Search this website. You can use fund codes to locate specific funds

Monthly Fund Commentary, July 2019

Please find below a summary of performance, activity and outlook from July 2019 from our fund managers.

Jonathan Pines Portfolio Manager

Market and Performance review

The MSCI All Countries Asia ex Japan Index fell by 1.32% in US Dollar terms in July. The Fund outperformed the benchmark on a relative basis over the month. The outperformance resulted primarily from our underweight India as the market underperformed and overweight Taiwan which outperformed. Stock selection in Taiwan and India also benefitted, offsetting stock selection in China.

ASE Technology, a Taiwan semiconductor packaging and testing services company, rose as management reported Q3 2019 guidance which was higher-than-expected with a positive view on 2020. This was due to seasonal new product launches for smartphone and 5G on the backdrop of improving sentiment from a pause in the trade war and Huawei ban. Powertech Technology, an integrated circuit package and memory assembly/testing company, rose after reporting in-line Q2 2019 results, on expectations for strong demand from customers in Q3 2019 and rising sentiment on the stabilising memory prices. Shares in Soulbrain rose more than 40% since Korea-Japan trade conflict surfaced on 1 July as investors speculated that this Korean manufacturer of semiconductor chemicals could benefit from localisation of Japanese Hydrogen Flouride etchant.

Cosco Shipping Ports, a Chinese port operator, fell amid investor fears that an escalation is US-China trade tensions could impair the throughput growth outlook. Non-exposure to Tencent detracted, as shares in China’s leading internet services provider rose. Tingyi, the largest Chinese food and beverage company with dominant position in instant noodles and leading market shares in selective soft drink categories, gave up some earlier gains due to slower-than-expected market share recovery.

Outlook

We are bottom up stock pickers, concerned almost exclusively about the price-to-value proposition at the stock level. As quality, Growth, ‘low volatility’ and momentum stocks continue to perform, we continue to find cyclical and Value stocks more attractive, with some trading below global financial crisis valuations.

Fraser Lundie Portfolio Manager

Market and Performance review

There were a few interesting developments in the global macro environment in the second quarter of 2019. Markets have been supported by increasingly accommodative Central Banks and the hope of progress in trade tensions. The Federal Reserve decided not to cut interest rates at its June meeting but indicated there may be rate cuts ahead. ECB President Draghi hinted at further monetary policy easing if inflation outlooks fails to improve. UK securities performed well over the quarter despite Brexit related uncertainty and the resignation of Theresa May.

The technical picture remained strong. Even though net supply turned positive for the first time since the start of 2018 as the weaker loan market led to issuers tapping the bond market instead. This positive supply was well digested by the market given the tailwind from strong inflows into the asset class as credit is again in strong demand.

Credit markets drew support from the growing stock of negative yielding assets. Higher quality performed better than lower quality on the back of demand for credits that have means to withstand macro volatility. Emerging Market bonds also had a positive quarter benefitting from a more supportive monetary policy backdrop.

The main sources of absolute performance were Basic Industry, Banking and Energy. The main detractor over the quarter was from the Index trades. Individual names that contributed to the Strategy’s positive performance over the period included Banking name Commerzbank, Basic Industry names Lennar and Technology name Dell. Individual detractors included Utility name NRG Energy, Basic Industry names Glencore and Syngenta.

From a ratings perspective BB and BBB names contributed the most to overall absolute performance. Geographically, absolute performance was driven from North America, the UK, Latin America and Western Europe.

Activity

During the quarter we increased our allocation to the Income bucket, particularly in Investment Grade, through names such as Telefonica and Verizon. In the Pair Trade bucket we added to our CDX IG and Rio Tinto trade. Credit curves remain steep, so we continued to optimise the Strategy’s roll down by selectively extending the maturity of certain names, such as Suzano.

US homebuilders remain our top sector pick in US high yield and we continued to increase our allocation to the sector through Lennar in the Core Long strategy. In Financials, we added higher quality securities such as Commerzbank’s newly issued AT1 (also part of the Core Long strategy).

Outlook

A dovish tone from the Central Banks across the globe and supportive comments from G-20 meeting improved investor confidence. Accommodative monetary policy is back on the agenda of the major central banks, this will increase the share of negative yielding assets, and will remain a tailwind for spread products. Better risk-adjusted return potential in Investment Grade and the higher-rated segment of High Yield credit given the slowdown in global economy.

Overall, we favour credits that are well positioned for macroeconomic weakness and have levers such as dividend cuts available to them.

