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SchrodersInvestment Outlooks 2015

Schroders Investment Outlooks 2015 brings together the views of Schroders’ global experts as they share their thoughts on the coming 12 months.

We hope that these outlooks will provide an informative snapshot of what to expect in 2015 and beyond.

For more articles, please visit the dedicated website, Schroders TalkingPoint www.schroderstalkingpoint.com.

Welcome toSchroders Investment Outlooks 2015

01 2015: Asian Bonds Rajeev De Mello Head of Asian Fixed Income 2

02 2015: Asian ex Japan Equities Robin Parbrook Head of Asian ex Japan Equities 4

03 2015: Business Cycle (European Equities) Steve Cordell European Equities Fund Manager 6

04 2015: Business Cycle (UK) Matt Hudson Head of Business Cycle equity team 8

05 2015: Chinese Equities Louisa Lo Head of Greater China Equities 10

06 2015: Convertible Bonds Martin Kuehle Investment Director Convertible Bonds 12

07 2015: Emerging Markets Debt Relative James Barrineau Co-head Emerging Markets Debt Relative 14

08 2015: European Equities Rory Bateman Head of UK and European Equities 16

09 2015: Global Bonds Bob Jolly Head of Global Macro 18

10 2015: Global Equities Alex Tedder Head of Global Equities 20

11 2015: Global Property Securities Tom Walker and Hugo Machin Co-Managers – Global Property Securities 22

12 2015: Japanese Equities Shogo Maeda Head of Japanese Equities 24

13 2015: Multi-Asset Investments Johanna Kyrklund Head of Multi-Asset Investments 26

14 2015: Multi-Manager Marcus Brookes Head of Multi-Manager Team and Robin McDonald Fund Manager 28

15 2015: UK Commercial Real Estate Duncan Owen Head of Real Estate 30

16 2015: UK Corporate Bonds Alix Stewart Fund Manager – Fixed Income 32

17 2015: UK Equities Philip Matthews UK Equity Fund Manager 34

18 2015: US Multi-Sector Fixed Income Andy Chorlton Head of US Multi-Sector Fixed Income 36

19 2015: Emerging Market Equities Allan Conway Head of Emerging Market Equities 38

Contents

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– Cyclical and structural factors will likely support Asian bonds and currencies in 2015

– Lower oil prices should be positive for emerging Asia on a number of measures given that the region is a net importer of energy

– Moderate global growth and low inflation mean that Asian corporate bonds should continue to offer a substantial yield advantage to similarly-rated peers in the US and Europe.

A slow, drawn-out global recovery with low commodity prices and inflation should continue to be positive for Asia. As a region with strong domestic growth, Asia remains a beneficiary from easy global monetary policies.

Both subdued growth and benign inflation in developed markets are likely to keep bond yields low, pushing investors to seek out higher-yielding assets. However, exporters need some buoyancy from their markets so Asian countries will be expected to benefit as better growth in the US, Europe and Japan materialises in 2015.

As a voracious user of energy to power growth, lower oil prices will be a strong positive for Asia. To produce each unit of GDP, the region will need energy to power its vital manufacturing base and get its goods to developed markets. With a dearth of their own resources compared to other emerging markets, most Asian countries are in fact large energy importers. Therefore, the slump in oil prices will cut trade deficits, limit inflation and, in a region which still favours subsidies for fuel and fertilizer use, also translate into lower fiscal deficits. All this means that central banks in the region are unlikely to increase policy rates as inflation continues to ease, thereby supporting Asian bonds.

Asia still attractive on structural basisIn a world dominated by weakening demographics, excess savings and insufficient demand, emerging countries in Asia could offer higher potential returns on investment. One of the main concerns in Europe, Japan and parts of developed Asia is the contraction of structural demand due to an ageing population. In stagnant or shrinking economies, companies will be more hesitant to invest but population growth is still largely positive in emerging markets. A rising middle class and a booming younger generation of consumers encourages more investment as companies have a brighter long-term outlook on growth. This is in stark contrast to certain developed markets, where ageing populations need the higher returns from investment to pay for their retiring workers.

Both cyclical and structural factors are positive for global investment in Asia, albeit with headwinds that can impact the timing of interest. When US Federal Reserve (Fed) interest rate rises eventually start, there is the risk that the US dollar appreciates and attracts capital flows back to the US. The current widespread belief is that the Fed will make its first move between June and October. Yet low inflation and a tepid recovery will keep it cautious in the timing of its exit and the speed of the policy rate normalisation. Some Asian countries have already preempted this move. India and Indonesia have acted to tighten monetary and fiscal policies ahead of any rate rise. Meanwhile other countries (Hong Kong and Singapore), which have been unable to hike rates due to their monetary policy links with the US, would benefit from additional policy flexibility.

“ The slump in oil prices will cut trade deficits, limit inflation and, in a region which still favours subsidies for fuel and fertilizer use, also translate into lower fiscal deficits.”

Outlook 2015:Asian Bonds

Rajeev De Mello, Head of Asian Fixed Income

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Headwinds and opportunitiesAnother potential hurdle for the region is the weaker Japanese yen. This has weighed on the currencies of countries which compete with the Japanese export juggernaut. Particularly hard hit have been Korea and Taiwan, both of which have expressed concern and seen their currencies weaken. However, our view is that the yen is now very cheap on a number of fundamental currency valuation measures. The strength of Korean trade surpluses shows that Korean exporters remain very competitive.

Furthermore, accommodative central banks and gradual growth should support Asian corporate bonds. While issuance has been strong, Asian corporates offer a substantial yield advantage to similarly-rated issuers in Europe and the US. This combination of moderate growth and low inflation should keep default rates in check in the region. As mentioned above, this all points to a broadly supportive environment for Asian bonds and currencies. Bonds can provide an astute diversifier to equities, and yields from Asian bonds continue to be significantly higher than those in developed markets.

Outlook 2015: Asian Bonds

“ In a world dominated by weakening demographics, excess savings and insufficient demand, emerging countries in Asia could offer higher potential returns on investment.”

Rajeev De Mello, Head of Asian Fixed Income

Rajeev joined Schroders in July 2011 and is based in Singapore. He previously worked at Western Asset Management as Senior Investment Officer, Country Head of Singapore, and member of the Global Investment Strategy Committee. Prior to that, he was Head of Asian Fixed Income at Pictet Asset Management. Until 2005, he was Head of Fixed Income with specific responsibilities for European bonds and Global bonds. He started his investment career in 1987 and has a Bachelor of Science in Economics (Hons), London School of Economics and an MBA from Georgetown University.

The views and opinions contained herein are those of Rajeev De Mello and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

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– After a strong credit cycle across the region, we face the hangover. Countries most dependent on Chinese growth look most vulnerable

– Valuations in Asia are high. There have been few economic/structural reforms to improve the business environment and corporate governance is generally poor in emerging Asia

– Preferred areas for investment are globally competitive industrials, select technology names, ASEAN and Indian retail banks, healthcare, and Hong Kong and Singapore property. Asian consumer and internet stocks are generally overbought and overvalued.

At the beginning of 2014 brokers in unison were recommending clients to buy North Asian markets (China and Korea) over Southeast Asian markets. We learnt long ago not to follow such market advice, and felt that given the generally superior quality of companies in Southeast Asia, these recommendations should be completely ignored. Sure enough Thailand, Indonesia, the Philippines and India have significantly outperformed Korea and China in 2014.

The point is that making money on Asian stockmarkets requires skilled investing in quality companies providing consistent shareholder returns, including dividends, trading at sensible valuations.

This means ignoring as much as possible a lot of noise around politics and macro-economic data, which can often be used to encourage poor investment decisions. Given the slowing global growth picture, a strong credit cycle in China and across the region, and high valuations for decent companies, we are sanguine about the outlook for Asian markets in 2015. Longer term, we believe the region continues to hold many significant advantages. Let us start by considering a structural factor that does worry us, as opposed to GDP statistics.

Technological change in Asia In a fast-changing world where technology and the ‘digitisation’ of economies are becoming more commonplace, businesses around the world will have to adapt. Asia is no exception. The vertiginous drop in the cost of processing power, combined with the rise of ‘intelligent machines’, means many current jobs may become redundant.

For a region that has traditionally been seen as both a source of cheap labour for manufacturing and having a young and rising middle class, the implications will be wide-reaching. Machines are increasingly replacing workers as industrial robots continue to simultaneously tumble in price and advance in intelligence. Decisions on where to locate manufacturing hubs are now based on proximity to the end market and where legal, tax, red tape and finance costs are most favourable. Asia (bar Hong Kong and Singapore) does not do well when it comes to ease of doing business. The days of Asia as the cheap workshop of the world are not sustainable.

Outlook 2015:Asian ex Japan Equities

Robin Parbrook, Head of Asian ex Japan Equities

“ In a fast-changing world where technology and the ‘digitisation’ of economies are becoming more commonplace, businesses the world over will have to adapt. Asia is no exception.”

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As a result of this, growth rates in Asia will likely disappoint over the coming years. Sluggish investment and cautious consumers will mean that growth rates will be slower than historic levels. What does this mean for investors? We are cautious about overpaying for Asian consumer names, with many still trading on extremely high premiums. In addition to this, we are also wary of traditional labour-intensive manufacturing businesses and commodity-intensive industries.

Where are the current opportunities in Asia? There are markets in Asia where the interests of minority shareholders are upheld and this is why we continue to favour listed companies in the likes of Australia, Hong Kong and Singapore and parts of Southeast Asia. These markets offer established franchises with professional management, strong balance sheets and cash flows, along with broader regional exposure. Our preferred areas for investment are globally competitive Asian industrial companies, select technology names, ASEAN and Indian retail banks, healthcare and some cheap Hong Kong and Singapore property companies. Asian consumer and internet stocks are generally overbought and overvalued.

With disruptive technologies impacting businesses everywhere, this means that, as always, it is imperative to invest in companies based on their individual merits and current share price, amidst an increasingly uncertain world. On this basis, we believe Asia continues to provide many strong investment opportunities.

Robin Parbrook, Head of Asian ex Japan Equities

Robin Parbrook has 23 years’ experience covering Asia, all of it with Schroders. Robin is currently the Head of Asia ex Japan Equities and also a regional and alternatives fund manager, based in Hong Kong. In 2008 he moved to Edinburgh to focus on managing Asian investment strategies with a focus on absolute returns, and returned to Hong Kong in August 2010 to continue to manage Asian Total Return as well as other Asian equity strategies. In his career he has successfully managed a range of Asian funds.

Outlook 2015: Asian ex Japan Equities

The views and opinions contained herein are those of Robin Parbrook and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

“ Our preferred areas for investment are globally competitive Asian industrial companies, select technology names, ASEAN and Indian retail banks, healthcare and some cheap Hong Kong and Singapore property companies.”

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– Quantitative easing remains a possibility in Europe

– Germany needs to stimulate internal demand and step up infrastructure spending

– The banks and telecoms sectors offer interesting investment opportunities.

The European economy is facing some weakness as we head into 2015. Recent macroeconomic data has indicated a slowdown across the eurozone and notably this is now extending to Germany, usually the region’s economic powerhouse. The third quarter GDP figures confirmed that recession has been avoided but the environment remains one of low growth.

Quantitative easing remains on the agendaThe European Central Bank (ECB) has taken measures to ease monetary policy. The steps taken recently – including the introduction of a negative deposit rate and the programme to buy asset backed securities – should provide a supportive environment for eurozone equities. The measures have resulted in a weaker euro, which could lead to positive earnings momentum in 2015. There may well be more unconventional measures yet to come in the form of QE, and certainly Mario Draghi has reinforced the impression that the ECB’s balance sheet will be expanded by €1 trillion.

Another important step taken by the ECB was the Asset Quality Review of the region’s banks. This showed that the banking system in the eurozone is now stabilised. With pressure on banks’ balance sheets easing, they can return their focus to the core activity of lending in order to support much-needed business investment and economic growth. Questions remain over whether the demand is there but the latest survey from the ECB indicates that overall demand for credit is picking up slowly.

