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Chester High Conviction Fund June 2020 Market Commentary

1 month (%) 3 months (%) 6 months (%) 1 year (%) p.a 3 years (%) p.a Since Inception pa %

Chester HCF (after MER) 1.5 20.5 -5.3 3.9 7.7 8.0

S&P/ASX 300 Accumulation Index 2.4 16.8 -10.5 -7.6 5.2 4.2

Value added (after MER) -0.9 3.7 5.2 11.5 2.4 3.9

“Everything can be taken from a man but one thing: the last of the human freedoms—to choose one’s attitude in any given set of circumstances, to choose one’s own way.”Victor Frankl

The quarter in review

We love our dog, his name is Paddy. Named after (Geelong champion) Paddy Dangerfield, he is a large groodle that is almost 3 years old. He is far too frisky, particularly with our 7 year old, but by and large gets spoiled rotten. Paddy cost us $2000 in January 2018, today, if you wanted to go on a 9-12 month waiting list, he would cost you $3500. The winners out of COVID-19? Dog breeders. That’s inflation right there.

With the extremes of greed and fear all rolled into one crazy 4 month period, 2020 is clearly the offspring of 1999 and 2008. We remarked last month that we (like all market participants) are experiencing a high degree of cognitive dissonance, whereby it is incredibly hard to reconcile the economic dislocation suffered by various industries and associated withdrawal of any earnings visibility, with the aggressive rebound in asset prices and markets through the sheer weight of government intervention. We are also acutely aware that asset markets are effectively no longer “free”, as central banks (most notably the US Federal Reserve (the Fed), and even the RBA to a lesser degree) have ensured price discovery using the risk free rate (nominally the 10 year bond, or the 3 year bond in Australia) has been severely compromised, as large portions of the US bond market are now effectively controlled by the Fed. If one half of the traditional capital structure (the bond market) is effectively “fixed”, then price discovery for the other half (equities) becomes that much more challenging. Maybe the most simple answer, (with the assistance of liquidity), is that markets have decided to look through COVID as a temporary event, and better times are ahead. As Melbournians, we hope so!

The mindset of “there is no alternative (to equities)” or TINA is still front of mind with interest rates likely to be near zero for an indefinite period. Do we look through earnings troughs and expect (hope) that the earnings recover for those sectors most impacted (broadly banks, cyclicals and consumer discretionary names) or do we continue to seek shelter in the more reliable earnings streams (consumer staples, healthcare and technology), all sectors that provided extremely strong returns over FY20, but broadly have far less valuation support as dispersion (the difference between high PE stocks and low PE stocks) has never been higher. The well flagged “fiscal cliff” in September in Australia as the JobKeeper program is due to expire also weighs heavily on future employment expectations and therefore aggregate consumption in Australia leading up to Christmas. We retain a degree of caution over the Australian economy for the simple reason that as international borders remain closed, and with that, migration, the demand for property, tourism and education continues to hamper any meaningful recovery, while many of the jobs in these sectors will increasingly rely on the JobKeeper program continuing. Our expectation is the government is acutely aware of this situation and will deliver targeted new packages to assist those industries that remain the most vulnerable. Clearly there have been winners and losers structurally from the enforced lockdown with the winners being online retailers and any stock that mentions the phrase “Buy Now Pay Later”. We remain deeply concerned with the banking sector and the commercial property sector, both sectors that will wear the full force of the weakening cash flows of consumers and ongoing ability to service mortgages or rent, particularly in the SME space.

While from an earnings perspective, the case for broad gains in markets is currently challenging, we do believe the Fed’s intervention in the credit market has removed a significant amount of downside risk. If markets really took a sharp leg lower, the obvious next step for the Fed is to start fixing the yield curve, and then if all else fails, start buying equities. Hence the Fed put that started with Alan Greenspan is still in place today. Given the mass social unrest unfolding in the US currently, the risk of over stimulating is far lower than the risk of under stimulating, thus on a probability weighted basis, we think stimulus programs are slow to be withdrawn. We readily admit we are in a bubble in certain sectors (mega Cap tech stocks), but while interest rates are zero, until inflation becomes a key focus again, anything is possible. We don’t have to agree with it, but we do have to invest in the market the way it currently operates, not the way we would like it to be. If anything, the remarkable dispersion in the market has only made us more focused on the forces we can control, which is fundamental analysis and appropriate risk /reward hurdles. Now, more than ever, is reason to focus on the underlying cash flow support of the businesses we invest in. Compelling investment opportunities are still around!

Risk Management becomes critical

From our perspective, risk management becomes vital over the next 12 months, while facing inevitable corrections and higher volatility that we suspect becomes “the norm”. The risk of not being invested to a large extent is outlined above, while we remain acutely aware of the economic challenges ahead of us and the dislocation to large chunks of society, which has only inflamed civil unrest. For us, risk management means appropriate portfolio construction to attempt to mitigate downside risk, while also exploring opportunities for capital and income growth. It requires very focused views on the stock specific risk of each holding. In that context, we focus heavily on the operating (earnings) risk, financial (balance sheet) risk and corporate governance (management alignment, labour force, reputational damage etc) risk of each stock in isolation. So portfolio construction takes on a very important role over the coming 12 month period, as we attempt to exit the social distancing measures, but also face the prospect of a looming US election, which will have an influence over the direction of asset prices given the stark policy differences of each party. A Democratic party win, would see a significant roll back of the Trump tax cuts, becoming a significant headwind for equity markets.

*The inception date of the Chester High Conviction Fund was April 26th, 2017, the NAV at June 30th, 2020 was 1.2243


So how does inflation appear with the prospect of a severe demand shock (significantly lower consumption) appearing highly deflationary currently? We believe the increase of money supply will spur higher velocity of money by directly targeting individuals, which will feed through to higher prices. The JobKeeper program and its US version the PPP, (Payroll Protection Program) are effective ways of targeting government stimulus directly at the consumer, while the more aggressive version will become a Universal Basic Income (UBI), where direct handouts to welfare recipients will continue on a permanently higher basis. This can only increase the velocity of money by putting cash directly with consumers, rather than the post GFC packages, which were aimed at the banking sector. The second part is the onshoring or localising manufacturing supply chains which will also increase the cost of doing business over the coming years. Clearly many OECD countries were caught out through the pandemic without access to PPE (personal protective equipment), something that is unlikely to be repeated, while the continuing aggressive rhetoric around the blame game of where the pandemic started has many industries questioning how reliant they are on Chinese or Asian manufacturing. While we could point to several examples, the most glaring currently is the defence sector in Australia, that while manufacturing many of the required products in Australia, much of the material is sourced from overseas (e.g. to build our Naval vessels), something which we believe changes relatively quickly.

In that context, we retain a view that gold holds a very useful place in portfolio construction. Historically gold equities have demonstrated non- correlated characteristics with other equity sectors, albeit not as much through 2020. Given our base case that fiscal deficits remain in place for a longer period of time than necessary (forever) the tailwind for gold, as a direct beneficiary of fiat currency debasement, leading into what is likely to end up as an inflationary outcome, suggests the backdrop for gold remains favorable for the foreseeable future.

So what are we focusing on?

