Amazon, Google, Woolworths, Tesla. No this isn’t an Ari Gold sales pitch(1) but rather a list of recent contract announcements by ASX companies we’ve seen greeted with enthusiastic share price reactions. Yet the reaction to government contract announcements is generally much more muted. Maybe comparing Government to Amazon as a counterparty is akin to the big value vs growth argument we’re currently witnessing but we do believe despite markets seemingly pricing in a recovery, (v, u or otherwise) in many parts of the economy, the heightened degree of certainty that comes from having government backing is being underappreciated. With the FY2021 federal budget this month drawing focus on government spending we thought it opportune to bring forward this thought piece we have been considering for some time. It is in some ways a follow-up to our April 2020 paper discussing the Defence sector(2) wherein we proposed that one of the key attractions of the sector in this uncertain environment is the strength of their key counterparty being in many cases a government department. Sugar Rush Hit or Complex Carbohydrates One thing that sticks with this writer from physical education classes at school is the lesson around simple vs complex carbohydrates. Complex carbohydrates contain longer chains of sugar molecules than simple carbohydrates which the body takes time to break down. They hence provide longer lasting energy than simple carbohydrates. We make this point because we believe there are analogies to the current level of fiscal spending and the much discussed “fiscal cliff”. In Australia; JobKeeper, JobSeeker, income support payments, early super withdrawals and other government programs have provided support during the pandemic, to the extent household incomes have actually been up over Q2 and Q3 but drop materially in Q4 (~AUD70bn) as programs are withdrawn. Many consumer discretionary names have benefited from this and experienced a sugar rush revenue surge with big jumps in like-for-like sales(3) i.e. HVN +30%, JBH +40%, SUL +30%, KGN+110%. Some of these rises are unsustainable and in some cases, like the data we have seen for gambling totes, are simply alarming. With the wisdom of hindsight, this tailwind appears obvious, but was less apparent to us in the 2Q. We have been focusing on businesses with a more sustainable benefit from fiscal spending. For example, approximately two months after our Defence paper was released the Australian Government, announced an AUD270bn 10-year package, an increase of AUD70bn (35%) from previous projections. Debt Investors price government deals differently Credit rating agencies assess the creditworthiness of corporations, i.e. their riskiness as a counterparty compared to the government. This transpires in what is called a credit spread, the difference between the yield of a corporate and treasury bond with the same maturity. Below we have included a table showing the current yields to maturity (YTM) of a handful of 10-year bonds in Australia. Source: Chester Asset Management, Bond Adviser daily rates sheet, bond rates as at 21/9/2020 The table highlights that debt investors require a return over and above that of a government bond, to be compensated for the risk of investing with that counterparty. Recently we heard the anecdote from a company that was securing debt and had jumped through hoops during previous bank diligence rounds. On this occasion that company had experienced a change in circumstances whereby they were managing assets backed by government contracts. The anecdote reminded us of the quote from the movie WogBoy “did you say government car?” whereby the bank that provided the debt didn’t even physically inspect the assets and provided a much lower rate under the knowledge they were secured against government backed assets. So, if debt investors who claim to be more stringent in their assessment of companies before allocating capital see government counterparties as less risky why doesn’t the same apply to equities? We consider this below with particular regard to ASX exposed equities and A-REITs. Equities with Government Counterparties We have performed an exercise filtering down the ASX300 to a list of companies with higher government counterparty exposure and attempted to demonstrate an earnings yield, comparable to a capitalisation (cap) rate, across the group. As we detail below, this cap rate is a function of risk, opportunity cost of capital and growth, hence we have tried to highlight some of these metrics by showing an average across the group (4). Source: Chester Asset Management, with data from IRESS, September 2020 – Noting some items here like debt cost and % of government revenue are not easily observable so are estimated by Chester A summary of some thoughts on these companies is presented below. Source: Chester Asset Management, September 2020 A-REITs We aren’t specialist property investors but do consider REITs(6) as part of our investment universe, An obvious but important point is that COVID-19 has certainly shined a light on counterparty risk. Among other things the pandemic seems to have accelerated the decline for Retail REITs(7) and created some uncertainty for the Office space, at a time when interest rates remain near record lows and there is a desire for steady income streams. Below, similar to the equities list above, we have filtered down the ASX300 REITs to some key metrics which we have averaged below. Astute readers might notice this doesn’t include retirement living(8) REITs, which we address later down the page. Source: Chester Asset Management, Company Presentation Material, IRESS, September 2020 What we note is that on a simple arithmetic mean basis Retail, Office and Industrial asset classes average out at a similar cap rate of ~5.7%, with an average debt cost of ~3.1%, WALE of 6.8 years and 96.5% occupancy for 1.2% LFL growth. Government as a counterparty represents ~9% of tenancies. We have chosen to focus on the cap rate for REITs because it is the key determinant in what these properties are worth, the inverse being the multiple at which net income is capitalised to calculate the net asset value of the