RSMR Invest Issue 7 Summer 2020 by rsmr

Invest ISSUE NO.7 â&#x20AC;¢ SUMMER 2020

The New Normal

TIME TO LOOK TO THE EAST

INVESTING IN UNCERTAIN TIMES

Baillie Gifford on superior long-term growth

Legal and General Investment Management look at navigating challenging markets

DEBT AND DENIAL Jupier are asking if governments and banks are trying to cure debt with more debt

UK PROPERTY MARKET

UK EQUITY MARKET TO DATE

RSMR look at why the domestic property market is so important

BlackRock share their insights on market movements

We’ve launched RSMR Active 2 to 10 portfolios to assist financial advisers in achieving improved investor outcomes, a simplified advice process and an enhanced overall client experience.

The portfolios combine strategic asset allocation, including key inputs from specific third parties, with RSMR’s established fund selection and portfolio construction methodology. If you’d like to talk about our approach and how we can help shape your client proposition, do get in touch on the details below.

01535 656555 | enquiries@rsmr.co.uk | rsmr.co.uk Important Notice This is intended for investment professionals and should not be relied upon by private investors or any other persons. Past performance is not a guide to future performance. The value of investments and any income from them can fall as well as rise, is not guaranteed and your clients may get back less than they invest. RSMR Portfolio Services Limited is a limited company registered in England and Wales under Company number 07137872. Registered office at Number 20, Ryefield Business Park, Belton Road, Silsden BD20 0EE. RSMR Portfolio Services Limited is authorised and regulated by the Financial Conduct Authority under number 788854. © RSMR 2020. RSMR is a registered Trademark

Contents

Summer 2020

06 FRANKLIN TEMPLETON: Assessing The Depth, Breadth And Resilience Of UK Mid-Cap Stocks 08 INVESCO: High Quality High Yield Corporate Bonds 12 BAILLIE GIFFORD: It's Time To Look East

BETTER TIMES WILL COME

AN UNEQUAL WORLD TRANSFORMATION AND WHAT THAT MEANS TO MARKETS

Back to Normality? Welcome to the Summer edition of our Invest magazine. Looking back at the Spring issue I see I quoted HM Queen from her broadcast to the nation when she said ‘We should take comfort that while we may have more still to endure, better days will return.’

14 16

T. ROWE PRICE: Managing A Global Equity Portfolio In This "New Normal"

Some 20 plus weeks on and many of us are starting the process of getting back to ‘normal’ yet if I’m honest I am still anxious to do things I never gave a second thought to just a few months ago. On the one hand I get frustrated that I’m no longer free to do anything I like alongside the need to act responsibly and recognise the virus remains ever present. As you will see from many of the articles in this issue the focus remains on investing during these extraordinary times. Life must continue and delays in making investments for the future may just cause additional problems that could be avoided with planning and advice right now. So, we hope that the articles provide additional ideas and content to help advisers in their discussions with clients whether they are held virtually with Zoom or Skype and the like or a traditional face-to -face meeting – suitably distanced of course! We’re living in a way we’ve never experienced before, what’s important to us will change and our path will be irrevocably altered. Please do keep safe in this unprecedented period in our lifetimes. Best wishes from the team here at RSMR. n

18 LEGAL & GENERAL INVESTMENT MANAGEMENT: Investing In Uncertain Times 20 AVIVA INVESTORS: Interview with Chris Murphy 22 BNY MELLON: Covid 19: A Fund Manager's Diary 24 ABERDEEN STANDARD INVESTMENTS: Income Investing in a Pandemic

SCHRODERS: Multi-asset Fund or Model Portfolio?

28 NINETY ONE: Keeping a Quality Focus in a Post-Covid World 30 JUPITER: Debt & Denial 32 J.P. MORGAN ASSET MANAGEMENT: Seeking Sustainable Income 34 M&G INVESTMENTS: Investing for Good: How to Target 'Real' Impact in Equities THE UK PROPERTY MARKET: THE JEWEL IN OUR CROWN OR THE THORN IN OUR SIDE?

Geoff Mills, Director, RSMR

38 FIDELITY INTERNATIONAL: The Unstoppable Ascent of Sustainable Investing

CONTACT DETAILS:

40 COLUMBIA THREADNEEDLE INVESTMENTS: UK Equities: Operation Dynamo to the Rescue 42 BLACKROCK: UK Equity Market to Date

Rayner Spencer Mills Research Limited Number 20, Ryefield Business Park, Silsden BD20 0EE. Tel: 01535 656555 or Email: enquiries@rsmr.co.uk All editorial and advertising enquiries should be directed to sarah.mcculloch@rsmr.co.uk

Invest magazine is published by Rayner Spencer Mills Research Limited (RSMR). The views expressed do not necessarily reflect the views of RSMR or any other party affiliated to RSMR, and no liability can be assumed for the accuracy or completeness of the content, nor should any of the content be used as the basis of any advice offered. Content is offered on an information only basis and intended only for professional financial advisers and should not be relied upon by private investors or any other persons. Content is published with all rights reserved and any reproduction of content, wholly or in part, must only be made with the written permission of the publishers. © RSMR 2020. RSMR is a registered Trademark.

www.rsmr.co.uk Summer 2020

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Richard Bullas Manager, Franklin UK Mid Cap Fund Franklin Templeton

ASSESSING THE DEPTH, BREADTH AND RESILIENCE OF UK MID-CAP STOCKS

he United Kingdom is in a phase of reopening businesses and economies, trying to get life back to some form of normality as lockdown restrictions continue to ease. The next few months will be crucial as businesses and consumers adapt to a new way of life.

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Summer 2020 www.rsmr.co.uk

The mid-cap market (represented by the FTSE 250 Index) has underperformed relative to the wider market during the first half of 2020, bearing the brunt of the pandemicdriven volatility and uncertainty.

We’ve seen some interesting underlying market dynamics. There’s been a large variation in style.

There are two potential scenarios we could see regarding the recovery. There is a heightened risk of additional waves of infections as we head into autumn and winter, which could cause a setback in the recovery we’ve seen so far. Or, the outbreak could weaken and the recovery continue to gather pace as consumers feel more comfortable going out and getting back to work—and thus spending more. The initial post-lockdown economic data seems to be showing a faster-than-expected recovery, but whether it’s based on short term pent-up demand or more sustainable demand that pulls businesses out of the downturn remains to be seen.

Data Points Don’t Tell the Whole Story

However, this underperformance doesn’t tell the whole story of the mid-cap space. We’ve seen some interesting underlying market dynamics. There’s been a large variation in style. Stock dispersion has been quite high even within the mid-cap universe.

We’ve observed stronger performance for structural growth stocks or growth compounders because their earnings are perceived to be under less pressure during this crisis period and it’s also these types of stocks that trade on the highest valuation multiples. Thus, the valuation dispersion within the market is at elevated levels and has produced an environment that could be characterised as a period of ‘growth at any price.’

At the other end, we’ve seen the underperformance of the more cyclical and value names. While we think earnings of cyclical and value stocks are likely to see a greater earnings hit than many growth stocks, on the flip side, their profits have greater upside into a recovery.

Mind the Gap The crisis period has accentuated a trend we’ve seen for a while—it has widened the valuation gap between highly rated growth stocks and the more cyclical names. Yet, this creates very attractive investment opportunities and amplifies why active stock picking is crucial to navigate this period. We look for value across the market, taking a styleagnostic approach to find attractively valued opportunities. We like structural growth opportunities in companies. For example, a telecoms-testing company that is geared towards fifth generation (5G) infrastructure looks attractive to us. While domestic consumer stocks may be facing operational challenges in the current environment, companies with underlying momentum, well-financed balance sheets and strong track records of growth and innovation look generally attractive to us.

Uncovering Opportunities The COVID-19 selloff felt like uncharted territory, but it seems recent economic and company data point to a bottoming in April, so we are starting to see early evidence of a recovery. The economic data is improving, and while the current fundamentals look challenging, the economy and many businesses are in early stage recovery mode. We have also been using the volatility and the weakness in the market to add to our portfolio, but we have remained very selective. Not only are we looking for companies that have strong balance sheets and adequate

financing to support them through this difficult period, but also where profits have strong recovery potential. Importantly, we’re also looking for management teams that we believe can strengthen their market position, so that coming out of this crisis they can operate more efficiently and grow market share. We seek out businesses that came into the downturn in good shape and can re-establish that momentum over the next few years. This is a period for business where the strong can get stronger and unfortunately the weak will struggle. Against this backdrop, we are optimistic that we will be able to navigate the crisis—no matter what comes next. n

▼ Latest Fund Profiles Franklin UK Smaller Companies Fund Franklin UK Managers’ Focus Fund

IMPORTANT INFORMATION For Professional Client Use Only. Not for distribution to Retail Clients. The value of investments and any income received from them can go down as well as up, and you may get back less than you invested. Past performance is not a guide to future performance. Opinions expressed are the authors at the publication date and they are subject to change without prior notice. Given the rapidly changing market environment, Franklin Templeton Investments disclaim responsibility for updating this material. Issued by Franklin Templeton Investment Management Limited, Cannon Place, 78 Cannon Street, London EC4N 6HL. Authorised and regulated by the Financial Conduct Authority. © 2020. Franklin Templeton Investments. All rights reserved.

www.rsmr.co.uk Summer 2020

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Tom Moore, Fixed Interest Fund Manager, Invesco

HIGH-QUALITY, HIGH-YIELD CORPORATE BONDS Tom Moore discusses capturing high yield returns and reveals some of the opportunities that the current environment has unearthed over the last few months.

igh-quality corporate bonds are rated just below investment grade and still have only modest longterm average default rates. Historically, 7% of BB-rated bonds globally default over a five-year time horizon. This group incorporates fallen angels (investment grade issuers downgraded to high yield) and rising stars (high-yield issuers with improving financials expected to be upgraded to investment grade).

Automobile manufacturing is, of course, a cyclical business and, operationally, this is the worst period in Fordâ&#x20AC;&#x2122;s history.

A good example of a high-quality corporate issuer is Iron Mountain. Not necessarily a household name in the UK, it is however the global leader in document and data storage and a longstanding issuer of bonds. The US company, which is also an S&P 500 Index constituent, traces its roots back to the 1950s when it stored documentation in a disused mine.

The stability of its business has allowed management to gear the balance sheet a little (the long-term targeted range is 4.5x-5.5x)

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and therefore makes it an ideal high-yield issuer. Nonetheless, it is not entirely immune from the Covid-19 shutdown. In particular, its services business will see big declines in the second quarter, but its records management segment should be less exposed. The company will take sensible precautionary steps such as costreduction programmes, capex cuts and lower M&A/project investments. S&P rates Iron Mountain as BB- and the sterlingdenominated bond we own in the Invesco High Yield Fund (UK), which matures in 2025, yielded 5.2% at the end of April.

Ford Motor company is another good example that we own in the fund and one that sits firmly in the fallen angels category. Ford was only very recently downgraded to high yield as a result of the disruption to production and sales due to Covid-19. It has had to shore up its balance sheet in the face of scepticism from the rating agencies and, in coming to the bond market, has offered an interesting investment opportunity with bonds being issued with coupons of 9% and higher.

