SPDR S&P/ASX 200 Fund

Transcription

1 Analyst(s): Rodney Lay, Tom Mills SPDR S&P/ASX 200 Fund Standard & Poor s View Standard & Poor's Fund Services has rated the SPDR S&P/ASX 200 Fund (the fund or STW) 'VERY STRONG'. This is based on the view that the fund provides effective, efficient, and inexpensive exposure to the benchmark S&P/ASX 200 Accumulation Index. The fund seeks to closely track, before fees and expenses, the returns of the benchmark. Consistent with this objective, STW is based on a full-replication portfolio-construction method, with the fund holding each of the 200 constituents stocks of the benchmark at market weight. The fund is issued and managed by State Street Global Advisors Australia Ltd. (SSgA). STW is a highly transparent and a relatively simple investment vehicle on account of its transparent portfolio-construction method. In addition to holding all 200 stocks, index changes are implemented on the day the changes take effect in the benchmark, and the manager does not take active risks with the objective of generating incremental revenue or alpha. Total costs are relatively low, partly due to the transactional efficiency of trading the fund on account of a deep and highly liquid secondary market, but we note that the competitiveness of the MER has declined relative to the fund's four most comparable ETFs (ranging from 0.15% to 0.24%). We will continue to monitor the situation. STW has proven to be a tax-efficient investment vehicle, especially when compared to the alternative investment option of index-tracking managed funds. However, the relative lack of redemption activity in the primary market has, in the past, created embedded capital gains and led to high capital gains distribution amounts in some half-year periods. The risks associated with embedded capital gains are likely to persist while units on issue continue to grow, and assuming equities markets increase over the longer term. STW's historical performance is true to its index-tracking style. Tracking error is low, averaging around 0.1% since inception, and the fund underperformed the benchmark by an amount largely attributable to its MER. S&P believes STW provides a strong value proposition for investors seeking beta exposure to the benchmark. It is cost efficient, performs in a manner true to style, and is highly transparent. It may also represent a relatively more tax-efficient investment vehicle than alternative indextracking investment vehicles; in a comparative sense, it may generate superior after-tax returns for investors with anything other than a zero percent marginal tax rate. Investor Suitability A precondition is the investor seeks a broad exposure to the Australian share market, with the fund's portfolio representing approximately 85% of the total Australian equities market. Investors who seek to diversify a broader portfolio or a long-term investment vehicle with a time horizon of at least five years. Taxation treatment of an ETF is a key differentiating factor and one that investors should consider if deciding between an ETF or an index-tracking fund. This is a "core and satellite" option with regards to portfolio construction, with the core component being the fund. Short term, the fund may be suitable for investors switching back into equities or to temporarily or indefinitely equitise a cash holding. Key Strengths It is a tax-efficient investment vehicle with very low realised capital gains tax (CGT) events, partly due to low portfolio turnover. Despite a less-competitive MER, the fund remains cost efficient with low internal brokerage costs, bid/ask spreads, and premium/discount to net asset value (NAV). Historical performance is very true to style, with very low tracking error and relative underperformance largely attributable to the MER. Structural strengths include a very liquid secondary market, a transparent and simple portfolio-construction method, and a futures contract with very low basis/tracking error risk. Portfolio construction provides a balance between cost minimisation and tracking error minimisation. Key Weaknesses The relative competitiveness of the fund's MER has deteriorated with directly comparable ETFs now charging lower MERs. Historically, the lower level of redemption activity compared to creation activity has created taxation efficiency risks that stem from embedded capital gains. On a pre-tax basis, the fund may continue to marginally underperform some index-tracking managed funds. This is not a poor reflection on the manager; rather that it intentionally limits use of value-adding strategies to capture incremental returns. Risks The portfolio holds 200 stocks, but there is a high degree of both stock and sector concentration risk. A higher degree of index changes and corporate actions may lead to higher portfolio turnover and increase tax in efficiency risks. Sector: Exchange-traded funds ASX Code: STW Investment Manager: State Street Global Advisors Australia, Limited. ETF Holdings: 200 Benchmark: S&P/ASX 200 Accumulation Index MER (%): 0.29 Inception Date: August 2001 Distributions: Half-yearly (June, December) Size (A$ mil.): 2,000 Release Authorised by: Leanne Milton The contents of this report are subject to the terms of the disclaimer on the final page. EXCHANGE-TRADED FUND Feb. 22, 2012 Page 1

