Australian Shares High Yield Portfolio Quarterly Update March 2015

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1 Australian Shares High Yield Portfolio Quarterly Update March 2015 Morningstar Style Box Value Blend Growth Gareth James Senior Equity Analyst Peter Warnes Head of Australian Equity Research Large Mid Small Equity Style % Equity Style Value 41.8 Equity Style Core 29.5 Equity Style Growth 28.7 Portfolio Overview The Australian Shares High Yield Portfolio rose an impressive10.8% during the March quarter, outpacing the 10.3% return of the S&P/ASX 200 Accumulation Index. Long-term portfolio returns remain very strong, with a 15.7% annualised return during the past five years versus just 8.6% for the benchmark. Portfolio returns are even greater when franking credits are included, however, we exclude them from our return calculation as the benefits vary depending on an individual's tax status. Yield compression and commodity price weakness remained key drivers of the Australian stock market in the March quarter. The 26% fall in the iron ore price pushed smaller miners towards the brink with knock-on effects for mining service providers. The 14% fall in the oil price piled even more pressure on oil and gas producers and Shell"s acquisition of BG Group could be the first of many in the sector. Despite commodity price weakness, the S&P/ASX 200 Accumulation Index still rose strongly during the quarter with the yield compression effect exceeding commodity price weakness. The ending of the resources boom has reduced resources stocks to 19% of the index, whereas interest-rate-sensitive stocks in the financials, real estate, utilities, and telecommunications sectors now comprise 56% of the index. The High Yield Portfolio generally avoids resources companies given the volatile nature of their profits, meaning commodity price weakness has been a tailwind for portfolio outperformance. Looking forward, we don"t expect commodity price falls to continue at the same rate and outperformance by typical income stocks is likely to become harder to achieve. Reflecting this view, we recently increased our exposure to BHP Billiton, believing the yield to be attractive and sustainable. High Yield Portfolio - Top 10 Holdings Telstra Corp Ltd Australia and New Zealand Banking Group Ltd Westpac Banking Corp APA Group National Australia Bank Ltd Commonwealth Bank of Australia BWP Trust BHP Billiton Ltd Wesfarmers Ltd Scentre Group Investment Growth of $10,000 Time Period: 1/08/2001 to 31/03/ ,00 47,50 40,00 32,50 25,00 17,50 10,00 Weighting % Commodity price weakness continues to weigh on the economy with unemployment at a 12-year high and iron ore price weakness creating a hole in the federal budget. The Reserve Bank of Australia's, or RBA's, decision to cut the cash rate by 25 basis points to 2.25% in February helped yields compress further and ASX-listed interest rate futures imply a further two 25 basis-point cuts by year end. Booming residential real estate prices represent a challenge to further RBA cuts, though without further cuts, the property market is likely to consolidate. Despite interest rate cuts and yield compression, negative interest rates in Europe and a 7% fall in the Australian dollar/u.s. dollar exchange rate during the quarter means Australia remains an attractive home for foreign capital. With bank deposit rates below 3% and portfolio holdings yielding 5%, or more than 6% with franking credits, yield compression can continue. Despite strong returns during the past year, portfolio metrics remain attractive with a weighted-average yield of 4.7%, or 6.0% grossed up. It remains heavily skewed towards high-quality companies with 96% of the portfolio in stocks with either a narrow or wide economic moat, and all holdings have either low or medium fair value uncertainty ratings 2, High Yield Portfolio S&P/ASX 200 TR

