Tilley Bestinvest - Newsletter

August 2014 6 Chesterfield Gardens, Mayfair, London, W1J 5BQ

tilneybestinvest.co.uk

020 7189 2400

info@tilneybestinvest.co.uk

Market & Economic Update MARKET COMMENTARY

Gareth Lewis CHIEF INVESTMENT OFFICER

Sophie Muller RESEARCH ANALYST

Developed market equities dipped into negative territory at the end of the month as investors reacted to more robust US economic data and the prospect of the US Fed raising interest rates earlier than expected. High yield bonds also suffered, as the asset class experienced a third successive week of big investor redemptions.

Meanwhile emerging markets equities continued to rebound from their Q1 2014 lows, spurred on by more positive manufacturing and GDP growth reports from China.

Outside of France and Germany, Eurozone business activity grew at the fastest pace since August 2007; however risks remain that expanded sanctions against Russia could derail the fragile recovery. In the meantime deflationary concerns persist, with the July inflation rate falling further to 0.4%.

In the US, Fed Chair Janet Yellen played down fears of a possible asset bubble at her July congressional testimony, advocating that equities, real estate and corporate bonds were in line with normal values; albeit acknowledging that prices in leveraged loans and high yield bonds may be inflated. Her comments followed the publication of the latest annual report from the Bank of International Settlements which suggested low interest rates had lulled financial markets into a false sense of security, a view which was subsequently echoed by the head of the International Monetary Fund in July. According to the published minutes of its June policy meeting, the Fed is on track to end the tapering of its stimulus programme by October.

Chart of the Month: US GDP accelerates in Q2 CHART OF THE MONTH EXPLAINED:

4

3

2

Performance

The US Department of Commerce announced that US real GDP grew by 4.0% in the second quarter of 2014, buoyed by upturns in personal consumption and private inventory investment, and beating economists’ average expectations of a 3.0% increase. This rebound from a 2.1% first quarter contraction, revised up from first estimates of a 2.9% fall, somewhat confirms the argument of officials at the Federal Reserve that the first three months of 2014 were an anomaly largely due to unusually severe weather conditions. These data, coupled with improving labour market conditions are in line with the Fed’s ongoing action to scale back its asset-purchase programme, expected to end by October 2014.

5

1

0

-1

-2

-3

Q4 2010

Q1 2011

Q2 2011

Q3 2011

Q4 2011

Q1 2012

US real GDP growth (Quarter on Quarter, annualised)

Q2 2012

Q3 2012

Q4 2012

Q1 2013

Q2 2013

Q3 2013

Q4 2013

Q1 2014

Q2 2014

Source: Thomson Reuters Datastream

Market & Economic Update August 2014

OUR VIEW – ASSET ALLOCATION SUMMARY GENERAL SUMMARY

• Our long-term view is largely unchanged and we continue to believe our more cautious outlook is rational. Global growth remains fragile despite underlying strength in the US, while China remains a major concern to the global economy in the medium term • While the Fed’s decision to maintain the rate of taper has helped create short-term stability, we believe it to be behind the curve and complacent over the prospects of rate tightening • Excess liquidity has decreased yields year to date, and continues to drive investor behaviour further along the risk spectrum • The distorting impact of excessive monetary stimulus is apparent across all asset classes • We have decided not to make any changes to the current allocations following the asset allocation committee meeting

EQUITIES

• The equity re-rating looks to be complete, reflecting greater political and economic confidence.

Developed world equities are expensive against their own history and are approaching fair value relative to bonds • Returns are being driven by excess liquidity rather than earnings growth and intra-equity correlations are high • US equities appear expensive on most valuation metrics, although resilient 2014 earnings forecasts have somewhat justified their premium rating • The recent rally in European equities has removed most of the valuation anomaly, although more pro-active ECB policy should provide further support and weaken the currency • Strong performance in Asia Pacific and Emerging Market equities has removed much of the valuation anomaly

FIXED INCOME – QUALITY BONDS & HIGH YIELD BONDS

• The market is currently being driven by technicals. Corporates have taken this opportunity to refinance at lower yields, meaning default rates are unlikely to rise in the near term as the ‘refinancing wall’ is pushed out • The fundamental outlook for credit continues to be supportive. However, valuations look compressed relative to recent history • Lack of bank lending continues to drive an increase in the size of the high yield market, with issuance year to date on track for a record year

