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INCOME SOLUTIONS FOR LIFE | PAPER 1

INCOME SOLUTIONS FOR LIFE | PAPER 1

www.leggmason.com.au/income-solutions-for-life 1800 679 541 | enquiries@leggmason.com

INCOME INVESTINGIN A LOW INTERESTRATE WORLD

We are now in a world where interest rates are at record lows and the reality is that they are likely to remain so for some time to come. Interest rates have fallen over 75%* in the past seven years posing income investors with a sizable challenge.To earn the same dollars of income from term deposits today requires an investment of up to four times as much as it did in 2008.

In this white paper, we outline what you need to know before dispelling some myths and offering some solutions about income investing in a low interest rate world.*Source: RBA

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INCOME SOLUTIONS FOR LIFE | PAPER 1

3% p.a.

Less than

What you need to know

2010: 2017:

8% p.a.

Term deposits falling short of living expenses

Inflation protection is a critical ingredient in any income solution

We are living longer, so growth of income matters

on a 5 Year Term Deposits

on a 5 Year Term Deposits

In 2010, one of Australia’s leading banks offered its customers a five-year term deposit rate of 8%. Today that same bank is offering less than 3% on a five-year Term Deposits and a little over 2% for a more popular 90-day term.

The steady fall in interest rates over the past seven years has exposed investors to heightened income risk and inflation risk - the risk that the real value of an income stream declines as the cost of living rises. As seen in the chart below, living costs have continued to rise as term deposit rates have continued to fall.

As an example, investing in a term deposit that has an interest rate of 3%, when inflation is running at 2.5%, means that, even though an investor is earning a nominal return of 3%, inflation is eroding 2.5% of that, leaving the investor with a real (inflation adjusted) return of just 0.5%.

For investors to be able to maintain their spending power and to protect, as well as maintain, their living standards they must ensure their income stream grows at leastin line with inflation. This is particularly importantfor people as they enter retirement, when they are likelyto incur increased costs in areas such as healthcare.

As every year passes Australians are living longer and this trend is forecast to continue. As we live longer there is growing risk that we outlive our savings – this is known as longevity risk. According to the Australian Treasury’s Intergenerational Report 2015, life expectancy for a man aged 60 in 2015 was for another 26.4 years and for a woman 29.1 years. By 2025, a man aged 60 can expect to live another 27.9 years and a woman 30.3 years.

With a relatively fixed capital base, inflation protection should be a central consideration in any retiree’s medium to long-term financial plan.Martin Currie research shows that over the past 20 years income needed to grow a total of 63% to offset the loss of purchasing power from inflation.

Investors in income products are looking for income streams that will allow them to maintain their living standards. This is a critical issue for people entering retirement, and to achieve this goal they must tackle income risk – the danger that the income paidby an investment will fall in response to interest rate changes and other factors.

Past performance is not a guide to future performance.Source: Martin Currie Australia, RBA, ABS, through 31 December 2016.Next 12 months expected income is calculated using the weighted averageof broker consensus forecast DPS of each portfolio holding.

Past performance is not a guide to future performance.Source: Martin Currie Australia, Factset. Starting with $100 income requirement in year 0, increasing anually in line with 2.5% p.a. inflation consumption. Data shown or illustrative purposes only.

Dec/10D ec/11 Dec/12 Dec/13 Dec/14 Dec/15 Dec/16

Income from Best Rate Term Deposit

Cost of Living - Australian CPI

$2,00

$4,00

$6,00

$8,00

$10,00Years

Inco

me

p.a.

100

110

90

80

05 10 15 20

63%

120

130

140

150

160

170

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INCOME SOLUTIONS FOR LIFE | PAPER 1

Source: Australian Treasury Intergenerational Report 2015

Australian’s projected life expectancy (years)

Life expectancy at birthMenWomen

91.5 92.6 93.6 94.4 95.193.6 94.5 95.3 96.0 96.6

26.4 27.9 29.3 30.5 31.529.1 30.3 31.5 32.4 33.3

16.9 18.2 19.3 20.4 21.319.3 20.4 21.4 22.3 23.1

2015 2025 2035 2045 2055

Life expectancy at age 60MenWomen

Life expectancy at age 67MenWomen

Investors seeking income should focus on solutions that can provide a sustainable, growing and real(after inflation) income stream, while also protecting their capital base. In our view, this requires a change in investor behaviour and the need to challenge some traditional investment approaches.

Income received from A$100 invested 15 years agoPast performance is not a guide to future performance.Source: Martin Currie Australia, Factset, RBA; as of 31 December.*S&P/ASX 200 Accumulation Index**Average ‘special’ rate (all terms).

Volatility over last 10 yearsPast performance is not a guide to future performance.Source: Martin Currie Australia, Factset, RBA; as of 31 December.*S&P/ASX 200 Accumulation Index.**Average ‘special’ rate (all terms).

Dispelling the MythsIt would be easy for investors to succumb to the steady stream of headlines and market noise that, for example, highlight the perils of investing in equities and the constant focus on short-term market movements.While this news can at times be relevant, what shouldbe of primary importance to income investorsis a sustainable and growing income stream.

