Market OutlookFebruary 2016

“The oldest and strongest emotion of mankind is fear, and the oldest kind of fear is fear of the unknown.” H.P. Lovecraft – 1925

There has been a lot of fear in markets in recent weeks and months and I think it is safe to say that, although it was positive overall, 2015 was fairly tumultuous from an investment perspective. Similarly 2016 has started with further bouts of volatility and in this turbulent environment investors are bound to worry about what the future holds. To make matters worse, all the major newspapers were recently gifted a convenient doomsday story courtesy of Andrew Roberts at the Royal Bank of Scotland when he suggested that investors should “sell everything”. In my opinion, Mr Roberts’ advice is not only wrong, but it is irresponsible. Ross Clark, writing in the Spectator astutely points out that Mr Roberts has some history as a ‘Cassandra’ having incorrectly warned of impending doom in 2010 and then again in 2012. Perhaps he is hoping for third time lucky and certainly if we did all follow his advice, his prophecy would become self-fulfilling. Investment should always be considered as long term and so advising investors to quite literally “sell everything” is wrong on so many levels. Last but not least, let us not forget that the organisation delivering this message is the same RBS that so badly mishandled its own finances in 2008 that it had to be bailed out by the tax payer. Mr Roberts’ pedigree is questionable at the very least.

Despite Mr Roberts’ assertions, I do not believe that we are facing a doomsday scenario. I do believe that we will face continued volatility during 2016, but it will by no means be one way and I think that some parts of the world economy will surprise. China in particular has been talked down over the last 6 months and almost written off and I am not convinced that is the right approach. Yes, there are issues as its growth settles to a more manageable rate, but I believe that these concerns are already priced in to current valuations.

I believe that the main causes of volatility in markets at the moment are simply down to change and uncertainty. The major change that has taken place has been the US Federal Reserve (the US equivalent of the Bank of England) decision to move away from quantitative easing (QE) and general monetary easing, to a strategy of gradually increasing interest rates, in response to the strengthening of the US economy. The uncertainty is due to the markets not understanding (or even misinterpreting) how this will affect economies around the world, since this is hugely different to the status quo that existed before. From November 2008 until very recently, the markets have been operating within a huge QE comfort blanket that has meant that pretty much all assets (the good and the bad) have performed positively. Now that the blanket has been taken away, markets are unsure as to what will follow and so we see these regular bouts of volatility whilst markets work out solutions and strategies to the new uncharted environment.

In 2016, we expect opportunities for active, discerning investors to increase - the rising tide of global QE that had lifted all boats will begin to ebb, and in that environment it will make sense to differentiate within and across asset classes. In this world, a focus on valuations and fundamentals

- ‘old school’ investing if you like - should be more important than it has been in recent years, when markets were backstopped by abundant and growing liquidity. Our head of investment, Jilly Mann, has highlighted this particular point in the following pages where she describes how we have rebalanced portfolios to benefit from value investing wherever possible.

Managing risk and volatility within portfolios is our key objective. All investors are looking for high returns and low risk but in reality that combination doesn’t exist and so compromises have to be made. Whilst risk can be minimised through careful research and diversification (eggs in different baskets), it can’t be eliminated and so the compromise is that the higher the potential return then the higher the associated risk. That said, most investors, after due consideration, can arrive at a combination of risk and reward that they are happy with.

The low interest rate environment that has become the norm during the last decade has necessitated change for investors. Some individuals have been forced out of their bank and building society comfort zones and into the equity markets. Quite simply they haven’t had much choice, either accept next to no returns or returns that are often volatile and unpredictable.

Undoubtedly, a properly constructed portfolio of diverse investments, split by geography and by asset class is the best solution for investors and history

has proved this, time and again. Nevertheless, when markets go through periods of extreme volatility, investors do get very worried and advisers need to be aware of this and be sensitive to their client’s concerns. From my personal experience I have noticed a considerable difference between those clients who have been invested for 5 years or more and those who have only been invested for 2 or 3 years or less. Those clients who have seen with their own eyes periods of volatility and investment losses followed by periods of resurgence and gains have ongoing faith that, in the long term, investment in a diversified portfolio of equities works.

People often ask me how we go about putting together an investment portfolio and they imagine that it must be a very complicated process. It is indeed complicated and there is a great deal of detailed research that is required to choose the right mix of assets to create a portfolio that will provide the optimum balance of risk and reward. However, the principles from which we start the process are simple and straightforward. We construct strategies that are designed to run for 3 to 5 years and beyond, in other words we are seeking to invest for the long term. In theory, we shouldn’t need to change the strategy going forward, but in reality the world around us changes constantly, some sectors will get overvalued and others will become devalued. A significant benefit of investing globally and in different asset types is that they tend to behave differently and so this creates the need to rebalance every so often, taking profits where they have been made and cutting losses where necessary.

