Autumn 2012

A TALE OF TWO ECONOMIESBTIM’s Joe Bracken on the global market outlook and what it means for investors

CATON’S CORNERBT’s Chief Economist shares his insights on 2012 so far

SMART INvESTINg Revisiting simple investment strategies to maximise your potential for return

Autumn 20122

3 A TALE OF TWO ECONOMIES

The greek debt problem, US economy and what the future looks like for investors

6 SO FAR, SO gOOd

Chief Economist, Chris Caton, on how the Australian economy is performing this year

8 SMART INvESTINg

The tried and tested truths of successful investing

10 FUNd PERFORMANCE

view and compare BT general Investment performances over the past five years

Autumn 2012: Contents

Welcome to Better Investor for Autumn 2012

In this edition we reflect on the first quarter of the year and consider the global outlook for coming months.

We speak to BT Investment Management’s Joe Bracken, who describes the current state of the debt crisis in Greece, and the likely impact to the global financial system if the Greek economy collapses. In contrast to the problems being endured in Europe, Bracken offers confident predictions for the growth of the US economy and for investors in general.

BT Chief Economist and resident contributor, Chris Caton, provides his regular market update in Caton’s Corner.

And finally, we revisit some of the basic investment principles that are important to think about when planning your investment strategy for the future.

We hope you enjoy this edition of Better Investor.

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Cover story

MARkET OUTLOOk: A TALE OF TWO ECONOMIESBetter Investor talks to Joe Bracken, BT Investment Management Head of Macro Strategies, about the global outlook for 2012, and what it means for investors.

How is 2012 looking so far?

It’s pleasing to say that 2012 is off to a better start than 2011 — it’s certainly looking better at this point. Generally, the world’s economy seems to be in better shape, or at least less shaky than it was last year, and there is more positive economic news, particularly coming out of the United States (US). Consequently, sharemarkets this year are up. That said, problems still persist, with the main economic issue on the horizon continuing to be high European debt levels.

How significant is the Greek debt problem?

Greece remains at centre stage, and continues to threaten European economic stability. While Greece decided to make significant cuts in order to qualify for the second bailout package from the European Union (EU), it’s nowhere near plain sailing ahead. We don’t think Greece can grow its way out of the severe economic malaise that it finds itself in. No matter what financial assistance the country gets in the short term, in the long term its underlying economic problems still remain, and this will bear down on markets for some time yet.

We believe that in the long run, Greece will need to leave the Eurozone, as its debt situation will make complying with EU membership rules impossible. Greece will then be left in the invidious position of no longer being able to go to the international markets and borrow at anything like the lower rates it was able to do so previously — simply, it will become very expensive for the country to borrow. This will prolong any kind of recovery by years, and could even prompt a slide into a depression.

The rest of Europe — the German, Italian and French banks, and the EU itself, will all have to write off the Greek debt they hold. Someone has to pay, and it’s going to be the European financial system that comes under strain and stress as a result.

Will a Greek default bring down the European Union, or worse still, the world financial system?

Fortunately, the answer is no — it’s very unlikely to destroy either.

The reasons are, firstly, that the EU has been reasonably proactive in trying to stabilise and boost the European financial system through

4 Autumn 2012

Cover story continued

the so-called LTRO (long term [debt] repurchase operation) activity that it is using to provide cheap money to financial institutions.

Secondly, we need to put the Greek situation in context. Remember that Germany, Italy and France together account for about 70% of the EU’s Gross Domestic Product (GDP). On the other hand, Greece, as well as Ireland and Portugal, are comparatively very small satellite economies which, from a European GDP point of view, are relatively insignificant. This means that a Greek exit from the Eurozone, while clearly serious, and which will make life very difficult for the Greek people, will not be of great enough magnitude to deal a death blow to the EU or the European economies.

