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Important information

Disclaimer:

This information has been provided by MLC Limited (ABN 90 000 000 402) a member of the National Group, 105-153 Miller Street, NorthSydney 2060. This material was prepared for advisers only.

Any advice in this communication has been prepared without taking account of individual objectives, financial situation or needs. Because of this you should, before acting on any information 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 30 002 641 661) and MLC Nominees Pty Ltd (ABN 93 002 814 959) as trustee of The Universal Super Scheme (ABN 44 928 361 101), 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 132 652 or on our website at mlc.com.au.

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 12 004 044 937 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.

Past performance is not indicative of future performance. The value of an investment may rise or fall with the changes in the market. Please note that all return figures reported are before management fees and taxes, and for the period up to 30 June 2009, unless otherwise stated.

The specialist investment management companies are current as at 30 June 2009. Funds under management figures are as at 30 June 2009, unless otherwise stated. Investment managers are regularly reviewed and may be appointed or removed at any time without prior notice to you.

MLC Investment Management Team Recent Activity5

MLC Investment Management TeamRecent Comments,
Updates and Articles6

Market Overview7

MLC Horizon 5Growth Portfolio10-14

MLC Long-Term Absolute Return (LTAR) Portfolio15-18

Diversified Debt Commentary19-24

Global Real Estate Investment Trust Commentary25-28

Australian Share Commentary29-33

Global Share Commentary34-37

Global Private Assets Commentary38-39

Appendix: Table of Investment Manager Returns40-41

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Recent Changes to the Strategic Overlay of the MLC Long Term Absolute Return Portfolio

The Global Financial Crisis and ensuing Global Economic Slowdown was a tail risk scenario unprecedented in modern times. Only with extraordinary monetary and fiscal policy intervention on the part of governments and central banks around the world have we avoided complete financial and economic market dislocation.

During the second quarter of 2009 it became clear that the plunge in real economic activity had ceased and there had been a stabilization of conditions. An economic disaster scenario appears to have been averted.

Major market declines typically mark the point at which prospective return potential versus risk is relatively high. This environment is not clear-cut. The path forward is extremely uncertain. On the positive side, precipitous policy action has reversed fears of financial collapse. This does not mean there will be a quick or smooth path back to economic normality. Fears of a deflationary slump are real; MLC also take seriously the risk of a shock rise in inflation. The immediate forces may be for an apparently benign combination of an inventory re-building burst of growth, and a sufficient improvement in confidence to limit deflation but not trigger inflation. But this is an exceptionally difficult environment for policy makers – it may not be possible to both underpin recovery and avoid significant inflation.

The MLC LTAR Strategic Overlay was adjusted during the June quarter with a series of incremental steps. Previous steps in this process include the allocation to Ruffer in February 2009. The exposure to emerging market equities was raised by 3% (4% in IDPS) and hedged global property and global shares unhedged were each increased by 2% during the quarter. These strategy changes increase the foreign currency exposure, taking advantage of Australian dollar strength.

While tail risk remains, downside risk is lower as markets have fallen significantly from their highs despite recent upswings. This means the potential downside risk for equity and listed property markets is lower than previously. Nevertheless, given the enormity of the shock that has been delivered to the global economy, there remains considerable uncertainty about the adjustment path. It is not yet clear that underlying global imbalances are being corrected, or at least that they are being corrected in other than a highly adverse manner. While the spendthrift Anglo world is now saving, the Asian savers are not spending – this combination could result in a prolonged adverse growth environment (a paradox of thrift). On balance, a less defensive position remains appropriate but caution still needs to be applied while our assessment is that equity markets have not sufficiently discounted these risks.

Manager meetings and reviews

Over the past 12 months, MLC Investment Management has undertaken 529 manager meetings. The broad asset class breakdown of these manager meetings is outlined in the below chart.


Your investment specialists regularly produce commentary and articles on topical investment issues. These are available on
mlc.com.au

Some of our recent updates include:

  • A fully scripted ‘Performance Preview Pack’ for the year ended 30 June 2009 to help facilitate more meaningful client conversations around fund performance in challenging market environments, The pack “lifts the lid” on the key drivers of the current economic environment, how this has affected investment markets and what this means for your clients.
  • A summarizedclient friendly commentary on the key drivers of performance for the range of MLC Multi-Manager funds over the year to June 2009 is on the client MarketWatch site.
  • The recent financial market chaos and plunge in liquidity of credit assets has helped focus mainstream attention on the risk posed by exposure to illiquid assets. This is particularly relevant to many Australian Superannuation investors in Industry Super funds with a high degree of illiquid exposure (eg Direct property, Infrastructure and private equity).

