by Moghseen Jadwat

Leading into the end of the financial year, there is often a strong demand from individual taxpayers to make payments for expenses in advance for goods or services that will be provided over the following year.  These prepaid expenses can include payments such as subscriptions to professional associations, interest on equity loans and insurance on income-earning properties.

Prepaid expenses are subject to prepayment rules, which prescribe that a prepaid expense that otherwise satisfies all the normal rules for deductibility is often only deductible over the period in which the goods or services are provided.  However, there are a number of circumstances where a prepaid expense may be immediately deductible.  One of these circumstances is where the 12-month rule applies.

What is the 12-month rule?

Simplified tax system (STS) taxpayers or individuals incurring deductible non-business expenditure, can claim an immediate deduction under the 12-month rule for certain types of prepaid expenditure that provides a benefit for a period not exceeding 12 months and ending in the next financial year.  Generally, interest on a loan to purchase a rental property, listed shares or units in widely held trusts falls in this category, so a prepayment of such interest for up to 12 months can be fully deductible.

Deductions for prepaid expenses that satisfy the 12-month rule may assist with cash-flow planning and also allows the payer to claim the deduction a full year in advance. This may be of particular benefit to those individuals taxpayers who are likely to be on a lower marginal tax rate in the next financial year.

The following examples illustrate when the 12-month rule may apply.

i. Deduction - where the 12-month rule is satisfied.
Michael is an STS taxpayer.  On 20 June 2006 he makes an interest payment of $50,000 for his Westpac Protected Equity Loan (Westpac PEL Plus) for a 12-month period from 20 June 2006 to 20 June 2007.

The prepayment satisfies the 12-month rule because it is for a period of service of less than 12 months that ends in the next year. Michael can therefore claim an immediate deduction of a significant portion of the $50,000 in the 2006-2007 income year (please refer to the ATO PR 2004/15* for guidance around the deductibility of interest under the Westpac PEL Plus).

ii. Deduction where the 12-month rule is not satisfied
On 1 July 2005 Eve paid $20,000 to cover interest on an investment loan for the period 1 July 2005 to 30 June 2006.  Because the payment is made in the 2005-2006 year and the interest relates to the same period, the prepayment rules will not apply and the interest expense can only be deducted in the 2005-2006 income year.

iii. Deduction with an eligible service period of more than 12 months
On 1 January 2006, Robert, a senior tax lawyer at a large financial firm, paid a $2,500 subscription for the monthly provision of a professional journal to cover the period 1 January 2006 to 31 January 2007.  As the eligible service period is more than 12 months, Robert must apportion his deduction over the 2006 and 2007 income years.  Robert's deductions are calculated as follows:

by Peter Mermelas

The Situation

Mark sold an asset making a capital gain for tax purposes of $60,000 with no discounts applying to this amount.  Mark is a high-income earner and is faced with paying tax of $29,100 ($60,000*0.485) on the capital gain of $60,000.  Mark also wants to increase his exposure to the equity markets.

Action Taken

Mark's financial planner recommends Mark apply for a Westpac Protected Equity Loan Plus (PEL Plus) to put himself in a position to benefit from potential income and growth in a portfolio of ASX listed shares whilst using the potential interest deductions to reduce his tax liability.  Mark believes that he will be able to fully utilise the same level of interest deductions at least for the next five years and can successfully manage the interest payment obligations.

In June 2006 Mark applies for a 5 year Westpac PEL Plus to the value of $577,500 over ANZ, WES and TLS (based on an indicative interest rate of 12.67% p.a.).  Mark is entitled to potential interest deductions of $62,178.  Westpac has obtained an ATO Product Ruling for the Westpac PEL Plus, PR 2004/15* which states that for a 5 year loan, the ATO allows an investor to deduct the lower of the Reserve Bank Bulletin Indicator Lending Rate for Personal Unsecured Loans (currently set at 11.90% p.a.) and 85% of the total interest charged by Westpac under the PEL Plus.  This equates to a potential yearly deduction of $62,178.  This amount is sufficient enough to offset the $60,000 Capital Gain in the current financial year.

