SUCCESSION MANAGED PORTFOLIO SERVICE MARKET & REBALANCE COMMENTARY - Q1 2017

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1 SUCCESSION MANAGED PORTFOLIO SERVICE MARKET & REBALANCE COMMENTARY - Q FOR PROFESSIONAL ADVISERS ONLY EXECUTIVE SUMMARY Equity markets performed strongly during the first quarter, as the modest acceleration in global economic growth that started last autumn continued into 2017 Asia ex Japan and Emerging Markets were the standout performers, with UK, European and North American equities also enjoying positive returns Conventional gilts gained during the quarter despite the continued pick-up in inflation, whilst UK investment grade corporate bonds benefited from benign economic conditions and Bank of England purchases The Succession ( active ) and Succession IDX ( passive ) strategies posted a positive return over the period, generally finishing in line or marginally behind their strategic benchmarks During the quarter we implemented changes to the strategies 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 31 March Strategy/Benchmark/IA Sector Q (%) 1 Year (%) 3 Years (%) Succession Global Growth FTSE UK Private Investor Global Growth TR IA Global TR Succession Growth Succession IDX Growth FTSE UK Private Investor Growth TR IA Flexible Investment TR Succession Balanced Succession IDX Balanced FTSE UK Private Investor Balanced TR IA Mixed Investment 40-85% Shares TR Succession Income Succession IDX Income FTSE UK Private Investor Income TR IA Mixed Investment 20-60% Shares TR Succession Conservative Succession IDX Conservative FTSE UK Private Investor Conservative TR IA Mixed Investment 20-60% Shares TR Succession Cautious MPS Cautious Composite Index (Platform) IA UK Gilt TR Source: Quilter Cheviot Limited, Lipper, a Thomson Reuters Company, 19 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 manager fund charges whilst benchmarks will not include any charges. Past performance is not a guarantee of future results. MARKET COMMENTARY For our latest comprehensive monthly and quarterly market commentaries, please visit our website via the following link and select your preferred document within the INDUSTRY INSIGHTS section on the right hand side of the page: 01

2 SUCCESSION STRATEGIES Q STRATEGY ATTRIBUTION ANALYSIS All index and fund returns are quoted on a total return basis in sterling terms. Fixed Interest: Brexit-related economic uncertainty and the election schedule in Europe provided a fillip to conventional gilts during the first quarter of 2017, with index-linked gilts posting similarly positive returns as inflation expectations remained elevated. Expectations that new US president Donald Trump would be able to quickly implement growth-friendly policies also suffered a sober reality-check, pushing down global bond yields including gilts in the process. The Succession 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 added to relative returns over the quarter as equity markets continued their strong recent gains. However, outperformance was also generated from underlying fund selection, with the Allianz Gilt Yield fund (+2.3%) the core conventional gilt exposure across the strategies benefiting from its long duration (a measure of sensitivity to interest rates) positioning and exposure to long-dated index-linked gilts. The strategies other bond fund holdings also gained over the period, with the PIMCO Global Investment Grade Credit fund (+1.6%) outperforming its benchmark due to security selection within financials as well as its overall sector positioning. Equities UK: The FTSE All-Share posted a total return of 4.0% over the quarter, broadly in line with the return seen last quarter albeit driven on this occasion by a bounce from mid- and smaller-cap companies. The period also saw a partial reversal in the prevailing style when compared to Q4 2016, with Growth stocks outperforming Value and sectors such as Oil & Gas losing ground against Consumer Staples, Health Care and Industrials. The differing returns across the strategies UK equity managers broadly reflected this trend, with the overall allocation finishing the quarter in line with the market. Highlights included the Investec UK Alpha fund (+5.7%), with holdings such as Inmarsat, Booker and an underweight exposure to Royal Dutch Shell helping to drive performance. It was also a positive quarter for the CF Woodford Equity Income fund (+4.7%), with strong performance from names including AstraZeneca, Imperial Brands and British American Tobacco. Finally, within the small cap space the strategies exposure to the River & Mercantile UK Equity Smaller Companies fund enjoyed a positive start to 2017, with continued gains from names such as Fevertree (the supplier of premium carbonated drinks mixers), Conviviality (the food and drinks distributor) and Boohoo (the online fashion retailer) ensuring the fund delivered a total return of 8.6% for the quarter. Equities International: International equity markets delivered positive returns in the first quarter of 2017, with the US market hitting all-time highs and Europe catching up with solid gains in March. However, it was Asia ex Japan and Emerging Markets which posted the strongest gains over the period, returning 11.7% and 8.9% respectively. Turning to North America first, the FTSE All-World North America TR index finished up 4.8% for the quarter, driven mainly by a relatively small number of large cap names in the Technology, Healthcare and Consumer Goods and Services sectors. The region remains one of our tactically overweight positions, and although this added to relative returns, our managers modestly underperformed over the period. This was due largely to the strategies holding in the Schroder US Mid Cap fund (+3.1%), a recent addition to portfolios which, despite generally strong stock selection within its mid-cap universe, suffered from its lack of exposure to large-cap Growth names such as Amazon, Facebook and Apple. As detailed above, these types of companies performed exceptionally strongly in Q1, and were responsible for a large percentage of the gains made by this market over the period. Across the strategies other international equity holdings, it was pleasing to see two of the other recent additions to the strategies the Baillie Gifford Japanese Income Growth (+4.5%) and Henderson Emerging Markets Opportunities (+11.2%) funds both finish ahead of their respective benchmarks. Elsewhere, the strategies exposure to Asia ex Japan and Europe ex UK both delivered positive absolute returns, though lagged their respective markets. The Stewart Asia Pacific Leaders fund (+9.1%) was impacted by stock selection in India as well as an absence of strongly-performing index heavyweights such as Samsung. In Europe, the JOHCM Continental European fund (+3.9%) endured an uncharacteristically difficult period of relative performance, with individual stock names and an overweight exposure to the Oil & Gas sector detracting over the quarter. Alternatives: The strategies Alternatives exposure delivered positive returns for the quarter, with marginal outperformance from the Commercial Property holdings offset by the Absolute Return holdings lagging their benchmark modestly. 02

