February 2013

Monthly Report

Schroder Australian Smaller

Companies Fund
Total return %
7
Schroder Australian Smaller Companies Fund (post-fee)
S&P/ASX Small Ordinaries Accumulation Index
Relative performance (post-fee)

1 mth

3 mths

1 yr

3.1
0.9
+2.2

12.9
8.5
+4.4

22.2
-2.4
+24.6

3 yrs p.a. 5 yrs p.a. Inception p.a.

12.6
2.6
+10.0

4.2
-3.8
+8.0

2.2
-5.9
+8.1

Please refer to www.schroders.com.au for post-tax returns

Past performance is not a reliable indicator of future performance

Inception Date: 14 Dec 2007, 5 years and 2 months.

1

Market cap
ASX 1 - 50
ASX 51 - 100
ASX 101 - 300
Non Index
Cash

Portfolio
0.0%
1.4%
67.9%
26.4%
4.2%

Benchmark
0.0%
0.0%
100.0%

Top ten holdings %

Skilled Group Ltd.
McMillan Shakespeare Ltd.
DuluxGroup Ltd.
Cash Converters International Ltd.
Technology One Ltd.
RCR Tomlinson Ltd.
Henderson Group PLC
Seven Group Holdings Ltd.
Tox Free Solutions Ltd.
Medusa Mining Ltd.
Total

Portfolio1
5.3%
4.8%
4.3%
3.8%
3.7%
3.7%
3.1%
3.1%
3.0%
2.9%
37.7%

Benchmark2
0.7%
0.9%
1.6%
0.4%
0.0%
0.3%
1.5%
1.2%
0.4%
0.8%
7.8%

Characteristics
No. of stocks
Portfolio turnover* (1 yr)
Volatility (5yr standard deviation)
Tracking error (3yr historic)

Portfolio1
52
35.2%
17.4%
6.5%

Benchmark2
198
23.3%

Commentary
The S&P/ASX Small Ordinaries Accumulation Index rose by 0.9%, while the Schroder
Australian Smaller Companies Fund (post-fee) rose by 3.1%, outperforming by 2.2% for the
month.

Broad trends across the small cap market continued in February, with reporting season only
reinforcing two themes currently of concern to small cap investors. Firstly performance of
small caps (S&P/ASX Small Ordinaries Accumulation Index) relative to large caps
(S&P/ASX 100 Accumulation Index) continues to disappoint, with underperformance of 4.8%
in February in the context of 28.5% underperformance over the past 12 months. Secondly,
within the small cap universe, resources underperformed industrials by 11.5% during
February in the context of 54.2% underperformance over the past 12 months.

What is driving market returns?

Other than the lagging Australian small cap market weighed down by small resource stocks,
stock markets in general are continuing their upward march. Theories around what is driving
the market higher, and ten reasons (there are always ten reasons for everything) why it will
continue, often emerge at times like this. An elegant explanation of more buyers than
sellers is addressed in Martin Conlons Australian Equity commentary this month and rather
than repeat that here we look at a couple of other market myths.
Three (of the ten!) reasons investors commonly hear regarding why equity returns are likely
to continue to improve are: the economy is doing better; fund flows into equities are picking
up and stocks are attractively valued. Although we have more than some sympathy for the
last comment, it is often hard to reconcile the timing of the stocks are cheap call when
markets have already performed so well and by definition prospective returns must have
dimmed.

GDP growth and stock market return correlations

Recent analysis by Jeremy Grantham of GMO adds to the body of research that concludes
in the long run GDP growth provides little explanatory power for the returns of equity
investors. This is simply a whole economy view of what we know from our own research into
industry and company revenue growth and the implications for equity returns.

