www.investors.asn.au

Passive Vs Active Funds: How Active Managers Add Value Chris Cuffe Chief Executive Officer Colonial First State Investments 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. The evidence that active works Proportion of returns better than

index 17 years to 31 October 1997 Less than -0.5% -0.5% to 0.0% 0.0% to 0.5% 0.5% to 1.0% 1.0% to 2.0% 13% 2% 10% 10% 19% 2.0% and above 46% Source: van Eyk Research Active managers are more consistent at adding value in falling markets

All Ordinaries Index falls All Ordinaries Index rises Consistency of adding value 73% 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. 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. Diversification lets not forget the needs of the investor! All Ordinaries Index composition as at April 30 2000 News Corp BHP Banks (big 4) Other 14.08% 5.53% 16.40% 36.01%

63.99% 100.00% Number of Companies 1 1 4 6 306 312 All Ordinaries Index composition as at April 30 2000 (contd) Banks & Finance Media Telecommunications Diversified Resources Other

19.05% 17.43% 12.91% 8.51% 57.90% 42.10% 100.00% Number of Sectors 1 1 1 1 4 20 24 All Resource Index composition

as at April 30 2000 BHP Rio Tinto Woodside Western Mining Other 38.42% 17.57% 9.61% 8.30% 73.90% 26.10% 100.00% Number of Stocks 1 1 1 1

4 47 51 All Ordinaries Index composition as at April 30 2000 (contd) Number of Stocks ASX 20 ASX 50 ASX 100 ASX 200 ASX 200 66.14% 82.46% 91.70% 98.25% 100.00%

21 55 110 212 313 Does this sort of concentration really suite the needs of an investor? Morale to the story Weighting an index by market capitalisation isnt necessarily a good diversification strategy if the index is heavily weighted to certain industries or stocks or only large companies Morale to the story (contd) 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 How would an indexed fund have behaved in 1987? Index weightings at 30 June 1987 Elders IXL Boral Industrial Equity Pacific Dunlop Bell Group MIM Goodman Fielder TNT Bell Resources Bond Corp Adstream Ariadne

FAI 18.43% Source: Macquarie 2.93% 1.91% 1.86% 1.61% 1.58% 1.57% 1.33% 1.20% 1.20% 0.73% 0.85% 0.86% 0.80% Efficient Markets

markets are efficient and pigs can fly! 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 Investing in a market where people believe in efficiency is like playing bridge with someone who has been told it doesnt do any good to look at the cards. Warren Buffet April 1990 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? Best & Worst Performing Stocks Top 100 Stocks by Market Capitalisation Returns for the year ended 30 April 2000 Best 1 2 3 4 5 6 7 8

9 10 ERG Limited Energy Developments Cochlear Limited Computershare CSL Limited News Corp Aristocrat Cable & Wireless Lang Corp Colonial Ltd Average Worst +215.42 +107.78 +94.71

+79.45 +73.71 +72.06 +64.51 +62.65 +61.29 +60.77 +89.23% 1 2 3 4 5 6 7 8 9 10

Lihir Gold Pasminco Pacific Dunlop Coca Cola Amatil Caltex Aust HIH Insurance Normandy Mining Mayne Nickless Smith (Howard) Tab Ltd Average All Ordinaries Accum Index 16.48% -57.91 -46.75 -42.48 -41.20 -38.07

-33.01 -31.27 -29.63 -27.89 -27.86 -37.61% Polarised Investment Performance $1,000 Investment 10 years ago Equal weighted 10 Stock Portfolio TOP 50 Companies only All Ords $2,876 11.1% pa Best $3,999 14.9% pa Source: Colonial First State, IRESS, Australian Stock Exchange.

Data is for period 31 December 1989 to 31 December 1999. Worst $393 -8.9% pa The split economy 1997 - 2000 The bad sectors Manufacturing Food Building materials Gold The good sectors Media Telecommunications Bank Privatisation Australia - Sectoral GDP Growth

1997-1999 Communications Construction Finance Retailing Transport Manufacturing 0 5 10 15 20 25 30

Percent change in value of output Source: ABS 35 40 ASX Sector Performance 300 Media Telcos 200 150 Banks 100 Build

Gold Jun-99 Feb-99 Oct-98 Jun-98 Feb-98 Oct-97 0 Feb-00 Food

Oct-99 50 Jun-97 Base = 100 250 Privatisation Greatest sale in history of the world CSL Limited Enormous shareholder value unleashed Privatisation PERFORMANCE SINCE LISTING OF GOVERNMENT FLOATS IN AUSTRALIA Capitalisation w eighted accumulated returns since listing from Institutional offer price Index (Aug-91 = 1000)

10,000 Performance (compound annual returns): GOV'T FLOAT INDEX: 33.2% ALL IND ACCUMULATION INDEX: 15.2% 8,000 J B Were & Son Q uantitative Research Govt Floats 6,000 4,000 2,000 All Industrials Source: JB Were

Aug-99 Aug-98 Aug-97 Aug-96 Aug-95 Aug-94 Aug-93 Aug-92 Aug-91 0

Infrastructure Rebuilding of old networks QLD $6 billion program NSW $13 billion program Boosting efficiency and productivity National electricity, gas and rail market 3x OECD average Auto addiction - Car registration > population growth Low investor awareness Infrastructure Sydney Harbour Bridge Traffic Growth Average Annual Daily Traffic 250,000 Harbour Tunnel releases pent up demand for

Harbour Bridge 150,000 Shortage of Vehicles and Petrol Rationing during War Years Year 1995 1992 1989 1986 1983

1980 1971 1968 1965 1962 1959 1956 1953 1950 1947

1944 1941 1938 - 1935 50,000 1977 Harbour Bridge traffic reaches maximum capacity

1974 100,000 1932 AADT 200,000 Technology Revolution Mature technologies - local Commodity - long distance Explosive growth in value added services voicemail, e-mail, mobile, data, internet 50

Fe b -00 Oct-99 Ju n -99 Fe b -99 Oct-98 Ju n -98 Fe b -98 Sh ar e Pr ice Bas e = 100 210 Internet Franchise Value 170

130 90 WA News Publishing and Broadcasting $17.00 $16.00 $15.00 Publishing & Broadcasting All Ordinaries Index / S&P ASX 300 $14.00 $13.00 $12.00 $11.00

$10.00 $9.00 $8.00 $7.00 $6.00 $5.00 $4.00 $3.00 Jan-96 Nov-96 Sep-97 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 Jul-98

May-99 Mar-00 Harvey Norman / Coles Myer vs All Ords $25,000 HVN CML All Ordinaries Index / S&P ASX 300 Value of $1000 Investment $22,000 $19,000 $16,000 $13,000 $10,000 $7,000

$4,000 $1,000 -$2,0001992 1993 1994 1995 1996 1997 1998 1999 2000

Miscellaneous points 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 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 dont allow flexibility to correct this, treble the investors risk in this sector

The coup de grce - the proof of the pudding is in the eating Colonial First State Imputation Fund Returns after fees (currently approx 1.80% pa) Years ended 31 December Year 1991 1992 1993 1994 1995 1996 1997 1998 1999 Fund

Return 61.4% 9.2% 54.9% -5.9% 32.4% 28.8% 19.5% 20.3% 19.9% All Ordinaries Accum Index. performance. 34.2% -2.3% 45.4% -8.7%

20.2% 14.6% 12.2% 11.6% 16.1% +27.2% +11.5% +14.5% +2.8% +12.2% +14.2% +7.3% +8.7% +3.8% Out-

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