2 Product Overview STW is structured as an Australian managed-investment scheme, with investor interests protected by the Corporations Act. STW is listed on the Australian Securities Exchange (ticker: STW) and can be traded like any other listed security. The underlying assets of the ETF, that is the constituent stocks, are held in custody by the Hongkong and Shanghai Banking Corporation (HSBC). There is no counterparty risk to SSgA. In the unlikely event the fund is wound up, the underlying securities will be divested and the proceeds distributed pro rata to all unit holders. SSgA has appointed Citigroup Global Markets Australia Pty Ltd. (CGMA) as a market maker and authorised participant (AP). CGMA is required to make a market in the fund and to continuously quote prices for the units. The appointment of an AP creates a "guaranteed" arbitrage mechanism in the primary market for those participating in the creation/redemption process. This "guarantee" also facilitates arbitrage volumes in the secondary market, which is an important determinant in minimising costs to investors in the form of the bid/ask spread and the premium/discount to NAV. Returns to investors consist of semi-annual distributions and capital gains/losses on the sale of units in the secondary market. All benefits associated with the underlying stocks flow through to investors, including dividends, franking credits, dividend reinvestment plan (DRP) discounts, and bonus and rights issues. STW was issued in August 2001 by the Australian subsidiary of SSgA, which is one of the largest global issuers of ETFs. The fund has grown to a market capitalisation of A$2.04 billion, as of November 2011, representing the largest ASX-listed ETF. STW is the only ASX-listed ETF that replicates the S&P/ASX 200 Index. Low High Income return Capital return Cost Manager experience Fees And Costs Investors in ETFs incur both direct and indirect costs comprising: A management expense ratio (MER); A bid/ask spread when buying and selling units; A potential premium/discount to NAV when buying and selling units; Portfolio transaction costs associated with turnover in the underlying constituent stocks which are captured in the NAV of the ETF. The costs are tabled below, with the bid/ask and discount/premium based on historical averages. Overall, STW is a very low-cost investment vehicle relative to both ETF and index-tracking managed fund averages. Fees And Costs Cost Amount (%) MER 0.29 Bid/ask 0.02 / 0.02 Premium/discount to NAV 0.00 Ex post total costs 0.31 MER The competitiveness of the fund's MER has declined relative to the fund's four most comparable ETFs (ranging from 0.15% to 0.24%). This is a situation we will continue to monitor. Bid/Ask Spread The bid/ask spread is an indirect cost borne by investors. The level of the bid/ask spread is a function of market liquidity in the ETF units. Primary market liquidity is inversely related to arbitrage risk which, in turn, is determined by the liquidity of the underlying securities, the availability of matching futures, and whether the underlying securities trade during or out of ASX trading hours. Secondary market liquidity is generally determined by FUM. Typically the bid/ask spread is generally lower for domestic, fullreplication ETFs with significant FUM. Conversely, international ETFs, where primary, secondary, and underlying liquidity are all lower, are generally characterised by wider spreads. These generalisations hold for STW. Sufficient liquidity in the constituent stocks and significant secondary market activity all generate a very low bid/ask spread. Based on a snapshot of intra-day trading and ASX data, the bid/ask spread of STW is around the 0.05% to 0.06% level, representing the lowest ETF bid/ask spread in the domestic market and materially below its broad market Australian equities ETF peers. We note that this ETF segment has average bid/ask spreads ranging from around 0.13% to 0.2%. Premium/Discount To NAV The following chart illustrates the monthly premium/discount to NAV performance of STW since inception. The figures are negligible, averaging around the one basis point (bp) level. This is a result of efficient primary and secondary arbitrage market, sufficient liquidity in the underlying stocks, and the fact that STW does not trade "out of hours". Portfolio Turnover Transaction Costs Portfolio turnover generates transaction costs such as brokerage, custody costs, and potential impact costs. These are indirect costs that detract from NAV. Turnover is a function of index-rebalancing, portfolio-construction optimisation techniques, and cash flow management associated with dividend flows and distribution payments. STW's portfolio turnover has been low, averaging 8% per year over the past five years. Of this, around 3% is attributable to index rebalancing with the residual due to cash flow management. The low turnover has limited trading costs but the manager also uses both internal and external crossing networks when the opportunity is available to further limit costs. When trading externally, SSgA's brokers offer competitive brokerage rates. Additionally, a limited use of futuresbacked cash position to equitise small amounts of cash is an important tool in transaction-cost minimisation. Portfolio Composition The portfolio is based on a full-replication construction method, comprising all 200 securities in the benchmark. Index changes are implemented on the same day as the index. As such, active weight positions by stock and sector are negligible. The contents of this report are subject to the terms of the disclaimer on the final page. EXCHANGE-TRADED FUND Feb. 22, 2012 Page 2

