Capital International Group | Quarterly Review | Q2 2016

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SECOND QUARTER 2016

INVESTMENT REVIEWINNOVATION | INTEGRITY | EXCELLENCE

CELEBRATING

Y E A R S I N B U S I N E S S

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Our VisionThe Capital International Group exists to improve lifestyles through increased prosperity

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Global equity markets could once again become concerned over China’s economic slowdown...

Volume: 14 | Issue: 2

Global EquitiesDominated by the Referendum Page 2

FRIDAY | 24 JUNE 2016The first quarter of 2016 has certainly contained enough financial market action to last the rest of the year...

BREXIT21st Century Renaissance? Page 4

WEDNESDAY | 29 JUNE 2016As unstoppable continental plates move millimetre by millimetre in different directions, pressure builds. Where there is a degree of fluidity this pressure can be released slowly across a multitude of small movements...

Country in FocusUS | Presidential Elections Page 6

THURSDAY | 09 JUNE 2016Investors around the globe are faced with lots of news flow in 2016 and no sooner will the EU Referendum vote be completed in the UK than all eyes will turn across the Atlantic...

Sector in FocusGlobal Commodities Page 8

FRIDAY | 06 MAY 2016Commodity investors were stunned in 2015 as major woes continued to negatively impact on prices of all commodities, especially oil...

Industry in FocusGlobal Banking Page 10

THURSDAY | 30 JUNE 20162016 has been a tough year for bank stocks globally as they continue to deal with the fallout from legacy issues whilst facing a period of introspection...

Sector in FocusDisruption in Media Page 12

TUESDAY | 28 JUNE 2016On 5th August 2015 Disney’s CEO, Bob Iger, announced that their most profitable enterprise, ESPN, had lost 3.2 million subscribers in the trailing 12 months...

Fixed Income ReportSecond Quarter Update Page 14

MONDAY | 20 JUNE 2016Once again the bond market has perplexed investors with the second quarter ending on historic low yields...

Celebrating 20 Years in BusinessPage 16

The Capital International Group has grown from a small business in Castletown to an international operation head-quartered in Douglas employing some 75 people...

Investment ReviewContents

Capital’s strength isPage 18

Stephen Ritch, freelance journalist, recently had the pleasure of spending an afternoon interviewing the staff at the Capital International Group. This is what some of them had to say...

Industry in FocusHedge Fund Insight Page 20

WEDNESDAY | 11 MAY 2016Investors need diversification in portfolios, however in recent years there has been clear evidence that various asset classes are becoming ever more closely correlated with each other...

Region in FocusGlobal Emerging Markets Page 22

FRIDAY | 20 MAY 2016The first quarter of the year saw emerging market equities gain 5.8% in US dollar terms as global economic conditions created a more favourable backdrop for the asset class,...

Industry in FocusRenewable Energy Page 25MONDAY | 09 MAY 2016Following the Paris climate conference (COP21) in December 2015, 195 countries adopted the first-ever universal, legally binding global climate deal,...

Region in FocusSouth Africa Update Page 26

TUESDAY | 28 JUNE 2016On 3rd June Standard & Poor’s confirmed South Africa’s credit rating at BBB- with a negative outlook....

Economy in FocusJapan Page 29

WEDNESDAY | 27 APRIL 2016The Japanese economy has been struggling in recent months and this has been reflected in poor equity market performance...

Country in FocusGermany Page 30THURSDAY | 30 JUNE 2016In GDP terms, the German economy is the fifth largest economy in the world and Europe's largest...

Group AnnouncementsOver the Quarter Page 33Continental Centurion, the Isle of Man Parish Walk and academic achievement from across the Group...

Sporting Events Page 34Representing the Isle of Man and racing around it...

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© Capital International Group 2016 Innovation Integrity Excellence

THURSDAY | 23 JUNE 2016

The quarter under review has been a difficult one for global equity markets to make much progress. Investors remain focused on Central Bank actions and the period has been

dominated by the EU Referendum in the UK. The FTSE 100 index managed a reasonable period in April with a 3.8% rise, however as May progressed and into June, nerves began to build ahead of the vote and from that peak the market bottomed at -7.6%. Overall on the quarter it is now registering a slight rise.

US equities have once again surprised with investors seizing on an improvement in a number of global economic indicators. Crude oil has become a key barometer for the health of global GDP and the price has risen per barrel from just over $40 to $50 at the time of writing. A dovish shift in the Federal Reserve stance has also pushed back interest rate rise expectations. Some of the leading economic indicators have picked up and some housing data has also improved in recent weeks. Consumption growth is healthy in the US with stable inflation and full employment. You call the top of the current US economic cycle at your peril.

Europe has managed to avoid another Greek crisis but there have been signs recently that confidence about the economic recovery has been waning. Many European equity indices have re-visited their February lows and the precipitous fall in bond yields has hardly helped. With a ‘Remain’ vote, the UK economy could well see a sharp pick up in H2 with delayed capital expenditure pulled through. Domestic focussed stocks will perform the best with a boost to the beleaguered Banking sector. Laggards could include some of the Commodity stocks and Exporters, which will be held back by a stronger level of Sterling. Commercial Property and the Housebuilders will also be impacted by a lack of inflows into the country.

Japan has unfortunately been facing the headwinds of a strong currency which negatively impacts large swathes of export reliant industries. This has been more related to global events than the domestic situation as you would expect that with not only QE but also negative interest rates that a currency should be weak. The bank of Japan could go more negative on interest rates at some point, after all Abenomics is an experiment!

The data from China in recent weeks at a headline level has reassured investors but delve deeper and major issues remain. We believe that as the year progresses, global equity markets could once again become concerned over the country’s economic slowdown. For instance, the net employment outlook index is back down at levels seen in mid-2009. Non-performing loans are rising rapidly and the pressure on the wider financial and banking system is building. This has tempered our overall Asia allocation for fear of contagion.

Global EquitiesDominated by the Referendum

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World Price at % Chg % ChgIndices 30-Jun-16 31-Mar-16 30-Jun-15 Quarterly 1 Year

UK Markets 6,504.33 6,174.90 6,520.98 5.33% -0.26%Dow Jones 17,929.99 17,685.09 17,619.51 1.38% 1.76%NASDAQ 4,842.67 4,869.85 4,986.87 -0.56% -2.89%S&P 500 2,098.86 2,059.74 2,063.11 1.90% 1.73%DAX 9,680.09 10,944.97 10,944.97 -11.56% -11.56%CAC 40 4,237.48 4,385.06 4,790.20 -3.37% -11.54%Nikkei 225 15,575.92 20,235.73 20,235.73 -23.03% -23.03%Hang Seng 20,794.37 26,250.03 26,250.03 -20.78% -20.78%FT All Gilts 187.36 170.33 170.33 10.00% 10.00%

Rates & Price at % Chg % ChgCommodities 30-Jun-16 31-Mar-16 30-Jun-15 Quarterly 1 Year

GBP/USD 1.3268 1.4394 1.5725 -7.82% -15.62%GBP/EUR 1.1982 1.2647 1.4101 -5.26% -15.03%GBP/JPY 136.912 161.937 192.023 -15.45% -28.70%SILVER 18.715 15.438 15.736 21.23% 18.93%GOLD 1317.00 1233.60 1175.00 6.76% 12.09%EUR Crude Oil 48.42 38.72 61.36 25.05% -21.09%US Fed Funds 0.50 0.50 0.25 0.00% 100.00%UK Base Rate 0.50 0.50 0.50 0.00% 0.00%ECB Base Rate 0.00 0.00 0.05 0.00% -

In the US, the S&P 500 index has risen once again with a 1.5% rise, with the Dow Jones up just over 1%, whilst the domestically focussed Russell 2000 index performed strongly, up 3.5%. Consumer confidence is high and so are home related sales, gainers in the sector over the quarter included Wal-Mart up 5.3% and Lowes up 4.9%. Commodity related stocks continued to rally with Newmont Mining up 30%, Transocean climbed 29% and Devon Energy was up 38%. On the negative front, the rising crude oil price hit airline stocks, with American Airlines down 27% and Alaska Air also down 27%. Other decliners included The Gap down 30%, Apple down 12% on sales slowdown fears and Goodyear lost 17.5%.

The FTSE 100 index has tried to rally as a status quo ‘Remain’ vote became more favoured with Banks leading the charge. Barclays rose 23%, Standard Chartered was up 22.5% and Royal Bank of Scotland rallied 14%. Commodity stocks remained firm with Fresnillo up 30%, Anglo American up 25% and BHP Billiton was up 12%. On the negative side, Burberry released disappointing sales growth with a slowdown in the vital Chinese market causing major issues, the stock fell 17%. Other stocks to fall included Sky down 13%, Sainsbury lost 10% and Marks & Spencer continued to struggle losing nearly 9%.

Continental European markets also tried to move higher with Germany up 3% and France up 2%. Banking troubles overshadowed Italy which lost 2.5%, fallers included Unicredit down 17%, Banco Popolare down 34% and Unipolsai lost 21%. Other fallers included Ericsson down 19%, Eutelsat down 40% on competition fears and Lufthansa declined 16%. On the plus side, Zodiac Aerospace was up 27%, Adidas gained 21% and RWE recovered 25%.

Asian equity markets were mixed with the Nikkei losing just over 3%, Hong Kong managed a 0.5% increase, whilst India was the strongest rising 6.5%. Risers included Hindalco Industries up 40%, Tata Motors up 26%, Toshiba rose 33% and Newcrest Mining was up 28%. On the decliners, Mitsubishi Motors lost 36%, Yokohama Rubber fell 27%, LG Chemical was down 23% and Japan Airlines dropped 17%.Capital

International

TransoceanOne of the world's largest offshore drilling contractors

and is based in Vernier, Switzerland. The company has offices in 20 countries, including Canada, US, Norway, Scotland, Brazil, Singapore, Indonesia and Malaysia. The company also owns 61 rigs including 28 ultra-deepwater floaters, 5 deepwater floaters, 7 Harsh-Environment Floaters, 11 Midwater Floaters, and 10 High-Specification jackup rigs.

Newmont MiningBased in Colorado, USA, Newmont Mining is one of the

world's largest producers of gold, with active mines in Nevada, Indonesia, Australia, New Zealand, Ghana and Peru. Holdings include Santa Fe Gold, Battle Mountain Gold, Normandy Mining, Franco-Nevada Corp and Fronteer Gold. As of the third quarter of 2014, Newmont was the world's second-largest producer of gold, behind only Barrick Gold.

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BurberryA British luxury fashion house, headquartered in London, England. Its main fashion house focuses on and distributes ready-to-wear outerwear, fashion accessories, fragrances,

sunglasses, and cosmetics. Established in 1856 by Thomas Burberry, originally focusing on the development of outdoors attire, the fashion house as moved on to high fashion.

EutelsatA French-based satellite provider with coverage

over the entire European continent, as well as the Middle East, Africa, India and significant parts of Asia and the US, it is one of the world's three leading satellite operators in terms of revenues. It's satellites are used for broadcasting 6,000 television stations, of which 600 are in HD, and 1100 radio stations to over 274 million cable and satellite homes.

Wal-MartThe company is an American multinational retail corporation that

operates a chain of hypermarkets, discount department stores and grocery stores. Walmart is the world's largest company by revenue, according to the Fortune Global 500 list back in 2014, as well as the biggest private employer in the world with 2.2 million employees.

Innovation Integrity Excellence© Capital International Group 2016

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WEDNESDAY | 29 JUNE 2016

As unstoppable continental plates move millimetre by millimetre in different directions, pressure builds. Where there is a degree of fluidity this pressure can be released slowly

across a multitude of small movements, but this is not the norm. More commonly, the continents become locked in a titanic struggle. With each decade that passes the pressure increases locking the plates ever more immovably together. Until one day something gives.

The shock that follows and the forces that are unleashed are terrifying, but as the ground shakes the foundations are laid for a new age of stability, opportunity and prosperity.

With the seismic shock of the British vote to leave the European Union still reverberating around the globe, it is easy to forget that this decision has been a long time in the making.

For more than half a century the European project and its institutions have been moving unstoppably towards an ideal of a European superstate. Born in the aftermath of two World Wars this noble idea was intended to bind the people of Europe together and deliver peace and prosperity. Initially this proved highly successful but slowly over the decades the European political class has pushed relentlessly against a second unstoppable force – the will of the European people.

