Product Review Artesian Corporate Bond Fund Class A

Transcription

1 Product Review Artesian Corporate Bond Fund Class A P 1-9 ANALYST: SHARMEEL SUKA APPROVED BY: JUDE MCDONNELL ISSUE DATE About this Review ASSET CLASS REVIEWED SECTOR REVIEWED FIXED INTEREST ALTERNATIVE INCOME TOTAL FUNDS RATED 13 About this Fund ASIC RG240 CLASSIFIED FUND REVIEWED APIR CODE PDS OBJECTIVE INTERNAL OBJECTIVE STATED RISK OBJECTIVE DISTRIBUTION FREQUENCY NO ARTESIAN CORPORATE BOND FUND - CLASS A ETL8268AU RETURN THE RBA CASH RATE +2.75% (NET OF FEES) THROUGH ALL INTEREST RATE CYCLES SEE ABOVE TO PROVIDE A BETA RETURN ON 80% OF THE PORTFOLIO AND AN ACTIVE ALPHA RETURN ON 20% OF THE PORTFOLIO QUARTERLY FUND SIZE $40.5M (APRIL 2018) FUND INCEPTION MANAGEMENT COSTS RESPONSIBLE ENTITY 0.88% P.A. EQUITY TRUSTEES LIMITED About the Fund Manager FUND MANAGER ARTESIAN CORPORATE BOND PTY LTD OWNERSHIP ARTESIAN CAPITAL MANAGEMENT (AUSTRALIA) ASSETS MANAGED IN THIS SECTOR $300M (JANUARY 2018) YEARS MANAGING THIS ASSET CLASS 15 Investment Team PORTFOLIO MANAGER MATTHEW CLUNIES-ROSS & DAVID GALLAGHER INVESTMENT TEAM SIZE 6 INVESTMENT TEAM TURNOVER STRUCTURE / LOCATION Investment process PERFORMANCE BENCHMARK LOW SYDNEY/MELBOURNE/SINGAPORE/LONDON/ NEW YORK RBA CASH RATE FIXED RATE BOND RANGE 0% 70% (TARGET 35%) FLOATING RATE NOTE RANGE 0% 100% (TARGET 55%) DURATION (INTEREST RATE) YEARS (TARGET 1 YEAR) FOREIGN ISSUER LIMIT 50% MINIMUM INVESTMENT GRADE EXPOSURE (ASSUMING A 20% ALLOCATION TO CASH) 72% MAXIMUM SUB INVESTMENT GRADE/UNRATED LIMIT 10% Fund rating history MAY 2018 INVESTMENT GRADE What this Rating means The Investment Grade rating indicates that Lonsec has conviction the financial product can generate risk adjusted returns in line with relevant objectives. However, if applicable, Lonsec believes the financial product has fewer competitive advantages than its peers. Strengths A conservative portfolio of investment grade (at purchase) securities. The employed risk limits and liquidity requirements are considered to be strict, ensuring a conservative portfolio. Weaknesses Short performance track record (less than three years). The Fund has one of the highest fees in the Lonsec Alternative Income peer group on an absolute basis. Ambitious return target, given the conservative nature of the portfolio. The Investment team is smaller and geographically dispersed, with long term industry experience concentrated in a few senior members. Performance may be challenged during periods of poorly performing credit markets. Fund Risk Characteristics BUSINESS SUSTAINABILITY RISK CAPITAL VOLATILITY CREDIT RISK FOREIGN CURRENCY EXPOSURE INTEREST RATE (DURATION) RISK LEVERAGE RISK REDEMPTION RISK SECURITY CONCENTRATION RISK SECURITY LIQUIDITY RISK LOW MODERATE HIGH Risk categories are based on Lonsec s qualitative opinion of the risks inherent in the financial product s asset class and the risks relative to other financial products in the relevant Lonsec sector universe. BIOmetrics Aggregated risks STD RISK MEASURE A Standard Risk Measure score of 3 equates to a Risk Label of Low to Medium and an estimated number of negative annual returns over any 20 year period of 1 to less than 2. This is a measure of expected frequency (not magnitude) of capital losses, calculated in accordance with ASFA/FSC guidelines. We strongly recommend that potential investors read the product disclosure statement or investment statement. Lonsec Research Pty Ltd ABN AFSL. No This information must be read in conjunction with the warning, disclaimer and disclosure at the end of this document. This report supersedes all prior reports.