3 The futures-backed cash holding is typically around 1% and will not exceed 2%. Basis/tracking error risk of the futures position is very low given the contract tracks the benchmark. While the portfolio holds 200 stocks, the Australian equities market is relatively concentrated, both in terms of the top 10 stocks (51.6% of the total fund) and sector (62.6% in financials and materials). Concentration risk is material. Top 10 Holdings (January 2012) Security % of Portfolio BHP Billiton 11.7 Commonwealth Bank of Australia 7.8 Westpac Banking Corp. 6.3 Australia and New Zealand Banking Group 5.5 National Bank of Australia 5.2 Telstra Corp. 4.0 Wesfarmers 3.4 Woolworths 2.9 Rio Tinto 2.9 Newcrest Mining 2.5 TOTAL 52.3 Exposure By Sector (January 2012) Sector % of Portfolio Financials 32.0 Materials 26.1 Consumer Staples 7.8 Energy 7.3 Industrials 7.0 Property Trusts 6.3 Consumer Discretionary 3.6 Health Care 3.4 Telecommunication Services 4.3 Utilities 1.6 Information Technology 0.6 TOTAL Portfolio Construction And Management The objective of the full-replication investment process is to match the benchmark's performance as closely as possible. This leads to a very simple and transparent portfolio construction and management process. Given the underlying liquidity of the constituent stocks of the index, there is a lesser degree of importance on how the manager seeks to optimise the balance between minimising transaction costs and minimising tracking error (TE) risk compared to some other ETFs. Additionally, unlike most index-tracking managed funds, the manager does not seek to generate alpha through various value-add techniques. Treatment Of Index Changes The manager implements index changes on the day they take effect in the benchmark. Given the fund's mandate and that investors can short it, the manager does not take on active risk by implementing changes either pre or post the day of the index change or going marginally underweight or at weight stock positions. It is worth noting that an anti-index effect is evident in recent years. Rebalancing on the day the index changes may therefore not adversely impact performance relative to an index-tracking manager that may have the flexibility to adopt active risks in relation to the timing of implementing portfolio changes. Implementing index changes on one day only may generate market impact costs. However, SSgA adopts practices to mitigate these risks. Where possible SSgA uses its internal liquidity, looking for opportunities to cross with other funds managed, which avoids both market impact and brokerage. Traders manage the trades that go to market, looking for external pools of liquidity or external crossing opportunities. They will also manage market trades on a participation basis, ensuring any market impact is kept to a minimum. Dialogue between traders and portfolio managers is ongoing so that any executions that could cause market impact are discussed and managed. Cash Flow Management Cash flows are a function of the receipt of distributions from constituent stocks and the payment of those distributions and any realised capital gains to unit holders. SSgA manages the process with an eye to achieving a balance between minimising tracking error, by reinvesting cash received into physical holdings of the index, and minimising transaction costs, by equitising the cash into futures rather than physical stocks. The manager will typically hold around a 1% futures-backed cash position. This level may build leading up to the distribution payment period but will not exceed 2% of the portfolio. Cash is allowed to build to a level sufficient to execute a cost-effective trade. The determination of the futures-backed cash holding amount is more about the need for cash flow, rather than the "science" of determining precisely the optimal level. However, with minimal basis risk inherent in the futures contract any potential for improved performance is probably negligible. Revenue Generation SSgA ceased securities lending in 2009 to allay retail investor concerns. Prior to this, the process generated incremental revenue of approximately 0.05% per year. The loss of potential revenue is, therefore, immaterial. In our view, stopping what was a prudent securities lending program is not a major negative factor. Risk Management The primary consideration in managing portfolio risk is tracking error. The official tracking error limit is 50 bps, but the portfolio is internally managed to an ex ante level of around 0.05%. Given an ex post measure will typically exceed the ex ante, the average historical level of around 0.1%, (excluding the global financial crisis or GFC period) indicates the manager has been successful in managing risk. The contents of this report are subject to the terms of the disclaimer on the final page. EXCHANGE-TRADED FUND Feb. 22, 2012 Page 3