Germany to stimulate demand in Europe?We would also highlight that the recent weakness witnessed in the German economy has potentially positive implications in terms of eventually stimulating demand within the eurozone. In our view, Germany’s recent weakness has been due partly to the tensions with Russia, which calls into question the sustainability of German industrialists relying on Eastern Europe for their growth. It has also partly been due to the economic slowdown in China. Germany therefore needs to try to rebalance its economy and stimulate demand both from within its own borders and from within the eurozone. Certainly, this will require a change of attitude and may take some time. Also, the German government needs to invest, particularly in domestic infrastructure, where it has underinvested for many years.

Banks and telecoms offer opportunitiesIn terms of areas of the market that could do well in the coming year we have already touched on the banking sector. The ECB is incentivising banks to lend via the Targeted Long-Term Repo Operations (TLTROs). With banks able to borrow from the ECB at ultra-low rates, the margins they can make on new loans will have a substantial positive impact on profits. The recovery of the real estate market in some parts of Europe is another factor that could help support the banks.

Outlook 2015:Business Cycle (European Equities)

Steve Cordell, European Equities Fund Manager

“ Overall we view the current situation as a good time to buy European equities.”

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The telecoms sector also looks attractive to us. Regulatory pressures have hurt returns amid the clampdown on roaming charges and mobile termination rates. That tough environment is now changing as regulators have turned their attention towards encouraging operators to invest, particularly in broadband. Some Scandinavian countries have already made this investment and operators have seen their revenues rise as a result. There is scope for this trend to be repeated across the rest of Europe.

Meanwhile, the precipitous fall in the oil price should provide a boost for corporate earnings in general as input costs come down. It is also good news for consumers and should increase spending power over the all-important Christmas period. We therefore see opportunities within the consumer cyclicals area of the market, such as leisure and tourism.

Good opportunity to buy European equitiesOverall we view the current situation as a good time to buy European equities. We would highlight the opportunity potentially on offer if the ECB does embark on a full-blown programme of QE, as many think it will. Government bond prices are currently high in Europe and yields are correspondingly ultra-low. QE would offer existing bond investors a good opportunity to sell their bonds to the central bank and use the proceeds to invest in the equity market.

Steve Cordell, European Equities Fund Manager

Steve moved across to Schroders as part of the takeover of Cazenove Capital in July 2013, having originally joined Cazenove Capital in 2002. Steve is a senior member of the Pan-European equity team at Schroders. Previously he was at HSBC Asset Management (Europe) Ltd where he was responsible for several retail and institutional Pan-European portfolios. Steve has 20 years of investment experience.

Outlook 2015: Business Cycle (European Equities)

The views and opinions contained herein are those of Steve Cordell and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

“ …the latest survey from the ECB indicates that overall demand for credit is picking up slowly.”

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– UK equities should make upward progress in the year ahead given the backdrop of moderate growth, low interest rates and subdued inflation

– Supportive monetary policy, with analysts and investors expecting continued policy intervention in the eurozone and Japan, should stave off deflation

– We are seeking out those Value defensive and Growth defensive stocks with lower ratings and resilient earnings such as telecoms and pharmaceuticals.

UK equities look attractively valued as an asset class and we believe that a backdrop of moderate growth, low interest rates and subdued inflation should allow further upward progress to be made in the year ahead.

However, a combination of patchy global growth and elevated indebtedness means the business cycle, and in particular peak economic growth levels, will be shallower than in the past. Periods of slower growth, as we have seen lately, will be met with concern on the part of investors and policy makers anxious about a return to recession and financial stress.

Nonetheless, despite this potential volatility, we believe that the potential for a recovery in capital investment and a likely increase in takeover activity are supportive, while the fall in the oil price should help to stimulate economic growth. UK equity investors in particular could stand to benefit in the meantime from a prospective dividend yield of 3.8% and dividend growth of 6–8%.

Deflation fears overdoneSupportive monetary policy, with analysts and investors expecting continued policy intervention in the eurozone and Japan, should help to stave off deflation. Indeed, deflationary fears have driven ‘gilt proxies’ (such as many of the utility companies found within Value Defensives, one of the seven style groupings followed by the Business Cycle equity team – see below), and they are now fully valued for their expected earnings growth and in the main we have limited exposure to this area.

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Source: Thomson Datastream, Schroders, data to 14 November 2014.

Outlook 2015:Business Cycle (UK)

Matt Hudson, Head of Business Cycle equity team

“ A combination of patchy global growth and elevated indebtedness means the business cycle will be shallower than in the past. ”

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Instead, we are seeking out those Value defensive and Growth defensive stocks with lower ratings and resilient earnings such as telecoms and pharmaceuticals. Elsewhere in our portfolios, we see value within the Financials style grouping, including on a selective basis the UK banking sector where we see positive signs of a recovery in the regulatory capital position and an improved focus on core activities and hence ultimately a recovery in shareholder returns as well. The recent weakness in Commodity cyclicals amid falling oil and metals prices should encourage a renewed focus by management teams on reducing capital investment and improving returns on equity, and we continue to monitor these developments carefully.

Low-growth worldWe entered 2014 feeling that it would be a year where the business cycle would start to mature and where economic growth would moderate from prevailing high levels. This has turned out to be the case, with somewhat patchy economic progress being made throughout the year. In the US and UK, economic performance has been decent with investors now looking ahead to an eventual normalisation of monetary policy. In contrast, the eurozone, Japan and China have experienced growth headwinds. We expect this divergence between the world’s largest economies to continue in the short term.

However, as the Federal Reserve looks to start raising rates at a time when eurozone and Japanese policymakers remain highly accommodative, the gap in GDP growth may well start to narrow. We remain of the view that stubbornly high levels of debt in the system will make for subdued global economic growth in the medium term.

The maturing of the business cycle continues to make us cautious of those early cycle stocks where margins have recovered and where valuations are full. We have already reduced exposure to the Consumer cyclical and Industrial cyclical style groupings which served us well when we came out of the 2008–2009 financial crisis.

Matt Hudson, Head of Business Cycle equity team

Matt was appointed the head of the Business Cycle equity team at Schroders in September and is directly responsible for running UK equity funds. He joined Schroders as part of the Cazenove Capital acquisition in July 2013 and is responsible for research in the banks, construction, mining, utilities and non-life insurance sectors. He has 14 years of investment experience. Prior to Cazenove, Matt worked for AIB Govett Investment Management before which he was a chartered accountant at PWC. He graduated from Cambridge University with a degree in History.

Outlook 2015: Business Cycle (UK)

The views and opinions contained herein are those of Matt Hudson and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

The seven style groupings of the Business Cycle equity team

– Commodity Cyclical Revenues linked either directly or indirectly to a commodity product such as oil, steel, gas, mining or bulk chemicals e.g. BHP Billiton

– Industrial Cyclical Manufacturing capital goods or with revenues linked to industrial production. Includes engineering, aerospace and construction e.g. GKN

– Consumer Cyclical Revenues reliant on consumer spending. Includes retailers, automotives, house builders and leisure e.g. Marks & Spencer

– Financial Revenues depend on interest rate spreads, financial markets and asset valuations. Includes banks, insurers and real estate e.g. Barclays

– Growth Revenues well in excess of GDP but sometimes with a degree of uncertainty or volatility. Includes luxury goods, medical technology and IT e.g. ARM

– Growth Defensive Grow revenues in excess of GDP with low volatility and high visibility. Includes pharmaceuticals and support services e.g. Compass

– Value Defensive Grow revenues at or below GDP with low volatility and high visibility. Includes telecoms, utilities, tobacco, and food retailers e.g. Imperial Tobacco

Source: Schroders.

“UK equity investors in particular could stand to benefit in the meantime from a prospective dividend yield of 3.8% and dividend growth of 6–8%.”

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– Chinese GDP growth can be expected to continue to moderate in 2015 amidst economic rebalancing and an ongoing anti-corruption campaign

– ‘New economy’ companies are generating strong growth as we remain positive on a number of China’s consumer and service-related industries

– Even with a pickup in NPLs and bankruptcies in 2015, we believe the liquidity environment will be kept supportive while the economy gradually deleverages from its past credit excesses.

Chinese GDP growth in 2014 slowed as expected amidst economic rebalancing efforts and an anti-corruption campaign. Going into 2015, growth can be expected to moderate further against a backdrop of continued reforms and a property market slowdown.

A benign liquidity environment with room for interest rate cuts (as we’ve seen recently) and targeted areas of policy support are also likely as China seeks to steer its massive economy away from the after-effects of its credit excesses, but at the same time tries to avoid a financial crisis or destabilisation of the economy and broader society in the process.

The resolve in addressing China’s imminent social and economic challenges is clear – even the Chinese Communist Party and its ruling elite are not spared – the ongoing anti-corruption drive has had a far-reaching impact. All this has led into the recently-concluded Fourth Plenum’s focus on an overhaul of its legal system and rule of law, seeking to provide further legitimacy to the Chinese Communist Party as China liberalises its economy further along its path of restructuring and rebalancing.

Progress on reforms mixedProgress on reforms so far has been mixed, and has been met with varying degrees of cynicism in the market, as well as success. Optimism over Sinopec’s initial state-owned enterprise (SOE) reform plans to bring in external partners for 30% of its marketing business faded when the end-buyers were eventually a group of 25 Chinese investors buying inconsequentially small stakes in the business. However, network infrastructure consolidation under a jointly-held company allowed for more efficient capital expenditure planning and allocation in the telecoms sector. Tariff deregulation and tax reforms have also allowed for more market-oriented pricing to take hold.

Reforms and policies will continue to feature significantly in China, and whilst we remain sceptical of the headline effects of SOE reforms, we can still expect to find select opportunities at the stock level – through evaluating the impact of policies and developments on specific businesses, instead of investing thematically and by sectors without delving into company specific dynamics and fundamentals.

Outlook 2015:Chinese Equities

Louisa Lo, Head of Greater China Equities

“ Reforms and policies will continue to feature significantly in China, and whilst we remain sceptical of the headline effects of SOE reforms, we can still expect to find select opportunities at the stock level.”

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Contrarian ideas look interesting‘New economy’ companies – gaming and e-commerce players to internet and media companies – continue to generate strong growth as China’s internet giants are increasingly dominant, with some even showing strong global ambition. Innovation and new technologies in the services sectors are fundamentally changing how the world goes about its day, from the purchasing behaviour of emerging market middle class consumers to the operations of global and multi-national corporations. Reflecting our positive view on China’s longer-term consumption theme over the past two years in our portfolio strategy, some emphasis has been placed on investing in new economy companies, as well as in consumer and services-related industries including internet, pharmaceuticals and alternative energy.

Conversely, where we are finding value and are perhaps admittedly being contrarian is on retail and consumer plays. The onslaught of competition from e-commerce has left some of the brick-and-mortar retailers very unloved, trading below their asset values and at trough valuations. Within the segment we’ve sought out those that are able to adapt to this fast evolving environment, have strong balance sheets and are now at the end of their cost rationalisation processes. With much of the negatives already priced in, and as market share losses to e-commerce players stabilise and sales growth start to pick up, the coming year might hold potential upside surprises.

Risks from past excesses continue to lurkRisks in the shadow banking system have not subsided. Economic growth has slowed in the wake of economic rebalancing and the anti-corruption campaign, and downward pressures on revenues and margins remain. The property sector continues to weaken outside the top tier cities as lower tier cities try to deal with the glut of supply from the over-investment and construction in recent years; leverage remains high for select property developers. However, the government has been obviously supportive given the sector’s importance to China’s overall economic picture – policies around mortgages for property buyers as well as funding for stronger property developers have been relaxed.

Save for a few headline defaults, loans look like they are being rolled over this year. A pickup in NPL (non-performing loans) and bankruptcies in 2015 are still therefore potentially likely scenarios, although we don’t expect this to lead to a widespread systematic risk event. These risks also imply that the liquidity environment will be kept relatively supportive and selective policy action and support may be provided to steer a gradual deleveraging and adjustment away from the previous credit binge.

Changes are creating opportunitiesLooking into 2015, we continue to find opportunities in insurance and consumption, as well as internet and services, as China tries to shift to a consumption-led economy, and are looking into nuclear energy related companies. Policy and government support will also continue to favour healthcare, environmental protection and clean energy related industries.

Whilst the broader macro and policy-driven environment brings up interesting investment themes and ideas, our focus remains on taking a disciplined approach to active investing and selecting quality businesses with strong fundamentals. As China works through its reform agenda, the initial and obvious opportunities around broader sectors and themes will make way for more discerning stock selection to drive longer-term returns.