We still remain relatively cautious with our portfolio construction as we enter FY21. We have a strong focus on relatively predictable cash flows in industries that appear less likely to be disrupted. Essential services are still prevalent in our portfolio, Woolworths (WOW) and CSL Limited (CSL) are our largest positions focusing on predictable cash flows. While we haven’t necessarily avoided the technology sector with several long term holdings (XRO, BABA US), our portfolio construction has seen the weights of the technology sector remain relatively small, as we have had challenges with many of the business models (discussed in more detail inside), and certainly see less valuation support. We have also placed more emphasis on industry leaders as we emerge from the lockdown period, whereby recapitalised balance sheets on certain stocks will ensure a far stronger industry position over the next 2-3 years than they have had previously. We categorise Qube Holdings (QUB), Aristocrat Leisure (ALL) and Ramsay Healthcare (RHC) in this category. We have also had a relatively meaningful allocation to companies that we consider to have strategic assets, whereby in a world of less global trade, these assets are increasingly relevant for the supply of raw materials. We categorise Lynas Corp (LYC) in this camp, and to a lesser extent, Synlait Milk (SM1) and Aurizon (AZJ). Gold, as previously mentioned, remains a significant holding as we enter FY21, with OceanaGold (OGC) our preferred name on valuation grounds.

The Portfolio

The CHCF gained 20.5% for the June quarter, outperforming the 16.8% rise in the ASX300 Accumulation Index. As we had outlined, the relentless stimulus of central banks has been a strong tailwind for the gold sector, which is currently around 12% of the fund. This is at the upper limits of our portfolio construction framework, but we see strong catalysts ahead for our preferred exposures. OceanaGold (OGC) has been one for the patient, as 2020 is a well flagged drop in production before a strong ramp up from 2021 through to 2028, without factoring in production from Didipio, an asset that is currently waiting on a renewed mining license to continue operating in the Philippines. This appears to be a binary outcome, and as such, it is not something we factor in to our core valuation which consists of stable producing assets in the US and NZ. At current prices OGC is trading on 4x EV/EBITDA in 2021, excluding Didipio, which would see a positive re-rating should a licence renewal be forthcoming. Excluding this, we see strong production growth from the Waihi district in NZ, underpinning our high conviction view that the gap between the share price and our valuation should close. Mineral Resources (MIN) is a long term holding of this strategy, where we continue to feel the capability of management, asset optionality and latent value in the business is underappreciated by the market. Refer our recent publication for more details. https://www.livewiremarkets.com/wires/can-mineral-resources-be-a-40-stock.

Saracen Minerals (SAR) has been a very successful gold operation, transforming from a single asset 5 years ago to now a diversified Australian miner with a JV with Northern Star for the Superpit in Kalgoorlie after purchasing half the asset in 2019. We see significant value to unlock from renewed exploration efforts around the Superpit and hence SAR remains a core holding. Proshares Short ETF (SH US) has been a way for the strategy to manage volatility over the past 4 years. Without taking a significant position, the exposure is there to provide downside protection in volatile markets. It worked well in March, and has detracted from performance over the past 3 months. It forms part of what we classify as our defensive sleeve, along with gold and cash, that offers non-correlated exposure to the ASX300. The fund has historically outperformed in down markets as a result of this defensive allocation. CSL also detracted from performance through the quarter as it was by and large used as a funding stock, being sold down to allow rotation into stocks that have more cyclical exposure. CSL will also face a headwind of sorts through 2021 as collections of plasma through social distancing has become harder, hence the volume growth will likely be 3-5% lower than previous estimates, leading to a softening of earnings expectations in FY21. The fund liquidity at the end of June was 13.8%.

Top 3 Holdings Portfolio Breakdown Top 3 Portfolio Attribution Bottom 3 Portfolio AttributionWoolworths Limited Consumer Staples 15.7% OceanaGold Proshares Short S&P500CSL Limited Gold 12.0% Mineral Resources CSL LimitedOceanaGold Industrials 11.0% Saracen Minerals Huon Aquaculture


Accumulated Performance by Financial Year - Same Strategy

FY14 (%)#

FY15 (%)

FY16 (%)

FY17 (%)*

FY18 (%)

FY19 (%) FY20 (%) Since Inception

Accum returnSince Inception

(%) p.a.

Same Strategy (after all fees) 11.2 24.5 17.4 11.2 28.3 -6.4 3.9 125.9 13.2

S&P/ASX 300 Accumulation Index 7.8 5.6 0.9 9.1 13.2 11.4 -7.6 46.1 6.0

Value added (after all fees) 3.5 18.9 16.5 2.10 15.1 -17.8 11.6 79.7 7.2

High active share For active managers to outperform long term, the fund has to be truly different from the benchmark. This strategy has had an active share of over 80% since inception.

Mid cap bias Broadly speaking, we find more interesting growth opportunities outside the large cap universe. For funds to perform well over an extended period, exposure to mid caps and small caps is essential.

Diversify with select Asian exposure Our experience in Asia has shaped the desire to access superior growth rates with high quality industry structures. Historically less than 10% of the fund, it provides strong diversification benefits.

Capital preservation focus The strategy has always allocated capital to non correlated exposures. Mostly this has been an allocation to gold equities, while cash and the option of a non-correlated ETF exposure offer downside protection.

Back owners of capital Allocating capital to management teams that think like owners is more likely to ensure longer term suc-cess. Alignment of interests is crucial. Managers must take a long term view.

Concentration in few ideas While a portfolio can be appropriately diversified with approximately 20 stocks, our mid cap bias and Asian exposure sees slightly more companies with a 25-40 stock portfolio we are comfortable with.

Own our decisions As a team, Chester has worked together for over 8 years, we each know our role and the strengths and weaknesses of each employee. We are proud of the culture we have built.

Keep it simple Ultimately, we allocate capital to sectors, companies and business models that we understand.

Focus on insights Do we have a different view than the prevailing wisdom of the market? Backing ourselves in unloved or undiscovered stories has been the most consistent source of alpha generation of this strategy.

Focus on cash flows We seek to invest alongside companies that either generate predictable cash flows in high quality industry positions, or determine an appropriate margin of safety where valuation is paramount.

The Chester High Conviction Fund Philosophy - It’s different

# The inception date of SGH Australia Plus was the 8th of October, 2013, where Rob Tucker was the sole Portfolio Manager, until his departure on February 28th, 2017.* The inception date of the Chester High Conviction Fund was April 26th, 2017, hence FY17 reflects 8 months of of SGH Australia Plus and 2 months of the CHCF.We note this is a statement of fact of the performance achieved by the fund during the time which Rob Tucker was the sole Portfolio Manager making active decisions on the SGH Australia Plus portfolio. We note performance is the record of the firm not the individual however past performance has been constructed from publicly available unit price data. Past performance is not necessarily indicative of future performance and should not be relied upon in making investment decisions.

Combined performance using the same strategy - SGH Australia Plus and the Chester High Conviction Fund

Note this graph is representative only of the combination of the same Portfolio Manager running the same strategy, and would only represent actual returns for unit holders that invested money at inception of SGH Australia Plus, withdrew those funds at the end of February 2017 and then invested all those initial funds again at inception of the Chester High Conviction Fund in April 2017. Note, this depicts returns after fees.

