Q2 16 GLOBAL AND MARKET OUTLOOK V5

MACRO ENVIRONMENTINCREASES IMPORTANCEOF SELECTIVITYby the London & Capital Investment TeamGlobal Macro & Market OutlookSecond Quarter 2016The views of the London & Capital Investment Teamacross the asset markets, examining the fundamentalbackground and factoring in the economic outlook.

PARTNERSHIPINVESTMENT CHOICEPRUDENCELondon & Capital’s approach to investingis the same as our approach to our clients.We listen and observe. We ensure we havea complete understanding and then investaccordingly to provide financial stability andinvestment returns. No hunches, just learningfrom homework and history.Call us on +44 (0)207 396 3200or visit londonandcapital.com

SUMMARY GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEWGlobal Macro Overview 2US 8 CONCLUSIONCanada 11Eurozone 14UK 17Japan 20China 23India 26Asset Markets Overview 29Equities 29Fixed Income 31Financials 33Hedge Funds 34Conclusion 361 Global Macro & Market Outlook Second Quarter 2016

Global Macro Overview GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEWIt was a tortuous start to the year, as realistic and unrealistic CONCLUSIONfears combined to create a significant market downturn in thefirst half of the quarter. Sentiment finally began to turn around bymid-February, with a significant divergence between Europeanrisk markets and the US and Emerging Market (EM), as thelatter completed a full turnaround. Concerns came from multiplesources including a precipitous drop in the Shanghai stockmarket to kick-off 2016, a further sharp decline in oil, overblownfears over a global recession and European bank capitalisation.As we did at the start of the year, it is critical to take astep back and examine the underlying economic risks andcompare these to what the market is discounting. In doingso, we saw early in the year that certain risk markets wereincreasingly discounting a significantly worse economicout-turn than the most likely outcome. Yes, global economicrisks were on the downside at the start of the year andremain so in certain regions, but market valuations such ascredit spreads have been discounting an outright recessionwith default rates rising to levels last seen during the financialcrisis period. It is right to argue that the global economy is notas robust as it should be after an unprecedented period ofzero rates and we have to reiterate our belief that we remaintrapped in an era of abnormal sub-par growth coupledwith low inflation. Overall, our global growth projection ismarginally lower at just below 3%, with the developed worldat c.2% and the developing economies at 4-4.5%.Central banks have had no option but to step back into the fray.The European Central Bank (ECB) action was anticipated butthe Fed’s dovish tone coming as more of a surprise. The ECBhas moved rates further into negative territory and belatedlyalso expanded its asset purchase programme. The Fed hasalso dropped two of the four potential rate hikes this yearresponding largely to global market concerns and the resultanttightening in financial conditions. China and India also remainon a loosening path responding to lower price pressures.2 Global Macro & Market Outlook Second Quarter 2016

The asset market outlook is not materially different from what GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEWwas expected last quarter. In the equity spectrum there is agreater domestic bias within our US and European allocations CONCLUSIONwhereas the UK allocations will have a greater internationalfocus. Corporate earnings are expected to rise by c.5% butwith no multiple expansion expected. In fixed income we haveidentified pockets of value within financials, selective emergingmarkets as well as a bias towards Euro and Sterling high yield.In this quarterly update there are three distinct sections: Thefirst looks at particular macro/market orientated risks, thesecond section outlines key country level macro analysis andfinally the asset market outlook.Macro risk analysisThere are always risks around but at times these can beoverdone and can lead to a form of paralysis. QuotingArchbishop Justin Welby1 (who was writing in a differentcontext but his words are equally applicable to managingassets) “when faced with risk there was a proper balance to bestruck between recklessness and terrified immobility”. He wenton to say “an obsession with managing risk led to cowardiceand paralysis of action”.In the early part of Q1, markets did seem to be almostparalysed by exaggerating certain risks and began to discounta whole host of outcomes some of them wholly conflictingvarying from recession, deflation, inflation, banking crisis, Fedrate hikes, cutting rates and so on. In other words almostanything was seen as a risk. Even though sentiment hasturned around there is a feeling that the uncertainty or paralysisis only just under the surface. We cannot provide definitiveanswers as it comes down to a matter of opinion but whatwe can reiterate is the factual information that we base ouranalysis on. Rather than examine all of these factors we willoutline our perspective on two particular issues: Risk of arecession and European banks.1Justin Welby – The Road to Canterbury3 Global Macro & Market Outlook Second Quarter 2016

