INVESTSMART GROUP LIMITED — Net Asset Value 2007

Jun 13, 2007

Fat Prophets Australia Fund Limited ACN 111 772 359 Level 33, 2 Park St Sydney, NSW 2000 02 8258 0015 fatfund@fatprophets.com.au

May 2007 NTA Release

14 June 2007

$\ddot{\mathbf{1}}$ . Details of Performance and Net Asset Backing at Month end

The net asset backing ("NTA") of Fat Prophets Australia Fund Limited ("Fat Fund") at 31 May 2007 was \$1.3982 per share on a before tax basis, calculated in accordance with ASX Listing Rule 19:12, and represents an increase of 2.44% over the month. The Fat Fund incurred a tax liability on realised gains of approximately 0.37% during the month, which is accounted for in this figure (see commentary below). By comparison, the Fat Fund's benchmark, the S&P/ASX 300 Accumulation Index, rose by 2.64% in May 2007.

After adjusting for the impact of taxation on both realised and unrealised gains, the Fat Fund's after tax NTA at the end of May 2007 was \$1.3108 per share, undiluted for the \$1.00 strike price options which can be exercised until 20 April 2008. If all of the April 2008 options were exercised at \$1.00; the fully diluted after tax NTA/share would be \$1.16.

$2.$ Performance Commentary

The major influences on the Fat Fund's performance versus the benchmark during the month of May 2007 were as follows:

Positive Influences			Negative Influences
Company	$\%$ move	Position	Company	$%$ move	Position
UXC Limited	27.3	Overweight	Perseverance Corp	$-15.6$	Overweight
Rio Tinto	15.2	Overweight	Commander	$-17.9$	Overweight
Great Southern	15.2	Overweight	Fortescue Metals	69.1	Underweight
Tap Oil	14.7	Overweight	Westpac Bank	$-3.7$	Overweight
AMP Ltd	$-6.0$	Underweight	ANZ Bank	$-5.8$	Overweight

$\overline{3}$ . Top 15 Holdings at 31 May 2007

Company	Symbol	% Weighting
BHP Billiton	BHP	10.29
National Aust. Bank	NAB	8.29
Westpac Banking Corp	WBC	6.13
ANZ Banking Group	ANZ	5.78
Commonwealth Bank	CBA	5.68
RIO Tinto Ltd	RIO	4.68
UXC Limited	UXC	3.55
Lihir Gold	LGL	3.02
Woolworths	WOW	2.83
Perseverance Corp	PSV	2.09
Lion Selection Ltd	LST	2.03
Tap Oil	TAP	1.97
Great Southern	GTP	1.92
IAG Group	IAG	1.87
Coffey International	COF	1.81

4. Commentary - Macquarie Microcosm

The Fat Fund more than kept pace with the rise in the S&P 300 last month despite carrying a hefty 13% cash weighting for most of the period. The weighting reflects the fact that we are extremely cautious over the valuation of Australian shares in the current environment and are having great difficulty finding appropriate securities which pass the "protection of capital" test other than those in the nether regions of the microcap space.

It's worth considering the market's reaction to the result of Macquarie Bank ("MBL") in mid May as an indicator of just how blase about valuations the market has actually become. Most of the media reporting focused on the remuneration of the key individuals at the bank, the capital raising, the long term story of Macquarie and the race of two or three shares to reach the \$100/share mark. In all, a party of mutual back slapping supported by nary a whimper from the analytical fraternity of how the party might just be getting a little out of control.

MBL's \$1.9billion of reported pretax profit contained around \$1.15billion of asset sale profits of one sort or another - 60% of the total reported number. Hence, on a harsh characterisation, the reported EPS of \$5.92/share comes down to the mid \$2.40's. It's harsh because if MBL couldn't recycle its capital (jargon for buying and selling assets) then they wouldn't employ quite so many of the 10,000 plus world wide employees, reducing costs and lifting profit.

When your correspondent went to school, he was strictly told that asset sales had a P/E ratio of 1x, by adding to net asset backing. You could calculate the value of a "business" by backing out NTA at market from the value of debt and equity. Not any more. The new math says that in MBL's case, asset sales deserve (in one broker's eye) a more conservative 10x multiple. That's at least less than the others who blindly continue to capitalise low grade profits at 17x earnings plus. Hence, at the recent peak of \$97 per share, the valuation of MBL was around 38x the most conservative statement of profit and probably around 27x a questimate (no-one actually knows the answer) of a realistic statement (cost adjusted) of recurring earnings.

