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Equities Commentary, August 2020

Please find below a summary of performance, activity and outlook from our fund managers.

Jonathan Pines Portfolio Manager

Market and Performance review

The benchmark MSCI All Countries Asia ex Japan Index returned 3.73% in August. The Fund underperformed the benchmark index over the period, primarily resulting from stock selection in Taiwan and China.

Youngone Corporation, a Korean manufacturer of outdoor clothing and products, gained with other clothing original design manufacturers as US retailer Gap reported better-than-expected earnings and on optimism relating to its bicycle division. Not holding Tencent contributed after US President Donald Trump signed an order restricting US persons from transacting with WeChat, its messaging and payments app. Haier Smart Home, a global home appliance manufacturer, rose after issuing results that showed strong revenue growth, in particular in its overseas businesses and as it advanced merger plans with its subsidiary.

ASE Technology, a Taiwanese semiconductor packaging and testing services company, and MediaTek, a Taiwanese chip supplier, both fell as shares of Huawei suppliers dropped after the U.S. Commerce Department announced new curbs. Samsung Electronics underperformed on continued weakness in memory prices.

We have added to mainly economically sensitive stocks with strong balance sheets that have been hit hard and continue to seek new opportunities where stocks have adjusted inappropriately in response to the changing economic landscape. We sold Trip.com into recent strength from its March lows and sold Lifestyle International amid a challenging outlook. We added to Kumho Petrochemical, which stands to benefit as a supplier for materials used in the medical glove production process and Asustek Computer, which is on a 6% dividend yield that we consider to be sustainable in the context of stable demand for its products.

Outlook

E-commerce, Mega Cap, Growth and Quality stocks have risen to record valuations as a result of an improved relative industry positioning and still lower interest rates. While the valuations of some of these companies are potentially justified in view of these new dynamics, others have in our view risen too much. While we are not calling a bubble in the largest benchmark names, there are some slightly smaller companies that are trading at valuations that are hard to justify given even optimistic assumptions. The market is highly focussed on opportunities among the fastest growing companies, while it ‘looks away’ from other stocks, which have the potential to rerate from depressed levels despite a less rosy outlook. It is in this second category that we believe there is better potential for outperformance over a medium-to-long term horizon.

James Rutherford, Portfolio Manager

Market and Performance Review

The MSCI Europe Index returned 2.94% in euro terms in August as market breadth increased and investors rotated towards cyclicals. The fund outperformed the benchmark index with both sector allocation and stock selection contributing to the excess return, with notable contributions from our underweight positions in consumer staples and utilities, overweight positions in consumer discretionary and information technology and selection in financials and industrials. These outweighed the detraction from both our overweight position and selection in health care.

Siemens Gamesa, Aena and Pandora were the largest individual contributors. Siemens Gamesa was boosted by positive structural tailwinds for the renewable energy sector and a positive read-across following Vestas Wind Systems’ earnings update, which highlighted that there had been no significant project delays. Meanwhile, both Aena and Pandora benefited from the rotation towards cyclical value.

Fresenius, ConvaTec and Grifols detracted the most. Although Fresenius reported decent Q2 results, it declined in response to weak performance in the health care sector and concerns about continued challenges relating to Kabi, its intravenous medicine business, which saw revenues disappoint due to fewer surgical procedures. ConvaTec reported solid earnings that were driven by better-than-expected margins but was also impacted by the weaker health care sector. Grifols was affected by a decline in blood plasma donations during the pandemic.

Activity

We took the decision to close our position in Grifols due to concerns that new therapies for Antitrypsin Deficiency and Myasthenia Gravis could significantly impact its earnings over the long-term.

Outlook

While the world waits for a coronavirus vaccine, there has been encouraging news about the development of less intrusive tests that have a much quicker turnaround time. This triggered the recent rotation towards the cyclical value companies that were most affected by the pandemic. However, if these tests are to have a transformative effect, they will need to be deployed successfully. As we are still some way off this point, we believe the rotation does not represent a sea-change in investor risk appetite. Instead, we see it as a healthy correction that removes some of the froth surrounding the companies that have benefited the most over the past few months.