PROPERTY

• This asset class provides a high yield and low correlation relative to other asset classes • Our preference is for UK commercial bricks & mortar, rather than listed property securities which have a high correlation to equity

COMMODITIES

• The asset class has rebounded due to an improvement in Chinese data and a bounce in emerging markets • The possibility of rising US inflation and interest rates has also been seen as a positive for the asset class, increasing demand

2

Market and economic update

Market & Economic Update August 2014

NORTH AMERICA, UK AND WESTERN EUROPE

• The US economy grew at an annualised rate of 4% in the second quarter of 2014, beating expectations of 3%, confirming that the recovery in the world’s largest economy is gaining momentum and adding to pressure on the US Federal Reserve with regards to raising interest rates.

• Eurozone inflation fell to 0.4% in July, according to flash estimates from Eurostat, down from 0.5% in June and below analyst expectations of 0.5%. This means inflation in the region is at a four-and-a-half-year low, last seen in October 2009 when prices fell 0.1%.

• According to Istat, Italy’s national statistics office, the Italian economy is unexpectedly back in recession, as GDP contracted by 0.2% in the second quarter of 2014 following a 0.1% contraction in the first three months of the year.

• These latest data releases from the Eurozone increase the pressure on the European Central Bank to take action, after keeping policy rates unchanged at its June meeting.

• UK inflation accelerated unexpectedly in June, to the highest level seen this year, at 1.9% year on year compared to 1.5% in May. Given subdued inflation has been a key reason behind the Bank of England’s ability to keep interest rates low, this has given rise to increased speculation of a rate hike.

Returns over last six months denominated in local currencies S&P 500 – PE: 18.7x, Yield: 2.1% FTSE 100 – PE: 13.4x, Yield: 3.5% DJ Euro Stoxx 50 – PE: 24.1x, Yield: 3.5%

10

5

0

JAN14

FEB14

Dow Jones Euro Stoxx 50 TR S&P 500 TR

Market and economic update

MAJOR DEVELOPED COUNTRIES’ EQUITY MARKETS

15

FTSE 100 TR

3

• US non-farm payroll rose less than expected in July, adding 209,000 jobs compared to 298,000 the previous month. The unemployment rate in the US remained relatively unchanged at 6.2%.

DEVELOPED MARKETS, PERCENTAGE GROWTH, TOTAL RETURN

Performance (%)

• The FTSE 100 TR index outperformed both the Eurostoxx 50 TR and S&P 500 TR indices in July in local currency, albeit falling by 0.12% over the month. The Eurostoxx 50 fell by 3.38%, mainly due to ongoing political fears, while the S&P 500 fell by 1.38% reflecting positive macroeconomic data which in turn reignited concerns of a sooner-thanexpected rate rise. In sterling terms, the Eurostoxx 50 TR index and the S&P 500 TR index returned -4.37% and -0.12% respectively.

MAR14

APR14

MAY14

JUN14

JUL14

Source: Lipper for Investment Management

Market & Economic Update August 2014

JAPAN, ASIA AND THE EMERGING MARKETS • Asia Pacific and emerging market equities sustained their strong performance through July, outperforming developed market equities, as the MSCI AC Asia Pacific ex Japan TR and MSCI Emerging Markets TR indices rose by 4.20% and 3.06% respectively. Both markets produced positive performance in sterling terms as well, returning 4.88% and 3.32% respectively.

• Key drivers of this strong performance in July included Chinese second quarter GDP growth of 7.5% year-on-year which was in line with expectations and an increase in the HSBC China Manufacturing PMI to 51.7, although this was revised down from its flash estimate of 52.0.

• The Topix TR index continued to rise in July, by 2.13% in local currency terms and 1.90% in sterling terms as corporate earnings in Japan profited from a weaker yen.

• Annual inflation in Japan fell to 3.60% in June, as the impact of the increase in consumption tax lessened slightly. The Bank of Japan has estimated that this tax hike added

2% to core inflation, and given the slowdown in energy prices is adding to the downward pressure, it is likely the Central bank will struggle to reach its 2% target.

• Inflation in Brazil slowed in July to 6.50%, after increasing for fiveconsecutive months, and remains within the Brazilian Central bank’s target range.

• The Russian Central bank increased its benchmark policy rate in July, by 0.50% to 8.00%. This action has been taken as geopolitical tensions continue to cause inflationary risks in the country.

