Transcript to follow.

Jeffrey Hutton: Australian corporate earnings kicks off this week. To give us an idea of what to expect, here is Peter Esho from City Index. Peter, thanks for joining us.

Peter Esho: Jeff, thanks for having me. It's a pleasure to be here.

Hutton: Well, firstly Peter, I just want to ask you about Gina Rinehart's purported investment in Fairfax. Is she seeing something in the media sector that others aren't?

Esho: Look I think so. I think what we've seen over the past few months is really the cyclical businesses in the Austrian market bounce off their lows. They have come down significantly from their highs during 2011. We saw retail stocks bounce from their lows, very, very depressed lows, of course. We saw the mining services businesses bounce off their lows. We saw resource stock companies themselves, uranium players, but we haven't seen media really bounce off its lows and it's been so depressed.

And I think this is a trigger as an investment, as an endorsement for a business like Fairfax, which has its fair share of challenges. Prior to this rate, it was trading on a price to earnings ratio of about six to seven times. This is a business that's still very profitable, a business that's very dominant in the online content space, a business that recently showed its ability to extract value from an online investment through Trade Me, a business which is shopping around it's radio assets and might find a windfall in selling, realizing value, paying off some debt.

And so, I think this will resonate well with the likes of APN, which is also been very heavily sold off. It's very dominant in the outdoor advertising space and I think also Ten Network Holdings, which has a outdoor advertising business, has got some very smart Australian media personalities on the Board and has recently stripped out costs and well-placed for eventually the cycle to pick up in media and advertising and that will all flow through to the bottom line.

So, I think this is the start of the media sector re-rating.

Hutton: P/E levels have come down quite a lot over the past 12 to 18 months. Do you think this season will be enough to encourage investors back into the market?

Esho: I think this reporting season will show that businesses out there are still earning some respectable numbers, but price to earnings ratio is a very important topic, because you obviously have the pricing, but in terms of the earnings it's not just the level of earnings, but it's the ability of those earnings to grow. If you're paying 20 times, for example, if you assume those earnings don't grow, it will take 20 years for you to make back your investment if 100% of the earnings are paid out.

So, I think price to earnings ratios will adjust on growth assumptions and unfortunately, I think over the next few years we are still in a relatively low growth environment. I don't think we'll get the large price to earnings ratio adjustments unless businesses can show their ability to grow above average levels in this current period. There won't be too many, but I think if you take the ASX 200, for example, you will have a handful of businesses that will show an ability to grow. They are the ones that could see that price to earnings ratios, perhaps expanding a little bit.

Hutton: Do you think we can expect more visibility about full year results out of this earnings season?

Esho: I don't think so. I think management has learnt the consequences of putting out assumptions out there that are the missed, and I think a lot of managers out there just don't have the visibility in their businesses. They don't have the confidence, and I actually think it's good that they are coming out and being quite honest saying they don't know what will happen. They are aware of the consequences of missing. I mean, if you exceed your targets, you get a pat on the back and you perhaps are rewarded a little bit, but the consequences of missing are far larger. So, I really don't think we are about to get that visibility in this reporting season.

Hutton: Okay. Then who are the winners and losers?

Esho: I think the good businesses are�the high quality businesses are not necessarily the businesses that will generate the largest returns in share prices going into this reporting season. Let's take Woolworths, for example. It's a fantastic business, but unfortunately the earnings assumption out there in the market are for growth of between 2% to 6% on what was a very good year last year. So, Woolworths is a very good business, but I don't think it will be a winner in terms of surprising the market or pleasing the market when it prints its earnings numbers.

I think there are a lot of businesses like media, for example, which have been heavily discarded, which will come out with bad numbers, but those numbers might actually be a trigger to see the share prices higher only because of valuations. I think there is a lot of bad news already priced into businesses. If that news comes in not as bad as expected, I think you could see a rebound in businesses like Pacific Brands, for example.

So, I think BHP, Rio Tinto will disappoint. We saw a glimpse into their production numbers over the past few weeks, and I think that disappointment will not be the absolute earnings of these businesses, it will be earnings relative to expectations. Expectations are just purely too high. Iron ore prices consolidated towards the end of 2011. They fell off their highs. They're ramping up their volumes, BHP and Rio Tinto, but the market is expecting growth. Prior periods where the earnings base has been very high, record high levels.

So, I think the expectations are for perfection and if you don't get that perfection, I think you could see a weakness or you might get gains, but I think you'll get better gains elsewhere in the businesses that expectations are so low it could actually come out and exceed really bad expectations.

Hutton: Peter Esho, thanks for your time today.

Esho: Thanks for having me.

Tim Murphy: Hi, I'm Tim Murphy, the Co-Head of Fund Research here at Morningstar. At the end of January, we're going to be transitioning to a new global analyst rating scale for our fund research. Many of you will be familiar with our existing Morningstar recommendations for funds, where every fund that our analyst team goes and visits and assesses, we give a rating of either highly recommended, recommended, investment grade, hold or avoid.

At the end of the January we're going to be transitioning to a new scale, where the scale will read gold, silver, bronze, neutral and negative. So, there is a couple of different reasons why we've done that and some important implications for you, as users of our research and our ratings.

Firstly, looking at why we've done this. There has been some feedback over the years that people would like to see an extra level of granularity among the positive funds that we rate, i.e. the funds that we recommend and that we like. So, to-date we've had two positive rating scales being recommended and highly-recommended. Going forward from the end of January we're going to have three what we'll collectively refer to as the Morningstar medalists.

So we'll have funds that are rated gold, silver or bronze. What that means is compared to the existing scale, funds that are highly recommended today will become gold rated funds at the end of January, while the extra level of granularity around funds that are currently recommended, will mean that some of those will become silver and some of those will become bronze. So therefore users of our research, you have an extra level of granularity to see where our conviction lies at different levels among the funds that we like.

As I said, collectively we'll be referring to these as the Morningstar medalists. So gold will represent funds that we have the absolutely highest conviction in their sector or asset class, but at the same time silver and bronze funds are still equally good funds that can play a valuable role in a portfolio.

So as users of our ratings, and you should ask yourself, is the funds in my portfolio Morningstar medalists and if not maybe look at other Morningstar medalist funds to consider for the portfolio.

This new rating will also bring our rating scale in line with what we're doing globally at Morningstar and Morningstar is a global business, we have more than a hundred fund analysts around the world. And so now, for those of you that are using us across different borders, you'll be able to have the same look and field through our research, whether it's in the U.S., in Europe, Asia or here in Australia.

As clients now looking forward, as I've said highly recommended will become gold, recommended funds today will be either silver or bronze. Funds that are currently rated investment grade which is the highest number of funds we rate at the moment, they will become known as neutral while on the negative side, we'll have funds that are currently rated avoid will become what we call negative.

Outside of that we'll also have terminology to use funds that are either not ratable because of lack of disclosure or under review where there has been a material change to people or process behind a fund.

So, going forward, neutral means a fund that is adequate and should do an adequate job at meeting its objectives, but the Morningstar medalists rated gold, silver and bronze are the funds that we think people should be focusing the most time and attention on and using in your client portfolios.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com.

Investors often behave in ways that run counter to their own interests. Carl Richards, a financial planner, a blogger for The New York Times, and a contributor to MorningstarAdvisor.com, has written a new book that address this tendency, and it's called The Behavior Gap. He is joining me via Skype to talk about it today.

Carl, thank you for joining me.

Carl Richards: My pleasure; thanks for having me.

Benz: There has been a lot of academic research around this topic of investors who are overconfident and how that can impede their investment results. Let's talk about a sketch that you've got in the book on that front and also the experiences that you've had with investors who are overconfident.

Richards: I think overconfidence, besides fear and greed, it seems to be the little third partner of this little group that�s always lurking around big mistakes. I think it's so tricky, because overconfidence is exactly how you would expect an expert to behave. [For instance,] you don�t want an underconfident surgeon.

Benz: I don�t.

Richards: I don�t know anybody that does. You also don�t want an overconfident surgeon. So where you cross that line between confident and self-assured, and overconfidence is really, really fuzzy.

It�s a problem of experts, and so whenever you are taking care of your own money, or if you are offering advice to other people on their money, you've got to consider yourself at least somewhat confident or else you wouldn�t be making those decisions.

The key is to figure out when we cross the line from confident to overconfident. It's really challenging. As I say in the book, if you are not worried about overconfidence, it's probably because you are overconfident.

So I think we just need to be more humble about the decisions we make when it comes to investments, and realize that often our gut is wrong on the investment side. Often it would make sense to run ideas past two or three people.

The other tricky thing about overconfidence that's really a whammy is that if you have a plan that you are very confident in, and you hold on and hold on and hold on, and then you finally capitulate, you are the one that�s going to suffer the most. Because the people who bailed out early, they didn�t suffer nearly as much as you did by being confident in your plan. So there is this really fine line--confident in your plan stick with it.

Benz: So the big risk of being overconfident in your view is that you can position your portfolio to benefit from one outcome but not really position it for outcomes that you didn�t anticipate.

Richards: That's really good point. I think we are notorious for not understanding ... we are very bad in understanding things we don�t know. I think often you position ... you think you've got one outcome.

We need to pick an individual stock, or even an industry--let's say I really feel strongly that commodities are going to do well next year. The fear with overconfidence is that you position a portfolio in a way that if you are wrong, you are going to really suffer. There is a conversation I like to have called the overconfidence conversation where you just ... give yourself permission to consider what would the impact be if I am right, and what conversely, and be careful, what would the impact be if I am wrong about this decision? How would my life change?

Benz: So the idea is that you don�t want to position your portfolio to benefit from all-or-nothing outcomes. You really want to think about what's the devil's advocate case for this thing that I think I am so sure about.

Richards: There can be reasons we'd want to roll the dice on an all-or-nothing outcome. But you certainly wouldn�t want to do that without at least recognizing that�s what you are doing.

Christine St. Anne: Last year the Australian dollar enjoyed some record highs, but will it continue to appreciate this year? Today I am joined by City Index's Kara Ordway to give us her view on the outlook of the Australian dollar and some of the major currencies.

Kara, welcome.

Kara Ordway: Thank you.

St. Anne: Kara, what's your outlook for the Australian Dollar? Do you think it will continue to appreciate?

Ordway: Yes, certainly. We've seen a very big rise for the Australian dollar over the first half of 2012. We have seen a high of 1.0573, which is quite a significant move for such a short period of time. What this has really come from, is more of acceptance of what is going on in the Eurozone. We are seeing a bit more risk appetite. Really, those equity markets from six-month highs has meant that people are more willing to buy into these high yielding currencies like the Australian dollar, and that's what has really pushed it higher at the moment. Now, we have seen all-time highs against the Euro, and these highs of 1.05 against the U.S. dollar, so it has really done quite well in the beginning part of this year.

Now, with the lower volatility that we are seeing at the moment, the high commodity prices, this has tended to keep it above these levels and consolidate around the 1.04, 1.05, that we are seeing at the moment. Now, what we also have to consider, is that the Australian dollar is a very high yielding currency, which means it's very expensive for traders to actually short that currency, and that's what's also kept it afloat over the first part of this year. So certainly, a very resilient Australian dollar, compared to what's going on in the Eurozone at the moment.

St. Anne: There has also been some talk about domestic interest rates easing. What implications would that have for the Australian dollar?

