INVESTMENT UPDATE. July 2017 PERFORMANCE UPDATE

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1 INVESTMENT UPDATE July 2017 PERFORMANCE UPDATE ASSET CLASS REVIEW HAPPY BIRTHDAY WOODFORD WHAT RISK ARE YOU TAKING WITH YOUR MONEY? FINAL COMMENT PERFORMANCE UPDATE It is unusual to find most of the major asset classes falling in a month, but June saw the FTSE 100, UK Gilts, UK Corporate Bonds and Gold all fall 2.44%, 2.25%, 1.22% and 2.48% respectively. We are pleased that our portfolios only fell by between 1.09% and 1.24%. The portfolios started the month showing good gains but a stronger sterling and falls in stock markets towards the end of the month resulted in losses for the portfolios. The best performing funds were the Asian equity funds which were the only ones to show positive returns over the month. Despite the uncertainty surrounding the UK and its Brexit negotiations, the UK economy is still performing well. This has led to calls for UK interest rates to rise. Rising interest rates will not be good for UK bonds which fell over the month (please remember we are underweight UK bonds). The monthly performance of the portfolios is shown below:

2 Summary of Portfolios June lived up to its reputation as one of the poorer months for investment returns, even in this bull market. We mentioned in previous investment updates that the summer months often produce lower returns for stock markets. In addition, UK Government bonds, corporate bonds and even gold fell this month. On a positive note, the portfolios included a number of funds that produced positive returns (or only small losses), which helped ensure the portfolios performed relatively well this month compared to the main asset classes. Going forward, July has given positive returns on average over the past five decades. The market weakness in June has generally been followed by a rebound in July, making it one of the better months of the generally weak summer season. Since 1970, the FTSE All Share has averaged +0.8%, about the 5th or 6th best performing month of the year, with positive returns in 53% of months. Recent years have seen strong performance in July, with gains in 6 of the past 8 years and averaging 3.3%. Cautious, Balanced and Adventurous Portfolios: We have seen a change in momentum, where Europe is starting to outperform the US on a relative basis, and last month we increased exposure to European equities within the Cautious and Balanced portfolios. The Adventurous portfolio already has an overweight exposure to European equities so no changes were necessary. We were pleased that the portfolios significantly outperformed the FTSE 100 and UK Gilts. This was largely due to the portfolios being overweight in defensive companies as well as Japanese and Asian equities, which all outperformed. Exposure to Japanese and Asian equities is higher than normal, as they are above trend and performing strongly. Dynamic Equity Portfolio: Despite the Dynamic Equity portfolio being our highest risk portfolio, it actually fell the least in June. This was largely as a result of the fact that we have invested some of the portfolio in Japanese smaller companies and Asia Pacific equities which actually grew over the month. The Dynamic Equity portfolio has performed strongly over the last 6 months, outperforming the FTSE 100 as follows: Foundation Portfolio: Due to the poor performance and continued downward trend of the Kames UK Equity Absolute Return Fund, the entire holding within the portfolio was sold. This has been a long-term holding and performed extremely well for a long period. However, through our continued monitoring of our underlying investments, we have picked up that the performance has started to lag alternative investments and detract from portfolio performance. Further to our investment philosophy, when we start witnessing prolonged periods of negative trend or underperformance we will sell the investment. The proceeds have been kept in cash and will be deployed when a better investment opportunity is found. The portfolio is overweight European equities already and to keep it within our risk tolerances, we cannot invest any more in Europe.

3 ASSET CLASS REVIEW This section will give you an insight into our current thinking, as we have attached some charts that look interesting. This month we look at emerging markets. China currently the best performing emerging market The Chinese stock market is arguably the world s most volatile stock market. The chart below is the China Shanghai A-Shares index which, as you can see, has had many booms and busts over the last 20 years: Clearly, if you invest at the right time and sell at the right time you can make a lot of money. However, if you get it wrong then you can lose a fortune as well. Our exposure to China in the portfolios is via the two trend-following funds which gain exposure to China via the ishares MCI China Index ETF. As you can see it has performed well in 2017: Brazil corruption is destroying the country Brazil should be one of the fastest-growing economies in the world and the stock market should be booming. However, corruption plagues the country. The stock market started to recover in 2016 and nearly doubled in value. Whilst the portfolios have benefitted from this, there is currently no exposure to Brazil as the latest corruption scandal threatens to topple the Government and undermine reforms aimed at pulling the economy from recession. You can see the volatility from the chart below and the 10% fall in the stock market in May 2017 due to the recent corruption:

4 India struggled since the financial crisis but good governance is taking over Similar to Brazil, corruption has ruled in India. However, 3 years ago Prime Minster Modi became India s 15 th Prime Minster. Since then he has attempted to improve governance and remove corruption. You can see how the stock market has grown since this date: The two trend-following funds currently have exposure to India and returns have been strong. In addition, the Adventurous and Dynamic portfolios have further exposure via the Jupiter India fund which has grown by 32% over the last year. Russia no return over 4 years The Russian economy is very dependent on the price of oil and gas. The chart below shows the price of oil (green line) and the Russian stock market (blue/red line) and you can see how correlated they are:

5 If you add in the unpredictability of Putin, you have an investment market that can be extremely volatile, with losses and gains of over 50% experienced in the last 4 years, but ultimately no return for a buy and hold investor: In Summary Emerging markets are not all the same, and when we break down the main components you can see how they all perform very differently. What is consistent though, is how volatile they are and how you can make extreme returns. Most investors simply buy and hold emerging markets which can be a rollercoaster ride. Our investment strategy simply invests when each market is on an upward trend and sells when they are on a downward trend, in an attempt to harvest some of the gains. Due to the volatile nature of each market, the signals to buy and sell are rarely at the bottom or top of the cycle, and you still have to miss large early gains and be prepared to suffer bigger losses when the market turns against you.