Risk of a global recession GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEWMarket and consensus estimates for economic growth wererather bullish coming into the New Year and received an CONCLUSIONalmighty jolt from the sharp fall in the Chinese stock marketthat quickly reverberated across global stocks. As a bear likemarket took hold this inevitably led to comparisons with thegreat “2008-2009” recession, as market sentiment basedmodels quickly began to project a recession. Risk measuressuch as volatility, options and risk appetite were all used askey parameters in projecting an impending recession. Ofcourse markets are hardly rational or accurate predictors ofrecession and as Paul Samuelson famously stated some yearsago, markets have accurately predicted nine of the last fiverecessions. However, it would be churlish to merely ignore suchsigns but the correlation is hardly compelling and not all marketbased indicators such as the government yield curve slope werein rec1e. PssroiobnaabrilyityteorfriRtoercye.ssion, 2016:Q1–2016:Q470 Yield curve slope and60 October 2015 WEO: 201–5:Q3 2016:Q2 US recessions April 2015 WEO: 2015–:Q1 2015:Q4 Source: Citi50403020100 United Euro area Japan Emerging Latin Rest of the States Asia America 5 worldWhat is the reality in the background?Growth did slow in the second half of 2015 to under 3% as theUS recorded just 1.4% growth in Q4 and Japan also slowed.Within the EM block commodity exporting countries slowedsignificantly, with Russia and Brazil in outright recessions.Offsetting this the majority of commodity importing countriesreceived a positive impulse including India and China, with theformer recording the fastest growth rate for many quarters.Nevertheless growth rates were lower but not implying arecession. It is also important to note that despite all of the drum4 Global Macro & Market Outlook Second Quarter 2016

beating the IMF has lowered their global growth projections by GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEWjust 0.2% to 3.2% for 2016 and by 0.1% to 3.5% for 2017. Thisis still higher than London & Capital's global growth scenario. CONCLUSIONBoth the developed and developing economies are growingalbeit not at the rates that would be consistent with historicallyloose monetary policy.The supportive factors‧‧ Consumer demand expanding in all developing countries. On average consumption accounts for c55% of GDP.‧‧ Real wage growth has received a boost from lower inflation and companies have received a boost from lower input prices (commodities).‧‧ Housing and ex-energy capital investment is on a positive trajectory.‧‧ Currency depreciation in a number of countries/zones (Eurozone, Canada and India) has provided a positive impulse to growth through improving terms of trade.‧‧ Extremely accommodative monetary and supportive fiscal policy in a number of countries including Canada, the US, Germany and Italy.The negative factors‧‧ Energy and commodity related investment has taken an absolute battering over the past 12-months, with the reductions at unprecedented levels as highlighted by the steep drop in rig count in the US. In some countries the drop was c25% last year lowering growth by c0.4%. The drag from this in the developed world is almost behind us but within oil exporting countries a further downward adjustment in spending is factored in to our growth projections.‧‧ Sluggish world trade growth as China rebalances (with a slow-down in import growth). Further concerns are being fuelled by fears of a currency devaluation if the People's Bank of China (PBoC) undertakes an aggressive Yuan devaluation strategy.‧‧ Low manufacturing confidence translating into lower industrial production.‧‧ Low inflation rates and negative interest rates across a number of major economies.5 Global Macro & Market Outlook Second Quarter 2016

Overall, even with a weaker growth profile in the US, Europe, GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEWUK and Japan a recession would require a contraction inconsumer spending which remains a remote possibility given CONCLUSIONthe underlying factors: Positive nominal and real wage growth,positive job creation, supportive housing, low interest ratesand higher credit availability. Non-energy capital expenditureis being sustained first and foremast by rising consumerdemand. However, companies themselves have been raisingcapital expenditure due to the need for replacement capital,new research and development and in some cases expandingplants in new regions, whilst benefitting from low interest ratesand a higher appetite for lending by banks as well. We willcontinue to monitor underlying trends in consumption andnon-energy capital expenditure and look for any significantdeterioration in either of these key driving forces.Part of the explanation for the fear of recession is that globalgrowth remains trapped in a sub-par trajectory and anymishaps can act as a destabiliser.European banking concernsEuropean bank stocks and subsequently bonds suffereda significant leg down in January as markets suddenlybecame concerned about a number of issues ranging fromdeteriorating earnings, the potential impact of negative interestrates, falling oil prices on the loan book, emerging marketimpact, recession impact and fears over AT1 debt couponsuspensions. Fall in European stocks quickly moved across toglobal banks underlying the broader risk markets, with creditspreads also widening. However, the situation has changeddramatically since the low point in early February, with bankbonds staging a recovery (as spreads have narrowed) whilstequities have continue to lag. Stocks lagging is justified giventhe deleveraging of bank balance sheets and the resultantlower ROE (return on equity).Rather than look at every aspect of the risk fears we will mainlyfocus on coupon suspension risk.6 Global Macro & Market Outlook Second Quarter 2016