$100,000

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Oct-1

3De

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4Ap

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4Au

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4De

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5Ap

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0

Same Strategy ASX300 Accum Index

SGH Australia Plus Track record -October 2013 to Feb 2017

125.9%

46.1%

13.2% CAGR

6.0% CAGR


1. The Death Rate

Why are equities rising if COVID-19 is such a threat? COVID-19 has been the biggest challenge confronting the global economy since WWII, and something foreign to all of us. Unlike others, we don’t profess to epidemiologists but we have read widely on statistics from other countries, whereby it appears the death rate, as opposed to the number of new cases in the US continues to fall, which suggests either a statisti-cally lower death rate than first assumed, or simply that there is a 4-6 week lag between new cases and the death rate. The Swedish example is a fascinating case study of a country that from the outset decided to not impose a lockdown, but instead a series of self determined social distancing measures. It initially had a spike in deaths, over 50% of which were in nursing homes, while over the past 4 weeks, the death rate has effectively flat lined, and the economy has stayed open. Was this the right response? There will be various case studies on the way each country has handled the administration of the pandemic, but because we are relatively simple, the death rate is the statistic that appears the most relevant to us, in terms of the health threat to society and how economies eventually reopen.

2. The US elections

The surge in the US market post Donald Trump’s election win in November 2016 was largely because he was seen as business friendly and ultimately delivered a range of tax cuts and reforms that gave reason for a surge in business confidence. We think the upcoming election will be one of the most divisive in recent history while we have heard it described as “Trump vs Trump”, with Biden effectively an onlooker. That is, the emotive response of either voting for or against Trump will determine the outcome. A Democratic election victory would see corporate earnings fall 15-20% on increased taxes, not to mention the higher personal tax rates equating to 5-7.5% for the wealthy. This does not provide a positive back-drop for markets and has certainly not been factored into the current market risk-on mindset, hence suggesting the market is currently discounting a Trump victory, rightly or wrongly.

3. Central Banks doing “whatever it takes”

Liquidity always goes somewhere. Given the extreme increase in money supply (shown on page 10), must of it finds its way into asset prices, and because much of it has been given directly to the public in handouts and payroll programs, this has found its way into the stock market. It has been well publicised the amount of day trading occurring on the Robinhood platform, which offers free brokerage to individuals in the US. Hence the day trading and speculation in the equities market is reaching fever pitch, which is all driven by excess liquidity. This forms part of the Fed’s mantra of doing “whatever it takes” to get the economy started again. Given the challenges of reopening that we are facing in Australia (and in many parts of the US), our view is the amount of stimulus will be withdrawn slowly and will provide ongoing tailwinds for asset prices and ulti-mately reflation. There is no other choice.

4. Our portfolio construction

We have included a discussion on the way we allocate capital from a portfolio construction perspective. While we have done this before, we find this more important than ever given the volatility in the market and the wide range of potential outcomes over the rest of 2020, leading up to and through the US election. We have always used the same framework and while the tilts to one “sleeve” can change, over time the allocation to defensives, predictables and cyclical companies has been relatively consistent over the life of this strategy. This portfolio construction has over time demonstrated an ability to outperform in down markets, where capital preservation, (in a long only context) remains a key focus.

5. The Technology sector - clearly, this time IS different? We revisit the way we assess the quality of each business on page 8, as investing in “quality” is something everyone wants to do, but we ask ourselves 7 questions specifically around the operating environment and in this context take a more detailed view of the technology and online e-commerce space. Clearly a part of the market that has seen exceptional returns over the past 12 months, and more so from the lows in March.

6. The looming “Fiscal Cliff” in Australia We think this notion of the JobKeeper program expiring in September (well it would have until the recent Melbourne lockdown) was well understood, while it now appears that it will be extended, for those that need it until at least the New Year. So this has effectively kicked the can a little further down the road. But it will still occur. Without question the biggest influence over consumption patterns (JB Hi Fi sales, Kogan sales etc) has been the government stimulus injection directly to the household, with forced lifestyle changes. We look at this on page 12. But we remain extremely wary of the mortgage and loan deferral rates (also on page 9) that amount to AUD240bn of loans to banks having been deferred, by over 780k customers. We remain extremely concerned at the number of businesses and individuals facing extreme hardship, making it difficult to reconcile point 7 below.

7. Valuations at extremes

We admit many of the traditional tools we look at to value assets and companies look extreme from a historical context today, largely because interest rates are effectively zero. This certainly makes fundamental analysis more challenging, but actually, we think more important than ever. With many pockets of the market showing signs of a speculative frenzy, we are very conscious of the risk/return profile of each holding. While we will continue to make mistakes, it won’t be because we are chasing momentum. These charts are on page 14.

8. China With the global relationship with China souring markedly since the outbreak of COVID-19 and the associated blame game, we look at the underlying economy, which remains one the key drivers of global growth. We will leave the geopolitics out of it for the sake of this discussion, but it appears inevitable that the relationship between China and the West has fundamentally broken and with it, Globalisation has changed forever.

“Earnings don’t move the overall market; it’s the Federal Reserve Board...focus on the central banks, and focus on the movement of liquidity....most people in the market are looking for earnings and conventional measures. It’s liquidity that moves markets.”Stanley Druckenmiller

What are we thinking about?


Stock Selection - Austal Ltd (ASB)

* This is not a securities recommendation or a solicitation to buy this security. It merely provides historical representation of the consideration the

fund undertakes when selecting securities for its portfolio.

ASB potential contracts over the next 2 yearsChart 4 Chart 5

Description

Austal (ASB ASX) is the largest provider of Aluminium ships in the world and has developed a long term successful partnership with the US Navy in providing Littoral Combat Ships (LCS) and Expeditionary Fast Transport Vessels (EPFs) over the past decade from its base in Mobile, Alabama. It also builds commercial vessels (fast ferries and vehicle passenger ferries) as well as Navy vessels out of its locations in Perth, Vietnam and the Philippines. It has a current order book of over AUD4.0bn or strong visibility for the next 3 years of operation. In Alabama, ASB is currently completing two key shipbuilding programs, the LCS in 2024 and the EPFs in 2023. The US defence contract for the delivery of these two programs currently accounts for around 70% of ASBs earn-ings. The US Government has recently announced a USD50m grant to ASB to upgrade the Alabama facility enabling steel vessels to be manufactured on site, which opens up an entirely new pipeline of opportunities for ASB to tender for.

Quality

ASB has developed a strong reputation for delivering LCS vessels to the Navy with increasing efficiency over the life of the contract, with labour hours per vessel decreasing more than 35% over the past 6 years, which has driven both a strong margin improvement, and a strong working relationship with the US Navy. The recent USD50m award from the US Government is testa-ment of the desires of the US Government to maintain key strategic shipbuilding capacity operating and enhances the companies total addressable market multiples (from just aluminum to aluminium and steel shipbuilding opportunities). With steel shipbuild-ing capability, ASB has multiple tender opportunities in front of it, which we discuss below. Combined with the Australian Navy recently awarding ASB a AUD350m contract in Perth (Cape Class Patrol Boats) and a pending deal to enter into a long term agree-ment at Subic Bay in the Philippines sees the strategic nature of ASBs skill set become more important over the next 5 years.