Kunjal Gala, Lead Portfolio Manager

Market and Performance Review

The benchmark MSCI Emerging Markets Index rose 2.21% in August. Emerging market equities rose in August for a fifth consecutive month. Positive economic data from China and signs of global growth over the third quarter, supported investor sentiment despite the continued spread of the virus which recorded 25 million cases globally. China Manufacturing PMI data for July came in at 52.8, indicating sustained expansion. Economic data for China in July was generally positive pointing to a continued recovery. India, Indonesia and South Korea reported a rise in daily new COVID-19 cases. However, the number declined in most other Asian countries. In Brazil, while the number of new cases remains high, the pace of gains slowed in July. The US Dollar moved lower against most major currencies after the US Federal Reserve affirmed its dovish stance and pledged support for further stimulus.

The fund outperformed the benchmark index over the period. Stock selection contributed to relative returns, notably in India and Russia. The (underweight) exposure to China also benefited as the Renminbi appreciated.

Techtronic Industries, a Hong-Kong listed manufacturer of cordless powertools, rose after reporting strong quarterly results driven by innovation in new product development. Techtronic has benefitted from the positive momentum in DIY and strong traction in ecommerce sales. Bharat Forge, a global manufacturer of automotive engine components, rose after quarterly results beat consensus expectations for EBITDA and highlighted an impressive focus on cost control and productivity, whilst operating at a lower utilisation capacity. Yandex, Russia’s leading search and e-commerce provider, rose on the improving outlook for both its taxi business and the Russian economy and currency. The company also benefited from the MSCI August rebalance and subsequent inclusion to the index.

Non exposure to Meituan Dianping, a Chinese e-commerce provider, detracted after the company reported a strong second quarter which highlighted expedited growth and an increase in market share in its food delivery business. Samsung Electronics underperformed on continued weakness in the DRAM industry and on concerns that the Huawei ban may act as a further headwind for its memory business. Delta Electronics, a Taiwanese global leader in switching power supply solutions, retreated as investors took profits following strong performance year-to-date.

Activity

The team sold Galaxy Entertainment given the impact of COVID-19 on the Macau casino and resort operator as well as an update to our exclusions policy. They trimmed several names including Tencent, Alibaba and Samsung Electronics following strong performance year to date. They continued building positions in Epiroc, a Swedish-listed mining tools and equipment company which derives most of its revenue from emerging markets countries, and Polymetal, a leading gold producer.

Outlook

Emerging markets have rallied strongly from the March bottom, initially driven by unprecedented central bank and government monetary and fiscal stimulus, subsequently from a gradual relaxation of lockdowns as markets anticipate an economic recovery in the second half of 2020. The broadening out of the recovery has extended investor interest to more Value sectors, sensitive to the economic recovery and trading at low valuations. Market sentiment has improved, and the focus has shifted to a sharp rebound in economic activity.

However, investors must weigh the possibility of further economic damage if the second wave lasts longer and economies are lockdown again. Also, the timing and efficacy of vaccines under development is far from clear, the business/consumer sentiment remains low and geopolitical tensions are rising. With US elections coming up, the Trump administration has engaged in an expanding clash with China on various fronts from Huawei, Hong Kong, apps such as TikTok, We Chat and 5G wireless technology to a blame game over Covid-19 and Taiwan. Tensions and rhetoric have escalated recently as the US election draws closer. The team believes that the world is likely to remain in a slow growth environment after the initial rebound. Hence, the Fund remains focused on growth/quality and marginally adding to cyclicality where the team feel that there is enough margin of safety and the company benefits from medium/long term catalysts.

Geir Lode, Portfolio Manager

Market and Performance Review

Global equity markets continued their advance in August and have now regained all of the losses from earlier in the year. The month saw a brief but sharp rotation towards value, although in the latter half of the month, markets returned to type as investors’ preference for Growth and Sentiment returned. Against this backdrop, the MSCI World Index returned 6.68%, in US Dollars.

Over the month, the Fund underperformed the benchmark index. From a sector viewpoint, selection in financials and health care contributed the most, partially offsetting detractions from selection in consumer discretionary and information technology. From a regional perspective, the contribution from selection in Europe was offset by detractions from selection in North America and Japan.

Delta Air Lines, Salesforce and AIA Group were the three largest contributors from stocks held. Delta Air Lines increased alongside value stocks at the start of the month, while approval of a blood plasma treatment for COVID-19 gave travel stocks a further boost. Salesforce reported very strong revenues driven by new business growth and strong retention. It also reported a better-than-expected outlook, citing improving new business trends. AIA Group reported a strong recovery in new business during Q2 as lockdown measures were relaxed.