4 The spike in tracking error during the GFC can be mainly attributed to the large capital issuance during this period, rather than indicating potential shortfalls in the risk-management process. Rolling 12-month Tracking Error (November 2011) Tracking Error 0.15% 0.10% 0.05% 0.00% Tax Event Efficiency Rolling 12-month TE Year S&P considers tax efficiency as a key differentiating feature of an ETF compared to the alternative investment vehicle; index-tracking managed funds. It is therefore an important component to an overall rating. One of the key purported benefits of an ETF is the potential for relative tax efficiency due to the creation/redemption process underpinning an ETF. For any ETF, the actual tax efficiency will be primarily a function of the level of redemption activity compared to creation activity, internal portfolio turnover; tax lot management, and whether the share parcels realised through portfolio turnover were acquired more or less than 12 months ago. STW's potential tax efficiency in relation to internal portfolio turnover is high given the low degree of turnover (8% per year over the past five years). This, in turn, is partly driven by the low turnover of the benchmark (an average of around 3% over the past five years). In relation to tax-lot management, SSgA uses a FIFO (first-in firstout) method in the creation/redemption process. This may be beneficial in one respect but disadvantageous in another. The benefit of FIFO is that it increases the likelihood that the share parcels realised due to portfolio turnover have been acquired more than 12 months ago. The capital gains distribution component is therefore eligible for the CGT discount in the hands of the investor. The disadvantage is that the use of the alternative LIFO (lowest-in first-out) method in the creation/redemption process is likely, in a rising market, to generate a lower capital return and therefore a lower capital return distribution amount. The degree of tax inefficiency that has crept into STW is largely due to the fact that the level of redemption activity has been less than the level of creation activity. In this case, the full tax-efficiency potential of an ETF is not being realised. S&P notes that during the GFC, share parcels were being realised (due to internal portfolio turnover) that were acquired as far back as 2003 and, on account of the significant bull market, had very large embedded capital gains. This highlights the inherent risk of a mismatch between the level of creation and that of redemption activity. The relatively low degree of redemption activity is partly evident in the following chart, which illustrates the historical half-yearly distribution profile. It distinguishes the distribution of dividend income, as received from the constituent stocks, and the distribution of realised capital gains, as generated by internal portfolio turnover. There have been periods in which material capital distributions have been made, reaching 4.7% in the 12-month period to December STW Distribution Composition (December 2011) 6-monthly Yield (%) H03 1H04 1H05 1H06 1H07 1H08 1H09 1H10 1H11 Income Distribution Capital Distribution Year Whether the capital distribution generates a poor after-tax outcome for investors depends on whether the share parcels being turned over are more or less than 12 months old. The following chart breaks down the capital distribution component into what was subject to the CGT discount and what was not. Since inception, 90% of the total capital distribution amounts were eligible for the discount. Only in the earlier years, where the degree of stock held for less than 12 months was relatively high, has there been a material component not eligible for the discount. So, while the relative lack of redemption activity has created embedded capital gains and the risk of tax inefficiency, the very low portfolio turnover combined with the FIFO method have served to ensure the risk has largely not materialised. Discounted Capital Gains Distribution Profile (November 2011) Capital Gains Distribution per Unit ($) Discounted Component Non Discounted Component Another component of tax efficiency is franking credits. As a predominantly Australian-equities large-capitalisation investment vehicle, the general level of historical franking has been high, averaging around 70% over the past 10-year period. The contents of this report are subject to the terms of the disclaimer on the final page. EXCHANGE-TRADED FUND Feb. 22, 2012 Page 4

