4 Shires Investment Commentary Winter and Spring 22

Investment Commentary

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Winter and Spring 2022

Expert Asset Management Investments | Pensions | Financial Planning

Commentary contents Themes

• 2022 Investment outlook • Russia & Ukraine

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• China props up the economy?

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• Cladding crisis – who will pay?

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• Turkey currency collapse

• How safe are British regulated banks?

Markets and Investing

• Portfolio Activity & Investments: Clinigen, Gore Street Energy Storage Fund, Elementis, Diaceutics • Markets & Investment Outlook: Bond market volatility, Is gold a good inflationary hedge?, The dangers of crypto currencies Compliance & Regulations

• Risk disclaimer

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Introduction

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Welcome to the 4 Shires investment commentary for the Winter and Spring of 2022.

In this edition we look at the investment outlook for 2022 given the rising interest environment. This is affected by the Ukrainian conflict which we review in detail and examine the state of play.

Economic difficulties are not just in Western Europe, and we look at differing levels, and effects, of state intervention in China and Turkey which are both run by long standing leaders with autocratic tendencies.

We also look at two facets of the British economy, the residential housing market

following the new rules on cladding and how safe the British banking sector is.

In our Markets section we look at the steep sell-off that has been happening in global bond markets, whether gold is a good hedge against inflation today and also at the dangers of investing in crypto currencies.

If there is anything you would like to discuss in the commentary, please don’t hesitate to get in touch.

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2022* Investment * outlook *

The(recent explosion in( inflation has( caused The ( ( ( ( US Federal ( Reserve ( Bank, ( (the Fed, ( had investment markets been saying for ( ( ( ( to turn (from where( they ( ( ( ( most( of ( 2021 that ( it were, in a growth mindset, to one where expected inflation to come under (( ( ( ( ( ( ( ( ( ( control ( th value (shares are( beginning to outperform. quickly.

The inflation data on 10 ( ( ( ( ( ( ( ( ( ( (February We have ( written ( ( extensively ( (on this ( 2022 showed 7.5% annualised inflation, the development over the past few years, highest inflation rate since 1982. This has ( ( that when ( markets( turn (it will( be ( since ( risen ( to 8.3% ( in( May. ( ( ( ( warning ( cyclical ( ( (( ( ( ( ( decisively( in favour( of( cheaper, ( from inflation. ( ( ( ( ( ( ( ( shares that( benefit

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interest rates in 2022, which is a rapid rate ( tightening ( ( ( given ( (where interest ( ( rates ( have of ( the past few ( decades, ( ( but ( nowhere( been over ( ( ( (they were ( ( ( ( the near as high as during ( ( ( ( ( ( ( 1980s. inflationary periods in the 1970s and

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The graph shows that UK bonds are expected to have negative real returns of ( ( ( ( ( ( ( between minus 3.5% and minus 1.0%. ( ( (( ( ( This means that investors are expected to(( ( lower( returns (than inflation, ( ( have eroding ( ( ( ( ( ( the true value of the income and, ( importantly, the( capital repaid at( the( ( of the ( (bond.( We are of (the view( maturity ( fundamental ( ( unattractiveness ( ( ( of that( this owning government ( ( ( debt ( (US, UK ( or ( anywhere else in the developed world) ( ( ( ( ( ( will ( ( mean investors abandon government ( ( ( ( (bonds( in ( favour of equities or are prepared to accept negative returns on their investments, with all( the problems ( ( that ( would ( cause. ( (We( think the former is the base case ( ( ( ( ( for the

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yields on governmment debt to continue to ( ( ( ( ( rise until a prospect of a positive real yield ( ( ( ( ( is in sight.

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Russia and Ukraine

The recent invasion of Ukraine by the Russian army has placed European security into sharp reverse. The days of peace since the end of the Cold War and the Yugoslav war of the 1990s have ended. In this article we will look at: • Why Russia has invaded Ukraine • How long could the conflict last • What this means for geopolitics

• What this means for the world economy • What this means for investors

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Why has Russia invaded Ukraine President Putin has long resisted the eastward expansion of NATO into the countries of the former Warsaw bloc, or those that were behind the iron curtain. He has been even more sensitive about any encroachment into the independent countries that were once part of the Soviet Union, such as Ukraine and Georgia. Putin follows the teachings of Alexander Dugin, a radical theorist and far right thinker who proposes a rebuilding of the territories and influence of the Soviet Union. Dugin is also an admirer of the the methodology of Hitler, and some of Hitler’s methods can be seen in Putin’s strategy.

Putin has been using the pretext of saying Russian minorities in former Soviet Union territories are under threat from local majority nationalities, which is rarely, if ever, the case. Perhaps he believes it is true, but it is most likely to be a pretext to exercise leverage used for territorial expansion. This has taken place in Abkhazia, South Ossetia,

Transnistria and now in the Donetsk and Luhansk Oblasts (regions) in Ukraine.