Valuation

Our assessed value for ASB is currently AUD5.00 per share, which assumes US shipbuilding earnings halve in 2024. ASB current-ly trades on 13.0x FY21 earnings which are largely already baked in given the long term agreements in place. They have given guidance in FY20 which has seen earnings upgrades based on the margin enhancement for the LCS program. ASB currently has AUD150m in cash on the balance sheet, which is around 13% of its market cap.

Insight

As we noted in April here (https://www.livewiremarkets.com/wires/have-you-got-your-bunker-in-order) we see the market as underappreciating near term earnings, a point we continue to emphasise in FY21 with the award of an additional EPF likely, the earnings from Cape Class Patrol Boats (CCPBs), potential contracts in the Philippines and additional awards by the US Navy. Ad-ditionally, after missing out on phase 1 (vessels 1-10) of the Future Frigate program FFG[x] we believe the market is underappre-ciating the longer term earnings potential and the US Government’s desire to support the industrial manufacturing base in the region. The long list of potential contracts (some of which are outlined below) suggests that with ASB’s track record, they will, be able to replace a large portion of lost revenue in FY24 onwards. Our base case assumes US earnings halve from FY24 but we see an upside case where earnings are maintained, if not expanded given heightened geopolitical tensions and focus on the South China Sea. With this backdrop, we note ASB is very well placed to participate, in the purchase of the Hanjin Shipyard in Subic Bay, Philippines with US private equity firm Cerberus. With the current geopolitical focus on the South China Sea this purchase would ensure that ASB has the potential to become a key component of maritime strategy in the region. The long term investment in the Philippines and Vietnam (to a lesser extent) will assist ASB manage their work flow from the Australian operations and allow margin enhancement over time. We would classify ASB’s shipbuilding capability as an essential service, and while tenders are large and lumpy, once awarded, offers a great deal of earnings visibility.

Source: Chester Asset Management Source: Chester Asset Management, Austal, Congressional Research Service

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buying period


Chester High Conviction Fund top ten holdings as at July 2020

Source: Chester Asset Management, Bloomberg consensus data as of July 9th, 2020. Note stocks are listed in alphabetical order

We have listed here our top ten holdings at the end of June 2020. Note we find that our stock weights can change over the course of a quarter or year. We broadly hold positions between 1% and 6% depending on our conviction level on the stock and the market capitalisation. Our conviction level is dictated by the broad art of combining 1/ the appropriate valuation of the stock, with 2/ our assessment of the quality of the assets and management team, overlayed by 3/ our expectation (or insight/edge) of the earnings direction. I.e. Do we think the market is mispricing earnings? For our thesis to hold, we require at least 2 of these 3 factors to be validated for the investment case.

To explain that in more detail we have used a slide from our presentation material (chart 7). Most of the stocks currently held in the top 10 holdings are classified as “Predictable” (Healthcare, Consumer Staples, Real Estate, Defence or Infrastructure) while Mineral Resources is the only cyclical as a top ten holding. The focus of the fund has been very much on essential services with relative cash flow certainty in this unique economic climate we find ourselves in. When we are allocating capital to those sectors that are more predictable in nature, our primary focus is the quality of the industry position they hold and relative cash flow certainty. We determine this by asking ourselves 7 questions around pricing power, barriers to entry, threat of disruption, etc. We also ask a range of questions around the management incentive structure and track record. Once we decide that a company is well positioned, we then seek at least one other “thesis” to hold true. For predictable companies, we need to be convinced around the quality first, and then valuation or edge. For cyclical or defensive (gold) companies, we need to have a high degree of confidence in the valuation support first (as by definition, we cannot be sure of how predictable the cash flows are). We then seek a degree of conviction around the management team and whether we have a unique insight (“edge”) to those particular assets. Thus for the cyclical or gold stocks, it is primarily a valuation driven decision first. Note we currently hold two gold stocks in our top ten holdings as part of our defensive sleeve, where we see over 60% upside to Oceana Gold on a valuation basis.

The one stock that may look out of place amongst the top 10 holdings is Eureka Group (EGH), a small retirement village operator that we have held for over 2 years. This is a long term holding where we see it providing retirement living options for low income earners (pensioners), where the cash flows are effectively government backed. We see its asset value using an 8% cap rate of around 42c per share, while it is currently trading at 32c per share, and a 5%+ dividend yield. The cash flows of the assets are highly predictable, and recycling capital into cash generating assets will drive earnings materially higher on a 3 year view from here. It meets all three criteria outlined below. Predictable cash flows that are well managed (highly impressive team) with valuation support and a high degree of confidence in the earnings outlook.

Chart 6

Source: Chester Asset Management

Chart 7

FY1 FY2 FY20 Yield FY21 Yield FY1 FY2 FY 1 ROE FY 2 ROE FY1 FY2 FY20 PER FY21 PERSales Growth Sales Growth DPS Growth DPS Growth EPS GROWTH EPS GROWTH

Atlas Arteria -36.7% 49.0% 2.0 4.7 -56.0% 133.0% 4.80 9.90 -19.3% 150.0% 48.9 19.5

Aurizon 2.9% 1.6% 5.7 6.0 21.0% 4.8% 12.10 12.60 19.2% 6.0% 17.7 16.7

Austal 9.2% 1.8% 2.3 2.5 17.2% 12.0% 12.30 12.40 45.3% 3.5% 14.3 13.8

CSL Limited 7.7% 10.5% 1.0 1.2 3.6% 14.0% 36.25 33.10 9.8% 12.7% 42.2 37.5

Eureka 11.6% 3.4% 3.3 4.0 nm 20.0% 8.50 8.70 4.3% 20.8% 13.8 11.4

Mineral Resources 45.3% 8.1% 3.1 3.3 25.0% 6.0% 18.10 12.90 88.4% -3.3% 13.7 14.1

Newcrest 2.6% 6.7% 0.8 1.2 -4.5% 42.0% 8.50 9.50 17.0% 28.4% 26.5 20.0

OceanaGold -7.8% 52.4% 0.3 0.6 nm nm nm 10.50 nm nm 73.4 8.7

Synlait Milk 22.6% 16.1% 0.0 0.0 nm nm 14.40 15.14 -12.1% 20.0% 16.6 13.8

Woolworths 6.2% 2.5% 2.5 2.7 3.0% 8.9% 16.20 17.90 0.2% 9.1% 29.4 27.0


Portfolio Construction

We have always broken down our portfolio construction into three categories as outlined on chart 8. We think of most sectors in the predictable bucket - healthcare, consumer staples, defence, infrastructure, etc as, in general, able to offer relatively predictable cash flow profiles from the industry structure they operate in. We are the first to admit this is a relatively primitive exercise given that many stocks have very different cash flow characteristics that may be categorised in several ways. For example, gaming or more specifically casinos have historically been relatively predictable cash flow generators, but COVID has derailed many of these formerly “predictable” sectors. We focus heavily on the industry structure and competitive advantages of each company when assessing the investment thesis for “predictable” stocks.We use the word “relatively” predictable, as sectors that are genuinely cyclical in nature (energy, commodities, retail, etc) there is always less certainty over the longevity of a cash flow cycle and sustainability of margins, hence given the uncertainty, we tend to desire much better valuation support in cyclical sectors.The “defensive” sleeve is comprised of positions that are historically uncorrelated to the ASX300. We classify gold equities with this lens, as chart 34 on page 14 highlights how well gold has held up in bear markets. Cash is often a residual position, while the fund does have the ability to own small positions in ETFs that are negatively correlated to the ASX300. Chart 9 illustrates how these “sleeves” have looked over the past 6 and a half years. On average, the allocation to predictable companies has been 60-70%, while cyclicals have averaged around 15% (10-20%) and defensives ranging from 10-25%. In general the holding to cash and gold has increased over the past 2 years as we have become increasingly concerned with the level of debt accumulation and fiscal stimulus needed to create GDP growth, while the backdrop of falling bond yields has also been a tailwind for gold. The unfortunate economic climate we find ourselves in now provides a very strong backdrop for gold, as we discuss on page 10, we are of the view that ultimately the actions of central banks has to be inflationary.The history of the strategy has been successful in delivering alpha, outside FY19, in which the fund was (in hindsight) too cyclical leading into the end of 2018, and then far too defensive during the first part of 2019.