What matters for shareholders is not how fast a company, industry or economy is growing
but how much of that growth through economic or industry structure or through sustainable
competitive advantages of the company is trapped to the owners of equity. High growth and
low barriers to entry whether it is the manufacture of smart phones or the production of iron
ore will invite endless new competitors until all excess returns have been distributed
amongst the enlarged competitor set leaving shareholders to wonder where all the
opportunity went. This concept is a foundation of capitalism and until a better economic
model is discovered it will dictate equity returns in the long run far more than whether
economic growth is fast or slow.

Fund flows and stock market returns

The reason du jour for current equity market performance is the great rotation out of
bonds, into stocks. Relative value between these two asset classes may explain some of the
recent equity market performance as the more buyers than sellers condition leads prices up
to a level where marginal buyers and sellers are more balanced between the two
alternatives, however looking at the track record of equity fund flows as a predictor of returns
may have the cause and effect around the wrong way.
1 The 'Portfolio' is the Schroder Australian Smaller Companies Fund
2 Benchmark is the S&P/ASX Small Ordinaries Accumulation Index
Unless otherwise stated all figures are as at the end of February 2013
Please note numbers may not total 100 due to rounding
*Turnover = (Purchases + Sales - Cashinflows + Cashoutflows) / (Market
Value(T0)+ Market Value(T1) - Cashflows)

Analysis done by Credit Suisse looked at whether fund flows predicted market returns or
whether market returns in fact predicted fund flows. You could know something about
human nature and nothing about statistics and you would get the right answer on this one.
Although causality is hard to pick up in real time when people are financially incentivised to
believe one answer (It is difficult to get a man to understand something when his salary
depends upon his not understanding it - Upton Sinclair) the reality is that market
performance is more likely to cause fund flows (correlation of 0.35) than fund flows are likely
to cause market performance (correlation -0.09). So people follow recent performance with
real dollars no great surprise there.

Schroder Australian Smaller Companies Fund

Fund objective

Commentary Continued

To outperform the S&P/ASX Small Ordinaries Accumulation Index after

fees over the medium to long term by investing in a broad range of
smaller companies from Australia and New Zealand.

Bottom up stock valuation now you are talking

Investment style

Fund details
SCH0036AU
$48,878,109
$0.7695
December 2007
0.60%/0.60%
$50,000
Normally twice yearly - June and Dec
1.10% pa plus performance fee of
20.5% pa of net outperformance

Sector exposure versus the benchmark %

-8.0

-6.0

Energy

-4.0

-2.0

0.0

2.0

Materials

0.9

Containers & Packaging

Unfortunately the same data is not available for Australian small companies, but using
similar long term through the cycle valuation metrics as the CAPE (such as price to book or
enterprise value to sales multiples), we can observe that in an absolute sense Australian
small caps are fair value to very marginally under-valued at this time. When looked at
relative to large caps (using the S&P / ASX 100 Index as the large cap benchmark) small
caps are also marginally better value than large caps but marginal enough that we
wouldnt want to get too over confident about the accuracy of these metrics.
The good news here is that the last two years of underperformance has removed a
significant (20% relative to large caps) over valued position embedded within the Small
Ordinaries universe predominantly centred around small resource stock valuations.
Although there isnt the compellingly large discount to large caps observed twice in the last
decade (2002-03, 2008-09) there is currently no penalty for adding the diversification
benefits that small cap stocks can provide to a broader equity portfolio.
As interesting as this all may be, none of it really matters as we are not buying fund flows,
whole economies or even index relative valuations. We are buying direct shares in a
company and in return for investing our capital we obtain claims to the future cash flows of
that firm or more accurately as minority shareholders without control we realistically obtain
claims to the future dividends. Those with control (either majority shareholders or the
management and board on behalf of all shareholders) are making the higher level decision
around how much of the future cash flows are earmarked to capital investment and what is
left for distribution and so in part we are also investing in their commercial judgement.

0.0

Contributors for the month included: Skilled Group, REA Group, Cash Converters
International, Codan and McMillan Shakespeare.

-5.7

Paper & Forest Products

0.0

Industrials

4.5

Consumer Discretionary

1.9

Consumer Staples

3.7

Health Care

Detractors for the month included: Southern Cross Media Group, Tox Free Solutions,
Invocare, Medusa Mining and JB HiFi.