INVESTMENT RISKS The value of investments and any income will fluctuate (this may partly be the result of exchange-rate fluctuations) and investors may not get back the full amount invested. The securities that the Fund invests in may not always make interest and other payments nor is the solvency of the issuers guaranteed. Market conditions, such as a decrease in market liquidity for the securities in which the Fund invests, may mean that the Fund may not be able to sell those securities at their true value. These risks increase where the Fund invests in high yield or lower credit quality bonds. The fund has the ability to make use of financial derivatives (complex instruments) which may result in the fund being leveraged and can result in large fluctuations in the value of the fund. Leverage on certain types of transactions including derivatives may impair the fund’s liquidity, cause it to liquidate positions at unfavourable times or otherwise cause the fund not to achieve its intended objective. Leverage occurs when the economic exposure created by the use of derivatives is greater than the amount invested resulting in the fund being exposed to a greater loss than the initial investment.

Automobile manufacturing is, of course, a cyclical business and, operationally, this is the worst period in Ford’s history. Ford has dealt with lots of challenges in the last couple of decades, but it has learnt from experience and it came into this crisis with US$30bn of liquidity. The decision to suspend its dividend will free up as much as US$2bn more in 2020. But even that provides only so much cushion, with an estimated cash burn of US$10bn in the second quarter. Cash from working capital will return to the business as soon as sales begin to rise, but precisely when that will happen is uncertain. However, Ford will be helped as part of the huge response by the authorities to this crisis. The Fed was quick to commit to direct support of the corporate sector through loans and purchases of corporate bonds in the secondary market. It is hard to believe that the company was not in the Fed’s thinking when it made the decision to include recently junked bonds in its purchase programme, and this move put to rest any real concerns about Ford’s access to capital in the near-term. n Continue reading. This article was taken from Tom’s recent article series ‘Three ways we capture returns in high yield’. For more insights and investment examples, as well as more information on the Invesco High Yield Fund (UK), please visit: invesco.co.uk/ highyield

The fund may be exposed to counterparty risk should an entity with which the fund does business become insolvent resulting in financial loss. As one of the key objectives of the fund is to provide income, the ongoing charge is taken from capital rather than income. This can erode capital and reduce the potential for capital growth. The Fund may invest in contingent convertible bonds which may result in significant risk of capital loss based on certain trigger events. The fund’s performance may be adversely affected by variations in interest rates. IMPORTANT INFORMATION This article is for Professional Clients only and is not for consumer use. All data is as at 21/05/2020 and sourced from Invesco unless otherwise stated. Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice. This document is marketing material and is not intended as a recommendation to invest in any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication. The information provided is for illustrative purposes only, it should not be relied upon as recommendations to buy or sell securities. For the most up to date information on our funds, please refer to the relevant fund and share class-specific Key Investor Information Documents, the Supplementary Information Document, the Annual or Interim Reports and the Prospectus, which are available on the Invesco website. Issued by Invesco Fund Managers Limited, Perpetual Park, Perpetual Park Drive, Henley-on-Thames, Oxfordshire RG9 1HH, UK. Authorised and regulated by the Financial Conduct Authority.

www.rsmr.co.uk Summer 2020

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IT’S TIME TO LOOK EAST First to emerge from the coronavirus pandemic, the Asia ex Japan region is in robust health and its innovative companies are thriving. Roderick Snell, co-manager of the Baillie Gifford Pacific Fund and deputy manager of Pacific Horizon Investment Trust, surveys the Asian landscape and argues that Asia is the place to look for superior long-term growth. As with any investment, your clients’ capital is at risk.

sia ex Japan was the first region to enter the coronavirus (Covid-19) crisis and, as it emerges, we can see that Asian countries are generally returning to normality in reasonable financial strength. The modest financial stimulus and monetary response observed across the region stands in stark contrast to the many trillions of dollars being deployed by western economies, where such profligacy will be a major financial burden for years to come, leading to slower growth and potentially weaker currencies. The majority of Asia ex Japan looks attractively placed in comparison. The world is now awash with trillions of dollars of stimulus seeking an economic return, and we ask ourselves where does this capital flow to? The increasingly debt-laden economies of the west, where near-zero or even negative interest rates look set to persist for many more years? Or the faster structural growth of Asia ex Japan, combined with limited balance sheet expansion and reasonable yields and interest rates? If the latter is correct, such an inflection point would be extremely supportive for Asian assets over the coming decade.

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An important change through the crisis has been an acceleration in the adoption of technology, improving economies of scale and strengthening the competitive moats around some leading technology firms. We believe this key trend will persist. China has arguably led the way, with several of the country’s internet companies seeing significant increases in user numbers and engagement under lockdown. Meituan Dianping, the online food delivery business, experienced a 400 per cent increase in grocery deliveries and employed more than 330,000 new delivery drivers. JD.com had to hire 20,000 new logistics employees to help with increasing ecommerce orders, while DingTalk, owned by Alibaba and considered the world’s largest collaboration service designed for companies, experienced downloads increasing fifteen-fold. We have also seen an acceleration of innovation across the traditionally less technology-savvy parts of the region. Just as SARS was a turning point in the birth of ecommerce in China in 2003, helping to establish companies such as Alibaba and JD.com, we believe Covid-19 could be doing the same for ecommerce across large parts of the ASEAN region.

ASEAN governments are also becoming more supportive of the online economy, quickly realising it is a far more effective medium for collecting tax receipts compared with offline cash transactions. We see a permanently higher shift in the adoption of the online economy across South East Asia. However, the potential impact of the virus on the development of competitive dynamics is arguably even more important than this surge of technology use. Surging demand initiated by Covid-19, has dramatically shortened the time required for companies to scale up and achieve dominance. The winners will establish themselves over the next couple of years rather than decades. This reduced timeframe will curtail the number of competitors entering the market, and profits will accrue to an increasingly small number of existing players. An enduring feature of this crisis is likely to be the strong getting stronger. Although increasing tensions with the west and a desire to diversify supply chains are likely long-term headwinds for Chinese export growth, this trend will create many specific winners and losers. We believe Vietnam will be one of the biggest beneficiaries. The country has already been the major winner from the relocation of manufacturing away from China, and any acceleration of this trend will fuel Vietnamâ&#x20AC;&#x2122;s exports further.

If the current global crisis is likely to create new secular trends and spur innovation, we believe Asia ex Japan could be one of the major beneficiaries. The region is coming out of this crisis first, in significantly better financial shape than western economies, with superior long-term growth prospects and more attractive valuations. The year 2020 may well be an inflection point where Asia ex Japan becomes a favoured asset class over the coming decade. We believe our strategy of growth companies focused on technology and innovation is extremely well placed in such an environment. Investors should turn their attention to the east. n

FOR FINANCIAL ADVISERS ONLY, NOT RETAIL INVESTORS. This article does not constitute, and is not subject to the protections afforded to, independent research. Baillie Gifford and its staff may have dealt in the investments concerned. The views expressed are those of Roderick Snell, are not statements of fact, and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. Baillie Gifford & Co Limited is authorised and regulated by the Financial Conduct Authority (FCA). Baillie Gifford & Co Limited is an Authorised Corporate Director of OEICs. The investments trusts managed by Baillie Gifford & Co Limited are listed UK companies and are not authorised and regulated by the FCA. All data is sourced from Baillie Gifford & Co unless otherwise stated.

www.rsmr.co.ukâ&#x20AC;&#x201A; Summer 2020

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Graham O’Neill, Senior Investment Consultant, RSMR

AN UNEQUAL WORLD TRANSFORMATION AND WHAT THAT MEANS TO MARKETS

he world is enduring the deepest peacetime recession in the past 150 years. Many investors have been surprised at the continued strength in equity markets and in this context, it could help to consider the market framework over three different time frames. In the short-term, news flow will drive market direction and volatility, as will the existence of vaccines/treatments, and economic data such as PMIs. Technical factors such as whether markets are overbought or oversold and the ratio of puts to calls are also important over shorter timeframes.

A return to trend growth Over the medium term, 2021 and 2022 could remain a positive period for markets. Previous eras of financial repression (when governments hold real interest rates below zero) have often been profitable for equity investors, especially in the early stages. In other words, markets front run negative real rates with a lower discount rate, driving equity valuations higher. Next year, the global economy is likely to return to trend

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Summer 2020

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growth, especially with the prospect of vaccines and better treatments being widely available.

Drug treatments and stimulus The UK has seen reduced mortality rates from use of the dexamethasone drug and Gilead have announced that their remdesivir treatment, currently administered intravenously and successful with less severe cases, is being trialled in an inhaler form. Gilead also claims that the drug is helping reduce mortality in more severe cases. Next year, there will still be huge stimulus in the financial system, both monetary and fiscal, and this will coincide with improving corporate earnings. With a backdrop such as this, it is unlikely to be a time to be too bearish on the medium-term prospects for equity markets. Longer term, from the mid-2020s, threats could emerge to valuation levels in the form of higher inflation, the withdrawal of stimulus, both monetary and fiscal, and less globalisation, but these are not an immediate concern to markets.

Pandemics and risk aversion There is no doubt that Covid-19 has transformed the world in an uneven and unequal way. The global economy has seen only muted growth in the 10 years post the Financial Crisis and ‘secular stagnation’, as described by Lawrence Summers, the former US Treasury Secretary, in his address to the IMF in 2013. Since then, there have

been stronger arguments for a Keynesian response to downturns.

set to keep rates at these levels, which is a form of financial repression.

He argued that a chronic excess of savings relative to capital investment was developing in the global economy, forcing down long-term interest rates and threatening a persistent shortage of demand. Interestingly, work by academics at the University of California Davis, looking at long term economic implications from pandemics, demonstrates that previous pandemics have resulted in an excess of savings at a time when a savings glut had not been a pre-existing condition in the world. Pandemics have also historically increased risk aversion in the private sector, resulting in higher savings rates, both by households and by businesses who invest less. In other words, both individuals and corporates will require higher levels of ‘rainy day’ money. Until an effective vaccine is found, consumer spending in sectors requiring high levels of personal service will remain under pressure and way below pre-pandemic levels. Covid-19 is only likely to increase the trend towards secular stagnation that manifested itself in the post GFC period.

With interest rates below the growth rate, the debt/ gross domestic product ratio is likely to eventually stabilise and, as long as an economy is growing, the post Financial Crisis period has shown that markets will become less concerned about fiscal deficits, as long as governments run primary budget surpluses. In other words, a surplus predebt servicing costs.

Paying for debt down the road

Politics and the 3Ps The US election is likely to be of increasing importance to the stock market. Trump is losing ground in opinion polls due to what some would describe as increasingly erratic actions, potentially over fears of an end to his term in office, which could result in prosecution.

Markets have once again proven this year that it is better to buy when the price is right and the news is bad, than when the news is good but the price is high.

