MANAGED PORTFOLIO SERVICE MARKET & REBALANCE COMMENTARY - Q1 2018

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1 MANAGED PORTFOLIO SERVICE MARKET & REBALANCE COMMENTARY - Q EXECUTIVE SUMMARY Volatility returned to financial markets with a vengeance in the first quarter, as January s sharp rise in equities was undermined by US wage growth concerns and fears of a looming global trade war Equity investors, particularly those exposed to the UK market, endured a turbulent period as a strengthening pound and waning sentiment combined to leave sterling-based returns firmly in the red Conventional gilts managed to eke out a small positive return over the first quarter, despite ongoing speculation about rising interest rates both in the UK and the US. In contrast, UK investment grade corporate bonds struggled as investors worried about rising protectionism, geopolitical risks and an increase in corporate borrowing costs Against this backdrop the MPS strategies posted a negative return, performing broadly in line with their respective benchmarks During the quarter we selectively reduced the strategies exposure to UK equities, rotating the proceeds into preferred international markets. We also implemented several fund switches to reflect our latest thinking, with further details included overleaf The table shows the performance of the MPS strategies for the 3 month, 1 and 3 year periods to 31 March Strategy/Benchmark/IA Sector Q (%) 1 Year (%) 3 Years (%) MPS Global Growth MPS Global Growth Composite Index IA Global MPS Growth FTSE UK Private Investor Growth IA Flexible Investment MPS Balanced FTSE UK Private Investor Balanced IA Mixed Investment 40-85% Shares MPS Global Income MPS Global Income Composite Index IA Mixed Investment 40-85% Shares MPS Income FTSE UK Private Investor Income IA Mixed Investment 20-60% Shares MPS Conservative MPS Conservative Composite Index IA Mixed Investment 20-60% Shares MPS Cautious MPS Cautious Composite Index IA UK Gilt Source: Quilter Cheviot Limited, Financial Express, 24 April All figures to 31 March Strategy performance is shown gross of management fees with all income reinvested, real returns may vary. IA Sector returns are net of the underlying fund manager charges while benchmarks will not include any charges. Past performance is not a guarantee of future results. INVESTMENT INSIGHTS For our latest INVESTMENT INSIGHTS, please visit our website via the relevant link: 1

2 TACTICAL POSITIONING OVERVIEW 31 MARCH 2018 The investment decisions implemented during the first quarter of 2018 can be summarised as an accentuation of the strategies existing themes. The allocation to UK equities has been reduced, and while we continue to monitor domestic valuation opportunities, our tactical preferences continue to lie overseas. As such, the positive tilt in favour of Japanese stocks has been further increased, while the strategies exposure to Asia Pacific and emerging markets has been added to, moves predicated upon our view that the global cyclical upturn has further to run. MPS BALANCED STRATEGY TACTICAL POSITIONING 31 MARCH 2018 There was little change across the strategies fixed interest positions, with the conditions for bonds more challenging than they have been in recent years. Inflation is picking up, especially in the US, and interest rates look set to rise in the UK as well. In Europe, the ECB s QE programme, which has been a big factor in depressing yields, is likely to be gradually wound down towards the year end. We are therefore continuing to take a cautious stance towards bond markets, although any rise in yields may be limited by ongoing geopolitical and trade tensions. In terms of credit risk, we are generally exposed to the more liquid and secure end of the spectrum. Credit spreads have widened in recent weeks but are still below historical averages, so we have a bias towards sovereign debt and have little High Yield exposure. Index-linked gilts still look fully valued to us, but at least they provide something of a hedge against political risk returning to the UK and causing a further fall in the pound. Finally, there was no change to the strategies underweight position to Absolute Return and Commercial Property funds, while across most portfolios cash positions remain modestly overweight. Q STRATEGY ATTRIBUTION ANALYSIS All index and fund returns are quoted on a total return basis in sterling terms. Please note that the summary below does not incorporate details of fund performance for a number of holdings within the MPS Global Income strategy. Further information relating to this strategy and its current allocations can be obtained from your usual Quilter Cheviot representative. Fixed Interest: Conventional gilts managed to eke out a small positive return over the first quarter, despite ongoing speculation about rising interest rates both in the UK and the US. However, much of that return came from longer dated debt as pension fund demand remained strong. In contrast, shorter-dated gilts fell modestly in value. The UK economy held up reasonably well amid the ongoing Brexit negotiations, although growth still lagged behind