With credit curves currently steep, we favour lending for longer over to stronger lenders. This is true in both High Yield and Investment Grade. Negative basis is at the very wides making cash more attractive than CDS in certain capital structures.

Convexity of the High Yield market got worse on the back of stronger performance in an environment of stable fundamentals and supportive technical backdrop. For High Yield portfolios it is becoming increasingly important to maximise the convexity by re-allocating capital away from negatively convex securities.

Gary Greenberg, Portfolio Manager

Market and Performance Review

The benchmark MSCI Emerging Markets Index returned -1.22%% in July. Emerging markets moved lower as the weakening global outlook and US Dollar strength pressured Asian markets. US-China trade talks resumed at the end of July, however little progress was made in Shanghai and both sides agreed to meet again in September. The Federal Reserve lowered US interest rates at the end of the month for the first time in 11 years with a 0.25% rate cut. South Korea was particularly weak as a trade dispute with Japan began to escalate and Turkey was the best performer as the central bank’s interest rate cut to 19.75% was greater than market expectations. At the sector level, Information Technology outperformed, and Materials lagged the most.

The Fund outperformed the benchmark index in relative terms over the period. Stock selection in China contributed the most to relative returns. Selected names in Mexico, Taiwan and Turkey also contributed positively, offsetting our overweight India which underperformed.

BIM, the leading hard-discount food retailer in Turkey, contributed the most as political uncertainty reduced following the conclusion of the Istanbul mayoral election, allowing investors to shift their focus back to the strong underlying fundamentals of the company. Shares in Tencent, China’s leading internet services provider, rose as the company looks set to gain with a strong new game pipeline and continued share gains in advertising. TSMC, the semiconductor manufacturer, rose as management guided for a better-than-expected Q3 2019 and highlighted that 5G rollouts are accelerating, offering strong visibility into 2020.

HDFC Bank, an Indian bank, detracted the most due to fears of an ongoing slowdown in India and its impact on retail lending. Shares in KB Financial, a Korean bank, dropped due to deteriorating sentiment around the domestic macro outlook and the likely prospect of cuts to interest rates. Samsonite International, the worldwide luggage retailer, fell as ongoing trade tariff concerns put pressure on the share price.

Outlook

After the initial respite from the US/China trade truce, Emerging Markets have reversed most of the gains this year and are c.20% below the 2018 peak, due to a slowing global economy, tariffs, supply chain disruption and, after hitting a bottom in 2018, a steady rise in the US Dollar. As a result, Emerging Markets relative to Developed Markets are trading at a 20% discount on price earnings and a significant 30%+ discount on price book despite enjoying a similar level of profitability. Central Banks globally are embarking on a simultaneous easing cycle led by the Federal Reserve and bond yields are likely to remain lower for longer. Few markets in Emerging Markets have major macro vulnerabilities this time, unlike in 2013, and most markets offer positive interest rates after adjusting for inflation. The prospect of reform accelerating is in play in India, Brazil and several other Emerging Markets. This backdrop of slower economic growth, a wide valuation discount, and lower yields are particularly beneficial for asset prices in economies that can grow despite global headwinds like trade wars. We note that several attractive secular themes, such as 5G, Data Centres, Premiumization, Financialization and Logistics remain in place in Emerging Markets and the sell-off offers opportunities to buy into them at attractive valuations.

Gary Greenberg, Portfolio Manager

Market and Performance review

The benchmark MSCI Emerging Markets SMID Net Total Return Index returned -1.32% in July. The Fund outperformed the benchmark index in relative terms over the month. Country allocation (combining currency) contributed the most to relative returns, notably the underweight Korea, which underperformed, the overweight United Arab Emirates, the best performing market and overweight Taiwan which outperformed. Selected names in China, Korea and Taiwan also contributed positively, offsetting stock selection in the UAE and Brazil which detracted.

Sinbon Electronics, a cable-assembly and connector-trading solutions provider based in Taiwan, rose after reporting Q2 2019 earnings beat, with margin improvement from industrial and medical segments being the key driver. SITC International, a Hong Kong-listed marine services company, rose on strong intra-Asia container shipping volumes and forecast demand growth thanks to fast growth in local economies and manufacturing relocation. Shares in Duratex, a Brazilian company manufacturing wood building materials, ceramics and metal fittings, rose sharply as pension reform progress boosted hopes for economic recovery in Brazil.

