spectrum strategic income fund - spectruminvest.com.au...- associated property risks and their...

Spectrum Strategic Income Fund

Superior

This report has been prepared for financial advisers only


INTRODUCTION

Key PrinciplesThe underlying principles of the assessment process are to:

- identify the long term commercial potential of the Responsible

Entity/Investment Manager;

- evaluate management’s capabilities, previous performance in the

specific industry and the stability of the organisation;

- evaluate identified markets (domestic and international existence,

stability and growth potential);

- benchmark key performance assumptions and variables against

industry peers;

- weigh up the relevant risks of the Responsible Entity/Investment

Manager;

- assess structure and ownership;

- determine if the Responsible Entity/Investment Manager is

structured in such a way as to protect investor’s interests; and

- allow an opinion to be formed regarding the investment quality of

the Responsible Entity/Investment Manager.

AssessmentSQM Research conducts a detailed site inspection of the projects/properties within the Responsible Entity’s/Investment Manager’s managed funds.

- The site assessment considers the following areas:

- sustainability of the site for the purpose intended;

- management skills, qualifications, capabilities and experience; and

- associated property risks and their management.

4½ stars and above

Outstanding Highly suitable for inclusion on APLsThe fund most often outperforms its peers and benchmark. In all cases the fund is operating to its mandate and product disclosure statement (PDS). There are no corporate governance issues. Management is extremely experienced and skilled and has access to significant resources.

High Investment grade rating

4 stars to 4¼ stars

Superior Suitable for inclusion on most APLsThe fund outperforms (or is likely to) its peers and benchmark the majority of the time. The fund most of the time has been operating within its mandate and PDS. There are very little to no corporate governance concerns. Management is of a very high calibre.

High Investment grade rating

3¾ stars Favourable Consider for APL inclusionThe fund may outperform its peers and benchmark the majority of the time or SQM believes this is a fund that has potential to be an outperforming fund over the medium term. Management is of a quality calibre but may not yet be fully tested. There are no corporate governance concerns or they are of a minor nature.

Approved

3½ stars Acceptable Consider for APL inclusion, subject to advice restrictionsThere is some degree of additional risk attached to the fund by way of performance. The fund may periodically underperform its peers and benchmark or it has not been fully tested. There may be some additional concentration risk. Management is generally experienced and capable. There might be corporate governance issues of a mid-level or corners over the Responsible Entities/Parent Entities financial position/performance.

Low investment grade rating

3¼ stars Caution required Not suitable for most APLsPerformance has been significantly under-benchmark and peers. There is a greater than average risk of underperformance over the medium term. There is a risk of the fund not operating to mandate or to its PDS. There are corporate governance concerns. Management has been operating in an average manner.

Unapproved

3 stars Strong Caution Required

Not suitable for most APLsThe fund is unlikely to perform to its mandate over the near term. There might be some greater than average corporate governance concerns. SQM has a number of concerns of management.

Unapproved

Below 3 stars Avoid or redeem Not suitable for most APL inclusion Unapproved

Star Rating*Investment products are awarded a star rating out of a possible five stars and placed on the following websites: www.sqmratings.com.au

Licensed Investment AdviserSQM Research is licensed as an Australian Financial Services Licensee, Licence No. 421913, pursuant to section 913B of the Corporations Act 2001. The licence authorises SQM Research to carry on a financial services business to provide general financial product advice only.

Privacy PolicySQM Research collects only a limited amount of personal information from its clients. Our privacy policy can be viewed at www.sqmratings.com.au. This will enable you to understand your rights, our obligations and what SQM Research does with any information it collects about you.

Fees charged for ReportSQM Research has received a fee from the fund manager for this report and rating.

General Financial Product AdviceThis advice will not take into account your, or your clients, objectives, financial situation or needs and will not be provided in respect of any other financial products. Accordingly, it is up to you and your clients to consider whether specific financial products are suitable for your objectives, financial situations or needs.

Report Date: 23 March 2018

Hold – The rating is currently suspended until SQM Research receives further information. A rating is typically put on hold for a period of two days to four weeks.

Withdrawn – The rating is no longer applicable. Significant issues have arisen since the last report was issued, and investors should avoid or redeem units in the fund.

Not rated – The fund has not been rated by SQM.

Star Rating Description Definition Investment Grading


CONTENTS

Summary 2

Fund Summary 3

SQM Research’s Review 3

Strengths of the Fund 7 Weaknesses of the Fund 7 Other Considerations 7 Key Changes Since the Last Review 7

Investment Process & Portfolio Construction 8 Investment Process Diagram 8 Process Description 8

Corporate Governance/Business Strategy 14 Key Counterparties 14 Parent Company 14 Investment Manager /Fund Manager 14 Responsible Entity 14 Management Risk 15 Funds under Management (FUM) 15

Management & People 17 Investment Team 17 Staffing Changes 18 Key Investment Staff 18 Remuneration and Incentives 19

Product Features - Fees & Redemption Policy 20 Buy/Sell Spread 20 Contribution Fees 20 Ongoing Fees 20 Overall Fees 20

Quantitative Analysis 21 Quantitative Insight 21 Returns and Risk 24

Asset Allocation & Risk Parameters 26 Recent Positioning 27


SQM Rating Superior. Suitable for inclusion on most APLs

Fund Details Fund Name Spectrum Strategic Income Fund

APIR Code ETL0072AU

Manager Spectrum Asset Management

Responsible Entity Equity Trustees Limited

Custodian State Street Limited

Investment Details

Fund Inception 31-May-09

Fund Size $45.6 million

Fund Type Australian Credit

Return Objective (PDS) in excess of the RBA Cash Rate

Internal Return Objective RBA Cash Rate + 1.50%

Risk Level (PDS) Medium

Internal Risk Objective Monitor and Manage Credit Spread Duration. Less Volatility than Equities

Benchmark RBA Cash Rate

Number of positions 39

Gearing (Fund) Nil

Investment Specifications Summary

Minimum Application $5,000.00

Redemption Policy Daily

Distribution Frequency Quarterly

ICR 0.75%

MER 0.75%

Performance Fee No

Buy/Sell Spread 0.15% / 0.15%

Currency Hedging Not applicable - All securities are A$ denominated

Time Horizon for Investment 3 - 5 Years.

Other

Turnover 20.1% (average over 2009 to 2017)

Top 10 Holdings Weight 34%

SUMMARY 2


SUMMARY 3

Fund Summary

Description

The Spectrum Strategic Income Fund (the Fund) aims to achieve higher returns than term deposits, with less volatility than equities while providing daily liquidity. The Fund invests in A$ denominated bonds, primarily corporate floating rate notes.

The Fund integrates a global macroeconomic/political assessment of the future level of interest rates with quantitative techniques, credit research and a disciplined portfolio construction process. The goal is to identify securities that offer an expected yield that is higher than the “fair” market yield for the credit risk of the investment. The Fund holds a diversified portfolio of debt and hybrid securities with a view to minimising losses of income and capital associated with investment risk.

The Fund is structured as an open-ended unlisted registered managed investment scheme.

About the Manager

Spectrum Asset Management Limited is a public, non-listed entity that is 100% owned by its principals, who each have a material equity stake in the business.It is an independent boutique not affiliated with any large financial institutions. The business was founded in 2001 by two of its current principals - Lindsay Skardoon and Christine Windeyer. It is a Sydney-based fund manager specialising in investing in corporate debt and income securities.

Fund Rating

The Fund has achieved the following rating:

Star Rating

Description DefinitionInvestment

Grading

4.25 stars SuperiorSuitable for inclusion

on most APLsHigh Investment

grade rating

SQM Research’s Review and Key Observations

1. People and Resources

Size and Resources of the Fund Management Company

The firm is a small and entrepreneurial independent boutique fund manager. Spectrum has five staff, four of whom are investment professionals. It relies on financial support and capital from its founding principals and current staff shareholders as it works towards self-sustaining stand-alone cash and accrual profitability. The growth of FUM has picked up significantly in the last 12-18 months when compared to the trends of previous years. The firm’s total FUM has doubled over the past twelve months to reach $90m.

