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Equities Commentary, February 2020

Please find below a summary of performance, activity and outlook from our Portfolio Managers.

Jonathan Pines Portfolio Manager

Market and Performance review

The benchmark MSCI All Countries Asia ex Japan Index fell 3.04% in February. The Fund underperformed the benchmark over the period. The underperformance resulted primarily from stock selection in China and Taiwan. Our underweight to India benefited the Fund.

Tingyi, an Asian-based food and beverage maker and market leader in instant noodles, rose in February on expectations of food-supply stockpiling as a result of the coronavirus outbreak. Non-exposure to Housing Development Finance contributed as Indian banks have been weak due to concerns for global growth. Nexon, a Japanese company which develops online games, rose after its Q4 2019 results were positive with sales in South Korea notably strong. The company also benefited as expectations have been higher for overall video-game activity amid the coronavirus outbreak.

Non-exposure to Tencent detracted as the company outperformed driven by expectations its services will be continued to be used indoors as the spread of the virus led to quarantine measures. KB Financial, which provides consumer and commercial banking-related services in South Korea, fell as concerns mounted for Korean banks due to the likely macro impact from the Coronavirus outbreak as interest rates will likely stay lower for longer. Kunlun Energy detracted given the expected near-term hit to China GDP growth, the ensuing global slowdown and downward pressure to the oil price and demand for gas.

Outlook

While not opining on the market’s short-term direction, in the medium-to-long term we believe current depressed valuations represent a buying opportunity. Valuations were already depressed for many of our holdings before this occurrence and are now cheaper. Interest rates will likely stay lower for longer benefiting all equities. Asia ex Japan valuations are attractive. While the economic outlook in several sectors looks uncertain, the low prices for which many securities are available provide a margin of safety and a likely satisfactory medium-to-long term performance outlook.

James Rutherford, Portfolio Manager

Market and Performance Review

European equity markets performed well for most of February, but the last few days of the month saw markets plummet as the COVID-19 outbreak began to spread across the globe. The Fund defended well during this period and ended the month having outperformed the MSCI Europe Index. This outperformance was driven by a combination of stock selection and sector allocation. Selection in Health Care, Industrials, Financials and Materials, alongside our overweight's in Information Technology and Health Care contributed the most to relative returns. These were partially offset by detraction's from our underweight in Utilities and selection in Information Technology and Consumer Discretionary.

Qiagen, Siemens Gamesa and Lonza Group were the largest individual contributors. Qiagen reported better-than-expected revenues and earnings after its consumables business posted healthy growth. Following the end of the month, the share price surged after Thermo Fisher agreed a deal to acquire the company. Siemens Gamesa reported a record orders intake in its Q1 results and now has a significant pipeline. This was offset by a weaker pricing environment in onshore wind, although it maintained its guidance.

In addition, Siemens bought Iberdrola’s 8% stake in the company, which boosted the share price. Lonza continued to rise after reporting better-than-expected results in January, while the Health Care sector outperformed during the sell-off.

The largest detractors were Wirecard, Adidas and Valeo. Wirecard reported strong preliminary FY2019 earnings and maintained guidance for 2020, but the share price fell faster than the market towards the end of the month due to its exposure to Asia and travel customers. Adidas, for which a significant volume of sales come from China, warned that it had suffered a materially negative impact from coronavirus. Valeo reported strong cash flows, but earnings and margins were below consensus due to higher-than-expected losses from joint ventures in India and China.

Outlook

China is at the epicentre of the COVID-19 outbreak. Given how central the country is to global growth and supply chains, it is understandably having a profound impact. While the focus was initially on the supply-chain shock as Chinese industrial production slumped, attention is now on the threat to demand as the virus spreads around Europe and North America. We have started to see a policy response, with a number of central banks cutting interest rates – notably the Federal Reserve, which slashed rates by 50bps. We think there is also likely be fiscal stimulus in the near future.

In the meantime, given the speed of the market moves and heightened volatility, all we can do is observe the evidence and try to understand the myriad first, second and third-order effects as best we can. We are broadly comfortable with our positioning, but if the sell-off continues we see a potential opportunity to buy names on our watch list or add to some existing holdings.

James Rutherford Martin Todd

Martin Todd and James Rutherford, Co-Portfolio Managers

Market and Performance Review

European equity markets performed well for most of February, but the last few days of the month saw markets plummet as the COVID-19 outbreak began to spread across the globe. The Fund defended well during this period and ended the month with an excess return.