2 P 2-9 ANALYST: SHARMEEL SUKA APPROVED BY: JUDE MCDONNELL ISSUE DATE RISK TO INCOME Features and benefits COMPLEXITY ESG AWARENESS Fee profile FEES VS. UNIVERSE FEES VS. ASSET CLASS FEES VS. SUB-SECTOR LOW MODERATE HIGH LOW MODERATE HIGH LOW MODERATE HIGH Fee BIOmetrics are a function of expected total fee as a percentage of expected total return. What is this Fund? The Artesian Corporate Bond Fund ( Fund ) is an actively managed, investment grade (at purchase) bond fund. The Fund s investment universe consists of Australian dollar-denominated, floating rate and fixed rate bonds, issued by Australian and international corporates, and cash. The Fund is managed by Artesian Capital Management ( Artesian ), a boutique funds management business, founded in 2004 as part of a spin-off from the ANZ Banking Group. The investment philosophy guiding the Fund focuses on the belief that, in the current low-interest rate environment, floating rate securities offer lower risk in the fixed income market in the face of potentially rising rates. The Fund predominately relies on fundamental credit analysis as well as relative value and technical market analysis to identify opportunities within its investment universe. The Fund aims to achieve a return of 2.75% p.a. (net of fees) in excess of the RBA cash rate through all interest rate cycles. In its short history (the Fund was launched in February 2017), the strategy has relied heavily on short-term, tactical, trading of bonds (mostly bought at issuance) to generate returns. While the Fund invests in both floating rate notes (FRNs) and fixed-rate bonds, it is managed with a bias towards the former. The Fund s mandate allows a maximum allocation to FRNs of 100%, with a target exposure of 55%, and a maximum allocation to fixed rate bonds of 70%, with a target exposure of 35%. Duration is not expected to materially contribute to alpha generation or be actively traded by the Manager. While the Manager has the scope to adjust duration within a range of 0 to 3.5 years, Artesian has indicated duration will typically not exceed one year. The Manager will utilise interest rate futures to hedge the interest rate risk. The Fund will invest in at least 90% of funds not invested in cash in investment grade credit (either BBB- or higher by Standard & Poors/Fitch or Baa3 or higher by Moody s). The Fund may hold up to 100% of its assets in cash (0-20% target). The Manager is restricted from buying sub-investment grade and unrated securities, however, the Fund has an allowable allocation of up to 10% to such securities, to allow for fallen angels (where an investment grade bond is downgraded or loses its rating). The Manager will limit the Fund s exposure to foreign issuers to 50%. The Fund is not able to be more than 55% invested in the financial sector and limits its exposure to any other industry to a maximum of 30% (per sector). The Fund s allocations to subordinated debt and ASX listed hybrid securities are limited to 25% and 10% respectively, however, the Fund is not permitted to invest in bank issued hybrid securities. The Fund aims to provide investors with daily liquidity and quarterly distributions, although it does not target a specific distribution rate. As per the PDS dated 22 December 2017, the Fund s management cost is 0.88% p.a., including a 0.67% p.a. management fee and 0.21% p.a. administration fee. The Fund is required to pay transactional and operational costs when dealing with the assets of the Fund. Transactional costs may include brokerage, settlement costs, clearing costs and applicable stamp duty when assets are bought and sold, the costs of (or transactional and operational costs associated with) certain derivatives, (such as derivatives for hedging) and the implicit costs or spread incurred on buying or selling the Fund s assets. These costs are an additional implicit cost to the investors and are not paid to the Responsible Entity, they are reflected in the unit price. During the financial year ended 30 June 2017, the total transaction costs for the Fund were estimated to be 0.12% of the NAV of the Fund, of which 92.81% of these transaction costs were recouped via the Buy/Sell Spread, resulting in a net transactional cost to the Fund of 0.01% p.a. Please refer to the Fund s PDS for further details. Using this Fund This is General Advice only and should be read in conjunction with the Disclaimer, Disclosure and Warning on the final page. Alternative Income sector products are typically managed with the aim of generating returns that exceed a cash benchmark (such as the RBA Cash Rate) by an arbitrary margin in other words, absolute return in nature. Product risk (standard deviation) expectations are generally positioned as low, barring periods of exceptional market circumstances. Lonsec suggests that the Fund should only be considered for those clients that are: a) seeking yields greater than those available in cash or cashlike instruments; and, more importantly, b) those prepared to accept low to moderate volatility in the unit price. Suggested Lonsec risk profile suitability SECURE DEFENSIVE CONSERVATIVE BALANCED GROWTH HIGH GROWTH For guidance on appropriate asset allocations and risk profiles, refer to the latest Lonsec Strategic Asset Allocation Review and Risk Profile Definitions on our website. Changes Since Previous Lonsec Review This is the Fund s initial review.

