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Q2 Commentary: As of 30th June 2018

Market summary

Pacific ex Japan equities slightly lost value in Q3 in GBP terms, primarily due to weakness in China.

The Chinese market was the main drag as the US implemented tariffs on a total of $250 billion of Chinese goods, some of which are set to increase in January, and threatened tariffs on a further $267 billion of goods. There was little progress in bilateral trade negotiations and China responded with tariffs on $110 billion of US goods. Meanwhile, Chinese macroeconomic data disappointed. The authorities announced a range of targeted economic support measures, including a shift to fiscal stimulus and credit easing. The central bank also re-introduced macro prudential measures to stabilise the renminbi.

Conversely, Thailand recorded a robust return with financials and energy stocks among the best performing names. The approval of laws required for a prospective election in 2019 was perceived as positive. Taiwan, where semiconductor stocks supported performance, and Malaysia also generated solid gains and outperformed.

Across the region, the best performing sectors were telecoms and energy. Oil prices climbed amid supply concerns linked to the re-imposition of US sanctions on Iran, the first phase of which took place during September. The worst-performing sectors were information technology and consumer discretionary.

Investment outlook

Following an extended period of low interest rates, the US Federal Reserve (Fed) continues to maintain a hawkish stance with further tightening of monetary policy. Rising bond yields and a strengthening US dollar remain potential headwinds for equity markets in the near term in a move towards normalisation. In contrast to previous “taper tantrums”, however, Asian emerging markets generally look better placed today from a macro perspective. Current account deficits for the most part have reduced, with most Asian countries running a surplus. Currencies have already weakened in recent years and inflationary pressures in the region remain benign outside of India and the Philippines. Recent renminbi weakness is not expected to continue aggressively given the risk of inciting capital outflows but policy risk has risen. Real interest rates remain reasonably attractive in most markets. While we may still see “risk-off”-driven selling of assets and FX in some countries in response to any sharp US dollar moves, our base case does not see this escalate to cause any systemic problems on the ground in Asia.

More recently, however, politics and protectionism with escalating trade tensions between US and China have taken centre stage as key drivers of markets and investor sentiment amid a sense of heightened uncertainty. The initial impact from the trade war and tariffs will be limited, but concerns are on the rise in terms of how this will go on to impact consumption and private investment, as well as potential disruption and relocation of existing supply chains.

Further to the risks to global growth brought by trade wars and protectionism, global markets are also having to contend with the combination of quantitative and monetary tightening as well as fiscal easing in the US and consequent US dollar strength. This together with higher oil prices are putting pressure on weaker emerging market countries and currencies.

Dividend investing remains relevant, especially in view of heighted uncertainties and risk aversion given its strong quality bias and some defensive qualities. In Asia, payout ratios have scope to increase as profitability and free cash flows rise. Structural improvements to corporate governance, aided by regulatory changes in some markets, further underpin longer-term rises in dividend payouts.

In terms of portfolio strategy, we continue to be invested across a well-diversified portfolio with little changed over the quarter. Our preferred areas of investment remain in select blue chip names in Australia, Hong Kong and Taiwan, across sectors including real estate, technology, consumer discretionary and banks.

Quarterly overview

The fund (NAV) posted a positive return over the quarter and outperformed the MSCI AC Pacific ex-Japan Net TR GBP index.

Geographically the main driver of returns was China, thanks to positive stock selection and overall underweight to the country. Stock selection in Taiwan also contributed. On the other hand, stock selection in Korea and Hong Kong detracted.

Looking at sectors, stock selection in information in technology was the main driver of returns and offset negative stock selection in materials and financials.

Discrete yearly performance (%)

	Q3/2017 - Q3/2018	Q3/2016 - Q3/2017	Q3/2015 - Q3/2016	Q3/2014 - Q3/2015	Q3/2013 - Q3/2014
Share price	4.5	11.5	43.4	-4.9	4.7
Net Asset Value	5.9	11.6	39.2	-2.9	6.5
MSCI AC Pacific ex-Japan Net TR GBP	5.0	17.4	38.9	-9.2	4.0

What are the risks?

Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.

Investors in the emerging markets and the Far East should be aware that this involves a high degree of risk and should be seen as long term in nature. Less developed markets are generally less well regulated than the UK, they may be less liquid and may have less reliable arrangements for trading and settlement of the underlying holdings.

The Company invests in smaller companies that may be less liquid than in larger companies and price swings may therefore be greater than investment trusts, companies and funds that invest in larger companies.

The Company holds investments denominated in currencies other than sterling, investors should note that exchange rates may cause the value of these investments, and the income from them, to rise or fall.

The Company may borrow money to invest in further investments, this is known as gearing. Gearing will increase returns if the value of the investments purchased increase in value by more than the cost of borrowing, or reduce returns if they fail to do so.

Investment in warrants, participation certificates, guaranteed bonds, etc will expose the fund to the risk of the issuer of these instruments defaulting. Deducting charges from capital can result in the income paid by the company being higher than would otherwise be the case and the growth in the capital sum being eroded.

As a result of the fees being charged partially to capital, the distributable income of the Company may be higher, but the capital value of the Company may be eroded.

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Please remember that the value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.

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Issued by Schroder Unit Trusts Limited, 1 London Wall Place, London EC2Y 5AU. Registered Number 4191730 England.

Schroder Unit Trusts Limited is an authorised corporate director, authorised unit trust manager and an ISA plan manager, and is authorised and regulated by the Financial Conduct Authority.

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