Chart 10 has been pulled directly from the Morningstar database of large cap Australian Equity strategies, whereby it highlights the strong track record relative to its peer group (ranked 8/350 funds over 1 year, and 19/318 over 3 years). While this is pleasing, the portfolio construction as described above, we think creates a differentiated product to our peer group. Largely because we use the defensive sleeve, our drawdown has been lower than the index and the peer group, which also shows in the beta of the strategy (0.91 vs peers at 0.99). This effectively means the fund demonstrates less volatility than the peer group, which is also shown by the standard deviation (16.62 vs 17.14).

But what it also highlights is the lower level of correlation (R-squared) to the index, which shows this strategy is only 84.64% correlated to the index, relative to the peer group correlation of 94.65%. The portfolio is designed this way deliberately, which we think becomes even more important over the next 12 months with increasingly volatile markets, thus ensuring some focus on capital protection (although it is a long only product) is paramount to the way we invest.Hence the fund (to this point, and past performance is no guarantee of future performance), has been able to demonstrate higher returns than many of its peers, for significantly lower beta (or volatility) and correlation. Thus, it has achieved its objective, while being a very different offering than most other Australian equity funds.

Chart 8



How we categorise sectors by cash flow type

How the portfolio has changed over time

The Chester High Conviction Fund is different to its peers

Source: Morningstar database of Australian Large Cap strategies, July 2020

Chart 9

Chart 10


How we think about Quality


Following on from our discussion on page 7, we have always used this framework for assessing the quality of an investment. We break down the quality of a business into 3 sections, business quality, management quality and financial quality and assess each factor using a series of questions. Above we have listed the questions we ask ourselves around the business quality, which is effectively trying to mitigate the operating risk (where possible) of each investment. The financial quality questions are based on the balance sheet and quality of earnings (cash generation), which is attempting to mitigate any financial risk (too much debt or leverage), while the questions we ask ourselves around management quality is trying to assess management’s alignment of interests as shareholders in the business, as well as any prospect of corporate governance risk associated with reputational damage of the business around ESG issues, such as being good corporate citizens around the environment, health and safety, diversity and social influence. For our own ranking system, we then rank each metric out of 10, for equal weighting across each of the three components. As outlined above, Xero scores 60/70 for business quality, which is rounded to a score of 9/10, which then combines with our ranking for financial quality and management quality (also out of 10) to provide us an overall assessment of the business “quality”.Clearly this is an exercise in subjectivity, but we find it instructive to assess each company along the same thought process. This exercise takes on relative importance for what we classify as “predictable” companies, where valuation is considered as a secondary tool. If we are assessing cyclical companies, then valuation becomes the primary tool. So these are the seven (relatively generic) questions we ask ourselves when looking at the business quality of each company. On page 9 we have a detailed summary of all the tech stocks that we have considered. When looking at these tech names, they obviously operate in different industries so comparing like for like is a subjective exercise. We do find it to be a useful thought process as we consider the investment thesis of each company though, outside the short term thinking of whether or not the earnings will exceed or disappoint consensus numbers. Obviously, this thought process doesn’t take into account the valuation of each company, where we (in aggregate) have had significant difficulty in valuing these businesses anywhere near their current share prices. We are categorically in a bubble in technology stocks.When looking at the answers above, we demonstrate a preference for Xero relative to the other tech companies, largely as a result of both comfort with the technology (we use and recommend it) and the large runway over the 5-10 year view for Xero to further raise prices. This will be a powerful driver of future cash flow growth with an incredibly strong franchise (we don’t think it will impact customer engagement). The other companies we have either less confidence (e.g. Afterpay) or less understanding (e.g. Altium) of how pricing plays out over the medium term.The question about whether these assets are easy to replicate is often the most challenging. If we are wrong about Afterpay (and the share price is suggesting we are), it will be largely as a result of us viewing Buy Now Pay Later (BNPL) Fintech’s as a highly competitive industry with many competing products and some aggressive pricing. If Afterpay (as the first mover advantage) has been able to build a viable ecosystem of retailers, then it itself (and its online portal) can become a very powerful distribution channel for these retailers. This is what we are trying to comes to terms with on Afterpay, notwithstanding the fact it looks (on our forecasts) heroically expensive. But we have been proven wrong many times before.

Chart 11


How we assess a sector in detail - Technology

The prospect of owning highly scalable businesses with high incremental margins and often, relatively low ongoing capital requirements ticks a lot of boxes for investors. Combining these features with often highly relatable products and brands and the case for including some tech in one’s portfolio is strong, but for us it always needs to have some valuation logic to it. There are many varied business models, the above table highlights all the tech names we have spent time reviewing. The differentiation of business models helps explain the huge valuation differences that exist across the market, as well as the share price dispersion seen across the sector over the past 12 months. This share price volatility has been further exaggerated in recent months as businesses have confronted the Covid-19 pandemic and investors have eagerly nominated certain technology companies structural “winners” from the crisis, clearly the BNPL sector is this year’s market darling. For most of the stocks above we fall at the valuation hurdle, with no “margin of safety” at all, combined with the inherent difficulty in forecasting cash flows into perpetuity for stocks that have few barriers to entry. We are very reluctant to use “EV/Sales” as a relevant metric, albeit for comparison to other similar companies has minor merit. Acknowledging the challenges of accurately forecasting the growth of technology companies over long periods (typically 10 years) and the sensitivity of valuations to changing inputs (growth rates and margins in 2024 as an example) this work consistently highlights just how much value the share prices of technology companies are attributing to the terminal years. That is, the performance of the business beyond a typical 10 year forecast period. It’s with this in mind that we attempt to gain greater conviction in the sustainability of technology businesses via our ‘Quality’ assessments. Evident in the range of Business Quality scores (out of 70) ascribed to our tech universe above, we see considerable variability in the quality of local tech companies. At the heart of these assessments is the question; how likely are these traditionally disruptive companies themselves likely to be disrupted by new technologies and competitors in the future?Pricing power remains very influential in how we frame our assessment, as does switching costs. That is, how costly would it be for customers to stop using the product/service. NextDC (NXT), a carrier-neutral data centre owner/operator is one example of a company that exhibits these characteristics and one that we have been a long-term investor in, albeit not at current prices. Equally, there is considerable value in being the recognised ‘first mover’ in an industry that has been disrupted, a characteristic shared by all of Seek (SEK), Carsales.com (CAR) and REA Group (REA). Through a combination of innovation and product enhancement, acquisition and brand development these businesses remain category leaders and by extension price-setters in their markets. There is little doubt that the last few months has seen a material uplift in the adoption of technology and for the likes of Kogan (KGN) and PushPay (PPH) it has led to higher usage of their service than they would otherwise have anticipated. On the other hand, the likes of EML payments (EML), Catapult (CAT) and Vista Group (VGL) have seen their industries heavily impacted by Covid restrictions implemented globally. The challenge for Chester remains identifying the winners of changing consumer patterns. The one constant in technology is normally, the winner takes (almost) all.