5 Peer Comparison For the purpose of conducting a comparative analysis, S&P has selected three index-tracking managed funds which track either the same benchmark as STW (Vanguard Index Australian Shares Fund) or the S&P/ASX 300 Accumulation Index (BlackRock Indexed Australian Equity Fund and CFS Wholesale Industrial - Australian Share Fund). The following table details the historical performance of each vehicle relative to their relevant index up to November Performance has been comparable, with the slightly higher performance of the indextracking managed funds reflecting the alpha component of their performance objectives. However, with the alpha component and the representative sampling of the S&P/ASX 300 Accumulation Index tracking funds, tracking errors are higher, but not to such a degree that it is inconsistent with their respective mandates. STW's performance is true to style, and the relative underperformance (-0.3% over five years) largely reflects the MER. The tracking error is particularly low. Investors should note that given STW's complete lack of alpha component, the ETF may underperform its managed fund cousins, albeit very marginally. Comparative Performance Relative To Benchmark (net of fees) ETF/Managed Fund 1 year 3 year 5 year TE SPDF S&P/ASX 200 Fund -0.4% -0.5% -0.3% 0.12% Vanguard Aust Shares Index Fund -0.3% -0.3% -0.2% 0.74% BlackRock Indexed Aust Equity Fund -0.2% -0.1% -0.1% 1.20% CFS WS Ind Aust'n Share Fund -0.3% -0.2% -0.1% 1.03% Source: S&P Fund Services. However, on a post tax basis, ETF investors may record higher returns. The following chart illustrates the historical distribution profile of the four. Two of the managed funds recorded material distributions over several years. The distributions were generated by a realisation of embedded capital gains which, in turn, was a consequence of large redemption requests from one or several institutional investors. For investors with anything other than a zero marginal tax rate, this may lead to relatively lower after-tax returns if a component of those returns is not eligible for the 50% CGT discount. Distribution Yield Comparative Analysis (November 2011) 25% 20% 15% 10% 5% 0% Jul-02 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 BlackRock CFS Vanguard STW Jul-10 Jul-11 The outcome graphically highlights how unit trust investors are subject to the trading activities of other investors. These risks are heightened when the unit holding is concentrated. Given their alpha component and marginal outperformance, a zero marginal tax rate investor may conclude that it may be advantageous to be invested in an index-tracking managed fund rather than an ETF. Investors should consider that access to such investments may be through a platform and that fees are incurred. Performance Ex ante tracking error was discussed above, with STW consistently tracking its benchmark. With respect to distributions, the income component has been relatively stable and, as expected, marginally below the S&P/ASX 200 Index, ranging from approximately 3.5% to 4% per year. Investors should note that the level of income will likely remain below the benchmark for several reasons. First, the distribution income received from STW is net of fees and expenses, while the indicative yield on the benchmark does not reflect any fees or expenses. Second, cents per unit (CPU) distributions are based on the number of units at the end of the distribution period. CPU distributions will be lower if new parcels of units are issued close to the end of the period. Similarly, CPU distributions will be higher if parcels of units are redeemed close to the end of the period. Neither affects total return, only the component represented by distributions as opposed to capital appreciation. Historical Performance (November 2011) Index Income Distribution (RHS) SPDR S&P/ASX 200 Fund (TR) Risk/Return Metrics (November 2011) Capital Distribution (RHS) S&P/ASX 200 Acc. Index Metric 1 Year 3 Year 5 Year Incept. Total returns -6.4% 7.5% -1.7% 6.3% Price returns -10.2% 3.2% -6.4% 1.8% Income returns 3.8% 4.5% 5.7% 4.5% S&P/ASX 200 Acc. Index -6.0% 8.0% -1.3% 6.7% Relative performance -0.4% -0.5% -0.3% -0.4% Standard deviation 12.1% 15.0% 16.1% 13.5% Tracking error 0.15% Source: S&P Fund Services. 8% 7% 6% 5% 4% 3% 2% 1% 0% Distribution Yield The contents of this report are subject to the terms of the disclaimer on the final page. EXCHANGE-TRADED FUND Feb. 22, 2012 Page 5

6 Management Group Profile SSgA is the investment-management arm of State Street Corporation. Founded in 1792, State Street is a major provider of services to global investors. State Street's shares are traded on the New York Stock Exchange. SSgA is the second largest manager of ETFs with US$257.6 billion in U.S. ETF assets and US$274 billion in total global ETF assets. Globally, SSgA offers 140+ SPDR ETFs in a variety of asset classes and is the provider of the world's two largest ETFs, the SPDR S&P 500 and the SPDR Gold Shares. It is also one of the largest institutional fund-management companies in the world with US$1.87 trillion in assets under management as of 31 Dec Team STW uses rules-based methodology and systems developed by SSgA globally. By the very nature and the size of SSgA, so-called key person risk is extremely low for such a product. However, S&P considers several members of the Australian team to be important in a number of respects, including the general education of the investment market about the product and ETFs in general. Overall, S&P has a very high regard for the local SSgA team. They are long-standing participants in the domestic market and exhibit a strong knowledge of the issues pertaining to ETFs in the domestic market, as would be expected. Graham Smith is a vice-president of State Street Global Advisors Australia Ltd. He joined in July 2004 as a manager in the business development team. His responsibilities include developing new business opportunities for SSgA's exchange-traded funds