The First State Diversified Growth Fund (DGF) returned 5.6% during the quarter, as financial markets found renewed optimism towards growth assets. The equity rally can largely be attributed to the dovish nature of the US Federal Reserve, in conjunction with other central banks.

The Fund aims to protect against UK inflation and provide capital growth by achieving a positive return (gross of fees and charges) of 4% in excess of UK RPI over rolling five-year periods.

The First State Diversified Growth Fund (DGF) returned 5.6%1 during the quarter, as financial markets found renewed optimism towards growth assets. The equity rally can largely be attributed to the dovish nature of the US Federal Reserve, in conjunction with other central banks. The Neutral Asset Allocation (‘NAA’) provided strong performance contribution through equities, while the Dynamic Asset Allocation (‘DAA’) provided a small positive contribution. The UK Retail Price Index (RPI) fell by 0.4% over the same period.

The Fund has delivered 2.6% p.a. (net of fees and taxes) since the inception in June 2015, 0.3% p.a. above UK RPI, with a monthly volatility of 6.2%. For reference, over the same period the FTSE 100 delivered 5.8% p.a with a volatility of 10.5%.

1 Net of fees and tax for the B GBP Accumulation share class

Performance overview

Source: Lipper IM / First State Investments (UK) Limited.

These figures refer to the past. Past performance is not a reliable indicator of future results. For investors based in countries with currencies other than the share class currency, the return may increase or decrease as a result of currency fluctuations.

Performance figures have been calculated since the launch date. Performance data is calculated on a net basis by deducting fees incurred at fund level (e.g. the management and administration fee) and other costs charged to the fund (e.g. transaction and custody costs), save that it does not take account of initial charges or switching fees (if any). Income reinvested is included on a net of tax basis. Source: Lipper IM / First State Investments (UK) Limited.

Investment process

The investment process comprises two building blocks. The first, which we call Neutral Asset Allocation (NAA), sets longer-term, beta allocations on a long-only basis. The second part, which we call Dynamic Asset Allocation (DAA), allows us to exploit shorter-term alpha opportunities through proprietary strategies that aim to be uncorrelated to broader markets. Further, DAA strategies aim to help manage risk through protection strategies. We review the DAA on a weekly basis.

For a comprehensive description of the investment process, click here.

Market review

Financial markets dispelled concerns regarding slowing global growth and global trade disputes seen in Q4-18 as lower-for-longer interest rates in the US buoyed growth assets.

Developed and emerging market equities provided double digit returns, or close to, while global bonds were broadly flat and commodity indices fell. This is the strongest equity market start to a year in over twenty years.

Portfolio performance and attribution

The NAA drove performance, as shown in Figure 1, in Q1-19. This was primarily a result of equity exposures, whilst exposure to both government bonds and high yield credit provided a small contribution. DAA positions provided a slight positive return.

Figure 1: Quarter-end performance contribution to 31 March 2019

Source: First State Investments as of 31 March 2019. Month end data since inception.

Figure 2 provides a decomposition of ex-ante risk, as well as return contribution for the quarter and the last year. UK and Global (ex-UK) equities added 4.6% over the quarter, while exposure to government and corporate credit added to returns as yields moved lower.

Currency hedging of the US and European equity holdings helped offset the impact of a rising Sterling over the quarter.

Within the DAA positioning, equities detracted 1.8%, while bond and currency exposures offset the impact, providing a return of 1.7% and 0.4%, respectively.

Figure 2: DGF return contribution

Source: First State Investments. Gross performance contribution might differ from official performance, due to data source, pricing, and timing.

Key drivers of performance over the period:

• NAA positions added 5.8%, primarily driven by returns from US and UK equities.

– UK equities added 1.3% while global equities added 3.3%.

– Developed market government bonds and cash contributed 0.1%.

– Corporate bonds added 0.4%.

• DAA positions added 0.1%, with gains within bonds and currencies offsetting equity positioning.

– Positions informed by our equity signals detracted 1.8%. This was due to the preference to reduce exposure in favour of other asset classes in a rising market.

– Bond positioning added 1.7%; the bulk of performance came from emerging markets. Long positions in Mexico, India and South Africa were the largest contributors. Short duration positions in Hungary and Korea were small detractors.

– Currency positions added 0.4% to performance. This was due to a long position in JPY and short EUR position.

– We saw a modest loss from protection strategies. This position relates to ongoing Brexit-related uncertainty and is an insurance policy we will likely hold until we have more clarity.

Portfolio positioning

Neutral Asset Allocation (‘NAA’) positioning

There were no changes to the NAA during the quarter. The next NAA review will be conducted in May 2019.

Figure 3: DGF Neutral Asset Allocation

Source: First State Investments

Dynamic Asset Allocation (‘DAA’) positioning

We began the quarter with a preference to reduce equity exposure in the short-term. This provided a reduction in exposure of 24% from the NAA. Over the quarter we added 5% equity exposure, ending the quarter with a reduction of 19%. This was primarily through the unwinding of our short position in emerging markets.

Within fixed income we added 1.0 year of duration over the quarter. The Fund began the quarter with a duration exposure 3.0. During the quarter, our views pointed to a supportive environment for fixed income over the short-term. We added 1.0 year of duration in Japan, removing a short position in UK rates and reducing our long position in emerging markets.

We reduced foreign currency exposure in the lead up to the March 2019 Brexit deadline, by hedging some currency exposures in the US and UK. Within emerging markets we shifted our exposure from Asia to Europe, and added to Nordic exposures (SEK and NOK).

Combined NAA and DAA fund portfolio positioning

The Fund has an equity exposure of 33%; we prefer the UK, US and Europe over emerging markets. The duration (interest rate risk) of the Fund is focused on emerging markets where we see the best opportunities. Foreign currency of the Fund decreased over the quarter to 23%.

Figure 4: Asset allocation

Source: First State Investments

Given equity and bond valuations, we continue to believe the NAA will be unlikely to deliver the required return to meet the Fund’s objective of RPI + 4% over a rolling 5 year period. To bridge this shortfall we have increased our risk budget to DAA (see figure 5 below).

Figure 5: Portfolio ex-ante risk

Source: First State Investments

Market outlook

Our market outlook remains unchanged from last quarter. We still expect that monetary and fiscal policies will continue to dominate, and trade tensions will periodically rattle the investment landscape.

Global growth appears to be slowing and nearing its final state. This is being led by the US; although we expect it to continue to outpace other developed markets. US fiscal stimulus is fading and signs that the economy is at the very late stages of the cycle may begin to appear.

Monetary policy shifts are expected to aid economic growth and be welcomed by financial markets. Central banks have turned dovish almost in unison. We expect this to weigh on the USD and benefit emerging market assets; especially bonds and currencies. Chinese efforts to stimulate growth should feed through to global growth and provide some respite from the late cycle US growth. Strong returns so far in 2019 make us cautious and we expect greater volatility for the rest of the year.

A summary of the Fund’s positions, along with changes over the quarter, can be seen in Figure 6.

Figure 6: Fund positioning and quarterly changes

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Important Information

This document has been prepared for informational purposes only and is only intended to provide a summary of the subject matter covered and does not purport to be comprehensive. The views expressed are the views of the writer at the time of issue and may change over time. It does not constitute investment advice and/or a recommendation and should not be used as the basis of any investment decision. This document is not an offer document and does not constitute an offer or invitation or investment recommendation to distribute or purchase securities, shares, units or other interests or to enter into an investment agreement. No person should rely on the content and/or act on the basis of any material contained in this document.

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