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  • Market review

    Market review

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    The second quarter of 2018 was primarily driven by US dollar strength, which had a significant impact on the performance of a range of assets

    The second quarter of 2018 was primarily driven by US dollar strength, which had a significant impact on the performance of a range of assets. The performance of Growth assets was generally mixed with significant divergence between emerging and developed markets. Within equity markets, emerging markets underperformed meaningfully, owing to a combination of the stronger dollar and more idiosyncratic issues from areas such as Turkey, Argentina and Mexico which weighed on broader risk sentiment. UK equities were the strongest performers, while US equities were also somewhat stronger against a backdrop of strong domestic earnings. Japan equities followed closely behind, and euro-zone equities also posted modestly positive returns. High yield markets meanwhile produced marginally negative returns. Emerging market debt endured a difficult quarter with significant retail investor outflows from the asset class. Local currency bonds underperformed hard currency bonds meaningfully, primarily owing to the strength of the dollar while some specific domestic issues also weighed on sentiment for the asset class.

    Within Defensive assets, the US dollar was the significant standout performer as it continued to gain traction as the safe-haven asset of choice, supported by strong economic data and healthy upside inflationary pressure. Relatedly, both the Japanese yen and euro weakened significantly over the quarter, reversing the trend from preceding quarters. Longerdated US Treasury yields ended the period relatively flat, after fluctuating over the quarter. The yield curve continued to flatten driven by a sell-off in the short end. Within uncorrelated assets, Gold prices continued to fall over the quarter as the prospect of rising interest rates in the US reduced its appeal as a non-yielding asset.

    At a glance - our asset class views

    ---o+++
    Equities
    North America  
    Europe ex UK  
    UK  
    Japan  
    Asia ex Japan  
    Emerging markets  
    ---o+++
    Government Bonds
    North America  
    Europe ex UK  
    UK  
    Japan  
    EM Hard Currency  
    EM Local Currency  
    IG Corporate Bonds  
    HY Corporate Bonds  
    ---o+++
    Currencies
    US dollar  
    Euro  
    Sterling  
    Japanese Yen  
    Asia ex Japan  
    Emerging Markets  

      View for the coming 6 to 12 months* Previous quarter's view

    *Views of Investec Asset Management’s Multi-Asset team and reflect preferences within respective asset class. As at 30.06.18.

    Key themes for the coming 6-12 months


    • Late cycle and signs of overheating – monetary policy is responding while growth slows to trend rate
    • Near-term recession risks – excluding a shock, risks are low but spending power is being squeezed
    • Liquidity withdrawal – “Quantitative tightening” will reduce liquidity over the year, offsetting positive growth impetus.

    For professional investors and financial advisors only. Not for distribution to the public or within a country where distribution would be contrary to applicable law or regulations.

    Important Information

    The information included here is not for general public consumption. If you are a retail investor and receive it as part of a general circulation, please contact us at +44 (0)20 7597 1900. The information discusses general market activity or industry trends and is not intended to be relied upon as a forecast, research or investment advice. The economic and market forecasts presented herein reflect our judgment as at the date shown and are subject to change without notice. These forecasts will be affected by changes in interest rates, general market conditions and other political, social and economic developments. There can be no assurance that these forecasts will be achieved. Past performance should not be taken as a guide to the future, losses may be made. Data is not audited. Investment involves risks: Investors are not certain to make profits. Where index performance is shown, this is for illustrative purposes only. You cannot invest directly in an index. Investec Asset Management does not provide legal and tax advice. The information contained in this document is believed to be reliable but may be inaccurate or incomplete. Any opinions stated are honestly held but are not guaranteed and should not be relied upon. This communication is provided for general information only and is not an invitation to make an investment nor does it constitute an offer for sale. This is not a recommendation to buy, sell or hold a particular security. No representation is being made that any investment will or is likely to achieve profits or losses similar to those achieved in the past, or that significant losses will be avoided. The securities or investment products mentioned in this document may not have been registered in any jurisdiction. In the US, this communication should only be read by institutional investors, professional financial advisers and, at their exclusive discretion, their eligible clients, but must not be distributed to US persons apart from the aforementioned recipients. In Australia, this document is provided for general information only to wholesale clients (as defined in the Corporations Act 2001). In Hong Kong, this document is intended solely for the use of the person to whom it has been delivered and is not to be reproduced or distributed to any other persons; this document shall be delivered to institutional and professional investors only. It is issued by Investec Asset Management Hong Kong Limited and has not been reviewed by the Securities and Futures Commission of Hong Kong. The Company’s website has not been reviewed by the SFC and may contain information with respect to non-SFC authorized funds which are not available to the public of Hong Kong. In Singapore, this document is for professional investors, professional financial advisors and institutional investors only. In Indonesia, Thailand, The Philippines, Brunei, Malaysia and Vietnam this document is provided in a private and confidential manner to institutional investors only. In South Africa, Investec Asset Management is an authorised financial services provider. Investec Asset Management Botswana, Unit 5, Plot 64511, Fairgrounds, Gaborone, Botswana, is regulated by the Non-Bank Financial Institutions Regulatory Authority. In Namibia, Investec Asset Management Namibia (Pty) Ltd is regulated by the Namibia Financial Institutions Supervisory Authority. This is the copyright of Investec and its content may not be reused without Investec’s prior permission. Outside the US, telephone calls may be recorded for training and quality assurance purposes. Issued by Investec Asset Management, April 2018.