In the case of Ukraine, the illegal seizure of Crimea and the ‘independence movement of the Donbas’ has created a strategic problem for Putin. The Donbas separatists are little more than Russian created movements, aided and abetted by Russian special forces. The strategic problem is that Crimea is linked to the Russian mainland by a single bridge and the Donbass region does not have control over the whole of their administrative regions, the Oblasts. Putin now wants to carve a landbridge between the two, and since 2014 we have viewed the situation in Ukraine as unfinished business.

Putin tried to solve the problem by ‘cutting the head off the snake’ by removing the democratically elected Zelensky government and get a puppet government to recognise the conquered territories in the South of Ukraine. When this failed, he has now changed his war objectives.

How long could the conflict last Putin had hoped to conquer Ukraine with a lightning, one week push to take Kiev, expecting the Ukrainian government to fold rather than fight. This miscalculation came from the retraining of the Ukrainian armed forces since the seizure of Crimea and parts of the Donbass in 2014 and the antipathy of the Ukrainians to the Russians dating back to the Stalinist period. In the 1920s and 1930s over 1.5m Ukrainianes were murdered by Stalin in what is known in Ukraine as the ‘Holodomir’.

However, Putin’s new strategic objective, which is to create a landbridge to Crimea along the Black Sea territories from Russia’s border, is more achieveable. Russian forces are pushing south from their current positions and pushing outward from Crimea. It seemed unlikely that the Ukrainians would be able to resist these movements without a lot more military hardware, and Nato has to date only sent light, handheld weapon systems.

The recent change in strategy by western countries, in particular the arrival of heavy weapons from Europe and the US, may well help to slow the Russian advance. For example, Poland has sent 240 Russian T72 tanks to Ukraine. President Biden’s recent $33bn request from Congress, which is almost certain to be approved, would mean a considerable step up in the support given to the Ukrainian military and economy at a critical point in the struggle.

If Putin does manage to carve out this landbridge, it seems likely he would then agree a ceasefire. This for Putin would be the end of his war. What we don’t know at this stage is whether Ukraine would agree to those terms. If they don’t agree, then a low intensity, guerilla war would probably ensue.

However, were the Western world to actually stop using Russian oil and gas, particularly those countries in Europe, then the war would probably stop far quicker. This embargo should also extend to metals’ supply. Dr Andrei Illarionov, Putin’s chief economic adviser (2000 – 2005), estimated

that a full oil and gas embargo would end Russian hostilities within 1-2 months.

Europe is sending billions of US$ every day to Putin’s coffers. President Zelensky’s request for a total ban is the right call, rather than increasing suffering via weapons supply and protracted conflict.

What this means for geopolitics Russia has tried for many years to disrupt the unity of Western institutions. Putin has provided loans, holidays and other incentives to populist politicians in Europe and has clearly intervened in elections. This has been quite effective, with the proof clearly in Trump’s election, Brexit (via funding for Vote Leave through Arron Banks), Italy’s Matteo Salvini, France’s Marine Le Pen and Hungary’s Viktor Orban.

However the Ukrainian invasion has united NATO and the EU in an unexpected way.

The EU has implemented some sanctions (albeit not enough due to a lack of on oil and gas embargo) and NATO has supplied sophisticated light weaponry to Ukraine which has been effective in stopping the Russian armour in certain areas.

Furthermore, Finland and Sweden, historically neutral countries, have applied to join NATO.

Russia continues to occupy an independent country, which it has done prior to the recent hostilities, overtly in Crimea and covertly in Donetsk and Luhansk oblasts (all citizens there have Russian passports). Were Russia to gain control of its landbridge to Crimea

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and the vast majority of the area inbetween, then it is likely that it would retain these areas. Putin is unready or unwilling (or both) to surrender any territory he has acquired as a result of the war.

If Putin retains Ukraine’s southeastern territories then a new Cold War would start, and this seems extremely likely. It is worth remembering that Ukraine had an estimated 19% Russian speaking population, although many prefer to remain within Ukraine and would not want to be part of Putin’s repressive Russia. 25% of NATO member Latvia’s population is Russian speaking, and a successful Russian territorial grab in Ukraine may well embolden Putin to carry on with his territorial expansion.

The Baltic States, Poland, Romania, Bulgaria and Turkey will become NATO’s front line with Russia. To this may be added Sweden and Finland. This border will be more heavily fortified, with a concomitant increase in infrastructure in addition to military weapons and increased troop levels.

For many years NATO’s defence expenditure has been shrinking, but now it will grow.

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What this means for the world economy?

The already difficult supply situation in the world has been made more complicated by the lack of raw materials from Russia. The lack of Russian oil and gas is causing price spikes and volatility in the energy markets, which has been benefiting all petroleum exporting countries and coal producers.

The coal price has been rising as it a substitute for petroleum production, at the expense of the reduction in global carbon emissions.