Ordway: Yes certainly, alongside all this resilience that we are seeing in these high numbers traded, actually what a lot of traders are saying now, is the Australian dollar is largely overpriced, and we are seeing a lot of technical levels now that are actually indicating that it has been over bought at these levels. One of the key factors in bringing it down would certainly be the RBA rate decisions over the first half of this year.

Now CPI numbers will be a large indicator of whether they have got room to bring those rates down. If inflation is eased then certainly, we will be looking for a rate cut in February, and certainly going on to into the second half of the year. So that's one of the reasons that we could see the Australian dollar actually trade lower, despite it trading so high at the moment. So, we'd be looking forward to that. And actually, saying that it's overbought, we're actually in a very fragile state for the Australian dollar at the moment, sitting on the edge of what's going on in Europe, and it wouldn't actually take a very large catalyst to bring it off those highs, at these overbought level.

St. Anne: Kara, you've mentioned the European situation, what about the euro, would that continue to be resilient?

Ordway: Well, we've seen a very resilient euro over the past couple of weeks, and actually throughout 2011 as well. So, we're trading around the 1.29, 1.30 levels, and despite going down to the 1.26 levels against the U.S. dollar at the first part of 2012, it's actually showing a further bit more of optimism going into the end of January. So, really though looking at the fundamentals, I see no real argument for the euro to trade higher than this 1.30 level.

I think, what we're seeing is these pockets of optimism where people are really desensitized at the moment of what is going on in Europe, and they're managing to push this euro higher at the moment. What's also a factor is that we're seeing record number of shorts in the euro market at the moment. So, that short side of the euro is really largely saturated at the moment. So, any movements upwards creating stops in the market, people having to come out of their short positions, and really when we're seeing these large amount of shorts, it's really indicating that the market is largely exhausted and it's not hard to facilitate a bounce at that time, when we're seeing so many shorts in the market, so that's why it's been so resilient.

Certainly, I don't know whether it will,  this will be able to continue into 2012. For me, as I said, there's no real meaningful reason for it to be trading this high. It's still above the average that it's... from when it opened in 1999. So, we're still on relatively safe levels, but certainly going into 2012, despite some probably capital flight and repatriation of funds back to the Eurozone, no one really knows what the exposure of Europe has to the rest of the world.

So, certainly for me, I'm still bearish on the euro going into 2012, and I think at the moment, the more realistic number we should be looking at is around the 1.20 level, rather than the 1.30 at the moment.

St. Anne: Kara, China's latest numbers indicated some easing in growth, what are the implications for the renminbi on the back of this slow growth?

Ordway: Exactly. Well, we've seen those growth numbers in China actually decline - they were released last week. Where growth was coming in around 10% we're now seeing it more around the 8% mark. So, certainly there is a definitely a slowdown in China occurring that is set to continue into 2012.

Now, what that implication has on the Yuan or the renminbi is likely not appreciate as much as it would first be thought. So, certainly the market expectations of appreciating have declined. China will be more reluctant to let it appreciate in these type of conditions and certainly what we'll see, whether the global conditions improve or decline, it's certainly going to be up to China as to how they appreciate it and when they appreciate it, and I doubt they will take any pressure from the U.S. despite all these factors.

St. Anne: Kara, finally what currencies are you bullish on?

Ordway: The currencies that we are looking at this year, definitely the Canadian dollar. They've got a strong fiscal start, so certainly looking to the Canadian economy for some support. It's not as overbought as other commodity currencies like the Australian dollar and the New Zealand dollar. So, certainly there the Canadian dollar is one to buy.

Also, actually the Norwegian krone. We've seen a lot more activity in the Nordic crosses over the past couple of months as traders try to get exposure within Europe not using the euro. They also have a large fiscal surplus, and so definitely the Norwegian korne is looking good over 2012.

But I definitely think this year will be characterized by a different dynamic in the FX markets, particularly driven by the euro. We are not going to see those traditional risk-on, risk-off trades. The correlation between the euro and the S&P has declined quite significantly. So, we are no longer seeing in terms of risk-on people, buying into the euro and that is really going to create a different dynamic throughout 2012 for the FX market. So, it will be an interesting one to look out for.

St. Anne: Kara thanks for your insights today.

Ordway: Thank you.

Christine St Anne: With the continued market volatility, gold has emerged as one of the few safe investments havens, but there are other precious metals that investors can consider. Today, I speak with CMC Markets' Ric Spooner about what other metals can add spark into your portfolio. Ric welcome.

Ric Spooner: Thanks Christine.

St Anne: Rick, besides gold, what other precious metals can investors look at?

Spooner: Well, people tend to think gold when they think precious metals, but there are other significant metals. The biggest traded ones are silver, platinum and palladium. But for most investors probably silver and platinum are the ones that are large enough, with big enough markets to operate in.

St Anne: So, what are the key characteristics behind these metals?

Spooner: Well, like gold they share the characteristics of precious metals, that is, they don't rust, they're basically indestructible and they're beautiful. So, they are metals that have traditionally been treasured and also used in jewelry. The key difference though with those other two metals is that they have a much higher industrial usage than gold. So, their pricing and demand is much more impacted by the world industrial production. Platinum in particular is used extensively in the motor vehicle industry and silver is used in electronic switching.

St Anne: You mentioned that these metals differ from gold. Does that have implications to the way they behave in an investor's portfolio?

Spooner: They both can be, and traditionally have been used as precious metals. So, like gold, from an investor's point of view, they are something that retains their value, is traditionally used as a hedge against weakening currencies, particularly weakening U.S. dollar and inflation. But the difference is that they will tend to outperform gold when you also have a situation where industrial demand for them is strong. So, investors are often well served to think about, not just if they believe that precious metals is appropriate for them, to think about which of the metals at the current moment might be the best.

St Anne: Ric, so how have these metals performed?

Spooner: Well, there has been quite a bit of a change over the last two years in the relationship between these metals. In the year running up to 2011, silver and platinum significantly outperformed gold. Really, throughout the rest of 2011 though or from April 2011 onwards, gold outperformed silver and platinum fill more heavily and that was because industrial production fell, as the world becoming increasingly concerned about the European situation.

St Anne: As these metals are available globally, do they have currency implications for investors?

Spooner: Yes they do, especially investors outside the U.S. or all the � most commodities and certainly these three metals are all quoted in U.S. dollars. And the implication of that is that for investors outside the U.S. the prices will underperform in their own currency if their currency outperforms. And certainly for Australian investors this has been something that has tarnished the performance of precious metals to some extent. Generally speaking in recent years, because the currency has been so strong and that had reduced the U.S. dollar gain.

St Anne: Ric, so how can investors minimize these currency implications? Can they, for example, look at hedging strategies?

Spooner: Yes. Well, when you're considering an investment in previous metals, it is a good idea to think about the currency implications and to also have a view about your local currency. A couple of things you can do there: one is, as you say, is to consider hedging the currency of your investment if it's large enough. Another alternative though is to look at CFDs as an investment tool because they�re your currency exposure is limited only to the profit or loss that you make and not to the whole face value of the gold or silver. So, if you are concerned then about a strengthening in your own domestic currency, then you can use a leverage product like CFDs as a way of getting around that largely.

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

Spooner: That's a pleasure, Christine.

Jeffrey Hutton: Self-managed super funds; they make up third of the superannuation industry and they are only going to get bigger. So 2012, what are the big issues they need to be thinking about. Well, Andrew Baker joins us from Perpetual to talk about just that.

Andrew thanks of joining us.

Andrew Baker: Thank you, Jeff.

Hutton: So Andrew, how do you account for the popularity of DIY Super?

Baker: We've seen a huge growth in the self-managed super funds, participants over the past few years and I think, given that the turmoil out of GFC and the experience that people had, I think at the heart of it, it is about flexibility and control, and again that transparency. So, many will do it all themselves, many might seek assistance with certain aspects of the running of a fund compliance or administration. But at the end of day it's their call, so it's not a product that they are in necessarily, it's a structure that's their own. So, I think it's that that's driving that behavior.

Hutton: This year concessional caps are the lowering of them to 25,000 is going to be a big issue, right?

Baker: Wall Street's very important to take advantage of all of those strategic opportunities and the caps being of vey high profile one. It does in fact need to fit into your strategic goals and objectives that you've set for short, medium and long-term. So, it's not just about sort of rushing in and taking advantage of the caps, it's about saying �does that fit into my strategy?, have I got my cash flows mapped for the year?�.

Its $25,000 and I mean a pre-tax or salary sacrificing that can be very powerful. But I think you did see some of that behavior in 2007 around the $1 million opportunity. So, putting money into super is one thing, but making sure that it's going to be efficiently invested is perhaps another. So, you do need to look at it holistically and not just sort of react to a deadline.

Hutton: That's all about the plan, isn't that right?

Baker: That's right and really understanding, what's the opportunity cost if I don't do it. So, if I'm not going to take that opportunity, what are the opportunities costs for me not doing that.

Hutton: That point you are making about the $1 million contribution, what was lesson of that?

Baker: If people were making contributions to super and not really thinking about the actual way that that was invested, they experienced severe loss of capital. So, if you adjust sort of piling significant amounts of money on top of your existing investment strategy without really considering that � do you see what I mean? You are separating strategic and tax issues from investment.

Some products, if you put money in it just basically sweeps across the investments that you are already in. Again with sort of breaking apart strategy from investment, you are able to say, well okay I can make the contribution but I might allocate it to cash as opposed to being in for a penny, in for a pound to that existing investment strategy.

Hutton: So, cash balances for the past couple of years have risen, I think to about 30% or so, those were the latest figures. Should trustees be moving out of cash and reallocating?

Baker: Well look, I mean, I think there's cash and then there's cash and fixed interest, and cash fixed interest and international fixed interest. Look, it's certainly been a consolidating program that many have gone through and waiting for investment markets to hit some level of perceived or real recovery before allocating through. Again, it comes back to the fundamentals: you really need to make sure you've allocated for short-term expenditure; you've got any capital expenditure in play. They�re the must haves, understanding those decisions, understanding what you need, before you can start to say well should I start to reallocate.

Once you've gone through that process of figuring out what you do need in cash from a liquidity perspective and start to move to the portfolio, we'll sure, that's when asset allocation needs to come to the fore. What are we telling our clients? It's a balance of making sure that we don't make any rash decisions. It's about understanding what your true risk profile is, going through the GFC on your own or with an advisor, what was your actual behavior? What did you do? What did you feel? It's understanding those questions, and answers to those questions, which will then drive well, do we retire in the current asset allocation and risk profile or do we change?

Even if you retire in the current asset allocation and risk profile that you have, yet you need to then test what's going on in underlying investments within that risk profile. So, alternative investments, direct property, which we do believe smoothes return, reduces risk. Let's face it, the Australian investment community has a love affair with Australian shares, and you've got a couple of big names in that ASX top 50 that carry huge amount of risk in many people's portfolio. Again, I think it comes back to fundamentals and not sort of, I guess, bowing to people's popular opinion, which is as soon as I see some opportunity in the ASX, I'll dive back in there, because I don't like this asset class and I don't like that asset class. It's not a prudent approach.

Hutton: Andrew, I suppose the point that I'm trying to get at is, are people going to continue to be risk-averse or will appetite for risk improve?

