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Monthly Fund Commentary
Please find below a summary of performance, activity and outlook for September 2018 from our fund managers.

You can also access the Fund factsheet for each product.

Market and Performance review

The Portfolio outperformed the benchmark index over the month. The outperformance resulted mainly from stock selection in China and our underweight India which fell more than 10% during the month.

Kunlun Energy, an integrated Chinese energy company, was the largest contributor after delivering better than expected first half results. The company’s earnings are sensitive to gas volume growth, which was strong as China continued to promote gas consumption as a cleaner energy alternative. Its Exploration & Production segment also attracted positive investor attention as oil prices rose. Beijing Enterprises, a diversified company, rose as 2018 interim results beat expectations due to strong piped natural gas volumes and distribution. PetroChina, the oil and gas exploration and production company, rose on the positive earnings impact of higher oil prices.

JD.com, a Chinese e-commerce provider, was the largest detractor on allegations (that have been denied) of non-financial criminal conduct by its (controlling shareholder) CEO, exacerbated by declining sentiment for non-profit making Emerging Market and technology growth stocks. Lotte Fine Chemical, which manufactures and sells chemical products in Korea, fell due to a decline in caustic soda prices. Not owning Taiwan Semiconductor Manufacturing Company detracted as the company reported good second quarter results. We used the market volatility to add to a number of names including JD.Com, Samsung C&T, Mediatek, Alibaba and Lite-On Technology. We sold out of Gail India and Tech Mahindra, which reached our target valuation, and trimmed a number of names that had outperformed.

Outlook

Rising US 10-year rates are bearish for all asset classes, except US Dollar cash. As the attractiveness of the 10-year risk free investment alternative rises as the yield climbs above 3.5%, and with it the rate at which the cash flows of risky investments are discounted, we expect ‘bubbles’ to pop globally. Prime candidates are property in various global centres (such as Hong Kong and London) and more expensive ‘yield’ stocks. Other likely casualties are some investments with a high proportion of their value made up of far-dated cash flows, that is some growth stocks. This is because a higher discount rate applied to distant cash flows will have a disproportionate effect on valuations.  Of course it is not inevitable that US rates will continue to rise, but conditions do seem ripe as US unemployment reaches multi-decade lows and large companies such as Amazon increase worker wages amid public pressure.

Emerging Market valuations are far from being in a bubble. Indeed, they are cheap relative to their history, and are attractively priced even in a world of a moderately higher risk free rates. Still, any sell-off in other asset classes will inevitably have a knock on effect on Emerging Market equities, which are considered by many investors to be an inherently riskier asset class. We, therefore, expect Emerging Market volatility to persist, and we continue to remain alert for opportunities presented by any dislocation to add to names that might be disproportionately affected.

Performance stated is the total fund return and may differ from the individual share class performance. For individual share class performance see the relevant factsheet.

F GBP Accumulating Factsheet

Market and Performance review

The benchmark MSCI Emerging Markets Index fell 0.53% (in US Dollar terms) in September weighed down by slowing Chinese credit growth, to tighter US monetary policy, rising oil prices and the 10-year yield on US treasuries and trade concerns. India fell 9.10% in response to tightening liquidity conditions and higher oil prices, particularly as the rupee has fallen sharply, further increasing the cost of imports in local currency terms. Energy led sector returns, posting 7.23% as oil prices moved higher and Real Estate fell the most, dropping 5.05%.

The Hermes Global Emerging Markets Fund was in line with the benchmark index in relative terms over the month. This was primarily due to country allocation, notably the overweight positions in China and India which underperformed and associated currency exposure which detracted. Strong stock selection in China and Russia helped offset these losses and selected holdings in Brazil which also detracted.