3 P 3-9 ANALYST: SHARMEEL SUKA APPROVED BY: JUDE MCDONNELL ISSUE DATE Lonsec Opinion of this Fund People and resources The Investment team is led by Artesian Chief Investment Officer Matthew Clunies-Ross and Portfolio Manager David Gallagher, who together constitute two of the three members of the Fund s Investment Management Committee. Clunies-Ross is a founding member of Artesian and has twentysix years investment experience having previously traded credit securities for several large investment banks (including ANZ) and having been involved in the management of Artesian s Global Corporate Bond Fund (previously Credit Arbitrage Hedge Fund). Gallagher s investment experience totals 14 years and includes tenure at the Royal Bank of Scotland and Deutsche Bank, where his responsibilities involved managing credit portfolios. As such, Lonsec views Clunies-Ross and Gallagher as adequately skilled to run the portfolio. Lonsec views key person risk to be moderate to high, given the Fund s reliance on Clunies-Ross and Gallagher s specialised skill set, focusing on short-term, tactical, bond trading, to generate alpha. This risk is more concentrated on Clunies-Ross, given his investment experience. The Investment Management Committee also comprises Marcus Bogdan, although he is not involved in the day-to-day management of the Fund and acts as an advisor/consultant to the Fund s portfolio managers. Bogdan has been involved in the financial services industry for 25 years, focused on equities, including time as a portfolio manager at Cooper Investments. Bogdan attends bi-monthly Investment Management Committee meetings whereby he is involved in discussions around portfolio positioning and market dynamics. Lonsec views Bogdan s involvement in the investment process positively, given it provides the portfolio managers with an alternative, equity-focused, view of financial markets. Lonsec also notes that the nature of Bogdan s role within the Fund ensures that accountability for decision making is focused on the portfolio managers (Clunies-Ross and Gallagher). The portfolio managers are supported by a Credit Analyst team of four, consisting of Kurt Tan (Senior Credit Analyst), Petar Zlatkovic (Senior Credit Analyst), Johny Tjheng (Senior Credit Analyst) and Dylan Er (Credit Analyst). The team covers approximately 50 issuers (out of an investible universe of ). Tjheng and Er s credit coverage focuses on the Asia Pacific region and hence they are the primary credit analysts for the Fund (responsible for 60% of the Fund s covered issuers). Er, the more junior of the two undertakes the majority of the credit analysis with Tjheng acting in a supervisory role. Compared with credit analysts across the Lonsec fixed income universe, Er and Tjheng fall on the lower end of the investment experience spectrum, with four and eight years experience, respectively. Zlatkovic (21 years) and Tan (15 years) are more experienced, although their coverage (North American and European issuers) only constitutes 40% of the Fund s covered issuers and 30% of the Fund s target asset allocation. Furthermore, both Zlatkovic and Tjheng are not purely dedicated to this Fund. Lonsec notes, however, that the Fund s investment universe excludes sub-investment grade issues at purchase, reducing the complexity of the credit analysis required, and that the number of issuers covered by each analyst (10-15) is viewed as a manageable workload. The investment team is geographically split between Melbourne (Clunies-Ross and Bogdan), Sydney (Gallagher), Singapore (Er and Tjheng), New York (Tan) and London (Zlatkovic). There is no formally held team meeting between the portfolio managers and Credit Analyst Team, however, Lonsec notes that the team (excluding Bogdan) regularly communicates via , telephone and Bloomberg. An advantage of a globally based team is that it facilitates a follow the sun approach to investing which allows the portfolio to be monitored on a 24-hour basis. While Lonsec acknowledges the regular communication between portfolio managers and credit analysts, it takes the view that face to face interaction helps to facilitate a stronger team culture and level of cohesiveness, particularly for smaller teams. Lonsec would like to gain a greater level of conviction in the quality of team interaction and culture and will monitor this at future reviews. Lonsec believes the investment team s alignment of interests with investors is moderate when compared to peers. Staff remuneration includes a variable portion and deferred equity shares in Artesian. CIO Matthew Clunies-Ross is co-invested in the Fund, although this is not an explicit requirement of the investment team. Variable remuneration is linked to factors such as funds under management growth as well as the profitability of Artesian and its parent company. While this is, to a degree, aligned to investor interests, Lonsec prefers structures where remuneration is more closely linked to fund performance. Research and portfolio construction The Fund s investment philosophy is based on the Manager s view that, in a low rate environment, the ideal investment strategy is to invest in floating rate notes (FRNs), to protect investors from the risk of rising interest rates. As such, the Fund places a greater emphasis on FRNs, however, it will also invest a portion of the Fund in fixed-rate bonds, hedging the associated interest rate risk. Lonsec agrees that the Manager s investment strategy is suited for a rising interest rate environment, but cautions investors that should the reverse occur (i.e. interest rates fall), the Fund will not experience the same tailwinds that other Funds (with higher duration and government bond exposure) will benefit from. Lonsec is pleased that the Fund pairs its aim to provide daily liquidity with a high-quality investment grade (at purchase) portfolio, which is an advantage compared to some peers who present a less rigid approach to liquidity management. The Manager s investment process focuses on pairing fundamental credit and relative value analysis to identify the most attractive opportunities in its investment universe, which focuses on investment grade, Australian dollar-denominated, fixed and floating rate bonds. The Fund frequently targets new bond issuances and will utilise short-term, intraday trading to extract value for investors. Lonsec notes that recent tailwinds in the credit market and

