SUCCESSION MANAGED PORTFOLIO SERVICE MARKET & REBALANCE COMMENTARY - Q2 2017

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1 SUCCESSION MANAGED PORTFOLIO SERVICE MARKET & REBALANCE COMMENTARY - Q FOR PROFESSIONAL ADVISERS ONLY EXECUTIVE SUMMARY Equity markets continued their upward trend in the second quarter of 2017, with an improving global economic outlook, reduced political uncertainty and positive corporate earnings revisions providing support across regions For sterling-based investors European, Asian (ex Japan) and Emerging Markets equities have been the standout performers year-to-date, with UK, North American and Japanese markets also enjoying positive returns in the first half of 2017 In contrast, conventional gilts sold off in June, reversing the gains seen in the first quarter as Bank of England policymakers debated whether to raise interest rates Against this backdrop, the Succession and Succession IDX strategies posted a positive return during Q2, broadly outperforming their strategic benchmarks in the process During the quarter we implemented changes to the strategies tactical asset allocations and underlying fund holdings, with further details included overleaf The table shows the performance of the Succession & Succession IDX strategies for the 3 month, 1 and 3 year periods to 30 June Strategy/Benchmark/IA Sector Q (%) 1 Year (%) 3 Years (%) Succession Global Growth FTSE UK Private Investor Global Growth TR IA Global Succession Growth Succession IDX Growth FTSE UK Private Investor Growth TR IA Flexible Investment Succession Balanced Succession IDX Balanced FTSE UK Private Investor Balanced TR IA Mixed Investment 40-85% Shares Succession Income Succession IDX Income FTSE UK Private Investor Income TR IA Mixed Investment 20-60% Shares Succession Conservative Succession IDX Conservative FTSE UK Private Investor Conservative TR IA Mixed Investment 20-60% Shares Succession Cautious MPS Cautious Composite Index (Platform) IA UK Gilt Source: Quilter Cheviot Limited, Financial Express, 17 July All figures to 30 June Strategy performance is shown gross of management fees with all income reinvested, real returns may vary. IA Sector returns are net of the underlying manager fund charges while benchmarks will not include any charges. Past performance is not a guarantee of future results. Investors should note that the illustrated past performance of the Succession Balanced strategy is taken from a pre-existing strategy which has been available on another platform for a period of more than 12 months. Performance figures quoted prior to 20 October 2014 include model returns of this preexisting strategy. Figures thereafter are taken from the model returns of the Succession Balanced strategy. 01

2 MARKET COMMENTARY For our latest INVESTMENT INSIGHTS, please visit our website via the relevant link: SUCCESSION STRATEGIES Q STRATEGY ATTRIBUTION ANALYSIS All index and fund returns are quoted on a total return basis in sterling terms. Fixed Interest: Conventional gilts posted negative returns during the second quarter of 2017, as the perceived change in attitude of central banks towards normalising monetary policy caused a sharp spike in yields. The 10-year gilt yield rose to 1.26% at the end of the month (the level at which it started the year), reversing in the process the gains seen in Q1. While the general election itself did not have a massive impact on bond yields, the ensuing speculation about austerity policies being watered down, as well as a potentially softer Brexit, also did not help gilts, leading to a total return of -1.3% from the FTSE Actuaries UK Conventional Gilts All Stocks index over the period. Elsewhere, UK investment grade corporate bonds comfortably outperformed conventional gilts, supported by strong investor demand for income. Global credit markets also fared well, delivering a return of approximately 1.6% for sterlinghedged investors, while high yield bonds also enjoyed another positive quarter off the back of strong investor risk appetite and a benign economic backdrop. As highlighted last quarter, the MPS strategies remain underweight fixed interest from an asset allocation perspective, a function of our relatively cautious stance on bonds in general given the historically low level of yields on offer. This positioning once again added to relative returns, though the majority of the outperformance seen over the quarter was generated at the underlying fund selection level. The Allianz Gilt Yield fund (-0.9%) the core conventional gilt exposure across the strategies fell over the quarter, but succeeded in partially protecting against the sell-off seen within this market. Elsewhere, positive absolute returns were seen from the strategies holdings in the AXA US Short Duration High Yield Bond (+1.0%), Legal & General Short Dated Sterling Corporate Bond Index (+0.4%) and PIMCO Global Investment Grade Credit (+1.6%) funds. Equities UK: The FTSE All-Share posted a total return of 1.4% over the quarter, with mid- and smaller-cap companies again outperforming their larger counterparts. Year-to-date total returns for the FTSE Small Cap (ex IT) and FTSE 250 (ex IT) now stand at 8.8% and 8.4% respectively, comfortably ahead of the 4.7% return from the FTSE 100 index. The period also saw a continuation of "growth" stocks outperforming "value", with sectors such as Oil & Gas, Basic Materials and Utilities posting negative returns over the period. The strategies UK equity holdings outperformed over the quarter, with a number of managers extending their relative gains year-to-date. The Artemis Income (+3.9%), Investec UK Alpha (+3.1%) and CF Woodford Equity Income (+2.6%) funds were three such examples, all benefiting from strong performance at the individual stock selection level as well as their underweight exposure to those poorly performing sectors mentioned above. The strategies allocation to the smaller end of the market also delivered firmly positive returns, with the River & Mercantile UK Equity Smaller Companies fund (+4.1%) enjoying continued strong performance from long-standing holdings across the AIM market. The Majedie UK Equity fund (0.0%) was the one notable laggard across the strategies, losing ground in the first half of the year following a very strong showing in Despite this short-term setback, our conviction in Majedie s collaborative, teambased approach one that combines top down input with in-depth bottom up research remains unchanged. Equities International: From a regional perspective Europe was the standout performer during the second quarter, with the FTSE Europe ex UK index returning 4.6% against an improving political, economic and corporate backdrop. In France, the election of Emmanuel Macron was received positively by markets, with significant asset flows into the region arising from the successful navigation of this perceived political hurdle. The French, Greek and Italian equity markets posted the best returns over the period, while Real Estate, Utilities and Financials led at the sector level. Pleasingly, the strategies European equity exposure outperformed at the fund selection level, while the overweight allocation to the region also contributed to relative returns. We further increased the exposure across several of the strategies towards the end of the quarter, while also making a change to our holdings. Further details can be found in the next section. North American equities ended down (-0.9%) in sterling terms over the quarter, a function of the dollar weakness seen during the period. The strategies exposure also finished in negative territory, underperforming the broader market as the Old Mutual North American Equity (-1.6%) and Schroder US Mid Cap holdings (-1.6%) lagged modestly. Elsewhere, returns from the strategies Asian allocations were positive, with the BGF Asian Growth Leaders (+2.8%) a new holding introduced in March also benefiting from its exposure to technology names. In Japan, the Baillie Gifford Japanese Income Growth fund (+2.2%) continued its strong start to the year with another quarter of outperformance. 02

