Christine St Anne: We're at the Australian Shareholders' Association's annual event in Sydney. Today, I'm joined by the ASX's Elmer Funke Kupper to talk about the market outlook and initiatives by the ASX. Elmer, welcome.

Elmer Funke Kupper: Thank you.

St Anne: Elmer, you recently reported an uplift in revenue and it comes at a time when market seems to be gathering strength. Do you expect that momentum to continue?

Funke Kupper: I think it's been particularly strong in February, March, April. So, at the half year results we said it’s still little fragile, retail investors are sitting on the sidelines. I think some of it has come back in the last two months. So, yeah, we've had much healthier trading volumes in the equity market, and combined with strong trading volumes in our other markets, we had quite a strong third quarter, yes.

St Anne: Elmer, on that point of investors sitting on the sidelines, there have, of course, been a lot of discussions about investors remaining in cash and term deposits. Do you think that they are going to start moving more into the listed equities markets?

Funke Kupper: I think investors make their own choice. I think during the GFC, we saw a drop-off in equities and a significant increase in bank deposits. While that doesn't help my company, it probably helped the economy, as of course banks rely on those deposits. So I think it was quite healthy that that happened. What we're now starting to see with interest rates coming down and yields coming up, and we're seeing the bank results recently paying very healthy yields, people are starting to go back into the marketplace. It seems to be somewhat of a hunt for yield and returns that many corporations seem to be responding to. They make up their own minds, investors make up their own minds, but if you put the two together, you can see that happening.

St Anne: Elmer, you've had fixed income ETFs, and now the ASX is looking to list bonds. Will that change the role of fixed income in an investor's portfolio?

Funke Kupper: Well, in some ways they already have fixed income investments through deposits in banks. I think that is effectively fixed income investment. We know that when we benchmark our market to other markets around the world, that we don't have a large or liquid corporate bond market. And we know from overseas markets, like Europe, that a healthy corporate bond market is something that investors value. So we've been looking at ways to start that process and create such a market for investors. An important first step is the quoting of Australian government bonds on the exchange, because that creates effectively a benchmark price for the corporate securities, because it's the lowest risk form of investing, and corporate securities then sit above it.

There's a number of other steps that we would need to take. We would quite like to see a longer-dated government bonds, so you can create a proper price curve for longer-dated securities. We need to simplify the documentation requirements and change their director liabilities for the corporate bond market. All that work is underway. So I'm hopeful that if you add all of that up, then in next 12 months we will start to see the corporate bond market slowly develop in Australia.

St Anne: Elmer, now with listed fixed income securities, and of course, we've had listed equities, how does that compare with the traditional funds management industry? Do you think investors are going to increase their allocation more to direct investing?

Funke Kupper: Well, fixed income ETF is a fund, of course, that's listed on the exchange in which you can buy units. I don’t see a big shift, and I think part of that is driven by what I call the weight of money. So if you look at the superannuation guarantee that keeps going up. We do know that the superannuation sector and the funds management sector will continue to grow. At the same time, we see self-managed super grow and personal investment grow. So where that ends up, I don't know. I'd like all of them to grow, of course, because that's part of what we do.

But I don't think we should underestimate the forces that make superannuation grow, like the increase in the guaranteed continue to grow there. We've got some very large superannuation funds already, and they will only get larger, and that sort of – that's where most of the money, I think, will go because it's this guaranteed inflow of money. And then private investors will make their own trade-offs between fixed income, securities, and deposits.

St Anne: Elmer, in your presentation, you mentioned dark pools and high frequency trading, and of course the role of ASIC. What about the role of the ASX? What role do you play in securing investor confidence when it comes to these sorts of trading tools?

Funke Kupper: We think retail investor confidence is everything. I think we've taken a different approach than some other exchanges, such as exchange in the United States and Europe. We have taken, if you will, a high ground here, because we think it's in the long-term interest of our market, and therefore in the long-term interest of the ASX that this is well managed. So, we raised a number of issues in the last two years on this issue, on high frequency trading and dark pools. I think ASIC has been listening to us. They've been listening to other market participants, and more importantly, they have been listening to investors, and I think they've come up with a measured approach and a series of steps that will control both dark pools and high frequency trading. But, of course, you have to recognize that we can never get rid of it. I mean, its effect of life, technology is effect of life, innovation is effect of life, and in many cases it's a good thing. So, we are trying to do is allow innovation, but manage the unhelpful side effects, and I think relative to other exchanges and other markets, I think ASX and ASIC have done that very well in Australia. In fact, we're seen as the poster boy of financial market regulation these days.

St Anne: Finally, Elmer, our company Morningstar has the opinion that the ASX has strong competitive advantages. How are you going to maintain that with the new entrants in the markets, like Chi-X?

Funke Kupper: Well, I think competition is  here to stay, isn't it. So, Chi-X has been growing. We believe Chi-X will grow and will compete. So, that's the world we live in today, and that will continue to be the case. So, our job is to make sure that we continuously improve the services for investors with our own trading products. We've built a new data center that allows us to generate a new form of incoming technical services, and all of that has gone relatively well. So, we've been competing I think well. But, of course, when your market share starts at 100 per cent, it can really only go one way, and I think our market share over time will decline as Chi-X grows. Our job is to make sure that we compete well and that we deliver great services to our clients, and of course, that our shareholders continue to benefit from a growing company, and that's the balance that we’re trying to find. I think so far so good.

St Anne:  Elmer, thank you so much for your time today.

Funke Kupper: You're welcome.

Christine St Anne: With June coming up, it's time to look at some inter-financially strategies. Today I'm joined by Westpac's David Simon to give us his take on some super-specific strategies. David, welcome.

David Simon: Thanks, Christine.

St Anne: David, there has been quite a few changes in superannuation. Is it still tax effective?

Simon: Yeah, sure. Look, I mean, superannuation is just a tax structure, and even though there is a lot of changes or a lot of suggestions and proposed changes around superannuation, it still remains the most tax effective structure in the Australian tax system. So a modular tax rate has a tax rate up to $0.465 in the dollar, which once you include Medicare, a company has a flat rate of tax of 30 per cent. But indeed superannuation whilst in accumulation phase has a tax rate of only 15 per cent, and indeed if you go to pension phase, it still remains at zero tax rate. So it's still a very applicable structure for investors.

St Anne: David, well, let's look at the current system. What sort of contributions could people make before the end of the financial year?

Simon: Superannuation is just one tax entity. So it's important that people have diversification, not just of asset classes, but indeed of tax entities. So there are so many changes around superannuation and they will continue to occur. As indeed, changes around individual's tax rates and what else. So it's really important that people are diversified around their tax structures to make sure they protect themselves somewhat around legislation.