and fostering strong relationships with master trusts and wrap account providers. Mr. Smith is well-known and well-regarded in the investment markets for his ETF knowledge. Prior to joining SSgA, Mr. Smith worked for a hedge fund for two years as distribution executive for Australian and New Zealand markets, focusing on sales to financial institutions and financial planners located in Australia and throughout Asia. Having previously worked for JP Morgan, Chase Manhattan, and Ord Minnett, he has over 13 years' experience in global financial markets across a wide range of product specialties, including managed funds, equities, fixed income, currency, futures, hedge funds, and credit. Mr. Smith has a business degree majoring in accounting from Charles Sturt University and a graduate diploma from the Securities Institute of Australia. Jonathan Shead is head of product engineering for the Asia-Pacific region. He joined State Street Global Advisors Australia Ltd. in August 2000 as a product engineer. His role is to assist in the development, marketing, and maintenance of a range of investment strategies with a particular focus on passive currency and passive equities. Mr. Shead is also a director of State Street Global Advisors Australia Services Ltd. which acts as trustee for a range of Australian unit trusts Prior to joining SSgA, Mr. Shead worked as a senior asset consultant and superannuation actuary at NSP Buck Pty Ltd. He has an economics degree from Macquarie University, and he is a fellow of the Institute of Actuaries of Australia. Susan Darroch is a vice-president of State Street Global Advisors Australia Ltd., and since 2001 has been head of the global structured products group in Australia. In 2008 she became the head for the Asia- Pacific ex Japan region. Mrs. Darroch manages a team responsible for both domestic and international equity funds under a number of strategies, including full-replication, wealth-weighted, shadow, and taxaware portfolio management. Prior to joining SSgA in 1999, Mrs. Darroch worked for Commonwealth Fund Services (CFS) for four years in the quantitative applications area managing indexed equity portfolios, and in the fixed interest team managing indexed fixed interest portfolios. Before joining CFS, she spent over eight years working in money markets and in treasury, both in Australia and London. Three of those years were spent working for Rothschild Australia Ltd. as a money market dealer. Prior to this, she gained experience working in different areas of banking and finance. Mrs. Darroch received an economics degree from Macquarie University. She also has a graduate diploma from the Securities Institute of Australia and has been admitted as a fellow of the Financial Services Institute of Australasia (Finsia). Funds Under Management SSgA offers seven ETFs in the Australian equities market, which have an aggregate market capitalisation of around A$2.5 billion as of Dec. 31, Funds Under Management (Dec. 31, 2011) ETF Market Capitalisation (A$ million) SPDR S&P/ASX 50 Fund 238 SPDR S&P/ASX 200 Fund 1,962 SPDR S&P/ASX 200 Listed Property Fund 282 SPDR MSCI Aust. Select High Yield Fund 32 SPDR S&P/ASX 200 Financials ex A-REIT Fund 12 SPDR S&P/ASX 200 Resources Fund 10 SPDR S&P/ASX Small Ordinaries Fund 7.0 The contents of this report are subject to the terms of the disclaimer on the final page. EXCHANGE-TRADED FUND Feb. 22, 2012 Page 6

7 ETF Rating Methodology The Exchange Traded Fund (ETF) rating philosophy emphasises the structural aspects of an ETF more than the abilities of the investment manager. The emphasis reflects the non-discretionary, rules-based nature of ETFs and the objective of generating beta and minimising index-tracking error, rather than alpha through discretionary investment selection. ETF Rating Process The evaluation of an ETF addresses: product features, investment process, performance, and team. In turn, each category comprises a number of subcategories including: fees and costs, tax-efficiency, securities lending, portfolio construction and management, historical performance and portfolio composition, and business management and team. ETF Rating Definitions S&P has assigned a 'Very Strong' rating to the product based on its conviction that it can meet its objectives over the stated time period. The product has scored exceptionally in a number of categories but may not be suitable for all investors. S&P has assigned a 'Strong' rating to the product based on its conviction that it can meet its objectives over the stated time period. The product has scored strongly in a number of categories but may not be suitable for all investors. S&P has assigned a 'Sound' rating to the product based on its conviction that it can meet its objectives over the stated time period. The product has scored satisfactorily in a number of categories but may not be suitable for all investors. S&P has assigned a 'Pass' rating to the product based on its conviction that it can meet its objectives over the stated time period. The product has passed a number of categories but may not be suitable for all investors. S&P has assigned a 'Weak' rating to the product based on its conviction that it cannot meet its objectives over the stated time period. The product has