Investment Team

Lindsay Skardoon is the designated Portfolio Manager for the Fund as well as being the firm’s Chief Investment Officer. He sets the investment strategy, determines sector weights, and manages security selection with input from the credit research team. He is a co-founder and significant shareholder in Spectrum Asset Management. He has over thirty years’ experience in interest rate markets in senior roles in Australia and Asia.

Damien Wood is Head of Research. He conducts credit analysis and generates trade recommendations based on the research and his assessment of relative value. Damien has 26 years’ experience in global credit markets, working in Sydney, London, Hong Kong and Singapore. The respective roles of Mr Skardoon and Mr Wood cover all aspects of research, analysis, dealing and investment management of the Fund.

Hamid Yahyaei supports Mr Wood in the research process. He assists in the development of financial models which underpin the credit analysis function. He joined Spectrum as an analyst in November 2015.

Christine Windeyer, as CEO, is made aware of all investment decisions and participates in the regular Micro meeting covering security research and portfolio construction.

2. Investment Process and Philosophy

Investable Universe

The table below provides details on Spectrum’s broad investable universe. It is the A$ tradeable debt securities market. There are more than 1000 securities available for investment. In addition to the major bond issues in the market the firm explores the less-researched less liquid segments of Australian Fixed Income market.

Spectrum invests surplus funds in term deposits from time to time. As standard practice, they invest only in deposits of major Australian banks.

Investable Universe as at Q4 2016

Sector A$ billion

Banks 170

Corporates 51

Asset-Backed Securities (ABS) 102

Kangaroos 188

Listed 44

A$ Eurobonds 54

Sub-Total 609

Australian Government Bonds 673

Total 1282

Sources: RBA, Reuters, CMC, UBS, Westpac


SUMMARY 4

Process / Philosophy / Style

The Fund’s style is a blend of deep-dive credit research combined with elements of macro research and quantitative techniques.

The investment approach of the Spectrum Strategic Income Fund combines top-down global macroeconomic and political views regarding interest rates with bottom-up quantitative techniques and in-depth credit research.

Securities in which the Fund invests may be issued by government bodies, corporations and, to a limited extent, specialist financing vehicles. To maintain a diversified portfolio structure, certain limits are imposed on security type, credit risk, industry and issuers.

The screening process places a strong emphasis on return of capital. Spectrum invests in issuers that are considered to have a sustainable business model and prudent financial management. Also considered are the absolute and relative value of the securities from an expected total return perspective. The strategic focus is on A$ corporate issuers that are both local and internationally based entities.

The key elements of the process are:

• Seek to protect capital by avoiding defaults

• Micro – outperform through investing in cheap securities

• Macro –outperform by adjusting credit risk in anticipation of expected changes in the credit cycle

Risk Management

Risk management focuses on diversification, careful security selection, allocation limits, low interest rate duration and containing credit spread duration to typically under three years. The Fund is predominantly a floating rate portfolio, therefore, has low levels of interest rate duration risk.

The risk framework revolves around the:

• Maturity profile within the Fund.

• Diversification.

• Mix of floating and fixed rate assets.

• Mix of securities listed and unlisted.

• Correlations between various sectors and securities being minimised. For example, Kangaroo bonds offer diversification away from Australian economic conditions.

• Understanding the credit spread duration of the Fund.

• A system of limits to reduce the concentration of risk.

3. Portfolio Characteristics

Portfolio Turnover

The Fund Manager’s style generates a low portfolio turnover of approximately 20% per annum, which assists in managing transaction costs and slippage.

Liquidity

While the process is biased towards the more liquid and tradeable issues within its universe, the liquidity of the asset class is nevertheless materially lower than more traditional fixed income markets, particularly when compared to fixed-rate large-issue high-grade bonds.

Despite this, liquidity is not a constraining factor for the Fund at its current size.

In the scenario where large requests for withdrawals are made simultaneously, the Fund may face liquidity risk. This is most likely to manifest as having to sell at discounted prices to generate redemption funds required. An inability to fully raise the required funds due to liquidity in a stressed market is also a possibility, although very unlikely.

Leverage

This Fund employs neither actual leverage (through borrowing by the Fund) or economic leverage (through the use of derivatives).

4. Performance & Risk

Return Objective & Performance

The return objective stated in the PDS is that the Fund aims to “generate returns in excess of the benchmark by investing in a diversified portfolio of debt and hybrid debt securities”. The formal benchmark is the “Cash Rate determined by Reserve Bank of Australia”, also known as the RBA Cash Rate Target Index. The Fund has an informal, internal return target of the RBA Cash Rate + 1.50% per annum.

Over the twelve-month period to Jan-2018, the Fund returned 4.71% (after fees) compared to 1.50% for the benchmark. This is an outperformance of 3.21%.


SUMMARY 5

Fund Excess Returns %: Half-yearly (net of fees)

Length of Track Record

The Fund has a history of 8.7 years (or 104 months). As a result, observations and analysis of the Fund’s returns will have some practical statistical value. While the Fund’s track record is reasonably long, it has not yet traversed a serious down cycle in credit markets, such as was experienced in the GFC of 2008 or the tech wreck of 2001.

Risk Objective

The Fund’s PDS states that the risk level of the Fund is considered to be “Medium – There is a risk investors may lose some of their initial investment. Medium risk investments tend to fluctuate in the short-term but can produce higher returns than lower risk investments over the long-term”. The Fund also has an objective of having lower volatility than equities, which is not at all an onerous goal for a fixed income fund.

The Fund’s volatility (standard deviation of monthly returns) over the year to Jan-2018 was 0.49% p.a. with a peer average of 0.67% p.a. and 0.12% p.a. for the benchmark.

Drawdown Experience

Drawdown Summary

Size of Drawdown (peak-to-trough)

Fund Bench Peers

Average -0.65% 0 -0.80%

Number 10 0 7

Drawdowns have on average been moderately better than the peer average. The benchmark, being a cash rate, has no drawdowns.

Correlation to Australian Equities

The Fund’s rolling three-year correlation with the ASX300 has been displaying a moderate but consistent downtrend over the last four years.

Over the life of the Fund, the rolling three-year correlation has averaged 35.6% with a high of 55.5% and a low of 18.5%. These volatility levels are around 10 to 30% lower than the peer group average.

5. Other Features

Fees

Base management fee:

• The total payable fee is 0.75% per annum of the Fund’s Net Asset Value (“NAV”)

• including/excluding GST and impact of RITC (Reduced Input Tax Credit)

• calculated daily and paid monthly

• peer group average is 0.57% per annum

• Expense recovery fee disclosed in the PDS - zero recovery fee. The manager bears this cost.

Buy/sell spread:

• total of 0.30% (0.15% buy /0.15% sell)

• peer group average is 0.18% (0.09% buy /0.09% sell)

Performance fee:

The Fund does not charge a performance fee

Governance

The Board of Directors of the Responsible Entity, Equity Trustees (EQT) consists of six independent directors (including the Chairman) from a total of seven members. SQM Research looks favourably at the inclusion of independent members on the Board of Directors – it is a meaningful way to enhance governance oversight. EQT’s Compliance Committee Charter requires that the Committee shall comprise at least three members all of whom (including the Chairman) are independent non-executive directors of EQT, with a quorum of two members required to attend a meeting. SQM Research views independence in an RE oversight body such as the Compliance Committee as a strong and favourable factor in Fund governance.

