Private Banking Global Wrap Up Bank of Ireland Private Banking

Private Banking Global ‘Wrap Up’ Bank of Ireland Private Banking Quarter 3, 2016 Investor Overview Investors scale the political ‘wall of worry’ If...
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Private Banking Global ‘Wrap Up’ Bank of Ireland Private Banking

Quarter 3, 2016

Investor Overview

Investors scale the political ‘wall of worry’ If ever investors needed proof that portfolio diversification and a long term outlook were invaluable in handling political risk, the third quarter provided it. Hot on the heels of the UK’s vote to leave the EU, investors had to contend with a dose of political bloodletting UK style as David Cameron resigned as Prime Minister leading to Theresa May’s accession to the role. On top of this, the impasse in Spain drifted on as the second election in June failed to produce a government. In the US Presidential candidates Donald Trump and Hilary Clinton battled it out in the race for the White House while the Italian government announced its constitutional referendum would be held on December 4th.

Tom McCabe Global Investment Strategist

And yet in the face of these political headlines investment markets rallied admirably over the summer with most asset classes producing positive returns (see chart 1). Investor sentiment towards risk assets was buoyed chiefly by a solid second quarter earnings season and by more evidence that the US Federal Reserve would take a very gradual approach to raising interest rates. It wasn’t all one way traffic for investors in the quarter though – commodities gave back some of their 2016 gains while sterling continued its slump, falling by another 3.3% in trade weighted terms. However in retrospect most investors would probably have been extremely relieved by the third quarter performance, particularly given the uncertain backdrop created by the BREXIT vote.

Chart 1: Investment Returns Q3 2016

Bloomberg Commodity Index (Commodities)

-3.9%

HFR Global Hedge Fund (Alternatives)

2.1% 1.8% 1.8%

European Corporate Bonds 0.7% 0.7%

European Government Bonds

4.1%

MSCI World (Equities)

UK IPD Index (Commercial Property)*

5.1% -4.3% -2.5%

-6.0% Q3 2016 Returns (€)

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

Q3 2016 (Local Currency)

Source: Bloomberg, October 2016, *Property Returns for the two months to end August On the economic front, last quarter we argued that a UK slowdown (and possible shallow UK recession) with minimal global fallout was the most likely economic result following the BREXIT vote. So far this scenario looks to be playing out. Not surprisingly the initial UK data following the vote were much weaker as businesses and consumers adapted to the more uncertain environment. However since then UK economic data has rebounded, helped in particular by sterling’s collapse. To illustrate this, chart 2 shows that the UK economic surprise index climbed to a three year high in the third quarter. Furthermore, we find that some of the dramatic UK economic downgrades published in the aftermath of the vote are now being revised back up. This creates the intriguing possibility that the UK could avoid recession altogether in 2017, something that investors could scarcely have imagined as they digested the vote result on June 24th.

Warning: Past Performance is not a reliable guide to future performance

Chart 2: Citigroup UK Economic Surprise Index 100 80 60 40

Readings above 0 = data better than expected

20 0

Readings below 0 = data worse than expected

-20 -40 -60 Dec-15

Jan-16

Feb-16

Mar-16

Apr-16

May-16

Jun-16

Jul-16

Aug-16

Sep-16

Source: Bloomberg, October 2016

Growth in the euro zone slowed in the second quarter although there has been negligible evidence that the BREXIT vote is weighing significantly on the economy. US economic growth was again sluggish in the second quarter but we remain confident of a pickup in the second half of the year, helped by a bottoming out in non-residential investment. Overall, 2016 global economic growth forecasts were generally unchanged during the quarter (see chart 3) and a small improvement in global growth in 2017 is still anticipated.

Chart 3: Evolution of 2016 Consensus Economic Growth Forecasts 6.6%

7%

6.6%

6% 5% 4% 3%

4.5%

4.3%

Global Growth Forecasts unchanged in Q3 2.4% 2.4% 1.9%

2%

1.9% 1.5%

1.7% 1.8%

1.7%

1%

0.5%

0.8%

0% World

US 6 months ago

UK

Germany

3 months ago

China

1 month ago

Japan

Asia Pacific

Current Forecast

Source: Consensus Economics, September 2016

Warning: Past Performance is not a reliable guide to future performance Warning: These figures are estimates only, they are not a reliable guide to future performance