But importantly, superannuation still, as I mentioned, does remain a very, very tax efficient vehicle for people to save for their retirement. Now, there are two different ways you can actually contribute to super. There is one way which is before tax and another way which is after-tax. Some of the examples of before tax contributions are going to be quite familiar. So that’s – it starts with the statutory employer contribution, so that’s about to go up. It's still currently 9 per cent, but that's about to go up and progressively up to 12 per cent over the next few years, and that's effectively your employer making contributions on your behalf into super.

You can also, as an employee, elect a salary sacrifice, and that's effectively to withhold some of the cash you receive from your employer and have your employer contribute that money in superannuation on your behalf before it's taxed at your marginal tax rate. Ideally, that would offer a more concessional tax rate for most Australians than otherwise.

The other form would be if you're self-employed. If you're self-employed, you are actually able to make a personal deduction, but indeed claim a tax deduction on that contribution right up to the cap of $25,000. So they are more the common before tax contributions.

The after-tax contributions include something called a non-concessional contribution, and that indeed has its own cap. So you can contribute – if you're aged 65 or below, you can actually contribute up to $150,000 per year as an after-tax contribution, or indeed you can bring forward three years’ worth of contributions and make a one-off one contribution of $450,000. Effectively that goes into the super fund tax free, and ideally it can come out tax free as well. So it's a really smart way to boost your retirement savings and transfer your assets from a taxable environment, your marginal tax rate, into a low-outbound tax rate through super.

You can make that contribution through cash, but indeed you can also make that contribution by using other investment security, such as listed shares. So you can effectively in specie transfer some shares into superannuation as after-tax contribution. That will cause a capital trigger event, which may or may not include tax. But eventually once it goes into the environment, it's certainly efficient from that point of view.

Other types of contributions include – that are after-tax include a co-contribution, where the government will provide an additional contribution on behalf of the superannuant, if they are a low income earner. So there are a variety of different methods people can boost their retirement savings.

St Anne: What about tax deductions? Can people look at that perhaps in the context of, say, capital gains?

Simon: Yeah indeed. So for an investor that – there are things that – some assets and I’ll use direct shares as an example. So, let’s say, an investor has direct shares in their own name, and then decides to have – make an after-tax contribution into superannuation whilst holding those shares and retaining those equities, that could create a capital gain event.

If that does create a capital gain event, they could – if they are self-employed or if they are an unsupported person, they could actually declare some of that transfer as what we call a concessional contribution or a personal deductible contribution. In turn, offset some of that capital gain, or if not all of it, by declaring some of that transfer as a tax deductible contribution.

St Anne: Finally, David, what about spouses? Do they have a role to play in some tax effective strategies?

Simon: I mean, look, there is two things around spouses. If you’re in a situation where you’ve got a primary income earner and a lower income earner being a spouse member, as long as they are earning a very low income – at up to $13,800, the primary income earner can actually contribute up to $3,000 as an after-tax contribution into their lower income earner spouse, and then actually declare or receive a $540 rebate in their tax return, which is effectively 18 per cent of the spouse contribution.

Another method of using the spouse is, if there is a one member that’s materially close to the age of 60, then the younger one can actually share their contributions or split their contributions to the older one. The benefit of that is that they are closer to 60, meaning that they can access their superannuation earlier than the younger spouse, but also access it tax free as well.

Christine St Anne: David, thanks so much for your super insights today.

David Simon: My pleasure. Thank you.

Christine St Anne: Gearing strategies certainly came under pressure following the global financial crisis. However, if sensibly implemented, these strategies can boost a person’s retirement savings. To talk about some of the sensible approaches, I am joined by BT's Cathy Kovacs. Cathy, welcome.

Cathy Kovacs: Thank you.

St Anne: Cathy, what makes a sensible gearing strategy?

Kovacs: Well, really depends on the individual, and it’s a pretty broad based word or term, gearing strategy. But, generally speaking, I think a strategy that allows somebody a comfortable level of borrowing. When I mean comfortable, it’s commensurate with their risk appetite, commensurate with their ability to repay their debt, if you are thinking about the loan component. The other side of that is, what are you borrowing to invest? So, aligning your gearing strategy with your long-term investing needs, diversified portfolio that helps you make – rates your retirement savings.

St Anne: On the point of a diversified portfolio, can some of these gearing strategies apply to more speculative stocks?

Kovacs: Yes, it can. But again, I think if you take the gearing away from the investment, we all know that we don’t put all our eggs in one basket. So what you could do is, alongside a diversified investment strategy, you could add a degree of risk through a more speculative stock. But keep in mind that when you are adding leverage, you’re already adding a degree of risk. The other thing about some speculative stocks is that, they don’t offer any dividends potentially, and so if people are looking at dividend income, they need to be aware that they won’t get that from a more speculative stock.

St Anne: In terms of dividend income, is it best for investors to reinvest their dividends when it comes to gearing strategies. What is the best approach?

Kovacs: It depends on the individual and where people are in their lifestyle. So a pre-retiree or retiree, in fact, might want the dividend income as part of their lifestyle needs. Someone else may be in the earlier stages of their investing career and might elect to reinvest those dividends to get the compounding benefits. Either way, whether you’re reinvesting the dividends or you’re taking them, if the stock pays a franking credit, you’re still getting the benefit of the franking credits. But I would add to that that people shouldn’t be relying on the dividends to make their interest payments, because in the event that the stock’s stops paying a dividend, you still need to be able to pay the interest on your loan.

St Anne: Cathy, what about installment warrants? Are they still popular with investors?

Kovacs: So to answer that question you really have to think about what is the custom value proposition of an installment warrant. So installment warrants are method of borrowing to invest or gearing inside a superannuation fund. So if you think about the growth in self-managed superannuation and the amount of equities that people are holding inside the self-managed super, the amount of cash that they are holding, the fact that people are going to be underfunded in retirement, all of those things say to me that a degree of borrowing in super is going to help people get to their retirement needs, and an installment warrant is just a way of doing that.

St Anne: How do installment warrants compare with other gearing strategies, such as margin loans?

Kovacs: In installment warrant, if you like, is a packaged solution. So it is more definitive. We tell you which stocks we will offer installment warrant over, so it's not a broad universe. The other thing is that, by definition, an installment warrant is a limited recourse loan. So in the case of a margin loan, you could have a margin call event. So if the value for your equity folds, you need to top up your capital,. You don't have that in the limited recourse loan. So in the even that your value of investment folds, you just don't have to make the second payment on installment warrant, or you could sell that installment warrant on the ASX at any time. So it's very liquid.

