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Strategy Guide Enhanced-Diversification Global Emerging Markets Equities April 2017 This document is for investment professionals only and should not be distributed to or relied upon by retail clients. It is only intended for use in jurisdictions where the relevant funds are authorised for distribution or where no such authorisation is required. ED Global Emerging Markets 1 About Standard Life Investments Standard Life Investments is a leading asset manager with an expanding global reach. Our wide range of investment solutions is backed by our distinctive Focus on Change investment philosophy, disciplined risk management and shared commitment to a culture of investment excellence. As active managers, we place significant emphasis on rigorous research and a strong collaborative ethos. We constantly think ahead and strive to anticipate change before it happens, ensuring that our clients can look to the future with confidence. As of 31 December 2016, Standard Life Investments managed €325.5 billion on behalf of clients worldwide. Our investment capabilities span equities, fixed income, real estate, private equity, multi-asset solutions, fund-of-funds and absolute return strategies. Headquartered in Edinburgh, Standard Life Investments employs more than 1,700 talented individuals. We maintain a presence in over 20 locations across Europe, North America, Asia and Australia. In addition, we have close relationships with leading domestic players in Asia, including HDFC Asset Management in India and Sumitomo Mitsui Trust Bank in Japan. Our parent, Standard Life plc, was established in 1825. A leading provider of long-term savings and investments, Standard Life went public on the London Stock Exchange in 2006 and is now a FTSE 100-listed company. Standard Life Investments launched as a separate company in 1998 and has quickly established a reputation for innovation in pursuit of our clients’ investment objectives. Our investors rank among some of the world’s most sophisticated and high-profile institutions. They include pension plans, banks, mutual funds, insurance companies, fund-of-fund managers, endowments, foundations, charities, official institutions, sovereign wealth funds and government authorities. Contents 1 Introducing the EDGEM portfolio 2 What is the EDGEM investment strategy? 4 How do we construct the portfolio? 2 ED Global Emerging Markets 6 What is our investment expertise? 7 Summary of benefits 8 Find out more Introducing the EDGEM portfolio Global emerging markets (GEM) offer an exciting investment opportunity. A combination of supportive demographics, growing economies and a multitude of world-class businesses provide a positive investment backdrop. However, many investors shy away from the asset class because of concerns about perceived risk and volatility. In response, we offer the Enhanced-Diversification Global Emerging Markets Equity (EDGEM) Strategy. Through this unique solution, we aim to deliver GEM equity-like returns over the market cycle – but with less than 70% of the volatility. A new choice Focus on Change EDGEM is a distinctive and truly blended combination of stock-picking expertise and diversified multi-asset strategies, drawing on Standard Life Investments’ demonstrable excellence in both these fields. Through this, we aim to deliver market-like returns with lower volatility – culminating, we believe, in superior risk-adjusted performance. Our investment process is underpinned by our Focus on Change philosophy. Through this, we seek to identify non-consensus change and to exploit this before the market view comes into alignment with our own. This applies whether we are looking at stock-selection ideas from the bottom up or at macro strategy development from the top down. A unique blend of stock-picking and multi-asset strategies From an equities perspective, due to the size and disparate nature of the GEM investment universe, many companies are often underresearched and consequently their scope for improvement is under-appreciated. This means many firms are mispriced relative to their underlying fundamentals. Our Focus on Change investment philosophy is therefore especially suited to unearthing these companies. Our 11-strong GEM equities team drives the stock-picking portion of EDGEM. We believe the most consistent source of alpha comes from bottom-up stock selection, and so the team focuses all its time, energy and resources at the company level. By doing so, we aim to ensure that our highest-conviction investment ideas enter EDGEM. Working in conjunction with the GEM equities team is our award-winning multi-asset investing team, consisting of over 50 investment professionals. Its goal is to develop a suite of multi-asset strategies that we expect not only to earn a positive return over a longer time horizon, but also to earn that return in a different way from GEM equities. These strategies – covering interest rates, currencies, relative value, inflation and opportunistic investments – contain a blend of emerging and developed market exposures, some of which are negatively correlated with GEM equities. This means that they can be expected