VIEWS FROM THE DESK (VFTD) January Time does not pass, it continues

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1 VIEWS FROM THE DESK (VFTD) January 2014 Time does not pass, it continues We have been contemplating the past, the present and the future in preparation for our year end report something that is difficult to do without reference to a calendar. The purpose of the calendar is to reckon past or future time; to show how many days until a certain event e.g. a religious festival, the date of the next Fed meeting or the opening match of the FIFA World Cup in Brazil - or to calculate how long since something important happened. Most of the oldest calendars were founded on the time interval from one new moon to the next; others were based on certain weather events; for example, the end of winter or - in the case of ancient Egypt - the rainy season and the annual flooding of the river Nile. Julius Caesar introduced January 1 st as the start of the year in 45BC - however, in the centuries that followed, the church did not like the wild parties that took place (sound familiar?) and argued it was an ancient mistake and should be abolished. Through the Middle Ages various New Year dates were used and it was not until well into the 18th century that the calendar we use today was uniformly adopted across Europe. So why have we started this quarterly commentary with a history lesson? As you know, the end of one year and the start of the next is the arbitrary time frame used to measure the relative performance of money managers versus their designated benchmarks and peers. This annual 'line in the sand' provides a behaviourally important metric to assess skill and judgement and is universally accepted as a sensible routine to adopt. A few minutes spent trying to rationalise this does lead one to question its real value, particularly when investing should be considered a long term assignment. Notwithstanding the above, we, too, have used the last 12 months period to review investment performance, enabling us to reflect on what we got right and what didn t go so well. Beginning with the latter, three things stand out; 1. Our view that the US dollar would strengthen versus sterling, as the US macro picture improved, has not manifested itself...yet. This has been the number one frustration for us and its impact on the performance of our sterling-based portfolios has been pronounced. Positive performance at the underlying fund level has been considerably muted and, in some cases, translated to negative returns. As you will have gathered from the opening sentence, we do expect this trend to reverse (has it already started?) More on this later. 2. Disappointingly, we timed some investment decisions poorly. In our Real Return and Growth strategies we added to our Emerging Market equity and debt exposures in May, just ahead of Ben Bernanke's now famous May 22 nd Fed tapering announcement. This proved a painful reminder that it is the 'unexpected' that moves markets and a structured investment process based on valuations and long term thinking will always be exposed to knee-jerk shifts in short term sentiment. 3. Portfolios were too conservatively positioned and this has impacted performance at two levels. Firstly, we were overly pessimistic about the economic outlook and began the year with insufficient 'risk on the table' then equities rallied hard, particularly during the first quarter. Secondly, as the year progressed, we left ourselves with too big an exposure to our 'shock absorbers' in certain strategies, which proved headwinds to overall performance.

2 Turning to the investment decisions we are proud of, there are several noteworthy comments to make. We exited from gold positions across our Income Strategy in November 2012 and had removed it across all remaining portfolios by January The price of gold fell by 28% through the year, the first negative return from this safe haven asset since Staying with the theme of safe haven assets, the other go-to investments fulfilling these criteria have traditionally been developed market government bonds. Our government bond exposure in 2013, via our position in Ignis Absolute Return Government Bond, posted a return of 6.02%, with a volatility of just 3.85%. Contrast this with US Treasuries which fell -3.3%, UK Gilts declining 4.2% and German Bunds which delivered a negative return of 2.2%. The manager s performance is exceptional, particularly in the context of traditional blended, safe haven allocations to gold and government bonds. Our decision to overweight four key equity sectors/regions through the year namely global healthcare, global technology, global listed infrastructure and UK equities proved very rewarding. JP Morgan Global Healthcare and Polar Capital Healthcare Opportunities were up 62.25% and 55.49% respectively through the year, in US dollar terms. GAM Star Technology rose by 46.40% (US dollar) and the Lazard Global Listed Infrastructure Fund generated a return of 26.73% (sterling). Cazenove UK Equity (+34.03%) and Heronbridge UK Equity (+30.11% for 11 months) performed very strongly too. The chart below helps calibrate just how good this performance was, both outright and against the main indices. Keeping with our UK equity funds, their performance should also be reviewed in the context of their return versus the broad UK equity benchmark namely the FTSE All Share Index. With dividends reinvested, the index delivered 20.81% through This illustrates the benefits of active fund management versus passive investing and this story of outperformance is repeated cross the majority of funds held in