4 P 4-9 ANALYST: SHARMEEL SUKA APPROVED BY: JUDE MCDONNELL ISSUE DATE the Fund s low level of assets under management has allowed it to trade nimbly and generate strong returns from these short-term trades, however, as it increases in size, Lonsec expects capacity constraints will limit the level alpha generated from such trades. Pleasingly, the Manager has made a commitment to close the Fund to new investors when assets under management increase to $500 million (AUD), however, this does not guarantee the Fund will meet its objective. Lonsec will continue to monitor this going forward. Lonsec views the Fund s investment objective of 2.75% p.a. (net of fees) in excess of the RBA cash rate to be ambitious, given the portfolio is limited to investing in investment-grade (at purchase) bonds, and notes that the Fund s ability to achieve such an objective over the longer term will rely to a degree on the Manager s ability to generate a reasonable portion of alpha form its short-term tactical trades. Bottom-up credit analysis is undertaken by the Credit Analysis team. Potential investments are initially screened via a proprietary credit grid, which summarises key quantitative and qualitative factors. If a bond is deemed eligible for the portfolio, credit analysts utilise Artesian s proprietary Relative Value and Fundamental credit models as well as their own balance sheet and company analysis to produce a trade recommendation, which is distilled into a credit research note for review by the portfolio managers. In conducting credit research, analysts attend meetings with issuing companies management, namely company treasurers. While the Manager s access to management may not be as wide-ranging as larger institutional investors, who have large credit and equity teams, Lonsec views the credit analysis undertaken by Artesian analysts to be sufficient given the lower level of credit risk associated with investment grade bonds. Macroeconomic research is the responsibility of the portfolio managers, Clunies-Ross and Gallagher, who make a top-down assessment of the macroeconomic and interest rate environment based on financial/ economic data sourced from Bloomberg, third-party research and input from Artesian s global traders. Lonsec views this research to be less sophisticated than larger, institutional investors who have access to economists and large capital market teams, but notes the approach taken is ultimately appropriate for the strategy given its limited mandate (i.e. the Fund does not invest in government bonds or currency). The final portfolio is constructed by the portfolio managers, who supplement the Credit Analysis team s research with their own knowledge of issuers, their macroeconomic views and their own relative value and technical analysis, to determine portfolio positioning. Positions are not subject to a stop loss limit and detracting trades may or may not be exited at the discretion of the portfolio managers. The portfolio managers take a shared approach to portfolio management, however, ultimate decision making lies with Clunies-Ross. Lonsec views the concentration of decision making responsibility within the investment process positively, as it places accountability for performance squarely on the portfolio managers. Risk management Risk is primarily managed within the Fund via its strict risk limits, which maintain the Fund s focus on investment grade corporate credits which are viewed to have better liquidity characteristics than riskier assets. Mandate limits are monitored and maintained by multiple parties, namely the investment team, the risk team and the Fund s administrator (MainstreamBPO). The Fund s design has a strong focus on liquidity, with stringent requirements mandated by the Manager as well as regular liquidity analysis conducted by the investment team, via Bloomberg. Further management of investment risk is undertaken by the investment and risk teams on an ongoing basis. The Portfolio Manager reviews the portfolio daily via the examination of several risk reports, generated using Bloomberg, that break down risk according to several factors, including (but not limited to) sector, region, credit rating and spread. The Artesian risk team also undertakes regular scenario and value at risk analysis of the portfolio. Lonsec considers the level of risk oversight undertaken within the Fund to be appropriate given the focus on investment grade securities and the Manager s assessment of liquidity prior to investing in a security. Performance Given the Fund was only launched in February 2017, there is a relatively limited track record with which to effectively assess performance. Lonsec prefers to make assessments based on a track record of at least three years. The Fund generated a return of 5.27% over the twelve months to April 2018, outperforming the RBA Cash rate by 3.77%. Along with favourable credit markets, Lonsec notes the small size of the underlying strategy in the first few months since its inception has allowed for concentrated positions in smaller bond issuances, which have subsequently generated significant returns. During the early months of the Fund s inception outperformance of the benchmark was very high, given the total strategy s funds under management (FUM) was only $4.6 million (April 2017), and since then, as FUM has increased, outperformance has fallen. As such, Lonsec anticipates that, as the strategy s assets under management increases, the alpha generated by the Fund is likely to normalise (reduce) to a level more in line with its performance objective. Overall Lonsec has initiated coverage on the Fund with an Investment Grade rating. Supporting this view is the Fund s conservative nature, an awareness of capacity constraints and strict risk limits with several levels of risk management and monitoring. Furthermore, the portfolio management team is headed by capable investment professionals with access to globally based resources. That said, Lonsec notes that the investment team is both small and geographically dispersed, which may hinder the development of a strong team culture. Furthermore, the Fund s investment

