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  1. 1. MLC Investments MLC Horizon 2 Income Portfolio About the Portfolio Target Asset Allocation The MLC Horizon 2 Income Portfolio MLC Wholesale Horizon 2 Income Portfolio aims to grow wealth for a low to Enhanced Cash, 10.0% Global Mortgages, 0.5% moderate level of expected volatility. Global Bank Loans, 1.1% IncomeBuilder, 12.0% The Portfolio is invested with a bias Global High Yield Bonds, Global Shares (unhedged), 1.5% towards defensive assets and gives Global Multi-Sector 4.0% Global Shares (hedged), priority to providing a regular income Bonds, 1.2% 1.0% Global Non-Government stream with some tax advantages. Bonds, 8.9% Global Property Securities, 4.0% The Portfolio is designed to be a Australian Property Global Government complete investment portfolio solution. Bonds, 6.1% Securities, 9.0% It’s well diversified within asset classes, Global Absolute Return across asset classes and across Bonds, 4.4% investment managers who invest in Australian Inflation-Linked many companies and securities around Bonds, 7.0% Australian Bonds, 29.4% the world. Source: MLC Investment Management MLC Horizon 2 Income Portfolio Performance 3 month 1 year 3 year 5 year Performance to 31 March 2010 % % % p.a. % p.a. MLC Wholesale 1.7 18.3 1.5 - (before taking into account fees) MLC Wholesale 1.4 17.1 0.6 - (takes into account fees) Source: MLC Investment Management Executive summary All the asset classes the Portfolio invests in provided positive returns for the year to 31 March 2010. Some of the higher risk asset classes, particularly higher credit risk bonds, Australian shares, Australian and global property securities, were strong this year due to robust corporate earnings and buoyant investor risk appetites. That’s why the Portfolio produced a double-digit return. While positive returns across all the asset classes offset the falls during the GFC, the extreme market moves of the last three-years are unusual for this Portfolio. These strong returns were achieved despite the upheaval in global bond markets during the quarter as a result of the sovereign debt issues facing Greece and other peripheral European countries nicknamed ‘PIIGS’. Further information is provided in the ‘Bond Story’ at the end of this section. Governments, particularly in the developed world, have borrowed massive sums to fund fiscal stimulus packages and the market is increasingly concerned about their ability to
  2. 2. service their debt. Somewhat surprisingly, the market is currently more concerned about some of the developed countries defaulting rather than some highly-rated companies and governments of emerging countries. In this environment of increasing government bond yields, the Portfolio’s focus on shorter-maturity government bonds has paid-off. Despite the market rebounding strongly over the past year, the global economy is still very fragile and there’s still the risk of more shocks which may unsettle the markets further. There will always be shocks, they come and go through time. Some become much larger than they first appear eg the sub-prime crisis was the beginning of what eventuated into the global financial crisis. And others pass fairly quickly with only small impacts on values. Investors can’t expect to avoid all the risks of investing without foregoing higher potential returns. While it may have seemed high risk investing a year ago, the market has charged on and paid handsome rewards to those invested in higher risk assets. We made some important changes to the Portfolio in February 2010. The changes are designed to strengthen defensive characteristics of the Portfolio and improve our ability to preserve capital when growth assets are weak. Details are in the MLC Investment Management Team Strategy Changes section and at Absolute returns The graph shows absolute total returns of the Portfolio over 1 year and 5 year periods. Historical Absolute Performance MLC Wholesale Horizon 2 Income Portfolio (after taking into account fees) 20% 15% 10% Return % p.a. 5% 0% -5% -10% -15% 2008 2009 2010 1 Year Ended 31 March Source: MLC Investment Management Contributors to the Portfolio’s absolute returns • Within the debt securities allocation, the higher credit risk sectors such as Global High Yield Bonds drove returns. Global high yield bonds have continued to outperform lower credit risk bonds in Australia and globally. Although the exposure to this sector is relatively small, the Portfolio was given a great boost because the one-year return of the sector was extremely strong. • Australian Shares (IncomeBuilder) returned +43.9% for the year and was a large contributor to returns, despite the Portfolio only having a modest allocation of 12% to this asset class. • Although Hedged Global Shares (+51.8%) and Australian Property Securities (+42.7%) provided strong returns, their contribution to returns was smaller given the lower allocation to these asset classes in the Portfolio of 1% and 9% respectively. MLC Wholesale review for the year ending 31 March 2010 Page 2 of 8