3.00

1.35

0.55 0.61

2.53

1.25

2.15

1.34

0.21

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Jun 14 Dec 14 Jun 15 Dec 15 Jun 16 Dec 16 Jun 17 Dec 17 Jan 18

Exce

ss R

etur

ns

latest data = 1 months ending Jan-18


SUMMARY 6

Growth of $10,000

+3.3

+5.6

+5.0

+0.3

+2.1 +1.8

+1.5

+0.1

+1.6

+5.1 +4.7

+0.5

+0.0

+1.0

+2.0

+3.0

+4.0

+5.0

+6.0

Dec 15 Dec 16 Dec 17 Jan 18

Fund Benchmark Peer Avg

Annual Returns

$10,000$11,000$12,000$13,000$14,000$15,000$16,000$17,000$18,000$19,000$20,000$21,000

May

09

No

v 09

May

10

No

v 10

May

11

No

v 11

May

12

No

v 12

May

13

No

v 13

May

14

No

v 14

May

15

No

v 15

May

16

No

v 16

May

17

No

v 17

Benchmark Fund Peer Average

FUM (Funds under Management)

The Fund currently has FUM of $45.6 million.

The Manager believes that capacity for this strategy is in the order of $1,500 million.

FUM Net Flows $m*

Jun-16 $17.6 -$0.30

Sep-16 $19.3 $1.50

Dec-16 $22.9 $3.42

Mar-17 $27.5 $4.17

Jun-17 $32.6 $4.76

Sep-17 $37.2 $4.31

4Dec-17 $44.1 $6.46

Jan-18 $45.6 $1.38

* estimated

Fund Performance to 31 January 2018 (% p.a.)

Total Return 1-Month 3-Month 6-Month 1-Year 3-Year 5-Year Inception

Fund1 0.33 0.83 1.97 4.71 4.50 5.43 8.59

Benchmark2 0.12 0.37 0.75 1.50 1.77 2.11 2.96

Peer Avg 0.48 0.96 2.02 4.67 3.94 4.43 6.79

Excess 0.21 0.46 1.23 3.21 2.73 3.32 5.63

1. Assumes dividend reinvestment. Returns for periods greater than one year are annualised. Return history starts Jun-2009

2. Benchmark: RBA Cash Rate


SUMMARY 6 SUMMARY 7

Strengths of the Fund

• A small but highly qualified investment and management team.

• Explores the less-researched less liquid segments of Australian Fixed Income market.

• Predominantly floating rate portfolio therefore low levels of interest rate duration risk.

• While there is more limited market liquidity compared to traditional large-issue bonds, liquidity is not a major issue at this FUM size.

• Strong track record over a seven-plus-year life, outperforming benchmark and peers by significant margins.

• Risk-adjusted returns (i.e. Sharpe Ratio) higher than peer group average over all periods and since inception.

• The volatility of the Fund has been lower than peers, out to 7 years.

Weaknesses of the Fund

• Key person risk is high.

• The credit risk characteristics of hybrid and high yield debt mean the Fund will likely display underperformance to benchmark during instances of increased market volatility or stress.

• While the Fund’s track record extends to almost 7.5 years, it has not yet traversed a serious down cycle in credit markets, such as was experienced in the GFC of 2008 or the tech wreck of 2001.

• While the process is biased towards the more liquid and tradeable issues within its universe, the liquidity of the asset class is nevertheless materially lower than more traditional fixed income markets such as government bonds. This will likely become a challenge as the Fund grows to a large size (multiples of current FUM).

• In the scenario where large requests for withdrawals are made simultaneously, the Fund may face liquidity risk at a larger FUM size than it is currently. This would most likely manifest as having to sell at discounted prices to generate redemption funds required. An inability to fully raise the required funds due to liquidity in a stressed market is also a possibility, although not very likely.

Other Considerations

• The Fund distributes quarterly income, the size of the distribution will be influenced by capital gains/losses generated by portfolio holdings.

• The management fee is higher than peer group average, as is the buy/sell spread.

• No performance fee.

• The style has a low turnover (approximately 20% p.a.), which assists in managing transaction costs and slippage.

• Low to modest correlation to Australian equities.

• Leverage is not employed in this Fund.

• The Fund invests in $A securities and hence avoids currency risk.

• A small and entrepreneurial fund manager with room to grow.

Key Changes Since the Last Review

• No changes to investment process since the previous review.


INVESTMENT PROCESS & PORTFOLIO CONSTRUCTION 8

Process Description

Universe

Investable Universe Spectrum’s broad investable universe is the A$ tradeable debt securities market. There are more than 1000 securities available for investment from the following security types:

• Listed and unlisted corporate debt, financial, government and government-related debt securities

• Listed hybrid debt securities and convertible notes issued by corporate and financial issuers

• Investment grade collateralised mortgage and debt obligations, residential and commercial mortgage-backed and other asset-backed securities

• International government agency securities issued in Australian dollars

• Term deposits and bank certificates of deposit and bankers’ acceptances

Investment Process

Top-down or Bottom-up

The investment process is a combination of global macroeconomic/political assessment of interest rates and individual bottom-up credit selection based on fundamental research.

The process has elements of both top down and bottom up. Spectrum undertakes a monthly macro meeting which provides a top-down perspective and sets the direction of the Fund over the next twelve months. This meeting includes big picture concepts such as geopolitical situations, and the drivers of credit spreads both domestically and internationally. A target credit spread over the next twelve months is then forecasted.

Bottom-up perspectives develop through the credit research process which generates views on credit risk, conducts sector assessments and develops security valuations both absolute and relative.

Investment Process Diagram


INVESTMENT PROCESS & PORTFOLIO CONSTRUCTION 8 INVESTMENT PROCESS & PORTFOLIO CONSTRUCTION 9

Research and Portfolio Construction Process

Idea Generation

Spectrum’s view is that the common drivers of corporate bond market inefficiencies stem from:-

1. investors’ anchoring of perceptions based on the recent past

2. the tardiness of credit rating agencies

3. the bulk of the domestic investor base being inexperienced with deteriorating credit environments

4. the reluctance of some local investors to invest in Kangaroo bonds due to lack of credit experience

5. the inability of some local investors to incorporate international influences on local securities promptly.

Communication and interaction between Analysts and the Portfolio Manager are vital in Spectrum’s investment process. The Analysts will conduct credit research and generate new ideas from their ongoing review of the investment universe and its opportunities. This includes tapping into their contact network of brokers, investment banks and sell-side researchers. The Analysts will also consider newly issued securities that might be relevant for the Fund. The Portfolio Manager has the ultimate responsibility for all investment decisions. Securities not recommended by Research are not invested in.

Research idea generation and portfolio construction are discussed in the weekly micro meetings and in a “bigger picture” sense during the macro meetings. The table below provides details of the meetings that form part of both security selection and portfolio construction processes.

Investment- Related

Purpose Decision Outcomes Frequency

Morning meeting

Collate micro and macro news from market movements overnight. Assess the potential impacts of news flow upon the portfolio. Allows for a discussion of any risks or areas of concern which need to be addressed.

Any news flow considered to have a potentially significant impact on the portfolio will be acted upon. For example, a piece of negative news released overnight concerning a credit will spur discussion to determine where the portfolio stands regarding exposure or opportunity.

Daily

Macro Meeting

Sets the general direction of the Fund over the next twelve months. Incorporates a big picture and globally focused view.

Determines the potential challenges to be faced in the market over the next twelve months and develops a 12-month credit spread target.

Monthly/ As necessary

Micro Meeting

Assess security valuations, movements in relevant market indices, assess newly issued securities and credit rating changes. The team reviews trade recommendations and buy/sell levels which have been set by ad-hoc credit research. Portfolio construction, the generation of ideas and future credit research to be conducted, are also discussed.

Determines whether any security valuations stand out in a total credit return sense and if any action should be taken concerning the holdings of the Fund. Is also a forum for the investment team to generate new ideas relative to credit research.

Weekly



Portfolio Construction Process

Spectrum runs a diversified portfolio with a bias towards floating rate securities. The two key macro parameters that the Fund actively positions are the average credit rating of the portfolio and the portfolio’s credit spread duration.

Due to the bias towards floating rate securities, a rise in the overall level of interest of rates is usually a positive factor for future returns. All else held equal, the income of the floating rate securities would rise with rising interest rates. However, interest rates alone are not the key factor to the Fund’s performance. A key driving factor of the Fund’s performance, especially over short-run periods, is credit spread. If credit spreads contract - all else held equal - the Fund experiences capital gains. If credit spreads widen, the Fund will experience capital losses that will reduce (or in severe scenarios, overwhelm) the income earned from interest payments.