This outperformance was driven primarily by stock selection with notable contributions from selection in Industrials, Health Care, Materials and Financials and our overweight in Information Technology. These were partially offset by detraction's from selection in Consumer Discretionary and Information Technology alongside our overweight in Energy.

Qiagen, Tomra and Siemens Gamesa were the largest individual contributors. Qiagen reported better-than-expected revenues and earnings after its consumables business posted healthy growth. Following the end of the month, the share price surged after Thermo Fisher agreed a deal to acquire the company. Tomra Systems reported Q4 earnings ahead of consensus helped by improved order intake in their sorting division. Siemens Gamesa reported a record orders intake in its Q1 results and now has a significant pipeline. This was offset by a weaker pricing environment in onshore wind, although it maintained its guidance. In addition, Siemens bought Iberdrola’s 8% stake in the company, which boosted the share price.

The largest detractors were KION Group, TKH Group and Valeo. KION and TKH Group declined alongside the European capital goods sector due to fears over the impact of Coronavirus on industrial production. Valeo reported strong cash flows, but earnings and margins were below consensus due to higher-than-expected losses from joint ventures in India and China.

Outlook

China is at the epicentre of the COVID-19 outbreak. Given how central the country is to global growth and supply chains, it is understandably having a profound impact. While the focus was initially on the supply-chain shock as Chinese industrial production slumped, attention is now on the threat to demand as the virus spreads around Europe and North America. We have started to see a policy response, with a number of central banks cutting interest rates – notably the Federal Reserve, which slashed rates by 50bps. We think there is also likely be fiscal stimulus in the near future.

In the meantime, given the speed of the market moves and heightened volatility, all we can do is observe the evidence and try to understand the myriad first, second and third-order effects as best we can. We are broadly comfortable with our positioning, but if the sell-off continues we see a potential opportunity to buy names on our watch list or add to some existing holdings.

Gary Greenberg, Portfolio Manager

Market and Performance Review

The benchmark MSCI Emerging Markets Index fell 5.27% in February. Equity markets initially shrugged off concerns about the Coronavirus, supported by the expectation that any negative effects of the outbreak would be temporary and localised. However, the increase in cases outside China, notably in Korea, Iran and Italy led to a sharp sell off towards the end of the month. The US 10-year treasury yield touched an all-time low at 1.1%. Commodity prices weakened, the WTI oil price falling 13% in February and bringing the total year-to-date decline to 27%.

China was the only Emerging Market to finish in positive territory, up 0.97%, despite the expectation China’s economic growth will slow sharply in the first quarter as authorities introduced significant restrictions on travel and production to reduce the spread of infection. Policymakers have responded with several supportive measures. The People’s Bank of China cut the loan prime rate by 10 basis points, and provincial governments waived VAT, social contributions and rent to ease the financial pain, particularly for smaller businesses. However, hopes of a quick and sharp recovery in Q2 could be premature given the slow recovery in production and the uncertainty around the extent to which the virus will continue to spread. In Korea, the country with the most confirmed COVID-19 cases outside China, consumer confidence fell sharply in February – the largest single month decline since June 2015. The close economic relationship between Korea and China also weighed on the economic outlook.

The Fund outperformed the benchmark over the period. Country allocation contributed positively to relative returns, notably the underweight commodity-sensitive markets South Africa and Saudi Arabia and non-exposure to Thailand, heavily impacted by the outbreak due to its dependency on tourism. Stock selection in China, Brazil, Korea and Taiwan had a positive impact, helping offset weaker stocks in India and the United Arab Emirates.

Nari Technology, a mainland China smart grid equipment supplier, rose as concerns that the appointment of a new Chairman of the State Grid Corporation of China (SGCC) would impact the pace of future grid investment proved unfounded as the SGCC said it would resume full construction of planned infrastructure. Shares in Tencent rose as its core online-game business benefits from more players staying at home due to the Coronavirus. Its mobile-game business is poised for faster growth into 2020 with its 9% sequential jump in Q3 sales, an acceleration from Q2's 5%. China Communication Services, a new generation smart services provider, rose as the telecom regulator held a meeting on February 22nd to urge telecom operators to accelerate standalone 5G network construction and roll out.

