Hub News #36

ISSUE 36

HUBNEWS WINTER 2018

A STOCKPICKER'S APPROACH TO MACROECONOMICS

EMERGING MARKETS: THE START OF A BULL MARKET

ARE FIXED INCOME MARKETS OVERVALUED?

MARKETS AT A CROSSROADS As monetary policy changes direction, which way next for equity and bond markets?

Goldman Sachs Asset Management (GSAM) is one of the world’s leading investment managers. With more than 2,000 professionals across 30 offices worldwide, GSAM provides institutional and individual investors with investment and advisory solutions, with strategies spanning asset classes, industries and geographies.

Our investment solutions include fixed income, money markets, public equity, commodities, hedge funds, private equity and real estate. Our clients access these solutions through our proprietary strategies, strategic partnerships and our open architecture programs.

For more information please contact gs-uk-tpd-adv@gs.com As of September 30, 2017. GSAM leverages the resources of Goldman, Sachs & Co. subject to legal, internal and regulatory restrictions. Š 2017 Goldman Sachs. All rights reserved.

www.GSAM.com

CONTENTS & WELCOME

CONTENTS 4. 150 Years Young: Investment Trusts 6. The Great Debate: Active & Passive 8. Weathering Heights 11. Emerging Markets 2018: The Beginnings of a Bull Market?

12. Defensification: Going Beyond Diversification 15. Brazil: Corajoso E Bonito 17. Are Fixed Income Markets Overvalued? 9. A Stock Picker’s Approach to Managing Macroeconomics 23. Irrational Decisions Create Opportunities 26. Japan: The New Market for Income-Seekers 30. The Rise Of Considerate Capitalism 32. Fixed Income in an Uncertain World 36. Signal or Noise?

39. World Pension Ages on The Rise: When Will You Retire?

WELCOME Stock markets have a ‘end of the party’ feel to them today. Everyone knows that the dancing has to stop, but at the moment, they’re having too nice a time.

The experience of Bitcoin suggests everyone should be wary of over-exuberance where they see it and as there can be little doubt that some parts of both bond and equity markets look highly valued today.

Interest rates are rising, inflation is becoming a greater risk, and there are plenty of reasons for caution.

That is not to say that there’s aren’t opportunities. 2017 saw financial markets polarised between fashionable growth, and unloved

value, and high valuations are not universal. In this edition of Hub News, we aim to draw your attention to some of the areas that have been left behind, where there still appears to be value. We also look at some of the issues likely to preoccupy markets in 2018, including inflation and the withdrawal of quantitative easing.

As always, we hope you find it an illuminating and insightful read.

Please send any thoughts or feedback to cherry.reynard@mipagency.com.

Cherry Reynard Editor www.adviser-hub.co.uk

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INVESTMENT TRUSTS

150 YEARS YOUNG In March the investment trust industry hits its 150th birthday. Mark Dampier, Research Director at Hargreaves Lansdown, talks to Holly Thomas about investment trusts and his long-standing investment in the Foreign & Colonial Investment Trust which started it all back in 1868.

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INVESTMENT TRUSTS

WHY DO YOU LIKE INVESTMENT TRUSTS? They are a fantastic, niche investment vehicle. There are two big advantages to investment trusts. Firstly, the ability to use gearing. Given that this tool can increase potential returns in a rising market – which is what we have had for the last 10 years – it’s a very attractive option for a trust manager.

The second is that they are closed-ended. This structure means that a fund manager cannot be forced to sell at a time he or she doesn’t want to in order to meet redemptions. This allows that manager to make truly long-term investment decisions in the interest of shareholders, without having to worry about holding sufficient cash to pay out. There are other pluses too, of course. Investment trusts can invest in areas that other funds can’t touch, such as unquoted shares and private equity.

Of course there is the risk that a trust will go to a discount, but for long-term investing that’s not such a worry if you can wait until the discount narrows.

ARE THEY A MASS-MARKET INVESTMENT VEHICLE? Many people might see them as a complicated alternative to funds – although I’m not sure all private investors truly understand those either.

Once you get your head around gearing and the unique pricing, the rest is pretty straightforward. The charges are relatively low, which means that investors would do well to consider them.

"I THINK THE FOREIGN & COLONIAL INVESTMENT TRUST IS A VERY GOOD CORE HOLDING" WHEN DID YOU FIRST INVEST IN THE FOREIGN & COLONIAL INVESTMENT TRUST? In the mid-1990s I took out an interest-only mortgage on my home in Bristol and wanted to run an investment vehicle alongside it that wasn’t an endowment. I had endowments already but wanted something more flexible.

F&C offered a savings plan (I think it was the first trust to do so) and because I didn’t have much money then, that suited me down to the ground. I paid in around £50 a month to begin with and increased the amount as and when my salary increased. It did the job and I managed to pay off a chunk of my mortgage.

DO YOU STILL OWN THE FUND? Absolutely. I still think that it’s a very good core holding, even with the changes that have inevitably been made since the nineties (when I first invested).

In early 2013, the trust’s exposure to overseas investments was increased, having previously been weighted towards UK companies. This has aided the trust’s performance as global equities have significantly outperformed our domestic market over this time.

The beauty of this kind of fund is that it’s a buy and hold. Investors can get caught up in investing and chop and change too often. The key is to find a good manager that can worry about the necessary changes on their behalf, leaving them free to go fishing!

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ACTIVE ACTIVE ACTIVE

ACTIVE VS PASSIVE

PASSIVE PASSIVE PASSIVE PASSIVE PASSIVE

THE GREAT DEBATE: ACTIVE & PASSIVE Tom Poulter, Head of Quantitative Research at Square Mile suggests that the debate on active versus passive needs to be re-framed, with a clear focus on finding the best funds to meet clients’ objectives.

Life is full of debate: milk before tea or tea before milk, cats versus dogs, the best James Bond? The investment industry is no different and is currently divided on the active versus passive debate, with strong feelings on either side.

At Square Mile we believe the debate needs to be re-framed a little. A portfolio should consist of a combination of the best funds to meet the clients’ objectives. That may be active, 0 6 ADVISER-HUB.CO.UK

passive or a blend of both, at a cost that represents value for money.

With that in mind, when is each type of approach appropriate? The decision will depend on several factors including the asset class and region, the cost sensitivity of the investor and their time horizon.

LIKE WITH LIKE Firstly, before we critique active or passive

funds, we need to make sure we are comparing both types of funds fairly. Currently, most investors compare a fund’s performance against its benchmark, which is usually an index or a sector. However, it is impossible for an investor to obtain the exact exposure and performance profile of a sector or an index, due to factors such as trading and management fees.

Square Mile believes that it is more appropriate to compare an active fund to an

ACTIVE VS PASSIVE

equivalent passive fund; for example a UK Equity fund benchmarked against the FTSE All Share Index should be compared against an equivalent passive fund that tracks the FTSE All Share Index. This gives a comparison that is closer to the investor’s real experience.

ACTIVE FUNDS Active funds have a number of appealing characteristics. Key for many investors is their ability to offer the potential to provide superior returns over the index. Although this is not guaranteed – and plenty don’t succeed – passive funds don’t have this ability at all.

Active funds can also offer other characteristics, such as generating an income, preserving capital and protecting against inflation.

“IT IS MORE APPROPRIATE TO COMPARE AN ACTIVE FUND TO AN EQUIVALENT PASSIVE FUND; FOR EXAMPLE A UK EQUITY FUND BENCHMARKED AGAINST THE FTSE ALL SHARE INDEX SHOULD BE COMPARED AGAINST AN EQUIVALENT PASSIVE FUND THAT TRACKS THE FTSE ALL SHARE INDEX. THIS GIVES A COMPARISON THAT IS CLOSER TO THE INVESTOR’S REAL EXPERIENCE.”

line with the index); however, they do remain exposed to the same overall risks as the market.

In general, passive funds are more readily understood by investors who know what they are going to get and can judge the progress of their investment more easily. This means lighter-touch monitoring and maintenance is required.

PERFORMANCE Square Mile has recently conducted some analysis on whether active funds in general have outperformed or underperformed their passive counterparts for several different sectors. As you can see from the chart below, on average over rolling three-year periods the average active UK equity fund has outperformed the average passive fund which tracks the FTSE All Share, while the average active UK equity fund was even able to outperform its benchmark.

We have also discovered that, in the Sterling Corporate Bond, North American and Sterling UK Gilt Sectors, on average passive funds have outperformed active funds while in the Global and UK All Companies sector, active funds have outperformed passive funds.

This reaffirms our belief that the decision to go active or passive is not binary. For most investors, the choice is usually not one or the other, but a bit of both.

Average Active & Passive Funds with FTSE All Share Index as benchmark

25%

20%

15%

10% Performance (% p.a)

The manager of an active fund has the ability to avoid significant drawdowns during periods of market stress. They can anticipate and respond to market turmoil, rather than simply following the index. This allows active funds to provide investors with a “smoother” journey.

Managers also have greater flexibility in where they can invest, so do not blindly invest in specific regions/industries and stocks. They can look forward, striving to find tomorrow’s winning companies, rather than relying on the index winners of yesterday. Investors have greater choice, allowing them to invest in a fund that best suits their needs.

5%

0%

-5%

PASSIVE FUNDS At the same time, there are a number of reasons why an investor would choose a passive fund. Notably, they are generally cheaper than their equivalent active fund. However, there are exceptions. In the UK All Companies sector, the OCFs range from 0.06% to 1.50% for passive funds, while the range for active funds in the same sector is 0.22% to 2.69% (source: FE Analytics as at 23rd November 2017).

Passive funds often have greater transparency, allowing investors to have greater insight into their portfolio’s risk characteristics, although this may change as active managers are being pushed (quite rightly) to improve disclosure.