scored weakly in a number of categories and may not be suitable for most investors. An 'On Hold' designation is a suspension of a rating pending further analysis of a material change in the characteristics of a product. Glossary Of Terms Exchange Traded Fund (ETF) Benchmark Authorised Participant (AP) FUM Funds Under Management Information Ratio MER Management Expense Ratio Sharpe Ratio Standard Deviation Tracking Error Ex Ante Tracking Error Ex Post Tracking Error Exchange Traded Fund (ETF): An ETF is an investment fund traded on stock exchanges, much like stocks. An ETF holds assets, such as stocks, and trades at approximately the same price as the net asset value of its underlying assets over the course of the trading day. Most ETFs track an index. The standard (e.g. an index) against which an ETF is measured against to evaluate performance. An entity chosen by an exchange-traded fund's (ETF) sponsor to undertake the responsibility of the creation and redemption process. The total value of the funds managed by an asset management firm. This is a measure of the relative reward for the relative risk taken excess returns of an investment (above the benchmark) divided by the tracking error. A positive information ratio would indicate efficient use of risk by the manager. This ratio is a calculation of investment management, marketing, trusteeship, legal, accounting and auditing costs among others, of an investment expressed as a percentage of the investment s net asset value. It is the ongoing charges for managing the investment. This is a measure of risk-adjusted performance, measuring the absolute reward for the absolute risk taken return of the investment minus the risk-free rate (e.g. bank bills) divided by the standard deviation. The higher the Sharpe ratio the greater the efficiency produced by the manager. Measure of the variability or volatility of the monthly returns of the fund. How closely a portfolio follows or "tracks" an index to which it is benchmarked. (the standard deviation of monthly excess returns against the benchmark). Predicted or forecast of tracking error. Historical or actual tracking error. The contents of this report are subject to the terms of the disclaimer on the final page. EXCHANGE-TRADED FUND Feb. 22, 2012 Page 7

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9 Financial Services Guide Financial Product Research reports distributed by Standard & Poor s Information Services (Australia) Pty. Ltd. in Australia February 2010 STANDARD & POOR S AUSTRALIA Level 45, 120 Collins Street Melbourne VIC 3000 Tel: (61) Level 27, 259 George Street Sydney NSW 2000 Tel: (61) Client Services Tel: (61) Provider The provider of this service is Standard & Poor s Information Services (Australia) Pty Limited (ABN ) ( Standard & Poor s ) at Level 45, 120 Collins Street, Melbourne, Victoria, 3000 Australia, phone (61) Standard & Poor s holds Australian Financial Services Licence Number Purpose of the Guide This document is a Financial Services Guide (FSG). It sets out information designed to assist you in understanding: 1. the services we offer you 2. how we are paid 3. any potential conflict of interest we may have 4. our internal and external dispute resolution procedures and how you can access them What Financial Services is Standard & Poor s authorized to provide to you? Under its Australian Financial Services License Standard & Poor s is authorized to provide financial product advice to retail and wholesale clients in respect of the following classes of financial products: (1) deposit and payment products including (a) basic deposit products, (b) deposit products other than basic deposit products, and (c) non-cash payment products (2) derivatives (3) foreign exchange contracts (4) debentures, stocks or bonds issued or proposed to be issued by a government (5) life products limited to investment life insurance products as well as any products issued by a Registered Life Insurance Company that are backed by one or more of its statutory funds (6) interests in managed investment schemes including investor directed portfolio services (7) securities and (8) superannuation. This Service includes the provision of financial product research reports that are of a general nature. A summary of the criteria applied by Standard & Poor s in its research on financial products can be reviewed on request. Investment Warnings Standard & Poor s provides general advice about financial products that may be accessed by wholesale and retail clients. Standard & Poor s financial product research includes statements of opinion, not statements of fact. Investors should make themselves aware of additional warnings included in specific financial product research reports. Financial product research and the information contained in financial product reports is of a general nature and has been prepared without taking into account the particular financial needs, circumstances or objectives of any person. Standard & Poor s recommends that investors seek independent expert financial advice from persons qualified to provide investment advice in the relevant territory before making any investment decision. Past performance is not necessarily a good guide to the future performance of a security or investment.