5 P 5-9 ANALYST: SHARMEEL SUKA APPROVED BY: JUDE MCDONNELL ISSUE DATE objective is considered ambitious relative to its conservative, investment grade portfolio and Lonsec has concerns that performance may be challenged in down-trending credit markets and as FUM increases. Finally, the Fund s performance track record is not long enough to assess the Managers ability to generate returns across varying market environments. People and Resources Corporate overview Artesian Capital Managment was founded in 2004 when it was spun out of ANZ Banking Group as a credit arbitrage hedge fund. Since 2004, Artesian has managed specialised funds focused on credit arbitrage and relative-value strategies across global financial markets. Artesian has offices based in Melbourne, Sydney, London, New York, Shanghai and Singapore. As at January 2018, Artesian has $AUD 560 million in funds under management. Size and experience NAME MATTHEW CLUNIES-ROSS^ POSITION CHIEF INVESTMENT OFFICER EXPERIENCE INDUSTRY / FIRM 26 / 14 DAVID GALLAGHER^ PORTFOLIO MANAGER 14 / 5 JOHNY TJHENG SENIOR CREDIT ANALYST 8 / 8 DYLAN ER CREDIT ANALYST 4 / 3.5 KURT TAN SENIOR CREDIT ANALYST 15 / 13 PETAR ZLATKOVIC SENIOR CREDIT ANALYST 21 / 1 ^ Investment Management Committee Member The investment team consists of six individuals: two portfolio managers and four credit analysts. Additionally, Artesian has a separate risk team, with three individuals responsible for this Fund. Both the investment and risk management team members are geographically dispersed across Artesian s offices in Melbourne, Sydney, London, New York and Singapore. Artesian Chief Investment Officer Matthew Clunies- Ross, Portfolio Manager David Gallagher and Marcus Bogdan (acting as an advisor) sit on the Investment Management Committee. Clunies-Ross and Gallagher are involved in the day-to-day management of the Fund as portfolio managers while Bogdan, with his equity investment experience, provides feedback when the committee meets (bi-monthly) and discusses markets and investment decision. Clunies-Ross and Bogdan are Melbourne based while Gallagher is located in Melbourne. Clunies-Ross is one of the founding partners of Artesian and has been involved in the management Artesian s Global Bond Fund for over 10 years. Prior to cofounding Artesian, Clunies-Ross spent 12 years at several investment banks including ANZ, HSBC and Macquarie Bank. He currently dedicates 80% of his time to the management of this Fund. Gallagher joined Artesian in June Prior to joining Artesian, he spent nine years in the United Kingdom working for Deutsche Bank and RBS in both portfolio and risk management positions. He currently dedicates 100% of his time to the management of this Fund. The Credit Analyst team is comprised of Kurt Tan (New York), Petar Zlatkovic (London), Johny Tjheng (Singapore) and Dylan Er (Singapore). Tjheng and Er s credit coverage focuses on the Asia Pacific region and hence they undertake the bulk of credit analysis for this Fund. Er is tasked with undertaking fundamental credit analysis and his work is overseen by Tjheng. Zlatkovic and Tan are each responsible for issuers based in Europe and the United States of America, respectively, and their research is utilised within this Fund when non- Australian based companies issue bonds in Australian dollars. The risk management team is headed by John McCartney (Chief Risk Officer). He previously held the position of Head of International Credit Trading within ANZ Capital Markets. McCartney joined ANZ in 1995, has held a series of securitisation and trading positions within the ANZ Capital Markets Group and joined Artesian at its inception. McCartney is based in New York and is supported by Artesian s Chief Operating Officer Tim Heasley and Chief Financial Officer Pankaj Khana, both of whom are located in Melbourne. Additionally, Artesian has an Administration and Compliance team of four based in Melbourne. Artesian utilises several third party service providers including Equity Trustees (Responsible Entity), MainstreamBPO (fund administration and registry services), J.P. Morgan (sub-custodian) and Gateway Financial Marketing (distribution). Remuneration Staff compensation comprises a mix of cash base salaries, variable remuneration and a deferred equity shares. Twenty percent of investment team members remuneration is variable and is linked to funds under management growth, the profitability of Artesian and the profitability of Artesian s parent company (Aroona Inc.). Analysts and portfolio managers bonuses may comprise a component of the Fund management fee and general company profits. Furthermore, the portfolio managers have a deferred equity share agreement with Artesian based on increasing funds under management over the next three years. Research Approach Overview Bottom-Up Research Credit analyst coverage is determined using a credit grid (which summarises key quantitative metrics based on public information) as the first point of screening. The Manager derives a quick snapshot of the fundamentals of each of the credits under their coverage which forms the basis of the Credit Analyst Team s research. Bottom-up credit research is undertaken by credit analysts via two different avenues: Fundamental Model: The Fundamental Model comprises the fundamental credit research undertaken by credit analysts. Credit analysts consider both bottom-up and top-down factors in their analysis of new and existing investments. This includes an analysis of sectoral themes, the regulatory environment for the issuing company as

