International Fund Solutions Investment Review and Outlook
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1 International Fund Solutions Investment Review and Outlook
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3 International Fund Solutions Market update Q The UK election result was certainly a big surprise to most political pundits, but the subsequent muted reaction in both UK equity markets and Sterling was probably a bigger shock. The FTSE 100 index remained above 7,500, whilst Sterling s decline from its mid-may peak was limited to just over -2%. Whilst a hung parliament was not predicted, uncertainty over the difficulty of future negotiations regarding the UK s departure from the EU certainly was, i.e. political risk had already been largely discounted. There also appears to be a growing belief that a hung parliament will increase the likelihood of a softer exit, with the Conservative party s reliance on the Democratic Unionist party for a majority generally viewed as more market friendly than a hard exit approach. Elsewhere, political factors have been particularly evident, with Trump reviving memories of Watergate, with his possible impeachment over the sacking of James Comey and the subsequent appointment by the Justice Department of a special council to continue with the Russian probe. In addition, Brazil again appears to have a President embroiled in a bribery scandal. Economic factors in the US remain broadly supportive, with buoyant consumer confidence and falling unemployment, at 4.4% below the Federal Reserve s estimated natural rate of 4.7%. Despite the slight weakness in GDP growth during Q1 due to idiosyncratic factors, the Federal Reserve, as expected, sanctioned another 25 basis point interest rate increase at its recent meeting, setting the target range for the federal funds rate to a 1.00% to 1.25% range. Despite weakness in the core inflation rate, which excludes food and energy, to a two year low at 1.7%, it was felt that the current strength in the jobs market warranted such action. A further increase is likely to be sanctioned before the year end, with further moves over the next few years, as the gradual process towards normalisation gathers pace. This process will be accompanied by plans for reducing the size of the Federal Reserve s balance sheet, which has spiralled to $4.5 trillion, currently accounting for about 15% of US Government debt and a third of long term issuance. Also, a significant portion of mortgage backed debt is held. The current approach of not replacing maturing bonds i.e. cancelling debt, will continue and is likely to moderately accelerate in the years ahead. In mid-june, US Treasury bond yields fell to their lowest levels since November 2016, with the ten year yield falling to 2.11%, down from a recent peak at just over 2.60% in mid-march. In the last few weeks of the month, yields edged higher to close the quarter at just above 2.30%, but still below the 2016 year end close at 2.45%. er US Treasury bond yields have been accompanied by a decline in the US dollar, which has fallen almost -5% on a trade weighted basis, but with more notable declines against the Euro (-8%), the Mexican Peso (-13%) and Gold (-8%). Unsurprisingly, the dramatic shift in investor enthusiasm following Trump s unexpected US election victory for reflationary investment strategies in preference to bond proxy deflationary strategies, has ebbed in recent months, with financials and cyclicals struggling. Improving corporate earnings releases have supported optimism in the global economy generally, which has boosted investor sentiment and pushed equity markets to record highs. First quarter earnings for members of the S&P 500 index were up 13.6% over the same period last year, with over 70% beating EPS estimates and 65% beating revenue estimates. This was the strongest first quarter earnings growth in nearly six years, with solid earnings growth in a number of sectors, most notably in technology. The continued strength of the technology sector has been a significant underlying theme, with the Nasdaq index up over 13% so far this year and IT companies being an important contributor to the underlying strength of the broader market indices. Since 2007, the S&P 500 Growth index has generally outperformed the S&P Value Index, apart from in 2012 and last year. This year, growth stocks look set to outperform again. Strong year-to-date equity gains have been made in all developed markets, with Europe and Hong Kong recording impressive double digit returns (in Sterling terms), compared to more subdued lower single digit returns in the broader based US, UK and Japan market indices. Beyond developed markets, emerging market equities have performed admirably, most notably in Quarterly Investment Review / 01
4 India, with record highs being set (in early June) and gains in the Nifty 50 index of just over 17%, supported by high GDP growth, favourable demographics and positive government reform. A falling oil price has also been of assistance. Despite the recent OPEC agreement to extend a supply squeeze into 2018, the current price at just above $46 is well below the psychologically important $50 threshold and almost 20% below the $57 peak in early January. In sharp contrast, China has recently suffered a credit downgrade for the first time in almost 30 years (Aa3 to A1) by Moody s rating agency, largely based on concerns over rising debt levels, leverage and forecasted lower growth, albeit still an impressive 5%. A surprising feature in the rise of global equities this year has been the persistence of ultra-low volatility, as measured by the VIX index, which has generally hovered between 10 and 13. For comparison, it breached 80 at the height of the financial crisis in November 2008 and rose above 40 in August 2015, when China devalued its currency and more recently to 22 following Trump s surprise election victory. Given the current geo-political risks, the growing uncertainties about future