mlc diversified debt teleconference july 2008. 2 general advice warning and disclaimer this document...

MLC Diversified Debt Teleconference

July 2008

2

General advice warning and disclaimerThis document was prepared by MLC Investments Limited (ABN 30 002 641 661), and MLC Limited (ABN 90 000 000 402), members of the National group of companies, as an information service without assuming a duty of care. Accordingly, reliance should not be placed by anyone on this document as the basis for making any investment, financial or other decision. While the information included is believed to be accurate, no member of the MLC Investments Limited or any member company of the National Group of companies accepts responsibility for any inaccuracy or for investment decisions or any other actions taken by any person on the basis of the material included.

An investment with MLC does not represent a deposit with or a liability of National Australia Bank Limited, MLC Investments Limited, MLC Limited, or other member company of the National Group of companies and is subject to investment risk including possible delays in repayment and loss of income and capital invested.

None of National Australia Bank Limited (ABN 12 004 044 937), MLC Investments Limited, MLC Limited, other member companies in the National Group of companies, the underlying fund managers of the investments, any trustees or their respective officers guarantee the repayment of capital invested, the payment of income, the performance of the specific investments selected by investors or the performance of any MLC products except where specified on the current disclosure document.

3

Agenda

• Economic and Investment Market update

• Building a diversified debt strategy

4

Agenda



5

The state of play• Too much liquidity

• Too much leverage

• Too much complacency

• Voracious risk appetites

• A benign macroeconomic environment

Have led to….

• Risk being way underpriced – too little reward on offer for risks that have not been properly understood

• In short, returns have been too high, and volatility has been too low, and this situation is now normalising

The problem was (and still is) much larger than just US sub-prime mortgages!

6

When too much debt just isn’t enough Total US debt as % of GDP

“In the end, the root of the problem is unavoidable. At some point US consumption will have to come into line with US incomes, and US growth will need to be built without constantly growing debt levels. This adjustment will be painful. The pain can be spread across time and across people, but it cannot be avoided.”

- Bridgewater 24 March 2008

7

US housing: the state of play

Source: Thomson Financial Datastream

Home sales have plummetted..

2500

3500

4500

5500

6500

7500

8500

Jan-93 Jan-96 Jan-99 Jan-02 Jan-05 Jan-08

Total home sales (new + existing)

'000 annualised

..helping to create a huge overhang of unsold homes

2

4

6

8

10

12

Jan-85 Jan-88 Jan-91 Jan-94 Jan-97 Jan-00 Jan-03 Jan-06

Unsold single-family homes to total sales ratio

..but more forced sales are likely as delinquency rates have soared.

1.0

1.5

2.0

2.5

3.0

3.5

Q2 1990 Q2 1993 Q2 1996 Q2 1999 Q2 2002 Q2 2005

Delinquency rate % of loans outstanding

Housing starts have fallen in response to sharply weaker demand..

500

1000

1500

2000

2500


Housing starts (lhs)

8

The US economy is probably in recession already


GDP growth is OK, but the leading indicators look lousy

-4

-2

0

2

4

6

8

10

Q1 1988 Q1 1991 Q1 1994 Q1 1997 Q1 2000 Q1 2003 Q1 2006

Conference Board leading index Real GDP

Annual change %

Consumer confidence is already at recession levels

35

45

55

65

75

85

95

105

115

125

135

Jan-88 Jan-91 Jan-94 Jan-97 Jan-00 Jan-03 Jan-06

Expectedconditions

Currentconditions

US University of Michigan consumer sentiment indices

9

No, it’s not just a US problem

Source: Thomson Financial Datastream, MLC Investment Management

EU, Japanese manufacturing confidence is following US lower..

-3

-2

-1

0

1

2

3

Q1 1990 Q1 1995 Q1 2000 Q1 2005

US EU-15 and Japan

Std deviations away from 5yr average

..and G3 consumer sentiment is also falling

-3

-2

-1

0

1

2

3

Q1 1990 Q1 1995 Q1 2000 Q1 2005

US EU-15 and Japan

Std deviations away from 3yr average

10

Some of the major central banks have started the rescue operation…

0

1

2

3

4

5

6

7

8

9

May-04 Feb-05 Nov-05 Aug-06 May-07 Feb-08

US Euro-area Japan

Canada UK

Official interest rates %

Source: Thomson Financial Datastream. US rate is target rate for Federal Funds. For Europe, short-term repo rate.Canadian rate is Bank of Canada policy rate. Australian rate is the RBA cash rate target. Chinese rate is the1yr benchmark lending rate. NZ rate is RBNZ cash rate target.