Sberbank and Mail.Ru rose in line with the domestic market as oil prices breached $80 due to supply demand constraints and news towards the end of the month the US Congress said it unlikely to pass a Russia sanctions bill before the mid-term elections. Separately, Mail.Ru announced a joint venture with Alibaba giving it a stake in AliExpress, the leading player in Russian e-commerce. Shares in China Mengniu Dairy, China’s leading manufacturer of dairy products, rose on H1 2018 results as top line growth beat expectations, mainly driven by product mix trade up and World Cup themed marketing and promotion. Mengniu also benefited as investors have been buying stocks perceived to be cushioned from the trade wars.

ICICI Bank, one of India’s leading private banks detracted the most as sentiment soured following the volatility induced by worries for the finances of non-banking finance companies (NBFC) as a result of the asset liability mismatch at Infrastructure Leasing & Financial Services Group (ILFS). Motherson Sumi, the Indian wire-harnessing and auto components manufacturer moved lower due to the weak sentiment on global autos impacted by trade tensions and slowing EU and China passenger car sales.

Chipbond, a Taiwan test and packaging integrated circuits, fell as Apple suppliers have been impacted by concerns of the US-China trade war, higher-than-expected price of the Apple XR and delay of the LCD iPhone.

Outlook

The tailwinds supporting Emerging Markets (EMs) in early 2018 improved economic resilience and corporate productivity, rising commodity prices and a benign US Dollar have given way to headwinds as trade disputes, high inflation, spiralling currencies and declining growth rates have led EM stocks into bear territory. It is rough out there, but EMs are broader and better than the crisis stricken economies that have dominated news flow, and we believe that many companies will progress despite the changing winds.

Looking beyond the troubled three (Turkey, Argentina, South Africa), macroeconomics in EMs are in relatively good health. Purchasing Manager Indices for all countries except Malaysia, Turkey, Korea and Russia are higher than 50, indicating economic expansion. We see reasonable growth and low interest rates and sensible economic policies in the majority of countries comprising the EM benchmark. This underpins a business environment for EM companies that are more robust than what the headlines portray. They are well positioned to take advantage of this. Expected free cash flow yields are on the rise, and forecast earnings per share across EMs are stronger than those for the US.

To us, the highs and lows of 2018 have reaffirmed one of our key convictions: that EMs are not a destination for short-term trades but for long-term investment in high quality, sustainable companies. Macro forces from US Dollar strength to commodity cycles, political fallout or economic mismanagement will inevitably buffet the universe, advancing or impeding stock prices. However, as the year to date has shown, they are ephemeral in comparison to the corporate fundamentals identified by stock analysis. Like ourselves, the companies we invest in aim to adapt to the current turbulence, act with discipline and capture long-term growth opportunities. We know, as they do, that these skills are hardearned and often require operating in adverse environments such as the current market. And that the insights gained from these experiences are valuable, capable of contributing to the positive, compounding returns throughout cycles that we have generated since inception and continue to seek however strong the tailwinds or headwinds become.

Performance stated is the total fund return and may differ from the individual share class performance. For individual share class performance see the relevant factsheet.

F GBP Accumulating Factsheet

Market and Performance review

The MSCI World Index returned 0.56% in September. Japan was the standout performer, North America and Europe increased modestly and Asia Pacific drifted lower. From a sector viewpoint, the rising oil price ensured that Energy was the top performing sector, while Real Estate, Financials and Information Technology were weak with the latter affected by concerns over a potential slowing pace of growth of semiconductors.

The Fund marginally underperformed the benchmark index over the month. From a sector perspective, selection was successful in Energy, but was offset by weakness in Information Technology and Industrials. At the regional level, selection was successful in North America, but weak in Europe, while other regions had a marginal influence. The largest individual contributions came from Aker BP, Facebook (which is not held in the Portfolio), Randgold and Marathon Oil. Aker BP and Marathon Oil benefitted from the rising oil price, while Aker BP’s CEO was bullish over the company’s long-term prospects, although we could see some volatility over the near-term. Facebook continued its downward trajectory following poor results in July. Randgold increased after agreeing a merger with Barrick Gold to create a global Gold mining giant. AMS, Micron Technology and Siemens Gamesa were the most notable detractors. AMS and Micron Technology fell due to weakness in the semiconductor sector after an industry survey suggested the pace of growth was slowing. Siemens Gamesa fell on concerns over pricing pressure in the wind power market.