The interest rate outlook changed little over the quarter. Expectations for US interest rate hikes among Federal Reserve members were pared back while following its review the Bank of Japan reiterated its loose monetary policy stance. The European Central Bank (ECB) raised some eyebrows by not extending its Quantitative Easing policy in September. However we remain confident the policy will continue for the foreseeable future. Over the next twelve months we believe risk assets can continue to make modest progress. Stock and property markets should benefit from a slightly stronger economy and continued low interest rates. Furthermore, the stock market earnings recession of the past 12-18 months looks to be coming to an end with global profit growth of 13% forecast for 2017. The outlook for government bonds is less certain, particularly given the plunge in yields this year. In short we think it is difficult to see much upside assuming the global economy holds up. On the currency side we still think the dollar can slowly grind higher although the gains won’t be as significant as in recent years. The scale and speed of sterling’s decline since quarter end has generated plenty of headlines. It is clear that politics more than fundamentals have been the key catalyst behind this, making forecasting the short term direction of the currency even more hazardous than normal! However, we don’t think it’s a given that sterling will continue to weaken from here, especially against the euro. As we pointed out above, UK data has surprised to the upside in recent months and if this continues then one would expect it should help the currency stabilise. Furthermore, in contrast to the Federal Reserve in the US, we still expect the ECB to maintain a very loose monetary policy. As we have seen in the past few years, as euro zone bond yields have moved lower the burden of the ECB’s monetary policy moves have increasingly weighed on the euro instead. We think this will continue to be the case, capping the potential for strong gains for the euro. Clearly politics has the potential to cause some volatility again in the final quarter of 2016 via the US Presidential Election. At the time of writing it appears Hilary Clinton is pulling away from Donald Trump in the race to be the next US President although the race could yet take further twists and turns. Therefore, portfolio diversification and that long term outlook could pay dividends yet again in 2016! Warning: These figures are estimates only, they are not a reliable guide to future performance

Equity Market Outlook

Quality delivers even when times are tough For the first time since 1999 the trifecta of the Dow Jones Industrial Average, the S&P 500 and the NASDAQ hit record highs. It’s headline grabbing news which many find puzzling. After all, there’s a lot of uncertainty - we receive a daily dose of geopolitical concerns from ‘BREXIT’ to Donald Trump to ISIS.

Deirdre Kennedy Senior Investment Manager

We’re living in a slow growth world, with GDP forecast to rise by 2-3% this year and next. As a result, monetary policy remains highly accommodative, with central bankers keeping interest rates low and engaging in Quantitative Easing programmes. This is good news for investors but very bad news for savers; there’s a paucity of good alternatives to real assets in this prolonged period of low interest rates. Around $13 trillion of sovereign and corporate bonds have a negative yield; this represents almost half of all western debt. The US 10 year treasury, at 1.8%, is technically a high yielding bond. The Irish 10 year hit a record low of 0.3% last month – just five “Investing should be years ago it was almost 12%. like watching paint dry or grass grow. If you Many investors are sitting on the side lines, afraid of want excitement take $800 and go to what’s to come and what it could mean for asset Vegas” – Paul values. By definition we cannot know the shocks Samuelson, that lie ahead but we can look at what happened Economist and Nobel Laureate. over the last 10 years. Between 2006 and 2016 we endured the Global Financial Crisis, the Great Recession and the Eurozone sovereign debt crisis - yet quality companies delivered double digit growth.

Group Fundamental top 10 holdings: Johnson & Johnson Apple Inc. Merck & Co. Samsung Electronics Microsoft General Dynamics Imperial Brands Smith & Nephew Medtronic Siemens

Over the last decade, the top ten holdings in Global Fundamentals, our flagship equity fund, grew their sales and earnings by 10% per annum and their dividends by 11% per annum, on average. The total return for investors in an equally weighed portfolio of these stocks was 13% per annum. So an investor that put €1 million into these ten names back in September 2006 would have over €3 million now. It’s never an easy ride, quality companies aren’t immune to the turbulence of stock markets, and an investor in these ten stocks experienced sharp declines in 2008. Over time the investments delivered though. In an ideal world equity prices would rise steadily every day, growing like Paul Samuelson’s grass. Unfortunately there will always be ups and downs in markets. Sitting on the side lines waiting for uncertainty to clear is tempting but it’s not a long term investment strategy, sticking with quality is. Global Fundamentals is a diversified global equity fund. The fund is actively managed and focused on quality companies trading at attractive valuations and providing sustainable dividends.

Bond Market Outlook

Another good quarter for bonds but little value left in sovereigns The third quarter of 2016 was another good one for global bonds and continued the trend of strong returns across bond markets. The perceived ‘safer’ parts of the bond markets such as US Treasuries underperformed while the best returns were achieved in the ‘higher’ risk areas such as Corporate, High Yield and Emerging Market debt.