0

1

2

3

4

5

6

7

8

9

May-04 Feb-05 Nov-05 Aug-06 May-07 Feb-08

Australia China

New Zealand

Official interest rates %

11

..but how much more debt can be rammed down the throats of consumers in the English speaking world?..


Australian household debt

020406080

100120140160180

Q1 1980 Q1 1985 Q1 1990 Q1 1995 Q1 2000 Q1 2005

as % of GDP

as % of disposable income

%

US household debt

020406080

100120140160180

Q1 1980 Q1 1985 Q1 1990 Q1 1995 Q1 2000 Q1 2005

as % of GDP


%

UK household debt

020406080

100120140160180

Q1 1980 Q1 1985 Q1 1990 Q1 1995 Q1 2000 Q1 2005

as % of GDP


%

12

House prices in the English speaking (!?) economies

50

100

150

200

250

300

Q1 1988 Q1 1991 Q1 1994 Q1 1997 Q1 2000 Q1 2003 Q1 2006

US UK Aust

Real (inflation adjusted) house prices. March quarter 1988 equals 100

Sources: Datastream, RBA, MLC Investment Management

13

“.. there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns -- the ones we don't know we don't know."…”

• What we don’t know…(and may not know, that we don’t know)? How far US house prices will fall? How much damage will be done to household balance sheets? The full impact on US financial institutions’ balance sheets (and

hence their ability to create credit)? The full impact on household spending and hence the economy? The full impact on corporate earnings

14

Previous US house price booms…

15

Previous US house price booms…and the subsequent busts

16

Australian economic prospects• Australian economic growth to slow significantly (either the economy slows ‘by

itself’ or RBA will make it slow!)

• (Patriotism has paid handsomely over past five years, but this will not last!)

Australia's economy accelerated while the G4 was slowing

0

1

2

3

4

5

6

Q1 2000 Q1 2002 Q1 2004 Q1 2006 Q1 2008

Annual growth in real GDP %

17

An already tight labour market became even tighter over the last year…

0

5

10

15

20

25

Jan-83 Jan-87 Jan-91 Jan-95 Jan-99 Jan-03 Jan-07

0

2

4

6

8

10

12% %

Trend unemployment rate (rhs)

Cash rate (lhs)

18

..helping to keep inflation above the RBA’s target range

The RBA's worst target 'miss' of the low-inflation era?

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

Q2 1989 Q2 1991 Q2 1993 Q2 1995 Q2 1997 Q2 1999 Q2 2001 Q2 2003 Q2 2005 Q2 2007

Consumer prices y/y% - average of RBA's preferred measures

19

Has RBA done enough? (Are borrowing costs too high?)

Nominal interest rates the highest since (at least) 1996..

0

2

4

6

8

10

12

14

Jan-95 Jan-98 Jan-01 Jan-04 Jan-07

Cash rate

Bank std. variable

Mortgage managers standard

Mortgage managers basic

Bank small/med. business rate

%

Source: RBA

..but higher inflation has kept real borrrowing costs lower

0

1

2

3

4

5

6

7

8

9

10

Jan-95 Jan-98 Jan-01 Jan-04 Jan-07

Cash rate

Bank std. variable

Mortgage managers standard

Mortgage managers basic

Bank small/med. business rate

%

Source: RBA, MLC Investment Management

20

Lending approvals are still falling

0

5000

10000

15000

20000

25000

Jun-99 Jun-01 Jun-03 Jun-05 Jun-07

Total ex-refinancingOwner-occupiers (ex-refinancing)Investors


$Am

21

Retail sales, confidence figures suggest rate are starting to have an effectRetail sales are slowing..