Chart 12

Source: Chester Asset Management, Iress

Information Technology - Valuation Summary

Companies

Year 1

Company Model LinkModelled

WACCTGR

Assumed

Shares on issue

(Millions)Market

PriceReference Valuation

Price Difference

Mkt Cap (AUDm)

Net Debt (AUD) EV (AUD)

Sales (AUD)

EBITDA (AUD) EBITDA%

Est Yr.1 EV/Sales

Est Yr.1 EV/EBITDA

Period Ending

Business Quality

Score (/70)

Financial Quality Score

Management

Quality Score

Business Quality Score

(Rank/28)

Xero (NZD) XRO 9.0% 4.0% 143.5 92.85 14,060 -125 13,935 794 173 21.8% 17.5 80.6 Mar-21 60 1

Megaport MP1 9.0% 4.0% 153.3 14.24 2,246 -150 2,096 87.5 -9 -10.3% 24.0 -232.9 Jun-21 55 4

NextDC NXT 9.0% 4.0% 342.3 11.31 5,192 -75 5,117 250 128 51.2% 20.5 40.0 Jun-21 54 6

Bravura BVS 9.0% 3.0% 243.6 4.47 1,114 -120 994 310 64 20.6% 3.2 15.5 Jun-21 45 23

Catapult CAT 9.0% 3.0% 190.4 1.23 233 -11 222 114 15 13.2% 1.9 14.8 Jun-21 50 13

Citadel CGL 9.0% 3.0% 245.6 3.93 243 75 318 169 45 26.6% 1.9 7.1 Jun-21 44 24

EML Payments EML 9.0% 3.0% 359.7 3.25 1,205 -100 1,105 188 54 28.7% 5.9 20.5 Jun-21 44 24

Fineos (EUR) FCL 9.0% 3.0% 272.0 3.02 1,066 -35 1,031 159 28 17.9% 6.5 36.4 Jun-21 51 12

Hansen Technologies HSN 9.0% 3.0% 198.2 2.87 575 130 705 307 84 27.4% 2.3 8.4 Jun-21 44 24

Iress IRE 9.0% 3.0% 174.9 10.74 2,074 150 2,224 570 132 23.2% 3.9 16.8 Dec-20 46 21

Jumbo Interactive JIN 9.0% 3.0% 62.4 10.91 703 -80 623 78 42 53.8% 8.0 14.8 Jun-21 44 24

Kogan KGN 9.0% 3.0% 103.5 17.64 1,790 -75 1,715 570 55 9.6% 3.0 31.2 Jun-21 46 21

Life360 (USD) 360 9.0% 3.0% 147.9 2.68 390 -71 319 114 -24 -21.3% 2.8 -13.1 Dec-20 37 28

Pushpay (USD) PPH 9.0% 3.0% 275.6 8.71 2,414 -35 2,380 273 81 29.7% 8.7 29.3 Mar-21 49 15

Red bubble RBL 9.0% 3.0% 257.7 1.96 501 -35 466 395 17 4.3% 1.2 27.4 Jun-21 50 13

Technology One TNE 9.0% 3.0% 319.3 8.18 2,791 -100 2,691 330 116 35.2% 8.2 23.2 Sep-21 47 19

Vista Group (NZD) VGL 9.0% 3.0% 228.6 1.18 275 -25 250 123 24 19.2% 2.0 10.6 Dec-21 52 9

Carsales.com CAR 9.0% 3.5% 241.4 17.93 4,399 380 4,779 440 236 53.6% 10.9 20.2 Jun-21 54 6

Domain DHG 9.0% 3.5% 584.3 3.05 1,840 150 1,990 275 94 34.2% 7.2 21.2 Jun-21 52 9

REA Group REA 9.0% 3.5% 131.7 105.21 13,797 100 13,897 880 525 59.7% 15.8 26.5 Jun-21 55 4

Seek SEK 9.0% 3.5% 351.6 21.66 7,562 1,150 8,712 1745 450 25.8% 5.0 19.4 Jun-21 53 8

Afterpay APT 9.0% 4.0% 275.9 71.74 20,096 150 20,246 890 70 7.9% 22.7 289.2 Jun-21 52 9

Altium ALU 9.0% 4.0% 130.3 33.50 4,440 -83 4,357 320 126 39.4% 13.6 34.6 Jun-21 59 2

Appen APX 9.0% 4.0% 122.9 35.93 4,429 -73 4,357 710 135 19.0% 6.1 32.3 Dec-20 48 17

Nearmap NEA 9.0% 4.0% 453.7 2.33 1,062 -30 1,032 113 26 23.0% 9.1 39.7 Jun-21 48 17

Pro Medicus PME 9.0% 4.0% 103.9 24.49 2,627 -48 2,579 70 49 69.3% 36.8 53.2 Jun-21 56 3

Wisetech WTC 9.0% 4.0% 318.2 20.17 6,585 -263 6,322 515 157 30.5% 12.3 40.3 Jun-21 47 19

Zip Co Z1P 9.0% 4.0% 390.4 7.63 2,827 1,050 3,877 350 -8 -2.1% 11.1 -516.9 Jun-21 49 15

AUDUSD 0.70

AUDEUR 0.62

AUDNZD 1.06

Source: Iress, Chester AM forecasts

Chester Valuation Details Enterprise Value (Current) Year 1 EstimatesMultiple

ComparisonMultiple

Comparison


When does monetary expansion become inflationary?

Source: Federal Reserve of St Louis

We often start with this credit expansion framework as it is unavoidable, and shapes the way we think. Clearly the demand shock of the economic lockdown has meant a deflationary outcome in the near term as simply, inventories need to be wound down and capacity utilisation needs to increase again, while the velocity of money (chart 14) has continued to slow. The velocity of money pick up is hard to predict as it is influenced by the psychology of investors and consumers. Given the significant acceleration in US money supply (chart 17 below), historically this tends to influence inflation, which then drives the velocity of money as consumers desire to spend or invest before goods or services become more expensive. This is hard to reconcile for a generation of investors as they have only ever experienced deflationary settings through technological advancement and globalisation of the labor force. Given we are of the view that globalisation has run its course, and onshoring of supply chains becomes more prevalent due to security of supply issues, the idea that inflation may soon reappear is logical to us. By soon, we mean in the next 12-18 months, as economies are reopened and the workforce is operating at full capacity.