From stocks held, American Tower, Lam Research and Lion Corp detracted the most. Tesla and Facebook, which are not held in the fund, were also significant detractors. American Tower reported lower-than-expected revenues and reduced guidance due primarily to a delay in leasing activity, although this is expected to recover later this year. Lam Research fell after the US administration announced further restrictions on Huawei’s use of US Technology in its products. Lion Corp reported disappointing earnings due to lower sales and product mix that favoured lower margin areas, although this was offset by cost reductions.

Activity

We sold out of the positions in HSBC and Swire Pacific during August as we sought to reduce exposure to Hong Kong and China due to the ongoing tensions within the region and between the US and China.

Outlook

Market commentators are fixating on the parallels between today’s growth rally and the internet bubble of the early 2000s, and it is clear in the numbers that parallels do exist: The price/earnings ratio of the MSCI World Growth is approaching double that of the MSCI World Value, an extreme level reached only during the internet bubble. However, in this world of eternally low interest rates it is perhaps difficult to use historical reference points to determine if the market is overvalued or if the growth premium is excessive.

Our concerns, therefore, are not necessarily the numbers, but the exuberance, which we have seen of late. This will likely bring volatility as investors’ swing between cyclical value and growth. The duration of such changes in investor preference still largely depends on bringing the coronavirus under control or finding a treatment or vaccine. Meanwhile, the Presidential elections, US-China tensions and a potential stalemate on Capitol Hill over further stimulus measures create a huge amount of uncertainty. As we have long said, we firmly believe that diversification will be vital in negotiating this febrile environment over the coming months.

Lewis Grant, Portfolio Manager

Market and Performance Review

Global equity markets continued their advance in August and have now regained all of the losses from earlier in the year. The month saw a brief, but sharp rotation towards value, although in the latter half of the month, markets returned to type as investors’ preference for growth and sentiment returned. Against this backdrop, the MSCI All Country World Index returned 6.12% in US Dollar terms.

Over the month, the Fund underperformed the benchmark index. From a sector viewpoint, selection in financials, materials and health care contributed the most, partially offsetting detractions from selection in consumer discretionary and information technology. From a regional perspective, contributions from selection in Europe, Latin America and Asia Pacific ex Japan were offset by detractions from selection in Japan and emerging Asia and our overweight in Europe.

Salesforce, Delta Air Lines and Royal Caribbean Cruises were the three largest contributors. Salesforce reported very strong revenues driven by new business growth and strong retention. It also reported a better-than-expected outlook, citing improving new business trends. Delta Air Lines and Royal Caribbean Cruises increased alongside value stocks at the start of the month, while approval of a blood plasma treatment for COVID-19 gave travel stocks a further boost. Royal Caribbean also issued positive commentary on forward pricing.

Tesla, which is not held in the Fund, was the largest detractor. From stocks held, Lam Research, Lonza Group and Lion Corp detracted the most. Lam Research fell after the US administration announced further restrictions on Huawei’s use of US Technology in its products. Lonza Group paused for breath after a strong run. Lion Corp reported disappointing earnings due to lower sales and product mix that favoured lower margin areas, although this was offset by cost reductions.

Activity

Trading activity in August was limited to modest trims of our positions in Accenture and Orsted.

Outlook

Market commentators are fixating on the parallels between today’s growth rally and the internet bubble of the early 2000s, and it is clear in the numbers that parallels do exist: the price/earnings ratio of the MSCI World Growth is approaching double that of the MSCI World Value, an extreme level reached only during the internet bubble. However, in this world of eternally low interest rates it is perhaps difficult to use historical reference points to determine if the market is overvalued or if the growth premium is excessive.

Our concerns, therefore, are not necessarily the numbers, but the exuberance, which we have seen of late. This will likely bring volatility as investors’ swing between cyclical value and growth. The duration of such changes in investor preference still largely depends on bringing the coronavirus under control or finding a treatment or vaccine. Meanwhile, the Presidential elections, US-China tensions and a potential stalemate on Capitol Hill over further stimulus measures create a huge amount of uncertainty. As we have long said, we firmly believe that diversification will be vital in negotiating this febrile environment over the coming months.

Hamish Galpin, Portfolio Manager

Market and Performance Review

The fund underperformed the benchmark index return of 5.70%. currency allocation was supportive, although stock selection and sector allocation detracted from relative returns. Positive stock selection in real estate was outweighed by negative selection in the industrials and consumer discretionary sectors.

