MLC Vanguard Share Index Fund March 2008 Annual Commentary

Transcription

1 March 2008 Annual Commentary Executive Summary: Share market conditions have been fragile for some months due to concerns the US sub-prime crisis would lead to lower US and global growth. Sentiment deteriorated in the March quarter as the US economic outlook and global credit market conditions worsened. All of this (and more) has unsettled global share markets, including the Australian share market. One year returns are now in negative territory for the first time since mid The -7% return by the S&P/ASX200 Accumulation Index in the year to 31 March 2008 reflects widespread share price weakness, with resource and energy stocks the most notable exceptions. However, while one year returns are in negative territory, longer term returns remain positive. The performed generally in line with its benchmark over the year, before the deduction of fees and taxes. Objective Your fund aims to provide long term growth that approximates the S&P/ASX 200 Index return with some tax advantaged income. The table below details how your fund performed up to 31 March 2008: FUND NAME 1 yr (%) 2 yrs 3 yrs 5 yrs 7 yrs 10 yrs MLC MasterKey Superannuation Vanguard MLC MasterKey Superannuation (Five Star) Vanguard MLC MasterKey Super Vanguard Australian Share Index Fund^ 14.4 N/Av N/Av N/Av N/Av N/Av MLC MasterKey Super Fundamentals Vanguard 14.9 N/Av N/Av N/Av N/Av N/Av MLC MasterKey Business Super Vanguard MLC MasterKey Allocated Pension Vanguard N/Av MLC MasterKey Allocated Pension (Five Star) Vanguard N/Av MLC MasterKey Term Allocated Pension Vanguard Australian Share Index Fund* N/Av MLC MasterKey Pension Vanguard Australian Share Index Fund ^ N/Av N/Av N/Av N/Av N/Av N/Av MLC MasterKey Pension Fundamentals Vanguard Australian Share Index Fund ^ N/Av N/Av N/Av N/Av N/Av N/Av MLC MasterKey Unit Trust Vanguard Australian Share Index Fund (including MLC MasterKey Investment Service)* N/Av: Returns for this period are not available, because the fund has not existed for this period of time. ^Returns are after management fees and taxes *Returns are after management fees and before tax

2 Your fund is invested across a portfolio of Australian shares that broadly matches the S&P/ASX200 Index. The diagram below shows the allocation of your Vanguard Share Index Fund.

3 Market Commentary The chart below shows the performance of the major asset classes over the March quarter and the year to March in Australian Dollar terms. Emerging markets For share investors, a quarter (and a year) to forget Global bonds Cash Aust bonds Aust shares Global shares Aust. REITs Global REITs Year Quarter Returns in $A (%) Overall returns for diversified funds were sharply negative for the quarter and negative over the year to March the first such annual decline for around five years. Real Estate Investment Trusts (REITs) posted another poor quarter after what was a dismal end to World sharemarkets remained under considerable selling pressure during much of the quarter, but regained some lost ground towards the end of March. The sharp falls in Australian and world sharemarkets during July and August 2007 proved to be short-lived, with share prices regaining much, and in some cases all, of the lost ground from mid-august through to the end of September. However, share prices resumed their decline during the latter stages of This is shown very clearly on the chart below, which plots the movement of some key global share indices since the end of June last year. By the end of March 2008, the world s major share price indices had fallen between 16% and 31% from the highs they reached during the second half of World share prices since the end of June 2007 End June 2007 equals Jun-07 Aug-07 Oct-07 Dec-07 Feb-08 Australia US Japan UK Euro-area EMEs Hedged global bonds were the best performing asset class over both the March quarter and the year to March. Government bonds were the star performers within the sector as corporate credits (particularly high yield corporates) lagged behind on concerns over credit quality. The Australian bond market ran against this global trend, with yields rising over the past year. The Reserve Bank of Australia raised official interest rates on four occasions. Official cash rates in Australia now stand at 7.25%, their highest level in over ten years. So what caused sharemarkets to drop? The falls seen in July and August were the result of the sub-prime mortgage crisis in the United States. The root cause lay in some of the riskier securities traded in US fixed income markets. Mortgage-backed securities, based on residential mortgages, have been around for a long time. However, over the last few years, home lenders have been increasingly willing to lend money to sub-prime borrowers, who may have either little in the way of a deposit, or reasonable credit history, or even ability to repay loans. While traditional US mortgages have tended to have fixed interest rates, many of these sub-prime mortgages have been sold with variable interest rates. Increasingly, these kinds of mortgages have been packaged-up and sold to investors. When US interest rates rose, a number of these borrowers defaulted on their loans. This in turn depressed the prices of these mortgage-backed securities. In addition to problems facing home borrowers, it is now clear that a number of investors in these securities either failed to understand, or failed to adequately price, the risk attached to them. In doing so, they were prepared to buy these securities and accept a yield that was simply way too low. In the case of some highprofile hedge funds that have gotten into difficulty, the problem has been compounded by borrowing money to invest in these securities. Investors became increasingly concerned about the possible impact of the US housing downturn on the US and global economies. Along with this, the uncertainty over just who has exposure to sub-prime loans and in what size has made it harder for even high quality institutions to obtain funds from the money markets. All of this unsettled global sharemarkets, and the Australian sharemarket was not immune. In mid-august, Australian and some world share prices bounced back sharply. Aggressive action by the world s central banks, led by the European Central Bank and the US Federal Reserve restored some measure of calm to money markets. However, over the remainder of 2007, and for most of the March quarter, it became

