Building a diversified portfolio with insurance linked ... · 7 Building a diversified portfolio...

For professional investors or advisors only Issue 9 | FOuRTH quaRTeR 2013

Building a diversified portfolio with insurance linked securities Funds

Schroder ISF1 EURO Corporate Bond

Schroder ISF EURO Equity

Schroders and Cazenove – a dream marriage with a successful future

Special feature

Schroder Property: Many REITs cheaper than ever before

The globalisation paradox

Miscellaneous

Fish and chips in newspaper

Cover photo: Daniel Ineichen

Schroders ExpErt Q4/20132

Contents

2 Contents

3 Editorial

News from schroders

4 News

feature

7 Building a diversified portfolio with

insurance linked securities

12 Questions for Daniel Ineichen

INvestmeNt Ideas

14 A good year for Patrick Vogel –

manager of the Schroder ISF EURO

Corporate Bond

fuNds

18 Schroder ISF EURO Corporate

Bond

22 Schroder ISF EURO Equity

28 Schroders and Cazenove – a dream

marriage with a successful future

33 Top performers

markets 35 Are emerging markets about to

retreat?

42 Market overview

specIal features

44 Schroder Property:

Many REITs cheaper than ever before

mIscellaNeous

50 History of Schroders: Schroders at

the height of the industrial revolution

servIce

51 Who we are

51 Publishing information

1 Schroder International Selection Fund is referred to as Schroder ISF throughout this publication.


Editorial

Things are really tough for investors right now. For several

years investment cycles have not been as regular and

predictable as they used to be. Instead, they are becoming

increasingly hard to forecast, and market opinion is divided.

On the one hand, economists are warning of rising

inflationary pressures, saying it is just a matter of time before

the quantitative easing by central banks all around the world

starts to have an impact on the real economy, and we all

have to start worrying about inflation.

On the other hand, experts in Europe in particular are

worried about the rising threat of deflation. The current

cocktail of weak demand, excess supply and monetary

easing is said to be sowing the seeds of deflation by creating

a zombie economy. In view of this, the only reason why

Europe has not yet been feeling the impact of deflation is

because tax increases, especially import duties and VAT, are

still concealing the underlying deflationary pressure.

So investors are facing a dilemma: which of the two

scenarios should they be braced for, and how can they best

protect their portfolios? Solutions are not just complicated

and expensive; for most investors they are hard to imagine.

First you have to correctly assess both the current situation

and a possible future scenario, which is no easy task: even

central banks often get their forecasts wrong.

Investors have a wide choice of interesting asset classes

available to hedge their portfolios against the risk of inflation:

commodities, infrastructure investments, index-linked bonds,

gold, currencies and farmland, for instance. However, they

should really only buy assets like this as a protection against

inflation if they are prepared to hang on to them until inflation

actually emerges. The same applies in the opposite direction:

however effective a strategy is in protecting against deflation,

it is only useful if that scenario materialises. If you are unsure

what you want to protect your assets against, you can end

up paying an unnecessarily high risk premium for assets that

either do not hedge your return or, in the worst case, reduce

it to below the market return.

A balanced multi-asset fund can use all the asset classes

needed to generate regular income while protecting against

short-term market turmoil. How long these are held is

decided by a professional. This leaves the portfolio managers

free to react flexibly to changes in market direction and

adjust the strategy to looming dangers at any time. They are

the ones responsible for limiting the impact of scenarios on

the portfolio – whichever may actually come to pass.

Multi-asset products are a complete solution for long-term

investors, offering optimal protection in times of uncertainty.

Whether inflation or deflation prevails, capital preservation is

in the hands of the experts. Where it belongs.

Yours

Inflation or deflation? Now what?

Ketil PetersenCountry Head Nordic Region


News from schroders

Notices

+ + + New Head of Product Development + + +

On 1 November 2013, Divyesh Hindocha will start as Head of Product Development and Defined Contribution at schroders, strengthening the team. He joins from consultants Mercer, where he spent more than 20 years in the investment division. Most recently, he was Global Director of Consulting, running the strategic research capacity of Mercer worldwide. He will be taking over the role held by Gavin Ralston on a temporary basis since his promotion to become Head of Official Institutions. Gavin will now be focusing solely on his own responsibilities.

Mark Lacey has been hired to join the schroders global energy equities team as joint fund manager. He and John Coyle will together manage Schroder ISF Global Energy and Schroder ISF Global Small Cap Energy. Mark has over 17 years’ experience in the global energy sector. He joins from commodities trader Mercuria Global energy solutions and previously spent over four years at Investec asset Management running its flagship Investec GsF Global energy and Investec GsF enhanced Global energy funds. Prior to that, he held a senior role at Goldman sachs as co-head of the energy team and has been recognised as the top oil and gas analyst in the Thompson Reuters extel awards. Mark will report to Peter Harrison, Head of equities, and in addition to acting as joint fund manager will also be advising the global equity team on energy stocks.Ben Wicks is also joining the energy team as a global sector specialist. From 1999 to 2002, Ben worked as a sector specialist at schroders covering basic materials, before leaving to join the uK government as a senior analyst for geopolitical risks.

+ + + mark lacey adds power to the schroders energy team + + +

mark lacey

divyesh hindocha


News from schroders

2 Source: Schroders. As at: 30 September 2013. The data relates to share class A, acc., EUR. 3 Source: Schroders. As at: 30 September 2013. 4 Source: S&P. As at: 30 September 2013 5 Source: Cazenove. As at: 31 July 2013. 6 Source: Schroders. As at: 30 September 2013.

+ + + maximiser fund range reaches almost eur 3 billion + + +

The Maximiser range, which mainly consists of dividend funds (income products), has now grown to around euR 3.1 billion6. It comprises a total of six retail and two special funds, of which two are also authorised for investors in the Nordic countries. Investors can chose between the ISF European Dividend Maximiser and Schroder ISF Global Dividend Maximiser, depending on whether they want a global or a narrower investment universe focusing on europe. Both were launched in 2007 and concentrate on income generation. all the funds in the Maximiser range target an annualised return of 8% from a two-stage investment process. To generate alpha, the fund managers use dividend distributions and covered calls (options combined with securities).

+ + + martin skanberg marks third anniversary running european equity fund + + +

schroders fund manager Martin skanberg is marking the third anniversary of taking over the successful Schroder ISF EURO Equity. Over this period he has beaten the benchmark handsomely: the fund has returned an average of 9.62% p.a. over the three years, while the MsCI eMu Net TR has gained a more modest annualised 6.50%2. schroder IsF euRO equity invests in equities from countries participating in european Monetary union, and with assets of over euR 1 billion3 it is one of the largest funds in its peer group. He was recently given a gold rating by standard & Poor’s4. The good performance over the last three years has been based on his “all weather” approach. The team-oriented bottom-up style identifies opportunities in europe he feels are mispriced. The approach is pragmatic and focuses on conviction and diversification, ignoring background macro-economic noise to pick out potential alpha.He believes the time is ripe for investors to once again look at the opportunities in the region rather than the risks.

martin skanberg

+ + + schroders acquires cazenove capital + + +

schroders completed the acquisition of Cazenove Capital Holdings Limited in august. The transaction was worth GBP 424 million (euR 496 million)5 and brings together two of the oldest asset management firms in London. In addition to the investment expertise added, the move will also enable schroders to further expand its private banking operation.

Read more on page 28.


News from schroders

+ + + schroder Isf Global dynamic Balanced turns four years old, and receives a €uro fund rating of 1 + + +

Managers Gregor Hirt and Patrick Brenner celebrated the fourth birthday of Schroder ISF Global Dynamic Balanced on 28 september 2013. Their “baby” was given its first €uro fund rating and received the highest possible score of 1 – “Outstanding”. The fund rating is an assessment by Finanzen publishers in cooperation with the Munich-based analysis firm FondsConsult. The rating reflects fund performance over four years, the risk the manager has taken and the likelihood of performance being repeated in future. The rating scale runs from 1 (Outstanding) to 5 (unsatisfactory). schroder IsF Global Dynamic Balanced targets a total return of Libor +3% over rolling five-year periods. It seeks to achieve this via direct investments and also by using passive instruments such as eTFs and futures, and actively managed equity and bond funds. Commodities and alternatives are permitted for diversification, either using derivatives or listed ReITs and funds.

+ + + schroder property hires french real estate specialist + + +

Thomas Guyot is joining the asset management team of schroder Property in France. In addition to leading and growing the French team he will also manage the French portion of the real estate portfolio in various schroder european funds. His role will also include supporting the managers of the listed european Real estate Investment Trust (eReIT), the open-ended swiss real estate fund Immobilien europa Direkt and the German-registered schroder european Logistik Fund (seLF) in investing and managing their assets in France. He joins from ICaDe, a French real estate investment firm, where he was Head of Commercial Property. Before that he was CeO of Compagnie la Lucette, a French ReIT controlled by Morgan stanley Real estate Funds in Paris.Thomas will be part of the european investment team headed up by Duncan Owen, Head of Property Investment, and will report to Tony smedley, Head of Pan european Funds.

thomas Guyot

we spoke in the last issue to tim van duren, product manager Insurance linked securities, about catastrophe (“cat”) bonds and schroders’ plans to launch a fund investing in this asset class towards the end of this year. to enable us to bring a product to market that meets our clients’ very high expectations, we turned to the people with the most experience in the business and took a stake in the swiss company secquaero advisors limited back in april. uuuu

Building a diversified portfolio with insurance linked securities

an interview with dirk lohmann, the inventor of cat bonds


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7

You brought the first cat bonds to market and are regarded as having invented them. when was that, and what drove the reinsurance industry to launch the product in the 1990s? It was 1993/94; the project started in 1993 with the aim of having it placed by the end of December, but things were not completed until January 1994. At the time I was a director of Hannover Re, and we wanted to increase our capacity for catastrophe risks in the wake of Hurricane Andrew in 1992. A lot of new reinsurers were set up in Bermuda in 1993, seeking to benefit from the increased demand and above all the higher premiums for catastrophe risks. Hannover Re was looking to strengthen its market position against this competition. Catastrophe reinsurance is a very capital-intensive business, and back then Hannover Re was not yet listed on the stock market. This meant our access to the capital market was limited, and so we opted for a new approach by securitising catastrophe risks. what benchmarks do you use when managing Ilss? There is little point in using benchmarks for traditional or alternative asset classes. We aim for an absolute return that is better on a risk-adjusted basis than that of the Swiss Re Cat Bond Total Return Index (Bloomberg: SRCATTR). This is only of limited use as a benchmark, since our strategies also invest in instruments that are not in the index. The Swiss Re index only covers bonds issued under Regulation 144A, the most liquid section of the market. Its relevance is fairly good for Schroder GAIA Cat Bond, because that fund has around 80% of its assets in cat

Secquaero is based in Switzerland and was founded in 2007. The firm manages two insurance linked securities funds worth around USD 263 million.1 We asked Dirk Lohmann, the inventor of the cat bond, to give us some deeper insights into the asset class and explain why catastrophe bonds are anything but catastrophic.

bonds. Unfortunately it is less useful for our other products, but there are no real alternatives.

