July 2014 — Over the Horizon Market Commentary by David Offer

The Australian share market was strong in July, with our All Ordinaries Index up 241 points to close at 5623, an increase of

4.5%. As we move into August and the start of the 2013/14 full year reporting season, there has been some recent

weakness, with our market off 1.1% at the time of writing. However, given the extent of global issues at the current time

and allowing for some companies already going ex-dividend, this is arguably not a bad outcome.

Next month we will look forward to providing an overview of the reporting season. To date, Telstra’s increase in profit by

14.6% to $4.3 billion as well as announcing an Off-Market Share Buyback stands out. In considering the merits of this

buyback, given the significant scaling likely for those who sell into the buyback and large capital component, we do not

believe it is appropriate to specifically buy shares to participate. However, for existing Telstra shareholders on a zero tax

rate such as superannuation funds that are in pension phase, it may be appropriate to submit existing holdings into the buy

back and to then buy back on market shares accepted. We will be in touch with investors who should consider this option

in September, mindful the closing date for the buyback is Friday, 3 October.

For those who can benefit from Off-Market Share Buybacks, all eyes will be on BHP Billiton when it reports on Tuesday, 19

August to see if its widely expected buyback comes to fruition. BHP Billiton is expected to report a profit of AU$14 billion

and is also likely to announce a spinoff of its aluminium, bauxite and nickel assets into a new company via an in specie

share distribution.

To date, there have been few nasty reporting surprises that come to mind … with QBE’s annual profit downgrade made

before the reporting season commenced with its annual share market confession. I suspect that when QBE finally reports

a clean result, without an accompanying annual profit downgrade, investors that have shown considerable patience over

the last 7 years will finally be rewarded.

Overall, the share market remains buoyant and this can largely be attributed to the lack of yield orientated investment

alternatives available elsewhere. Government bonds have traditionally been a safe haven for more conservative income

orientated investors but, as illustrated below, the 10 year sovereign bond rates for Australia and many other countries

presently offer very slim pickings.

Country 10 Year Note Type Rate Australia CGB 10 Year 3.39%

United States T-Note 10 Year 2.34%

United Kingdom UK Gilt 10 Year 2.33%

Germany BUND 10 Year 0.95%

France BTAN 10 Year 1.35%

Italy BTP 10 Year 2.61%

Japan JGB 10 Year 0.50%

Hong Kong HKG 10 Year 1.89%

Germany now joins Japan and Switzerland as a developed nation able to borrow money at less than 1% for a decade.

With the interest rate payable on long term sovereign debt continuing to trend down, bond markets don’t paint a positive

picture towards strong and improving global economic growth. Low bond yields also suggest investors have an extremely

benign outlook on inflation. If proven right, investors in government bonds stand to make next to nothing on the nominal

rates they are prepared to accept for the next decade. If proven wrong, they run the risk of significant capital loss should

the downward trend in long term debt yields reverse.

With neither investment alternative attractive, investors are looking elsewhere. The impact of investors chasing yield is

clearly obvious in our high yielding industrial shares such as the banks, Telstra, Wesfarmers and Woolworths. It is now

also having an unexpected impact in the hybrid security space, a form of investment that is well represented in many

income and more capital stable orientated portfolios. Some unexpected windfalls have eventuated as detailed with the

examples provided in the following table.

Security Code Date Issued

Current Price

Income Paid

Capital Growth

Total Return

Annualised Return

Return To Maturity

Bank QLD Pref. Shares

BOQPC 27/12/2012 $109.34 $10.46 $9.34 19.8% 11.5% 5.81%

Suncorp Unsecured Note

SUNPD 23/05/2013 $104.00 $6.91 $4.00 10.9% 8.7% 4.51%

Commonwealth PERLS VI

CBAPC 18/12/2012 $106.50 $11.02 $6.50 17.5% 10.1% 5.18%

ANZ Preference Shares

ANZPD 08/08/2013 $105.95 $6.41 $5.95 12.36% 12.3% 5.60%

Macquarie Notes MQGPA 11/06/2013 $106.01 $6.73 $6.01 12.74% 10.9% 5.37% Crown Unsecured Notes

CWNHA 17/12/2012 $109.75 $13.88 $9.75 23.6% 13.8% 5.28%

For risk adverse investors, lending money to the banks as opposed to putting your money on deposit in the banks has

clearly been the better investment proposition over the last few years. With the capital growth that has eventuated,

coupled with the above average income paid, many of hybrids such as those above have provided returns since listing that

are comparable to what one would expect from a normal year of returns from direct share investment.

However, the returns experienced to date will not continue going forward. Factoring in the loss of capital that will arise in

these securities as they are eventually redeemed at their respective face values of $100, the total returns these securities

offer to maturity is much more modest and in the order of 5.3%.

It is worth noting that in the hybrid space, the market is giving less regard to the security of the underlying investment. For

example, the Macquarie and Crown Notes now offer a comparable return to the more secure Commonwealth PERLS VI

security. When investors start to discount risk, this can signal a fully valued market.

So hungry is the market for yield, that Commonwealth’s PERLS V, which are due to be redeemed for $200 in October, are

trading at $203 ex interest. Investors are prepared to buy and lock in a small loss just to have an allocation in the new

securities that will replace them. On that note, we expect to secure an allocation in the new CBA hybrid security, which is

expected to offer a grossed up yield in the vicinity of 5.5%. When compared to the yield of existing listed securities and

low risk profile of Commonwealth bank, this appears likely to be an attractive offer.

We are not adverse to taking profits on some of the above income securities to maintain portfolio liquidity or switch to the

more attractively priced upcoming Commonwealth Bank issue and, to that end, should you hold such securities and would

like to discuss further, please do not hesitate to contact our office and we would be happy to discuss this with you.

Likewise, please contact our office should you wish to discuss any other aspect of your investment portfolio.

Sincerely

David Offer

AUTHORISED REPRESENTATIVE 259188

Director

HORIZON INVESTMENT SOLUTIONS PTY LTD

SUITE 1, POST OFFICE PLAZA, 153 VICTORIA STREET, BUNBURY WA 6230

T. 08 9791 9188 F. 08 9791 9187

E.david.offer@horizonis.com.au www.horizoninvestmentsolutions.com.au

Horizon Investment Solutions Pty Ltd, ACN 083 142 438, ABN 79 668 035 212, AFSL 405897

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