Shares in NMC, which owns and operates hospitals in the Middle East, fell sharply after Louis Freeh, the former FBI director appointed by the Board to oversee an investigation into the allegations made by short seller Muddy Waters presented his review. He found businesses controlled by a founder of NMC and an associate allegedly accessed US$335 million in secret off-balance sheet financing without the knowledge of NMC’s Board. On February 27th, the Board requested that the Financial Conduct Authority (FCA) temporarily suspend its shares to "ensure the smooth operation of the market” and fired its chief executive, suspended a member of its treasury team and gave "extended leave" to its finance chief. These latest events relating to NMC lead the team to lower their estimate of “fair value” to a 70% discount to the last close prior to the suspension of the shares, or 281p. IRB Brasil, a reinsurer, fell following a short report raising questions about the company’s accounts. The team spoke to management, local analysts, and a reinsurance specialist but did not regain confidence in the company and began selling out as a result. Motherson Sumi, an Indian ancillary wire-harnessing and auto components provider to global OEMs, fell primarily due to disruptions to its supply chain in China. Motherson operates 27 facilities in China which were impacted in February. All except one facility in China have resumed operations.

Outlook

The Coronavirus seems to have peaked in China and the team think that it will soon peak in Korea. The mortality rate is low but certainly there is a possibility that it turns into a major event which restricts global economic activity. However, they think it is more likely that it will be contained. Strategy exposure to leisure and travel is limited. The team own Galaxy Entertainment Group which operates casinos and hotels in Macau, and Samsonite, the global luggage provider. They have no positions in Thailand which has a high dependency on tourism, and may look to add to the position in China as the market continues to sell-off. The overweight to India has benefited the Fund as the country has remained relatively unscathed from the Coronavirus outbreak. The Coronavirus may tip the world economy into recession but on balance the view is that this will not happen. The team are not making any changes in the Fund except for buying opportunities when they become cheaper. They are doing research on high-quality companies that have been hit and if they prove to be attractive then we will pick them up.

Geir Lode, Portfolio Manager

Market and Performance Review

The last days of February saw markets plummet as the COVID-19 outbreak began to spread across the globe. Risk appetite collapsed, and our risk aversion monitor highlighted a degree of risk aversion not seen since the financial crisis. This was also reflected in the Alpha Model, which showed investors had a strong preference for attractively priced companies with high quality characteristics, such as balance sheet strength and good corporate behaviour. This was at the expense of Growth and Sentiment, which had been favoured for much of the preceding period. Against this backdrop, the MSCI World Index returned -8.45% in US Dollars.

Over the month the Fund underperformed the benchmark index, although using close of business prices, which the attribution is based on, the Fund outperformed. From a sector viewpoint, selection was successful with Health Care and Real Estate contributing the most. These were offset by a detraction from selection in Communication Services. From a regional perspective, selection in Europe was successful, while North America was a notable detractor.

Barrick Gold, American Tower and Biogen contributed the most to relative returns. Barrick Gold reported strong earnings and benefited from Gold’s status as a safe haven asset. American Tower reported mixed earnings against a difficult comparison, but it benefited from its defensive characteristics as markets fell in late February. Biogen increased after winning a legal challenge from Mylan over the validity of its patent on Multiple Sclerosis drug, Tecfidera.

The largest detractors from stocks held were Delta Air Lines, Marathon Oil and Royal Caribbean Cruises. Nvidia, which is not held in the Fund, was also a notable detractor. Delta Airlines and Royal Caribbean declined alongside travel and tourism stocks, which have been significantly impacted by the COVID-19 outbreak. Marathon Oil declined alongside the oil price, which was also hit by the COVID-19 outbreak due to fears of declining consumption.

Outlook

China is at the epicentre of the COVID-19 outbreak, while the number of cases internationally are accelerating with every continent (bar Antarctica) seeing new instances, prompting the World Health Organisation to raise their warning to “very high”. The SARS crisis of 2003 is perhaps the most obvious precedent, but China is a very different animal today than it was back then. While it is difficult to model its impact, the key role China now plays in global growth and supply chains (as well as the growing number of cases internationally) means the effects on the global economy is likely to be profound. This was reflected by the spike in volatility, the sharp decline in Global Equity markets in late February and the Federal Reserve’s subsequent 0.50% rate cut.

We cannot claim to be experts on epidemics, but history tells us that outbreaks such as this tend to be temporary. However, what remains unknown is how temporary the outbreak will be. Clearly, the longer the duration, the worse the economic impact and it will be important to assess whether there will be any lasting impact on companies. As such, the team continue to monitor the Fund closely and are paying particular attention to what the companies are saying in the current earnings season. Moreover, we would expect any companies with declining fortunes to be identified in the Alpha Model, which will enable the team to act quickly should they see a significant and lasting deterioration in the fundamentals.

We shifted to a more defensive stance favouring quality characteristics, such as balance sheet strength and consistent cash flow generation, late last year as markets reached all-time highs and downside risk increased. This increased exposure to quality has undoubtedly helped the Fund through this turbulent time.