More pointedly, the conditions for an MBL don't get much better - reasonable economic growth and masses of liquidity to facilitate the raising of new funds, and the concomitant leverage which facilitates the acquisition of assets and earning of the Macquarie layers of fees. Whilst we are not as bearish on the Macquarie business model as others, the valuation placed upon it is rather high given where we are in the market's cycle of liquidity.

But MBL is not alone in being in this position - indeed, the company represents a simple example of why we are so cautious on domestic equities. MBL sits with a small group of other Australian companies who have taken their models and products successfully around the world into major markets. These securities (Worley, Computershare, CSL, Cochlear, Resmed. Leighton etc.) routinely trade at mid 30's multiples of current year earnings - and high 20's of 2008 - despite earnings which are either cyclical or dependent upon Government legislation.

The overall industrial market (excluding financials) is now trading at 18.5x fiscal 2008 earnings, mainly as a result of ongoing re-rating of a consistent 10-11%pa earnings growth pattern which has emerged over the past four - five years. This re-rating - which on our analysis has given investors about 8% (roughly a third) of their return per annum over the past four years of the current bull market - can't go on for ever. It certainly won't if bond yields start to rise much further – they are up 125 basis points from the low point of Ausaust/September 2005. The flip side of the strong domestic economic growth numbers announced in early June being a sharp back up in risk free interest rates. These premium rated companies are "long duration" stocks i.e. they derive perceived long term income streams, and their valuations are highly susceptible to rises in long term bond rates. We haven't seen too many downward valuation revisions of these companies as yet.

It's worth remembering in this context that if you buy a company on a P/E of 13x with 7% per annum expected growth, and another on a P/E of 23x, with 13%pa expected growth, it takes ten years for the P/E's to equalize out.

In the wake of all this, we continue to have a constructive view towards the major resources companies where further unexpected increases in coal prices and specific other metals are fuelling further upgrades to earnings and cash flow. So long as these companies repatriate funds back to shareholders in an appropriate way, given their massive returns on invested capital and the obvious barriers to entry on their patch, they remain undervalued.

Since the month end, we have further increased our cash weighting through the disciplined sale of shares which have met our price targets - Tassal Group, Tower Australia and Tower Limited as well as Espreon. Our current cash weighting is around 14%.

Sub-Contract Extension

Fat Prophets Funds Management Australia Pty. Limited ("FPFMA") and Tidewater Asset Management Ptv. Limited ("TAM") announced on 24 May 2007 that the existing sub-contract arrangement for the management of Fat Fund from FPFMA to TAM would be extended by a further two years and is now scheduled to run until 20 April 2010.

Andrew Brown^{a &} Steve O'Hanna^a

On behalf of Fat Prophets Funds Management Australia P/L

Andrew Brown and Steve O'Hanna are emolovees of Tidewater Investments Limited who currently manage $\mathbf{a}$ the Fat Fund under a sub-contract agreement dated 24 May 2007.

This report has been prepared solely for the benefit of the Fat Fund and its shareholders. It summarises information on the financial products held by the Fat Fund and the views of the Fat Fund as at the date of preparation of the report. These views and financial products may and will change after the issue of this report. No assurance can be given by the Fat Fund or Fat Prophets Funds Management Australia Pty Limited (the Manager) or Tidewater Investments Limited (the sub contract manager) as to the accuracy and completeness of the information used to compile this report. Past performance is not necessarily indicative of future nerformance

By making this report available, the Fat Fund and the Manager are not providing any general advice or personal advice within the meaning of section 766B of the Corporations Act regarding the Fat Fund, any potential investment in the Fat Fund or any investments or potential investments of the Fat Fund. This report is made without consideration of any specific person's investment objectives, financial situation or needs. The Fat Fund, the Manager and directors and employees of the Fat Fund and the Manager do not accept any liability for the results of any action taken or not taken on the basis of the information contained in this report, any negligent mis-statements, errors or omissions.