  3. 3. Detractors from the Portfolio’s absolute returns • Global government bonds have been relatively weak this year due to concerns about the increase in supply. Governments, particularly in the developed world, have had to borrow massive sums to fund fiscal stimulus packages, raising concerns about their ability to service their debt. Because the Portfolio has more exposure to government bonds with a shorter-term to maturity, the Portfolio wasn’t as impacted by rising expectations of increases in interest rates in most developed countries. • The three-year return from Global Shares and Australian and Global Property remain negative. The chart shows asset class contributors to the return Contribution to Total Return by Asset Class MLC Wholesale Horizon 2 Income Portfolio (before taking into account fees) 20 (annualised for periods greater than 1 year) 15 Return Contribution % 10 5 0 -5 IncomeBuilder Global Shares - Global Shares - Australian Global Property Debt Securities Total Hedged Unhedged Property Securities Securities 3 months to Mar-2010 1 year to Mar-2010 3 years to Mar-2010 5 years to Mar-2010 Source: MLC Investment Management MLC Wholesale review for the year ending 31 March 2010 Page 3 of 8
  4. 4. Asset class role and performance Detailed commentaries for each asset class are available online Asset Class Role in Portfolio 1 year performance Australian Shares - The Australian share allocation in your portfolio invests through the While the market recovery and the Fund’s subsequent positive absolute return +43.9% in the year is pleasing, IncomeBuilder MLC IncomeBuilderTM’ strategy. The primary objective of MLC income growth isn’t likely to occur this financial year. This is directly due to the uncertain economic IncomeBuilderTM is to invest in companies that are expected to deliver environment, the subsequent fall in corporate earnings and the decision by many companies to cut dividends. (12%) a growing dividend stream over time. The strategy is also expected Distribution growth is unlikely to emerge until we return to a more normal and certain earnings environment 2 Managers to generate tax effective returns, which is meant to benefit investors when companies are happier to increase dividends. given the income focus of the Portfolio. Major contributors to returns for the year came from an overweight position to Fairfax Media and Lion Nathan (purchased by Kirin late in 2009), and an underweight position in CSL, QBE and Woolworths. On a less positive note, detractors include overweight positions to Telstra, Foster’s, Primary Health Care and Metcash, as well as an underweight position to Commonwealth Bank. Global Shares (unhedged) Global Shares invests in global companies listed in sharemarkets The unhedged Global Shares strategy returned +19.6% for the year, before fees and taxes, beating the market from around the world. The strategy also invests in emerging by +1.3%. This number has been driven by strong excess returns from Sands Capital (+25.9% over the (4%) markets, helping capture key opportunities from these new markets. benchmark) and Dimensional (+15.7% over the benchmark). The mix of managers with different styles of 8 Managers investing helped the strategy throughout the year. All managers provided positive, double-digit absolute returns for the year. Capital (-7.9% below the benchmark) and Walter Scott (-6.7% below the benchmark) lagged the market over the year in an environment where companies with higher risk levels rose above the conservatively placed quality companies favoured by these managers. Global Shares (hedged) In addition to what’s discussed above, returns are hedged back to The hedged Global Shares strategy returned +51.8% for the year. The substantial performance difference the $A, significantly reducing the impact of currency movements on when compared to the unhedged strategy was due to the rise in value of the $A against a basket of currencies (1%) returns. which represents Australia’s major trading partners by +25% for the year. All countries contributed positively, In addition to those managers with manager performance the same as in the unhedged strategy. above, there are 2 specialist currency managers. Australian Property Securities The strategy is designed to provide comprehensive exposure to The Australian property securities strategy returned -0.9% in the March quarter and +42.7% in the year to 31 Australian listed property securities (including REITs). It aims to March. Resolution Capital continues to perform strongly with a return of +44.5% in the year, which was 2.5% (9%) deliver growth by using investment managers who invest and higher than the market’s return. Challenger’s return was in-line with the market. 2 Managers diversify across many companies and securities within that asset class. Returns from property are generally expected to be higher than those from bonds, but lower than shares. Global Property Securities The strategy is designed to provide comprehensive exposure to The return from the Global Property strategy over the year of +85.2% was +3.3% above the market’s return. global listed property securities (including REITs). It aims to deliver Morgan Stanley (+58.4%) was the prime contributor to the out-performance as Resolution Capital (+41.4%) (4%) growth by using investment managers who invest and diversify and LaSalle (+42.7%) underperformed. REIT strategies contributing to this outperformance included: 3 Managers across many companies and securities within that asset class. Returns from property are generally expected to be higher than those • overweighting Manhattan office specialist SL Green MLC Wholesale review for the year ending 31 March 2010 Page 4 of 8