Baker: Yeah. Look, I think there is a couple of things in play. I think clients do understand that bring in cash for ever is not going to achieve their goals and objectives. So, they are starting to head back in and probably six or eight months ago it was when we started to see people moving back in. But interestingly seeing people head back into international assets was very interesting. And, I mean we've always stuck to our guns from our recommendations point of view, but saying clients more open to that I think the currency helped.

Whilst we very much have their own views on asset allocation and investment selection, we also respond to our clients requests and particularly the high net worth space, they kin of know what they want, where their interests lying, and that's the space. Australian equities, looked they have remained very strong throughout. So, we will see rebalancing into Australian equities, but I think most of the clients that we've had experienced with have retained those allocations. They were very, very loathed to sell down those positions.

Hutton: So, what are the big bumps coming up in 2012, I suppose Europe will be one of them?

Baker: We do see tough times in Europe, there is no doubt about it and particularly potential recession. However, whether that will have the impact or massive impact that some people are saying, not sure. We do see the U.S. actually starting to improve. So, no recession in the U.S. really is our view. Then Australian markets, well some research is showing potential 10% returns and coming back to good growth and income.

What we do think though is that portfolio construction will be very much about income, and that's a bit of a change to the sort of addiction to growth that many have had in investment markets really over the past several years. We don't see huge growth being the driver of investment decisions. It needs to come back again to fundamentals, which is, what is this investment going to yield me? Which should also then drive the value of that - price of that asset, over the longer term.

Hutton: Andrew Baker, thanks a lot for joining us.

Baker: No problem. Thanks very much, Jeff.

Christine St Anne: Market volatility will no doubt continue in 2012, and with that investors could be making some of the common mistakes of last year. To avoid these pitfalls, I'm joined by Westpac's David Simon.

David, welcome.

David Simon: Thank you.

St Anne: David, one of the common mistakes is staying out of market. What kind of investment opportunities are investors missing out on by doing that?

Simon: Yeah, sure. I mean, investors are naturally pessimistic and scared due to the current economic and political turmoil that is currently being witnessed in markets. Obviously, many investors tend to put off their decisions to invest days, months, and sometimes even years. Now this procrastination is one of investments � investors' most common mistakes, and it's obviously driven by fear of failure.

Now interestingly, there's some evidence to show that deferring or delaying investment decisions actually cause quite a significant opportunity cost, and one example, and the example is quite a significant one: if an investor choose to invest in the S&P 500 in March 2009, by the middle of November that year, they could have actually received a 51% return. Now, if the investor actually only deferred or procrastinated their decision by a period of only two months, that return would only be approximately half at 26% for that period.

St Anne: Investors are also continuing to favor cash. Are there any mistakes regarding diversification?

Simon: Yeah, diversification is a risk management technique that investors use to effectively ensure that their assets are, a range of asset classes and their investments, are not just in only one particular class, effectively not having all your eggs in one basket. Now cash is a certain and secure asset class. However, for an investor that only chooses to invest for a period for up to 3 years, that investment class may actually be the correct one. Nonetheless, cash has never been the best performer after inflation and tax for a period of 5 years or more. So, diversifying across a range of investment asset classes such as growth assets, as well as income assets may offer the opportunity for capital growth, and a better return than cash.

St Anne: David, with this market volatility, investors are also tempted to time the market. What are key pitfalls behind that?

Simon: Yeah. That's an interesting one. Certainly, some people that sold their shares before the global financial crisis have done very, very well, and considering that markets are still well below their pre-GFC levels, those investors are still smiling pretty. However, it's not often where investors that try to time the market actually get it right, and indeed investors that choose to time the market based on gut feel, speculation, and indeed without a strategy often fail.

Interestingly, recent data shows that if an investor invested in the Australian share market over the past 20 years, they'll have returned an average of around 7% per annum. However, if that same investor tried to time the market over that 20 year period, and missed out on the 20 best days during that period, their investment return would have reduced down to about 2.5% per year.

St Anne: David, investors tend to also chase numbers. What are the issues behind that especially in periods of market volatility?

Simon: Yeah, sure. Look, history has taught us that the normal and traditional asset classes such as shares, property, cash and bonds don't follow a normal or regular pattern. In fact, last year's best performer often becomes the following year's worst. Indeed over the last 20 years, for six out of the last 20 years, the previous best performing asset class actually did become the worst performing asset class a year thereafter. In fact, no single asset class has enjoyed any more than three consecutive years of being the best performing asset class over the last 20 years.

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

Simon: Thank you.

Jeffrey Hutton: 2011 was a tough year for a lot of investors, but 2012 could be different. Lower interest rates, cheaper blue-chip stocks could mean that this is your year to get financially fit. So, joining us to discuss how to do that is Viviane Parsons from the NAB.

Viviane, thanks for joining us.

Viviane Parsons: Thanks, Jeff.

Hutton: Viviane, is 2012 a golden opportunity to get financially fit?

Parsons: I believe so in terms of -- I guess there's two ways to look at it. From an economic point of view, obviously, interest rates are expected to drop, so that means for the Australian mum and dads with a mortgage that they'd obviously be able to pay-off more of their principal debt, if they accelerate their repayments. A good opportunity, I guess, in that sense. For those that actually derive an income from their savings, it's quite the opposite. Their income is going to be reduced, and they may want to look at other avenues to derive an income over the next 12 months.

Hutton: Are we actually being more frugal?

Parsons: I think since the GFC, we've certainly seen a point where people are trying to reduce their debt, or perhaps also liquidate assets to then reduce their overall commitment. But I think 2012 will really see that go a little bit further. People are a little bit more cautious and certainly will try and move ahead without making the same mistakes that they may have done before the GFC.

Hutton: Budget can be pretty daunting, how do you go about making one?

Parsons: Thing you never want to do really, but I guess my advice would be to really make that your new year's resolution. There are some great online tools, moneysmart.gov.au, which is an ASIC sponsored website is a fantastic tool to really prompt you on where you spend your money, help you plan to prioritize, and perhaps also look at what you can save on.

Hutton: Is there a checklist that people should keep in mind?

Parsons: Well, surely, those online tools are a good way to start, but then again look at areas such as what you spend on insurance, what investment products you're invested in, areas where you can perhaps save and as I said earlier, prioritize, really try and spend what you can afford, and don't make the mistake of overspending, get credit card debt accumulated because that obviously is quite clearly not the way to run a budget.

Hutton: Apart from the obvious benefits of getting financially fit; paying off credit card debt, what are the opportunity costs involved? Say, if I have a credit card debt of about $10,000, what could I have used that for?

Parsons: Yes, certainly. 2012 from a market outlook as well, may bring an opportunity, where we see perhaps a comeback in equities. So, that could be certainly the case that people may be too focused on paying debt back and, instead perhaps, should look at avenues to seek some capital growth. I mean, we have been through some very volatile times, and it's likely to perhaps continue. But these times also in history are an opportune time to invest, and yet get some capital growth over the long-term.

Hutton: Lower interest rates are a double edged sword. If term deposits aren�t yielding as much as they used to, how do you make up the difference?

Parsons: Yeah. Look, I always try and explain to people that even in retirement, they are most likely not to spend their whole savings in the next couple of years. So certainly there is an incentive to protect the capital from inflation, as well as still seek some capital growth in retirement.

And at the moment, we see for example in Australia, the dividend yields from blue-chip Australian share much higher than what interest rates are doing, plus there's lots of tax incentives that come with that. So, I do believe that anyone approaching retirement certainly should have received advice by now.

For those that are over 50, there's also an opportune time up to June 30th to utilize their salary effectively by salary sacrificing that into superannuation. There is going to be a change in the amount you're able to place into that tax effective retirement scheme. As of 2012 July, the amount is significantly going to be dropped from $50,000 currently to $25,000. So, really people who are in that age bracket should get some advice around that.

Hutton: Generation Y has a reputation for wanting it all and wanting it now. Are they getting better at managing their money?

Parsons: To be honest, I haven't seen it at this stage. I am hopeful that perhaps they will have learned out of this GFC that we've gone through to perhaps align their spending a little bit to what their earnings potential is, but at the moment, yeah I'm quite doubtful. I haven't seen it at this stage.

Hutton: Viviane Parsons, thank you so much for your time today.

Parsons: Thank you.

Nicholas Grove: Given the recent high levels of natural catastrophes and extreme weather events, both here and overseas, investors may be wondering if higher claims costs, lower insurance margins, and lower profits for the general insurers are here to stay. Here to help investors get an idea of what to expect from the general insurers in 2012, I am joined by Morningstar's Senior Equities Analyst, David Walker.

David, thanks very much for joining us.

David Walker: Thanks, Nick, it's good to be back.

Grove: First of all, David, roughly speaking, what sort of claims costs are the insurers expected to incur as a result of these recent events?

Walker: IAG is looking at around $400 million to $420 million in total catastrophe claims for the first half; Suncorp about $360 million to $420 million; and QBE had a run of nearly $500 million in claims towards the end of the year. Now these huge claims bills stem from the devastating hailstorm in Melbourne on Christmas day, the floods in Thailand for IAG and for QBE. Various other global catastrophes for QBE, like Hurricane Irene in the Americas, and the - another smaller New Zealand earthquake on the 23rd of December.

So the insurers had the bad luck of a run of severe simultaneous catastrophes towards the end of the first half and that's what we are seeing.

Grove: David, we all know how unpredictable the world and the weather can be, but should shareholders simply accept storms and earthquakes and bushfires et cetera, as being part and parcel of investing in these companies, and if they can't take the heat, get out of the kitchen?

Walker: Shareholders in Australia and Australasian general insurance companies need to understand that they are taking on concentrated exposure to: hailstorms, other storms, severe weather, earthquakes, natural disasters in Australia and New Zealand, which is a region prone to volatile weather, and particularly in New Zealand to earthquakes. Now with QBE, you could always say it's globally diversified, and it manages to lay-off some of that Australasian regional risk worldwide, however even QBE is not immune as we've just seen. If there's a run of catastrophes worldwide all at the same time, that's what happened towards the end of the second half. Even they are not immune, they had a huge profit downgrade on Friday. So, this kind of exposure to unpredictable weather and earthquake risk is part and parcel of being a shareholder in a general insurance company. Similarly, general insurance companies also bring exposure to investment markets, because they invest billions of dollars in premiums into the markets and that can be volatile as well.

Grove: David, in your opinion, should shareholders expect a better or worse year in 2012 for the general insurers compared to 2011?

Walker: It depends completely on the number and severity of catastrophes, and on what happens in the investment markets. All of those variables are not predicable. So, the outcome for general insurance shareholders by the end of 2012, it will depend on the number and severity of catastrophes in Australia and New Zealand for IAG and Suncorp. Co-incidents of global catastrophes for QBE, reinsurance costs and pricing, and how well the insurers can pass all those on to customers and investment market volatility, and we are � as we all know in a period of particularly high volatility in investment markets.

So it's very hard to forecast the earnings and dividends of the general insurance company, when it depends on the weather; it's hard enough to forecast investment markets, let alone the weather as well, and yet as we can all see this is a major influence on the profitability of a general insurance company. The best you can really do is evaluate how well they price and layoff and diversify their risks. But even when they do that with the best will and skill in the world, if there's a run of catastrophes all at the same time, they can't avoid heavy claims costs.

Grove: Do the Australian insurers still stand in good stead in terms of their reinsurance programs and capital positions?