In terms of predictions for 2016, I think we will continue to see volatility in the coming months, but I also think that at some point, the dust will settle and calm will return, as will the sustainable returns that a carefully considered long term approach provides.

The overriding theme across the portfolio positioning for 2016 is one of value rather than growth. In essence, value investing means buying at the right price and selling at the right price.

It sounds obvious, but few managers follow this ethos, preferring instead to follow a momentum driven growth strategy, which if not monitored closely can lead to managers chasing returns beyond a price at which the stock remains a viable

investment. In recent months, value investing has fallen out of favour and has underperformed the wider market as growth investors have benefited from rising stock momentum. We feel that 2016 may signal a turnaround in this dynamic and throughout this edition we shall discuss how a value thread runs through many of the changes we have made to position the portfolios for the coming months.

As a result of this realignment of the portfolios towards value investments, we shall also position more of the portfolios into sectors which have been unloved by the market over the past few years, financials being a good example of this.

Fixed Interest Absolute Return

Property UK Equity

European Equity US Equity

Global Equity Japan Equity

Asia Pacific Equity Emerging Market Equity

Up Down Level

Fixed InterestWe retain a zero weighting to pure fixed interest funds in many of the portfolios, having sold our remaining weighting in the Threadneedle Emerging Market Bond fund in our income portfolios. We had previously retained this fund as the yield continued to be extremely healthy, enough to offset much of the underlying capital risk for income investors. We have included the Invesco Perpetual Global Financial Capital fund in our income portfolios instead. This fund aims to benefit from the reform and rehabilitation of global financial institutions following the financial crash of 2008. Financials may still receive a bad press day to day, but from an investment perspective, they represent the sector which has singularly transformed its business strategy and risk approach more than any other. The Invesco fund is able to take advantage not only of the changes which the financials themselves are making, but also the changes imposed upon them by Government and regulators. The Global Financial Capital fund fits particularly well within income portfolios as it continues to generate a yield of over 5%, which is significantly higher than the falling yields found elsewhere in the fixed interest sector.

Our ethically biased portfolios continue to hold the Rathbone Ethical Bond, Royal London Ethical Bond and the EdenTree Amity Sterling Bond funds (EdenTree being the rebranded name of what was Ecclesiastical Asset Management). Our ethical portfolios do not comprise investment into property and so the Fixed Interest funds provide the risk reducing element of the portfolios. Although we are generally concerned about the merits of many fixed interest funds, the three ethically biased funds have continued to produce returns of between 2% and 3% for the past 12 months. This is not a spectacular return, but as a relatively low risk investment to balance out the rest of the portfolio, they are producing positive returns.

Whilst the world becomes re-accustomed to rising interest rates, we would anticipate fixed interest continuing to be an unpredictable area for investment. The managers we do invest with are seeking to take advantage of not only the improved position of financials , but also improving yields for marginally lower grade credit where unrealistic default levels have perhaps been factored in.

We have increased our exposure to the Threadneedle Monthly Extra Income fund. This fund comprises up to 80% UK Equity with around 20% of fixed interest, although those weightings can vary to a degree. The equity section is made up of large UK household names with a bias towards generating a yield from a value perspective. The Fixed interest element provides some risk reduction and further boosts the yield to investors. The fund falls in the underused UK Equity & Bond sector yet marries the expertise of Threadneedle’s UK Equity Income and Strategic Bond managers. Whilst the fund is higher risk than a pure fixed interest fund, it is lower risk than a pure equity fund. The fund has attracted a 5 star rating from Morningstar and at only around £420 million in size offers an alternative, more

flexible way of accessing these highly rated managers. I consider this a fund that may attain an increasing role in our portfolios over time. Along similar lines, we have also maintained our weightings to the Jupiter Monthly Income and Artemis Monthly Distribution funds, who invest in a similar mix of fixed interest and equity with a healthy yield.