Your strategies invest in life and non-life risks, which include cat bonds and pandemic risks; can you explain the different risks in more detail? In terms of structure, our investments are similar to traditional reinsurance treaties. The risk is transferred in the form of a reinsurance treaty to a special-purpose vehicle licensed as a reinsurer in the Cayman Islands or Bermuda. Normally it is an event-based structure, i.e. if a particular pre-defined event such as an earthquake in Japan or a hurricane in Florida exceeds a particular magnitude. These events typically have a probability of occurring once every 50 or 100 years. You also get aggregate cover, which protects against a cluster of events in a single year or relates to a specific claims ratio. The SPV finances itself by issuing high-yield bonds. The size of the issue is equal to the amount of the cover in the underlying reinsurance treaty, and the coupon reflects the reinsurance premium. Investors get interest at a rate that reflects the risk, but have to bear the default risk if the event materialises.

for which groups of investors are your products relevant? That depends on the product. Our Secquaero ILS Fund is domiciled in the Cayman Islands and is definitely only for institutional investors. By that we mean pension funds, foundations, insurers, private banks, family offices, sovereign wealth funds, funds of hedge funds and large companies. Schroder GAIA

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1 Source: Secquaero. As at: 30 September 2013.

Funds

8Schroders ExpErt Q4/2013

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FeaTuRe

an interview with dirk lohmann

Cat Bond is UCITS-compliant and open to a wider circle of qualified investors.

have there been any total losses in the past on insurance linked securities?Yes, it happened to more liquid cat bonds in 2005 and 2011. One had a default of almost 100% in 2005 because of Hurricane Katrina. The loss was around USD 190 million. 2011 saw three defaults: one for the Japanese earthquake (USD 300 million) and two tranches of a placing covering a cluster of tornadoes in the US (USD 200 million in total). 2011 was therefore one of the worst years for losses since the launch of cat bonds, but the liquid segment (as measured by the Swiss Re Cat Bond Total Return index) still delivered a positive return of 3.33%. It is not clear how much was lost in private OTC transactions. These also saw losses from floods in Australia, the earthquake in Christchurch, New Zealand, and floods in Thailand. There were no losses from Hurricane Sandy, which hit the east coast of the US in October 2012, even though four bonds were exposed to this event. They suffered temporary price falls in the secondary market immediately after the event, but have now completely recovered. how do you manage risk in your funds? We pay great attention to our cumulations (clusters of the same risk) in the various regions (e.g. Florida and hurricane risk, San Francisco and earthquakes, Europe and storms, etc.) and use a special program that simulates storm and earthquake events. This was developed by Secquaero and has 10,000 simulated events for each region of danger; we test very carefully

how our holdings react under different scenarios. The aim is to minimise tail risk and optimise return against this risk. Unlike with other asset classes, we focus on drawdown risk rather than profit maximisation. Since ILSs are alternative fixed-income securities, the upside is limited anyway. That is why it is especially important to concentrate on minimising downside risk. Over the years we have found there is little difference between managers in good years, but a great difference when things go in the opposite direction and claims have to be absorbed. This was very apparent in March 2011, when the Swiss Re Cat Bond Index fell by 3.9% and some managers were down more because of private OTC transactions, whereas our fund only lost 0.38%.

You assume the market will continue to grow because investors are increasingly looking for asset classes that are not correlated. how big is the market at the moment and how big do you think it could be in future? The size of the market depends a bit on how you define it. If you only look at liquid cat bonds, right now the market is around USD 18 billion. Adding on illiquid private OTC cat bonds takes it to an estimated USD 45 billion. Then there are securitised life risks, which might represent another USD 20-30 billion. That is just traditional securitisations, not the life settlements market (a sort of secondary market for life policies owned by elderly policyholders, mainly in the US; we are not active in that market). Things are developing at a rapid pace. Latest forecasts are for the market to double in the next few years.

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many famous investors like warren Buffett invest in insurance risks. they often call Ilss “gateway drugs”. why is that, and what do investors over here still have to learn?ILSs are definitely a complex asset category that needs a certain amount of specialist knowledge. But to be honest, that applies to many other assets too. I don’t really agree with Warren Buffett. You should bear in mind that his company Berkshire Hathaway is very active in underwriting catastrophe risks, so he is far from being a neutral party. The capital market is competing with Berkshire Hathaway. It used to be one of the few reinsurers that could take on a catastrophe reinsurance treaty up to USD 500 million on its own. The other big reinsurers tend to have lower limits because they have a large client base and already have to deal with large cumulations, clusters of the same risks. Where an SPV issues a bond syndication, the capital market can underwrite limits of USD 500-750 million. Berkshire Hathaway has therefore lost its quasi-monopoly position. What counts is assessing risk correctly. To do that you need a certain expertise, which specialist managers like the combination of Secquaero and Schroders have. The team at Secquaero, for instance, has more than 180 years’ combined experience in the reinsurance industry. It can model risks in both life and non-life and boasts excellent contacts in the

reinsurance market. You need this to be able to identify and value attractive risks. We strongly advise against buying cat bonds directly without performing a special analysis first.

many thanks for the interview.

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Source: Bloomberg, Swiss Re Global Cat Bond Total Return Index from 4 January 2002 (start date) till 30 September 2013

Impact of events on the swiss re Global cat Bond Index280

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Hurricane Katrina, followed by Rita & Wilma

↓

Hurricane Sandy

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Hurricane Ike, default Lehman Bros

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Japan earthquake and tsunami

↓

Funds


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Insurance linked securities

how do they work? Investors have been showing increasing interest in cat bonds as an asset class, especially since the financial crisis, not least because they are almost entirely uncorrelated with other asset classes and offer a return that is more than attractive.

Statistics from the major insurers show that the number of natural catastrophes around the world is rising. Between 1970 and 1979 researchers only noted 964 such major events, but there were 2,788 in the first six years of the new millennium alone. The worldwide economic losses caused in 2005 alone came to over USD 150 billion, and the trend is rising.

To avoid major financial problems, all reinsurers are increasingly issuing catastrophe or cat bonds to investors on the capital market. This involves the two parties swapping roles: the buyer takes on the risk (or some of it), in exchange for a premium. The insurance company then becomes a policyholder and has to pay the premium. Investors are betting on the catastrophe not happening, or only causing minor damage.

All sorts of risks are securitised, from hurricanes on the coast of the US to earthquakes in California and Japan. The securities run for three years on average and offer two sources of return: the first is linked to the money market, because the capital is placed on deposit. The second is determined by the risk insured – the higher the risk, the greater the additional return. a degree of caution is warranted, though: in extreme cases investors might have to walk away empty handed. this happens if the catastrophe materialises and the claims insured have to be paid.Cat bonds are issued by companies, primary insurers and reinsurers using a special-purpose vehicle, or SPV. The underlying

schroders expertikon

risk in the transaction is transferred to the investor who buys the bond. Investors buy a security where the interest and repayment are linked to the occurrence of an event (or multiple events) defined in the loan agreement, such as a storm in Germany or an earthquake in Japan. They receive basic interest on the capital invested. They also receive a risk premium in exchange for taking on the risk of loss should a defined event materialise and trigger the cat bond. The proceeds of the issue are managed by a fiduciary (a commercial bank) appointed by the SPV and invested in high-grade bonds (e.g. sovereigns) to secure the risk securitised by the bond. The amount an investor may potentially lose depends on the structure of the individual cat bond. Normally, investors’ capital is reduced in line with payments made from the SPV to the originator. In the event of a partial claim, the basic interest and risk premium are paid (only) on the remaining capital.

If you would like to learn more about insurance linked securities, please contact us at: [email protected]


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how a cat bond is structured

sponsor/reinsured party

Premium

Claim

Interest payments

Issue proceeds

Issue proceeds

Interest on capital investment

Investorsspv

capital investment (fiduciary assets)

Funds


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Daniel Ineichen, Manager of Schroder GAIA Cat Bond

QuestIoNs for daNIel INeIcheN

what was your first really formative experience of money?I have always been interested in it. When I was a young boy my favourite toy was a Playmobil pirate ship with a treasure chest and gold ducats. You could make up lots of stories about it. For my sixth birthday I was given a glass boot full of sweets. Once it was empty I started to use it as a piggy bank and collected 10 centime coins. I didn’t raid it until it was full up and I was a teenager. how did you fund your studies?I was helped by my parents and I did a range of part-time jobs. I was a tennis instructor, sold concert tickets and had an office job at a bank.

do you have a professional role model?No. I find inspiration in all sorts of places, but I try to go my own way.

what do you consider to be the stupidest stock market saying?Buy low, sell high. Anyone can say it, but very few can do it.

who would you most like to give a piece of your mind?When I think something matters, I speak out. Otherwise, I don’t think it’s helpful to just tell people what they should or shouldn’t do.

what book should every fund manager read?Among the financial classics it has to be “Manias, Panics and Crashes” by Charles Kindelberger. Easy to read and absolutely essential. Outside the specialist field there are a whole host of books that are just as good. One of them is “A Listening Heart” by David Steindl-Rast.


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where do you find the motivation if your fund is underperforming the competition, and what do you do when you are doing better?The fund is focused on the clients who invest in it. I want to get the best possible results for them. It is important to examine why you did better or worse than the competition. You can only change things and do well in the longer term if you understand the reasons for what happened.

and what about a treat when your fund outperforms?Satisfied clients and a good feeling. But standing still means going backwards.

what are you proud of?It may sound trite, but I’m proud of our ILS group. We have put together a great team that really knows all there is to know about the asset class.

what has made you really angry recently? Now I have a young daughter I get annoyed at all the violence shown on television, even in the afternoon. Adults don’t notice it so much. And you can always get annoyed about the traffic.

do you collect anything, and if so what?It used to be the gifts that you get inside Kinder eggs.Now it’s bills.

what was the last thing you bought on eBay?A giant playhouse with music and lots of features for my daughter. They don’t make them any more.

facebook is...a key step in the evolving way we communicate. Personally I prefer silent mode.

what is your favourite tv show?Two and a Half Men was cool when it still had Charlie Sheen in it.

and what makes you instantly turn off?My wife likes to watch the Austrian weather panorama cams when she wakes up. There are more exciting things out there – especially on cloudy days.

what would you choose: a football match or a rock concert?Tough choice. Live, it would have to be rock; but in general football is king.

what was the last match or concert that you attended?Bruce Springsteen in Zurich as the sun was setting. Brilliant.

what fashion crime are you most willing to forgive yourself and others?According to my wife it’s the wonderful beige pullover I wore on our first date (which I still have). I say it worked...

do you prefer wine or beer with a meal?A glass of red wine is the perfect accompaniment. I am currently into wines from Spain and Austria.

what luxury item would you have trouble giving up?My foam-injected, specially adjusted ski boots. They make a sunny winter’s day on the slopes comfortable and even more perfect.

where would you like to live if you were no longer a fund manager?I like being outdoors, especially in the mountains, but I also enjoy the comfort that goes with the infrastructure in a city. Switzerland manages to combine these elements amazingly well. When I am no longer a fund manager I would like to take time to travel a lot. Travelling broadens your horizons and is also so enriching.

what sort of aid projects have you supported lately?I have supported Medecins Sans Frontières for years, also Back to Life, a charity that gives people a future in India and Nepal, especially children. It’s a great institution. I also plan to support a project to preserve the rainforest in future.


