Schroder ISF Emerging Markets Debt Absolute Return

Third quarter 2014 For professional investors and advisers only

Quarterly Fund Update Schroder ISF Emerging Markets Debt* Absolute Return Cumulative returns to 30 September 2014 (%)

Investment objectives  No losses in any 12 month period

C accumulation shares gross USD returns

 Maximise returns whilst achieving the above

Investment approach 340

 Absolute Return approach based on comprehensive country research

300 260 220

 The investment process follows four types of analysis: Fundamental, Quantitative, Chart and Sentiment

180 140 100 60 20 -20 1997

1999

2001

2003

2005

2007

2009

2011

2013

2015

 Broad investment universe including currencies, local and external debt (sovereign, corporate and convertibles) in over 50 countries  Long-only, no leverage, no complicated derivatives

3M

6M

1 yr

3 yrs

5 yrs

10 yrs

SI

Fund

-1.49

0.18

2.34

8.46

14.03

83.67

311.94

JPM EMBI+

-2.11

3.58

7.84

22.07

43.56

122.72

326.43

JPM ELMI / ELMI+

-3.93

-2.23

-1.86

2.42

4.74

63.51

203.65

Calendar year returns (%) Fund

JPM EMBI+

JPM ELMI / ELMI+**

YTD 2014 2013

1.73

7.16

-1.71

0.92

-8.31

-2.04

2012 2011

5.44

18.04

7.45

0.79

9.20

-5.19

2010 2009

3.01

11.83

5.68

19.72

25.95

11.69

-0.25

-9.70

-3.85

8.32

6.45

16.04

2008 2007 2006

14.60

10.48

12.30

Annual Rate of Return Annual Volatility

9.55

10.81

6.53

6.21

10.25

7.42

Sharpe Ratio Sortino Ratio

1.22

0.89

0.63

2.40

1.13

0.74

 Risk controlled by liquidity based diversification limits, portfolio stop-loss and use of cash

Rationale for allocating  As a low-risk or entry level EMD exposure or combined with standard EMD beta managers  As an Absolute Return strategy, designed to diversify risk and enhance returns

Key fund information Fund manager

Abdallah Guezour + Team

Managed fund since Fund launch date

17 July 2000

Fund size

USD 4,456 million

29 August 1997

Source: Schroders as at 30/09/14

Since Dec 1998 ***

Correlation Positive Quarters

1

0.61

0.59

82.54

74.60

69.84

Maximum Drawdown Best Month

-9.26

-19.71

-19.93

8.84

8.52

5.52

Worst Month

-3.71

-13.79

-8.73

Source: Schroders ** ELMI used until 31/01/02 (index discontinued) *** Dec 1998 – since current team

* Schroder International Selection Fund Emerging Markets Debt is referred to Schroder ISF EMD throughout this document

Schroder ISF Emerging Markets Debt Absolute Return

Third quarter 2014 For professional investors and advisers only

Portfolio positioning 30 September 2014 (%) Country exposure Brazil

Fund weighting

Duration

0.5

14.0

Hungary

1.5

6.6

Mexico

0.9

17.3

Indonesia

0.7

7.4

South Africa

0.9

12.2

Vietnam

0.4

3.0

External Debt

4.9

Brazil^

8.9

6.5

Czech Republic†

1.3

1.3

India

4.1

1.8

Indonesia^

5.5

7.4

Korea†

3.2

0.6

Malaysia†

1.2

0.8

Mexico†

12.0

0.8

Philippines

1.6

0.2

Poland†

4.7

1.2

Serbia

1.2

3.7

South Africa†

2.8

7.9

Thailand†

3.3

2.6

Vietnam

4.5

5.1

Local Debt

54.3

US Treasury Bonds

3.3

G3

3.3

Cash

37.5

37.5

40

30

24.5

22.3

20

8.6

10

3.7

3.3

0 Asia

Europe

Africa/Middle Latin America East

G3

Cash

Fund Summary (%) Yield to Maturity

1.98

USD Exposure Duration (years)

83.5

Average Credit Rating Corporate Bond Exposure

A+

Current Yield No. of Holdings

3.12

2.98 0.9 78

Sector allocation (%) G3 3.3%

Cash 37.5%

Local Debt 54.3%

External Debt 4.9%

Source: Schroders ^ Partially hedged † Fully hedged

Review  The constructive investment stance adopted at the beginning of this year has been tempered during the third quarter as markets started to come under pressure. The Fund scaled back a number of core exposures for risk control reasons. The Investment Team has also adopted a more cautious stance on a number of bond and currency markets for the following reasons: i.

