Linking Science and Systematic Investing Extracting Value in a Low-Return World

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1 01/ / / / / / / / / / / / / / / / / / / / / / / / / / / / /2017 DuraWealth Linking Science and Systematic Investing Extracting Value in a Low-Return World Miroslav Durana, PhD, mdurana@durawealth.com, Wayne Cawood, wcawood@durawealth.com, Jean de Skowronski, jdeskowronski@durawealth.com, Pierre Montézin, pmontezin@durawealth.com Outline Executive Summary Projected lower annual returns by 2021: 3%-6% for equities and below for high grade European bonds A Transforming World: the rise of Industry 4.0 and its net positive effects The DW Global Disruptive Innovation Index couples both, higher returns and societal transformations Appealing valuations and financial health of the DW index equity portfolio strengthen its investment case... 4 Conclusions... 5 References... 6 Biographies... 6 Note and disclaimer... 6 Executive Summary In the current fast transforming world, DuraWealth manages equity investment solutions that reflect this reality. Today s very low interest rates (see Fig. 1), with projected increases of just (depending of country) for 2017 and beyond, lead investors to the quest for new investment products that replace lowyielding bonds and other credit instruments. This increasing demand for new investment products is furthermore supported by modest growth prospects and the vital need to address societal, environmental and technological challenges 1-4. In this context, the two DuraWealth global equity index strategies are part of the responsible investment framework (see Fig. 2). These strategies have been delivering alpha by outperforming the MSCI World Equity AC Index net returns since July 2007, in both bull and bear markets, as shown in Fig. 3 and in our latest study 1. The current research study focuses on reasons for the expected lower investment returns key drivers transforming our society their impact on the global economy beyond 2020 the equity investment solutions reflecting this transforming world and delivering higher returns vs main asset classes. The two DW global equity indexes, with core methodologies developed in 2007 and 2008, feature real track records and generate superior alpha in global portfolios 1. Since January 2010, the DW Global Disruptive Innovation Index outperformed the MSCI World Equity AC Index net total return by 10. p.a. in USD and 10.4% p.a. in CHF (see Fig. 10). The relevance of sectoral investing, its diversification effect and risk-return benefit in global portfolios, including balanced and pension portfolios, will be described in our next study. 1. Projected lower annual returns by 2021: 3%-6% for equities and below for high grade European bonds Thanks to the exceptional economic and business conditions of the last 30 years, US and Western Fig. 1: Ultra-low or negative money market interest rates [%] since January 2015 (Source: FED, ECB, SNB, FIS, DuraWealth) Fig. 2: Responsible investing streams: SRI i.e. «Socially Responsible Investing», ESG i.e. «Environment, Social, Governance» (Source: Impact Space, Burckart Cons., DuraWealth) Fig. 3: Both DW Global Equity Indexes outperform the MSCI World Equity Index in both bear (in 2008 and 2011) and bull markets (Source: S&P Dow Jones, FIS, DuraWealth) 2017 Durawealth Ltd Refer to the disclaimer on page 6 1/ New investing era with ultra-low and negative interest rates since 2015 Libor CHF 3M Libor USD 3M Libor EUR 3M Libor GBP 3M Libor JPY 3M Socially Neutral Investing Investing that deploys capital with the anticipation of generating returns to the investor but no (expectation) of generating positive social (societal) and/ or environmental impact. It includes SRI (negative screening) and/or ESG (positive screening) Responsible Investing (RI) Impact Investing Socially (societally) motivated investing that deploys capital with the anticipation of generating financial returns to the investor alongside with positive social (societal) and/or environmental impact DuraWealth global equity trackers Philanthropy Socially motivated funding that deploys capital with the anticipation of generating positive social and/or environmenttal impact for society but no financial returns for the funder Yearly Index Performance [USD, %] Year Year Year Year Year Year Year Year Year Year 2007* MSCI World AC Index (NTR) DW Global Resource Efficiency Index (TR) Relative performance vs MSCI AC DW Global Disruptive Innovation Index (TR) Relative performance vs MSCI AC Note: * since

