Steve sent me the following information for the benefit of members based on recent discussion about the change in fee structure. Hopefully it explains some of the rationale behind the change and answer some of the questions about whether the objectives have changed. ---------------------------------------------------------------- Objectives of fund at inception: (Based on historical performance of the ASX at inception of the fund) Trade strongest Blue Chip share portfolio for reasons of safety. (Risk management) Dollar Cost Trade so as not to be predictive and to produce a regular income in the order of at least 10% pa. Levy fees based on out-performance of the S&P 200 index. Trade strongest Blue Chip share for reason of safety Blue Chip portfolios by definition are conservative. The reason for such a conservative stance are based on the fact that many client investors use the Lazy dollars in their properties to create an income stream sufficient to cover their property portfolio holding costs as well as to provide an enhance lifestyle. Investors of this nature prefer the lower risk simply because they do not wish to increase the risk profile of their portfolios and of course no one wishes to place their PPOR equity at a higher risk. Historically on the Australian market, Blue Chip portfolios have matched and generally exceeded the S&P 200 index. The very conservative level of risk allows for the option to margin lend (leverage) and thus vastly increase cash flow, which one would not normally entertain, certainly not with the equity of your PPOR at risk. Dollar Cost Trade so as not to be predictive and to produce a regular income in the order of at least 10% pa Dollar Cost Trading takes advantage of market volatility to produce an income. It operates independently of upwards or downward trends in the market and should always based on ‘normal’ volatility levels produce realized profits for distribution in excess of 10% pa. The 10% projection of realized profit which is distributed each year is based on the lowest historical volatility levels of the ASX and this income level is INDEPENDENT OF THE FUND FEES, or the basis upon which these fees are charged. The basis of fees charged will affect the unit price and NOT the income level. Levy fees based on out-performance of the S&P 200 index The long term (historical) performance of the S&P 200 index is in the order of 10% to 12% pa depending on your income tax level. On historical level the expected out performance in NORMAL MARKET CONDITIONS, based on current performance since inception, would be as follows: Fund Performance since inception: (As at 31st March 2007) $1.00 at inception = $1.87 22.26% average per year Performance fee based on out-performance against normal market condition would thus have been: 22.26% - 12% (assuming lowest tax rate) = 10.26% out-performance. 10.26% out-performance at 0.394625 = 4.05% per year. At inception when this basis of fee collection was suggested everyone seemed very happy that this was fair. After all, the fee would come off the ‘cream’ as has been suggested. Normal market conditions HAVE NOT existed since exception. In fact the S&P 200 index has performed at about twice the historical average these past few years. The NavTraDe system has produced everything asked of it: It has out-performed the actual shares it has traded. (Blue Chips) Please note that the S&P 200 index has outperformed Blue Chips every year since inception. (This is not normal in the long term, and generally only happens at times of low interest rates.) Income distribution average of 15% per year has been produced, which is 50% higher than was suggested. A fund manager cannot predict what a market will do and can only perform in terms of what market conditions dictate. Perhaps some would feel happier to have paid over 4% in fees each year had the market performed at the average 12%, rather than ZERO fees with a market performing at 20%+ The performance of income at 15% per year has been exceptional, especially when combined with being able to leverage such a safe (Blue Chip + DCT) portfolio. Example: (Without capitalized interest) 15% income return x 2 (50% margin loan) = 30% income return per year Less cost of the margin loan of 8.5% = 21.5% Even assuming that the original funds were borrowed from a LOC at 7.37% rate, then the return = 14.13% The cash flow position with correct structuring (capitalized interest) would be: 30% income less LOC rate of 7.37% = 22.63% It is this very CASH FLOW that allows the investor to hold many, many much more growth asset like property. (Which ultimately is where the wealth as in capital growth is created.) The market has performed abnormally for 4 years since inception allowing for only minor fees to be produced against such market conditions. The choice remains: close the company down and return the unit holders funds to them levy the very reasonable fixed fee and continue to produce the excellent returns as mentioned above. I might very strongly suggest that if given the choice upfront that market conditions would be double the historical average in the next 4 years, that all investors would VERY HAPPILY have opted for a 1.5% fee and 15% income each year. The markets are exceptionally high at this time, hence the funds holding over 40% in cash at this date. This is a very defensive stance and offers best protection against a market decline. Some might choose to think that current upwards trends will persist forever . . . I don’t think so. Based on a 20% market decline at our current holdings, the fund would out-perform the index by in excess of 12%. (Simply because of the amount of cash holdings) This would result in a fee of 4.74% of FUM = $185 million x 4.75% = $8.76 million. Amortize that back over funds under management held each year and it represents MORE THAN DOUBLE what a 1.5% fee would accrue. Yes I am thus tempted to carry on with the performance only fee simply because I don’t believe that current market conditions can persist . . . but can you imagine the outcry if we do accrue such an enormous single fee, especially post a market crash. In fairness to unit investors and share holders the choice to change to the fixed fee, after operating almost fee free for 4 years appears to be the best balance. Lastly, the best way of looking at this is that assuming a 1.5% fee from now until year 10, then the average fee over the 10 years will be 0.90% per year on the retail fund and 0.66% on the wholesale fund. Steve Navra. .