trends in global financial liquidity have become less supportive (see outlook section below);

ii.

developments in countries such as Indonesia and Brazil warranted (temporarily) some caution because of the July Presidential election in Indonesia and the uncertainties ahead of the October Presidential election in Brazil;

iii. further escalation in China’s economic slowdown has been reported with more weakness in the country’s property

market and more evidence of slowing imports demand; iv. poor seasonal trends with market weakness occurring traditionally between the summer months and end of

October before a strong rebound towards the end of the year.

Schroder ISF Emerging Markets Debt Absolute Return

Third quarter 2014 For professional investors and advisers only

 Overall, EM bond and currencies are clearly in the process of transitioning from a period of expansionary US monetary policy to a period of less favourable financial liquidity. The third quarter brought further evidence of the continuing divergence in private credit creation between the US (where loan growth remains firm) and most EM countries (particularly China) where the credit cycle remains in a clear downward phase. The US Dollar appears to be the biggest beneficiary of these diverging credit cycles. The renewed weakness in EM currencies should be viewed within this context.  Another key development during the quarter is the apparent end of the “differentiation” between markets. The weakness in currencies has become broad based and has been followed recently by EM bond yields creeping higher (with the potential to accelerate) and this, in turn, is also starting to affect credit spreads and stock markets.  Because of these unfavourable global liquidity conditions, our favourite investments have not been immune. Despite the high yields on offer in Brazilian local bonds and the significant improvement in policy frameworks in countries such as Indonesia and India, these markets have so far failed to perform as we expected. For this reason, we scaled back our exposures in September but with the view to reinstate these positions in the next few weeks.  This increase in cash during the quarter under review puts the Fund in a good position to re-invest at even more attractive valuations in countries where politics as well as macro-economic fundamentals have already started to improve (see outlook section below).

Investment Outlook Global  Although the Federal Reserve is in the process of terminating its asset purchases programme, the recovery in US commercial bank lending remains remarkably resilient. This dichotomy between recovering US private credit growth and weakening official money creation should continue to provide a strong support for the US Dollar. This, in turn, has a negative impact on global financial liquidity.  Deteriorating global financial liquidity could sooner rather than later lead to a major market scare. China, where the credit cycle remains the most overextended, is likely to be the epicentre of this potential crisis (see below). Intensifying deflationary forces emanating from China could accelerate the recent weakness in EM currencies (with some potentially at risk of overshooting) and could also lead to an abrupt re-pricing in EM credit markets (corporate spreads). However, this is also likely to provide a cap for yields of high quality government bonds.  Emerging Markets are clearly facing the double whammy of headwinds from tighter US monetary policy and China’s deteriorating growth trajectory. Selected EM countries (e.g. Brazil, India and Indonesia) appear to be doing enough in terms of policymaking in order to muddle through. These countries have already witnessed substantial exchange rate adjustments, tighter monetary policies and improvements in their reform prospects.  Within this context, the Fund will maintain an overall defensive stance and will focus on selected investment opportunities in EM Government Debt markets with a particular preference for local bonds in Brazil, Indonesia, India, Vietnam and South Africa. These markets should be supported by their improved valuations and by the policies which have been initiated recently with a target to cure the inflationary and the balance of payments pressures which appeared 12-24 months ago. We also stand ready to seize good buying opportunities which are likely to emerge in currency markets. In this regard, we are looking for convincing evidence that the ongoing broad based trend of exchange rate depreciations has run its course in order to reinstate core currency exposures at more attractive valuation levels (see below).

Asia  The outlook for Asian assets will remain clouded by the escalating pressures on China’s credit system. Recent episodes of “mini stimulus” have not stabilised the property market, as both prices and transactions are now falling on a broad basis nationwide. The recent surge in foreign funding by domestic banks is starting to fade, which is likely to impact negatively an already fragile domestic liquidity environment. Unfortunately, little has been done to promote a cleansing of the financial system. The political reform clock has even been turned back as evidenced by the recent street protests in Hong Kong. We maintain our view that an economic crisis in China remains a distinct possibility within the next year.  With this deteriorating growth outlook in the region, the key question is whether monetary authorities in countries with the most vulnerable balance of payments and highest policy rates (India and Indonesia) will soon earn the right to relax monetary policy? We believe so.  Both India and Indonesia have recently elected leaders who have good credentials in governance and in reforms. We believe that this political shift will soon be rewarded by easier domestic monetary conditions, particularly given the abating inflationary pressures and the more manageable trade deficits. Therefore, the clearest opportunities for high returns in Asian fixed income remain in the local currency bonds of Indonesia and India. These markets are expected to provide returns in excess of 10% p.a., in US$ terms, in the next 12-24 months. The same could be said about local bonds in Vietnam but here the upside potential has now been reduced by the recent collapse in yields, which we have used to take some profits.