Outlook

Record earnings in the US, combined with signs of increasing consumer spending, ensured that the divergence between the US and the rest of the world continued. This has undoubtedly been helped by the tax cuts and expectations that this will continue to remain high. Indeed, the Q3 earnings season is forecast to be another record.

While the tax cuts will undoubtedly bolster earnings, there are a number of potential risks that could dampen this optimism. The most significant remains the trade tensions with China, highlighted by the US imposing of a further $200bn of tariffs. The mid-term elections have delayed this becoming an issue just yet; the 25% tariff is due to be implemented next year, giving time for further talks. Elsewhere, the rising oil price hints at a potential increase in inflation, raising the possibility of more rate rises, impacting consumer’s pockets in the process. Higher rates could also lead to a stronger US Dollar, which could also impact earnings.

This leads us to our main concern at the moment. With markets, and the US in particular, continuing to rise, any disappointment could lead to a reversal in market sentiment both in absolute terms and also from a factor viewpoint. This could result in a sharp swing towards lower quality value areas and provide equity investors with a bumpy ride over the coming months.

Performance stated is the total fund return and may differ from the individual share class performance. For individual share class performance see the relevant factsheet.

F GBP Accumulating Factsheet

Market and Performance review

European equity markets advanced over the month as a rising oil price led to renewed momentum in commodity names. This was reflected in the strong performance of the Oil & Gas and Basic Materials sectors, and contributed to a resurgence of the value factor at month end. Both allocation and stock selection detracted from relative returns in September.

The overweight position in Information Technology was a drag on relative returns and the only meaningful influence from allocation. Stock selection was successful in Consumer Goods, but this gain was outweighed by weakness in Oil & Gas and Industrials. The largest individual contributors were Sberbank, Lundin Petroleum and ConvaTec. Sberbank increased after the US Senate’s Banking Committee suggested that sanctions might be more effective on sovereign bonds rather than Russia’s banking sector. It also benefited from a rising oil price, which is positive for the Russian economy. Lundin was also boosted by the rising oil price as well as positive results from its two month production test in the Barents Sea. Elsewhere, Novo Holdings Chief Executive Kasim Kutay lifted shares in ConvaTec after he said the company looks “as if it’s getting back on the growth track”. Novo Holdings owns a 20% stake in ConvaTec.

Siemens Gamesa, ASML and Deutsche Boerse were the largest detractors. Siemens Gamesa fell on concerns about pricing pressure in the wind power market, while ASML tumbled alongside the semiconductor sector after an industry survey pointed to a slower pace of growth. Deutsche Boerse also drifted lower despite little specific news. The number of stocks in the Portfolio fell by one during the month following the sale of KION Group. While it’s long-term prospects remain positive, we have some concerns over the nearer term. The capital expenditure backdrop looks to be waning, amid higher raw material prices, which could delay or even reduce orders. For the time being, we prefer to watch developments on the sidelines.

Outlook

We can understand investor nervousness about Italy and Brexit. However, we also need to remember that, in Europe, nothing is ever certain. Companies do not have the luxury of delaying decision making until everything clears up. They need to stay focused on their growth strategies, regardless of the external environment. When corporates are making 5 – 10 year investment decisions,

the worries we have today can seem trivial in the grander scheme of things. The reality is that businesses adapt, they innovate, and they find new growth opportunities.

To a certain degree, we welcome the uncertainties. When fear is ripe, opportunities emerge. We acknowledge the tail risks. We know it is hard to price the risk around Brexit, Italy and the EU, but history tells us that Europe can adapt. There have been new concerns every year since the financial crisis, and 2019 will be no different. As we have said before, we need to separate the market from the economy. Europe is out of favour, but as it is quietly delivering growth, this is a good time for active equity investors.

Performance stated is the total fund return and may differ from the individual share class performance. For individual share class performance see the relevant factsheet.

