Australian Shares

• The risk factors that have been building through the year came to the fore in May.

• Firstly and most significantly, the problems is Europe refuse to fade away despite a series of proposals by policy makers to deal with liquidity and funding needs. The second issue is that the scale of the debt certain countries have built up looks too high to be resolved through fiscal austerity alone.

• Until this is resolved it will impact on business and consumer confidence leading to downgrades to growth, which has a flow-on effect to the global economy. It is also impacting funding markets, which has a flow-on effect to the rest of the banking system.

• The market’s concerns on global growth have been elevated by a sense that the US, having been strong in April, hit a flat patch in May. We still believe though that the strong position of the corporate sector combined with pent-up demand should lead to a reasonable investment-driven recovery in the economy in the second half.

• Ongoing tightening in China adds to the uncertainty. We anticipate another 3 to 6-month window of aggressive measures targeted at property, triggering an inventory correction in certain commodities. However, we see this as an opportunity to re-invest in certain commodity stocks.

• On the domestic front, the proposed mining tax has triggered some significant reactions. It is difficult to assess the effect on new investments and therefore the engineering sector.

• Our conclusion is that projects already started will go ahead, but some in feasibility stages will get delayed until there is more clarity on the policy. Our exposure to the sector is orientated towards companies with a smaller amount of direct resource project exposure in Australia.

• In conclusion we expect the overall uncertain environment to prevail for the near term. It is important to note that such uncertainty brings opportunity and the portfolio is seeking to take advantage of the fall in the market to add to positions, particularly in companies which are not just relying on the cycle to see profits improve, but rather have specific opportunities to drive earnings.

Fixed Income & Cash

• The RBA raised the cash rate by 0.25% to 4.50% in May but left it unchanged at its June meeting. Market pricing has now removed any prospect of further policy tightening by the end of the year.

• The key for Australia will be any possible contagion from European debt market concerns into other markets, particularly Asia which is Australia’s largest export region.

• Other factors to keep note of include increased tension between North and South Korea and any policy action from the Chinese government as it seeks to slow domestic demand and particularly the housing market.

• We remain positive on the outlook for corporate securities, although there may continue to be some volatility in the nearer term.

• The 3-year bond yields ended the month down 50 basis points at 4.78% while the 10-year bond saw yields fall 29 basis points to 5.42%.

• The portfolio changed its duration position back to benchmark at the start of the month.However, the strong rally in the 3-year part of the yield curve has resulted in the portfolio re-instating its defensive position and sold 3-year bonds at 4.60%.

• The portfolio is currently 0.33 years below the benchmark. We are of the opinion that 3-year bonds are expensive relative to cash rates.

• Bond issues with an explicit government guarantee underperformed its respective commonwealth government bonds. We remain aggressively overweight this sector and we continue to expect this sector to perform well.

• For credit, global growth and more specifically company earnings expectations may prove to be on the optimistic side and therefore a more measured approach to risk-taking is prudent. Credit spreads have backed up and while optically valuations look appealing, our concerns about the outlook and poor market sentiment caution us against taking long positions in credit in the short term until the situation becomes clearer.

• We do, however, remain constructive over the medium to long-term on the asset class as corporates have improved their balance sheets, refinancing risks have fallen, company earnings will remain healthy and default rates will continue to decline.

Listed Property

• At current prices, the sector is trading on a 13.1 x PE, and delivering a 6.2% distribution yield and 0 to 2% pa medium-term growth. Earnings and balance sheets are stable.

• We look to improving direct property and equity markets for the next leg-up in the sector.

Read the full version of the May fund manager's commentary on www.btim.com.au/Fund Commentaries