3 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 Japanese equities was increased, reflecting our positive outlook for this market on the basis of relatively cheap valuations, reduced political risk versus other regions and the prospect of it being a beneficiary of a cyclical global upturn The strategies UK equity exposure was selectively reduced, most notably in Succession Balanced where the proceeds have been used to increase the allocation to Absolute Return funds We increased the allocation to Absolute Return funds within Succession Income, funded principally by a reduction in the strategy s Fixed Interest exposure The strategies remaining index-linked gilt exposure was sold, with the position initially trimmed in November following the exceptionally strong returns seen from the asset class in The proceeds of these sales were used principally to increase the strategies exposure to conventional gilts The strategies cash levels were selectively reduced At the fund selection level we made changes to the strategies UK, North America and Asia Pacific equity allocations. Of these, the most significant change was to the strategies North America equity exposure, where we have exited our holdings in the Polar Capital North American and Vanguard US Equity Index funds, and introduced the Old Mutual North American Equity and BlackRock North American Equity Tracker funds as higher-conviction ideas. The first new holding within the space the Old Mutual North American Equity fund follows a quantitatively driven process predicated on the belief that markets are not fully efficient, and often diverge from their fundamental value due to investors behavioural biases. The process seeks to incorporate exposure to a number of drivers of equity returns, including (amongst others) valuation, quality, growth, market expectations, management quality and momentum. The fund is run by a highly experienced team of three portfolio managers (together with a further three analysts), with the managers having worked together since The portfolio typically comprises stocks, and is fairly sector neutral, limiting itself to a position of plus or minus 5% relative to the MSCI North America Index. As such, we see the fund as a core holding within the region, though one that has demonstrated impressive flexibility (and outperformance) in recent times, with its shift towards Value names in the first half of 2016 proving to be well rewarded in the final six months of the year. The second new holding the BlackRock North American Equity Tracker fund is a low-cost index-tracking fund which provides exposure to large and medium-sized North American companies. As such, its introduction expands the strategies index-tracking exposure to incorporate the whole of the region (including Canada) instead of the US alone. Coupled with the sale of the Vanguard US Equity Index (which tracked both large and small companies within the US market), these changes ensure that exposure to smaller companies within the North American equity market is now obtained solely through the strategies active holdings, with the Schroder US Mid Cap fund currently our preferred holding in this space. The final change to the allocation was a reduction in the total passive weighting to the North American equity market in favour of an increase in the strategies exposure to active managers in the region. This is a move which reflects our view that this is potentially a more favourable environment for active US stock pickers than has been the case in recent years. We have therefore sought to position the strategies exposure to the region in such a way as to enable our active managers the freedom to express their high conviction ideas in pursuit of long-term outperformance whilst continuing to ensure that a core, low-cost diversified exposure is maintained through the index-tracking holdings. To summarise, the resulting positioning provides a broadly value-orientated, small and mid-cap tilt within the allocation, factors that we are keen to capture at the current time. Within the strategies domestic equity exposure we reduced exposure to the Investec UK Alpha fund in favour of the existing Majedie UK Equity holding, ensuring that the fund now sits as the joint-largest weighting within the strategies UK equity allocation alongside the Artemis Income fund. The last notable change was the introduction of the BlackRock GF Asian Growth Leaders fund to the strategies Asia ex Japan allocation. This holding has been added alongside the existing Stewart Investors Asia Pacific Leaders holding on an equal-weighted basis. The fund, led by the Hong-Kong based manager Andrew Swan, is pragmatic in its style, sector and country biases, and has also recently been transitioning away from quality growth companies into more cyclical value names. As such, we feel it is an excellent complement to the Stewart team s more expensive universe of holdings, and ensures a broader and slightly less defensive exposure across the region, one in keeping with our current outlook. 03