On Thursday 23rd June 2016 the pressure of these opposing forces finally gave way and the British people voted to leave the European Union.

To be clear this is not simply a British issue. It is true that the British have been most vocal and forceful in their opposition to ever closer integration, and to the great frustration of Europhiles in Brussels. It is also true that the political arguments, on both sides, degenerated into little more than rabble rousing and threats, stirring up ugly and at times disgraceful prejudice and fear. However, the underlying issue is much more fundamental. The European Union has not been listening to the people of Europe, and over many decades.

The fundamental premise of democracy is that parliament and governments represent the will of the people they are elected to serve. The test of any democracy is simple; Government and State are always the servant of the people, never their master. This truth has been long overlooked in Brussels, absorbed in the grand plan. Not only have they not been listening to the people, they have actively sought to overrule, overturn or manipulate the will of the people.

Never more clearly was this demonstrated than with the Lisbon Treaty. Rejected outright in its former guise as the European Constitution by the peoples of France and the Netherlands, what was the response of the European Commission? Change the name and push ahead regardless. The rationale in the European Commission was simple, noble ends justify any means.

The discord would not exist if the EU was delivering the prosperity it promises, but nothing could be further from the truth. By any measure the Euro experiment has proved an unmitigated disaster. The economic reasons why are well understood and I remember studying them at University over a quarter of a century ago. In reality the European Union has been a relentless drag on global growth for the past 20 years and the Eurozone has hardly grown at all in the last decade. Seven years on and Europe has done little to address the financial and banking crisis that has paralysed the continent.

While the European elite have talked of grand plans, ordinary people have suffered desperately. Many southern countries have experienced economic destruction on a massive scale driving unemployment to over 20%. In Britain it has been the younger voters who have been most vocal in wanting to remain in the EU, but this stands in complete contrast to much of Europe where youth unemployment has reached staggering proportions of up to 50%. These are levels that have almost always led to revolutions in previous eras, and yet the EU has done little to address these problems. Astonishingly, for some this weakness has been seen as an opportunity to push for complete unification.

It cannot be said that Britain did not try to change the direction of the European Union from within. On the contrary, so much was the frustration at Britain’s seemingly obstructive stance over many years that champagne corks popped in many quarters across Europe when the vote to leave became clear. That sense of release will also be felt in the UK over the coming months. No longer must we battle constantly with our friends and neighbours to get our point of view across. There comes a time when two opposing views must go their separate ways for the good of both, no matter how deep the bond between the parties or how difficult the separation.

That time was reached on the 23rd June 2016. In the immediate aftermath there is shock, distress and almost bereavement. But as the tremors die down there will be a tremendous release of positive energy both in the UK and in Europe. Decades of tension will be replaced by a sense that at last we can move forward, not as one European nation but as good neighbours and close friends.

For the UK, there will undoubtedly be substantial challenges in the short term, but I believe these obstacles can be readily overcome. Over the longer term the UK has a tremendous and unique opportunity to be at the centre of the global free market economy, driving prosperity across national borders and political constructs.

The European Union arguably faces even greater short term challenges, but again I believe this moment will be precipitous and profoundly positive. Europe must now confront an unavoidable decision. Push ahead for complete unification, or listen to its people. Even in the heart of the European Commission there is a realisation that there can only be one answer. Once understood, the great institutions of Europe can be properly harnessed and peace and prosperity will be well within reach.

BREXITEurope’s 21st Century Renaissance?


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Investors around the globe are faced with lots of news flow in 2016 and no sooner will the EU Referendum vote be completed in the UK than all eyes will turn across the Atlantic. By the

start of 2017 (the 20th January to be precise) there will be a new US leader and it seems as though we are now close to arriving at the nominated Democrat and Republican candidates for the November elections.

Despite the fact that Bernie Sanders claims he is still in the race to be the Democrat representative, Hillary Clinton will become the first ever woman to be a major party Presidential candidate. Her supporters argue she has unparalleled qualifications for the job after a lifetime in public service in which she has served as first lady, New York senator and secretary of state under Barack Obama. President Obama, who defeated Clinton’s first bid for the Democratic nomination in 2008, is widely expected to endorse Clinton in the coming days.

The Republican candidate will be Donald Trump and quite frankly his campaign developed such momentum that he moved from being a rank outsider to a credible winner of one of the most protracted election campaigns in the world. Trump’s core policies are hard to tie down and he can be contradictory in his views and has indeed changed his mind several times. He is often described as a populist and wants tax cuts and a balanced budget with no reductions in key areas such as healthcare.

Remember that the Electoral College drives the Presidential outcome and the popular mandate has been reflected successfully in 48 of the 52 elections. A state's number of electors equals the number of representatives and senators the state has in the United States Congress. In the case of representatives, this is based on the respective populations. Each state's number of representatives is determined every 10 years by the United States Census. The candidate who receives a majority of electoral votes (270) wins the Presidency. The number 538 is the sum of the nation's 435 Representatives, 100 Senators, and 3 electors given to the District of Columbia.

The 2016 Republican National Convention will take place from July 18 to 21, 2016, in Cleveland, Ohio while the 2016 Democratic National Convention will take place from July 25 to 28 in Philadelphia, Pennsylvania. This will be followed by both candidates’ crisis crossing the nation in expensive extravaganzas to win the State vote.

Country in FocusUS | Presidential Elections & the Equity Market


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Innovation Integrity Excellence

Hillary Clinton and Donald Trump clearly dislike each other, with Clinton calling him ‘temperamentally unfit’ to be President and argued that his claim to make America great again, was code to actually take America backwards. He is certainly Protectionist in some of his views. Similarly, Trump has attacked Hillary and her husband, former President Bill, as prime examples of ‘turning the politics of self-enrichment into an art form’.

The election will come against an important backdrop with the US economy in the latter stages of one of the longest economic cycles in history. Despite the full employment situation, unemployment is now down to 4.5%, real incomes have been falling across most income bands for the last fifteen years. There is a widespread feeling that both parties want to introduce some form of minimum wage increase.

The Federal Reserve have only moved once in tightening interest rates and keep holding off, far longer than the market previously expected. Although, the cessation of Quantitative Easing, has actually created a significant amount of ‘shadow’ tightening. Despite the fall of the oil price in the last 18 months very few of the benefits have flowed into increased consumer spending. There are signs that the ultra- low yields are forcing people, notably in the older age groups, to dramatically increase their savings rate.

Equity returns during presidential election years have been on par with long-term averages so there is no obvious historical trend of higher or lower stock market performance during presidential election years, despite the uncertainty of a potential transition of political power.

Clearly the economic conditions prevailing at the time will have a significant impact, with positive conditions supporting the incumbent party. Many observers believe that the actual impact on sectors is overall neutral, although Healthcare has been weak. This was a reaction to Hillary Clinton outlining plans to reduce drug prices. Volatility can then develop in the first year following an election, as the market digests change, and then gradually increases to its peak in the second year of the cycle.

Facts & Figures

Capital ■ Largest city

Washington, D.C.New York City

Official languages None at federal level

National language English

Ethnic groups 62.1% White77.4% (Including Hispanics)13.2% Black5.4% Asian1.4% Native2.5% Other/Multiracial17.4% Hispanic/Latino

Demonym American

Government Federal presidential constitutional republic

■ President Barack Obama ■ Vice President Joe Biden ■ Speaker of the House Paul Ryan ■ Chief Justice John Roberts

Legislature ■ Upper house ■ Lower house

CongressSenateHouse of Representatives

Independence from Great Britain ■ Declaration ■ Confederation ■ Treaty of Paris ■ Constitution ■ Last polity admitted

4 July 1776 1 March 1781 3 September 178321 June 178824 March 1976

Area 9,857,306 km2 (3rd/4th)3,805,927 square miles

Water (%) 7.1Total Land Area 9,158,022 km2

3,535,932 square miles

Population2015 estimate2010 census

322,014,853 (3rd)309,349,689 (3rd)

Density 35/km2 (180th)90.6 per square mile

GDP (PPP)TotalPer capita

2014 estimate$17.419 trillion (2nd)$54,629 (10th)

GDP (Nominal)TotalPer capita

2014 estimate$17.419 trillion (1st)$54,629 (5th)

Currency US Dollar ($) (USD)

Time Zone Summer (DST) (UTC−4 to −10)

Drives on the Right

Calling Code +1

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FRIDAY | 06 MAY 2016

Commodity investors were stunned in 2015 as major woes continued to negatively impact on prices of all commodities, especially oil. Also assisting in this was a strengthening US Dollar

and a slower Chinese economy. Looking ahead, three key catalysts for bullish surprises can be highlighted:

Surprises from geopolitical events can trigger shortages in the supply of key commodities used for energy and also influence gold and silver prices and have a bullish effect on some of the other commodities like platinum and non-precious metals like copper, lead, tin titanium and zinc to name a few. We have already seen gyrations in iron ore prices in 2016 and volumes traded, especially on China’s Dalian Commodity Exchange where volumes soared to 7.6 billion metric tonnes (76.2 million contracts) during March in the first quarter, far exceeding the previous high of 32.6 million contracts that was set in December, according to the bourse’s data.

It is only a matter of time before another disruption to commodity trade flows occur, according to many analysts who specialise in the Commodities Sector, with energy or food-related looking vulnerable in the Middle East or Russia or both. Turkey has now also joined the list of countries in dispute with Russia. Saudi Arabia is also suffering from a burgeoning population in need of jobs and the economy needs modernising in order to alleviate its dependence on oil as primary source of revenue for the government and its people.

Wahhabism is also a problem not only for the House of Saud, but for the world as a whole as it encourages the spread, not only in Saudi Arabia and surrounding lands, but internationally of this ultraconservative religious branch of Sunni Islam.

Sector in FocusGlobal Commodities

In today’s world of inter-connectivity and interdependence based on agreements and pacts that affect safety in homelands and internationally, and keeps track of migration and mass movement of displaced refugees, it is more important than ever to have good relations with key international partners for the west, and everyone else. Today Mohammed bin Abd Al-Wahhab's teachings are state-sponsored and are the official form of Sunni Islam in twenty first century Saudi Arabia.

Saudi Arabia is your ultimate rentier state which receives and derives a substantial portion of its national revenues from the rent of indigenous resources to external clients. The ruling al-Saud family provides all the services that a traditional government would provide in the western world, like housing, health care, education and they supply various subsidies, and this is oil funded by the substantial oil reserves.

Due to rising instability in the Middle East and the effects of the Arab Spring across the region, the al-Saud family upped the spending on social care via salary increases, public sector job creation and housing subsidies.

The oil glut and accompanying global slide in oil prices and metals prices have exacerbated the economic woes for commodity dependant countries like Russia and Saudi Arabia, Brazil, and South Africa, to name a few. Of course these countries used to rely heavily on exports to China, and China is adapting with problems of overcapacity and nurturing their own consumption spending upwards to become more sustainable. Not to mention Petrobras and Brazil’s president Dilma Rousseff’s pending impeachment and whether it should be taken right to the end.


US Dollar With currency moves and gyrations notoriously hard to predict and difficult to forecast, the confident consensus of further dollar gains seems inappropriate, even foolish, especially when observing the Federal Reserve’s carefully worded statements and long deliberated consensus meetings when one word, the latest being “caution” can put a damper on wild expectations for much higher interest rates. The Fed sees inflation reaching its goal of 2% annually before the end of next year, while the market is implying at 10-year inflation expectation of approximately 1.65%.

If inflation does not reach the Fed’s required target of 2% in the next decade, it would almost be impossible to for them to raise the interest rates much at all over the same time period. Of course there are times when the market has taken a divergent view from the Fed, and this could be due to a plethora of factors ranging from measuring indices to surveys etc. But it looks like we are in a low yield, low inflation expectation era, at least for now! If the dollar starts to change direction, commodities could surge.