MLC has always taken the issue of liquidity and equitable pricing seriously, to ensure we provide our investors with daily access to their unit linked funds. To ensure we can provide this access, MLC has a formal approach to the assessment of liquidity and equitable pricing.For more information on this issue please refer to MLC’s White Paper entitled:“Liquidity and Equitable Unit Pricing – March 2009”.

The Lottery Effect of Volatility– MLC does not believe volatility should be seen as the definitive measure of risk. Risk, to clients, is the likelihood they will not achieve their financial objectives. However, the dispersion of returns (volatility) does impact whether clients achieve their financial objectives. This paper examines the contribution the dispersion of returns has on outcomes.

  • MLC Investment Management’s views and analysis on7 year return potential for asset classes and the range of MLC’s diversified portfolios has been updated to reflect end June 2009 market valuations.
  • Amanda Heyes, MLC Investment Specialist, puts 'The Chaser' under the microscope and finds that the power of compound interest over long periods of time can have an incredible impact on your clients’ wealth.
  • Traditional portfolio construction approaches have been under intense scrutiny throughout the recent financial crisis. In his article - The do's and don'ts of portfolio construction, John Owen, Senior Investment Specialist for Australian shares and global property provides some insights on how NOT to make the same mistakes.
  • Kerry Napper, MLC's Capital Markets Research Analyst, looks at what history can tell us about the effect of banking crises on developed and emerging economies.
  • Don't forget to have a look at the Marketwatch site for an update on the impacts of the financial crisis and economic downturn on recent income distributions for the MLC MasterKey Investment Trust, Unit Trust and Investment Service and helping clients through tough times.

Investment returns over the past 12 months were very poor, with the typical balanced fund likely to have posted a -11% return for the year. REIT and share markets were the main culprits, while Government bonds posted solid returns as investors continued to seek safety, and the world’s central banks drove official interest rates down to unprecedented levels. Within the bond universe, the dispersion of returns among the various sub-classes was truly remarkable. While Government nominal bonds in the developed markets performed well, every other debt securities sub-class performed poorly in the December 2008 quarter. Corporate bond spreads widened dramatically, particularly after the failure of the US investment bank Lehman Brothers in mid-September 2008. Deflation fears meant that markets had little interest in inflation protection, and consequently inflation protected securities also performed extremely poorly.

However the unbridled pessimism that characterised market sentiment in late 2008 abated during 2009, and markets became less pessimistic about the outlook for the global economy. The functioning of world money and credit markets has progressively normalised. The result has been sharply higher share prices, higher commodity prices, much tighter credit spreads and higher Government bond yields.

Economic conditions in the world economy deteriorated over the course of the year. All the world’s major developed economies are now firmly ensconced in recession. In the case of Japan and the UK, the recession is as severe as any in living memory.

Here in Australia, economic growth has slowed to a crawl over the past year, and the economy has almost certainly fallen into recession, despite the fact that economic data released in recent months have tended to surprise on the upside. Retail spending seems to have been supported by the Government’s cash hand-outs. Housing finance has picked up – particularly for new housing construction – spurred on by extremely low interest rates, and the Government’s grants to first home buyers. However, we have yet to see the full effect of the global recession on exports or business investment.

Moreover, every leading indicator of employment is pointing to sharply higher unemployment rates over the coming year.

Hopes that the major emerging market economies of China and India could sail through this crisis relatively unscathed appear to have been dashed. Chinese growth in particular slowed significantly – industrial output growth fell to its slowest pace in a decade. However, more recent data out of China suggest that some pick-up in growth may be underway.

Trade and production data in some of the world’s most trade dependant economies – including Japan, non-Japan Asia, and Germany – have been notably worse than elsewhere in the last few months. Much of this weakness appears to reflect the collapse of trade finance activity, and indeed world trade, in the wake of the Lehman Brothers failure (see charts below). There remains considerable debate as to whether the Lehman Brothers failure represents an unavoidable consequence of the financial crisis or a policy blunder. We lean towards the latter interpretation.

In March 2008, another US investment bank, Bear Sterns, was facing failure, and because of the institution’s pivotal role in the US and global financial system, the US Treasury and Federal Reserve engineered a bail-out of the institution by JP Morgan, under which the business of Bear Sterns was absorbed into JP Morgan, and the troubled assets of the institution were taken on and guaranteed by the Federal Reserve. In the wake of that operation, market participants felt that the rules of the game were reasonably clear: viz, any institution that occupied such a pivotal position in the system would have the support of US Treasury and Federal Reserve if it faced difficulties. As a consequence, market participants felt relatively confident in acquiring the short-term debt obligation of such entities, continuing to utilise them as counterparties for a range of transactions, and holding their equity. By allowing Lehman to fail, the rules of the game appeared to collapse, and with it, confidence in the system.