AT1 coupon risk GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEWThe European regulators comments late last year on themechanism for coupon payments on AT1 debt suddenly CONCLUSIONsprang into focus in late January and was largely the catalystfor the severe sell-off in bank share and bond prices. Themarket fear was that coupon payments would be suspendedby a whole host of institutions, although Deutsche Bank (DB)was at the epicentre following the release of a quarterly loss.DB subsequently released a statement stating that there wassufficient liquidity to pay coupon payments on AT1 debt. Theyalso announced a bonus pool in excess of €2 bn which madea mockery of the non-coupon payment threat. As shown byDB, there was never any real threat of such a suspension inour view in any case for the largest European banks as all ofthem had sufficient capital.Following the furore at the beginning of the year, the ECB andEuropean Banking Authority (EBA) moved to clarify the issueand stated that AT1 investors deserve particular protectionand that their intention was not to impose any hard restrictionson banks with regard to coupons. They also clarified theprimacy of coupon payments above dividends and bonuses.In essence the regulation clarification removed the threat ofongoing volatility over AT1 debt around earnings release.Our basic thesis of running an overweight in bank debt(focussed on G-SIFIs’ and National Champions) was stirredbut not shaken over the past quarter and we reiterate some ofthe key points underlying our positive stance:‧‧ Far more resilient balance sheets – rising CET1 ratios.‧‧ Improving quality of balance sheets.‧‧ Increasing amount of liquid assets.‧‧ Regulatory drive enabling banks to become standalone economically viable entities. 7 Global Macro & Market Outlook Second Quarter 2016

US Economic Outlook GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEW‧‧ Slight downward growth revision for 2016 to 2% from 2.5% CONCLUSION led by domestic demand.‧‧ Consumers remain the main driver for the economy.‧‧ Gradual monetary tightening as politics keeps fiscal policy side-lined.OverviewQ1 data has been mixed, including a relatively strong labourmarket, confidence levels stabilising within manufacturing andservices, a strong dollar hurting net trade and a slightly lessrobust consumer. In light of this, our GDP growth projectionhas been lowered by 0.5% to 2% and is disappointingparticularly in context of a prolonged period of zero interestrates. There are challenges ahead but these should notoutweigh the undoubted domestic strengths. The Fedhas adopted a far more dovish tone concerned by globalconditions but has left itself rather vulnerable to a pick-up ingrowth momentum. US: Non-farm payrolls. Source: Oxford Economics/Haver Analytics.8 Global Macro & Market Outlook Second Quarter 2016

US: Consumer prices GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEW Source: Oxford Economics/Haver CONCLUSION Analytics.Key detailsDomestic demand will continue to be main contributors togrowth this year, with consumption, housing and businessinvestment all set to grow steadily. Consumer spendingcontinues to be the key component. Last year, consumptionwas resilient in the face of market turbulence and fears abouthigher interest rates. Consumers are still confronted withmarket turbulence but risks of a steep rise in rates will be lessof a headwind this year. The ingredients are certainly presentfor relatively robust personal spending this year given solidemployment gains, higher real disposable income, lowerhousehold leverage and supportive household formation.A robust jobs market will underpin the consumer, with theunemployment rate at its lowest since 2008. A broad rangeof employment indicators also improved over the past yearremoving a large part of the labour market slack. There is littleto suggest that employment growth will slow in 2016 andwage growth should also gradually pick up. This should boostreal disposable income, which has already received a decentboost from lower inflation. Ex-energy business investment isset to expand modestly. The external sector will continue tobe a drag on growth due to a combination of a strong dollarand lacklustre domestic demand from many trading partners.World trade growth has slowed to the weakest since the 20089 Global Macro & Market Outlook Second Quarter 2016