Lewis Grant, Portfolio Manager

Market and Performance Review

The last days of February saw markets plummet as the COVID-19 outbreak began to spread across the globe. Risk appetite collapsed, and our risk aversion monitor highlighted a degree of risk aversion not seen since the financial crisis. This was also reflected in the Alpha Model, which showed investors had a strong preference for attractively priced companies with high quality characteristics, such as balance sheet strength and good corporate behaviour. This was at the expense of Growth and Sentiment, which had been favoured for much of the preceding period. Against this backdrop, the MSCI ACWI Index returned -8.08% in February.

Over the month the Hermes Global Equity ESG Fund underperformed the benchmark index, although using close of business prices, which the attribution is based on, the Fund outperformed. From a sector viewpoint, the largest contributions came from selection in Health Care and Information Technology, while selection in Communication Services and Consumer Discretionary detracted the most. From a regional perspective, selection in Europe was successful, while North America and Emerging Asia were notable detractors.

TJX, Lonza Group and ASML contributed the most to relative returns. TJX reported strong results driven by its Home Goods division and rising margins. Lonza continued to rise after reporting better-than-expected results in January, while the Health Care sector outperformed during the sell-off. ASML benefited from Intel’s expectation-beating revenue guidance and capital expenditure plans for 2020.

The largest detractors were Royal Caribbean Cruises, M&T Bank and Delta Air Lines. Royal Caribbean and Delta Air Lines declined alongside travel and tourism stocks, which have been significantly impacted by the COVID-19 outbreak. M&T Bank fell at the end of the month as investors sought more defensive assets in the sell-off.

Outlook

China is at the epicentre of the COVID-19 outbreak, while the number of cases internationally are accelerating with every continent (bar Antarctica) seeing new instances, prompting the World Health Organisation to raise their warning to “very high”. The SARS crisis of 2003 is perhaps the most obvious precedent, but China is a very different country today than it was back then. While it is difficult to model its impact, the key role China now plays in global growth and supply chains (as well as the growing number of cases internationally) means the effects on the global economy is likely to be profound. This was reflected by the spike in volatility, the sharp decline in Global Equity markets in late February and the Federal Reserve’s subsequent 0.50% rate cut.

We cannot claim to be experts on epidemics, but history tells us that outbreaks such as this tend to be temporary. However, what remains unknown is how temporary the outbreak will be. Clearly, the longer the duration, the worse the economic impact and it will be important to assess whether there will be any lasting impact on companies. As such, the team continues to monitor the Fund closely and are paying particular attention to what the companies are saying in the current earnings season. Moreover, we would expect any companies with declining fortunes to be identified in the Alpha Model, which will enable the team to act quickly should they see a significant and lasting deterioration in the fundamentals.

We shifted to a more defensive stance favouring quality characteristics, such as balance sheet strength and consistent cash flow generation, late last year as markets reached all-time highs and downside risk increased. This increased exposure to quality has undoubtedly helped the Fund through this turbulent time.

Hamish Galpin, Portfolio Manager

Market and Performance Review

The total return of the benchmark index in February was -9.19%. Developed Market Small Cap stocks lagged their Large Cap peers, which returned -8.6%. In the US, Small Caps suffered similar falls to their Large Cap counterparts with the Russell 2000 (a Small Cap index) returning -8.5%, versus the S&P500, which returned -8.4%.

The Fund outperformed the benchmark index in February. AMN Healthcare, Yaoko and Steris Healthcare contributed the most to relative returns. Towards the middle of the month, AMN Healthcare announced fourth-quarter results which were ahead of expectations, helped by labour disruption. They also guided to a stronger first-quarter revenue outlook. Steris Healthcare also reported third-quarter results ahead of expectations and benefited from broker upgrades. Japanese supermarket and drugstore operator Yaoko also contributed to the Fund’s relative performance.

The largest detractors, SSP Group, Relo Group and Wintrust Financial, were all significantly affected by concerns of how the spread of Coronavirus will affect their industries. SSP, the food travel experts, commented that the virus had had a large impact in Asia, with sharp declines in passenger numbers. In response to the sharp fall in sales, the Group is taking action to reduce costs, including the temporary closure of units and reduced operating hours in affected areas. Despite releasing earnings ahead of expectations Relo Group’s shares fell during the month. Wintrust Financial also saw share price weakness alongside other financials towards the end of the month.

Outlook

Short-term volatility notwithstanding, it is something of a relief that the paradigm of the last few years – liquidity-driven excessive valuations in certain parts of the market and a very narrow focus - seems to have come to an end. Once the current period of excess volatility settles down, a higher background level of volatility than has been the case in recent years, and a greater influence of fundamentals in the share prices of companies, should result in a better stock picking environment for active managers.