  • A letter from your PM



    Variable geometry

    - A letter from Philip Saunders,
    Co-Head of Multi-Asset Growth

    Philip Saunders

    There are some impressive examples of ‘variable geometry’ in nature – swifts and peregrine falcons have an extraordinary ability to adjust their aerodynamic profiles in flight – but, despite the claims, this ability is rare in the investment management world. Asset allocators who appear to have been particularly successful at navigating major bear markets in the past on closer examination have generally done it as the result of structural or stylistic biases, as opposed to timely asset allocation choices. More often than not, ‘bull capture’ in the subsequent recovery and growth cycles has been disappointing. So few asset allocators have consistently demonstrated the ability to vary their portfolios to optimise their performance in both bull and bear market conditions.

    Why is this the case? Market timing is not impossible, but it just happens to be difficult. In an ideal world we would have significant strategic exposure to growth assets for most of the time, scaling exposure back aggressively into phases of cyclical overheating and then redeploying back into growth assets at significantly higher risk premia, when positioning has been sufficiently washed out. Having one’s cake and eating it as it were. It sounds relatively straightforward but in practice we know it is anything but. History does repeat itself in markets in terms of cyclical behaviour, but variability and timing can differ greatly. De-risking too early can be as damaging in terms of opportunity costs and long-run returns as being too late. The strongest returns tend to be made at the start of a typical cycle and towards its end.

    So, if we accept that primary asset allocation is difficult, what should we do as investors? We could simply stick to our strategic knitting and hold an appropriate mix of assets on a genuinely long-term basis hoping that cyclical volatility simply ‘comes out in the wash’. Retrospectively, this may have been an effective strategy given the long (and connected) secular bond and equity bull markets that have prevailed since the early 1980s. Even so, this would have arguably left a lot on the table, particular in the secular equity bear market that followed the heady ‘dot-com’ peaks Variable geometry A letter from Philip Saunders in March 2000. Certain exposures within asset classes and some asset classes themselves display high degrees of cyclicality, periodically offering extremely attractive returns but often insufficient compensation over the longer term.

    We believe that it is possible to improve on basic buyand- hold strategies, both in terms of returns and risk efficiency, but that conventional purely top-down decisionmaking frameworks are inadequate. Our ‘Compelling Forces’ decision-making methodology is designed to help us align the strategic asset allocation of our portfolios to cyclical conditions. Put simply, we should be prepared to ‘vary’ portfolio ‘geometry’ when conditions dictate. It makes sense to progressively moderate exposure to growth assets as evidence of later-cycle overheating accumulates – putting up with some opportunity costs if need be – but also to have a high propensity to rebuild exposure to growth assets when risk premia have risen substantially. We accept that valuation alone tends to be a particularly poor timing tool, which is why we combine it with analysis of fundamentals factors – both cyclical and other – and consideration of market price behaviour. Such decisions can be materially improved upon if ‘bottom up’ signals play a significant role in the assessment of each asset class and as sources of verification or nonconfirmation of macro indicators. On the one hand, these may typically consist of individual and clusters of securities, such as cyclical versus non-cyclical sectors or combinations of varying balance sheet quality and on the other local surveys of micro conditions.

    The other key consideration is a requirement for effective structural diversification at all times to provide portfolio resilience. In this regard we use a ‘Growth’, ‘Defensive’ and ‘Uncorrelated’ classification of holdings which focuses on their behaviours individually and collectively under stress. This provides the necessary insulation from unforeseen events, and, crucially, the ability to re-allocate, as a capital provider, to the episodic opportunities arising from periods of stress.

    Philip Saunders
    Co-head of Multi Asset Growth

  • Equities

    Equities

    ---o+++
    Equities
    North America  
    Europe ex UK  
    UK  
    Japan  
    Asia ex Japan  
    Emerging markets  
    The US economy remains the key driver of global economic growth. Consumer and business sentiment is at all-time highs, and earnings growth continues to underpin US equities

    North America

    -- - o + ++
    North America  

    The US economy remains the key driver of global economic growth. Consumer and business sentiment is at all-time highs, and earnings growth continues to underpin US equities. Quantitative tightening from the US Federal Reserve (Fed) poses a challenge to most Growth assets, not least US equities, suggesting a more volatile outlook.