Schroder ISF Emerging Markets Debt Absolute Return

Third quarter 2014 For professional investors and advisers only

 We returned from our recent research tour of SE Asia with a cautious view on Thailand and Malaysia because of the prevailing poor political dynamics. Elsewhere, caution is also warranted because of the low yields on offer and the fact that the current level of currencies has yet to reflect the rapid weakening in Chinese import demand.

Eastern Europe, Middle East and Africa  Policymakers in Central Europe will continue their attempts to revive growth by maintaining ultra lax monetary policies. Despite the significant improvements in the balance of payments, subdued growth and the lack of interest rate support are detrimental for regional currencies. We remain on the sidelines for now but we stand ready to reinstate exposures to selected currencies (Polish Zloty and Hungarian Forint) when we have convincing evidence that the recent depreciation trend has run its course.  At present, the investment climate in the region remains also affected by the lingering conflict in Eastern Ukraine. Despite the recent ceasefire agreement, Russian authorities continue to apply pressure on Ukraine through various channels such as trade, gas deliveries and accelerated debt repayments. The West is likely to maintain economic sanctions, which are now starting to impact the Russian economy more seriously with higher inflation, declining foreign investment and accelerating capital flight. Therefore, the Fund will continue to avoid Russian and Ukrainian assets until a more credible framework for the resolution of this crisis has been found.  Turkey’s economic rebalancing has recently progressed but this process remains incomplete as the country continues to be highly reliant on short-term capital inflows. For now, the gradual weakening of the Lira serves as a shock absorber but an overshoot (with serious ramifications on bond yields and on credit spreads) remains possible. South Africa’s macro-economic imbalances are also large but this has already been reflected in the historically high bond yields and in the large depreciation (-30% from peak) of the Rand real effective exchange rate.  The recent military intervention of a large coalition of Western and Arab countries against radical Islamist militants in Iraq and in Syria may limit the progress of ISIS. However, the region remains at risk of more serious civil wars because of the continued lack of a democratisation process in the Middle-East, the absence of a conflicts resolution framework and the gradual decomposition of states such as Iraq and Syria.

Latin America  A strong Dollar, weak commodity prices and political uncertainties ahead of the October presidential elections have created the conditions for a perfect storm for Brazilian assets. For this reason, long-dated Brazilian local bond yields remain stubbornly high at 12%. We remain of the view that once the election has passed, the new administration is likely to follow a more conservative fiscal path. Therefore the policy should witness in 2015 a switch to “tighter fiscal and easier monetary” mix. We stand ready to gradually reinstate the Fund’s exposure to Brazilian bonds to a target of 15% of NAV once we have more evidence that this more bond friendly policy mix is starting to occur.  We remain fundamentally bullish on the Mexican Peso. Unfortunately, this currency is suffering at present from the unfavourable environment highlighted in the “Global” section above. The ongoing cheapening of the Peso will likely be used to reinstate exposure as we continue to believe that Mexico’s ambitious reform programme is in the process of stepping up the country’s long-term growth trajectory.  We continue to avoid Andean countries on account of unappealing valuations (low bond yields, low credit spreads and unattractive real effective exchange rates). These countries are also extremely vulnerable to further slowdown in demand from China.  Sovereign credit spreads in Argentina and Venezuela are perhaps more appealing but both countries remain unfortunately at risk of a disorderly default. In the absence of a leadership change in these countries, a dangerous mix of populism, stagflation and capital flight could lead to an economic collapse particularly now that global liquidity is tightening and commodity prices are trending weaker.