In the short term, the rise of populism demonstrated by concerns over inequality, which resulted in the vote for Brexit, the election of Donald Trump, and the global spread of the Black Lives Matter movement, strongly suggests that austerity policies will not be adopted. How debt is paid for over the longer term will become more of an issue down the road, but it is likely to involve some form of higher taxes, together with debt monetisation. A consistent positive is that the annual cost of servicing debt is likely to remain negative in real terms and below the nominal growth rate of an economy and central banks seem

Investors should focus on 3Ps in the campaign. The first P is for ‘pandemic’ which is the number of cases/deaths; this will be a judgement on how Trump has responded to the coronavirus. The second P is for ‘production’, in other words the state of the economy at the time of election. The third P is ‘personality’, how each candidate comes across. Compared to Biden, Trump has a strong presence on social media. There is no doubt that he will attack Biden as an ‘establishment figure’ and Biden has been known to struggle in events with live questioning. As the election moves closer, the difference in tax policies for corporates between Republicans and Democrats will also attract attention.

Recovering markets Markets are now once again entering a period of financial repression, where central banks deliberately hold interest rates below the level of both inflation and nominal economic growth, which will aid deficit reduction over the medium term. Post the Financial Crisis, periods of financial repression have provided positive returns for equity investors, although these returns have been front loaded with recovering markets benefitting from the lower discount rate applied to corporate earnings. Markets have once again proven this year that it is better to buy when the price is right and the news is bad than when the news is good but the price is high. n

www.rsmr.co.uk Summer 2020

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David Eiswert, Portfolio Manager, Global Focused Growth Equity Strategy

MANAGING A GLOBAL EQUITY PORTFOLIO IN THIS “NEW NORMAL”

he crisis goes on, and much of the world remains in some form of lockdown as the coronavirus continues to impact nearly every aspect of society. Financial markets have rebounded strongly, however, and appear to be looking to the future and the other side of this pandemic.

our opinion) going into this crisis. The virus has boosted their positions and accelerated their adoption – this is part of what makes this kind of cycle very different. A final point here is more academic – if the Fed is going to buy every asset class, if central banks are going to step in and support the economy through the virus – then earnings multiples should go higher, especially as there is more credit available and interest rates are lower. The fact that asset prices go up after that sort of response is not surprising. You could argue that there is now even more liquidity out there than before the virus. While there are parts of the economy that are disasters and potential risks to the equity market recovery, there are many that are going to improve. This bifurcation means a more challenging job for stock pickers.

While there are parts of the economy that are disasters and potential risks to the equity market recovery, there are many that are going to improve.

Have markets rallied too much in the near term, given the uncertainty? When we look out 12-24 months, we think equities offer good return prospects versus most alternatives. We must remember that this is a natural disaster and not a credit cycle. That's important. Another point is valuation. Companies like Netflix, Amazon and Zoom were not overvalued (in

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Investing for the changes that lie ahead Near term, the outlook for global equities is still highly uncertain given the possibility of further drawdowns. There remains a lack of clarity over the spread of the virus and the eventual decisions that will need to be made to balance a return to work, alongside ongoing infection controls. Many signs point towards an ongoing normalisation of economic activity in China from low levels, but we continue to monitor the situation closely. What’s important for investors is to be actively managing risk and making decisions for both the short-term improvements, and the longer-term changes that will materialise, identifying the secular growth companies that will be beneficiaries of the change that is coming; a future where people travel less, technology is adopted more (ecommerce, automated factories) and health care companies are seen with new positive eyes as aids to societal normalisation. Such changes will require thought and active management, given the disruptive nature on indices and presumed norms. Technology companies are also hiring huge

INVESTMENT PROFESSIONALS ONLY. NOT FOR FURTHER DISTRIBUTION. IMPORTANT INFORMATION

amounts of staff to deal with the rise in demand, and this should help perceive them in a better light compared with the villains they have been portrayed on Capitol Hill in recent years. There are still significant and unpredictable risks to manage, and a measure of diversification remains key. Longer term, there are also real and unanswered questions of how do governments finance stimulus packages, and how can rising debt levels be serviced? Despite the near-term uncertainty, we feel optimistic over the medium term (12-24 months) that a new bull market can potentially be born from equity valuations that are lower, as we see stabilisation and then normalisation of economies. n

Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested. Issued and approved by T. Rowe Price International Ltd, 60 Queen Victoria Street, London, EC4N 4TZ which is authorised and regulated by the UK Financial Conduct Authority. © 2020 T. Rowe Price. All rights reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the bighorn sheep design are, collectively and/or apart, trademarks or registered trademarks of T. Rowe Price Group, Inc. 202007-1249118

www.rsmr.co.uk Summer 2020

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Justin Onuekwusi Head of Retail Multi-Asset Funds

James Carrick, Global Economist

INVESTING IN UNCERTAIN TIMES

Global financial markets have begun to recover from the sharp sell-off which began in late March. While investors were initially encouraged by countries lifting their COVID-19 lockdowns and positive progress towards developing a vaccine, signs of a second wave have disrupted sentiment once again. To help navigate these challenging markets, we have identified three investment portfolio risks and three interesting opportunities that we believe financial advisers should know about.

What are the three biggest risks to investment portfolios right now? The second wave We are concerned about a second wave of COVID-19, especially in recent weeks where we have seen the virus come back from near zero levels in places like Australia, Japan, Hong Kong and Israel. The fact that the virus has emerged again in Japan and Hong Kong – areas that have a high-mask wearing culture – is a concern. In the US, it was previously assumed that the growth of the virus was constrained to a few states

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including Florida, Texas, Arizona and California. However, we have seen that it is more broad-based than that, with 80% of US states seeing rising hospitalisation cases in the past few weeks.' The virus has also re-emerged or is rising again across Europe, notably in Spain, the Netherlands and Belgium.

US tech concentration conundrum US tech is driving US equity returns and has outperformed the S&P500 throughout 2020 so far no matter if markets have been up or down. Whilst this may sound like a compelling case to buy US tech, we believe there is a significant concentration risk that advisers need to know about. The US makes up 60% of global equity indices². Within the US, the top five stocks – *Microsoft, *Apple, *Amazon, *Google (*Alphabet), and *Facebook – add up to nearly a quarter of the S&P 5003. Tech is truly dominating the US and as a result, global indices. To illustrate: *Apple and *Microsoft combined take up a larger share of global equity indices than the whole of the UK While we do not have an issue with tech, we believe some advisers may be accidentally exposing their portfolios to this concentration risk, especially if they are index investing.

US/China relations It appears that the US’s continued challenges dealing with COVID-19 and the resulting economic impact is harming President Trump’s chances of winning the upcoming elections. As a result, we anticipate US/China relationship will become increasingly tense as Trump may seek to blame China for his country’s problems and raise his anti-China rhetoric. This will have a significant impact on trade discussions. We are monitoring the likelihood of a Democratic win and its impact on financial markets. A Democratic win may result in a reversal of tax cuts and lead to a healthcare reform and will also raise questions over how left-wing Joe Biden will be. While we feel it is too early to position portfolios for this eventuality, we are keeping an eye on things as they develop.

What are three interesting potential investment opportunities you’re seeing currently? Forestry stocks Within our Multi-Index funds, we have begun to invest in timberland companies which own forests and the associated lands as their main assets. This is part of our strategy to invest in listed alternative to help improve diversification as forestry stocks tend to behave quite differently to equities. Forestry stocks have also sold off recently, so we believe there is a strong valuation case. High yield While we no longer think high yield is the ‘opportunity of a lifetime’ as we previously stated in the first quarter, we believe there are still some opportunities within this space. High yield retracement has not been as quick as US bonds, European bonds or UK credit so they are still reasonably appealing in our view. In addition,

central bank support buying fallen angels and high yield exchange-traded funds (ETFs) can help create some potentially interesting opportunities. Artificial intelligence We continue to see great potential in technology, but we do not like the concentrated nature of the sector. As a result, we are diversifying our exposure by introducing an artificial intelligence (AI) equity ETF in some of our Multi-Index funds as we believe AI is less sensitive to tech cycle movements, tends to be low leverage and has high growth rates. n

KEY RISKS Past performance is not a guide to the future. The value of an investment and any income taken from it is not guaranteed and can go down as well as up, you may not get back the amount you originally invested. Views expressed are of Legal & General Investment Management Limited as at 23 July 2020. Forwardlooking statements are, by their nature, subject to significant risks and uncertainties and are based on internal forecasts and assumptions and should not be relied upon. There is no guarantee that any forecasts made will come to pass. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be solely relied on in making an investment or other decision. *For illustrative purposes only. Reference to a particular security is on a historic basis and does not mean that the security is currently held or will be held within an LGIM portfolio. The above information does not constitute a recommendation to buy or sell any security.

www.rsmr.co.uk Summer 2020

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“THERE IS TOO MUCH FEAR ABOUT THE SHORT-TERM OUTLOOK FOR UK EQUITIES” Chris Murphy, Senior Portfolio Manager

Just as nature abhors a vacuum, investors abhor uncertainty. The global coronavirus pandemic has certainly delivered on this front. Chris Murphy, senior portfolio manager for the Aviva Investors UK Listed Equity Income Fund, shares his thoughts on the current market environment and where he sees risks and opportunities emerging.

What are your current thoughts on the COVID-19 crisis? The world is going through an unprecedented shock; it is quite different to anything we have ever experienced in that a forced lockdown resulted in many companies closing their doors overnight. When markets dip in a ‘normal’ economic cycle, businesses have the opportunity to cut costs and adjust their underlying models. But there was no real warning of what would happen to the economy as a result of this virus spreading and the situation means companies have not been able to adjust their costs quickly enough as revenues collapsed. It really is, here is that word again: unprecedented.

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Many companies have made the decision to defer dividends....even as an income manager I am fully supportive of that in the short term.

How concerned are you about company profits and dividends? For me it is not just about profits, but about how the pandemic impacts cash flow. Companies need cash flow to pay their dayto-day expenses. This doesn’t exist currently and unsurprisingly it has had a knock-on effect on dividends. Many have made the decision to defer dividends. Now even as an income manager I am fully supportive of that in the short term. It is much, much more important that businesses survive this crisis and look after their employees and supply chains. This is particularly important for bigger companies that help provide funding through working capital for smaller suppliers.

How have you adjusted the portfolio in the short term as the crisis has unfolded? We focus on the long term, and the key for us is to make sure the portfolio is in the best position once the market recovers. If we look after the capital account in periods like this, there will be a bigger pool of assets in the future for the unit holder to generate income from. I am not buying companies that are ‘cheap’ or because they are the only dividend payer in town. We have instead focused on ignoring the market noise (as much as possible) and tried to work out where companies are going to be in two or three years’ time. Well-known names we have added to in the portfolio include Intermediate Capital Group, Schroders and Prudential. Other more stable businesses that have held up well, such as Tesco and Unilever, we have reduced positions in.