to diversify the equity risk in EDGEM. They can also provide downside protection when the market is under pressure. We then blend these multi-asset strategies with the stock picks from our GEM equities team to create the EDGEM portfolio. Reasons to invest ¬ EDGEM is a unique proposition that seeks to provide GEM-like equity returns with substantially lower risk than equity-only investing. ¬We utilise return-seeking, enhanceddiversification strategies to provide a more resilient portfolio. ¬EDGEM provides access to the best ideas of our GEM equities team and our awardwinning multi-asset investing team. ¬The strategy is based on a proven, robust and repeatable investment process. ED Global Emerging Markets 1 What is the EDGEM investment strategy? Our EDGEM investment strategy is a three-stage fusion of bottom-up stock selection, portfolio optimisation and multi-asset strategies. Stage one – our best stock ideas We believe that the most consistent source of alpha comes from bottom-up stock selection. As such, we focus our sizeable resources on company-level research. We aim to identify positive drivers of change within a company that the rest of the market has yet to price in - a non-consensus insight - and exploit this ahead of the market view coming into alignment with our own. Idea generation and research The majority of our investment ideas are generated from the information and analysis we garner from our one-to-one company meetings. Collectively, our GEM equities team conducts around 1,000 meetings annually and covers around 250 stocks. These meetings are used to ascertain the company’s own views and expectations of their future prospects and the markets in which they invest. We also search and test for corroborating evidence with their competitors, their suppliers and customers to give us a complete picture. High-conviction selection Our process for evaluating our highestconviction ideas is team-based, with robust debate encouraged and incentivised throughout the process. The culmination of the GEM equities team’s debate is a list of around 20 of our best GEM equity ideas. These form the core of the equity portion on EDGEM. Our EDGEM investment strategy Our scale allows a broad and unbiased investible universe 250+ stocks Idea Generation 3,000+ stocks We look for Focus on Change opportunity a t c ompa ny level 250+ stocks 150+ stocks Research We formalise and review our research by way of consistent “five question” analysis 150+ stocks Stock Selection We select on materiality, conviction and global thesis corroboration 20 Best GEM Best Ideas List Portfolio Construction 2 ED Global Emerging Markets 20 stocks Stage two – neutralise factor risk With EDGEM, we seek to capture as much of the stock-specific risk of our GEM best ideas as possible, while seeing to neutralise exposure to unwanted risks arising from various factor influences, such as country, sector or style bias. We do this by adding around 180 additional stocks identified by a proprietary optimisation process. These will be additionally filtered by our GEM equities team. Overall, this process facilitates the identification and position sizing of stocks that are optimal at diversifying away undesirable risks. We then combine these stocks with our best ideas to create the equity portion of EDGEM. This process ensures that around 90% of EDGEM’s active risk is driven by stock-specific risk. Stage three – increase portfolio resilience Our multi-asset investing team develops bespoke return-seeking strategies to work in conjunction with EDGEM’s equity portfolio. This adds a robust layer of diversification that seeks to substantially reduce volatility in EDGEM. These strategies are typically selected from five main investment groups. Interest rates – these strategies are based on our expectation for changes in interest rates across major world economies. Relative value strategies – we take advantage of differences between equity markets or sectors, where we expect one to rise relative to the other. Currencies – we identify currency pairs where we expect one to generate a positive return against the other, from a combination of carry and spot movements. Inflation – an agreement to exchange a fixed percentage for a realised inflation rate (or vice-versa) on a given notional amount, for a given term. Opportunistic – investment opportunities that are complementary to EDGEM’s investment objective but not captured by the other categorisations Overall, these strategies act as diversifiers and shock absorbers for EDGEM because they behave differently from GEM equities. They also have the potential to make money in declining GEM equity markets although this is not guaranteed in all markets. EDGEM: Investment process STAGE ONE Stock selection Highest conviction stock ideas based on materiality, conviction and global thesis corroboration 20 Best Ideas list Our best stock ideas STAGE TWO STAGE THREE Portfolio optimisation Optimiser supports the identification of additional stocks and position sizes that diversify away undesirable risk Strategy selection Interest rates, currencies, relative value, inflation and opportunistic strategies picked in conjunction with equity Optimised