2 European equity and bond returns were substantially higher than their long-run trend. Strong global GDP growth, lifted by positive demographics, productivity gains, strong corporate profit growths, sharp declines in inflation and in interest rates were the main drivers for the exceptional investment returns in equities and bonds. During the period, the average real total returns were 7.9% for US and European equities, 5. for US bonds and 5.9% for European bonds. These returns were 1.4% above the 100-year average for US equities, 3% for European equities, 3.3% for US bonds and 4.2% for European bonds respectively (see Fig. 6) 6. These exceptional market conditions are now weakening and even reversing. Indeed, global GDP growth is expected to slow down close to 2% by 2025 and 2035 (see Fig. 4). The sharp decline in inflation and interest rates has ended. GDP growth is likely to be modest as labour-force expansion and productivity gains have slowed down. Corporations face new competitive pressures as new companies expand and new digital technologies and automation disrupt today s business models. Renowned industry experts expect annual returns of 3.2% (median value) to 6. for global equities with a possible downside of -2 and below for high grade European bonds by 2023E with a possible downside of -1. Cash and money market annual real returns in key currencies, with expected CPI of 0.9% to 2. p.a., are projected to be negative in the next 5-7 years (see Fig. 5-6) 5,7-8. In illiquid investing, private equity and hedge funds are likely to deliver 8% and 3%-6% p.a. (depending on strategy), respectively 7,8. In addition, in the next 10 to 20 years, yearly returns are expected to be lower than in the past. In the expected modest-growth scenario, total real return is likely to be for equities and 0-1. for bonds in the US and Europe (see Fig. 4-6) 6. In this context, new investment solutions are required to offset the coming years waning financial returns. 2. A Transforming World: the rise of Industry 4.0 and its net positive effects For the past 250 years, the 1 st, 2 nd and 3 rd Industrial revolutions have transformed our society, increased life quality and wealth. Industrial production was transformed by steam power in the 19 th century, electricity in the 20 th century and computers since the 1970s. These three waves of technological progresses did lead to greater employment shifts and wealth creation. Today, another societal transformation has started and most industries experience the fourth wave of technological advancements, namely the rise of new digital industrial technologies known as Industry 4.0. Big data applications, the Internet of Things (IoT), devices related to the 4 th Industrial Revolution (i.e. Industry 4.0), new less or non-invasive health-care therapies and environmentally friendly and resourceefficient solutions are all new areas that are transforming our society, as highlighted in Fig. 7. As these areas feature superior growth prospects, namely double-digit annual growths 1, the Industry 4.0 is having a net positive effect on the global economy and on society Fig. 4: Projected lower annual real GDP growth by Europe includes Germany, France, Italy and UK, while EU27 shall grow 1. p.a. (PPP) by 2030 (Source: McKinsey, PwC, DuraWealth) Fig. 5.1: Expected annual returns of main asset classes: - global equity, commodities and real estates in USD - cash, bonds and credits in Euro (Source: Schroders, Robeco) - bonds in Euro, cash and credits in USD (Source: Willis Tower Watson) Fig. 5.2: Expected annual returns and volatilities of main asset classes: global, Europe (Source: Robeco, DuraWealth) Fig. 6: Historical (3-year average, annualized) and expected real returns (annually) for equities and bonds (10-year tenors) in the next years. Europe includes Italy, France, Germany and UK. (Source: McKinsey, DuraWealth, multiple sources) 2017 Durawealth Ltd Refer to the disclaimer on page 6 2/6 4% 3% 2% 1% 1 8% 3% -3% % 6% 4% 2% 2.7% 1.9% Annual GDP growth: Historical Growths and Projections by % % US Europe World