Glenn Freeman: I'm Glenn Freeman for Morningstar and I'm joined today by Martin Conlon, head of Australian equities with Schroders Investment Management.

Martin, thanks for joining us today.

Martin Conlon: Thanks for having us, Glenn.

Freeman: We're discussing your Australian Equities Fund today, which last month won the Morningstar Fund Manager of the Year Award for its category. What's the role of Australian equities within an investment portfolio?

Conlon: I think probably taking it back to simple building blocks, equities are always for me an important part of any portfolio just on the basis that companies provide the cash flows that provide the returns on just about all investments.

Australian equities clearly just need to be viewed in terms of like any other equity around the world. A business that makes money and is profitable and generates returns over time, that's how investors make money.

Yes, there are some issues there on the diversification in the Australian market and the dominance which banks, et cetera, obviously have in that index courtesy of their profitability over time. But on the positive side, I think, things like franking the extra tax benefits that domestic investors get will still mean that domestic equities will and always should be a fairly significant part of any Australian investor's portfolio.

Freeman: Active management is something that Morningstar measures on a regular basis. How active is your fund and what's your view on the debate around the level of active share in managed funds?

Conlon: I think it's a really good question. But the way we tend to look at it is that you don't want to just be active for the sake of being active. It's got to make sense.

And there will be times that the large companies being large elements of the profit within the Australian economy are undervalued and perhaps they might be the best investments and that means sometimes you want to gravitate towards the index or the bigger constituents in the index. Sometimes you want to gravitate away.

You don't just necessarily want to say, I'm always going to be underweight those big stocks and overweight the smaller end of the market, which is how a lot of people get their active share.

You want to let that outcome fall out rather than be a premeditated outcome. And certainly, with a lot of the trend towards ex-20 funds, et cetera, that has happened over the recent times, we think a lot of money has shifted out of the larger end of the market and towards the smaller end.

And if anything, at the moment, you might be in a situation where most of the overvaluation is actually at the small end.

Freeman: And Martin, which type of retail investor will find most value in your Australian shares fund?

Conlon: It's a bit of everything, but honestly, for us, it's far more about the mentality of the investor and the ability for them to match their timeframe with ours, because we are long-term investors.

We tend to have pretty low turnover. We're looking at making money in the medium to long-term. And that sometimes means that you're prepared to depart a lot from the index and people will have to stomach some volatility versus the index.

Unfortunately, we tend to measure risk relative to the index as the risk list position. That to us is sometimes a bit of a crazy thing to do. But from our perspective, the most important thing is to say, if you want to make money, you got to make sure that your timeframe is focused on investing in a business because it's going to make money in the long run, not because you're speculating and trying to punt, if you like, better than the next fund in the short run.

Freeman: Just finally, what areas of the Australian market are you most bullish on and are there any parts that you think investors should be cautious about?

Conlon: We still probably tend towards finding the most value in resource stocks. Obviously, they've been through significant ups and downs over the last four or five years.

But we often look at it and say, Australia is where it is because we've got good low-cost resources that have made the country money for a long period of time. Yes, commodity prices will always be volatile.

But actually, these are very good long-duration businesses that tend to make good money and as long as you're prepared to take the rough with the smooth, then the long-run outcomes we think will be pretty reasonable. And in terms of where valuations sit, that tends to be where we still find the most value.

At the other end of the spectrum, with very low interest rates and an environment where people still have a reasonably avaricious for yield, then we found a situation where a lot of defensive assets that provide income are trading at elevated valuations.

Sectors like healthcare, albeit that they might have reasonable demographic tailwinds, et cetera, are trading at very aggressive valuations and there is a fair amount of speculation in technology, things like that.

So, we think you got to be a little bit balanced. Risk appetites are pretty high. Speculation is running high in the equity market. It's running high in the property market. That to us says that the opportunity and the time to take risk, an aggressive level of risk is probably not now and you better off looking to more fundamentally-based cash flows that are at more attractive valuations.

Freeman: Thanks very much for your time today, Martin.

Conlon: No worries. Thanks Glenn.

Freeman: I'm Glenn Freeman for Morningstar. Thanks for watching.