• The Chilean Central bank took the opposite stance in July, cutting interest rates for the first time this year, by 0.25% to 3.75% as inflation in the country continues to exceed target, in the short term.

• Indian equities rallied after the newly elected government, headed

by Prime Minister Narendra Modi, revealed a budget intending to improve growth in the country and bolster foreign investment.

ASIAN & EMERGING MARKETS, PERCENTAGE GROWTH, TOTAL RETURN 16 14 12

Performance (%)

10 8 6 4 2 0 -2 -4 -6

JAN14

FEB14

MSCI AC Asia Pacific ex Japan TR

MAR14

APR14

MAY14

JUN14

Source: Lipper for Investment Management

Topix TR MSCI Emerging Markets TR

Topix PE: 16.2x, Yield: 1.8 % (Country yields and PEs relate to a sample of stocks that cover at least 75% of each market’s capitalisation and are denominated in local currency) 4

Market and economic update

JUL14

Market & Economic Update August 2014

• Duration sensitive fixed income assets rallied during July, while a selloff in risk assets meant the high yield bond market was the worstperforming fixed income market in July; the BofA Merrill Lynch Global High Yield TR index fell by 1.41% in dollar terms (falling 0.16% in sterling terms). The fall in high yield value was largely due to outflows from the sector, highlighting the long discussed lack of liquidity in bond markets.

• This compares to the BofA Merrill Lynch Sterling Corporate Bond TR index which increased by 0.48% during the month.

• UK Gilts were one of the bestperforming fixed income sectors in July, with the UK 10-year gilt yield falling due to continued geopolitical risks in both the Ukraine and the Middle East. While US 10-year treasuries increased modestly over the month, many peripheral European sovereign yields rose, due to increased political tensions and the need for an extended accommodative policy from the European Central Bank going forward.

• Portuguese sovereign debt suffered as a result of the apparent urgent need to recapitalise Banco Espirito Santo, one of Portugal’s main banks.

• China’s domestic bond market avoided its second-ever default during July, after the Shanxi local government arranged for Huatong Road & Bridge to repay its bond principal in full, somewhat contradicting the Central government communication that defaults were necessary for the market to re-establish discipline.

5

Market and economic update

FIXED INTEREST MARKETS, PERCENTAGE GROWTH 6

5

Performance (%)

FIXED INCOME

4

3

2

1

0

JAN14

FEB14

MAR14

BofA Merrill Lynch Eur Currency HY Const Hdg GBP BofA Merrill Lynch Sterling Corporate Bond TR

APR14

MAY14

JUN14

JUL14

Source: Lipper for Investment Management

Market & Economic Update August 2014

• The Japanese yen weakened meaningfully against the US dollar in July. Although Japanese equities performed strongly during the month the previously strong correlation between the equity market and currency in Japan has begun to diminish.

• Sterling appreciated relative to the euro and Japanese yen in July, by 1.03% and 0.23% respectively.

However, the currency weakened against the US dollar by 1.28%.

CURRENCY RETURNS RELATIVE TO GBP, PERCENTAGE GROWTH 1

0

Performance (%)

CURRENCIES

-1

-2

-3

-4

-5

JAN14 Euro Japanese yen US dollar

6

Market and economic update

FEB14

MAR14

APR14

MAY14

JUN14

JUL14

Source: Lipper for Investment Management

Market & Economic Update August 2014

COMMODITIES • Both the S&P GSCI index and the Bloomberg Commodity Index (previously Dow-Jones UBS Commodity index) fell in July, by 5.30% and 4.98% respectively.

• The top-performing S&P GSCI subindex in July was S&P GSCI Coffee, returning 11.39% during the month and 76.20% year to date.

This follows a downgrade on 2014 crop estimates from Terra Forte, the Brazilian coffee trader, which in turn has raised concerns about next year’s harvest and coupled with unseasonal rains in the region has muddied the supply picture.

• The next best performing sub-indices were S&P GSCI Zinc and Aluminium, which returned 6.80% and 5.65% respectively. For a second consecutive month, both S&P GSCI Live Cattle and Feeder Cattle were among the best performers, in July returning 4.83% and 3.96% respectively.

• The worst performing sub-index by quite some margin was S&P GSCI Lean Hog, falling by 22.32%. This was followed by S&P GSCI Corn, Cotton and Natural Gas, which fell 14.75%, 14.47% and 13.90% respectively.