On Wednesday 27 April 2016 the Federal Reserve held interest rates unchanged whilst at the same time left the door open to a possible rate hike in June, although the US central bank’s policy-setting committee (FOMC) said the labour market had shown signs of further improvement despite a recent economic slowdown and it is closely monitoring inflation in line with its inflation target of 2% (as measured by the annual change in the price index for personal consumption expenditures). The overnight lending rate’s range target varies from 0.25% to 0.5%. The Fed hiked rates in December of last year for the first time in nearly a decade. The Fed expects inflation to remain low in the near term due partly to earlier declines in energy prices.

However it remains confident that inflation would rise to their 2% target over the medium term. They are however still proceeding “cautiously” in raising rates due to uncertainty in the world economy and the lack of inflationary pressure at home. Currently Fed policymakers project two rate hikes in 2016 compared to four hikes predicted back in December. This all makes a case stronger for a weaker dollar while the rest of the world plays catch-up, which can support commodity prices and possibly be the catalyst for the start of a bullish rally in commodities.

Supply/Demand BalancesThis extended slide in commodities’ prices is setting up for a much needed equilibrium and return to supply/demand being balanced across a wide range of commodities. Miners and energy companies still felt the pain throughout the fourth quarter last year and the throttling of supply will likely be extended. US natural gas is a good current example of energy being produced that has recently been trading below the cost of production of even the most efficient producers. This all is in aide of a cut in the overall supply in the nearer term which can only be supportive of commodities.

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© Capital International Group 2016

EnergyThis seems to be superficially low and suffering from bad psychology surrounding OPEC and non-OPEC members’ inability to put a freeze on output, with Iran back from the cold and the old rivalry between Saudi-Arabia and Iran not yet buried, and the US urging the Saudis to share the region with Iran, this all impacted on the psyche of oil investor and buyers. Seasonal fluctuations in temperatures being milder than expected did not help make the case to support the prices of natural gas or oil. There is however a shortage in gas starting to develop and draw-downs will eventually exceed production until the prices start to improve. On top of declining supply you have Russia-Ukraine tensions still simmering in the background all in support of gas and oil.

Base Metals Prices are still hugely influenced by China and what happens in China, and though there is still some woes expected in things like copper and nickel, the Chinese central government’s restructuring will see a reduction in credit being supplied to loss making overcapacity which in turn will lead to a tightening market for base metals although the individual inventories held for each type of metals will still impact the shorter term moves in prices up or down with potential downside still for copper.

Precious Metals These can perhaps benefit from an increase in geopolitical concerns or macroeconomic developments. Gold can benefit from sluggishly increasing inflation which, if followed by another incremental rate increase, will keep real interest rates dampened so that real rates do not negatively impact on the gold price. With real interest rates suppressed an asset like gold looks attractive as it does not have a yield per se. Platinum, of which South Africa produces 70% of global supply, have a neutral outlook due to the fact that a weak rand, caused by political woes, has delayed further supply cuts, and investor sentiment has been dented by the VW Emissions scandal, as platinum is used in the exhaust systems as a catalytic converter, coincidentally to convert toxic pollutants in exhaust gas to less toxic pollutants.

Agricultural Commodities These are expected to reach the bottom and start to show sign of recovery in 2016. With these commodities we can state that conditions look favourable for rapeseed, palm oil, cocoa, sugar and rubber. Although agricultural production on the major continents look set to favour the prices of these commodities, the dollar that seems range bound or weaker, also supports these commodities. Planting problems caused by droughts also mean there might be short supply in some parts of the world and that imports will be necessary. Meat prices are starting to recover after planting season droughts in large parts of the world caused oversupply, but this is expected to change to at least trade sideways if not slight recovery mode.

We have seen five years of the commodities bear market we can realistically expect bullish surprises. This could be the starter or instigator for strong recovery rallies in 2016 and after.


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2016 has been a tough year for bank stocks globally as they continue to deal with the fallout from legacy issues whilst facing a period of introspection regarding their future business models. A minority have fared well, trading well above pre-crisis levels (Wells Fargo for example); others are still trading well below this point (Standard Chartered amongst others). At face value, the sector appears to be relatively cheap on a valuation basis, however, is this enough to

compensate for the inherent risks associated with it?

Much rests on whether the assets on the balance sheet are valued correctly and their sensitivity to the prevailing economic conditions. On the former point, given that many banks are trading below book value, investors suspect not (a price-to-book-value below one indicates that the company is destroying shareholder wealth rather than creating it). Price-to-book value is a metric often used to compare banks since most financial assets are valued frequently (stale prices can render this measure inaccurate), however, there is still some discretion in how certain assets are valued.

For example, some loan repayments may have a degree of uncertainty associated with them that banks may be reluctant to recognise on the balance sheet as any write-downs would lead to a reduction in the book value of equity (leading to a loss of shareholder wealth). Moreover, due to the economic sensitivity of bank assets (which comprise mostly of loans and credit to households and companies), a reduction in the value of these assets due to an economic downturn can have swift and significant repercussions for bank shares.

An increased regulatory burden has also made life more difficult, with more stringent targets for equity capital ratios and frequent stress testing of bank balance sheets. There is no doubt that this harsher regulatory landscape will put a squeeze on profitability going forward, however, on the other hand, an adherence to these stricter rules may increase shareholder confidence that there are no further nasty surprises hidden in the reported figures. Generally speaking, the institutions that have performed the poorest in recent years have been those with significant investment banking operations. Given the volatile nature of these revenues, investors may be applying a discount due to this lack of visibility/consistency of earnings.

Industry in FocusGlobal Banking | Fear the Financials?

Impact of Negative Interest RatesUntil fairly recently, the concept of negative interest rate policy was something discussed only in academic circles; however, it is now an economic reality, with the central banks of the Eurozone, Japan, Switzerland, Sweden and Denmark having dropped their interest rates below zero over the last few years. In theory, negative rates should reduce borrowing costs for households and companies, thereby increasing loan demand.

However, there are a number of factors as to why this mechanism is not functioning properly. Demand for loans is still relatively weak, household balance sheets are still being bolstered and business confidence remains fragile, with both groups continuing to horde cash. Individuals and businesses cannot be forced to borrow so banks are having to compete aggressively to obtain new lending business.

This, combined with a reluctance to pass on negative rates to customers, tends to squeeze bank profits by reducing their net interest margins (the difference between the rates at which they borrow and offer loans). If profitability continues to fall then banks may actually scale back lending, contrary to the intended outcome of central bank policy. Moreover, if banks are effectively forced to charge depositors, cash may leave the system to reside ‘under the mattress’, depriving lenders of a crucial source of funding.

For example, sales of safes in Japan have doubled from a year ago. Admittedly, this is more of an emotional response to negative interest rates than an economic one, however, it provides an insight into the fragile confidence of Japanese households and the potential failure of central bankers to communicate their intentions to the populous.

On a larger scale, banks themselves are also indicating a willingness to defy their respective central banks by exploring options that would see portions of their excess deposits stored in vaults. Given that this would entail fairly high storage costs, it indicates the pressure that banks are under to find solutions to this issue. It also points to a natural resistance level to further rate cuts, whereby money leaves the system at an accelerating rate and monetary policy becomes increasingly ineffectual (the law of diminishing returns).


Regional Update | USTellingly, US banks are more highly rated than their European counterparts, reflecting their greater success at tidying up their balance sheets, the relatively stronger state of the US economy (large banks tend to exhibit a fairly high correlation to GDP growth) and the closer proximity to a normalisation in interest rates (better margins). That said, US bank stocks have still be weak this year due to moderation in the Federal Reserve’s tone on the future path of interest rates and worsening credit quality in some areas of the economy (shale gas companies for example). Given that stocks had rallied in anticipation of improving fundamentals, these developments were seen as a setback. Also, a dearth of mergers, acquisitions and initial public offerings have a depressed the revenues of the big investment banks such as Goldman Sachs.

Other developments in the US include new accounting rules that come into force in 2020. Under these, US banks will be forced to recognise losses on loans starting from the point of origination (as previously mentioned, the current standards require write-downs only when losses become ‘probable’). This assessment of probable losses will be based on a combination of experience and forecasting. The rule change has run into opposition from banks who claim that it will deter lending and introduce further volatility in earnings. More recently, the Federal Reserve announced the results of its latest round of stress tests for 33 institutions. All passed barring the US subsidiaries of Santander and Deutsche Bank, which were quoted as having “broad and substantial weaknesses across their capital planning processes” (a sign that some of the European banks are still playing catch-up).

The latest round of stress tests were an important milestone for banks seeking to distribute more capital to shareholders in the form of dividends and stock buybacks and demonstrates that most institutions have significantly strengthened capital buffers and internal controls, given that the conditions of the tests were arguably more extreme than those faced during the financial crisis.

Regional Update | AsiaDespite falling margins caused by a gradual slowdown, most banks in the region remain highly profitable. The region should also benefit from continued loose monetary policy in the US and the liquidity that this provides. There has been some cyclical deterioration in loan books, however, this remains fairly benign and central banks have the scope for a loosening of fiscal policy if necessary (they are slightly more constrained on the monetary policy front as easing could lead to unwanted currency depreciation). One country that is a cause for concern is China, given that a significant slowdown would be a drag on the whole of Asia, however, if the constraints of volatile capital flows and tighter liquidity constraints ease, then there will be further scope for further interest rate cuts.

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Regional Update | UKThe immediate aftermath of the EU referendum result saw bank share prices tumble, with the sector falling on average by around 15-20%. According to Bloomberg, the trading days immediately following the referendum saw one of the sharpest negative shifts in analyst sentiment on record. Barclays, Royal Bank of Scotland and Lloyds Banking all had the ratings on their stock cut by at least six analysts. Each will face a multitude of issues and uncertainties in the coming months and years as potentially tortuous negotiations take place.

Domestically-focused banks such as Lloyds are exposed to the prospect of an ensuing recession in the UK, the risk of another push for a Scottish referendum and significant exposure to the domestic housing market which is showing signs of cooling. Others, such as Barclays, with large investment banking divisions, are faced with the loss of ‘passporting’, which allows them to operate across the EU without having to set up local subsidiaries. The more multinational banks such as HSBC look the most insulated at present, with their exposure to Asia now seen as a help rather than a hindrance (due to the non-sterling revenue). Another potential headache for the UK government is that it could be lumbered with its remaining holdings in Royal Bank of Scotland and Lloyds for a lot longer than planned. Given that they are both now trading well below the government’s breakeven price, they will be reluctant to sell at a significant loss, putting additional strain on government resources.

Regional Update | EuropeDespite the rhetoric from European leaders, Brexit risks derailing the fragile recovery in Europe and, more seriously, putting the entire European project in jeopardy. Subsequently, reaction to the leave vote was extremely strong in European markets with some of the largest casualties being bank stocks. European banks were already going through a difficult and painful turnaround process without the additional uncertainty caused by Brexit – European banks need economic growth and confidence to improve and Brexit risks both of these. Italian banks have been especially hard hit given that they were already under significant pressure due to high levels of non-performing loans in the economy.

The Italian government has already begun making contingency plans to support its banks with capital injections and/or loan guarantees, citing exceptional circumstances (which enables them to avoid EU rule breaches on state aid) Government bond yields in the so-called peripheral economies have been on the rise. Given that most Eurozone banks hold significant quantities of their government’s debt, there is a strong link between the health of the country and that of its banks, this is also an indication of heightened risk aversion. Moreover, further monetary easing is likely to hurt the banks who are already reluctant to pass on negative interest rates in full for fear of deposit flight.


SummaryDespite all the negativity surrounding the sector, there are a number of potential bright spots, especially for the better capitalised banks operating in the right areas. Sentiment is seemingly about as bad as it can get, banks will be a beneficiary of (eventual) interest rate rises, margins have stopped falling, de-leveraging has taken place, litigation risks have subsided, capital buffers have been built up and companies are increasingly in a position to return capital to shareholders in the form of buybacks and dividends. Overall, risks still dominate the investment decision, however, we see opportunity in broad exposure to funds and/or investment trusts investing in financials and well as some of the leading individual names.

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TUESDAY | 28 JUNE 2016

On 5th August 2015 Disney’s CEO, Bob Iger, announced that their most profitable enterprise, ESPN, had lost 3.2 million subscribers in the trailing 12 months, leading

to a wave of concern over emerging digital disruption. The share price fell 9% that same day and that was against a backdrop of total revenue growth of 5% and net income growth of 11%.