Will you take advantage of opportunities over the medium to long term? We have intentionally not made wholesale changes to the portfolio: we feel it is far better to ‘drip feed’ money in a period like this as opposed to trying to second guess a market recovery or the exact bottom. A history of investor returns proves that retail investors in particular are quite bad at that,

and currently we are a fair way from finding out the full extent of the pandemic’s effect. Ultimately, the way we structure the portfolio, the way we analyse stocks and think about companies and cash flows over the long term has not changed. When clients ask if we are trading more as a result of prices falls my answer is always no: in a volatile market I am not going to try to be clever and guess where prices may or may not move to. During the global financial crisis, we didn't change the way we ran the portfolio either and that comes back to having confidence in our belief structure and philosophy of what we are trying to achieve, as well as knowing the types of [quality] businesses we want in our portfolio.

Is there a concern some companies may not survive this crisis? To an extent, there is too much fear driving movement in the short term. Take the financial services sector where some company share prices dropped overnight. Intermediate Capital Group was around £11 [as of mid-April]; I trimmed some of the existing position on valuation and for portfolio construction purposes at £19 at the start of the year. It went as low as £6 at the end of March, yet its business model is unchanged – so we added to the position. The price movement is an example of fear and greed at work in the market, which we like to avoid. It is also easy to lose sight of what is going on: this isn’t a black hole. There is a finite period of time for which this can go on and there is light at the end of the tunnel at which point we believe dividends will return. And we do expect the majority of companies, once this has crisis has ended, to return as dividend payers.

Is it possible to offset the volatility portfolios are experiencing? When the market moves as much as it has and as quickly as it has, it is very difficult to make changes to large positions. In a ‘normal’ downturn, whatever that may look like, there is better line of sight of volatility occurring

and there is usually time to move the portfolio around to protect capital. Today, we can do this at the margin but I suspect most investors have either been on the right or the wrong side in terms of names held. For example, we hold a number of ‘self-help’ story stocks which, in a normal slowdown would have continued to do very well. But take a stock like Melrose which bought GKN, an engineering and manufacturing company supplying the aerospace and auto sectors. Car sales have effectively stopped overnight globally, and therefore the short term is going to be very difficult for them. Most companies will simply write this year off, and so there is a need to keep an element of flexibility in portfolios. There often has to be a big judgement call in the portfolio, too. I see myself as an investor rather than a spectator and I would rather support a business through a difficult time and buy more when the share price drops in anticipation of a recovery later when it comes through . n

IMPORTANT INFORMATION The value of investments and the income from them will change over time. The Fund price may fall as well as rise and as a result you may not get back the original amount you invested. This document is for investment professionals only. Except where stated as otherwise, the source of all information is Aviva Investors as at 12 August 2020. Unless stated otherwise any opinions expressed are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. For further information please read the latest Key Investor Information Document. Issued by Aviva Investors UK Fund Services Limited. Registered in England No. 1973412. Authorised and regulated in the UK by the Financial Conduct Authority. Firm Reference No. 119310. Registered address: St Helen’s, 1 Undershaft, London EC3P 3DQ. An Aviva company. RA20/0700/22082020

www.rsmr.co.uk Summer 2020

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Murdo Maclean, Client Investment Manager at Walter Scott

COVID-19: A FUND MANAGER’S DIARY Before the momentous events of Q1 and Q2, few investors were prepared for a pandemic that derailed global growth. Here, Walter Scott fund manager Murdo Maclean provides his account.

or Murdo Maclean, fund manager with investment firm Walter Scott, the months preceding the Covid-19 pandemic were a period of intense due diligence. “It might be hard to recall given subsequent events,” he says, “but if you cast your mind back to 2019, people were worried about valuations. Even against a backdrop of macro-economic uncertainty, equities remained on a tear. This posed a fundamental question: Had markets outrun themselves?” For the investment team, the response was a year-long exercise of re-evaluating not only every current holding but also companies on the watch-list. It meant each of the stock champions revisiting their stocks and carrying out due diligence to justify current exposures. The question, says Maclean, was whether the team felt comfortable with maintaining those positions given the thenelevated prices.

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It was against this background that the first news of a new virus spreading in China began to filter through. As day followed day, and news of the spread of the virus became more worrying, the team began to wonder whether the market was fully pricing in risk. “We knew there would be knock-on effects but at that stage couldn’t be sure exactly what they’d be,” says Maclean. As events unfolded, the team began to apply worst-case scenarios as a natural continuation of their earlier due diligence exercise. They looked at the strength of balance sheets and how resilient companies were likely to be as lockdown measures came into effect. They also scaled up dialogue with company management to get a direct line on how their holdings might respond to future stresses. “We had a close line of communication – not just with company leaders but also trusted sources in the market,” says Maclean.

“We wanted to know how companies were planning to manage staffing, whether they’d applied for furlough, what their debt covenants were, what their cash balances were like and whether they had access to revolving debt facilities. Really, it was a search for red flags as much as anything.”

A focus on fundamentals In the event, he says, changes to the portfolio were relatively few – and those made were often based more on fundamentals than anything pandemic-related. The investment team exited holdings in a global coffee brand, for instance, not simply because of Covid-19 but more on the view that management had misallocated capital which meant a weakerthan-expected balance sheet. They also reduced exposure to the energy sector. Again, this was stock-specific and reflected diminished confidence in that company’s ability to deliver growth in the coming years – rather than anything directly related to the pandemic. In the pharmaceuticals sector, the team believed speculation about a treatment for Covid-19 had pushed one holding to somewhat unrealistic levels and so reduced exposure there. On the flipside, the team added exposure to select holdings in the healthcare and technology sectors, on a view that those companies were fundamentally sound and possessed an exciting long term growth outlook. “Did we carry out a wholesale revision of holdings?” asks Maclean. “No. We took a view: There are risks all the time. We wouldn’t own companies in the first place if we didn’t think they’d be able to deliver. The fact that we made so few changes to

the portfolio during the largest market dislocation for a generation is testament to the strength of those companies and the decision-making process that led up to us taking those positions in the first place.”

When history rhymes… Here, Maclean points to the lessons of history. Companies with staying power are those that, as likely as not, have already experienced crises and thrived on the back of them, he says. “Our due diligence at the start of 2020 showed that. We looked at how successful companies had weathered the storm through the Global Financial Crisis and whether they shared any characteristics.” This, then, is the lesson learned from the pandemic, according to Maclean: that companies already on their knees are unlikely to gain market share let alone survive when a crisis comes along. “It’s how companies are positioned heading into the storm that’s important; not what they’re doing as the crisis swirls around them,” he concludes. “As an investor you can accept falling revenues during periods of market stress but what you need to know is how that company’s positioned once the worst has passed. Are they well placed not only to survive but to thrive as well? That’s really what you’re looking for when the crisis hits". n 'Investment Managers are appointed by BNY Mellon Investment Management EMEA Limited (BNYMIM EMEA), BNY Mellon Fund Management (Luxembourg) S.A. (BNY MFML) or affiliated fund operating companies to undertake portfolio management activities in relation to contracts for products and services entered into by clients with BNYMIM EMEA, BNY MFML or the BNY Mellon funds.

It’s how companies are positioned heading into the storm that’s important; not what they’re doing as the crisis swirls around them. The value of investments can fall. Investors may not get back the amount invested. Income from investments may vary and is not guaranteed. For Professional Clients only. This is a financial promotion and is not investment advice. Any views and opinions are those of the interviewee, unless otherwise noted. This is not investment research or a research recommendation for regulatory purposes. For further information visit www.bnymellonim.com

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Charles Luke, Investment Director UK Equities

INCOME INVESTING IN A PANDEMIC – FINDING A WAY THROUGH

s a consequence of the global pandemic, we currently find ourselves in unchartered waters. Daily life has been altered beyond recognition for many of us and will likely remain that way for some time to come. It’s unfamiliar territory for investors too, as we grapple with the effects of the wide-scale lockdown on companies, economies and financial markets For income investors in particular, the environment is completely unprecedented. In the UK, 43 of the FTSE’s 100 companies have cancelled, cut or suspended their dividend payments. That includes major UK companies that have previously been considered totems of dividend security. Companies have taken these actions for a variety reasons. Banks and insurers face regulatory pressures, and have been told by the Bank of England’s Prudential Regulatory Authority not to pay dividends. Others companies have taken government assistance during the pandemic and so have refrained from paying shareholders for fear of bad press. For a number of businesses though, it’s about taking a cautious approach and preserving cash when the economic outlook remains so opaque. This backdrop is obviously important to income investors, given the significance of dividends and dividend growth for

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investment returns. We were already dealing with a world of low growth, low interest rates and low inflation. Then the pandemic came along and added to these pressures. This year, income is expected to be 40-50% lower than 2019. So what kind of investment approach might help income investors navigate this new terrain?

Quality counts Income investing hasn’t had the most positive press recently, with the collapse of a highprofile fund and other scandals. We have always maintained that income investing should never be about chasing high yields. Rather, it should be about long-term quality and sustainability. And it’s at times like these, when corporate distress is high, that such an approach can prove its mettle. We look for dependable high-quality companies with strong balance sheets, which enable them to continue to grow their business, reinvest in it, perhaps partake in M&A, and grow their earnings year on year. These quality businesses are more likely to be able to pay dividends, even when conditions change or are challenging. Similarly, we focus on companies with compelling long-term structural growth stories, perhaps with global brands or valuable intellectual property. In the current environment, some of the strongest companies should be able to grow stronger.

Dare to diversify The pandemic has and will continue to affect different companies and sectors in different ways and at different times. As always, it makes sense to be well diversified and not overly dependent on any one economic scenario, sector or company. Dispersion across mid-cap and large-cap stocks can be a good idea too, as can exposure to other types of investments. For example, we have the ability to write options in some of our UK equity funds, which can provide a valuable uncorrelated income stream.

ESG specialists can really show its worth, especially during a crisis. It can help get to the heart of a company’s dynamics and identify what might be changing in its business. Augmenting this with the views of independent experts and first-hand insights from meeting with company management can reveal the ‘full picture’ of an investment. While the right conclusions are not always drawn, identifying an improvement in a company before the market does can lead to healthy gains.

Know your companies

Final thoughts…

Company fundamentals matter, now more than ever, and it pays to know investee firms inside and out. Understanding their business models, believing in their management teams and recognising their competitive advantages can help manage investment risk.

In situations like now, there is always a strong temptation to churn portfolios and react to short-term newsflow and noise. But it’s exactly at points like these that it’s important to keep focused on the long term and maintain a conservative approach.

How a company deals with the environmental, social and governance (ESG) aspects of its operations can also be a sign of quality. ESG considerations are embedded in the investment process at Aberdeen Standard Investments. That’s because we believe companies that behave responsibly and look after their ESG issues are more likely to deliver sustainable investment returns and better outcomes for all. A rigorous ESG approach fits ‘hand in glove’ with our quality-income focus.