Tom Baragry Head of Multi-Manager Funds

Global growth expectations have generally stabilised over the summer. We are expecting global growth of 2.4% in 2016, increasing to 2.7% in 2017. Developed economies continue to be modestly downgraded while Emerging economies are now being upgraded. The UK referendum in June to leave the EU is likely to have a negative impact on growth in Europe but as yet there is little evidence of this. In fact so far UK exporters and tourism businesses are benefitting strongly from the sharp drop in sterling. However corporates are likely to defer investment plans until they have greater clarity of what BREXIT entails. In contrast to other developed economies the US is at a different stage of its interest rate cycle. The US Federal Reserve left its interest rates unchanged at its July and September meetings but said that the case for an increase before year end has strengthened. Investors now expect the Federal Reserve to increase US rate by 0.25% at its December meeting and a further 0.50% during 2017. Rising interest rates will be negative for US bonds and the US Treasury market was the only section of the global bond market to post negative returns in the quarter.

Table 1: Bond Market Performance Index

Local Currency

Q3 2016

Year to Date

Citi WorldBIG Index (Euro hedged)

0.2%

5.6%

Citi EuroBig Index

0.9%

5.9%

Citi EuroBIG Sovereign Index

0.7%

6.4%

Citi EuroBIG Corporate Index

1.8%

6.1%

Citi USBig Treasury Index

-0.3%

5.0%

Citi USBig Mortgage Index

0.6%

3.6%

Citi US Investment Grade Index

0.5%

5.9%

Citi US High Yield Index Citi Global Emerging Sovereign Index

5.5% 2.1%

15.6% 11.0%

Source: Bloomberg, October 2016 Warning: Past Performance is not a reliable guide to future performance Warning: These figures are estimates only, they are not a reliable guide to future performance

Yields on Government issued bonds continue to be pushed down to new historic lows by Central Bank policies (see table 2) to the extent that yields are now negative on 33% of global sovereign bonds and a further 32% had a yield between 0% and 1%. The yields on 10 year German bunds went negative for first time in history in June. As a result bond investors have been moving away from sovereign bonds into corporate, high yield and emerging markets in a search for positive yielding bonds. There appears to be little value in sovereign bonds given the negative yields and US Treasuries should continue to underperform if the Federal Reserve increases interest rates in December. While there appears little short term upside the bond markets globally will be supported by the fact that interest rates will be kept low by Central Banks. Table 2: Government Bond Yields (30 September 2016)

Country

2Yr Yield

5Yr Yield

10Yr Yield

30Yr Yield

US

0.76%

1.15%

1.59%

2.32%

UK

0.10%

0.22%

0.75%

1.49%

Japan

-0.29%

-0.25%

-0.09%

0.46%

Switzerland

-0.94%

-0.84%

-0.55%

-0.05%

Germany

-0.68%

-0.58%

-0.12%

0.45%

Ireland

-0.45%

-0.38%

0.33%

1.15%

Source: Bloomberg, October 2016

Warning: Past Performance is not a reliable guide to future performance

Alternative Market Outlook

Alternative thinking key to overcoming modern day investment challenges The phrase ‘patience is a virtue’ is as true in investing as it is in life and in the never ending search for new sources of return and diversification high net worth individuals (HNWIs) are deploying more money to less liquid or private market alternative investments than ever before. These investments include Private Equity, Private Debt and Real Assets.

What is involved in…. Kevin Quinn

Private Equity

Investment Director

Investing in the equity of quality companies, taking them private and creating value through operational improvements.

Private Credit

Lending to quality companies, directly or through mezzanine financing.

Real Assets:

Investing in property, infrastructure and related securities.

Big institutional investors such as the family offices who manage the financial affairs of the world’s wealthiest families have been investing heavily in private market opportunities for years. For most individuals however, investing in private markets is very new and not without its challenges. Private market opportunities can be illiquid, they can be concentrated on one or a small number of opportunities, they can be expensive and you need significant pools of capital to access the best deals to name but a few. However when used appropriately and allocated to in a diversified and risk controlled manner they have the ability to add huge value to investors by accessing unique market segments that cannot be reached through traditional listed investments such as lending to small and midsize companies or rental income from unlisted property. As forward looking returns returns from public markets shrink and investor required returns remain constant the difference between the two will need to be reconciled. People are unlikely to want to work longer to make up the short fall between what they need to retire and what their public market investments are generating in their pension or investment accounts. As a result investors of all types from US endowments like Harvard and Yale to individuals are increasing allocations to alternative investments across the liquidity spectrum. The alternative investment arena is undoubtedly complex however armed with knowledge, sound financial advice and a good investment partner it could significantly benefit investors over the long term.