InvEStmEnt IdEaS

1 Source: Morningstar Direct: One year from 27.08.2012-27.08.2013 (EUR, A Acc, NAV to NAV). 2 Source: Morningstar. As at: 30 August 2013. 3 Source: Mercer. As at: 30 June 2012.

Before joining Schroders, Patrick was responsible for the very successful Euro Corporate Fixed Income Fund at Legal &

General over the period 2007-2012 (see chart 1). At

Schroders he now follows the same investment approach that helped him beat the iBoxx Euro Corporates Index by 86%3 in good markets and 87% in poor markets over five years.

schroder Isf euro corporate Bond has been managed by patrick vogel, head of european corporate Bonds, since 27 august 2012. In his first year at schroders patrick achieved a cumulative performance of 5.4%1 and was ranked in the top quartile2 of his peer group, maintaining his outstanding track record.

a good year for patrick vogelmanager of schroder Isf euro corporate Bond

Total return in %

Source: Mercer. As at: 30 June 2012.

Patrick Vogel Top quartile Average Bottom quartile Benchmark (iBoxx Euro Corporate)

chart 1: patrick vogel’s performance at l&G

By Tobias Eppler, Investment Analyst at Schroders in Frankfurt

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InvEStmEnt IdEaS

Immediately upon joining, he implemented a stronger thematic approach. Credit analysts are encouraged to analyse securities from the thematic perspective and project forward various scenarios. One of his current investment themes is the improving outlook for the UK economy. He has a large overweight position in the country. Rising property prices are helping consumer confidence, for instance. Another portfolio theme is non-cyclicals in Europe. Patrick is worried about a possible recession in France, so in January he bought a bond issued by the utility EDF and has profited since then from the narrowing spread (see chart 2). In March he predicted that European growth would be weak, so he bought a credit default swap on ThyssenKrupp bonds to actively protect the fund against market risk. As chart 2 shows, the bet against cyclicals has proved a shrewd decision. Trading in credit default swaps on ThyssenKrupp has exploded in 2013. The slow process of selling the North and South American division has nourished speculation that Germany’s largest steel group will have to take more large writedowns. As such, Patrick protected the portfolio against losses and also profited from the rise in the price of ThyssenKrupp credit default swaps.

He sees himself as a pure alpha manager who invests in themes that beta managers have not yet spotted. Unlike most managers, he is not overweight in financials at the moment. It is important for him to generate alpha consistently across all phases of the market.

Z spread CDS spread

Source: Bloomberg Z spread for EDF 5.375% 2049 on 23 January 2013, and Thyssen 5-year CDS spread bought on 6/7 March 2013. As at: September 2013.

Bond purchase – EDF 5.375% December 2049 (left-hand axis) Bond hedge purchase – Thyssen 5-year CDS (right hand axis)

chart 2: purchase of edf, thyssenkrupp hedge

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InvEStmEnt IdEaS

over 76% of alpha comes from issuer selection

4 Source: Schroders. As at: 31 August 2013.

Looking at the performance attribution4 for Schroder ISF EURO Corporate Bond, he has managed to do this.

He typically has a low tracking error because his portfolio includes securities for bull markets and bear markets. So the overall risk in the portfolio remains low and easy to get a grip on. Derivatives are only used when cash bonds cannot be used to implement an idea, e.g. credit default swaps on individual names to protect against spread widening (as with

is uncertain and highly volatile, the manager can hold up to 20% in total in cash and top-rated government bonds.

outlook: Overall, we think the prospects for Europe are increasingly favourable and the region may enjoy ideal conditions, especially compared with emerging markets, where the situation is getting gloomier. Growth will be low, but as most European countries seem to be getting over the recession the difficulties Europe has been dealing with should start to clear.

We are particularly optimistic about the potential for Spain. The country has undertaken painful but necessary reforms; high unemployment and low labour costs mean the country is well placed for a new era of growth. Spain could follow the same path as Iceland and some of the Baltic states, which have survived their difficulties, made major reforms and done well since. Non-performing loans at Spanish banks should gradually decline, returning them to health in a few years.

All over Europe companies remain cautious and are continuing to repay debt. We expect default rates to remain low. In emerging markets, by contrast, they are likely to rise. We are therefore avoiding European companies that have developed these countries into their major markets in recent years.

ThyssenKrupp). Index futures are only used to reduce duration risk and stay neutral against the benchmark.

Under Patrick’s management, Schroder ISF EURO Corporate Bond remains invested predominantly in good and very good corporate bonds, as it was designed to do. Smaller amounts may be invested in high yield, emerging market and convertible bonds to improve returns. In difficult periods when the market

date fund return

Index return

outper-formance

Sep 2012 0.92% 0.70% 0.21%

Oct 2012 1.18% 1.05% 0.13%

Nov 2012 1.12% 0.89% 0.23%

Dec 2012 1.09% 0.86% 0.23%

Jan 2013 -0.97% -1.17% 0.20%

Feb 2013 1.42% 1.32% 0.10%

Mar 2013 0.57% 0.50% 0.07%

Apr 2013 1.78% 1.36% 0.42%

May 2013 -0.08% -0.24% 0.16%

Jun 2013 -1.66% -1.57% -0.08%

Jul 2013 1.12% 0.82% 0.30%

Aug 2013 -0.07% -0.21% 0.14%

total 6.55% 4.34% 2.21%

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Source: Schroders, gross of all fees, based on end of day market prices for benchmark comparison.


InvEStmEnt IdEaS

*Equivalent to 3.09278% of the net asset value per share.5 The level of the distribution is reviewed annually and could be changed. If its income is insufficient to cover these payments, these payments may

reduce the fund’s capital.

share class a, eur accumulation

share class a, eur fixed distribution

share class a, eur accumulation, duration hedged

share class a, eur fixed distribution, duration hedged

ISIN LU0113257694 LU0425487740 LU0607220562 LU0616493440

Launch date 30 June 2000 30 April 2009 4 May 2011 4 May 2011

Distribution Fixed distribution of 3%5 p.a.; paid semi-annually

Fixed distribution of 3%5 p.a.; paid semi-annually

Initial charge Up to 3% of the total subscription amount*

Management fee p.a. 0.75%

Benchmark Bank of America Merrill Lynch EMU Corporate Index

Fund manager Patrick Vogel

schroder Isf euro corporate Bond

n The capital is not guaranteed.

n Non-investment grade securities will generally pay higher yields than more highly rated securities but will be subject to greater market, credit and default risk.

n A security issuer may not be able to meet its obligations to make timely payments of interest and principal. This will affect the credit rating of those securities.

n Currency derivative instruments are subject to the default risk of the counter party. The unrealised gain and some of the desired market exposure may be lost.

n Investments denominated in a currency other than that of the share-class may not be hedged. The market movements between those currencies will impact the share-class.

n Investment in bonds and other debt instruments including related derivatives is subject to interest rate risk. The value of the fund may go down if interest rate rise and vice versa.

n It may be difficult to sell quickly positions of one or more companies to meet redemption requests upon demand in extreme market conditions.

n The Fund may hold indirect short exposure in anticipation of a decline of prices of these exposures or increase of interest rate.

n The Fund may be leveraged, which may increase its volatility.

n An “all-weather” bond fund that aims to outperform steadily across the entire market cycle

n Combines top-down macro strategies with bottom-up securities selection

n Exploits several sources of return: duration, yield curve, and country, sector and security selection

n Invests predominantly in investment-grade corporate bonds

n Currency positions always fully hedged into euro (i.e. no currency risk for EUR-based investors)

Investment opportunities Investment risks

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let’s focus on what matters – corporate bonds and a higher return!

what next from patrick vogel’s team?

Peter Johansen Senior Institutional Sales, Nordic region

“why should the world care if a bag of rice falls over in china?” the world may well not care, but one person who does is patrick vogel, fund manager of schroder Isf euro corporate Bond. his thematic investment approach is based on looking carefully at just such things and their consequences, projecting them forward and turning them into successful investment ideas. he has already demonstrated that he is on the right track, as you can read in the investment ideas of tobias eppler from page 14 onwards.

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1 Source: www.statista.com. As at: 30 September 2013

Patrick is acting like many other investors in an environment of low interest rates and spreads, where

yields on investment-grade corporate bonds have fallen sharply in recent years. Insurance companies and pension funds are under increasing pressure to meet obligations to clients that they entered into when rates were higher. Nordic insurers have warned on many occasions that the cost of the expansive monetary policy is being borne by their clients. Low interest rates have big side-effects, they note. When it comes to investing new money, insurers now have big problems achieving the returns they need for the interest rates they have guaranteed to their clients.

One partial solution adopted by many investors has been to move into high yield bonds, an area some would not feel comfortable in. Junk bonds normally have

a lower rating, which brings with it both higher yield and higher risk. Also, some investors are banned for regulatory reasons from investing in risky high yield bonds on a large scale and some are simply looking to diversify their domestic tilted fixed income exposure.

It is therefore time for an alternative strategy. Patrick Vogel and his team have come up with a EURO Credit Conviction strategy that is scheduled for launch towards the end of this year.

why the new strategy?The average yield of 2% currently available on investment-grade corporate bonds is not attractive enough for many investors on a total return basis – especially as it is almost completely swallowed up by the current 1.4% rate of inflation1 and is also at risk should yields move up again. A higher yield is therefore needed to generate a

positive return in the face of everything stacked up against investors in this low-interest environment. The fund manager therefore has to (and will) be given more flexibility that would be possible with a straightforward investment-grade corporate bond benchmark, so as to be able to identify promising opportunities regardless of the sector.

At the present time, these are definitely to be found in high yield. But what if investors cannot or do not want to invest further in a pure high yield bond fund? What is needed is a balanced mixture with high potential, and this is what Patrick Vogel and his team are seeking to offer.

To meet the need for more return, though, there is no choice but to invest in higher-yielding bonds, and these entail higher risk. When buying them, the manager must therefore seek out relatively good issuer ratings, in order to avoid uu

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defaults or a sudden widening of the spreads on individual bonds. Patrick Vogel is confident that he can successfully make this selection, and has already proved it with the Schroder ISF EURO Corporate Bond.