Having declined in July, shares in Open House recovered to surpass June levels after they released a Q3 earnings update which beat market expectations. Diversified Oil & Gas rose as, despite reporting a loss for the first half of the year, the company raised the interim dividend as a reflection of the Board’s confidence in the company’s outlook. Shares in Nifco, a manufacturer of engineered plastic products for use in autos, rose as management announced cost reduction plans which triggered broker upgrades.

The single largest detractor was Brunswick, a manufacturer of recreational marine products and boat engines, as the stock sold-off despite limited news flow after a period of strong performance. Shares of Brooks Automation, who provide precision instruments for technology manufacturing, surged at the end of July on the back of strong quarterly results and softened through August as investors took profits. Jack Henry & Associates, who provide technology systems for financial institutions, corrected sharply in August as the company reported disappointing sales and forward guidance, despite reporting better-than-expected profits.

Activity

The fund made one new purchase in August by initiating a position in Soitec, a French manufacturer of engineered substrates for semiconductors which improve the performance of the final product, aiding greater energy efficiency among other characteristics. This position was funded by trimming positions in Jungheinrich, Evolution Mining and Petra Diamonds.

Outlook

We will continue to keep close watch on stocks in the fund that have a higher risk profile in the current economic environment. It is clear, though, that large parts of the market have been sold down heavily on fears of the impact of COVID-19. Even with a recent recovery, this should still generate some attractive buying opportunities into well positioned businesses for investors such as ourselves with long-term horizons. Furthermore, a return, finally, to more normal levels of volatility once the current situation has settled down is very favourable to active managers and their prospects for beating their benchmarks. Smaller companies’ indices are largely below their long-term trends, which is not necessarily the case for large caps, and which bodes well for the asset class.

Martin Todd, Portfolio Manager

Market and Performance Review

Global equities continued to rise in August with some rotation towards Value stocks at the end of the month. Whilst COVID-19 case numbers rose in some countries, death rates remained low which allowed continued optimism for restarting economies.

The fund slightly underperformed the benchmark index in the period. Stock selection was supportive to relative returns in the month, particularly in industrials and financials. However, this was outweighed by negative sector allocation mainly due to our overweight in the health care sector which rose less than the market in the month.

Hannon Armstrong’s shares rose after announcing strong second quarter earnings and successfully completing further successful fund raising with the issuance of green bonds. Tomra’s shares rose in August with limited news flow, following a good second quarter earnings release in July. Siemens Gamesa’s shares rose following further wind turbine contract wins.

Cogna Educacao was the largest detractor from relative performance as their campus business was hit hard by the pandemic lockdowns. Not holding Apple also detracted from relative performance during the month as the company saw further share price strength following strong earnings in July and ahead of their stock split. Our holding in Illumina also detracted in the month. The company’s share price fell after their second quarter earnings missed expectations due to pandemic-related disruption, with many research customers remaining closed or working at limited capacity.

Activity

We made no new purchases or complete sales in the month but did trim our holding in Duerr to enable us to top up Umicore following share price weakness.

Outlook

Whilst we have been encouraged by the strong second quarter reporting season and resilience of the majority of our companies which have reported so far, the outlook remains uncertain. We have seen guidance upgraded by a number of our companies, but the overall tone remains cautious. For many companies, visibility on a new normalised level of demand won’t be evident until the fourth quarter at the very earliest, perhaps not until Summer 2021.

Nevertheless, we remain confident of the long-term outlook for our strategy; impactful companies are essential to help service the unmet needs of the environment and society and are therefore exposed to enduring sources of demand. COVID-19 has resulted in a paradigm shift for responsible strategies in general as it has put focus on the critical need to build resilience in healthcare, food and water security, and across supply chains. It has also put climate change and worker rights under the spotlight. As governments worldwide look to fiscal stimulus to support re-opening economies, we believe that companies addressing the SDG’s remain best placed to benefit.

Hamish Galpin, Lead Portfolio Manager

Market and Performance Review

The MSCI All Country World SMID Cap Index benchmark returned 4.88% in August. The fund underperformed the benchmark index return in the month. Stock selection detracted from relative returns in the period; positive stock selection in real estate and health care was outweighed by the aggregate of negative stock selection elsewhere, including industrials and consumer staples. Currency also detracted slightly whereas sector allocation was supportive of relative performance.

Techtronic Industries’ share price rose after the company announced solid first half results, showing good growth from H1 2019 and beating market estimates. Open House’s shares, having fallen in July with their share sale, rose back to surpass June levels after they released a Q3 earnings update which beat market expectations. Relo Group also reported quarterly earnings in August which beat expectations and lead to broker upgrades.