The other thing is, which I like to think about when I am thinking about gearing in super, is that installment warrants are really easy way to get exposure and geared exposure inside your superannuation fund. So if I decided that I would like to get geared exposure to the ASX 200 tomorrow, I can do that by calling my stock broker or going to the online broker with the ASX code that allowed me buy an installment warrant over an ASX 200 ETF, for example. So it's a really simple way to get geared exposure in your side of super fund.

St Anne: Cathy, thanks so much for your time today.

Kovacs: Thank you.

Nicholas Grove: The big two miners, BHP Billiton and Rio Tinto, released their quarterly production numbers earlier this week. And here to give investors an idea of which company put in their best performance, I'm joined again by Morningstar's Mark Taylor. Mark, thanks very much for your time today.

Mark Taylor: Thanks, Nick.

Grove: Mark, firstly to BHP, which commodities were the key drivers of its numbers and did those numbers contain any surprises?

Taylor: Well, the key drivers of earnings are unchanged. It's iron ore, copper and oil and gas prices, and then weren't any major surprises in prices or production numbers. If anything, that was marginally ahead of expectations despite the fact that volumes were off quite sharply due to cyclones and weather events.

Grove: Mark, how did Rio's numbers stack up and were there any surprises there?

Taylor: Very similar actually. And for Rio, iron ore is pretty much everything at the moment. Its numbers were marginally below expectations, but not meaningfully so, and in fact both Rio and BHP said that their full-year earnings projections were intact. So, while there might have been swings in the quarter itself, they will be making those up over the balance of their fiscal years.

Grove: Mark, in your opinion which company delivered the most pleasing set of figures?

Taylor: Well, I don't think there was any one area or one company that stood out, particularly in the quarter, as being more pleasing than the other, but just as a general statement, BHP's figures, I think, are more pleasing because they're just not quite so focused on one area. It's not all iron ore. Oil and gas is important for them and that did reasonably well, especially the shale gas in the States is starting to come to the fore, so that's quite pleasing.

Grove: Finally Mark, was there anything in BHP's third-quarter numbers or Rio's first-quarter numbers that are going to alter your full-year earnings forecasts, or is it all steady as she goes at this stage?

Taylor: It's pretty much steady as she goes. The one thing that did happen was the pit fall failure at Bingham Canyon in the States for Rio, but that was announced pre-quarter, so it was already factored in, but that is going to result in lower copper production for them and some added costs and lower revenue. So that has hit their earnings a little, round about 5 per cent or so, but by the time the quarterly came out, that wasn't news.

Grove: Mark, thanks very much for your time today.

Taylor: Thanks, Nick.

Christine St Anne: While the Australian markets have experienced the ups and downs, Wilson Asset Management has managed to outperform the market since the GFC. To give us an insight into how the portfolios work, I’m joined by Geoff Wilson.Geoff, welcome.

Geoff Wilson: Thank you very much.

St Anne: Geoff, first thing; how wide is the investible universe for Wilson Asset Management?

Wilson: We look at every listed company. So, we had maximum flexibility. I really believe in investing. It's incredibly important to have maximum flexibility. We tend to focus on mid- and small-cap industrials because that's where we believe we can have a real competitor advantage, and what that is, is our ability to find companies that are undervalued. We spend a lot of time meeting with management. We would have over a 1,000 company visits a year and probably see over 800 to 850 odd companies.

St Anne: On that point about industrials, what sort of value are you finding in that sector?

Wilson: The small industrials has had a good run like the large – like the overall market, but we are still seeing value in that sector. Some companies we have been buying recently are the likes of Cash Converters, Hills Industries, Brickworks, those types of businesses.

St Anne: Geoff, you're also invested in financials, but not the major banks. So, what sort of companies do you have investments in?

Wilson: In financials, our exposure tends to be in two parts. One is we buy because we are a listed investment company and we have three listed investment companies. The large one is WAM Capital, then its WAM Research and then WAM Active. I spent a lot of time analysing the sector, and what we do is buy other listed investment companies, when they try to get sizeable discounts and our larger holdings are Century, Ironbark, Emerging Leaders, and in all those three companies there are some interesting dynamics at the moment.

Also, we look at the smaller financials, where we have had exposure there. Magellan has been a very good performer for us. We bought them at the $2 llevel. We have been selling them recently. Another one is Clime Investment Management. To me, that's a little Magellan. At the moment, they are really excited to get some good fund flows run by John Abernethy. Those types of companies make out the rest of that.

St Anne: You already mentioned a number of stocks. Are there particular companies that you're bullish on?

Wilson: Brickworks – I mean, companies would be very happy talking about that where are the holders or buyers, would be the likes of Brickworks, also Automotive Holdings. We think there would definitely be a merger with AP Eagers over the next six months, and it could be a big fully franked dividend liberated there. Another company we are buying discount assets, we bought some more today is Keybridge. They are the type of companies.

St Anne: Geoff, finally, how is the merger with Premium playing out for your business?

Wilson: It's been really good for WAM Capital. WAM Capital merged with Premium. We had about $220 million odd of assets, Premium had about $85 million of assets. In the end, about 65 per cent of Premium shareholders decided to become WAM Capital shareholders. The merger went through on the 31st of December 2012. We had a Board meeting on the 2nd of January. There the Board decided to liquidate all the premium investments, which we did, and now that money has been managed as we manage the rest of our money.

What WAM Capital shareholders have picked up is the ability to utilise $46 million of tax losses and also franking credits to allow about 40 million fully franked dividend to be paid out. So, it's been a very good merger from WAM Capital’s perspective.

St Anne: Geoff, thank you so much for your time today.

Wilson: Thanks very much.

Nicholas Grove: This week saw Woolworths release its sales and revenue results for the third quarter, while Woolies' archrival Coles, owned by the Wesfarmers conglomerate, will release its results next week. Here to give investors an idea of how these two companies are faring as we head towards the end of the fiscal 2013 year, I'm joined by Morningstar's Tim Montague-Jones. Tim, thanks very much for your time today.

Tim Montague-Jones: You're welcome.

Grove: First of all, Tim, how did Woolies' third-quarter sales shape up in your opinion, and were there any surprises in the figures, either positive or negative?

Montague-Jones: It was a strong quarterly result, but we had expected that. The comparable sales number was up about 5.3 per cent, which is a strong number for group sales. The number the last quarter over the December half year was strong, because what happened over Christmas was we've had lower interest rates, rising equity values, and favourable weather as well, which has encouraged retailers to sell more products. So, retail conditions across the board have risen, and Woolworths as well as Wesfarmers are doing reasonably well at the moment, and that was apparent in this result.

Grove: What kind of performance are you expecting when Wesfarmers reports its retail sales next week?