Where there is a difference between the interest charged on the PEL Plus and potential interest deductions claimed by Mark, PR 2004/15* advises that this difference should be treated as part of the cost the put Option (being the capital protection feature in the Westpac PEL Plus).  The difference is not deductible for tax purposes.

Portfolio for PEL Plus

by Anthony Lax

Annually around June 30 investors who wish to build equity portfolios will look to do so in a tax effective way.  The Westpac Protected Equity Loan Plus (PEL Plus) is a popular investment that may achieve both goals simultaneously.  In June each year individual investors are able to pre pay 12 months of interest for the following financial year and generally obtain the deduction in the financial year in which it is paid.   Sadly many of these investors and their financial planners organise their affairs too late and miss out on setting up their PEL Plus portfolio before 30 June 2006.


Of course, there is a strong case for setting up a share portfolio under the PEL Plus in other months in the calendar year, and there can still be tax benefits in doing so.  One reason behind this is the ability for individual investors to maximise potential interest deductions and manage cash flows through the use of the flexible interest payment structures offered by the PEL Plus.  Investors have the ability to switch their interest payment frequency in June from monthly in arrears to prepaying interest annually in advance.  This means that if a PEL Plus was set up in July the investor has the ability, through the flexibility of the interest payment frequency, to be entitled to 24 months worth of interest deductions in the first financial year of the PEL Plus investment.

This flexibility allows investors to manage their investment cash flows and the timing and extent of interest deductions, as illustrated in the example below.

Example

Scenario:
Sarah, who is paying tax at the highest marginal tax rate, receives a bonus in late February from her employer of $30,000.  Sarah has decided she will work until July 2006 and then leave her current employment to take a 6-month overseas holiday before returning to Australia in January 2007.  Because of her professional skills, which are in high demand Sarah and her financial planner have no fears that she will not be able to find excellent employment shortly after her return to Australia.  Sarah would also like to build her long-term wealth through exposure to Australian shares.

Solution:
Using the flexible interest payment options offered under the PEL Plus, Sarah is able to implement an investment strategy that would allow her to generate allowable deductions in the financial years when they can be utilised, in addition to managing her cash flows over the 3-year PEL Plus loan term she selected.  The size of the PEL Plus Sarah takes out will be determined by, amongst other things, her ability to make interest payments and the potential optimum level of allowable deductions she would be likely to receive under the PEL Plus.

Sarah can take the following steps to manage her potential cash flows and interest deductions:

1. As Sarah has received a bonus, she could firstly apply for a PEL Plus at the beginning of March 2006 and make initial interest payments monthly in arrears.

In June 2006, Sarah could then switch her payment frequency and prepay 12 months worth of interest in advance, i.e. prepay interest for the 2006/2007 financial year.  As a result, Sarah can potentially obtain 16 months worth of allowable interest deductions for the financial year 2005/2006.  She would not have to pay interest for the 2006/2007 financial year, while she is travelling and not deriving income.

2. In June 2007 Sarah could then instruct Westpac to change the interest payments for the 2007/2008 financial year back to monthly in arrears once Sarah is back at work.  As a result Sarah would be able to pay interest out of her monthly salary and may be entitled to at least 12 months worth of interest deductions in the 2007/2008 financial year (please refer to the ATO Product Ruling 2004/15* for guidance around the deductibility of interest under the Westpac PEL Plus).

What's more, with the Westpac PEL Plus there are no margin calls throughout the life of the loan so Sarah will not be required to make any unplanned payments.

In this example, Sarah is able to use the flexibility of structuring the interest payments under the PEL Plus to effectively manage her cash flows and potentially enhance the allowable deductions generated by this investment.  In addition, under the PEL Plus, she will benefit from all the ordinary dividends and potential franking credits associated with the shares in her portfolio. These amounts will be used under the loan to reduce the balance of the loan.  Sarah can also enjoy all upside in the portfolio without suffering any of the losses incurred by individual shares thanks to the full capital protection offered under the PEL Plus at maturity.

For more information please call your Financial Planner or Westpac on 1800 990 107.