most global peers. On a positive note, inflation pressures diminished somewhat as the impact of sterling s depreciation began to wear off. However, wages also began to increase, which was great news for consumers but meant that the Bank of England felt compelled to signal that further rate hikes were on the agenda. At the end of March, 10-year UK government bond yields had risen to 1.35% but 30-year yields dropped to 1.71%, resulting in a much flatter yield curve. Index-linked gilts marginally underperformed conventional gilts over the quarter, as inflation expectations eased. UK investment grade corporate bonds struggled during the first quarter and underperformed conventional gilts by around 2%. The asset class was affected by the general reduction in risk appetite as investors worried about rising protectionism, geopolitical risks and an increase in corporate borrowing costs. Global credit markets also sold off, returning around -1.7% on a sterling-hedged basis. The MPS strategies remain underweight the asset class at the headline level. In a period of declining equity markets and marginally positive gilt returns, this ultimately cost portfolios relative performance over the period. Returns were also modestly negative at the underlying fund selection level, as the Allianz Gilt Yield fund (0.0%) lagged the FTSE Actuaries UK Conventional Gilts All Stocks index (+0.3%), though this was due principally to end-quarter timing. Across the strategies credit exposure, returns were marginally negative across the board, as the AXA US Short Duration High Yield Bond (-0.4%), Legal & General Short Dated Sterling Corporate Bond Index (-0.7%) and PIMCO Global Investment Grade Credit (-1.1%) funds all ended the quarter down. 2

3 Equities UK: The FTSE All-Share index returned -6.9% for the first quarter of 2018, significantly lagging other equity markets in local currency terms. Mid- and small-cap indices both finished marginally ahead of the broader index for the quarter, while the mega-cap FTSE 100 brought up the rear, delivering a total return of -7.2%. With a strengthening pound, rising bond yields in the US and increasingly negative sentiment towards the domestic market, large-cap international earners (in particular the so-called bond proxies ) were very much in the firing line. Amidst these conditions, the strategies UK equity holdings unsurprisingly delivered a negative return. However, it was pleasing to see the allocation outperform the broader market, with strong relative returns from the Artemis Income (-3.5%) and Investec UK Alpha (-5.7%) funds. Returns from the Majedie UK Equity (-6.2%) and Old Mutual UK Alpha (-6.2%) holdings also finished ahead of the index, while the exposure to the LF Woodford Equity Income fund struggled prior to its sale during the quarter. Equities North America: The FTSE North America index delivered a total return of -4.5% in sterling terms for the first quarter of 2018, with the majority of this fall attributable to sterling s sharp rise against the dollar. Indeed in local currency terms losses were far more muted, with growth stocks once again showing the way in terms of market leadership. Several Technology names started the year in rip-roaring fashion, and while Facebook was among a number of stocks to exhibit significant volatility towards the end of the period, it proved to be an extremely satisfying quarter for the strategies exposure to the PrivilEdge Sands US Growth (+5.3%) fund. Holdings in Netflix, ServiceNow and Amazon were amongst several of the team s positions to enjoy a spectacular start to Pleasingly, the strategies allocation to the Vulcan Value Equity fund (-0.8%) also markedly outperformed over the quarter, despite its focus on value stocks remaining very much out of favour as an investment style. The strategies other active holding the mid-cap orientated Iridian US Equity fund (-5.4%) finished marginally behind the index for the quarter. Equities Europe ex UK: After a strong start to 2018, the FTSE Developed Europe ex UK index finished in the red for Q1, returning -4.6% in sterling terms following a sharp fall in March. The strategies exposure modestly outperformed the broader market, with both the JOHCM Continental European (-4.0%) and Henderson European Selected Opportunities (-4.2%) funds offering a small measure of downside protection. Equities Japan: The FTSE Japan index returned -2.6% in sterling terms during the quarter, with yen strength partially offsetting declines seen in the wake of growing concerns surrounding global trade. While the Baillie Gifford Japanese Income Growth fund (-1.8%) continued its strong relative performance from last year, the prevailing anti-cyclical conditions proved difficult for the Eastspring Japan Dynamic fund (-5.1%) to navigate. As such, after a strong 2017 in terms of stock selection, the strategies exposure to Japan gave back a small degree of recent outperformance in the first quarter of the year. However, following a recent meeting with the Eastspring team we remain firmly convinced of the merit of the fund s position within the strategies. Equities Asia Pacific ex Japan: The