Montague-Jones: Well, they're both doing very extremely well. The bigger are getting stronger, and the weaker are getting weaker. Both Woolworths and Wesfarmers have significant market power, and they're taking market share away from the smaller independents. So, we expect Wesfarmers also to report - or the Coles part of the Wesfarmers Group - to report strong revenue growth as well. If you look at the actual statistics of retail sales for the month of February, they've increased quite strongly since January. So the tide is coming up and it's lifting the returns of all the major groups.

Grove: Tim, what are you expecting in terms of dividends from both Woolies and Wesfarmers for the full year?

Montague-Jones: Woolworths has a payout ratio of 70 per cent, meaning about 70 per cent of its earnings are paid out in the form of fully franked dividends, and we calculate that to be about $1.30 for the full year. For Wesfarmers, its payout ratio is higher, at about 90 per cent, and on our calculation we look at a full-year dividend payment of $2 per share.

Grove: Finally, Tim, what are going to be the major themes confronting these companies in the 2014 financial year that investors should keep in mind?

Montague-Jones: That's an interesting question. Both groups are going to be, I believe, under a lot of pressure from the ACCC (the Australian Competition and Consumer Commission), because their market power is significant and they're getting stronger. There's a threat to smaller groups who want to kind of kick up a bit of political pressure for some action to be taken. So, I think that will be a concern for both groups. If we look at specifically Woolworths, for them next year a big component of the earnings growth is going to be Masters, which is a home improvement store portfolio, which is increasing, and that will be a key focus to see the performance of that group next year. For Wesfarmers, obviously, it's Target, which has not been performing that well and they've recently appointed a new managing director to the group. It would be interesting to see what their turnaround strategy is going to be and how successful it will be.

Grove: Tim, thanks very much for your time today.

Montague-Jones: You're welcome, Nick.

Christine St Anne: MFS Investment Management recently won the Morningstar's Fund Manager of the Year Award in global equities. It's also an investment firm that has performed during flat markets. To give us a little insight into the investment processes, I’m joined by Marian Poirier. Marian, welcome.

Marian Poirier: Thank you.

St Anne: Marian, what sort of companies does MFS like to invest in?

Poirier: The focus MFS has really is investing in quality companies, companies that quite often have been around for a long time, and we aim to make sure that they are around for quite a few years going forward, companies like a lot of leading global brands. Some of the luxury goods names like LVMH Louis Vuitton, just choosing them as an example. They are the sort of the company doesn't have to discount the prices. One of the other things with LVMH that's key is they are now starting to derive quite a significant portion of their revenue from the emerging markets. So, thinking about their product positioning going forward.

One of the other companies which was one of our large contributors last year to our significant outperformance was Heineken, another global brand and another company that’s deriving quite a bit of the revenue from emerging brands.

But it's got to be companies that are able to grow their earnings sustainably going forward and so that’s really the sort of companies that look forward to invest in.

St Anne: Our recent research report had noted that you tend to sing during benign market, can you give us some little insight into the investment processes that allow you to do that?

Poirier: Rest assured, I’m not going to start singing. We've done a lot of research actually in terms of different types of markets and how we perform accordingly. And we've done some research recently in terms of looking at the history of our global equity capabilities. So going back as far as 1992 and looking at – dividing it up into quarters, looking at periods where the market has outperformed by more than 5 per cent and markets where the time periods – apologies when the market has underperformed by more than 5 per cent and then in between, and in all quarters, all performance types of period, we outperformed. Probably the portion in the middle so between minus 5 and plus 5 is where we outperformed the most regularly.

So we delivered the most quarters of outperformance, but the magnitude of that outperformance tends to be more in the markets that you referred to, Christine, sort of the words falling quite a bit. And I think that that is really dying to our focus on quality.

Talking to a lot of our analysts internally, one of the things that they say a lot is when – and I have seen this happen. When they are pitching ideas to the investment team, the focus in that discussion is not about the potential upside and how much more this company can deliver and how that will translate into performance, 95 per cent of the discussion is on the buying side.

How can this go wrong? How can your thesis fall apart? What happens if currencies fluctuate? What happens if commodity prices fluctuate? There is no predicting where they are going to go. There is a lot of stress testing. So, we invest in those quality companies that I mentioned that are going to outperform, no matter what the market environment is like, and again it's coming back to quality. If you are investing in a quality company, quite often they will outperform in both periods.

St Anne: Marian, also, your portfolio managers have a personal stake in the business. How important is that to ensuring performance?

Poirier: I think its key. You know, if you are in charge of managing so much of the money for clients, you need to – I know the expression overused as it is, having skin in the game – having your own personal money invested alongside that of your clients, I think its key to delivering performance.

St Anne: David Mannheim is a very well-respected portfolio manager, and of course, one of your co-lead managers, what about key person risk? How do you overcome that?

Poirier: Even going back before that, I actually think one of the ways we overcome key person risk, is we hire the right people to begin with. And I will give you a couple of examples of the way it works. There is a very long and lengthy process, number of interviews that people go through before they get hired by the firm, but right from the onset it is all about being part of a team. There are no stars, and I know that you mentioned Dave Mannheim, and he is co-PM with Roger Morley. But you would never hear either of them talk about portfolio without talking about the platform and the team of people behind them. One of our co-head of Asian Equity Research, Simon Gresham, who is based here in Sydney, and he has, sort of, coined the phrase or he has used it to me quite a few times. He said that every one’s voice is heard at this firm and he likes that.

An another example is Roger Morley, when he was interviewing, he gave me few insights and he said quite often it's 30, 40 interviews before he joined the firm, and he said that one day after having met with maybe 10, 15 people from the investment team, senior management, what he loved and one of the reasons that he ended up accepting the role was because he couldn’t work out who was important, and that I think says volumes for the way that we manage the firm.

St Anne: Marian, that’s a positive note to end up on. Thank you so much for your time.

Poirier: It's nice to chat.

Christine St Anne: Morningstar recently released its global equities wrap-up, and found a number of managers that outperformed. To give us a little insight, I’m joined by Morningstar’s Kathryn Young. Kathryn, welcome.

Kathryn Young: Thanks so much for having me, Christine.

St Anne: Kathryn, so who were the top performing managers and what sort of attributes did they have?

Young: Well, we noticed a few trends that really drove performance over 2012 in global equities, and I think investors were familiar with a lot of those. So, one of those is that growth outperformed value on average. So, strategies we cover with a growth bias tended to do better than a value bias. And one of the big reasons for that is that many of those, sort of, ‘expensive defensives’ that people have heard a lot about, and these are the firms with large consumer brands, global consumer brands that people recognize. Those tended to do very well.

And a lot of people, lot of investors say that it’s because the market was putting a premium on safety and a little bit of yield in this environment. So, the managers that we cover that tend to have a quality growth strategy did very well. And among those are MFS Global Equity, Magellan Global, and Platinum International brands.