Should the investment team expect a widening in the overall level of credit spreads, they will act to reduce the portfolio’s credit spread duration and/or act to increase the average credit rating of the portfolio. Both are defensive measures in the face of a poor market environment

Should credit spreads be expected to fall, the credit spread duration of the portfolio can be increased, and the average credit rating can be lowered. This exposes the Fund to greater risk but also greater return if the expected fall in credit spreads does take place. With these two levers, the Fund can adapt to changing market conditions as required.

The key to portfolio performance, in the long run, is avoiding defaults and distressed restructures of securities.

The Manager uses relative value techniques and expected investor demand as basic tools for allocating security weights in the portfolio. The Manager does not use hard science on optimisation but rather a delicate balance between returns, anecdotal evidence, avoidance of default, diversification benefits and shape of the credit curve.

Credit Risk

At the portfolio level, credit risk is assessed by computing an average credit rating for the Fund. Spectrum gives a credit rating for each of the credits it has exposure to and seeks to monitor the live credit ratings designated by the major rating agencies on a daily basis. Spectrum uses three different methods to compute the average credit rating of the portfolio.

The first method is a linear straight line scoring method utilising the lesser of the two ratings provided by Moodys and S&P. Securities that are not rated are considered in this process to be worse than a CCC rated security, reflecting the conservative mindset of the investment team.

The second method repeats this process but incorporates the internal credit ratings assigned by the investment team for the non-rated securities.

The third method is to compute the credit rating of the portfolio with respect to the S&P global default rates database.

On a monthly basis credit risk is assessed using the Thomson Reuters “Starmine” platform, which generates assessments of credit risk from three different perspectives:

1. the equity market’s expectation of credit risk

2. credit risk based upon historical and forward-looking accounting ratios

3. credit risk based upon text mining the internet about the business

The rating outcomes of these three methods as of September 2016 for the Spectrum Strategic Income Fund is displayed below.

Linear Rating System Adjusted Linear Rating System S&P Implied Defaults

A- A BBB+


INVESTMENT PROCESS & PORTFOLIO CONSTRUCTION 10 INVESTMENT PROCESS & PORTFOLIO CONSTRUCTION 11

Portfolio Construction Process...continued

Sector/Industry and Security Selection Management

Lindsay Skardoon manages the portfolio and is responsible for the overall performance of the Fund. Each morning a number of screens are reviewed and assessed. Such screens include the performance of Aussie Itraxx, our correlation matrix, a review of overnight futures markets, a review of the overnight US and European Bond markets, and a review of overnight news services.

Overnight movements are discussed in the morning meeting. Both the Portfolio Manager and Credit Manager discuss their respective outlooks. Lindsay Skardoon is responsible for producing an overnight macro newssheet, and Damien Wood is responsible for producing an overnight micro sheet (i.e. focussed on individual credits).

Each morning the portfolio is reviewed for pricing fairness in the report supplied by the Custodian.

Each morning the portfolio is reviewed for outliers spread changes. If a security’s spread has contracted significantly from the previous day, then that security is identified and discussed informally.

Every Thursday a Micro meeting is held, and all securities within the portfolio are discussed. Securities of possible interest are identified including those that are owned, those that may be disposed of and those are considered for purchase. The Manager does not make allocations in accordance with a TAA/SAA model.

If the Manager has a strong conviction on a security, based on the research process, then the Manager could decide to take the full weight as per the risk limit or takes a partial holding.

Factors that play a part in this decision-making process are:

• Liquidity

• Local demand vs Offshore demand (For example, a strong European brand name may not be well recognised locally but may attract strong European interest)

• Does the security help diversify the portfolio?

• Is the security positively correlated with other securities in the portfolio?

• Does the security increase or decrease diversification?

• Availability of the issue

• Lead Managers and co-managers to the issue

• Secondary market making activities

• Is the security in an index?

• How cheap is the security?

The Spectrum Strategic Income Fund has a bias towards floating rate securities that limit the interest rate duration risk of the overall portfolio. The Portfolio generally is split 85% floating and 15% fixed. Often the proportion of floating to fixed is higher. A weighting bias towards fixed is dependent upon the level of interest rates and their general direction.

The credit cycle outlook drives cash levels. However, in times of stress or periods of uncertainty where there is a significant chance of major unsystematic risk developing the Portfolio Manager has the discretion to hold larger portions of cash. Holding cash is seen a strategic defensive position used to ameliorate significant potential risks.

Turnover

The Fund is not a high turnover fund. On average the Fund turns over approximately 20% of the portfolio in any given year. Presuming a stable fund size the bulk of this may be driven by the need to reinvest matured or redeemed securities.

It is important to note that the Manager seeks to minimise the number of securities sold and these are only sold if the issuer either has a questionable and deteriorating balance sheet or where the security has become expensive.



Sell Discipline The decision to sell a security is based on several factors:

• If the security is at risk of becoming stressed, or if there is some new information that has come to light that could affect the security’s performance.

• If the Manager believes that the security has achieved its expected credit spread contraction, and so offers limited future performance. In other words, the security no longer offers relative value to its peers and is considered to be expensive.

• Alternatively, many securities are redeemed by the issuer on a call date or conversion date.

• A security would be sold if it was to lose its bond characteristics and become more equity-like as in the case of preference shares taking on equity-like characteristics.

Risk Management Unlike a typical bond or equity fund, the major concern for a credit fund is default. A market movement of 3 standard deviations can have a meaningful impact on the short-term performance of the Fund but does not necessarily cause significant permanent damage.

The most important risk for a credit Fund is to minimise unexpected shocks such as default, restructure or distressed exchange which can cause an unrecoverable loss to the portfolio.

Accordingly, Spectrum’s efforts on risk management are to: -

• ensure diversification within the portfolio,

• aim to minimise the risk of default.

• measure risk in the portfolio’s components with reference to the Fund’s credit spread duration.

• understand the interplay of duration and the maturity pattern.

• monitor each individual security’s financial position to detect a deteriorating financial position or sector weakness.

The risk framework revolves around the:

• Maturity profile within the Fund

• Diversification

• Mix of floating and fixed rate assets

• Mix of securities listed and unlisted

• Correlations between various sectors and securities being minimised. For example, Kangaroo bonds offer diversification away from Australian economic conditions.

• Understanding the credit spread duration of the Fund.

• A system of limits to reduce the concentration of risk.

By maintaining a short-ish credit spread duration, the Manager believes that the Fund is kept to a reasonable risk-reward position. The current spread duration is approximately 3.5 years. As a guide, the Manager has maintained a credit spread duration of approximately 3.0 to 3.5 years over the term of the Fund

The Portfolio Manager “standard” cash balance is in the region of 3%-7% which acts as a minor risk buffer.

Trading/Implementation

Trade Execution The Fund is not an active trader. It does, however, take an active approach to evaluating credits and selling those that have become very expensive or where they no longer offer diversification or where the financial position could be strained. Trading decisions are made based on both the current return and whether the security is rich or cheap compared to its peers. A deteriorating financial position changes the outlook.

The person responsible for trading securities within the Fund is the Portfolio Manager Lindsay Skardoon.



Hedging and Derivatives

• The Spectrum Strategic Income Fund does not take any currency risk. The Fund only invests in A$ securities.

• The Spectrum Strategic Income Fund does not use leverage.

• The Spectrum Strategic Income Fund does not use derivatives.

• The Spectrum Strategic Income Fund is a long only fund and cannot have a net short position in any single sector or security.


CORPORATE GOVERNANCE / BUSINESS STRATEGY 14

Key Counterparties

Parent Company

Spectrum Asset Management Limited is a public, non-listed entity that is 100% owned by its principals, who each have a material equity stake in the business.