Fears of spreading subscriber losses spurred a broader media stock sell-off with Viacom, 21st Century Fox, and Comcast shares falling between six and twenty percent in the same week. Concern over disruption in the media industry has been rising in recent years and we have seen examples of its impact in recent history; notably the increase of piracy and file sharing over the turn of the century, and the collapse in print media advertising revenue over the second half of the last decade. The latter of the two still remains firmly in investors’ minds, possibly a tremor for the quake that might follow.

To give some perspective, by 2010 total US newspaper advertising revenue had fallen by over two thirds and was at levels last seen in the 1950s. The cause; digital disruption in the shape of the increasing use of the internet search engine. While this may have been a shock to some, others had been anticipating the shift for some time, indeed as early as 1964 Marshall McLuhan observed that the media industry’s reliance on classified ads made it vulnerable; “Should an alternative source of easy access to such diverse daily information be found, the press will fold”. Today, high-tech media companies such as Google, Facebook, and Twitter provide far greater ad distribution than any traditional media company.

Improved connectivity through an increased access to mobile data is driving a change in how we are accessing digital news content. The amount of news accessed through smartphones jumped significantly in over 2015 with average weekly usage growing from 37% to 46%. Two thirds of smartphone users are now using the devices for news every week while smartphone ownership rates continue to rise and are reaching saturation amongst young adults.

While the browser is still a common device, particularly in the work place, we are seeing mobile apps levelling the playing field and in the UK, mobile apps are now more popular than browsers for accessing news content. This is the most prevalent trend for news producers and its emerging importance is emphasised by the age demographics; the smartphone is the main device for accessing digital news for 25% of people but this figure rises to 41% for those aged under 35.

This rise in mobile phone usage is giving social media more of a role in the distribution of online news. Social media platforms are not seen as a destination for accurate and reliable journalism but are increasingly becoming the route to gain access to it. This has prompted the rise of media companies such as Buzzfeed and the Huffington Post, which is now one of the most visited sites in the US.

Sector in FocusDisruption in Media

Facebook may become a significant player in this market, including its subsidiaries, WhatsApp and Instagram, and is already exploring ways it can enter the market. The recent release of its Instant Articles feature allows publishers to have their articles viewed directly through the Facebook App without additional formatting, adding native and video advertising as a revenue stream. However, this nascent side of news publication also raises concerns over the lack of transparency around the algorithms that surface content and whether publishers will receive fair return for the quality content that drives social media usage.

It is not just news media which is noticing the change, total digital advertising revenues are growing but those from non-mobile devices have only achieved 9% annually during the last five years whilst those from mobile devices have grown at an impressive 100% per annum. That is from a very low base but in absolute terms mobile devices now account for a third of US digital ad revenues from a negligible position in 2010. This overall growth in digital advertising is in spite of the fact that many adverts can be blocked using software so the focus is now on more integrated methods, namely native advertising, which essentially disguises adverts by using similar formatting to that of the editorial.

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The television industry is also in the midst of a digital revolution. Traditional networks, with a legacy of linear programming (broadcast programming at set times) are now finding themselves competing with a number of alternative offerings. From the days of the humble VCR to today’s digital recording and on demand services we are now able to consume programming as and when we desire. Faster broadband has led to an increasing availability of high quality content online which is allowing consumers to be more selective so they are now cancelling or reducing the size of their subscriptions to linear broadcasters in greater numbers.

The demographics are again skewed towards the younger generation and there are also an increasing number who have never subscribed to a network. The rate of growth in mobile and online television has so far surpassed any decline in traditional consumption and further decline is expected to occur steadily over time but there is an element of cultural lag which could shift rapidly. On-demand viewing is expected to eclipse linear viewing within the next three years and last year was the first time the number of households that owned a television fell in the United Kingdom.

Exclusive and top rated content is now crucial to broadcasters as lower tier programming now struggles to receive the same viewership. Media rights for top sports and blockbuster events have seen the biggest cost inflation as they provide more predictable revenue. Original content has also become ever more important to compete in this market with the number of scripted original series doubling in the last five years. Online services now produce over 10% of these serials and popular exclusive content is considered paramount to attracting subscribers and remaining competitive.

The current trends in consumer habits indicate that traditional media companies are under threat from digital disruption but these companies are already making steps to compete in the digital space and, if the change is as steady as it has been, they may keep up with the pace of evolution. Journalism is has already experienced some obsolescence in print and is now seeking to consolidate the value it provides society. Other media is not as far along the disruption cycle. The pace of change is difficult to decipher and we are not yet sure if we are seeing revenues rolling over. We have yet to see any online video content providers successfully implement live content consistently which is currently and anchor for broadcasters. One thing is for certain, volatility will continue in this market. We have seen Netflix fall 8% after announcing more expenditure on original content only for markets to settle within the week. Acute price shifts in response to subtle data changes remains likely and corporate strategy remains key.

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MONDAY | 20 JUNE 2016

Once again the bond market has perplexed investors with the second quarter ending on historic low yields. The phrase ‘lower for longer’ has never been more apt, incredibly,

calendar year to date has seen the ten year UK Gilt yield fall by 44%. This has mainly been driven by the extreme fears ahead of the EU Referendum vote in the UK. Indeed, Central Banks have cited the ‘Brexit’ risk as the main driver for leaving interest rates unchanged. During the quarter we have witnessed the German Bund yield on ten year maturity go negative. In Switzerland, there are now only two issues which offer a positive yield and rates are negative out to 2049!

Fixed Income ReportSecond Quarter Review | Pre-Brexit

UK GDP data has been weak in recent weeks and the Referendum is clearly having a major impact on delaying spending decisions. It is hard to estimate the full impact but in the medium term it is likely to have knocked between 0.5-1% from 2016 GDP. The overall growth rate for the current year has been revised down to 2%.The benefit of a ‘Remain’ vote could not only see a relief rally in markets but also a growth spurt in H2 as capital expenditure projects are given the go ahead.

It will be interesting to see the Bank of England response to the Referendum. They believe a ‘Leave’ vote could ‘materially alter the outlook for output and inflation’. They are likely to boost the liquidity in the banking system rather than target interest rates, certainly in the initial stages.

During mid-June, the German ten year yield turned negative for the first time in its history. Indeed over 50% of German bonds are now ineligible for the ECB QE due to the yield being less than the deposit rate. Many analysts believe that if the Central Bank does not relax the parameters that the number of German bonds it can buy will run out by the end of the year. Unfortunately a stronger Euro has led to a sharp slowing in trade levels with virtually flat new German manufacturing orders. The ECB has also struggled to meaningfully boost the credit cycle, with lower borrowing rates not actually substantially increasing the levels of net borrowing. Forecast GDP growth across the region in 2016 should be 1.7% with a 1.8% expansion predicted for 2017.

Clearly Europe is hugely worried by the ‘contagion’ that would impact the region, should a ‘Leave’ vote occur in the UK. Debates on membership are likely to occur in many countries, notably those in Northern Europe which have a close trading relationship with the UK.

Progress in Japan remains painfully slow and there currently seems to be a weakening in the momentum of core inflation, falling below 1% in the core rate for the first time in nearly a year. We expect further easing by the Bank of Japan in July and the current ten year yield is an incredible -0.16%. Indeed, the IMF has recently called for a more flexible monetary policy framework – “Without bolder structural reforms and credible fiscal consolidation, domestic demand could remain sluggish, and any further monetary easing could lead to overreliance on depreciation of the yen,” the IMF said.

High yield credit spreads look set to continue to widen with both rising levels of corporate debt and falling profit margins acting as drags on the sector. We highlighted last quarter the concerns regarding liquidity and these have not abated. Issuance in the sector has been running at approximately 40% below 2015 levels.

The Federal Reserve became more dovish as the quarter progressed with the likelihood now of possibly only one increase during 2016. Despite full employment levels in the US economy, Janet Yellen believes there are now long term forces that will mean that aggressive interest rate rises are not needed. She has cited poor productivity growth and aging populations as two key areas of concern. Productivity is a major worry as it is one of the principal drivers behind wealth creation. Currently US labour productivity is trending close to the lows seen post the Second World War. From 2010 to 2015, labour productivity rose just 0.6% per year on average. That’s after averaging nearly 1.9% growth in the previous six years and 2.8% in the decade from 1994 to 2003.

The concern for the US Central Bank following the exceptionally weak May jobs number is that since 1960, an employment growth slowdown has preceded every recorded recession. A September increase in interest rates could also be problematic given the impending US Presidential election. US Treasuries are still offering investors a yield pick-up over other Sovereigns given the rate risks but as time goes on the premium could look tempting. Currently the ten year Treasury is yielding 1.6% and the thirty year issue is offering 2.4%.

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The Capital International Group has grown from a small business in Castletown to an international operation head-quartered at Capital House, Douglas employing some 75 people in the Isle of Man and South Africa. Throughout, the Group’s success has been driven by their

core values of innovation, integrity and excellence.

Those values were embedded from day one in August 1996 when the company’s founding father Peter Long decided ‘to bring a bit of the City of London to the Isle of Man’ and set up a stock broking business with his sons Anthony and David and colleagues Mark Wilkinson, Robert Floate and Brian Moreton. It would be a business that would conduct its dealings guided by the unshakeable principle by which he – and the London Stock Exchange – had always abided: ‘My word is my bond’.

While Peter has stepped down as Chairman to enjoy his retirement and leave Anthony and David at the helm, his signature style remains central to what distinguishes the Capital International Group.

Peter’s time in the City of London, as a partner in one of the oldest stock broking firms, Laurence Prust & Co, as a member of the London Stock Exchange and later as a senior executive with James Capel & Co in South East Asia, combined with a distinguished military career, first in National Service and later the Territorial Army, has always shaped his approach not only to business and but also to life.

“Steely determination” is often a phrase used to describe him. I recall when we were starting the business he was determined to make things happen. It was that steely determination which led to securing our FSC licence.’

Peter added: ‘It took nine months to obtain that licence - and the Isle of Man’s reputation was key to securing it.’

Chief Investment Officer David recalled: ‘Getting that licence was testament early on to Peter’s determination and persistence, while his seven days a week workload set the tone and culture for the business.’

Capital’s Group Company Secretary Robert Floate has known Peter for more than 30 years and recalled: ‘Those early days when we were setting up the business were exciting times and it took real tenacity and doggedness on Peter’s part to secure our licence.’

David continued: ‘Peter always viewed the Capital business model in terms of partnership rather than one distinguished by a “cut and thrust” approach. At Capital we believe business is very much about relationships and that means delivering on your promises and Peter never fails.

‘We form partnerships not only with our employees and clients but also with our suppliers and, importantly, with the Isle of Man through our close working relationship with the government, in particular with the Department of Economic Development. Today we’re writing around 50 percent of our new business in South Africa, but all that is processed and delivered here in the Island.’

Anthony had originally planned to go into engineering; it was only when, aged 19, he accompanied his father on a business trip to the Far East that he changed his mind. ‘Up to that point I thought stock broking was boring. But two weeks spent with my father, watching how he networked with his customary steely determination to meet the key decision-makers, ministers and high-net worth people; how he was always at least seven steps ahead of everyone else; how well informed he was about the region’s current affairs; and, of course, how the client always came first, changed my opinion completely.’

Peter’s research was – and still is – meticulous. ‘His filing system is a case in point,’ said Anthony. ‘He hasn’t entirely embraced the digital age and keeps meticulous files on financial matters, people in business… even on his latest passion, bee-keeping.’

‘My military background instilled the discipline while my career in the City - where your word really was your bond and which in those days was very much a self-disciplining institution - is responsible for the level of importance I have always placed on integrity,’ said Peter, adding: ‘When I was working in the Square Mile, if you were disciplined by the governing council of the London Stock Exchange, then your career would be over.’

Anthony, taking up the mantle of Chairman for the Group, said: ‘Peter approaches everything with military precision. He’s a perfectionist and won’t let anything go until it’s absolutely right - he’ll review and revise until he’s completely satisfied.

Celebrating 20 Years in BusinessLooking at the 'Long' View...