But that's not the only thing that drove performance. Another big driver was that financials was the best performing sector over the year and that really came on the back of the ECB’s comments that they would do whatever it takes to save the European Union. So, financials did really well and those strategies that were heavily invested in financials also did well. So, some of those are PM Capital Absolute Performance, that was the best performer by far, and also Templeton Global Trust that had quite a bit of financials and did as well.

St Anne: So what are the implications for investors from all of these?

Young: Well, it's really interesting to talk about these things. All right. It’s interesting to talk about what drove performance and who were the top performers, but I think the most important thing for investors to get out of that is what it reminds you about investing in general and investing in managed funds, in general. And that is that investors should remain focused on the long term. So, these things that I just talked about expensive defensives, growth outperforming value, those are short-term things. Right that happened over one year.

But we really think that that's not – what happened last year is no guarantee or even real indicator about what’s going to happen over the coming year or the coming five years. And one good way to explain that is that growth and value have really exchanged leadership a lot.

So, over the past 10 years, they've gone back and forth. Value actually outperformed growth from the early 2000s through about 2008. And so they have exchanged leadership, but they have ended up roughly about the same place in terms of cumulative returns over that period.

So what's important to remember is stay focused on the long term, maintain adequate diversification across tiles, and you should be fine.

St Anne: The Australian market has been very popular in terms of income. Do global equities offer that same level of income?

Young: Well, it's a good question. Obviously, income is very important to a lot of investors right now. In Australia, we looked at that for our global sector wrap up, and we found that really Australian strategies, Australian-focused equity strategies, do offer more income than their global counterparts, and that probably makes sense to a lot of Australian investors.

Telstra, the big banks, they offer consistent and relatively high dividends. So, it's a problem because those investors, retirees or other investors who were very dependent on the income generated by their portfolio, they still need to maintain adequate asset class diversification, even though they have a focus on income.

So, it gets to be a little bit tricky, and we think that people who are focused on income they do have a good reason to have more of a bias towards Australian equities in their portfolio. But part of the good news is that product providers, fund managers are realizing that there is this void in the market, and so there have been some products coming out. But still early days for those, so it’s a little bit tough to say how well they can really meet investor needs and we are keeping eye on that.

St Anne: Kathryn, thank you so much for your time.

Young: Absolutely happy to help.

Christine St. Anne: The focus for many retirees is income and yet many of these retirees remain focused in a conservative portfolio. Today, I'm joined by Legg Mason's Reece Birtles to talk about rethinking your income solutions. Reece, welcome. Reece Birtles: Thank you.

St. Anne: Reece, one of the findings from your survey is that many investors expect an 8 per cent return. Is that a realistic objective?

Birtles: Yeah, it's going to be very difficult for investors to achieve 8 per cent returns going forward. When you look at fixed interest markets with the strength in the government bond yield at about 3.4 per cent, if you look at term deposits with best rates around 4.2 per cent now, and even equity income portfolios with a benefit of franking credits for retirees achieving around 7.5 per cent return. It's going to be very hard to go to blended portfolio with an 8 per cent return.

St. Anne: Another key finding is that investors are concerned about inflation, but remain focused on income. What about the role of growth in a portfolio?

Birtles: Inflation is very important to retirees. With a 20 year life expectancy, 2.5 per cent inflation is going to have a significant impact on purchasing power over time. So to achieve growth in an income stream, greater than the inflation rate requires investing in either real assets like infrastructure, utilities, or property or in equity income type strategies, which have the benefit of profits growing over time and growing the dividend streams.

St. Anne: Reece, term deposits remained very popular with many retirees. What about the effectiveness of a conservative portfolio to addressing their income concerns?

Birtles: When you look at the needs in retirement, it's about a stable and growing income. The interesting thing about term deposits is whilst that capital might be stable the income is actually quite variable with the interest rate cycle. So, for example term deposits have gone from yielding 6.2 per cent to about 4.2 per cent today over the last two years, which actually represents a 30 per cent decline in retirement income if you are invested in term deposits.

St. Anne: With the need to increase growth assets what sort of companies should investors look for in order to achieve their income goals?

Birtles: We think equity income strategy is very different in terms of how they should be designed than your typical funds that you've seen to-date. Being benchmark away it doesn't make any sense in retirement. You don't want significant concentrations in one company because if something was to occur to it, it could have a significant impact on your retirement income.

We also think you should be invested in high-quality companies that have less variable earnings. So high-quality companies are going to be less susceptible to shocks from competitors or the changes in technology. We think you need to look quite broadly, it's not just about the top 20 companies, you need to get strong diversification in the income stream from dividends.

St. Anne: Reece, thanks so much for your insights today.

Birtles: Thank you.

Christine St Anne: Perennial Investment Partners recently won the Morningstar Fund Manager of the Year in the fixed income category. Today I'm joined by Noel Murphy to talk about the opportunities in the fixed income market. Noel, welcome.

Noel Murphy: Thank you.

St Anne: Noel, we're now in a low yield environment. Is there still value to be found in fixed income?

Murphy: Well, I think they can to a limited extent, but we have to be realistic. Bond yields are lot lower now than they were, say, 10 or 20 years ago. So, I think, our view is that largely the bond market has been in a long-term structural rally that's largely come to an end. So I see good value in fixed interest as a defensive investment if we were heading into recession, but that's not our expectation at this stage.

St Anne: Within the context of asset allocation, what sort of approach should investors take when it comes to managing their fixed income portfolio?

Murphy: Well, I think they've got two choices, and it's a philosophical question. Investors need to decide whether they are going to take a strategic long-term sit and forget approach, where they don't try and time the market in fixed interest and just have a permanent strategic asset allocation, or they take a more tactical approach. I think it's the second approach that we would advocate for the time being. Given how low long-term interest rates are, we believe that a tactical approach to fixed interest is more appropriate in the current environment.

St Anne: Noel, as a bond manager, what sort of value are you finding in the market?

Murphy: Well, we're not particularly keen on Commonwealth Government bonds, but by contrast we like State Government bonds. We like floating rate investment grade credit, specially the banks. We think that's a good story. We also have like listed property – the bonds issued by listed property trusts and some infrastructure investments. There is an area where we are quite concerned, and that's US high yield. We think that's probably fully priced, and if anything, may surprise people in delivering poorer returns going forward.

St Anne: Hybrid securities have also been quite popular among investors. Noel, did they have a role to play in a fixed income or defensive portfolio?

Murphy: Well, I think they have a very limited role. For the time being we think they are offering good value. So I think as a yield enhancement they are fine, but they should never be a significant part of any defensive portfolio, in our view.