2 High Yield Portfolio - Complete List of Holdings Portfolio Date: 31/03/2015 Code Style Box Economic Moat Fair Value Uncertainty Portfolio Weight % Telstra Corp Ltd Australia and New Zealand Banking Group Ltd Westpac Banking Corp APA Group National Australia Bank Ltd Commonwealth Bank of Australia BWP Trust BHP Billiton Ltd Wesfarmers Ltd Scentre Group Spark New Zealand Ltd Woolworths Ltd Charter Hall Retail REIT Sonic Healthcare Ltd Cash Account AMP Ltd AGL Energy Ltd TLS É Narrow Medium 14.7 ANZ Ç Wide Medium 8.2 WBC Ç Wide Medium 8.1 APA É Narrow Medium 7.3 NAB Ç Wide Medium 7.1 CBA È Wide Medium 7.0 BWP Ë Narrow Medium 6.1 BHP È Narrow Medium 6.0 WES È Wide Medium 5.5 SCG È Narrow Medium 4.6 SPK Ê Narrow Medium 4.5 WOW Ç Wide Low 4.4 CQR Ê None Medium 3.7 SHL É Narrow Medium AMP É Narrow Medium 2.8 AGL Ç Narrow Medium 2.7 Note dividends for Spark New Zealand are imputed for New Zealand residents. Australian residents receive unfranked dividends with a supplementary payment. Morningstar Investment Committee members own the following securities held by the portfolio: BHP, NAB, TLS, WES Holdings-Based Style Map Holdings-Based Style Trail Micro Small Mid Large Giant Deep-Val Core-Val Core Core-Grth High-Grth Micro Small Mid Large Giant Deep-Val Core-Val Core Core-Grth High-Grth High Yield Portfolio S&P/ASX 200 TR High Yield Portfolio S&P/ASX 200 TR The above chart shows the portfolio and index style mix. The shaded area is the region in which 75% of the portfolio's holdings fall. The above chart shows the portfolio and index style mix over time, the smallest dot representing the earliest date.

3 Portfolio Fundamentals Display Benchmark 1: S&P/ASX 200 TR Inv Bmk1 Cat Avg Average Market Cap (mil) 24, , ,646.2 P/E Ratio (TTM) Debt to Capital % (TTM) ROA % (TTM) ROE % (TTM) Asset Allocation Portfolio Date: 31/03/2015 % Stock 96.5 Cash 3.5 Total 10 Transactions in the Quarter We increased our holding in BHP Billiton in March from 3.5% to 5.9%, funded by a reduction in our APA Group holding from 11.5% to 7.1%. APA Group was trading at a 17% premium to fair value whereas BHP Billiton was at a 14% discount, meaning the transaction reduced the portfolio's weighted-average price-tofair-value ratio from 1.05 to The proportion of holdings with moats and low or medium uncertainty ratings was unchanged. The net dividend yield was also unchanged, however, the portfolio's weightedaverage grossed-up yield increased from 5.79% to 5.85%. BHP Billiton is a high-quality business with a narrow economic moat and medium uncertainty ratings, and the stock is in our Best Stock Ideas. Other cheaper alternatives lacked either the quality or dividend sustainability required for the Income portfolio. As one of the largest stocks on the market, BHP Billiton offers exposure to a high-quality, diversified portfolio of low-cost and long-life resources assets. The diversified nature of BHP Billiton's portfolio should smooth out the earnings volatility normally experienced by mining companies. BHP Billiton is also one of the lowest-cost producers of iron ore in the world, meaning it should be able to withstand weak iron ore prices as other miners cease production and the market tightens. The company has a long history of paying and growing fully franked dividends and has committed to continue to do so in future. BHP Billiton's dividends have grown every year since The purchase means our underweight exposure to the materials and energy sectors reduced from 11% to 8% below market weight. We continue to rate APA Group highly and the company retains its narrow economic moat and Exemplary stewardship ratings. However, the current demand for yield investments has pushed the shares above our fair value estimate to the point where the expected returns are low and the shares are overvalued. Equity Country Exposure Portfolio Date: 31/03/2015 % Australia 95.3 New Zealand 4.7 Total 10 Equity Sectors (GICS) Portfolio Date: 31/03/2015 % Materials 6.3 Consumer Staples 10.3 Healthcare 3.8 Financials 49.4 Telecom Services 19.9 Utilities 10.4 Total 10