Samsonite International, the worldwide luggage retailer, fell as ongoing trade tariff concerns put pressure on the share price. Mahindra Logistics, an India logistics services provider, detracted due to the slowdown in the supply chain management business and ongoing slowdown in the automotive sector (60% of revenues). Hong Kong-listed Shenzhen International, which operates toll roads, logistic hubs, services and ports, moved lower due to further Renminbi deprecation.

Outlook

After the initial respite from the US/China trade truce, Emerging Markets have reversed most of the gains this year and are c.20% below the 2018 peak, due to a slowing global economy, tariffs, supply chain disruption and, after hitting a bottom in 2018, a steady rise in the US Dollar. As a result, Emerging Markets relative to Developed Markets are trading at a 20% discount on price earnings and a significant 30%+ discount on Price to Book despite enjoying a similar level of profitability. Central banks globally are embarking on a simultaneous easing cycle led by the Federal Reserve and bond yields are likely to remain lower for longer. Few markets in Emerging Markets have major macro vulnerabilities this time, unlike in 2013, and most markets offer positive interest rates after adjusting for inflation. The prospect of reform accelerating is in play in India, Brazil and several other Emerging Markets. This backdrop of slower economic growth, a wide valuation discount, and lower yields are particularly beneficial for asset prices in economies that can grow despite global headwinds like trade wars. The team note that a number of attractive secular themes, such as 5G, Data Centres, Premiumisation, Financialisation and Logistics remain in place in Emerging Markets and the sell-off offers opportunities to buy into them at attractive valuations.

Geir Lode, Portfolio Manager

Market and Performance Review

The MSCI World Index increased by 0.50% in July, due primarily to strength in North America. All other regions underperformed the broad market, particularly Europe, due to a combination of Brexit and softer economic data. The Alpha model highlighted a market environment that rewarded Growth, Profitability and Sentiment, while Valuation, Capital Structure and Corporate Behaviour struggled.

The Fund underperformed the benchmark index in July. From a sector viewpoint, the contribution from selection in Health Care was offset by detractions from stock selection in Consumer Discretionary, Financials and Industrials. From a regional perspective, stock selection in North America and Pacific ex Japan were the main detractors, while Europe and Japan had a marginal impact.

Procter & Gamble, Delta Air Lines and Nokia were the largest individual contributors. Alphabet was also a large contributor, but not owning the C shares offset most of the gains. Procter & Gamble rose after reporting strong organic sales growth with all divisions performing better-than expected. Delta Air Lines reported earnings ahead of expectations, reflecting stronger passenger revenue growth and better-than-expected company guidance for Q3. Nokia reported consensus-beating earnings, driven by improved network sales and strong orders in its software IP routing & Optical divisions.

The largest detractions came from GTT, Aena and Siemens Gamesa. GTT fell due to declining Liquefied Natural Gas (LNG) prices on the back of several major new projects to meet increasing demand for the fuel. However, the company raised 2019 guidance with the CEO stating that GTT was “at the beginning of a period of strong growth” as demand for LNG grows due to the coal-to-gas switch and the emergence of LNG as a shipping fuel. Aena reported revenues that were slightly ahead of expectations, but earnings and net income disappointed as cost pressures in Spain offset strong results in its retail division and better-than-expected cash generation. Siemens Gamesa reported disappointing results, which saw better-than-expected sales, but a reduction in its margin guidance.

Outlook

After a relatively benign period for Global Equity markets in July, volatility has spiked in the face of the US-China trade tensions, which erupted once more in early August. China, in response to President Trump’s latest tariff threats, allowed the Yuan to weaken to levels not seen since 2008, while also suspending imports of US agricultural produce. The truth is that these tensions have never truly disappeared and while we expect more volatility around the dispute, we continue to expect a resolution. One source of further volatility could be the impending US elections, which may see President Trump seek to shore up his support base by ‘protecting’ US industry. Elsewhere, there remain several other risks including increasing social unrest (most notably in Hong Kong and Russia) and the increasing prospects for a no-deal Brexit, which could add to the uncertainty.

This backdrop has undoubtedly led to a lowering of earnings expectations allowing, in the US at least, almost three-quarters of companies to beat expectations (with a varying degree of quality). Quality companies with proven growth have stood out, which has resulted in a widening spread between the cheapest and most expensive stocks. This should eventually normalise, so it will be important to remain valuation conscious to protect the Fund for when the snap-back occurs.

Hamish Galpin, Portfolio Manager

Market and Performance review

The MSCI World Index returned 0.57% in US Dollar terms in July. The Fund narrowly underperformed the benchmark on a relative basis over the period.

