Market Pulse 2 — Investment strategy

Tails of the unexpectedMarkets were unpredictable in 2016, with the surprise votes for

Brexit and Donald Trump affecting investment returns. We explore

possible scenarios for the year ahead and discuss the importance of

remaining optimistic, selective and disciplined.

www.kleinwortbenson.com

In this issue

5 — EquitiesStrong tailwinds in the global economy are providing opportunities for growth in corporate profits, but price-to-earnings ratios show US company valuations are stretched.

6 — Fixed incomeCorporate bonds performed relatively well throughout 2016, with both investment grade and high yield providing positive returns as credit spreads tightened.

7 — CurrenciesAnalysis of past elections suggests that a left-wing victory strengthens a currency, while a right-wing win weakens it, impacting the short-term volatility of returns.

8 — CommoditiesOil prices have fallen despite starting the year in a relatively strong position. Yet forecasts suggest prices could pick up soon and continue to rise over the next few years.

9 — Real estateThe surprise Brexit vote led to a loss of confidence in the UK commercial property sector, which is only now starting to recover.

10 — Markets at a glanceThe Federal Reserve raised interest rates as the US economy continues to show signs of growth.

ILLUSTRATION TO GO HERE

125mm wide x 112mm high

© Peter Greenwood — FolioArt

Second quarter 2017

by Mouhammed ChoukeirChief Investment Officer

The exquisite unpredictability of markets was on full parade in 2016, and investors are still breathless. Very few believed populist anger would lead to “Brexit” or “President” Trump, or that a crashing oil market would be rescued by a deal underpinned by Saudi’s altruism towards Iran. Indeed, markets are replete with occurrences that make mockeries of expectation. Here are some unlikely – but eminently feasible – scenarios that markets are not pricing-in for 2017.

1. Anno Trumpini: Post-Trump expectations of US growth fall flat, but Europe is a champion.

In the aftermath of the US election, global investors appear convinced that huge US infrastructure spending and slashed taxes will bring about President Trump’s “guaranteed” annual economic growth of 3.5% and stoke inflation. However, there are strong reasons why this may not happen. That level of growth has not been hit in the US for over a decade and wildly pumping fiscal stimulus into the economy will do nothing to address fundamentally poor demographics – made worse by immigration curbs – or slowing productivity. It will certainly not help underemployed people get the high-paying jobs for which they don’t have the skills. There could also be some major negative shock, perhaps of the President’s own making – a scandal causing him to rapidly lose his mandate to govern, perhaps? The Federal Reserve may well spend another year being much less active than it sets out to be.

Conversely, expectations are for the euro zone to meander along, growing well under 2%, a little better than recent years, but still deep in a rut. However,

conditions on the ground would suggest a breakout year for the euro zone is possible. Unemployment has finally fallen below 10%, an important milestone in the region’s recovery. Economic confidence is at multi-year highs. Inflation has leapt to 1.1%, despite deflation seeming imminent just months ago. Yet this recovery may finally give the Germans enough reason to force the European Central Bank to tighten monetary policy by reducing quantitative easing and raising rates. The euro zone powerhouse is doing fabulously well economically and wants all this stimulus to end before it causes it to overheat.

2. Not so hard: Brexit negotiations go fabulously well.

The prevailing consensus is Brexit will take longer, and be tougher, than expected. Britain’s ambassador to the EU, Sir Ivan Rogers, has unexpectedly and abruptly resigned, just a few months before the UK is expected to start formal Brexit negotiations. The vast majority of economists at the end of 2016 still believe Brexit will harm the UK’s longer-term economic prospects. The British pound is taking the brunt of the political uncertainty, beginning 2017 at multi-decade lows.

Of course, the majority of pundits could well be wrong… again. Europe has huge incentives to treat the UK well in negotiations and many thorny issues may well be resolved this year. The UK is Europe’s “investment banker”: the City provides 75% of foreign exchange trading and hedging products for the EU, and supports half of all lending. Moreover, the UK exports £26 billion of financial services to the EU and imports just £3 billion. A sharp break in that liquidity and capacity support could be detrimental to financial stability in the EU. On the other

Tails of the unexpected

Market Pulse — Investment strategy

hand, the UK could easily find alternative suppliers of chemicals and wine. This gives the UK more leverage than many believe.