crisis and the outlook is not particularly rosy with the US dollar GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEWstill expected to strengthen against major trading partners,whilst a rise in US consumption will inevitably lead to CONCLUSIONhigher imports.Policy backdropThe Fed has adopted a far more dovish tone on the back ofworsening external conditions and the resultant tightening infinancial conditions. To some extent the Federal Open MarketsCommitte (FOMC) has merely confirmed market expectations.FOMC doves are definitely in the ascendancy (although thehawks are still present) and have removed two of the four ratehikes that were implied by internal projections in 2016. Ourbase case of rates rising gradually by 1% over the next 18months remains intact. There are dangers for the Fed in itsstance as it is pretty clear that external conditions have been akey driving force in their change of tone but if domestic growthpicks up or inflation rises, will they continue to ignore thesepressures? The Treasury market has been underpinned bymarket volatility and the Fed’s new stance. Another positive isthat the Fed’s balance sheet will not be shrunk until rates havenormalised (i.e. no danger in 2016 or 2017). Fiscal policy hasbeen on the sidelines and we expect no change with an evercolourful Presidential election season ahead. 10 Global Macro & Market Outlook Second Quarter 2016

Canada Economic Outlook GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEW‧‧ 2016 growth looking more robust.‧‧ Consumers and net trade key sources of growth but energy CONCLUSION sector will be a drag on growth.‧‧ Significant fiscal loosening announced with monetary policy on hold.OverviewThe domestic economy slowed in 2015 buffeted by weakercommodity prices (in particular oil) and slower Chinese growth,with growth at a fairly mediocre 1.2%. We have lowered theprojected growth rate for 2016 by 0.5% to 1.25% largely due tothe continuing drag from the energy sector and net trade. Thefact that the US as a major trading partner is continuing toexpand is a positive particularly as growth is being driven by theconsumer which should help exporters. However, the economyhas slowed and continues to face other external and domesticthreats leaving the risks overall on the downside. The Bank ofCanada (BoC) has recently hit the pause button and given theloosening in fiscal policy it may sit on its hands a bit longer. Canada: Monthly GDP by industry. Source: Oxford Economics/Haver Analytics.11 Global Macro & Market Outlook Second Quarter 2016

Canada: 2016 Budget GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEW deficit outlook. Source: Oxford CONCLUSION Economics/ Department of Finance.Key detailsBusiness investment was a large drag on the economy in 2015and remains a risk in 2016 despite the recent rise in oil andbroader commodity prices. Significant cutbacks have alreadybeen announced in the commodity and oil sectors (centredacross certain Provinces such as Alberta). There has been asurprisingly large movement of labour out of Alberta into bettergrowth provinces such as Ontario and Quebec. It feels as ifthe restructuring in the energy sector is not just a temporaryphenomenon. Away from energy there are indications thatcapital expenditure should begin to rise but the overallcontribution will be extremely small and the risk is that it maywell be a drag yet again this year. A weaker currency shouldhelp, as net exports should emerge as a main strength helpedby relatively strong US personal spending, whilst importsshould be lower this year. The outlook for consumption will becritical given the weakness elsewhere in the domestic market.There is good news as consumers should be supported by abuoyant labour market, higher real earnings, looser monetarypolicy and higher credit lending. As inflation eases real incomegrowth will receive an additional boost on top of the tax relatedchanges introduced by the new Liberal government. This setsthe scene for spending to rise by c1.5% this year and shouldrecord faster growth rates in the medium-term.12 Global Macro & Market Outlook Second Quarter 2016

Policy backdrop GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEWThe BoC hit the monetary pause button in Q1, partially dueto slightly better economic data but largely as it waited for CONCLUSIONthe new budget. The Liberal government’s new budget wasexpansionary and will lead to budget deficits of c.1-1.5% overthe medium-term. The main focus is on an extra C$120 bn ofinfrastructure spending over the next decade and this shouldprovide a direct boost of 0.5% (per annum) to economicgrowth over the next few years. There are further measuresto redistribute taxes to low/medium wage earners that arealso growth supportive. This fiscal loosening will lead to higherbond issuance across the yield curve including a new 3-yearbond. However, Canada has fairly low debt levels and will runfairly small budget deficits so that its AAA rating should be inno danger. The BoC will be in no rush to loosen policy at thisstage. It gave itself room for manoeuvre by shifting the lowerbound on interest rates to -0.5% from +0.25% late last yearand also included the possibility of asset purchases inits armoury.13 Global Macro & Market Outlook Second Quarter 2016

