“Passive Vs Active Funds: How Active Managers Add Value”

1. “Passive Vs Active Funds: How Active Managers Add Value” Chris Cuffe Chief Executive Officer Colonial First State Investments

2. Extract from investment philosophy of Colonial First State Investments “Market indices, or ‘benchmarks’, are not a measure of good investments; rather they reflect an average of all investments making up the relevant index - both good and bad. We believe that the dynamic nature of investment markets enables us to add value through our active approach, and, as such, we aim to achieve investment returns above those of relevant market indices.”

3. The evidence that “active” works

4. Proportion of returns better than index 17 years to 31 October 1997 Less than -0.5% 13% -0.5% to 0.0% 2% 0.0% to 0.5% 10% 0.5% to 1.0% 10% 1.0% to 2.0% 19% 2.0% and above 46% Source: van Eyk Research

5. Active managers are more consistent at adding value in falling markets Consistency of adding value All Ordinaries Index falls 73% All Ordinaries Index rises 60% Source: van Eyk Research Why? Generally active managers have processes that screen stocks for quality - hence value is added by avoiding “disaster” stocks that index managers will be forced to hold.

6. Conclusions of van Eyk research “….it is stock selection that is driving returns not the industrial share tilt (most pronounced in the 1990s).” “Active managers on average do add value. This is not by chance or by the grace of an inefficient benchmark, but through good stock selection.”

7. Diversification let’s not forget the needs of the investor!

8. All Ordinaries Index composition as at April 30 2000 Number of Companies News Corp 14.08% 1 BHP 5.53% 1 Banks (big 4) 16.40% 4 36.01% 6 Other 63.99% 306 100.00% 312

9. All Ordinaries Index composition as at April 30 2000 (cont’d) Number of Sectors Banks & Finance 19.05% 1 Media 17.43% 1 Telecommunications 12.91% 1 Diversified Resources 8.51% 1 57.90% 4 Other 42.10% 20 100.00% 24

10. All Resource Index composition as at April 30 2000 Number of Stocks BHP 38.42% 1 Rio Tinto 17.57% 1 Woodside 9.61% 1 Western Mining 8.30% 1 73.90% 4 Other 26.10% 47 100.00% 51

11. All Ordinaries Index composition as at April 30 2000 (cont’d) Number of Stocks ASX 20 66.14% 21 ASX 50 82.46% 55 ASX 100 91.70% 110 ASX 200 98.25% 212 ASX 200 100.00% 313 Does this sort of concentration really suite the needs of an investor?

12. Morale to the story • Weighting an index by market capitalisation isn’t necessarily a good diversification strategy if the index is heavily weighted to certain industries or stocks or only large companies

13. Morale to the story (cont’d) • Think about ‘risk’ as not the amount of difference to the benchmark (tracking error) but the likelihood of investing in a poor company or concentrating investments too much in one sector

14. How would an indexed fund have behaved in 1987?

15. Index weightings at 30 June 1987 Elders IXL 2.93% Boral 1.91% Industrial Equity 1.86% Pacific Dunlop 1.61% Bell Group 1.58% MIM 1.57% Goodman Fielder 1.33% TNT 1.20% Bell Resources 1.20% Bond Corp 0.73% Adstream 0.85% Ariadne 0.86% FAI 0.80% 18.43% Source: Macquarie Equities

16. Efficient Markets markets are efficient and pigs can fly!

17. Efficient market theory • New information is quickly and widely disseminated in the investment community so that each stock represents its true current value based on all that is known about the stock

18. Investing in a market where people believe in efficiency is like playing bridge with someone who has been told it doesn’t do any good to look at the cards. Warren BuffetApril 1990

19. Some probing questions • How efficient would capital utilisation by public companies be in the absence of active shareholder scrutiny and hence active management? • Would we want the private sector to operate like the public sector?

20. Best & Worst Performing Stocks Top 100 Stocks by Market Capitalisation Returns for the year ended 30 April 2000

21. All Ords Best Worst $2,876 $3,999 $393 11.1% pa 14.9% pa -8.9% pa Polarised Investment Performance • $1,000 Investment 10 years ago • Equal weighted 10 Stock Portfolio • TOP 50 Companies only Source: Colonial First State, IRESS, Australian Stock Exchange. Data is for period 31 December 1989 to 31 December 1999.

22. The bad sectors Manufacturing Food Building materials Gold The good sectors Media Telecommunications Bank Privatisation The split economy 1997 - 2000

23. Australia - Sectoral GDP Growth1997-1999 Percent change in value of output Source: ABS

24. ASX Sector Performance

25. Greatest sale in history of the world CSL Limited Privatisation • Enormous shareholder value unleashed

26. Privatisation Source: JB Were

27. Rebuilding of old networks • QLD $6 billion program • NSW $13 billion program Infrastructure • Boosting efficiency and productivity • National electricity, gas and rail market • 3x OECD average • Auto addiction - Car registration > population growth • Low investor awareness

28. Average Annual Daily Traffic 250,000 Harbour Tunnel releases pent up demand for Harbour Bridge 200,000 150,000 AADT Shortage of Vehicles and 100,000 Petrol Rationing Harbour Bridge during War Years traffic reaches maximum capacity 50,000 - 1932 1935 1938 1941 1944 1947 1950 1953 1956 1959 1962 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 Year InfrastructureSydney Harbour Bridge Traffic Growth

29. Technology Revolution • Mature technologies - local Commodity - long distance • Explosive growth in value added servicesvoicemail, e-mail, mobile, data, internet

30. Internet Franchise Value

31. Publishing and Broadcasting Source: Iress Whilst every care has been taken in compiling the above information, Colonial First State Investment Managers (Australia) Limited accepts no responsibility for any errors or omissions

33. Miscellaneous points

34. All investors do, in aggregate, hold the index - thus market timing is important • Active management does not equate to undisciplined management • Transaction costs have been decreasing for active managers - stockbrokers fees and stamp duty around half what they were 4 years ago

35. Are index funds steadily changing to become active in disguise? Extract from 11 December 1997 edition of Money Management….“BBL Fund Management MD Norman Sinclair says Barclays Global Investors’ new index fund is flawed as it replicates the All Ordinaries Index. The All Ords is grossly overweighted in the resources sector by international standards. Funds that don’t allow flexibility to correct this, treble the investors’ risk in this sector”

36. The coup de grâce - the proof of the pudding is in the eating

37. Colonial First State Imputation FundReturns after fees (currently approx 1.80% pa) Years ended 31 December Year Fund All Ordinaries Out- Return Accum Index. performance. 1991 61.4% 34.2% +27.2% 1992 9.2% -2.3% +11.5% 1993 54.9% 45.4% +14.5% 1994 -5.9% -8.7% +2.8% 1995 32.4% 20.2% +12.2% 1996 28.8% 14.6% +14.2% 1997 19.5% 12.2% +7.3% 1998 20.3% 11.6% +8.7% 1999 19.9% 16.1% +3.8%