ex-us Real GDP growth: Real GDP growth: E Main Asset Classes: Expected annual returns E % % 1.3% % % -0.1% Robeco E Schroders E Tower Watson E Cash or money markets (Euro, US) High grade gov. bonds (Euro 10Y) Investment grade credits (Euro, US) Global developed equities Commodities Real estate (indirect) 0.7 Main Asset Classes: Projected return vs volatilities E Projected returns E Projected volatility E 3% 6% 18% 2 18% Cash or money markets (Euro) High grade gov. bonds (Europe 10Y) Investment grade credits Global developed equities Commodities Real estate (indirect) % 1.7% 1.6% Historical real returns ( ) Equities and bonds: Historical and projected total real returns 7.9% 7.9% 5.9% 5. Historical real returns ( ) Projected real returns Projected real returns ( ) ( ) US equities European equities US bonds European bonds

3 1 Environment Smart Home Connected appliances Smart fridges, lights 2 Materials Wearables Composites Smart glasses, watches A1 Life Science Connected Health Genomics Non-invasive cures Inf. Technology 2D/3D IT-architectures Quantum computing Tools Electron Microscopes Photolithography Automation. Industrial Internet Remote asset & car control 3D printing A2 Smart Grids & City Smart metering Smart environ. mgmt. Time Fig. 7: The markets benefitting from Industry 4.0 are regrouped into five sectors i.e. environment, materials, life science, information technology and tools (i.e. instruments) with above twenty application areas (A1, A2 ). Selected companies (left) producing transformative technologies (right) are leaders in their industries (Source: DuraWealth, McKinsey, WEF, industry data) The traditional industrial model is still based on the principle of decreasing product and labour costs and increasing volume of industrial goods. This paradigm has its limitations. Given the growing diversity of customers and their expectations, coupled with larger resource constraints, this model is expected to evolve towards more intelligent and automated business models that will enable to produce new, more personalized, more intelligent and more resourceefficient products in most industries. These products are all connected to Industry 4.0. The deployment of Industry 4.0 is expected to have major net positive effects on the capital employed by companies which quickly adopt this new business model. Indeed, these companies will make better use of their physical assets. Profitability will improve through labour cost reduction, higher automation and an enhanced asset utilization rate. Margins will increase by a few percentage points thanks to the higher value of the products and by greater customization and flexibility. Finally, Industry 4.0 allows better asset utilization (reduction of product changeover time, reduced machine down-time, inventory and maintenance times and costs) As a result, industries producing and/or using Industry 4.0 solutions will better leverage their asset base, draw on less capital, all this leading to an increased profitability and a higher ROCE (return on capital employed). This will create more investment opportunities financing new projects and create new jobs. According to a Roland Berger study, Industry 4.0 initiatives are expected to increase the ROCE by more than 10 percentage points to over 28% (depending of the sector), as well as 420 bn net profits and savings with net positive effects on job creation in developed Europe by Automation, robotics, artificial intelligence and machine learning is expected to raise productivity growth globally by 0.8% to 1.4% annually in the next few decades The DW Global Disruptive Innovation Index couples both, higher returns and societal transformations To reflect this transforming world and to circumvent lower investment returns on the main asset classes (see section 1), we designed a systematic global equity Fig. 8: DuraWealth dedicated systematic investment process USA Japan Germany UK Taiwan South Korea Netherlands Denmark Step 1: Selection of multi-sector markets linked to the Transformative & Disruptive Innovation Selection of the related industries & sectors Step 2: Sector allocation in the related markets DW Systematic Screening of transformative technologies 6.8% 3.4% 3.3% 3.2% 10.4% Step 3: Systematic screening of firms (MSCI World) with transformative technologies SRI filter: Exclusive firms in tobacco, alcohol, military, gambling, adult entertainment, nuclear 13.4% Step 4: Quant Filter Market Cap & Liquidity & Volatility & ESg 26.1% Step 5: Index 30 stocks Fig. 9: DW Global Disruptive Innovation Index with its country asset allocations and top five companies (Source: USD, as of , FIS, DuraWealth) Tesla Hitachi High-Tech Asml Holding Mobileye Alexion 3.6% 3.6% % % % 4. Ann. Return (top bars) Ann. Risk (bottom bars): 01// present [USD] % 14.8% % 18.3% 17.8% Durawealth Ltd Refer to the disclaimer on page 6 3/6