European Economic Outlook GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEW‧‧ 2016 growth still projected to be in a 1.5-2.0% range led by domestic demand.‧‧ Consumers and business investment will be the main sources of growth.‧‧ The ECB has responded to low growth and low inflation and will remain a force.Overview CONCLUSIONThe economy continues to recuperate bolstered byaccommodative ECB monetary policy, better labour marketdynamics and a stronger consumer sentiment. Eurozone GDPis set to accelerate marginally from the 1.5% growth rate seenin 2015 (still lagging behind the US and UK). Germany willremain the shining light but some of the peripherals are closeon its heels despite the political concerns in Spain and theterror attacks in France. The ECB has been extremely activethis year although we would argue belatedly so, with a furtherrate cut and an expansion in asset purchases. This may not bethe end of ECB action.5 %yoy Euroarea Inflation Euroarea Inflation. HICP Core Source: DB and4 Morgan Stanley.3210-1 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 201614 Global Macro & Market Outlook Second Quarter 2016

4.0 Forecasts Euroarea Inflation. GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEW3.0 Source: DB and Morgan Stanley.2.01.00.0-1.0-2.0-3.0-4.0 2003 2005 2007 2009 2011 2013 2015 2017 2001 Consumption Government Investment Net Exports InventoriesKey details CONCLUSIONDomestic demand will be the main source of growth this yearas consumption and business investment accelerate modestly.Households are escaping the crisis era as the employmentpicture continues to improve as highlighted by the drop in thearea-wide unemployment rate to its lowest since the financialcrisis. Despite recent political and banking issues, Spain andItaly are likely to be in the forefront for jobs growth but evenGermany and France should record solid jobs growth. Realwage growth has also picked up and confidence levels arerising from relatively depressed levels. In fact in Germany theinfluential union IG Metall are asking for a wage hike of up to5%. Capital expenditure will also be supportive as investmentacross the Eurozone is on a firmer footing. ECB action has ledto a significant drop in lending rates and a resultant pickup inbank lending to companies. This remains important for Europe,as European companies are far more reliant on banks thantheir US counterparts. Interestingly, the German investmentcycle has been weaker reflecting concerns over demand inChina and the US and the former is likely to continue to bea drag on German growth and investment due to its largeproportion of engineering companies. Weakness in world tradegrowth has not had a significant impact to date but remainsan area of concern. However improving trade due to a weakerEuro and lower labour costs has certainly been beneficial andon balance should be supportive in 2016.15 Global Macro & Market Outlook Second Quarter 2016

Policy backdrop GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEWThe ECB responded aggressively last month as it loweredboth its growth and inflation projections. There were three CONCLUSIONkey measures: Cutting rates further into negative territory,expanding the asset purchase programme by €20 bn to€80 bn per month and four new Targeted Longer-TermRefinancing Operations (TLTRO) programmes. The end datefor QE for the time being is still March 2017. However, unlikethe botched response in December the QE expansion wasimmediate and widened the net to include investment gradenon-financial corporate bonds. This has widened the potentialasset purchase pool by €500 bn. In forward guidance,Mr Draghi has indicated that the ECB is unlikely to cut ratesany further and will rely far more on QE. The measures areof course designed to support growth whilst also boostingbanks but the main target is higher inflation or at least endingthe threat of deflation. To this end some ECB measures are inplace ready to be used again by late summer if needed. 16 Global Macro & Market Outlook Second Quarter 2016

UK Economic Outlook GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEW‧‧ Economic growth has slowed and risks remain on the downside, with exceptionally low inflation.‧‧ Consumer demand remains the key source of growth.‧‧ The Bank of England (BoE) remains on the side-lines as the BREXIT referendum approaches.Overview CONCLUSIONThe UK economy has been a star performer over the past fewyears despite fiscal austerity and it is likely that this positionmay come under threat despite relatively strong consumptionand investment. There was considerable momentum intothis year but also pockets of concern such as external tradeand the looming European referendum that could yet dentconfidence and significantly lower growth projections. However,at this stage neither should derail the economy although itcould trim the projected growth rate of 2.5% for 2016. Policywill be broadly supportive this year, with the BoE expected toremain on hold for most of the year. 65 1.5 UK PMIs have tracked lower over recent months,60 1 suggesting a moderation in GDP. 0.5 Source: Deutsche55 0 Bank and Markit, Haver Analytics.50 -0.5 -145 UK composite PMI (LHS) -1.540 -2 GBP growth (%, qoq, rhs)35 -2.5 Apr-06 Sep-06 Feb-07 Jul-07 Dec-07 May-08 Oct-08 Mar-09 Aug-09 Jan-10 Jun-10 Nov-10 Apr-11 Sep-11 Feb-12 Jul-12 Dec-12 May-13 Oct-13 Mar-14 Aug-14 Jan-15 Jun-15 Nov-15 Apr-1617 Global Macro & Market Outlook Second Quarter 2016