growth trends in China and the problems that the United Kingdom s departure from the EU poses, this is rather surprising and perhaps reflects a degree of complacency. Global debt has reached an all-time high at Source: Bloomberg $217 trillion (Q3 2016) according to a report issued by the Institute for International Finance, which is equivalent to approximately 325% of the world s gross domestic product (GDP). A large proportion of this rise stems from greater issuance from emerging markets, most notably China, which accounts for the lion s share. Whilst interest rates are low and economic growth is strong, the re-financing of this debt burden is manageable, however this could become more problematic should either US interest rates normalise faster than expected, or global economic growth rates struggle. Of more concern, leverage has increased markedly, notably in the corporate sector, but also with hedge funds and more worryingly, retail investors, where margin debt has more than trebled since the post financial crisis low in February Hence, any short term negative market pull back is likely to be exaggerated, as geared stock positions are sold. In such an environment, one would expect the VIX index to once again rise above 20, but hopefully not re-test the more exaggerated levels experienced in the past. Discretionary portfolio performance summary Following on from an impressive first quarter of outperformance, all our discretionary Sterling and US dollar based international model portfolios outperformed their respective benchmarks on a relative basis in the second quarter. In our international Euro models, our Balanced, Growth and Equity models, again, outperformed, but our Conservative, and Fixed Income models lagged. In terms of attribution, the equity allocation has continued to benefit from overweight exposures to mid-cap sectors in the United Kingdom, Europe and Japan, together with an overweight exposure to emerging markets. The thematic exposures have also assisted, with technology, healthcare, infrastructure and emerging market consumption all adding value. The fixed income allocation has benefited from the corporate and emerging market exposures, whilst the short duration policy has assisted during periods of drawdown, most notably in the last few weeks of June, when Government bond yields rose sharply. Outlook VIX Index 2009 Last price 200 day moving average So far this year, investment returns have continued to exceed expectations, despite political uncertainties on both sides of the Atlantic, fuelled by low interest rates, subdued inflation and impressive first quarter corporate earnings. assets have continued to flourish, with global equities, high yield corporate and emerging bonds performing well, with key themes dominating, most notably, technology. The mid-cap sector in the UK has also excelled, with the FTSE 250 clearly outperforming the FTSE 100, a trend matched in Europe (but not in the US), with mid and small cap sectors outperforming their large cap counterparts. These current trends appear to be well supported, but given the possibility of market complacency, a short-term retracement cannot be ruled out / 02 Quarterly Investment Review
5 International Fund Solutions Discretionary Strategies - Asset Weightings 5% 10% 5% Global Equity 10% Growth 75% 95% Global Equity 95.0% Fixed Income 0.0% Absolute Return Fixed Income 0.0% Inflation-Linked Fixed Income 0.0% Multi Asset Target Return 0.0% 5.0% Global Equity 75.0% Fixed Income 10.0% Absolute Return Fixed Income 5.7% Inflation-Linked Fixed Income 1.8% Multi Asset Target Return 2.0% 5.5% 5% Moderate 8% 27% /Moderate 20% Balanced 55% 25% Conservative 20% Global Equity 55.0% Fixed Income 20.0% Absolute Return Fixed Income 11.4% Inflation-Linked Fixed Income 3.6% Multi Asset Target Return 4.0% 6.0% 40% Global Equity 27.0% Fixed Income 40.0% Absolute Return Fixed Income 14.3% Inflation-Linked Fixed Income 4.5% Multi Asset Target Return 5.0% 9.3% 13% 12% /Moderate 35% 40% Fixed Income Global Equity 12.0% Fixed Income 40.0% Absolute Return Fixed Income 20.0% Inflation-Linked Fixed Income 3.6% Multi Asset Target Return 7.0% 14.8% 100% Global Equity 0.0% Fixed Income 100.0% Absolute Return Fixed Income 0.0% Inflation-Linked Fixed Income 0.0% Multi Asset Target Return 0.0% 0.0% As at 30 June 2017 Quarterly Investment Review / 03
6 International Fund Solutions Standard Bank International Funds Limited Multi Manager Global Equity Fund The Global Equity Fund built on the solid first quarter performance with further absolute and relative gains. The US dollar C share class rose 5.27%, while the sterling C share class gained 2.30%. Both classes comfortably outperformed the reference benchmark index. Performance was strong from most of the underlying managers, the exception again being the US regional managers, where narrow sector and stock leadership proved a headwind for many active US managers. The European funds were the star performers, with all of our managers significantly ahead of benchmark. There was also notable outperformance from our Asian and emerging markets managers while the thematic technology, healthcare and China consumer funds also added value. It has been encouraging to note that recent equity market gains have been supported by improving corporate earnings and the improvements have been broad based across geographies and industry sectors. Our managers have fed back that this earnings improvement has been driven by top lines sales expansion rather than margin improvements or share buybacks which is indicative of a general pick-up in global growth. Themes Technology. The technology sector continues to take share of the global economy and this trend is only going to accelerate. Our managers can access investment themes with genuine exponential growth opportunities as we progress towards the digital age. Healthcare. Global healthcare demand is set to grow substantially in the decades ahead due to ageing demographics in developed market