Louisa Lo, Head of Greater China Equities

Louisa Lo has 21 years of investment experience, with 18 years at Schroders. She is currently the Deputy Head of Asia ex Japan Equities team and responsible for the overall aspects of the Greater China Equities business, based in Hong Kong. She is a specialist fund manager for Greater China mandates and lead manager of Schroder ISF* Taiwanese Equity. Prior to joining Schroders, she spent three years working as a research analyst with two securities firms, focusing on Asian electronics stocks. She is a CFA charterholder and has a Master’s degree in Applied Finance, Macquarie University.

*Schroder International Selection Fund is referred to as Schroder ISF.

Outlook 2015: Chinese Equities

The views and opinions contained herein are those of Louisa Lo and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

“ Looking into 2015, we continue to find opportunities in insurance and consumption, as well as internet and services, as China tries to shift to a consumption-led economy, and are looking into nuclear energy related companies.”

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– Demand from a large number of institutional investors is likely to remain strong, with bond investors using the interest rate protection of convertible bonds and equity investors continuing to exploit convertibles’ downside protection

– Valuations of convertible bonds are fairly valued to borderline cheap. Generally such a backdrop can be a good time to invest in convertibles

– The primary market in 2014 was very active, and we saw an increasing universe of outstanding convertible bonds. We believe that new issue volumes will remain strong and could even increase in 2015.

Following the return of volatility to equity markets from the summer of 2014 onwards, only two things could soothe the nerves of the Schroders convertible bond team in Zurich: good convertibles and Swiss chocolate. Fortunately we had both in abundance. Now, with attractive valuations and demand remaining strong, what lies ahead for the hybrid asset class?

ECB lagging in liquidity raceCompared to previous recoveries, the current economic improvement from the 2008 recession is still slow and will need longer than usual. Recent US growth data show the diverging trend between the US and Europe, as the Federal Reserve’s (Fed) quantitative easing (QE) clearly caused the US economy to accelerate at a far greater pace than the eurozone. QE drew to a close in the US – at least for the time being – in October 2014.

Elsewhere, we think that the European Central Bank (ECB) will need to pick up the liquidity baton and up its pace in the liquidity race. The Bank of Japan surprised markets on the final trading day in October, with an announcement of vastly increased asset purchases. At the same time, the lower yen will continue to give the Fed yet another good reason to delay introducing any tightening policy.

With the ECB lagging behind in the liquidity race, it has started its Asset Backed Securities purchase programme, but still needs to do more to fulfill Mario Draghi’s Jackson Hole promise of doing even more of ‘whatever it takes’. The low eurozone inflation figures, paired with historic low yields for German bunds, evoke the ghost of ‘Japanisation’. The eurozone needs more than a weaker euro to bring the economy back onto a sustainable growth path. We expect further supportive monetary policy from the central banks in 2015.

We will start the New Year with a clear overweight to equity exposure. A healthy bias towards US IT and biotech will help us to participate from continuing pace of the US economy. At the same time, we have little-to-no exposure to the energy sector.

Equities to guide convertiblesThe main driver of performance for convertible bonds in 2015 will be the equity market. Due to the attached conversion right – which offers investors the chance to switch the bond into equity – a strong equity market is good news for investors in convertibles. However, as a hybrid strategy which combines equity and bond features, convertibles retain a degree of capital protection, which makes them attractive for fixed income investors. Given that both credit and sovereign yields have fallen to historic lows, the

Outlook 2015:Convertible Bonds

Martin Kuehle, Investment Director Convertible Bonds

“ The strategic growth tilt, participation in the equity market via a long-term option, paired with strong credit selection, can provide investors with a good mixture of equity exposure and safety.”

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potential for investors to retain bond-like qualities while potentially benefiting from supportive equity markets can make convertibles a compelling opportunity.

The convertible bond market is niche; it is characterized by high investor demand but can suffer from periodic patches of low new issuance. This can have a significant effect on convertible valuations in certain segments of the market. At a regional level, convertible bond market characteristics can also vary widely. Being aware of these differences is integral to generating outperformance. The US convertible market is by far the biggest, most efficient and over the long-run, the most fairly priced. At the other end of the spectrum, Asia is the smallest, least liquid and on average comes with the highest credit exposure.

Attractive valuationsTo invest successfully in convertibles, therefore, diligent internal research is crucial. Modelling conversion rights and detecting cheapness of convertible bonds is part of our daily work. We will start 2015 with a slight undervaluation of convertible bonds. Implied volatility, the main measure of quantifying convertible value, stands at under 30%, which gives investors a cheap access right to long-running equity market participation. Generally such a backdrop can be a good time to invest in convertibles.

Cheapening of implied volatility in 2014

TRI Global Focus – Implied Volatility Long-term historic average

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Source: Schroders, November 2014.

Active primary marketThe primary market in 2014 was very active, and we saw an increasing universe of outstanding convertible bonds. At Schroders we believe we have the necessary market weight to be an active player in the primary market. With long-term rates in the US starting to rise, we forecast a solid new issue market for 2015. Within the large and most effective US market we expect further growth companies from IT and healthcare coming to the market. We are carefully aware that the equity market rally and the extreme tightening of credit spreads will attract all sorts of companies to come to the market. Hence, 2015 will be a year where bond selection will be crucial.

Volatility to prevailDespite all the market noise created by geopolitics from Ukraine to Iraq, we feel that investors can retain a risk-on bias. We expect equity markets to remain supportive for the start of 2015. In contrast to the start of 2014 when volatility had been low – even too low – we believe that more volatile market conditions will prevail. This should not upset investors after a long rally. In fact, we think that stockmarket setbacks are a healthy part of a long-running bull market and that convertible bonds offer a compelling risk-reward profile. Convertible bond valuations, which have recently fallen, mean that convertibles are fairly priced for the asymmetric return profile they offer (i.e. they maximise upside potential while capping downside risk). The strategic growth tilt, participation in the equity market via a long-term option, paired with strong credit selection, can provide investors with a good mix of equity exposure and safety.

Martin Kuehle, Investment Director Convertible Bonds

Dr. Martin Kuehle started his career as a trainee with Westdeutsche Landesbank in Germany in 1990 and went on to study economics and management at the Universities of Münster in Germany and St. Andrews in Scotland. He graduated from St. Andrews with a Master Degree in Economics (MLitt) and a PhD in Management and Economics. In 2000, he joined Credit Suisse Asset Management in London as a Risk Manager. He went on to head the priority client team of Deutsche Bank’s German and Austrian institutional brokerage clients from 2003 to 2006. From 2007 to 2013, he was a Senior Partner at Fisch Asset Management where he looked after institutional clients in Germany and Austria and acted as a global product manager for the two convertible funds Fisch managed for Schroders. In November 2013 Martin joined Schroders as an Investment Director for convertible bonds. Martin is a Member of the Chartered Institute for Securities and Investments in London and serves on CISI’s national Advisory Committee in Switzerland.

Outlook 2015: Convertible Bonds

The views and opinions contained herein are those of Martin Kuehle and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

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07

– Divergence among the countries that make up the emerging markets sector is set to continue

– Currency depreciation is likely to be a major theme, particularly in countries linked to the euro and those impacted by lower commodity prices

– Reform-minded politicians could significantly improve the outlook for a number of countries.

Though the asset management industry treats emerging markets as a single entity, those countries that comprise the grouping continue to go in different directions, a trend that is almost sure to define 2015. The main drivers of this development - lower commodity prices, divergent monetary policy from major central banks, and differing responses to their regional impacts—show no signs of abating.

Growing divergence to continueThe universe is almost evenly split between countries with positive and negative trends in the terms of trade, current account deficits of more than 3%, and real exchange rates above or below their ten year-averages. So, lower commodity prices will benefit primarily emerging Asia, and hit the rest of the asset class. Even countries normally viewed as being pillars of policy rectitude like Colombia are facing growing current account deficits amidst declining terms of trade. More directly-affected oil producers like Nigeria, Venezuela, and Russia will be under increasing pressure should oil prices stabilize in a low $80 price range. An extended period of triple-digit oil prices led to a ratcheting up of spending that is now under pressure. On the other hand, some countries like Chile and Indonesia which are commonly viewed as major commodity exporters, are actually feeling the benefits of lower oil prices that more than offset the hit from lower prices in commodities which they primarily export.

Currency depreciation likelyEuropean emerging markets directly linked to the euro like Poland, Hungary, and Romania will likely endure an extended period of currency depreciation as the European Central Bank continues its campaign to soften the euro. Asian countries may decide that they need to follow suit, given the sharp depreciation in the yen. In Latin America, lower commodities and the stronger dollar will continue to drive currency depreciation there. In 2014 many EM central banks were able to lower interest rates in response to softer global growth. However, the pressure of lower currency levels will curtail that ability, and should that intensify central banks may be forced to respond with higher rates even with lower growth prospects.

Grounds for optimismAll is not gloomy, however. A big slate of elections in 2014 have given Indonesia and India reform-minded leaders who could turn sentiment more positive if political systems can be bent to their agenda. Even in Brazil, the return of a disappointing incumbent may lead to reforms simply on the back of sheer necessity, as poor fiscal policy led to a complete reliance on monetary policy that has only exacerbated recessionary growth prospects. Argentina will almost certainly see a more market-friendly leader in elections in late 2015.

“ Despite all of its problems, emerging market debt could still produce satisfactory returns when looked at relative to the global fixed income universe.”

James Barrineau, Co-head Emerging Markets Debt Relative

Outlook 2015:Emerging Markets Debt Relative

15

Despite its problems, emerging market debt could still produce satisfactory returns when looked at relative to the global fixed income universe. Most of emerging market debt is investment grade and is trading at average spreads relative to US Treasuries. Yet in a world where German ten-year bunds yield below 1%, European high yield is at about 4%, and US high yield is at about 5% (with a large component at risk in energy issuers), the yields on emerging market debt look attractive.

Non-investment grade dollar bonds are likely to struggle, however. The sovereign universe here is stressed oil producers like Venezuela and Nigeria which are likely to be forced to adjust currency regimes and fiscal policies or face potential crises. Corporate non-investment grade is also heavily exposed to commodities. Corporate issuers with dollar liabilities and local currency revenues are likely to face continued pressure. Local currency investing will continue to be out of favour as the strong dollar story steams along. However, relative to history, currencies are inexpensive and local rates are very attractive relative to developed markets. There will certainly come a time when this combination attracts investors, but this likely requires stabilization in commodities and more clarity on developed market monetary policy endgames.

Outlook 2015: Emerging Markets Debt Relative

“ Relative to history, currencies are inexpensive and local rates are very attractive relative to developed markets.”

James Barrineau, Co-head of Emerging Markets Debt Relative

Jim Barrineau joined Schroders in April 2012 as Co-Head of Emerging Market Debt Relative. Prior to joining Schroders, he worked as a Senior Portfolio Manager-Sovereign from 2010 to 2012 at ICE Canyon, an alternative investment firm specialising in emerging market debt. Jim worked as an emerging market debt and currency strategist for Alliance Bernstein from 1998 to 2010, with primary responsibility for Latin America. From 1996 to 1998, Jim was the Latin American equity strategist at Salomon Smith Barney, and from 1994 to 1996 he was the emerging market debt strategist at the same firm. From 1988 to 1994, he was a senior economist for the US government.

The views and opinions contained herein are those of James Barrineau and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

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– Monetary policy remains loose and QE remains a possibility in the coming months, but governments need to do more to stimulate aggregate demand

– Corporate profitability should improve given the stable economic environment with exporters benefiting from a weaker euro

– European equities remain attractively valued versus their own history, as well as compared to other regions and asset classes.

Europe’s economic recovery has been unpredictable during 2014. It has been our view for some time that the recovery would be protracted and uneven, and the recent data has done little to contradict us. The sluggish macro environment does not mean all is doom and gloom in terms of the outlook for European equities; on the contrary, we see equity market weakness as a buying opportunity.

ECB actions are helping but governments also have a part to playThe main concern facing Europe is that low levels of inflation may turn into deflation. This is not a new issue and we do not believe that the probability of deflation is high. The European Central Bank (ECB) has already taken significant steps to ease credit conditions and boost growth in the eurozone. Some of these measures – such as the purchases of asset backed securities - are only just being implemented so their full impact is yet to be felt. Moreover, we see a high probability that full-scale quantitative easing (QE) could be introduced if deflationary worries in Europe persist. Each of the three QE programmes in the US sparked a period of strong upward momentum for the US equity market and we would expect the response in Europe to be similarly positive for share prices.