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Ros Lynch has benefited from that painstaking research and filing. Capital’s first graduate trainee in 1999, she left to pursue a career in compliance in Dublin, returning to the company earlier this year to take up the post of group chief compliance officer. She recalled: ‘Peter was great at giving you articles he’d researched as background for your role. He was also a fantastic letter writer; I still have the letter he sent me when I left to work in Dublin.

‘Peter engages with you on all levels. He was always hugely supportive of Capital employees - at work and in their outside activities. He was also the architect of Capital’s legendary boardroom lunches and cocktail parties, which remain hugely popular with clients. ‘And he keeps in touch with people; when he forms a bond with someone, it’s a lifetime bond.’

Kirsten Gorry was one of Capital’s first employees outside of the family, joining in 1997. Now Chief Operations Officer she said: ‘Peter cares about the staff. He’s a firm believer in “If you look after the staff they will look after the business.”

‘And there’s still that personal touch at Capital: no answer-phones but a “real person” at the other end of the phone. Peter’s an honourable man, and a devoted family man and here at Capital there’s a sense of being part of a family, too.’

Robert Floate agreed. ‘Peter saw the business as a family and from the outset employees were looked after through thick and thin. He’s a man who engenders loyalty and gives generously of his time.’

Peter continued: ‘I wanted Capital to have a welcoming atmosphere and to create a sense of happiness… and I’ve always felt Capital was a very happy firm.’

Technical strategist with ECU Group plc Robin Griffiths worked with Peter at James Capel. He said: ‘I thoroughly enjoyed working with him. His energy was tireless, he was very entrepreneurial and a great host. ‘It takes a lot of guts and vision to move to the Isle of Man and start a new business. He’s done a terrific job from day one and it’s great that the business is remaining in the family.’

Peter recalled: ‘When Anthony and I were setting up the business no one knew us, so personal contacts were vital and we began by building a client base in life companies as I’d witnessed and researched their growth throughout the late 80s and early 90s.

TheManx BeeImprovement Group

Isle of ManBeekeepersFederation

‘We were determined to build not only the business but also the skills of our people, for they are the building bricks of the company and it’s vital to surround yourself with professionals. In this way you create a self-perpetuating system.’

Another ‘self-perpetuating system’ is that of the bee colony. Since retiring Peter has approached his new hobby, bee-keeping, with his signature meticulous attention to detail and quest for perfection.

He said: ‘Bees are an as near-perfect social system as you can get; the queen is boss but is ruled by the workers. I find the colony’s organisation and structure fascinating. The hive’s the sum of its parts, with each contributing to the same outcome, the honeycomb, so strong and rigid, it’s a marvel. Similarly Capital’s strength has always been more than the sum of its parts, it’s about building something together.’

David said: ‘Bees appeal to Peter’s precise nature, and that’s reflected in how we work at Capital. He always wanted to do things better, and our products and services were born out of his belief in the importance of forensic research.

‘Those products and services are also ground-breaking, because right from the start we saw ourselves as a financial solutions provider responding to customer demand, of which the Capital Liquidity Account is a prime example.’

Anthony said: ‘The nature of our business is having to adapt to change, to transition from reliance on a domestic market to securing new international business. This is crucial and the Capital International Group is in the throes of completing that transition.’

David added: ‘Capital is a respected and increasingly recognisable brand overseas which is helping us to accelerate winning new international business. And the opportunities are out there, such as in South Africa and Dublin.’

Anthony said: ‘Business today is very different from when Peter set up Capital; it’s more difficult, punitive and legalistic.’

His father agreed: ‘Business has indeed changed; now it’s all process and rigour and seldom any flair.’

‘At Capital, though,’ said Anthony, ‘our guiding principles remain the same today as they were when we started out 20 years ago: innovation, integrity, excellence.’

Stephen Ritch, freelance journalist, recently had the pleasure of spending an afternoon interviewing the staff at the Capital International Group. This is what some of them had to say...

While Group Chief Executive Anthony Long and Chief Investment Officer David Long may be at the helm of the Capital International Group the enduring sense of ‘family’ resonates throughout the Capital household among its 70-strong workforce.

This close relationship has always underpinned the resilience and success of the business, which this year is celebrating its 20th anniversary. Peter Long, father of Anthony and David, and the Group’s founder, has always said:

“Capital’s strength has always been about the sum of its parts, and how together we become stronger. Those ‘parts’ encompass the staff, its IT infrastructure and those who support the business - all that make the Group what it is today.”

Among those within the Group is Debbie Fox, nine years in customer services and most often working from behind the reception desk at Capital House.

“I may be working on my own on reception some of the time but I’ve always felt very much part of not only the customer services team, but also of the Group operation as a whole, because in customer services you’re effectively working for all the other areas of the business. The Capital culture is such that everyone feels part of something bigger and, importantly, everyone feels valued.”

Helen Long has been with the company from the outset 20 years ago and now works in operations. “Capital is always keen to retain its people; there are a good number here who’ve been with the company for 10 or more years, so there’s a wealth of knowledge that’s been built up."

"As a company we’ve developed a great deal over the last 20 years and, like any business, we’ve had our ups and downs, but we’ve always drawn on the positive elements and built on that together.”

Taking up the theme, Chief Operations Officer Kirsten Gorry, who joined Capital in 1997, said: “The reality is that here you’re supported through the good and bad times, so people are always keen to return that support. Capital invests in us and, in turn, we invest ourselves in Capital.”

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Gill Porter, a senior manager in investment and customer services, has been with the Group for nearly 17 years. “In customer services we’re dealing with clients but then we’re also interacting with all our colleagues across the business, so we do feel part of the bigger operation.”

“And while many companies will say they have an ‘open door’ policy, at the Capital International Group that really does mean something. Anthony, David and all the other senior management are very approachable. Part of ‘the family environment’ is that no one feels excluded and everyone feels recognised, integral and involved.”

Capital’s corporate social responsibility approach reflects its close connections to its workforce, as Gill explained: “The charities supported tend to be those which, in one way or another, have touched the lives of one of us.”

She added: “We support each other and then, together, we support the business. At Capital, everyone knows where we’re trying to get to and what we’re aiming for and we’re all working towards that goal.”

Gill’s colleague Olivia Ramsay has been with the company for six years, and recognises that at Capital, ‘innovation, integrity and excellence’ is no mere marketing phrase.

“You definitely don’t feel like you’re just a number. I don’t view my work as just being in customer services, but as being part of one big team - and I really do look forward to coming to work each day. Plus, you know that if you want to take professional exams and progress your career, Capital will encourage and support you all it can.”

Julie-Anne Osland has been with the Group a little under six years is a member of the business development team. “Capital’s core values - innovation, integrity and excellence - are crucial and really do mean something. I started in the dealing department but then chose to go into business development. Following on from what Gill has said, people do support each other here. For example, the head of business development Antony Kelsey, has been my mentor and pivotal in my training and career development.”

“Here you’re not ‘lost’ in the company. Your opinions and ideas are welcomed and listened to and your contribution valued. This is great for building up your confidence. Everyone - no matter what their role or position - is important to the business."

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Celebrating 20 Years in BusinessCapital’s strength is ‘greater than the sum of its parts’

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"Peter Long has always been very supportive of the people who work here. That’s definitely been passed down to the next generation.”

Antony Kelsey who also joined the Group about six years ago continued: “The core values, originally instilled by Peter Long, of innovation, integrity and excellence are still relevant 20 years on. They permeate the business and determine how we deal with our people and our clients. By and large at Capital people ‘leave well’ and ‘join well’ and that’s certainly testament to the Long family approach to business; a business which takes pride in and has invested in the Isle of Man and is keen to play its part in the island’s future success.”

“But today’s business environment is very different from that of 20 years ago, and so the challenge is to balance retaining that ‘family DNA’ element with developing the business in today’s far more difficult climate. As we’ve grown as a company there’s also the challenge to ensure people still have a sense of ‘being part of something bigger’; that’s hard to maintain, especially now we have a small team in South Africa. We do, though, make regular visits to our colleagues in the Cape Town office who, in turn, come to the Isle of Man.”

Mr Kelsey added that while the family legacy component set Capital’s fundamental ethical and cultural tone, it should always ‘drive not constrain’ future business growth.

“It’s because of our core values that Capital has become more resilient, flexible and fleet of foot.”

“As the business has expanded there could have been the risk of people feeling isolated from what’s happening in other departments, but that’s not the case, thanks largely to Anthony Long’s practice of gathering everyone together for regular Company updates, which certainly makes people feel more motivated.”

Mr Kelsey said it was not only the business that had grown. “Capital is always keen to give people opportunities to grow, to advance their careers and help them to realise their potential; this adds value to their own and ultimately, the company’s prospects.”

“As Peter Long has said, our people are ‘the building blocks’ of the Capital International Group.”

Written by Stephen Ritch

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20 Page


WEDNESDAY | 11 MAY 2016

Investors need diversification in portfolios, however in recent years there has been clear evidence that various asset classes are becoming ever more closely correlated

with each other. This is a problem. One asset class that is supposed to boost overall portfolio diversification is hedge funds. Managers have become hugely wealthy by charging high management fees and adding to this by additional performance fees. With an estimated over 10,000 global hedge funds and funds of hedge funds according to Hedge Fund Research Inc (HFR) - near the record high in 2014 - investors and analysts say that many managers are chasing the same ideas, driving spreads downward and lowering potential returns. This is at a time when the fund industry is being driven more and more by falling fees and passive strategies.

The name "hedge fund" originated from the paired long and short positions that the first of these funds used to hedge market risk. Over time, the types and nature of the hedging concepts expanded, as did the different types of investment vehicles. Today, hedge funds engage in a diverse range of markets and strategies and employ a wide variety of financial instruments and risk management techniques. The traditional measure of risk is volatility, or the annualised standard deviation of returns. Surprisingly, most academic studies demonstrate that hedge funds, on average, are less volatile than the market. For example, over the period from 1994 to 2009, volatility (annualised standard deviation) of the S&P 500 was about 15.5% while volatility of the aggregated hedge funds was only about 8%.

They would typically charge 2% annual management fee with a 20% performance fee over a stated performance target. This has made the industry leaders very wealthy. For instance, the world’s 25 highest-paid hedge fund managers earned a combined $11.62 billion in 2014 and $21.5 billion in 2013. Consider that many tracker funds now only charge 0.1% and you can see the issues facing the industry. The hedge fund industry also remains concentrated with the 20 largest funds controlling 57% of the total hedge fund Net Asset Value. Many of the newer funds launched in the last ten years have struggled to gain traction with assets and many have closed.

In the boom years the leveraging within hedge funds produced stellar returns, however the most recent history is far from compelling. In the first quarter of 2016 the average fund declined by 0.8%. That follows a loss of 1.1% for the average fund in 2015, and a gain of just 3% in 2014. In other words, the average investor has earned a cumulative 1% since the start of 2014. Market conditions have been difficult for the hedge-fund community. Sudden shifts between “risk-off” and “risk-on” markets, such as the dramatic market turnaround in February, are very hard to time. Official intervention in the markets, either through central banks or regulatory action, can also provide significant headwinds.

Interestingly, London remains a hedge fund powerhouse with £275 billion of Assets Under Management (AUM). This is second only to New York globally in terms of the size of the hedge funds industry with £700 billion AUM. Hedge fund asset growth in the UK and Europe is outpacing that of the US. In the first half of 2015 investment of some £9 billion was placed into European-based institutional hedge funds, compared to net outflows of capital in US-based funds over the same period. The three biggest companies in the UK include Man Group, Brevan Howard and Winton Capital.

Man Group is one of the world’s largest independent alternative investment management businesses and a leader in liquid, high-alpha investment strategies. Trading since 1783 (originally as a sugar brokerage) and has 25 years of experience in alternative investments with $78.6 billion assets under management (as at 31 March 2016). The company has several operations but two of the main brands are AHL which has a track record spanning around two decades. Trend following strategies use sophisticated computer algorithms to identify trends, which allow them to trade hundreds of diverse markets simultaneously, and avoid biases introduced by human emotions. It invests in 400 liquid markets. The other company is Man GLG, founded in 1995, which has built up a widely respected group of investment professionals who cover equity, macro, emerging markets, credit, fixed income, convertible bond and thematic strategies. It employs 141 investment professionals operate in a collaborative environment, unconstrained by a house view.