Important information
Westpac Banking Corporation ABN 33 007 457 141, AFSL 233714 (“Westpac”) is the issuer of the Westpac Protected Equity Loan Plus (“PEL Plus). A product disclosure statement (“PDS”) is available for the Westpac PEL Plus. A copy of the Westpac PEL Plus PDS and a copy of Westpac’s Financial Services Guide can be obtained by calling 1800 990 107 or visiting www.westpac.com.au/structuredinvestments. You should obtain and consider the PDS before deciding whether to acquire, continue to hold or dispose of the Westpac PEL Plus.  This information is of a general nature and does not constitute any recommendation, tax or investment advice as to the suitability of PEL Plus.  This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs. The information in this newsletter is factual only. It does not constitute financial product advice. Before acting on this information you should seek independent financial advice to determine its appropriateness to your objectives, financial situation and needs.  The taxation position described is a general statement only and should only be used as a guide. It does not constitute tax advice and is based on current tax laws and their interpretation. Westpac financial planners are not qualified to give tax advice. The individual situation of investors may differ and investors should seek independent professional tax advice on any taxation matters.  *ATO Product Ruling The Product Ruling issued by the Australian Taxation Office is only a ruling on the application of the taxation law and is no way expressly or impliedly a guarantee or endorsement of the commercial viability of the Westpac PEL Plus, or the soundness or otherwise of the Westpac PEL Plus as an investment, or of the reasonableness or commerciality of any fees charged in connection with the Westpac PEL Plus.  The Product Ruling is only binding on the Commissioner of Taxation if the Westpac PEL Plus is implemented in the specific manner provided in the Product Ruling.  Investors should read the PDS available for the Westpac PEL Plus in their entirety and seek professional advice to determine whether or not this product meets their investment needs.  Copies of the Product Ruling can be obtained by calling Westpac on 1800 990 107. The projections given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the projections are based are reasonable, the projections may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these projections.  Information current as at 3 May 2006.

by Samantha Millward

Westpac launched its first series of Self Funding Instalments in February 2004 and the popularity of Westpac Self Funding Instalments has risen as investors have begun to understand how the investment can provide solutions to their investment challenges.

There are a number of strategies that individuals and Trustees of SMSFs can use when investing in Westpac Self Funding Instalments. This article outlines five of the strategies.



Use as an alternative to Margin Lending

Advantages in using SFIs over Margin Lending include:

• No margin calls.
• SFIs are low maintenance geared equity investments, meaning that there are no physical payments required¹ from you during the investment term.
• Margin Loans require margin calls if there are unfavourable movements in the Underlying Security price.
• Management of cashflow is automatic with the cash component of the dividends being directed to pay off the loan. Interest is added to the loan on an annual basis.
• Downside is limited through the Put Option.
• Margin Loans have no downside protection.
• SFIs provide exposure to the Share market without the obligation to acquire the full legal ownership of the underlying Securities (repaying the loan, being the completion payment, is optional).
• Margin Loans are secured with the Securities owned by the investor.
• Interest relating to the cash component of the dividend is reimbursed and used to further reduce the loan. The amount of interest is calculated from the ex-date to the next Annual Interest Date.
• You will not have to adjust your holdings of SFIs due to a fluctuation in the Securities price.
• If you are unable to satisfy a Margin maintenance call when the Loan to Value Ratio (LVR) increases, the Margin Lender may sell some or all of your Securities to protect your Margin Loan.
• You are able to relinquish your Loan obligations by selling your SFIs on the ASX at any time, or by exercising the Put Option on the Expiry Date.
• A fee may be applicable when repaying your Margin Loan early.

by Moghseen Jadwat

Leading into the end of the financial year, there is often a strong demand from individual taxpayers to make payments for expenses in advance for goods or services that will be provided over the following year.  These prepaid expenses can include payments such as subscriptions to professional associations, interest on equity loans and insurance on income-earning properties.

Prepaid expenses are subject to prepayment rules, which prescribe that a prepaid expense that otherwise satisfies all the normal rules for deductibility is often only deductible over the period in which the goods or services are provided. However, there are a number of circumstances where a prepaid expense may be immediately deductible. One of these circumstances is where the 12-month rule applies.

What is the 12-month rule?