portfolio c.180 additional stocks 15-25 Enhanced Diversification strategies Neutralise factor risk Increase portfolio resilience ED Global Emerging Markets 3 How do we construct the portfolio? The EDGEM management team (comprising GEM equity and multi-asset managers) is responsible for overall portfolio construction. We blend together a portfolio encompassing our best stock ideas, the equity diversifiers from the optimiser and a selection of multi-asset strategies that are hand-picked to work best with the equity portfolio. Typically, the final equity portion of the portfolio holds around 200 stock positions accounting for some 70% of the overall portfolio allocation. These will be chosen by our GEM equities team and will consist of two distinct sections. This will be complemented by approximately 1525 multi-asset strategies, accounting for around 30% of the portfolio allocation. We implement these strategies effectively and efficiently by using a variety of market tools and instruments (direct investment, index futures, currency forwards, swaps, etc.). Once employed, we regularly monitor and review each strategy to ensure its continued suitability for inclusion in EDGEM. 1. A central portfolio of 20 of our highestconviction stocks that seeks to benefit from the finest of our alpha-generating capabilities. Risk management We have extensive risk management infrastructure in the portfolio to both participate in the portfolio construction process and to ensure our investment team operates within the fund investment framework. 2. The 180 GEM equity stocks from the optimisation process. These are too small individually to have stock-specific factor, but in aggregate can reduce large unwanted risk. EDGEM portfolio 20% Total stand-alone risk (%) 18% 16% Currencies 14% Credit 12% 10% 8% 6% 4% Inflation 16.1% Interest Rates Diversification volatility 8.94% RV Equity Equity Expected volatility 10.86% 2% 0% Black line indicates MSCI Emerging Market Index volatility Source: Standard Life Investments, APT, Enhanced Diversification Global Emerging Markets (EDGEM) portfolio, 31 December 2016 In the example above, the total standalone risk of the portfolio can be calculated by combining all of the rectangles (19.8%). This represents the amount of return-seeking risk deployed in the portfolio. This is higher than GEM equity market risk, which was 16.1% as of 31 December 2016, and explains why we believe the portfolio can generate equity-like returns. However, the expected volatility of the portfolio is substantially lower than equity market volatility. This is because of the diversification benefits of our portfolio construction. 4 ED Global Emerging Markets EDGEM performance In order to test our investment approach, we ran the EDGEM strategy as a model portfolio for 3 years, prior to the launch of the fund in December 2014. The model portfolio was managed in strict accordance with EDGEM’s investment philosophy and process, and outperformed the index by 4.4% with 65% of GEM equity volatility. It did so across a period that included both strong and weak market conditions. The chart below shows the performance pattern of the model portfolio. We would expect the portfolio to underperform in strongly rising markets, but to be much more resilient in down markets, and this has been visible in the live portfolio. EDGEM model portfolio performance 140 Investment objective 130 ▸ GEM equity like returns over the market cycle ▸ 70% GEM equity volatility 125 Launched 03 December 2014 135 120 ▸ Model portfolio began December 2011 115 Annualised performance (from 01 December 2011 to 30 November 2014) 110 ▸ EDGEM 8.9% ▸ MSCI EMF 4.9% 105 100 Monthly volatility (monthly)** 95 (from 01 December 2011 to 30 November 2014) EDGEM Model* Nov 14 Jul 14 Sep 14 May 14 Jan 14 Mar 14 Nov 13 Jul 13 Sep 13 May 13 Jan 13 Mar 13 Nov 12 Sep 12 Jul 12 Mar 12 May 12 Jan 12 Nov 11 90 ▸ EDGEM ▸ MSCI EMF 9.7% 15.0% MSCI Emerging Markets * EDGEM Model from 01 December 2011 to 30 November 2014 ** Volatility is monthly ex-post Source: Standard Life Investments, Enhanced Diversification Global Emerging Markets (EDGEM) model portfolio performance in USD from 01 December 2011 to 30 November 2015 Past performance is not a guide to future performance. The value of an investment may go down as well as up and cannot be guaranteed; an investor may receive back less than their original investment. “A differentiated and innovative alpha focused solution for investors who seek GEM Equity market returns over the cycle without the same potential equity drawdown.” Alistair Veitch Investment Director ED Global Emerging Markets 5 What is our investment expertise? The enhanced-diversification equity investment group oversees EDGEM. It consists of investment professionals from across Standard Life Investments, with a range of backgrounds and areas of expertise. The group’s role is to review, debate and, where necessary, challenge the investment decisions within EDGEM. This will include assessing the overall structure and diversification dynamics of the portfolio. Throughout this process, the group will also draw on the insights from our global asset class teams, benefiting from the collective