4 Performance Relative to Peer Group Peer Group (5-95%): All Managed Investments - Australia - Equity Australia Large Blend Return Risk-Reward Time Period: 1/08/2001 to 31/03/2015 Return Australian Shares - High Yield Std Dev S&P/ASX 200 TR High Yield Portfolio - Market Performance Time Period: 1/08/2001 to 31/03/2015 Up Period Percent Down Period Percent Best Month Top Quartile 2nd Quartile 3rd Quartile Bottom Quartile Worst Month Best Quarter Worst Quarter Up Capture Ratio Down Capture Ratio 3 Month CYTD 1 Year 3 Years (%p.a) 5 Years (%p.a) Since Incp (% p.a) Australian Shares - High Yield Inv Bmk Quarter Performance The 10.8% return achieved by the Australian Shares High Yield Portfolio in the March quarter was particularly strong, and well above long term equity market returns. The pleasing 0.7% outperformance of the benchmark S&P/ASX 200 Accumulation Index was driven by our underweight position in resources stocks which suffered from commodity price weakness. Longer-term performance is impressive at 22% compounded for three years, versus the benchmark return of 16%. The concentrated nature of the portfolio means holdings are often overweight the benchmark and good stock selection translates into index outperformance. Contributors Portfolio outperformance was, once again, driven by commodity price weakness and yield compression. Our lack of exposure to oil stocks including Santos, Origin Energy, Oil Search, and Woodside Petroleum were all key contributors to outperformance, as the oil price fell a further 14%. A lack of exposure to Fortescue Metals Group and Rio Tinto, were also key contributors as the iron ore price fell a further 26%. Longer term, we expect the iron ore price to remain low, whereas we expect oil price weakness will be cyclical. However, most oil stocks are not of sufficient quality for inclusion in the Income portfolio as many lack competitive advantage, bring commodity price risk and do not provide the stable, and preferably growing, income we seek. Portfolio holdings that helped outperformance included our overweight positions in APA Group, AMP and AGL Energy. All three stocks benefitted from good financial results during the February reporting season as well as yield compression among blue-chip stocks. Detractors Woolworths was the only portfolio holding with a negative return during the quarter, despite announcing record profit margins within its Australian food and liquor business with its interim result in February. The market remains concerned discount supermarkets Aldi and Costco will cause price deflation and operating deleverage for Woolworths, thereby causing profit margins to compress. We also forecast profit margin compression, but consider Woolworths to have sufficient headroom to remain an attractive investment. Spark New Zealand was the largest detractor from outperformance despite generating a positive return of 1.5% as the portfolio's weight is much larger than the index weight. The company reported a disappointing interim result in February with competition making revenue growth challenging. Other detractors from outperformance largely comprised stocks we didn't own that performed well, including Macquarie Group, Toll Holdings, and ResMed Inc. These stocks were excluded from the portfolio either because of a lack of economic moat or a relatively low dividend yield. Risk Time Period: 1/08/2001 to 31/03/2015 Return % pa Std Dev Downside Deviation Alpha Beta R2 Sharpe Ratio (arith) Tracking Error Inv Bmk