Passive funds are also exposed to less active risk (the risk associated with not performing in

-10%

-15% Jul 08 Jan 09 Jul 09 Jan 10 Jul 10 Jan 11 Jul 11 Jan 12 Jul 12 Jan 13 Jul 13 Jan 14 Jul 14 Jan 15 Jul 15 Jan 16 Jul 16 Jan 17 Jul 17 Average Active Fund

FTSE All Share Index

View the full active & passive report by visiting www.squaremileresearch.com/Insights/ entryid/383 ADVISER-HUB.CO.UK 0 7

SQUARE MILE Square Mile is an independent investment research business that focuses first and foremost on in depth, qualitative fund research, which is at the heart of what we do. Our research is distinguished by its depth and detail.

Rather than just explaining what a fund does and how it is constructed, we seek to understand how a fund behaves, whether it will consistently deliver on its objectives, and whether it represents good value for investors.

We focus on identifying “best-in-class� funds and gaining the fullest possible knowledge and understanding of those funds. Our research process is fuelled by qualitative research that focuses on the fundamentals: manager and environment; investment philosophy and objectives; investment process; portfolio construction; management of risk; and value for money. Ultimately it is about enabling our clients to identify funds for their customers which deliver the required outcomes.

We make this research available in our Academy of Funds.

W: www.squaremileresearch.com/Academy-of-Funds T: 020 3700 7393

EMERGING MARKETS

INVESTING IN EUROPE

Ewan Thompson Neptune Investment Management

EMERGING MARKETS 2018: THE BEGINNINGS OF A BULL MARKET? NEPTUNE’S HEAD OF EMERGING MARKET EQUITIES, EWAN THOMPSON, HIGHLIGHTS THE KEY EMERGING MARKETS DEVELOPMENTS LAST YEAR AND EXPLAINS WHY THE OUTLOOK FOR THE ASSET CLASS IS SO POSITIVE IN 2018. expected to continue along its recent path of internal reform 2017 Review: Emerging markets continued their recent and rebalancing, ultimately improving the quality of growth strong run in 2017, completing their first back-to-back and embracing financial reform on a gradualist basis, years of outperformance against developed markets since therefore avoiding a more serious growth slowdown. This 2009-2010. Moreover, whilst 2016 saw only a marginal healthy economic foundation is likely to see rising inflation outperformance (due to a sharp correction at year-end after and rising bond yields to a moderate degree. However, when Donald Trump’s election success), 2017 witnessed a much accompanied by accelerating growth this is unlikely to derail stronger relative performance. emerging market outperformance.

Global markets in general were driven by the first period A rising growth cycle will continue to boost capacity of synchronised global growth witnessed since the global utilisation and therefore provide considerable financial crisis in 2008, a backdrop traditionally highly operational leverage, and by extension an ongoing favourable to emerging markets assets. In recovery in corporate earnings. Moreover, the particular, 2017 was a year of stability for the “Index heavyweight lack of a pressing need for capital Chinese economy, where ongoing supply-side stocks Tencent and expenditure, due to excess capacity having reform and economic rebalancing Alibaba nearly doubled been built out in the previous cycle, means continued, driving corporate profits and in 2017. Performance was excess cash flow will not be absorbed wages higher. This robust growth backdrop dominated by the top 20 completely by capex but rather returned was also met with sustained low inflation stocks by market to shareholders. Indeed, the outlook for globally and therefore long-term bond capitalisation, which is free cash flow across emerging markets yields remained contained, creating often the case in the early years of a bull market.” even outstrips the positive story for something of a ‘Goldilocks’ environment for underlying earnings. emerging markets.

Having suffered for seven years in a A major feature of recent emerging market global economic down cycle, emerging markets are returns has been the extremely strong performance likely to undergo a renewed credit cycle as business of the largest stocks in the benchmark, especially those in investment and consumption both pick up, with private the technology sector (which accounts by itself for half of sector credit at extremely low levels comparable to levels the index’s total return). Index heavyweight stocks Tencent seen in the aftermath of the Asian Financial Crisis. and Alibaba nearly doubled in 2017. Performance was Given the significant discount of emerging market assets dominated by the top 20 stocks by market capitalisation, to developed markets and the economic and earnings which is often the case in the early years of a bull market. growth premium available, we expect 2018 to see emerging markets continue to outperform and regain much of the 2018 Outlook: We anticipate an ongoing supportive macro considerable underperformance experienced in the highly backdrop for emerging market outperformance in 2018 as atypical period of 2010-2016. global growth continues to gather momentum. China is ADVISER-HUB.CO.UK 0 9

OUTLOOK

WEATHERING HEIGHTS: HOW TO INVEST IN 2018 How can investors weather the heights in asset valuations and the potential risks in 2018? The GSAM team believes this environment calls for a dynamic approach to asset allocation, and a flexible and broad-reaching approach to equity and bond selection.

Can equities continue to rise from their current heights? Investors ask us this question more than any other and our answer remains yes.

Valuations are high relative to history but the macro environment is remarkably benign for financial markets and valuations should be judged in that context.

We think equity markets will be carried to new highs by a supportive macro environment in 2018. Headwinds are present though. The US economy is at risk of overheating, tighter financial conditions could slow the European recovery and Chinese growth stimulus seems likely to be moderate following the 2017 Party Congress. Geopolitical risks related to North Korea or US trade relations could flare up at any time.

How can investors weather the heights in asset valuations and the potential risks in 2018?

We think this environment calls for a dynamic approach to asset allocation, an equity strategy that looks beyond the major developed market benchmarks and a fixed income approach that seeks returns outside of developed market government and corporate bonds.

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OUTLOOK

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QUESTIONS FOR 2018

1

CAN THE GLOBAL ECONOMIC EXPANSION CONTINUE?

Yes. We expect the global expansion to continue, carrying global equity markets to new highs in 2018.

• We think the economic and market cycle is well supported and has yet to fully mature.

• Investors will likely need to navigate more risks, including moderating growth, central bank tightening and geopolitical developments.

• We believe emerging market (EM) economies will outperform developed economies, supporting EM assets.

Investment Implications With the global economic expansion likely to continue, we prefer equities over credit and credit over rates. EM, outside of China, is a bright spot and we continue to prefer EM over developed market (DM) assets. We prefer equity over credit, and credit over rates as we think the expansion has yet to fully mature. We prefer EM relative to DM.

2

ARE EQUITIES OVERVALUED?

No. We see US and other developed market government bonds as the overvalued asset. Outside of bonds, we think valuations are justified by current macro conditions.

• US equity valuations are elevated relative to history but continue to offer a reasonable risk premium over other assets.

• We think equity valuations in Europe, Japan and Emerging Markets are attractive relative to the US. • Central bank tightening could be a catalyst for broad market volatility. Outside of bonds, we think the main impact will be in currencies though equities could also see a shorter-term drawdown.

Investment Implications We think global equity returns are likely to be positive in 2018 but much more moderate compared with 2017, with greater risk of meaningful drawdowns. We think this favours a dynamic approach to asset allocation and a preference for European, Japanese and emerging market equities.

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IS 2018 THE YEAR CENTRAL BANK POLICY TIGHTENING STARTS TO MATTER?

Probably. While investors may worry about changes to central bank asset purchase programs, we think rate hikes are the more likely source of volatility.

• We think markets are well prepared for a gradual and well-telegraphed unwinding of central bank balance sheets.

• Rate hikes are probably the bigger risk as we think market expectations for Federal Reserve rate hikes are unrealistically low.

• With tight labour markets, central banks are setting a lower bar for rate hikes despite only gradually rising inflation.

Investment Implications We are bearish on US and other developed market government bonds, and cautious on corporate and mortgage-backed bonds. We believe higher US rates are likely to temporarily favour the US dollar versus other developed currencies.

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WHAT GETS DISRUPTED NEXT?

Consumer staples look vulnerable to disruption in 2018. Major online retailers are becoming bigger players in staples, pressuring traditional leaders in the sector.

• The internet has broken down traditional barriers to entry for consumer staples companies.

• Online retailers are developing their own staple brands and marketing them through voice-activated assistant devices with the advantage of proprietary data.

• Longer term, we see disruption coming to virtually every business sector we invest in, with autos a prime candidate to follow consumer staples.

Investment Implications We look to invest in the beneficiaries of disruption and limit our exposure to those that are being disrupted. Within consumer staples, we favor niche brands that are benefitting from lower barriers to entry, and we try to avoid second-tier brands that are vulnerable to the growth of online retailer brands.

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WHAT MARKET TRENDS ARE WE SEEING THROUGH THE LENS OF BIG DATA?

Big data can reveal subtle and often unnoticed connections between companies that may impact their performance.

• The digitalization of entertainment stretches across software companies as well as traditional brick-and-mortar firms.

• The resurgence of luxury goods and services has cut across economic sectors.

• More companies are pointing to changes in regulation as a possible business risk.

Investment Implications Our thinking shouldn’t be constrained by traditional definitions of businesses and sectors.

As technological upheaval continues, the importance of thinking broadly about unexpected connections between companies will continue to grow. We believe that investors should think critically about what constitutes a company’s peer group and about market themes and secular changes that may connect otherwise disparate companies.

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HOW TO INVEST IN 2018?

We believe investors should look beyond traditional asset classes and borders.

• Continued economic expansion favours global and Emerging Market equities.

• Elevated valuations favour active and alternative approaches to traditional markets.

• Central bank tightening favours diversified sources of yield.

Invest for continued global growth The economic and market cycle has yet to fully mature. Invest for continued global economic expansion through developed and emerging markets.

“WE THINK GLOBAL EQUITY RETURNS ARE LIKELY TO BE POSITIVE IN 2018 BUT MUCH MORE MODERATE COMPARED TO 2017, WITH GREATER RISK OF MEANINGFUL DRAWDOWNS. WE THINK THIS FAVOURS A DYNAMIC APPROACH TO ASSET ALLOCATION AND A PREFERENCE FOR EUROPEAN, JAPANESE AND EMERGING MARKET EQUITIES.”

Manage the risks of elevated valuations US equity valuations are high relative to history, but continue to offer an attractive premium over other assets. Consider implementing buy-write and alternative strategies for elevated valuations.