At the heart of the new EURO credit conviction strategy lie bonds rated BB and BBB that the team consider attractive. The number of these has shot up since the Lehman crisis, so today it is easier to select attractive and relatively strong corporate bonds within this range. Nevertheless, under the new strategy the maximum invested in high yield bonds will be 30%, with an average rating no lower than BBB-.

If interest rates go up againPast experience has shown that when rates rise, corporate bonds with a somewhat lower rating and hence a higher risk premium (spread) are often less volatile and perform better. They normally only do so when the economic environment improves. This is precisely the scenario in which spreads on high yield bonds do well and tend to tighten. This spread narrowing provides a buffer against higher interest rates. For “normal” investment-grade corporate bonds the buffer effect is less strong because their spreads are already relatively low since they are regarded as less risky. This is the case with bonds rated AA and A, for

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If you have any questions on the new strategy or would like to arrange a meeting, please get in touch.

Peter Johansen

Senior Institutional Sales, Nordic region

[email protected]

Direct phone: +45 3373 4896

instance. Bonds with a weaker rating, such as the BBB and B-rated paper in the EURO Credit Conviction strategy are able to compensate for a rise in interest rates through the relatively high risk premium, giving positive overall returns even in such an environment.

The fund that Patrick Vogel is planning is therefore suited to investors aiming for a high total return over three to five years but who are also prepared to compromise on ratings. Needless to say, with a conviction strategy of this sort spreads can be rather more volatile. However, since the spreads are higher overall, the portfolio should in fact be better suited to an environment of rising interest rates than a pure investment-grade corporate

bond portfolio. As such, the prospects of actually achieving the higher total return targeted are correspondingly good.

The portfolio will of course still be well diversified, with an average rating that is investment grade. Some individual bonds may, however, count as high yield. The fund will come in a UCITS wrapper.

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Martin Skanberg Fund Manager, European Equities

schroder Isf euro equity

european equities – something is going on! why now is a good time to take another lookEurope has been the problem child of the global economy since the debt crisis erupted in 2010. Many European countries have been stuck in recession since then. Not only southern Europe, but also France and the Netherlands have experienced contraction. But now there are increasing signs that the eurozone may, with luck, have put the worst behind it. Countries grew again in the second quarter for the first time in a long while. The outlook is turning positive, and the eurozone is the top pick for analysts. A recent survey showed that fund managers are more positive on the region than they have been for six years. Support for the good prospects is also coming from central bank policy.

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1 Source: OECD (Organisation for Economic Co-operation and Development). As at: August 2013

“The recovery in the eurozone provides grounds for optimism”When ECB President

Mario Draghi said in summer 2012 that he would do

“whatever it takes” to save the euro, European equities enjoyed a strong boost. This statement and the associated action by the European Central Bank helped gradually restore confidence in the eurozone and pushed up share prices. But there is still further to go. The latest economic upturn in the eurozone means domestic profits are likely to become more important, driving share prices up further.

the economic engine is only just getting up to speedData released over the summer show the European economy has reached a turning point. The eurozone more or less came out of recession in the second quarter of 2013, growing 0.3% quarter on quarter. Even though growth in the single currency zone was uneven, it was still helpful to see that Portugal produced the largest positive surprise by growing 1.1%. Germany, the powerhouse of the region, continued expanding at a healthy 0.7%1.

Both leading indicators and various purchasing manager indices provide grounds for optimism. The eurozone recovery is picking up speed. The industrial and service sectors grew faster in August than they have done in over two years. The London-based Markit purchasing managers’ composite index rose 1.2 percentage points in August to 51.7 points. Over 4,000 companies were polled about production, order intake, employment and input costs. Experts had only been predicting a slight rise to 50.9. For the second month in a row the index was above the 50 level that indicates growth. Before that it had signalled contraction for 17 successive months. The business climate index in the eurozone also rose in August for the fourth month in a row. Consumer sentiment is improving as well.

Growth helping domestic earnersTo some extent, the greater stabilisation in the economic and political landscape seen in the eurozone over the past year has already been reflected in equity prices. Nevertheless, European equities remain

consumer confidence in europe

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Source: Thomson Reuters Datastream. As at: 15 August 2013.

MSCI Europe (left-hand axis)

Consumer confidence indicator (right-hand axis)

1,800

1,600

1,400

1,200

1,000

800

600

400

5

0

-5

-10

-15

-20

-25

-30

-3506/93 06/95 06/97 06/99 06/01 06/03 06/05 06/07 06/09 06/11 06/13

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relatively cheap compared with other regions, especially the booming US.

What is more, not all European stocks have done equally well in the past 12 months. The top performers have been high-quality growth stocks such as basic food companies with strong brands and an international presence. These have profited from their exposure to emerging markets and the growth in the US. They now look expensive, though, and vulnerable to sagging growth in emerging economies. By contrast, companies with a presence in Europe, and the eurozone in particular, have been laggards. Stocks like these are likely to provide the highest returns now. We therefore have a preference for companies with activities in Europe rather than emerging markets and see favourable prospects in some southern countries.

“The second support for European equities is the recovery in domestic earnings.”

The recovery seen in European stocks in recent months may help to remove the

“crisis discount” that investors were applying when the eurozone was bumbling from one rescue package to the next. As the risk of a crisis recedes, investors can now focus on the second support for European equities: the prospect of a recovery in domestic earnings.

hunting for undervalued opportunitiesEuropean equities not only offer solid assets compared with other regions; they are also trading on historically low valuations at present. The hunt for safe havens and dividends has meant that some of the more defensive areas of the market, such as consumer staples, are now looking expensive. Others, like telecoms, banks and utilities are now on P/E ratios below their historic averages.

But valuation alone is not enough for us to base investment decisions on. We carry out extensive research to identify the best opportunities. We look for turning points or changes that are not yet priced in. Many companies in Europe have used the last few years to cut costs and restructure and are now well placed for the future. Companies with strong, market-leading offerings in their domestic markets are

Source: UBS European Equity Strategy Team. Fund data as at 19 August 2013

Presence in emerging markets Presence in the eurozone Presence in the US Presence in Europe

relative performance of european stocks with different regional presences

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120

115

110

105

100

95

90

85

80

7501/07 07/07 01/08 07/08 07/0901/09 01/10 07/10 01/11 07/11 01/12 07/12 01/13 07/13

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especially well placed to benefit from the recovery that is getting underway. Europe also has some stocks (e.g. in the luxury goods sector) that simply have no equivalents in other regions.

The increase in mergers and acquisitions is a sign that companies themselves are aware of the opportunities available in some of these sectors. Improved borrowing terms and more robust business confidence have also helped revive M&A. One example is the telecoms sector, which investors had been avoiding but which is now coming back to life. Sector valuations had fallen as companies encountered headwinds from high debt levels, tighter regulation and consumer reluctance to spend. Now companies have healthier balance sheets and the pressure on consumers is gradually easing, competitors have seized the opportunity to snap up cheap assets. In some cases this has been to strengthen their own offering in specific markets, as when Vodafone acquired Kabel Deutschland. Others are looking to build up their presence in Europe, like América Móvil bidding for KPN. AT&T is also known to be interested in European telecoms companies.

The current cheap valuations in Europe are an indication of how low earnings have been. European profits are presently 40% below their 2006 peak and forecasts remain very subdued; a stark contrast to the US, where earnings estimates have already exceeded past highs. The sector in Europe where profits have been most sluggish but are now recovering fastest is financials. With European GDP growing and revenues picking up, we are starting to see earnings momentum gather speed. The earnings gap versus the US should soon be closed up, and there is a chance that share prices in Europe will reach new highs in 2016. Sectors such as financials, energy and telecoms should lead the recovery, as they have had the greatest structural difficulties.

“The earnings gap versus the US is closing”

Investors therefore have a clear opportunity to profit from undervaluations in Europe. The apparent investment risks mean that peripheral

European countries in particular have been treated like poor relations. We believe that at stock level there are plenty of opportunities where the remaining risks are priced in and the potential rewards are high.

some risks remainOf course, Europe still has to deal with the consequences of the crisis, and unemployment in some countries is still worryingly high. The Greek jobless tally reached a new peak of 27.9% in June, with young people particularly badly affected. The eurozone may be slowly emerging from recession, but growth is still fragile, and not just in the periphery. The Netherlands, part of Europe’s hard core, saw GDP fall 0.2% in the second quarter of 2013. Another risk is the credit cycle, which has not yet turned. This is partly due to weak demand, but a lack of supply as banks cut back on lending is also to blame. Even though GDP has now stabilised, we need to see the credit cycle turn decisively if GDP growth is to pick up. The European Central Bank says demand for loans is now rising. The situation needs to be monitored closely.

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Source: Thomson Reuters Datastream. Based on data from 31 December 1982 to 30 June 2013

n Valuation range n Current valuation ● Average valuation

Graham & dodd p/e for different european sectors

50

45

40

35

30

25

20

15

10

5

0

max 80x max 147x

Healthcare Consumer staples

Consumercyclicals

Telecoms Financials Industrials Utilities Materials Energy Technology Total

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The ECB has promised to keep monetary policy loose, but the threat of external risks remains. In September the Fed decided not to start tapering, but when it does begin to tighten rates Europe will be affected too. In our opinion these risks are generally recognised and outweighed by the potential profits to be made. Careful company analysis allows us to identify those opportunities that offer the most enticing returns.

share class a, eur, acc. share class a, eur, dist.

ISIN LU0106235293 LU0091115906

Launch date 17 January 2000 20 November 1998

Initial charge Up to 5% of total subscription amount*


Benchmark MSCI European Monetary Union Net TR

Fund manager Martin Skanberg


the fund is in the top quartile over the current year, 1 year, 3 years and 5 years.

Source: Schroders. As at: 30 September 2013.

rated B by feri.

Source: Feri EuroRating Services. As at: 30 September 2013. Highest rating: A. Lowest rating: E. *Equivalent to 5.26315% of net asset value per share.

Ratings as at 30 September 2013.

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Important note: The views and opinions contained herein are those of Martin Skanberg, Fund Manager – European Equities, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

3 Source: Schroders. As at: 30 September 2013. Performance applies to share class A, acc. in EUR. 4 Source: MSCI. As at: 30 September 2013. 5 Source: Schroders. As at: 30 September 2013.


n Schroder ISF EURO Equity seeks to exploit price opportunities in the dynamic eurozone market.

n There are no restrictions or style bias; the manager can use the full range of opportunities that present themselves.

n Diversified by stock, sector, country and company size to reduce risk.

n Strong and independent research: the European equities team includes 11 fund managers and 10 analysts specialising in different sectors and regions.

n The capital is not guaranteed.n The Fund will not hedge its market risk in a down cycle. The

value of the fund will move similarly to the markets.