  5. 5. Asset Class Role in Portfolio 1 year performance from bonds, but lower than shares over the medium to long term. All • overweighting Japanese Real Estate Operating Companies such as Mitsubishi Estate and Mitsui returns from this asset class are fully hedged back to the Australian Fudosan dollar. • underweighting Japanese REITs which underperformed the global index by a substantial margin. Enhanced Cash (10%) Preservation of capital, particularly in recessionary and credit crunch Cash delivered a positive return this year but it wasn’t as high as other debt sectors. Because cash is an environments and when interest rates and inflation are rising. inherently conservative asset class, there’s little opportunity to generate excess returns without taking on risk. 1 Manager Antares, our cash manager, actively manages enhanced cash and outperformed the market benchmark by positioning the Portfolio to benefit from increases in the official cash rate. Australian Bonds These are investment grade bonds issued by the Australian Australia is one of the first developed countries to start raising interest rates because our economy fared government, semi-governments, companies etc. They tend to relatively well during the GFC. The market has factored in more increases, with cash rates expected to (29.4%) perform well in environments of falling interest rates and inflation. In increase to 5.5% by the end of 2011. When interest rates rise, the value of bonds falls. 2 Managers some scenarios, such as a recession or deflation, these bonds are The Portfolio invests in Australian bonds with shorter terms to maturity to provide some protection from likely to do well – which means they often provide excellent increases in interest rates. This strategy paid off in this environment as yields rose mostly in the 2-3 year terms diversification in negative scenarios. whereas the Portfolio’s Australian bonds duration is close to 1 year. While this environment is not ideal for Australian bonds, the other sectors more than compensated overall returns this year. On a positive note, the Australian managers, UBS and Antares both still outperformed the market. They positioned their portfolios for an increase in interest rates and adopted a short duration position which paid-off. Global Government Bonds In addition to the information on Australian bonds, global government Global government bonds are one of our new specialist debt sectors, resulting from the changes announced in bonds are limited to sovereign or treasury issued bonds and they February. Previously these bonds were included in global nominal bonds and multi-sector bond strategies. (6.1%) generally provide a good risk-return trade-off because they’re Although the quarter didn’t see much movement, global government bond yields have been rising (and returns 1 Manager diversified across many countries, each with a different interest rate have been weak) over the past year due to concerns about the increase in supply of bonds needed to fund environment. Government bonds perform well in credit crunches. huge budget deficits. Attention at the end of March was on the 10-year swap spreads (difference between AA- rated bank swap rates and US Government Bonds yields) which turned negative. Negative swap spreads reflect that markets perceive AA-rated banks’ risk of default to be lower than US government credit. While negative swap spreads have occurred in emerging countries in the past, this is a first for the US. We’ve less than a quarter’s performance for Goldman Sachs as they’re a new manager. Global non-government bonds These are investment grade bonds issued by government agencies, Global non-government bonds are also one of our new specialist debt sectors. Previously these bonds were (8.9%) companies etc. In addition to the information on Australian bonds, included in global nominal bonds and multi-sector bond strategies. global non-government bonds generally provide a good risk-return With interest rates in Australia rising quite quickly, being diversified across global non-government bonds 2 Managers trade-off because they’ve a diversified exposure across many boosted returns this year. We saw returns from the falling yields on corporate investment grade (higher credit different industries, companies and countries (each with a different risk) securities from March 2009 onwards. Within corporate bonds, financials did particularly well. interest rate environment). We’ve less than a quarter’s performance for Wellington Management and Rogge as they’re new managers. MLC Wholesale review for the year ending 31 March 2010 Page 5 of 8
  6. 6. Asset Class Role in Portfolio 1 year performance Global multi-sector bonds Global multi-sector bond strategies have a longer-term focus and the The Portfolio has a small exposure to this sector because it has a longer term focus. Prior to the changes, the (1.2%) managers have discretion to invest in the different debt sectors sector was named Real Return Strategies as the managers had an objective to achieve a return above based on their own view - another source of diversification. inflation. The managers now have a market-oriented benchmark. A previous real return manager, PIMCO was 3 Managers re-appointed to a global multi-sector bond mandate but Bridgewater, the other real return manager was removed. Amundi and Franklin Templeton have joined PIMCO as managers in this sector. PIMCO (+18.6%) provided an excellent return this year due to their credit exposure, particularly to corporate bonds issued by financials. This sector was the strongest contributor to returns within the debt component of the portfolio this year. Global Absolute Return Bonds These are flexible strategies where managers have discretion to We added an allocation to global absolute return bonds from February, managed by Deutsche. Comments on invest across a broad spectrum of bonds to achieve a higher return returns will be possible from the June quarter onwards, as this is a new manager. (4.4%) than cash. They’re used as a low risk diversifier to Australian bonds 1 Manager and enhanced cash. Australian Inflation-Linked Inflation-linked bonds