4 clear that the effects of the crisis on the economy and financial markets were likely to be more prolonged than earlier thought. Conditions in US money markets have (if anything) worsened despite the Fed increasing its efforts to inject liquidity. In March, the crisis claimed perhaps its largest scalp with the collapse of US investment bank Bear Sterns, and its subsequent Fedassisted takeover by JP Morgan. Economy Despite the best efforts of the US Federal Reserve, it is now highly likely that the US economy has fallen into recession. Housing indicators have generally continued to worsen. Residential building activity has now declined for eight consecutive quarters. House prices are still declining. Measures of business and consumer sentiment are either at or close to recession levels, and the unemployment rate has continued to drift higher. However, signs of weakness in consumer spending, and other categories of demand have only recently started to appear, and seem to have much further to run. Elsewhere, economic indicators in Europe and Japan have also taken a turn for the worse. While there are certain to be relative winners and losers in the current environment, no economy is likely to be totally immune from the effects of what is clearly a global financial crisis. Sentiment survey data in Europe, the UK and Japan, as well as key leading economic indicators, have already turned down signalling the likelihood of weaker growth ahead. Across Asia, the more open economies of South East Asia are likely to be hardest hit by a US recession. Much of their exports are ultimately dependant on US consumer and business demand a good percentage of those exports are intermediate goods and components that are funnelled via China to customers in the major economies. The Chinese economy is likely to be a relative winner in the current environment. While China s export growth is likely to slow significantly (and there are early signs of this occurring) domestic spending is not likely to slow dramatically, despite efforts by the Chinese authorities to tighten monetary policy settings over the past year. In Australia, economic growth has accelerated over the past year, fuelled by strong growth in business investment and a resurgent consumer. Employment growth has remained very strong, and the unemployment rate declined further. These developments did little to assuage the Reserve Bank s concerns about inflationary pressures in the economy, at a time when the RBA s preferred measures of inflation had already drifted towards the upper end of their target range. More recently, these inflation measures have moved significantly above the Bank s ceiling Consumer prices y/y% - average of RBA's preferred measures Q Q Q Q Q As a consequence, the RBA went against offshore trends by tightening monetary policy over the past year. In the Bank s most recent statements, they have noted that tighter credit conditions in global and domestic money markets have acted as a de-facto tightening in monetary conditions, and that there are signs of a slowdown in domestic spending. Retail sales have declined modestly in recent months. Consumer confidence has fallen sharply, while business surveys show that both overall trading conditions and confidence have eased. While the RBA still has a bias to tighten further, a deteriorating global environment, as well as the fact that Australian interest rates are already at reasonably high levels (at least by the standards of the past decade) should encourage the Bank to keep rates on hold over the coming months. Strategy Commentary Global market conditions deteriorated during the March quarter and short-term returns have subsequently moderated. While sentiment has been fragile for some months, as investors came to accept (albeit slowly) that the US sub-prime crisis has serious global ramifications, recent economic data suggesting the US was close to (or already in) recession has raised investor concerns. In addition to the economic challenges in the US, the contraction in the availability of credit globally and the upward re-pricing of the credit that remains accessible have led to a downgrade in global growth expectations, and an associated reduction in forecast corporate earnings. In addition, local factors such as the upward trend in Australia s rate of inflation, which has forced the Reserve Bank to raise the cash rate on four occasions since August 2007, has led market participants to conclude that the best news on earnings growth is probably behind us. In response to these market and economic difficulties, the Australian share market has weakened and the volatility of returns has increased. After reaching an alltime high early in November 2007, the Australian share

