STRATEGIC PORTFOLIO SERVICE QUARTERLY INVESTMENT OUTLOOK

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1 STRATEGIC PORTFOLIO SERVICE QUARTERLY INVESTMENT OUTLOOK Winter 2017 Introduction Our Strategic Portfolio Service has been established for nearly nine years and provides active quarterly management of riskgraded portfolios alongside specialist fixed interest and income yielding portfolios. These are suitable for pension funds, ISAs and unit trusts, trust investments and self-invested personal pensions. We currently manage circa 231 million of funds in this way for our clients. This quarterly market outlook sets out our views of the market and the changes we recommend to our portfolios. If you would like more information on our Strategic Portfolio Service, please contact us on Executive Summary Stock markets have performed well for us so far in 2017 and once more we adjust portfolios to accommodate the positive outlook whilst questioning the consensus views. There are signs that activity is now more self-sustaining. The malaise of British politics, a weakening May government and Brexit taint our view looking out from the UK of the general upswing occurring elsewhere in the world. The facts are that the global economy continues to grow, with every major economy expanding. Despite Fed balance sheet tightening, global quantitative easing still continues through the ECB and Bank of Japan. Most telling, the usual global inflation pressures that cause central banks to apply the brakes sharply are absent. Above trend growth with low inflation continues for the time being. Growth has picked up in Japan and Europe whilst deflation fears have eased. The French elections have put paid to political risks for now in Europe. Company valuations do matter and America is not cheap, but absent any other catalyst, such elevated valuations imply subdued but positive returns, but not the advent of a bear market. Without wishing to tempt fate after a good year for risk assets, it is too early to play defence! Our views and main changes to our portfolios include the following: Medium risk portfolios have achieved circa 8% returns year to date with expectations now more subdued as markets adapt to the changing monetary policy environment. A weak Conservative government and Brexit negotiations are not inspiring confidence in the UK economy. Real wages and consumer spending are under pressure. We reduce once more our UK exposure by shifting 2% from UK equities and allocating 1% to Europe and Japan apiece. Newton Real Return is removed from all portfolios whilst we add a new fund, GAM Credit Opportunities, to our fixed interest allocation. Risk is also diversified by adding to our defensive strategies with Premier and Jupiter. America poses the highest risk as quantitative easing (QE) is replaced by quantitative tightening (QT) as its $4.5 trillion balance sheet starts to be reduced. The Fed s interest rate path may have steeper steps than market expectations. Our strong global equity position outside of America remains balanced by a well-diversified fixed interest portfolio, defensive positions in our absolute return strategies and a sensible weighting to commercial property in the UK, which avoids central London.