Investment opportunities Investment risks

prospecting for gold in europe with schroder Isf euro

equity

Martin Skanberg has been managing the schroder Isf euro

equity for three years, and has beaten the benchmark

handsomely over that period: the fund has returned an average of

9.62%3 p.a. over three years, while the MSCI EMU Net TR gained

a more modest annualised 6.5%4 over the same period.

Schroder ISF EURO Equity invests in equities from countries

participating in European Monetary Union, and with assets of over

EUR 1 billion5 it is one of the largest funds in its peer group. It has

been in the top quartile for years and was recently given a gold

rating by Standard & Poor’s. Many of the issues that have been

weighing on Europe are now said to be behind us, and the time is

ripe for investors to start focusing on the opportunities in the

region, rather than the risks. Schroder ISF EURO Equity is ideally

placed to capture the fresh interest in equities as an asset class.

Martin Skanberg took the fund over in May 2010, in the middle

of the turmoil caused by the first Greek rescue package. As the

performance shows, he has successfully guided the fund through

a host of difficult situations. The good performance over the last

three years has been based on his “all weather” approach. The

team-oriented bottom-up style identifies opportunities in Europe

he feels are mispriced. The approach is pragmatic and focuses on

how to profit from europe with us

conviction and diversification, ignoring background macro-

economic noise to pick out potential alpha. Portfolio construction

pays attention to a benchmark, but he can deviate from it by

+/-5 % at stock level and by +/-10% at sector and country level.

Tracking error should be 4-6%. His stated objective is to beat the

MSCI EMU Net TR by 4 percentage points over rolling 12-month

periods.

In recent months Martin has switched his “prospecting for

gold” away from a qualitative growth focus towards a more value-

oriented approach focused on central and southern Europe,

which has paid off so far.

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a dream marriage with a successful future

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The coming together of these two long-standing English companies is a little like a marriage. These family companies are connected not

only by the fact that they have been charting the stormy waters of the markets for more than 200 years, and have emerged unscathed (when many other long-standing companies in the UK financial industry have either lost their independence or have gone under – Barings and Warburg spring to mind). They are also linked by their shared understanding of how to bring together their experience, forward-looking knowledge and highly capable employees to successfully serve their clients.

But what do we know about this company with the rather strange name, Cazenove? It has nothing to do with the famous Italian Giacomo Casanova, who was more notorious for his many lovers than for his novels. Nor does Casanova’s rather less successful involvement in the lottery – which he introduced to Germany from Genoa – have any connection with the company Cazenove.

In fact, Cazenove’s roots go back as far as the late 17th century, when the Huguenots fled France. In 1819, Phillip Cazenove became a partner in the business of his brother-in-law, John Menet, and founded Cazenove with him in 1823. From the 1940s onwards, Cazenove was one of the biggest names in the London securities trade. The group’s asset management division was spun off at the start of the 21st century and began operating under the name Cazenove Capital Management. In 2010, it was acquired by the private wealth manager Thornhill Holdings. And in July 2013 the big event took place – the “wedding” with Schroders. Now that the regulatory authorities and shareholders have approved the transaction, worth

schroders and cazenove – two family companies that go back centuries, a wealth of investment expertise and new funds that inspire investors’ dreams.

london – Home to investment companies and banks with a strong heritage.

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GBP 424 million (EUR 496 million), the two oldest London-based asset managers are officially united. Following the acquisition, Schroders now manages client assets totalling around EUR 307.2 billion1. The successful completion of the transaction means that Schroders’ fund range will now also be extended: from now on Schroders will be responsible for distributing the strategies managed by Cazenove Capital, which are already used in some Nordic portfolios. Over the coming year, most Cazenove funds will also be merged into the Luxembourg SICAV Schroder ISF. Cazenove Capital has proven expertise in the area of European and UK equities in particular, but the company’s outstanding range of funds also includes UK bond funds. For example, rating agency Feri regards the cazenove uk equity fund2 as a very good product; it was awarded the top A3 rating and has already generated a return of 27.97%4 this year. Citywire has also issued an AAA rating to the work of Julie Dean, who

1 Source: Schroders. As at: 30 September 2013. 2 Currently not registered for sale in Norway and Finland. 3 Source: Feri. As at: 30 September 2013. 4 Source: Lipper. As at: 11 September 2013. This applies to share class A, acc. in USD.

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manages this fund. the cazenove pan europe fund received a B rating from Feri, which denotes above-average performance6. It comes top in the Morningstar “European Large-Cap Blend Equity” category7. Investors in this product have already enjoyed a positive return of 25.14%8 this year.

As well as expanding the range of funds on offer, the acquisition of Cazenove Capital has also bolstered

the investment teams for bonds and European equities. Andrew Ross, previously Chief

Executive Officer at Cazenove Capital, will take over the management of UK Private Banking and report directly to

Philip Mallinckrodt, Schroder Group Head of Private Banking.

The acquisition of Cazenove Capital and its exceptional

investment team is a success in two respects: in addition to

the investment expertise acquired, Schroders now also has an

5 Source: Citywire (AAA rating for Julie Dean). As at: 30 September 2013. 6 Source: Feri. As at: 30 September 2013. 7 Source: Morningstar. As at: 30 September 2013. 8 Source: Lipper. As at: 11 September 2013. This applies to share class A, acc. in EUR.

opportunity to further expand its own private banking operation.

All in all, we consider this to be a happy ending/beginning to the story – two strong, successful family companies will from now on tread a common path, and write what we hope are many more successful chapters in the Schroders story for you.

the cazenove uk equity fund

share class B, GBp, acc. share class B, eur, acc.

ISIN IE0032376455 IE0032376562

Launch date 31 December 2002 31 December 2002

Minimum initial subscription

GBP/EUR 5,000

Initial charge 5.00%


Benchmark FTSE All-Share Index

Fund managers Julie Dean

Fund objective The fund targets long-term capital growth and returns through investments in any sectors of the UK market.

fund overview and performance objective

Fund manager Julie Dean follows an investment approach based on the business cycle. This aims to outperform the British equity market while keeping volatility below the sector average. Over the medium term, the fund aims to outperform its benchmark (FTSE All-Share Index) by 3% (net of fees) each calendar year. The tracking risk is up to 8%. There is no guarantee that this objective will be achieved.

ratings5

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the cazenove pan europe fund

share class B, eur, acc.

ISIN IE0032374633

Launch date 2 January 2003


GBP 5,000



Benchmark FTSE World Europe Index

Fund manager Steve Cordell

Fund objective The fund targets long-term capital growth and invests in equities of companies based in continental Europe and the United Kingdom. It invests predominantly in equities of large and medium-sized companies.


Fund manager Steve Cordell adjusts his approach to the business cycle and manages the fund as a broadly diversified investment in equities of core European countries. Over the medium term, the fund aims to outper-form its benchmark (FTSE World Europe Index) by 2% (net of fees) each calendar year. The tracking error is up to 8%, but is generally kept at 3-6%. There is no guarantee that this objective will be achieved.

the cazenove european equity (ex uk) fund

share class B, eur, acc.

ISIN IE00B0189X88

Launch date 28 May 2004


GBP 5,000



Benchmark FTSE World Europe ex-UK

Fund manager Steve Cordell

Fund objective The fund targets long-term capital growth. To achieve this, at least two-thirds of the fund assets are invested in equities of companies based in EEA or EU member states (except for the United Kingdom) and in Switzerland or that predominantly generate their sales and/or profits in these countries or are predominantly active in these countries.


The fund manager Steve Cordell takes a flexible approach to European equity investments, exploiting investment opportunities throughout the entire business cycle as far as possible. The medium-term objective of the fund is to outperform the benchmark (FTSE World Europe ex-UK Index) by 2% (net of fees) each calendar year. The track-ing risk is up to 8%, but is generally kept to 3-6%. There is no guarantee that this objective will be achieved.

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the cazenove uk absolute target fund

share class p1, GBp, acc. share class p1, eur hedged, acc.

ISIN GB00B39VWX15 GB00B39VWY22

Launch date 18 July 2008 18 July 2008


GBP/EUR 1,000



Benchmark FTSE All-Share Index

Performance fee 20% of the fund’s outperformance versus the benchmark FTSE All-Share Index, following the high water mark principle.

Fund managers Steve Cordell & Julie Dean

Fund objective The fund targets absolute returns which are to be achieved by means of targeted investment strategies, regardless of the market conditions or indices in the United Kingdom. It is focused on securities with large and medium market capitalisation.


Fund managers Steve Cordell and Julie Dean aim to generate a positive return whether share prices rise or fall; they also aim to ensure lower volatility than the equity market. The fund focuses on large and mid caps, with the aim of achieving a return of 8 - 10% p.a.(net of fees) in the medium term, with less than two-thirds of the volatility of the FTSE All-Share Index (adjusted in accordance with the changed IMA Targeted Absolute Return Sector definition as of 3 June 2013). There is no guarantee that this objective will be achieved or that the performance will be positive.

ratings8

the cazenove strategic debt fund

share class a, GBp, acc.

ISIN IE00B29MPR28

Launch date 10 December 2007


GBP 250.000



Benchmark Three-month Treasury bills (UK)

Fund manager Peter Harvey

Fund objective The fund targets a total return that is higher than the income from an investment in UK Treasury bills with a maturity of up to three months in the same period. To achieve this, at least two-thirds of the total assets are invested flexibly in debt securities with a low or no credit rating.


The fund manager Peter Harvey can invest flexibly across the entire bond spectrum, according to where he sees the greatest relative value. Over the medium term, the fund aims to generate a gross return that is significantly above the money market. However, there is no guarantee that this investment objective will be achieved.