3. Bone China: The long-awaited implosion happens this year.

China remains stable, unbelievably so. Fears of an economic implosion rocked markets early last year, but, remarkably, the country grew at an annualised rate of 6.7% in the first three quarters, bang in the centre of its stated target of between 6.5% and 7%. Guess what? The Chinese Vice Finance Minister states he is confident his country grew at an annual rate of 6.7% in the fourth quarter of 2016 too. Even if these figures are real, authorities were forced to rely once again on leverage-driven infrastructure spending to prevent a short-term crisis. Banks were also encouraged to lend to the private sector, but much of this ended up in housing: prices in first-tier cities such as Shanghai were up by 30% in 2016.

2 — Kleinwort Benson — Second quarter 2017 This article was first published in January 2017

Key points

• Markets were unpredictable in 2016, with events including the vote for Brexit and President Donald Trump reshaping the investment environment.

• Professional forecasters and pollsters could be wrong again this year with their predictions. But whether or not they are correct, there is no way of knowing how markets will react.

• No matter what 2017 brings, we ask our clients to do three things: be optimistic, be selective and be disciplined.

Market Pulse — Investment strategy

The Chinese yuan is at an eight-year low versus the US dollar, down more than 6% in 2016, and the country’s foreign currency reserves continue falling: just two years ago, reserves were $4 trillion; they are $3.1 trillion now. These are signs that all is not well on the inside. Many experts expect a day of reckoning to come at some point. It may well be this year.

Investment implicationsPollsters, political prognosticators, financial forecasters and average punters will be wrong about many of their expectations for 2017. Even if they are right, there is no way to know how markets will react. In 2016, no one saw Brexit or a Republican clean sweep. Even if they had, rationale investors would have shorted risk assets, been long on safe havens or held cash to ride out the ensuing volatility. They would have been wrong. Equities? Up. US dollar? Stronger. Government bonds? Sold off. Gold? Fell hard from an intraday peak. The VIX? Way down. Lesson: trying to divine the future is impossible; it may also be useless.

We encourage our clients to take three important tenets to heart, no matter what the year brings.

First, be optimistic. There are lots of causes for concern in the current macro environment. We are in the midst of an unprecedented paradigm shift due to populist political pressures. If that were not enough, another tremendous transition is taking place in global monetary policy. Uncertain times often present ripe conditions to invest. Over the past five years alone – the euro zone crisis, the US debt shutdown and downgrade, the slowdown in Chinese growth, and lately Brexit and Trump – the global equity market is up 56.6% (or 11.4% per year). It is when everything looks rosy that one should be cautious. That is when risk is often at its highest.

Second, be selective. Nearly a decade on from the financial crisis, global economic growth is still insipid despite the colossal efforts of central banks around the world to stoke growth. These efforts, while largely fruitless in their primary cause, continue to underpin equity and bond markets. However, at least in the US, this unprecedented monetary support is coming to an end; other central banks will eventually follow as well.

Therefore, the “rising tide” of liquidity-driven asset price increases will no longer “lift all boats”. Furthermore, valuations across a number of asset classes and sub-asset classes are no longer cheap, led by the second longest equity bull market in history, and the continuation of a three-decade strong bond bull run. From this stage, we must be ready to accept a lower return for each level of risk than we have historically received. Not too long ago, cash in a savings account yielded 5%. Today, equities may well struggle to achieve that. Still, opportunities are ever-present and when they arise, one should maximise them: increasing dispersion in market returns simply means that investors should be more careful and discerning than in the recent past.

Finally, be disciplined. We live in a world where events unfold very quickly and markets can move with staggering speed. It is easy to want to react. Often, that emotional impulse is wrong. A disciplined and robust investment process that seeks to evaluate long-term fundamentals rather than focus on short-term movements is key to navigating uncertainty. It is critical to eschew the “noise” that inevitably surrounds periods of great change. By focusing on indelible drivers of long-term asset returns – such as valuation, momentum and sentiment – short-term movement and uncertainty can be prudently managed.

Kleinwort Benson — Second quarter 2017 — 3This article was first published in January 2017

4 — Kleinwort Benson — Second quarter 2017

Market Pulse — Investment strategy

House views

Equities Neutral The macro backdrop and upswing in earnings are supportive for global equity prices and we remain constructive. However, in the context of historically high global valuations, we continue to seek attractive levels to add to positions. Our preference is for markets with more attractive valuations and improving earnings forecasts, such as those in the euro zone.