Teradyne, the US semiconductor testing equipment producer, was the top contributor to relative returns in July. The company reported strong Q2 earnings and raised its outlook, driven by growth in 5G infrastructure, network and memory test spending. RPM International, the US-listed specialty chemical company, rose after delivering a well-received set of Q4 earnings and offered an optimistic outlook for sales growth in the Financial Year 2020. WD-40 reported above consensus earnings, driven by strength in Europe and Asia of its Multi-Use product.

The largest detractor was German forklift truck maker, Jungheinrich, which reported weaker-than-expected forklift truck orders and cut guidance, citing a “gloomier macroeconomic environment”. Glanbia fell after reducing guidance after a difficult first half of the year, citing global trade dynamics in key international markets for its performance nutrition unit. Petra Diamonds declined on concerns that the company would have to raise funds through an equity share sale as part of its debt refinancing, something which the company denied.

Outlook

Declining economic growth has been a recent concern for the market, exacerbated by the tariff dispute. We remain of the view that we are in a structurally low growth environment (and a flat yield curve one), which may mean occasional “recessions” in key markets, as defined by two quarters of negative GDP. This does not mean, however, that a material recession is imminent despite the longevity of the current economic expansion. Altogether, this is a favourable backdrop for active managers searching for price anomalies (and by contrast, a less favourable one for index-driven ETFs).

James Rutherford, Portfolio Manager

Market and Performance Review

The FTSE All World Europe Index increased by 0.47% in July. During this time, investors preferred higher multiple areas of the market, which led to a widening of the performance spread between Growth and Value. From a sector viewpoint, this was reflected in the outperformance of Consumer Goods (particularly Staples) and Oil & Gas, while Basic Materials, Health Care and Financials all lagged. Against this backdrop, the Fund outperformed its benchmark index. The excess return was driven by stock selection in Technology, Consumer Goods and Industrials, which offset detractions from selection in Health Care and Oil & Gas.

Worldpay, Nokia and Adidas were the largest individual contributors. FIS Worldpay increased ahead of its acquisition by Fidelity National Information Services. Meanwhile, European Union regulators also granted the merger the required regulatory approval. Nokia reported consensus-beating earnings, driven by improved network sales, and strong orders in its software IP routing & Optical divisions. Adidas rose ahead of its results announcement.

The largest individual detractors to our performance were Siemens Gamesa, Sika and Aena, while not owning Nestle also proved to be a significant detractor. Siemens Gamesa reported disappointing results, reducing its margin guidance due to pricing pressure and logistical issues in Northern Europe and India. Sika fell after reporting results that were below expectations, which led to a bout of profit taking following a strong run. Aena reported revenues that were slightly ahead of expectations, but earnings and net income disappointed as cost pressures in Spain offset strong results in its retail division and better-than-expected cash generation.

Fund activity was limited to the active management of existing positions in July. We topped up Barratt Developments, a recent addition to the Fund, and trimmed our positions in Legrand and Novo Nordisk. Both Legrand and Novo had performed well, but we felt near-term risks were building amid a more challenging macro environment for Legrand and US drug-pricing threats for Novo Nordisk.

Outlook

The valuation gap between quality growth and cyclical value is at extreme levels due to a cocktail of synchronised monetary easing and the ongoing global trade tensions. However, focus has now shifted to Q2 earnings, where we have seen aggregate downgrades: Cyclical sectors have experienced the worst downgrades, while defensive, quality growth sectors have held up much better. Although this was largely expected, it has meant that the style dichotomy has continued apace.

We typically focus on a three-to-five-year view, but we are cognisant that in the near-term the continued outperformance of the quality growth area of the market leaves some of these stocks vulnerable to even a slight disappointment. Our focus, therefore, will be on managing existing positions to reflect the increasing risk this poses.

Mark Sherlock, Portfolio Manager

Market and Performance Review

The Russell 2500 rose 1.04% in US Dollar terms in July. Expectations of a cut to US interest rates and the European Central Bank (ECB) hinting at an easing package, helped to drive some markets to all-time highs. On the last day of the month, the Federal Reserve lowered US interest rates for the first time in 11 years with a 0.25% rate cut. US-China trade talks resumed in late July, but little progress was made in Shanghai. Both sides agreed to meet again in September.

The Fund underperformed the benchmark index on a relative basis over the month. The underperformance was driven by stock selection, notably in the Consumer Discretionary, Technology and Energy sectors. Selection in Health Care and Producer Durables helped pair the losses.

