MLC Annual Review
September 2009
MLC Investment Management
Level 12, 105 –153 Miller Street
North Sydney NSW 2060
Important information
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 September 2009, unless otherwise stated.
The specialist investment management companies are current as at 30 September 2009. Funds under management figures are as at 30 September 2009, unless otherwise stated. Investment managers are regularly reviewed and may be appointed or removed at any time without prior notice to you.
MLC IncomeBuilderTM Commentary
Benefits and risks of Australian shares
/ When you invest in Australian shares, you effectively own a “share” in companies listed on the Australian share market.Things to consider:
- Returns are driven by many factors including the economic environment, as this tends to influence company profit expectations.
- The Australian share market is currently dominated by a few industries such as Materials, Financials and REITs.
- Australian shares may provide tax advantages through dividend imputation (franking) credits.
- Australian shares can be volatile and are usually included in a portfolio for their growth characteristics.MLC IncomeBuilderTM however, is different from most Australian share investments as it focuses on generating a growing income.
Objective
/ The objective of the MLC IncomeBuilderTM strategy is to invest in companies that are expected to deliver a growing dividend stream over time.The Fund is also expected to generate tax effective returns.The fund is also expected to outperform the S&P/ASX 200 All Industrials Accumulation Index (“All Industrials”) over rolling 4 year periods, but this is not a core focus of the fund.
How you can assess performance
/ You can assess performance based on the annual growth in dividends received from the underlying companies.There is no Market Benchmark for the Fund due to its focus on growing dividends.
Where MLC invests your money
/ The Fund invests primarily in Australian companies that have the potential to provide future growth in dividends.The Fund is expected to generate tax effective returns by:
- investing in companies expected to have high franking levels, and
- carefully managing the realisation of capital gains.
Executive summary
/ What a difference a few months makes. In your June quarterly report, we noted that the Australian share market’s financial year return was the worst for 27 years. Here we are barely three months later and the market’s one year return is back into positive territory. The All Industrials Index, having risen for four consecutive months to September, is now up by 8.6% from a year ago. This welcome recovery has been in response to tentative signs of economic recovery, better global credit market conditions and a reporting period in August-September that revealed company profits hadn’t fallen as much as the market was expecting.As an income focused fund, MLC IncomeBuilderTM has had a good track record of growing annual distributions, having done so for eight consecutive years. However, achieving MLC IncomeBuilderTM’s growing income objective this year will be very challenging because the economic slowdown has hit the profitability and dividend paying potential of many companies. An early clue as to the likely impact on your distribution for the year occurred in August when the quarter’s 1.15cents per unit distribution came in 40% lower than last year’s.
The secondary objective of MLCIncomeBuilderTM is to generate returns better than the market (in this case the S&P/ASX200 All industrials Accumulation Index). It is pleasing to report that MLC IncomeBuilderTM’s 14.7% return for the year is not only in positive territory (compared to the negative result just three months ago) but also significantly better than the market’s return.
This sound result was due largely to the stock selection of Maple-Brown Abbott who manages 70% of your strategy. Their stock selection, which includes companies with “defensive” characteristics who have been able to maintain or grow their dividends has been beneficial to you. Your other manager, Vanguard also achieved a positive return that was slightly in excess of the market’s.
The table outlines the performance
/ Performance to 30-Sept-09 / Product / 5 Years % pa / 3 Years % pa / 1 Year % / 3 Months %MLC IncomeBuilder Fund
(takes into account fees) / MLC Wholesale / 7.4 / 0.2 / 13.6 / 24.8
MLC IncomeBuilder Fund
(takes into account fees and tax) / MLC Masterkey Super Fundamentals / - / - / 13.5 / 22.5
MLC Masterkey Gold Star / 6.9 / 0.3 / - / -
MLC IncomeBuilder Fund (before taking into account fees and tax) / MLC Wholesale / Masterkey Super / 8.4 / 1.1 / 14.7 / 25.2
S&P/ASX 200 All Industrials Accumulation Index / 7.4 / -0.9 / 8.6 / 26.1
AbsolutePerformance
/ MLC IncomeBuilderTM is a unique fund because its primary focus is on providing investors with a growing income stream. As the following Annual Distribution chart shows, MLC IncomeBuilderTM has a very strong history of growing annual distributions. Since the Fund’s inception in 1995, there have been only two years (1998 & 2001) when the MLC IncomeBuilderTMUnit Trust failed to grow its underlying income distribution. This is a sound result considering the many market and corporate earnings cycles that have been experienced over that period.However, the economic environment we are in today is probably the most challenging in MLC IncomeBuilderTM’s fifteen year history and expectations of another rise in MLC IncomeBuilderTM’s distribution this year are probably misplaced. The profit reporting period in August/September demonstrated that there has been aslowdown in corporate profitability and many companies have responded to this and the uncertain outlook by cutting their dividends.This has had an impact on MLC IncomeBuilderTM’s quarterly distributions this year, which have been lower than last year’s.