However, many of the European countries are heavily-dependent on these hydrocarbons for their economies, and, being landlocked, are asking for time from the EU before the mooted Russian oil ban comes into place. It is unlikely Russian gas can be replaced in mainland Europe this year or possibly next. Part of the problem has been a lack of investment in oil and gas production capacity and the ‘shutting-in’ or closing down of European fields due to low oil and gas prices. Reversing that underinvestment will take a long time. This lack of energy could be a brake on growth in Europe in the coming few years unless the Ukraine Russia situation is resolved or new supply and infrastructure can be introduced.

Sanctions of Russia’s most wealth and powerful businessmen, the ‘oligarchs’, has caused significant problems. The oligarchs cannot access any of their overseas assets that are invested in financial institutions around the world. Transactions in US$ and Euros are problematic for many of the richest Russians and their businesses.

However, not all oligarchs have been sanctioned, notably Vladimir Potanin, who controls Norilsk Nickel. Norilsk supplies 15% of the world’s Nickel that is needed for batteries to power the energy transition and 40% of the world’s palladium production.

Palladium is used in catalytic converters for cars and hydrogen powered energy cells. So there is not a level playing field for sanctions, and there are ways around for Russia and the oligarchs which they are exploiting.

Global food supply has definitely been affected by the Ukraine invasion as the country is one of the largest grain exporters in the world. Large quantities of the grain.

is exported to the poorer countries in the world, for example Egypt. The Russian control of the Black Sea makes it impossible for Ukraine to export through its primary port, Odessa. This is helping to cause food price inflation which, in turn, is causing riots and instability in the countries where large parts of the population are dependent on this food source.

The nervousness caused in Central Europe by the invasion of Ukraine has caused a boost to armament expenditure in Europe.

Many European members of NATO have been spending less than the minimum 2% of GDP for a long time. Germany, the worst offender for under-spending has committed to spend an extra EUR100bn in 2022 and 2023. It is likely that this surge in expenditure will be across NATO’s European members.

What this means for investors World markets have been shaken up by the war in Ukraine, and the sanctions that affect oligarchs and Russia have caused commodity prices to surge, particularly those of metals, oil, gas and food. Wars between superpowers, even proxy wars, are bound to have a large impact on economics and markets. The inflationary pressures from the war are causing problems for individuals and companies. We list below a selection of investments we hold for clients that we perceive to be direct beneficiaries of the current situation.

On the day of the invasion of Ukraine we increased our weightings in Bae Systems, the UK’s largest defence company. Several months prior to the invasion we had already

increased our holding in Chemring, another UK defence company. Our view is that the scale of increase in defence expenditure in Europe will favour these two companies, as well as others, and what were considered to be dull, steady cash flow stocks are now growth stocks that ought to command a higher stock market rating.

We already have exposure to commodity stocks through Rio Tinto and BlackRock World Mining, and have recently switched from BHP to Glencore on a relative valuation basis. These companies give excellent exposure to commodities where there is tight supply as well as strong demand. Valuations remain attractive in the sector given the huge need for metals for the energy transition.

The oil and gas sector is also a beneficiary of the recent surge in prices. We have modest exposure here, notably to Shell and Seplat Energy. The former has benefited from its hydrocarbon extraction in a time of high prices. The latter is a Nigerian exploration and production company with great potential.

There are other areas in the economy that are seeing higher prices as a result of the Ukraine conflict. Food products are one of these. These are famously difficult to invest in, with Cargill in the US being one of the largest agricultural food businesses.

Unfortunately Cargill is unquoted, as are many similar companies. Furthermore, food production can increase given the large amount of fallow land in the EU and elsewhere, so price spikes rarely last a long time.

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( China ( props ( up the( economy? ( ( ( ( ( ( ( ( ( ( (( ( ( ( ( ( ( ( ( ( The recent Covid outbreak in China has resulting low attendance at work and lack of ( been met ( with( unremitting lockdowns ( ( by(Xi (output( from ( firms. (The stock ( market ( ( has ( (Xinping’s ( government. ( ( This ( has( caused ( slumped ( ( over the( past year (see graph problems in global supply chains due to the

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CSI300 China stock index (April 2021 to April 2022)

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(Chart source: Bloomberg)

China has launched several rounds of that has caused a crisis of confidence in(the ( economic stimulus measures in April. The sector. were( to encourage ( first (set of measures ( ( ( ( ( ( ( lending by banks (majority owned by the Part of the reason for the government’s ( ( ( ( ( ( ( ( ( ( ( ( ( state) ( for infrastucture ( projects( as (well as ( ( desire to cool ( the ( housing ( market ( ( is because ( measures to prop up the fragile property its citizens cannot afford to buy a property (( ( ( ( than ( one ( child, ( which is(hampering sector. Infrastructure( expenditure is usually for more ( by the Chinese ( (( ( stop ( the population ( ( decline in( used government to ( the( need to ( stimulate ( economic ( ( ( However, the policy ( has backfired( as growth. However, the ( China. need to support the housing market came the housing market has cooled so quickly ( ( ( ( ( ( ( ( ( ( ( from the government’s squeeze on over- that it has caused a sudden drop in prices. ( leveraged ( ( developers ( ( such ( as Evergrande( This( has( taken( away ( consumer( confidence. ( (

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But the level of business activity has declined substantially, with only $1.7bn of IPOs in Hong Kong in the first quarter, a 90 per cent decline year on year. This is is partly due to restrictions on overseas listings and the nervous state of markets due to current economic conditions as well as the war in Ukraine. The two month lockdown in Shanghai and the rolling lockdown in Beijing is stifling economic growth. It is likely that the economy will contract in the second quarter.

