top-down outlook is very uncertain
 Govt plans for a National Broadband Network and the structural
separation of TLS creates great uncertainty over TLS’ future
earnings and capital structure
 TLS does not pass the Industry and Risk filters
 Private healthcare industry has strong fundamentals (ageing
and rising population, rising participation rates, 4 major players)
 PRY well positioned in Medical Centres and Pathology
 PRY valuation is attractive (PER 13.4x, Div yield 5.7% ff)
 Risk has been significantly reduced after recent capital raising
Lonsec Direct Model Portfolios
Summary
• Investment Philosophy - Active, focused on absolute returns,
top-down process, high conviction portfolios
• Investment Process – Four-step, top-down process with four
stock filters (ICVR); risk mitigated at the portfolio and stock
selection level
• Two model portfolios – Core and Income
• Seeking strong absolute performance over the long-term
Lonsec Australian
Market Outlook
November 2009
William Keenan
Snr Equity Strategist