3 Alternatives: The strategies Absolute Return exposure delivered a marginally positive return over the quarter, with the Invesco Perpetual Global Targeted Returns (+1.0%) and within the lower-risk strategies Newton Real Return (+1.1%) funds the standout performers. Returns from the strategies Commercial Property exposure were positive on both an absolute and relative basis, with the F&C Property Growth & Income fund (+5.1%) enjoying a particularly strong quarter to bring its year-to-date return to 7%. SUCCESSION STRATEGIES Q PORTFOLIO CHANGES To summarise, the key changes to the strategies asset allocations over the quarter were as follows: The strategies exposure to European equities was selectively increased, a move that reflects our continued positive outlook for this market on the basis of an improving economic environment, diminishing levels of political risk and positive corporate fundamentals The strategies exposure to Japanese equities was again selectively increased, with the allocation maintained as one of our key overweight exposures at the regional level We have closed our modestly underweight allocation to UK equities across the strategies, a move that reflects more our constructive outlook for risk assets than a wholesale change in our view on the domestic economy We have increased the exposure to Absolute Return funds within the Succession Growth and Succession Conservative strategies, having already raised this allocation within Succession Balanced and Succession Income earlier in the year The strategies cash levels were selectively reduced in the process At the fund selection level we have selectively introduced a new position within the strategies European equity allocation, while also moving the existing Emerging Markets equity holdings to an equal-weighted basis. Starting with Europe, we have exited the strategies exposure to the BlackRock Continental European Income fund in favour of the Henderson European Selected Opportunities fund. This move concludes the work undertaken to increase the economic sensitivity of the strategies exposure to the region, and was decided upon in the wake of the first round of the French election, when our positive outlook for European equities was reaffirmed. The addition of the Henderson fund to the strategies removes some of the more defensive biases that we had identified as a potential source of concern in a pro-cyclical market environment. John Bennett, the manager of the fund, is pragmatic in nature and his current positioning of the portfolio reflects our own broadly positive outlook for the region. Indeed, the fund s investment process provides the flexibility to rotate into sectors that are typically under-represented within the BlackRock fund, and Bennett s recent activity has certainly increased the value characteristics of the portfolio in recent times, with a move away from Healthcare in favour of an increased allocation to Banks the most notable example. The rationale for this rotation was based partially upon the valuation premium of certain sectors appearing high relative to history, but also the team s view that selected European Banks are finally investable, both in terms of their financial strength (with their dividend yield well covered) and lowly valuations. Paired alongside the incumbent allocation to the JOHCM Continental European fund, the result of this change is an exposure to two core managers that better reflect our outlook for European markets. Both remain broadly positive in their outlook and positioning, as well as relatively large cap in nature, and ensure synchronicity with our overweight allocation to this region. The final change of note was the repositioning of the strategies Emerging Markets equity holdings to an equal-weighted basis, having previously been tilted in favour of the more "value"-orientated Lazard Emerging Markets fund. The resulting position ensures a more balanced exposure to the low beta, high quality bias of the Henderson Emerging Markets Opportunities fund alongside the positive tilt towards global reflation obtained from the Lazard holding. SUCCESSION IDX STRATEGIES Q STRATEGY ATTRIBUTION ANALYSIS Fixed Interest: The Succession IDX strategies fixed interest holdings generated positive relative returns during the second quarter of 2017, with the diversified exposure to the Vanguard UK Investment Grade Bond Index (+0.5%), Legal & General Short Dated Sterling Corporate Bond Index (+0.4%) and Legal & General Global Inflation Linked Bond Index (+0.2%) funds all outperforming the total return of -1.3% seen from the FTSE Actuaries UK Conventional Gilts All Stocks index over the period. Equities UK: The strategies exposure to the HSBC FTSE 250 Index fund (+3.7%) was once again the highlight in another positive period for UK equity market returns. 03