There’s also the ‘siren call’ of investing in lower-quality companies with better near-term dividends. However, we believe that approach seldom works. In our opinion, there is never a right time to buy lowquality higher-yielding companies for their dividends. Instead, we prefer to maintain a laser focus on quality companies that we believe can stay the distance. At the same time, we remain vigilant to the downside risks and the upside opportunities that will arise as we navigate these uncertain times. n

A combination of in-depth proprietary research, experienced investment teams and

Investment involves risk. The value of investment and the income from them can go down as well as up and investor may get back less than the amount invested. Past performance is not a guide to the future.

www.aberdeenstandard.com

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Gillian Hepburn, Intermediary Solutions Director, Schroders

MULTI-ASSET FUND OR MODEL PORTFOLIO?

hat does your Centralised Investment Proposition (CIP) look like? Following the introduction of the PROD regulations in January 2018, many advisers reviewed their client segmentation and then ensured that appropriate products and services were being delivered to their client groups. This included investment solutions.

the total cost of ownership to the client. The removal of VAT for many MPS solutions is also now making them more cost competitive.

In a previous life, when I helped advisers to define their CIP, segmentation was often based on client assets with the higher net worth clients being offered a DFM Portfolio, mid-range clients a model portfolio solution and lower value clients a multi-asset fund.

AVAILABILITY: Both funds and models are available on platforms but the distribution agreements required are different and it can often be easier to make a fund rather than a model portfolio solution available.

PROD has led many advisers to implement more sophisticated segmentation with lifestages now more prevalent and investment solutions often including active, passive, blended options and the ability to meet clients’ ESG preferences. But what about the wrapper? Why would some clients be invested in a fund with others directed to a model portfolio? When might a financial adviser chose one over the other?

Consider some key differences: COSTS: There is an urban myth that model portfolios are more expensive than funds due to the DFM charge. However, management charges also apply within a fund so it’s important to look at

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TRADING CHARGES: When any listed investments are held within a model, these are subject to dealing charges by the platform. These can vary significantly depending on how these are charged and could be a challenge for smaller investments or regular contributions where charges eat into the investment. A fund might be a better option in some circumstances.

Platform technology sometimes restricts the holding of some investments within a model portfolio (e.g. investment trusts, ETFs). This limitation would not apply within a fund structure thereby potentially giving access to a broader range of investment opportunities for investors. REPORTING: One of the benefits of a model portfolio is that all the holdings can be viewed and reported on by the platform. Often described as ‘look through’, the client can see all the underlying investments and have comfort that they are fully diversified. This is often cited as one of the main challenges of a fund. Whilst multi-asset funds also include a broad range of holdings, platform reporting often does not show this adequately however, some asset managers are now turning to technology solutions to deliver better quality

reporting and â&#x20AC;&#x2DC;look throughâ&#x20AC;&#x2122; for multi-asset funds. TAX EFFICIENCY: When investing in a model portfolio, the investments are directly held by the client, therefore any changes made by the manager could be subject to Capital Gains Tax unless the model is held within a tax efficient wrapper (e.g. Pension, ISA). Any clients who have fully funded their pension and ISA allowances may incur CGT when holding the model in a General Investment Account and due to the discretionary nature of the portfolio, potential CGT is outside the control of the financial adviser. Is there a way to get the best of both the MPS and unitised worlds? We believe so with the Schroder Portfolio range which blends these. The new funds provide the benefits of a model portfolio service with the efficiencies of a unitised fund. Our multi-asset funds invest in a range of assets, including investment trusts and exchange traded funds. Using asset

allocation from Schroders, the investment committee is also supported by independent fund research from Rayner Spencer Mills Research. The portfolios are under constant review and formally rebalanced on a quarterly basis. The active/ passive debate is no longer binary and increasingly financial advisers are blending these to deliver both risk adjusted performance and cost efficiencies. This approach makes sense and the Schroder Portfolios are constructed with this in mind believing that some markets are more efficient than others. All the considerations above simply demonstrate that there is not a one size fits all solution and no right or wrong answers as to whether one option is more beneficial than another. We firmly believe that financial advisers require choice from their investment partners . n l Visit www.schroders.co.uk/outsourcing to find out more about our investment solutions.

IMPORTANT INFORMATION Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested. Schroders has expressed its own views and opinions which may change. This information is not an offer, solicitation or recommendation to buy or sell any financial instrument or to adopt any investment strategy. Nothing in this material should be construed as advice or a recommendation to buy or sell. Reliance should not be placed on any views or information in the material when taking individual investment and/or strategic decisions. No responsibility can be accepted for error of fact or opinion. Issued by Schroder Investment Management Limited, 1 London Wall Place, London EC2Y 5AU, registered No. 1893220, who is authorised and regulated by the Financial Conduct Authority.

www.rsmr.co.ukâ&#x20AC;&#x201A; Summer 2020

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KEEPING A QUALITY FOCUS IN A POST-COVID WORLD

fter a more dramatic start to the new decade than anyone predicted, the Quality investment team at Ninety One explains why the current UK equity environment is suited to a focus on resilient companies that can offer downside protection during falling markets, and meaningful participation in rising markets. As we navigate the summer months of a remarkable year, it is worth reminding ourselves that the outlook from here is still very uncertain. From an economic perspective, the UK is now in a significant recession, and while governments globally – and particularly in the UK – have tried to mitigate some of the downside, the reality is when companies are not investing, consumers aren’t spending and banks aren’t lending, it is very difficult to see economic growth recovering quickly, or a 'V-shaped' recovery. It is going to take time for confidence to trickle back into the economy and the confidence that the economy needs comes from the science and not from politicians. Therefore, the crucial catalysts to watch for are whether a vaccine is created, or whether we get a second wave of the virus. With that in mind, markets could remain volatile. Trying to explain the sharp equity rally against such a bleak economic backdrop is not without its challenges. A phrase

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that comes to mind is ‘TINA’ (there is no alternative) and, to a degree, equities still remain the go-to place where many feel they can capture positive returns. Having said that, valuations remain full, and this low growth environment will make it very difficult to generate top line growth or an improvement to margins. Therefore, investors should consider focusing on owning those companies that can navigate a world of geopolitical and economic stress, and structural change.

What are the characteristics of a quality company? Within the Quality investment team at Ninety One we define high quality companies as those with hard to replicate, enduring competitive advantages, dominant market positions with sustainable business models that enables them to grow their profits over time. These companies have strong, healthy balance sheets, and typically low capital intensity, which means they convert their profits into cash. This is crucial; measuring the amount of cash a company generates as a percentage of its market cap is our key metric that we use across our UK, global and regional quality funds; whether they focus on growth or income for investors. Whatever the economic backdrop, revenues tend to be repeatable for quality companies because they tend to offer products and services that people need. This can relate to a huge breadth of businesses, from medical device makers to elevator

The value of investments, and any income generated from them, can fall as well as rise. Where charges are taken from capital, this may constrain future growth. Past performance is not a reliable indicator of future results. Investment objectives and performance targets may not necessarily be achieved, losses may be made. Important information This communication is for institutional investors and financial advisors only.

manufacturers through to staple food producers: all make goods that are needed through any form of economic environment, ensuring a stable cash flow stream. However, this is still not enough to make an investment. Most important of all – and this is an area often overlooked – is capital allocation. This can literally make or break a company. How does a business reinvest its cash flow? Does it return it to shareholders through share buybacks or dividends? Does it pay down debt or does it reinvest this capital at high rates of return back into the business? Companies with prudent, positive capital allocation policies are likely to provide sustainable returns through any form of equity market.

How do such companies tend to perform over a cycle? Another compelling feature of these companies is this operational resilience typically translates into share price resilience during downturns, while also being able to participate meaningfully during rising markets. These companies can maintain their high levels of return through long periods of time and, often, markets underestimate the ability for such companies to continue to grow, reallocate capital appropriately and, ultimately, grow the value and the cash flow they can return to shareholders.

Within the RSMR-Rated, Ninety One UK Alpha Fund, at least two-thirds of the portfolio is invested in these resilient Quality companies. We are also able to take advantage of best-of-breed cyclical businesses and restructuring/recovery opportunities that are trading on attractive valuations. We believe these are the cyclical businesses best positioned to thrive in a post-COVID world. It’s this blend of Quality and quality cyclical businesses that, we believe, should see the Fund best positioned to navigate the volatile markets ahead. It’s important to stress that we remain in a deeply uncertain environment with very real risks facing investors. No matter what happens with the battle against COVID-19, the Brexit scenario is rearing its head again as the UK and EU seek to agree a trade deal. There is a high possibility that we have a ‘no deal’ at the end of this year and that will have a significant impact on many companies. Therefore, in our view, this lends itself to a focus on allocating capital to these defensive, resilient companies that can provide more certainty in these uncertain markets. l For more information on the Ninety One UK Alpha Fund and our Quality approach to investing, visit www.ninetyone.com/uk/ quality

The information may discuss general market activity or industry trends and is not intended to be relied upon as a forecast, research or investment advice. The economic and market views presented herein reflect Ninety One’s judgment as at the date shown and are subject to change without notice. There is no guarantee that views and opinions expressed will be correct and may not reflect those of Ninety One as a whole, different views may be expressed based on different investment objectives. Although we believe any information obtained from external sources to be reliable, we have not independently verified it, and we cannot guarantee its accuracy or completeness. Ninety One’s internal data may not be audited. Nothing herein should be construed as an offer to enter into any contract, investment advice, a recommendation of any kind, a solicitation of clients, or an offer to invest in any particular fund, product, investment vehicle or derivative. Investment involves risks. Past performance is not indicative of future performance. Any decision to invest in strategies described herein should be made after reviewing the offering document and conducting such investigation as an investor deems necessary and consulting its own legal, accounting and tax advisors in order to make an independent determination of suitability and consequences of such an investment. This material does not purport to be a complete summary of all the risks associated with this Strategy. A description of risks associated with this Strategy can be found in the offering or other disclosure documents. Except as otherwise authorised, this information may not be shown, copied, transmitted, or otherwise given to any third party without Ninety One’s prior written consent. © 2020 Ninety One. All rights reserved. Issued by Ninety One, August 2020.

www.rsmr.co.uk Summer 2020

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Ariel Bezalel, Head of Strategy

Harry Richards, Fund Manager, Fixed Income.

DEBT AND DENIAL

Are governments and central banks trying to cure a debt problem with more debt? As policy intervention drives markets higher at the same time as economic data nosedives, Ariel Bezalel and Harry Richards discuss where they are finding opportunities and avoiding pitfalls in today’s bond markets.

Is fiscal policy losing its potency? Risk assets have had a spectacular recovery since the middle of March, yet government bond markets signal a very different reality. Almost $12.4 trillion of government bonds now yield below zero, with Canada, the UK, Ireland and Belgium joining the negativeyield club. It’s an overused word, but we really are in ‘unprecedented’ territory – over 90% of global economies are in a recession, which is even higher than in the Great Depression, while 40% of countries are seeing falling inflation. Global debt levels have soared, with governments adding around $10 trillion of debt in the last few months. When combined with central bank measures, this amounts to around $25 trillion of stimulus. Corporate debt levels have also ballooned. Evidence shows that central bank support is being used to boost corporate cash balances rather than invest in productive assets, which is likely to be a big headwind to growth. But you can’t cure a debt problem with more debt. The debt burden means that fiscal policy is losing its potency. In the 1950s, $1 of debt generated around $0.8 of GDP; today it’s less than $0.4. This is a global trend. Fiscal stimulus is acting like a sugar rush – it’s effective for a couple of quarters but

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starts to wane as too much debt and ageing demographics weigh on economic activity. In our view, this accumulation of debt will hasten the ‘Japanisation’ effect across the developed world with yields grinding ever lower. As bond yields fall, we believe yield curves will continue to flatten. The 10-year US Treasury yield could well drift down to zero, perhaps even lower, while the 30-year bond yield could trade below 1.0%. This is

Fiscal stimulus is acting like a sugar rush – it’s effective for a couple of quarters but starts to wane as too much debt and ageing demographics weigh on economic activity.

supportive for government bond prices and that’s why we are bullish on medium-to-longdated US Treasuries. Australia is another market where we believe there are strong returns to be made in government bonds.