Walker: IAG recently announced a 13% increase in its reinsurance bill for 2012. Now that was somewhat better than many forecasters were expecting one year ago, after the last summer's natural disasters, but it's still a double digit increase, and they'll have to pass that on to customers. However, we think they will in time. Suncorp's reinsurance year is on a financial year basis. So, we won't know the increase in their reinsurance costs for FY '13 until around about the end of June this year.

QBE's reinsurance arrangements are complicated because they are global. Stocks is a bit of a black box. They also underwrite their own inventory insurance, so it's a bit harder to tell. However, the 13% outcome for IAG is not bad under the circumstances, and suggests that IAG management was able to negotiate a fairly good outcome for shareholders under the circumstances. Because, you got to remember this company has just been through yet another year of disaster claims well above budget, well above allowances, which means that disaster claims were also, therefore above allowances for the reinsurers. It would have been more than they were expecting. So, a 13% increase for higher level of cover is not bad under the circumstances.

On capital; Suncorp has surplus capital, and intends to make a capital return to shareholders, once investment markets have settled down, not at this time. QBE's capital position is also strong. IAG's capital position is not tight, but needs monitoring. We wouldn't want to see it too much lower, and if there were a run of major hits, in terms of catastrophes or if investment markets deteriorated very severely, then we'd have to be a bit more concerned. What you might see from IAG is the underwriting of the DRP for example is to make sure they retain a bit more of their capital they would be paying out in the dividend.

Grove: David, thanks very much for joining us.

Walker: My pleasure. Thank you.

Christine St Anne: Ian, can I just ask you about the banks? There's been a lot of discussion that the cost of funding could increase in Europe, which clouds the outlook for 2012. What's your view?

Ian Huntley: For the Australia banks, they are dependent on offshore wholesale funding, let's say roughly 25% of their book. Now there's some � there's obviously some issues there with continuing with money coming out of Europe, but on the other side of it, you�ve got to realize that the big four Australian banks are among the most highly rated in the world, and you've got a period where money is flying around the world and it's becoming increasingly frightened that lending money to European banks.

So of course, there's going to be some money looking to come to Australian banks because they are extremely highly rated and there seems to be increasing the U.S. money market funds have been for quite a while lending into Europe, now some of them are lending into the Australian banks. So, I am certainly not wishing to jump out of any window. I own Australian bank shares, and I can assure you, I sleep very well at night, and bank the dividends with the greatest of glee. If some silly idiot offshore or the panicked merchant there wants to sell them at a lower price, I'll buy some more.

St Anne: Daniel, are you sleeping well at night with your bank portfolio?

Daniel Needham: I have a slightly different view on the Australian banks. I mean, I think that the funding situation � I agree with what Ian was saying. I think that they've significantly improved their funding situation relative to say 2008, where a much larger portion was from the foreign capital markets, and you know, the level of credit growth is much more sustainable for the banks at the moment. I don't think we're seeing significant expansions of balance sheets. My concern�

Huntley: It's lousy.

Needham: My concern is that there was a lot of credit growth, and this is kind of where you�ll probably see the differences between Ian and myself. I see residential property prices in Australia as being relatively high, and the banks themselves have a significant exposure to that asset. Whilst the asset quality is good now, a deterioration in that asset quality I think could create some pressure for the banks, and so I think, there's a reason why the banks are trading on high dividend yields and lower valuations. I think, you're being � because there is a risk on the credit quality of the bank balance sheets and so I think you should be getting a higher reward for that risk.

So, my concern is that there is significant credit growth in Australia, property prices went up significantly on the back of that, and there was additional credit growth on the back of the First Home Buyers Grant, which gave it another spurt up, and if we do have an environment where growth in Australia slows and unemployment moves up, I think that the banks could be under pressure in that situation with credit quality deteriorating. But I don't think it's a 2012 problem, I think, this is a longer term challenge for the banks.

Huntley: By the way, I do not agree with my friend there too. I think, he's got this crystal ball, he looks at it for China � the other one looks at an Australian residential market, and I think they're out there somewhere. Look, you�ve got to remember that Ian Macfarlane, when he was Head of the Reserve Bank in Australia in 2003, put in a hell of a credit squeeze on our home lending, because there was a bubble, there was a developing bubble, and unlike our American friends, Mr. Macfarlane - and he even held a seminar about it, and it was discussed and reported in the press - he decided to hit the developing bubble before it became a catastrophe.

Mr. Greenspan believed that, you did it after the catastrophe. It was easier to mop up than stop, and America is paying for it, right? But that was the broad Australian market that he stopped and slowed down, and if you look at the credit aggregates as to lending to Australian housing since then have come down ever since. They are actually very low now, about 5%, very low. It should be higher.

Now since 2003 with the � for want of a better word, the financial bubble, the upper market in the city, in the CBDs and the financial districts of Australia, they ran very strongly, and that actually was a global situation. Now, that's coming off now, and certainly you can get your 25% falls and 30% falls in areas like Mosman, mainly Toorak in Melbourne right? That's still � it's a limited effect. The broad Australian market, it's fine, and that's where people like Jeremy Grantham and my friend here completely miss it. The one other huge major thing these guys are totally missing is that part of the problem in the U.S. and the U.S. people, a lot of U.S. commentators say. 'Oh, because we stuffed it up, everyone else must too. We are the cleverest, we are the Americans.' By the way, I love America.

Now, a long time ago, possibly in the '30s, American credit standards were changed from full recourse on home lending to nonrecourse. That meant that when you borrowed money for a home, if you could no longer keep up your payments, all you did was to loose your home, okay. It�s a very major difference.

In Australia, if you default you'll lose everything including your wife�s jewelry, the whole works, the car, the lot. You are tied up and your credit rating is horrific ever after. There is tremendous pressure on you. Our credit lending standards are never exploded like the U.S. That is why our banking system remained in good shape all through the GFC and continues to. Our housing defaults are extraordinarily low. They are pinpricks, right since the GFC, and they're going to continue that way, because what happened in America, they had a massive weakening in credit standards, and then half of their lending market crashed, it collapsed. That was the size of their shadow banking market, which was a serious mess with absolutely no concept of a holding of security on behalf of the lenders. We didn�t have it, because we have less than 1% shadow banking type lending in Australia. That�s why we are in good shape. You got to understand the credit market and what went wrong to relate to the future of housing crisis in Australia.

Then compared to the United States, broadly we are a middle-class country. We don�t have the same extraordinary lows and heights in incomes. That�s enough on that one. One could go into more detail, but I have spent a lot of time on that and I have lived through many, many housing crashes in Australia, 1974. All the things that have molded the minds of Mr. Macfarlane and also the current Governor of the Reserve Bank and also the banking culture and the leaders of our banking system.

Needham: I agree with the comments about the United States, but I think within Australia, I agree that the supplies � and there wasn�t an excess amount of development in Australia. I think that the types of credit vehicles in the expansion of the shadow banking system effectively didn�t happen in Australia, certainly not to the same levels in United States. I think that the supply-demand picture for residential property in Australia is much, much more positive than the United States. But I think that � I guess my view is that the affordability and the fact that property is an asset that is handed from an inter generational perspective, and right now there is a lot of property that�s owned by the baby boomers and a lot of that's owned outright, and a lot of the mortgages in Australia actually interest only investment properties because there is a significant tax incentive to own investment property. I think that creates risk, investment property creates that risk. At the same time�

Huntley: Yeah, if it was overblown, yeah.

Needham: �and there�s also large amounts of unfunded future pension liabilities for retirees.

Huntley: What? Compared to the United States, you�ve got to the joking. We�ve got this extraordinary superannuation system. We are so far ahead of just about every other country in the world. It�s a joke.

Needham: Yeah, but the consumption level for people to even maintain two-thirds of their pre-retirement income, they're going to have to downsize their properties.

Huntley: Oh, sure.

Needham: So, they're going to consume their property, and I think that they will be able to maintain. I agree, like the pension system is much better. So, I think we could see some more supply of housing come on to market.

Huntley: Well, that's been going on for years.

Needham: Yeah, and I think it's going to increase, because the baby boomers are going to start to consume their property more and more. I think that the difference between � say what, it's a very different property situation in the U.S., but I still think that supply is going to cause a re-pricing of property, as younger people who need to access credit; they need to borrow relative to their income. I think that we could see some downward � either in real terms, I think we could see property prices, sort of trend across for quite a long period of time.

The potential that we get hit as much as Ian, sort of thinks, we could have a big issue in China, should that happen property could correct significantly. But I think, it's going to be - I don't think we are going to see the same type of real share price increases � sorry, property price increases that we have seen previously.

Huntley: I'm not looking for any particular residential property prices, but we go to - broadly, for sometime even though people are a lot smarter than me about it, do see over next few years high single-digit, low double-digit growth. They certainly know the markets better than I do, but I have been following property for longer time. But you got to understand that the Australian markets have lots of different sectors in it. The market probably up to about $1.5 million in Sydney is probably showing slight increases in prices, while the up market $2 million and above, probably coming off.

It's not one simple situation. Various areas do better than others, and other areas, they are worse. So, it depends a lot where you are looking. Queensland, for instance, this year has been the worst hit of all. But next year as the various flood relief programs start pumping through and all those major gas developments start being � employing people and the rest of it. It's a massive driver of the Queensland economy. I think, you will see some � over the next three years, I would argue that you would see some decent increases in your basic residential prices in Queensland. It's pretty simple - it's come off such a low base, and there is going to be fair revival there. But you�ve go to look at it - you got to get into the detail on this one, because you don't have the massive shock across the boards that you've had in the United States.

St. Anne: Gentlemen, thank you both for your time.

Needham: Thank you very much.

Huntley: Thank you.

Christine St. Anne: With China, are you still optimistic about the country?

Ian Huntley: I have been positive in China for a long time. Ever since '93, we had a seminar and we had the then Economist for RIO explaining that China was the next Japan, which was the explosive growth story in the '60s and '70s; and then just behind it was India. Early in 2000's, we saw China take off and we looked at India and China, 38% of the global population wanting to catch up, and that's a tremendous force. It's no way a credit battle, that's sort of typical of a number of American observers looking - I could say some rude words about it, but somewhere else. You just got to focus on 1.4 billion people in China who for 200 years went through a series of civil wars and got nowhere.

Surveys of sentiment in China actually show that about 80% happy. We might not like their system, but you�ve got to remember, the system they have has improved the lot of their living tremendously in the last 20 years, and it's continuing to do it. That's the driving force. For god's sake, I read an offshore commentator the other day saying, look at all these vacancies, they are comparing it to Britain. What�s it got, about 60 million people and this is 1.4 billion. Some people cannot get it into perspective. I�m looking for China in 2012, my worst case would be 7% growth, I think it's more likely to be 8%. I think they've already started to ease their monetary pressure, which is bringing down pressure on the relatively high priced residential real estate market. But I�m looking for them to start dropping interest rates in about March.

I don't think Europe is an enormous major problem at all. It will carve off a bit. But you got to remember, the major driving in China is those 1.4 billion and they need from still, almost scratch, to develop their infrastructure. It's just an enormous driver and there is so much more to do, and they are doing it, and they are doing it well. And what they are doing at the present time is, stopping too much heat. But then people, they listen to all those wonderful experts throughout the world telling that the real estate market is crashing and that's the end of the world. Now these jokers can't even look at the fact that China's building 10 million affordable houses per annum as part of their current five year plan. They conveniently forget that, and that is absorbing a huge number of materials. It's not dissimilar in materials consumption to the upper market stuff. I just get lost listening to it all.