Investment Manager / Fund Manager

The business was founded in 2001 by two of its current principals – Lindsay Skardoon and Christine Windeyer. It is a Sydney-based fund manager specialising in investing in corporate debt and income securities. It has generally been modestly profitable and has now embarked on a growth programme which it believes will see material upswing in FUM and profits. The Principals state they are willing and able to fund any expected losses (should they occur) over the coming years. The motivation for this is their belief that there is solid growth potential in this area of investment, and that their business is highly scalable. The current shareholders have recently made additional commitments of capital, generally on an “as-needed” basis. The aim is to provide adequate “runway” for the firm to execute on its growth ambitions.

Responsible Entity

Equity Trustees (EQT) is a financial services company head- quartered in Melbourne. Established in 1888 and listed on the Australian Securities Exchange (ASX) in 1985, EQT provides a range of products and services to a diverse client base including fund managers, managed funds, superannuation funds, and financial planning. Equity Trustees acts as Responsible Entity or Trustee for over 80 major Australian and international investment managers.

The Board of Directors of the Responsible Entity (RE) consists of seven directors, six of whom are independent, including the Chairman.

The Board’s key responsibility regarding EQT’s Responsible Entity activities is to ensure the company has adequate systems of internal controls and appropriate monitoring of compliance activities.

The Equity Trustees Board Charter (Apr-2016) mandates that the Board adhere to the following principles:


CORPORATE GOVERNANCE/BUSINESS STRATEGY 15

• The Board will comprise an appropriate number of directors of whom a majority are independent non- executive directors and ordinarily reside in Australia.

• The Board will be led by an independent chair who is not the same person as the Managing Director.

• Directors, collectively, are to have the appropriate balance of skills, knowledge, experience, independence and diversity to enable it to discharge its duties and responsibilities effectively.

• The Board assesses at least annually whether its Directors are independent

• Board meetings are to take place at least quarterly.

• Two members of the Board form a quorum.

Management Risk

Funds management businesses rely on the operational capabilities of key counterparties. A critical element is the corporate ability of the Responsible Entity to monitor operational performance and to meet the regulatory and statutory responsibilities required. For any investment fund, there is a risk that a weak financial position or management performance deterioration of key counterparties could temporarily or permanently compromise their performance and competency. This can adversely affect financial or regulatory outcomes for the Fund or associated entities.

Based on the materials reviewed, SQM Research believes that Spectrum and associated key counterparties are qualified to carry out their assigned responsibilities. Management risk is rated as being moderate.

Funds under Management (FUM)

The Fund is approximately $45.6 million in size at Jan 2018.

FUM Net Flows $m*

Jun-16 $17.6 -$0.30

Sep-16 $19.3 $1.50

Dec-16 $22.9 $3.42

Mar-17 $27.5 $4.17

Jun-17 $32.6 $4.76

Sep-17 $37.2 $4.31

Dec-17 $44.1 $6.46

Jan-18 $45.6 $1.38

* estimated

FUM for Fund under Review ($mill)

$0

$5

$10

$15

$20

$25

$30

$35

$40

$45

$50

Dec

-07

Dec

-08

Dec

-09

Dec

-10

Dec

-11

Dec

-12

Dec

-13

Dec

-14

Dec

-15

Dec

-16

Dec

-17

Quarterly Net Flows ($million)

-$1

$0

$1

$2

$3

$4

$5

$6

$7

Jun-1

5

Sep-1

5

Dec

-15

Mar

-16

Jun-1

6

Sep-1

6

Dec

-16

Mar

-17

Jun-1

7

Sep-1

7

Dec

-17

Mar

-18


Distributions

The Fund has discretion in choosing the frequency of distributions. Distributions occur on a quarterly basis, subject to the availability of distributable income.

In a scenario where the Fund’s realised losses and expenses exceed income in a distribution period, the Fund may elect not to make a distribution during that time.

The nature of the strategy and the high average yield of the portfolio produces a stream of income, which to a material degree flows through to distributions.

Distribution Date

Distribution CPU

Unit price$

Distribution %

31-Dec-15 2.1600 $1.02940 2.10

31-Mar-16 0.6700 $1.04100 0.64

30-Jun-16 2.6300 $1.03230 2.55

30-Sep-16 0.5400 $1.03830 0.52

30-Dec-16 0.9600 $1.03820 0.92

31-Mar-17 0.5705 $1.05150 0.54

30-Jun-17 1.2600 $1.04990 1.20

30-Sep-17 0.5404 $1.05590 0.51

31-Dec-17 0.5631 $1.06460 0.53

A General Note on Distributions for Managed Funds

The Responsible Entity of a Managed Fund will provide for a regular schedule of distributions, such as monthly/quarterly/ semi-annual or annual. This is subject to the Fund having sufficient distributable income.

The official total distributable income available to pay to investors is determined for the period of that Fund’s financial year. By distributing the net taxable income of the Fund to investors each year, a Fund itself should not be liable for tax on its net earnings.

If a Fund makes distributions more frequently than once over the financial year, those distributions will be made based on estimates of the distributable income for that distribution period. The final total amount of distributable income available for passing on to investors can only be calculated after the close of the financial year, based on the Funds taxable income for that year.

If the total distributions a Fund pays out exceeds total tax income for that particular financial year, the excess amount may be treated as a return of capital rather than income. This will possibly have tax implications for the investor.

Due to the considerations outlined above, there may be periods in which no distributions are made, or a Fund may make additional distributions

A Fund’s ability to distribute income is determined by the performance of the Fund and general market conditions. Accordingly, there is no guarantee a Fund will make a distribution in any particular distribution period.

2.160

0.670

2.630

0.540

0.960

0.571

1.260

0.540 0.563

0.00

0.50

1.00

1.50

2.00

2.50

3.00

Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Dec-17

Distribution Amount - cents per unit

CORPORATE GOVERNANCE/BUSINESS STRATEGY 16


MANAGEMENT & PEOPLE 17

Key Investment Staff

Name Responsibility / Position Location Years with Company Years with Industry

Lindsay Skardoon Portfolio manager / CIO Sydney 17 30

Christine Windeyer CEO / Principal Sydney 17 30

Damien Wood Head of Research / Principal Sydney 3 26

Hamid Yahyaei Credit Research Analyst Sydney 3 3

Average 9.5 22.3

Investment Team

The roles of each member of Spectrum’s investment team are described below:

Meeting Purpose Frequency Participants

Micro Meeting Security Research, Portfolio Construction, Portfolio and Performance Review.

Weekly Damien Wood - Leads meeting. Hamid Yahyaei - Notetaker. Christine Windeyer

& Lindsay Skardoon are participants.

Macro Meeting Asset Allocation, Investment Strategy, Macro View Setting

Monthly Damien Wood - Leads meeting. Investment team are all participants.

Management Meeting Assess and act upon any management related issues or opportunities which

have arisen.

Weekly Management will take notes if need be upon necessary business items.

Compliance Meeting Risk Management Quarterly Rick Steele - Notetaker. Christine Windeyer - Leads Compliance

Board Meeting Are held for any issues, situations or opportunities that require a collective decision to be made by the board of

Spectrum.

As required / at least Quarterly

Each board member is an active participant

SQM Research believes the practice of constant communication and the broad-based inclusion of team members in decision-making is a vital ingredient to the success of the process. Interactive peer review and collaboration across a tightly knit group of experienced investors will likely make the best use of their combined intellectual property and shared history.

Meeting Schedule

The table below shows meetings that form part of the overall process.

Team Member Role Role outline

Lindsay Skardoon Portfolio Manager Sets the investment weights and manages the portfolio.

Damien Wood Head of research Conducts credit research into the investable universe of the fund. Covers A$ credit - including domestic and offshore issuers.

Christine Windeyer CEO Oversees all the operations of the business and is made aware of the investment operations conducted by Lindsay, Damien and Hamid.

Hamid Yahyaei Analyst Assists in the research process. Covers A$ credit - including domestic and offshore issuers.