Brunswick Corp, having rallied strongly in the previous months, failed to rally with the market in August with limited news flow. Mapletree’s shares also fell in August following a strong run. The company announced quarterly earnings noting the challenges caused by COVID-19 but showed confidence with their proposal to acquire the remaining 60% stake in 14 US data centres. Yaoko’s share price rose in the month following a strong first quarter earnings update, but the shares later fell most likely due to profit taking and some rotation in markets.

Activity

We added two new holdings to the fund in August, Breedon and Soitec. Breedon is a leading construction materials group in Great Britain and Ireland, operating a vertically integrated business model that provides control over costs and the capture of margins through the value chain. We believe that there are opportunities to engage towards the SDGs for better resource and energy efficiency as well as decent work. Soitec is a French manufacturer of engineered substrates for semiconductors which improve the performance of the final product, aiding greater energy efficiency among other characteristics. As a manufacturer, we believe that their human and fixed capital base provide engagement opportunities.

Outlook

We will continue to keep close watch on stocks in the fund that have a higher risk profile in the current economic environment. It is clear that large parts of the market have been sold down heavily on fears of the impact of COVID-19. Even with a recent recovery, this should still generate some attractive buying opportunities into well positioned businesses for investors such as ourselves with long-term horizons. Furthermore, a return, finally, to more normal levels of volatility once the current situation has settled down is very favourable to active managers and their prospects for beating their benchmarks. Smaller companies’ indices are largely below their long-term trend, which is not necessarily the case for large caps, and so bodes well for the asset class.

Mark Sherlock, Portfolio Manager

Market and Performance Review

Equity markets continued to rise amid a generally better-than-expected quarterly earnings period, despite macroeconomic data remaining weak. Equity prices remain buoyed by central bank stimulus and the markets focus on longer-term normalised activity.

The Fund underperformed the benchmark index in August. Underperformance was primarily driven by stock selection in the producer durables and technology sectors and outweighed positive selection in utilities. Sector allocation, a fall-out of the bottom up process, marginally detracted from relative returns, primarily driven by the funds underweight to consumer discretionary.

The top single contributor was Timken (manufacturer of bearings and related components) as the company reported better-than-expected results as they were able to manage declining margins better-than-anticipated. Cubic Corporation (transport payment systems) recovered from a weak July as quarterly earnings and full year guidance were slightly ahead of expectations. The transportation systems segment delivered solid results while the defence business remains under pressure and, despite delays due to COVID-19, the pipeline activity is encouraging. Woodward (aircraft control components) rose as the company reported better-than-expected quarterly results, primarily due to effective cost management and resilient demand in aerospace defence.

Brunswick (recreational marine products), the single largest detractor, sold off after a period of strong performance. Power Integrations (mixed-signal semiconductor components) also sold off after a period of strong performance as quarterly results came in in-line with expectations. Brooks Automation (precision instruments for technology manufacturing) share price surged at the end of July on the back of strong quarterly results and softened through August as investors took profits.

Activity

Since late March, equity market performance has largely been driven by enhanced risk appetite supported by central bank liquidity and a continuation of behaviour where momentum and growth outperform. As a reminder, the Fund has a long-term holding period and turnover is typically low. We look for entry points into high-quality companies bought below our assessment of their intrinsic value.

In August, we initiated a new position in Skechers, a high-quality stable branded footwear company at an attractive valuation, and added to National Instruments and PerkinElmer. We funded these positions by exiting CAE, a pilot training company, as we believe that the air-travel recovery is going to be more protracted than previously expected. We also reduced our holdings in Alliant Energy and Cubic Corporation.

Outlook

We believes the US economy should continue to recover as people return to work and consumers continue spending, supported by record monetary and fiscal stimulus. The risk remains that COVID-19 infections continue to rise. However, health outcomes are improving. Importantly, funding for new credit issues remains strong, providing companies with liquidity, and rates are expected to remain low. As we approach the US presidential election, we are likely to see more headlines about the potential outcomes, but we believe this is less significant than in previous elections. We believe the Fund is well positioned in high quality stocks with attractive profitability and strong balance sheets, and valuation levels should help mitigate downside risk whilst providing attractive upside potential.

Note: the equities commentaries above are as of 31 August 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.

On 26 June 2020, all sub-funds of the Federated Hermes Investment Funds Plc umbrella were renamed to incorporate the new Federated Hermes brand

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