Brevan Howard was founded in 2002 and is often seen as the largest macro hedge fund in the world. Global macro is a hedge fund strategy that aims to profit from large economic and political changes in various countries by specialising in bets on interest rates, sovereign bonds and currencies. The managers tend to use both quantitative analysis and qualitative evaluations to understand global relative price movements, liquidity, volatility, business cycles and other macro-economic conditions, so as to profit from them. Assets have fallen sharply at the company in recent years, now down to $20 billion. There are signs that the company are increasingly turning to retail investors for funds, rather than just the large institutional accounts.

Founded in 1997, Winton Capital is a systematic investment manager that uses the scientific method to develop advanced investment systems. The firm has $30 billion in assets with The WDP, being the flagship programme. It invests long and short, using leverage, across global futures, forwards, and cash equities. It is the least constrained application of the Winton Investment System. Consistent, risk adjusted returns are the key desired outcome.

Industry in FocusHedge Fund Insight

Page 21


Brevan Howard Asset Management LLP

Type Private

Industry Investment management

Founded 2002

Founder Alan Howard

Headquarters St. Helier, Jersey

Products Hedge funds

AUM US$40 billion

Website www.brevanhoward.com

Man Group plc

Type Public

Traded as LSE: EMG

Industry Financial services

Founded 1783

Founder James Man

Headquarters Riverbank House2 Swan LaneLondonUnited Kingdom

Area served Worldwide

Key people ■ Jon Aisbitt ■ Emmanuel Roman ■ Jonathan Sorrell ■ Luke Ellis ■ Pierre Lagrange

ChairmanGroup CEOCo-PresidentCo-PresidentChairman Man Group Asia & MD GLG

Products Investment products

Revenue US$1,135 million (2015)

Operating Income US$184 million (2015)

Net Income US$171 million (2015)

Number of employees 1,078 (March 2015)

Divisions Man AHLMan GLGMan Numeric InvestorsMan FRM

Website www.man.com

Winton Capital Management

Type Private

Industry Investment management

Founded 1997

Headquarters London, England

Key people David Harding

AUM US$30 billion

Number of employees 450

Website www.wintoncapital.com


22 Page

FRIDAY | 20 MAY 2016

The first quarter of the year saw emerging market equities gain 5.8% in US dollar terms as global economic conditions created a more favourable backdrop for the asset class,

with the US dollar peaking and the crude oil price bottoming in January. We also saw emerging market currencies appreciate against the US dollar for the first time since October, gaining about 5% since late January, with double digit returns in March alone for Russia’s ruble and Brazil’s real, aided by the US Federal Reserve’s commitment to low interest rates in order to support global growth and stability.

Emerging markets equities showed their sensitivity to changes in macroeconomic indicators, gaining 13.2% in March alone, a level last matched in October 2011. Notably, small cap stocks have lagged large cap stocks as the universe has less exposure to the energy sector. It’s probably too early to predict if this current environment represents a rally in a bear market or an inflection point to a more sustainable long term recovery for emerging markets.

Region in FocusGlobal Emerging Markets

Since the normalisation of US monetary policy was announced in spring 2013, emerging economies have been constantly exposed to new shocks. Economically, the drop in commodity prices that began in mid-2014, which came at the same time as the Chinese slowdown, may have benefited all end-consumers but hit net commodity exporters hard, through depreciation in their currencies, higher inflation, tightening of the policy mix, etc. In the wake of additional geopolitical idiosyncratic shocks, Russia and Brazil look like the big losers among emerging economies with both suffering recessions of close to 4% in 2015, recessions that are unlikely to end until late 2017. Not all emerging countries have been affected the same by falling commodity prices and the Chinese slowdown. Commodity-exporting economies that had adopted hawkish monetary and fiscal policies such as Mexico, Chili, Peru and Colombia, had room to mitigate the impact of tighter financial conditions caused by the depreciation of their currencies, unlike Venezuela and Brazil, for example.

For net commodity-importing countries, particularly Asian ones, lower commodity prices have helped offset the impact of the Chinese slowdown to such an extent that most of these countries’ growth in 2015 was about the same as in 2014. Central Europe, meanwhile, benefited from both lower commodity prices and a strong German economy. All in all, GDP growth in emerging markets shrank by about one percentage point from 4.8% in 2014 to 4% in 2015. While all regions were hit by slower growth, there were still some wide divergences. For example, while emerging Europe and Latin America turned in slightly negative growth rates, Asia expanded at almost 6%. However, there were also wide differences between countries within the same region. Countries do not differ on the basis of growth criteria alone. Central bank monetary policies have also been tightly restrained by the international economic environment. Whereas net commodity-exporting countries have had to raise their key rates to varying degrees, in reaction to pressures on their exchange rates and domestic inflation, Asian and Emerging Europe countries have begun monetary easing cycles due to de/disinflationary pressures from the euro zone, as well as China.

The resilience of major economies should provide some support for emerging economies. First of all, in advanced economies, the euro zone and the United States in particular, economic indicators are relatively reassuring, even if they still point to soft growth. In the US, job market figures in particular calmed the markets, and a recession appears to be less likely. Moreover, US rates are likely to be tightened less than had been expected a few weeks ago. The median Fed Fund projections of FOMC members is now just two Fed funds hikes in 2016, down from four at the December FOMC meeting. Emerging economies, whose financing conditions have worsened considerably since 2014, are expected to be less constrained in terms of monetary policy, which will provide a boost for these countries.

Since 2011, emerging markets have tended to underperform developed markets. This has been the case in particular since mid-2014, when commodity prices began to fall even faster. It was also at a time that individual economies also started to face their own, specific problems, such as in Brazil. But so far this year, emerging markets have managed to weather the turbulence caused by volatile oil prices and concerns over China. In recent years, emerging markets have accustomed us to short-lived spikes.


Page 23


In the Eurozone, in addition to economic indicators, the ECB’s announcements made on the 10th of March were well above the markets’ expectations, in contrast with after the Council of Governors’ meeting last December, and that should make it possible to stabilise growth in the euro zone. Moreover, measures announced by the Chinese authorities reinforce the premise that China is likely to avoid a hard landing. And, regarding oil, February discussions between producing countries, while not resulting in any concrete agreement, at least prevented a further drop in prices.

All these factors have helped lower risk perception and make risky assets more attractive, including emerging assets. However, while global uncertainty has receded and risk perception has declined, it’s probably wise to remain cautious. In Europe and the euro zone geopolitical risks, terrorism, political instability in peripheral countries, the migrant crisis, and a possible Brexit, could undermine growth if they were to last or gather in strength. In the United States, while a recession is quite unlikely, manufacturing figures point to downside risks. In China, the authorities are clearly trying to switch growth models without major disruption, but any transition process is inherently uncertain and the risk of an incident can never be ruled out. Meanwhile, commodity-exporting countries and some Asian countries closely integrated with China have not begun or completed their own process of adjusting to more diversified production models. With commodity prices likely to remain low for a long time to come and with demand relatively sluggish, it will be even more difficult for these countries to carry out the reforms they need, in order to stabilise growth in the medium term.

Emerging markets have held up well at the start of this year. The stabilisation of oil prices and topping off of the dollar have proven to be powerful catalysts, especially as these markets appeared to be oversold and inexpensive. However, economic fundamentals remain shaky and caution is still in order. The re-balancing of the Chinese economy towards more consumption is a slow process and corporate de-leveraging has only just begun. That said, cyclical recoveries always begin with tactical rallies, during which it is better not to be underweight. For this tactical rally to turn into a cyclical rally several conditions probably need to happen. China’s economy will have to continue to stabilise, given its impact and influence over other emerging economies. Oil and industrial commodities will have to continue to rally, the Renminbi will have to remain stable and the US dollar mustn’t rise too much. If these conditions are met, emerging markets could well provide a positive surprise this year.

TerminologyIn the 1970s, 'Less Developed Countries' was the common term for markets that were less 'developed' than countries such as the US, Western Europe, and Japan. These markets were thought to provide greater potential for profit, but also more risk from various factors. This term was thought by some to be politically incorrect so the 'emerging market' label was created. The term is misleading in that there is no guarantee that a country will move from 'less' to 'more developed'; although that is the general trend in the world, countries can also move from 'more' to 'less developed'.

Originally brought into fashion in the 1980s the term is sometimes loosely used as a replacement for emerging economies, but really signifies a business phenomenon that is not fully described by or constrained to geography or economic strength; such countries are considered to be in a transitional phase between developing and developed status. Examples of emerging markets include many countries in Africa, most countries in Eastern Europe, some countries of Latin America, some countries in the Middle East, Russia and some countries in Southeast Asia. While researchers have described activity in countries such as India and China as emerging markets, how a market emerges is little understood.

At the beginning of the 2010s, more than 50 countries, representing 60% of the world's population and 45% of its GDP, matched these criteria. Among them, the BRICs. Plus, we are now seeing the term 'Rapidly Developing Economies' being used to denote emerging markets such as The United Arab Emirates, Chile and Malaysia that are undergoing rapid growth.

It is difficult to make an exact list of emerging (or developed) markets; the best guides tend to be investment information sources like EMIS, (a Euromoney Institutional Investor Company) and The Economist or market index makers (such as Morgan Stanley Capital International). These sources are well-informed, but the nature of investment information sources leads to two potential problems. One is an element of historicity; markets may be maintained in an index for continuity, even if the countries have since developed past the emerging market phase. Possible examples of this are South Korea and Taiwan. A second is the simplification inherent in making an index; small countries, or countries with limited market liquidity are often not considered, with their larger neighbours considered an appropriate stand-in.

In the future it is thought that investors will not necessarily think of the traditional classifications of 'G10' (or G7) versus 'emerging markets'. Instead, people will look at the world as countries that are fiscally responsible and countries that are not. Whether that country is in Europe or in South America should make no difference, making the traditional 'blocs' of categorisation irrelevant. The relevance of the terminology 'emerging country' comparing the credit worthiness of so-called emerging countries to so-called developed countries may also come into question. According to their analysis, depending on the criteria used, the term may not always be appropriate.

The 10 Big Emerging Markets (BEM) economies are (alphabetically ordered): Argentina, Brazil, China, India, Indonesia, Mexico, Poland, South Africa, South Korea and Turkey. Egypt, Iran, Nigeria, Pakistan, Russia, Saudi Arabia, Taiwan, and Thailand are other major emerging markets.

24 Page


MONDAY | 09 MAY 2016

Following the Paris climate conference (COP21) in December 2015, 195 countries adopted the first-ever universal, legally binding global climate deal, due to come into force

in 2020 and designed to avoid damaging climate change, with the aim of keeping long-term global warming below 2 degrees Celsius. This global action plan commits governments to the almost entire replacement of fossil fuels by cleaner energy in the second half of this century.

In conjunction with the proposals outlined, institutions such as the World Bank announced plans to aid developing countries in fulfilling their COP21 pledges by supporting the addition of significant new capacity, with up to $29 billion of fresh renewables financing annually by 2020. Whilst this is creating further momentum for the renewables sector, by no means is the industry dependent on these grand plans for validation of the renewables investment case, having experienced many years of sharply rising capital investment – it is estimated that global investment in the renewables sector has been around $2.3 trillion since 2004.

This dramatic increase in the size of the industry and recent technological innovations are now helping to drive down generation costs, allaying long-standing concerns that many projects are too dependent on government subsidies to be economical. In fact, a recent Bloomberg report cited solar and wind auctions in Mexico and Morocco that ended with winning bids from companies that promised to produce electricity at the cheapest rate, from any source, anywhere in the world.

According to a recent UN-commissioned report, 2015 saw further investment into the Renewables sector. The key findings of this report were $285.6 billion of fresh capital committed to renewables (excluding large hydro-electric projects) – a figure that includes early-stage technology and research and development as well as spending on new capacity. This equates to a 5% gain from 2014’s figure and exceeded the previous annual record ($278.5 billion) achieved in 2011. Other notable milestones included new allocations to renewables investment outstripping that of coal and gas-fired generation by a ratio of around 2:1 last year.