5 market has recorded negative monthly returns for five consecutive months. The market was particularly weak in the March quarter with the S&P/ASX200 Accumulation Index falling by -14%. One year returns were also adversely impacted with the -7% return for the year to 31 March 2008 the first instance of negative one year returns by the Australian share market since June The global credit market contraction and weaker economic growth outlook has had a more pronounced impact on some market sectors than others. The Consumer Discretionary Index was the worst performer over the year, declining by -24% due to investor concerns that an economic slowdown and higher domestic interest rates would hit consumers and their discretionary spending. Share prices of retailers such as David Jones (-20%) and Harvey Norman (-17%) were subsequently marked down. In contrast, retailers such as Woolworths (7%) who sell consumer staples (food, groceries) and producers of beverages such as Lion Nathan (-1%) were treated less harshly. The impact of tighter credit markets and the associated challenges faced by companies and trusts to refinance existing short-term debt commitments was reflected in the -23% return by the Listed Property Index in the year to 31 March. The collapse of Centro Properties (-96%) and Centro Retail s (-80%) unit prices late in 2007 had a contagion effect with investors, perhaps indiscriminately, marking down other listed property trust prices, irrespective of their debt profile. For example, Macquarie Countrywide fell by -43% and Valad Property Group by -50%, making Westfield Group s -13% fall appear comparatively mild. Financial stocks were also weaker as deteriorating credit market conditions and higher borrowing costs have led some market participants to question the banks profit outlook. All five of the major banks underperformed the market index with St George Bank (-27%) the worst performer and Westpac (-10%) the best. Insurance stocks were also weak with AMP falling -21% and Insurance Australia down by -37%. Resource companies continue to dominate the performance stakes. Expectations of significantly higher contract prices for bulk commodities such as iron ore and coal and continued demand by China helped the resource majors BHP Billiton and Rio Tinto to rise by 20% and 55% respectively. Fortescue Metals price performance continues to astonish, rising by 222% over the year despite not having commenced iron ore extraction from their mines. The Energy Index was also strong, increasing by 16% as oil prices pushed through US$100 per barrel. Santos and Woodside Petroleum were beneficiaries, rising by 43% and 38% respectively. The escalating price of gold contributed to Newcrest Mining s 52% share price performance. Aside from the Materials and Energy sectors, Healthcare was the only other sector of note performance wise, rising by 9% over the year. However, this was due largely to CSL which increased by 34% compared to Sonic Healthcare (-7%) and Resmed (-28%) who lost ground. Where to from here? Clearly, the global macroeconomic outlook has deteriorated due to the US sub-prime crisis, the credit market contraction and the economic slowdown in the US. While it could be argued that the strength of the resources sector may help cushion the Australian economy, the Reserve Bank is clearly determined to slow the economy in order to bring inflation under control. All of this suggests that the outlook is less buoyant and less certain than the environment we have been in for some years, which suggests that returns will be lower than those of the last five years. However, it is important to put the current and prospective returns environment into perspective: While the -7% one year market return to 31 March may be disappointing, investors have (until recently) benefited from a strongly positive market cycle and an extended period of double digit returns. Most investors who have been accumulating retirement savings or are already retired and have invested part or all of their retirement portfolio in Australian shares have benefited from this strong return environment. Longer term returns are still strongly positive, despite the negative result for the last year. In the three and five years to 31 March, the Australian sharemarket has increased by 14% per annum and 18% per annum (respectively). This means someone who invested $100,000 in Australian shares on 31 March 2003 and received index like returns for the five years to 31 March 2008 would have seen their portfolio (gross) value rise to $228,776. Investment returns do fluctuate through time. Periods of both positive and negative returns are normal and should be expected when investing. Vanguard passively manages a portfolio of approximately 200 stocks on behalf of MLC using its optimised replication technique. This strategy is designed to replicate the performance of the S&P/ASX200 Index, achieving very broad diversification with low turnover, reducing the impact of transaction

6 costs and taxation. Purchases and sales of stock only occur in response to changes to the Index and as a consequence of cash flows. The performed generally in line with its benchmark over the year, before the deduction of fees and taxes. Disclaimer: Please note that all figures reported in this fund commentary are before management fees and taxes, unless otherwise mentioned. Any advice in this communication has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on any advice in this communication, consider whether it is appropriate to your objectives, financial situation and needs. You should obtain a Product Disclosure Statement or other disclosure document relating to any financial product issued by MLC Investments Limited ABN and MLC Limited ABN and consider it before making any decision about whether to acquire or continue to hold the product. A copy of the Product Disclosure Statement or other disclosure document is available upon request by phoning the MLC call centre on or on our website at An investment in any product offered by a member company of the National group does not represent a deposit with or a liability of the National Australia Bank Limited ABN or other member company of the National Australia Bank group of companies and is subject to investment risk including possible delays in repayment and loss or income and capital invested. None of the National Australia Bank Limited, MLC Limited, MLC Investments Limited or other member company in the National Australia Bank group of companies guarantees the capital value, payment of income or performance of any financial product referred to in this publication.