countries. Using a specialist manager with industry expertise we are able to access exciting new technologies in medical science along with leading healthcare services and pharmaceutical businesses. Emerging Market Consumption. Our focus is on the domestic wealth cycle of emerging countries where demographics and organic growth make for a powerful long term investment thesis. Japan. Japan is a classic market for stock pickers, with an under researched and broad investment universe. We do not view Japan as a short term macro trade, instead we source managers with the research skills to uncover market leading companies in niche areas. Multi Manager Global Balanced Fund The Global Balanced Fund posted a positive return for the quarter, with the US dollar C share class gaining 1.69% and the sterling C class 0.79%. The sterling class return was fractionally ahead of the reference benchmark for the quarter while the US dollar class was fractionally in arrears. The Fund retained a modest overweight exposure to equities and a corresponding underweight to bonds during the period which was a marginally positive contributor to performance. The underlying fundamentals, momentum and sentiment remain favourable for equities, however valuations are stretched by many measures which has discouraged us from increasing the allocations further. Performance has been driven predominantly by the equity allocation, where our thematic allocations to Chinese consumption, technology, healthcare and Japan all added value. The regional UK managers outperformed while the regional US managers struggled, hence the divergence in relative performance between the currency classes. The fixed income strategy remains focussed on short duration and investment grade credit funds, during the quarter this performed broadly in line with benchmark. Multi Manager Absolute Return Fund The Absolute Return Fund posted a positive return for the quarter, with the US dollar share class gaining 1.58% and the sterling class 1.00%. The US dollar class return was comfortably ahead of the reference benchmark for the quarter, whilst the Sterling class was fractionally behind. In both Fund classes, there is yet to be a negative month during 2017 (no doubt, tempting fate), with a mixture of corporate, convertible and emerging market debt funds, combining with three core multi-asset target return funds, to produce consistent positive monthly returns, whilst also maintaining a degree of non-correlation between the selected underlying funds. / 04 Quarterly Investment Review
7 Contact Information Philip Smith - Head International Investment and Fiduciary tel: +44 (0) philip.smith@standardsbg.com Helen Holmes - Head Business Management tel: + 44 (0) helen.holmes@standardbank.com David Jardine - Head International Fund Solutions tel:+44 (0) david.jardine@standardbank.com Simon Bradbury - Senior Manager tel: +44 (0) simon.bradbury@standardbank.com Tony Wood - Senior Fund Manager tel: +44 (0) tony.wood@standardbank.com Carl Stirrup - Senior Fund Analyst tel: +44 (0) carl.stirrup@standardbank.com Standard Bank International Investments Limited Standard Bank House La Motte Street St Helier Jersey JE2 4SZ Important Information This does not constitute an invitation to buy or the solicitation of an offer to sell securities or to accept deposits or to provide any other products or services in any jurisdiction, to any person to whom it is unlawful to make such an offer or solicitation, nor should it be construed to constitute any investment advice. Legislation or regulations in jurisdictions relevant to you may prohibit you from entering into certain transactions with us and we strongly recommend that you contact your financial or legal adviser in this regard. It is your responsibility to inform yourself about and to comply with such restrictions. The value of investments may fall as well as rise and investors may get back less cash than originally invested. Prices, values or income may fall against the investors interests and the performance figures quoted refer to the past, and past performance is not a reliable indicator of future results. Investments may be quoted in foreign currencies and investors should be aware that the changes in rates of exchange may have adverse effects on the value, price or income of the investments. If your base currency is not the same as that of your investments, your return may increase or decrease as a result of currency fluctuations. Standard Bank International Investments Limited is regulated by the Jersey Financial Services Commission. Registered in Jersey No Standard Bank International Investments Limited is a wholly owned subsidiary of Standard Bank Offshore Group Limited a company incorporated in Jersey. Standard Bank Offshore Group Limited is a wholly owned subsidiary of Standard Bank Group Limited which has its registered office at 9th Floor, Standard Bank Centre, 5 Simmonds Street, Johannesburg 2001, Republic of South Africa. Telephone calls may be recorded. These views are the opinion of the Investment managers only. They do not reflect the views of Standard Bank Group and should not be considered as investment advice. Neither should this be considered to be a Research Report under SEC rules or Investment Research as defined by FCA rules as it has not been prepared in accordance with legal requirements to promote the independence of investment research and it is not subject to any prohibition on dealing ahead of the dissemination of investment research. Copyright Morningstar, Inc. All Rights Reserved. Morningstar Rating as of 31 May 2014, in the Global Large-Cap Blend Equity Morningstar Category Standard Bank International Investments Limited is regulated by the Jersey Financial Services Commission. Registered in Jersey No Standard Bank International Investments Limited is a wholly owned subsidiary of Standard Bank Offshore Group Limited a company incorporated in Jersey, registered No RMC B
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