4 SUCCESSION IDX STRATEGIES Q STRATEGY ATTRIBUTION ANALYSIS Fixed Interest: The Succession IDX strategies fixed interest holdings generated positive returns during the first quarter of 2017, though lagged the broader gilt market due principally to the portfolios short-duration credit exposure. Equities UK: Returns from the strategies UK equity exposure finished marginally ahead of the broader market over the first quarter, with the HSBC FTSE 250 Index (+5.1%) benefiting from the strong start to 2017 enjoyed by mid- and smallercap companies. Equities International: Strong returns from international equity markets helped drive the strategies headline returns, with Asia ex Japan and Emerging Markets the standout performers. Elsewhere, the strategies overweight exposure to Europe ex UK also added to relative performance. Alternatives: The strategies Commercial Property exposure delivered positive returns over the period, with the Aberdeen UK Property fund finishing up 1.6% for the quarter. SUCCESSION IDX STRATEGIES Q PORTFOLIO CHANGES At the asset allocation level, the following changes were implemented in Q1: We introduced an allocation to Absolute Return funds across the Succession IDX strategies, with further details outlined below The strategies exposure to Japanese equities was increased, reflecting our positive outlook for this market on the basis of relatively cheap valuations, reduced political risk versus other regions and the prospect of it being a beneficiary of a cyclical global upturn The strategies UK equity exposure was selectively reduced The strategies remaining index-linked gilt exposure was sold, with the position initially trimmed in November following the exceptionally strong returns seen from the asset class in The proceeds of these sales were used principally to increase the strategies exposure to conventional gilts Finally, the strategies cash levels were reduced At the fund selection level, the main change to the strategies was the introduction of an allocation to Absolute Return funds within the portfolios. We see this move as another positive development in the evolution of the Succession IDX strategies, building upon the solid performance foundations laid to date whilst retaining the portfolios lower-cost, predominantly indextracking ethos. Back in early 2015, we incorporated the first non-index holding (the Aberdeen UK Property fund) within the strategies Commercial Property exposure, believing that the marginally increased costs incurred from doing so were outweighed by the diversification benefits that a direct bricks and mortar allocation to the asset class brings. In a similar fashion, we perceive the incorporation of Absolute Return funds within the Succession IDX strategies as an effective way of pursuing diversified sources of returns whilst also assisting in the overall risk management of the strategies, and have introduced a number of differentiated funds to ensure exposure across a broad range of investment styles. The three holdings we have purchased are the Julius Baer Absolute Return Bond, Invesco Perpetual Global Targeted Returns and Old Mutual Global Equity Absolute Return funds all high-conviction ideas held within the Succession strategies, thereby ensuring we are already extremely familiar with the approach being taken by these managers. The final change of note to the portfolios was the incorporation of the BlackRock North American Equity Tracker fund on an equal-weighted basis alongside the existing Vanguard US Equity Index fund. This move ensures the strategies indextracking exposure is expanded to incorporate the whole of the region (including Canada), instead of the US alone. 04

5 SUCCESSION & SUCCESSION IDX TACTICAL POSITIONING 31 MARCH 2017 The changes made to the Succession and Succession IDX strategies during the first quarter of 2017 reflect our broadly positive outlook for equities, with North America, Europe ex UK and Japan our key overweight positions. SUCCESSION & SUCCESSION IDX BALANCED STRATEGIES TACTICAL POSITIONING 31 MARCH 2017 Within the strategies bond exposure, we have maintained our preference for UK sovereign debt over credit, whilst exiting the allocation to index-linked gilts in favour of conventionals following the former s recent outperformance and elevated valuations. We have also selectively reduced the portfolios cash levels, though continue to retain an allocation across the medium- to lowerrisk strategies that affords us the flexibility to take advantage of opportunities as and when they arise. Finally, Absolute Return holdings have been selectively increased across the strategies, though alongside Commercial Property we retain our underweight position to Alternatives relative to the portfolios strategic benchmarks. CONCLUSION Market momentum has slowed as political rhetoric meets economic reality. Our view is that the US has the financial capacity to support a reflation trade, but as the timescale has been pushed out a period of equity market consolidation is likely. One of the main supports for markets is that, after several years of slightly disappointing profits, corporate earnings should recover strongly in This mainly reflects the turnaround in energy and mining as well as financials, as banks restructure, loan demand picks up and higher bond yields improve margins. Global earnings are expected to rise over 14% this year and around 10% excluding commodities. The high weighting to energy suggests UK profits could increase by over 20% similar to emerging markets and double the 10% estimated for the US. Despite the region s relatively lacklustre growth prospects, exposure to exports, cyclical industries and financials will help Eurozone companies increase profits by 18%. Some of the improving outlook for earnings has already been discounted, but a prospective average valuation of 16x and a 2.5% dividend yield (4% in the UK) should allow equity indices to make further modest gains from here. Source: Quilter Cheviot, Lipper, a Thomson Reuters Company, April 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