INVESTSMART GROUP LIMITED — Net Asset Value 2008

Oct 13, 2008

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September 2008 NTA Release

1. Details of Performance and Net Asset Backing at Month end

The net asset backing (“ NTA ”) of Fat Prophets Australia Fund Limited (“ Fat Fund ”) as at 30 September 2008 was $0.9425 per share ex dividend on a before tax basis, calculated in accordance with ASX Listing Rule 19:12. Adjusting for the 2.75c per share dividend paid on 23 September 2008, this represents a decline of 9.59% over the month. By comparison, the Fat Fund’s benchmark, the S&P/ASX 300 Accumulation Index decreased 9.94% in September 2008.

After adjusting for the impact of taxation on both realised and unrealised gains, the Fat Fund’s after tax NTA at the end of August 2008 was $0.9852 per share . Given the recent volatility of market, shareholders should be aware that the subcontract manager estimates that the unaudited pre tax NTA of Fat Fund derived from portfolio valuations (not management accounts) as at the close of business on 13 October 2008 was approximately $0.8776 per share .

2. Performance Commentary

The major influences on the Fat Fund’s performance versus the benchmark during the month of September 2008 were as follows (* denotes acquired during month):

Positive Influences	Positive Influences	Positive Influences	Negative Influences	Negative Influences	Negative Influences
Company	% move	Position	Company	% move	Position
QBE Ins 11% Overweight Lihir Gold 17% Overweight NAB -1% Overweight Lion Selection -1% Overweight Woodside -19% Underweight			Beach Petroleum -21% Overweight Telstra -4% Underweight Bravura -51% Overweight Mundo Minerals -27% Overweight EBI Alt Inv Trust -19% Overweight

The performance of the Fat Fund in September is of limited relevance in light of October’s events, where the ongoing crisis of confidence between financial institutions and their interaction with the investing public has seen further severe falls in stockmarket indices.

As a starting point, the discovery for many of “risk pricing” has come about in the saddest manner. UK savers entrusting their nest eggs to Icelandic banks might have thought twice if they realised the three institutions had an average €407,400 of assets per person in Iceland – a country with the same population (320,000) as Coventry. By way of comparison, the Big Four Australian banks combined have the equivalent of about €52,000 per capita. This provides a stark illustration that the current contagion is now like no other before it.

It clearly contains elements of each of the three hitherto most cited equity market downdrafts: centering on 1929 - 31, 1973-75 and 1987, but is best described, as being a dramatically more exaggerated (in every sense) version of the 1997 and 1998 crises. Whilst tempted to write a doorstopper on the current crisis (someone will), at this juncture we’ll try to briefly place our thinking in perspective.

FAT PROPHETS AUSTRALIA FUND LIMITED ACN 62 111 772 359

Level 33, 2 Park St, Sydney NSW 2000 telephone 02 8258 0015 fatfund@fatprophets.com.au

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It is hard to fault the responses of most central banks and Governments to the current situation. The 1930’s cataclysm is seen in hindsight as a failure of free trade and the US banking system, which prompted the instigation of deposit insurance as well as separation of investment and commercial banking; the 2008 response has been to nationalise failing institutions, and re-emphasise depositor insurance as well as flooding the system with liquidity. Similarly, the origins of 1973-75 bear no resemblance to the current difficulties: the breakdown of currency convertibility, rampant inflation, and in the worst of the developed markets at the time, the UK (down 68% from peak to trough), significant industrial unrest. Policy responses in the UK were particularly poor with credit controls and tax increases heightening the gloom brought on by the Three Day Week.

The current situation is arguably an outrageous version of the 1998 crisis; unlike LTCM and the Russian Government, modern day derivative markets have simply run out of control, and no private sector balance sheet has proved capable of coping with the leverage. The inter-connected nature of global credit and retail deposit markets, has heightened the contagion, despite the best efforts of regulators and central bankers.

That we have reached uncharted territory of modern day fear is clear from all measures of risk and volatility; at the time of writing, the yield on junk bonds is around 14% higher than that of a US Government bond, and the volatility priced into US stock index options is in excess of 60% per annum. Given that these two measures were at the absurd levels of 2.4% and 11% in mid 2007, the magnitude of shift in such a short time span, in the variables underpinning the pricing of financial assets is astounding. For financial institutions stuck in a rigid mark to market regime, the impact of this rapid shift is untenable.