are similar to conventional bonds except that Breakeven inflation is the difference between the yield on nominal government bonds and inflation-linked Bonds repayments are directly linked to inflation. They therefore offer bonds. It provides an indication of whether inflation-linked bonds represent good value. The breakeven inflation effective medium to long-term protection in periods of high inflation or rate has continued to drift higher to 3% which is higher than actual inflation and is the top of the RBA’s target. (7.0%) expected inflation, with some volatility in returns due to their long That’s why Australian inflation-linked bonds underperformed Australian bonds over the year. 2 Managers term nature. Returns can be quite soft during periods where markets anticipate very low levels of future inflation, such as at the start of 2009. Global High Yield Bonds These are bonds issued by companies with a credit rating below The credit spread (difference between yields on high and low credit risk securities) has now narrowed from their (1.5%) investment grade. They usually pay higher rates of interest than peak at almost 22% in December 2008 to 6% at the end of March 2010. Spreads are now close to long-term more credit worthy securities because they’ve a higher risk of default. averages, reducing the potential for further gains. 2 Managers Investing in the high yield sector enables us to capture the expected Even though exposure to the sector is small, it was still the best performer this year by a large margin. Our high long-term premium paid for investing in securities with higher risk of yield bonds delivered a return just under 50%, so even a 1.5% allocation gave the Portfolio’s returns a good default. High yield bonds tend to perform well in credit expansionary boost. periods and global booms. WR Huff (+47.1%) and Oaktree (+42.9%) have produced excellent returns, with Oaktree only marginally underperforming the market benchmark. Global Bank Loans Global bank loans are a source of funding through which companies We added an allocation to global bank loans in February, managed by Shenkman Capital. Comments on (1%) rated as “high yield” can finance their operations and growth returns will be possible from the June quarter onwards as they’re a new manager. aspirations. They tend to perform well in credit expansionary periods 2 Managers and global booms. Global mortgages Mortgages are bonds which use property as security. They tend to From February there’s a distinct allocation to global mortgages, managed by Stone Tower. Comments on (0.5%) perform well in credit expansionary periods and global booms. returns will be possible from the June quarter onwards. 1 Manager Previously exposure to global mortgages was via global nominal bonds, multi-sector bonds and high yield bonds. MLC Wholesale review for the year ending 31 March 2010 Page 6 of 8
  7. 7. Bond story – Sovereign debt and the risks of using an index approach The sovereign debt issues facing much of Europe (and to a lesser extent other developed economies including the US and Japan) is the latest in a string of examples highlighting the need to take an active approach to managing bond portfolios. Investments in an indexed bond fund are usually determined by ‘market weighting’. That means investments are in the governments and companies that issue the most bonds, irrespective of whether they offer good value. We believe a more rationale way of making an investment decision is by assessing whether a bond’s return will compensate for the risk of default. All of our global bond managers constantly assess the relative creditworthiness of both company and government bond issuers and position their portfolios accordingly. They’re skilled at assessing risks and have resources to do extensive research. They don’t rely on the media for their information because when information hits the media it’s readily priced into the value of securities. That’s why active management is one of the key ways we manage exposure to risks such as the potential for governments around the world to default on their debt. Another way we manage our exposure to specific risks is through diversification. We diversify the Portfolio across debt sectors, within debt sectors and across investment managers. By doing this, our exposure to any one country or company is usually smaller than the rest of the market. Although we may not always avoid the investments that turn bad, it usually reduces the impact because we’ve many small holdings, rather than a few large holdings. Unsurprisingly, the Portfolio’s debt strategy has very little country exposure to the ‘PIIGS’. As at 31 March 2010 the exposure was: Country Exposure in MLC Horizon 2 Income Portfolio’s debt strategy Portugal (P) 0.0% Italy (I) 0.5% Ireland (I) 0.1% Greece (G) 0.0% Spain (S) 0.3% TOTAL ‘PIIGS’ 0.9% EXPOSURE This equates to less than 1 cent in every dollar invested in the Portfolio. MLC Wholesale review for the year ending 31 March 2010 Page 7 of 8
  8. 8. Important information This information has been provided by MLC Investments, a member of the National Group, 105-153 Miller Street, North Sydney 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 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 31 March 2010, unless otherwise stated. The specialist investment management companies are current as at 31 March 2010. Funds under management figures are as at 31 March 2010, unless otherwise stated. Investment managers are regularly reviewed and may be appointed or removed at any time without prior notice to you. MLC Wholesale review for the year ending 31 March 2010 Page 8 of 8