Credit expansion has driven GDP since 1971Chart 13

When does deflation become inflation?Chart 16 Not until the velocity of money picks up

Source: Jefferies Source: Jefferies

CPI will ultimately catch up to Money supplyChart 17 USD gold price inflation adjusted - goes higher?Chart 15

Source: UBS Source: Macro Trends

Source: Fed Reserve of St Louis, Bloomberg

Chart 14

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US thoughtsThere are so many ways to cover off the issues facing the US, one page doesn’t do it justice, suffice to say the upcoming election is critical for the future direction of policy, which looks very different under the Democrats or Republicans. The tax headwinds under the Democrats would be taken poorly by the stock market as a means to redistribute wealth, while the prospect of a serious MMT (Modern Monetary Theory - that is, printing money directly for the benefits of citizens) looks likely, to the detriment of the USD and the deficit, which would widen further than chart 19 below indicates. We do shrug with this type of analysis, but the US Central Bank hasn’t really ramped up its new round of QE (money printing, even though the Fed balance sheet has expanded by USD3.0tn over the past 3 months) when compared to Japan, which is the clubhouse leader. We presume because of the dire predicament of corporate America’s debt burden, and the ongoing risk to total employment, that the Fed is forced to continue to buy corporate debt. 83% of the US workforce is employed by small business, which will feel the full force of the impact of the pandemic. By and large, the listed US companies (S&P500) in aggregate, are larger and better capitalised, but corporate debt in aggregate appears unsustainably high. Source: Mauldin Economics, calculatedriskblog.com

Chart 18

Source: Credit Suisse

Chart 19

Source: Goldman Sachs

Chart 20 The US reopening has stalled

The largest deficit ever

Many US jobs will be permanently lost

Keep issuing debt to US corporatesChart 22

Source: Jefferies

Chart 21 US Fed can still print for a long time to catch Japan

Source: UBS


AustraliaWe are relatively visual, and chart 23 illustrates the fiscal cliff in Australia perfectly. Through the COVID bonus, JobKeeper, JobSeeker and Superannuation access, Australian households have had and extra AUD35-40bn in the 2nd and 3rd quarters to spend. Given many mortgages (chart 24 below) have been deferred, which equates to AUD246bn of loans not being paid off, the tailwind for online shopping and electronics goods has been a once in a generation event. We confess we missed this thematic tailwind as it occurred, but as of now, remain enormously concerned with both the fiscal cliff (as it unwinds) and the impairment charges to the banking sector as these loans are asked to be serviced again. Suddenly those on the JobKeeper program may find themselves without a job, come to the end of their assistance, and at the same time have to start servicing their debt outstanding. So while we applaud the Australian Government for handling the crisis as proactively as they have, and expect further measures to be introduced, we are of the view that with commercial property under stress, the risk that banking impairment charges look closer to 1991 than 2008 is real. We have kicked the can down the road, but the end of the road is still there.

Source: Goldman Sachs

Chart 23

Source: Jefferies

Chart 24

Source: UBS

Deferred Loan payments by category

What happens to consumption in the 4th Q?

At least mortgage rates will continue lowerChart 27

Source: Macquarie Research

Personal credit growth can’t improve until jobs doChart 25

Chart 26 Bank impairment charges, more to come?

Source: Jefferies


ChinaPutting to one side the elephant in the room regarding trade tensions and the dispute over Hong Kong, we have tried to assess how China the economy is progressing, as it does influence our thinking around the demand for our raw materials. The medium term issue of migration and capital flows into Australia from China we will tackle with more clarity next quarter. It remains a large swing factor in the Australian education sector and property prices. Chart 28 highlights that China has embarked on a targeted spending approach via the issue of local “special” bonds, which will increase over 70% on 2019 issuance. Most of these will be for provincial infrastructure or real estate projects. Domestic consumption remains key for raw materials given our view that global demand for Chinese exports will be greatly diminished through 2020, hence we remain very selective on individual commodity exposures. Iron ore remains very tight as we enter FY21 given the inability of many countries (mostly Vale in Brazil) to meet export targets given COVID shutdowns, This has been a bonanza for the West Australian producers, but appears unlikely to last as this supply (Vale) reopens. Source: SMM

Chart 28

Source: SMM

Chart 29

Source: SMM

Higher exports, higher exposure to global slowdown

Local special bonds will underwrite the economy

China’s share of global steel productionChart 32

Source: SMM

Iron Ore at Chinese ports in 2020 still at low levelsChart 30

Chart 31 Fixed asset investment recovering, led by real estate

Source: Credit Suisse

is expected to fall from 2020 onwards


Charts that make you go hmmm...

Source: Chester Asset Management, Bloomberg

Chart 33

Source: Sprott Asset Management

Chart 34

Source: Jefferies

Chart 35 Global gold stocks still 50% below 2011 levels

Gold as a hedge in down markets

World growth index/World value index - a top?

Source: Perville Global, Bloomberg

ASX Industrials PE is 58% above the long term average

Chart 37

Chart 36

Tech PER vs real rates being negative?Source: Goldman Sachs

It’s actually just a way for us to not have to write as much. We come across many charts over the course of our readings and being relatively visual, subscribe to the notion that a picture can tell 1000 words.Much of our thinking is framed by “lines that move up or down” so we simply show a select range of charts that we have come across...without having to explain them!

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Our executive summary

Equities

All else being equal, equities remain attractively valued relative to bonds. There has been significant dispersion between long duration assets (led by technology and healthcare companies with the lower risk free rates leading to higher valuations) and eco-nomically sensitive stocks (cyclicals) that in some cases, are at historically high levels of dispersion (the spread between the high growth stocks and low growth stocks). By and large we prefer to be contrarian with our investments which has been remarkably difficult over the past 5 years. This may be famous last words, but we can’t see the recent trend of technology outperformance continuing throughout FY21. The valuations are simply fanciful in many cases.

While we remain cautious on the pace of an economic recovery from COVID-19, we have started to (incrementally) add to select stocks that are more cyclically exposed.But by and large, our focus remains onEssential services - WOW, CSL, ASB, ALX, EGHIndustry leaders - ALL, QUB, RHCStrategic assets - SM1, LYC, CNUGold - OGC, NCM, SAR

There is a wide variation in the possible outcomes over the coming 12 month period with the current outbreak of COVID-19 in Australia and in many states in the US. Combined with a divisive US election looming, we believe a focus on appropriate risk man-agement of the portfolio from a stock specific perspective, is critical.Having said that, we are genuinely excited by many of the stocks in the portfolio today, where we can justify materially higher prices over the next 12 months. As we have demonstrated over the past 7 years with this strategy, the returns we generate do deviate significantly from the benchmark, where we are proud of the track record of the strategy, delivered with lower volatility than the ASX300.

Gold

Gold effectively has a dual purpose. As a store of safety in uncertain times, which we have just witnessed, and as a store of value when inflation occurs, which hasn’t occurred yet, but appears inevitable with the increase in the money supply. It has proven highly successful in outperforming when equity markets fall through the course of history and hence remains a valuable alloca-tion to the portfolio construction. We spend much of our time analysing gold equities which are selected primarily on valuation grounds first, and then an assess-ment of the quality of the resources and cost of extraction. Clearly management competency and a track record of delivery is also an important variable.