That said, ECB President Mario Draghi has made the point on a number of occasions that the central bank cannot do all the heavy lifting on its own. In order to create a sustained economic recovery in Europe, the ECB also needs governments to take appropriate fiscal measures in conjunction with structural reforms in order to stimulate aggregate demand. In our view, Germany’s insistence on balanced budgets is laudable but a more flexible approach is needed to respond to the reality of the economic cycle.

Stage is set for corporate earnings to improveAnother factor that offers a significant opportunity is the scope for earnings improvement in Europe.

12 months forward earnings per share

Outlook 2015:European Equities

Rory Bateman, Head of UK and European Equities

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20

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June1994

June 1991

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Source: Datastream, data to 30 September 2014.

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Profit margins for eurozone businesses still lag far behind their US counterparts and closing the gap could help deliver sizeable share price upside. As well as an improved backdrop in terms of credit conditions, there are other factors that could provide a catalyst for an improvement in profits.

One of the most obvious results so far of the ECB’s looser monetary policy has been the weakening of the euro. The strength of the currency was a major headwind for eurozone equities, particularly exporters, in the early part of 2014. That headwind has now eased and the currency is likely to weaken further, especially with the US Federal Reserve poised to raise interest rates next year. The weaker euro should be a source of positive earnings momentum in 2015.

Banks offer strong recovery potential The banking sector is one important area where we see the potential for significant improvement in terms of profits. Banks have been subject to myriad pressures, most notably with regard to potential recapitalisations. The ECB’s recently-concluded Asset Quality Review has demonstrated that the worst is over from that respect and banks should now have the confidence to return to lending. We would expect European banks to emulate the recovery already seen in the profitability of US banks. As lending growth picks up, our forecasts indicate that banking profitability will escalate quite substantially over the coming three to five years, leading in turn to a significant positive impact on net income.

European banks net income € billion 2007-2017e

Source: Schroders estimates, top 29 listed European banks, as at August 2014.

Europe remains attractively valuedThere is also the impact that fund flows could have in the eurozone. While flows have improved since the nadir of the eurozone crisis, we are still some 40% off the levels reached during 2001-07 so there is still a substantial amount of money on the side-lines that could potentially make its way back into European equities. Moreover, current valuation levels would tend to suggest that European equities remain an attractive area in which to invest. The pan-European market trades on a cyclically-adjusted price-to-earnings ratio of around 16x, compared to the 30-year average of 20.8x and to the US market on around 27x. We feel that represents a very compelling opportunity.

Outlook 2015: European Equities

2007 2008 2009 2010 2011 2012 2013 2014e 2015e 2016e 2017e

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OtherSpain and ItalySwitzerlandGermanyFranceNordicUK

Rory Bateman, Head of UK and European Equities

Rory Bateman joined Schroders in April 2008 and is Head of the UK and European Equity Team. His responsibilities include managing Pan European Equity portfolios, including Schroder ISF European Equity Focus and Schroder ISF European Large Cap, and management of the other portfolio managers and European research analysts. Prior to joining Schroders, Rory spent 12 years at Goldman Sachs Asset Management where he was the portfolio manager for Continental European Equities for eight years. In addition, Rory has 12 years’ experience as an analyst covering numerous sectors across the European market.

The views and opinions contained herein are those of Rory Bateman and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

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– Some of the mechanisms that have driven volatility down are disappearing, but we believe that a rise in volatility is normal, and central to generating outperformance

– However, all but the most liquid asset classes may be difficult to exit in times of market stress, which investors should bear in mind

– We continue to believe that markets in the US and the UK are not reflecting the probability of rate hikes by the middle of 2015.

Volatility in bond markets was conspicuous in its absence through the majority of 2014. Although market commentary was laden with indications of surprise – at the ongoing compression of yields, the degree of policy accommodation or dramatic swings in macroeconomic data – market volatility remained curiously stifled. However, September and October offered something of a reality check. With the Federal Reserve (Fed) ending quantitative easing, as well as resurgent fears over global growth, volatility has made a comeback.

While some investors have viewed this as a cause for concern, we believe that as the monetary policy environment becomes more normal, a natural escalation of volatility from recent lows is to be expected. Furthermore, volatility is central to generating outperformance, and its recent escalation has not significantly altered our expectations for bond markets in 2015.

The US, the UK and what growth means The US economy is growing at a healthy rate, and should continue to strengthen. Stronger employment has fed through to higher levels of consumption, and from here we expect that wage growth should begin to escalate. Inflation and wage growth have remained low in recent prints, given the downward pressure on key inputs like the oil price. However, we expect that lower oil and fuel costs will ultimately prove a boon to consumption, and this will trickle down into rising wages as the Fed’s oft-quoted “underutilisation of labour resources” is used up.

All of this adds up to a well-supported case for a tightening cycle by the Fed. We believe that interest rate markets currently underestimate the probability of rate hikes by mid-2015. We also expect volatility – which has been suppressed by low base rates and quantitative easing (QE) – to begin to close in on higher historic averages over the course of the next year.

In the UK, the period of robust growth momentum appears to be moderating, with the cooling property market and a weaker eurozone likely to dampen economic expansion. Nonetheless, domestic growth is – and will remain – sufficient to continue to close the output gap and tighten the labour market. While there are some structural factors which will curtail the ability of the Bank of England to impose lengthy and severe rate hikes, interest rate markets expect a later and slower hiking cycle than we do.

“ Volatility is central to generating outperformance, and its recent escalation has not significantly altered our expectations for bond markets in 2015.”

Outlook 2015:Global Bonds

Bob Jolly, Head of Global Macro

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The eurozone remains fragile, but markets are more realisticThe problems in Europe’s economy, meanwhile, have grown dire. Confidence has taken a further hit following the slowdown in German data, while regional inflation continues to flirt with the all-important 0% level. The crisis between Russia and Ukraine, as well as China’s softer growth numbers, have taken their toll on German industry. That being said, we believe that markets in Europe are more reflective of current events than either the US or the UK, and that the majority of the economic pessimism has now been priced in.

The announcement of the European Central Bank’s programme of Asset Backed Securities (ABS) and covered bond buying is being treated with scepticism, with few investors confident that the scheme is large enough to make a real impact on the economy. There is growing consensus in markets that sovereign QE will be announced in 2015, although political hurdles remain high. We favour sovereign exposure in the eurozone over US Treasuries, and believe that the spread of southern European sovereign bond yields over German bunds could tighten further when QE is announced. In this scenario, we also expect to see further weakness in the euro.

Emerging markets offer some opportunities, but some hidden dangersWithin the broad emerging market space, our view is that value is challenging to find overall. However, rises in volatility tend to affect emerging economies in more pronounced and varied ways than developed markets. This can give rise to some isolated opportunities in long maturity sovereign debt. The current weakness in commodity prices provides a supportive environment for Asian markets, but has hurt Latin America. There are also some opportunities where central banks have hiked interest rates to support their currencies. However, with local currency bonds, investors need to be mindful of the potential for currency risk in emerging markets, which can cannibalise returns very quickly.

We feel it is important to highlight – given our expectation of higher volatility – that going forward all but the most liquid asset classes will be increasingly difficult to exit during times of market stress, owing to changing bank behaviour and regulation. Care needs to be taken to ensure that portfolio positioning and trade sizes are appropriate to compensate for any periods of diminished liquidity.

Outlook 2015: Global Bonds

“ Going forward, all but the most liquid asset classes will be increasingly difficult to exit during times of market stress.”

Bob Jolly, Head of Global Macro

Bob joined Schroders fixed income team in September 2011, as Head of Global Macro. Prior to joining Schroders, Bob worked for UBS Global Asset Management, where he was Head of Currency, UK Fixed Income and Global Sovereign. Before UBS, Bob spent two years with SEI Investments, developing customised solutions for institutional pension fund clients. The majority of Bob’s investment career was spent at Gartmore Investment Management. He is a CFA charter holder.

The views and opinions contained herein are those of Bob Jolly and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

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– We see 2015 as being characterised by an ongoing divergence in global growth that will create attractive pockets of investment opportunity for stockpickers

– Given lower energy prices, we believe that US consumption has the potential to accelerate, to the benefit of durables and luxury goods-related companies

– In Japan and Europe, ongoing currency weakness is likely to support those companies with a global footprint.

Global equities are likely to paint a mixed picture in 2015, with the extent of economic recovery diverging across regions. While fundamentals remain positive in the US which should help to drive global growth in 2015, uncertainty lingers in Europe, Japan and most of the emerging markets.

Overall, analysts’ expectations currently reflect a lower growth environment in 2015. We believe there could be positive surprises at both the aggregate level regarding global growth and strategic inflows into equities from large asset owners globally, and from a bottom-up stock perspective, albeit in an environment of heightened volatility. We continue to find an abundance of compelling opportunities.

A buoyant US consumerThe US equity market performed well in 2014, with the S&P 500 breaking a number of record highs over the year. In an environment of improving economic growth, companies have been performing well and generating strong earnings growth. We are, however, starting to see earnings momentum slow (see graph below) as companies struggle to maintain levels of strong growth seen over the last couple of years. Market consensus still expects high double-digit earnings growth in 2015, which may be a challenge given a slower growth backdrop and pressure on margins.

Trends in earnings expectations by region

Source: BofA Merrill Lynch Global Quantitative Strategy, MSCI, IBES, as at 31 August 2014.

Outlook 2015:Global Equities

Alex Tedder, Head of Global Equities

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“ India is the only bright spot in [emerging markets] in our view: it has an exciting investment story, with exceptional demographics and a vibrant private sector.”

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However, there are areas which could potentially surprise market expectations to the upside. Discretionary consumption has generally fallen short of expectations in an environment of subdued real income growth and efforts to restore personal balance sheets. However, a tighter jobs market and ongoing weakness in the oil price, amongst other things, boosts consumer purchasing power and should contribute to the potential for an acceleration in discretionary spending. With improving employment prospects and more money to spend, we expect to see US discretionary spending as a percentage of disposal income rise, to the benefit of durables and luxury goods-related companies. We are finding some interesting ideas in this space, particularly amongst the auto-related companies which we believe are likely to gain from a stronger consumer as well as the trend towards greater connectivity and automation in the industry.

It is worth mentioning that we do not expect the consumption recovery story to be derailed by potential interest rate hikes in 2015. Rate rises will likely prompt some volatility, but ultimately we believe the Federal Reserve will ease into a tightening phase slower than many in the marketplace currently expect and that consumption will be robust enough to withstand this.

Tailwinds for some European and Japanese companiesIn contrast to the improvement seen in the US, European and Japanese economic growth has slowed and policy measures implemented to support growth have resulted in weaker currencies. This is good news for companies with a global footprint as they are likely to enjoy a boost to earnings and increased competitiveness in the global marketplace.

We are more constructive about Japanese equities relative to the European market. Japanese Prime Minister Abe’s recent decision to delay the second consumption tax increase will be supportive for the economy and for domestic equity buyers while improved corporate governance is likely to attract more foreign equity buyers. Furthermore, corporate tax cuts over the next few years will boost companies’ earnings. In Europe, companies have managed to post good results but this has largely been on the back of extensive cost-cutting measures while actual revenue growth has been negligible. But overall, the softer European economy is likely to weigh on the market in 2015 and curtail the ability of European companies to generate meaningful earnings growth.

Emerging markets: India the only bright spot The emerging markets are a concern and our earnings outlook for three of the four BRICs is negative. India is the only bright spot in our view: it has an exciting investment story, with exceptional demographics and a vibrant private sector. Although the economy and the market have both done well in 2014, we think they have further to go. The new government’s policy initiatives are encouraging and should benefit domestically-orientated companies, particularly those with exposure to fixed capital formation and financial services. The Indian consumer should also receive a welcome boost from lower energy prices and reduced inflationary pressure.

Diverging global growth creates opportunitiesThere remain, of course, a number of geopolitical risks that could emerge (or re-emerge as the case may be) during the year. We expect this, along with the divergence of global growth and monetary policy action to generate some volatility in 2015. It may not be an easy ride for equities, but we believe this divergence will also create attractive pockets of investment opportunity, to the benefit of stockpickers, and see plenty of scope for earnings surprises in 2015.