UK: Retail sales volumes. GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEW Source: Deutsche Bank and OEF. CONCLUSIONKey detailsConsumers have been the main driving force and the economyremains on track to record the fastest growth rate for almosta decade. The labour market is strong, with robust job growthand falling unemployment. There are pockets of skill shortagesappearing which should begin to permeate into higher payrewards. Real income growth is set be over 3% as low inflationpersists. In the background, household finances are better asinterest rates have been kept low for a long period. Of coursehousing remains integral to the fate of consumer spending andthere is little to hit sentiment, with interest rates likely to remainlow. However, recent government measures should cool thebuy-to-let sector. A whole range of housing indicators includingmortgage lending, approvals, transactions and affordabilityare all fairly positive. Rather encouragingly capital investmenthas been a good source of growth. Companies have beenfairly nimble and have ramped up capital expenditure dueto favourable financing conditions and the desire of banksto lend. Survey intentions from the CBI amongst others arefairly positive. Investment is set to rise in real terms by 4.5-5%over the next couple of years. The referendum is a potentialnegative for the economy at least in the short-term as there issome evidence that business confidence is being hit(albeit marginally).18 Global Macro & Market Outlook Second Quarter 2016

Policy backdrop GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEWThe BoE remains on hold, with inflation significantly belowtarget and economic concerns over the forthcoming EU vote. CONCLUSIONGovernor Carney has turned more dovish and is more in stepwith the majority on the Monetary Policy Committee. Thechange in tone by the Fed has more or less been mirroredby the BoE. The main BoE target (Inflation) is undershootingsignificantly and is set to remain way below target for aprolonged period. As expected the Financial Policy Committeeand the Chancellor have taken steps to cool the buy-to-letsector of the housing market as part of its wider remit. Overallthe BoE is expected to adopt a fairly cautious stance and movegradually particularly given the impact of China, the volatility infinancial markets and the fact that even when the Fed moves itwill do so only slowly. Fiscal policy will continue to remain a dragon the economy. 19 Global Macro & Market Outlook Second Quarter 2016

Japan Economic Outlook GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEW‧‧ Mild economic growth confirmed and risks are still on CONCLUSION the downside.‧‧ Consumption is key and is mixed.‧‧ Look for monetary and fiscal measures to bolster economic growth.OverviewHas Abenomics failed? Growth has slowed, inflation is closeto zero as deflationary concerns have returned and the Yenhas rallied despite negative interest rates. Worryingly inflationexpectations have continued to move lower. The economicmomentum into 2016 was still relatively weak, with headwindsfrom China and an erratic consumer. The economy is stillexpected to expand but by a rather modest 1%, with the riskson the downside. The support of a weaker Yen has begunto wane as sluggish world trade growth has had an adverseimpact. Although, the Bank of Japan (BoJ) has moved ratesinto negative territory, further monetary and fiscal action is onthe cards. Japan: 5yr-5yr swap rate. Source: OEF. 20 Global Macro & Market Outlook Second Quarter 2016

Japan: Inflation. GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEW Source: OEF. CONCLUSIONKey detailsOn the surface the revised Q4 2015 GDP numbers (at -0.3%from -0.4%) were better but the mix pointed to a weakerconsumer and early 2016 indications are rather worrying.Consumption declined sharply late in 2015 and variousspending related indicators are rather mixed; real spendingfalling, retail sales weak through the turn of the year, realdisposable income growth suddenly slowing markedly andbusiness and service sector sentiment turning lower. Thissuggests that overall consumption growth will remain tepidthis year. A tight labour market should be good news forwage negotiations but maybe outweighed by lower inflationexpectations that tends to reduce wage growth. Businessinvestment that had been fairly resilient following upwardrevisions in Q3/Q4 last year is set to weaken if the mostrecent Tankan Survey turns out to be accurate. The basicenvironment is certainly conducive to businesses stepping upinvestment as bank lending is edging higher, interest rates arestill low and corporate profitability is fairly robust. But there isthe continuing external threat to growth. The recent marketturmoil in China is hardly positive for Japan and it remainsvulnerable as about a fifth of Japanese exports go to China.Although some of this may be offset by the US,slower world trade growth will clearly be negative for overallgrowth prospects.21 Global Macro & Market Outlook Second Quarter 2016