St Anne: Finally, Noel, there's been a lot of discussion about interest rate cuts. What sort of impact would that have on fixed income?

Murphy: Well, ironically, I don't think further falls in the RBA cash rate will have much influence on bond yields. I think we're probably seeing the low in bond yields in Australia. So, despite the fact that the Reserve Bank may cut another 25 basis points, I don't think it's going to be a big influence on bond yields or bond returns going forward.

St Anne: Noel, thanks so much for your insights today.

Murphy: Thank you very much.

Christine St Anne: Morningstar has wanted its coverage to include equity income funds. These funds adopt derivatives to boost the income in their portfolio and are relatively new to the Australian market. To tell us a little bit more about these strategies, I am joined by Morningstar’s Tom Whitelaw. Tom, welcome.

Tom Whitelaw: Thank you.

St Anne: Tom, can you give us an idea about how these funds work? What exactly is meant by derivative income?

Whitelaw: Okay. So as the name suggests, derivative income strategies are basically looking to support the traditional elements of equity income, such as franking credits and dividends, by supplementing a derivative overlay strategy to kind of add that extra income in there. So the most common tool used by the derivative income manager is the buy right.

St Anne: Can we delve a little bit further into these strategies? How does the buy right strategy work?

Whitelaw: What the buy right does is, kind of, as the name suggests, the manager would buy a holding in the stock, and then they would write an option over the top of that to garner some additional income. So it's probably easy to use a real world example, so let's take BHP. So this morning BHP was trading at around $36. So, say, the manager would buy the stock at $36. Then immediately write the option, say, $40, kind of giving them a 10 per cent upside. They'd probably get about 1 per cent payment for that, let's say, to keep the math simple. So that means that if the stock rises 10 per cent, they'd actually get 11 per cent, so they're doing pretty well. If the stock falls, they've kind of got that cushion of the 1 per cent. But then if the stock rises through 10 per cent and upwards, then they're kind of missing out, because as soon as that stock rises through $40, they are essentially naked BHP. So they no longer hold it in the portfolio. So that's why you’ll find a number of managers write multiple options around these strategies to avoid being called away.

St Anne: Tom, there are number of these strategies in the Australian market. Are they all the same, or do they differ?

Whitelaw: Yes. So with this derivative income approach, most managers try to do the same thing. They try to do as we said. They garner that additional income from selling options. But the way they go about that can be quite different. So take two of the most common ones in the market at the minute; you've got Colonial First State and you've got Zurich Denning Pryce.

So the Colonial First State guys, Rudi and Jason, will take what Matthew Reynolds does on the core Australia fund as their starting point. Then they look to write options, positions, call options over the top of those holdings to kind of garner that additional income. They also talk very closely with the stock analysts as well. So that's kind of more a tactical approach to doing this. They look at where they expect the stock to go, will it run through this strike price, kind of what’s good value. Then it's kind of seen more as – the income is seen more as a complement to the growth that you would be getting core.

Whereas, the Zurich Denning Pryce guys, so Michael Pryce is very much the atypical derivatives trader. He has kind of done it for a long-long time; very important in this kind of game. It's much more shorter term, kind of more technical trading around the derivatives to kind of – to get that income pickup, and he also limits himself to the ASX50.

St Anne: You mentioned a number of managers. So what sort of qualities do investors need to look for when using a manager to oversee these strategies?

Whitelaw: So, as I mentioned, experience is one of the most important things that we stress with these types of strategy. So time on the crease is imperative. It is very – it sounds quite simple, you just kind of buy a stock, write an option and away you go, but there’s kind of multiple facets that kind of operate behind this, and you kind of really need to understand the market, the market depth, kind of what price you're paying for some of this volatility and what not. Then when you've got managers using over-the-counter auctions, as some of them do – not the ones we’ve mentioned, but some guys do go over the counter, then it’s even more important, because there is no real buyer. At the end of the day, you've kind of got to sell it back to the guy you bought it from, and kind of broker relationships are very, very important there.

St Anne: From your preliminary research, Tom, have these strategies delivered for investors?

Whitelaw: Well, they've certainly delivered income, but you kind of got to take that as a whole when you look at the total return. So over the last three years, for example, the two guys we spoke about before, on a total return perspective delivered around 6 per cent and 7 per cent total return. From an income side, if you split out the income from that, they probably delivered around 9 per cent and 10 per cent income. You can kind of see the mismatch there. So that means that the actual growth has actually fallen by about 3 per cent or 4 per cent, so actually value of the investment would have fallen by about 3 per cent to 4 per cent. So investors just need to be cognizant of that fact. So, although you might be getting your income and might be taking the income, the actual value might be falling. So you invest $100,000, and the first year you get the 10 per cent; brilliant, you've got your $10,000 of income. But should that underlying investment have fallen 4 per cent, certainly the next year you get your 10 per cent again, which is great, but you are only getting $9,600. So it's just something to be aware of.

St Anne: On the point of value, can these strategies work in a bull market?

Whitelaw: Yes. I mean, that still work insomuch as they're still doing what they said they do. They’re still providing you this income, but that growth aspect becomes even more important, because, as we mentioned at the outset, you are writing away some of the potential upside of this stock above a certain point. So in a bull market, you’d expect prices to be rising more rapidly and more of these strike prices getting hit, getting called away in more of these stocks. So you will find that these strategies will lag in a bull market, yes.

St Anne: Tom, thanks so much for your time today.

Whitelaw: Thank you.

St Anne: Morningstar subscribers can get access to more in-depth research on these strategies by going to the Morningstar website and looking under the funds tab.

Christine St Anne: Hyperion recently won the Morningstar's Fund Manager of the Year Award in the small companies and large company category in Australian equities. To give us a little insight into their investment processes and finding value beyond banks and resources, I'm joined by Hyperion’s Tim Samway. Tim, welcome.

Tim Samway: Thank you.

St Anne: Tim, just to begin with, can you give us an insight into your investment processes, and how they’re different between the large company portfolio and the small company portfolio?

Samway: So, our investment process is focused on buying quality businesses, quality predictable businesses, and we don't really vary that process between large and small caps. We don't make much of a distinction between large and small caps in our investment process, simply because we are looking for quality small caps and we are looking for quality large caps.

St Anne: Your portfolio doesn't seem to have a big exposure to the major banks or the resource companies. Is there value to be found in the Australian market beyond those two sectors?

Samway: Well, interestingly enough, our portfolio is not very heavily weighted to banks and resources, and it hasn’t been over the last year, year and a half. We found a lot of value in the online sector. The Wotifs, the Seekss, the Carsales, the REAs, Trade Me, that business – those businesses, I should say, were somewhat unloved a couple of years ago, but we saw the opportunities in having effective little stock exchanges of a type. It's sort of an exchange effect that goes with those, sort of, businesses. They are quite protected from competition and we saw the opportunity for predictable long-term growth with them.

