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Q1 2019 Commentary

Market summary

Pacific ex Japan equities rebounded strongly from the sell-off in the previous quarter. Most markets closed higher, helped in part by progress in US-China trade negotiations. The dovish shift by major central banks also boosted sentiment. Global growth concerns remained a drag, however. In particular, China’s economy grew at its weakest pace since 1990 last year. January-February data pointed to a continued slowdown. The Chinese government lowered its full-year growth target to 6-6.5% and outlined higher public spending and tax cuts, while the central bank cut the reserve requirement ratios for banks.

Against this backdrop, markets in China and Hong Kong performed well. Aside from easing trade tensions, Chinese stocks were further buoyed by index provider MSCI’s move to increase the weighting of China-listed shares in its benchmark indices. Gains were also fuelled by anticipation that Chinese authorities would continue to introduce supportive policies to counter the economic slowdown.

Elsewhere, Australian shares were lifted by advances in mining and energy firms. Taiwanese stocks also finished higher. South Korean stocks underperformed amid the abrupt end to the US-North Korea summit and concerns over corporate earnings.

ASEAN markets also trailed the broader region. Malaysia and Indonesia were the biggest laggards. The Philippines and Thailand fared better though the latter was held back by uncertainty surrounding the election outcome; official results are not expected until May.

Investment outlook

A shift in policy stance from the US Federal Reserve (Fed) and the Chinese authorities towards more accommodative positions have marked a significant reversal in sentiment coming into 2019.

In the US, subdued inflation data and more dovish Fed commentary have significantly lowered market expectations for future interest rate increases. Tapering of the Fed balance sheet is also likely to end sooner than previously thought. In line with this more accommodative stance, long bond yields have come down from their November highs. Although a flattening yield curve points to slower global growth, in a world where the US dollar remains the key reserve currency and many Asian economies need to adjust their own policy stance (at least loosely) along with the Fed to support their local currencies, this shift in US dollar money markets has positive implications. Not only does it reduce the need for further local rate hikes, it also improves the outlook for global capital flows into non-US markets.

We have also seen an important shift in China’s policy stance in the last few months. Reserve requirement ratios have been cut and banks have been encouraged to lend more aggressively to small and medium-sized enterprises (SMEs) and the private sector. The sharp pick-up in total social financing in January’s credit data suggests that local financial institutions are responding to this top-down guidance. Fiscal spending also appears to be picking up to support growth, with lower taxes for consumers and SMEs being announced and an acceleration of some infrastructure spending coming through.

Trade tensions between the US and China have also eased somewhat as progress appears to have been made in trade talks between both sides. A weaker oil price also reduces inflationary pressure and improves disposable incomes for consumers around the region. These have been seen as supportive of medium-term growth and should offer favourable liquidity conditions.

On a medium-term view, structural deflation will also mean that bond yields remain lower for longer. The demographic trend of an aging global population will be supportive of dividend investing in the longer term.

Dividend investing is starting to look attractive again as interest rate expectations moderate. Its strong bias to quality businesses with sound capital structures and strong cash flow generation remains relevant as the nearer term growth outlook remains uncertain. In Asia, where payout ratios remain relatively low, historically low gearing and burgeoning free cash flows present the best conditions for dividends to surprise on the upside. The propensity for dividends to surprise in Asia is further helped by improving corporate governance and regulatory changes in the region.

Given this backdrop, we continue to tread carefully in equity markets. However, some defensive names including bond proxies have performed well and look attractively valued. 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.

We maintain a bottom-up investment approach and we continue to look for good companies where we can see a strong income case and potential for capital growth.

Quarterly overview

The fund posted a gain and finished ahead of the MSCI AC Pacific ex-Japan index over the quarter.

In terms of countries, the underweight to China detracted most from performance. Our holdings in Taiwan also held back performance. Stockpicking in Hong Kong was unfavourable, though that was outweighed by the positive impact from our overweight position there. Singapore holdings added value but our overweight position pared gains. Stock selection in Thailand and South Korea were beneficial.

At the sector level, stock selection and the underweight position in consumer discretionary were key drags. Another main detractor was stock selection in financials, though that was partially mitigated by the positive impact from our underweight position there. The overweight to real estate and stockpicking in communication services lifted performance.

Discrete yearly performance (%)

	Q1/2018 - Q1/2019	Q1/2017 - Q1/2018	Q1/2016 - Q1/2017	Q1/2015 - Q1/2016	Q1/2014 - Q1/2015
Share price	2.8	4.2	39.0	-6.5	23.0
Net Asset Value	5.5	4.4	32.8	-1.5	19.5
MSCI AC Pacific ex-Japan Net TR GBP	3.0	8.5	35.8	-8.6	18.3

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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