Diversify income sources as central banks tighten We are bearish on US and other developed market government bonds, and cautious on corporate and mortgage-backed bonds.

Consider investing in Emerging Markets debt and municipal bonds.

Navigate the forces of disruption Disruption is an ongoing driver of risk and return globally. In our view, the disruptive impact of technology is likely to be even bigger in Emerging Markets, creating compelling opportunities.

Uncover insights from Big Data Quantitative strategies employing deep analysis of big data can potentially uncover return opportunities through market themes and secular changes that connect otherwise disparate companies.

For the full Investment Outlook, make sure to visit www.GSAM.com/Outlook

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D

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DEFENSIVE INVESTING

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DEFENSIFICATION: GOING BEYOND DIVERSIFICATION A defensive approach starts with a genuine understanding of the resilience of the cash flows supporting the dividends and coupons paid by individual securities, say John Stopford and Jason Borbora, portfolio managers on the Investec Diversified Income Fund.

WHY BE DEFENSIVE? Reading the signs of financial markets is always difficult, and the market environment today makes for a particularly tough analysis.

Buoyed by unorthodox central bank stimulus, many stock markets have risen to expensive levels while investors have been drawn into riskier and higher yielding bonds in 1 2 ADVISER-HUB.CO.UK

their hunt for income.

Despite the absence of asset price volatility, investor concerns are rising. How should they protect against the risk of a market sell-off now that this bull market is one of the longest on record?

Investors are right to be wary as avoiding significant losses can materially impact

performance. Over the last 20 years, for example, an investor in the FTSE All Share who missed just the worst five months of performance would have beaten the index by over 600%.* (*Source: Investec Asset Management, Bloomberg, June 2017) At Investec Asset Management, we believe the key to good investment defence lies in

DEFENSIVE INVESTING

looking beyond the traditional, simplistic ‘top-down’ approach to portfolio construction that many investors adopt.

To us, the characteristics of an asset class matter much more than its ‘equity’, ‘bond’ or ‘alternative’ label. Instead of focusing on traditional asset allocation, or holding a fixed proportion of bonds, equities and other asset classes in a portfolio, we choose to place a greater emphasis on understanding an investment’s ‘true’ behaviour and its relationship with the economic cycle.

Those securities we identify as providing attractive, sustainable income with potential for capital appreciation are used to build a holistic portfolio with a mix of different exposures capable of achieving our investment objectives.

The composition of the fund is actively managed, with no reference to any benchmark, to reflect changes to the economic backdrop, the risk environment and the on-going desirability of each holding.

By taking these decisions, we aim to reduce the impact of drawdowns on the portfolio and improve investors’ probability of meeting their goals over long-term periods.

WHY? In doing this, we seek to construct a portfolio that is genuinely diversified across a range of assets with growth, defensive and uncorrelated characteristics. Moreover, by investing only in securities with sustainable income streams and capital growth potential, we believe we can build a portfolio better able to handle episodes of market weakness and reduce the severity of drawdowns.

Finally, a clear focus on downside risk management recognises that negative events can occur at any time, making it prudent to scale back exposure try to limit their effects.

These three layers of portfolio design underpin the objectives of the Investec Diversified Income Fund to deliver an income of between 4%-6% per annum, with scope for capital growth and ‘bond-like’ volatility – which we define as less than half that of UK equities.

DIVERSIFICATION VERSUS ‘DEFENSIFICATION’ The Diversified Income Fund aims to provide a defensive return made up of an attractive level of income, as well as capital growth over the medium-term. The best way to achieve this consistently, we believe, is through the proper implementation of what we have termed ‘defensification’.

Within equities, for example, the perception that a company’s high dividend yield is a guide to its likely returns is erroneous. Simply because a company is paying out a high proportion of its earnings does not mean this is sustainable.

What if the company is in distress or investors are forcing down the share price in anticipation of a dividend cut?

Similarly, high yields on sub-investment grade corporate bonds or emerging market debt may simply be warning of the risk of default.

Chasing yield without taking account of the accompanying risks can lead to painful capital drawdowns that far outweigh the level of income offered; often an asset offers a high yield because of the proportionately higher risks

“INVESTORS ARE RIGHT TO BE WARY AS AVOIDING SIGNIFICANT LOSSES CAN MATERIALLY IMPACT PERFORMANCE. OVER THE LAST 20 YEARS, FOR EXAMPLE, AN INVESTOR IN THE FTSE ALL SHARE WHO MISSED JUST THE WORST FIVE MONTHS OF PERFORMANCE WOULD HAVE BEATEN THE INDEX BY OVER 600%.*”

it presents. A bottom-up approach seeks to understand the sustainability as well as the level of an investment’s income stream in addition to its potential for capital appreciation.

Take sub-investment grade corporate debt as an example. Those at the bottom of the credit rating spectrum, where the average yield over the past 10 years has been nearly double that of their more highly rated peers, suffered a drawdown in 2008/09 of nearly 20 percentage points more than less-risky BBB/BB rated issues.

Similarly, equities with the highest dividend yields underperformed the broader stock market during the financial crisis. A top-down approach may be able to achieve yield but it may come at the expense of resilience and capital.

Disclaimer: Past performance is not a reliable indicator of future results, the level of income may rise as well as fall. Inc-2 share classes take their charges from capital. This could constrain future capital and income growth. The Fund may invest more than 35% of its assets in securities issued or guaranteed by an EEA state. Your clients’ capital is at risk.

Specific risks Currency exchange: Changes in the relative values of different currencies may adversely affect the value of investments and any related income. Default: There is a risk that the issuers of fixed income investments (e.g. bonds) may not be able to meet interest payments nor repay the money they have borrowed. The worse the credit quality of the issuer, the greater the risk of default and therefore investment loss. Derivative counterparty: A counterparty to a derivative transaction may fail to meet its obligations thereby leading to financial loss. Derivatives: The use of derivatives may increase overall risk by magnifying the effect of both gains and losses.

This may lead to large changes in value and potentially large financial loss. Developing market: Some countries may have less developed legal, political, economic and/or other systems.

These markets carry a higher risk of financial loss than those in countries generally regarded as being more developed. Interest rate: The value of fixed income investments (e.g. bonds) tends to decrease when interest rates and/or inflation rises. Multi-asset investment: The portfolio is subject to possible financial losses in multiple markets and may underperform more focused portfolios.

To find out more about how we implement ‘defensification’ in the Investec Diversified Income Fund visit www.investecassetmanagement.com/DIF

INVESTEC DIVERSIFIED INCOME FUND: A PORTFOLIO BEYOND DIVERSIFICATION A more defensive approach looks beyond simple diversification and the top-line yield offered by assets. Rather, it requires a genuine understanding of the resilience of the cash flows supporting the dividends and coupons paid by individual securities. This involves looking at measures such as profitability, the stability of cash generation, the debt burden and how much flexibility there is to deal with a changing economic environment.

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Advert Placement

BRAZIL

Andrew Greenup FirstState Investments

CORAJOSO E BONITO BRAZIL IS ‘BOLD AND BEAUTIFUL’ WHEN IT COMES TO INFRASTRUCTURE. ANDREW GREENUP, OF FIRST STATE INVESTMENTS, EXPLAINS WHY. Brazil is a big, geographically unique, country with many renewals as well as a legal system that operates very slowly. social, political and economic challenges. However there For listed companies, he would describe Brazil’s infrastructure is widespread acknowledgement within the country that as a trade-off between the potential for strong growth greater investment in infrastructure is part of the solution to prospects (both organic and inorganic) with higher than overcome these challenges. average risks.

As Brazil slowly emerges from its economic depression, risks to traffic and earnings forecasts for infrastructure assets are to the upside. Andrew spent a week in Past performance is not a guide to future performance.

Brazil visiting infrastructure companies, assets, This information is directed at professional clients regulators and government in Curitiba, Brasilia only and is not intended for, and should not be “For existing Brazilian and São Paulo to assess the future prospects relied upon by, other clients. The value of infrastructure assets, as the for its toll road, airport and railway sectors. investments and any income from them may country slowly emerges Brazil’s politicians are strongly go down as well as up. Investors may get back from its two-year economic committed to building new infrastructure less than the original amount invested and depression, he now believes the risks to traffic and using private capital under its widely-used past performance information is not a guide earnings forecasts for concession model. This, combined with an to future performance. Changes in exchange Brazilian infrastructure aggressive privatisation program and rates between currencies may also cause the assets are to the upside.” distressed asset sales from multiple value of the investments to go down or up. For construction companies, creates a large further information on risks, please refer to the pipeline of investment opportunities for domestic Risk Factors section in the Company’s prospectus. and foreign players.

Issued by First State Investments (UK) Limited which is These significant growth opportunities do not come authorised and regulated by the Financial Conduct Authority risk-free; a scandal-plagued federal government, a (registration number 143359). Registered office Finsbury Presidential election in the second half of 2018, uncertainty Circus House, 15 Finsbury Circus, London, EC2M 7EB, number surrounding concession rebalancing, amendments and 2294743. Telephone calls with First State Investments.

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FIXED INCOME

ARE FIXED INCOME MARKETS OVERVALUED? Bonds may be expensive, but in reality, there are few ‘cheap’ assets anywhere, and the fixed income market may be at the right price for the current market environment, argue John Pattullo and Nicholas Ware at Janus Henderson

A comment we regularly hear from our clients, whether in individual meetings or at investor events, is that “bonds are expensive”. This, of course, is a fair point but is at odds with our current thinking. The reality is that in today’s world there are no ‘cheap assets’; and those that are, are cheap for good reasons.

In our view it is no longer possible to argue that bonds are cheap. Instead, we believe they are probably at or around fair value and reflect the current market environment in which we have low volatility, low defaults, low inflation and a reasonable level of global growth.

Owners of bonds get their returns from two places: income and price movements. In light of current valuations, where spreads have tightened significantly post the Global Financial Crisis, we think that future bond returns will mostly come from the ‘income’ element. This is an environment in which a carry strategy (ie, collecting the coupon) still works, because there are many bonds with reasonable levels of coupon to ensure a good income stream.