Although we have seen the first moves from the Federal Reserve in America to increase interest rates, we don’t yet see inflation as inevitable. Ordinarily rising interest rates are a sign of inflation, but the rate of increase is mooted to be slow and the continuing Quantitative Easing policy of Europe and Japan is a headwind for inflation. An aspect to watch shall be the effect on inflation figures once the impact of the recent oil price declines falls out of the reporting season. Falling commodity prices have held inflation back for a long time now and although it is not anticipated that the oil price shall rise imminently, as time passes the rapid fall will disappear from inflation reports and one would expect to see some kind of material uptick in inflation expectations. None of this leads us to believe that we should revert to index linked bonds or gilts at this juncture. In a previous edition of Market Outlook I explained how UK index linked gilts had returned around 19% in 2014 and to put that in perspective, they returned -1.10% through 2015. Looking at 2016, it is hard to find reasons why returns would rise significantly in the index linked sector without some major economic factors taking hold.

PropertyWe have maintained our allocation to the Legal & General UK Property Trust. The fund returned just under 10% to investors through 2015 on the back of consistent incremental gains. The fund is one of the top performing UK commercial property funds and offers a realistic yield of 2.7% at present. The yield is important, because other property funds may offer a higher yield, in excess of 3.5%, but typically their overall return is less sustainable. L&G have recently issued a report on the property sector explaining how the double digit returns in commercial property prices have finally shown signs of slowing with in their view, the supernormal returns from property appearing to be behind us. In their stead, future returns are likely to be founded on economic criteria such as yield and rental growth, which is the basis for sustainable property returns ongoing. One of the factors driving this is the reduction in supply of commercial property. Official figures show that the construction activity was the weakest for 30 years in the five years leading up to Q2 2015.

In part this was due to global construction slowing after the global financial crisis, but allied to this existing space has suffered from underinvestment, meaning that it is less suitable for modern occupiers and large swathes of previously commercial land have been converted into residential development, thus further diminishing commercial stocks. The net effect of all this is a reduction in vacant property, more competition for prime locations and rental growth now beyond just the confines of London. L&G are expecting rental growth to average 2.8% per annum annually from 2016-2018, which is nearly double the rate over the past five years. Interest rates clearly affect the property sector more than many other sectors, but with L&G factoring in a new average base case of 3% interest rates in the future, they consider current rental

growth to be sustainable without a market correction or momentum driven trading.

Absolute ReturnWe have increased our weighting to this sector significantly. Since we reintroduced the Henderson UK, European and Threadneedle UK Absolute Return funds to our portfolios in the middle of last year, they have performed well. Over the last 6 months of 2015, the UK funds returned around 4% to investors. The European version was more pedestrian in its returns, but nonetheless produced a positive figure for investors. We have decided to reduce our weighting to the Henderson European Absolute Return fund, but increase our weightings to both of the aforementioned UK Absolute Return funds. Our outlook for Europe is now more positive, as explained later in this report, and so we feel that the UK funds are better placed to produce the stable returns we seek in the lower risk portfolios. The Absolute Return sector maintains its place in portfolios as the lower

risk element and the funds which we have chosen are designed to produce returns of around 5% per annum. The Threadneedle and Henderson funds invest in different strategies and provide a balanced return to investors. In our moderate risk portfolio, Absolute Return comprises 14% of the portfolio.

UK EquityWe have retained our allocations to our existing UK Equity funds. The Marlborough Multi Cap Income and Miton UK Value Opportunities funds have been exceptional performers in our portfolios. Both funds focus on smaller companies for the majority of their investments and they have both proved resilient to choppy market conditions. We have increased our allocation to the Miton fund and have been impressed with the clinical way in which the fund is managed to protect investors and only trade assets at the right price. Coming back to our opening theme, the Miton fund is a value biased fund. There is a concern that UK smaller companies have performed so well through

The chart below demonstrates UK Commercial Property Construction Orders

from 1965 to date.

2015 that they may offer less return to investors through 2016, but the income and value nature of both the Marlborough and Miton funds means that they are more specific in the type of stocks they are looking to invest in across smaller companies and therefore, are better placed to maintain performance for the coming months than many of their more generalist peers.

Two funds which have underperformed of late are the Schroder Income and Recovery funds, both value biased funds. 2015 was a poor year for both funds compared to their own historical returns and alternative UK equity funds. We decided, however, to increase allocation to both funds across the portfolios. It would be easy to sell out of these holdings rather than increase them, but these funds are true diversifiers and whilst we don’t wish to see any fund underperform, the managers have stuck to their guns on their investment thesis and the signs are there that their style of investing may be rewarded through 2016.