Teradyne (automated test and industrial automation equipment), contributed the most after the company’s quarterly results and outlook topped estimates. This was led by stronger-than-expected results in semiconductor test as growth in 5G infrastructure, networking and memory test spending continued. Shares in RPM International (manufactures paints and protective coatings), rose after delivering a well received set of Q4 earnings. The company increased quarterly and yearly sales and offered an optimistic outlook for sales growth in financial year 2020. West Pharmaceuticals (drug delivery systems) rose higher after raising its 2019 sales and earnings guidance as organic revenue growth and margin trends continue to improve.

Shares in 2U, the online education services provider, fell the most as the company reported a weak set of results citing heightened competition and regulatory issues. As a result, management have lowered guidance for revenue growth. Oceaneering (the offshore service and products company) shares dropped after delivering weaker-than-expected revenue to reflect the company’s Q2 results and after signalling a weaker outlook. Gartner (the research and advisory firm) posted solid Q2 2019 results but fell as management lowered their full-year guidance.

Outlook

The overall market appears reasonably priced, but in certain areas we are seeing pockets of overvaluation, with individual stock prices decoupling from fundamentals. However, we are still finding value in many parts of the market and remain focused on investing in high-quality companies that should benefit if the market moves higher but protect investors’ capital during any pullback.

Lewis Grant, Portfolio Manager

Market and Performance Review

The MSCI All Country World Index increased modestly in July as gains in the Americas were offset by detractions in Europe, due to a combination of Brexit and softer economic data in the region, and Emerging Asia, with Hong Kong and Korea the laggards. The Alpha model highlighted a market environment that rewarded Growth, Profitability and Sentiment, while Valuation, Capital Structure and Corporate behaviour struggled.

The Fund marginally underperformed the benchmark index in July. From a sector viewpoint, contributions from selection in Information Technology, Health Care and Consumer Staples were offset by detractions from stock selection in Industrials and Financials. From a regional perspective, selection in North America detracted and was the only meaningful influence on relative returns.

Delta Air Lines, ASML and Procter & Gamble were the largest individual contributors. Delta Air Lines reported earnings slightly ahead of expectations, reflecting stronger passenger revenue growth which led to better-than-expected company guidance for Q3. ASML posted earnings ahead of expectations, driven by strong momentum in logic spending and higher margins. The company also reiterated guidance for 2019. Procter & Gamble rose after reporting strong organic sales growth with all divisions performing better-than-expected.

The largest detractors were Hyundai Engineering & Construction, Thermo Fisher and Eagle Materials. Hyundai Engineering & Construction decreased due to one-off litigation costs in the UAE. However, the company has a strong order backlog for both its domestic and overseas businesses, while housing revenue continues to exhibit strong growth. Thermo Fisher’s Q2 results were broadly in line, but organic revenue growth was lower-than-expected due to a data centre outage, which resulted in order and shipping delays towards the end of the quarter. Eagle Materials fell after releasing disappointing Q2 earnings, which was driven by lower volumes and the pricing of gypsum wallboard.

Outlook

After a relatively benign period for Global Equity markets in July, volatility has spiked in the face of the US-China trade tensions, which erupted once more in early August. China, in response to President Trump’s latest tariff threats, allowed the Yuan to weaken to levels not seen since 2008, while also suspending imports of US agricultural produce. The truth is that these tensions have never truly disappeared and while we expect more volatility around the dispute, we continue to expect a resolution. One source of further volatility could be the impending US elections, which may see President Trump seek to shore up his support base by ‘protecting’ US industry. Elsewhere, there remain several other risks including increasing social unrest (most notably in Hong Kong and Russia) and the increasing prospects for a no-deal Brexit, which could add to the uncertainty.

This backdrop has undoubtedly led to a lowering of earnings expectations allowing, in the US at least, almost three-quarters of companies to beat expectations (with a varying degree of quality). Quality companies with proven growth have stood out, which has resulted in a widening spread between the cheapest and most expensive stocks. This should eventually normalise, so it will be important to remain valuation conscious to protect the Fund for when the snap-back occurs.

Tim Crockford, Portfolio Manager

Market and Performance Review

The FTSE World Europe ex UK Index increased by 0.32% in July. During this time, investors preferred higher multiple areas of the market as the performance spread between growth and value continued. Against this backdrop, the Fund underperformed the benchmark index in this period. The underperformance was driven by allocation, through our underweight position in Consumer Goods and overweight in Oil & Gas. Currency also detracted, due primarily to the underweight position in the Swiss Franc. Elsewhere, contributions from stock selection in Technology, Basic Materials and Utilities were offset by detractions from Industrials, Oil & Gas and Health Care.