Deflation vs inflation There has been a lot of excitement about a spike in money supply recently, but the velocity of money – the rate at which money is exchanged – is declining. In fact, it has been doing so for several decades in Europe, the US, China and Japan. Until this picks up, it’s unlikely we’ll see an increase in inflationary pressures. In our view, we are still in a deflationary environment. The game changer would be more extreme policy innovation, such as Modern Monetary Theory (MMT). But we think that point is still one to two years away.

Taking calculated risk Dodging the landmines is just as important as picking credits that can thrive in this environment. While central banks may have prevented a liquidity crisis, an insolvency crisis is looming. In the US, the base case from Moody’s is for default rates in high yield to rise to about 14%, and up to 8% in Europe. These are levels not seen since the 2008 financial crisis. That’s why we are focusing on companies with robust fundamentals. We are avoiding more cyclically exposed sectors, such as autos, industrials and some of the materials businesses, that we feel are extremely indebted, especially after accessing the emergency loans used to shore up liquidity during this crisis.

Case study: Albertsons Q3 and Q4 reporting seasons will inevitably deliver a lot of negative surprises. The key to avoiding these, and to delivering strong performance during these periods, is thorough credit analysis.

beverage, and TMT sectors and are seeing an improvement in their credit profile as a result of Covid-19. Albertsons is a good example of a high yield business with an improving credit profile. The BB-/B2 rated US-based supermarket chain owns around 40% of its stores and its in-store pharmacy makes it a convenient one-stop shop. Our calculations tell us the company’s store portfolio, manufacturing plants and distributions centres are worth over $11 billion which equates to more than 1.6x their net debt, providing strong asset coverage and some downside protection for bondholders. Albertsons was already paying down debt ahead of its recent IPO, and with Covid-19 driving food sales up, deleveraging is accelerating meaningfully. We expect that improving fundamentals should drive strong performance. We also think rating agencies are likely to upgrade Albertsons given its financial metrics are now approaching those of its investment grade rival, Kroger, which would act as another catalyst for spread tightening in the company’s bonds.

Conclusion The rally continues to be driven by stimulus rather than economic fundamentals. We believe that an insolvency phase should be expected over the next year. We believe this is a credit-picker’s market and remain focused on finding companies with robust business models that can withstand the uncertainties ahead while offering attractive total return potential. With deflation likely to dominate proceedings for a while yet, a healthy allocation to government bonds, even at these low yields, also remains warranted. n

Please note: Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. The views expressed are those of the individuals mentioned at the time of writing are not necessarily those of Jupiter as a whole and may be subject to change. This is particularly true during periods of rapidly changing market circumstances. Important Information: This document is intended for investment professionals and is not for the use or benefit of other persons, including retail investors. This document is for informational purposes only and is not investment advice. Every effort is made to ensure the accuracy of the information, but no assurance or warranties are given. Holding examples are for illustrative purposes only and are not a recommendation to buy or sell. Issued by Jupiter Asset Management Limited which is authorised and regulated by the Financial Conduct Authority, registered address is The Zig Zag Building, 70 Victoria Street, London, SW1E 6SQ, United Kingdom. No part of this content may be reproduced in any manner without the prior permission of Jupiter Asset Management Limited. 25978

In high yield, we are focused on the better-quality end of the market (BB-rated credits and high Bs) and avoiding low quality Bs and CCCs. We like through-the-cycle businesses with bonds that offer security against high quality collateral. Many of these are in the pharmaceutical, food and

www.rsmr.co.uk Summer 2020

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Karen Ward, Chief Market Strategist for EMEA

Michael Bell, Global Market Strategist

Hugh Gimber, Global Market Strategist

SEEKING SUSTAINABLE INCOME

entral bank actions so far this year have performed the essential role of keeping government borrowing costs low but, for those seeking income, the negative side effect is that low-risk income options are increasingly scarce.

Investors have been turning to higher risk asset classes, including equities, for income over recent years, yet dividend cuts have become a hot topic as companies look to shore up balance sheets against the shock from Covid-19. While we acknowledge that many companies â&#x20AC;&#x201C; particularly those who are receiving

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government support â&#x20AC;&#x201C; may find it difficult to maintain payouts over the coming months, it is essential not to mistake what, for many firms, will be a cyclical issue for a structural one. On a regional basis, we see US dividends as most resilient. The lower dividend payout ratio of the US market provides companies with more flexibility to maintain dividends in periods of weaker earnings. Higher use of buybacks provides a buffer for companies to cut before dividends are hit. Regulatory pressure on banks, in particular, has also been lower so far in the US than in Europe. Riskier parts of fixed income, such as corporate credit and emerging market debt,

Dividend payout ratios %, three-month rolling average

Source: FTSE, MSCI, Refinitiv Datastream, Standard & Poor's, J.P. Morgan Asset Management. US: S&P 500; Europe ex-UK: MSCI Europe ex-UK; UK: FTSE All-Share; EM: MSCI Emerging Markets. Dividend payout ratio shows 12-month trailing dividend per share divided by 12-month trailing earnings per share. Past performance is not a reliable indicator of current and future results. Data as of 31 May 2020.

are other areas that may warrant attention when hunting for income. The Federal Reserve’s decision to buy both investment grade and high yield credit for the first time helped to pull spreads back from their widest levels in March, but credit spreads still sit significantly above their levels of the start of 2020. Central bank purchases in both the US and Europe should provide something of a backstop for corporate bond prices in the second half of the year, although we advocate an increasingly selective approach as investors move further down the quality spectrum and the need to differentiate between (more temporary) liquidity issues and (more permanent) solvency issues becomes more important. Outside of fixed income, real assets may also have a larger role to play in portfolios as an alternative income source. While asset prices in areas such as infrastructure have not been immune to the pressures seen in public markets so far this year, income streams have broadly remained stable. But, of course, investors will need to be able to accept lower liquidity as the trade-off for moving into these types of asset classes. The risks of overstretching for yield when hunting for income have been made very clear by the market volatility so far in 2020. Higher levels of income can only be achieved via higher levels of risk in some shape or form. Rather than ramping up risk to achieve a fixed yield target, incomeseeking investors may be better off using a wide range of asset classes to build well-diversified portfolios that are in line with their risk appetite, and accepting the level of yield available as a result. n

l You can download the full report and read more from our team of experienced Market Insights professionals here

For Professional Clients/ Qualified Investors only – not for Retail use or distribution. This is a marketing communication and as such the views contained herein are not to be taken as advice or a recommendation to buy or sell any investment or interest thereto. It should be noted that the value of investments and the income from them may fluctuate in accordance with market conditions and investors may not get back the full amount invested. Past performance and yield are not a reliable indicator of current and future results. There is no guarantee that any forecast made will come to pass. J.P. Morgan Asset Management is the brand name for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide. Our EMEA Privacy Policy is available at www. jpmorgan.com/emea-privacy-policy. This communication is issued in Europe (excluding UK) by JPMorgan Asset Management (Europe) S.à r.l.and in the UK by JPMorgan Asset Management (UK) Limited, which is authorised and regulated by the Financial Conduct Authority.

www.rsmr.co.uk Summer 2020

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Ben Constable-Maxwell, Head of Sustainable and Impact Investing at M&G Investments

INVESTING FOR GOOD: HOW TO TARGET 'REAL' IMPACT IN EQUITIES

quick Google search for “impact investing” reveals more than 300 million results. Interest in this previously niche part of the investment universe is growing fast, reflecting a desire by investors to help address the world’s major social and environmental challenges. The current coronavirus pandemic, while understandably dominating the world’s thoughts, is just one of a long list of such challenges – and there are an increasing number of options for those looking to invest for purpose as well as profit. The proliferation of products, however, does present a problem. With so much choice, how can you pick the right one for you? Before this, there is another challenge to overcome. How can you differentiate genuine impact funds from those that are simply masquerading?

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This focus on achieving impact should of course then be reflected in what the fund invests in. When it comes to approaches that invest in listed company shares, the impact for fund investors will largely be a function of the impact delivered by companies in the portfolio. To pick impactful stocks, fund managers need to gauge the extent to which a company’s purpose is genuinely focused on addressing key societal and environmental issues. Its impact must be intentional, not accidental, and should be reflected in deeds as well as words.

Consider the process

Look at intentions

Like any investment strategy, there should be a robust and repeatable framework to consistently evaluate the case for potential investments. When investing in equities for impact, while intention sets the agenda, design and process are the functional tools that actually enable the delivery of the impact.

There are worse places to start than looking at a fund’s objectives. A bona fide impact fund should have its non-financial goals hard-coded into its DNA. Impact funds should by design seek to address the world’s major social and environmental challenges.

Importantly, it is always about more than simply excluding certain sectors that cause harm, like tobacco or weapons, or companies whose practices rate poorly on non-financial measures, like pollution or corruption. Such “screening” is useful, but it is only a first step.

When you’re looking to pursue real impact with an investment, there are a few key qualities that you can look for, in my view.

Rather than being an afterthought, or a secondary consideration, impact-related objectives should at least be on a par with financial goals.

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Impact investors need to consider how most effectively to deliver the desired impact. It helps to focus first on the challenge at hand and then invest in the solutions. The solution can be assessed by clearly identifying and measuring the positive impact that a company generates. One way is to map impact against the United Nations Sustainable Development Goals (SDGs). These are a universally recognised articulation of the most pressing challenges facing people and the planet, from addressing poverty to combatting climate change. We can map a company’s activities to a primary Goal, as well as any relevant secondary Goals, and quantify their contribution towards achieving them. I believe we can look not only at the progress companies make against the SDGs through their own products and services, but also at how they enable other companies to deliver a positive impact. It requires a lot of extra work; but by combining this impact investment case with the financial investment case, fund managers can pick companies that have the potential to deliver profitable growth alongside positive impact. We believe it is a powerful combination.

Focus on outcomes Measuring the impact of your investments is a central tenet of impact investing. I believe investors should expect impact fund managers to evaluate and report the impact that is being delivered – and also articulate what they themselves are doing to drive that impact forward.