Simplified tax system (STS) taxpayers or individuals incurring deductible non-business expenditure, can claim an immediate deduction under the 12-month rule for certain types of prepaid expenditure that provides a benefit for a period not exceeding 12 months and ending in the next financial year.  Interest on a loan to purchase a rental property, listed shares or units in widely held trusts falls in this category, so a prepayment of such interest for up to 12 months can be fully deductible.

Deductions for prepaid expenses that satisfy the 12-month rule may assist with cash-flow planning and also allows the payer to claim the deduction a full year in advance. This may be of particular benefit to those individuals taxpayers who are likely to be on a lower marginal tax rate in the next financial year.

The following examples illustrate when the 12-month rule may apply.

1.  Deduction where the 12-month rule is satisfied

Michael is an STS taxpayer. On 20 June 2005 he makes an interest payment of $50,000 for his Westpac Protected Equity loan (Westpac PEL Plus) for a 12-month period from 20 June 2005 to 20 June 2006.

The prepayment satisfies the 12-month rule because it is for a period of service of less than 12 months that ends in the next year. Michael can therefore claim an immediate deduction of a significant portion of the $50,000 in the 2005-2006 income year (please refer to the ATO PR 2004/15* for guidance around the deductibility of interest under the Westpac PEL Plus).

2.  Deduction where the 12-month rule is not satisfied

On 1 July 2004 Eve paid $20,000 to cover interest on an investment loan for the period 1 July 2004 to 30 June 2005. Because the payment is made in the 2004-2005 year and the interest relates to the same period, the prepayment rules will not apply and the interest expense can only be deducted in the 2004-2005 income year.

3.  Deduction with an eligible service period of more than 12 months

On 1 January 2006, Robert, a senior tax lawyer at a large financial firm, paid a $2,500 subscription for the monthly provision of a professional journal to cover the period 1 January 2006 to 31 January 2007. As the eligible service period is more than 12 months, Robert must apportion his deduction over the 2006 and 2007 income years. Robert’s deductions are calculated as follows:

2005–06
$2,500 x 182 / 397 (1 January 2006 to 30 June 2006) = $1,146

2006–07
$2,500 x 215 / 397 (1 July 2007 to 31 January 2007) = $1,354

Over the 2005-2006 and 2006-2007 income years, Robert will get a total deduction of $2,500.

For further information please contact your financial planner or Westpac on 1800 990 107.


Important information
Westpac Banking Corporation ABN 33 007 457 141, AFSL 233714 (“Westpac”) is the issuer of the Westpac Protected Equity Loan Plus (“PEL Plus). A product disclosure statement (“PDS”) is available for the Westpac PEL Plus. A copy of the Westpac PEL Plus PDS and a copy of Westpac’s Financial Services Guide can be obtained by calling 1800 990 107 or visiting www.westpac.com.au/structuredinvestments. You should obtain and consider the PDS before deciding whether to acquire, continue to hold or dispose of the Westpac PEL Plus.
This information is of a general nature and does not constitute any recommendation, tax or investment advice as to the suitability of PEL Plus.
This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs. The information in this newsletter is factual only. It does not constitute financial product advice. Before acting on this information you should seek independent financial advice to determine its appropriateness to your objectives, financial situation and needs
The taxation position described is a general statement only and should only be used as a guide. It does not constitute tax advice and is based on current tax laws and their interpretation. Westpac financial planners are not qualified to give tax advice. The individual situation of investors may differ and investors should seek independent professional tax advice on any taxation matters.
*ATO Product Ruling  The Product Ruling issued by the Australian Taxation Office is only a ruling on the application of the taxation law and is no way expressly or impliedly a guarantee or endorsement of the commercial viability of the Westpac PEL Plus, or the soundness or otherwise of the Westpac PEL Plus as an investment, or of the reasonableness or commerciality of any fees charged in connection with the Westpac PEL Plus. The Product Ruling is only binding on the Commissioner of Taxation if the Westpac PEL Plus is implemented in the specific manner provided in the Product Ruling. Investors should read the Product Disclosure Statement available for the Westpac PEL Plus in their entirety and seek professional advice to determine whether or not this product meets their investment needs.  Copies of the Product Ruling can be obtained by calling Westpac on 1800 990 107.
Information current as at 11 April 2006.

by Lauren Milner

In June 2004 Westpac launched its Interest Loan (IL) for the Protected Equity Loan Plus (PEL Plus) attracting strong interest amongst investors.