ASM International, ASML and Orsted were the largest individual contributors to relative returns in July. ASM International benefited from increased logic spending when reporting earnings ahead of expectations. ASML posted earnings ahead of expectations, driven by strong momentum in logic spending and higher margins. The company also reiterated guidance for 2019. Orsted increased after New York State awarded a contract to supply 850MW of capacity as part of the biggest-ever deal for offshore wind power in US history.

The largest individual detractors to our relative performance were Siemens Gamesa, Sika and KION Group, while not owning Nestle also proved to be a significant detractor. Siemens Gamesa reported disappointing results, reducing its margin guidance due to pricing pressure and logistical issues in Northern Europe and India. Sika fell after reporting results that were below expectations, which led to a bout of profit taking following a strong run. KION fell after rival, Jungheinrich, released disappointing results citing deteriorating market conditions. KION subsequently released above consensus revenues and earnings, driven by its industrial trucks division and also maintained guidance.

Outlook

The valuation gap between quality Growth and cyclical Value is at extreme levels due to a cocktail of synchronised monetary easing and the ongoing global trade tensions. However, focus has now shifted to Q2 earnings, where we have seen aggregate downgrades: cyclical sectors have experienced the worst downgrades, while defensive, quality Growth sectors have held up much better. Although this was largely expected, it has meant that the style dichotomy has continued apace.

We typically focus on a three-to-five-year view, but we are cognisant that in the near-term the continued outperformance of the quality Growth area of the market leaves some of these stocks vulnerable to even a slight disappointment. Our focus, therefore, will be on managing existing positions to reflect the increasing risk this poses.

Tim Crockford, Portfolio Manager

Market and Performance review

The MSCI All-Country World IMI Index returned 0.30% with North America outperforming the rest of the World and Europe in particular. The Fund underperformed the benchmark index in the period as contributions from stock selection in the Asia Pacific and Latin America were more than offset by detractions in North America and Europe. From a sector viewpoint, selection in Utilities, Materials and Consumer Discretionary was successful, but outweighed by detractions from selection in Industrials and Health Care, while the overweight position in the latter sector also a headwind.

The largest individual contributors were Kroton Educacional, Carl Zeiss Meditec and Orsted. Kroton increased alongside the broader Brazilian market, although there was little specific news on the company. Carl Zeiss increased after reporting strong results and an upgrade to its guidance. This was driven by strong growth in Asia and supported by a recovery in its US business and a better-than-expected margin improvement. Orsted increased after New York State awarded a contract to supply 850MW of capacity as part of the biggest-ever deal for offshore wind power in US history.

Illumina, Abcam and Siemens Gamesa were the largest detractors. Illumina fell after reporting disappointing results due to a delay in a large order, ongoing consumer weakness and lower-than-expected sales of sequencing systems and consumables, which led the company to cut guidance for financial year 2019. Abcam declined after its trading update, which saw revenues that were slightly lower than expectations, although margins and guidance matched consensus. Siemens Gamesa reported disappointing results, reducing its margin guidance due to pricing pressure and logistical issues in Northern Europe and India.

Outlook

The trade dispute between the US and China continues to be the single biggest headwind to global growth and despite a recent thawing of the tensions, any deal appears to be far from imminent. This has undoubtedly led to a more dovish stance from the central banks, but whether this action will have much of an impact, beyond providing some support for equity markets, is unclear.

Against this uncertain backdrop our investment approach remains unchanged. We continue to look for new companies that we believe will benefit from the emerging growth opportunities arising from countries’ need to meet the 2030 Sustainable Development Goals. Such firms should be less exposed to geopolitical and macroeconomic risks over the longer-term. If growth expectations recede, they should attract a premium valuation as they are less reliant on the cycle. If growth picks up, however, the markets’ failure to correctly price in these emerging growth opportunities should help them deliver earnings ahead of expectations. We believe this will help the Fund achieve positive relative returns over time, regardless of the prevailing style preferences or the macroeconomic backdrop.

Hamish Galpin, Portfolio Manager

Market and Performance review

The MSCI All Country World SMID Index benchmark returned 0.20% in July. Developed Markets outperformed Emerging Markets SMID stocks in the period, returning -0.3% and -2.5% respectively. The outcome was also similar across the market cap spectrum with Large Caps in Developed Markets returning -0.2% and Emerging ones behind at -2.5%. In the US, SMID stocks performed in line with Large Caps as both the Russell 2500 and the S&P500 returned 0.5%. RPM International, Genesee & Wyoming and West Pharmaceuticals were the largest individual contributors in July.