Look, sure China is going to have some speed bumps, but I would think for the next 10 years with -- maybe with something -- obviously there has got to be some downturns. But I guess this is going to be a wonderful background to Australia; and as for margins, yes they are very high and a number of our major resource groups like BHP and Rio, but alot of other companies are struggling in a two-speed economy. Now of course, if China did slump their currency would fall, and then a number of those other companies would do a lot better; and of course a major component of our index is the banks. The banks, I don't think they could be terribly affected by an easing off in China. But I think we�d actually do quite well, because interest rates would come off and the housing market would improve. There are lots of balancing acts in our economy, and I'll just leave at that, because you�ll ask more questions. But I've got strong views in China and they've been very-very thoroughly researched.

Daniel Needham: So with -- just some comments on that � I mean, I think that I agree that there are some very powerful fundamentals in China. I mean the population story is very clear, you know, that they are going to be increasing, like their wealth is increasing. Their share of output globally is going to increase, I agree with all that, but how assets are capitalized, you can't conjure up investment spending on infrastructure, and be almost -- ignore the price that you're paying for the assets, and effectively the price of capital in China is being heavily distorted. There�s huge amounts of unproductive investments that are happening. The growth that's being in China is an investment led growth, it's not being led by sustainable investment driven by consumption � internal consumption needs. It's government controlled, government directed investment and it's being capitalized by a shadow banking system.

China doesn't have a secret sauce or a magic pudding. They are subject to the same economic principles that have dictated capital systems throughout the world, throughout history; and the credit aggregates are scary, 187% debt-to-GDP in China. The credit growth has been, extraordinary.

Huntley: What?

Needham: So, the government debt is estimated to be about 100% of debt-to-GDP. The shadow banking system, added to that, gets you near 200% debt-to-GDP. Credit growth in China is extreme, and that's what driving growth at the moment.

I agree that the increase in productive capacity from these infrastructure investments is going to add long-term growth to China, but how that's capitalized matters. How it's being financed, matters; and whether it comes out via � you can manipulate a banking system as much as you like. It's either going to come out of via inflation, it's going to come out via civil unrest, or it's going to come out via capital leaving China and moving somewhere else via capital flow. So, I think there is a potential for risk in China around how these investment spending, infrastructure spending, property spending is being financed, and they're not subject to different rules than any other economy. Japan is a good example. Japan was great. What about the '90s in Japan, after the property boom?

Huntley: Hey, that was after 30 years.

Needham: Sure. But the growth we're seeing in China, is happening at a much faster rate that happened in Japan.

Huntley: Not particularly, not in the early years. I think my friend here needs to look at American history in the 19th century. That's when America built its infrastructure. American growth then was driven by infrastructure growth, and that was � there was ups and downs right? But they sold land an all this sort of thing, railways went through across the country.

Needham: Like the 1830�s in Chicago?

Huntley: Land became a lot more valuable. Sure, but that was the big picture all through that period, with ups and downs, and you had -- if you look at the American economy in the early 1900s, which � there is a wonderful book 2007-1907. If you put the figures on the American economy, the growth rates, up on the board and said, who is this? Everyone would say China. No sorry, it's the United States. High single-digit growth; and that was as late as that. I�m listening to people arguing about China � I say, this is what was happening in America in the 20s. They�ve just left out a whole damn 120 years.

Needham: The 20s was a fuel for one of the greatest depressions, effectively finance and speculation related depressions in the world.

Huntley: I have studied the depression very closely. But as I said, they just left out 120 years, and I reckon that with China, it probably needed to go back at least 50. Now, the China banking system isn't the same size as the overall debt market, and China has probably got a lot of very good things in it. Because, what's happening there is private enterprise banks are beginning to understand what debt and recoveries are all about, and I certainly don't agree with the level of debt that our friend is talking about, nor do I look upon the Chinese banking system as the same as the Western worlds. I look at it, in some ways, as the way the central government is channeling, what we would think of subsidized capital into the economy. And I don't think the infrastructure is being overcapitalized.

St Anne: Moving on to upper parts of world. Daniel, what's your view on Europe? Do you think the situation there can be resolved?

Needham: Europe is a challenging situation, because the fact with a single currency, I mean it's been spoken about a lot. You have significant amounts of debt and in the peripheral parts of Europe, and they don't have a currency and so they can't devalue their currency and make themselves more competitive. They also can't ease financial conditions. I mean, I think we're getting closer and closer to a unified Europe, and I think that we're going to see Germany take a much stronger position in Europe, and I think that there is going to need to be some painful deleveraging depressions in the peripheral parts of Europe, and that's going to have to be subsidized by Germany and the larger European nations.

It's happening at the moment. I mean, the potential for that to just fall out of hand and one of the big European banks to go down is very high at the moment. We actually see Europe, there is some good investment opportunities in Europe. I think that there are parts of Europe that look quite attractive. I mean, people are pricing an Armageddon in many-many good companies that are not solely focused on generating profits in Europe. I think there is a lot of excessive pessimism about Europe, although there are some big challenges and there is potential for a financial crisis to occur. But, we're actually buying European companies at the moment. We think there are some good opportunities and I think that it's one of those classic areas where investors get overly pessimistic and in that environment, you are able to pick up some bargains.

St Anne: Ian, do you see the same sort of opportunities in Europe?

Huntley: I�m more an investor in Australia, but I think there will be opportunities in Europe. That's the reason why I think the markets will come back towards the middle of this year and it could be a fair bit of panic. I think that will come from Europe. Then I think there would be good buying in Europe, but you've got a sort of a German lover, an Italian financier and a French policeman trying to run Europe. Look, they don�t get along; and Germany wants to keep its money to its chest.

They don't like spending money on Italians, the Spanish. They are in trouble, that's their problem, nein! nein! There is a problem there. I agree that there is too much fear about it and it's very-very interesting how that fear has driven down the multiples in Australia and in the United States. Whereas the companies underneath are doing pretty well. I think there is certainly some opportunity there.

I think there may be better still opportunities in Europe, a bit down the track, and I would be watching the Euro continue to fall. Because the period of Euro's strength, while the banks were pulling capital back into Europe, I think that's ended. And now the Euro is coming down as people see more and more strife there. Of course, it's putting the U.S. dollar up a touch. But I'd be a bit more slow with Europe, but not if I was major investor, I�d be looking for value, sure.

St Anne: What about the U.S.? The commentators have been quite pessimistic about the country. Daniel, what's your view on the U.S.?

Needham: I think the U.S. economy is actually in better shape than people were giving it credit for in 2011. I think there was some one-off effects that slowed the economy down. There was ridiculous wrangling over a debt ceiling which was ultimately always going to be approved.

I think that Europe, you can see growth has clearly being slowing in Europe, but the U.S. to me still looks fairly strong from a growth perspective. They've got bigger issues in 2012, as they see the austerity measures or the budget cuts being introduced. But as an economy, I think that the U.S. is a very diversified economy. They are very innovative and productive and they can move their technology and capital around, probably better than almost any other economy. So, I am not as bearish as some commentators are, but from a valuation perspective, the measures that we think have some type of medium term predictability about them, suggest that the U.S. isn't cheap. But I think that � there aren't any as many value opportunities in the U.S. as there are in Europe. But at the same time, I think the earnings and growth is much stronger there than people  are giving it credit for.

Huntley: I agree with my friend about the United States, but I think that it�s large economy and there is a number of sectors in it which are doing very well. A number of businesses are doing fine; and I think there is actually some good value there too. It's amazing how innovative that country is. Hey, I'm not disagreeing with my friend.

Christine St Anne: For our year-end review, we thought we'd speak with our very own Ian Huntley and Daniel Needham to give us their views of the key events this year and their forecasts for 2012. Gentlemen, welcome.

Daniel Needham: Thank you.

St Anne: Ian if I can begin with you, you've been relatively optimistic about the share markets. Can we expect some sort of miracle rally for next year?

Ian Huntley: I don�t know if you are correct in saying I'm usually optimistic. Sometimes I'm very -- quite pessimistic but I do make mistakes; I don't necessarily get it right all the time. Look, since 2009, I have looked for the market to see-saw broadly between 4,000 and 5,000 on the Australian All Ordinaries Index.

Now, take it which way you will, whether that's optimistic or pessimistic, some people had it going to 7,000, I certainly didn't, and I really haven't changed my mind a great deal this year. I looked for a Christmas rally from October, and certainly we have had an up-tick. That could easily go further, but I still think that it will then go back down into the middle of next year, and there will be a quite a bit of gloom around, but the stocks will be excellent buying. I basically think there is lot of fear around but Australian businesses are doing pretty well.

St Anne: Daniel, you've mentioned a black swan in your reports. Do you expect this swan to reemerge next year?

Needham: I mean, I think that one of the things that I talked about was not necessarily that an extreme event would happen, but the fact that Australia is very dependent on China, specifically metallurgical coal and iron ore, and effectively the bottleneck in the seaborne iron ore market caused significant increases in prices and that increased their terms of trade. That filtered through to profit margins, both in the mining sector as well as in the mining services sector, and that's meant that we have had an extreme expansion in profit margins in Australia over the last, probably seven years.

Now, should something happen in China, should the investment led boom stumble or should there be some type of unforeseen event in China, Australia could become significantly negatively affected from that, so we could see profit margins collapse in Australia, and so in that situation -- and I'm not saying it's going to happen -- but that�s a potential event, this Australian share market could trade on, you know, 4% profit margins with P/Es of 6 or 7. In that event, you could see the S&P 200 below 2,000.

Now, I'm not saying that's a base case. I'm saying that's an extreme event, but at the same time I think that, you know, on trailing valuation measures, the market looks inexpensive, but from a trend fundamentals perspective, which is what we look at, if you normalize earnings in Australia, it's still heavily overvalued in our view, but again, I take what Ian has said that there is a lot of fear around, a lot of investors are underweight equities, and that makes a potential buying environment for equities and probably supports them in the shorter term. I mean, I think that there is a lot of pessimism out there about the global economy at the moment, and in those types of environments, it doesn't take much to surprise investors to the upside and cause a short covering type of rally. So, on a medium to long-term basis, we still think Australia isn't an attractive equity market. We think that the China led investment boom is simply a credit bubble but has lots of stories around it.

St Anne: Finally, investors have faced an unprecedented level of volatility, what�s your tips for keeping their faith in the share markets?

Needham: The framework that we use is a evaluation driven framework and we focus on capital preservation and we're going to miss out on the big booms and the big rallies, the latter parts of them, but at the end of the day we�

Huntley: That�s nice.

Needham: But we think we can pick assets up that are very cheap when most other people are writing them off and that's where we make most of our money through the cycle, and from that perspective, I think focusing on capital preservation first is important.

I think that assessing assets based off of what kind of income you can get, having conservative assumptions about the capital appreciation, I think that framework is going to lead you towards having a reasonable amount in banks, property trust in Australia. You know, the term deposit rates are pretty appealing for Australian investors. I think relative to other parts of the world, you can get a decent return without taking too much risk.

So, I think that a diversified portfolio for an Australian investor is looking pretty good, and so I think making sure you've got a framework to assess markets that you don't get sucked into the emotion and the mania and the headlines, and you try to avoid making those bad decisions. I think this is the environment where investors need to have a framework.

Huntley: There are parts of that that I would question. Now, people think that putting their money on bank deposits has this wonderful security about it, I'm not bothered. I certainly think the banks are stable, I have no troubles with that, but I think interest rates can fall.