5 GICS Sector Weights Relative to Benchmark Financials Telecom Services Utilities Consumer Staples Materials Healthcare Industrials Energy Consumer Discretionary Technology GICS Industry Group Weights Relative to Benchmark Telecommunication Services Utilities Real Estate Food and Staples Retailing Health Care Equipment and Services Consumer Durables and Apparel Household and Personal Products Automobiles and Components Capital Goods Software and Services Media Retailing Food, Beverage and Tobacco Insurance Banks Consumer Services Commercial Services and Supplies Pharmaceuticals and Biotechnology Diversified Financials Transportation Energy Materials Australian Shares - High Yield S&P/ASX 200 TR Sector and Industry Weightings Analysis The Australian Shares High Yield Portfolio sector exposure remained little changed during the March quarter, though we increased our BHP Billiton holding, and resources exposure, to 6.5% of the portfolio in March. Banks, real estate, telecommunications and utilities represent 77% of the portfolio given their defensive characteristics that align well with the portfolio's objectives. Sector exposures reflect both our macroeconomic thesis and preference for high-quality and sustainable earnings. Earnings growth is likely to be lower than for companies in the Morningstar Growth Equities Portfolio, and more capital-intensive sectors such as materials and upstream energy will tend not to feature as they typically do not provide the sustainable yield required. The financial sector is our largest exposure, at about half of the portfolio, comprising 30% banks, 14% real estate and 3% diversified financials. The wide moat-rated "big four" banks are a good fit for the portfolio with medium fair value uncertainty ratings and highly regarded management teams. All, except National Australia Bank have Exemplary stewardship ratings. Grossed-up yields of near 7% are among the highest for moatrated stocks in the S&P/ASX 200 Index. The average price-to-fair-value ratio of 0.93 for the big four banks also appeals, both in an absolute sense and relative to the index at The telecommunications services sector remains the portfolio's second-largest sector weighting, at 19%, and the largest overweight position versus the benchmark's 6% weighting. Sector exposure comprises a 15% weight to Telstra Corporation and 5% weight to Spark New Zealand, formerly Telecom Corporation of New Zealand. Telstra has a net yield near 5%, grossed up to 7%, while Spark New Zealand offers a yield of 5.6% including supplementary dividends. They both have narrow economic moats stemming from low-cost advantages and long-established dominant positions in their domestic markets, enabling attractive and sustainable earnings and dividends. These attributes make them valuable portfolio holdings. Real estate is the third-largest sector exposure, with a 14% weighting versus a 7% benchmark weight. Real estate appeals to the Income portfolio given the relatively stable earnings streams and above-average yields. We prefer REITs with long-term leases and high-quality tenants, fixed or inflation-linked rent increases and low vacancy risk relative to the more volatile and less predictable developers. The portfolio owns BWP Trust and Scentre Group, which fit that bill. BWP Trust's earnings are secured by long-term leases to hardware powerhouse Bunnings. Scentre Group offers exposure to high-quality shopping malls which enjoy dominant positions in premium locations in Australia and New Zealand. Our second-largest overweight position is to the utilities sector, comprising 10% of the portfolio against a benchmark weight of just 1%. Utilities stocks are a core holding for many income portfolios and typically provide highly defensive earnings, high payout ratios and strong and stable dividends. The portfolio has only a 6.1% exposure to materials via diversified, high-quality and low-cost miner BHP Billiton, and very little exposure to upstream energy. The materials and energy sectors comprise 14% and 4% of the benchmark respectively so we're significantly underweight both. Resources producers are generally unsuited to the portfolio given their capital intensity and exposure to cyclical commodity prices, attributes which generally don't support stable yields. Our natural aversion to resources for this strategy means the portfolio is likely to outperform in resources bear markets

6 Returns Relative to Benchmark As of Date: 31/03/2015 Return month YTD 1 year 3 years 5 years Since inception* (31/07/2001) Australian Shares - High Yield S&P/ASX 200 TR Performance measures are expressed net of fees, but before costs and taxes are deducted. Dividends are reinvested in the portfolio. The performance displayed is for the Australian Shares High Yield Portfolio and represents modelled performance only. This performance will differ from actual performance depending on factors such as transaction timing and any divergence from constituent weightings. * Where inception date is not the beginning of a month, returns are calculated using a start date which is the first day of the month following inception. Selection Effects Time Period: 1/01/2015 to 31/03/2015 Underperform Outperform Relative Weight Overweight Underweight Relative Return Best Selections Investment Type Weight +/- Return +/- Effect 1 APA Group Stock Woodside Petroleum Ltd Stock Rio Tinto Ltd Stock Suncorp Group Ltd Stock Fortescue Metals Group Ltd Stock Santos Ltd Stock AMP Ltd Stock Oil Search Limited Stock CSL Ltd Stock Origin Energy Ltd Stock Insurance Australia Group Ltd Stock BlueScope Steel Ltd Stock Amcor Ltd Stock Alumina Ltd Stock Sonic Healthcare Ltd Stock Worst Selections Investment Type Weight +/- Return +/- Effect 1 Spark New Zealand Ltd Stock Aggreko PLC Stock Macquarie Group Ltd. Stock Charter Hall Retail REIT Stock Woolworths Ltd Stock BWP Trust Stock Telstra Corp Ltd Stock Toll Holdings Ltd Stock QBE Insurance Group Ltd Stock ResMed Inc DR Stock Qantas Airways Ltd Stock Newcrest Mining Ltd Stock Incitec Pivot Ltd Stock Iluka Resources Ltd Stock Henderson Group PLC DR Stock