4 investment framework via indexes in the sectors associated with resource-efficiency and transformative i.e. disruptive innovation technologies. The objective is to suitably reflect today s transforming world and to fulfil the growing investor s quest for new investment products with superior financial returns. Indeed, we expect greater capital flows to be directed to these high growing sectors in the future (Source: McKinsey, KPMG, BAML). The markets that will benefit the most from the Industry 4.0 solutions are regrouped in five sectors i.e. environment, materials, life science, information technology and tools as shown in Fig. 7. Within these five sectors, over twenty application areas (A1, A2 ) with various transformative technologies are identified and classified. These markets are set to grow over 8%-12% p.a. i.e. 4x faster than the global economy to more than 1.2 Trillion USD in 2021 and beyond 1. Companies producing Industry 4.0 solutions will raise their competitiveness, productivity and margins thanks to optimized production of high-margin products. This finally leads to a higher shareholder value. In the DW systematic investment process, the related sectors and industries linked to transformative technologies are first classified as well as their transformative technologies (step 1 and 2). Then, the companies producing these particular technologies are systematically screened globally and allocated to the respective sectors (step 3). In steps 4 and 5, the predefined market criteria rank companies at sector levels to obtain the DW index (see Fig. 8). The DW Global Disruptive Innovation Index (hereafter: DWNI Index), based on a systematic methodology designed in 2007, tracks the performance of 30 listed companies producing transformative technologies (see Fig. 9). This index is reviewed quarterly and rebalanced semi-annually to stay wellbalanced at sector and company levels and to be compatible with the UCITS IV diversification rules. Since January 2010, the DW Global Disruptive Innovation Index features superior risk-adjusted returns vs the MSCI World Equity AC Index, the MSCI World Equity & Nasdaq 100 Composite 70/30 net total returns and the returns of selected peers and other main asset classes, as shown in Fig Appealing valuations and financial health of the DW index equity portfolio strengthen its investment case Reasonable price to earning valuations: Per 17 April 2017, the P/E 2018E of 15.4 for the DWNI Index equity portfolio is lower vs 15.8 for the MSCI World Equity AC and 16.0 for the S&P500 Index portfolio (see Fig. 12). The mean annual EBIT growth rate 2018E of 13. for the DWNI Index portfolio is higher vs 11.1% for the MSCI World Equity and 11.9% for the S&P500 Index, respectively, as shown in Fig. 12. Solid financial health: The mean current ratio (i.e. a liquidity ratio that measures company s ability to pay short- and long-term obligations) of the DWNI Index portfolio is 2.3. For an appraisal, the mean current ratio of the technology (hardware) giant group (Apple, Cisco, Intel, Qualcomm, Hewlett Packard and IBM) is / / / / / / / / / / /2013 Fig. 10.1: DW Global Disruptive Innovation Index with superior risk-adjusted returns vs peers in USD, as of (Source: FIS, DuraWealth) / / / / / /2011 Performance since 01/2010 [USD] Fig. 10.2: DW Global Disruptive Innovation Index with superior risk-adjusted returns vs peers in CHF, as of (Source: FIS, DuraWealth) Fig. 11: DW Global Disruptive Innovation Index with superior riskadjusted returns vs main asset classes, in USD as of (Source: FIS, DuraWealth) 09/ / / / / / / / / /2016 Ann. Return (top bars) Ann. Risk (bottom bars): 01// present [CHF] 01/ / / /2013 FTSE EPRA Real Estate Developed Index UBS ETF HFRX Global Hedge Fund Index Bloomberg Commodity Index (TR) ishares Global Government Bonds (TR) MSCI World Equity AC Index (TR) 4.1% 5.6% 7.4% 17.8% 18.3% 18.8% 17.8% 01/ Performance since 01/2010 [CHF] 05/ / / / / / / / / / /2016 Ann. Return (top bars) Ann. Risk (bottom bars): since 01/2010 [USD] Private Equity Index (TR) -6.4% -0.7% 0.8% 4.7% 4.1% 5.4% 7.8% % / % 14.8% Durawealth Ltd Refer to the disclaimer on page 6 4/6