Looking ahead, the key issue is the longevity of Australia’s economic resilience and how much company earnings and dividends will recover. The behaviour of the market in the last six months, where the All Industrials Index has risen 40%, suggests that the bad times are over and it is clear sailing from here. However, markets are typically forward looking and the market recovery that you have seen in the last six months is based on expectations that future company earnings will recover, and not on what is happening today.
Based on the comments many companies have given to Maple-Brown Abbott, any meaningful earnings recovery is still off in the distance. Companies they have visited are saying that business conditions today and in the near future remain challenging – conditions are better than they were but they are still challenging. Earnings aren’t expected to recoveruntil the first half of 2010 and few companies will be prepared to increase dividends in such an environment. This suggest that company dividends will remain under pressure and may fall a further 10-15% in 2010. This is why we believe your MLC IncomeBuilderTM distribution for the year will be lower than last year’s.
Based on your recent distribution for the three months to 31 August, our caution may not be misplaced. The August quarter distribution was 1.15 cents, 40% lower than last year’s quarterly distribution.
It is important to highlight the two main reasons for the decline in distribution:
1.Dividends are down across the board (with few exceptions).
2.We have amended our distribution policy to be more conservative. This means that on a quarterly basis MLC IncomeBuilderTM will only distribute interest and income received by Australian companies. Any income received from offshore companies or listed unit trusts is withheld from the quarterly distribution and will be included in the final distribution of the financial year. This change is to ensure that the Fund does not over-distribute during the financial year. All things being equal, this means you will likely notice your quarterly distributions are less than the corresponding quarter the previous year.
Perhaps a more meaningful way to analyse the Fund’s distribution is on a 12 month basis. In the table below, which compares the income that has been distributed for the last four quarters, you can see that the underlying income distribution for the 12 months to 31 August 2009 was down 11% when compared to the corresponding period in 2008.
We understand the lifestyle constraints that a lower distribution this year may impose on you. We may in fact be overly cautious in flagging this to you if economic recovery here and overseas is faster than we expect. However, we think it is prudent to be cautious so that you can plan accordingly. Realistically, MLC IncomeBuilderTM’s ability to grow income distributions is largely dependent on the dividends paid by companies it owns. As we have already seen, many companies have either cut their dividends or warned that their dividend policy may need to be revised if earnings remain under pressure.
MLC IncomeBuilderTM also aims to achieve a return above the S&P/ASX200 All Industrials Accumulation Index, though it should be noted that this is secondary to the primary objective which is to grow income.
The total return of MLC IncomeBuilderTM in the year ended 30 September 2009 was 14.7%, which is a significant turnaround from the negative result you received in the year to 30 June. It is also very pleasing that this return is significantly better (+6.1%) than the market benchmark return.
Annual distribution
/Quarterly Underlying Income Distribution Comparison
/ 2007/8 (cpu) / 2008/9 (cpu) / % ChangeNovember / 2.36 / 2.78 / 18%
February / 1.88 / 2.00 / 6%
May / 3.05 / 2.28 / -25%
August / 1.91 / 1.15 / -40%
Total (12 months) / 9.20 / 8.21 / -11%
Source: MLC IncomeBuilderTM Unit Trust
Your managers
/ MLC has appointed two investment firms, Vanguard and Maple-Brown Abbott, to manage the MLC IncomeBuilderTM strategy.Maple-Brown Abbott manages 70% of the portfolio on an “active” basis. This means that Maple-Brown Abbott restricts their stock selection to only those companies they believe will contribute to MLC IncomeBuilderTM’s objectives. We believe Maple-Brown Abbott is perfectly suited to the MLC IncomeBuilderTM mandate as their investment approach (which also tends to be low turnover) targets attractively valued companies with dividend growth potential to be held for the long-term.