In addtion, Chinese consumers are not spending in the way they did in the first lockdown.

Measures to stimulate the economy include reducing reserve requirements at banks, which means reducing how large the reserves the bank need to hold against specific types of economic activity. With lower reserve requirements, banks can increase their lending. Other measures included infrastructure spending. However, increased lending and infrastructure spending doesn’t work if businesses do not need to invest and infrastructure is already well invested in China. The former will see investment into bad businesses which will encourage bad loans to grow and the latter type of investment will likely see low value infrastructure that won’t meaningfully increase the country’s productivity.

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Xi Xinping will face the largely rubber stamp central committee of the communist party meeting in the Autumn at which he aims to be appointed leader for life. He will point to the relative success of the communist party’s approach versus the approach of the West and its far higher

death rates. However, the risk is that with a difficult economy there will be unrest, or, to be precise, more unrest than there is currently.

We do not believe his appointment to be in jeopardy, but predicting global events recently has been unreliable. What is more concerning is the effect a slowing Chinese economy could have on global growth given that Chinese growth accounts for 20% of global GDP growth from now until 2026.

With consumer confidence at low levels, shipping facing huge delays and factory output at low levels, China’s problem could become the world’s problem.

Turkey currency collapse

The Turkish Lira has endured multiple currency crisis in recent years, but what makes the current crisis unique is that it is not caused by the country’s economic fundamentals as it has in the past, but almost entirely by the actions of its president, Recep Tayyip Erodgan. The Lira dropped by almost 50% against the dollar in 2021 and so far shows no sign of a recovery in 2022.

The problems started when Erodgan fired well-respected central bank chief Naci Agbal in early 2021 and replaced him with party loyalist Sahap Kavcioglu. This action alone led to the lira dropping by 15%, although it recovered somewhat in the following weeks before 500 basis points of rate cuts in late 2021 saw the currency plummet. Erdogan is convinced that cutting interest rates will boost exports and generate high economic growth ahead of the general election next year and declared himself the ‘enemy of interest rates’.

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Turkish Lira/Euro – ECB – 1 year performance

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Erdogan’s support ratings have been Cladding crisis – Who will pay? following a( similar (trajectory ( to the ( Lira, ( ( ( ( ( ( ( ( The debate about illegal and dangerous with his political party, the AKP, losing ( ( ( ( ( ( ( ( ( ( ( ( ( cladding has been on-going since the control of (Istanbul and in the ( Ankara ( ( 2019( (Grenfell( Tower fire ( in ( 2017 ( in which( 72 elections. ( (Opinion ( (polls suggest ( ( voters( are people ( ( died. At first,( high-rise ( ( tower blocks deeply unhappy with the economy, with ( ( ( ( ( clad in similar ( ( materials ( ( ( to Grenfell were the three ( out (of four ( Turks in January ( ( saying ( the (subject( of( scrutiny, but ( the( scale ( of the ( government was mismanaging the economy (MetroPoll 2022). Erodgan has promised to project became apparent in 2020, when bring inflation under control, but with his ministers guided that over 800,000 UK unwillingness to raise interest rates, the homes should be assessed for fire risk. Until inflationary spill over effects of the Ukraine the work to make the properties safe is either "crisis and supply chain pressures, means that fully costed or complete, valuers cannot assess the buildings worth, preventing he will have his work cut out. lenders from issuing mortgages on those

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properties. This has effectively made hundreds of thousands of homeowners stranded and unable to sell.

Michael Gove, Secretary of State for Housing and Communities, is pursuing the housebuilders to stump up the cash needed to solve the safety issues. There is no confirmed figure yet, but £4bn across the housebuilders with profits over £10m is thought to be the number the government is likely to request/impose. Gove recently proposed a new Building Safety Bill, which includes measures such as blocking planning permission and not signing off building control on new developments for those developers who have not overhauled the cladding on buildings they built. More importantly, the bill will also allow building owners to take legal action against manufacturers who use defective products on developments that have since been found to be unfit for habitation. The power will stretch back 30 years and allow the recovery of costs which have already been paid out.

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This is not only an issue for the housing building sector and for those stuck in unsellable properties. The Prudential Regulation Authority (PRA) are increasingly concerned about the impact the cladding crisis might have on financial stability. They claim the government has not yet grasped the scale of the cladding crisis and expects that the cost to mortgage lenders will be larger than those outlined so far. The PRA has been urging mortgage lenders, including Lloyds and Nationwide, to conduct thorough audits of their loan books to determine how much capital is at risk because of the crisis.

