Preserving capital in a volatile market

1. Preserving capital in a volatile market “Australian Leaders is offering investors an alternative to a traditional equity fund, most of which have performed poorly since the advent of the financial crisis. Over the last 3 years ALF has grown by 50% net of fees, while the market and most institutional funds have moved sideways Justin Braitling Chairman

2. Europe’s Problems in a Nutshell • Monetary Union proceeded in absence of fiscal & political union. • Flagrant breaches of the original Maastricht Treaty conditions - specifically in failure to comply with the fiscal disciplines of the Stability and Growth Pact. • Divergence in pace of supply-side and public sector reforms rendered Southern Europe uncompetitive in comparison to Northern peers. Leading Too: • Fiscal and trade imbalances have pushed sovereign debt to unsustainable levels (Greece, Ireland, Portugal).

3. Southern Europe has become uncompetitive Divergent unit labour costs and productivity • Lack of reforms and loss of markets to Eastern Europe has resulted in divergence in unit labour costs and productivity. • Access to cheap funding lead to fiscal and property bubbles. Internal imbalances surge

4. Crisis of Solvency, Liquidity and Growth • Fiscal sustainability is a function of debt levels relative to both the size and growth of an economy along with the cost of funding debt. • Argentina defaulted in 2001 with half the debt levels of Italy (when measured as a percentage of GDP). • Italy’s debt has become unsustainable in spite of a relatively low deficit, as the economy is shrinking and its cost of funding has escalated sharply. • A fifth of Italian public debt falls due over the next year. It will be a race against time as recession risk looms in the Euro-zone (EZ).

5. Fiscal Sustainability- Restore Solvency Bagehot’s Rule for Central Banks as published in Lombard Street (1873)-“Lend without limit, to solvent firms, against good collateral, at high rates and walk away from insolvent institutions”. • Solvent countries receive liquidity support from official sources: ECB, Rescue Fund, IMF. • Insolvent countries (Greece/Portugal) return to solvency through either significant debt restructuring and/or an orderly exit from the EZ.

6. Restore competitiveness Fiscal and Trade deficits have to be funded, further adding to the stock of public debt unless consolidated. These imbalances need to be addressed or else debt levels will keep rising. Imbalances can be addressed either by: • Internal devaluation – Structural reforms that lead to a depreciation in prices and wages estimated at 30%. • External devaluation of Euro or exit currency block and relaunch domestic currencies. • Fiscal consolidation through austerity.

7. Maintain Liquidity • Solvent countries who lose access to capital markets should be funded by official lenders (EU, EFSF, IMF). • The rescue fund (EFSF) lacks sufficient money and the Central Bank (ECB) has no mandate to act as lender of last resort through monetising state debts. Spreads on 10y EFSF bonds over German Bunds

8. Growth is panacea for all ills in Euro-Zoneas Europe faces recession. Rapid loss of momentum leading towards recession in EZ • Policy needs to shift quickly to restoring growth and competitiveness • via both: • Monetary stimulus through lower rates and quantitative easing, and • A weaker Euro coupled with a reversal of austerity measures in core Europe.

9. A reminder of US structural imbalances Government spending has to consolidate Unemployment is becoming embedded Consumption has to contract Housing Sector will take years to recover

10. Headwinds are significant for fragile recovery Leading indicators are turning down Fiscal drag to take 1% off growth Euro-zone crisis another 1% off growth Credit tightening a further burden

11. Soft Landing in China

12. China’s unbalanced growth

13. Europe is not alone with banking problems

14. Australia: Growth has disappointed in 2- speed economy But significant scope to stimulate if environment gets tough...

15. Summary BAML Research Australia: In relatively good shape given committed level of investment spending and significant scope to ease both monetary and fiscal conditions

16. What if we have a recession in advanced countries: ? If deep recession, corporate profits could fall by 50%. Sep00 Peak EPS $57; Trough ~$40 (~30% downside) Jun07 Peak EPS $91; Trough ~$40 (~56% downside)

17. Portfolio Construction in difficult times • Banks • Resources • Industrials • Defensives • Cash

18. Banks Short term Underweight/Medium term hold • System credit growth has stalled – households & businesses are deleveraging. • Margins improving – banking oligopoly has returned with ongoing asset repricing. • AA rated paper highly sought after. • Wholesale funding task moderated with low balance-sheet growth. • Banks are well capitalised with little asset risk • Fully franked dividend yields @ 7.5-8% will support shares in the absence of deteriorating asset performance. • Australian banks have significantly outperformed and are vulnerable to further weakness offshore. • Preference for ANZ, WBC over CBA, NAB.

19. Banks in better shape then pre-GFC Loan Growth slows but margins recover Stronger funding position Stronger Capital Position- Core Tier 1 ratio Reduced risk of losses on corporate portfolios

20. Outperformance of Australian Banks

21. Resources - Underweight • If Industrial production in China continues to grow above 10%, commodity markets are undersupplied & prices will find support at current levels. • The unwinding of speculative positions is putting pressure on commodity prices in the short term. • Some traders are struggling to get letters of credit, resulting in some cancelled cargoes. • In absence of a collapse in commodity prices, large diversified miners (BHP, RIO) are trading at significant discounts to fair value and look attractively priced. • We would expecting to see further corporate activity in the sector particularly in coal (COK, WHC). • If western economies weaken, China unlikely to provide offsetting support of a scale provided during GFC

22. Defensives- Overweight • Consumer Staples, Gambling, Healthcare, Telecom & Utilities are all defensive sectors. • The safest investments in this environment are in companies that can deliver solid growth irrespective of economy trends. Preferred investments: • Woolworths: With Coles outperforming, WOW shares have been de-rated and now offer an attractive entry point into an outstanding business. • Tattersall’s; a combination of monopoly state lotteries and totalisator operations – 10% dividend yield. • Telstra; Selling their weakest business the PSTN to the NBN for $11bn – sustainable 10% dividend yield. • Woolworths; Food deflation has weighed on margins. • Asciano; Strong growth in coal haulage already contracted.

23. Telstra-Modest but reliable growth

24. Industrials - Underweight • Economically sensitive sectors have underperformed as economy has been weaker than expected. • Deep cyclical’s priced for failure; Qantas, OneSteel, Boral. • These companies all have cyclically exposed businesses that are losing money (Qantas International, Steelmaking, Boral US) along with valuable businesses that are performing well (Jetstar, OneSteel Materials, Boral Construction Materials). • There is significant value emerging in these companies as the residual value in the weaker businesses has been written off by investors. • While the currency has been a headwind for many of these trade exposed sectors, as the Australian dollar falls returns improve and value is restored

25. TEN QAN BLD MYR

26. Historic Exposure In the 2009 financial year ALF’s shareholder funds increased 26% while the All Ordinaries Index fell by 22%.

27. Fund Snapshot

28. Portfolio Returns: Performance to 30 September2011

29. LICs Performance Source: JBWere Listed Investment Companies, September 2011