Now, if one takes -- looks at the interest rates in Europe and United States and says, well the worst case could happen if, my friend here says, the rest of world is going to end up in a deep hole down there and well, we could have our interests rates pretty low okay, if you just take, you know, our friend�s view of the world. But in Australia, if you carefully look through, just as in the United States, you can find first class defensive income stocks that are quite happy to own, right through all that, and that's what we've been recommending for quite some time.

Needham: So, is that U.S. based?

Huntley: No, Australian.

Needham: Australian.

Huntley: Well, I'm not working on U.S. stocks, but I do realize that � I am sufficiently interested in the U.S. market to realize that they are there as well, and I'm sure if you looked at a quality, reasonable dividend paying, defensive stock portfolio in the United States over the last couple of years that would have outperformed indices, taking out Apple, that would have outperformed the indices pretty well. I think you got the odd skyrocket over there like Apple, but in Australia these things are just wonderful and you got security of capital and security of income. You don't have security of income in your deposits, but do have security of capital. And that's where retirees get really hammered, and I have seen it a number of times. For instance, when deposit rates came down from 17% to about 5%, retirees were screaming, where is my income? It's bloody sad and it's one reason I hope that our Australian interest rates don�t fall much further.

Needham: I think that, you know, a diversified portfolio in my mind is a portfolio with some good companies in there and that have got good yields and they are inexpensive. If you can find some good property trusts that have got good yields, inexpensive. I think having some � I agree that when the reinvestment risk for term deposits is probably � it's not accounted for by many investors.

Huntley: That�s what I am saying.

Needham: Yeah, exactly. I agree with that, but the good thing I guess in some ways is that when � if rates do come down, it's normally associated with a difficult economic environment, and so you tend to find that stocks are probably cheaper. So, the cash frees up at the time when you can actually deploy it into more attractive. So yeah, I think the idea that you're going to be able to get these levels of interest rates term deposits forever I think is certainly not a � is not a good assumption to make.

Huntley: That's where the risk is.

Needham: Yeah.

Huntley: People thinking, you know, the explosion and people putting money into bank deposits has been a wonderful thing for the banks.

Needham: Absolutely.

Huntley: It's halved their reliance in offshore money.

Needham: Yep, yep.

Nicholas Grove: Despite Australia's banking system being ranked the third safest in the world by the major ratings agencies, it's no secret that bank bashing is a popular local pass time. But as we head into the New Year what should investors expect from the big four. Here to help us answer this question, I'm joined by Morningstar's David Ellis.

David thanks very much for joining us.

David Ellis: Thank you, Nick.

Grove: First of all, David, as an investment what are the main strengths and advantages of the big banks heading into 2012?

Ellis: Well, definitely the main strengths are the balance sheets, the earnings stability, and what I see is the key advantage for an investor, of course, is the sustainable dividends. So, the dividends are high at the moment, share prices are relatively low, and we argue that those dividends are sustainable going forward. So the banks, of course, the four major banks have got such a strong market position in Australia, dominate the retail banking and net interest margins are good - under pressure a little bit, but still should be maintainable. Another clear advantage is that we see that asset quality, loan quality is improving, and bad debt expense is falling, although at a lower or slower rate than in previous financial years.

So, the capital positions are increasing, improving, balance sheets are stronger, the asset quality is better, margins are stable, bad debts are lower, dividends are higher. It's pretty simple. A number of the banks had record dividends in the 2011 financial year. We see those dividends being at least maintained and more than likely in the next few years, maybe not next year but maybe a year after, or the year after that we would expect the payout ratios, the dividends to actually increase, which is a very positive and good sign for investors.

Grove: On the flipside, David, what are the key risks that the banks carry with them into the new year?

Ellis: Well, obviously there's a lot of uncertainty globally emanating out of Europe particularly. There are also questions over the U.S. economy and the U.S. banking system. A lot of those global issues are affecting the cost of funding, and the four major banks do rely on wholesale funding for roughly about 40% of their funding needs and roughly about half of that is sourced from offshore. So the disruption or dislocation that's occurring particularly in Europe is affecting funding costs. There�s no question about that. It is a big risk, but to counter that risk we've got strong increases in customer deposits here in Australia as investors are deleveraging, households are deleveraging, businesses are deleveraging.

There's an aversion for risk assets such as equity investments. So, bank deposits are continuing to grow and to grow strongly. So that's countering the increased risks of � in the wholesale funding markets offshore. So, the problem with the funding costs is that it's exerting pressure on margins, and even though now the Reserve Bank has cut the cash rate twice in the last two months, by 25 basis points each time, there is pressure on the banks to not pass on further cash rate cuts in full �partially or in full. So, there's pressure on the margins, but the banks have got a lot of the levers to pull and to use to limit the damage that may arise from higher wholesale funding costs.

Grove: David, we constantly hear about the big banks coming under fire from politicians, the public and various media outlets. In your opinion, is this warranted?

Ellis: Well, there's no question the four major banks in Australia are very unpopular from the public's perspective. The politicians see the banks as easy targets to criticize. The massive � the very significant profits the banks generate, the very strong market positions they hold, the pricing power they benefit from and the relatively high senior executive salaries that are a feature of the banks make them, as I said, an easy target. However, and this is a big however, there is a lot to be said for having a strong and stable, and profitable financial system. You only have to look at what's happening in Europe where in certain countries the financial � on the banks, the financial systems are under a lot of pressure, and it's leading to a credit crunch. So, the banks are just not lending. Some banks � obviously, there's a lot of � some of the economic issues, the austerity issues are leading to social unrest in certain countries, whereas we don't have that. We don't see that occurring any time soon.

Grove: Finally, David, how well positioned are the big banks to weather any kind of left field Black Swan-like events should they pop up in 2012?

Ellis: That's a hard question because depending on what type of black swan event it is, all I can say is they are well positioned, well placed to cope with unexpected events that may occur globally. But, you can't give it an ironclad categoric guarantee that they would cope with all types of events. But certainly their balance sheets are strong and are continuing to strengthen. Their earnings are strong. The Australian economy is relatively resilient even though economic growth is slow, below trend, but it's still resilient.

We've got a � our federal government has low government debt. The Reserve Bank controls the cash rate. The cash rate is at 4.25%. So if economic conditions deteriorate, Reserve Bank is in a position, has the flexibility to reduce the cash rate, which because of our large proportion of variable home loan rates in Australia, that monetary policy transmission is effective and timely.

So we have a number of levers, and it's not just the banks, it's the government, it's the Reserve Bank, it's the economy. We have a number of levers that provide support and would limit the damage caused by an unexpected black swan event. But you can't rule it out completely.

Grove: David, thanks very much for joining us.

Ellis: Thank you, Nick.

Nicholas Grove: 2011 was a year that wasn't kind to the share market and the local resources sector also didn�t escape unscathed, but what can investors expect from this sector in 2012. Here to help us prepare, I'm joined by Morningstar's Mark Taylor.

Mark, thanks very much for joining us.

Mark Taylor: Thanks, Nick.

Grove: First of all, Mark, where do you see bulk commodity prices heading in 2012, generally speaking?

Taylor: Well, we are coming off of the back of a recent slump in prices that was to levels that, we think, was unsustainable in many cases like for iron ore, where it was below the cost of production for many high-cost Chinese producers. So, we see some positive momentum leading into the beginning of the New Year, but in the longer term we expect to see a gradual decline in bulk commodity prices, including iron ore just as new lower cost production comes on stream, particularly from the three majors, BHP, Rio and Vale.

Grove: Looking to the year ahead, Mark, should investors be looking at the larger or smaller end of the resources spectrum or both ends?

Taylor: Well, it would be a very, very rare event for us to be recommending investors focus on smaller end of the market, and it's definitely not a time to be doing that when you got the likes of BHP and Rio on single-digit prospective P/E multiples. Their balance sheet is very strong and they're in such an incredibly strong position, and if there is some more market weakness, they can take advantage of that because they've got the balance sheets and the firepower to ride these sorts of things through. They're masters of their own destiny because they are so strong.

Grove: Mark, you recently spoke about the importance of balance sheet strength, when it comes to resources companies. Given the global macro environment, how important will balance sheet stability be in 2012?

Taylor: Well, I think it is going to be important because even if things do start to improve, there is still going to be that heightened uncertainty in people's minds. So it is going to be more difficult to borrow money. There is going to be wider margins of safety required in terms of investments in new assets. Banks are going to want to see a much wider margin of safety.

So, companies probably are going to have to have more money set aside for project development than they may actually need. So, there's multiple fronts where to have a stronger balance sheet, it's going to be far better � or it's going to put you in much stronger position than competitors.

Grove: Finally, Mark, what is the key thing investors should bear in mind, when investing in the resources sector in the coming year?

Taylor: Well, I think you've just got to remember fundamentally that the resource sector is characteristically cyclical, so you got to take the good with the bad, have a longer term investment time horizon, understand that you might not make instant returns, but if you're buying value, low-cost quality companies in the longer term, that's going to put you in good stead. It's a same old story, but it�s a story that it lasts the test of time.

Grove: Mark, thanks very much for joining us.

Taylor: You're welcome, Nick.

Christine St Anne: 2011 is a year most people would like to forget. The rollercoaster markets continued, while the U.S. and Europe are still struggling with their economies. Against all this gloom, we spoke to a number of investment managers to get their views of a 2012.

Scott Tully, who oversees the multi-manager business for Colonial First State, says the views of his managers differ to the general outlook.

Scott Tully: Look, I think, a lot of managers are seeing that, in many ways, the global economy is actually not too bad or at least better than, perhaps, what the general view of all the headline risk is. So, there are managers, who often talk to us about the strength of corporate balance sheets, and we are seeing this in the States, some improving numbers around employment and retail sales, and that sort of thing. But obviously, overlying that is the situation in Europe, and the risks that that provides. So, they are a little bit caught there, though there is opportunity, they�re seeing companies that are quite healthy, but understanding the broad environment may turn bad at least in a market sense for a period of time.

St Anne: Andrew Pease from Russell Investments also sees opportunities.

Andrew Pease: It has been an amazing year. And certainly, I think, when you look at markets in aggregate, they are all looking cheap. We've got Japanese equities trading on price-to-book value of under 1. We've got U.S. equities on multiples of about 11 times. We've got Chinese equities on single-digit price-to-earnings multiples. So, everything looks cheap, but the problem is, it's all cheap for a reason, and it's a matter of working out where those reasons are and how likely they are to be sustained, which would tell you where the ultimate value is in the market.

St Anne: So, where are these opportunities?

Pease: Well, it depends on your time horizon, anything could happen over the next six months, unfortunately with how things are playing out in Europe. So, you really have to look beyond that when you're thinking about setting up a portfolio. So, just taking it at the very broad level and trying not to get too smart about playing particular sectors, the Australian share market with a dividend yield pushing up to 5% is very good. Historically, there have been no occasions where the dividend yield has been above 4.5% when the market hasn't delivered you very strong returns over the ensuing five and 10 years. So, there's a lot of those opportunities out there in emerging markets, and those are things that everyone talks about. But again, it's a market that looks relatively undervalued right now. So, that's going to be a place to play too. But unfortunately, all of these longer-term considerations - the market can look cheap now, but it can also look even cheaper in six months' time depending on how things play out in Europe. So, there's good long-term value, we all know that, but it's a matter of whether we have that degree of patience or not.