6 HAPPY BIRTHDAY WOODFORD 9 June 2017 marked the third anniversary of trading for the Woodford Equity Income fund. The fund is managed by one of the UK s most high-profile fund managers, Neil Woodford. With a total return of % over its first three years, the fund is ranked first in its sector and ahead of the FTSE All Share index which delivered a total return of % over the same period. What does the fund invest in? The fund s objectives are to provide a reasonable level of income (currently 2.95%) together with capital growth. This will be achieved by investing primarily in UK listed companies. However, the fund has had an average exposure of 15% to overseas equities, which is much more than the average in the sector. Overseas equities have performed much better than UK equities, and this has been one of the main reasons why the fund has outperformed. In addition, the fund has invested nearly 7% in unlisted companies. Unlisted companies are extremely small companies which cannot be traded on normal stock markets. They are high risk, but have performed extremely well. This has again been a contributing factor to the outperformance. Why do we invest in the fund? Neil Woodford is arguably the UKs highest-profile fund manager. He has an excellent long-term track record, having managed the highly successful Invesco Perpetual High Income fund since 1988 before moving to set up the Woodford Equity Income fund in Many of the team of analysts followed him to his new business and he continues to use the same investment process. This investment process has a history of finding companies that tend to outperform in the difficult periods and thus losses have been minimised. Having more stable returns is exactly what we look for. The fund therefore forms a core holding in our portfolios. Will it continue to perform well? In 2015 Neil Woodford launched a new fund - the Woodford Patient Capital Trust. This fund invests in a portfolio of early-stage companies, many of which are unquoted. The performance since launch (see below) has been poor, despite stock markets making good gains. Early-stage companies have more binary outcomes - extremely attractive rewards for success but also risk of capital loss (as some businesses will inevitably fail to fulfil their potential). They are also illiquid and difficult to sell. As discussed above, these types of company account for 7% of the Woodford Equity Income fund and have been one of the main reasons why the fund has outperformed, as the ones that he has purchased in the fund have performed very well. There is therefore a risk that the fund could select some of the early-stage companies that fail and the fund underperform significantly. Also, if investors start to pull money out of the fund then the unlisted companies that are difficult to sell will form a larger part of the fund and this could affect performance. Summary The fund manager has an excellent track record and an investment process that has time and again selected those UK companies to produce steady and consistent returns. Neil Woodford now identifies opportunities by investing in early-stage UK companies, which increases the risk and potential rewards. We therefore have to be aware of this excess risk and continually monitor the fund and its holdings to ensure that our clients are not exposed to excessive risks.

7 WHAT RISK ARE YOU TAKING WITH YOUR MONEY? One of the most important factors that affects the returns of your portfolio is the risk that you are taking. Our objective is to reduce the risk of your portfolio during times of economic difficulty, and increase it during the good times. In essence, we protect your wealth during bad investment periods and keep you fully invested to ensure you benefit during good investment periods. If this is achieved successfully, then the overall risk to your portfolio will reduce, and your losses will be minimised during the bad times. But how do we measure the risk that you are taking? The best measure is something called volatility. This is simply a measure of how much your portfolio moves on a daily/weekly basis. For example, if a portfolio grows by 10% in a month, and then falls by 5% the next, it is much more volatile than a portfolio that grows by 2.5% in each of the two months. So, what are the risks in our portfolios? As our investment philosophy pursues a trend-following investment strategy, you should expect volatility to increase after a strong period of stock market returns, but be much lower during periods of weaker investment returns. The volatility of the portfolios relative to their benchmarks is as follows: Broom Consultants Investment Portfolios 1-Year Volatility Volatility Since Launch Benchmark Funds 1-Year Volatility Volatility Since Launch Cautious Cautious Balanced Balanced Adventurous Adventurous Dynamic Equity * Dynamic Equity * Foundation * Foundation * In comparison, the UK Stock Market s FTSE 100 index has a volatility of 8.94 over 1 year and since launch, and the Emerging Market Equities Benchmark has a volatility of over 1 year and since launch. *Please note that the Foundation and Dynamic Equity portfolios launch date was different from the Cautious, Balanced and Adventurous.

8 FINAL COMMENT June lived up to its reputation of being a month with below-average returns. However, the portfolios held up relatively well and, if history is anything to go by, should have a good July. One of the tools that help to generate positive returns is to invest in higher-risk emerging markets, but to overlay a trend following process so that you try and miss the large losses that regularly occur. When we decide to invest in a fund manager like Neil Woodford, we have to analyse carefully why they are outperforming or underperforming. If they are outperforming by taking excessive risk then we may not feel that the fund is a suitable investment for the level of risk required by the portfolio. This involves carefully analysing why the fund is performing as it is. Broom Consultants Limited Sterling Court, 4 Gresham Road, Brentwood, Essex. CM14 4HN Tel No Authorised & Regulated by the Financial Conduct Authority Please note that this document does not constitute a recommendation. It is intended only to provide you with a guide to how Broom Consultants manages client money. The past is not necessarily a guide to future performance. The value of any investments can go down as well as up and you may not get back the full amount invested. Taxation is subject to change and you may have to pay tax on any gains. The Broom Consultants portfolios are unlikely to exactly mirror our clients portfolios due to the timing of the initial investment and the speed of response to our fund switch recommendations as well as the effect of charges. The figures above therefore assume a client invested on the launch day and have responded immediately to our recommendations. As from the middle of 2016, the portfolios have been run on a discretionary basis by WM Capital Management. All figures and charts are provided by Financial Express.