8 Source: Morningstar OBSR Analyst RatingTM; Citywire (AA rating for Steve Cordell) As at: 31 July 2013.

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The table shows a selection of Schroders funds that are among the top performers in their peer groups in the current year and over one, three and five years.

top performers

schroder Isf Quartile rank/ peer group

morningstar peer group

fund performance

(translated into euro)

current year – 70 schroders funds in the first and second quartiles

schroder Isf european smaller companiesA, EUR, acc., LU0106237406

1 10 / 54 Europe Small-Cap Equity +25.48%

schroder Isf frontier markets equityA, USD, acc., LU0562313402

1 2 / 13 Global Frontier Markets Equity

+22.80%

schroder Isf Global convertible BondA, USD, acc., LU0351442180

1 2 / 19 Convertible Bond – Global +9.96%

schroder Isf european equity alpha A, EUR, acc., LU0161305163

1 9 / 60 Large-Cap Value Equity +18.05%

one year – 66 schroders funds in the first and second quartiles

schroder Isf european smaller companiesA, EUR, acc., LU0106237406

1 8 / 53 Europe Small-Cap Equity +33.90%

schroder Isf frontier markets equityA, USD, acc., LU0562313402

1 4 / 13 Global Frontier Markets Equity

+24.15%

schroder Isf Global convertible BondA, USD, acc., LU0351442180

1 4 / 19 Convertible Bond – Global +9.93%

schroder Isf Global multi-asset IncomeA, USD, acc., LU0757359368

1 3 / 39 USD Cautious Allocation +0.40%

three years – 65 schroders funds in the first and second quartiles

schroder Isf Global climate change equityA, USD, acc., LU0302445910

1 5 / 33 Sector Equity Ecology +8.91%

schroder Isf emerging europeA, EUR, acc., LU0106817157

1 1 / 50 Emerging Europe Equity +4.74%

schroder Isf asian convertible BondA, USD, acc., LU0351440481

1 2 / 9 Convertible Bond – Asia/Japan

+2.18%

schroder Isf taiwanese equityA, USD, LU0270814014

1 1 / 10 Taiwan Large-Cap Equity +8.09%

five years – 70 schroders funds in the first and second quartiles

schroder Isf Global climate change equityA, USD, acc., LU0302445910

1 3 / 25 Sector Equity Ecology +7.21%

schroder Isf emerging europeA, EUR, acc., LU0106817157

1 2 / 48 Emerging Europe Equity +7.61%

schroder Isf asian total returnA, USD, acc., LU0326948709

1 1 / 27 Asia Allocation +16.89%

schroder Isf taiwanese equityA, USD, LU0270814014

1 2 / 9 Taiwan Large-Cap Equity +14.61%

source: Schroders, Morningstar. As at: 30 September 2013. Performance based on NAV of share class on an EUR basis/translated into EUR. Calculated net of the annual management fee and internal fund costs and based on reinvestment of all income (BVI method). Investments in foreign currency are subject to exchange rate fluctuations. Past performance is not a reliable indicator of future performance. Peer group and rating data: Morningstar.

schroders exPeRT q4/201334

MaRKeTs


Markets

This was further exacerbated by the political unrest in Brazil and Turkey and the military coup in

Egypt. The extent of the slump brought back bad memories of the Asian crises of the 1980s and 1990s, which in turn triggered fresh reservations about emerging markets. Has anything changed since then? And does the deterioration in fundamentals mean that the worst is still to come, given that interest rates in the US

In the middle of this year, the prices of emerging market bonds fell further than they have in two centuries – crises excluded (chart 1). This major slump was caused by a string of unfortunate circumstances: the markets expected the US Federal Reserve to scale back its bond-buying programme, growth in China, Brazil, Russia and other emerging markets weakened, and commodities prices came under pressure.

are emerging markets about to retreat?

are rising and the central banks may withdraw liquidity?

We would like to answer these questions with two basic theories:first: We do not believe that market volatility and weaker growth will lead to a general deterioration in the creditworthiness of emerging markets. Of course, there will be credit downgrades and renewed impetus for structural reforms, and some countries may possibly

come under longer-term pressure. But overall, we believe that the significant structural changes made over the past ten years will enable countries to survive this cyclical decline.second: Prices fell so steeply that we can identify major return potential in selected emerging market bonds. The key factor here will not be the direction of US yields, but the speed at which yields rise. In view of the closely interlinked global markets, uu

Alexander Moseley, Senior Portfolio Manager, Emerging Markets Debt Relative

chart 1: one of the biggest collapses outside a crisis

EMBI = Emerging Market Bond Index. CEMBI = Corporate Emerging Market Bond Index. GBI-EM = Government Bond Index – Emerging Market.

Source: JP Morgan, Bloomberg and Schroders.

period emBI Global

period cemBI Broad

period cemBI Broad

high Yield

period GBI-em Globaldiv

Mar-Sep 2002 -10.1% Mar-Sep 2002 -3.0% Jul 2003 -0.4% Mar-Jun 2006 -7.1%

Jul 2003 -3.5% Jul 2003 -3.0% Apr-May 2004 -3.5% Aug-Nov 2008 -22.9%

Apr-May 2004 -6.9% Apr-May 2004 -4.3% Mar-Jun 2006 -1.8% Jan-Feb 2009 -11.3%

Mar-Jun 2006 -4.0% Mar-Jun 2006 -1.9% Aug-Nov 2008 -40.2% May 2010 -4.3%

Aug-Nov 2008 -21.7% Aug-Nov 2008 -25.0% May 2010 -4.5% Nov 2010 -4.6%

Nov 2010 -3.2% Nov 2010 -1.1% Nov 2010 -1.3% Aug-Nov 2011 -9.1%

Aug-Nov 2011 -4.2% Aug-Nov 2011 -6.3% Aug-Nov 2011 -14.2% May 2012 -7.3%

May-Jul 2013 -9.7% May-Jul 2013 -5.8% May-Jul 2013 -5.8% May-Jul 2013 -11.3%


Markets

further capital outflows are certainly to be expected in the emerging markets if US yields rise considerably. And higher volatility requires higher compensation. Essentially though, we anticipate that the US Federal Reserve will not increase the US overnight rate for another one or two years – as official representatives have repeatedly stated – and that US yields will rise only slowly following the now generally expected gradual tapering of quantitative easing. In these circumstances, we believe there are good earnings opportunities for emerging market bonds.

why pessimism is exaggerated Following the latest sell-off, the question being asked is no longer how to best invest in emerging market bonds, but whether to invest at all. There are four reasons for this pessimism, which we believe are mitigated by strong counter-influences. On current valuations, investors are pricing in a significant amount of bad news. In our view, this pessimism is not justified.

current account balances have worsenedThere is a great deal of concern that, due to the larger current account deficits in combination with significant refinancing needs abroad, countries will be more

susceptible to an abrupt end to capital inflows. In other words, the pessimists are arguing that the emerging markets are facing the threat of a classic balance of payments crisis.

Of the 22 emerging markets in chart 2, however, ten still have current account surpluses, and the foreign positions of two other countries – Poland and Romania – have improved. This leaves only ten countries that will in actual fact probably have to correct their current account balance. This is likely to happen through currency devaluation or weaker growth, i.e. trends that are already happening. However, we believe the correction will probably run more smoothly than in the

uu

chart 2: Not all countries have problems with their current account balances

Source: Haver and Schroders.

current account balance

n Change in the current account balance (2012 versus 2007) Current account deficit (total for fourth quarter of 2012)

Nig

eria

Mal

aysi

a

Chi

le

Chi

na

Thai

land

Per

u

Can

ada

Ukr

aine

Indo

nesi

a

Indi

a

Vene

zuel

a

Japa

n

Arg

entin

a

Bra

zil

Rus

sia

Phi

lippi

nes

Fran

ce

Uni

ted

Kin

gdom

Col

ombi

a

Ger

man

y

Turk

ey

Mex

ico

Sou

th A

frica

Italy

Kor

ea

Net

herla

nds

Uni

ted

Sta

tes

Aus

tral

ia

Pol

and

Por

tuga

l

Spa

in

Hun

gary

Rom

ania

Irela

nd

Gre

ece

Kaz

akhs

tan

15

10

5

0

- 5

-10

-15

GDP in %


Markets

uu

past, due to the massive holdings of liquid foreign currency reserves and investments by foreign private investors, which can be used to service debts and avoid defaults (chart 3). The volume of net foreign assets is on average almost double the level recorded in the crisis a decade ago. In addition, the financial situation is more stable, because a far higher proportion of government debt is in local currencies. Consequently, the countries are likely to be able to avoid financial crises. The most frequently cited problem countries with weak foreign positions – Turkey, Ukraine and Indonesia – therefore represent only a small proportion of the entire asset class.

rising us interest rates will reduce liquidityOne problem the pessimists emphasise in particular is that the proportion of foreign investors in the local bond markets is now very high, following the record inflows over the past five years (chart 4). If interest rates in the US rise, these investors could withdraw their money and leave a trail of devastation behind them. The emerging markets therefore face the question of whether there is a fixed group of investors who will remain loyal to the local bond markets. If there is such a group, a rise in yields in the US and a stronger US dollar are not likely to affect the emerging markets significantly more than industrialised countries, which should mean that a crisis can be avoided.

The large group of national investors (banks and pensions funds) and the growing positions of institutional investors from industrialised and emerging markets (central banks,

picture bar above:

Pages 40–41 (l-r): India, Sri Lanka, Vietnam, Saudi Arabia.

Pages 42-43 (l-r): Kenya, Malaysia, Chile, Maldives.

Pages 44-45 (l-r): Taiwan, Mongolia, India, Jordan.

chart 3: record foreign currency reserves could cushion outflows


official foreign currency reserves

in USD billions

9

8

7

6

5

4

3

2

1

004 05 06 07 08 09 10 11 12 13

n India n Chinan Russia n Other emerging marketsn Brazil

chart 4: Not all foreign investors are likely to withdraw their money

Source: Citi Research.

foreign ownership of local currency bonds

Peru Mexico Turkey Malaysia Hungary Poland Indonesia Brazil

in USD millions

70

60

50

40

30

20

10

007/07 06/08 05/09 04/10 03/11 02/12 01/13


Markets

insurance companies and pension funds) suggest that the share of foreign investors on the local bond markets is likely to remain high for structural reasons, as is the case on the bond markets of industrialised countries.

Growth in the emerging markets is slowingThat is true, but it is not grinding to a complete halt (see chart 5). The emerging markets are still achieving economic growth of 3-4%, compared with 0- 1% in the industrialised countries, and they are responsible for an impressive 80% of global growth. We also do not believe that the emerging markets will generally be forced to raise interest rates this time in

uu chart 5: the global economy continues to perform synchronously, with the emerging markets as the engine


real Gdp growth

Industrialised countries Emerging markets

Year-on-year change, in %

121086420

- 2-4-6

90 92 94 96 98 00 02 04 06 08 10 12 14

The growth “beta” of the emerging markets is synchronised, but the growth “alpha” is intact.

]

chart 6: Industrial products make up the majority of exports from emerging markets

Source: OECD-WTO database on global trade in value added.

commodities exports

n 2009 n 1995

Sau

di A

rabi

a

Rus

sia

Sou

th A

frica

Aus

tral

ia

Nor

way

Indo

nesi

a

Bra

zil

Vie

tnam

Net

herla

nds

Mal

aysi

a

Arg

entin

a

Mex

ico

Rom

ania

Turk

ey

Fran

ce

Pol

and

Ger

man

y

Taiw

an

Uni

ted

Sta

tes

Sin

gapo

re

Uni

ted

Kin

gdom

Hun

gary

Kor

ea

Japa

n

Indi

a

Chi

na

Thai

land

Hon

g K

ong

Phi

lippi

nes

1009080706050403020100

Export value creation in %


Markets

order to meet inflation targets or hedge foreign currency liabilities. Various countries are in fact likely to further reduce interest rates in order to cushion the slowdown in growth. They also have no problem with currency weakening, at least up to a point. Notable exceptions are Brazil, Turkey, Indonesia and India, which are currently in the process of raising interest rates. However, they are not representative of the asset class as a whole.