FTSE Developed Asia Pacific ex Japan index returned -6.1% over the period, with the strategies underlying holdings which invest across a broader range of markets than this benchmark outperforming over the quarter. During the quarter we made changes to the strategies fund holdings, with further details outlined below. Equities Emerging Markets: The FTSE Emerging index returned -2.2% in sterling terms in Q1, significantly outperforming developed markets albeit with wide dispersion in performance across the constituent countries. While Brazil and Russia finished in positive territory, with China also performing well, India and the Philippines lagged. The strategies exposure marginally underperformed at the fund selection level, with the Janus Henderson Emerging Markets Opportunities fund (-4.3%) in particular enduring a difficult Q1 off the back of a tough period for several holdings including Tiger Brands, Newcrest Mining and PZ Cussons. Alternatives: The strategies basket of Absolute Return / Hedge Fund holdings fulfilled its role in generating a positive return over the quarter. Indeed, against a backdrop of volatile equity and fixed interest markets it was pleasing to see strong performance from the Old Mutual Global Equity Absolute Return fund, which delivered a total return of +3.1%. Returns from the other holdings proved mixed, with the higher-risk Aspect Diversified Trends fund (-0.8%) enjoying a notably strong start to the year before selling off aggressively in February. The allocation to this fund was trimmed during the quarter. Lastly, the performance of the strategies Commercial Property allocation was also positive, with the larger position in the Aberdeen UK Property Feeder Unit Trust fund (+1.5%) offsetting the falls posted by the more pan-european focused F&C Property Growth & Income fund (-1.9%). 3

4 Q STRATEGY CHANGES Please note that the summary below does not incorporate details of recent activity within the MPS Global Income strategy. Further information relating to this strategy and its current allocations can be obtained from your usual Quilter Cheviot representative. To summarise, the key changes to the strategies asset allocations during the quarter were as follows: We selectively reduced the strategies exposure to UK equities, moving the allocation to an underweight position from a tactical perspective We selectively increased the strategies exposure to Japanese equities, adding to existing fund holdings and raising the portfolios overweight tactical allocation to this market We selectively increased the strategies exposure to Asia Pacific (ex Japan) equities, moving the allocation to an overweight position from a tactical perspective We also selectively increased the strategies exposure to emerging markets equities, which again has been moved to an overweight position from a tactical perspective A number of corresponding changes were also made at the fund selection level within the strategies. Starting with the UK, we took the decision to exit the LF Woodford Equity Income fund during the quarter, redeploying the proceeds across the existing holdings in the Investec UK Alpha and Majedie UK Equity funds. Central to this decision was the desire to seek a more balanced allocation to the UK equity market, an objective that we feel is best served by adding to these positions as opposed to introducing a new fund. In summary, this move has led to an increase in the weighted average market cap of the strategies exposure to the UK equity market, while the bias towards domestic earners (and away from companies with international sales) has also been reduced. During the quarter we also exited the River & Mercantile UK Equity Smaller Companies fund, a holding that performed exceptionally well in This move was made in the wake of the sudden departure of lead portfolio manager Philip Rodrigs, with the proceeds allocated to the HSBC FTSE 250 Index fund. Turning to the strategies Asia Pacific ex Japan allocation, and the decision was made to exit the Stewart Investors Asia Pacific Leaders holding in favour of the Veritas Asian fund. While we continue to rate the Stewart Investors team highly, this change was implemented to ensure that our positive outlook towards the region is suitably reflected at the underlying fund level. Managed by Ezra Sun at the boutique investment management company Veritas Asset Management, the Veritas Asian fund is positively positioned in anticipation of an attractive corporate growth cycle, with a bias towards companies exhibiting strong growth and earnings momentum. The manager takes a pragmatic approach to portfolio construction, and has recently increased the fund s exposure towards Chinese companies, while at the sector level Technology, Consumer Staples and Consumer Discretionary names feature heavily at the current time. With these characteristics in mind, we believe this fund to be an excellent complement to the strategies existing exposure to the region. Elsewhere, we increased the strategies exposure to the Lazard Emerging Markets fund, a decision made in tandem with the increase in headline allocations to emerging markets