-0.5

0.0

0.5

1.0

1.5

2.0

Jan-06 Jul-06 Jan-07 Jul-07 Jan-08

Seasonally adjusted Trend

m/m%

…and consumer sentiment has plummeted

60

70

80

90

100

110

120

130

140


Index

Source: NAB Survey

22

NAB business survey points to weaker growth

-20

-15

-10

-5

0

5

10

15

20

25

Mar-97 Mar-99 Mar-01 Mar-03 Mar-05 Mar-07

Actual businessconditions

Confidence

Net balance (%)

Source: NAB Survey

23

Asset Class Returns to June 2008

*

-40%

-35%

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

Aust. S

hares

Global

Shar

es -

Hedged

Global

Shar

es -

Unhedged

Aust R

EITs

Global

REIT

s Hed

ged

Aust N

omin

al D

ebt

Global

Inv

Grade

Debt H

edged

Aust. C

PI lin

ked d

ebt

Aust. C

ash

US Hig

h Yie

ld D

ebt -

Hed

ged

An

nu

alis

ed

Re

turn

s (%

pa

)

3-Months

1 Year

3 Year

Source: MLC Investment Management

24

Global economic and investment prospects

• Global economy slowing down (the US is in recession now)

• ..but the Chinese economy is well-placed to weather the storm (good news for some parts of the Australian economy)

• The US Federal Reserve now understands the magnitude of the problem, and is responding..

• ..and the economy and financial markets will eventually recover..

• ..but we are most unlikely to see a repeat of the kind of investment returns seen in recent years.

25

Agenda



26

Question: Is the same debt portfolio suitable for all investors regardless of risk profile?

Why Diversified Debt?

Roles of Debt within a portfolio:

• Reduce risk (dampen volatility)

• Protect capital

• Provide steady income

• Enhance returns

• Diversification in economic environments where other asset classes may perform poorly

27

A tailored diversified debt strategy can diversify across….

Different risks:• Interest Rate Risk• Inflation Risk• Credit Risk• Currency Risk• Domestic & Global exposures

Different types of assets:• Sovereign• Corporate• High yield• Emerging markets• Inflation-linked

May also include commodities, hybrids, equity securities from capital restructures

Result is a strategy focussed on real capital preservation, with higher long-term return seeking strategies

28

Typical debt sector funds provide limited market exposure

50%50%

Australian Nominal Debt(All Maturity)

Global Investment GradeNominal Debt Hedged(All Maturity)

Debt sub-sector allocations


29

Philosophy on Diversified Debt

1. Start with a wide definition of opportunity set;

2. Understand investor demands from debt assets;

3. Tailor strategy risk profiles to client needs;

4. Build robust strategies via environmental diversification;

5. Be flexible with manager and mandate strategy;

6. Continually innovate & evolve strategy

Outcomes:• Avoid segmentation effects• Understand risks you are taking (& being compensated for)• Robust portfolio construction: across sectors & managers

30

Start with a broad opportunity set

Domestic Global GovtCorporate

/ Securitised Inv Grade Sub-IG

Nominal ILBs Physical Derivative $-MarketBond

Market

SecuredUnsecured & Sub Debt

Bank Debt

BondsPublicIssue

Private Placement

Domicile Issuer Credit Rating

Inflation Exposure Implementation Maturity

Capital Structure Funding Source Raising

Fluidity in strategy creates opportunities, reduces costs & avoids segmentation effects

31

Understand investor demands from debt differBased on:• Investment Objectives;• Risk Profiles;• Investment Time Horizon

Asset Allocation 0/100 30/70 50/50 70/30 85/15

Risk Profile Conservative Growth

Investment Horizon Shorter Longer

Nominal / Real capital preservation focus

PredominantlyNominal

PredominantlyReal

32

Tailor investment strategy accordingly

Four key investment risks

Interest rate risk Inflation risk Credit risk Currency risk

Domestic v

Global

Resulting

strategy

0/100Low = 1.8 years

duration

Protection via

cash, short

maturity nominal

debt and ILBs

Small allocation

to HY and EMD

100%

strategically

hedged

Predominantly

domestic

Nominal capital

preservation,

lower volatility

risk/return

outcome

30/70

50/50

70/30

85/15Higher = 4.7

years duration

Protection via

ILBs, real return

strategies and

commodities

Greater exposure

to high yield,

emerging

markets

Small unhedged

exposure for

diversification,

more manager

flexibility

Balance of

domestic and

global

Real capital

preservation,

higher real return

seeking strategy

Asset Allocation

33

Understand economic exposures of sub-sectors

Economic growth

High

Low

Investment Grade Corporate Debt High Yield Corporate Debt

Emerging Markets Debt

Commodities

Nominal Government Debt

Inflation Linked Government Debt

Cash and Short Term Securities

Inflation

Inflation Linked Government Debt

Commodities

Cash and Short Term Securities

Nominal Government Debt

Investment Grade Corporate Debt

High Yield Corporate Debt

Emerging Markets Debt

Seek diversification so returns are not dependent upon specific macro-economic scenarios