Many market observers believe that economic growth in the emerging markets is slowing in isolation from developments in the industrialised countries – a new version of the decoupling theory. In fact, however, the growth slowdown in the

the level of debt in the private sector has risenIt is true that lending growth in China, Brazil, Turkey and a number of other emerging markets is not sustainable (chart 7). And it is true that these countries will have problems getting a grip on the consequences of this fast credit expansion, and that the measures entailed will inhibit economic growth. Politicians must ensure the stability of the financial system in an orderly way.

But these countries are not the norm – they are exceptions, albeit very important ones. The financial systems of most other countries are either being relieved through deleveraging or have recorded moderate growth since the financial crisis of 2008.

emerging markets and trends in the industrialised nations have taken place in perfect synchronicity for large parts of the past decade. This is because the majority of exports from middle-income emerging markets are of industrial products and not commodities (chart 6). And the global manufacturing cycle is indeed global, so a synchronised slowdown should not come as a surprise. In our view, it would be more unusual if there were significant divergences in these growth trends. But this is exactly what many experts forecast: an acceleration in economic growth in the industrialised countries in the second half of 2013 along with a continued slowdown in the emerging markets.

uu

chart 7: lending growth was unusually strong in only a few emerging markets

Source: Fitch, Haver and Schroders.

change in lending to the private sector as a proportion of Gdp (2012 versus 2007)

Thai

land

Sou

th A

frica

Turk

ey

Chi

na

Bra

zil

Ser

bia

Mal

aysi

a

Pol

and

Col

ombi

a

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nesi

a

Rus

sia

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ania

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u

Indi

a

Mex

ico

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lippi

nes

Arg

entin

a

Vene

zuel

a

Sau

di A

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a

Pan

ama

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eria

Ukr

aine

Hun

gary

Egy

pt

GDP in %

40

30

20

10

0

-10

-20

n fast credit growth


Markets

Total debt in the emerging markets – i.e. of governments, companies and private households – is still significantly lower than in the industrialised world. This is important, because it means that fewer resources as a proportion of GDP are required for the recapitalisation of the banking system. In other words, although the possible recapitalisation required by the banks is still significant, it is far lower than in industrialised countries relative to available funds.

selected emerging market bonds offer significant return potentialHow much negative sentiment is priced into emerging market bonds? A lot, in our opinion. The pessimistic scenario for the emerging markets is now well known, and the growth slowdown that started at the beginning of 2013 has already progressed a long way. However, we believe that market participants are ignoring or do not fully appreciate the strengths outlined above.

In many emerging markets, real yields are now back at their five-year average and are markedly higher than those in industrialised countries (chart 8). The real effective exchange rates of ten of the 13 largest emerging markets with local investment markets are now below their long-term trend levels (chart 9). In South Africa – the most extreme example – the Rand has lost 35% of its value over the past one and a half years. There are good

uu

1 Calculation using the average consumer price index for the past three months compared with the prior year.

chart 8: real yields in the emerging markets offer good return potential

Source: Bloomberg, Haver and Schroders.

real 10-year yields1

n July 2013 n April 2013

in %

NG

N (B

B-)

CO

P (B

BB

)

BR

L (B

BB

)

HU

F (B

B)

PLN

(A-)

PE

N (B

BB

)

TRY

(BB

+)

IDR

(BB

+)

MY

R (A

-)

ZAR

(BB

B)

CA

D (A

AA

)

JPY

(AA

-)

MXN

(BB

B)

AU

S (A

AA

)

US

D (A

A+

)

IHB

(BB

B+

)

PH

P (B

BB

-)

GE

R (A

AA

)

RU

B (B

BB

)

RO

N (B

B+

)

GB

P (A

A+

)

5

4

3

2

1

0

-1


Markets

Important note: The views and opinions contained herein are those of Alexander Moseley, Senior Portfolio Manager, Emerging Markets Debt Relative, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

fundamental reasons for this, but the real point is that a massive valuation adjustment has already taken place.

In the emerging markets, the spreads of USD-denominated government bonds – both investment and non-investment grade – and first-class corporate bonds over their US equivalents are higher than at any point in the last eight years. Since absolute growth in the emerging markets is still stronger than in the US, we do not

believe this difference is justified. One area of the emerging markets in which spreads over the US have not increased is high-yield corporate paper.

There is no doubt that a decline in liquidity would affect the emerging markets and that, in view of their higher interest rate volatility, higher compensation is required. But since a significant amount of bad news is already priced in, future performance will

predominantly depend on how quickly yields rise in the US. In general, we anticipate that the US Federal Reserve will increase the US overnight rate – as official representatives have repeatedly stated – in one to two years at the earliest. And since a gradual tapering of quantitative easing is generally anticipated in September, the most likely scenario in our view is a slow rise in US yields. We believe this means that selected emerging markets offer very good return potential.

chart 9: real exchange rates are now below their long-term trend level

Source: JP Morgan and Schroders.

real effective exchange rates as at end-June as a % of the 10-year trend

Mex

ico

Per

u

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a

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a

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5

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-5

-10

-15

-20

Change in %


Markets

uk We have upgraded our UK growth forecast, partly because of a recent very positive sentiment survey, and partly because of easing connected with house building, which should support earnings growth. UK companies appear to be benefiting from loose monetary policy, as the Bank of England predicted. We do not expect base rates to be hiked before 2016.

schroder Isf uk equity

market overviewequities

us The US remains our preferred market, despite the current volatility caused by political and regulatory risk. It remains unclear what the Fed will do and when, but we expect the monetary environment to remain cautious. US equities are still cheap, but no longer as attractive compared with other markets. There is also an increasing chance of more corporate actions in future, as cash flow is directed towards M&A and share buybacks.

schroder Isf us small & mid-cap equity

europe (ex uk) European equities continue to offer attractive opportunities. However, the ongoing political risks associated with the region still represent an obstacle to capitalising on these. Steady progress on the macro front can be seen – if you believe the latest company surveys – but structural debt trends in the peripheral countries remain a problem.

schroder Isf european special situations

emerging markets Looked at across the entire investment universe, emerging market valuations are gradually becoming more attractive. We nevertheless remain selective, as we expect economic growth to slow down again.

schroder Isf emerging markets

Japan Prime Minister Abe’s intended stimulation of the economy partly by means of a weak yen, seems to be bearing fruit. Everyone knows that further structural reforms are needed to provide long-term sustainable growth. But despite that, there are some small signs that the soft yen is gradually bringing in revenues. The rate of currency depreciation is slowing, though, and potential negative effects are looming from a consumption tax hike.

schroder Isf Japanese opportunities


Markets

Government bonds We remain underweight in developed

market sovereigns. Our biggest underweight is in US treasuries, although we are reviewing our position here, as market sentiment has been improved by the steady recovery in the US real estate market and the Fed announcement deferring the tapering of quantitative easing. We remain neutral on UK gilts, and also have a neutral view on Bunds, which are caught between two balancing forces: improving growth prospects and the rising risk of political uncertainty following the German election.

schroder Isf euro Government Bond

high-yield bonds We continue to prefer high-yield over

investment-grade bonds, because of their lower duration risk and higher carry in an environment that is still characterised by low default rates. Last quarter saw a narrowing of the spread between European and US high yield, as European issues performed much better, and also because they were less affected by the rumours of Fed tapering. We therefore remain positive on Europe, but are aware that political uncertainty may return.

schroder Isf Global high Yield

corporate bonds The biggest influence on the asset

class is still the possibility that the Fed may put an end to monetary loosening. Fundamentals remain solid, though, given the improving growth outlook in the eurozone and the US. Spreads have been stable over the past three months and look fair value.

schroder Isf euro corporate Bond

Index-linked bonds Valuations are still not very inspiring,

despite the recent rise in real yields. Break-even inflation remains high, so we remain neutral.

schroder Isf Global Inflation linked Bond

emerging market bonds At current valuation levels, spreads

look very attractive. We prefer emerging market bonds in US dollars, since we believe the global yield curve will stabilise again after the next Fed meeting.

schroder Isf emerging market debt absolute return

commodities We have upgraded the commodity

sector again, especially as investors’ general mood towards this asset class has brightened. We are neutral on industrial metals. The same goes for energy, although we are aware of the risk of capacity bottlenecks. We are now positive on precious metals, as the recent poor sentiment on the money markets, which had hurt prices, has improved significantly, and the gold price is also moving up.

schroder Isf Global resources equity

property Our view on property has improved

slightly. The recent uptick in UK economic data has helped the housing market, although this is mainly confined to London. We see no improvement on the continent, especially in the commercial segment, as vacancies are still too high. Only in a few cities in Germany and northern Europe do we expect growth in the rental sector.

schroder Isf Global property securities

expected performance:

Positive Neutral Negative

Bonds alternative investments


SpEcial fEaturES

44

There have been a number of significant events in the property security markets so far this year, that have driven investors to make decisions without focusing on fundamentals. Unfortunately, these events have led to an unfair depression of the property securities sector in general, and REITs in particular.

JapanAt the beginning of the year, in response to the Bank of Japan (BoJ) injecting huge amounts of liquidity into the markets, there was a strong rally in Japanese Real Estate Investment Trusts (JREITs). The BoJ aimed to invest roughly $1.3 billion into the $70 billion JREIT sector. Consequentially, JREIT share prices rocketed by 50% during the first quarter of 2013 and were trading at up to 60% premiums to net asset value (NAV). In our view, we felt that this was unsustainable – despite some predictions that rents would rise as much as 20% this year which we believed was unlikely. As at the end of

the third quarter average office rents had, in fact, declined by 2.7% for the year. The other concern over JREITs is the limited liquidity. Investors, with meaningful holdings, can find it a struggle when trying to sell out at the prices quoted in the market. Once the BoJ announced that it had almost

completed its purchases, the JREITs dropped back almost immediately. JREITs surged again (over 16%) in September, possibly due to suggestions made by a government-sponsored economic panel that

pension funds should allocate more funds to JREITs. This, again, was not as a result of any significant change in fundamentals.

schroder property: many reIts cheaper than ever before

“We prefer companies that can directly manage their assets in order to increase their value or income stream”

schroder property: many reIts cheaper than ever before

Andrew Robbens,Product Manager Global Property securities at schroder Property


SpEcial fEaturES

45

We do not tend to invest in JREITs, as we prefer companies that can directly manage their assets in order to increase their value or income stream. JREITs are not permitted to engage in development activities and they tend to hold lower quality stock. Our preference has been to invest in taxable development companies, but despite significantly stronger fundamentals their performance lagged JREITs. Recently, Japanese development companies have closed this gap and their fundamentals remain considerably stronger than their JREIT counterparts.

hong kong/chinaHong Kong has suffered on the back of a slowdown in China and the fear of rising US interest rates. The Chinese economy, however, appears to be turning the corner with stronger data points coming through. Hong Kong will hopefully be the beneficiary of improvements in the Chinese economy. However, following the Federal Reserve (Fed) Chairman’s, Ben Bernanke, speech, stock prices of Hong Kong office and retail property companies are struggling to recover. This has been despite falling vacancies and

recovering rental levels. Nevertheless, this has created opportunities. Companies currently look attractive at 35-45% discounts to NAV in a market which would ‘normally’ trade at discounts of 20-25%. The Hong Kong commercial sector needs two million square foot of new commercial space each year to fulfil normal demand. Currently only half this is being developed. In China, the higher-quality residential companies continue to report strong sales. Although our overweight to Hong Kong and China has been a significant detractor to returns year-to-date, we believe that the companies we hold should offer significant upside potential as the economic situation improves. This is obviously subject to governments not introducing crippling measures which stunt growth in the sector.

united statesIn the US, there has been a raft of speculation as to the pace of recovery and knee-jerk reactions to statements from the Fed. The immediate reaction to Bernanke’s announcement, that its bond-buying programme would be tapered, was a surge in bond yields and

“In China, the higher-quality residential companies continue to report strong sales.”