In circumstances such as these, it is hard to be anything but bullish - providing you have a sound asset base and manageable liability profile. Yes you read it correctly. As an ungeared LIC, the Fat Fund is in this situation despite being relatively fully invested over the past few months. It is now clear we went early on some securities, but many of our shareholdings are priced at a fraction of attributable value – a price destruction which has taken place over a period of only weeks.

When looking at value, we are trying to factor in some level of slowing in economic conditions. The key difference going forward for economic policymakers will be to prevent the ongoing successive crises of confidence in markets, whereby greed is perpetuated by use of (cheap) liquidity injected to avert the previous crisis. Remember, the depth of depression in August/September 1998 as LTCM was wound down and the Russian Government defaulted on its debt, was shortly supplanted by a ludicrous boom in conceptual dot.com stocks rocketing to a zenith in the subsequent eighteen months. Government intervention in the current crisis, merely over the past month, is on a scale hitherto unseen: Fannie Mae, Freddie Mac, AIG, in the US and the UK Government engaging in actions which dwarf what it did in 1974-5. The nationalisation of Bradford & Bingley, forced merger of HBOS, increase in deposit guarantees and most of all the willingness to invest in preferred banking equity and flood the market with liquidity is unprecedented in the country’s recent history. The 1975 New Years Day rescue of Burmah (which liberated Woodside) is small beer indeed.

These bailouts will come at a price – a profit for Governments to unwind their equity positions – but the ultimate price will be greater regulation of the more byzantine areas of financial markets. The credit default swap (CDS) market – the beating heart of this particular crisis - has no reasonable use whatever, with no private sector institution holding a balance sheet to singularly pay out default of a whole asset class. Like open-ended property trusts, they belong in the wastebin, together with various other toxic derivative instruments, the inventions of greed and self interest rather than economic value creation. Just last week, ingrates and speculators on both sides closed out their positions in respect of Lehman Brothers CDS – a staggering US$400billion with a gross loss of US$365billion (although net losses are estimated at only US$8billion) against a last disclosed on-balance sheet debt position of US$163billion.

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For investors, there is a double edged sword. The de-leveraging process now being undertaken is akin to “cold turkey” for the addict: painful and uncomfortable but ultimately good for you. It is providing once in a lifetime (yes, lifetime) opportunities to make new fortunes from vulturing assets at a fraction of their real worth, if the finance to do so is available. The Commonwealth Bank deal to acquire Bank West is a good case in point. Forget that they are banks – it’s a distressed holding company selling a division to a strategic buyer, at $600million under the buyer’s entry cost. Other deals will slowly emerge from the woodwork, with investors slowly but surely willing to back the acquirer by putting up equity (and debt) on reasonable terms. For the time being, cash holders can write their own tickets, as Warren Buffett has done already with GE and Goldman Sachs – 10% preferred stock with five year at the money options. We are clearly cognisant that the deleveraging of zero priced risk to hitherto unseen prices demanded for risk is occurring very rapidly. Further evidence that these type of deals are happening will be a strong sign of confidence returning to markets.

The toughest part will be to assimilate the inevitable slowdown in economies despite the injections of cash. Consumer confidence has been rocked, and within Australia, as with most developed countries, the demographics of retiring baby-boomers dictate that stockmarket collapses (as with property) have a real wealth effect. Reconstructed hippies have been amongst the most demographically advantaged people in history, growing up at a time of low real asset prices, which then exploded, as well as being the first mass generation who inherited significant net worth from their parents through the property market. We can’t econometrically model the impact of declining stock prices at or close to retirement, let alone the multiplier effects the (wealth not income) weakened consumer will have. As we saw in the early 1990’s in the wake of the junk bond/S&L debacle in the US, markets have a habit of clearing more rapidly than students and academics imagine. Don’t forget that stockmarkets bottom well ahead of the trough in the real economy.