• Year to date the Bloomberg Commodity index has returned 1.74%, outperforming the S&P GSCI Index which increased 0.12%.

Individual commodity returns have been diverse over the period, ranging from 76.20% to -25.72%.

S&P GSCI Coffee has been the best performing, returning 76.20% as previously mentioned. The worst performing sub-indices include S&P GSCI Cotton, Soybeans and Corn, returning -25.72%, -16.29% and -15.40% respectively.

COMMODITIES PERFORMANCE – JULY 2014 11.39

Coffee 6.80

Zinc

5.65

Aluminium

4.83

Live Cattle

3.96

Feeder Cattle

2.94

Cocoa

2.86

Lead 1.29

Copper -1.19

Platinum -2.86

Nickel Heating Oil

-2.87

Gold

-2.97

Silver

-3.06

Gas Oil

-3.18

Brent crude

-4.94

Bloomberg Commodity Index

-4.98 -5.30

S&P GSCI index

-6.50

Soybeans

-6.83

U.S. crude oil Unleaded Gasoline

-8.08

Wheat (COB)

-8.18 -8.61

Sugar -10.64

Wheat (Kensas) -13.90

Natural Gas Cotton

-14.47

Corn

-14.75

Lean Hog

-22.32 -25

-20

-15

-10

-5

0

5

10

15

Returns (%) Source: Thomson Reuters Datastream

Commodity monthly performance, July 2014. Indices highlighted in red. Data in the above table in US Dollars.

7

Market and economic update

Market & Economic Update August 2014

HEDGE FUNDS

HEDGE FUND RETURNS, TOTAL RETURN

• The HFRX Global Hedge fund index was the worst performing of the HFRX sub-indices in July, returning -0.84%. The remainder of the subindices returned between 1.81% and -0.47% over the month.

1.8

1.6

Performance (%)

• HFRX Macro/CTA and HFRX Equity Market Neutral took top spot this month, returning 1.81% and 1.50% respectively, followed by HFRX RV: FI-Convertible Arbitrage which increased by 1.34% in July.

2

0.8

0.6

0.4

0.2

0

• Year to date HFRX ED: Distressed Restructuring remains the best performing sub-index by quite some margin, returning 4.44%. Given its poor performance in July, the worst performing sub-index year to date is now HFRX Equity Hedge, returning -2.19%.

JAN14

MAR14

APR14

MAY14

JUN14

JUL14

Source: Lipper for Investment Management

MONTHLY IPD RETURNS 2.5

2

Performance (%)

• Capital growth in June for the industrial, office and retail sectors were 1.90%, 2.10% and 1.10% respectively.

FEB14

HFRX Global Hedge Fund GBP

• The IPD UK Property Monthly Total Return index increased by 2.09% in June, compared to 1.57% in the previous month.

• While income returns remained steady at 0.50%, property values rose by 1.59%, the highest monthly figure since March 2010.

1.2

1

• The only other HFRX sub-indices to post a negative performance in July were HFRX Equity Hedge and HFRX Equal Weighted strategies, which returned -0.29% and -0.47% respectively.

PROPERTY

1.4

1.5

1

0.5

0

OCT13 Capital growth

NOV13

DEC13

JAN14

FEB14

MAR14

APR14

MAY14

Income return

* Index data is released mid-month and therefore figures are only available with a one month lag 8