The chart (Fig 1) shows the typical returns from various fixed income assets and equities over selected periods.

Enough bonds in investors’ portfolios?

Another question we receive is whether we believe bonds are ‘under-owned’? It is clear that equities have attracted significant inflows and investors are feeling quite euphoric; typical late cycle characteristics.

Equally, as fig 1 shows, fixed income asset classes have performed well on a 10-year view.

We would not argue that either asset class is cheap, but we do believe that investors should seek diversification by holding an appropriate level of bonds. Bonds, and particularly higher-quality ones, tend to do well if equities sell off and so provide investors with that diversification. To illustrate this,

while the S&P 500 index was down 38% in 2008 at the height of the crisis, the US investment grade (high quality) corporate bond index returned 7.9% and US 10-year Treasury 17%.

We think a lot of investors are currently focusing on where things can go wrong for bonds. The asset class has enjoyed a particularly strong run, with yields on US Treasuries reaching a July 2016 low of 1.36% (lower yields mean higher prices), although they have since climbed by over 1% from this low point*.

“WE THINK A LOT OF INVESTORS ARE CURRENTLY FOCUSING ON WHERE THINGS CAN GO WRONG FOR BONDS.” Fig 1

* 10-year US Treasuries yield around 2.3%, as at 6 November 2017.

Historical total returns for fixed income and equities Total Return (%)

Annualised Returns (%)

YTD

2Y

3Y

5Y

10Y

US corporate IG

5.7

5.3

3.8

3.3

5.6

Euro IG

2.9

3.7

2.7

3.9

4.7

Sterling IG

3.6

8.2

6.5

6.3

6.5

US HY

7.5

9.7

5.6

6.3

7.7

Euro HY

7.2

7.1

5.8

7.3

8.0

Sterling HY

7.9

9.5

8.3

9.4

13.5

US leveraged loans

3.7

5.8

4.1

4.5

4.4

European leveraged loans

0.3

3.2

5.3

6.0

4.6

S&P 500

16.9

13.7

10.8

15.2

7.2

ADVISER-HUB.CO.UK 1 7

FIXED INCOME

Rate rises – what will the impact be?

Investors also question whether the fact that the US economy is doing well, and Federal Reserve officials are suggesting more rate hikes are likely in the near future, means that bonds are no longer a worthwhile investment? We suggest that they still are, mainly because rate rises are likely to be measured.

The economy, while growing, is expanding far less quickly than historical norms; inflation is also well anchored. We have long thought that Japan provided interesting parallels for other developed markets, given its ageing population and recovery from a debt-fuelled crisis.

Based on the experience of Japan, we think that while we will see interest rates increasing; the rises are likely be measured and provide only a small headwind, that coupons should be able to more than offset. Also, within our portfolios, if bond yields rise, we will be able to reinvest our maturing bonds into more attractive ones with higher yields, which in time should boost fund returns.

Outlook and valuations Fig 2 is a comparison of the yields on various fixed income asset classes. Based on this, we are still constructive on investment grade and do see reasonable value, particularly within BBB-rated bonds in the US, while within high yield we still think that there is room for further compression in yields in the US. The theme we expect to play out in 2018 is that the global economy will continue to do well.

Defaults will likely continue to be low, so we favour higher yielding credit on a relative basis. The key will be to continue to be selective and remain disciplined with late cycle conditions evident in the level of dispersion between sectors. This is magnified by significant technological and industry changes impacting certain industries and reflected in our approach of avoiding certain sectors altogether. It also drives our belief that being index-agnostic ultimately helps our investors.

Fig 3 reveals a high level of valuation dispersion within high yield, a valuation which is less apparent within investment grade given its higher quality (eg. lower levels of leverage).

To illustrate, high yield corporate bond spreads in sectors with percentile ranking of 50 and above are now wider than their historical average spread (over the period from 2000 to now), which is indicative of sector issues, but 13 of the 20 sectors are trading in the bottom quartile (tighter spreads than their historical average).

We expect high yield dispersion to remain elevated and this should benefit us as opportunities present themselves for credit picking.

An additional point to note is that we have seen money flowing into alternatives, with investors chasing returns. These alternatives are often complex investment structures promising higher returns to compensate for the lower liquidity available versus traditional fixed income instruments. A lot of these strategies are unproven and the depth of liquidity in these markets is quite shallow. We still think investing in the relatively liquid developed world fixed income markets is a better way to seek to deliver superior risk-adjusted returns to our investors.

Summary The questions we are currently being asked by investors are very valid. At a valuation level, while 1 8 ADVISER-HUB.CO.UK

Fig 2

Current yields across global fixed income markets

Yeild % 6.0 5.7 5.0

4.2

4.0

3.0

3.2 2.4

2.0

2.3

2.0

1.0

1.2 0.6

0.3

0.0 US corp IG

Fig 3

Euro corp IG

Sterling corp IG

Sterling corp IG

Euro HY

Sterling HY

UST 10Y

German Bund 10Y

UK Gilt 10Y

High yield bond valuations - ranking by sectors

Retail stores Broadcasting Pharmaceuticals Secondary oil/gas producers Diversified telecom Healthcare / supplies Oil services Telecoms FInance Metals and Mining Satelite Utilities Gaming Chemicals Gas pipelines Services Home builders Technology Cable Containers 0

10

20

30

40

50

60

70

80

Percentile rank

many high-quality credits are trading at fairly expensive levels, in our view they are justifiable taking into account our macroeconomic outlook and the quality of the issuers. Furthermore, given the need for income, we remain overweight high yield and the lower-end investment grade corporate bonds.

In summary, we believe that the value proposition for investing in fixed income assets remains intact.

Fig 1: Source: Bank of America Merrill Lynch, Credit Suisse, Janus Henderson Investors, as at 31 October 2017.

Fig 2: Source: Bank of America Merrill Lynch, Bloomberg, Janus Henderson Investors, as at 8 November 2017.

Fig 3: Source: The Yield Book Inc, FTSE Index, Goldman Sachs Global Investment Research, Janus Henderson Investors, as at October 2017.

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MACROECONOMICS

sterling-based investments (Fig 1) and the sharp decline in the currency supports a view that Brexit is an accident waiting to happen for the UK economy.

This bearish view is not my central scenario.

Brexit brings with it all the uncertainties that politics can throw up, but I believe it is highly unlikely that the negotiating process will end in stalemate. Even now, at the height of the uncertainty, the UK economy is performing robustly.

Indeed, the short-term price for the Brexit vote has almost been paid in full, in that the spike in inflation that eroded real consumer spending power has played out and is about to reverse.

A key risk now to investors in the UK stock market is a material recovery in sterling and a violent rotation away from the international earnings that dominate the FTSE 100 index, into domestic-facing companies currently trading on recession-type valuations. Sterling assets are now undervalued on a risk-adjusted basis and I have increased investments in domestic companies in my portfolios.

A STOCK PICKER’S APPROACH TO MANAGING MACROECONOMICS Mark Barnett discusses how shifting monetary policy and geopolitical volatility have the potential to recalibrate the status quo across a number of sectors

As an investor in a global stock market such as the UK’s FTSE All-Share Index, I am acutely interested in the various aspects of the macroeconomic environment. In an increasingly globalised market, interest rates, economic trends and politics interweave and interact to influence markets.

My interest in these macro drivers is academic to an extent: as a stock picker I am ultimately interested in the financial performance of the companies I own and how that will shape their path to sustainable dividend growth. While the economic cycle can make a difference to the smoothness of that path, it does not have to be the defining factor to performance over the long term, particularly for medium-sized companies or niche players who can grow organically by winning market

share, sometimes capitalising on the ups and downs of the economic cycle along the way.

However, I feel we have reached inflection points across a number of global macro and political fronts; high valuations in certain sectors, shifting monetary policy and geopolitical volatility have the potential to recalibrate the status quo across a number of sectors.

While stock markets have enjoyed a pretty smooth ride since the 2012 eurozone crisis, the macro risk now seems to me to be very much to the downside, with the exception of the perceived Brexit risk to the UK economy.

Brexit – creating valuation anomalies to be exploited The significant underperformance of

Monetary tightening – now underway The ‘normalisation’ of monetary policy and the return to positive real interest rates looks set to gather pace. This has implications for valuations in many parts of the market, which I think have been inflated by the consequences of super-low interest rates. Although there are structural causes of low price and wage inflation, I now feel that bond markets could sell off even within that paradigm.

I do not find it bullish that the US Federal Reserve is openly declaring itself perplexed over the relationship between unemployment, wages and prices. The Bank of England is being similarly coy about committing itself to further rate rises whilst Brexit uncertainty persists.

What we can say is that 10-year bond yields at or below the rate of inflation worldwide in these economies are probably unsustainable unless we are heading for an economic downturn.

Politics – another destablising influence Politics in most key democracies cannot survive another recession without a total re-think of fiscal policy and how to protect the interests and income of the labour market. A re-run of the post-2008 quantitative easing policies would not be welcomed by those voters who associate it with growing wealth inequalities.

In aggregate, the rising prominence of inter-generational issues – including elevated house prices, the exponential rise in social security and pension liabilities – and the force of populism have brought key Western governments to an inflection point. These issues are set to influence policy makers and will be critical to the Conservative government over the course of this parliament.

Equity valuations - currently elevated Against a backdrop of robust economic growth, monetary tightening in the US may not be a major problem for equities if earnings keep rising cyclically. Too many segments of this market have been boosted by the long-term growth agenda (large cap tech) and the ADVISER-HUB.CO.UK 1 9

BEHAVIOURAL FINANCE

significant level of share buybacks, however, to the extent that US corporates are now the only marginal buyers of equities. Technically, the US market now feels vulnerable to a de-rating.

Another key driver of equity markets has been the recovery in commodity prices. This has been coupled with renewed confidence that the Chinese drive for more balanced growth can be achieved.