Measuring impact from investing in equities isn’t an exact science, however, and there are a number of approaches. Some attempt to distil the impact you can have – litres of water saved, for instance, or even lives – with every £10,000 invested in a fund. I think there is a danger here of oversimplification and overclaiming. Unless you are investing to target one specific impact goal, such as cutting carbon emissions, we question the validity of aggregating multiple companies’ impacts at portfolio level, and then allotting them to a specific amount invested. While admirable as a strategy for communicating impact, to do so tends to be overly reliant on assumptions. I believe it’s more accurate to focus on each given company’s impact, assessing how it is performing against the relevant sustainability goal. By establishing key performance indicators that are pertinent to that company’s delivery of an impact outcome, we can assess how the business is making a positive contribution to the SDG and use our investment to push for progress over time. We believe that companies with a clear and impactful purpose are more likely to remain dedicated to these goals over the long term.

The views expressed here should not be taken as a recommendation, advice or forecast. The value and income from any fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise. There is no guarantee that any fund will achieve its objective and you may get back less than you originally invested. This financial promotion is issued by M&G Securities Limited which is authorised and regulated by the Financial Conduct Authority in the UK and provides ISAs and other investment products. The company’s registered office is 10 Fenchurch Avenue, London EC3M 5AG. Registered in England and Wales. Registered Number 90776.

However fund managers measure impact, transparency with our investors is all-important, and never more needed than in times like these. By sharing what we see as impact, by continuing to develop our tools for measuring and managing it, and importantly by flagging when it falls short, we can shine a light on how investors can deliver “real” impact where it is most needed. n

www.rsmr.co.uk Summer 2020

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UK PROPERTY MARKET

Robin Ghosh, Senior Research Manager, RSMR

Katie Poulson, Marketing Officer, RSMR

n the UK we’re obsessed with the property market, and we have a high rate of property ownership with 65% of households in England being owneroccupiers. Housing is the biggest component of most household’s wealth and has a big impact on the economy. Rising house prices are central to our economy and lead to an increase in consumer confidence so it’s a great barometer to measure how the wider economy is faring. Why is a thriving housing market good for the economy? Activity in the housing market has a multiplier effect. It’s not just about the buying and selling of houses, the spending that filters through after the sale, such as estate agent fees, building and decorating, makes the housing market a great vehicle for generating economic activity. UK house prices in general, experienced some spectacular growth over the last few decades up until the Global Financial Crisis (although there were also periods of market weakness), and over the last ten years, they’ve made a fair recovery. Due to the wealth effect, rising house prices generally encourage consumer spending and lead to higher economic growth. A sharp drop in house prices adversely affects confidence and construction and can contribute to an economic recession. Why has the housing market continued to rise? In the UK there is a chronic shortage of property and a lack of new property. Immigration and societal changes, with one in four families requiring two homes due to separation or divorce, have increased demand. The cost of land and strict building laws have led to a structural shortage of houses. To maximise profit, builders focus on the higher end of the market, meaning that new, affordable housing is rarely available. The property market also has wider implications for the UK economy. For nearly 30 years, Britain has had a trade deficit, meaning it imports more than it exports,

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but this deficit remains manageable because of vast inward foreign investment channelled to UK property. International investors make up around half of all UK commercial property transactions and a large proportion of residential sales. If this investment stops, it will put pressure on property prices, affect UK GDP and tax revenues, and worsen the current account deficit of the country. Lockdown has had a devastating effect on the housing market. Mortgage applications fell to around 8,000 in March from 70,000 in February, representing a huge reduction in activity. Four months of falling prices represent the worst performance of the market in the last decade. To try and sustain confidence in an asset class that accounts for most of the country’s wealth, Chancellor Rishi Sunak has recently announced a reduction in stamp duty. He’s supporting first time buyers and those at the lower end of the property market by cutting out stamp duty on house purchases under £500,000 until March 2021. This will cost the Treasury £3.8 billion, about 0.4% of the total tax take. You may ask why the government is utilising billions of taxpayers’ money to prevent house prices from falling at a time when the most disadvantaged people in society have been hit by the economic fallout of coronavirus, but as we’ve already seen, property prices remain key to our economic success. Whether the government’s intervention is enough remains to be seen. The property market isn’t out of the woods yet and, with the UK in desperate need of taxation, it could be hit by capital gains tax in the longer term. Taxation in this area wouldn’t normally be considered due to the negative impact it would have on the property market and the wider economy, but the tax deficit will have to be plugged somehow and the possibility of changes to how capital gains tax is calculated in the future is already being floated in the press. Britain should arguably be less dependent on the property market but for now house prices go hand in hand with economic prosperity. n

GSAMFUNDS.com

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We believe investors today are faced with a series of trends that are likely to redefine the investment landscape over the next five years. While trends evolve over time, we think that investors are able to position themselves in anticipation of many of these today. Contact your GSAM representative for more information on the key trends that we believe investors should consider when constructing their portfolios.

For Third Party Distributors Use Only – Not For Distribution to your clients or the General Public. This material is provided at your request for informational purposes only. It is not an offer or solicitation to buy or sell any securities. In the United Kingdom, this material is a financial promotion and has been approved by Goldman Sachs Asset Management International, which is authorized and regulated in the United Kingdom by the Financial Conduct Authority. THIS MATERIAL DOES NOT CONSTITUTE AN OFFER OR SOLICITATION IN ANY JURISDICTION WHERE OR TO ANY PERSON TO WHOM IT WOULD BE UNAUTHORIZED OR UNLAWFUL TO DO SO. Prospective investors should inform themselves as to any applicable legal requirements and taxation and exchange control regulations in the countries of their citizenship, residence or domicile which might be relevant. Views and opinions expressed are for informational purposes only and do not constitute a recommendation by GSAM to buy, sell, or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change, they should not be construed as investment advice. Confidentiality: No part of this material may, without GSAM’s prior written consent, be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorized agent of the recipient. © 2019 Goldman Sachs. All rights reserved. 163557-OTU-952840

THE UNSTOPPABLE ASCENT OF SUSTAINABLE INVESTING The assumption that shareholder returns should be maximised at any cost has been challenged by Covid-19, further embedding sustainable investing as a future destination for asset flows. Head of Equities in Asia Ned Salter explores the drivers behind this transformation and their consequences for investors. Key points n The crisis has accelerated the adoption of sustainable capitalism and companies are striving to protect and support employees, customers, suppliers and communities.

The bottom line isn’t the top priority that once was.

n At the height of recent market volatility, securities issued by companies at the top of Fidelity’s proprietary ESG ratings scale on average outperformed those with lower ratings.

n As asset owners start to target sustainability metrics beyond traditional financial obligations, they drive managers of that capital to invest with those principles in mind – creating something of a virtuous circle. The bottom line isn’t the top priority that once was. In decades past, corporate earnings calls focused on quarterly earnings

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per share, performance relative to past quarters and future expectations. These numbers express the priorities of shareholder capitalism and its measures of corporate success.

While valuation metrics are unlikely to change, we’ve heard CEOs and CFOs demonstrate a very different focus on their earnings calls since March. They are striving to communicate different numbers, which represent their efforts to protect and support employees, customers, suppliers and communities. The Covid-19 crisis has accelerated the adoption of sustainable capitalism, in particular on matters related to the social good which may ultimately prove to be ground-breaking. There is growing recognition in the corporate world that its

existence as a system for allocating resources is based on an implicit licence granted by society, one that can only be strengthened by seeking win-win, rather than win-lose, outcomes.

Mapping the transformation on-the-ground We have been able to map this transformation of corporate purpose via our monthly survey of more than 140 of our analysts worldwide. For example, over half of the responses to the May Fidelity Analyst Survey indicated an increase in company plans to step up focus on workers, consumers and the wider community as a result of the pandemic. Across sectors and regions, our analysts said that the health of staff has been at the forefront of managementsâ&#x20AC;&#x2122; minds, and companies will devote more attention to employees safety and wellbeing in the future. The survey also found that for some companies, demonstrating good corporate citizenship and support for the communities in which they operate is now an essential part of building and sustaining brand equity post-crisis.

Corporate action and sustainable capitalism Listening to what companies are saying is useful, but tracking what they actually do is better. Many listed companies are changing the way they allocate funds. They are reducing share buybacks, slashing dividends and cutting executive bonuses, and instead are guaranteeing jobs and providing extended paid sick leave, enhanced health coverage and child care. This focus on employee safety and improving employee satisfaction is a recognition that the increased productivity and goodwill earned from these measures will help companies survive and thrive in the long run, as illustrated by an example picked out by our analysts below:

Mengniu throws lifelines to its supplier chain Chinese dairy producer China Mengniu has kept its commitment to buy milk from

dairy farms and honoured its procurement obligations through the crisis, despite lower expected end-demand. Mengniu also provided zero-interest funding to support farms with temporary financial liquidity problems. Not only will this help farmers survive, but it also stops a lot of raw milk from going to waste. Mengniu plans to convert this raw milk to milk powder to store as inventory for future use. This will hurt margins in the near-term, but crucially it protects its supply chain and the sustainability of the business over the long-term.

Implications for the future These developments will have both intended and unintended implications for assets. On one hand, some companies could face lower profit margins due to higher labour costs, costs for compliance with environmental regulations and cost inflation stemming from localised supply chains. More sustainable private consumption patterns and adherence to circular economy principles could also constrain top line revenue growth. Taken together, this could result in more gains in the real economy at the expense of financial assets. On the other hand, as a greater number of companies focus on the long-term sustainability of their business models, picking the right investments should still lead to consistent and high returns. Itâ&#x20AC;&#x2122;s important to remember that compounding returns from cash generating, long-duration investments with high survival rates are the bedrock of long-term investing. In the near-term, investments in sustainable companies should benefit from improving valuations for high ESG scores, augmented by outsized fund inflows. These companies will also have better access to lower cost and longer-term funding, an advantage that serve them especially well, if and when rates begin to rise. It is likely that the extreme and tragic experience of the Covid-19 pandemic has resulted in a permanent change to the mindset and attitudes toward sustainable capitalism. If the door to combining corporate purpose and the common good was open a crack before the crisis, the events of the last five months have thrown it wide open. n

Important information This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of investments in overseas markets. The value of bonds is influenced by movements in interest rates and bond yields. If interest rates and so bond yields rise, bond prices tend to fall, and vice versa. The price of bonds with a longer lifetime until maturity is generally more sensitive to interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuers ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between government issuers as well as between different corporate issuers. Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities, but is included for the purposes of illustration only. Investments should be made on the basis of the current prospectus, which is available along with the Key Investor Information Document and current and semi-annual reports, free of charge on request, by calling 0800 368 1732. Issued by Financial Administration Services Limited and FIL Pensions Management, authorised and regulated by the Financial Conduct Authority. Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. UKM0820/31908/ SSO/NA

www.rsmr.co.ukâ&#x20AC;&#x201A; Summer 2020

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Richard Colwell Head of UK Equities

UK EQUITIES: OPERATION DYNAMO TO THE RESCUE?

hen global markets rolled over in midFebruary, investors would have been hardpressed to persuade anyone of the speed or gradient of the plunge that followed as the

economic toll of Covid-19 lockdown was rapidly discounted by the market. Despite the apparent suddenness of the move, it notably occurred some weeks after the virus had first emerged in the Chinese province of Hubei, leading the great bull run to succumb to what US hedge fund manager Paul Singer aptly described as the “slowest moving black swan in history” .