Likewise, given the even smaller size and consequence of the Greek economy on a global scale, Greece’s problems have even lesser chance of bringing the entire international economy down. Regardless of whether Greece exits from the Eurozone or not, for the rest of the world, life and business will go on. The US and other countries, Australia included, will still continue to export worldwide, including to Germany, France and Italy, and they in turn will continue to export their products worldwide. All this taken into account, while lots of people are worried, we don’t believe the issues in Greece are serious enough to bring on another Great Depression.

How is the US faring, and economically how does it compare to Europe?

The US outlook is brightening, which is very important because the US is the country to lead the world out of recession — and that actually appears to be happening. The US consumer, economically the most important in the world, is spending more. Manufacturing is expanding, domestic vehicle sales are trending upwards, unemployment rates are falling and the US sharemarket has really taken off since the beginning of the year — the S&P 500 was up about 11.5% from the start of January to the end of February, which was ahead of the rest of the world. Overall, the US economy seems to be on track to recover and grow again, which is very encouraging.

As mentioned, the European outlook is less cheery but that aside, the purchasing managers index (PMI) for Europe is hovering around 50 (out of 100), which indicates Europe overall is neither expanding nor contracting. However, when you take a closer look at the data, you find that only the German economy is expanding, and that others, Italy and France included, are contracting. Clearly, lots of European economies are still in trouble, and really not yet back on the growth path. Generally, in Europe, consumers aren’t spending — retail sales, no doubt crimped by austerity measures, are weak, and industrial production is down and quite disappointing.

“The US — the world’s most powerful and important economy — is getting back on track, leading to what you could call a kind of grinding recovery.”

What we see when comparing the US and Europe is a ‘tale of two economies’. The US — the world’s most powerful and important economy — is getting back on track, leading to what you could call a kind of grinding recovery. Europe, on the other hand, is experiencing some economies going backwards, and the introduction of austerity measures and budget cuts in some countries means any serious recovery will be delayed for some time.

What about other regions and countries, and Australia?

In the Middle East, there is lots of sabre rattling going on with Iran over its nuclear program, and if tensions continue to increase, or worse still escalate into military conflict, the main economic effect for the rest of the world will be an increase in the price of oil. Already oil prices have risen this year, and greater tension in the Middle East, including intensifying conflict in Syria and ongoing instability in Egypt and elsewhere in the region, will only exacerbate oil price hikes. Right now it’s difficult to predict outcomes in this volatile part of the world, so we will just need to keep a close eye on it and be prepared for almost anything.

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Closer to home, data coming out of China indicates that its economy is performing reasonably well. China continues to export plenty of products to the US and Europe, and there is also significant domestic Chinese demand, all of which appears to be keeping the Chinese economy afloat at the moment. A healthy Chinese economy is particularly important for Australia given the mining industry’s dependence on it.

In Australia, the December quarter and Christmas retail figures were lacklustre; house prices year-on-year in many parts of the nation continue to fall, despite what may be a more recent lift in auction prices; inflation is reasonably in control at 2-3%, which is where the Reserve Bank of Australia (RBA) wants to keep it; and one more interest rate cut is likely this year. The RBA is being reasonably cautious and keeping a very keen eye on Europe, and if rates need to be cut again, they will be.

This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs. Past performance is not a reliable indicator of future performance.

A positive outlook for investorsFortunately, things appear to be getting better, not worse. We are looking at a world economy that’s generally growing, albeit below trend — but at least it is growing rather than contracting. This change is welcomed by share investors, because sharemarkets react positively to growth.

Many Australian companies are currently offering very attractive dividends and dividend yields. For the cautious investor moving into the Australian sharemarket, it makes sense to buy higher dividend yielding companies, as these will provide a return on dividends alone that’s at least comparable, if not better than the return from term deposits — but shares also include the potential for capital growth.

With international equities, I think investors should be cautiously looking to buy. At this stage, much of the uncertainty of last year is behind us, and headway is slowly being made. The Greek problem, while not gone, is more understandable now and many people have factored in a lot of very bad news on that front. Currently, there are some quite reasonable arguments to move back into international shares, particularly into quality US shares, followed by European shares.