Quantitative Analysis  Despite recent US Dollar strength, which has led to some deterioration in US competitiveness, our Quantitative Model shows that the country risk score for the US remains firmly positive. The US economy is supported by improving “Growth Dynamics” and by a clear upturn in the “Credit Cycle”. Developed and Emerging European countries (nearly without exception) have maintained the improvements achieved over the course of the last 2 years which resulted from the adjustments in external accounts as well as from the lower reliance on foreign funding.  In Asia, South Korea, the Philippines, Taiwan and Malaysia continue to achieve positive country risk scores. India, Indonesia, Thailand and Vietnam still have negative scores but these are gradually recovering from the “crisis levels” they have each reached at different points in time during the course of the last 1- 4 years. In contrast, China remains the country where vulnerabilities have reached a point of no return on account of the overextended credit cycle, rapidly deteriorating competitiveness and weaker balance of payments indicators.  In Latin America, the Quantitative Model highlights the weakening growth combined with the increasing current account deficits as the most serious vulnerability for all countries in the region. Country risk scores for Mexico and Brazil are out of the danger zones recently reached thanks to strong “Sovereign External Liquidity” and to improved competitiveness (following the currency depreciations of recent months).

Schroder ISF Emerging Markets Debt Absolute Return

Third quarter 2014 For professional investors and advisers only

 Elsewhere, tentative signs of “re-balancing” in Turkey and South Africa are still highlighted by the Model. These adjustments are still too small to avert an external liquidity crisis for Turkey. In the case of South Africa, external vulnerabilities are shown to be more manageable.  Our Valuation Models show that despite the recent price falls, EM bonds and currencies have yet to reach compelling valuations. Exceptions are the exchange rates of Hungary, Russia, Taiwan, South Africa and local bonds in Russia and South Africa. In the External Debt sector, issuers with attractive valuations are: Argentina, Pakistan, Croatia, Greece, Russia, Egypt and Ivory Coast. Finally, Stock Markets valuations have broadly become less appealing. Stock markets in Korea, Taiwan, Czech Republic, Greece, Hungary, Russia and Egypt are still scored attractively from a macro valuation standpoint.

Chart Analysis  Long-dated Developed bond markets have so far failed to break out of the multi decade long-term downtrend in yield. However, the short-end of the US curve is now bearish with 2 and 5-year yields breaking higher. For this reason, the rebound from the 2013 decline in long-dated US treasury prices may have run its course. We need to see the US 30year yield break below 3.05% for us to reaffirm our bullish view (adopted at the beginning of the year but recently tempered). Until then, we remain “Neutral”.  Last quarter, Pattern Analysis suggested the move lower in EM External Debt yields may be coming to an end. This bearish pattern in formation is now corroborated by Momentum indicators, which have recently turned negative. Overall, EMBI+ yields are completing the “right shoulder” of a long-term reversal pattern which would be confirmed by a break above 6.65%. When this level is broken, a spike in yield towards a target of 8.7% is likely. EM Corporate Bonds exhibit similar negative readings.  The outlook for Local Emerging Market Debt has deteriorated with the exceptions of Vietnam, Korea and India which remain positive. For low yielding EM local bonds, chart readings are broadly in line with our assessment for US treasuries (see above). We downgraded the technical outlook for Brazil from “Bullish” to “Neutral” as the weekly MACD for yields has crossed higher. For Indonesia, we retain our “Neutral” stance on yields with 9-9.20% for 10-year remaining a key level that, if broken, would turn the outlook decisively bearish.  In contrast to last quarter, Emerging Market and G3 currencies are expected to weaken against the US Dollar and in many cases the moves could be impulsive. If Indonesia Rupiah breaks above $/IDR 12,300, a move to $/Idr 16,000 is likely. The Philippine Peso appears on the verge of starting a 3rd wave (impulsive decline against the $US).The same could be said about Taiwanese and Singapore Dollars, which are breaking out of 3 year ranges. Regarding Brazilian Real, a convincing break above $US/BRL level of 2.45 could lead to an acceleration with to a target of $US/BRL 3.