RPM International rose after delivering a well received set of Q4 earnings and offered an optimistic outlook for sales growth in Financial Year 2020. Genesee increased after Brookfield Infrastructure agreed to acquire the company for $112 per share ($6.3bn). West Pharmaceuticals increased after raising its 2019 sales and earnings guidance as organic revenue growth and margin trends continue to improve.

The largest detractors were Glanbia, Petra Diamonds and Samsonite. Glanbia fell after reducing guidance after a difficult first half of the year, citing global trade dynamics in key international markets for its performance nutrition unit. Petra Diamonds declined on concerns that the company would have to raise funds through an equity share sale as part of its debt refinancing, something which the company denied. There was little specific news regarding Samsonite, but the Hong Kong stock market was weak amid public protests over proposed extradition laws to China.

Outlook

Declining economic growth has been a recent concern for the market, exacerbated by the trade dispute. We remain of the view that we are in a structurally low growth environment (and a flat yield curve one), which may mean occasional “recessions” in key markets, as defined by two quarters of negative GDP. This does not mean, however, that a material recession is imminent despite the longevity of the current economic expansion. Altogether, this is a favourable backdrop for active managers searching for price anomalies (and by contrast, a less favourable one for index-driven ETFs).

Fund performance returns are in base currency of the Fund and are calculated at close of business, gross of management fees. Fund performance returns at a Share Class level are calculated at midday and are net of management fees. Share Class performance returns can be found on the relevant factsheet. Source: Northern Trust.

Fraser Lundie Portfolio Manager

Market and Performance review

There were a few interesting developments in the global macro environment in the second quarter of 2019. Markets have been supported by increasingly accommodative Central Banks and the hope of progress in trade tensions. The Federal Reserve decided not to cut interest rates at its June meeting but indicated there may be rate cuts ahead. ECB President Draghi hinted at further monetary policy easing if inflation outlooks fails to improve. UK securities performed well over the quarter despite Brexit related uncertainty and the resignation of Theresa May.

The technical picture remained strong. Even though net supply turned positive for the first time since the start of 2018 as the weaker loan market led to issuers tapping the bond market instead. This positive supply was well digested by the market given the tailwind from strong inflows into the asset class as credit is again in strong demand.

Credit markets drew support from the growing stock of negative yielding assets. Higher quality performed better than lower quality on the back of demand for credits that have means to withstand macro volatility. Emerging Market bonds also had a positive quarter benefitting from a more supportive monetary policy backdrop. Individual names that contributed to the Strategy’s positive performance over the period included, Banking name Commerzbank, Basic Industry name Toll Brothers, and Financial Services name Air Lease. Individual detractors included Utilities name NRG Energy, Banking name Deutsche Postbank and Energy name Range Resources.

From a ratings perspective BB and BBB names contributed the most to absolute performance. Geographically, absolute performance was driven from North America, Western Europe, the UK and Latin America. From a Strategy perspective, strong performance came from the Best Selection bucket, supported by Income, Quality and Tactical trades.

Activity

Overall, lower quality issues continued to underperform, so the Strategy benefited from its higher quality exposure. US homebuilders remain our top sector pick in US High Yield, and we increased our allocation to the sector through Toll Brothers in the Best Selection bucket. In Financials we added higher quality securities such as Commerzbank’s newly issued AT1 (also part of the Best Selection bucket).

We switched CDS into cash bonds where basis is at the wides, such as in AerCap and L Brands. We sold names we believed had limited upside potential, such as Ziggo and UPCB.

As the High Yield market’s convexity has deteriorated, we reduced exposure to securities trading above their call price, such as IQVIA, Altice, CSCHLD, LKQ, Severstal and ADT. To protect the Strategy we initiated a short position in the Bund and also on Syngenta due to our concerns about its ESG profile. In Utilities we increased our pair trade between NRG Energy and its renewable energy spin off Clearway Energy. 

Outlook

A dovish tone from the Central Banks across the globe and supportive comments from the G-20 meeting improved investor confidence. Accommodative monetary policy is back on the agenda of the major central banks; this will increase the share of negative yielding assets and will remain a tailwind for spread products. Better risk adjusted return potential in investment-grade and the higher-rated segment of High Yield credit given the slowdown in the global economy.

Overall, we favour credits that are well positioned for macroeconomic weakness and have levers such as dividend cuts available to them.