Policy backdrop GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEWThe accommodative BoJ monetary stance will continue asQQE (Quantitative and Qualitative Easing) is bolstered by the CONCLUSIONintroduction of negative nominal interest rates. Policymakersare rightly concerned by the sharp decline in inflationexpectations as surveys covering businesses and consumersall point in the same direction. The fear is that it could lead tolower nominal and real wage growth and endanger growthand plunge the country back into deflation. The sharp rally inthe Yen will not help either. Although, the BoJ left the size ofasset purchase programme unchanged at 80 trillion Yen (16%of GDP) it is expected to raise this to 100 trillion in comingweeks. This programme already includes corporate bonds,equity-linked ETFs, J-REITs and was extended to acceptanceof foreign currency denominated loans on deeds as eligiblecollateral and extending the maturity of Japanese GovernmentBond purchases. The BoJ is likely to cut rates further intonegative territory. Fiscal policy is likely to be loosened witha new supplementary budget likely to provide an extrasupportive leg to economic growth including ditching theconsumption tax hike. 22 Global Macro & Market Outlook Second Quarter 2016

China Economic Outlook GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEW‧‧ Elevated market volatility is a sign of a painful economic CONCLUSION rebalancing underway.‧‧ Our GDP growth projection of 5-5.5% is retained which is lower than official projections.‧‧ Active policy intervention will continue in 2016.OverviewThe New Years day market rout re-ignited fears of a hardlanding in China and although growth is slowing a recessionis not on the cards. However, we reiterate our commentsfrom last quarter: A painful rebalancing is underway andthis transformation cannot be completed in a hurry. Fixedinvestment accounts for almost half of GDP and this is clearlynot sustainable. We retain our projection of a more modest5-5.5% growth pace over the next few years. There are otherchallenges for the policymakers including articulating a clear FXpolicy and managing deleveraging in key parts of the economy. Housing prices and sales. Source: Oxford Economics and CEIC Data.23 Global Macro & Market Outlook Second Quarter 2016

One-year deposit rates GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEW vs CPI. Source: Oxford CONCLUSION Economics and CEIC Data.Key detailsThe government has been cutting spending through thestate owned enterprises which has contributed to investmentslowing down. Additionally, the removal of the oversupplyin housing is also underway. We are in for a period ofinvestment growth of 3-5% per annum and of course as itaccounts for half of the economy it will result in significantlylower growth rates unless the contribution from consumptionand net trade can pick-up. Although, Chinese consumershave been spending at a faster rate, consumption stillaccounts for just 35% of GDP and cannot rise fast enough inthe short-term to counteract the impact of slower investment.However, with strong wage growth and low inflation boostingreal incomes the backdrop for consumption is fairly good.Spending on services is also on the rise particularly for theburgeoning middle class. It is often overlooked that servicesector growth has now surpassed manufacturing and thisgap should continue to widen. Taking into account thevarious aspects consumer spending should grow by 6-7%,contributing around 2.5% to overall growth. A key weaknessis slowing industrial production.24 Global Macro & Market Outlook Second Quarter 2016

Policy backdrop GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEWThe recent National Policy Congress (NPC) confirmed ourview that policymakers will use active intervention to smooth CONCLUSIONthe inevitable economic rebalancing. They will continue touse a combination of monetary and fiscal measures. On themonetary front, the PBoC has already injected liquidity intobanks and cut interest rates including the RRR (ReserveRequirement Ratio). However, rates can still fall by another100-200bps over the next year. On the fiscal front, there area number of measures including a new 'urbanization' policyto help new migrants and will provide direct assistance tolocal governments to facilitate this. Whereas local governmentborrowing is being cut back the central government willramp up the fiscal deficit to transfer money to the provinces.Additionally, the NPC has reiterated its intention to useinfrastructure spending to boost growth, market interventionwill also come to the fore including a further managed Yuandevaluation and measures to prop up the stock market.A potential Yuan devaluation is the riskiest of the toolsavailable as any large move has the potential to destabilisea number of Asian economies and as a result global growth.Chinese authorities are well aware of this and will be cautiousparticularly as the currency now has a weighting in the SpecialDrawing Rights.25 Global Macro & Market Outlook Second Quarter 2016