Maple-Brown Abbott made a significant contribution to your return. Their overall return was 16.9% and this was 8.3% higher than the market. This is an outstanding result which they achieved in some of the most difficult market circumstances for many years. Their small margin of underperformance in the quarter is due to companies such as Telstra and Fosters who are consistent dividend contributors butwho underperformed companies more exposed to economic recovery.
Vanguard manages 30% of the portfolio on an index basis, which delivers a portfolio that largely mirrors the stocks and their respective weightings within the S&P/ASX200 All Industrials Index. Not surprisingly, this means the return of Vanguard is generally close to or resembles the performance of the index. This was the case in the year to 30 September 2009, with Vanguard returning 9.5%.
The appointment of Vanguard is consistent with MLC IncomeBuilderTM’s primary objective to grow income distributions because their index-based approach provides access to the dividend income flowing from all the companies within the industrials market. Vanguard’s index approach is also beneficial from a tax perspective as it typically entails very little portfolio turnover.
Manager summary table
Manager / Style / Tailored mandate? / Key role in strategy / Key performance pointsMaple-Brown Abbott / Value based active stock selection / Yes / Focus on dividend growers / Range of company contributors
Vanguard / Index replication / No / Index replication / Index like returns
Note: These are our judgements and the actual outcomes may differ to this. It is difficult to explain the role of any manager in a few words. Details of overall expectations were discussed in our Strategy Enhancement document.
The graph shows manager excess returns vs index
/Strategy exposures
/ As mentioned earlier in this report, MLC IncomeBuilderTM’s stock selection tends to be biased to industrial companies (rather than resource based companies) as, over time, they have demonstrated a more consistent track record of growing dividends. While your active manager, Maple-Brown Abbott, is not excluded from owning resource companies, their focus on companies that provide a growing and sustainable dividend stream has meant that resource companies have not been owned by MLC IncomeBuilderTM for some years.Sector exposure as at 30 September 2009
/The following table shows the top ten stocks by portfolio weight in the MLC IncomeBuilderTM Portfolio as at 30 September 2009
/ Stock Name / Industry Sector / Portfolio WeightNational Australia Bank / Financials / 10.1%
ANZ Banking Group Ltd / Financials / 9.6%
Westpac Banking Corporation / Financials / 9.3%
TelstraCorporation Ltd / Telecommunication Services / 6.9%
Commonwealth Bank of Australia / Financials / 6.4%
Wesfarmers Ltd / Consumer Staples / 4.3%
BramblesLtd / Industrials / 3.9%
FostersGroup Ltd / Consumer Staples / 3.5%
Westfield Group / Financials / 3.2%
Woolworths Ltd / Consumer Staples / 2.9%
MLC review for the year ending 30 September 2009Page 1 of 10
Stock story
/Coca-Cola Amatil is a company that almost seems tailor made for an income-focused fund like MLC IncomeBuilderTM. As this chart shows, Coca-Cola Amatil has a strong history of growing its dividends over the last ten years.
In 1999-2000, the company paid a dividend of 12 cents per share (“cps”). Last year’s dividend was 39 cps, more than three times what it was ten years ago. This year looks like being the tenth consecutive year of dividend growth as the 18.5 cps interim dividend paid in October was 8.8% higher than last year’s interim.
So, if you bought $10,000 worth of Coca-Cola Amatil shares on June 30, 1999 (at $3 per share) and owned them through to today, you would have received dividends totalling $8,800 over this period, plus franking credits along the way as well.
This is what MLC IncomeBuilderTM is designed to capture for you – accessing the growing dividend streams of growing companies like Coca-Cola Amatil. MLC IncomeBuilderTM has owned Coca-Cola Amatil for a number of years (it is currently 2.4% of your strategy) so you have benefited from the company’s impressive track record of dividend growth and franking credits.
MLC review for the year ending 30 September 2009Page 1 of 10