Key Investment Staff

Lindsay Skardoon: Founder and Portfolio Manager

Mr Skardoon is one of the Principals who founded Spectrum in 2001. He is Chief Investment Officer and carries portfolio management responsibilities at the firm. He has over thirty years of experience in interest rate markets, encompassing senior roles in Australia and Asia with Westpac, Potter Warburg and Dresdner Kleinwort Benson before taking up his role at Spectrum. He has dealt with a wide range of interest rate securities including hybrids, convertible bonds, asset-backed securities, derivatives, swaps. He has traded both primary and secondary issues, both listed and unlisted, in a range of currencies.

Mr Skardoon holds a BSc from the Griffith University, a Graduate Diploma in Banking and Finance from Monash University, a Masters in Applied Finance from Macquarie University and a Masters in Business Administration from Melbourne University. He is a member of the National Investment Committee of the Heart Foundation of Australia.

Christine Windeyer: Founder and Principal

Ms Windeyer is one of the Principals who founded Spectrum in 2001. She is Chief Executive Officer of Spectrum and is responsible for overall operations and business development as well as supporting research and investment management at the firm. She is also Spectrum’s Compliance Officer. Ms Windeyer has over thirty years’ experience in debt markets with leading domestic and international banks, including Citibank, Westpac, National Australia Bank and Chase Manhattan before founding Spectrum. She was Head of Loan Syndication at Westpac and Head of Debt Origination at NAB.

Ms Windeyer holds a BSc from the University of Sydney and a Postgraduate Diploma in Financial Management from the University of New England. She represented NAB on the AFMA debt markets committee.

Damien Wood: Principal

Mr Wood joined Spectrum in 2014 and manages the research function at the specialist investment manager. He has around 25 years of experience in global credit markets and has worked in Sydney, London, Hong Kong and Singapore. Much of Mr Wood’s experience was gained working for Credit Suisse both in Singapore and Sydney where he was Head of Asia Pacific Fixed Income Research from 2004 - 2012. His experience captures a wide array of credit deals including mezzanine finance for corporates/banks and highly structured finance facilities. Mr Wood has worked in the credit team at AMP in Sydney and led the credit research teams of ING Barings and Barclays Capital in Asia.

Mr Wood holds a Masters of Business Administration from the University of Queensland, a Bachelor of Financial Administration from the University of New England and a Graduate Diploma in Applied Finance from the Securities Institute of Australia.

Hamid Yahyaei: Analyst

Mr Yahyaei joined Spectrum in 2014 as an intern and formally as an analyst in November 2015. He assists in the development of financial models which provide an analytical basis for Spectrum’s investment decisions. He assesses the factors which drive the performance of assets held by Spectrum, as well as potential investment opportunities. Hamid holds a Bachelor of Applied Finance from Macquarie University with Distinction and was awarded the Australian Finance Conference Prize for Money & Finance in 2015.

Staffing Changes

There have been no departures of key staff in the past 3 years. The table below outlines the additions made to the business to strengthen its capabilities over the past 3 years.

Name Start Date Background

Damien Wood Nov-14 Mr Wood joined Spectrum as a Principal in 2014. He brings around 26 years of experience in global credit markets, primarily in research

Hamid Yahyaei Dec-14 Mr Yahyaei was brought on by Mr Wood to assist in the research function of the business.

James Jarvis Feb-16 Mr Jarvis acts as an authorised representative for Spectrum. He has over 15 years of industry experience in wealth management, investment sales and relationship management.

Jarrod Brown Nov-16Mr Brown joined the team as an authorised representative in late 2016. He was most recently CEO of Bennelong Funds Management and has over 20 years’ experience in banking and funds

management.

SQM Research observes that the levels of investment experience are strong across a small but well-knit investment team.



Remuneration and Incentives

Currently, the senior professionals in the firm are Spectrum shareholders. Compensation is therefore derived from a mix of salary, incentives and dividend payments. At this stage, there are no products for which a performance fee is charged.

Success through strong performance of its funds and growth in funds under management translate to growth in the value of the equity holdings that the principals have in the business. This motivates the principals to ensure they are doing all that is required to support the future success of Spectrum.

Mr Yahyaei is the only member of the investment team who is paid a salary. The business development managers are paid a monthly retainer.

Executive board members are not rewarded separately from their roles as executives. Non-executive board members may be paid director’s fees subject to their performance as a director and at the discretion of the majority of directors.

SQM Research believes access to firm equity, and client-focused performance bonuses act as strong incentives for optimising staff engagement and productivity. The structure at Spectrum provides powerful alignment of interest for the investment team to deliver on client objectives and grow the business.

The co-founders are clearly focussed on clients’ needs and medium to long term results.


PRODUCT FEATURES - FEES, REDEMPTION POLICY 20

Buy/Sell Spread

A buy/sell spread is applicable as follows:

• total of 0.30% (0.15% buy / 0.15% sell)

• the peer group average is 0.18% (0.09% buy /0.09% sell)

This spread represents the difference between the application price and the withdrawal price of the Fund, a reflection of transaction costs relating to the underlying assets.

Ongoing Fees

Base management fee:

• 0.75% per annum of the Fund’s Net Asset Value (“NAV”)

• including/excluding GST and impact of RITC (Reduced Input Tax Credit)

• calculated daily and paid monthly

• peer group average is 0.57% per annum

Expense recovery fee disclosed in the PDS:

Zero recovery fee.

Entry/Exit Fees

Buy Spread (%) 0.15%

Sell Spread (%) 0.15%

Ongoing Fees

Management fee (% p.a.) 0.75%

Expense recoveries (% p.a.) Nil

Cost of Fund1 (% p.a.) 0.75%

ICR2 (% p.a.) 0.75%

Performance Fee None

1 Management fee and expected expense recoveries. 2 Indirect costs ratio

Performance Fees

The Fund does not charge a performance fee.

Overall Fees

If held and redeemed within 12 months, total transaction costs would amount to 1.05% of investment in the Fund. This figure includes the MER, expense recovery and the buy/sell spread. It does not consider rebates or negotiations or any potential performance fee.

SQM Research observes that:

• The Fund management fee is 0.75% p.a., which is 18 basis points higher/lower than the peer group average of 0.57% p.a.


QUANTITATIVE ANALYSIS 21

Metrics 1-Year 3-Year 5-Year Inception

Tracking Error (% p.a.) – Fund 0.49 1.13 1.20 3.21

Tracking Error (% p.a.) - Peer Average 0.67 1.52 1.43 2.41

Information Ratio – Fund 6.55 2.41 2.77 1.75

Information Ratio - Peer Average 5.39 1.54 1.76 1.78

Sharpe Ratio – Fund 9.61 4.00 4.43 2.65

Sharpe Ratio - Peer Average 8.20 2.87 3.36 3.24

Volatility - Fund (% p.a.) 0.49 1.12 1.23 3.25

Volatility - Peer Average (% p.a.) 0.67 1.50 1.44 2.44

Volatility - Benchmark (% p.a.) 0.00 0.08 0.14 0.33

Quantitative Insight1

Note: All return and risk data reported in this section are after-fees and for periods ending Jan-2018 unless otherwise stated.

Risk/Return Data to 31 January 2018

Total Return 1-Month 3-Month 6-Month 1-Year 3-Year 5-Year Inception

Fund1 0.33 0.83 1.97 4.71 4.50 5.43 8.59

Benchmark2 0.12 0.37 0.75 1.50 1.77 2.11 2.96

Peer Avg 0.48 0.96 2.02 4.67 3.94 4.43 6.79

Excess 0.21 0.46 1.23 3.21 2.73 3.32 5.63

1. Assumes dividend reinvestment. Returns for periods greater than one year are annualised. Return history starts Jun-20092. Benchmark: RBA Cash Rate

1. Note: Sharpe and Information Ratios are not reliable comparison tools in periods where both the Fund and its peers/benchmark record a negative result

4.71 4.50 5.43

8.59

1.50 1.77 2.11 2.96

4.67 3.94 4.43

6.79

1-Year 3-Year 5-Year Inception

Total Return % pa

Fund Benchmark Peer Average

3.21 2.73

3.32

5.63


Fund Excess Return over Benchmark

0.04

0.56

1.00

1.80


Fund Excess Return over Peer Average



The Fund has displayed strong performance across all periods against both benchmark and peers. These returns exceed the PDS objective, Spectrum’s internal targets and SQM’s expectations for the Fund relative to its fee level and volatility.

