A Year of Living Dangerously My first visit to Jakarta was in 1981. If you have ever seen the movie “The Year of Living Dangerously” you will see a fairly vivid and accurate interpretation of Jakarta at that time. Arriving at Halim Airport, one was greeted by the sights of heavily armed military guards, dilapidated infrastructure, and an extremely inefficient bureaucracy working under the oppressive heat of central Java. In the movie, protagonist Billy Kwan states “most of us become children again when we enter the slums of Asia” and at that time, the entire city of Jakarta seemed like a massive slum, with beggars everywhere, the cities ubiquitous canals teeming with waste and garbage and the streets clogged with vehicles of every description spewing out clouds of smoke and pollution. I did indeed become a child in the slums of Jakarta, intimidated by its extremes but also filled with awe and wonderment at the underlying beauty and potential of the nation and people of Indonesia. My first trip to Indonesia, which occurred when I was 18 years old, was not some random event. Roughly a year prior I had applied to become a member of the Canada World Youth (CWY) youth exchange, which was the brainchild of Pierre Trudeau’s close friend Jacques Hebert. The purpose of the CWY exchange was to send young Canadians to a variety of developing countries with the intent of exploring and understanding how the proverbial “other half” lives. Suffice it to say, being chosen to attend this youth exchange (it lasted close to 8 months) was one of the great turning points in my life and it initiated a love affair between myself and this Southeast Asian nation that continues to burn brightly to this day. My most recent visit to Indonesia was to celebrate the 35 th anniversary of the CWY exchange. Of course, the Jakarta that I returned to is not that Jakarta of old. Now when one flies into Jakarta one arrives at the fairly modern Sukarno-Hatta International Airport and is whisked from the airport to the downtown in a brand new silver bird taxi that speeds down a toll road that is as modern as Toronto’s 407. My hotel, the Grand Hyatt, is spectacular in its moderness and from my hotel window the city’s horizon is filled with hundreds of modern sky scrapers, not a single one of which was built prior to 1981. This is not to say that Jakarta is perfect. The canals are getting better but remain polluted and poverty can be found easily in the side streets. But nonetheless the economic development of Jakarta has been nothing short of spectacular over the past thirty years. VOLUME XIII OCTOBER 2010 INVESTMENT ISSUES • STRATEGIES • INSIGHTS FROM DONVILLE KENT

2 ROE REPORTER | DKAM Bernanke’s Year of Living Dangerously The economic cycles of Europe and North America have been dominated by a demographic phenomenon that has been in place since the end of the Second World War – and is affectionately known as the post WWII baby boom! This surge in baby making, which began in 1946 and finished in 1964 has provided our economy with successive waves of aggregate demand which have provided a form of stimulus that has pulled us out of most, if not all, of our economic downturns over this time. However, this demographic tail wind is now long in the tooth and has begun to fade and eventually it will have the opposite effect – it will become a demographic drag. So why are demographics so important? Most Canadians are familiar with the writings of David Foot and his blockbuster book Boom, Bust and Echo . In the book he points out that households consume differently at every stage of their lives. In our early years we tend to be consumers and acquirers whereas in middle age we tend to become savers. The overall impact that each of us has upon aggregate demand is very much dependent on one’s age and tends to peak in one’s middle years only to successively fall off over time. No single consumer has any measurable effect on aggregate demand but when we look at it as an entire cohort we see that the aging effect is having an important impact on today’s economy. A demographic slowdown has therefore been in the cards for decades. However, low interest rates and the resulting expansion in leverage that occurred in most western countries over the past 10-15 years allowed aggregate demand to remain relatively robust and mask what should have been a gradually deteriorating demographic picture. With the final bursting of the debt bubble in 2008, this offsetting stimulus is now gone. In the aftermath of 2008 most western countries now face the twin pillars of weak aggregate demand due to deteriorating demographics and weak aggregate demand due to the unwinding of leverage on a massive scale. So where to from here? As we see in figure 1, virtually all developing nations are in a much better shape demographically than virtually all western countries. In the developing world strong aggregate demand comes from a large and relatively fast growing population base that is still very much centered on the prime consuming and acquiring age groups. At the same time, consumers in many of these countries face relatively low debt burdens for reasons ranging from cultural factors to underdeveloped banking systems. Regardless of the underlying factor, in the coming years countries like India, Indonesia and Brazil are likely to enjoy strong demographically driven economic growth (with little deleveraging drag) while most western economies will face slow demographically driven economic growth (with significant deleveraging drag).