F GBP Accumulating View Factsheet

Market and Performance review

The Russell 2500 Index returned -1.52% in US Dollar terms in September. The S&P 500 edged higher given the strength of macro data. US consumer confidence hit its highest level since 2000, while the monthly average of initial jobless claims fell to the lowest level since 1969. Wage growth rose to the highest level since 2009. At the sector level, Energy returned the most, rising 1.49% while Finanial Services lagged the most, falling 2.82%. The Fund outperformed the benchmark index on a relative (geometric) basiss. The outperformance was driven by stock selection in Financial Services and Health Care, offsetting weak stock selection in Materials and Processing and the underweight Energy which detracted.

Cooper Companies (contact lenses and surgical products) was the largest individual contributor after reporting a solid quarter, with Cooper Vision accelerating, daily disposable lenses posting growth of over 40%, and recent acquisition Paragard showing upside. We continue to like the stock’s setup as the top line should benefit from a recently increased salesforce coupled with a solid lens portfolio.

West Pharmaceuticals (drug packaging & dispensing solutions) rose as it continues to deliver above market growth underpinned by its strategy to shift clients to high value products. Gartner (research and advisory across all business functions) moved higher as investors viewed its divestitures of two non-core smaller businesses as strategically positive.

Teradyne (semiconductor test and measurement) was the largest individual detractor due to volatility in the memory test environment and normal seasonal (Q3) weakness regarding key customer (Apple) application processor testing. Community Bank System (East coast bank) fell as investors booked profits after a period of strong performance and Brooks Automation (wafer manufacture automation and cryogenics) gave back some of the recent gains that followed an agreement to sell its semiconductor cryogenics business at a very attractive price. We added AO Smith, a manufacturer of water heating equipment. The company benefits from its leading market share in the domestic residential and commercial (gas) water heater markets, a substantial distribution network, pristine balance sheet and attractive growth prospects in non-US markets.

Outlook

The US economy is benefiting from a healthy economic backdrop, with accelerating growth and low unemployment supported by recent legislative initiatives, specifically corporate tax cuts and deregulation. We believe this will translate into broad based earnings growth for small- and mid-cap businesses over the coming year, driving the market higher. While risks (such as Federal policy or a geopolitical event) remain, the Fund retains a tilt to economically sensitive sectors such as industrials and materials, and we continue to focus on high quality companies that should benefit if markets move higher but protect investors’ capital during any pullback.

Performance stated is the total fund return and may differ from the individual share class performance. For individual share class performance see the relevant factsheet.

F GBP Accumulating Factsheet

Market and Performance review

The MSCI All Countries World Index returned 0.44% during September. The positive return was driven by the developed markets, while Emerging Asia weakness, due to the ongoing trade tensions, dragged the Emerging Markets lower. From a sector viewpoint, the rising oil price ensured that Energy was the top performing sector, while Real Estate and Information Technology were weak with the latter affected by concerns over a potential slowing pace of growth of semiconductors.

The Fund modestly underperformed the benchmark index over the month. From a sector perspective, there was notable success from stock selection in Energy which was outweighed by weakness in Information Technology. At the regional level, selection was particularly strong in Emerging Asia, but outweighed by detractions in Europe, North America and Japan.

The largest individual contributions came from Abbott Laboratories, Aker BP and Hyundai Engineering & Construction. Abbott Laboratories increased after a study found its Mitraclip device cut the length of hospital stays for heart failure patients. Aker BP benefitted from the rising oil price, while its CEO was bullish over the company’s long-term prospects, although we could see some volatility over the near-term. Hyundai Engineering & Construction increased on little specific news over the month.

Micron Technology, ASML and Siemens Gamesa were the most notable detractors. Micron Technology and ASML both fell due to weakness in the semiconductor sector after an industry survey suggested the pace of growth was slowing. Siemens Gamesa fell as the oil price started to rise.