properties. I.e. capitalisation rate = annual net operating income / value. There are a number of factors that can affect the cap rate of a property but simplistically these factors are: risk, opportunity cost of capital and growth expectations. We address each of these in detail below with particular regard to the retirement living operators. Risk Two key risks to assess when investing in REITs is the collectability of rent (a function of counterparty risk) and vacancy. On collectability we think the following image is very interesting, showing rent collections in the June Quarter 2020. Source: Ingenia FY20 results presentation Regarding retirement living operations rent is in most cases effectively underwritten by a government counterparty. What do we mean by this? Tenants within these communities generally receive fortnightly pension payments from the Australian Government. Upon the pension being received it is automatically debited to the accounts of the village operator (before being touched by the tenants). Additionally, particularly in the case of villages the pension is also coupled with a rental assistance rebate paid directly by the Government to the retirement living operator. I.e. the ultimate counterparty of retirement living operators is the Federal Government, hence the risk of the operator not receiving rent is potentially much lower than office, industrial and retail operators. On vacancy risk, our understanding is that lockdowns have resulted in increased demand for the vulnerable and the isolated seeking support and community. This has transpired to a material step up in inquiries within communities/villages and is also reflected in record occupancy levels of retirement villages. We further note expected tenure of tenants is ~10 years with tenants agreeing to long-term leases vs AREITs WALE average of 6.8 years. In the case of LIC tenants agree to a 90-year lease over the land their property is situated on. Opportunity Cost of Capital One company we spoke to during reporting season suggested there is material demand for quality property assets but there was a heightened focus on “beds and sheds” given the uncertainty around retail and office. Sheds refers to Industrial REITs, where cap rates for quality assets are in the 4s. We believe the conversation around beds was clearly referring to ‘Build to Rent’ as an asset class but can also extend to the retirement living space. Growth It’s hard to argue that the e-commerce trend driving the attraction of Industrial REITs isn’t a powerful thematic, but the demographic trend of an ageing baby boomer population is also quite appealing. Industrial REITs aside is the trend of an ageing population and the escalators built into leases (3.5% p.a. in LIC’s case) a potentially more attractive growth opportunity than Retail, Office or other REIT classes? We think it’s worth considering. Below we have tabled the ASX pure play retirement living providers, noting the list was longer prior to corporate activity in Aveo and Gateway Communities(9). Source: Chester Asset Management, Company Presentation Material, IRESS With potentially less risk, appealing characteristics(10) vs other REITs and attractive growth we suspect there is room for cap rate compression. At premiums to NTA this may be somewhat priced in, particularly for LIC, but we believe provides for valuation upside in the likes of EGH and INA. Conclusion The point of this exercise was not to say that every company that has government contracts will necessarily outperform those that don’t, but it does provide food for thought. I.e. it’s worth thinking about avoiding the sugar crash and considering whether it’s time to load up on carbs. (1) As seen in the TV Show Entourage, episode the Script and the Sherpa (2) Have you got your bunker in Order (3) I.e. FY21 YTD sales (4) Which can be further compared to the entire market and a FY22 growth rate (5) (Operating Cash Flow after tax excluding interest – capex)/ Enterprise Value (6) Real Estate Investment Trust (7) We don’t have space in this article to get into a debate around Retail REITs so will leave the comment at that (8) We have collectively considered land lease communities and retirement village operators (9) EGH is notably not an ASX300 company but has been considered by Chester as a company with exposure to this thematic (10) Including potential further industry consolidation

There is an asymmetry of information in markets which is one of the key reasons buyers and sellers are willing to transact at a given price, as investors try to make perfect decisions with imperfect information. So, what if we were closer to having perfect information, surely our decision making should improve right? That’s the theory of insider trading. A practice that despite the common misconception, does exist in a governed, legal form which is what we are referring to herein. At Chester we have material personal investments in our fund because we believe in what we do and believe aligning our interests with those of unit holders, enhances our stewardship of their capital. We seek the same when we invest in companies. I.e. we seek an alignment of interests between us and the board and management, which often comes with equity ownership. For this reason, we are encouraged when insiders take to buying stock and pause for consideration when insiders sell. What can be gleaned from insiders' trading? We wouldn’t want to cheapen a 50k word PHD by trying to replicate their work with a shorthand article but below we have attempted to quantify some of the historic studies to give us a point of reference on insider dealing. Despite debates around its application as a decision-making input, evidence does exist to support the notion insider dealing can lead to alpha generation. Source: Table prepared by Chester Asset Management but refer Further reading for links to referenced study This is by no means an exhaustive list and doesn’t include studies that argue to the contrary regarding insider dealing. However, it does provide evidence we have done at least some reading and provides a reference for anyone wanting to do further reading. How to interpret insider trading Following