We expect to have clarity on the government’s decision by the end of March, which should reduce the uncertainty on the listed housebuilding sector in the UK and provide some relief to trapped homeowners.

How safe are British banks?

The Bank of England in 2021 has reviewed the banking sector, assessing it during a period of severe economic turbulence. They asked the 8 largest UK regulated banks what would happen if the following economic scenario were to happen:

• GDP were to fall by 9%, with a sudden spike down at the beginning of the drop

• This drop to follow on from the problems arising from Covid in 2020 • GDP to drop by 37% over a 3 year period when compared to 2019’s GDP

• UK residential and commercial property to fall 33% in value

• Unemployment to surge by 5.6% to reach 11.9% • Unemployment and growth to begin to recover later, but output to remain suppressed relative to 2019

• No further government stimulus during the period

What might seem like a near perfect storm of financial stress should, in a normal scenario, cause a banking crisis. But not this time.

Banks ended 2021 with strong balance sheets rebuilt during the financial crisis and protected by government support for businesses during Covid. Tier 1 capital against which these big banks lend

amounted to 16.5%. Bear in mind that Royal Bank of Scotland went into the financial crisis with a circa 7.3% tier 1 capital ratio which evaporated very quickly due to the financial losses incurred by the bank and its customers.

The Bank of England has set a reference rate of capital to show banks today are expected to weather the current storm. This is circa 7.7%, although it varies depending on the bank. All banks were above this level.

The charts below show how the stress tests in 2019, 2020 and 2021 came out.

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Portfolio Activity & Investments

The invasion of Ukraine by Russia has set the pace for global financial markets at a time of rising interest rates. We have responded where we felt it was appropriate, but portfolio turnover has remained modest as we feel our clients’ holdings are, to a large extent, well positioned for the current economic environment.

We have benefitted from a few takeover bids, notably Clinigen, the pharmaceutical business, and we are awaiting clarity on a bid in residential care business, Caretech, from the founders. We have benefitted from the surge in electricity price rises and increased usage of battery storage in the Gore Street Energy Storage Fund. Our holding in chemical company Elementis has been less beneficial so far, but we remain confident of our investment thesis and figures have shown continuing growth in profitability. We increased our holding in the UK’s largest defence company, BAE Systems, on the day of the invasion of Ukraine. This has aided performance.

Finally, for our AIM portfolio clients we have initiated a position in Diaceutics, a company that is vital to the success of many of the new drug development breakthroughs.

This is particulary important for AstraZeneca, another key client holding, who are Diaceutics largest customer.

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Clinigen

We exited our position in global pharmaceutical and services company Clinigen following a bid for the company.

UK based private equity group Triton were the acquirors and increased their bid price to 925p per share in cash, up from 883p in December, in order to clinch the acquisition.

Clinigen specialises in niche commercial drugs and offers services that run clinical trails, helps with distribution, and helps with areas such as packaging and medicine sourcing.

The largest shareholder in Clinigen was Elliott Associates, managed by legendary money manager Paul Singer. The fund was rumoured to be interested in taking Clinigen private itself, however they seem satisfied with the latest bid by Triton.

* Street * * * * Gore Fund * * Energy * Storage * *

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The 3 producing assets in Texas that are more (( (during ( ( ( ( ( ( ( ( ( ( ( ( ( ( ( ( ( ( ( ( ( ( ( ( ( fund offers battery energy storage solutions frequently used than the European ( ( (( (( (( (( (( ((((

for the grid network’s customers. The ( ( ( ( balances( ( energy supply (( (( during company periods of generation ( ( low solar(( or (wind ( ( as ( ( well as(being used by generation businesses (( (( (( ( ( (( to access( the (( load. (( (( ( ( peak demand

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** Elementis

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17

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( ( ( ( ( ( ( products ( ( in Asia ( and ( the( use ( A (new ( position in( speciality( (chemicals ( personal care (company ( ( ( ( ( ( ( ( ( ( Elementis was started in Q4 of of talc in manufacturing to reduce single use ( ( company (rebuffed 2 takeover ( ( plastics. ( The ( ( shares ( trade on ( 1.1x (book 2021. The ( ( rivals( at (130p (and 160p in( the last ( value, significantly ( ( (lower than the ( long-term ( bids from ( ( ( ( ( ( ( ( ( ( 12 months, which should underpin the share average of 1.4x. At the recent trading ( the( short-term. ( ( (Elementis ( ( (is update in April, ( ( revenues( were up ( 7%( yearprice (over vertically ( (integrated, ( ( owning ( many ( of its(raw on-year( and the ( company ( ( announced ( it material inputs, which provides a level of might sell its high value chromium business. ( (( ( ( ( ( ( ( ( ( ( ( ( cost Elementis highlight ( (inflation control. ( ( ( is well ( ( We( believe ( that any ( disposal would ( (( positioned growth markets, for ( the ( ( in structural ( ( ( ( value( of( the (remaining business. ( (

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example the growing demand for premium

* * BAE Systems

(

18

The is BAE the ( UK’s ( largest( defence contractor ( ( ( The( invasion of( Ukraine ( ( has highlighted ( Systems, the old British Aerospace.