Outlook 2015: Global Equities

Alex Tedder, Head of Global Equities

Alex re-joined Schroders in July 2014 as Head of Global Equities, having commenced his investment career at Schroders in 1990, promoting European Equity mandates alongside Schroders’ Private Equity operation. In 1994 he moved to Deutsche Asset Management Ltd, where he worked in various capacities including Managing Director and Head of International Equities / Portfolio Manager. He was lead manager of the Deutsche International Select Equity Fund (MGINX) from inception in May 1995. He also previously served as co-manager of DWS International Fund, DWS Worldwide 2004 Fund, Deutsche Global Select Equity Fund and Dean Witter European Growth Fund. Alex re-joined Schroders from American Century Investments in New York, where he worked from 2006 as Senior Vice President and Senior Portfolio Manager (Global and Non-US Large Cap Strategies). He was lead manager of the American Century International Growth Fund (TWIEX) from July 2006 to March 2014.

The views and opinions contained herein are those of Alex Tedder and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

“ It is worth mentioning that we do not expect the consumption recovery story to be derailed by potential interest rate hikes in 2015.”

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– A shift in asset allocation from very large pension schemes is likely to boost property demand in 2015, while supply levels remain at relative lows

– Global economic growth remains uncertain, and 2015 could reveal either a strengthening or weakening in data. We believe property is well positioned for either eventuality, relative to other asset classes

– Hong Kong continues to be one of the cheapest markets globally; however, the slow progress of the Chinese economy has been a fringe concern for investors for over a year and is now becoming a key issue.

As we head into 2015, we believe that the property sector can offer investors a degree of stability as the global economy struggles to recover.

This has been acknowledged by some of the largest government pension schemes including the world’s largest government scheme, the Japanese Government Pension Investment Fund (GPIF), and Europe’s largest pension fund, the Norwegian Government Pension Fund, which have both increased allocations to real estate by 5%1 . These two allocations alone amount to over US$50 billion of buying power.

A significant amount of the capital allocated to real estate is seeking prime property, including trophy assets, which tend to be held by the listed sector. This is giving listed companies the opportunity to realise gains at stretched valuations and redeploy these gains into new opportunities.

The flood of capital has not, though, boosted supply in many markets. In London – one of the world’s most buoyant real estate markets – the Deloitte Real Estate’s London Office Crane survey states that office space under construction has fallen to a three-year low and office space across central London has been running at below-average levels for five years. We believe that these effects will support the fundamentals of the listed sector in the major global gateway markets through 2015.

Economic news should support propertyThere are two likely economic scenarios we anticipate as we head into 2015. The first is that the global economy weakens which will put pressure on central banks to keep interest rates low and to continue their policies of quantitative easing. Due to its resilient income stream, this is likely to lead to a continued demand for property from investors searching for yield.

On the flipside, a strong economic growth scenario will most likely lead to interest rate rises. As long as these rises are the result of sustainable economic growth, then the property sector should see increased occupier demand as companies look to expand. This in turn will lead to rental growth and should offset any increased borrowing costs property firms may be exposed to. Companies with property in secondary locations may struggle, as occupier demand is likely to be stronger in major cities and prime locations, which are normally held by the larger quality names in the sector.

1 Source: Property Week and Investment & Pensions Europe.

“ A significant amount of the capital allocated to real estate is seeking prime property, including trophy assets, which tend to be held by the listed sector.”

Outlook 2015:Global Property Securities

Tom Walker and Hugo Machin, Co-Managers – Global Property Securities

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Can the US continue its good run?The US listed property sector has delivered over 20% returns so far in 2014, but the key question now is whether there is any more juice left in the tank. Undoubtedly a large number of US property companies are trading at fair value, but we still believe that there is upside potential on a selective basis. Real estate fundamentals remain solid and the initial outlook for 2015 appears to be positive across most major property types. San Francisco, Seattle and New York City continue to experience growth on the back of demand from the tech, media and telecommunications (TMT) sector, which is showing no signs of slowing down. We are also seeing continued demand for office and industrial property in hydrocarbon centres on the back of the fracking boom.

China continues to slow, but Asia still looks relatively cheap.The slow progress of the Chinese economy has been a fringe concern for investors for over a year and is now becoming a key issue. Whilst stimulus measures are in place, there is a headwind of high property supply – some 3 million excess units per annum – that is hurting prices and slowing volumes given that real estate accounts for 10% of GDP. Despite the relaxation of home purchase restrictions in many areas, the fundamentals are still looking weak, with a slowdown in residential sales and economic growth.

Hong Kong continues to be one of the cheapest markets globally. Nonetheless, employment concerns, lower consumption levels and anti-corruption measures in China are feeding into sluggish growth. We cannot see a catalyst for a re-rating of this market in the short term but any positive news from China in 2015 may result in a positive shift in sentiment.

UK surprises for the right reasons whilst the eurozone strugglesIn Europe, a select number of companies continue to surprise to the upside; those with exposure to London offices have seen strong rental growth. We anticipate that this trend will continue as a lack of development finance results in low levels of supply. In our view, the main upside risk in the short term is that the inflow of capital from Asia and the US could trigger a widespread fall in property yields, which could push annualised total returns over 10% per annum for a limited period. The main downside risk is that the sovereign debt crisis could re-ignite if deflation takes hold and governments fail to meet targets to cut their budget deficits.

We will remain keenly focused on companies whose prices do not reflect the risk-adjusted value of their respective businesses. Our view is that this approach will continue to serve our investors well as we head into 2015.

Outlook 2015: Global Property Securities

Tom Walker Co-Manager – Global Property Securities

Tom joined Schroders in July 2014 as a fund manager for Global Property Securities, with over 15 years of real estate experience. Prior to Schroders Tom was deputy head of global listed real estate at AMP Capital from 2005 to 2014 after working with Jones Lang LaSalle for six years. Tom holds a BA in politics from the University of Newcastle-upon-Tyne and a Graduate Diploma in Real Estate from London South Bank University. He holds a MRICS accreditation.

The views and opinions contained herein are those of Tom Walker and Hugo Machin and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

Hugo Machin Co-Manager – Global Property Securities

Hugo joined Schroders in July 2014 as a fund manager for Global Property Securities, with over 15 years of real estate experience. Prior to Schroders Hugo was Head of European listed real estate at AMP Capital from 2006. He has also worked with ING Investment Management in Sydney, and the Welcome Trust. Hugo holds an MSc in Real Estate Finance and Investment from Reading University, and a Diploma in Cross Border Valuation.

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– Strong corporate earnings growth along with continued yen weakness should provide support for Japanese equities in 2015

– Improving corporate governance looks set to make further gains in 2015 with a series of developments aimed at encouraging senior management to enhance governance

– Our bottom-up stockpicking approach continues to focus on sustainable mid- to long-term earnings growth and valuation.

The euphoria in Japanese equities that we witnessed in 2013 was somewhat tempered this year as stock prices in Japan came to terms with a raft of disappointing economic data following a consumption tax increase in April.

The correlation between the Japanese yen’s weakness and rising stock prices continued to drive the market later in the year and the TOPIX index is in positive territory year-to-date. The consumption tax hike in April – which saw an increase from 5% to 8% – contributed to slowing growth, the extent of which became apparent by two consecutive quarters of negative GDP growth (in real terms) for the second and third quarters.

Taxes and electionsThe headline-grabbing news for Japanese stocks came in a flurry of announcements. First, there was late October’s ramp-up in the Bank of Japan’s quantitative easing (QE) programme as it announced plans to significantly increase its purchase of Japanese government bonds (JGBs) as well as risk assets, Japanese equity ETFs and J-REITs (real estate companies). And only a few weeks later Prime Minister Abe announced a postponement to a consumption tax originally planned for October 2015 and called a snap election for December 2014. The 18-month delay of the second consumption tax increase – which will see it go from 8% to 10% – means the rise will be implemented in April 2017 without any further postponement. There was also positive news in October when Japan’s government pension fund, GPIF – the world’s largest of its kind – announced a reduction of its bond portfolio by allocating more positions to Japanese and global equities.

As a result of these developments, the yen has continued on its depreciation trend while the stockmarket received a boost from the end of October in to November.

Resilient economyDespite the recent setback after April’s consumption tax hike, evidenced by an unexpected two negative quarters of GDP growth, we remain positive on the improving trend of Japan’s economy. The tightening labour market continues to suggest constant wage growth, which we think will support the inflationary trend that the Bank of Japan has targeted. Given that the second consumption tax increase has now been postponed we believe the benefits of higher wages over the next two years will start to feed through to the real economy and that this will result in a solid recovery in domestic consumption next year. Furthermore, the country’s listed firms are more resilient than one might assume. Japanese companies are expected to derive more than half of their earnings from overseas operations.

“ Corporate earnings growth is still expanding at a solid pace in Japan, and more importantly we are witnessing landmark advances in corporate governance in Japan.”

Outlook 2015: Japanese Equities

Shogo Maeda, Head of Japanese Equities

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Although global growth is slowing, the trajectory is likely to be one of a modest recovery led by the US over the coming years. And within Japan, we are also seeing an encouraging picture. Corporate earnings continue to improve and corporate capital spending budgets are also being expanded, which should hopefully translate into higher growth in domestic demand.

Upside to corporate earningsAs mentioned previously, corporate earnings growth is still expanding at a solid pace in Japan and there are further drivers that will likely see this trend continue. One is the positive impact of yen weakness, which has not been fully realised in company earnings forecasts. Many exporters are still factoring in an average dollar/yen rate of around 100-105 yen – while the current exchange rate stands at around 118 yen to the greenback.

Further positive news for Japanese companies could come in the form of corporate tax cuts, one of the key initiatives in Abe’s growth strategy. With Japan’s rate among the highest in the world’s developed economies, a reduction in the top rate from the current 35% to less than 30% over a period of a few years could continue to support corporate earnings in the medium term.

More importantly, from a mid to long-term view, we are witnessing landmark advances in corporate governance in Japan. Measures aimed at improving governance include requiring outside directors on company boards, the creation of the JPX400 – an index with quantitative and qualitative criteria, including a higher return-on-equity (ROE) and the enforcement of Japan’s stewardship code. Early 2015 should see continued reform. The Tokyo Stock Exchange will set up a corporate governance code. Reflecting such a development, an increasing number of companies have announced share buybacks to reduce their cash pile and improve ROE. All of the above means that the outlook for Japan Inc. going into 2015 looks encouraging.

Focus on fundamentalsSo where will we be looking for opportunities in 2015? Sustainable mid- to long-term earnings and valuations are what we are focusing on when we look at which companies to invest in. This would preferably come through company-specific growth drivers as opposed to just betting on the cyclical recovery or macroeconomic tailwinds such as only on a weaker yen.

We are finding cyclical stocks including autos, electrics, and some parts of machinery attractive, given their potential for upward revisions to earnings, while being mindful of valuations. We also like trading companies and financial stocks given their cheap valuations. Turnaround opportunities among out-of-favour stocks are also an area where we see additional investment ideas as we go into 2015. As always, we continue to remain disciplined and strictly adhere to our bottom-up stockpicking approach, leveraging our in-house fundamental research platform on the ground.

Outlook 2015: Japanese Equities

“ Sustainable mid- to long-term earnings and valuations are what we are focusing on when we look at which companies to invest in.”

Shogo Maeda, Head of Japanese Equities

Shogo Maeda is Head of Japanese Equities, based in Tokyo, and joined Schroders in January 2006. He has previously worked at Goldman Sachs Asset Management, where he was Head of Japanese Equities, before becoming Managing Director & Chief Investment Officer for Asia Pacific equity fund management. Shogo is a CFA Charterholder and has a Masters in International Affairs from the School of International Affairs, Columbia University. He also has a BA in Economics from Wesleyan University.

The views and opinions contained herein are those of Shogo Maeda and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

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– The US continues to lead the recovery but growth momentum elsewhere is weak. As such, we favour assets that can cope with subdued levels of growth

– Equities performance is likely to remain narrow – we prefer those areas of the market where corporate earnings trends are most well-established

– The outlook appears tough for commodities although there could be opportunities after recent steep price falls.