The drive by the Xi presidency to cut back on inefficient metals production for environmental reasons raises the question of whether steel production in 2017 will continue to push higher. Housing and infrastructure are giving way to services, technology and electrification as the drivers of economic growth, an overall headwind for metals prices.

Portfolio positioning – valuation opportunities in certain domestics, pharma and oil & gas Despite my views on commodities, I am confident that oil & gas equities in the major integrated groups are on an efficiency mission and that current dividends are affordable below current oil price levels.

When it comes to ‘bond proxies’, I have become more cautious. I have sold holdings in Reckitt Benckiser and Smith & Nephew, and reduced my position in the tobacco sector. I see the US Food & Drug Administration plans to launch a consultation on lowering nicotine levels in combustible cigarettes and to review the future classification of non-combustible products as much an opportunity for the industry as a threat. The US remains the most affordable market for smokers globally; as prices rise in the tobacco industry, so companies are able to more than offset volumes with higher prices.

This remains our investment case for now.

Pharma performance since 2015 has been a major disappointment. However, I continue to find attractive risk/reward opportunities in new and developing therapeutic areas and remain optimistic that this sector can perform – even in a weak market scenario. Share prices will continue to react to news flow on drug pipelines, but it is important to remember that the major pharma companies are well diversified with strong cash flows and a high degree of discretion over long-term costs across areas including R&D and sales and marketing.

Sterling and UK-focused sectors and stocks are central to the future performance of my portfolios, where investments are diversified across life insurance, retail, travel, support services and a plethora of specialist financial businesses. Specialist real estate companies feature prominently in my portfolios: quality real estate portfolios are selling at historic discounts in REIT share prices which strikes me as an attractive entry point for the sector (Fig 2).

At the individual stock level, it happens that a collection of previously well-regarded companies currently held in my portfolios have seen very weak share price performance in the last two years. Provident Financial, Capita, Babcock, Next, easyJet are the most recognisable names. As a result there is a recovery element in these holdings over and above the normal market rotation potential.

2 0 ADVISER-HUB.CO.UK

Fig 1

Fig 2

Outlook – global risks elevated, but the UK market offers stock picking opportunities.

The performance of the UK stock market continues to be dominated by the countervailing forces of better-than-expected global economic growth and ongoing UK domestic political concerns. A sense of complacency may now exist over the global growth outlook. A combination of high valuations in certain sectors, shifting monetary policy and a volatile geopolitical environment may provide a catalyst which alters this bullish global outlook.

By contrast, the market seems unwilling to look beyond the uncertainty of the Brexit negotiations when it comes to valuing sterling assets which, by historic standards, are now heavily discounted. Again, this seems unlikely to persist for long.

By proceeding cautiously, employing a well-tested investment process based on fundamental company analysis and a prudent approach to valuation, there are opportunities for profitable investment in companies with the potential to deliver a sustainable flow of dividend income in the event of more volatile market conditions.

Important information This document is for Professional Clients only and is not for consumer use. The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested. Past performance is not a guide to future returns. Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice. This document is marketing material and is not intended as a recommendation to invest in any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication. The information provided is for illustrative purposes only, it should not be relied upon as recommendations to buy or sell securities.

Invesco Perpetual is a business name of Invesco Asset Management Limited, Perpetual Park, Perpetual Park Drive, Henley-on-Thames, Oxfordshire RG9 1HH, UK. Authorised and regulated by the Financial Conduct Authority.

We don’t just invest money for our clients – we invest the hours, months and years of hard work it has taken to earn it.

It’s not just about investing in one of our funds; it’s about investing in a belief that life is what you make it.

Each of us at Invesco Perpetual shares that belief and that’s what drives us – we are fully focused on delivering what truly matters to our clients – their objectives, their dreams.

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.

Mr Hayles Furniture maker for 27 years

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BEHAVIOURAL FINANCE

IRRATIONAL DECISIONS CREATE OPPORTUNITIES Behavioural finance may be well established, but investor behaviour continues to drive anomalies in markets, says J.P. Morgan Europe Dynamic manager Blake Crawford.

What is the underlying philosophy of the Europe (ex UK) Dynamic fund?

The fund is run from our behavioural finance process. This aims to strip emotion out of investing, basing our judgement on the fundamentals of individual companies alone. The basis of our process is that key market participants make irrational decisions, and that leads to mispricing in stock markets. By identifying where those behavioural biases occur, we can find opportunities and create alpha, while also ensuring we don’t fall into the same behavioural traps.

We still find these anomalies in spite of behavioural finance being a well-established discipline. If you look at performance over any time period, these traits still play a part in markets.

Can you give an example of how this works in practice?

Herding is a well-recognised behavioural phenomenon. This is the idea that there is safety in numbers. This has its merits, but can suppress the power of individual thought. We have observed that sell side analysts are prone to this type of behaviour – they tend to upgrade or downgrade corporate earnings in small increments, rather than deviating too far from average expectations. This consistent bias fails to recognise the magnitude of an upgrade cycle or a downgrade cycle. We find and exploit it where we see this happening.

Over-confidence would be another example.

This is a human constant; for example, almost no-one believes that their marriage will end in divorce, although statistics have shown that around 50% do1. It is no different in financial markets. Over-confidence leads to a confirmation bias, meaning that investors tend to ignore information that goes against their 2 2 ADVISER-HUB.CO.UK

original decision. They become over-confident in their ability to predict markets.

How does this work within the fund?

We look at facts. What are the earnings telling us about a stock? One of the key aspects of our process is the breadth of our market coverage. A traditional asset manager will have a group of sector specialists, who feed into a portfolio manager who combines ideas together aiming at delivering return for a given level of risk.

What we do is slightly different. We rely on

“THE BASIS OF OUR PROCESS IS THAT KEY MARKET PARTICIPANTS MAKE IRRATIONAL DECISIONS, AND THAT LEADS TO MISPRICING IN STOCK MARKETS. BY IDENTIFYING WHERE THOSE BEHAVIOURAL BIASES OCCUR, WE CAN FIND OPPORTUNITIES AND CREATE ALPHA.”

the sell-side analysts to produce research and that gives us a wider web – around 1,500 stocks.

In the background, we have a number of quantitative processes focusing on the key behavioural biases that help us whittle down that universe to a more manageable size. They roll into our key criteria of value, momentum and quality and give us an indication of where we need to do more work.

We’re constantly monitoring news flow to see if there are opportunities on the horizon. If a company releases a new set of results, and analysts upgrade, we would look into those and try and understand what the changes are. If an analyst has gone against consensus, and against the human behaviour of herding described earlier, we would look into that as well. Maybe this analyst has an edge.

How many stocks does the fund hold?

The portfolio typically has 50-100 stocks. It’s not at the top end of concentration. We aim to diversify and manage risk appropriately2. At the moment, we are at the lower end of the middle of that. The overall number will depend on the environment.

How does any macroeconomic information feed into your process?

We are driven by the bottom up, looking at the individual stock basis. The top-down picture will feed through to earnings changes and that is where we focus our attention. You’ll typically find that if a region is doing well, such as Ireland, it will feed into the corporate earnings. When it feeds through into earnings, that’s when it comes onto our radar. Is it an exciting opportunity?

Is the valuation attractive? That’s when the economic environment feeds into our positioning.

In terms of domicile, it is tricky. There are companies domiciled in a particular stock exchange, but when you look at the underlying exposure, it doesn’t always tally up with where it is listed. Sometimes investors penalise a company domiciled in, say, Greece, even if it doesn’t have much earnings exposure there. At the height of the Greek crisis, there was a bottling company listed there, which was punished for listing in Greece even though its

BEHAVIOURAL FINANCE

exposure was global. They moved their listing to the UK. The underlying earnings stream is much more important than where they are listed.

We have no stock, sector or country constraints. We leverage off the entire expertise of our 50 or so investment professionals within J.P. Morgan Asset Management to get the best ideas into the fund.

What is your current positioning? Do you have any notable themes in the fund?

One of the areas we like is technology hardware and equipment and particularly semiconductors. At the moment there is a huge increase in semiconductor components – for smart devices, phones and cars. Some component makers are involved in the value chain, such as French-listed ST Microelectronics or BE Semiconductor. There are also companies, such as Siltronic and SOITEC, which manufacture silicon wafers in the semiconductor value chain.

Within banks, we have exposure, but are being selective. At present, we like the banks that are well-capitalised with decent asset

quality that can pay dividends to shareholders and are leveraged to the recovery trend within Europe. This would include banks such as ING and KBC. What is the case for European investment at the moment?

2017 had a stacked political calendar – elections in France, Germany, the Netherlands.

Now we have got through that, political risk seems to be diminishing. There is supportive macroeconomic data – unemployment is falling, consumer confidence is rising and Purchasing Manager’s Index indicators are very strong. At a microeconomic level, this is translating into strong earnings growth.

When we look at valuations on a relative basis, they are not stretched. As long as we get earnings growth, there is still a good opportunity to make returns.

(Morningstar Rankings/Universe as at 30.09.17).

For more information go to : jpmorgan.am/eud 42% of UK marriages end in divorce. Office of National Statistics October 2017 Diversification does not guarantee investment returns and does not eliminate the risk of loss.

1 2

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There is no guarantee that any forecast made will come to pass.

Investment is subject to documentation which is comprised of the Prospectus, Key Investor Information Document (KIID) and either the Supplementary Information Document (SID) or Key Features/Terms and Condition, copies of which can be obtained free of charge from JPMorgan Asset Management (UK) Limited. Our EMEA Privacy Policy

What is the long-term track record of the JPM Europe Dynamic (ex UK) Fund The fund has strong performance since inception and top quartile returns over five years

is available at www.jpmorgan.com/jpmpdf/1320694304816.pdf.

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Which is why our “best ideas” JPM Europe Dynamic (ex-UK) Fund focuses on European economic recovery. jpmorgan.am/eud A

LET’S SOLVE IT.

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Past performance is not a reliable indicator of current and future results.