Outlook

-2.5

Information Technology

4.8

Telecommunication Services

2.4

Utilities

-1.0
-2.5

Capital Markets

Financials

Consumer banks

0.0

Diversified Fin Services

-0.2

Insurance

0.0

Real Estate Mgmt & Dev

Property Trusts

6.0

1.6

Construction Materials

Metals & Mining

4.0

-4.5

Chemicals

February 2013

So what does matter? Well in the context of the current arguments (GDP growth, fund flows
and valuation) we fall firmly into the camp that suggests valuation and specifically a measure
of long term valuation at the time of investment is a pretty important factor to determine
future investment returns. This is most compelling when at its most simple and analysis of
U.S stock market returns between 1881 and 2011 (Shiller) highlight that the periods of
greatest subsequent 10 year returns (average +16.1% p.a) began at Cyclically Adjusted
Price to Earnings (CAPE) ratios that averaged 10.9x. The CAPE is a P/E ratio constructed
using the average earnings over the last ten years so as not to mistake a cyclically high or
low point in earnings as a sustainable number. Unsurprisingly, the periods of the lowest 10
year market returns (average -3.3% p.a) began at an average CAPE of 23.3x. With no hint
of irony then, the U.S CAPE as at the end of February was 23.34x not exactly a screaming
buy signal if history is anything to go by but perhaps the kindest thing to be said is that in
the current financially repressed world it may be the best option.

Schroders is a bottom-up, fundamental, active growth manager of

Australian equities, with an emphasis on stocks that are able to grow
shareholder value in the long term.

APIR code
Fund size (AUD)
Redemption unit price
Fund inception date
Buy / sell spread
Minimum investment
Distribution frequency
Management costs (p.a.)

Monthly Report

-0.3
-6.4

A fresh set of financial results delivered in reporting season and large near term share price
reactions have created opportunities for the portfolio on both the buy and sell side of the
ledger. We have added some new names to the portfolio during the month that have
attractive return expectations and have been realising a number of our longer term portfolio
holdings that performed well and are no longer offering attractive return prospects.
The changes to the portfolio should result in two meaningful impacts - the long run
prospective returns of the portfolio are improving as we move into stocks with greater upside
but in the short run the portfolio exposure to momentum will decline. We expect the coming
months will provide further opportunity to continue rotating the portfolio into areas of better
risk adjusted prospective return.
David Wanis

Unless otherwise stated all figures are as at the end of February 2013
Benchmark is the S&P/ASX Small Ordinaries Accumulation Index

Contact
www.schroders.com.au
E-mail: simal@schroders.com
Schroder Investment Management Australia Limited
ABN 22 000 443 274 Australian Financial Services Licence 226473
Level 20 Angel Place, 123 Pitt Street, Sydney NSW 2000
Phone: 1300 136 471 Fax: (02) 9231 1119

Investment in the Schroder Australian Smaller Companies Fund ('the Fund') may be made on an application form in the Product Disclosure Statement dated 1 February 2011, available
from the Manager, Schroder Investment Management Australia Limited (ABN 22 000 443 274 AFSL 226473) (Schroders).
This Report is intended solely for the information of the person to whom it is provided by Schroders. It should not be relied on by any person for the purposes of making investment
decisions. Total returns are calculated using exit price to exit price, after fees and expenses, and assuming reinvestment of income. Gross returns are calculated using exit price to exit
price and are gross of fees and expenses. The repayment of capital and performance of the Fund is not guaranteed by Schroders or any company in the Schroders Group. Past
performance is not a reliable indicator of future performance. Unless otherwise stated the source for all graphs and tables contained in this report is Schroders. Opinions constitute our
judgment at the time of issue and are subject to change. This report does not contain and is not to be taken as containing any financial product advice or financial product
recommendation. For security reasons telephone calls may be recorded.