7 Allocation Effects Time Period: 1/01/2015 to 31/03/2015 Relative Weight Underperform Outperform Overweight Underweight Relative Return Best Weighting Weight +/- Return +/- Effect 1 Energy Utilities Pharmaceuticals and Biotechnology Materials Capital Goods Worst Weighting Weight +/- Return +/- Effect 1 Diversified Financials Food and Staples Retailing Commercial Services and Supplies Transportation Consumer Services Cumulative Attribution Effects Time Period: 1/04/2014 to 31/03/2015 GICS Industry GroupCumulative Attribution Effects Cumulative Allocation Effect Cumulative Selection Effect Cumulative Active Return Attribution Effect % Attribution Effects Allocation Effect Selection Effect Active Return

8 Equity Sectors (GICS) Time Period: 1/04/2012 to 31/03/ / / / / / /2015 Energy % Materials % Industrials % Consumer Discretionary % Consumer Staples % Healthcare % Financials % Information Technology % Telecom Services % Utilities % Equity Style Valuation Time Period: 1/04/2012 to 31/03/ / / / / / /2015 Value % Core % Growth % Equity Market Capitalization Time Period: 1/04/2012 to 31/03/ / / / / / /2015 Giant % Large % Mid % Small % Micro %

9 Investment Methodology and Process Portfolio Mandate and Typical Positioning High Yield Portfolio Strategy The Australian Shares High Yield Portfolio is an actively managed concentrated portfolio consisting of our best income ideas in the S&P/ASX 200 Index. The Portfolio is constructed with a focus on long-term fundamental value and bias toward businesses with sustainable competitive advantages (economic moats) and predictable cash flows. Total return from the High Yield Portfolio will tend to be driven more by income than capital appreciation, although both are desirable. High Yield holdings have expected sustainable net yields greater than or equal to the benchmark using the estimates of our research team. In addition, coverage companies with above average dividend per share growth prospects over the next five years receive preference, all else equal. We may occasionally initiate a position with less than benchmark net dividend yield if the gross yield is greater than the benchmark s net yield, dividend per share growth prospects are well-above average, or to increase the portfolio's share of high quality (narrow or wide economic moat) companies. Dividend sustainability is a key consideration and is partially accounted for by not allowing Very High or Extreme uncertainty ratings into the Income Portfolio, as this reduces exposure to difficult to predict cash flows. Moreover, high uncertainty stocks are infrequently purchased. Sustainability is further tested by ensuring potential and current holdings can meet the above criteria with long-term normalised payout ratios. Preference is given to companies that can sustain unexpected shocks and still provide attractive yields. Investment Strategy Committee Process Australian Shares Portfolios are managed by their portfolio managers and Morningstar's eight-person investment strategy committee which comprises selected members of the equities research team. Committee meetings reinforce rigor and consistency of research methodology through collaborative debate on proposed and existing holdings. A constant feedback loop between Morningstar s research team and investment committee members leverages team strengths in vetting stock calls and portfolio holdings. This constant cycle strengthens team culture, expertise and ratings, minimising key-person risk and common behavioural pitfalls. The committee is experienced and well-resourced, ensuring stability and succession planning. Representation from each sector team ensures cross-market expertise. Committee members have average industry experience of 17 years and average tenure with Morningstar of 10 years. We are not averse to an occasional portfolio manager change, as the driving forces behind our portfolio construction process are our bottom-up research and investment committee overlay. In-depth research by our large, global, and experienced analyst team is the bedrock of our portfolio management process and facilitates our high conviction investments. We have more than 100 equity and credit analysts globally, covering around 1,700 stocks and 700 debt issuers, making us one of the largest independent research teams in the world. Our 20 Australian and New Zealand-based analysts cover about 230 Australian and New Zealand stocks which includes extensive research reports, timely event analysis, actionable special reports, and deep discounted cash flow modelling on every company. This is complimented by our local credit research to help us assess the complete capital structure and preserve capital while pursing upside opportunities. Investment Committee Feedback Loop