Europe (ex UK) Positive Earnings growth expectations have been revised up recently and valuations remain cheaper than the global average. Risks are mainly linked to upcoming elections.

Japan Positive Japanese equities look very attractive both in absolute and relative terms. Their price-to-earnings and the cyclically adjusted price-to-earnings (CAPE) ratios are the lowest in the developed world. EPS growth forecasts for 2017 and 2018 have been revised sharply higher.

Pacific (ex Japan) Neutral Valuations are attractive at present. However, there are potential risks from an uncertain global trade environment and rising US interest rates.

UK Neutral UK equities remain cheap compared with their peers. But recent data points to a deceleration in economic activity. Furthermore, downward pressure on sterling is now limited given the cheapness of the currency.

US Negative With stretched valuations, higher bond yields and the Federal Reserve likely to raise key rates three times this year, upside is now limited and we would look for opportunities elsewhere.

Emerging markets (EMs) Neutral EMs have outperformed on the back of stimulus in China, rising commodity prices and the gradual recovery in global trade. We see limited upside given the volatility of EM equities; rising inflation (which will deter EM central banks from cutting their rates further to boost growth); and because raw materials price gains are likely to be smaller than in 2016.

Government bonds Negative With the dissipation of deflation fears and expectations for further rate hikes in the US, bond yields should continue rising. Although rates are likely to remain lower than in previous cycles, we advise caution. Nonetheless, we continue to hold government bonds in multi-asset class portfolios for diversification and risk management purposes.

Conventional Negative We are maintaining a short duration stance given the poor valuation of conventional government bonds.

Index-linked Neutral Outperformance from linkers has reduced potential returns although they remain useful instruments in light of the shift in inflation expectations.

Credit Positive Spreads have compressed but yields are still attractive.

Investment grade (corporate) Positive We prefer investment grade corporate to sovereign bonds as they offer better yields. However, total returns are likely to be modest.

High yield (corporate) Neutral High yield bonds continue to offer attractive yields (around 5.3%), while exhibiting fairly constrained volatility.

Emerging market sovereign debt (in local currencies)

Negative Valuation is favourable on both a yield and a currency basis. However, a volatile currency backdrop makes them risky, especially in the near term.

Foreign exchange

EUR/USD Positive Expectations for stronger US growth following Trump’s victory triggered a dollar rally but the trend soon reversed and upside is now limited versus most of the G10. Expected Fed rate hikes may trigger a bout of renewed dollar strength but it is unlikely to last. The euro should bounce back later this year as the ECB turns less accommodative.

GBP/USD Negative A resilient economy has helped sterling stabilise, leaving the currency 15–20% undervalued versus the US dollar on purchasing power parity terms. However, higher import prices may lead to successively higher inflation, weaker household consumption and slower growth. Tense “Brexit” negotiations could further encourage sterling weakness.

USD/JPY Neutral With the Bank of Japan still very accommodative, USD/JPY has been mostly driven by US rate expectations, risk appetite and outflows from institutions for foreign investments.

Emerging Negative Periods of rising US rates are typically associated with emerging currency weakness.

Real estate Negative Since the start of 2016, a combination of lofty valuations, reduced pace of capital growth, stamp duty changes and “Brexit” concerns have diminished the attractiveness of the asset class. We remain negative on short-term outlook for the UK commercial property market.

Diversified commodities Positive After a five-year bear market in diversified commodities, a floor in oil prices proved a catalyst for the asset class to regain positive momentum. A compelling valuation case also exists when examining the components of expected return for the index.

Gold Neutral Prices may rise in the short term. But the trend will soon reverse if “Frexit” is avoided.

Kleinwort Benson — Second quarter 2017 — 5This article was first published in February 2017

Market Pulse — Equities

Key points

• The S&P 500 index continues to reach record highs on a near daily basis.

• Cyclically adjusted price-to-earnings ratios show US company valuations are stretched.

• President Trump’s promises of US infrastructure spending and tax cuts for businesses are a key driver of recent momentum in US equities.

by Elliot WaltonInvestment Analyst

The S&P 500 is smashing through previous record highs on a near daily basis. The year-to-date performance so far is 5%, double that of the FTSE 100. One reason for the latest leg in this multi-year equity market rally is earnings. The fourth quarter of 2016 picked up strongly from the third, which broke a year-long spell of outright contraction (figure 1).