    We retain our preference for high-returning companies with earnings visibility that appear cheap given their cash-generating abilities.

    Europe ex UK

    -- - o + ++
    Europe ex UK  

    Fundamentals are relatively supportive, with strong sales growth and a generally more supportive macroeconomic backdrop for the euro zone, although this continues to moderate somewhat. Valuations do not yet appear a constraint to further upside.

    Longer term, any normalisation from the European Central Bank (ECB) through tapering is a potential headwind, while political risks from countries such as Italy do remain, although they are somewhat more contained.

    UK

    -- - o + ++
    UK  

    We retain our neutral stance towards UK equities. Fundamentals and valuations alike are mixed with the former looking more favourable in areas like homebuilders, while areas like media and retail appear relatively cheap. However, neither appear overly compelling.

    Sterling continues to drive the overall direction of performance, with UK equities enjoying a strong second quarter amid sterling weakness. Uncertainty remains around Brexit negotiations as attention increasingly turns to March 2019 when the UK is scheduled to formally leave the EU.

    Japan

    -- - o + ++
    Japan  

    Japanese equities remain a long-held core theme of ours. Valuations continue to appear attractive and fundamentally there are strong stock buyback trends providing attractive opportunities at the company level. We are focused on companies with improving profitability driven by ‘self-help’ initiatives including capital efficiency.

    Longer term, tightening from the Bank of Japan (BoJ) or any protracted period of yen strength are concerns, although it would take a meaningful move from current levels for either to become a significant hindrance.

    Asia ex Japan

    -- - o + ++
    Asia ex Japan  

    For Asian equities broadly, fundamentals are still weak relative to other emerging markets and structural issues continue to act as a constraint, as reflected by our score.

    In China, policy planning has been consolidated and centralised to focus explicitly on supply-side reform. China appears to be serious about the current reform programme, which should support the structural prospects for the Chinese economy and its equity market.

    Emerging markets

    -- - o + ++
    Emerging markets  

    Emerging market equities are supported by the relatively robust late cycle environment, against a backdrop of supportive global growth. Valuations are also undemanding versus history and attractive relative to developed markets, particularly after a weaker second quarter.

    The asset class has seen an increase in long institutional positioning over the past 18 months, although positioning is not stretched given the extent to which the asset class has been shunned for the past five years.

      View for the coming 6 to 12 months* Previous quarter's view

    *Views of Investec Asset Management’s Multi-Asset team and reflect preferences within respective asset class. As at 30.06.18.

  • Bonds

    Bonds

    ---o+++
    Government Bonds
    North America  
    Europe ex UK  
    UK  
    Japan  
    EM Hard Currency  
    EM Local Currency  
    IG Corporate Bonds  
    HY Corporate Bonds  
    We view US Treasuries as one of the cheaper areas of the developed market government bond space

    North America

    -- - o + ++
    North America  

    We view US Treasuries as one of the cheaper areas of the developed market government bond space. While the US economy continues to perform strongly and the Fed is slowly normalising monetary policy, much of this is already priced into US Treasuries, particularly further out along the yield curve.

    An unexpected bout of second-round inflationary pressure (prices and wages moving higher together, accelerating inflation) or the expansionary fiscal programme could, however, still see upward pressure on yields.

    Europe ex UK

    -- - o + ++
    Europe ex UK  

    The improvement in the euro-zone economy and the ECB’s normalisation of monetary policy, against a backdrop of expensive valuations, make any sustained rally in core euro-zone bond yields appear unlikely.

    In peripheral countries, we note the political situation remains fragile in select areas such as Italy and we remain negative on the outlook for these bond markets. Such bond markets have also benefited from quantitative easing from the ECB which is set to be unwound in due course.

    UK

    -- - o + ++
    UK  

    After the Bank of England (BoE) decided against raising interest rates in May with inflation falling, UK assets reacted by pricing in a more dovish outlook. However, the BoE appears committed to normalising policy and the recent bounce in economic data supports this.

    With UK gilts flagging as expensive on our monitors, we believe yields are likely to sell off as the BoE looks to hike interest rates.

    Japan

    -- - o + ++
    Japan  

    The Japanese government bond market remains largely dominated by the BoJ, with measures such as direct yield targeting limiting the scope for yields to move either way in the short term.

    However, we expect to see scope for the Bank to shift its yield target higher or to reduce bond purchases as the Japanese economy strengthens.

    Emerging Markets Hard Currency

    -- - o + ++
    Emerging Markets Hard Currency  

    We remain relatively cautious around hard currency debt, primarily due to extended positioning. The rising LIBOR rate environment, and the related likely rotation from leveraged ‘yield tourists’ as the relative appeal of less risky assets increases, is also a headwind for the asset class.