Overall, our economic outlook could be reasonably described as cautiously optimistic. While there’s bound to be a few road bumps along the way, there are more reasons to be cheerful about the state of the world economy than there were six months ago. Things are looking a bit brighter, and that’s got to be good for investors who have had a rough ride in the last few years. There’s fair reason to believe this year and the next few ahead will be smoother.

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Caton’s Corner

SO FAR, SO gOOdWhen we say that nothing has really happened this year in US and European economies, does this mean well for Australian investors? Dr Chris Caton, BT’s Chief Economist, provides a global economic update for the first quarter of 2012.

No news is good news

As we began the quarter, the media spin doctors were in overdrive as we were bombarded with news that the World Bank was forecasting a global recession worse than the GFC, and the International Monetary Fund (IMF) also chimed in with a dramatic lowering of global growth prospects.

The truth is that there actually was no news — the World Bank didn’t forecast another global recession. It simply warned that it could happen, making the valid point that a further recession would be difficult to counteract because both fiscal and monetary policy are already very loose in most economies. The chief of the IMF sounded an equally dire warning of the downside risks.

These two bodies, rightly, issue updated forecasts only every six months. But markets don’t sit around thumb-twiddling — they react in real time to the ongoing flow of news. Last July, before the latest round of European paper hit the fan, the consensus view for global growth this year, as measured by Consensus Economics, was 3.6% and by January 2012, that

forecast had been reduced progressively, by a full percentage point, to 2.6%. The World Bank’s forecast, at 2.5%, was simply catching up with the view of global growth already incorporated in the sharemarket’s thinking.

Such negative rhetoric is not really intended to inform you and me; it is designed to increase the pressure on policymakers, particularly in Europe, to get on with job of finding a solution.

International developments

The ASX 200 rose to record an increase of 6.9% for the first quarter of the year. The US share market did even better, with the S&P500 index up by 12% in the quarter. This is the best start to a calendar year since 1998.

The US market appears to have performed better than the Australian over the past three years, and the single biggest reason for this is that the earnings of US companies have increased faster than those of Australian companies. Firstly, productivity growth has been faster in the US than in Australia, and secondly, the US dollar has fallen while the Australian dollar has

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How did this happen? One possible answer is a changed attitude by employers. The GFC came after several years in which the unemployment rate had been falling, and new skilled workers had been hard to find. Having worked hard to hire, employers tended to hang on to their existing workers, but did cut their hours. In 2012, uncertain about the economy’s prospects, particularly outside of mining, employers were reluctant to hire, but obtained more labour input by increasing the hours of those already employed.

It may be this two-speededness that accounts for the extremely negative mood about the Australian economy right now. Sometimes we need to remind ourselves that Australia hasn’t had an official recession for two decades, that the banking system survived the GFC well, house prices have not collapsed (except in some areas), there is no public debt problem and unemployment is far lower than in the rest of the developed world (except for Japan)!

So it came as a surprise when the Reserve Bank of Australia (RBA) didn’t lower interest rates in the quarter. This partly reflects the fact that it sees less of a threat from the European situation than it did in late-2011. It also believes that the Australian economy is continuing to grow at a reasonable, albeit unbalanced, overall rate.

The hike in some lending rates by the banks was a small surprise. I have written about this before. Briefly, the banks are correct when they say that their cost of funds is not determined solely by the cash rate, and that this cost has risen recently. But it is also correct that the cash rate does have some effect and that, if the RBA is unhappy with the current level of lending rates, it will move the cash rate to wherever is necessary to achieve lending rates that it is happy with.

The bottom line

So far, we are tracking well and three months into 2012, I see no reason (yet!) to change my end-of-year forecast of 4700 for the ASX 200.

Chris Caton Chief Economist

risen. Since, in both cases, the listed companies make a lot of money offshore, these currency movements have boosted US earnings but cut into Australian earnings.