The UK gaps in European defence and the ( ( ( ( ( ( ( ( ( ( ( ( and of the ( many ( ( countries ( ( within ( ( NATO(( dependence ( ( on the ( US within( NATO. ( (( have been spending insufficient sums on Many countries have announced increased ( ( ( ( ( ( ( ( ( ( ( ( ( defence ( (over the ( past( 20( years.( The UK’s ( ((expenditure, ( ( with Germany ( ( ( announcing ( ( military effectiveness is at a low ebb, with the EUR100bn of increased allocation to ( ( ( ( ( ( ( ( ( ( ( ( British Army unable to fight on two fronts defence. BAE sits between the US and ( ( ( ( ( ( ( simultaneously as frontline troops are now Europe and operates across multiple product down men.( The(Royal Navy ( areas ( to only( 75,000 ( ( including ( ( naval shipbuilding, ( (fighter ( has 2 carriers but still lacks the Joint Strike jets (they have circa 12% of the revenue of ( ( ( ( ( (( ( ( ( ( Fighter squadrons to equip them and there the F35, the Joint Strike Figher), land are insufficient ships to fulfil the carrier systems (tanks and other tracked vehicles) as support role. well as cyber security and electronic systems.

(( ( ( ( ( ( ( (

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( ( (

* Diaceutics

( is( a( company that ( works ( with( the Diaceutics ( (pharmaceutical ( ( companies ( ( in( the( largest ( to provide ( them (( with( data ( on (the(best world testing (diagnostic) for each( ( ( laboratories ( ( product sold. They are able to access ( across ( ( ( of the (phases( of drug ( revenue several development ( ( and into ( (production. ( ( ( ((

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While this ( ( sounds a( simple ( ( task, ( their( database is critically important for the drug ( ( ( ( ( ( companies. Many of the newer drugs will ( ( ( ( ( ( only work on patients with specific criteria.

These new generation, targeted ( ( ( ( ( drugs can cost tens or hundreds of thousands of ( ( ( ( pounds for a course and so the speed and accuracy of finding if a patient will benefit

(

( from ( the drug ( can mean millions ( of extra( ( (profits( for the ( companies, ( as well as( ( (improved (patient outcomes. ( ( ( ( ( (

The company has developed a web-based portal( for to( access ( drug companies ( ( the ( information which is accelerating growth ( ( ( ( ( ( at the company.

Diaceutics is at an early stage( ( ( ( ( ( ( of development and we expect earnings to ( ( ( ( ( ( ( from the current 2.46p per share ( rise rapidly ( ( ( ( ( ( expected for 2022 to circa 4p per share in ( 2023. If surplus cash is taken off the ( valuation, ( the ( p/e ( multiple for( Diaceutics ( ( ( could ( ( be 37.6x for(( December 2022, ( ( (falling ( to 22x December 2023.

( ( ( ( ( ( ( (

" 19

Markets & Investment Outlook

In this section we look at a few topical areas of financial markets. In the first article we look at bond market volatility, which has seen steep falls in bond prices and losses for bondholders. We also look at whether gold is an effective hedge against inflation.

Finally, we review the dangers of cryptocurrencies in the light of the current phase of ‘risk-off ’ in markets.

Bond market volatility

The recent turmoil in the bond markets is unsurprising although dramatic. The Federal Reserve Bank (the Fed), the US central bank, has removed the extra liquidity it was pumping into the bond market. In addition, the Fed has started tightening the benchmark Fed Funds interest rate 0.5% at a time and will continue to do so until inflation appears to be under control. In other government bond markets, inflation relative to bonds implies significant, albeit very late, tightening. For example, UK inflation in the second half of 2022 is expected to exceed 10% while UK interest rates languish at 1%, and in the Eurozone, inflation is circa 8% while the ECB interest rates are 0%.

20

So why do we say the bond market turmoil is unsurprising? Inflation was thought to be beaten as a result of the world’s economic policies, notably monetarism. However, since the Covid outbreak and, to an extent, over the decade and a half since the financial crisis, monetary policy has been extremely loose. This is due to the printing

of money via Quantitative Easing, bond buying by central banks and ultra-low interest rates in the main markets of the developed world (US, Japan and the Eurozone). At times the interest rates in the Eurozone and Japan have been negative. If you print enough money and pump liquidity into the financial system, you will get inflation. Coupled with supply shocks coming out of China, high energy prices as a result of the Russo-Ukraine war and tight labour markets due to low birth rates, the result is explosive inflation. The yawning gap between key central bank lending rates, inflation and government bond yields can only result in one outcome – falling bond prices and rising bond yields (see table below).

Governments in the developed world have been working to get inflation back into the financial system to erode the future value of the bond payments they have to make.

However, this is playing with fire in monetary terms because once inflation becomes entrenched in financial systems it can be very difficult to get shot of it.