The strong tailwinds in the US and global economy are clearly translating into an increasing ability for corporates to grow their profits. However, we note that heightened expectations led to fewer companies than usual beating forecasts (figure 2). To date 428 companies have reported their earnings of a total 505 – 85% of the total companies in the S&P 500 Index.

Stretched valuationsNevertheless, while US companies are clearly doing better on aggregate, valuations are stretched. The cyclically adjusted price-to-earnings ratio – a measure of current prices in the context of the business cycle – is elevated, at 28.3, well above the long-run average of 17. This is a risk for two reasons. First, equities tend to produce below-historical returns from positions of above-historical valuations. Second, the risk of a sharp sell-off is also heightened when valuations are elevated.

Much of the recent momentum in US equities was driven by the election of Donald Trump as president in November 2016. Many investors appear convinced huge US infrastructure spending and slashed taxes will bring about President Trump’s “guaranteed” annual economic growth of 3.5%. However, there are strong reasons why this may not happen.

The anticipated level of growth has not been achieved in the US for more than a decade, and wildly pumping fiscal stimulus into the economy will do nothing to address fundamentally poor demographics or slowing productivity. Moreover, higher-than-expected inflation may cause the Federal Reserve to raise rates sooner than expected, which would act as a headwind to the economy and corporate earnings.

On balance, we believe our underweight exposure to US equities is warranted in a global equity portfolio.

Earnings growth returns but for how long?

Source: Factset, Kleinwort Benson.

Past performance does not guarantee future performance.

Figure 2: Great expectationsS&P 500 aggregate earnings per share, reported earnings vs analyst expectations year-over-year growth.

Source: Factset, Kleinwort Benson.

Past performance does not guarantee future performance.

Figure 1: Earnings turnaround S&P 500 aggregate earnings per share, reported year-over-year growth.

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Market Pulse — Fixed Income

6 — Kleinwort Benson — Second quarter 2017 This article was first published in January 2017

by David GoebelQuantitative Analyst

Corporate bonds were a great investment in 2016. When hedged back to sterling, low-risk global investment-grade bonds returned just under 6%, while their riskier high-yield brethren were up 15%. That even compares favourably to global equities, which returned 8% in similar currency-hedged terms.

Much of that return came from tightening credit spreads over the year. The credit spread is the difference in yield between a corporate bond and an equivalent risk-free government bond. It represents the extra compensation an investor receives for the risk of the issuer not being able to repay the bond (defaulting).

The prices of all fixed income instruments are subject to the movements of government bond yields. However, corporate bonds receive an extra benefit from a tightening in spreads – or, are disadvantaged from a widening.

Unfortunately, while narrowing spreads are a boon for investors in terms of performance, they are also a cause for concern. The closer corporate bond yields get to those of equivalent government bonds, the harder it becomes to get closer still, and the less credit-risk compensation investors effectively receive. While performance can always be driven by the movement of underlying yields, there comes a point at which spreads are much more likely to widen than tighten, causing bond prices to fall.

Tightening spreads deliver positive returns despite rising yieldsLast year, spreads widened until mid-February before beginning a tightening trend. Client portfolios benefited from our increasing exposure to high yield bonds in May. They continued to deliver positive total returns as their spreads further tightened, despite the headwind of rising yields after the US election in November.

The average spread on global investment grade bonds and global high yield are currently 1.2% and 3.9%,

respectively. A comparison with history shows each bond category as being expensive but not excessively so. Since 2001 the average spread on investment grade bonds has been 1.5% and for high yield 5.8%. Current spreads are higher than they were in mid-2014. They are higher still than where they languished from 2004 to 2007 before blowing out as the global financial crisis hit (figure 3).

Government bonds are expensive, yet they have an essential role to play in diversifying equity risk in multi-asset portfolios. Within our credit allocation, we prefer high yield to investment grade bonds. While being mindful of spreads, the spread tightening we have seen is justified given the improving trajectory of the world economy and falling default rates. Credit returns are likely to be more constrained from here, but absolute levels of yield in high yield bonds (around 5.5%) are attractive given their short duration (approximately four years on average, globally), which will prove defensive if yields continue to rise.

Key points

• Corporate bonds performed well in 2016, with much of the return coming from tightening credit spreads.

• Client portfolios benefited from our increasing exposure to high yield bonds halfway through the year.

• While bonds are expensive in historical terms, they are not excessively so, and continue to deliver positive returns.