The rationale for both funds is to purchase quality companies at the right price, as the managers consider this to be the greatest driver of long term returns. The problem is that the market hasn’t rewarded this approach as many companies have seen positive price upticks, which are momentum driven rather than sustainable. That isn’t to say that the managers will buy anything if it looks cheap, commodities are a good example of that. Glencore Plc is one of the world’s largest mining companies, yet its shares have fallen over 70% in value over the past 3 years. Based purely on price, this may appear to be a good investment for a value investor as it is cheap, but the Schroder managers won’t invest in this stock at the moment, because although you could drop lucky and grow your investment 4 times over, it still isn’t a viable company to invest in across all the other due diligence criteria.

The chart below shows how FTSE miners have more or less halved in price terms since the summer:

FTSE miners have more or less halved in price terms

since the summer.

Source: Thomson Financial Datastream. FTSE UK Mining price index data over the six months to 17 December 2015.Past performance is not a guide to the future.

A sector where the managers are finding good value is financials, which repeats another theme from earlier and with the increasing need for dividends from the UK stock market, the banks especially stand tall as well capitalised, stable institutions with cash to return to investors. Unfortunately, the nature of value investing is that sometimes it is out of favour and investment fundamentals go out the window. We think that 2016 may see a reversion to traditional stock selection, buying at the right price and holding for the longer term being one of them.

US and EuropeWe have maintained our weighting to US equities and retained the Threadneedle American Extended Alpha fund. Artemis have shown strong performance of late, but we continue to have more faith in the Threadneedle proposition which held up well during the latter part of 2015 when markets started to wobble. They have also boosted their research team with a key analyst from Columbia (the US arm of Threadneedle) with specialist expertise in running this type of strategy which augurs well for the future. On the income side, we have replaced the Fidelity Index US fund with the Threadneedle US Equity Income fund. This fund has been in existence for a while, but not always accessible to UK investors. The fund generates a higher yield of 3% than any alternative US income fund and has combined that with strong capital growth as well.

We have increased our weighting to European equities by way of increasing allocations to the Threadneedle European Select and Schroder European Alpha funds as well as introducing the Neptune European Opportunities fund for higher risk portfolios. The Schroder European funds are further examples of value investing and whilst the income version in particular has a strong track record, the growth version has been a little more unpredictable. The Schroder manager has again been looking closely at valuation and whilst trying to remove some of the political consternation arising in Spain and France, he sees real corporate reform taking place in Spain and Italy over and above core Europe (i.e. Germany). This strategy hasn’t been rewarded over the past few months and his stock picking skills will be key over the next six months, but as an investment thesis based on an understanding of which areas will benefit from continuing European monetary policy, these funds should do well.

The Neptune fund last featured in our portfolios a number of years ago and has struggled since the global financial crisis. Based on pure past performance, this fund should not be near our portfolios, however, putting that to one side and assessing how the fund is positioned for 2016, we consider this to be a contrarian play on European equities. The manager has remained in situ throughout this time and has the courage of his convictions. He is heavily weighted towards financials, technology and consumer cyclicals, areas of the market which across broader Europe have been frowned upon in recent years. European banks though are now well positioned to function as banks again in the truest sense and the underlying economies have recovered to the extent that manufacturing and employment rates are starting to improve. Not everything

has been fixed by a long way in Europe and the lag of European equity valuations to the UK or US is no longer wide as the easy returns have been made, but that is an environment where the Schroder and Neptune managers may prosper and others may well drop behind markedly.

Asia and Japan We have reduced our Asian equity exposure by selling out of the Schroder Small Cap Discovery and Invesco Perpetual Pacific funds and marginally reducing our Threadneedle China Opportunities holding. We have diverted some of this allocation to the Baillie Gifford Global Discovery fund as detailed later in this report, with the majority of this allocation being invested into Japan. The Invesco and Schroder funds have performed well during the time that we have owned them and have provided access to smaller companies across Asia as well as a selection of Japanese companies. With regard to Schroder, we feel that a more global view may provide a better risk/return ratio over the coming year than purely Asia. We wish to adopt a meaningful weighting to Japan within the portfolios rather than an allocation via Invesco. We have been reluctant to invest in Japan as a sector in its own right, because for too long it promised much and delivered little. We feel that this is changing now though and aside from the eased monetary policy, there is genuine corporate reform taking place. Historically, Japanese companies have preferred to maintain profits rather than return them to investors, but Abe’s reforms have created business competition and enterprise zones where their renowned technological skill is now being married with improved business management.