3 portfolios. We can be confident in saying our fund selection routines are adding real value bringing us to the final highlight of things we got right. The increased use of funds where the manager has extended flexibility and a broader range of tools and levers with which to fulfil their mandates. These include our strategic bond funds for example, which may use derivatives to reduce duration (i.e. manage their sensitivity to interest rates) or our equity funds that use long and short positions to express their investment views. Nowhere is this better illustrated than within our allocations to Emerging Market equities. The MSCI EM Index fell 2.4% (US dollar) last year however, the Fidelity FAST Emerging Market fund delivered a staggering 17.45% (US dollar). In our lower risk Real Return strategies we have used the Blackrock Emerging Markets Absolute Return fund and captured a return of 4.84%, enduring circa 60% less volatility than the index along the way. We are mindful the exceptionally strong numbers quoted in this what we got right section have not necessarily translated into strong overall portfolio performance particularly for our Growth Strategy investors. We have already highlighted the key reasons behind this but would like to reemphasize the impact sterling strength, versus the US dollar, had on returns. By way of an example, we invested in the above mentioned Fidelity FAST Emerging Market Fund on 12 th June 2013 and in US dollar terms the fund delivered 14% to the end of the year; in sterling terms this translated to a return of just over half of this, specifically 7.94%. We traded into Morgan Stanley Diversified Alpha Plus one of our multi asset class tools and levers funds on the 5 th July. By 31 December 2013 it has returned 4% in USD terms, but had lost 6.53% in sterling terms. This FX translation has been painful, but one which we are confident will reverse. Indeed, since the start of the year, the US dollar has already gained versus sterling. It would seem we are not alone in our currency views, as driven by client demand, we have launched three new discretionary solutions all denominated in US dollars. Two are dollar versions of existing strategies namely $ Income and $ Real Return with the third being Equity Growth, which has a mandate to outperform the MSCI All Countries World Index. The latter, whose first portfolios were invested in June, is currently annualising in excess of 18%. Having spent a lot of time reviewing the past, we would like to walk you through our thoughts for what lies ahead in calendar year 2014 and how we are positioned for this, following our Annual Investment Committee meeting held on 30 th November. The major binary macroeconomic risks which have dominated the investment landscape over recent years including the failure of the euro, a prolonged global recession and collapsing China growth have dissipated to varying degrees and, whilst there are always things to worry about, the outlook is much less opaque than it has been. The world s economy (if not its weather!!) seems more predictable and set against this

4 backdrop, investor confidence has understandably risen. Economic stabilisation is increasingly apparent and one could argue this relates to the greater visibility we have for the future prospects of growth, inflation and interest rates. This said, broad confidence in the outlook has lead to higher asset prices, resulting in valuations generally being less compelling than they have been for some time. Moreover, we should not forget that we remain in the midst of the greatest monetary experiment of modern times and the risk of policy errors must be a key input in assessing the relative merits of investment decisions. Now that we are in an environment of unsynchronised central bank policies, across the major economic centres, we anticipate periods of heightened financial market volatility, particularly around monthly central bank meetings. Based on this, our broad investment views are as follows: At the asset class level, we prefer equities to bonds but caveat that we still see value in some sectors of the fixed income market specifically short duration funds and long-short credit strategies We are under-weight commodities but, given our commitment to maintain/grow purchasing power, we do have exposure through a specialist energy equity fund where valuations are attractive and through a fund combining long-short commodities with inflation linked bonds Retain our US dollar overweight With respect to our regional exposure, we are overweight the UK and have built our positions in Europe (Real Return and Growth) and Japan and China (Equity Growth). On the subject of Europe, and to quote one of our favourite strategic bond managers: growth is not great anywhere but growth is everywhere (Ariel Bezalel, Jupiter). This has helped shape our decision to use long-short solutions Finally things to keep an eye on as the year progresses. If there is one thing we are focused on (apart from the US dollar!) it is the consensus nature of current investment views. To quote Benjamin Franklin - when everyone is thinking the same no one is thinking. Nothing goes up for ever and equity markets have had a strong run. This is not to say that they won t go higher, but to do so we need to see growth in topline sales, as opposed to corporate cost cutting. Falling unemployment may pose a real risk in the form of rising wages and may happen sooner than expected. Not only will this impact margins, it will also be inflationary something few seem to be talking about.

5 The other challenge to equities may come from the bond market itself. Rising yields naturally mean losses for fixed income assets; however they also lessen the relative attractiveness of equities on a risk-adjusted basis (the so called equity risk premium). To conclude we would like to thank you for your continued support and trust in us. One of the nice things about this industry is the opportunity to keep on learning. We have taken away some valuable lessons from In particular, the need to ensure we head into the new year with portfolios pre-positioned for the investment environment ahead. Clients will note we have been unusually active over the past couple of months. This does not reflect a change in investment style, simply our desire to be better prepared for the calendar year ahead. Julia and Russell

6 Performance of discretionary strategies Income Strategy ( ) % Jan Feb Mar Apr May Jun July Aug Sep Oct Nov Dec YTD Based on Model Composite Real Return Strategy ( ) % Jan Feb Mar Apr May Jun July Aug Sep Oct Nov Dec YTD Based on Model Composite Growth Strategy ( ) % Jan Feb Mar Apr May Jun July Aug Sep Oct Nov Dec YTD Based on Model Composite Last month s composite performance numbers are currently being calculated and will be provided on request. The performance detailed above is for illustrative purposes only and reflects the returns across Affinity Private Wealth s Income, Real Return and Growth model strategies, net of 0.95% management fees. This does not constitute investment advice and past performance should not be viewed as an indicator of future performance. Affinity Private Wealth is a trading name for APW Investors Limited, which is regulated by the Jersey Financial Services Commission. Registered office 24 Seale Street, St Helier, Jersey JE2 3QG.