Thinly spread

Source: Factset, Kleinwort Benson.

Past performance does not guarantee future performance.

Figure 3: Global corporate bond spreadsCorporate bond spreads are higher than their pre-global financial crisis levels.

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2008

by Nick LowsonSenior Portfolio Manager

On 23 June 2016, the UK electorate voted to decide on membership of the European Union (EU). The outcome, unexpected by many, caused sterling to tumble. Within a month, the trade-weighted pound was about 10% lower than its level a month before the vote.

Unquestionably, the decision had a big impact on investor returns. Many labelled Donald Trump’s presidential election victory the result of a similar populist phenomenon, but the dollar closed about 3% higher a month after the election compared with a month before.

The Brexit referendum created more uncertainty whereas Trump’s win, although not predicted by most, at least gave some direction. So surely that must be the

Key points

• Around an election, a currency appears to strengthen on a left-of-centre win and generally weaken on a right-wing win.

• Exceptionally, although Donald Trump’s election victory was also a surprise, the US dollar, like under Reagan, has since gained in value.

• With key elections across Europe this year, the euro could experience periods of elevated volatility.

Kleinwort Benson — Second quarter 2017 — 7This article was first published in February 2017

Does it matter which way the vote goes?

tendency for elections? But it isn’t. While many studies look at the trend of the dollar over a presidency, it is interesting to look solely at the election itself.

Since President Jimmy Carter, the trade-weighted dollar usually strengthened over the month before and after the election of a Democrat by 4%, whereas for Republicans, it depended on who won. The dollar declined 4% when George Bush Sr and George Bush Jr were elected, but rose with Reagan and Trump – possibly due to expected spending plans.

In the UK, since 1974 sterling tended to rally a few percent over a similar period after Labour came to power (except Tony Blair’s victory in 2005). But it tended to weaken for a fortnight following a Conservative victory before making some gains (except David Cameron’s surprise majority in 2015), and is usually lower over a month-before-month-after period.

Left or right?It seems a right-wing win weakens a currency while a left-of-centre strengthens it, even in Japan (figure 4). Over the past 20 years, the yen fell a few percent – aside from Prime Minister Shinzo Abe’s 2014 win – with each Liberal Democratic victory (the Japanese conservatives) and strengthened more than 5% when the centre-left Democratic Party won in 2009.

Consequently, with the euro zone facing six planned national general elections within 12 months, the euro may get a bit jumpy. No definite trend has really emerged yet – especially as national votes are less meaningful to the EU as a whole – but it does seem that the euro rallies when left-of-centre parties win in larger euro zone countries – unless the victor is François Hollande.

For the long-term investor – more interested in economic fundamentals, the interplay of interest rates and relative purchasing power – the transient effect of elections may not be a prime investment factor. Yet, it can have an impact on the short-term volatility of returns.

Source: Bloomberg, national electoral records, Kleinwort Benson. *Sterling data prior to 1998 is dollar sterling exchange rate.EU data based off EU, French, German, Dutch, Italian, Spanish and Polish election dates. EU elections classed broadly as right-wing or left-wing based on national spectrum.

Past performance does not guarantee future performance.

Figure 4: Election winners and losersAverage local trade-weighted* currency change 30 days before and after an election (%).

Market Pulse — Currencies

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Left wing Right wing Excluding 2015 David Cameron win Excluding 2005 Tony Blair win

Excluding 2012 François Hollande win

by David GoebelQuantitative Analyst

Until the end of February, oil had been trading calmly this year at around the $55 level, providing a welcome relief from the bouts of volatility seen throughout 2016. This respite was mostly thanks to a production cut agreed by the Organisation of the Petroleum Exporting Countries (OPEC) at their meeting in Vienna on 30 November.

Recently, oil prices have once again taken a lurch downward, however, with the West Texas Intermediate (WTI) benchmark breaching the $50 mark – suffering its worst one-day fall for 13 months on 8 March (figure 5).

There appear to be several factors at play that have “spooked” the market. With oil prices appearing to stabilise above the $50 level, shale producers in the US increased production rapidly, leading to stockpiles of oil increasing dramatically. What was forecast to be 1.7 million barrels per week became 8.2 million in reality.

Since the start of 2015, the US has been amassing oil much more quickly than has been seen in the past (figure 6), and levels have reached an all-time high of 528 million barrels. Increasing production by shale producers makes cuts agreed by OPEC less useful in constraining supply.