Return AnalysisLast 8

Calendar yearstp Dec-17

Last 12Half-yearsto Dec-17

Last 104Monthsto Jan-18

v. Benchmark v. Benchmark v. Benchmark

Periods of +ve alpha 8 11 82

Avg outperformance 4.23 2.40 0.71

Periods of -ve alpha 0 1 22

Avg underperformance None -0.28 -0.52

Hit Rate 100.0% 91.7% 78.8%

Benchmark: RBA Cash Rate

The Fund has outperformed its benchmark on all rolling three year periods since its inception. As the table above shows, the quantum of outperformance has been consistently greater than that of underperformance. The Fund’s hit rate is also very sound at 79% for monthly observations.

Risk

The Fund’s volatility (standard deviation of monthly returns) has tended to be modestly lower than peers out to 5 years, and higher on a since inception basis.

0.49

1.12 1.23

3.25

0.00 0.08 0.14 0.33 0.67

1.50 1.44

2.44


Volatility % pa

Volatility - Fund (% p.a.) Volatility - Benchmark (% p.a.) Volatility - Peer Average (% p.a.)

0.49

1.13 1.20

3.21

0.67

1.52 1.43

2.41


Tracking Error % pa

Tracking Error (% p.a.) - Fund Tracking Error (% p.a.) - Peer Average

The Fund’s tracking error (standard deviation of monthly excess returns) has tended to be modestly lower than peers out to 5 years, and higher on a since inception basis.



As another perspective, the Fund’s rolling 3-year volatility (of monthly returns) has varied from a low of 1.12% p.a. to a high of 4.45% and averaged 2.51% over the rolling observations of the Fund’s lifespan.

The risk outcomes as described above regarding volatility and tracking error are consistent with the PDS statements about risk and are in line with SQM’s expectations for this Fund.

SQM has measured and reported tracking error in the tables above. Since the Fund’s benchmark has almost no volatility, the tracking error readings add no new information to observations gained from studying volatility. The tracking error of the Fund is almost identical to its volatility (standard deviation).

Drawdowns

Drawdown Summary:

Size of Drawdown (peak-to-trough)

Fund Bench Peers

Average -0.65% 0.00% -0.80%

Best -0.06% 0.00% -0.81%

Worst -1.58% 0.00% -1.50%

Numer 10 0 7

Length of Drawdown (in months)

Fund Bench Peers

Average 2.7 0 4.6

Note: Length of Drawdown (in months) measures time from peak to trough and back to previous peak level.

Drawdowns have on average been slightly better than the peer average. The benchmark has had zero drawdowns, as expected from a cash-based index.

Snail Trail

The snail trail chart and tables below depicts the combination of the Fund’s rolling 3-year excess returns and rolling 3-year volatility. There are 69 observations in total.

The tables below display the distribution of these observations across the risk/return quadrants as well as the overall frequency of Outperformance v. Underperformance, and of High-Vol v. Low-Vol.

As shown in the table below, the Fund is in the optimal upper left-hand quadrant - Q1 (higher return, lower volatility) 0% of the time. It is important to note that in the case of cash-style benchmarks such as here, the top left-hand quadrant is unachievable as it is not possible to deliver lower volatility

than what is virtually zero for the benchmark. In this case, the optimal position is Q2 (higher return, higher volatility) which the Fund occupies 100% of the time.

Snail Trail Distribution by Quadrant

69 datapoints Lower Vol Higher Vol

Higher Return 0 69

Lower Return 0 0

Q2 (Optimal)

Hi-Return, Low-Volatility 100%

Single Factor Frequency

Higher Return 100%

Lower Return 0%

Higher Volatility 100%

Lower Volatility 0%

Risk-Adjusted Returns

The Fund displays strong risk-adjusted returns as measured by Sharpe ratios for 1, 3, and 5 years when compared to peers. The since inception figure is below the peer average.

Correlation

Fund Correlation to Min Max Avg

Rolling 3 yrs S&P/ASX 300 18.55% 55.45% 35.63%

Rolling 3 yrs MSCI World -2.22% 35.29% 18.06%

69 data points

Modest to moderate correlation of the Fund’s returns with the S&P ASX300 index. Low to modest correlation to global equities.

9.61

4.00 4.43 2.65

0.00

21.93

14.97

9.09 8.20

2.87 3.36 3.24


Sharpe Ratio

Sharpe Ratio - Fund Sharpe Ratio - Benchmark Sharpe Ratio - Peer Average



Returns

Tail Risk

The tail risk chart below shows a modest positive correlation with the ASX300 in times of equity market extremes.

(The analysis in the paragraph below looks at the performance relationship of the Fund to the ASX300, a practice that SQM has set as common across asset classes in Fund reviews. This approach recognises that for the large bulk of financial planner clients, their key traditional asset class risk regarding size and volatility is to Australian equities. Exploring that relationship is useful regardless of the asset class of the Fund itself, as it is helpful to understand how a Fund has acted in times of Australian equity market stress in terms softening or exaggerating the negative performance experienced at such times.)

The table below details the ten largest negative monthly returns for the ASX 300 since the inception of the Fund. This is compared to the Fund’s performance over the same ten months. The Fund’s correlation of returns to the ASX300 returns over this period is +26% while posting five positive returns against the ten negative returns of the Australian stock market, and outperforming the market 10 times out of 10.

The sum of returns over those ten months was -58.9% for the ASX 300 and +0.9% for the Fund, a difference of +60% in favour of the Fund. These figures point to some defensive characteristics of the Fund in the face of extreme equity tail risk.

Worst Market Monthly Returns vs Fund Return Same Month. Market: S&P/ASX 300 TR Timeframe: from Jun-2009 to Jan-2018

Rank Date Market Fund Difference

1 Aug-15 -7.70% 0.83% 8.53%

2 May-10 -7.54% -1.58% 5.96%

3 May-12 -6.74% -0.58% 6.16%

4 Sep-11 -6.28% -0.17% 6.10%

5 Jan-10 -6.17% 1.58% 7.75%

6 Jan-16 -5.45% 0.41% 5.86%

7 Sep-14 -5.37% -0.06% 5.31%

8 Jun-15 -5.32% -0.61% 4.71%

9 May-13 -4.54% 0.98% 5.51%

10 Jul-11 -3.83% 0.15% 3.98%

TOTALS -58.93% +0.94% +59.87%

Correlation +26.1% Positive Return: 5 Beats Market: 10

Rolling Returns

Rolling Correlation to ASX300

0%

2%

4%

6%

8%

10%

12%

14%

May

09

Nov

09

May

10

Nov

10

May

11

Nov

11

May

12

Nov

12

May

13

Nov

13

May

14

Nov

14

May

15

Nov

15

May

16

Nov

16

May

17

Nov

17

Benchmark 3yr Return Fund 3yr Return 3 yr Return Peer Avg

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

May

09

Nov

09

May

10

Nov

10

May

11

Nov

11

May

12

Nov

12

May

13

Nov

13

May

14

Nov

14

May

15

Nov

15

May

16

Nov

16

May

17

Nov

17

Fund: 3 yr Correlation with S&P/ASX 300 TRPeer Avg: 3 yr correlation to S&P/ASX 300 TR