Was that it? In response to the total collapse in the markets, the first upward pulse was always going to be spectacular and we have indeed gone on to witness one of the sharpest rebounds on record, as global markets surged. We appeared to have experienced a “Dunkirk moment” as the central banks and a flotilla of government support schemes sailed to the rescue to seemingly avert economic catastrophe. While the full extent of our policymakers’ very own “Operation Dynamo” remains to be seen, as equity investors we have been left wondering …was that it?!

We appeared to have experienced a “Dunkirk moment” as the central banks and a flotilla of government support schemes sailed to the rescue

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For our part, while we are also taking some reassurance from the level of policy support, we think it would be premature to declare victory for markets – and we question whether the potentially

bruising economic path into next year is indeed fully discounted. However, we do not pretend our edge is in calling market turning points and can certainly see the current rally moving higher from here. Indeed, a euphoric “melt-up” could ironically mark the top of this initial rebound, as shorts are covered and the last of the pessimists are pulled in. We recall that after the March 2000 sell off, markets rallied to new highs before falling away from June. This time, if the resurgence back towards all-time highs is be sustained, it strikes us that the economic outcome will need to be more ‘V-shaped’ than appears warranted by the balance of probabilities.

The price for policy support The policy response has certainly been phenomenal in its scale, far outweighing the intervention that occurred back in 2008-09. Had the government and central banks not stepped in as swiftly and immensely as they did, global markets and economies would be facing devastation at present. As a price for securing their survival, UK corporates have accepted stringent cost-cutting measures, and we fully expect the equity raises seen in recent months to continue. This environment, against a backdrop of rising unemployment and diminished GDP, will prove a stern test for the consumer and business confidence needed to sustain the economic recovery that we all want. Our sense is that this will be a phase requiring leadership from the government and not the central banks.

What could the final phase of the downturn look like? So if we must first cross the valley before climbing back towards the sunlit uplands, what could take us into the final phase of the downturn? In our view, this could arrive post the expected rebound in Q3 GDP growth that follows the deep contraction of Q2. And where the Covid-19 crisis delivered us a severe supply shock, it could well be the demand

shock that takes us into the deflationary bust of the final phase. The task of repairing the UK’s public debt pile is one of the drivers behind our view that following the short, sharp deflationary shock of this recession we could be set for the first sustained period of “super-normal” inflation for over 30 years. While cognisant of this sea change in the investment backdrop, we are optimistic that such a scenario could deliver a firm tailwind for the dwindling cohort of value investors. While we commend the many investors who have in recent years very successfully sought “herd immunity” in Big Tech-led quality growth names, we are unconvinced of the risk/reward they offer at today’s valuation multiples. This extreme crowding effect has however ensured any nascent rally in more value-oriented names has found few friends in the market!

The long-term outlook Taking a longer-term view, we subscribe to the view that the Covid crisis has primarily been an accelerator rather than a change agent. What was inevitable has simply been rushed forward at a greater speed, including: deglobalisation as China and the US de-couple; the shortening of supply chains; and the rise of e-commerce and digitisation. In constructing our UK equity portfolios for long-term outperformance, we acknowledge secular trends but think it is crucial to maintain optionality by also owning companies that do not necessarily conform to widely championed themes. We are operating in a world of extremes that have only been amplified through the crisis. And despite our somewhat gloomy economic comments, we are excited by the range of opportunities presented by the extreme valuations out there. We will be sticking to our DNA as patient, conviction investors and continue to use short-term volatility to build on our long-term track record of delivering attractive risk-adjusted returns. n

Important information: For use by Professional and/or Qualified Investors only (not to be used with or passed on to retail clients). Past performance is not a guide to future performance. The value of investments and any income is not guaranteed and can go down as well as up and may be affected by exchange rate fluctuations. This means that an investor may not get back the amount invested. Your capital is at risk. This material is for information only and does not constitute an offer or solicitation of an order to buy or sell any securities or other financial instruments, or to provide investment advice or services. The mention of any specific shares or bonds should not be taken as a recommendation to deal. The analysis included in this document has been produced by Columbia Threadneedle Investments for its own investment management activities, may have been acted upon prior to publication and is made available here incidentally. Any opinions expressed are made as at the date of publication but are subject to change without notice and should not be seen as investment advice. Information obtained from external sources is believed to be reliable, but its accuracy or completeness cannot be guaranteed. This material includes forward-looking statements, including projections of future economic and financial conditions. None of Columbia Threadneedle Investments, its directors, officers or employees make any representation, warranty, guarantee or other assurance that any of these forward-looking statements will prove to be accurate. Issued by Threadneedle Asset Management Limited (TAML). Registered in England and Wales, Registered No. 573204, Cannon Place, 78 Cannon Street, London EC4N 6AG, United Kingdom.

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UK EQUITY MARKET TO DATE

Luke Chappell, Managing Director, BlackRock

n this note we outline our views on the UK market year to date, providing insight on market movements, government actions to compensate for the economic shutdowns, the value/ growth debate as well as an outlook.

2020 has been dominated by two issues. One, the global Covid-19 pandemic, which continues to sweep through economies and stock markets, with equities seeing declines in the first quarter that matched those of 2008. The second has been the truly unprecedented global announcements of fiscal and monetary stimulus to provide respite to the markets, as depicted below showing the measures announced as a percentage of GDP. Volatility spiked in the first quarter as financial markets came under pressure and uncertainty prevailed as to the scale and duration of the downturn as well as the shape and timing of any recovery or risk of a second wave of transmission. The worst affected sectors were those hit by lockdowns, particularly those with an element of discretionary consumer spending such as travel and leisure and general retail. The Oil sectorâ&#x20AC;&#x2122;s decline, in the face of collapsing commodity prices, was matched by the fall in banks and other financial sectors, whilst defensive sectors fared better.

After the shock of the first, the second quarter was marked by a more thoughtful consideration of the effects of the global pandemic including: the future scale of government intervention; societal impacts including the resurgence of racial tensions and civil unrest; the changes to human behaviour, both short- and long-term; the potential for vaccines and treatments to avert a second wave, and the financial changes to companies and industries. Stock markets responded favourably to continued efforts from policy makers to stave off the worst impacts and global equities delivered the strongest second quarter returns since 2009 as many economies worldwide began to ease restrictions. Volatility remained heightened though, as fears of a second wave of the pandemic continued to circulate. UK indices made gains, led by small- and mid-caps, but lagged the resurgence in the US market where Technology continued to drive returns. Macro-economic themes continued to drive sector performance. Financials continued to perform poorly as investors worried about loan provisions and pressure on margins from low interest rates. As China led the recovery from the pandemic, so the Miners and other industrial cyclicals rallied in response to the prospect of higher investment spending and strong

Global fiscal measures as a percentage of GDP, year to date 2020 30

% of GDP

25 20 15 10 5 0

USA

Japan

Euro area

Loan Guarantee

Germany

France

Loan Guarantee

Italy

Spain

Canada

Stimulus Measures

Sources: BlackRock Investment Institute with data from Refinitiv Datastream, 9 June 2020. Notes; the chart shows actual and expected fiscal guarantees spending measure and actual loan across certain developed market economies.

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Summer 2020â&#x20AC;&#x201A; www.rsmr.co.uk

Risk: Reference to the names of each company mentioned in this communication is merely for explaining the investment strategy and should not be construed as investment advice or investment recommendation of those companies.

metals prices. Many sectors impacted by the pandemic continued to underperform, but general retailers bucked the trend as investors sought potential beneficiaries of pent-up consumer spending.

On Dividends and Equity Issuance

Outlook

Dividend cuts and suspensions have become commonplace amongst UK companies, in some cases demanded via regulatory intervention, whilst other companies have made headlines for announcing cuts, including Royal Dutch Shell which cut its dividend for the first time since the Second World War by two thirds. Responses to the pandemic have varied significantly across the market, with some companies accepting as much government support as is available and others publicly declining or, where they have previously accepted furlough payments, now declaring that these will be returned. We have also seen an exceptional level of equity issuance, principally driven by the need to improve short-term liquidity to prepare for an extended period of lower demand. We think it is likely that this issuance will continue, albeit we may see a shift away from those needing liquidity to those wanting to capitalise on opportunities presented as the shape of the recovery becomes clearer.

Whether there is a ‘dash for trash’ or ‘junk rally’ akin to what we saw in 2009 when financial easing led investors towards the most financially-distressed stocks, I will not be changing my investment philosophy or process. That rally proved relatively shortlived as the reality of scarce real and nominal economic growth led to a premium being paid for growth. Significant uncertainty is likely to prevail with regard to the magnitude and duration of Covid-19. Whilst there is evidence of recovery, we are still far from normalisation. I am equally mindful that whilst the current focus is on Covid, we shouldn’t ignore USSino tensions, on-going Brexit uncertainty and the US elections in the fourth quarter. In the midst of the ongoing uncertainty, many, if not most companies have withdrawn earnings guidance in recent months, so there is somewhat of a vacuum of information which has led to the wide dispersion in forecasts (see graph below). Our approach was made for these times. It is our job to parse the wealth of information and take a view on which companies are best positioned to adapt to these times. As a team, we are focusing on company meetings; we’ve met about 760 companies year to date (Source; BlackRock Corporate Access as at 30th May 2020). These help us to determine which businesses have sustainable competitive advantages, with strong management teams and sufficiently flexible balance sheets to make them relative winners with cash flows that are likely to persist. n

There has been significant debate over the performance of value and growth. In our view, the definitions of ‘value’ and ‘growth’ need not be mutually exclusive. I believe that the market, whilst relatively effective at pricing growth over the relatively short horizon of 12-24 months, is increasingly less efficient over longer horizons. Frequently, in my view, the market materially and serially under-values and under-appreciates the scope and duration of long term growth. Value, like any valuation metric, is just a story about composition and duration of cash flows and the discount rate we apply to them.

UK earnings estimate dispersion 30 25 20 15 10 5

10 20 11 20 12 20 13 20 14 20 15 20 16 20 17 20 18 20 19 20 20

Earnings dispersion

UK earnings estimate dispersion

Source: BlackRock Investment Institute with data from Refinitiv Datastream, 26 June 2020. Notes: Line shows the aggregate standard deviation of analyst earnings estimates around the average. Higher values indicate a greater level of analyst uncertainty.

RISK WARNINGS Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy. Changes in the rates of exchange between currencies may cause the value of investments to diminish or increase. Fluctuation may be particularly marked in the case of a higher volatility fund and the value of an investment may fall suddenly and substantially. Levels and basis of taxation may change from time to time. IMPORTANT INFORMATION This Material Is For Distribution To Professional Clients (As Defined By The Financial Conduct Authority Or Mifid Rules) Only And Should Not Be Relied Upon By Any Other Persons. Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel: + 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock. Any research in this document has been procured and may have been acted on by BlackRock for its own purpose. The results of such research are being made available only incidentally. The views expressed do not constitute investment or any other advice and are subject to change. They do not necessarily reflect the views of any company in the

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