2 Since the start of the year the strong overweight equity position has been reduced to one of marginal overweight. UK equities now stand at 11%, down from 17% in January in a balanced portfolio. The increasing breadth of the global economic expansion is pointing to a long lifespan with Europe, Asia including Japan, being the focus of our interest to generate positive returns going into Economic Outlook Growth is cruising at above-trend rates across the world, but inflation is key to the policy and market outlook. Inflation is picking up in the US but moving sideways and no longer deflationary in the Eurozone, supporting monetary policy divergence. The long road from financial crisis to recovery passed another milestone in September when the US Federal Reserve announced that its asset purchase programme, or QE, is finally being unwound. The process will start slowly, with an initial $10 billion of treasuries and mortgage-backed securities being allowed to run off, or more appropriately, being re-financed by real investors. The aim is to reach a level of $50 billion per month later next year. The move towards quantitative tightening has begun. It is widely accepted that quantitative easing played a role in boosting asset markets; the question now is whether turning the process around and withdrawing liquidity will send asset prices into reverse. Financial markets have also long believed that the Fed will deliver nothing like its stated intention of seven 0.25% rate hikes between now and the end of We believe the Fed might actually be right with the pace of their programme, but the new forecast terminal rate or peak being set at 2.75% rather than at 4% or above. As private investors decide whether to refinance the bonds which the Fed is no longer rolling over, it is these projections of long-term rates that are critical to supporting financial markets. Banks, insurance companies and pension funds will continue to demand these bonds as they replace Fed demand. Whilst the Fed has reached an historic milestone, central banks elsewhere are still fully engaged in QE, with the result that global liquidity in aggregate will continue to rise. The pace of liquidity growth will decelerate as we move through This is still expansion, and positive for equity markets. In the UK, the Bank of England has strongly suggested it is finally ready to raise interest rates after a decade of false starts and inaction. The sudden change in communication is perhaps puzzling, especially as data suggests the economy is fragile at present. Inflation has picked up, partially due to the fall in the value of sterling, and perhaps the Bank is desperate to get back to some form of normalisation, helping to protect the pound from any further weakness. However, the torturous Brexit negotiations, or even no deal outcome, means investment internally and externally in companies is somewhat cautious. Expenditure by the consumer and savings rates are both reducing as real wages come under attack. The cry to end the public sector 1% pay cap grows ever louder in response, so the Bank of England is likely to reverse the knee-jerk rate cut that followed the Brexit vote, with a quarter percent rise in November. Previous guidance had suggested there would be no rate rise until July 2019, after the Brexit outcome was clear, so now the change of stance with an expected 0.25% in 2018 and a further 0.25% in 2019 on the cards. This leaves interest rates no higher than 1% in two years time, and whilst relatively benign, it is difficult to see any great strength in the underlying economy which warrants a rate rise environment. Economic GDP projections of circa 1.6% also look somewhat optimistic given the general air of uncertainty prevailing. Real wage growth, particularly in the construction sector, has turned down sharply and is an indicator we will watch carefully, suggesting the UK economy is cooling quickly. Portfolio Positioning We maintain our marginally overweight equity position with an emphasis on European and Asian equities. Opportunities in the fixed interest sector lead us to add further conviction as markets now start to price in a more realistic expectation on central bank policy. The table below shows the overall asset allocation and strategic portfolio positions. The diversification and non-correlation of assets to global equities remains of paramount importance.

3 Strategy Portfolio Strategy Portfolio Asset Class Cash 72% 32% 13% 6% 12% Fixed Interest SPS Fixed Interest 16% 29% 29% 27% 24% 17% 11% 6% 4% 72% 24% UK Equity 4% 6% 7% 11% 14% 15% 15% 15% 12% 14% Global Equity 9% 25% 35% 42% 48% 56% 65% 73% 83% 36% Absolute Total Return 8% 18% 19% 17% 15% 13% 10% 6% 2% 16% 18% Global Property 4% 8% 8% 8% 8% 8% 8% 8% 6% 5% 8% Market Implications Equity indices hitting new highs inevitably stirs talk of stretched valuations. The assumption is that valuations are bound to some long-term mean and will revert to norm. The world is a little different today and we find historical comparisons less useful. The future looks different from the past, partially due to structurally lower interest rates, and viewed through this lens, we believe equity valuations are not that extreme. The sustained global expansion is providing a positive back-drop for corporate earnings. Earnings are growing at a faster than 10% pace in all major regions; analysts forecasts for once are not being downgraded whilst holding steady in the US and Europe and are indeed still rising in Japan and emerging markets. More than eight years into the current bull market, it is reasonable to worry that we might be near the top. Goldman Sachs has completed interesting research comparing the current bull market with other similar periods. After studying five particular areas including unemployment, inflation, bond yields, various growth indicators and company valuations they conclude that a cyclical bear market does not seem imminent. Their logic is that tight labour markets tend to lead to higher inflation which in turn triggers interest rate rises and weaker growth expectations. Underpinning this belief is that global inflation will remain low and therefore monetary policy will be allowed to remain loose. Their conclusion is that we are more likely to enter a period of lower returns, but there is no reason to think that a downturn is about to occur. Shares remain supported by relative valuation arguments being that returns, especially dividends, provide a higher overall result than cash or fixed interest investing. Expectations for returns in commercial property markets have risen since the dark Brexit cloud appeared over the UK real estate market. outlook is reasonable, with few tenants in distress. If anything, the absence of certainty is encouraging tenants to secure their current accommodation rather than make plans for taking on new space. There is certainly no debt-fueled construction boom or oversupply in markets at present, with central London being our only concern should financial institutions move some of their operations to Europe. The relative weakness of sterling has actually helped to attract overseas buyers into the market. Office space outside of London, with industrial and logistics, are also hitting the sweet spot, with low vacancy rates as the internet shopping boom demands more and larger warehouses. The bond market continues to be driven by the investment theme that has dominated the post-crisis world, the search for yield. The gap between yield on safe government bonds and that of the riskier corporate debt has narrowed over the years. This tightening of yields over the years has also come to an end. The key driver of the whole bond universe is central bank monetary policy, but with markets slowly coming to the realisation that interest rates are rising, the value of existing bonds have started to price in the necessary adjustment. Our fixed interest holdings are split between two camps. The first being the ultra-safe cash alternative bonds, providing security and little downside risk. The other half, such as the new GAM Credit Opportunities Fund, seeks high yield returns from strong institutions issuing junior debt. The strength of banks, for example, has risen significantly in recent years, with the chance of default remaining relatively low. Returns are high for a relatively low level of risk.