Fortunately, the European situation has not worsened over the quarter; indeed one can make the case that it improved. In late-2011, the European Central Bank announced its Long-Term Refinancing Operation (LTRO), which provides cheap money to the European banking system, thereby keeping it liquid. Although this programme does not fix the problem it stabilises the situation and buys time for the affected countries to get their fiscal books in order. But it may, of course, be too late for Greece.

Meanwhile, concern about a slowdown in China intensified with the Government downgrading its 2012 forecast to just 7.5% GDP growth. This number is actually broadly consistent with the previously-announced 5-year plan, and the economy almost always does better than this official forecast but the current state of the Chinese economy is difficult to interpret.

Even if it were to slow, what happened in 2009 suggests that the authorities are quite adept at getting it going again. The risk to Australia is not so much that China will slow, but that the nature of its growth will change. China has been a magnificent story for Australia not just because of its size and its pace of growth, but also because it has been so commodity-intensive, due to the heavy volume of construction and infrastructure spending. By one calculation, per unit of GDP, China uses more than four times as much steel as the global average. That requires a fair bit of iron ore! In the future, China’s growth will come more from consumer spending, so its commodity-intensity will slow.

The domestic scene

There was a dramatic slowdown in employment growth in Australia over the course of 2011. In the fourteen months to February, employment has risen by only about 30,000, the sort of gain that was recorded every month on average from mid-2009 until end-2010. The unemployment rate, however, has scarcely risen, sitting at just 5.2%. The flat employment story has not been reflected in a faster rise in unemployment because the rate of growth of the working-age population has slowed dramatically, and the participation rate has declined.

The views expressed in this article are the author’s alone. They should not be otherwise attributed.

Autumn 20128

Investing

SMART INvESTINgIt pays to think about some of the basic principles of investing when re-examining your investment strategy. These simple rules can help maximise your potential for financial returns and give you confidence when making those important decisions.

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‘Stay invested’, ‘don’t put all your eggs in one basket’, ‘time in, not timing the market’. You’ve probably heard it all before, but despite the clichés, there is still a lot of value in these tried and tested investment fundamentals.

Diversify your investments

Diversifying, or not putting all your eggs in one basket, is a key element of successful, long-term investment.

In any given year, certain ‘asset classes’ — be they Australian or international shares, bonds or cash, or property — behave differently. And, there are individual assets within those broader asset classes that also perform differently. Some will go up, some down, and if you can invest in only the ones that go up, just like picking all the winning horses or Lotto numbers, you will make a fortune. But in financial markets, no one can consistently pick only winners, as no one has a real, working crystal ball.

The way around this is to manage the risk and invest across a range of assets and broader asset classes, where a dip in the fortunes of one holding can be offset by a rise in another. This way you will get steadier and smoother returns. No big rushing rises perhaps, but less likelihood of savage and sudden falls.

The easiest way to achieve broad diversification is through a diversified managed fund, such as a ‘balanced’ managed fund, which in some cases can give you exposure to literally hundreds of underlying assets, managed by a diversified range of fund managers. It’s serious diversification.

Understand and manage risk

Then there is risk, another fundamental aspect of investing. Put simply, the higher the risk you take, the greater your potential return or reward, but also the greater the potential

loss if things go sour. Investing in more risky assets like shares and property should generate higher returns over the long term than less risky, more conservative assets such as fixed interest/bonds and cash. But over the short term, the less risky assets are likely to provide you more stable and secure returns.

An interesting feature of risk for investors is that over time you can smooth out the impacts of short-term market fluctuations. To illustrate: over one or two years, shares, a relatively risky investment, can be up or down like a rollercoaster. But over five to ten years, for the long-term investor, the market and its returns are historically likely to be trending upwards, despite short-term dips.

The secret with investment risk is not to avoid it, but to manage it. It’s a very personal decision, so you need to understand what the most appropriate level of investment risk is for you given your stage in life, financial situation, goals, and how well you want to sleep at night. To do this, it’s worth getting sound, professional, financial advice.