Outlook

Record earnings in the US, combined with signs of increasing consumer spending, ensured that the divergence between the US and the rest of the world continued. This has undoubtedly been helped by the tax cuts and expectations that this will continue remain high. Indeed, the Q3 earnings season is forecast to be another record.

While the tax cuts will undoubtedly bolster earnings, there are a number of potential risks that could dampen this optimism. The most significant remains the trade tensions with China, highlighted by the US imposing of a further $200bn of tariffs. The mid-term elections have delayed this becoming an issue just yet; the 25% tariff is due to be implemented next year, giving time for

further talks. Elsewhere, the rising oil price hints at a potential increase in inflation, raising the possibility of more rate rises, impacting consumer’s pockets in the process. Higher rates could also lead to a stronger US Dollar, which could also impact earnings.

This leads us to our main concern at the moment. With markets, and the US in particular, continuing to rise, any disappointment could lead to a reversal in market sentiment both in absolute terms and also from a factor viewpoint. This could result in a sharp swing towards value and provide equity investors with a bumpy ride over the coming months.

Performance stated is the total fund return and may differ from the individual share class performance. For individual share class performance see the relevant factsheet.

F GBP Accumulating Factsheet

Market and Performance review

European equity markets advanced over the month, as a rising oil price led to renewed momentum in commodity names. This was reflected in the strong performance of the Oil & Gas and Basic Materials sectors, and contributed to a resurgence of the value factor at month end. Stock selection was the main driver of the relative underperformance in September as contributions from Basic Materials and Utilities were outweighed by detractions from Industrials, Financials and Telecommunications. Allocation had a modest positive influence, due primarily to the overweight in Oil & Gas.

The largest individual contributors were GTT, Lundin Petroleum and Equinor. GTT increased after recent data indicated the LNG market tightened over the summer, which suggests that an increase in supply could be just around the corner. Lundin and Equinor were boosted by the rising oil price, while Lundin reported positive results from its production test in the Barents Sea. Siemens Gamesa, Sartorius and KION Group were the largest detractors. Siemens Gamesa fell on concerns about pricing pressure in the wind power market, while Sartorius tumbled following a strong period of performance and as investor switched allegiance to Value. KION Group fell over supply chain issues that have affected it over the second quarter. The CEO, reiterated that it is on track to meet its guidance for 2018. The position in Intesa SanPaolo was closed due to the ongoing political uncertainty in Italy, surrounding whether its governments’ budget proposals will breach EU regulations. This has overshadowed the company’s fundamentals merits and increased Intesa’s downside risk.

Outlook

We can understand investor nervousness about Italy and Brexit. However, we also need to remember that, in Europe, nothing is ever certain. European corporates are no stranger to uncertain politics, and those that have prospered have been businesses that have shown they can adapt quickly, rather than delaying decision making until everything clears up. They have stayed focused on their growth strategy, regardless of the external environment. When corporates are making 5-10 year investment decisions, the worries we have today can seem trivial in the grander scheme of things. Good businesses adapt, innovate, and they find new growth opportunities. Some of our longer holdings have done that extremely well over the course of the last decade, as a very slow and shallow recovery has played out.

To a certain degree, we welcome the uncertainties. When fear is ripe, opportunities emerge. We acknowledge the tail risks. We know it is hard to price the risk around Brexit, Italy and the EU. History tells us that Europe can adapt. There have been new concerns every year since the financial crisis, and 2019 will be no different. As we have said before, we need to separate the market from the economy. Europe is out of favour, but it is quietly delivering growth – this is a good time for active equity investors that can weather shortterm volatility.

Performance stated is the total fund return and may differ from the individual share class performance. For individual share class performance see the relevant factsheet.

F GBP Accumulating Factsheet

Past performance is not a reliable indicator of future performance. The value of investments and income from them may go down as well as up, and you may not get back the original amount invested. It should be noted that any investments overseas may be affected by currency exchange rates.

The views and opinions contained herein are those of the author and may not necessarily represent views expressed or reflected in other Hermes communications, strategies or products.