St Anne: For Patrick Farrell, who manages Advance Investment Solutions multi-manager team, lack of confidence is stopping many companies from tapping into these opportunities.

Patrick Farrell: Look, I think markets are exhibiting plenty of opportunities at the moment, all right. It's a situation, where you need to not necessarily buy into a lot of the situation that's going on at the moment, but companies themselves are in really, really good positions. They've got great cost of capital or access to capital. They've got a lot of cash on their balance sheets. Their balance sheets have never been healthy. What they lack at the moment is just a bit of confidence, a bit of confidence to invest in terms of what their future is going to be, and that then will translate into hiring as well. So, a lot of hiring plans have been put back, but that doesn't necessarily mean that companies are in a little trouble. It just means that they need to wait and see where some of the certainty is going to come through into the future.

Now, a good situation is opportunities that arise out of this sort of market volatility will come up all the time. It just means that we need to be a little bit more nimble, a little more flexible about how we take those opportunities on board. And our managers are certainly doing that.

St Anne: Despite the volatility, these managers also believe Australian investors should move away from their home bias.

Pease: Well, Australian shares have underperformed quite measurably over the last couple of years, and particularly against U.S. shares. So, an investor would have been much better off being in hedged U.S. equities over the last three years than being in Australian shares. So, we went through that period of strong outperformance in the period before the global financial crisis, and that's now being matched by period of underperformance. So really, I think, the lesson of that is that yes, there are some benefits in home country bias, particularly the tax benefits and imputation credits are a wonderful thing, but I think the lesson of the last decade has been, whereas home country bias was rewarded during the 2000s, it certainly hasn't been rewarded over the last few years, which again just goes back to that simple boring message that people like me go on about all the time, which is diversify, diversify, diversify because that's the best way of making sure that you are getting the best of the returns that are available out there.

St Anne: Patrick Farrell says that this could also be missing out on opportunities by maintaining a home bias.

Farrell: I would not necessarily say keeping a home bias advantage is the best thing to do at the moment. Obviously, a lot of the rest of the world has issues and it has problems, we are not necessarily going to be immune from those problems, but what I do say is that, if you start to sort of restrict the opportunity set that your portfolios are accessing, then you are missing on those opportunities. You are not being able to provide a good diversified outcome. This is where the flexibility comes into it. So, I would actually say having a more diversified portfolio, giving yourself and your investors more options about where to find these good opportunities is the best investment process to actually have.

St Anne: So, how do these managers ensure the investment managers that they oversee capture the right opportunities?

Farrell: It does require a little bit of a change to the way that they would go about their normal sort of process, because even though an investment horizon will sort of come about for one year, two years, they need to think about that. They need to think about what does the future hold, but at the same time, you can't afford to ignore the market environment that we are in. Volatility is going to stick around for the next sort of 12 months at least. So, we need to be able to take advantage of that volatility as much as we possibly can. So, it's not just about opportunities that we find, but there are plenty, it's also about how we manage the risk on the other side of things.

Tully: Yes. Actually, we think, there is two types of managers that will take advantage of the opportunities that present themselves, but they are actually quite contradictory in some ways in terms of their style. So, one end of this spectrum, you've got managers that are very nimble in what they do. So, they will see opportunities, they will take advantage of that opportunity and they will get out of it within an appropriate time frame.

The other end of the spectrum are managers that are taking possibly a macro view or top-down view on the world, but look at it in a medium-term sense. So, they will position their portfolios for that medium-term outlook, but they'll have to hold the course through what will be some testing times. They won�t be able to necessarily realise their views for a couple of years. So, there is two types of managers, the short term and essentially the medium term.

St Anne: Andrew Pease ensures a blend of managers across different styles, and the lesson for investors is to diversify across a range of asset classes.

Pease: Well, I think, it's a matter of really � again, it's a diversification story, not being too style specific. So what Russell does is, we're multi-asset, multi-styles. So, we try to pick what we think are the best investment managers across all styles, then blend them in portfolios, which hopefully will achieve consistent outperformance. So, we will have some growth managers where growth is working, we will have some value managers where value is working, we will have some quant managers wherein quant is working, but the basis of what we do is, is we can pick all of these managers, the ones that we have the highest confidence in can outperform in their style, which hopefully will give their best performance over time.

But I think, more generally for investors is that they really do need to think, not just have an equities focus but be thinking across asset classes. So, we're looking it to have global and domestic equity exposure. We are looking at emerging markets, but also be looking at infrastructure, be looking at unlisted property. We're looking at also in infrastructure, looking at unlisted infrastructure, looking at absolute return strategies, looking at fixed income, looking at credit and high-yield business and great opportunities. So, I think the message right now more than in any other time that I can recall in my time in investment markets is really make sure you have the best spread possible, because trying to pick which asset class is going to be the best one in this type of environment is going to be a really hard task to get right.

St Anne: So, we expect the volatility to continue, but opportunities do remain. As the old investment rules apply, diversify and stick to your investment strategy. Christine St Anne for Morningstar.

Nicholas Grove: 2011 is a year many investors would probably rather forget, but what can they expect from the equities market in 2012. Here to help us prepare, I'm joined on the line by Morningstar Head of Equity Strategy, Ross Bird. Ross, thanks very much for joining us.

Ross Bird: Good morning, Nick. How are you?

Grove: I'm well, thanks Ross. First of all, what are going to be the most important influences, both positive and negative and external and internal, on our share market in 2012?

Bird: Yes, look I think 2012 is going to be another interesting year. In many ways, just a continuation on from 2011. I think some of the major themes that we had to grapple with this year are going to continue on next year and remain as the major themes. Let's go through the list. First of all, we start with sort of China and India, which are both important trading nations for Australia.

Their GDP growth has been quite strong of late. We expect GDP growth in both countries to slow somewhat a little bit next year. Not to say that�s doom and gloom, it's more just the rate of growth, not be absolute; whether it�s going to grow or not, and we still expect them to grow strongly, but just maybe sort of slowing a bit from current levels.

So, some slowing there, but in absolute terms still very robust growth numbers that will require ongoing higher volumes of raw materials and energy from countries such as Australia. So, overall good, but just some moderate slowing from what we have seen this year and any past years.

For Europe, unfortunately, I think it's going to continue to be very much the same as this year. It is going to continue to struggle through, and we would not be surprised to see Europe go back into recession, at least for part of next year. Very difficult to sort of say for how long with what's going on there, but overall very, very weak growth if any growth at all for next year. No magic wand in Europe. It's going to take some years for them to sort their issues out, so in the meantime, relatively weak growth, if indeed possibly negative for a while there.

In the U.S., again, some of the recent economic data has been a little bit more positive than we were counting on, so that�s the good news, but nevertheless we still expect to see a bit of a muddle through recovery in the U.S. next year, similar to this year. GDP growth currently at 1.5% year-on-year for the third quarter there, somewhere around sort of 1.5%, 2%, is sort of where we're looking for the U.S.

So, again, a very slow recovery in this cycle compared to previous cycles coming out of a downturn and the key there is sort of jobs growth and housing activity, which is just taking a very long time to recover.

I think moving on domestically to Australia; look, general economic activity overall is quite solid, but we are still very much in our two-speed economy as we have discussed previously. So look overall, Nick, in many cases, similar conditions to what we've seen in 2011. I think, the broad themes currently out there are going to continue. However, Australia is likely to perform quite well in a relative sense compared to many of its other OECD peers, which is good news domestically, but I�d say challenges remain overseas.

Grove: Ross, which sectors of the share market are you most bullish about?

Bird: Yes, look, it's an interesting topic given the framework we've just discussed from a very broad macroeconomic basis. Obviously, investors, not just here, but around the world are going to remain very cautious and very nervous about challenges ahead that we've just discussed. So, I think in that environment, we need to continue to look at those sectors that are sort of effectively,  non-cyclical, very essentially related to either services or products that we need in our everyday lives, things that we can't do without so to speak, and businesses that are not too dependent on growth from overseas, particularly in overseas, western economies.

So, really, we are looking at those defensive industrial sectors, such as: consumer staples, healthcare, utilities, and some infrastructure companies; telecommunications looking good, and we're also � from a medium-term perspective, while we sort of maintain a positive view on China and India in the medium term, notwithstanding a few little challenges just in the shorter-term, we continue to have a favorable view on energy and the resources component of the material sector, you know, the production of iron ore, coal, base metal, such lot. But, just noting that the short-term is going to be a little bit challenging as China and India, sort of, overcome their inflation challenges there, but from a medium term point of view still very positive on those segments.

I think the domestic banks, again are in very good shape, and fundamentally we maintain a positive view on the banks as well. Nick, however, as we have seen this year sometimes investors view global banks as global banks and banks tend to get tarnished with a very broad brush when something bad happens overseas. Not that it has anything directly to do with our banks, but it's just the way investors behave. So, probably banks are going to continue to trade on very attractive looking multiples, but in an operating sense they're going to perform � continue to perform well. So, we do love them fundamentally, but we just have to be a little bit patient in terms of, sort of I think, seeing the full results, come through from the good work that those banks are doing.

Grove: On the flip side, Ross, which sectors of our share market are you most bearish about?

Bird: We continue to be sort of fairly cautious towards the more cyclical sectors, ones that are just reliant on strong economic growth to see businesses do well. So, we continue to be cautious on the consumer discretionary sector, where I discussed the retailing situation just prior. Just to say, I don�t think the interest rate cuts we've seen from the RBA today is sufficient to really sort of kick start the consumer and getting them back into the store per se, overlaying that of course with the structural changes we're seeing in retailing with online sales and the strengths of the A$ making overseas purchases sort of cheaper and even sort of traveling overseas and people spending their money overseas rather than here.

I still think that those sort of influences are still going to be around to make life tough for the discretionary retailer. Also cyclical industrials, companies in the building materials trade, non-mining construction sort of areas, I mentioned the non-essential retailing sort of areas, manufacturing businesses with the strong A$, likely to continue to find the going tough in 2012.

Grove: Finally, Ross, what is the most important thing investors should bear in mind when heading into the New Year?

Bird: I think, we are in an environment where there are ongoing challenges ahead at very much a global level. We always sort of have to come back to the principles of sound portfolio management, and of course, that is always choosing high quality companies. At Morningstar we have what we call �moat ratings�, which try and reflect the qualities of companies, so we would certainly suggest that portfolios should have preponderance of moat-rated companies in their portfolios, which the moat ratings can be found on the Morningstar website of course.

Companies with strong track records through a range of economic scenarios, not just companies that could do well in good times; we need to be comforted by holding companies that can perform well in challenging times, because no doubt we are in the midst of that sort of situation at a very broad level.

Also, I just mentioned in the previous question focusing on those companies that offer essential services or products for our everyday life, so companies involved in the utilities industry, telecommunication industry, things that we can't live without basically. I think, there it's important that the companies in those sectors that are well run, I think will be well supported by investors.

We also, I think, just need to keep in mind that while we are expecting more ongoing, if you like, bad news out of Europe and from time-to-time maybe from the U.S., we just always have to keep in mind that equities as an investment class are for the medium to long-term, and we � we don�t want to get too caught up in headlines and get too nervy. Indeed these conditions often present the best of buying opportunities for the right sort of stock.