6 P 6-9 ANALYST: SHARMEEL SUKA APPROVED BY: JUDE MCDONNELL ISSUE DATE well as relevant macroeconomic factors. Bottom-up, company-specific analysis includes an examination of the issuing companies balance sheet, business model, as well as forecasting and scenario analysis of factors such as leverage and prospects for future issuances of debt. Financial data is updated periodically based on company releases. Ad-hoc and one-off, event-driven information will be analysed and incorporated should the Manager deem it to be relevant. Analysts will undertake their analysis by utilising publicly available data and engaging in regular communication with company management via investor meetings with company treasurers, either in person or via remote communication. Relative Value Model: The Relative Value Model is housed in Bloomberg constructed to determine an issue s fair value (FV) and relative value (RV) by tracking spread movements of the credits under coverage. The Manager evaluates spread movements over time as well as across sectors, rating bands and credit spread bands to derive a fair valuation and relative valuation consistent with prevailing market conditions. The Fundamental Model and Relative Value Model are utilised by analysts to prepare research reports for each bond issue at a minimum of once a quarter. Factors such as the release of company announcements, new issuances and unforeseen news/events will trigger more frequent reporting. Three categories of reports are generated, namely New Issue Analysis, Company Updates (to recalibrate views post company news/ announcements) and Tactical Trading Calls (in response to new pricing opportunities). These reports include a business update, relative value analysis and trade recommendation. All credit research is stored via cloudbased software and the wider investment team receives automatic updates when reports are produced/updated. Artesian also utilises Moody s CreditView Financial Metrics, which is a subscription service which enables them to access the models, standard reports, and rating methodologies used by Moody s analysts in its credit rating process. Macroeconomic Research The portfolio managers conduct their own separate analysis of the Australian and global macroeconomic/ interest rate environments. This consists of examining third-party research, central bank reports/ communications and Bloomberg economic data (wage growth, unemployment, employment participation rate, inflation, retail sales, capital expenditure etc.) as well as ongoing communication with Artesian s globally based analysts and 24hr trading desk. Macroeconomic and top-down sectoral views are also discussed by the Investment Management Committee (Clunies-Ross, Gallagher and Bogdan), which meets on a bi-monthly basis. Portfolio Construction Overview INVESTMENT STYLE BENCHMARK UNAWARE TYPICAL NUMBER OF SECURITIES EXPECTED PORTFOLIO TURNOVER TARGET DURATION 40% PER MONTH 1 YEAR As part of its initial screening process, the Manager identifies credits and places them under coverage based on the Fund s mandate, prevailing macroeconomic themes and a relative valuation of the credit universe. The portfolio primarily invests in investment grade, fixed and floating rate corporate bonds, denominated in Australian dollars. The portfolio managers review credit research reports and communicate with credit analysts on an ongoing basis to source investment ideas for the portfolio. Credit analysts present to the portfolio managers every time they generate or update a trade idea/report and from here the portfolio managers undertake their own analysis and factor in their macroeconomic views to determine portfolio suitability. Portfolio metrics, current market conditions, market outlook, duration positioning and trade recommendations are discussed by the Investment Management Committee (Clunies-Ross, Gallagher and Bogdan) on a bi-monthly basis. This committee also provides a forum for Bogdan to provide feedback to the portfolio managers, based on his knowledge of and experience managing money in equity markets. The following factors are considered by the portfolio managers when determining trade inclusion and position sizing: The issuer s AUD funding curve Global maturity profile of the issuer Likelihood of further debt issuance Issuer reputation Rational for AUD debt issuance (e.g. Australian operations, diversification of funding base) Level of issuance within the sector Type of issuance (fixed or floating) Yield and attractiveness to offshore buyers Maturity Total market issuance Performance of comparable issuances Level of supportive market dynamics Relative value Demand/supply dynamics of the bookbuild (for new issuances) The portfolio has a permissible duration range of 0 to 3.5 years, however, the Manager will typically aim to minimise the duration risk within the portfolio (with a target duration of one year). Duration is managed at two levels: (1) at an individual bond level and (2) at a portfolio level. When the Manager purchases a fixed rate bond, it will also sell an appropriate number of interest rate futures to hedge the interest rate risk of that particular bond. Duration is also examined at a portfolio level and, depending on the portfolio managers views on interest rates, interest rate hedges are adjusted to achieve the appropriate overall duration positioning. Should the Manager wish to increase the portfolio s duration, it will not take long interest rate future positions but will instead remove the interest rate hedges it has in place. While both Gallagher and Clunies-Ross work closely to build the portfolio, the final decision around portfolio positioning rests with Clunies-Ross.