4 Tactical Asset Allocation Summary The diagram below is a representation of our tactical positions relative to the longer term strategic models, ranging from strongly underweight to strongly overweight. It represents our general position, assuming a moderate risk portfolio. Government & Investment Grade Bonds Strong Underweight Underweight Neutral Overweight Strong Overweight High valuations amidst possibility of central bank policy error. High risk with low reward characteristics. High Yield & Emerging Markets Bonds General Emerging Market growth supports debt. Extra yield above sovereign debt reasonably attractive. Developed Market Equities Emerging Market Equities Economic expansion outside of US continues. Corporate earnings remain robust. Europe and Asian markets favoured. Economic reforms and corporate fundamentals support valuations. Concerns over China s growth rate persist. Property Property outside London offer stability of rental yield. Weak sterling attracting overseas buyers. Absolute Return Strategies Specific global themes appear rewarding. Risk mitigation strategies for equity sell-off provide protection. Conclusion Most major economies are growing at or above trend and companies have been experiencing sound earnings growth. Stock markets have generally celebrated in response, with global equities reaching new highs. The outlook remains robust. As ever, we look for concerns, perhaps China slows or the Trump administration becomes even more inept, but we don t see a catalyst to derail the train at present. We still see a respectable probability that the global economy continues on its expansionary path, which would broadly be supportive for risk assets such as equities. The Eurozone economy looks particularly robust and Japan looks unusually strong. Our concerns remain closer to home as the hard road to a soft Brexit is likely to continue for many more months to come. Iain Halket, Director Chairman of HFS Milbourne Investment Committee October 2017 Risk warning: Property funds In the event the fund has insufficient liquidity to cover all withdrawal notices on a particular date; redemptions may be deferred until there is sufficient liquidity within the funds. Property valuations are determined by independent property experts and are based on opinion rather than fact.

5 Summary of movements recommended this quarter: Strategy Portfolio New Fund Introduced Fixed Interest GAM Credit Opportunities +3% +3% +3% +3% +3% +2% +2% +2% +8% +2% Removal of Funds Newton Real Return -2% -4% -5% -5% -5% -5% -4% -3% -2% -4% Change in Percentage Holding for Existing Funds Investec UK Alpha -1% -1% -1% -1% -1% -1% CF Woodford Equity -1% -1% -1% -1% -1% -1% -1% -1% -2%* -2% Jupiter European +1% Blackrock European Dynamic +1% +1% +1% +1% +1% +1% Schroder Tokyo Hedged +1% +1% +1% +1% +1% +1% +1% +1% +2%** Premier Defensive Growth +2% +1% +1% +1% +1% +1% +1% +2% Jupiter Absolute Return +1% +1% +1% +1% +1% +1% +1% AXA Sterling Credit Short Duration Bond -4% Kames Absolute Return Bond Please note the above is based on the Old Mutual platform model for any Fidelity FundsNetwork/Aegon plans the cash and money market funds are different. Please refer to fund fact sheets for details. For this quarters switch for Fidelity FundsNetwork/ AEGON ISA and Pension clients the Fidelity Strategic Bond holding will be switched from the gross version of the fund to the net version of the fund. Please note due to tax changes for these funds from April 2017 there is now no difference in these funds. *Fund removed from portfolio **New fund introduced to portfolio -4%