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JAPAN

JAPAN THE NEW MARKET FOR INCOME-SEEKERS Japanese equities have traditionally offered little for incomeseekers. That is all changing, argues Karen See, co-manager of the Baillie Gifford Japanese Income Growth Fund

2 6 ADVISER-HUB.CO.UK

JAPAN

How does the Japanese Income Growth Fund fit into Baillie Gifford’s broader Japan exposure?

Our Japan team runs a number of different strategies. The Japanese Income Growth Fund invests across the market cap spectrum, including smaller and some larger companies. It is an extension of what we already do. For every prospective investment, the team will look at the industry background, the competitive advantage, the management team, the financial strength of the company and how it executes and exploits its opportunities.

Only once we have completed that analysis do we start thinking about yield. All the Baillie Gifford fund managers are analysts as well, so we all generate investment ideas. From there, the difference is often how we put together the portfolio. Around 70% of the holdings in the fund are held elsewhere in other Baillie Gifford portfolios. We can then tweak the individual portfolio weightings to create extra yield.

100. As a result of both the growth focus as well as the relatively low dividend concentration in Japan, there isn’t a particular sector skew to the portfolio as you might find with other income-focused strategies.

How do you divide the portfolio?

We think of the portfolio in four main buckets. The first is ‘secular growth’ companies. These are the classic growth companies – disruptive internet companies, for example - and these have potentially the highest risk if they don’t succeed. Then we have ‘growth stalwarts’. These are companies with a durable competitive advantage and a deep moat protecting their business. They are cashflow generative – hopefully growing while still maintaining their dividend payments. The Japanese Income Growth Fund will tend to have more in this area than our other Japanese strategies.

We then have a ‘special situations’ pool. These are companies where we see value hidden in the company’s financial assets, either in the form of cross-shareholdings or cash; or something has gone wrong with the earnings and we see particular triggers that could unlock their potential. Finally, we have ‘cyclical growth’ companies.

At the moment, secular growth is around 40% of our portfolio. That said, we don’t have targets for any of these buckets and can be flexible. Recently we have seen more opportunities in the secular growth bucket.

Japan has historically been seen as a fallow market for income seekers – how has this changed?

We first considered launching this strategy 10 years ago, but when we looked at the market there simply weren’t enough companies with growth and dividends, so we parked the idea. It was only around two to three years ago, following significant structural changes in Japan, that this changed. A big part of this was the Corporate Governance Code that launched in 2015. It created a Do you view the macroeconomic different relationship between Japanese "THERE IS NO REASON WHY situation in Japan as generally supportive? companies and their shareholders.

JAPANESE DIVIDENDS Looking at structural trends, what is A problem in Japan had been that CAN’T NORMALISE. IT IS A happening in stock markets and the companies didn’t understand economy, Japan is an exciting and shareholder returns. They didn’t tend to VERY EXCITING PHASE FOR interesting place. We are potentially at interact much with shareholders and THOSE LOOKING FOR the point where we are seeing inflation, would pay a dividend only to show INCOME IN JAPAN." after a long round of deflation and low themselves as a serious and responsible interest rates. This is affecting how management team, rather than to reward companies think about capital expenditure shareholders. There weren’t many and hiring. There is an acute labour shortage in independent directors. As recently as 2010, Japan. Companies need to look at whether they hire only half of listed companies had a single more people or invest more in information technology in independent director. This meant no one challenged preparation for the moment when the labour force declines. existing practices.

The deflationary mindset is still entrenched in many cases.

There has been a dramatic change in the number of Companies initially laughed off the possibility of a rise in inflation. independent directors on Japanese boards in a short space of Now, some are starting to entertain the idea. The government is time. Now, almost 90% of companies have two or more trying to change the tax system to encourage companies out of independent directors which, in turn, should lead to more cash hoardingThere is significant change afoot in Japan. challenge to the way management treat shareholders and their dividend payments.

Can you talk about the impact on dividend payouts to date, and into the future?

Dividends in Japan have already risen significantly and there remains potential for them to rise further. The corporate cash pile has increased – Japanese companies now sit on 250 trillion yen in cash. Over half of Japanese listed companies have a net cash position, but they’re not doing much with it and it’s not earning any return. They have a 30%-35% payout ratio, compared to 60-80% for other developed markets. There is no reason why Japanese dividends can’t normalise. It is a very exciting phase for those looking for income in Japan.

What is the dividend target on the fund?

Our only hurdle is that the portfolio should yield more than the market. We don’t want to be in a situation where we have to give up growth potential to boost the yield. We believe it is more sustainable to invest in a company that can grow its earnings and dividend over time. In this way, it matches Baillie Gifford’s growth philosophy. Growth companies are the key to generating a healthy stream of growing income.

The concentration of the dividend pool in Japanese markets is a lot less than it is in the FTSE 100. According to Bloomberg, at the end of 2016 in Japan, the top 10 companies were only a quarter of the dividend pool, compared to over half of the FTSE

Important Information and Risk Factors For advisers and intermediaries only. The information contained within this article has been issued and approved by Baillie Gifford & Co Limited. Baillie Gifford & Co Limited is authorised and regulated by the Financial Conduct Authority (FCA).

Baillie Gifford & Co Limited is a unit trust management company and the OEICs’ Authorised Corporate Director. All portfolio data is source Baillie Gifford & Co at 30 September 2017 unless otherwise stated. As with any investment, your clients’ capital is at risk. The Fund’s share price can be volatile due to movements in the prices of the underlying holdings and the basis on which the Fund is priced. The index data referenced herein is the property of one or more third party index provider(s) and is used under license. Such index providers accept no liability in connection with this document. For full details, see www.bailliegifford.com/legal The views expressed in this article should not be considered as advice or a recommendation to buy, sell or hold a particular investment. The article contains information and opinion on investments that does not constitute independent investment research, and is therefore not subject to the protections afforded to independent research. Some of the views expressed are not necessarily those of Baillie Gifford. Investment markets and conditions can change rapidly, therefore the views expressed should not be taken as statements of fact nor should reliance be placed on them when making investment decisions.

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SUSTAINABILITY

THE RISE OF CONSIDERATE CAPITALISM Fund managers are increasingly being asked to play a role in ensuring good corporate behaviour, but strong ESG analysis is a crucial part of delivering shareholder returns, says Rupert Krefting, head of corporate finance and stewardship at M&G.

Companies are coming under increasing scrutiny from governments and regulators, not just for the returns they deliver to shareholders, but for the way those returns are generated.

Increasingly, investors see both the risks in poor governance and also the opportunities presented from solving long-term structural problems around the globe, such as climate change. Rupert Krefting, head of corporate finance and stewardship, leads this charge at M&G, holding companies to account, and helping the group’s fund managers make better investment decisions.

For Krefting, responsible investment is more 3 0 ADVISER-HUB.CO.UK

than just voting; it is part and parcel of being an active investor. He says: “It means investing for the long term, being active, engaging with companies and their management team, using our shareholdings to vote at AGMs. The most important part is engaging with companies; a lot of the other things can be done by passive investors. We want to be asking the intelligent questions that hold companies to account and influence management’s behaviour.”

Responsible investing comes with many names and acronyms. Krefting defines it as all the ‘non-financial’ aspects of a company’s operations; those elements that can’t be seen on

the balance sheet or profit and loss statement.

These considerations are having an increasingly profound effect on shareholder returns. He points to recent cyber-crime to show the impact of poor governance on share prices, such as when Equifax's cyber disclosure caused the share price to fall 30%.

The group’s engagement criteria are wide-reaching and they will vary their focus according to the nature of the company involved. “With a technology company, for example, emissions aren’t as relevant,” Krefting says. “But it’s crucial for oil and gas companies.

For a technology company, we want to talk more

SUSTAINABILITY

about governance and social issues, regulation or cyber security. The key thing is to draw out the relevant issues on a stock-by-stock basis.”

The analysis is a collaborative effort with the fund managers. Krefting sees his role as there to help the fund managers make better decisions, to understand the risks they are taking in individual investments, and also where the opportunities lie. He says: “Prior to a meeting with company management, we will plan what we’re going to talk to them about with our central analysts. We think about the most relevant ESG factors and draw out the key issues – whether that is health and safety, or the supply chain or how they treat their employees.”

“We are here to add value to the investment teams. It is not just about looking at the investment risks but also the opportunities. For example, with the transition to a lower carbon economy, there is such a huge investment required that there are opportunities in new investments as well as risks from stranded assets.”

At each stage, Krefting and his team are trying to have a wide-reaching conversation with corporate management teams. While some will simply want to trawl through the results presentation, he believes it is important to get beyond that and understand the real issues confronting the company.

Companies are becoming increasingly receptive to being asked these questions. Partly, he says, this is because at M&G, they take a non-confrontational, collaborative approach. He adds: “If you show that you are a long-term shareholder, and are generally supportive of the company, management will take on board what you are saying. The more shareholders start asking non-financial questions, the more corporate management teams will get used to it

and ultimately, it will influence their behavior. If no-one asks the questions, management may not take action.”

He says certain topics are more sensitive than others. For example, cyber security can be an uncomfortable topic for many companies

“WE ARE HERE TO ADD VALUE TO THE INVESTMENT TEAMS. IT IS NOT JUST ABOUT LOOKING AT THE INVESTMENT RISKS BUT ALSO THE OPPORTUNITIES. FOR EXAMPLE, WITH THE TRANSITION TO A LOWER CARBON ECONOMY, THERE IS SUCH A HUGE INVESTMENT REQUIRED THAT THERE ARE OPPORTUNITIES IN NEW INVESTMENTS AS WELL AS RISKS FROM STRANDED ASSETS.”

because it has such commercial impact. He says: “We have learned that we need to open up with ‘what do you have in place?’ rather than ‘when were you last hacked?’.”

Ideally, the team will always have time to meet management and do in-depth research.

However, this is not always possible, and the group will also do shorter reviews that the fund management teams can use quickly. This will

take in elements such as the past history of its management team, its board structure, tax and accounting and give an overall review. This can help the fund managers frame their analysis ahead of a broader review.