“…the higher the risk you take, the greater your potential return or reward.”

Don’t panic

To make your investment strategy work best for you, understand and apply these key concepts, and if you do need some professional financial advice and help, don’t be shy seeking it. Whatever you do, don’t panic. It has been a tough few years on the markets, but the world’s not about to end anytime soon. Don’t hang back, keep investing, and take advantage of being able to buy into some good investment assets at relatively low prices.

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FUNd PERFORMANCEBT General Investments performance (% pa to 31 March 2012)

Fund name 3 mths 1 yr 3 yrs 5 yrs 10 yrs CPU*

DiversifiedBT Active Balanced Fund 4.73 -1.09 8.28 -1.80 N/A 0.06BT Active Balanced Fund — NEF1 4.71 -1.44 7.96 -2.06 3.32 0.00BT Asset Selection Fund1 4.94 -0.48 8.74 -1.53 3.85 0.50BT Balanced Returns Fund1 4.16 -0.62 7.55 -1.48 3.26 0.42BT Future Goals Fund 5.68 -2.82 8.07 -3.35 2.81 0.00BT Income Plus Fund 3.00 3.31 7.57 0.48 3.80 0.49BT Split Income Fund1 2.31 4.83 7.83 1.77 4.44 0.57Diversified sharesBT Diversified Share Fund 8.39 -3.30 7.85 -4.58 N/A 0.00BT Diversified Share Fund — NEF1 8.41 -3.51 7.60 -4.84 0.92 0.00BT Split Growth Fund1 9.23 -0.06 9.73 -4.44 0.25 0.49International sharesBT American Share Fund2 11.26 5.44 5.24 -3.08 -3.56 0.00BT Asian Share Fund2 11.77 -3.32 9.96 -0.28 3.54 0.00BT European Share Fund2 10.53 -4.28 4.19 -7.15 -1.49 0.00BT Global Share Fund2,3 9.08 0.38 5.88 -6.72 -3.27 0.00BT Japanese Share Fund2 9.03 3.54 -3.23 -9.22 -5.17 0.00BT International Fund2 8.85 -0.36 5.44 -7.30 -3.99 0.00BT International Share Fund1,2 8.97 0.15 6.12 -6.71 -3.59 0.15BT Technology Fund4,5 17.59 10.73 13.70 1.25 -2.42 0.00Australian sharesBT Australian Share Fund 8.19 -6.26 9.26 -1.87 6.59 0.00BT Core Australian Share Fund1 8.16 -6.53 9.03 -2.14 6.17 0.00BT Imputation Fund 7.73 -5.66 8.71 -2.78 7.61 0.60BT Natural Resources Fund1 7.67 -18.81 14.19 2.60 13.04 0.00BT Select Australian Share Fund1 8.29 -6.03 9.59 -1.52 6.95 0.22BT Smaller Companies Fund 18.16 1.97 24.98 1.61 12.53 0.00PropertyBT Property Securities Fund 7.37 1.36 14.01 -11.37 2.21 0.91Fixed Interest/incomeBT Australasian Bond Fund1 0.21 9.15 6.28 5.88 5.33 1.04BT Fixed Interest Fund 0.24 9.11 6.27 5.73 5.04 0.40BT Global Bond Fund1 -2.20 2.53 -8.87 -0.07 -0.65 0.00CashBT Cash Management Trust 0.90 4.00 3.58 4.53 4.54 N/ABT Premium Cash Fund 1.05 4.63 4.17 5.13 5.18 N/A

1_This Fund is closed to new investors.2_The investment manager for this Fund changed on 5 June 2006. Performance before this date may not be directly comparable.3_This Fund is closed to new investors and additional investment from existing investors.4_Previously known as the BT TIME Fund.5_ The investment manager and the benchmark for this fund changed on 5 June 2006. Performance before this date may not be directly

comparable.Performance figures are calculated net of all fees and before taxes. NEF = Nil Entry Fee* Distribution CPU is calculated for the period 1 January 2012 to 31 March 2012General Investments includes all Investment Options in the BT Investment Funds and BT Classic Investment Funds ranges, and the BT Balanced Deeming Fund and BT Global Share Fund. The BT Premium Cash Fund investment option is available through the BT Premium Cash Fund PDS. Please note that our Select Manager Investment Options are not listed.