In recent years we have danced to the central bankers’ tune. With rates pinned at 0% we correctly judged that the path of least resistance, for developed equities in particular, was up. As we move into 2015, however, it might be time to sit some of the dances out.

Seeking assets that can withstand low growthThe desynchronised nature of the global economic recovery is to some extent good news: firstly, potential inflationary pressures in the US are being suppressed by economic weakness elsewhere; secondly, a strengthening US dollar is allowing other economies to ‘borrow’ some of America’s dynamism.

The challenge is that in the absence of a more vigorous global economic recovery, it is difficult to rotate into the cheaper assets which tend to be more cyclical. This is why we remain stuck in a loop, endlessly chasing yield and pushing already expensive assets to even loftier levels.

Against this backdrop, we are shifting gears. Where previously we had emphasised ‘making hay while the sun shines’, we are now focused on avoiding potholes. Rather than relying on knee-jerk responses to central bank announcements, we prefer to focus on assets which can cope with anaemic economic growth. This leads us to avoid credit-related asset classes due to expensive valuations and potential illiquidity. Yes, yields could keep on grinding lower but it feels increasingly speculative at this point.

Supportive earnings trends in some equity marketsWithin equities, we expect performance to remain narrow and we are emphasising markets and sectors where corporate earnings trends are most well-established. To entice us into more cyclical areas we need to see deep discounts. The US, which is very much leading the recovery, continues to be one of our favoured markets. Ample liquidity along with earnings potential and growth momentum support our positive view.

We also take a positive view on Japan. Abenomics has led to a substantial depreciation in the yen, while the increasing focus on corporate governance combined with a shift of asset allocation by the national pension fund towards domestic equities has provided a further boost to equities. Even though longer term the prospects for the domestic economy remain bleak, these policies are positive for many asset markets.

Outlook 2015:Multi-Asset Investments

Johanna Kyrklund, Head of Multi-Asset Investments

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European growth continues to disappoint and even Germany is now suffering as emerging market weakness undermines its export markets. A significantly weaker euro is required to help mend the eurozone which will need greater decisiveness from the European Central Bank. Emerging markets remain stuck between disappointing growth in core exports markets in Europe and Asia and tightening US dollar liquidity.

Commodity correction may lead to opportunitiesAs we expected, commodities have struggled this year. While the cyclical backdrop is not supportive, we may find opportunities in 2015 given the correction we have seen already. Energy prices have fallen a long way and are now trading around the marginal cost of production but Saudi Arabia appears to be tolerating prices at this level as it enables them to gain market share. Metals prices have also suffered but should continue to receive some support from Chinese policy makers who maintain an easing bias.

Bonds to be buffeted by data noiseGovernment bonds remain vulnerable to oscillations in US labour market statistics but ultimately we believe that risks remain skewed towards deflation rather than inflation. Global growth momentum (with the exception of the US) is weak. Given this backdrop, we believe that Janet Yellen, chair of the Federal Reserve, is not under any immediate pressure to raise rates. In this environment UK government bonds provide a hedge against a further slowdown in growth momentum, since gilts benefit from safe-haven flows if the economic environment in Europe deteriorates, while they offer a more attractive yield than German bunds.

Outlook 2015: Multi-Asset Investments

Johanna Kyrklund, Head of Multi-Asset Investments

Johanna joined Schroders in March 2007. She is Head of Multi-Asset Investments, a member of Schroders’ Global Asset Allocation Committee and manager of the Diversified Growth funds. Before joining Schroders, Johanna specialised in asset allocation strategies. She has worked at Insight Investment and Deutsche Asset Management. Johanna is a CFA Charterholder and has a Degree in Philosophy, Politics and Economics from Oxford University.

The views and opinions contained herein are those of Johanna Kyrklund and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

“ Rather than relying on knee-jerk responses to central bank announcements, we prefer to focus on assets which can cope with anaemic economic growth”

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– Assuming global aggregate demand can continue to expand in 2015, equities will likely offer a greater short-term prospective return than fixed income

– Nevertheless, we judge equity valuations from a longer-term perspective, particularly in the US, to be on the expensive side at present

– A combination of factors has the potential to confound very low expectations for Europe next year.

We end 2014 with almost every asset class offering investors scant potential return for their risk. Five years into a period of unprecedented interest rate suppression, this should come as no surprise. The returns generated from every mainstream asset since 2009 have been striking. Those returns are now in the past. We believe the next few years will be characterised by lower returns, more volatility and greater risk.

The backdropWe are going to cop out here and leave politics to one side for the purposes of this outlook. The economic backdrop is foggy enough! Suffice to say we will comment throughout the year on this particular risk factor.

To try and summarise consensus expectations for growth in 2015, we would say that investors are very optimistic about the US (yet still don’t believe the Federal Reserve (Fed) will raise rates) and to a lesser extent the UK, are willing to give Japan and much of Asia the benefit of the doubt for now (but are sceptical of China), and hate Europe full-stop.

Starting as we often do at the bottom, for our sins, we think the combination of an expanding European Central Bank balance sheet, a gradual pick-up in credit growth due to record low funding costs for corporates and consumers, and the disposable income boost from lower oil prices has the potential to confound very low expectations for Europe next year.

Momentum in the US looks sustainable at least into 2015, meaning the Fed should follow through and begin raising rates. We’ll defer to our 2016 outlook for a judgment of how the economy absorbs what will likely be baby steps towards a tighter policy backdrop.

If US rate hikes don’t occur next year, the likely scapegoat will be a deflationary impulse emanating from China – the elephant that never leaves the room. The risks to China and other emerging markets will correlate highly with the strength of the US dollar in our view. Dollar bulls need to be careful what they wish for. A strong US currency, all else being equal, is not bullish for emerging market liquidity.

Not banking on bondsAlmost irrespective of one’s economic outlook, the margin of safety in fixed income markets is wafer thin. Aggregate yields globally are as low as they have ever been. Spreads are also closing in on their all-time tights. As a result, correlations within fixed income have picked up worryingly. Traditionally fixed income does not do well in a rising rate environment. If US rates do rise in 2015 as the Fed is telling us they are likely to,

Outlook 2015:Multi-Manager

Marcus Brookes, Head of Multi-Manager Team, and Robin McDonald, Fund Manager

“ We remain very optimistic about future investment opportunities, just not present ones.”

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every fixed income asset class will take a hit. In spite of this, judging by the scale of continued inflows, the majority of investors appear comfortable with the risk/reward set-up. We’re not, and therefore have only limited exposure. By definition, prospective returns today are pretty much as low as they have ever been, risks are high and liquidity is terrible. Investors need to tread carefully here.

We have a healthy cash balance across our portfolios at present, with some diversification into US dollars. Cash is currently considered an inferior asset as it generates a zero return. We believe it will become more desirable as the market sets about discounting higher US interest rates.

Expensive equities Assuming global aggregate demand can continue to expand in 2015, we would have sympathy with the view that equities offer a greater short-term prospective return than fixed income. Nevertheless, we judge equity valuations from a longer-term perspective, particularly in the US, to be on the expensive side at present. This tells you next to nothing about their potential for 2015, but does indicate their vulnerability to disappointment. Like fixed income, from a positioning standpoint, investors appear very comfortable with the risk/reward trade-off in US equities. Once again, we’re less sanguine. What equity risk we are taking is predominantly outside of the US, favouring Europe and Japan particularly. Both markets have relative value on their side and the potential for a catch-up in profitability. In contrast, US equities trade at historically high multiples of historically high earnings. The emerging market complex also strikes us as vulnerable to disappointment and we have next to no exposure there.

Fertile ground for alternativesFortunately, we believe the environment is becoming ever more fertile for short-selling, allowing us to generate uncorrelated returns in what may otherwise prove a difficult backdrop for investors. This opportunity set extends beyond equities, to bonds and foreign exchange markets also. The faith investors have placed in the Fed this cycle has made shorting a largely unprofitable exercise. We expect this to change.

Raging bull market enters new phaseThe bull market that began in March 2009 has been one of the most rewarding in history, yet the economic recovery to date has been one of the weakest. With the US economy now on a firmer footing, the Fed should intervene less in asset markets in 2015.

Not for the first time we have been premature in moving to emphasise capital preservation within the portfolios (will we ever learn?!) while this new investment environment unfolds. However, such is the unbalanced set-up within markets in our view, when (not if) investors decide to become temporarily more risk-averse, the likely re-pricing will be swift.

We remain very optimistic about future investment opportunities, just not present ones. For the time being we consider capital preservation the most prudent strategy for the portfolios. This will change as the opportunity set evolves.

Outlook 2015: Multi-Manager

Marcus Brookes, Head of Multi-Manager Team

Marcus joined Schroders in July 2013 following the acquisition of Cazenove Capital. Prior to the acquisition he was the Head of Multi-Manager at Cazenove Capital, which he joined in January 2008. During his career Marcus has held Multi-Manager linked roles at Gartmore, Rothschild Asset Management, and his investment career commenced in September 1994 when he joined Friends, Ivory and Sime. Marcus qualified from University of Stirling with a MSc. in Investment Analysis.

The views and opinions contained herein are those of Marcus Brookes and Robin McDonald and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

Robin McDonald, Fund Manager

Robin joined Schroders in July 2013 following the acquisition of Cazenove Capital. Prior to the acquisition he was a fund manager at Cazenove Capital, which he joined in October 2007, responsible for co-managing the Multi-Manager fund range. Robin has previously held Multi-Manager linked roles at Gartmore, Insight Investment Management and Rothschild Asset Management. Robin began his career in September 1999 when he joined Bank of New York (Europe) Limited as a Client Relationship Executive. He is a CFA charterholder.

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– London experienced the strongest rental growth in 2014 and we expect it to stay in the lead over the next 12 months

– The recovery in the economy combined with low levels of development means that the balance between demand and supply is now swinging in favour of landlords

– Risks to our outlook include the possibility that UK economic growth is much weaker than forecast, so that the upswing in rents stalls rather than accelerates.

2014 has been a good year for UK commercial real estate and unleveraged total returns are likely to be close to 20%. Most of this year’s performance has been driven by a favourable fall in property yields, as investors seek income. Looking ahead to 2015 we expect that total returns will remain in double figures, but that rental growth will make a larger contribution.

The recovery in the economy combined with low levels of development means that the balance between demand and supply is now swinging in favour of landlords and we anticipate that rental growth will accelerate.

The capital’s commanding positionLondon experienced the strongest rental growth in 2014 and we expect it to stay in the lead over the next 12 months. In the office sector, the emergence of central London as a powerhouse for international accountancy, law, media and technology companies has pushed vacancy rates back down to pre-crisis levels, not just in the prime locations of the City and West End, but also in less established areas such as Farringdon, Kings Cross and the South Bank.

In previous cycles this squeeze on space and upswing in rents would have triggered a big increase in development and encouraged companies to move to cheaper offices in outer London, or other cities. However, so far we have seen relatively little new office building in central London, partly because stricter capital adequacy rules mean that banks are now less willing to fund projects and partly because competing residential schemes are often more profitable. Moreover, central London now has such a deep pool of highly-qualified labour that some companies are even re-locating to the centre from outer London or the wider South-east, even though rents and business rates are more expensive.

Retail rents risingSimilarly, retail rents in many parts of London are rising on the back of strong population growth. To some extent London’s population growth – around 100,000 people a year – is simply a function of its vibrant economy, as people move to where the jobs are located.

In addition, we are also seeing an interesting social change as increasing numbers of young professionals – the so-called Generation Y – choose to live in inner London rather than copy their parents and move to the suburbs. This in turn is leading to the rapid gentrification of areas such as Brixton, Hackney and New Cross which were previously relatively poor. It also echoes the “Great Reversal” seen in several large US and German cities.

Outlook 2015:UK Commercial Real Estate

Duncan Owen, Head of Real Estate

“ While rental growth outside London is patchier, some regional markets are definitely coming out of hibernation.”

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Reawakening regional marketsWhile rental growth outside London is patchier, some regional markets are definitely coming out of hibernation. In the office sector, Manchester stands out as the strongest of the big regional cities, thanks to the success of its professional services. In addition, we are also seeing good demand for office space in Bristol and Edinburgh and certain smaller markets such as Aberdeen, Brighton, Cambridge and Reading with strong local economies.

In the industrial market, rents are now rising by 2% across the South-east and Midlands. Part of this is due to a cyclical upturn in demand from traditional occupiers such as builders’ merchants, but part is also due to the rapid growth in parcels, driven by online retail.