Tensions in the OPEC camp are already running high, with Saudi Arabia’s energy minister commenting that production cuts are not guaranteed to carry on into the second half of the year, something markets previously seemed to have taken for granted. OPEC meets again in May, which should provide some clarity. However, further potential for volatility could come from announcements on energy policy from the Trump administration.

Despite this recent fall, Bloomberg analysts still forecast the price of WTI oil per barrel will pick up, ending the first quarter at $53 and the fourth quarter at $57. Longer-term projections are that the price will continue with an upward trend, reaching $66 by 2020. Our portfolios have exposure to the price of oil via diversified commodity products, where some volatility is diversified among other, uncorrelated, commodities.

Potential for volatility

Market Pulse — Commodities

Key points

• Oil was trading calmly at the start of the year due to an OPEC production cut, but prices have now fallen.

• Since the start of 2015, the US has accumulated oil much more quickly than it has in the past.

• Forecasts suggest prices will pick up and continue to rise over the next few years.

8 — Kleinwort Benson — Second quarter 2017 This article was first published in March 2017

Source: Factset, Kleinwort Benson.

Data from September 1982 – March 2017. Past performance does not guarantee future performance.

Figure 6: All-time highThe US has recently been amassing oil much more quickly than in the past.

Source: Factset, Kleinwort Benson.

Data from March 2012 – March 2017. Past performance does not guarantee future performance.

Figure 5: Sharp downturnOil prices have dipped recently, with many factors impacting the market.

US crude total oil inventory, million barrels (left) WTI oil price (right)

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by Delyth RichardsHead of InvestmentSolutions

UK commercial property valuations have recovered from their post-Brexit declines, although possible weaker economic growth may create more challenges ahead. Most sectors remain in balance and are not under threat from high levels of oversupply. Vacancy rates are generally low. Even high-street retail – a sector where vacancy levels remain of concern – has seen a modest decline in vacancy rates from 14% to 12% over the past three years. Construction has been muted with the exception of the City of London, where we have concerns.

Commercial property yields remain stable and continue to provide an attractive level of income for investors. As spreads between primary and secondary UK property have compressed, more UK investors are considering overseas opportunities, with sub-asset classes,

such as infrastructure, still compelling due to their long-term contractual cash flows.

Rising bond yields and future increases in interest rates are headwinds for the asset class. But UK commercial real estate remains attractive to overseas buyers, where sterling’s recent depreciation has created better value opportunities for US dollar-based investors.

We continue to forecast that 2017 will remain a subdued year for UK real estate, and that the uncertainties of Brexit and a potential Scottish referendum may result in some occupiers delaying new letting decisions. Anecdotal feedback from market participants confirms that some businesses are delaying decisions to develop, invest in or take leases on commercial property.

At the end of April 2016 we sold our direct UK property exposure as capital values started rolling over, and added exposure to broad commodities instead. This has been beneficial to client portfolios, delivering higher returns than if we had retained our allocation to direct

Market Pulse — Real estate

Challenges ahead for UK commercial property

Key points

• UK commercial property valuations have recovered from the fall they suffered following the Brexit vote.

• We maintain our forecast that 2017 will be a year of subdued growth for UK real estate.

• We have discovered a range of investment opportunities in direct property, such as healthcare assets.

UK property of 23% over ten months from 20 April versus 2% returns from direct real estate, as measured by IPD (figure 7).

We are always looking for attractive opportunities to reinvest in property as we like its diversification benefits in a multi-asset portfolio. Quoted UK and global real estate investment trusts (REITs) sold off following the vote for Brexit and are offering investors compelling valuations. Some have now met our quality and valuation selection criteria, resulting in their inclusion in our equity portfolios. This is driven by bottom-up, company-specific selection drivers rather than a positive view on the sector as a whole.

We are reviewing investment opportunities in direct property, such as healthcare assets (GP surgeries, medical centres and pharmacies) and long-leased opportunities, typically more than 20 years, that offer inflation-linked rents (supermarkets, budget hotels and strategic assets). At this stage, we continue to evaluate these ideas, seeking those with attractive downside protection to offer investors the best risk-reward characteristics.

Figure 7: Property vs commoditiesMonthly returns, March 2016 = 100

Figure 8: IPD Property IndexMonthly returns (%)

Source: Factset and Kleinwort Benson. Source: Factset and Kleinwort Benson.