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Global Bond yields, Inflation and Interest Rates

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The global bond markets have fallen significantly over the past year. The table below shows ( ( ( ( ( ( (( ( ( ( (( ( the losses that have occurred in local currency terms (i.e. unhedged) for the major global ( ( ( ( ( ( ( ( ( ( ( ( bond indices.

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21

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What markets are really concerned about is where bond yields might peak from here.

There is resistance around 3.2% on the key global benchmark bond, the US 10 year Treasury. It approached this level recently and then retreated. We expect this level to be breached at some point this year.

In the UK, given the enormous disparity between inflation and interest rates, it is much harder to gauge the destination of 10 year bond yields. Until bond yields exceed inflation, it is hard to know when they might peak. Economists are divided about the destination of rates. Some are saying a recession will come sooner than elsewhere in the world, thereby eviscerating the need to raise rates much. However, other economists are saying that interest rates must rise meaningfully to tame inflation. I suspect a level nearer 4% to 5% is a level that will choke off any inflation. The effect on the economy may be severe, but the wealth of the nation could decline a lot more if sterling depreciates further. This is what Bank of America are currently predicting, and they estimate the GBP/USD exchange rate could fall to $1.10 in the next 12 months from its current $1.25 level.

Higher interest rates could prevent some of that drop, but many believe economic performance must improve substantially first, which may be difficult if Britain enters a trade war with the EU over the Northern Ireland protocol.

22

What is certain is that bond market volatility, notably falling prices and rising yields, will continue until the financial markets feel that they have confidence in central banks and governments’ desires to tame inflation.

Is gold a good inflationary hedge?

Inflation is now a primary concern for investors. The huge monetary stimulus following the pandemic created vast demand for goods and services with limited supply.

Furthermore, the crisis in Ukraine has only heightened the inflation fears with the price of oil hitting 14 year highs, whilst nickel and wheat also hit record highs. So where can investors get protection from inflation? Gold is a proven long-term hedge against inflation but its performance in the short term is less convincing.

From the 1970s to the early 1980s there was a strong correlation between high inflation and strong gold returns. According to a study by the World Gold Council, since 1971, gold has returned 15% per annum on average when inflation has been higher than 3%, compared to just over 6% per annum when inflation is under 3%.

However, if we look at the data more closely, one can observe that, although gold appears to offer a reasonable hedge over the long term, its credentials in this aspect are less clear over shorter time periods. As shown in the chart above, the relationship between gold and inflation has been weaker over the last couple of decades than at any other point. The argument for this weaker relationship is that we have been through a period of low inflation. Now that inflation is rising (dramatically) for the first time in over a decade, the expectation is that the gold price will increase. However, it is important to look at what drives the gold price. As gold does not pay an income, have a maturity

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Gold price chart (1970 to 2022)

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*

" 23

The Dangers of Cryptocurrency

Cryptocurrencies have become a major financial asset in the last few years, particularly over the last 24 months. They have essentially become a new asset class as an alternative to more traditional forms of investing. So popular have the likes of Bitcoin, Ethereum and Ripple become that, according to a study by NerdWallet, almost a third (31%) of 18- to 24-year-olds would rather invest in cryptocurrency than save into a workplace or personal pension! In many cases this is because of the perceived risks involved in investing in pensions, with over a quarter (26%) of young adults saying that they were reluctant to save into a pension because they felt it was too risky. However, the risks involved in investing in this asset classes are far more apparent than other classes and are discussed below.

24

Even someone with little knowledge of cryptocurrencies will likely be aware of how volatile they can be. Huge price swings have become part and parcel of the cryptocurrency landscape. Between July and October 2021 alone, Bitcoin traded both below £22,000 and above £48,000. These boom-and-bust periods can make it very hard to predict the long-term price performance of cryptocurrencies. And while that is true of any investment, the scale of the volatility seen in the cryptocurrency sector and the tendency for prices to move for dubious reasons – as a result of tweets posted by Tesla’s Elon Musk, for example – means you must keep in mind how sharp and sudden losses in crypto value can be. When buying cryptocurrencies, you bear more of the responsibility for the storage of your assets than you would with other investments. You will store your cryptocurrencies in a digital crypto wallet, encrypted with a private key.

Since these private keys are extremely long,

you will also be given a 12 word phrase known as a seed phrase, which can be used to recover funds and access your wallet. If you forget this phrase, or lose your copy of it, your cryptocurrency assets will very likely be lost forever. This means investing in cryptocurrencies can leave you at the mercy of human error, which is no small thing.

The aspects of cryptocurrency storage that make them prone to human error are also puts make them in danger of hacking and other security breaches. In August 2021, for example, $600 million (£433 million) in cryptoassets were stolen when the Blockchain site Poly Network was hacked. Digital crypto wallets, such as mobile and desktop apps, are also called ‘hot wallets’. This means that, while they are easily accessible as they are stored online and are heavily encrypted, the internet connection required means they are not 100% safe from hackers.