The Australian banking system has been staggeringly strong in the wake of events elsewhere. This largely reflects a more conservative stance towards lending to leveraged structures some two to three years ago as well as an enshrined lower LVR approach to residential property than US or UK counterparts. It is notable that most parts of Continental Europe, which have a very conservative approach to residential property lending, have been immune from losses in that area; the tendency has been to squander these benefits on US toxic property waste in the investment banking area. Whilst Australia will have its corporate disasters in a few mini-reprises of 1987-90 (“you only get one **** in your lifetime and I’ve had mine”); in the main they are likely to be contained to the financial asset traders rather than the wider economy. (aren’t you glad the LBO of Qantas didn’t happen…?) Many of the assets are held offshore and the damage to these structures was done very quickly given their reliance on negligible pricing of risk.

However, the biggest systemic economic imbalances are now starting to appear as a result of the RBA’s ludicrous monetary policy stance over the past three years. The flight of hot money out of A$ assets in the past three to four months as a reducing yield premium of the A$ over US$ money is compounded by falling commodity prices and the global desire for US$ as a reserve currency. Whilst the 1% reduction in official rates by the RBA in early October is very welcome, there should be many more to come. The main damage to the currency has been (over)done and the A$ looks very cheap on any medium term view. It’s decline from mid July has restricted the translated prices of hard hit commodities to falls of around20-25% rather than the 50%+ US$ falls seen since that time as traders liquidate all positions for cash and respond to a perceived slowing of Chinese growth. There are many emerging bargains in the resource area, although they now require a longer term view of assets rather than earnings. For the first time in five years, broker analyst commodity price forecasts are above spot levels – materially so. The forthcoming downward earnings revisions, even if spot prices rebound sharply, are likely to be ugly. We continue to stick to the diversified majors with a sprinkling of gold and oil, where none of the shares ever reflected the spike in prices of the underlying commodity.

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With ten year bond yields at 5%, Australian stocks on a trailing PE basis are as cheap as they have been in well over two decades versus bonds – since the inflationary impact of the 70’s and 80’s was squeezed out of Australia. Even ascribing an extremely poor environment for corporate earnings over the next two years. stocks remain very cheap on a forward basis. We can find vast swathes of the market trading at well below long term value, in companies which will be around for the future. Outside of the financial (including property) sector, corporate gearing is generally modest.

We acknowledge having moved to invest our cash reserves early, when valuations were attractive, at some cost to the fund’s absolute (not relative) performance. We are investigating moves to cautiously gear the fund, within the parameters allowed, but have not doe so yet. In the past month, the Fat Fund has traded at the fringe with some additional money committed to Rio Tinto; our main exercise has, however, continued to be to repurchase our own shares, which provides us a very cheap quality portfolio at upwards of a 15% discount to NTA. We remain overweight financials, very large cap resources and investment companies whilst underweight basic industrials. Whilst aghast at some of the abuses we have witnessed, we too now have the “greed gene”, but only from buying vastly undervalued securities.

3. Top 15 Holdings at 30 September 2008

Company	Symbol	% Weighting
BHP Billiton	BHP	12.33
National Aust. Bank	NAB	7.82
Westpac	WBC	7.74
Commonwealth Bank	CBA	6.69
QBE Insurance	QBE	5.12
ANZ Bank	ANZ	4.62
Woolworths	WOW	4.28
RIO Tinto	RIO	3.39
Lion Selection	LST	3.15
Soul Pattinson (W.H)	SOL	2.90
St.George Bank	SGB	2.55
Beach Petroleum	BPT	2.53
Lihir Gold	LGL	2.34
GPT Group	GPT	2.20
Everest Babcock & Brown Alt. Inv. Trust	EBI	2.16

Andrew Brown[a & ] Steve O’Hanna[a ] 14 October 2008

• a: Andrew Brown and Steve O’Hanna are employees of Tidewater Investments Limited. A controlled entity of Tidewater Investments Limited, Tidewater Asset Management P/L (AFSL# 302802) currently manages the Fat Fund under a sub-contract agreement dated 24 May 2007 with fat Prophets Funds Management Australia P/L.

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 Asset Management Pty. 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 performance. 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.