across a number of the strategies. Having endured a difficult 2017 in relative terms, we believe the style characteristics of this fund sit nicely alongside the current Asian and emerging markets holdings. Finally, we trimmed the strategies holdings in the Aspect Diversified Trends fund in favour of adding to existing positions in the LFIS Vision UCITS Premia fund. CONCLUSION Following 3% global growth in Q1, we expect GDP to pick up again to around 3.7% over the remainder of the year. In emerging economies, growth is likely to be 4.8% vs. 2.4% in industrialised countries both marginally higher than However, the risk of an escalation in the China-US trade confrontation should not be under-estimated, as in reality the $375bn merchandise deficit cannot be cut by anything close to President Trump s $100bn target. For example, although China purchased around 20% of US oil exports in 2017 and could absorb more, this would not resolve the merchandise or the more contentious intellectual property deficits. The best guesstimate is that the measures announced so far will reduce China s GDP by less than 0.2%. Of the other key emerging economy contributors, India continues to grow more rapidly than China, while Brazil and Russia are accelerating modestly. Given their sensitivity to trade flows, these markets have held up relatively well and benefited from dollar weakness. In industrialised economies, the US and Eurozone head the league table, while Japan and the UK lag their G7 counterparts by a substantial margin. However, the outlook for the UK has improved in recent weeks as, to the relief of the corporate sector, a Brexit transition phase is close to agreement, boosting sterling to $1.40. Although major challenges remain and markets may be over-optimistic about the eventual outcome, 1.6% GDP growth is still expected this year. Pressure on real 4

5 incomes should ease as inflation normalises and wage growth picks up, but Brexit uncertainty will continue to impact business investment and exports. Despite sub-trend growth, the Bank of England still expects interest rates to rise earlier and to a greater extent than previously anticipated. However, as the UK economy is not strong enough and too highly indebted to match US rate rises, we expect 0.25% increases in the second and fourth quarters, leaving rates at 1% by yearend. The global corporate profits outlook remains buoyant, with growth of 15% expected this year. Although estimates have been shaved for Japan (7%) and the Eurozone (10%) over the past month, they have increased for the US (19%) and UK (8%). The upgrades are energy, materials and financials but not technology with downgrades mostly confined to the consumer, utility and telecom sectors. In the absence of a deep recession, which we do not anticipate, valuations now look interesting, especially in the Eurozone and UK, where they are back to longer-term averages. Emerging markets also appear particularly attractive. However, rising interest rates and bond yields usually lead to a reappraisal of discounted cash flows and earnings, a general market de-rating (as share prices lag higher profits) and also sector / style rotation. This suggests potential upside in equity markets may be accompanied by a change in leadership and a move from growth to value stocks. Source: Quilter Cheviot, Financial Express, April 2018 Investors should remember that the value of investments, and the income from them, can go down as well as up and that past performance is no guarantee of future returns. You may not recover what you invest. QUILTER CHEVIOT One Kingsway London WC2B 6AN t: +44 (0) w: quiltercheviot.com This document has been prepared for information purposes only and is not a solicitation or an offer to buy or sell any security. It does not purport to be a complete description of our investment policy, markets or any securities referred to in the material. The information on which the document is based is deemed to be reliable, but we have not independently verified such information and we do not guarantee its accuracy or completeness. Quilter Cheviot Limited is registered in England with number , registered office at One Kingsway, London, WC2B 6AN, England. Quilter Cheviot Limited is a member of the London Stock Exchange; is authorised and regulated by the UK Financial Conduct Authority; has established a branch in Jersey and is regulated under the Financial Services (Jersey) Law 1998 by the Jersey Financial Services Commission for the conduct of investment business in Jersey and by the Guernsey Financial Services Commission under the Protection of Investors (Bailiwick of Guernsey) Law, 1987 to carry on investment business in the Bailiwick of Guernsey; is regulated by the Dubai Financial Services Authority as a Representative Office (and its business name in Dubai is Quilter Cheviot Limited (DIFC Representative Office)); and has established a branch in Dublin, Ireland with number and is regulated by the Central Bank of Ireland for conduct of business rules. Accordingly, in some respects the regulatory system that applies will be different from that of the United Kingdom. 5