insiders' leads in buying and selling decisions is a bit like Sex Panther perfume (per the movie Anchorman), 60% of the time it works every time. This was evident in our review of historical literature and in the director trades of FY2019 and FY2020. We make the following points, some of which are somewhat obvious. Director buying has greater information than director selling. This famous Peter Lynch quote sums it up best "insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise." Without detracting from the above quote, buying is sometimes undertaken by insiders to game markets and assist capital raising efforts, a phenomenon common but not limited to small cap resource companies The closer to the coalface the better. As the Perich family may attest, executives buying and selling is a better signal than a non-executive director, given Management should have a better understanding of the day to day operations. Some papers have even gone as far as suggesting CFO trades are more profitable than CEO trades Director trading as a signal is more powerful the smaller the company Obvious point but the more directors transacting (and obviously the more material the stake) the better the signal. We have tried to show this as a % of market cap in the tables below One-off opportunistic trades (i.e. one off on-market buying) is more powerful than “routine” trades. The Cohen, Malloy and Pomorski 2010 study showed this best with 0.82% abnormal monthly return vs 0% for routine trades Insiders can often act well in advance of good news so the phrase “stay the course” is relevant Stocks with high free cash flow yields that are subject to insider buying have even stronger outperformance than low free cash flow yield purchases There can be many false flags. Just ask any investor who got spooked because Bevan Slattery sold 10 million NXT shares in November 2014 at AUD1.95/share, or 3.3 million MP1 shares in May 2019 at AUD5.11/share Director Transactions in FY19 and FY20 Most market participants will refer to Bloomberg for cues regarding insider trading but we have noted that the Bloomberg data doesn’t necessarily split insider dealing into on-market trades and other trades. While we can’t speak to the accuracy or completeness of the data contained in Market Index it does appear to offer greater information content than Bloomberg, albeit at the expense of extra manpower inputting data and working spreadsheets, to compile the following tables. We won’t provide a stock by stock analysis of each of these but in the subsequent paragraph we provide some examples of how Insider dealing has contributed to the Chester decision making process. Source: Chester Asset Management with data from Market Index Source: Chester Asset Management with data from Market Index Decision making examples While we don’t necessarily run screens searching for material director trades to identify stocks to buy, sell or avoid it does feature in our assessment of a company’s governance and in our decision making by testing or adding to our conviction. Below we have listed a subset of examples of the input of insider dealing within our process. ORA. We sold out in FY2019 given deteriorating fundamentals and management turnover. Multiple directors (MD and Chairman) selling in March 2019 contributed in our decision making to exit the position OGC. Multiple material director purchases in November 2019, including by the MD and Chairman added to our conviction in building a position. Refer Underappreciated and unloved Gold RWC. The (final) AUD367m 10% sell down and severing of ties by the original founders in February 2019, less than 12 months after the acquisition of John Guest left us very cautious and out of the name in 2019 UMG. Multiple (14!) director purchases (including executives) on-market in the past 6 months has increased our conviction in the stock MIN. Material director purchase (AUD19m) in May 2019 supported our buy on the stock right before our note, A different kind of Portfolio Manager IMD. Director selling in December 2019 provided an opportunity to test our thesis but didn’t change our decision to hold A2M. Material share disposals in August 2020 by the Chairman, interim CEO, AsiaPac CEO and other Executives leaves us cautious on the outlook for the company Energy. Multiple energy names have seen recent insider buying which has drawn our attention Technology. We have recently witnessed Directors selling in a number of technology companies above what we see as fair value for the company Owners of capital We will look to release a more detailed paper on executive remuneration and tenure in the coming 6 months but as noted in our opening, part of our thought process on insider dealing extends to the overall level of insider ownership. We find that owners of capital have much stronger alignment of interests with shareholders than non-owner stewards of capital (executives without significant stakes or long tenures) which as evident in the graph below has historically translated to outperformance. Another somewhat obvious point but the smaller the company the more likely it is for founders and owners of capital to exert more influece over the direction and success of the company, hence aligning ourselves to passionate and entrenched founders / CEOs is something we pay a good deal of attention to. There are plenty of reasons why owners of capital outperform including but not limited to the culture in the company driven by the mindest of its founders to challenge industry norms and persevere. Jeff Bezos, who is probably the most famous founder of our time, also has some of the most expensive failures was once quoted as saying, "If you decide that you’re going to do only the things you know are going to work, you’re going to leave a lot of opportunity on the table". Source: First Republic Bank Conclusion We would all love to be able to utter the phrase “I am not uncertain” in our stock selection. With information asymmetry not just a feature but one of the key reasons markets exist maybe the best we can hope for is less uncertainty. Hence insider dealing and ownership should be incorporated as factors to consider in a portfolio decision making framework.