5 The estimated mean debt to shareholders equity amounts 53% for the DWNI Index portfolio vs 78% for the above-described technology giant group. The mean operating margin 2018E of 22. for the DWNI Index portfolio is significantly higher than the operating margins of 10.4% for the MSCI World Equity and of 11.2% for the S&P500 Index portfolio (see Fig. 12). Tesla is the only company in the DWNI Index equity portfolio not profitable yet. Complimentary risk profile: The annualized volatility of the DWNI Index equity portfolio of 14.8% is slightly higher than the volatility of the MSCI World Equity AC of 14. (see Fig. 12). Based on historical data, the risk profile is 5 on the scale of 1-7. Probable capital market scenarios: In case of a market correction, the DWNI Index portfolio may not correct more than the global equity markets. In the case of market recovery, the DWNI Index portfolio is likely to recover faster than the global equity markets due to its great exposure to high growing industries. The abovedescribed scenario is the core scenario with a probability of 7. The higher and the lower economic growth scenarios, with a probability of 1 and 1, respectively, may lead to average equity real returns of up to 7. annually and higher volatilities across main asset classes, respectively. Conceivable asset allocation: The described instrument is especially suitable for balanced (with 60/40 debt/equity), growth (with >6 equity, private equity, real estates) and institutional portfolios, as well as for responsible investment portfolios. Investors seek yields and new liquid equity products are in demand. As the world gets more global, connected and transformed, most companies adopt global business models. In this regard, the geographical limits of company s domicile or place of listing are outdated as it may lead to lower returns for the unit of risk taken. In this regard, a geographical limit in the equity asset category of an institutional portfolio can be offset by using the risk budget approach in constructing the investment portfolio. Hedging to the currency of the respective region may be an option. For instance, a EUR-hedged class may be used in its allocation in the asset category «Equity» Europe. A longer view horizon has an edge: The DW Global Disruptive Innovation Index portfolio aims to exceed the MSCI World Equity AC index net total returns over cycles by annually, mainly thanks to its great tilt to highly growing markets, coupled with smart systematic investment methods, as described above. To suitably benefit from the associated market dynamics described above, a medium view (>3 years) should be considered. Main features of the certificate on the DW Global Disruptive Innovation Index (ISIN: CH ): (+) a listed instrument on the Swiss Stock Exchange SIX (see note on page 6), with real-time pricing and daily NAV calculations PE 2017E % % Ann. Sales Growth 2017E 4.8% Fig. 12: A sound PE of 15.4 (right scale), higher profit growth of 13. and margins of 22. in 2018E for the DWNI Index portfolio vs % and 10.4% for the MSCI World Equity, respectively (Source: FIS, FactSet, Thomson IBES, DuraWealth) (+) highly liquid and scalable to over 1 bn in assets (+) sound fee structure (+) low portfolio turnover: the index is rebalanced every six months and compliant with UCITS rules (+) managed by a reputed Swiss Bank with Moody s LT Deposit Rating of Aa2 (+) real track record of the underlying index with core methods developed in 2007 (+) simple management and reporting (SIX, Bloomberg, Reuters and Telekurs) (-) a relatively concentrated global equity portfolio (-) the issuer risk. For more information, please refer to the note on page 6. Conclusions % Ann. Sales Growth 2018E Forward Ann. Growth 2017E, 2018E: Sales, Profit, Margin and PE ratios PE 2018E 13.2% 16.9% Ann. Profit Growth 2017E 11.1% 13. Ann. Profit Growth 2018E 8.9% 20.9% Profit Margins 2017E 10.4% 