Government spending and bond yields

The enormous increase in deficit spending across the globe to ensure the unemployed workforce can pay bills has left (and will leave) most central banks with an insurmountable debt burden. There is no longer any pretense of any political party anywhere to try to repay these debt burdens the future generations are faced with. Interest rates simply cannot rise with the amount of debt issuance by central banks, and it appears we are more likely to see negative interest rates in the US, than higher interest rates in the foreseeable future.With this backdrop, the only way interest rates ever rise is with significant inflation, as the only way the debt burden to society gets repaid, is through asset reflation, or in some cases, debt forgiveness.Central Banks (led by Japan) have had no other playbook since the GFC, and will continue to issue new bonds to finance the deficit spending of governments, and the debt burden. Since Alan Greenspan, Fed governors have always issued a “put” on the stock market with new easing policies, which in the next downturn, eventually becomes yield curve control, and ultimately direct equity purchases, if needed.

Currencies

We generally make sweeping comments about the direction of currencies which turn out to be wildly inaccurate. But we will try again.Given the level of deficit spending in the US relative to Europe, and the relative success in getting the economies reopened safely, it appears the US dollar may be weakening (relative to the EUR), which is broadly helpful for emerging economies that are faced with high USD loans. It also augurs well for commodities that are priced in USD.Generally speaking, we were surprised with the strength of the AUD through the worst of the pandemic, but point to both the in-terest rate differential in Australia and the strength of our terms of trade (iron ore exports) that suggests the AUD remains higher than we originally anticipated, which acts as a mild headwind for AUD denominated offshore earners starting FY21.

Risks

The outlook remains more clouded than normal as we enter FY21. Heightened uncertainty with the course of the pandemic, social unrest, trade disputes and elections suggests a wide range of outcomes are possible. If 2020 has taught us anything, an ability to be nimble and change our assessment of the likely outcomes is critical to not only protecting capital, but identifying opportunities when they arise.

Chester High Conviction FundFact Sheet

What is the Chester High Conviction Fund?• It is a predominantly Australian equities portfolio with the right

to invest up to 10% of its assets in Asia. It will hold between 25-40 stocks

• A Concentrated, high-conviction portfolio• Highly Index unaware, with better sector diversification than the

ASX300 universe• Focus on risk adjusted returns and capital preservation

The Chester High Conviction Fund is a differentiated Australian equity fund in that it has the right, but not the obligation to invest in the highest quality companies listed in Asia, without necessarily taking full emerging market risk. We believe our experience in Asia, having visited China over 40 times in the past 13 years, gives us a unique insight into the most influential driver of the Australian equity and property markets. The approach is long-term, applying a high conviction methodology that seeks to optimise after-tax returns to investors.

The Chester High Conviction Fund is not bound by external indices, allowing the Fund to invest only in those companies that meet its strict investment criteria. While the fund will look very different to the benchmark ASX300 index, we believe it will offer greater sector diversification and therefore, over the long term, offer more appropriate returns for the level of risk investors are exposed to.

The Chester High Conviction Fund is run by Chester Asset Management as the Investment Manager, using Copia Investment Partners as the Responsible Entity and Trustee. NAB is the custodian of the assets.

A strong focus on capital preservation The Chester High Conviction Fund will focus heavily on stock specific risk and assesses the operational, financial and corporate governance risks of each investment on its own merits.

Fund at a glanceInception date April 2017

Objective To outperform the ASX300 Accumulation Index by 5%

on a rolling 3 year basis

Fee 95bp base fee plus a 15% performance fee based on

outperformance, after fees, of the benchmark. The

performance fee is subject to a highwater mark

Style Tilt towards quality and growth, but with an emphasis

on a valuation margin of safety

Investment strategy

Invests in a concentrated portfolio of companies

offering outstanding long-term potential. A company’s

weighting is mainly determined by the likelihood of a

company achieving superior returns over 5 years. The

fund has a predominant bottom up stock picking style

overlayed with portfolio diversification and risk

controls.

Active Share This is the % of the portfolio that is different from the

S&P/ASX 300 index. This will range between 70-90%

Benchmark S&P/ASX 300 Accumulation Index

Number of Holdings

Will range between 25-40 stocks with up to 10%#

invested in Asia

Investment universe

Generally within the largest 300 companies listed on

the ASX, plus companies listed in Asia with a focus on

Asian domestic consumption. This increases the

investment universe by 40-50 investible stocks

Typical company characteristics

We look to invest in companies that display sustainable

earnings growth which is characterised by free cash

flow growth. We look for a valuation margin of safety

as capital preservation is a key focus for the fund.

Risk Guidelines • Maximum stock weight

• Large Cap = 8% soft, 10% hard

• Mid/Small Cap = 4% soft, 5% hard

• Asian Stocks = 2% soft, 3% hard

• No less than 25 stocks, no more than 40

• Maximum active sector position = +20% GICS tier 2.

That is no more than 20% over weight one industry

sector.

• Up to 100% invested in ASX300 stocks

• Between 0% - 10%^ invested in Asian stocks

• Between 0% - 20% invested in Cash

• Expected Tracking Error 5% – 10% (but not limited)

• Derivative overlay or non correlated ETFs can be

taken as portfolio protection

^This represents a soft guideline. Price movement may move the exposure above this range.

Why include the Asian stocks?1. We want access to the best quality companies in Asia, at the right

price. It is the choice, but not the obligation to invest in emerging companies with strong local franchises.

2. The strong rise in the sheer number of Asians entering the middle class and the growth in disposable income suggests that this is a multi year trend that is very hard to access by restricting the investible universe to Australian listed stocks.

3. Investors appropriately diversify their portfolio by enhancing returns with a focus on the domestic demand thematic within Asia.

4. It offers Australian investors a wider opportunity set without the requirement to have money invested in Asia through a pooled vehicle.

The Chester High Conviction Fund Competitive Advantage1. Portfolio Managers with significant experience in Asia

2. Portfolio Managers with a proven long term track record in stock selection and a small FUM starting base

3. Absolute alignment of interest between the portfolio managers and the clients as we invest along side our unitholders

Chester High Conviction FundFact Sheet

Disclosure Statement: This document is for wholesale investors only. Chester Asset Management may hold positions in companies mentioned in this newsletter. This is general information and is not intended to constitute a securities recommendation. Chester Asset Management is not licensed to give advice and does not warrant that past performance is an indication of future performance. A reference to a Fund or a company as to an outlook, or possible factors affecting future performance should not be relied upon or considered as being a statement of likelihood of future performance. While the information contained in this newsletter has been prepared with all reasonable care, Chester Asset Management accepts no responsibility or liability for any errors or omissions however caused. Performance results are presented after all management and custodial fees and after all performance fees and trading costs. All fees are disclosed in the Information Memorandum and is available upon request. Before you make a decision to invest in the Fund you should obtain an Information Memorandum as it contains crucial information including risks. *We note this is a statement of fact of the performance achieved by the fund during the time which Rob Tucker was the only Portfolio Manager making active decisions on the Australia Plus Portfolio. We note performance is the record of the firm not of the individual however past performance has been constructed from publicly available unit price data.

Notes Page

Contacts

Rob Tucker

[email protected] 904 888

Anthony Kavanagh


Luke Howard


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