skills of hundreds of investment professionals within Standard Life Investments. The result is a more comprehensive and rigorous EDGEM strategy. Our reputation as a leading investment manager is based on the exceptional quality of our people. We have never embraced a ‘star fund manager’ mentality. Our EDGEM investment group is testament to the benefits of this collegiate approach. EDGEM Management Team Alistair Veitch* Ronnie Petrie Jason Hepner Scott Smith 25 Ind. / 2 SLI 28 Ind. / 21 SLI 19 Ind. / 19 SLI 11 Ind. / 11 SLI Financials, Consumer, Telcos Banks, Real Estate, Metals & Mining Portfolio Manager Portfolio Manager Asian Equities SICAV GEM Pension Fund EDGEM Equity EDGEM EDGEM EDGF EDGF EDGEM ¬ 11 strong Equity Team ¬ 60 strong Multi-Asset (MAI)Team ¬ Average of 17 years industry experience ¬ Average of 15 years industry experience ¬ Dual role of analyst and portfolio manager ¬ Specialist roles of fund management and implementation, risk management and strategy ¬ Sector specialists ¬ Dedicated quantitative analyst support ¬ Team manage total of US$8.7bn assets* *Source: Standard Life Investments, as at 30 June 2016 6 ED Global Emerging Markets ¬ MAI Team manage US$217.0bn* Summary of benefits Through the EDGEM portfolio, we offer a number of benefits for investors. ¬ The portfolio gives investors the potential for GEM equity-like returns over the investment cycle with substantially lower risk than equity-only investing. ¬ EDGEM provides access to experienced and established teams with proven track records. ¬ We strive for excellent bottom-up stock selection and alpha capture expertise from our highly experienced GEM equities team. ¬ Our industry-leading multi-asset specialists seek to produce return-seeking enhanceddiversification strategies to create a more durably diversified portfolio. ¬ We have a dedicated team of risk experts that create superior risk management and control frameworks. The strategy may be suitable for investors who: The strategy may not be suitable for investors who: ¬seek capital appreciation over the long term ¬do not want to take any risk with their capital – equity investments are not risk-free ¬would like to invest in an actively managed portfolio ¬have an investment time horizon of at least five years. ¬are not prepared to accept temporary losses as a result of the nature of equities, bonds and currency markets. ED Global Emerging Markets 7 Find out more For more information, please visit www.standardlifeinvestments.com where you will find contact details for your location. Visit us online standardlifeinvestments.com 8 ED Global Emerging Markets Important Information The opinions expressed are those of Standard Life Investments and are subject to change at any time due to changes in market or economic conditions. This material is for informational purposes only. This should not be relied upon as a forecast, research or investment advice. It does not constitute an offer, or solicitation of an offer, to sell or buy any securities or an endorsement with respect to any investment vehicle. The value of an investment can fall as well as rise and is not guaranteed. An investor may get back less than they put in.The fund uses derivatives extensively to seek its investment objective. Standard Life Investments Limited is registered in Scotland (SC123321) at 1 George Street, Edinburgh EH2 2LL. Standard Life Investments Limited is authorised and regulated in the UK by the Financial Conduct Authority. Standard Life Investments (Hong Kong) Limited is licensed with and regulated by the Securities and Futures Commission in Hong Kong and is a wholly-owned subsidiary of Standard Life Investments Limited. Standard Life Investments Limited (ABN 36 142 665 227) is incorporated in Scotland (No. SC123321) and is exempt from the requirement to hold an Australian financial services licence under paragraph 911A(2)(l) of the Corporations Act 2001 (Cth) (the ‘Act’) in respect of the provision of financial services as defined in Schedule A of the relief instrument no.10/0264 dated 9 April 2010 issued to Standard Life Investments Limited by the Australian Securities and Investments Commission. These financial services are provided only to wholesale clients as defined in subsection 761G(7) of the Act. Standard Life Investments Limited is authorised and regulated in the United Kingdom by the Financial Conduct Authority under the laws of the United Kingdom, which differ from Australian laws. Standard Life Investments Limited, a company registered in Ireland (904256) 90 St Stephen’s Green Dublin 2, is authorised and regulated in the UK by the Financial Conduct Authority. Standard Life Investments (USA) Limited is registered as an Exempt Market Dealer in Canada and as an Investment Adviser with the US Securities and Exchange Commission. Standard Life Investments (Corporate Funds) Limited is registered as an Investment Adviser with the US Securities and Exchange Commission. Calls may be monitored and/or recorded to protect both you and us and help with our training. www.standardlifeinvestments.com © 2017 Standard Life, images reproduced under licence INVBBRO_14_1264_ED_GEM_Fund Guide_TCM 12 ED Global Emerging Markets 0517