34

Create flexibility in manager and mandate allocations

Multiple managers per sector

Mul

tiple

sec

tors

pe

r m

anag

er

NS

IM

UB

S

Bla

ckR

ock

Oak

tree

WR

Huf

f

PIM

CO

Brid

gew

ater

Number of Mandate Types 4 3 2 2 1 2 1

Cash and Short Term Securities Investment Grade Nominal Debt Inflation Protected Debt Investment Grade Nominal Debt High Yield Debt Emerging Markets Debt Inflation Protected Debt Diversified Real Return Strategy

Aus

tral

iaG

loba

l

* NSIM, UBS, BlackRock and PIMCO manage both short maturity and all maturity mandates

35

Continually innovate & refine strategy

1985 Multi-manager domestic strategy commenced

1991 Introduction of new debt classes & styles· Global sovereign debt· Index enhanced Australian fixed interest· Australian inflation linked securities

1997 Introduction of:

Short term high quality global credit & mortgages

2000 Treat debt as 1 global asset classIntroduction of new debt sub-sectors:

· Extended global credit & mortgages

· Global inflation linked bonds

· Global high yield debt

· Global emerging markets debt

2003 Introduction of:

A tailored debt strategy for each diversified portfolio

Unshackling managers from benchmarks

2005 Real Return strategies evolved

·

· ·

2007/8 Alternative debt

MLC Diversified Debt Fund Exposures

37

MLC Diversified Debt Fund provides exposure to a greater range of debt sub-sectors

24%

24%11%1%

8%

32%

Australian Nominal Debt (All Maturity)

Australian Inflation Protected Debt

Global Investment Grade Nominal DebtHedged (All Maturity)

Global Investment Grade Nominal DebtUnhedged (All Maturity)

Global High Yield Debt Hedged

Global Diversified Real Return Strategy

Debt sub-sector allocations


38

With access to four non-standard debt sub-sectors

24%

24%11%

1%8%

32%

Australian Nominal Debt (All Maturity)

Australian Inflation Protected Debt

Global Investment Grade Nominal DebtHedged (All Maturity)

Global Investment Grade Nominal DebtUnhedged (All Maturity)

Global High Yield Debt Hedged

Global Diversified Real Return StrategyDomestic Inflation Protected Debt

Returns driven by real yields plus actual

inflation

Global Unhedged Nominal Debt

Small allocation to foreign currency for

diversification

Global High Yield Debt

Higher yielding corporate debt

securities

Global Real Return Strategies

Flexible global mandates designed to achieve inflation plus return outcomes

39

Investment Manager Allocations

28%

20%12%

16%

4%

4%16%

NSIM

UBS GLOBAL ASSETMANAGEMENT

BLACKROCK

PIMCO

WR HUFF ASSETMANAGEMENT

OAKTREE

BRIDGEWATERASSOCIATES

Source: MLC Investments


40

Diversification benefits versus growth assets*

Ten worst calendar quarters for Australian Equities (1998- June 2008)

The MLC Diversified Debt Strategy has preserved capital

and outperformed cash during past negative equity markets

* Based on the All Maturities Strategy of Horizon 5 (Superannuation) before investment fees and tax. Australian Equities returns shown are for the ASX 300 Index, Domestic Cash returns shown are for the UBS Australia Bank Bill Index.

