Balanced Fund Update

September Quarter 2008

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Market review A tumultuous quarter in financial markets culminated in a dramatic intensification of the credit crisis following the bankruptcy of Lehman Brothers in mid-September. The credit crisis is getting worse to the point where credit is not available to many good companies, particularly in the US and Europe. As a result, the global economic outlook has deteriorated dramatically in the past month. A global economic recession later this year and in the first half of 2009 appears to be central case. This has, in turn, undermined equity markets as profits are expected to fall precipitously from well above trend to well below trend in the next 18 months.

*This composition is representative of the composition of the Wholesale Balanced Fund. Slight variations however do occur between the Funds. Rounding used in the presentation of data may result in minor addition errors.

• Financial markets have already priced in a lot of bad news on economic growth and profits. As a result, even accounting for a big fall in profits, valuations in credit and equities appears very attractive.
• However, momentum remains unremittingly negative and there is no clear catalyst for a sustained turnaround. We expect central banks will respond with further interest rate cuts and governments will re-double in their attempts to open up credit markets again. For a sustained turnaround in equity markets we need these measures to have been implemented with reasonable prospects of success so that investors can look over the valley of economic disappointment ahead of us.
• The other notable factor in the past quarter is that the deleveraging process is not only affecting asset class returns, but stock selection is also being affected by the ongoing deleveraging of active strategies in equity and bond markets. The result has been some seemingly ‘random’ movements in both equity and credit markets.

• The further intensification of the credit crisis is continuing to undermine returns in the Balanced funds.
• A virtual shut down in some key credit markets has substantially weakened global economic growth prospects in the year ahead.
• As a result, equity markets fell significantly in the September quarter.
• The return for the Balanced funds in the quarter was -4.40%, which was under the benchmark return of -2.96%.
• Over the quarter, tactical asset allocation (TAA) added substantially to performance primarily reflecting an underweight equity position, overweight short dated fixed income instruments and currency positioning in the Brazilian Real, Japanese Yen and Great Britain Pound.
• The value add from TAA was, however, more than offset by detractions from stock selection in Australian and global equities and Australian and global bonds.
• Notwithstanding the under-performance in the past quarter, the Fund has still significantly out-performed its benchmark over the past year with performance of -12.95%, compared with the benchmark return of -15.89%. The strategies which have made the biggest contribution to this out-performance have been tactical asset allocation and qualitative Australian equities.

• Equity markets are approaching interesting levels, although we are still cautious in the near term given our view on the intensity of the looming global economic slowdown. Government bond markets should be supported by the global slowdown in economic growth and the expected falls in headline inflation over coming months.
• The global economic slowdown and falling commodity prices also support a view that the $A will struggle, even after the recent precipitate falls.
• The Australian economy appears to have some major supports lacking in the US and Europe, including a robust banking system and lots of room to move for monetary policy and fiscal policy. That said, if the global economy falls into recession (as appears likely) and commodity prices continue to fall the Australian economy is likely to experience at least a mild recession.
• The disarray in financial markets is creating opportunities in equity and credit markets in individual names which we are aiming to exploit. However, we expect conditions in markets will remain quite challenging until governments get some traction in their efforts to fix the credit crisis and we have some clarity on the magnitude of the downturn in global economic growth.

• an orientation towards growth assets;
• a bias toward Australian assets; and
• active asset allocation, security selection and risk management.

• Seek a fund which aims to provide a combination of capital growth and income.
• Accept the risk that moderate volatility may be experienced.