10 2 Standard & Poor s Financial Services Guide Who does Standard & Poor s act for when providing the financial services? Standard & Poor s acts independently of any other person and provides its reports on its own account. It has no affiliation or association with any financial product or entity or related party of any financial product or entity for which it has published a research report. All views expressed in financial product research reports reflect Standard & Poor s views regarding any and all of the subject financial product or entity. How are any fees, commissions or other benefits calculated for providing the financial service? Standard & Poor s may be paid by the issuer of the financial product or entity to issue a research report and may receive subscription fees from clients. The remuneration of Standard & Poor s representatives is not related to the performance of any financial product or the fees paid to Standard & Poor s by any entity. Complaints and dispute resolution Standard & Poor s has established procedures for dealing with enquiries and complaints. If you have any enquiries or concerns about the services and products provided by Standard & Poor s you can call S&P Client Services on , send an to clientservices_pacific@standardandpoors.com or write to Standard & Poor s Client Services at Level 45, 120 Collins Street, Melbourne, Victoria, If you are not satisfied with the resolution of any complaint you will be directed to an external dispute resolution service such as the Financial Ombudsman Service (FOS). Standard & Poor s is a member of FOS. The contact details for FOS are as follows: GPO Box 3, Melbourne Victoria 3001, Telephone Toll Free , Fax (61) , info@fos.org.au, Website www. fos.org.au. Ratings Basis Standard & Poor s bases its financial product research on current information furnished to Standard & Poor s by the issuer of the financial product or obtained from sources that Standard & Poor s considers reliable. Standard & Poor s does not perform an audit in connection with any rating and may rely on unaudited information. Because of the possibility of human or mechanical error by our sources, Standard & Poor s or others, Standard & Poor s does not guarantee the accuracy, adequacy, or completeness of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. Readers should make their own inquiries. Subsequent information may result in financial product research being changed or withdrawn at any time. Please contact S&P Client services on for the most recent financial product research. Compensation Arrangements Standard & Poor s has professional indemnity insurance cover under a global professional indemnity insurance policy held by its parent, The McGraw-Hill Companies, Inc. which meets the compensation arrangement requirements of section 912B of the Corporations Act. Publication Basis While Standard & Poor s reserves the right to disseminate the financial product research, it receives no payment for doing so, except for payment for subscriptions or for access to its publications. Copyright & Trademarks This publication is 2010 Standard & Poor s Information Services (Australia) Pty Limited ( Standard & Poor s ) a wholly owned subsidiary of The McGraw-Hill Companies, Inc. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form by any means, electronic or otherwise, without the prior permission of Standard & Poor s. McGraw-Hill, Standard & Poor s & The McGraw-Hill Companies, TM are the respective proprietary trademarks of The McGraw-Hill Companies, Inc. and Standard & Poor s Financial Services LLC, in which all rights are reserved and which are protected by registration in a number of territories. Officers of The McGraw-Hill Companies, Inc. Harold W. McGraw, III, Chairman, President and Chief Executive Officer; Kenneth M. Vittor, Executive Vice President and General Counsel; Robert J. Bahash, Executive Vice President and Chief Financial Officer; Frank Penglase, Senior Vice President, Treasury Operations. Law This Publication is intended to constitute a Financial Services Guide pursuant to section 941A of the Corporations Act to the extent that the recipient of this service is a retail client as defined by the Corporations Act; and is issued subject to the laws of the state of Victoria and the Commonwealth of Australia and all matters arising from it or its use shall be subject to the exclusive jurisdiction of the Courts of Victoria. Copyright 2010 Standard & Poor s Information Services (Australia) Pty Limited. All rights reserved