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The information in this edition of Better Investor is current as at April 2012 and is given in good faith and has been derived from sources believed to be accurate at this date. It is general information only and should not be considered a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs. Returns shown are historical and you should remember that past performance is not a reliable indicator of future performance. This newsletter may contain material provided directly by third parties. While such material is published with necessary permission, BT Financial Group (BTFG) accepts no responsibility for the accuracy or completeness of, or endorses any such material. Except where contrary to law, BTFG intends by this notice to exclude liability for this material.

Things you should know General Investments includes all Investment Options in the BT Investment Funds and BT Classic Investment Funds ranges, and the BT Global Share Fund. The BT Premium Cash Fund Investment Option is available through the BT Premium Cash Fund PDS. Please note that our Select Manager Investment Options are not listed. Westpac Financial Services Limited ABN 20 000 241 127/BT Funds Management Limited ABN 63 002 916 458/BT Funds Management No.2 Limited ABN 22 000 727 659 are the responsible entities and issuers of units in the Funds referred to in this issue of Better Investor. A Product Disclosure Statement (PDS) is available for each of the Funds and can be obtained by calling us on 0800 800 661, or visiting www.btonline.co.nz . You should obtain and consider the PDS before deciding whether to acquire, continue to hold or dispose of units in the Funds. An investment in the product(s) is not an investment in, deposit with or any other liability of Westpac Banking Corporation ABN 33 007 457 141 (the Bank) or any other company in the Westpac Group. It is subject to investment risk, including possible delays in repayment of withdrawal proceeds and loss of income and principal invested. The Bank is not the issuer of the product. Neither the Bank nor any other company in the Westpac Group stands behind or otherwise guarantees the capital value or investment performance of the product(s).

How are these returns calculated? Performance figures are calculated net of all fees and before taxes. Unless otherwise stated, performance data represents the combined growth and distribution return from holding units for the specified time period in the fund, calculated on the last day of each relevant month using exit prices. We assume distributions are reinvested (net of fees, if any), and ongoing management fees and expenses are deducted. The stated returns do not take into account entry fees, tax at the unit holder level, and inflation. For updated performance information, please visit www.btonline.co.nz . All figures are in Australian dollars. Exchange rate fluctuations between the Australian dollar and the New Zealand dollar affect the New Zealand dollar value of the return for New Zealand investors. If your distribution is paid to your New Zealand bank account, the exchange rate at which the AUD distribution was converted to NZD was $1.2533.

Make your cash work for you with the BT Premium Cash Fund

1_ BT Premium Cash Fund was the winner of Money Magazine’s Best of the Best award in the ‘Best Cash Management Trust’ in 2006, 2007, 2008, 2009, 2010 and 2011.2_ The Fund returned 4.19% based on a seven day average annualised rate of return ending at 1 April 2012 (assuming distributions have been reinvested). The interest

rate is quoted after deducting the 0.40% management costs. Investments can go up and down and past performance is not necessarily an indication of future performance. Future performance is not guaranteed.

Accelerate your savingsThe BT Premium Cash Fund has won Money Magazine’s Best of the Best award in the ‘Best Cash Management Trust’ category for six consecutive years1.

w Competitive and variable rate of return of 4.19%p.a2

w Access to your funds at any timew Low management cost of 0.40%p.aw Apply with only $5,000 or $2,000 with a regular investment plan

For further information about the BT Premium Cash Fund visit www.btonline.co.nz to download the BT Premium Cash Fund PDS or call 0800 800 661.

NZBT8358B-0412mc