Normally when an investor applies for a Westpac PEL Plus, Westpac lends 100% of the investment amount to the purchase shares of their choice from the Westpac PEL Plus Term Sheet.  Investors then elect to either prepay the Westpac PEL Plus interest annually in advance monthly in arrears.

By applying for an IL, investors have the option to borrow 12 months interest on the Westpac PEL Plus.

Put simply, the IL is a fixed rate interest-only loan to fund 12 months worth of interest.  Once the loan application is accepted, investors are only required to pay the interest on the IL and then at the end of the 12-month period, the principal of the IL is due.  At the time repayment of the IL is due, investors may apply for another IL in order to pay the next year’s Westpac PEL Plus interest in advance.

Many investors see the IL as an ideal funding option if they wish to enjoy the longer-term benefits of owning leading Australian Shares for a very minimal cash outlay.

Below is an example of how the IL works for a five year, $750,000 Westpac PEL Plus where the investor has elected to borrow the first year’s interest payment through an IL.

by Samantha Millward

1. What is the Westpac PEL Plus?
Westpac PEL Plus is an interest-only loan package which enables investors to build a share portfolio with 100% borrowed funds.  Investors can lock in gains and extract cash from an existing shareholding without having to dispose of those shares.

Furthermore, there is no risk of loss in the value of an investor’s capital investment at maturity, regardless of how the share portfolio performs.



2. What are the benefits of the Westpac PEL Plus?

• Invest in the share market with no capital contribution (interest and fees are payable).
• Implement an investment strategy similar to negative gearing in property.
• Ability to protect 100% of the Loan value of the investment (i.e. there is no capital loss upon maturity).
• Maximise overall potential profits i.e. gains from profitable investments will not be offset by losses from unprofitable investments at maturity.
• Investors have access to ordinary dividends or distributions and potential franking credits.
• Trade high-performing securities to lock-in profits from any capital growth during the Loan Term.
• Benefit from potential tax deductions associated with gearing.
• No margin calls.

by Samantha Millward

1. What are Westpac Self-Funding Instalments?
Westpac Self-Funding Instalments (SFI) are a listed geared investment package that may provide enhanced returns on an equity portfolio.

With a “built-in” loan, SFI allow investors to purchase leading Australian Shares and Units (underlying Securities) in two payments or “instalments”.  After making the first payment investors obtain many of the benefits of share ownership and potentially advantages of gearing.


2. What does Self-Funding mean?
Self Funding means that the dividends investors receive for holding the SFI will be used to reduce the amount of the Loan.

Given this reduction, the Loan will also be further reduced through a reimbursement of the pro rata amount of the interest paid.

3. What are the features and benefits of Westpac SFIs?
The key benefits of investing in Westpac SFI are:

• a low maintenance geared equity “package”;
• no margin calls;
• 5 and 10 year investment terms
• no loan application or credit checks;
• the repayment of the Loan is not obligatory, although Westpac does have a mortgage over the Underlying Securities to cover the Loan. If the Loan is not repaid, Westpac will sell the Underlying Securities and use the proceeds to repay the Loan;
• cash dividends are used to reduce the Loan Amount;
• low minimum investment amount;
• ability to build a portfolio through regular investments;
• eligible for SMSF and other superannuation funds, in certain circumstances;
• potential interest deductions;
• interest is paid only on the actual Loan Amount;
• a liquid investment traded on the ASX;
• unlock cash from existing share holdings (not available to superannuation entities); and
• increased exposure to capital growth, dividends and franking credits (in certain circumstances) in a range of leading Australian Securities.

by Samantha Millward

IAG Special Dividend

On 12 April 2006, Insurance Australia Group Limited (IAG) announced that it would pay shareholders a fully-franked special dividend of $0.125 per ordinary share.