St Anne: Besides the online companies team, what other sorts of companies do you like?

Samway: Yes, of course. I mean, there are businesses in the various funds. I will try and split them up. Businesses like Iress, we really like that business. It's gone through a very difficult period over the last couple of years. It sells to the financial sector and the financial sector has struggled, and yet Iress has done very well. It's a quality business, and it's able to take its business model and replicate it in other countries very successfully. They’re certainly doing some good things in the UK at the moment.

St Anne: Tim, your funds run a very concentrated portfolio. How do you overcome stock-specific risk?

Samway: Well, the real risk that we are managing is buying fundamentally sound businesses, that is the risk that we buy a business that’s not a quality business. And we do the work to make sure that we are actually buying predictable, growing earning streams, and the real secret to that is being brutal in non-owning businesses that don’t pass the test, and not owning a bit of them, just owning none of them.

The second risk really that you need to manage with owning a concentrated portfolio is pricing risk, and that’s just being very disciplined about even if a company is a quality business, not overpaying for it if it’s actually – if its valuation is too stretched. So we often have periods where we have quality businesses that we really, really like, but we don’t buy them because they are too expensive. So, in that case, for example, the GFC actually provided us with some terrific opportunities to pick up quality businesses, because they were oversold during that period.

St Anne: Finally, Tim, with your portfolios not exposed to the major stocks like the banks, how do you address investor perceptions when the funds deviate from the index?

Samway: Well, they do. Our funds have lagged the benchmark at times in short-term periods. And the way that we have addressed that over a very long period of time, now 16 years, is to talk to investors in advance about the fact that it will happen that when you are running benchmark in sensitive portfolios, that is ones that aren’t constructed around the benchmark and are focused on just buying really good quality businesses, that there will be times where we will underperform. But the real focus for investors should be, firstly, capital protection, and secondly, long-term outcomes, because that’s what investors should be looking to.

And I guess it's helped that. We have had three periods over the last 16 years where we have underperformed for a short period of time, and then outperformed for a long period of time thereafter. And I think that repetitive nature of that cycle has given investors’ confidence that we can continue to deliver in the long term.

St Anne: Tim, thank you so much for your insights today.

Samway: It's my pleasure.

Christine St Anne: Perpetual Investments was named Fund Manager of the Year at this year's Morningstar awards. The award acknowledged the quality of investment processes across a number of strategies managed by Perpetual. Today, I am joined by the company's Deputy Head of Australian Equities, Charlie Lanchester, to give us an insight into some of these strategies.

What do you look for in a company?

Charlie Lanchester: At Perpetual, first and foremost we have four quality filters, which are fundamental to how we invest. So if a company doesn't pass these four quality filters, we simply won't even look at them, and those four filters around good management, conservative levels of debt, recurring earnings and a quality of business that we can understand. Once a company passes those four filters, it goes into our investable universe and then is ranked by the analysts, a strong buy down to a sell, and the portfolio managers like myself then build the fund from there.

In terms of valuing stocks we're very flexible. We look at all different valuation methodologies. There's no right or wrong way of looking at companies, and that's where really the art of investing comes in.

Do you favour particular sectors?

No, not at all, we are very much bottom-up stock pickers, so to speak. So we're always looking at all aspects of the market within those quality filters for opportunities where the market is mispricing a particular stock. So, no, we don't really invest on a macro type basis or even a sector basis. It's very much a stock-by-stock analytical call.

How do you manage the fund when it lags during some market cycles?

It's hard. Right now my – the Industrial Share Fund is lagging a little bit, its particular index. That said, investors are very happy, because the index is up more than 30 per cent so far this year. In general, Perpetual funds due tend to lag slightly in very strong markets, because we are much more focused on defending the downside, or protecting the downside in more difficult markets. So, in general, when you look back over many years, we've outperformed strongly in down markets and lagged a little bit on the upside in good markets.

How do you manage the responsibility of overseeing a number of strategies?

It's a bit of a balance. I spend most of my time, to be fair, managing the funds. Perpetual, only one of the strengths of working at a larger institution instead a lot of the stuff around managing the business is taken away from you. So we spend a lot of time just looking at stocks, visiting companies and on the road, and that's really what I love to do. At the same time, I do allocate some of my time to managing the team. We've made some good enhancements I think over the last couple of years in how we measure individual performance, which after all is the key to fund management.

How do you add value when managing a large portfolio?

There's certainly a sense of responsibility which comes with having large stakes in a number of companies. That said, we've managed a large amount of money for a long period of time. I’ve been in Perpetual now for 14 years and we've been a large fund manager really for most of that time. And I think we've proven that we can still outperform the index on a consistent basis, and I think there are some strengths of being a large fund manager in the Australian market.

Nicholas Grove: As the curtains draw across earnings season this week, many investors will be wondering which companies put in a good performance and which failed to live up to expectations. Meanwhile, many other companies' results may have simply left investors scratching their heads. Thankfully, here to shed some light on these companies' results, I'm joined by Morningstar head of equities research, Peter Warnes.

Peter, thanks very much for your time today.

Peter Warnes: Thanks Nick. It's always good to be here.

Grove: First of all Peter, let's start with the positives. Which of the big caps put in the most pleasing performances in terms of both earnings and dividends?

Warnes: Nick, I think before we get to the individual stocks, I think we have to address the situation that the reporting season overall was positive. I think the expectations were fairly low, albeit that we've had a robust reporting season. Yes, there has been some positives and some negatives, but overall the positives outweighed the negatives and that's why the market continues to push higher.

In terms of the individual big-cap stocks that delivered, if you like, strangely enough or maybe not so strange, they came from that defensive space. The retailers Woolworths and Wesfarmers via Coles; the healthcare via Ramsay, CSL, Primary Health Care; and in the banks, the only big bank that reported was CBA. And then you've got the Telstra report which didn't surprise, but it was just a great solidifier, if you like, for confidence - and it should be of no surprise. I mean, defensive stocks do always perform and should deliver in a market or an economy that is under a little bit of pressure.

Outside that, IAG, that was a very good result, and in addition to that, Leighton and Brambles we also liked. I think of the big caps, honestly, Woolworths was a very good result, strong where we thought that it would be strong, in the supermarkets, and really they have delivered where there was quite a few skeptics out there. When you've got the Australian supermarket operation with an EBIT margin of 7.73 per cent against Coles at 4.7 per cent, that was a marvelous performance.

Grove: In your estimation, Peter, which company delivered the biggest upside surprise?