The failure of Lehman Brothers followed a period where key US institutions such as the investment bank Merrill Lynch, the world’s largest insurer AIG, and key US mortgage lenders Fannie Mae and Freddie Mac had been taken over, nationalised, or sent into bankruptcy. Institutions in the UK and Europe have faced similar difficulties. It is now clear that during the aftermath of the Lehman Brothers failure, the world financial markets and economy stood on the edge of an abyss. Flows of credit that are the lifeblood of the world economy in many cases ceased. For exporters and importers, trade finance was extremely difficult to obtain. Corporate debt markets became dysfunctional, and in the case of high yield securities, there was no market to speak of. Interbank lending markets were severely restricted, and cost of funding for the world’s banks soared.

In response, the world’s monetary authorities stepped up their injections of liquidity and asset purchases. Later in the year, further capital injections were made into US banks by the US Treasury, and by year’s end, the major US car makers were in line for emergency funding from the same program that had been set-up to aid troubled financial institutions. President Obama’s much anticipated $789 billion stimulus package passed through the US Congress in February. Additionally, a $275 billion housing plan aimed at preventing foreclosures and attempting to stabilise the housing sector was introduced.

During the past year, policymakers have continued to take steps to address this crisis that are unprecedented in both their nature and scope. Fiscal policy measures have been taken in many countries, including here in Australia. The world’s central banks have reduced official interest rates aggressively, and injected huge amounts of liquidity into the financial system in a bid to get money and credit markets working again. These efforts are critical, because in the absence of properly functioning markets for credit, and financial institutions willing to lend, traditional monetary policy is close to impotent, and generating a sustainable recovery in private demand will be close to impossible.

At the time of writing, conditions in money and credit markets have continued to improve, although they have yet to return to anything that might be described as normal trading conditions. Share prices, while still sharply higher than their recent lows, have fallen across the globe. While there has been some improvement evident in the economic data released across the world so far this year, the recession is far from over. Share markets seem to have gotten ahead of themselves in the latter stages of the financial year, and consequently, their partial retreat appears entirely justified.

At MLC, we spend a good deal of time assessing the medium to longer-term outlook for economies and investment returns. Before this rally began in early March, prospective investment returns for domestic and global shares, and for non-Government securities looked very favourable – significantly higher than historical averages. Given the size and speed of the recovery so far, those prospective returns have come down sharply, but are still reasonably favourable.

In the short term, we believe the pathway towards sustainable recovery – both in the economy and investment returns – remains highly uncertain. What kind of news would we need to hear, what questions need to be answered and what developments would we like to see in order to become more optimistic?

Here is a list, but by no means an exhaustive one.

  • So far, the loan and securities losses faced by banks and other financial institutions have mostly been related to the US housing market collapse. Just how bad will the non-housing credit losses be in this recession, and do the banks have enough capital to cushion against those losses? The US Federal Reserve suggests that the major US banks need to raise relatively little capital to provide that cushion. For our part, we think US banks need to raise considerably more capital than the $75 billion or so identified by the Fed.

  • In the US and elsewhere in the English speaking world, households have increased their saving. In Australia, this has been achieved (so far) with very little weakness in consumer spending, but the US and UK have not been so lucky, and consumer spending in those economies has fallen sharply. Sharply lower household wealth has triggered higher rates of saving – a reversal of the trend of the past decade or more. It remains unclear how far this trend has to go – we have no way of knowing in advance just how high the saving rate will need to rise in these economies (and hence how weak, and for how long, consumer spending will be).
  • While the problems in the world’s banking system have restrained the supply of credit, the demand for credit from the private sector has been very weak. We need to see signs of a pick-up in credit demand. Just when will the private sector’s appetite for credit improve – not the kind of voracious, unsustainable appetite for credit that led the world to financial obesity, just normal, garden variety demands for credit for home building and business investment? Thankfully for world bond markets, this lack of appetite for debt has allowed Governments to have the field all to themselves when it comes to borrowing money. Even after their recent sell-off, long bond rates are still very low historically. At some point however, the competition for funds between Governments and a resurgent private sector is likely to be problematic for bond markets.

At the end of the day, the share market is a snapshot of the businesses that comprise the economy. Over time, those businesses profit from meeting the needs of their customers, pay dividends, and reinvest in order to grow. Share markets mostly reflect that reality. Extended periods where share markets fail to deliver are rare, but they have happened. Consequently, not everybody can or should have all their eggs in the basket labelled ‘shares’.