Market and economic update

JUN14

Source: Thomson Reuters Datastream

Market & Economic Update August 2014

DATASHEET – LATEST MARKET RETURNS TO THE 31 JULY 2014 PERCENTAGE RETURNS FOR MAJOR ASSET CLASS INDICES. Market

1m

3m

6m

2013-14

2012-13

2011-12

2010-11

2009-10

3 Year

5 Year

S&P 500 TR

-0.1

3.0

6.5

5.0

29.2

14.3

14.2

20.5

55.1

113.4

FTSE All-Share (Ex-IT) TR

-0.3

-0.3

4.5

5.6

24.3

0.5

14.9

19.3

31.9

80.7

FTSE 100 TR

-0.1

0.0

5.4

5.3

22.0

0.7

14.2

18.2

29.3

74.4

FTSE Europe ex UK TR

-3.7

-4.0

2.4

4.1

36.0

-12.8

12.6

11.9

23.6

55.7

FTSE EuroTop 100 TR

-2.2

-2.3

3.9

4.3

29.2

-8.1

12.3

11.1

23.8

54.4

EuroStoxx 50 TR

-4.3

-4.1

2.5

5.6

38.0

-17.5

7.1

5.3

20.2

35.5

Topix TR

1.9

10.4

3.1

-0.2

29.0

-7.2

8.4

5.8

19.5

37.0

MSCI AC Asia Pacific ex Japan TR

4.9

8.8

13.9

7.3

11.4

-5.2

15.7

22.9

13.4

61.2

MSCI Emerging Markets TR

3.3

8.5

12.9

3.9

5.7

-9.5

12.4

27.3

-0.6

42.2

Numis Smaller Companies (Ex-IT) TR

-1.1

-2.4

-2.9

10.2

40.4

-1.4

24.2

25.7

52.7

138.4

BofA Merrill Lynch Eur Currency HY Const Hdg GBP

-0.3

1.1

4.4

11.2

18.0

7.0

8.6

33.5

40.4

103.4

Markit iBoxx Sterling Corporates TR

0.5

1.5

3.2

5.8

6.2

10.1

7.0

16.0

23.7

53.6

BofA Merrill Lynch Sterling Corporate Bond TR

0.5

1.6

3.0

5.9

5.6

11.2

7.6

17.0

24.3

56.4

Euromoney Global Mining TR

6.2

7.5

11.4

8.0

-15.0

-29.5

25.0

28.7

-35.3

4.1

Bloomberg Commodity TR

-3.8

-7.2

-1.3

-8.9

-9.5

-7.2

15.8

12.5

-23.5

-0.3

S&P GSCI TR

-4.1

-3.4

-0.9

-10.5

4.0

-2.9

16.7

5.3

-9.6

11.0

Gold Index

-0.7

-0.1

0.2

-12.0

-16.2

4.3

32.9

31.8

-23.1

34.7

FTSE WMA Stock Market Balanced TR

0.1

1.4

4.7

4.7

16.6

3.7

11.7

15.1

26.6

62.7

FTSE WMA Stock Market Growth TR

0.0

1.4

5.1

4.7

20.1

1.8

12.7

16.3

28.0

67.8

FTSE WMA Stock Market Income TR

0.3

1.2

4.1

4.4

11.9

5.7

10.8

13.5

23.5

55.3

LIBOR GBP 3 Months

0.0

0.1

0.3

0.5

0.6

1.0

0.8

0.7

2.1

3.6

US Dollar

1.3

0.0

-2.7

-10.2

3.3

4.8

-4.6

5.9

-2.8

-1.8

Japanese Yen

-0.2

-0.7

-3.5

-14.1

-17.9

3.5

7.1

16.3

-27.0

-9.1

Euro

-1.0

-3.5

-3.4

-9.5

11.4

-10.2

5.2

-2.7

-9.5

-7.3

*1 Year ending 31 July. Source: Lipper (to 31 July 2014 in GBP. Currency movements are vs. sterling.)

9

Market and economic update

Market & Economic Update August 2014

IMPORTANT INFORMATION The value of your investments, and the income derived from them, can go down as well as up, and you can get back less than you originally invested. Any indication of past performance or quoted yields should not be considered a reliable indicator of future returns. Before investing in funds, please check the specific risk factors on the key features document or refer to our risk warning notice, as some funds can be highrisk or complex, or can be susceptible to risks particular to the geographical area or industry sector in which they invest. Prevailing tax rates and relief are dependent on your individual circumstances and are subject to change.

Any research or analysis contained in this document has been undertaken by ous for our own use and may be acted on in that connection. The contents of the document are based on sources of information believed to be reliable; however, save to the extent required by applicable law or regulations, no guarantee, warranty or representation is given as to its accuracy or completeness. The document may include forward-looking statements which are based on our current opinions, expectations and projections.

It is provided to you only incidentally, and should not be considered a personal recommendation or advice to invest. Any opinions expressed are subject to change without notice.

The Tilney Bestinvest Group of Companies comprises the firms Bestinvest (Brokers) Ltd (Reg. No. 2830297), Tilney Investment Management (Reg. No. 02010520), Bestinvest (Consultants) Ltd (Reg. No. 1550116) and HW Financial Services Ltd (Reg. No. 02030706) all of which are authorised and regulated by the Financial Conduct Authority. Registered office: 6 Chesterfield Gardens, Mayfair, W1J 5BQ. 130814-0623 10

Market and economic update