22. Profit Margins 2018E MSCI World Equity S&P500 Index DWNI Index MSCI World Equity S&P500 Index DWNI Index A new investment framework is required in the current fast transforming world to offset waning financial returns in main asset classes in the coming years. In this environment, multi-sector equity investing coupled with the systematic screening of companies producing transformative technologies in related sectors offer an appealing investment case 1-4. The DW Global Disruptive Innovation Index equity portfolio aims to exceed the MSCI World Equity AC index net total returns over cycles by over annually, thanks to its great tilt to sectors with double-digit growth prospects, coupled with a smart systematic investment method, reasonable valuations and the solid financial health of the associated companies. Since January 2010, the DW Global Disruptive Innovation Index has outperformed the MSCI World AC net total returns by 10. p.a. in USD and 10.4% p.a. in CHF, as shown in Fig. 11. This equity strategy offers diversification benefits in global balanced and institutional portfolios, as it will be described in our next study Durawealth Ltd Refer to the disclaimer on page 6 5/6

6 References 1. DuraWealth: - Quest for Real Returns, 2016 PDF 2. KPMG: Future State The global megatrends shaping governments, KPMG: Investing in the future, PwC: The World in 2050: How will the global economic order change, Willis Tower Watson: Global Investment matters, 2016 and Five-year capital market outlook, McKinsey Global Institute: Diminishing Returns, Robeco: Expected Returns , 2017 and Wilshire: Report on State Retirement Systems, Schroders: Seven-year asset class forecast returns , Roland Berger: Think Act beyond Mainstream, BCG, Man and Machine in Industry 4.0, McKinsey: A future that works: Automation, Employment and Productivity, 2017 Biographies Miroslav Durana, PhD Wealth Management with 25 years in Banking (Credit Suisse, LODH, UBP) and Technology MSc., PhD in Physics (ETH Zurich, Lausanne), MBA (HEC Lausanne) Wayne Cawood Chief Technology Officer with 20 years in IT & Audit (Orange SA, WCT Consulting) and Technology M.Com. (University of Johannesburg) Pierre Montézin Chief Risk Officer with 25 years in banking (Swiss Finance & Property, Société Générale) Master of Business Law (Université de Paris II), Master of Ec. & Finance (SciencesPo) Jean de Skowronski Wealth Management with 25 years in banking (Credit Suisse, BNP Paribas) Master in Law (University of Fribourg), MBA INSEAD Note For more details on the Actively Managed Certificate (AMC) on the DW Global Disruptive Innovation Index listed on the Swiss Stock Exchange (SIX), please click on this e-link: AMC on DW Global Disruptive Innovation Index. Disclaimer DuraWealth is a licensed asset management company, founded in 2014, and supervised by the Financial Market Authority (FMA) in Liechtenstein. For more information or full access to the website please get in touch with us at info(at)durawealth.com. This research was produced by DuraWealth. It is dedicated for qualified investors only, and shall not be partly or fully copied, reproduced or distributed externally conform to Swiss, Liechtenstein and any applicable foreign law. The information in this document is based on sources considered to be reliable, but its accuracy and completeness is not guaranteed. The information is subject to change at any time and without obligation to notify the investors. This document is not an official confirmation of terms. Past performance is no indication of future performance, and some performance data do not take account of the commissions and costs incurred on the issue and redemption of shares or fund units. The information does not release the recipient from making his / her own assessment. In particular, the recipient is advised to assess the information, with the assistance of an advisor if necessary, with regard to its compatibility with his/her own circumstances in view of any legal, regulatory, tax and other implications. This document is expressly not intended for persons who, due to their nationality / place of residence or their investor s profile, are not permitted access to such information under Swiss, Liechtenstein and any applicable foreign law Durawealth Ltd Refer to the disclaimer on page 6 6/6