Key dates for this event are as follows:

Ex-date: 18 May 2006
Record date: 24 May 2006
Payment date: 26 June 2006


For holders of IAG shares under PEL Plus, the special dividend reduces the value of the Security that Westpac holds under your PEL Plus.  In order to preserve the value of this Security, Westpac will reinvest the special dividend of $0.125 per share to buy additional IAG shares on or about 18 May 2006.  The additional holdings will be purchased in the same name as your PEL Plus and held as security for the Loan.

For IAG Instalment holders, Westpac has elected to apply the $0.125 special dividend and the pro rata interest refund payable by Westpac to reduce the Completion Payment of its IAG Instalments.

by Steve Harris

Welcome to this month's Bluewater section of Round Up.  We are able to report on Bluewater’s performance in March 2006.

The latest official Net Asset Value ("NAV") for Bluewater A Shares have been reported by the Administrator for 31 March 2006 at $1.0391  (February $1.027).

We are awaiting estimated returns for April. These results are normally available approximately 2 weeks after month end with final results 4 weeks after month end.


Financial Market Review for February

Global equities performed strongly in March, with markets in Europe and Asia outperforming those in the US. The MSCI World index gained 2.49% in local currency, and 2.24% in US dollars. In the US, the S&P 500 gained 1.11%, while the Russell 2000 small cap stock index gained 4.72%. MSCI Europe gained 3.39% in local currency. The UK market returned 3.86% in local currency. The Japanese equity market recovered from its recent losses, as MSCI Japan gained 4.48% in Yen.

Gottex Market Neutral Fund - Allocation to Various Hedge Fund Styles

Relative Value Funds (Allocation 43%)
Event Driven (Allocation 34%)
Hedged Equities (Allocation 22%)
Tading 1%

Gottex Market Neutral Fund - Performance of Various Hedge Funds Styles

All of Gottex’s Funds posted solid gains in March, led by strong equity market returns which in turn fuelled positive returns in many equity-related hedge fund strategies. Performance was driven by strong gains in convertible arbitrage, where, despite low levels of equity volatility, bonds continue to richen from the lows that were seen last summer. They have increased their allocation to convertible arbitrage managers over the past few months and expect continued strong performance going forward.

Quantitative market neutral managers continue to deliver solid performance. Event-driven equities and merger arbitrage once again delivered good results. Gottex continue to favour these strategies in their portfolios and they have benefited from an active calendar of corporate activity combined with a good equity market environment.

The hedge fund managers that lagged in March were primarily focused on long volatility equity strategies. These are typically funds which are included in the portfolio as protection against a sudden market dislocation. With S&P volatility falling below 8% this month and returning to some of its lowest levels ever, these managers lost some value as time decay on their option positions worked against them. Fixed income and mortgage arbitrage managers are also having a difficult time generating returns that exceed Libor. The flat yield curve, low volatility and tight spreads have made it difficult for managers to find arbitrage opportunities and realize profits on their trades. Gottex have reduced their positions in these strategies over the past few months and were therefore not significantly impacted by the lower returns.

Gottex’s outlook on hedge fund returns remains positive although the second and third quarters have historically been more difficult periods for hedge fund managers to generate returns. However the technicals in the market remain positive with less capital chasing an increasing set of opportunities, particularly in the event-driven equity space. They remain cautiously optimistic on the equity market overall, but believe that markets in Japan and Asia will likely continue their strong performance. Gottex remain defensive with respect to credit risk and have maintained positions with hedge fund managers that will perform well if the volatility in the market were to increase.

Outlook

Gottex’s broad outlook for the economy and financial markets has not changed. They feel that growth will continue to be strong, while productivity growth and globalization will continue to keep a lid on core inflation. The US labour market is getting tighter but they expect the US Federal Reserve to continue to push short term rates higher with 1 or 2 more 25 bps moves the most likely outcome. They think equity markets will continue to deliver solid returns, although valuations are less compelling than they have been. Gottex like Asian equity markets from a secular perspective and they feel that the US and Europe will lag behind Asia. Merger and acquisitions activity from corporations and private equity sponsors is expected to remain robust. As a result the environment for event driven trades will continue to be attractive. Spreads remain tight on many fixed income assets, but there continues to be strong technical pressures keeping spreads low. Gottex plan to maintain relatively low exposure to corporate credit, while they are neutral on mortgage and asset-backed securities. They are positioned with a long equity volatility bias in the portfolios. Gottex maintain that equity volatility is likely to increase in the US and in Europe, while it likely to stay at its recently elevated levels in Asian markets. They continue to favour the opportunities in non-traditional hedge fund strategies.