Sentiment Analysis  At the beginning of this year, investors’ bearishness towards bond markets was at an extreme. Our Sentiment indicators show that this is no longer the case. It appears that predominating talks about European deflation and the concomitant recent fall in yields have led to a more constructive view amongst investors towards bonds. While this warrants some caution, the Consensus Forecast Model (CFM) still shows that yields are overwhelmingly expected to rise by investors (in a 12-month horizon) in nearly all the 25 markets covered by our data series. This continues to be supportive for investments in bonds from a “contrarian investing” standpoint.  The recovery in flows to EM bonds initiated in April 2014 has continued but it has lost some momentum in recent weeks. This recovery has been more robust for EM External Debt and less so for EM Local Debt. The next few weeks are likely to be crucial as any renewed outflows (which may occur as a result of the recent increase in volatility) could turn the Sentiment outlook bearish for the asset class. For now, we retain a broadly constructive view on EM bonds. This stance is supported by the fact that the CFM maintains buy signals for the majority of EM local fixed income markets. Exceptions are Turkey, Poland and Czech Republic.  As the “hunt for yield” continues, investors remain overinvested in corporate bond markets. In this regard, the EM Corporate universe, where a combination of poor liquidity and proliferation of “carry trades”, could sooner rather than later lead to an abrupt re-pricing.  Sentiment Analysis has turned more US Dollar positive this quarter with our monitoring of surveys of investors’ positioning turning negative for Developed currencies. Regarding EM exchange rates, many have given a negative “Sell” signal based on the CFM readings. The Indian Rupee and the Brazilian Real are particularly vulnerable because of heavy positioning. In contrast, currencies in Poland, Hungary and South Africa have seen reduction in exposures by investors and “Buy signals” from our Sentiment indicators could occur in the period immediately ahead.

Monitoring of Opinions of Great Investors  Most of the great investors (Gurus) we monitor are highlighting that the global economy is experiencing renewed weakness. Marc Faber reported that Asian economies are in a broad based slowdown while Felix Zulauf continues to warn against the deflationary forces emanating from Europe and from China. Zulauf believes that the Chinese will have no choice but to devalue the Yuan significantly, by 10% or even 25%, which will be negative for many commodities and other asset prices.

Schroder ISF Emerging Markets Debt Absolute Return

Third quarter 2014 For professional investors and advisers only

 Guru investors remain broadly cautious towards most assets as they remain of the view that markets are mispriced because of continued “monetary manipulation”. Geopolitics is a concern for Seth Klarman who states: “complacent investors continue to ignore a growing array of global trouble spots”.  A number of guru investors downplay the US recovery but still expect the US Dollar to strengthen against both Emerging and Developed markets. Nearly all agree that Central Banks will maintain easy monetary policies and will even resort to renewed money printing as economic and market conditions deteriorate further. Zulauf and others believe gold will become very attractive again but still see downside risks for now. Abdallah Guezour / Geoff Blanning / Guillermo Besaccia / Nick Brown / Malcolm Melville – 3 October 2014

Important Information This document does not constitute an offer to anyone, or a solicitation by anyone, to subscribe for shares of Schroder International Selection Fund (the “Company”). Nothing in this document should be construed as advice and is therefore not a recommendation to buy or sell shares. Subscriptions for shares of the Company can only be made on the basis of its latest Key Investor Information Document and prospectus, together with the latest audited annual report (and subsequent unaudited semi-annual report, if published), copies of which can be obtained, free of charge, from Schroder Investment Management (Luxembourg) S.A. An investment in the Company entails risks, which are fully described in the prospectus. Past performance is not a reliable indicator of future results, prices of shares and the income from them may fall as well as rise and investors may not get the amount originally invested. Schroders has expressed its own views and opinions in this document and these may change. This document is issued by Schroder Investment Management Ltd., 31, Gresham Street, EC2V 7QA, who is authorised and regulated by the Financial Conduct Authority. For your security, all telephone calls are recorded. Risk Considerations The capital is not guaranteed. In order to access restricted markets, the fund may invest in structured products. Should the counterparty default, the value of these structured products may be nil. Non-investment grade securities will generally pay higher yields than more highly rated securities but will be subject to greater market, credit and default risk. A security issuer may not be able to meet its obligations to make timely payments of interest and principal. This will affect the credit rating of those securities. Investments in money market instruments and deposits with financial institutions may be subject to price fluctuation or default by the issuer. Some of the amounts deposited may not be returned to the fund. Currency derivative instruments are subject to the default risk of the counterparty. The unrealised gain and some of the desired market exposure may be lost. Investments denominated in a currency other than that of the share-class may not be hedged. The market movements between those currencies will impact the share-class. Investment in bonds and other debt instruments including related derivatives is subject to interest rate risk. The value of the fund may go down if interest rate rise and vice versa. Emerging markets will generally be subject to greater political, legal, counterparty and operational risk.