Additionally, developing world investments in renewables topped those of developed nations for the first time in 2015, with the developing world (including China, India and Brazil) committing $156 billion (up 14% on 2014) versus the $130 billion (down 8%) committed by developed countries. As in previous years, the report shows the 2015 renewable energy market was dominated by solar photovoltaics and wind, which together added 118GW in generating capacity, far above the previous record of 94GW set in 2014. Wind added 62GW and photovoltaics 56GW. More modest amounts were provided by biomass and waste-to-power, geothermal, solar thermal and small hydro.

Industry in FocusRenewable Energy

Despite the overwhelmingly positive news-flow coming from the sector, there have been a number of cautionary tales of late. SunEdison, formerly one of the largest renewable energy development companies in the world, has just become the largest US bankruptcy of the year, listing $16.1 billion of debt and $20.71 billion of assets. At its peak the company was valued at around $10 billion. The company used low-cost capital to expand rapidly and then employed financial engineering to hive off some of its completed projects into so called yieldcos, which offered their cash flows to income-starved investors, while the company secured cash for further projects/acquisitions without losing control over the projects held within the yieldcos. The acquisition-led strategy then began to stall as investors balked at some of the later deals and financing dried up. Cash flows could not cover debt repayments and the company subsequently applied for bankruptcy protection.

The intermittent nature of power generated by renewable energy is also something that has yet to be fully overcome. Large gluts resulting from ideal conditions force conventional generation to shut down (most of which is designed to operate continuously), putting further pressure on their continuing viability. At the other extreme, abnormal weather conditions can also cause problems, especially if there is an over-reliance on one particular form of renewable energy. For example, Venezuela is facing a major drought, which has dramatically reduced water levels at its main hydroelectric dam. As a result, the government has imposed a two-day working week for public sector workers as a temporary measure to help it overcome this energy crisis.

Most countries have invested in a diverse renewable energy mix to avoid these issues however. In 2015, more attention was drawn to battery storage as one way of providing fast-responding balancing to the grid, whether to deal with demand spikes or variable renewable power generation from wind and solar. As alluded to earlier, ‘lumpy’ electricity supply and a lack of innovation in electricity storage technology to deal with this issue has been one of the main limiting factors in renewables becoming a primary source of energy generation. However, new innovations, especially battery technology in the electric car industry are helping to bridge this gap.

Despite all these impressive figures, renewable energy only accounted for around 10% of global electricity generation last year, with the existing stock of conventional generation capacity continuing to dominate. This demonstrates the continuing compelling growth story for the industry, with the added caveat that finding attractive investments in this sector remains challenging, with few companies finding the right business model for sustainable growth, in what is still a relatively fledgling industry.

Page 25


26 Page

TUESDAY | 28 JUNE 2016

South African Sovereign Credit RatingOn 3rd June Standard & Poor’s confirmed South Africa’s credit rating at BBB- with a

negative outlook. This is one notch above “junk” status and confirms similar ratings given by Mood’s and Fitch over the past few months. A number of commentators and economists were expecting a downgrade in June, or still expect a downgrade in the December review period. Against a background of falling commodity prices over the past two years, a severe drought and political blunders, South Africa’s credit rating has been close to “junk” status for some time. However, reading of the detailed S&P report does give some hope for South Africa avoiding a downgrade later this year or in 2017.

Declining GDPSA’s GDP has been quite volatile over recent years. The volatility relates largely to fluctuating fortunes in the mining and agricultural sectors. Factoring in strikes and declining commodity prices, quarterly GDP has been as high as plus 5.1% in Q4 of 2014 and as low as -2% in Q4 2015. (See chart) Although the South African Reserve Bank (SARB) is forecasting positive growth for 2016 as a whole, it is possible that the economy could show two consecutive quarters of negative growth and enter a technical recession. Moody’s are well aware of this and comment as follows in their May review - “while we expect the economy to expand by only 0.50% in 2016, we expect growth to rise to 1.5% in 2017. Moreover, ongoing structural reforms and diminished infrastructure bottlenecks offer upside potential for growth over the medium term” Other positives mentioned include a more stable and reliable electricity supply, less working days lost to strikes and the likely end to the drought.

Region in FocusSouth Africa Update

Drought Brought on by el NiñoA second contributor to the poor GDP performance in Q1 was lower output in agriculture, which declined by 6.5%. Although agricultural exports are not very significant, SA is mostly self-sufficient in food production. However with the current drought the country has been forced to import large quantities of maize. This has a knock-on effect on the balance of payments, made worse by a weak rand.

Municipal Election | 03 August 2016Political campaigning is in full swing in the run up to the elections on 3rd August. The Democratic Alliance (DA) is contesting all major municipalities and the Economic Freedom Fighters (EFF) have been very vocal in their criticism of Jacob Zuma and the African National Congress (ANC) The ANC has been losing ground in recent elections and the trend is likely to be maintained, if not accelerated, in August. Instability is obviously not good for our credit rating or investor sentiment, as there has already been some election rioting and looting. However, a reduction of the ANC majority could result in pressure to grow the economy to reduce unemployment and to accelerate labour and structural reforms.

Declining Mining ProductionGrowth in China and other emerging economies has been slowing over the past few years. Oil and commodity prices have fallen sharply since mid-2014. South African exports have consequently suffered and impacted negatively on GDP. The recovery in oil and most commodities in recent months could mean that the worst is over. Large stockpiles of oil and commodities would need to be worked off before a sustainable rise in the commodity prices can occur. During the Q1 this year mining contracted by 18% and was the major contributor to negative growth for the quarter. (See chart)

South Africa GDP Growth Rate

Industry Growth Rates


Jul 2013 Jan 2014 Jul 2014 Jan 2015 Jul 2015 Jan 2016

6%

4%

2%

0%

-2%

-4%

3.7%

5.1%

1.2%

-1.5%

0.5%

2.1%

4.2%

1.9%

-2.0%

0.3% 0.4%

-1.2%

Finance

Trade

Government

Manufacturing

Personal Srvs

Construction

Transport

Electricity

Agriculture

Mining

-20% -10% 0% 10% 20%

1.9%

1.3%

1.1%

0.6%

0.6%

0.5%

-2.7%

-2.8%

-6.5%

-18.1%

Page 27

Facts & Figures

Capital

■ Largest city

Pretoria (executive)Bloemfontein (judicial)Cape Town (legislative)Johannesburg

Official languages11 languages

Afrikaans, Northern Sotho, English, Southern Ndebele, Southern Sotho, Swazi, Tsonga, Tswana, Venda, Xhosa, Zulu

Ethnic groups(2014)

80.2% Black8.8% Coloured8.4% White2.5% Asian

Demonym South African

Government Unitary constitutional parliamentary republic

■ President Jacob Zuma ■ Deputy President Cyril Ramaphosa

Legislature ■ Upper house ■ Lower house

National People's CongressNational CouncilNational Assembly

AreaTotal Area 1,221,037 km2 (25th)

471,443 square milesWater (%) Negligible

Population2015 estimate2011 census

54,956,900 (25th)51,770,560

Density 42.4/km2 (169th)109.8 per square mile


2015 estimate$725.004 billion (30th)$13,215 (90th)


2015 estimate$323.809 billion (35th)$13,215 (88th)

Currency South African Rand (ZAR)

Time Zone South African Standard Time(UTC+2)

Drives on the Left

Calling Code +27

Internet TLD .za

Rising Interest RatesSlow economic growth combined with unpopular political activity, including the firing of the Minister of Finance in December 2015, the court ruling against President Zuma where he was found guilty of not acting in the best interests of the constitution and the scandal around the “state capture” by the Gupta family; have all led to a weak rand over the past two years.

The SARB has responded to higher inflation by raising interest rates by 2% since Q1 2014. SARB action, so far, has not reduced inflation or prevented the rand from weakening. One questions whether the SARB is paying too much attention to inflation and not enough to economic growth. Economist Brian Kantor sums it up as follows -“Interest rate increases do nothing useful to contain inflation in a world where the supply side shocks are pushing prices higher and household spending lower. What they do is to reduce household spending further than would have been the case with stable or lower interest rates. For every one percent increase in the repo rate, the Reserve Bank forecasts a 0.4% reduction in GDP growth over two years.” In his view rate increases prejudice rather than enhance our credit rating. The SARB monetary committee kept rates unchanged in May, so perhaps they are taking note of Moody’s comments.

Some PositivesIn spite of all the negative sentiment at present, SA has some convincing positive factors in its favour. Without going into much detail they include the following:

■ A first world infrastructure

■ First world banking and financial institutions

■ Good track record in fiscal management and financial discipline

■ No default events (on bonds or loans) since 1983

■ SA remains the gateway to Southern African countries

■ More stability in the supply of electricity

ConclusionIt is clear that the credit rating process is an on-going assessment of the country that takes all factors into account and is forward looking. As SA is sitting on the knife edge it would not take some major new negative event to tip the rating into junk status. All it would take is a further deterioration in economic growth or a continuation of the drought.

However the rating agencies forecasts are for growth to recover later this year and into 2017 and also for the drought to end. So we believe that the pessimists that assume a downgrade in December or early in 2017 is almost a certainty, are being too negative and that in the short term the positives outweigh the negatives.


28 Page


Page 29


WEDNESDAY | 27 APRIL 2016

The Japanese economy has been struggling in recent months and this has been reflected in poor equity market performance. In the last calendar year for instance, the Nikkei 225 Index

is down 13.5%. The economy is flirting once more with renewed deflation and we expect the Bank of Japan to undertake further policy measures to boost activity.

For instance, the March Tankan survey showed weaker inflation expectations than in December 2015, both in the corporate sector and in domestic households. Indeed the Central Bank noted that capital expenditure plans had also been reduced in the wake of the slowdown in emerging economies. The form of easing will likely be through an increase in the pace of purchases in its ¥80 trillion in annual bond purchases by around ¥5-10 trillion.

Very weak inflation is also an outgrowth of a tumbling economy that is teetering on the verge of recession. Japan’s GDP contracted 1.1% annually in the fourth quarter of 2015. That was the second time the economy contracted in three quarters. With Japanese factory output plunging in February, a technical recession – defined as back-to-back quarters of contraction – is certainly possible in the first quarter. The most recent Purchasing Managers Index data showed the steepest decline in activity since January 2013.

Forecasts for full-year growth show that the Japanese economy is set to improve marginally later this year. The International Monetary Fund pegged Japan’s GDP growth at 1% in 2016, however this may prove to be a struggle in reality. They also argued that Japan should adopt a target for wages growth, lift pay in the public sector and raise the minimum wage as part of efforts to boost incomes and spending in the economy. It will be interesting to see the full impact of the recent Kyushu earthquake on wider economic developments.

The exposure to a slowing Chinese economy has also proved to be negative with Japan having five times the economic exposure to China than the US economy has and double that of Continental Europe. This of course can be a double edged sword, with Japan remaining the most leveraged play on global GDP recovery.

The trauma of long term stagnation is entrenched in Japan. This experience of long term stagnation - two decades - has made firms very conservative in distributing higher wages and against increasing dividends and investing in real assets because of worries that the Japanese economy might fall into another stagnation. The country has been struggling with poor demographics for some time but investors more recently have started to fret about the overall debt levels in the economy.

Zero interest rates have disguised the underlying danger posed by Japan’s public debt, likely to reach 250% of GDP this year and spiralling upwards on an unsustainable trajectory. The primary budget deficit stands at 4.5% of GDP and analysts have estimated that real interest rates need to be at -1.5% in order for the Government to balance the books.

Economy in FocusJapan

If they run out of local investors to fund the debt, some observers believe that they will have to turn to external sources or inflate their way out of the situation. The Central Bank already own 34.5% of the government bond market as of February, and this is expected to reach 50% by 2017.

Japanese officials admit privately that a key purpose of ‘Abenomics’ is to soak up the debt and avert a funding crisis as the big pension funds and life insurers retreat from the market. The other unstated goal is to raise nominal GDP growth to 5% in order to ‘bend down’ the trajectory of the debt ratio, a task easier said than done. There has also started to develop a sense of domestic unrest concerning Abenomics. The weakness of the Yen and the deeply unpopular sales tax are seen as two major problems. With food self-sufficiency only running at 39%, the currency movements have driven up import prices with food alone accounting for 80% of domestic inflation.

The Central Bank is likely to push back the timing for the achievement of the 2% price stability target. They will also set out the new growth strategy which is characterised by its identification of 10 specific sectors that are expected to grow, such as artificial intelligence, health care, the environment and energy.