The economic backdrop is likely to continue to be lacklustre, which favours Small Caps and their superior growth prospects. In addition, the low Beta nature of the Fund - masked by the low volatility environment but really coming to the fore now - should provide downside protection if the market situation deteriorates further.

Martin Todd and Mark Sherlock

Martin Todd and Mark Sherlock, Co-Portfolio Managers

Market and Performance Review

Although Global Equity markets started the month quite buoyantly, the last days of February saw markets plummet as the COVID-19 outbreak began to spread across the globe. Although its effect on the global economy is still yet to be fully understood, it could be significant given that China is a key driver of global industrial growth.

The Fund outperformed the benchmark index in the period with stock selection the largest driver of relative returns. On an individual stock basis, healthcare names Emergent BioSolutions and Qiagen were among the top contributors, alongside the recycling company Tomra Systems. Emergent BioSolutions announced results for Q4 2019 during the month which saw sales slightly lower in the quarter, but a positive outlook statement. Qiagen released positive results and produced a Coronavirus test to be distributed globally. Tomra Systems reported Q4 earnings ahead of consensus helped by improved order intake in their sorting division.

Amongst the large market falls, Abcam, Carl Zeiss Meditec and Cogna Educacao were the largest relative detractors to performance. Abcam shares fell with increased short selling in the name. Carl Zeiss Meditec reported increased sales in Q1 but noted corona virus concerns in their outlook. Cogna Educacao completed a share sale to raise over $500m in February, a move to cut debt and allow them to make further acquisitions.

Outlook

China is at the epicentre of the COVID-19 outbreak. Given how central the country is to global growth and supply chains, it is understandably having a profound impact. While the focus was initially on the supply-chain shock as Chinese industrial production slumped, attention is now on the threat to demand as the virus spreads around Europe and North America.

We remain firmly focused on identifying companies that are likely to benefit over the long-term by helping to address the challenges facing society and the environment as highlighted by the UN SDGs. The team continue to monitor the Fund’s behaviour and its approach to risk management is centred on high conviction stock selection. In the event that the sell-off continues, we see it as an opportunity to buy additional names from our watch list and add to existing holdings.

Mark Sherlock, Portfolio Manager

Market and Performance Review

The Russell 2500 Index fell 8.39% in US Dollar terms in February. Global equity markets suffered a sharp selloff in February triggered by a significant number of cases of Covid-19 reported outside of China. Fears of a slowdown led investors into safe haven assets with gold prices surging and government bond yields forced lower with the US 10-year ending the month marginally above 1%. Oil prices fell sharply in February on global growth concerns, reflected in the weak performance of Energy and Industrial stocks. Health Care was the best performing sector. While recent macro data for the US suggests the economy remains healthy, the market has been pricing in further monetary stimulus by the Federal Reserve with three further rate cuts expected this year.

The Fund underperformed the benchmark index over the period. Underperformance was driven by stock selection, notably in the Technology and Financial Services sectors.

The top four contributors for the month were all Healthcare companies that outperformed on the outbreak of Covid-19 outside of China. AMN Healthcare services (healthcare staffing services), ICU Medical, (provider of infusion therapy (IV) equipment and supplies) and Steris (sterilisers and washers) contributed the most to portfolio attribution.

Gartner (research and advisory) fell sharply with the market after a recent strong performance. Wintrust Financial (financial services) fell as interest rates continued to move lower and investors reacted. Cubic Corporation (transport payment systems) detracted as the service company which has long-term contracts and an improving cash flow, has currently been volatile amid the market sell-off. services) fell as Q4 2019 costs proved a drag on short-term profitability.

Outlook

US SMID company earnings could be more resilient than large cap, given approximately 80% of revenue is derived from the US versus 55% for companies in the S&P 500. Notwithstanding the Covid19 outbreak, the US economy remains in reasonably good shape, with a robust consumer supported by a benign Federal Reserve and an upcoming election cycle which is likely to prove supportive to markets. Nevertheless, after a strong run for the market in 2019, incremental gains will need to be driven by underlying earnings growth. We see opportunities in areas of the market where macro or geopolitical uncertainty appears to have led to attractive risk/return profiles. Our focus remains on finding high-quality companies that should provide a degree of protection in down markets and may benefit if the market moves higher.

Note: the equities commentaries above are as of 27 February 2020. For coronavirus-related updates, please visit our dedicated webpage.

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

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.


 

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