Property Market Outlook

Global Investment volumes slow, no BREXIT impact so far Global commercial real estate investment sales volumes fell by 19% in Q1 2016 compared to a year earlier. This begs the question - is this a sign of change in the capital markets after five years of steady growth, or a temporary blip induced by global economic jitters?

Paul McKee Senior Property Asset Manager

In our view the first quarter of 2016 was an object lesson in the extent to which the commercial real estate investment market has gone global. Commercial real estate investment activity dropped back in nearly all the world’s major markets (not just in the UK post BREXIT), causing the global aggregate to fall to US$183 billion, down 19% over Q1 2015. Crucially, however, activity in Q1 2016 was only low by the standards set in 2015. Market turnover in Q1 2016 was 3% above the Q1 2014 level and two and a half times that in Q1 2010. There was no single cause for the turnaround in commercial real estate investment. In 2015, there already were signs that investment activity was reaching a plateau. As investment volume growth became more reliant on faster growing economies (such as China for example), growth scares were always likely to pose a potential threat to activity in the global commercial property market. When viewed in this context therefore, the record high for commercial real estate investment turnover in Q4 2015 probably represented the greater anomaly. Turning to Ireland, to date the Brexit referendum result has had no discernible impact on the appetite for Irish commercial property investments. If anything, it has boosted the volume of enquiries for prime real estate with several Euro-denominated funds having increased their capital allocations of late. Pricing remains steady at the beginning of September 2016, although investors are increasingly focussed on core assets, which suggests there may be some softening in pricing for secondary assets. Investors continued to be encouraged by the continued strength of occupational activity in the Irish market as well as the potential for some further rental growth in the medium term.

Warning: Past Performance is not a reliable guide to future performance

Table 4: Bank of Ireland Private Banking Investment View*

Allocation

Scale (1-5)

Comment

Public Equities

4

Long term public equity valuations reasonable relative to history

Government Bonds

2

Yields are extremely low compared to historical norms

Corporate Bonds

3

More attractive than government bonds, selective opportunities in investment grade and Emerging market credit

Liquid Alternatives

4

Absolute return strategies producing cash plus type returns are a good substitute for government bonds

Illiquid Alternatives (Private Markets)

4

Offer potential for strong long term inflation adjusted returns

Property

4

Low interest rate environment favours real assets such as property

Cash

2

Negative rates on Euro zone deposits make cash look unattractive

Source: Bank of Ireland Private Banking, October 2016 *Note: Scale (1: Very unfavourable, 2: Unfavourable, 3:Neutral, 4: Favourable, 5 Very Favourable). This is meant to be illustrative only and reflects our broad asset class views over the meduim to long term. Any changes to a fund's allocations will also take into account other facotrs including the fund's investment objective and its particular investment guidelines.

Warning: Past Performance is not a reliable guide to future performance Warning: These figures are estimates only, they are not a reliable guide to future performance

Warnings and Disclaimers Bank of Ireland Private Banking Limited PO Box 12478 40 Mespil Road, Dublin 4 +353 1 637 8600 Fax: +353 1 637 8631 Dockgate House, Dockgate, Galway +353 91 566 301 Fax: +353 91 565 437 32 South Mall, Cork +353 21 425 1527 Fax: +353 21 425 1539 www.privatebanking.ie

Warning: If you invest in a product you may lose some or all of the money you invest. Warning: The value of investments may go down as well as up. Warning: Past performance is not a reliable guide to future performance. Warning: These figures are estimates only, they are not a guide to future performance. Warning: The investment may be affected by changes in currency exchange rates. Bank of Ireland Private Banking Limited (BOIPBL) believes any information contained in this document to be accurate but BOIPBL does not warrant its accuracy and accepts no responsibility whatsoever for any loss or damage caused by any act or omission made as a result of the information contained in this document. Any investment, trading or hedging decision of a party will be based on their own judgement and not upon any view expressed by BOIPBL. Reference in this document to specific securities should not be construed as a recommendation to buy or sell these securities, but is included for the purposes of illustration only. You should obtain independent professional advice before making any investment decision. Any expression of opinion reflects current opinions of BOIPBL as at July 2016. Any opinion expressed (including estimates and forecasts) may be subject to change without notice. This publication is based on information available as at April 2016 For private circulation only. Not to be reproduced in whole or in part without prior permission. Bank of Ireland Private Banking Limited is regulated by the Central Bank of Ireland. Bank of Ireland Private Banking Limited is a member of Bank of Ireland Group. RC: RC117-16