We have selected the Morant Wright Nippon Yield and Neptune Japan Opportunities funds for our allocation. The Neptune fund is a more contrarian investment as the fund can demonstrate quite a variance in return. The fund manager has positioned the fund over the long term ready for a devaluation in the Yen. At times this position, which is markedly different to many of its peers, can seem to underperform, yet at other times his view is proven correct and the returns pick up. 2015 saw the Yen devalue, but we don’t think that we have seen the last of such currency movements. The Neptune fund also tends to focus on larger cap Japanese names, which contrasts well with the Morant Wright fund. The Morant Wright Nippon Yield fund is one that we have been monitoring for some time, but it has not always been available to investors. The fund is run on a “value” style investing in stocks that are financially strong (i.e. lots of cash), attractively valued (low Price/Book Ratio), ideally with a sustainable business and lastly with an above average dividend yield. These four criteria haven’t changed since the fund was launched in 2008. The fund has consistently out-performed the market at a reduced level of volatility. Morant Wright specialise in Japanese equities and do not invest across other regions. Whilst Japan remains in the early days of cultural business reform, we feel that the combination of these two funds is a sensible way to re-enter the region.

Emerging MarketsWe have slightly reduced our weighting to emerging market equities, but more significantly we have equalised our holdings across the Henderson Emerging Market Opportunities and Fidelity Emerging Markets funds. Previously, the Fidelity fund was our larger allocation, however, the Henderson fund has performed in line with our expectations over the past few months and we wish to balance the

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allocation between both funds. The Standard Life Global Emerging Market Equity Income fund retains its place in the income portfolios. There are not many emerging market equity income funds to choose from and over the longer term, the Standard Life fund has been the top performing income fund. The fund manager believes that most of the negative sentiment towards the emerging markets is well factored in and 2015 marked a new low in investor confidence in the emerging world. That said there are still many stocks that continue to perform well regardless of the wider economic situation; internet penetration and e-commerce in particular are areas where the managers are able to find strong companies with growing dividend yields and the feeling is that these companies have survived the worst of the downturn and are well positioned to succeed during the years ahead.

Global Equity and CommoditiesWe continue to find little opportunity in commodities. There is no doubt that prices are low, but there remains little in the way of a catalyst to halt the decline in commodity prices and reverse sentiment towards either energy, precious metals or industrials. The continuing worries surrounding Chinese industrial output weigh heavy on commodities and with oil hitting new lows over the past weeks, it becomes ever harder to estimate a fair price for either oil or gold as a starting point for recovery.

In broader global terms, we have added the Baillie

Gifford Global Discovery fund across more of our portfolios. This fund has been running for a number of years and despite its strong performance has been largely ignored by many investors. The fund is a global smaller companies fund and has replaced the Schroder Small Cap Discovery fund. We consider there to be greater prospects of growth in global smaller companies than solely Asia over the next few months. Many of the holdings within the fund are technology driven. For example, Tesla Motors is leading the way in automotive technology, MarketAxess Holdings is a state of the art online trading platform, and pharmaceutical companies with a focus on genetic screening. Whilst value investing is our preference for much of the portfolio, we feel that the Baillie Gifford fund does offer some fairly unique growth potential which is uncorrelated to the wider portfolio. We maintain our holdings in the Artemis Global Income and Schroder Global Healthcare funds.

In summary, 2016 promises to be unpredictable, but it is a time to revert to investment fundamentals and to be bold with our convictions. Chasing last year’s winners isn’t the right approach and whilst a value bias based on buying and selling at the right price may not look pretty at times, it is the right strategy for the long term. In a world where normality is starting to return and Central Banks raise interest rates and issue less money into markets, we hope that a portfolio comprising fund managers who have been in situ through a variety of market conditions and have weathered the storms through sensible investment criteria, will finally be rewarded through 2016.

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This document is provided for information purposes only and does not constitute any form of financial or investment advice. Past performance is not a guide to future investment performance. The value of your investments as well as any income derived from them can fall as well as rise and you could get back less than the amount invested. We believe the information in this brochure to be correct at the time of going to press and is based on our current understanding of legislation and tax allowances which may change in the future. As such changes can’t be foreseen we cannot accept responsibility for any loss accessioned to any person as a result of action or refraining from action of any item herein. Printed and published by Moore Stephens Financial Services (East Midlands) limited. Authorised and regulated by the financial conduct authority.

February 2016

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Jon TelfordManaging Director

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Jilly MannHead of Investment

jilly.mann@msfs.co.uk

Kieron BraceInvestment Manager

kieron.brace@msfs.co.uk

Simon AshbyInvestment Manager

simon.ashby@msfs.co.uk

Paul DawesInvestment Manager

paul.dawes@msfs.co.uk

Natasha DuncanInvestment Manager

natasha.duncan@msfs.co.uk

Richard McDonaldInvestment Manager

richard.mcdonald@msfs.co.uk