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The diversified commodity exposure was unhedged (US dollars) until 18 November and then moved to a sterling hedged share class. Past performance does not guarantee future performance.

Kleinwort Benson — Second quarter 2017 — 9This article was first published in March 2017

Market Pulse — Markets at a glance

Most began the year expecting US interest rates to march inexorably upwards, diverging sharply from other major global central banks, which are still in active “loosening” mode. However, while the Federal Reserve (Fed) did exactly as expected, raising its benchmark interest rate to between 0.75% and 1% in March, Fed chair Janet Yellen remained tentatively committed to “just” two more rate hikes this year, and three each in 2018 and 2019.

The fact US inflation has risen to a five-year high of 2.7%, or that core inflation is at 2.2%, did not cause an upward reassessment of the Fed’s stated trajectory. Furthermore, there is still no concrete detail on the new US administration’s “double growth” rhetoric, leaving little pressure to tighten monetary policy.

On the other hand, European Central Bank President Mario Draghi left no doubt €60 billion in assets will continue to be purchased each month throughout the year. However, some saw the first seeds of tightening monetary policy in his mention of a “cursory discussion” about “tweaking” forward guidance.

Adding fuel to this fire, the euro zone economy is recovering faster than thought, and political risk is diminishing. As a result, far from the US dollar to moving toward parity versus the euro, as many expected at the start of the quarter, the euro has strengthened (figure 10), and 10-year German bonds yields rose in line with US Treasuries (figure 10).

The quarter was also witness to a number of major political events. In the Dutch elections, the far-right populist party of Geert Wilders put up a good showing, but a game-changing “Nexit” was not to be. The Dutch election result has also caused a lowering in the odds for a populist victory by Marine Le Pen in upcoming French elections (figure 11).

Rate expectations

Figure 10: The euro zone economy is recoveringThe euro has strengthened and 10-year German bonds yields have risen in line with US Treasuries.

Source: Factset and Kleinwort Benson. Data as at 31 March 2017.

Figure 11: Spread of 10-year French government bonds over German 10-year government bondsFrance’s presidential election campaign has unsettled its government bond market.

10 — Kleinwort Benson — Second quarter 2017

Figure 9: Investment returns (%)

Source: Factset and Kleinwort Benson. Data as at 31 March 2017.

Returns are in local currency unless stated and assume net dividends and interest payments reinvested.

Q1 2017 Last 12m Last 24m Last 36m Last 48m Last 60m

Developed market equities 5.6 18.0 13.4 29.6 54.2 76.8

Emerging market equities 7.5 16.6 8.1 22.6 27.4 35.7

Developed government bonds 0.1 0.2 3.3 11.5 12.9 18.2

Emerging market government bonds 3.2 7.5 13.7 23.9 24.3 39.2

Global investment grade corporate bonds 1.2 4.0 5.1 12.5 15.1 24.1

Global high yield corporate bonds 2.7 15.0 12.3 15.4 24.4 41.7

Oil (WTI spot price only) -5.8 32.0 6.3 -50.2 -48.0 -50.9

Gold 8.4 1.3 5.5 -2.7 -21.9 -25.1

Agriculture (spot price only) -0.6 2.1 -1.5 -29.4 -33.5 -34.9

Hedge funds 1.6 6.2 -1.6 -1.3 3.3 6.9

Global property 0.9 2.8 4.2 29.8 33.1 66.8

Listed private equity (in US dollars) 8.1 22.2 17.3 20.9 48.1 88.6

Source: Factset and Kleinwort Benson. Data as at 31 March 2017.

0.2

0.3

0.4

0.5

0.6

0.7

0.8

Mar '17Dec '16Sep '16Jun '16Mar '16

-0.2

0.0

0.2

0.4

0.6

1.2

1.6

2.0

2.4

2.8

Mar '17Dec '16Sep '16Jun '16Mar '16

US 10-year government bond yield (left)

German 10-year government bond yield (right)

1.02

1.04

1.06

1.08

1.10

1.12

1.14

1.16

Mar '17Dec '16Sep '16Jun '16Mar '16

1.07

$

EUR/USD exchange rate

General risk informationThis publication is intended to give an insight into the thought processes that lie behind our investment views and our investment strategy.

The information in this publication is provided for information purposes only and does not take into account the investment objective, the financial situation or the individual needs of any particular person. It is not an offer to buy or sell any particular security or investment.