3 ROE REPORTER | DKAM Figure 1 - Comparitive International Demographics % of Population India Indonesia Brazil US China Canada Germany Japan Age 0 - 14 31% 28% 27% 20% 20% 18% 14% 13% Age 15 - 64 64% 66% 67% 67% 72% 66% 66% 64% Age 65 + 5% 6% 6% 13% 8% 16% 20% 23% Source: CIA World Factbook So why this short dissertation on comparative demographics? Currently, economic headlines in newspapers from Jakarta to New York talk about a potential currency and trade war between the US and China (although I would argue that this is really a broader struggle between the developing world and the developed world). The underlying issue sees the US (the west) trying to deal with the issue of a lack of aggregate demand by attempting to tap into China’s (and other emerging markets) strong aggregate demand. This is occurring through the mechanisms of interest rates with the knock on effect that this has on currencies. This strategy goes by the intriguing name “beggar thy neighbor”. Of course, the problem here is that no nation wants to provide unlimited access to their markets via unrelenting currency devaluation. Historically, countries that devalue their currencies typically produce better economic growth, corporate profits, and therefore stock market performance. However, the opposite is also true and countries that feel they are under attack through the competitive devaluations of their trading partners will look to erect trade barriers to prevent their aggregate demand from going elsewhere via currency devaluations. Where does Canada fit in to all these currency issues? It is difficult to say if the trade tensions between the US and China will evolve into a trade war. In the meantime, commodity based economies like Canada (and Australia) are enjoying the benefits of having one foot in the western camp (low interest rates) and one foot in the emerging markets camp (strong aggregate demand). Demand for commodities ranging from Potash to Iron Ore remains extremely robust while interest rates in Canada are more reflective of the slowdown in aggregate demand that is the norm in most western countries. This provides for an extremely positive background for investors in the Canadian economy in general and Canadian equities in particular.

4 ROE REPORTER | DKAM Of course, macro indicators are all fine and good but our strategy has always been built around buying excellent businesses at good prices, and by that definition we consider an excellent business to be one with an ROE of 20% or better and providing us with at least two units of growth per unit of valuation (i.e. a G/PE ratio of 2.0x or better). In figure 3, we highlight the raw numbers on some of our largest positions and what can be seen very clearly is that we are still able to identify and own a well diversified basket of growth stocks that enjoy superb business economics (high ROE’s) with superb valuations (low P/E ratios). When we can’t find stocks with these characteristics we know it’s time to run and hide but when the macro trends remain positive and stocks are still cheap – we remain comfortable being long. Figure 3 - Cheap Canadian Stocks Relative to Growth Company Yield Mkt Cap ROAE (%) P/E - 2011 G/PE (%) ($MM) Normalised (x) (x) Constellation Software (CSU) 0.50% 921 70% 8.9 7.8 Home Capital (HCG) 1.30% 1,678 24% 7.7 3.2 Can Energy Services (CEU) 4.60% 283 23% 8.8 2.6 Direct Cash (DCI.UN) 6.80% 282 23% 9.3 2.5 Carfinco (CFN.UN) 3.90% 144 28% 11.5 2.5 MTY Food Group (MTY) 1.40% 252 24% 11.0 2.1 Paladin Labs (PLB) NA 522 22% 10.6 2.1 Altus (AIF.UN) 7.80% 305 15% 8.2 1.9 Source: Donville Kent Estimates Concluding remarks Bernanke’s “Year of Living Dangerously” does not appear to be an immediate threat to the Canadian market – for now Canada appears to be nicely sheltered within the sweet spot of the global market place. Q3 result season is just starting here in Canada and my expectation is that Q3 results season will be strong and that Canadian stocks, which have been performing well since the end of summer will continue to move higher. While concerns about a currency or trade war loom, Canada remains ideally positioned to extract the best that is available from the global economy as it stands right now. The market feels really good – call me if you want to chat – JP Donville 416 – 364 – 8886.