The biggest topic on his agenda at the moment remains climate change, where there is lots of regulatory activity. The Financial Stability Board has created a task force for climate change disclosure, for example. This looks at the physical risks to assets from climate change, and the risks in transitioning from a high carbon to a low carbon economy.

Two other areas likely to be important for companies in the shorter term are cyber security and diversity. Krefting says: “Cyber security is coming up the list of important topics pretty fast. It can be very price sensitive and is costing companies an increasing amount of money.

They not only have to contend with the expense, but also of their loss of reputation and brand. Companies will have to be more open about this in future with the new data protection regulations coming in next year.

Diversity speaks for itself, but M&G is a strong supporter of the 30% Club aiming to get greater representation of women in senior management positions.”

In addition to the financials, Krefting believes strong analysis of environmental, social, and governance criteria is likely to be crucial in delivering returns for active shareholders in the future.

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RISING RATES

FIXED INCOME IN AN UNCERTAIN WORLD Higher interest rates do not necessarily mark the start of a rate rising cycle or higher yields, argues Ben Edwards at BlackRock.

RATE OUTLOOK AND CATALYSTS FOR MOVEMENT The first UK interest rate rise for 10 years does not, in our view, mark the beginning of a traditional rate rise cycle. Govenour of the Bank of England Mark Carney's comment, when announcing the rise that “households are well positioned” for the rise appears, in our view, improbable, given depressed levels of personal saving and wage growth and limits restricting equity release from property. Even where interest rates continue rising, longer-term yields will not automatically follow. From 2004-6 there were 17 hikes to the US Fed Funds rate but 10-Yr Treasury notes remained largely range-bound. This pattern has continued as 10-Yr Treasury yields failed to rise materially over the last two years despite the announcement of four rate rises by the Federal Reserve, aided by healthy flows into fixed income. Closer to home, flows have been especially strong for the Sterling Strategic Bond category1, with fixed income investors appearing to value flexibility.

WHAT COULD HAVE DERAILED US – AND WHY IT DID NOT Global reflation has been a constant question within the global markets over the past few years. Globally US$20tn has been spent by central banks to stimulate inflation but central banks’ targets remain elusive. This is evident as US and eurozone ‘core’ inflation is now lower than when global Quantative Easing (QE) began during the financial crisis and medium-term inflation expectations have fallen from where they were just 5 years ago2.

Alongside global reflation, what has been dubbed as ‘Trumpflation’, has concerned global investors. However, despite Trump’s brash claims during his election run, so far, the US President has proved more successful in delivering anti-free trade, and anti-growth measures as well as stoking geo-political risk than enacting pro-growth, expansionary policy. Promised tax cuts, fiscal spending and deregulation have been delayed and watered down from those envisaged when Treasuries sold off in November 20163. Even as tax cuts now look more likely, the Fed will likely offset its effect, to some extent, with tighter monetary policy – given the US economy’s proximity to full capacity.

INCOME OPPORTUNITIES IN STERLING CORPORATE BOND MARKETS For fixed income, at least, we are not expecting any near or medium-term derailment to the 35-year bond bull market. Stubbornly low inflation and lower long-term policy rates from the European Central Bank and the 3 2 ADVISER-HUB.CO.UK

Federal Reserve Bank, compared with previous cycles, support government yields at lower levels. However, corporates continue to face a relatively positive backdrop for earnings and, subject to management teams’ conservatism, support the strong credit quality of companies we lend to.

We believe that valuations currently favour sterling investment-grade bonds, relative to Euro or Dollars. And given that less than half the market are bonds from specifically UK companies4, we are able to build portfolios that capture what we consider more attractive valuations but are still defensive with regard to potential Brexit risk.

Technical factors, such as continuing demand by defined benefit pension schemes, together with US$17bn of coupons and redemptions that require re-investment in the fourth quarter of this year5, will strongly support the asset class. We expect institutional demand for UK credit to remain strong and support total returns. With AAA to A-rated sterling corporate bonds returning on average less than 2% excess of government bonds annually (Figure 1), our strategy of focusing on opportunities in

RISING RATES

Total Excess Returns 2010 - 16)

Fig 1

£ Corporate Bond Index

Eur BB

BBB

A

AA

AAA 0%

2%

4%

6%

8%

Source: BlackRock, Bank of America as at 31 August 2017. Annualized benchmark and excess returns are Bank of America Merrill Lynch Sterling Corporate and Collateralized Index. Past performance is not a reliable indicator of current or future results

BBB and BB-rated corporates has benefited investors. We continue to see most value in BBB-rated sterling corporate bonds and have reduced our high yield exposure recently, as generic valuations have become less compelling.

To find out more about our Sterling Fixed Income product range please visit BlackRock.com/uk or contact your local sales representative.

Source 1: The Investment Association. September 2017 Source 2: Sources: BlackRock Investment Institute, with data from Federal Reserve and New York Fed, June 2017.

Source 3: BlackRock as at 17 October 2017 Source 4: HSBC, Markit, S&P Capital IQ. Non Financial corporates in the iBoxx GBP Corporate Index. 31 October 2017 Source 5: BlackRock, Mercer European Asset Allocation Survey 2017.

Important information This material is for distribution to Professional Clients (as defined by the Financial Conduct Authority or MiFID Rules) and Qualified Investors only and should not be relied upon by any other persons. Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority.

Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel: 020 7743 3000. Registered in England No. 2020394. For your protection telephone calls are usually recorded. BlackRock is a trading name of BlackRock Investment Management (UK) Limited. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy. Capital at risk. The value of investments and the income from them can fall as well as rise and is not guaranteed. You may not get back the amount originally invested. Changes in the rates of exchange between currencies may cause the value of investments to diminish or increase. Fluctuation may be particularly marked in the case of

“EVEN WHERE INTEREST RATES CONTINUE RISING, LONGER-TERM YIELDS WILL NOT AUTOMATICALLY FOLLOW. FROM 2004-6 THERE WERE 17 HIKES TO THE US FED FUNDS RATE BUT 10-YR TREASURY NOTES REMAINED LARGELY RANGE-BOUND.”

a higher volatility fund and the value of an investment may fall suddenly and substantially. Levels and basis of taxation may change from time to time. Any research in this document has been procured and may have been acted on by BlackRock for its own purpose. The results of such research are being made available only incidentally. The views expressed do not constitute investment or any other advice and are subject to change.

They do not necessarily reflect the views of any company in the BlackRock Group or any part thereof and no assurances are made as to their accuracy. This document is for information purposes only and does not constitute an offer or invitation to anyone to invest in any BlackRock funds and has not been prepared in connection with any such offer. © 2017 BlackRock, Inc. All Rights reserved. BLACKROCK, BLACKROCK SOLUTIONS, iSHARES, BUILD ON BLACKROCK, SO WHAT DO I DO WITH MY MONEY and the stylized i logo are registered and unregistered trademarks of BlackRock, Inc. or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners.

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Hot prospects An encouraging outlook for longterm economic growth, improving infrastructure and a renewed appetite for reform are spurring fresh investment interest in India.

A recent research trip gave me the opportunity to meet with Indian businesses and government ministers to learn more about the potential opportunities and challenges facing the country.

Did you know?

7th

India has the world’s

largest GDP level

9th

biggest stock exchange.2

223.6m

Total Indian air passenger traffic in 2016 (a rise of 17.6% over 2015). India is expected to become the largest aviation market by 2030.

123m

The number of diabetics in India by 2040 (a rise of 78% over 2015)3.

India faces pressing healthcare challenges, including a rise in developed market diseases.

19

average return % The on equity of Indian

x2

Things are changing in India. Long overshadowed by rapid growth in neighbouring Asian markets such as China, India’s reputation for bureaucracy and the often glacial pace of its economic liberalisation programme have deterred many investors.

Now, 70 years after India achieved independence, energetic Prime Minister Narendra Modi is determined to act decisively to deliver real economic change.

Recent meetings with Indian ministers and businesses left me with both optimism for the overall prosperity of the country and a belief the government is genuinely committed to business friendly reform.

Some good progress has already been made. Last year Modi launched a major ‘demonetisation’ programme – taking high value Indian bank notes out of circulation and replacing them with new ones – in a bid to crack down on corruption, raise tax compliance and drive digital money adoption. In July, the

Indian government introduced the Goods and Services Tax (GST).

This replaces existing federal and state levies to streamline domestic taxes across India, reducing complexity and should decrease bottlenecks caused by border checkpoints.

India has recently initiated some major infrastructure improvements across roads, air, ports and rail, and Modi wants to attract a wave of new foreign direct investment (FDI) by slashing business red tape.

According to government data, India attracted $60 billion in FDI in the year to March 2017, up 8% from the previous year.1 From a sectoral perspective we see attractive potential in a range of sectors, with a focus on the consumer, who will continue to benefit from rising wages and a recovery in the broader economy as well as growing access to a wider range of goods and services including cars, healthcare, the internet and financial services.

That said, the Indian economy is not without its challenges.

Widespread poverty, the sheer volume of old bad loans in the Indian banking sector and a longer term issue with regard to job creation for the large population in the future, remain challenging. But the signs are the economy is improving and India now at last has the political will to drive positive economic change.

listed firms since 2001.2

Naomi Waistell Indian power generation capacity has more than doubled in the past 10 years.4

Portfolio manager, Emerging Market Equities, Newton

1 Reuters. India scraps foreign investment board in push for more FDI. 24 May 2017. 2 Economist. Making money in India. 26 August 2017. 3 BMI and the International Diabetes Federation (IDF).

4 The Economist. Powering ahead. 29 July 2017. For illustrative purposes only.

Find out more today. www.bnymellonim.com/uk/em

IMPORTANT INFORMATION For Professional Clients only. Any views and opinions are those of the investment manager, unless otherwise noted. BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation and its subsidiaries. BNY Mellon Investment Management EMEA Limited (BNYMIM EMEA) and any other BNY Mellon entity mentioned are all ultimately owned by The Bank of New York Mellon Corporation. Issued in UK by BNYMIM EMEA, BNY Mellon Centre,160 Queen Victoria Street, London EC4V 4LA. Registered in England No. 1118580. Authorised and regulated by the Financial Conduct Authority. AB00128-049, exp 28 Feb 2018 T6289. 11/17.