7 P 7-9 ANALYST: SHARMEEL SUKA APPROVED BY: JUDE MCDONNELL ISSUE DATE Risk Management Risk limits SEPARATE RISK MONITORING DURATION YES YEARS FLOATING RATE BONDS 0%-100% FIXED RATE BONDS 0%-70% INVESTMENT GRADE DEBT (AT PURCHASE) 72%-100% NON-RATED AND SUB INVESTMENT GRADE DEBT 0%-10% SECTOR (EX FINANCIALS) 0%-30% FINANCIALS 0%-55% FOREIGN ISSUERS 0%-50% SUBORDINATED DEBT 0%-25% ASX LISTED HYBRIDS (EX BANK ISSUED HYBRIDS) 0%-10% ASX LISTED BANK ISSUED HYBRIDS NOT PERMITTED SINGLE BOND EXPOSURE (AS PERCENTAGE OF PORTFOLIO) 0%-20% SINGLE BOND EXPOSURE (AS PERCENTAGE OF BOND ISSUE) 0%-10% CASH 0%-100% FOREIGN CURRENCY EXPOSURE NOT PERMITTED The risk limits stated are hard limits which must be adhered to. Risk monitoring Portfolio Manager David Gallagher, Chief Investment Officer Matthew Clunies-Ross and Chief Risk Officer John McCarthy are tasked with monitoring the portfolio risk on a daily basis. The portfolio manager generates profit/loss, risk and interest rate reports on a daily basis, which are reviewed by the Chief Investment Officer and Chief Risk Officer. Further risk analysis is regularly undertaken by the investment team, using Bloomberg, covering contribution to total risk by spread, credit duration, sector, country and yield. Value at risk and scenario analysis of the portfolio is also conducted by the risk management team on a weekly and monthly basis, respectively. Prior to execution, the Portfolio Manager runs a pretrade compliance check, whereby all risk metrics are analysed relative to the mandate risk limits. Artesian s internal compliance team also conducts a compliance check on a daily basis. MainstreamBPO, the Fund s registry provider and administrator, conducts post-trade compliance checks on the portfolio. Liquidity Monitoring Liquidity analysis is conducted, through Bloomberg, on a regular basis. Artesian will only invest in bonds/ issuers they consider liquid, as defined by: High-frequency of issuance in public markets Public deals (greater than AUD 100m in size) Well-established credit curve and large offshore issuance program (for foreign issues) Three dealer quotes a day per issuance High number of dealers involved in issuance over and above the lead managers Risks Credit risk Investing in non-sovereign debt securities, such as corporate bonds, typically carries with it an increased level of credit risk. Credit risk generally refers to the extent of a borrower s willingness or ability to repay their debt. Higher credit risk generally infers a greater risk of capital loss. Credit investments are typically split between investment grade (AAA to BBB-) and subinvestment grade (BB+ to D). The Fund is restricted from buying sub-investment grade or non-rated debt securities, but also has a permissible, combined, allocation of 10% to both to allow for fallen angel s (investment-grade issuers which are downgraded or lose their rating after they have been purchased by the Fund). Liquidity risk Under abnormal or difficult market conditions, some normally liquid assets may become illiquid, restricting our ability to sell them and to make withdrawal payments to investors without a potentially significant delay. Interest rate risk The yield and face value of securities can be affected by interest rate movement. In instances where interest rates rise, the face value of certain fixed-rate securities may decline. Equally, in circumstances where interest rates decline, the yield of certain floating rate securities will drop to reflect the floating rate nature of the yield. Equally, longer-term interest rate expectations have the ability to impact the value of longer-dated fixed-rate securities. The expectation of future rates is embodied in the yield curve. Derivative risk The Manager may use derivatives, such as interest rate futures, to hedge interest rate risk arising from the corporate bonds in the portfolio. Risks particular to derivatives include the risk that the value of a derivative may not move in line with the underlying asset and the risk that a particular derivative may be difficult or costly to trade. Derivatives will only be used for risk management purposes. Derivatives will not be used within the Fund for speculative or gearing purposes. Other risks Please refer to the Fund s PDS for more details on the other risks identified by the Manager and the Responsible Entity.