However, we remain sceptical about the prospects for a widespread recovery in retail rents outside London. Although total retail sales are now increasing quite quickly, most of the growth is online and the latest wave of bank branch closures (as people convert to mobile banking) is a reminder of the structural challenges facing retail property. In general, the only parts of the sector we favour are convenience stores, which are benefiting from the switch to “small basket shopping” and retail warehouses, which provide retailers with efficient and affordable space.

Risks and returnsTurning to the investment market, we think that the current level of the Investment Property Databank (IPD) All Property Index initial yield (5.5% at end-October 2014) represents fair value relative to other assets. If you adopt a textbook approach and assume that in future, 10 year gilt yields will settle at around 4% over the medium term, add on a risk premium of 3.5% to compensate for depreciation, tenant default and illiquidity and then subtract long-term rental growth at around 2% p.a., then an initial yield of 5.5% looks sensible.

There are three main risks around this outlook. The first is that UK economic growth is much weaker than forecast, so that the upswing in rents stalls rather than accelerates. The second is that over-exuberant investors buying in the market push down the All Property yield to under 5% by the end of 2015. While that would generate bumper total returns next year, we believe that parts of the commercial real estate market could then be vulnerable to rising interest rates in 2016–2017. The third risk is the uncertainty which would be generated if the next Government decides to hold a referendum on EU membership in 2017. That could be quite damaging, particularly for London. Approximately half of central London offices are owned by foreign investors and the flipside of London’s highly qualified, cosmopolitan workforce is that it is quite mobile and could leave relatively easily.

Overall, and given a reasonably high yield and a further rental growth as the economy improves, we expect that next year will see another solid performance from UK commercial real estate. The latest Investment Property Forum (IPF) Consensus Forecast suggests total returns of between 10–12% in 2015.

Duncan Owen, Head of Real Estate

Duncan joined Schroders in January 2012. He was previously CEO of Invista, having led its creation and IPO as a newly formed property fund management business listed in London. Invista was formed in 2006 from the fund management business of Insight Investment Management Limited. He joined Insight in 2003 following its acquisition of Gatehouse Investment Management, the real estate investment management boutique which he co-founded. He was the Managing Director of Insight’s property division and a main board director at the firm. Previously he was a director at LaSalle Investment Management and a partner at Jones Lang Wootton.

Outlook 2015: UK Commercial Real Estate

The views and opinions contained herein are those of Duncan Owen and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

“ Given a reasonably high yield and a further rental growth as the economy improves, we expect that next year will see another solid performance from UK commercial real estate.”

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– We believe that UK corporate bonds offer a good source of returns for 2015, provided investors are looking in the right places

– Long-dated UK credit looks compelling relative to euro equivalents, and is well supported from structural and technical perspectives

– On a historic basis, yields on UK corporate bonds remain low, and this makes returns challenging to come by for those investing passively. However, the increase in volatility that we are expecting provides a richer environment for generating outperformance through rigorous credit selection.

In the past five years, the world’s major central banks have been in uncharted waters, and markets have been led into strange new territory.

The extraordinary experiments in monetary policy have led to historically low levels of volatility, markets awash with liquidity, and bond yields which are close to – or even below – zero. With sweeping changes to the policy environment looming in 2015, we still believe that UK corporate bonds offer a sound investment opportunity due to relative value, structural supports and technical drivers. Investors just need to know where to look.

The Federal Reserve (Fed) has now stopped quantitative easing, and the Bank of England (BoE) stopped some time ago. The next natural step in our view – as the environment normalises for these central banks – is for rates to begin to increase. We expect that in both the US and the UK, rates will rise in 2015. However, while the UK economy has been performing very well, there are a number of economic and political headwinds which mean the outlook for UK economic growth is less clear going forward. This is likely to limit the scale and speed of tightening that the BoE can implement, and provides the first of the three key points that we believe will support UK corporate bonds for the coming year.

Duration risk vs. credit riskGoing into 2014 many investors were optimistic about economic growth and worried about rising interest rates. This meant a lot of assets continuing to flow in to short-duration, high yield and strategic bond funds, as well as equity and multi-asset income funds. In the hunt for yield driven by government intervention in financial markets, investors have become comfortable taking on additional corporate credit risk, but less sanguine about interest rate exposure or ‘duration’. This is because default rates (the number of companies defaulting on their debt repayments) have been suppressed by low volatility, whereas interest rate risk has appeared to be more pertinent as the UK economy has continued to improve. As we have described above, while we believe that the UK’s economic growth will continue in 2015, there are a number of headwinds. These include a General Election, possible “Brexit” risk and slow growth in the eurozone; the UK’s largest trading partner. This is also occurring in an environment where global inflation remains very subdued. This has diminished the relative risk posed to longer dated bonds, where duration risk is higher but there are fewer ‘tourists’ in the asset class. Therefore, some longer-dated assets are, in our view, under appreciated by investors.

Outlook 2015: UK Corporate Bonds

“ The increase in volatility which we are expecting provides a richer environment for generating outperformance through credit selection.”

Alix Stewart, Fund Manager – Fixed Income

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Long-term demandThe positive thesis for long-dated UK credit goes beyond the economic drivers. UK pension funds have a lengthy history of buying long-dated corporate bonds. In the past, this demand has been sufficient to significantly compress long-term corporate spreads versus the equivalent medium-term assets. The aversion to duration risk over the past 18 months, as well as the UK government’s announced changes to compulsory annuity purchases, has significantly reversed this trend. Yet the technical support offered by pension funds remains intact. From a regulatory perspective, pension funds are to still incentivised to use fixed income assets to match liabilities.

Further, both in the US and in Europe, pension funds are underexposed to long-dated credit assets when compared to the UK, and we anticipate similarly sustained long-end demand in these regions. This is important, as there is usually a strong correlation between fixed income markets when significant events occur. The recent departure of Bill Gross from bond investor PIMCO emphasised how fears over large capital outflows can have a market impact beyond domestic borders. In October, we again saw fears over US corporate duration damage UK valuations; fears which we believe are overblown.

Relative value, and a good hunting groundThis means that the sterling credit market, on a relative basis, looks cheap compared to other regions and Europe in particular. With GDP growth in the eurozone almost entirely absent and dangerously low inflation, highly accommodative monetary policy will remain in place for a very long time. Low growth and low inflation are therefore supportive characteristics for investment grade bonds from a policy perspective. While this latter point has been priced into valuations by the euro market, sterling credit looks better value. Setbacks in fixed income markets in October have only enhanced this relative value.

On a historic basis, yields on corporate bonds remain low, and investors have correctly highlighted that this makes ‘beta’ returns – those generated by broad market participation – challenging to come by. However, by using an innovative theme-based approach to analysing companies and markets, we believe a number of interesting opportunities can be found. As economic and political uncertainties remain into the coming year, we see good opportunities within sterling credit, while the increase in volatility which we are expecting provides a richer environment for generating outperformance through credit selection.

Outlook 2015: UK Corporate Bonds

Alix Stewart, Fund Manager – Fixed Income

Alix Stewart joined Schroders in August 2012 as a Credit Portfolio Manager. Alix began her career in 1994, and gathered fifteen years of experience managing corporate bonds, before taking the role of Head of UK Fixed Interest at UBS in 2011. Alix holds a BSc (Hons) in Economics and Mathematics from University of Leeds.

The views and opinions contained herein are those of Alix Stewart and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

“ We still believe that UK corporate bonds offer a sound investment opportunity due to relative value, structural supports and technical drivers. Investors just need to know where to look.”

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Having delivered a broadly flat performance in 2014, the aggregate valuation of the market has not changed significantly. The market expects low single digit earnings growth in 2015, which is slightly lower than had been anticipated for 2014 a year ago. Earnings expectations have been scaled back during the course of 2014 and projections for global growth cut.

Share valuations remain close to their long-run average, which gives us comfort in the market’s aggregate level, and it is possible to find relative value in certain cyclical sectors that have de-rated in 2014. In general, risk and reward appears to be more broadly balanced than in the recent past. The prospects for the market’s more domestically-focused companies remain reasonably positive. Falling unemployment and signs of real wage growth coming through should support the British consumer and interest rate rises, when they materialise, have been well telegraphed and are likely to be relatively small.

Challenging timesMany challenges face the global economy, not least an uncertain Chinese growth outlook and the spectre of deflation in the eurozone. The recent dramatic decline in the oil price could further support growth. By contrast, this time last year the emphasis was very much on monetary tightening as the US Federal Reserve prepared to taper its quantitative easing (QE) and markets fretted about UK interest rate rises. The market is particularly pessimistic about Europe, where we should see additional stimulus measures in 2015, and Japan has bolstered its own unconventional monetary policy drive by extending QE.

The consensus view is that the modest level of global growth will persist into 2015, with the eurozone the major culprit again. Indeed, the latter’s structural problems remain unsolved, while sentiment in Germany has been more negative than expected as a result of the Russia/Ukraine conflict.

The broader market is not cheap, but equally it is not excessively expensive. Following the de-rating of the more cyclical elements we see some relative value again in certain more cyclical companies. The media sector also catches our eye, including Daily Mail & General Trust and the FTSE 250 events companies Informa and UBM. Similarly, the software sector is presenting interesting opportunities with IT infrastructure services business Computacenter worth highlighting.

Outlook 2015:UK Equities

Philip Matthews, UK Equity Fund Manager

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“ In general, risk and reward appears to be more broadly balanced than in the recent past.”

– Share valuations remain close to their long-run average, which gives us comfort in the market’s aggregate level

– Many challenges face the global economy, not least an uncertain Chinese growth outlook and the spectre of deflation in the eurozone

– We believe that value still exists within the domestic banks and house builders, despite the latter being among that small cadre of companies to have benefited in the past year from earnings upgrades.

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Conversely, some of the more defensive companies with more resilient earnings streams have rerated strongly in 2014. We remain happy to hold such businesses – including Imperial Tobacco, publisher and information provider Reed Elsevier and medical equipment group Smith & Nephew – but are aware of their increased valuations and so may recycle money out of such areas.

Domestic winnersAmong the UK-focused companies, we believe that value still exists within the domestic banks and house builders, despite the latter being among that small cadre of companies to have benefited in the past year from earnings upgrades. However, it is worth bearing in mind that the general election in May could prompt volatility among the house builders, gambling companies, bus and rail operators and utility firms, all of which are potential targets for political interference.

Philip Matthews, UK Equity Fund Manager

Philip joined Schroders in October 2013 to manage UK equity portfolios. He joined from Jupiter, where he had worked since 1999 managing both retail and UK institutional portfolios. Philip managed the Jupiter Growth & Income Fund from April 2006 and acted as the Deputy Fund Manager of Jupiter Income Trust.

Prior to joining Jupiter he worked at Chesterton in the Residential Investment and Development department. Philip has completed all levels of the CFA exam and holds a degree in Modern and Medieval Languages from Cambridge University.

Outlook 2015: UK Equities

The securities and sectors mentioned above are for illustrative purposes only and are not to be considered a recommendation to buy or sell. The views and opinions contained herein are those of Philip Matthews and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

“ The market is particularly pessimistic about Europe, where we should see additional stimulus measures in 2015.”

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It’s true; the Federal Reserve (Fed) will likely move to raise interest rates next year, but that is not necessarily going to be the only story of 2015.

The fixed income market may become segmented in 2015. We expect the yield curve will continue to change shape. As a result, investors are likely to have very different experiences depending on the themes they are focused on. We believe that pension funds and insurance companies should continue to be major sources of demand for longer dated credit risk, as will foreign investors who are taking much more interest in US fixed income given the yield starvation elsewhere.

The municipal market should continue to offer value for tax-paying investors in the US. High yield and emerging market debt markets have proven in 2014 that the additional yield they offer comes with additional risk.

Market segmentationWe have recently spent a lot of time looking at the impact that interest rate rises have had on different parts of the market during previous rate rising cycles. Each cycle is different. The timing and magnitude of the rate moves differs, as does the starting point. Today’s market is certainly different than the last time the Fed embarked on raising rates.

The one definitive conclusion from looking at previous episodes is that the impact on market segments will not be uniform. Many commentators love to talk about the changing language coming from the voting members of the Fed, but forget to mention that an increase in the Federal Funds rate does not translate to a parallel shift across the yield curve. In fact, a flattening of the yield curve is probably a lot more likely, given the current steepness that exists.