SpEcial fEaturES

46

a sharp decline in income oriented vehicles of any kind, especially REITs. The Fed then went into damage-limitation mode releasing statements to allay peoples’ fears.

US REITs appeared to bear the biggest share of the sell off as other higher yielding stocks seemed to weather this news. While several theories as to why REITs were so unfairly treated have been put forward, we believe these are weak, especially when assessing the position of higher quality large-cap US REITs.

If interest rates do go up there are concerns that property companies will have an increased cost of debt. Most of the larger quality names hold substantially lower levels of debt than they did a few years ago and, in any case, have already negotiated favourable terms. Therefore, they are fairly well protected over the short-to medium-term from any impact this could have on their profit margins. Smaller-cap companies may be at more risk if bond yields continue to rise, and interest rates do go up, as they may find it difficult to raise funds to finance opportunities.

Company results for many of the quality REIT names are beating expectations. As the economy heads towards a recovery, the quality names, with superior characteristics in the most attractive locations, should see an increase in demand as companies look to expand their workforce. So we would hope to see even better results from these property companies during a recovery as supply is put under greater pressure. This is obviously dependent on location and sector.

There are also concerns that cap rates will rise with the increase in bond yields and this will put pressure on property values. However, in the markets in which we invest, there is simply not enough supply for the demand out there. In a recovery, we feel that this divergence will increase as companies look to expand.

The other issue in the US is the dispersion in trading levels between large caps vs. small caps. Large-caps continue to appear undervalued and small-caps overvalued. Our preference is for large-cap companies as they tend to attract better quality management teams and own portfolios of centrally

“The past several quarters have seen sizeable outflows of REIT assets from non-dedicated investors (generalists) and passive REIT strategies (ETFs)”

what are reIts?

real estate investment trusts are companies that have their shares traded on a stock exchange, derive their earnings primarily from managing property and are subject to special conditions regarding structure and tax.

International: REITs and REIT-like structures have become established in 23 countries. The US became the first country to introduce them in 1960, followed by the Netherlands in 1969 and Australia in 1985. It was not generally until the last few years that REITs made an appearance in other countries. Although the details of REIT legislation vary from country to country, the basic structures are similar, so for example they are widely exempt from tax at company level and must pay out a specific percentage of their earnings to shareholders.

schroders expertikon


SpEcial fEaturES

47

located, high quality property. Sitting here in the second half of 2013, with the threat of rising interest rates at the forefront of investor psyche, we are surprised that the larger-cap REITs have not recouped some of their relative performance. The reason may be more technical than fundamental, as the past several quarters have seen sizeable outflows of REIT assets from non-dedicated investors (generalists) and passive REIT strategies (ETFs) – and large-cap companies are “over-owned” by such investors. This phenomenon has made the value proposition for large, high-quality companies quite interesting on both an absolute and relative basis. The question of when this anomaly will reverse is a challenging one to answer given how difficult it is to predict when broader sentiment towards the REIT sector will become more favourable.

conclusionThe fund uses the FTSE EPRA/NAREIT Developed index as a comparison as this is perceived to be the industry standard. It can be difficult for active managers to outperform this index due to its structure. The index is more concentrated towards the small to mid-cap end of the spectrum. This can be problematic, from a relative performance perspective, for fundamental investors whose focus is on companies with quality management teams and property portfolios (predominantly found in larger cap companies) – especially during the market environment we are currently experiencing. With the market selling out of these and the fact that the index includes JREITs, the potential for relative outperformance is challenging even for passive managers.

The repricing of property securities is most likely the result of normal overselling which occurs during periods of fear. As concerns over interest rates and China growth subside, we would expect prices to reflect underlying fundamental trends. With a number of quality property companies trading at attractive levels of discount to NAV – twinned with the lack of supply in most major developed markets – a recovery, however modest, should serve them well.

We believe our portfolios, which have a large-cap bias and a focus on high quality, are well positioned for a recovery. Recent sell offs have resulted in attractive opportunities in the high-quality companies we hold. Detractors from our relative performance, such as our overweight to Hong Kong/China and our bias to US large caps, should reverse as investors become more confident of an economic recovery.

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FIxE

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the reliable route to decent income

Baron Bruno von schröder (1867-1940).

schroders exPeRT q4/201349

MIsCeLLaNeOus

In 1913, the German empire was already the second-largest trading nation in the world, a little behind the

colonial power that was the British empire, and still ahead of the US. The Wilheminian era, named after the Prussian Kaiser Wilhelm I, saw the first great economic miracle. But the United Kingdom, too, was flourishing, and held a position of almost untouchable dominance – at the time, the British empire covered one-quarter of the earth’s land mass. It was the very first industrialised country and from the beginning of the 19th century had the largest trading fleet in the world by some distance. The pound sterling became the most important European currency, as at the time the UK was the only country to enjoy currency stability – contrasting with mainland Europe, where the Franco-Prussian war had been followed by several currency reforms. In addition, a significant proportion of trade, particularly in Germany, was financed with UK loans, so sterling became Europe’s leading currency.

It was at this time that John Henry, who was now 59 years old and had been working for the firm for 40 years, was facing an important question: who should succeed him at the head of the firm when he retired? In the end, he decided in favour of his nephew Bruno Schröder. Born in Hamburg, the son of Johann Rudolph Schröder I and Clara Louise Schröder, both members of the Schröder family by birth, he had already spent a year working for his

the end of the 19th and beginning of the 20th century was a time of high industrialisation. Germany went from being an agricultural to an industrial country and was notably able to significantly strengthen its position relative to the pioneer of industrialisation, the united kingdom.

history of schroders

schroders at the height of the industrial revolution

uncle in London on a voluntary basis in 1888. He was just 21 years old at the time. Subsequently, from 1892 onwards, he had worked in Germany for another Schröders company, Schröder Gebrüder & Co. This Hamburg merchant bank was steeped in the Schröder family history, having been founded in 1846 by the brothers Bernhard Hinrich Schröder I and Johann Rudolph Schröder II in 1846. Schröder Gebrüder & Co. had close ties with its sister firm in London and at the end of the 19th century was the largest supplier of saltpetre to Germany, France, Belgium and the Netherlands.

Bruno Schröder was made a partner of Hamburg bank in 1893, but a few months later received another offer, which he could not turn down. John Henry invited him to come to London and work for J. Henry Schröder & Co. Bruno Schröder realised that this was a unique opportunity that he could not pass up. So it was that on 1 January 1895, at the age of just 27, he became a partner in the London firm. Bruno was a born businessman and knew how to invest the firm’s assets in such a way as to earn higher returns with little risk. For instance, instead of investing only in highly liquid trade bills, he opted for higher-yielding bonds. Thanks to skilful trading, excellent ties with Germany and Hamburg's increasing importance as a centre for trading, Bruno made J. Henry Schröder & Co. one of the elite trading companies. Like his uncle John Henry, Bruno Schröder was a great philanthropist. In recognition of his generous support for German and British

foundations, he was ennobled by Kaiser Wilhelm II in 1904 and became Baron Bruno von Schröder. Six years later, after the death of his uncle, he became the main partner in the London firm and moved into The Dell, the manor near London that he had inherited. From there, he was able to devote his full attention to the business.

The UK, with London as its financial centre, was at the heart of a flourishing global trade, and J. Henry Schröder & Co. was faced with increasing competition from the European mainland. The economic boom of the Promoterism era and the rapid advance in industrialisation in Germany meant that, for instance, more and more German banks were opening up branches in London. Deutsche Bank, for instance, opened a branch in London in 1873, followed by Dresdner Bank in 1895 and the Disconto-Gesellschaft in 1899. In spite of all this, J. Henry Schröder & Co. went from strength to strength, enjoying greater success than ever: with equity of GBP 3.65 million in 1913, it was one of the leading trading houses of the time – only commercial bank Kleinwort had more assets under management. Shortly before the outbreak of the First World War, the firm was at the highest point in its history, yet remarkably had achieved this with just two partners and 40 employees. But then came the assassination in Sarajevo on 28 June 1914, and the world was turned on its head.


Miscellaneous

Publishing informationPublished by: Schroders Denmark Filial af Schroder Investment Management (Luxembourg) S.A. Store Strandstræde 21, 2nd, DK-1255 Copenhagen

Editor: Lars K. Jelgren

Copy deadline: 18 October 2013

Graphics: A. Punkt, Darmstadt

Important InformationThis document does not constitute an offer to anyone, or a solicitation by anyone, to subscribe for shares of Schroder International Selection Fund or Schroder GAIA (the “Companies”). Nothing in this document should be construed as advice and is therefore not a recommendation to buy or sell shares. Subscriptions for shares of the Companies can only be made on the basis of its latest prospectus together with the Key Investor Information Document, latest audited annual report (and subsequent unaudited semi-annual report, if published), copies of which can be obtained, free of charge, from Schroder Investment Management (Luxembourg) S.A. An investment in the Companies entails risks, which are fully described in the prospectus. Past performance is not a reliable indicator of future results, prices of shares and the income from them may fall as well as rise and investors may not get back the amount originally invested. Schroders has expressed its own views and opinions in this document and these may change. This document is issued by Schroder Investment Management Fondsmæglerselskab A/S, Store Strandstræde 21, 2nd Floor, DK-1255 Copenhagen.For your security, all telephone calls are recorded.Third party data is owned or licensed by the data provider and may not be reproduced or extracted and used for any other purpose without the data provider‘s consent. Third party data is provided without any warranties of any kind. The data provider and issuer of the document shall have no liability in connection with the third party data. The Prospectus and/or www.schroders.com contains additional disclaimers which apply to the third party data.

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. . . over 65% of all Schroders ISF funds are ranked in the first or second quartile over one year?

Source: Morningstar; 10 September 2013

. . . over 66% of all Schroders ISF funds are ranked in the first or second quartile over five years?


. . . over 71% of all Schroders ISF funds are ranked in the first or second quartile over five years?


. . . Schroders has 36 funds with 5-star ratings from Morningstar – more than any other investment company?


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