With credit curves currently steep, we favour lending for longer over to stronger lenders. This is true in both High Yield and Investment Grade. Negative basis is at the very wides making cash more attractive than CDS in certain capital structures.

The convexity of the High Yield market worsened on the back of stronger performance in an environment of stable fundamentals and supportive technical backdrop. For High Yield portfolios, it is becoming increasingly important to maximise the convexity by re-allocating capital away from negatively convex securities.

Fraser Lundie Portfolio Manager

Market and Performance review

There were a few interesting developments in the global macro environment in the second quarter of 2019. Markets have been supported by increasingly accommodative Central Banks and the hope of progress in trade tensions. The Federal Reserve decided not to cut interest rates at its June meeting but indicated there may be rate cuts ahead. ECB President Draghi hinted at further monetary policy easing if inflation outlooks fails to improve. UK securities performed well over the quarter despite Brexit related uncertainty and the resignation of Theresa May.

The technical picture remained strong even though net supply turned positive for the first time since the start of 2018 as the weaker loan market led to issuers tapping the bond market instead. This positive supply was well digested by the market given the tailwind from strong inflows into the asset class as credit is again in strong demand.

Credit markets drew support from the growing stock of negative yielding assets. Higher quality performed better than lower quality on the back of demand for credits that have means to withstand macro volatility. Emerging Market bonds also had a positive quarter benefitting from a more supportive monetary policy backdrop.

The main sources of absolute performance were Basic Industry, Energy and Banking. The main detractor over the quarter was from the Index trades and the options overlay. Individual names that contributed to the Fund’s positive performance over the period included Basic Industry name Toll Brothers, Financial Services name AerCap and Energy name Enterprise Products. Individual names that detracted included Energy names Range Resources, Antero Resources and Petroleos Mexicanos.

From a ratings perspective BB and BBB names contributed the most to overall absolute performance. Geographically, absolute performance was driven from North America, Western Europe, the UK and Latin America.

Activity

During the quarter, we continued to reallocate some of our High Yield exposure towards Investment Grade corporates and Financials. As the convexity of the High Yield market deteriorated further, we reduced our exposure to securities trading above their call price, such as IQVIA, CSC Holdings and LKQ. With credit curves remaining steep, especially in investment-grade, we continued to rotate into longer dated securities where possible, such as in WPX Energy, Suzano and HCA Healthcare.

The persisting negative basis is a prevalent theme in the market at present. In order to manage it, we switched CDS positions into cash bonds to benefit from their better risk return profile in names such as Toll Brothers, Avis and Telecom Italia.

Given the very tight spreads on synthetic bonds, we initiated a short position on the iTraxx Crossover as part of the Fund’s hedge bucket. We also added some short dated out of the money options on the CDX HY to improve the Fund’s convexity profile. 

Outlook

A dovish tone from the Central Banks across the globe and supportive comments from G-20 meeting improved investor confidence. Accommodative monetary policy is back on the agenda of the major central banks, this will increase the share of negative yielding assets, and will remain a tailwind for spread products. Better risk-adjusted return potential in Investment Grade and the higher-rated segment of High Yield credit given the slowdown in global economy.

Overall, we favour credits that are well positioned for macroeconomic weakness and have levers such as dividend cuts available to them.

With credit curves currently steep, we favour lending for longer over to stronger lenders. This is true in both High Yield and Investment Grade. Negative basis is at the very wides making cash more attractive than CDS in certain capital structures.

The convexity of the High Yield market worsened on the back of stronger performance in an environment of stable fundamentals and a supportive technical backdrop. For High Yield portfolios, it is becoming increasingly important to maximise the convexity by re-allocating capital away from negatively convex securities.

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.

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.


More Insights

Hermes SDG Engagement Equity Fund - H1 2019 report
What real-world impacts did we achieve through our engagements in the first half of 2019?
Annual Impact Report, 2018
In our inaugural Annual Impact Report, we reflect on how the fund has fared in its first full calendar year.
Ecommerce in Russia – a moonshot in the making?
Russia’s ecommerce industry is a rare gem within the troubled wider economy.
Salesforce: investing in a low-carbon future
Salesforce has cut its net greenhouse gas emissions to zero and delivered a carbon-neutral cloud.
Russian ecommerce: moonshot thinking?
During a recent research trip to Russia, we confirmed our view that the nation’s ecommerce industry is a rare gem within the troubled wider economy.
Impact Report, Q2 2019
In our latest Quarterly Impact Report, we examine the Hermes SDG Taxonomy.