    Like other emerging market assets, the fundamentals remain relatively positive on balance, although this is more than offset by the technical factors described above.

    Emerging Markets Local Currency

    -- - o + ++
    Emerging Markets Local Currency  

    Our view on emerging market local currency bonds has moderated somewhat over the past quarter. While the inflationary environment remains supportive, valuations appear less attractive relative to areas of developed markets and indeed hard currency bonds.

    That said, we still see opportunities in select areas such as Indonesia where fundamentals remain robust and valuation appears compelling.

    Investment Grade

    -- - o + ++
    IG Corporate Bonds  

    While fundamentals are still positive, with favourable leverage and corporate earnings trends, expensive valuations continue to weigh on the prospects for the asset class as a whole with corporate spreads looking particularly tight.

    Market price behaviour is also generally looking less supportive with the ECB looking to halt corporate bond purchases in December of this year, and with investor inflows generally subsiding.

    High Yield

    -- - o + ++
    HY Corporate Bonds  

    Like with investment grade markets, the fundamentals are sound, with strong leverage and corporate earnings dynamics, while market price behaviour support is again diminishing as an indirect consequence of the ECB’s proposed tapering of investment grade bond purchases.

    Valuations are again the main constraint with spreads against government bonds particularly tight. The asset class remains a beneficiary of the late cycle environment but as history has proven, high yield corporate credit is often one of the first casualties of any recession.

      View for the coming 6 to 12 months* Previous quarter's view

    *Views of Investec Asset Management’s Multi-Asset team and reflect preferences within respective asset class. As at 30.06.18.

  • Currencies

    Currencies

    ---o+++
    Currencies
    US dollar  
    Euro  
    Sterling  
    Japanese Yen  
    Asia ex Japan  
    Emerging Markets  
    We believe the Japanese yen is the most attractive major currency in our universe

    US Dollar

    -- - o + ++
    US dollar  

    While the US dollar is helped by robust economic growth and tightening monetary policy, the currency remains relatively expensive with downside pressure from a growing twin deficit (fiscal and current account).

    We believe the tailwind of higher rates is in the price and other opportunities elsewhere appear more attractive, particularly after its second-quarter rally.

    Euro

    -- - o + ++
    Euro  

    After a series of relatively disappointing data prints, the euro has weakened somewhat improving valuation further from last quarter. A pick-up in data, coupled with the prospect of ECB normalisation which is looming ever closer, should prove supportive for the currency.

    However, in the more medium term, downside risks exist given structural concerns about weak inflation and wages, where any upside pressure has typically been fairly limited and transitory.

    Japanese Yen

    -- - o + ++
    Japanese Yen  

    We believe the Japanese yen is the most attractive major currency in our universe. Japan’s economy is growing strongly, with inflation showing signs of picking up while the yen is very cheap, particularly against the US dollar.

    The currency also remains attractive as a Defensive asset and, as such, is a useful hedge for our portfolios, particularly as we reach the later stages of the business cycle.

    Sterling

    -- - o + ++
    Sterling  

    Like with UK gilts, sterling has priced in a more dovish outlook from the BoE after a decision not to proceed witha rate hike in May. As such, valuation appears relatively attractive against a backdrop of somewhat improving fundamentals.

    Sterling has largely been trading within a range recently, and we would expect this to continue to some extent as the market continues to reappraise the prospects of both Brexit and rate hikes.

    Asia ex Japan

    -- - o + ++
    Asia ex Japan  

    Asian currencies still look particularly vulnerable to further downside. We view these currencies as expensive while investor positioning is long.

    Many Asian economies also still appear at the peak of their financial cycles. This dynamic will likely undermine their economies and we expect the currency markets to bear the brunt of any adjustment process that will be necessary. Several of these currencies, such as the Korean won, are also likely to come under pressure from protectionism as President Trump steps up his agenda.

    Attractive valuations still support the currency, while much of the good news from positive economic data appears priced in. More broadly, medium-term risks lie to the downside due to structural concerns about weak inflation and wages, where any upside pressure has typically been fairly limited and transitory.

    Emerging Markets

    -- - o + ++
    Emerging Markets  

    In an asset class with significant regional variation, we remain positive on select, attractively valued currencies. Fundamentally, we favour countries with a strong terms-oftrade underpinning with less reliance on US dollar financing.

    More broadly, a synchronised global recovery in economic growth points to reduced downside risk, although a leg higher in the US dollar will put further pressure on many of these currencies, not necessarily limited to just those with higher amounts of US dollar debt.

      View for the coming 6 to 12 months* Previous quarter's view

    *Views of Investec Asset Management’s Multi-Asset team and reflect preferences within respective asset class. As at 30.06.18.