8 P 8-9 ANALYST: SHARMEEL SUKA APPROVED BY: JUDE MCDONNELL ISSUE DATE Quantitative Performance Analysis - annualised after-fee % returns (at ) Performance metrics 3 MTH 6 MTH 9 MTH 12 MTH FUND PEER MEDIAN FUND PEER MEDIAN FUND PEER MEDIAN FUND PEER MEDIAN PERFORMANCE (% PA) STANDARD DEVIATION (% PA) * EXCESS RETURN (% PA) OUTPERFORMANCE RATIO (% PA) WORST DRAWDOWN (%) TIME TO RECOVERY (MTHS) NR 1 NR 1 1 SHARPE RATIO * INFORMATION RATIO * TRACKING ERROR (% PA) * FUND: ARTESIAN CORPORATE BOND FUND - CLASS A LONSEC PEER GROUP: FIXED INTEREST - ALTERNATIVE INCOME BENCHMARK USED: RBA CASH RATE CASH BENCHMARK: BLOOMBERG AUSBOND BANK BILL INDEX AUD * PERIODS LESS THAN 12 MONTHS ARE NOT CALCULATED TIME TO RECOVERY: NR - NOT RECOVERED, DASH - NO DRAWDOWN DURING PERIOD Growth of $10,000 over one year Snail trail Risk-return chart over one year Outperformance consistency

9 ISSUE DATE P 9-9 ANALYST: SHARMEEL SUKA APPROVED BY: JUDE MCDONNELL Glossary Total return Top line actual return, after fees Excess return Return in excess of the benchmark return Standard deviation Volatility of monthly Absolute Returns Tracking error Volatility of monthly Excess Returns against the benchmark (the Standard Deviation of monthly Excess Returns) Sharpe ratio Absolute reward for absolute risk taken (outperformance of the risk free return (Bank Bills) / Standard Deviation) Information ratio Relative reward for relative risk taken (Excess Returns / Tracking Error) Worst drawdown The worst cumulative loss ( peak to trough ) experienced over the period assessed Time to recovery The number of months taken to recover the Worst Drawdown Snail Trail A trailing 12-month relative performance and relative risk measurement over the benchmark. The trail is generated using a 12-month rolling window over the specified period About Lonsec Lonsec Research Pty Ltd (Lonsec) is an investment research house with specialist areas of expertise, that was originally established in 1994 and the current entity was registered on 23 June From 1 July 2011, Lonsec became a fully owned subsidiary of Lonsec Fiscal Holdings Pty Ltd, a privately owned entity with a multibrand strategy of providing leading financial services research and investment execution. Lonsec believes that professional financial advisers need informed opinions on the best investment strategies and financial products to provide real value for their clients. To meet this need, Lonsec has in place an experienced research team, which draws on a robust research process to undertake in-depth assessment of managed fund products. Analyst Disclosure and Certification Analyst remuneration is not linked to the research or rating outcome. Where financial products are mentioned, the Analyst(s) may hold the financial product(s) referred to in this document, but Lonsec considers such holdings not to be sufficiently material to compromise the rating or advice. Analyst holdings may change during the life of this document. The Analyst(s) certify that the views expressed in this document accurately reflect their personal, professional opinion about the matters and financial product(s) to which this document refers. The Head of Research at Lonsec has abstained from the reviewing and rating process for this financial product, due to being a former employee of the issuer of the financial product. LONSEC STRONGLY RECOMMENDS THIS DOCUMENT BE READ IN CONJUNCTION WITH THE RELEVANT PRODUCT DISCLOSURE STATEMENT IMPORTANT NOTICE: This document is published by Lonsec Research Pty Ltd ABN , AFSL No (Lonsec). Please read the following before making any investment decision about any financial product mentioned in this document. Disclosure at the date of publication: Lonsec receives a fee from the fund manager or financial product issuer(s) for researching the financial product(s) set out in this document, using objective criteria. Lonsec may also receive a fee from the fund manager or financial product issuer(s) for subscribing to research content and other Lonsec services. Lonsec s fee is not linked to the rating(s) outcome. Lonsec does not hold the financial product(s) referred to in this document. Lonsec s representatives and/or their associates may hold the financial product(s) referred to in this document, but details of these holdings are not known to the Analyst(s). Disclosure of Investment Consulting services: Lonsec receives fees for providing investment consulting advice to clients, which includes model portfolios, approved product lists and other financial advice and may receive fees from this fund manager or financial product issuer for providing investment consulting services. The investment consulting services are carried out under separate arrangements and processes to the research process adopted for the review of this financial product. For an explanation of the process by which Lonsec manages conflicts of interest please refer to the Conflicts of Interest Policy which is found at: general/lonsecresearchconflictsofinterestpolicy.pdf Warnings: Past performance is not a reliable indicator of future performance. Any express or implied rating or advice presented in this document is limited to General Advice (as defined in the Corporations Act 2001(Cth)) and based solely on consideration of the investment merits of the financial product(s) alone, without taking into account the investment objectives, financial situation and particular needs ( financial circumstances ) of any particular person. It does not constitute a recommendation to purchase, redeem or sell the relevant financial product(s). 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