So, we always have to maintain those disciplines of sound portfolio management, maintain diversity through portfolios, maintaining a sense of where fundamental value is, and if the market gets too sort nervous or bearish on particular sectors or stocks that can represent good fundamental buying to the medium term.

I also think, again what's emerging from 2011 and will continue next year, is that the importance of dividend yield as part of the overall investment returns in the portfolio. So again, looking for companies that have strong, reliable, dependable dividends, I think with a good franking component ideally is very much the focus as well, and really just being prepared to take that medium-term approach to portfolio management.

Grove: Ross, thanks very much for joining us.

Bird: Thank you, Nick. It's a pleasure.

Christine Benz: I'm Christine Benz for Morningstar.com.

I recently interviewed Christopher Philips, who is a senior investment analyst in Vanguard's Investment Strategy Group. One of the topics we discussed was whether investors are better off investing in a broadly diversified emerging-markets fund or opting for single-country emerging-markets funds.

So, Chris, you have recently done some very timely research into a category of investments that's been very hot over the past several years: emerging markets. There has been a lot of interest in investing in specific emerging markets. You have done some research that looks at the benefits and the drawbacks of doing that. Let's take a look at some of your findings.

Christopher Philips: Absolutely. So, the big thing we hear now is that, "I want to focus on China as an investment because their economy is growing so strongly. We know that they hold a bunch of U.S. debt, and there is this whole trade issue between the U.S. and China. So, I want to really focus my investment on emerging markets, but I really want to concentrate on China as a core investment."

Benz: ... Or India or whatever it might be ...

Philips: Or India, or really any emerging market out there. Latin America is another great example because of a potential relationship to commodities.

So, what we attempted to do was really show that focusing on any specific country comes with a lot more risk than benefit, and it's a little bit more synonymous with investing in a single stock. So, a single stock, you certainly have return expectations, but you have potential wild swings in volatility which can be very detrimental to the risk-adjusted returns that you get in a portfolio.

So, we went through and we did some analysis around the risk and return trade-offs, the linkages between economic growth and market returns, the idea that I can play the dollar in some type of currency bet. So, we looked at a bunch of different views for evaluating the role of single countries.

Benz: So I would like to highlight that research that you and the team here have done on whether market performance follows from economic growth. I think it's a little bit counterintuitive, but what you found is that there isn't a particularly close correlation?

Philips: Yes, and I think the counterintuitive nature is the best way to sum it up. When you think of the rationale for investing in emerging markets, it's that I want to be able to capture that long-term expected high economic output, the high economic growth...

Benz: ... Of a China or India or whatever it might be.

Philips: Exactly, of any of the high-growth countries out there. And when you think very broadly, it makes perfect sense that as an economy performs, corporate profits will be linked to that economy, and therefore the stock market should ultimately be linked to that economy.

Well, with emerging markets, and actually with developed markets as well, what we've seen is that it tends to actually breakdown in terms of correlation, so that you have, say, the U.S. that has economic performance that is in line with that of the U.K., and yet market performance has been vastly different. So, you get this dynamic where, by investing in a China that you expect 10% growth, you don't actually get the benefits from that because you don't get paid for expectations that come true, and it is the same with earnings. So, if I invest in a company that has earnings expectations of 10% growth, and they achieve that, well, that expectation is already baked into the prices. So, you're not being paid for stuff that's already being baked into prices. You need to be able to predict outperformance, outsized growth going forward. And if something is already expected to grow 10%, then you have to expect it to grow 15% or 20%, and that's just extremely difficult to do.

Benz: Right. In terms of something that actually does tend to predict market performance, valuation, you did not find that even by focusing on those countries that appear to be trading at very low valuations--so if someone is conscious of prices and opts to get in, then--you didn't find that that was necessarily predictive of good market performance in single emerging markets either?

Philips: Yep, and that's actually one of the most counterintuitive aspects here, because we all hear that valuations are the single most important metric for future performance, particularly in equities. Then when you get to broad market equities, it's even more important. The challenge with emerging-market countries is that there are so much country-specific risk, and in the analysis, we actually used an example of, say, Venezuela, where Venezuela, before the market was shutout to private investors, had a P/E ratio of around six to eight times earnings, broad earnings across all Venezuelan companies.

So, if you saw that and relative to its history and relative to global markets, Venezuela would have looked like a tremendously attractive investment; however, if you invested and then all of a sudden you got shutout, you would have had a negative 100% return. So, the idiosyncratic or country-specific risk completely overwhelms valuations, especially in emerging markets.

Benz: So, the broad takeaway from all this research, if you can't really trust low valuations to guide you to the right markets or you can't trust growth prospects to guide you to the right markets, it sounds like you would argue that you are better off buying a broad basket of emerging markets rather than trying to bet on single countries.

Philips: Absolutely, and just using the valuations example--while they don't work in individual specific countries, they actually do work when you start aggregating them up into the broad emerging-market space. So, looking at aggregate valuation, we can say, effectively, that if emerging markets have a reasonable valuation, then we should expect some returns going forward. So, we think a lot of this does work in the broad space, just not in very specific targeted spaces.

Benz: Okay. Thank you, Chris. This is very useful research, and I think really timely.

Philips: Very welcome.

Holly Cook: For Morningstar, I'm Holly Cook. I'm here today with Allan Conway, he is head of global emerging market equities at Schroders. Allan, thanks very much for joining me.

Allan Conway: It's a pleasure.

Cook: So the last time we talked was a year ago, at that time we were talking about the outlook for emerging markets. You described, at that time, developed-world equity markets as being submerging markets and questioned why investors would want to invest there when they could be putting their money into emerging markets. Has the fundamental view towards the emerging markets changed? Because they've really had rather a torrid year.

Conway: Well, actually the idea that the developed markets were submerging economies has proven to be absolutely right, and particularly in Europe. I think the thing that we got wrong was underestimating the ability of politicians to mess things up, and you're seeing that really in Europe. And the frustrating thing from an emerging perspective is that there has been a sentiment overflow into emerging. All of the things we are worried about today in the global economy emanate from those developed submerging economies, as I put it. Emerging actually themselves don't suffer from those problems, but there has been a significant sentiment impact on them.

Cook: At the time, we were talking about overheating in the emerging markets and I had asked you whether you thought there was perhaps a bubble coming up. And at that time you said that we were a long way off overheating levels, but that perhaps 2012 could be the year for a bubble. Presumably that view has been postponed?

Conway: Definitely. I think overheating is now off the agenda. We are not worried about inflation anymore. Indeed, the concerns these days are things like, �would China go for a hard landing?� and we don�t think so. So we've really moved away from that, but, yes, I think the impact on the global economy, particularly of what's been going on in Europe and weak growth in the U.S., means that we are a long way from having to worry about bubbles at the moment.

Cook: So what would you say to a potential investor who says, well, emerging markets equities haven�t really worked for me over the past year, certainly developed world markets haven't exactly either but at least I know where I stand there and the current valuations are so cheap that perhaps those potential returns have more promise in the developed world. What would be your response?

Conway: I think that�s absolutely incorrect. Firstly, let's remember that emerging stock markets have absolutely decoupled in the same way as the emerging economies have. Over the last 10 years or so emerging is up some 480%. Most of the developed markets over that period are up 30% or 40%.

So you've had huge decoupling. Going forward, we expect that to continue. This year emerging, despite having very good economic fundamentals, have underperformed because investors have generally got nervous, they have taken money off the table, and particularly, I think, retail investors have viewed emerging as being higher risk.

Now, actually that's a misconception. Emerging markets today are the low risk investment. Whether you're looking at any of the macroeconomic indicators, whether you are looking at levels of government debt, emerging are low, declining; developed are high and increasing. Fiscal situation in emerging is much better, current account much better, levels of reserves--let's remember the sight after the last EU Summit of Europeans dashing off to China to see if they can get bailout money, reserves are very high in emerging.

Today the risks are all in the developed world: not only do you have low growth, but that low growth is going to continue as these economies are served with massive debt. You could have fiscal austerity for the foreseeable future, low growth; emerging--strong growth, strong economic fundamentals, will feed through into earnings and returns. So today I think investors are faced with a choice: would you go for strong economies, strong fundamentals with strong growth;  or do you go to these tired, old developed economies?

By the way emerging evaluations are extremely attractive. We are down at around 8.5 times and if you look historically when the markets have been this cheap over the following 9 to 12 months you've had anything from a 60% to 75% return. We think that�s perfectly possibly providing you get a general improvement in sentiment and that�s all its going to take.

Cook: So I know that your team operates a strategy where you try to get approximately 50% of your returns from stock selection and 50% from country selection. Has the so called Arab Spring and some of the developments there, have they opened up more opportunities? Does a post-Gaddafi Libya, for example, present an interesting opportunity for you?

Conway: Well we must distinguish between emerging and frontier markets and of course Libya, for example, isn�t even a frontier market let alone an emerging. The key market in the region of course from an emerging perspective is Egypt. And the Egyptian situation is of course extremely volatile, there is a lot of uncertainty. Valuations are attractive and overall we are quite positive on Egypt. But I think it's one you have to be watching very, very closely because it really is dependent on the final political outcome and we think that�s going to work out, but it needs careful monitoring.

The other countries: by and large the Gulf countries are all within the frontier index rather than the emerging index. There again we are pretty positive valuations, have come down. But it does require very close monitoring because the general political environment, although it�s improving there is a high degree of uncertainty.

Cook: So, do the events that we've been talking about--both in the developed world and in the emerging and frontier markets--how would I perhaps see those manifested in your portfolio changes over the last 12 months?

Conway: For most of this year we've been running a pretty cautious portfolio. So, for example, we are running a beta below 1, around 0.96, and we�ve been running quite a bit of cash. As a result, our flagship Global Emerging Fund has outperformed so far this year by about 330 basis points. It�s been a good year. Now interestingly, what we are looking at in the short term is probably putting that cash in, because it looks as though, finally, the Germans, ECB, they get it; and it look as though we won�t have the solutions to the European problem but we at least have a plan in place that looks as though it's got the ability to make progress and as sentiment improves we think emerging markets will be one of the key beneficiaries. They�ve sold off more than you would have expected this year, therefore when there is an improvement in sentiment, we expect them to bounce back more significantly and we've already started to see that at the end of last week.

Cook: So how does perhaps your short-term outlook for emerging markets, say over the following 12 months, how does that differ perhaps from your longer term view?

Conway: I think we�ve got to get used to a global economy that�s going to look pretty weak, very anaemic growth, for the next few years actually. I think Europe, even if it comes up with some form of solution, we are going to have years of trying to resolve these high government debt situations. Obviously, fiscal austerity is going to be order of the day. That�s also going to be true in the States. U.S. growth is looking better than Europe, but it still looks very anaemic. We should have seen a much stronger picture in the U.S. than we have done, given the depth of the recession.

It�s largely been a jobless recovery in the U.S. Japan, of course, weak growth too. The developed world is going for foreseeable future--for the next three to five years minimum--to have very weak and anaemic growth while it tackles debt problems. Emerging will look very strong by contrast, but I think one�s going to have to focus on things like domestic demand in emerging and one�s going to have to focus on things like yield, yield is going to become much more important in the world of slow growth.

Cook: Allan, thanks very much for joining me. I look forward to seeing you again in a year�s time and hopefully we�ll have something slightly more positive to look forward to.

Conway: I hope so. Thanks.

Cook: Thanks again. For Morningstar I�m Holly Cook. Thanks for watching.