A table showing the history of official monthly NAVs of Bluewater Class A shares is available at the Westpac website under Structured Investments.

http://www.westpac.com.au/internet/publish.nsf/Content/PBISPSSI+Bluewater+performance

If you have any questions, please contact your Financial Adviser or Westpac on
1800 990 107.

1 Sourced from the administrator, Liberty Ermitage Luxembourg SA.
Information sourced from Gottex Monthly Reports

Westpac Banking Corporation has an interest in Bluewater A Shares, and in Bluewater Funds Management SPC.

by Andrew Hanlan

Sharemarkets volatility on the rise

World share markets are continuing to rally on rising confidence in global economic conditions. In this article we update our view on economic prospects, interest rates and currencies - and assess what that means for equity markets.

The international environment is proving to be more buoyant that we anticipated, with upside surprises across a number of regions - notably the US, China and Japan. We have upgraded our world growth forecast for this year to 4.5% - up from 3.9% in December - marking the third consecutive year of 4% plus growth. The US appears to have a little more momentum - now forecast to expand by 3.8% in 2006 and China continues to power ahead, with growth likely to be 9%.

Brisk world demand is fuelling higher commodity prices - whereas we had expected 2006 to be a turning point in the cycle. Copper prices for example are surging - jumping 70% so far in 2006, building upon a 40% increase in 2005.

Prospects for 2007 remain a matter of debate. Notably, what will be the impact of rising global interest rates and sharply higher petrol prices? Our core view remains that higher interest rates will have a dampening impact and that global growth will moderate to 3.8% in 2007 - albeit a still healthy environment. However, the alternate view is that the world economy will sail on - with some forecasting growth of 4.75%.

The Aussie dollar is proving to be stronger for longer in this global environment. Rising commodity prices are supportive, as are shifting interest rate differentials. The US dollar has been on a softer trend this year, as monetary conditions tighten in Europe and Asia. The upshot is that we now expect the Aussie dollar to be around US74¢ by end 2006 - rather than US66¢ as we were forecasting back in December.

Wall Street enjoyed another positive month. The S&P500 advanced 1.2% in April and is hitting fresh post 2001 highs early in May. The gains are being driven by fundamentals. The economy expanded by 4.8% annualised in the March quarter and domestic sales surged 6%. This is translating into better than expected earnings.

Interest rates do, however, remain a key issue for US corporates. The US 10 year bond rate has jumped to over 5.10% - from 4.2% a year ago. This is adding to corporate borrowing costs and weighing on the US housing sector. A downturn in the US housing market is still in prospect - as suggested by the forward indicators.

The Australian share market is surging to record highs, increasing 2.4% in April and breaking through the 5,400 mark in the immediate aftermath of the Commonwealth Budget - to be up 13% for the year to date. The resource sector is outperforming in the current environment - with the materials sector up 21% so far in 2006. The P/E ratio suggests that the market is not yet overvalued - however, the market does tend to pull-back on those days when commodity prices fall. Moreover, the sharp run-up in metal prices (such as copper) appears to include a speculative element. But for 2006, with the world economy powering along, resource companies are likely to enjoy strong profitability.

Domestic prospects are however more mixed - with the Reserve Bank lifting interest rates by 0.25% and sharply higher petrol prices reducing consumer spending power. We don’t expect a follow-up rate rise - but the risks in 2006 are tilted to higher not lower rates. The Government’s tax cuts - giving $10 a week to the average worker - will act as only a partial offset. Consumer spending is likely to be sub-par in 2006, but not substantially so, and the housing sector recovery will be delayed. Also, the high Aussie dollar will act as a headwind for price sensitive exporters - particularly international tourism.