Calendar Quarter Australian Equities

MLC Diversified Debt Strategy

Domestic Cash MLC DDS versus Australian Equities

MLC DDS versus

Quarterly Total Return



Cash

Mar-08 -14.61% 2.06% 1.82% 16.67% 0.24%

Sep-01 -11.80% 3.40% 1.30% 15.30% 2.10%

Sep-02 -6.50% 3.80% 1.30% 10.40% 2.60%

Jun-02 -5.10% 2.20% 1.10% 7.30% 1.00%

Mar-03 -2.80% 1.90% 1.20% 4.70% 0.70%

Dec-07 -2.70% 1.50% 1.70% 4.20% -0.20%

Sep-98 -2.00% 4.30% 1.30% 6.30% 3.00%

Dec-00 -2.00% 4.00% 1.60% 6.00% 2.40%

Sep-99 -2.00% 1.30% 1.20% 3.20% 0.00%

Jun-98 -1.90% 2.90% 1.20% 4.80% 1.70%

AVERAGE -5.14% 2.74% 1.37% 7.89% 1.35%

41

And a strategy expected to preserve capital during negative equity markets*

Negative growth asset scenarios Australian Equities

Total Return p.a.

Expected Excess Return per annum of

MLC Diversified Debt versus Cash

Global depression or stagnation (1930s) -18.5%

Financial collapse Risk -16.8%

Aust Deflation – destructive (Japan 1990s) -13.4%

Recession -7.7%

Aust economic crisis, world weak -6.9%

Market bust, economy not okay (rise in correlations)

-4.9%

Aust only bust (world economy not weak) -3.6%

Global conflict / war -3.5%

Credit / monetary contraction -2.9%

Bubble bursts (economy okay) -1.6%

Global Catastrophe adverse economic environment -1.5%

Stagflation -0.6%

Investor Pessimism - rise in risk premiums -0.3%

0.6%

-0.7%

2.4%

0.8%

-0.9%

0.6%

1.2%

1.2%

1.8%

2.0%

2.3%

0.7%

4.1%

* Based on MLC scenario analysis modelling over a 5 year time horizon. Returns are nominal returns, before tax but after investment manager fees

Diversified Debt is expected to outperform Cash by an average of +1.2% p.a.

42

Inflation erodes real purchasing power over time

Value of $100,000 today Value of $100,000 in 10 years time with inflation of 3% p.a. is $74,000

Inflation erodes

purchasing power

56% of the MLC Diversified Debt Fund is invested in inflation protected debt and real return strategies

43

What differentiates a diversified approach to debt strategy?• Consider debt as one allocation to minimise impact of market

segmentations

• Tailor approach to client requirements – across multiple dimensions/risks

• Emphasise relevant diversification – look at economic exposures

• Combine manager skill sets and tailor mandates

• Continuous refinement of investment strategy

Only possible via efficient implementation and scale

44

MLC provides a complete debt sector solution

The MLC Diversified Debt Fund provides:

• Access to non-standard debt sub-sectors

• The ability to tailor a customised strategy

• A strategy focussed on generating real returns

• A strategy focussed on capital preservation when its needed most

45

Sector Strategy Returns

0%

2%

4%

6%

8%

10%

12%

AustralianNominal Bonds

(short)

AustralianNominal Bonds

(all)

AustralianInflation Linked

Securities

Global NominalBonds (short)

Global NominalBonds (all)

Global HighYield Debt

GlobalDiversified Debt

Real ReturnStrategies

Cash

% pa

Manager 1 yr returns Manager 3 yr returns

Performance of MLC’s debt strategy components

Real return strategies have performed strongly in the current environment

Gross returns to 30 June 2008


46

NOMINAL RETURNS - Rolling 1 Year Risk/Return since tailored debt strategy inceptionDec-03 to Jan-08

Diversified Debt Strategy

Cash

0%

2%

4%

6%

8%

10%

12%

0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0%

Standard Deviation

No

min

al R

etu

rnRealised risk/return outcomes


Product Overview

48

MLC Diversified Debt FundObjective Aims to provide returns higher than cash, over the medium to

long-term, from a diverse range of mostly debt investments.

Investment Strategy Primarily invests in a diversified range of Australian and global debt assets and other assets, where the overall risk and return characteristics are expected to be similar to debt. The Fund may also have some exposure to growth and other assets such as commodities, hybrid assets and shares. The Fund is currently actively managed. The Fund’s foreign currency exposure is predominantly hedged back to the Australian dollar.

Investment fees / MER

0.43 - 0.75%

Based on chosen platform

Platforms Available MasterKey and MasterKey Custom

Research Ratings Lonsec – Investment Grade

mlc diversified debt teleconference july 2008. 2 general advice warning and disclaimer this document...

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