As we know from experience in the UK, it is entirely plausible for different market segments to become dislocated from one another, and even move in opposite directions. Many investors have reduced their exposure to interest rate moves – or ‘duration’. More accurately, many have shifted duration exposure to short-dated bonds, in both credit and municipals. This is the very part of the market likely to be most directly impacted by short-term interest rate increases.

Outlook 2015:US Multi-Sector Fixed Income

Andy Chorlton, Head of US Multi-Sector Fixed Income

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– There will be significant focus on the Federal Reserve, and the expected end of the ‘zero interest rate’ policy

– Investors must ensure that their obsession with ‘Fed watching’ doesn’t blind them from the opportunities across the fixed income market.

“ High yield and emerging market debt markets have proven in 2014 that the additional yield they offer comes with additional risk.”

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We published a paper last year titled ‘The Great Re-Rotation’, which focused on the demand from US private sector pension plans for longer-dated investment grade corporates. A year later, we have been surprised that this did not have a more material impact on the market, but we do not think that demand has gone away. Long dated credit is cheaper now than this time last year, and should benefit from this natural buyer base.

Pension plans continue down the path towards more liability-conscious investing. Although we did not get our timing right, this year we think this dynamic remains in place. This involves a change in mind-set to one of relative returns and away from an absolute return focus.

Value in credit?Since the financial crisis, corporate credit risk had been the gift that keeps on giving. However, as of early December, excess returns in the US have turned negative. Credit curves have steepened through the year and confidence has been adversely impacted by the volatility we have seen in the second half of 2014.

However, the fundamental backdrop remains broadly supportive for credit investors. Naturally, we need to remain vigilant – we must remain wary of shareholder-friendly actions and a lack of discipline from corporations – but we anticipate some interesting opportunities in corporate credit. Investors with a longer-term investment timeframe should do better than short-term players. Recent price moves are more about sentiment and liquidity concerns than a change in the ability of the average investment grade corporate to pay back the principal and the coupon on their debt obligations.

High yield and emerging markets have been a challenge for investors over the last couple of months. If there is one positive that has emerged from the recent moves it is that it should begin to provide a more stable technical backdrop. In both markets, security selection remains key.

It is no longer appropriate to make broad statements about emerging markets as an asset class, as some sovereigns are solid investment grade names. Similarly in high yield, there is a difference between the struggling energy issuers and more stable sectors which are well positioned for the coming months.

Demand from foreign investors Demand and supply distortions can often have a material impact on markets but are frequently discounted in favour of discussions on more dynamic topics such as growth, inflation and rate expectations.

We believe that further demand for US credit from overseas investors is not fully appreciated by market participants. Clients in Europe and Asia are showing a renewed level of interest in US corporate bonds. Starved of yield in their home markets, international investors are taking a much closer look at the US. With over 50% of government bonds around the world yielding less than 1%, a 7–10yr US corporate bond portfolio yielding above 3.5% certainly gets some attention.

In 2015, the Fed’s decisions will undoubtedly be important, but investors should not be blinded by what happens at the short-end of the yield curve. We expect volatility to continue, opportunities to emerge and the potential for different parts of the market to move independently. Liquidity is deteriorating, but that is just another inefficiency on which we will look to capitalize.

Outlook 2015: US Multi-Sector Fixed Income

The views and opinions contained herein are those of Andy Chorlton and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

“ We expect volatility to continue, opportunities to emerge and the potential for different parts of the market to move independently.”

Andy Chorlton, Head of US Multi-Sector Fixed Income

Andrew is Head of US Multi-Sector Fixed Income based in New York. He leads the team responsible for all Multi-Sector strategies including the Value portfolios. These include Core, Long Duration and Tax-aware strategies. Andy joined Schroders in 2013 following the acquisition of STW Fixed Income Management, where he had worked since 2007.

At STW, Andy was Principal, Portfolio Manager and a member of the team responsible for managing $11 billion in Multi-sector portfolios including Core, Short and Long Duration and Tax-aware strategies. Andy holds a Bachelor of Social Sciences in Economics and Spanish from the University of Birmingham. He is also accredited as a Chartered Financial Analyst.

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As 2014 has progressed, what has become increasingly apparent is the sub-trend and divergent nature of the recovery in global growth. The only developed economy really showing momentum is the US while growth in the eurozone and Japan is stalling and unorthodox policy measures are being increasingly employed. Consequently, rather than assessing how global emerging markets (GEMs) will fare in a global expansionary cycle, we find ourselves instead focusing on how GEMs might perform in a low growth world.

Lower growth for longerGEMs would be expected to be among the primary beneficiaries of a global cyclical upturn given their higher beta1 nature. However, while GEMs’ exports, in particular manufacturing and industrials have been increasing, the overall effect has so far been more muted than would otherwise be expected at this stage in the cycle.

Meanwhile, import demand for commodities has been weak. A slowdown in the commodity cycle is partly to blame, not least with the US progressing towards energy self-sufficiency, together with the longer-term diminished effects of global trade liberalisation and a slowdown in off-shoring. Weak demand from the US has so far not been reinforced by demand in the eurozone, Japan and China, where growth has slowed and the overall backdrop for GEMs to perform in has become more challenging.

Subdued export growth has weighed on earnings and Institutional Brokers’ Estimate System (IBES) consensus earnings growth expectations of around 10% over the next 12 months look susceptible to potential disappointments. We believe instead that investors should look to GEMs’ primary growth driver of domestic demand, together with the potential positive ramifications of reform implementation, for a positive economic and earnings growth catalyst in 2015.

Opportunities – strong domestic demandThere has been much negative market sentiment surrounding disappointing emerging markets export growth. However, we believe investors should not lose sight of the significant underlying domestic demand-led growth in the emerging world. Do not forget the combined population of China and India is over 2.5 billion, let alone the remaining emerging countries, and an expanding middle class is driving strong consumption demand and accounting for an increasing share of wealth creation globally. This structural story remains in its infancy and we believe will continue to create strong investment opportunities.

Outlook 2015:Emerging Market Equities

Allan Conway, Head of Emerging Market Equities

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– In 2015, rather than assessing how GEMs will fare in a global expansionary cycle, we find ourselves instead focusing on how GEMs might perform in a low growth world

– GEMs look supported by strong domestic demand growth and reform potential, which in combination with robust fundamentals and attractive valuations, make for a positive case

– However, challenges remain, primarily revolving around a strong US dollar, which leads our outlook to be more muted than would otherwise be expected during a global cyclical upturn.

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Opportunities – the new reformers An important positive for GEMs could come from the increasing number of countries that are embarking on reform programmes to boost or sustain growth. In many cases this follows the election of pro-reformist leaders; for example Narendra Modi in India, Peña Nieto in Mexico, Joko Widodo in Indonesia and Xi Jinping in China. Common reform requirements include the need to rein in the influence of the state on the economy and release the potential of the private sector. However, the necessary reforms are typically country-specific; for example, China is looking to transition its economy away from credit and investment and increasingly towards domestic consumption growth, while in the case of India, there is a greater need for investment and infrastructure spend to reduce supply bottlenecks. While the reform process is unlikely to be smooth in either case, over time, the reforms could lift GDP meaningfully.

Shifting market sentimentEmerging market equity mutual fund flows have been very volatile over 2014 and it is possible this volatility could continue into 2015 given the still-uncertain global backdrop. The year started with an extraordinary level of investor bearishness towards GEMs, as reflected by net outflows of over $40 billion from dedicated funds. Since then flows have reversed somewhat but year-to-date there have still been outflows of around $10 billion, according to fund flow data firm EPFR Global.

However, significantly, there is a strong case to be made that concerns have already been more than priced in by the market. GEM valuations are attractive with the MSCI Emerging Markets index trading at price-to-earnings (P/E) ratio of around 10.5 times, which is an approximate 10% discount to history and over a 50% discount to the S&P 500 referencing the Shiller P/E ratio – this is the largest discount for over 10 years.

Forward price earnings

Emerging Markets USA World

Forward P/E 10.5 14.7 14.0

EPS Growth 10.5% 10.8% 10.7%

PE/EPS Growth 1.0 1.4 1.3

Source: Schroders, FactSet, IBES, MSCI, data shown to 16 October 2014.

Outlook 2015: Emerging Market Equities

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8

10

12

14

16

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22MSCI EM 12m Forward P/E

20142012201020082006200420022000199819961994

Average

“An important positive for GEMs could come from the increasing number of countries that are embarking on reform programmes to boost or sustain growth.”

“Our 2015 outlook for GEMs is constructive but more muted than would otherwise likely be the case in a more ‘normal’ global expansionary phase of the cycle.”

The challenge of a stronger US dollarIn 2015 we believe the primary challenge facing GEMs is the potential ramifications of future monetary policy normalisation in the US. For example, the prospect of restrictive policy on the US dollar bears monitoring closely given a stronger US dollar has historically been correlated with weak GEMs relative returns versus developed markets. That said, the US dollar has already strengthened sharply on a real effective exchange rate basis over 2014 and we believe it is unlikely that the dollar will continue to appreciate at such a pace in 2015.

It also looks too early to start worrying about interest rate hikes at this stage of the cycle, not least since equities tend to perform well during the initial rounds of rate increases as the positive impact of strong economic growth outweighs the tighter financing environment. Furthermore, although the US is one of the best performing developed economies, its recovery has been sub-trend which may lead interest rates, when they are finally increased, to peak at much lower levels than during a more ‘normal’ cycle. In combination with expansionary policy in the eurozone and Japan, global liquidity is likely to remain supportive for some time to come.

Clearly some emerging economies are more vulnerable than others to higher US interest rates. However, the adjustment process has been underway for many of the perceived weaker economies who in some cases now have narrower current accounts, more competitive currencies and have slowed loan growth. Subsequently, when policy is eventually tightened in the US, we would expect the impact to be more muted than the summer of 2013, not least since the prospect of interest rate hikes is now well known and, at least to some extent, looks to already be priced into the market.

Tail risksTail risks remain, most notably in Ukraine and the Middle East, although given the global nature of the current crises, any significant deterioration in either situation is likely to have global rather than emerging markets-specific ramifications. While the recent pressure on energy prices is creating strains on the budgets of certain energy-producing emerging countries, lower prices are a benefit to the energy importers and overall should boost global consumption demand to the potential benefit of GEM exporters.

Cautious optimism for 2015Our 2015 outlook for GEMs is constructive but more muted than would otherwise likely be the case in a more ‘normal’ global expansionary phase of the cycle. We are currently positioned with a portfolio beta1 of around 1 (i.e. our overall market sensitivity is broadly in line with the index) and we are fully invested, although have a net underweight exposure to the more cyclical sectors2 (materials and energy combined). Generally speaking, we have overweight positions in markets which could benefit from potential reformist policy and markets which are beneficiaries of a pick-up in manufacturing and industrial exports and weak energy prices.

We are mindful that the ramifications of a stronger US dollar, a potential tighter financing environment and weak commodity prices could have a negative impact on emerging markets equities. Nevertheless, over 2015 we believe GEMs should deliver reasonable absolute and relative returns compared to developed markets, supported by attractive valuations, strong domestic demand and improving exports.

The views and opinions contained herein are those of Allan Conway and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

Outlook 2015: Emerging Market Equities

Allan Conway, Head of Emerging Market Equities

Allan joined Schroders in October 2004 as Head of Emerging Market Equities. He is a fellow of the Securities Institute (FSI), Member of the Institute of Chartered Accountants (ACA) and has a BA (Hons) Degree in Economics from York University. His investment career began in 1980 and he previously worked at WestLB Asset Management, where he was Head of Global Emerging Markets and later Chief Executive of WestAM (UK) Ltd and LGT Asset Management, where he was Head of Global Emerging Markets.

1 Beta measures the average extent to which a fund moves relative to the broader market. The beta of a market is 1. A fund with a beta of more than 1 moves on average to a greater extent than the market. A fund with a beta of less than 1 moves on average to a lesser extent. If beta is a minus number, it is likely that the stock and the market move in opposite directions.

2 Particular types of industry/sectors that are most sensitive to the business cycle. These sectors tend to experience higher revenues in periods of economic expansion and lower revenues in periods of economic contraction.

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