At present, cryptocurrencies are largely unregulated and decentralised (although if global governments have their way, this may change in the future). In fact, for many, that is their biggest appeal. Yet this also leaves investors without regulatory protection in the case of theft and hacking, and at risk of encountering cryptocurrency scammers. Due to this, and the extreme price swings possible in crypto, the Financial Conduct Authority (FCA) even goes as far as saying that investors should be prepared to lose their entire investment.

We view cryptocurrencies as uninvestable as we are not sure what we are buying, we can’t trust where they are stored and increased regulation is likely to remove investors, some of whom are criminals, from the market.

Investment Outlook

Bond and Stock markets in the first half of the year have continued to be in a tug of war between whether growth or value investments will be more attractive. Global technology shares have been under pressure, although we still believe that further losses are highly likely as volumes are still modest relative to a financial capitulation of confidence that is usually seen at the end of what has been a frothy and enormous bull market.

However, value shares and those with some measure of inflation protection are performing better and are likely to continue to do so. Many of these stocks are found in the UK and this has helped to make the UK one of the best performing markets in the world this year.

As mentioned above, we expect bonds to perform poorly in the second half of this year, and possibly beyond. Inflation rates

are too high for current interest rate levels and central banks are playing catch up to reality having been surprised by the strength of inflation.

With regard to currencies, we favour the US dollar as likely to remain a safe haven for investors cash, and it is beginning to offer increasing yields. We expect sterling to remain weak, with the Euro somewhere in between GBP and USD.

Rising interest rates and wages coupled with a supply shock are not a recipe for benign asset markets, and we remain cautious for global growth prospects in 2022. However, proactive asset management is critical in these times and at 4 Shires we remain cognisant of the risks to client wealth from the current situation.

JLS/DIS/HAH – 2/6/22

D

25

80.00%

4 Shires investment performance

70.00%

Time Weighted Return

60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00%

1 year

2 years

3 years

4 years

Risk D

2.29%

34.64%

18.35%

18.12%

Risk E

3.30%

34.64%

15.52%

14.35%

Risk F

0.53%

26.06%

10.93%

14.35%

Risk G

0.35%

29.62%

15.34%

18.88%

Risk I

4.97%

35.09%

12.60%

13.22%

UK IMI

6.92%

33.37%

8.72%

10.08%

Risk A Risk B

Graph to 6th June 2022 (source: 4 Shires) showing the average performance of all of the portfolios on each risk scale.

26

D

5 years

6 years

7 years

8 years

9 years

1.52% 24.11%

42.82%

35.64%

52.90%

57.61%

21.22%

41.20%

35.78%

61.47%

20.25%

43.06%

40.14%

58.44%

60.74%

25.95%

46.68%

40.98%

64.75%

71.37%

20.15%

34.34%

31.00%

48.87%

69.80%

18.84%

46.96%

36.01%

42.00%

58.92%

Notes: Performance is measured to 05/06/2022. All 4 Shires performance figures are net of management fees, VAT, stamp duty and commi ssi ons. Total return measures include dividends and income received. Time weighted return measures consider deposits and withdrawals to/from the portfolio. The performance for each risk scale includes every portfolio in that risk scale at that time.

Disclaimer: The value of investments and the income you get from them may fall as well as rise, and there is no certainty that you will get back the amount of your original investment. You should also be aware that past performance may not be a reliable guide to future performance.

27

Important - Compliance Section

In this section of the commentary, we would like to remind our clients and prospective clients of the following regulatory topics:

Customer Protection – The Financial Services Compensation Scheme

Clients are reminded that the UK has a generous financial compensation scheme that can provide redress to clients that have suffered financial losses due to bad advice outside the normal scope of market movements. In addition, if a firm were to fail, then customers may receive compensation.

The amounts of compensation that can be received for investments are up to £85,000 per person, per firm.

The payouts are funded as a levy on all regulated firms in the sub-sector of the industry that the firm operates in.

28

The details on the scheme can be found at: www.fscs.gov.uk.

At 4 Shires we sincerely hope that you will have no reason to complain about our services as we always strive to offer high standards of advice to all our clients.

Furthermore, we maintain a strong balance sheet against market turbulence with capital in excess of the FCA’s requirements.

If clients wish to complain, please contact us immediately and we will give it our earnest attention and respond as promptly as possible. All complaints need to come via 4 Shires Asset Management. If you are not satisfied with the response of 4 Shires, you have the right to take the matter further to the financial ombudsman (www.financialombudsman.org.uk) for review.

Risk Disclaimer

The value of investments and the income you get from them may fall as well as rise, and there is no certainty that you will get back the amount of your original investment. You should also be aware that past performance may not be a reliable guide to future performance. This document is not intended as investment advice.

Any security mentioned in this commentary is for information purposes only and is not a recommendation to buy. 4 Shires, its clients and its staff may own some of the investments that we mention in this report.

D

4 Shires Asset Management 01747 824600 info@4-shires.com www.4-shires.com

4 Shires Asset Management Limited is authorised and regulated by the Financial Conduct Authority (FR3N number 557959). Company number 7657527