This publication does not constitute advice. All potential investors should seek and obtain advice specific to their circumstances from a qualified financial adviser before making investment decisions. The value of investments, and the income from them, may fall as well as rise and the investor may not get back the amount initially invested. Past performance does not guarantee future performance. Fluctuations in exchange rates may cause the value of investments denominated in currencies other than sterling to fall or rise. The effects of charges and an investor’s personal tax circumstances may reduce any returns. Tax treatment depends on an investor’s individual circumstances and may be subject to change. Kleinwort Benson does not provide tax advice. Investors should seek and obtain tax advice specific to their circumstances from a qualified tax professional.

Regulatory informationThis publication has been approved and issued in the United Kingdom by Kleinwort Benson Bank Limited. Kleinwort Benson is the brand name of Kleinwort Benson Bank Limited. Kleinwort Benson is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. The firm reference number is 119269 and Kleinwort Benson is a member of the London Stock Exchange. Kleinwort Benson is a company incorporated in England and Wales with company number 2056420 and VAT number GB 629 2807 22. Registered Office 14 St. George Street London W1S 1FE. Telephone +44 (0)20 3207 7000. Telephone calls may be recorded.

Kleinwort Benson is the brand name of Kleinwort Benson (Channel Islands) Investment Management Limited which is a company incorporated in Guernsey with company number 59377. Registered Office Dorey Court Admiral Park St Peter Port Guernsey GY1 3BG. It is regulated by the Guernsey Financial Services Commission for the conduct of investment business. Telephone calls may be recorded.

Kleinwort Benson is the brand name for Kleinwort Benson (Channel Islands) Limited which is a company incorporated in Guernsey with company number 52103. It is regulated by the Guernsey Financial Services Commission for Banking and Investment Services. Kleinwort Benson is also authorised and regulated by the United Kingdom (‘UK’) Financial Conduct Authority (‘FCA’) in respect of UK regulated mortgage business and its FCA firm reference number is 310344; registered office, Dorey Court, Admiral Park, St Peter Port, Guernsey GY1 3BG. Telephone number +44 (0)1481 727111. Telephone calls may be recorded.

Please note Guernsey is not part of the UK and when you conduct business with Kleinwort Benson outside the UK you will not be eligible for: (a) the protections provided under the UK’s

Financial Services and Markets Act 2000 other than protections relating specifically to UK regulated mortgage business; or (b) referring complaints to the UK’s Financial Ombudsman Service. However Kleinwort Benson’s UK regulated mortgage business is covered under the UK’s Financial Services Compensation Scheme (‘FSCS’). You may be entitled to compensation from the FSCS if Kleinwort Benson cannot meet its obligations in relation to UK regulated mortgage business. This depends on the circumstances of the claim. Further information about the FSCS is available on the FSCS website www.fscs.org.uk or on request from FSCS, 10th Floor, Beaufort House, 15 Botolph Street, London EC3A 7QU. Telephone 020 7741 4100 or Freephone 0800 678 1100.

Kleinwort Benson places all client deposits with a spread of approved counterparties including other parts of the Societe Generale Group (the “Group”). As such their financial standing is linked to that of the Group. Depositors should form their own view of the financial standing of the Group based upon publicly available information.

Kleinwort Benson is a participant in the Guernsey Banking Deposit Compensation Scheme (the ‘Scheme’). The Scheme offers protection for ‘qualifying deposits’ up to £50,000.00 subject to certain limitations. The maximum total amount of compensation is capped at £100,000,000.00 in any 5 year period. Full details are available on the Scheme’s website www.dcs.gg or on request. Please note deposits with Kleinwort Benson outside the UK are not covered by the UK FSCS.

Kleinwort Benson (Channel Islands) Limited’s activities in Guernsey are covered by the Channel Islands Financial Ombudsman (“CIFO”) and you are therefore eligible to refer complaints to this service. Further information about the CIFO is available on its website www.ci-fo.org. The CIFO can also be contacted on 01481 722218 or 01534 748610 and its address is PO Box 114, Jersey, Channel Islands JE4 9QG.

Kleinwort Benson — Second quarter 2017 — 11

Market Pulse

UK+44 (0)20 3207 7400enquiries@kleinwortbenson.com

Guernsey+44 (0)1481 727 111guernsey@kleinwortbenson.com

For details of our services and general information about Kleinwort Benson please visit www.kleinwortbenson.com