4 Equities International: The strategies overweight exposure to Europe ex UK added to relative performance, with the holding in the Legal & General European Index fund returning 6.3% over the quarter. Alternatives: The strategies Commercial Property exposure delivered positive returns over the period, with the Aberdeen UK Property Feeder Unit Trust finishing up 1.6%. In contrast, the allocation to the ishares (formerly BCIF) Global Property Securities Equity Index fund (-0.7%) finished in marginally negative territory. SUCCESSION IDX STRATEGIES Q PORTFOLIO CHANGES At the asset allocation level, the following changes were implemented in Q1: The strategies exposure to European equities was increased, a move that reflects our continued positive outlook for this market on the basis of an improving economic environment, diminishing levels of political risk and positive corporate fundamentals The strategies exposure to Japanese equities was again selectively increased, with the allocation maintained as one of our key overweight exposures at the regional level We have closed our modestly underweight allocation to UK equities across the strategies, a move that reflects more our constructive outlook for risk assets than a wholesale change in our view on the domestic economy We have selectively increased the exposure to Absolute Return funds within the IDX strategies The strategies cash levels were selectively reduced in the process There was little change at the fund selection level, with the introduction of the Newton Real Return fund within the IDX Income and IDX Conservative strategies the one notable addition. This move ensures the exposure to Absolute Return within these strategies (which retain a larger allocation to this asset class) is spread across a broad range of differentiated funds that, in aggregate, seek to obtain stable returns with a low correlation to traditional markets. Elsewhere, we reduced our exposure to the Vanguard FTSE UK Equity Income fund in favour of an increased allocation to the strategies FTSE All- Share and FTSE 250 index holdings. SUCCESSION & SUCCESSION IDX TACTICAL POSITIONING 30 JUNE 2017 At the headline level there is little quarter-on-quarter difference to our positioning across the Succession and Succession IDX strategies. Rather, it is the emphasis of these tactical allocations that we have changed. As such, we remain biased towards equities, with North America, Europe (ex UK) and Japan our key overweight positions relative to strategic benchmarks. This is in contrast to the UK, where we maintain a neutral allocation. SUCCESSION BALANCED & SUCCESSION IDX BALANCED STRATEGIES TACTICAL POSITIONING 30 JUNE 2017 Within the strategies bond exposure, we retain a cautious stance overall. Although gilt yields did rise modestly during the last quarter, they still remain close to historical lows and do not appear to offer much value, especially when elevated levels of inflation are taken into account. Unfortunately, most other parts of the bond market also look expensive following a prolonged period of strong returns. We are therefore focusing on quality and liquidity, while also seeking to earn a competitive return. We remain of the opinion that yields will be slow to rise, and expect the Bank of England to keep interest rates low for the foreseeable future. Elsewhere, we have further reduced the portfolios cash levels, having already lowered levels earlier in the year, ensuring that the strategies now hold only a very modest overweight position. And finally, Absolute Return holdings have been selectively increased across the strategies, though alongside Commercial Property we retain our underweight position to Alternatives within the portfolios. 04

5 CONCLUSION Eight years into the economic cycle and with equity markets touching new highs, exceptional year-on-year returns and no sign of a correction, it is hardly surprising that many investors are feeling cautious. However, a combination of rising nominal GDP and relatively slow monetary tightening is a benign environment for risk assets, and strong 2017 corporate earnings will provide additional support. While the tapering of central bank balance sheets requires close monitoring for signs of tighter credit conditions, equities can still make progress. A modest rise in bond yields should also be expected. The past year has seen above average sector rotation and this has provided opportunities for active investors. Falling bond yields in recent years have helped growth stocks out-perform value and, although the former are now looking expensive, valuations are still nowhere near tech bubble territory. If tapering by central banks results in a steeper yield curve, value stocks typically represented in most markets by financials could come back into favour. Analysts forecasts of a 14% increase in global corporate earnings puts world equities on a forward price/earnings ratio of 17x. This is above the longerterm average, but by no means extreme. The US looks the most expensive and Asian/ Emerging Markets the cheapest with Europe (including the UK) somewhere in the middle. Income-seeking investors will continue to be attracted by dividend yields and these are well supported by profits at this stage in the cycle. Source: Quilter Cheviot, Financial Express, July 2017 QUILTER CHEVIOT One Kingsway London WC2B 6AN t: +44 (0) w: quiltercheviot.com 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. 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. Quilter Cheviot Limited is a member of the London Stock Exchange and authorised and regulated by the UK Financial Conduct Authority. 05