Warnes: Nick, there were obviously some smaller caps that went very well. I would think from my perspective, I think CSL was an outstanding performance. Given that it's a global leader - you have big market shares and where they've really made significant ground was increasing market share in the emerging markets, small gains in the larger, more developed markets, a wonderful cost control, and when you're working off a $1-billion base, to come in with a 24 per cent increase, it's a very, very strong result. And a new CEO coming in after McNamee's departure, I think that company is in great shape, and I would think that was the highlight of, if you like, the big caps in my mind.

Grove: On the flip side, Peter, which companies' results did you find to be the most disappointing?

Warnes: Nick, there always are some disappointments. Look, I wouldn't call Rio and BHP or any of those, the major resource stocks, disappointing. People knew what was happening with prices of commodities, and there was some guidance there and what have you. So I wouldn't call them disappointing.

One stock that I forgot to mention on the positive side in the resources space, which I think was the feature of the resources space, was Woodside. That was a marvelous result as well from the positive side.

Now, back to negatives. Look, the mining services, anything mining-facing or resource-facing was under pressure as we know. Disappointments - well, I suppose Ausdrill, certainly UGL disappointed - we thought that was going to happen, because the activity was much, much slower.

Elsewhere, I think Origin Energy disappointed with a loss of customers in retail energy to AGL, strangely enough. And of course, as you know, Origin bought New South Wales retail energy assets from the government and they've lost a little bit of share there. And niggling increasing costs and their massive LNG project in Queensland offset the market. Smaller stocks - SAI Global disappointed, Billabong is a serial underperformer. But other than that, I'm just trying to think of others. There were some there, but not dramatic.

Grove: Which big-cap do you think delivered the biggest negative surprise?

Warnes: Yeah. I think Origin again. It was something that came out of left field a little bit. The other one that was a bit negative and certainly disappointed was Cochlear and that came in early in the reporting season, so you tend to forget about them three weeks later. But that disappointed. And I think it disappointed, because the market was looking for them to continue to increase their market share in the developed market if you like. And whilst the overall number of units sold was up nicely, the overall majority of those were sold in China, which was low-margin and it would appear on the surface that they did lose market share in the developed markets and that was the US and Europe.

And so that was a disappointment and that stock did come back quite sharply. So, Origin and Cochlear I think were the two that in big-cap space that were disappointing.

Grove: Finally, Peter, what themes do you think will characterize the market as we close out the final four months of the 2013 financial year?

Warnes: Nick, the economy looks like its stabilizing and there are relatively comfortable levels of activity. Yes, mining and resource activity is slowing. Investment in that area is peaking. Job creation is struggling. I would think that still there will be some focus on defensive stocks, because they have really delivered in the first half. And my gut feel is the market is just ahead of itself at the moment. I wouldn't be surprised at all to see it pull back a little bit pre-June and then strengthen going into the back half of this year.

Grove: Peter, thanks very much for your time today.

Warnes: Pleasure, Nick, always a pleasure.

Christine St Anne: Despite some optimism growing in Europe key issues remain. Today I'm joined by Vanguard’s Peter Westaway, to look at five specific challenges now facing Europe. Peter, how is Europe grappling with its peak to reduce its debts?

Peter Westaway: Well, I think the real problem for Europe is that it’s starting from a position where some of its countries have very high debt. They have very high deficits. And even though they are starting to implement physical consolidation programs, it takes a very long time for that to show up in debt ratios falling.

So, for most countries they still haven’t got themselves back into their fiscal surplus, which is one of the conditions that would help debt ratios to come down. And of course, because their growth rates are still so low, in some cases actually negative that means the denominator, effectively the ratio is still going up. So all told, debt ratios probably aren't going to start coming down convincingly until at around 2015 and 2016. But the right policies are being put in place for it to start happening.

St Anne: Do you see any light at the end of the tunnel in terms of growth in Europe?

Westaway: Well, we’ve just seen yet another quarter of negative growth in euro area and the euro area as a whole. And we’re probably not going to see positive growth for the aggregate euro area until probably the middle of this year 2013.

I think we're probably just starting to see these countries bottoming out in terms of recessions. Some of the forward-looking indicators is looking a little bit more promising, and just the very fact that some of the most aggressive physical consolidation is probably already happened.

So, arithmetically that means that growth start to become a bit less negative. Nothing more generally as Germany starts to pick up, as some other parts of the world start to get a bit stronger, that will also help Europe as well. But I mean let’s not hit ourselves. I don’t think we’re going to have anything like strong growth, more than 1.5 per cent for the next couple of years. It’s a long haul, I am afraid.

St Anne: Peter, are you starting to see any countries that are beginning to claw back their competitiveness?

Westaway: There are a few. I mean, a lot of countries lost a lot of competitiveness because they had low interest rates that they never really enjoyed before. They had a credit boom, say countries like Ireland, Spain, Greece, Portugal; all let their inflation rip, wage growth was too high.

Now the recession is really biting in these countries that then obviously act as a dampener on wage growth. So that's helping competitiveness to come back. Probably the country that’s doing best is Ireland where they’ve clawed back healthy, probably more than 50 per cent of their lost ground and that's partly because they are one of the countries that’s just inherently more flexible. They don’t have some of the problems that some of the other countries have on the structural reform side.

St Anne: Structural reform is of course another challenge in the region. Are you seeing any gaps in particular countries?

Westaway: There are a lot of big gaps, and really in some ways those challenges are the most important because until a lot of these periphery countries just start performing like a modern economy should, it is going to be very difficult for these countries to move forward. I mean the main gaps are in areas for example, wage flexibility, the ability of firms to hire and fire workers, restrictive practices in a number of industries, which means that there closed jobs, which makes it difficult for the economies to be dynamic.

And then there are just more generally, infrastructure spending, education spending, sort of being held back for a long time in these countries. And so all of these things together will help some of these periphery countries grow. But these benefits don’t come through quickly, it takes a long time.

St Anne: Peter, finally, are the European banks still vulnerable?

Westaway: Yes, banks are very much in the kind of epicenter of sovereign crisis, and it's in a way, the interrelationship between the banks and the sovereigns that makes it so difficult. You know, countries like Greece bought – the banks in Greece bought sovereign debt that brought them down and then in countries like Spain and Ireland the banks went burst, and the government had to bail them out. So banks and sovereigns are in this deadly embrace.

Gradually, we're seeing recapitalization happening. And that’s helping, but while growth is so low, there are still a lot of very impaired assets on these balance sheets, and the exposure of the banks to sovereign debt and to the bank debt of other countries means that there is an intensification of the sovereign crisis. Banks are very vulnerable and they won’t be able to lend money to firms and households and that could cause the recession to intensify again. Hopefully that won’t happen, but that’s the risk.

St Anne: Peter, thanks so much for your time today.

Westaway: Thank you.