POLITICAL RISK

“FINANCIAL MARKETS ARE CERTAINLY CALMER THAN THEY WOULD BE WITHOUT CENTRAL BANKS’ LIQUIDITY. IN GENERAL, THE KNOWLEDGE THAT STRONG INSTITUTIONS LIKE CENTRAL BANKS WILL INTERVENE IN TIMES OF CRISIS COMFORTS INVESTORS.” 3 6 ADVISER-HUB.CO.UK

POLITICAL RISK

SIGNAL OR NOISE: INVESTORS AND POLITICAL RISK IN 2018 Equity markets have proved resilient to recent political risks. Central banks and changes in the energy market have helped to maintain stability. The rise of populism and uncertain global growth may pose fresh challenges in 2018, says Lucy O’Carroll, Chief Economist at Aberdeen Asset Management.

Proliferation of weapons of mass destruction. Terrorism.

Populism. A newly emboldened Russia. The world is an unsettled place, but financial markets are relatively calm. A few factors could yet jolt them.

US equity markets have sustained a significant portion of their post-election gains, despite the headlines speculating over possible Russian interference in the US presidential election, North Korean missile launches and a multitude of other potentially alarming events.

Such market insouciance is not particularly unusual. Since World War II, the US benchmark S&P 500 has fallen by an average 3.5% in response to shocks ranging from the Cuban missile crisis to the 2014 Crimean conflict. It has also typically regained its pre-shock levels within an average of five days.

Financial markets are certainly calmer than they would be without central banks’ liquidity. In general, the knowledge that strong institutions like central banks will intervene in times of crisis (such as rate cuts in the wake of the 9/11 terrorist attacks) comforts investors.

The energy market may be playing a part, too. Oil prices, once a key means of transmitting shocks between markets and economies, are now far less sensitive to events in the Middle East and other oil-producing countries and regions.

The shale revolution has transformed global oil markets in the past decade, reversing a long decline in US output, challenging OPEC’s influence and helping to trigger the sharp drop in prices that began in 2014.

But there are political risks worth dwelling on in 2018.

The current pick-up in global growth may not continue. Nor would it be guaranteed to insulate investors from political and geopolitical shocks. The recent global rebound still falls short of the sort of robust, inclusive recovery that might defuse some of the tensions underlying rising populism.

The rise of populism The forces behind populism have been many years in the making and may take as long to overcome. In previous decades, broadly centrist governments responded in similar ways to economic and political events. The rise of populism appears to have broken this consensus.

Populist governments tend to have narrower, nationalist interests that are not well served through international

cooperation. In this environment, institutions such as the G20, tasked with finding international solutions to international problems, will struggle. This is a concern in calm global conditions – even more so if events take a more troubling turn.

Questioning central banks Other institutional frameworks could be tested in 2018.

Central banks may have helped calm markets, but they now face a crisis of confidence. With inflationary pressures far weaker than predicted, markets are questioning whether central banks still have a handle on how their economies work or how to respond to shocks.

If the removal of extraordinary policies does unsettle financial markets, central banks may not be able to rely on politicians to back them. Populists such as President Trump could find central banks a convenient political scapegoat during any shock. The danger is that institutional credibility is undermined just when it is needed most.

Don’t ignore familiar risks Even apparently familiar risks need to be monitored closely.

Events with a capacity for repetition, such as North Korea’s missile tests or Israeli-Palestinian tensions, can have a diminishing impact on financial markets over time. A shock feels less like a shock when it is a familiar one. Investors tend to give a metaphorical shrug. But repeat events may be symptoms of a bigger shock to come.

The rational response to these risks is to keep a calm head. After all, investors may appear sanguine because they are simply looking beyond short-term ‘noise’, focusing instead on the fundamental strengths of economies or companies. This makes sense. Adjusting portfolios to address a particular risk can be costly, and it can potentially undermine longer-term investment strategies.

Against a backdrop of global recovery and capital continuing to flow relatively freely, the economic fundamentals arguably should carry greater sustained weight than political risks. Politics is not the be all and end all, but expect it to have a big bearing in 2018.

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RETIREMENT

WORLD PENSION AGES ON THE RISE: WHEN WILL YOU RETIRE? State pension ages are rising around the world.

Schroders Head of Editorial Content, Andrew Oxlade, compares increases in different countries and suggests how people can still retire early.

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RETIREMENT

State pension ages are rising around the world.

Most countries will increase the point at which people can withdraw payments to 67 in coming decades.

Some governments have been more aggressive. The UK and Ireland will increase the age to 68, and the British government has indicated that more, even higher ages are inevitable.

The model common in most developed countries – start work at 18 to 21 and retire at around 60 to 65 - no longer looks viable as governments try to balance pension obligations with stretched public finances.

however. The government has indicated a policy of aiming to allow British citizens to spend 33.3% of their adult working lives in retirement, which is the basis for the rises outlined so far. It was also the basis for accelerating the rise to 68

THE BRITISH EXAMPLE Britain is now on to its last crop of retirees able to claim their state pension at 65. It will be set at 66 by 2020, 67 by 2028, and to 68 in 2037.

As is occurring in many other OECD countries, the pension ages of women, who tend to have a lower retirement age, are being unified.

These age hikes could be pulled forward 4 0 ADVISER-HUB.CO.UK

PENSION PLANS ACROSS THE WORLD This story is repeated across the world, and in many cases the figures make for even more damning reading.

Some countries are starting with even larger debt. The US has a debt-to-GDP ratio of 106%, Italy’s sits at 133%, and Japan’s is at around 250%.

Japan is arguably the biggest ticking time bomb of all, with no clear way to defuse the situation. Around 30% of people in Japan are aged 65 and over, a far higher ratio than any other large country. That proportion will grow rapidly given the country has the highest life expectancy globally, one of the lowest fertility rates and negligible immigration.

WHY STATE PENSIONS WILL BECOME LESS GENEROUS Rising life expectancies have also had a part to play. According to the World Bank, life expectancy at birth in the UK has risen from 75 to 82 over the past 30 years.

Additional pressure comes from a growing demographic imbalance where there are fewer workers for every retired person. This is not due solely to longer lifespans: the long-term trend in most Western countries is for lower birth rates.

Typically, the fertility rate required to replace an existing population is 2.1 children per woman.

According to the latest data, the average for the 35 countries in the Organisation for Economic Co-operation and Development (OECD) is 1.7. Many countries, including Germany, Japan and Spain sit at 1.5 or lower.

That means the ratio of workers to dependants - those who do not contribute economically – has fallen and will keep falling for decades.

Due to the confluence of these factors, government pension obligations have risen dramatically. At the same time, their ability to fund them has come under pressure.

As a result, governments have been left with little choice but to drive up state pension ages. This in turn has a knock-on effect on many private pensions, which typically use the state pension age as a guide.

least 2.5% a year, regardless of inflation, may also be removed.

SAVING FOR A DIFFERENT FUTURE

“OVER THE NEXT 50 YEARS THE COST OF FUNDING THE UK STATE PENSION IS FORECAST TO SOAR DUE, IN PART, TO INCREASED LONGEVITY. IT IS ESTIMATED THAT ONE IN THREE OF THOSE BORN TODAY WILL LIVE TO 100. THE OFFICE FOR BUDGET RESPONSIBILITY EXPECTS THE STATE PENSION COST TO RISE FROM 5% OF THE ECONOMY IN 2021-22 TO 7.1% OF GDP IN 2066-67.”

from 2046 to 2037, announced last month.

But the British government may go further.

A Department for Work and Pensions report in 2017 referenced a “32% scenario”. In this scenario, the state pension age could hit 70 by as early as 2054. In other words, those under 30 today would be working until 70. But even this could be conservative.

Over the next 50 years the cost of funding the UK state pension is forecast to soar due, in part, to increased longevity. It is estimated that one in three of those born today will live to 100.

The Office for Budget Responsibility expects the state pension cost to rise from 5% of the economy in 2021-22 to 7.1% of GDP in 2066-67. The UK government already has high debts, the equivalent of 90% of GDP. It should also be noted that the “private pension age” – the age at which you can access your own pension savings – is also likely to rise in the UK. It is currently fixed at 55 but there are plans to link it 10 years below the rising state pension age, which would see it rise to 58 by 2057.

Another question is whether the regular payments will be inadequate in the future. The UK already has one of the least generous state pensions in Europe, capped at a maximum of £159.55 a week, or £8,297 annually.

Other guarantees may also be eroded. A promise to increase pensions in the UK by at

To achieve a comfortable retirement, it would be prudent for indivduals to take on more responsibility - to create their own savings and become less reliant on state support. Research suggests this may already be happening.

The 2016 Schroders Global Investor Study, which analysed the views of 20,000 investors in 28 countries, suggested that it was the countries with the lowest expectations of state provision that demonstrated the greatest appetite to learn about investing.

In Belgium for instance, investors expected the government to provide 31% of retirement income, but only 78% wanted to know more about investment. In Hong Kong, investors said they only expect a state pension to make up 5% of their retirement income, but 94% wanted to know more about investing.

Schroders’ Lesley-Ann Morgan said: “Every country’s pension system is unique and presents its own specific challenges for an individual.

“However, for all the differences, the fundamental principles of saving for retirement and making those savings last a lifetime are very similar. Success depends on how much you contribute and when, and the rates of return you achieve.

“In retirement, the added complexity of an unknown life expectancy means careful planning is required to ensure those savings are both adequate and will last as long as possible.

“As for rising state pension ages, it is one aspect of a wider trend: government support for the retired will become less generous in the future. Individuals will need to provide more of their own retirement income. That means saving as much as they can as soon as they can.”

XXXX

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