The chart below compares the volatility of Australian share and term deposit income over the last 10 years. The volatility of the income stream from term depositsis more than double that volatility of the dividend stream from Australian equities, and the income from dividends is materially higher. The focus for investors needs to change from valuing total returns to valuing income returns both today and in the future.

The Myth: Most investors are familiar with the conceptof capital volatility. We know, for example, that share prices go up and down. The advantage of term deposits and fixed annuities is that they do not have the capital volatility of shares.

The Reality: As an income investor, the volatility of the income stream should be the first concern. As the next chart shows, the income generated from an investment in the share market has outstripped what would have been received from a term deposit and has widened significantly in recent years.

Myth 1: Hidden volatility – focus on the income stream

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INCOME SOLUTIONS FOR LIFE | PAPER 1

The Myth: The basic concept of an annuity is that it provides the investor with a secure income streamfor a specified period of time. The capital is protected, providing the investor with apparent peace of mind.

The Reality: An investor can pay a high price for‘peace of mind’. Before investing in an annuity it isworth keeping the following questions in mind:

Will it allow for my capital to grow?

Will it protect against longevity risk?

Will it protect against inflation risk?

Does it provide sufficient income?

What are the underlying fees?

What happens to the annuity in the event of my death?

Does it incorporate any flexibility and liquidity?

Relying solely on a term deposit or annuity to delivera sustainable income stream is not realistic due to current low interest rates and the ongoing risks associated with these types of solutions. As with any investment strategy, a balance of different assets, approaches and styles is optimum in meeting desired outcomes

Myth 2 : Term deposits and annuities – not theonly solution

Think carefully about diversificationIn a traditional asset allocation approach the greater the diversification the better! However, care needs to be taken in building a diversified income solution for Australian investors. Remember that the cost of living and inflation risks that Australian retirees face are largely Australian in nature and therefore it makes sense that the invested assets match that risk.

In addition, we are fortunate that the Australian market provides relatively high levels of income which enables fund managers to construct investment solutions tailored for a retirees needs.

Past performance is not a guide to future performance.Source: Martin Currie Australia, Factset; as of 31 December 2016. Data shown for illustrative purposes only. Based on the representative Martin Currie Australia Real Income account. AREIT: S&P/ASX AREIT Index, Global REIT: MSCI Global REIT Index, Global Utilities: MSCI. Global Utilities Sector Index,Global Infrastructure: MSCI World Core Infrastructure Index, US REIT: S&P US REIT Index. *Assumes zero percent tax rate and full franking benefits realised in tax return.

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INCOME SOLUTIONS FOR LIFE | PAPER 1

How Legg Mason can helpAt Legg Mason we have purposefully developed our range of income solutions to meet the needs of Australian investors seeking sustainable income. This suite provides investors with a high level of flexibility, whether it is playing a specific role within a client’s broader investment strategy or providing an all-encompassing ‘one-stop’ income solution.Since 2010, Legg Mason has been a pioneer of income investing, having recognised that future interest rate falls would cause stress across client portfolios.

The picture above illustrates our Diversified Income Strategy, which is designed to be a one-stop income solution investing across four underlying asset classes with the objective of delivering a growing and sustainable income stream.Each of the underlying building blocks – Australian equity, Australian real assets, Australian fixed income and cash –is managed by an experienced and dedicated team with a strong track record.

Any reference to “Legg Mason Australia” or “Martin Currie Australia” is a reference to Legg Mason Asset Management Australia Limited ABN 76 004 835 849 AFSL 240827. Martin Currie Australia is a division of Legg Mason Asset Management Australian Limited. Neither Legg Mason Australia, nor any of its related parties, guarantee the repayment of capital or performance of any Fund referred to in this document. Past performance is no guarantee of future performance. Applications to invest in the Legg Mason Martin Currie Real Income Fund (ARSN 146 910 349) can be made using an application form comprising part of the current Product Disclosure Statement, which is available from our offices or on our website at www.leggmason.com.au. Certain eligibility criteria applies. Legg Mason Australia does not guarantee the accuracy or completeness of this document. To the extent permissible by law, Legg Mason Australia accepts no liability in contract, tort (including negligence) or otherwise for any loss or damage suffered as a result of reliance on this document. This paper has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person. Before making an investment decision you should read the Product Disclosure Statement carefully and you need to consider, with or without the assistance of a financial advisor, whether such an investment is appropriate in light of your particular investment needs, objectives and financial circumstances. Investments are subject to risks, including but not limited to possible delays inpayments and loss of income or capital invested. These opinions are subject to change without notice and do not constituted investment advice or recommendation. Legg Mason and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only and is not intended to provide and should not be relied on for tax, legal or accounting advice.

DESIGNED TO DELIVER A SUSTAINABLEAND GROWING INCOME STREAM

DiversifiedIncome

EquityIncome

RealIncome

FixedIncome

Pioneers andinnovators of

Income Solutions

Avoidcomplexity, deliver

transparency

Aligned witha client’s realworld income

objectives

LeverageLegg Mason’smulti- affiliate

income spectrum

Capital growth potentialFocus on qualityInflation protectionLiquidity

Designed withincome as the

objective not just an outcome

Tax optimisationMinimise longevity riskLower volatility

Legg Mason Income

Building Blocks