Return and Risk

-10%

0%

10%

20%

30%

40%

50%

60%

70%

80%

May

09

Nov

09

May

10

Nov

10

May

11

Nov

11

May

12

Nov

12

May

13

Nov

13

May

14

Nov

14

May

15

Nov

15

May

16

Nov

16

May

17

Nov

17

1 month Excess Fund: Cumulative Excess

Cumulative Excess Returns



Return and Risk

Rolling Information Ratio

Snail Trail

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

May

09

Nov

09

May

10

Nov

10

May

11

Nov

11

May

12

Nov

12

May

13

Nov

13

May

14

Nov

14

May

15

Nov

15

May

16

Nov

16

May

17

Nov

17

Fund 3yr Info Ratio 3 yr Info Ratio Peer Avg

-10.0%

-7.5%

-5.0%

-2.5%

0.0%

2.5%

5.0%

7.5%

10.0%

-10.0% -7.5% -5.0% -2.5% 0.0% 2.5% 5.0% 7.5% 10.0%

Fund

: Rol

ling

3yr

Exce

ss R

etur

ns

Fund: Rolling 3yr Excess Volatility

Tail Risk - Returns in Worst Australian Equity Down Markets since Fund Inception

Rolling Volatility

Drawdowns

98.098.298.498.698.899.099.299.499.699.8

100.0

May

09

Nov

09

May

10

Nov

10

May

11

Nov

11

May

12

Nov

12

May

13

Nov

13

May

14

Nov

14

May

15

Nov

15

May

16

Nov

16

May

17

Nov

17

Benchmark Drawdown Fund Drawdown Peer Avg Drawdown

0.0%0.5%1.0%1.5%2.0%2.5%3.0%3.5%4.0%4.5%5.0%

May

09

Nov

09

May

10

Nov

10

May

11

Nov

11

May

12

Nov

12

May

13

Nov

13

May

14

Nov

14

May

15

Nov

15

May

16

Nov

16

May

17

Nov

17

Benchmk Std Dev 3yr Fund Std Dev 3yr 3 yr Volatility Peer Avg

Rolling Sharpe Ratio

0.00

1.00

2.00

3.00

4.00

5.00

6.00

May

09

Nov

09

May

10

Nov

10

May

11

Nov

11

May

12

Nov

12

May

13

Nov

13

May

14

Nov

14

May

15

Nov

15

May

16

Nov

16

May

17

Nov

17

3yr Sharpe Ratio Fund 3yr Sharpe Ratio Peers


ASSET ALLOCATIONS & RISK PARAMETERS 26

The table below outline limits on the Fund’s asset allocation and other risk parameters:

Fund Constraints Permitted Range or Limit

Investment grade securities 0-100%

Sub-investment grade and unrated securities 0-25%

Australian trading bank 0-50%

Non-Australian trading bank 0-15%

Sectors other than banks 0-30%

Floating rate securities 50-100%

The Fund’s history of asset allocation and sector metrics are detailed below:

Fund Allocations over Time

Jul-2009 to Sep-2017

Fixed income AverageWeight

MaxWeight

MinWeight

as at Sep-17

Sovereign / Government 0.0% 0.0% 0.0% 0.0%

Investment Grade Corporate 68.1% 85.2% 43.3% 62.7%

High Yield Corporate 2.9% 8.5% 0.0% 1.9%

Hybrids / Preferreds 8.5% 44.8% 3.0% 7.0%

MBS 7.9% 17.2% 0.0% 6.2%

Cash 6.1% 29.1% 0.3% 17.3%

Other 6.5% 16.1% 0.0% 4.9%

Geographic AverageWeight

MaxWeight

MinWeight

as at Sep-17

Australia 74.9% 83.6% 64.0% 71.2%

USA 2.8% 8.8% 0.0% 6.7%

UK 5.0% 11.9% 0.0% 0.0%

France 3.0% 7.9% 0.0% 5.8%

Other Europe 10.2% 22.2% 3.4% 9.5%

Korea 2.0% 8.1% 0.0% 2.7%

Other 2.4% 6.5% 0.0% 4.1%

Currency AverageWeight

MaxWeight

MinWeight

as at Sep-17

AUD 100.0% 100.0% 100.0% 100.0%



Recent Positioning

Comments from the Fund’s fact sheet dated Jan 2018 are reproduced below as a perspective on the Manager’s strategy and style

Market Commentary

The Fund has now generated 26 months of positive monthly returns. The Fund’s performance saw the contribution of capital growth as flat, whilst income contributed 30bps to the total return for the portfolio.

January 2018 was a month of change. During the month we saw bond yields rise, the U.S. yield curve flatten and commentary from central bankers suggesting that the era of free and easy money is rapidly coming to an end. Well, at least, slowing considerably.

As a result, bond markets weakened over the month. In the U.S. the hurdle of the debt ceiling was avoided - just. However, negotiations over raising the ceiling continue and the ceiling may be breached early February. Bond markets globally are becoming wary as they see issuance by governments rising and central bank support for prices falling. This could lead to broader market uncertainty and eventually credit spreads widening.

The outlook for A$ credit spreads is relatively stable in the near term with prospects of widening in late 2018. A number of issuers came to A$ market over January. These have generally been well bid post launch. The tenor of choice for issuance was five years. Bonds came from the following issuers:

• United Energy Distribution

• Bank of Queensland

• ANZ

• CBA

• NAB

• Qatar National Bank

• Bendigo and Adelaide Bank

• Deutsche Bank

• Rabobank

• Suncorp-Metway

• Newcastle Permanent Building Society

The Fund did not participate in any of these deals as spreads or diversification benefits were considered insufficient. A$ 10-year fixed rate bond yields have risen over 30bps so far, this year and look set to be dragged up by global yields over the next year. Australian government 10-year bonds now are sitting at just 5bps higher yield than US Treasuries. This is well below its historical norm.

For bank issuance the five-year sector is a key bellwether. This is a key source of funding for Australian mortgages. Should US$ and A$ bond yields keep rising there may be some pain for mortgage holders. This will cause some issues with the RBA as it tries to keep rates steady and the economy growing. The increase in mortgage rates may also prove to be an interesting discussion for the banks as they attempt to explain to the public why mortgage rates have risen.

Nonetheless an increase in bond yields and mortgage rates generally will have the impact of slowing the economy. The RBA may find itself constrained as it will be difficult to ease rates when rates are rising globally. In such a case the currency could become a casualty. Looking towards February the key movements in the Australian market will be influenced by both the European and U.S. bond market movements. Rising high yield spreads are starting to pressure spreads in the U.S. and this could lead to a

widening of investment grade spreads in Australia. Volatility looks to be increasing and this could prove opportune for the Fund.



Spectrum Strategic Income Fund Composition as at Jan-2018

Top 10 Holdings (% of Fund)

Security Fund %

Cash 9.70

Bank of Queensland 5.60

BNP Paribas 4.80

Verizon 4.50

International Finance Corp 4.40

HSBC 4.40

UBS 4.40

National Australia Bank 4.40

Ausgrid Finance 4.40

Network Finance 4.40

Total 51.00

Legal Structure Fund %

Senior Secured Property 1.00

RMBS 5.00

Sub-debt 15.00

T3 Capital 2.00

Senior Unsecured 53.00

Preference Share 7.00

Covered Bond 3.00

Other 4.00

Cash 10.00

Industry Fund %

Australian Banks 18.00

Bank - UK 4.00

Bank - Dutch 4.00

Bank - French 5.00

Bank - Singapore 3.00

Bank - Swiss 8.00

Australian Insurance 10.00

Infrastructure 17.00

RMBS 5.00

Property Secured 1.00

Property 9.00

Materials 1.00

Other 5.00

Cash 10.00

Ratings Fund %

AAA 12.00

AA - 15.00

A + 10.00

A 14.00

A- 2.00

BBB+ 26.00

BBB 7.00

BBB - 7.00

BB+ 0.00

Unrated 7.00

Fixed / Floating Fund %

Fixed 14.00

Floating 76.00

Cash 10.00

© SQM Research 2018

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This document contains statements which reflect current views and opinions of management and information which is current at the time of its release but which may relate to intended or anticipated future performance or activities. Such statements and financial information provided have been estimated only and are based on certain assumptions and management’s analysis of the information available at the time this document was prepared and are subject to risk and uncertainties given their anticipatory nature. Actual results may differ materially from current indications due to the variety of factors.

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