Creating added value totaling ¥30 trillion (US$364 billion) through the "4th industrial revolution" in which productivity would be enhanced dramatically via information and telecommunications technology, and expanding the market size of health care and medicine from ¥16 trillion to ¥26 trillion - by amply incorporating these numerical targets into the growth strategy, the government aims to realise a nominal gross domestic product of ¥600 trillion by 2020.

Any lack of policy action generally causes the Yen to strengthen and this will act as a headwind for the domestic equity market. The current earnings season is highlighting the concerns of exporters such as Canon and Toyota regarding the currency.


30 Page

CapitalInternationalCapitalInternational


In GDP terms, the German economy is the fifth largest economy in the world and Europe's largest. Germany is a leading exporter, being the third largest exporter in the world with €1.13

trillion in goods and services exported last year, and benefits from a highly skilled labour force. Germany is a founding member of the European Union and the Eurozone. However, Germany faces significant demographic challenges to sustained long-term growth. Low fertility rates and a large increase in net immigration are increasing pressure on the country's social welfare system and necessitate structural reforms.

Reforms launched by the government of Chancellor Gerhard Schroeder, deemed necessary to address chronically high unemployment and low average growth, contributed to strong growth and falling unemployment. These advances, as well as a government subsidised, reduced working hour scheme, help explain the relatively modest increase in unemployment during the 2008-09 recession, the deepest since World War II. The new German government introduced a minimum wage of about €8.50 per hour that took effect in 2015.

Stimulus and stabilisation efforts initiated in 2008 and 2009 and tax cuts introduced in Chancellor Angela Merkel’s second term increased Germany's total budget deficit, including federal, state, and municipal, to 4.1% in 2010, but slower spending and higher tax revenues reduced the deficit to 0.8% in 2011 and in 2015 Germany reached a budget surplus of 0.9%. A constitutional amendment approved in 2009 limits the federal government to structural deficits of no more than 0.35% of GDP per annum as of 2016, though the target was already reached in 2012.

The German economy suffers from low levels of investment, and a government plan to invest €15 billion during 2016-18, largely in infrastructure, is intended to spur needed private investment. Following the March 2011 Fukushima nuclear disaster, Chancellor Angela Merkel announced in May 2011 that eight of the country's seventeen nuclear reactors would be shut down immediately and the remaining plants would close by 2022. Germany plans to replace nuclear power largely with renewable energy, which accounted for 27.8% of gross electricity consumption in 2014, up from 9% in 2000. Before the shutdown of the eight reactors, Germany relied on nuclear power for 23% of its electricity generating capacity and 46% of its base-load electricity production. Domestic consumption, bolstered by low energy prices and a weak euro, are likely to drive German GDP growth again in 2016.

German economic growth last year was supported by exports and private household demand. Export performance has been very good over the past 10 years, keeping the share of industry in domestic value added at an unusually high level of 22%. Exporters continued to gain significant market shares in part owing to the depreciation of the euro. Exports of transport, electronic and optical equipment as well as chemicals, for which Germany has a long standing comparative advantage, were particularly strong.

Country in FocusGermany

Facts & Figures

Capitaland largest city

Berlin

Official languages GermanDemonym GermanGovernment Federal parliamentary republic

■ President Joachim Gauck ■ Chancellor Angela Merkel ■ President of the Bundestag Norbert Lammert ■ President of the Bundesrat Stanislaw Tillich ■ President of the Federal Constitutional Court

Andreas Voßkuhle

Legislature ■ Upper house Bundesrat ■ Lower house Bundestag

Formation ■ Holy Roman Empire 02 February 962 ■ German Confederation 08 June 1815 ■ German Empire 18 January 1871 ■ Weimar Republic 11 August 1919 ■ Federal Republic 23 May 1949 ■ EEC Foundation[d] 01 January 1958 ■ Reunification 03 October 1990

Area

Total 357,168 km2 (63rd)137,847 square miles

Population2015 estimate 81,770,900 (16th)

Density 227/km2 (58th)583 per square miles


2015 estimate$3.842 trillion (5th)$47,033 (20th)


2015 estimate$3.371 trillion (4th)$41,267 (20th)

Currency Euro (€) (EUR)

Time Zone ■ Summer (DST)

CET (UTC+1)CEST (UTC+2)

Drives on the RightCalling Code +49Internet TLD .de and .eu

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Empirical evidence suggests that decentralised management, with significant worker involvement, has provided incentives for product improvements, helping exporters to compete on quality, while offshoring production to low wage countries has reduced costs of intermediate inputs. However, weakening growth in emerging economies has started to weigh on exports. Demand is therefore shifting from external sources to private households, which are projected to remain the main driving force for growth in the near term. Household consumption will be backed by strong real wage growth, as cheap oil has impaired consumer prices, while a tight labour market and the introduction of the national minimum wage have pushed up nominal wages.

Demand for housing continues to rise, pushing up housing rents and prices in urban centres and spurring construction. Loose monetary conditions and expansionary fiscal policy, in part reflecting government spending for the needs of newly arrived refugees, provide further stimulus to domestic demand. Wage growth has raised labour unit costs somewhat, but price competitiveness remains strong and inflation is still very low. Mortgage lending to households has picked up, while lending to non-financial businesses remains subdued.

Overall, GDP is projected to remain solid in 2016 and 2017, as domestic consumption remains strong and the demand for German exports in the euro area recovers and compensates emerging economies weakness. The newly arrived humanitarian immigrants will start looking for jobs only gradually and immigration is assumed to diminish. The cyclical unemployment rate is expected to remain low, but the natural rate will rise because of the large number of refugees with a long distance from employability. Consumer price inflation is projected to rise, as wage growth has picked up, there is little remaining economic slack, and as the effect of the fall in oil prices will wear off. Weaker export growth, robust domestic demand growth and lower net foreign capital income are projected to reduce the current account surplus.

A sharper slowdown of activity in emerging markets and renewed weakness of activity in the euro area could weaken exports more strongly than projected, reduce investment, and spill over to consumer confidence. The German economy depends more on world trade than most because of the high weight of exports in GDP and the relatively high share of investment goods exported to emerging economies.


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CELEBRATING


Capital International Group

WEDNESDAY | 18 MAY 2016

All at the Capital International Group would like to congratulate Peter Miller on completing the 100 mile Continental Centurion qualifying walking race in Schiedam, Netherlands over

the weekend. Peter finished with an incredible time of 23:08.27, which was 30 minutes quicker than his previous best in Castletown in August 2015.

Speaking about his triumph, Peter said “finishing is an amazing feeling but beating my previous best feels that little more special.” Well done to all who took part and volunteered at the event. We hope your feet aren't too sore!

Over the Quarter

SATURDAY | 18 JUNE 2016

A huge congratulations to all the entrants who took part in this year's Isle of Man Parish Walk - nearly 1,400 registered including four for the Capital International Group.

We are very proud to announce that our very own Rachael Butterworth, #1331, made it to Peel (the under 21’s finish line in Peel), Pauline Clague, #1007, came 141st, Antony Kelsey, #578, came 82nd and Paul Moran, #615, came 41st. Paul was the third fastest first time finisher, completing the walk in just 20 hours, 24 minutes and 46 seconds. All reached the finish line!

Out of all the entrants, 155 people completed the 85 walk, so this is an amazing achievement!

So, same again next year then guys?!?

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MONDAY | 06 JUNE 2016

We are delighted to announce that Steve Woods has passed the Introduction to Securities & Investment module of the Investment Operations Certificate (IOC) which

is the first unit of three that are required for the certificate.

Jacques De Villiers has passed his 3rd and final module in Derivatives for the CISI Investment Advice Diploma. The IAD is a demanding Level 4 qualification specifically developed to comply with the examination standards of the RDR.

Also, Rhodes Jay Brown has passed two more exams (P2 Corporate Reporting and P3 Business Analyst) and is now preparing for his last two exams necessary to become ACCA qualified.

Huge congratulations to you all – well done!


34 Page


SUNDAY | 01 MAY 2016

On Sunday 1st May, Robert Floate, Group Compliance and Company Secretary at Capital International Group, and his crew took part in the Round the Island Race 2016.

Sailing his yacht, ‘Tan It’, Robert commented that together with his crack, albeit scratch crew most of whom had not been on the boat before, he led from the start and quickly made the Point of Ayre in about 30 minutes – overtaking the beautiful 120 year old cutter ‘Master Frank’ (which had started 10 minutes earlier – and later retired due to gear failure) in the process, and never letting go in challenging conditions. With the wind SW 6-7 gusting 8, especially on the West Side of the Island, it made the 6.5 hour beat from Point of Ayre to Chicken Rock long and rather uncomfortable.

Approaching the Chicken Rock, seas were still rather high and special mention has to go to the gap between Calf and Chicken rock where the sea was very, very confused at the time when Tan It and second placed Polished Manx were rounding, with breaking waves and big ‘holes’ to drop in to. However, once Tan It had cleared Langness the spinnaker was up and the ‘sleigh ride’ down the east coast began – extending the lead and taking only three hours from the Calf to Ramsey - finishing in just over 10 hours and not quite an hour ahead of the next yacht Polished Manx. All in all not a bad days work ‘at the office’ for Robert, with ultimately 4 trophies to collect!

Sporting EventsRepresenting the Island

FRIDAY | 17 JUNE 2016

Everything is football crazy at the moment, although the majority of the focus is on Euro 2016 in France there is in fact another international football event taking place in

South Tyrol, Italy - Europeada 2016.

www.europeada.eu/en/teams/gruppe-e/ellan-vannin/

This year we will see Ellan Vannin competing in Group E of this 24 team tournament organised by the Federal Union of European Nationalities. Kick-off starts on Saturday 18th June and runs through until 26th June.

This four yearly tournament allows all participants to promote their culture and language internationally and once again will enable Ellan Vannin to promote the rich heritage and culture of our Isle of Man. Since its formation in 2014 the team has competed in the CONIFA World Football Cup in Sweden, the NIAMH Challenge Cup in the Isle of Man and the CONIFA Euros in Hungary having played 13 matches with a record of 10 wins and 3 defeats.

Furo Davies, FATCA Administrator at the Capital International Group, who plays for Rushen United AFC has been selected to represent the Isle of Man at the tournament. We wish him and the rest of the team the best of luck and with Furo up front we are sure to see some excellent football.

Round the Island Race

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This document has been prepared for information purposes only and does not constitute an offer or an invitation, by or on behalf of any company within the Capital International Group of companies or any associated company, to buy or sell any security. Nor does it form a constituent part of any contract that may be entered into between us.

Opinions constitute our judgement as of this date and are subject to change. The information contained herein is believed to be correct, but its accuracy cannot be guaranteed.

Any reference to past performance is not necessarily a guide to the future. The price of a security may go down as well as up and its value may be adversely affected by currency fluctuations.

The company, its clients and officers may have a position in, or engage in transactions in any of the securities mentioned.

The regulated activities are carried out on behalf of the Capital International Group by its licensed member companiesCapital International Limited, Capital Treasury Services Limited, Capital Fund Services Limited Capital Financial Markets Limited and Capital International Fund Managers Limited are all licensed by the Isle of Man Financial Services AuthorityCILSA Investments (PTY) Ltd, trading as Capital International SA, is licenced by the Financial Services Board in South Africa as a Financial Services Provider (FSP No 44894)Capital International Limited is a member of the London Stock ExchangeRegistered Address: Capital International Group, Capital House, Circular Road, Douglas, Isle of Man, IM1 1AGRegistered Address: CILSA Investments (Pty) Ltd, Office NG101A, Great Westerford, 240 Main Road, Rondebosch 7700, South Africa

Isle of Man | Head OfficeCapital International GroupCapital HouseCircular RoadDouglasIsle of ManIM1 1AG

www.capital-iom.com

T : +44 (0) 1624 654200 F: +44 (0) 1624 654201 E: [email protected]

South Africa OfficeCapital International SAOffice NG101AGreat Westerford240 Main RoadRondebosch 7700South Africa

www.capital-sa.com

T : +27 (0) 21 201 1070 E: [email protected]


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Capital International Group | Quarterly Review | Q2 2016