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13 Portfolio Overview An actively managed portfolio of Australian equities, focusing on companies trading at relatively attractive valuations with greater than average sustainable net yield expectations. Sector Specialist Managed Accounts Asset Allocation Return Objective Time Horizon Risk Profile Growth Assets % Defensive Assets % Australian Shares Core S&P/ASX 200 Accumulation Index 7 years High Australian Shares High Yield S&P/ASX 200 Accumulation Index 7 years High Australian Shares Small Cap S&P/ASX Small Ordinaries Accumulation Index 7 years Very high Property S&P/ASX 200 REITs Accumulation Index 5 years High Global Shares MSCI ACWI Accumulation Index (Net Dividends Reinvested) 7 years High Cash Bloomberg Australian Bond Bill Index 2 years Very low This document is issued by Ibbotson Associates Australia Limited (ABN , AFS Licence No ) ( Ibbotson ). Ibbotson is a member of the Morningstar group of companies ( Morningstar ) Morningstar, Inc. All rights reserved. In compiling this document, Ibbotson has relied on information and data supplied by Morningstar and other third party information providers. Whilst all reasonable care has been taken to ensure the accuracy of information provided, neither Ibbotson, Morningstar nor their third party information providers accept responsibility for any inaccuracy or for investment decisions or any other actions taken by any person on the basis or context of the information included. Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar or your adviser. Past performance is not a reliable indicator of future performance. Neither Ibbotson nor Morningstar guarantees the performance of any investment or the return of capital. The information provided is general advice only has been prepared without reference to an individual person s objectives, financial situation or particular needs. You should consider the advice in light of these matters and if applicable the relevant disclosure document before making any decision to invest. To obtain advice tailored to your situation, individuals should contact a professional financial adviser. For a copy of the relevant disclosure document, please contact our Distribution Team on Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004

14 Diversified Managed Accounts Asset Allocation Return Objective Time Horizon Risk Profile Growth Assets % Defensive CPI+ 0.75% Rolling 1 year Low Defensive Assets % Conservative CPI+ 1.0% Rolling 3 years Low to Medium Balanced CPI+ 2.5% Rolling 5 years Medium Growth CPI+ 3.5% Rolling 7 years Medium to High High Growth CPI+ 4.5% Rolling 9 years High High Growth Plus CPI+ 5.0% Rolling 10 years High 95 5 Diversified Income CPI+ 2.0% Rolling 4 years Medium This document is issued by Ibbotson Associates Australia Limited (ABN , AFS Licence No ) ( Ibbotson ). Ibbotson is a member of the Morningstar group of companies ( Morningstar ) Morningstar, Inc. All rights reserved. In compiling this document, Ibbotson has relied on information and data supplied by Morningstar and other third party information providers. Whilst all reasonable care has been taken to ensure the accuracy of information provided, neither Ibbotson, Morningstar nor their third party information providers accept responsibility for any inaccuracy or for investment decisions or any other actions taken by any person on the basis or context of the information included. Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar or your adviser. Past performance is not a reliable indicator of future performance. Neither Ibbotson nor Morningstar guarantees the performance of any investment or the return of capital. The information provided is general advice only has been prepared without reference to an individual person s objectives, financial situation or particular needs. You should consider the advice in light of these matters and if applicable the relevant disclosure document before making any decision to invest. To obtain advice tailored to your situation, individuals should contact a professional financial adviser. For a copy of the relevant disclosure document, please contact our Distribution Team on Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004