India Economic Outlook GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEW‧‧ The economy is set to expand by over 7% still shy of PM CONCLUSION Modi’s initial projections.‧‧ Investment and net trade will be sources of risk.‧‧ The Reserve Bank of India (RBI) remains accommodative as external risk indicators improve.Overview:The economy has strengthened over the past few quartersand it has topped recent growth charts. Clearly lower energycosts have been a positive development whilst industrialproduction and consumption have both trended higher overthe past year. The economy is set to grow over 7% but thereare risks particularly from slower world trade growth. There are,as always, fears of significant capital outflows from emergingmarkets. However, the economy is now far more resilient thanthree years ago and should be able to withstand both Fed ratehikes and intermittent volatility spikes. However, more actiondoes need to be taken to ensure that the external vulnerabilityis reduced. The RBI has built up quite a bit of credibility andhas the room to cut rates even further. India: Prices and interest rates. Source: OEF and HSBC.26 Global Macro & Market Outlook Second Quarter 2016

The central government's GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEW fiscal prudence has preserved domestic CONCLUSION stability. Source: OEF and HSBC.Key detailsThe economy continues to buck the global trend as activityactually accelerated in the second half 2015 helped by strongmanufacturing and a pick up in investment. The underlyingtrends point to growth of 7-7.5%, with the risks marginally onthe downside. A potential drag from the external sector andweak investment remain downside risks. In the case of theexternal sector, export growth has been hit primarily by theslowdown in demand across Asia. Any further slowing in worldtrade growth will have a negative knock-on effect. However, itis important to note that China is not a major trading partnerand the country is less prone to Yuan devaluation. Investmentrisks are all domestically orientated, with a backlog of stalledprojects a major impediment. Stalled projects are close torecord highs of almost INR 10 trillion. The crackdown on thestate owned banks has also curtailed lending to the privatesector. Nevertheless, overall investment will still grow by 6-7%but without the constraints it may well have been closer to 8%.There are a number of high profile longer-term infrastructureprojects in the pipeline including a potential high-speed railnetwork that should boost long-term potential growth. Indianconsumers had turned a bit cautious late in 2015 spookedby global concerns and a temporary rise in inflation but signsin 2016 are more promising. As consumption is far moreimportant for India than China, it is important that this slow-27 Global Macro & Market Outlook Second Quarter 2016

down is just temporary. The labour market and wage growth GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEWremain supportive and if inflation eases in coming months it willprovide a further boost. CONCLUSIONPolicy backdropThe Central Bank cut rates yet again in early April as inflationcontinued to ease and fiscal policy was in line with itsexpectations. The repo rate was cut by 25bps whereas thekey marginal lending facility was lowered by 75bps. TheRBI maintained an accommodative stance and with globaluncertainties the RBI will have the room to cut rates furtherthis year. The Central Bank also introduced a number ofmicro measures that are designed to improve the monetarytransmission mechanism. Fiscal policy (in contrast to China)is unlikely to be as active as the government is facing taxshortfalls and is determined to reduce the budget deficit.The state owned banks will receive further capital injectionand some further reforms will be enacted to ease up theinvestment bottlenecks. 28 Global Macro & Market Outlook Second Quarter 2016

Asset Market Outlook GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEWEquities CONCLUSIONThe first quarter of 2016 oscillated wildly with global equitymarkets falling sharply in January before recovering from mid-February to quarter end. The main drivers of equity marketscontinues to be central bank actions, China and commodities.US‧‧ The US equity market appears fairly valued given the outlook of anaemic earnings growth and a heightened risk environment.‧‧ The strength of the US Dollar continues to impact US corporates but given the status quo the magnitude of this will begin to lessen as the year progresses.‧‧ The upcoming first quarter earnings season is anticipated to show a year-on-year decline in earnings.‧‧ Despite the recent bounce, we believe that commodity and industrial cyclicals should still be avoided as valuations are not cheap enough given the outlook and it is likely to be lower for a longer term.‧‧ Volatility is expected to stay at elevated levels with further uncertainty, as such as the US Presidential elections, causing market concerns.Europe‧‧ European equities underperformed global equities in the first quarter with a strong Euro being especially unhelpful and the ECB monetary actions did not act as an incremental positive for equity markets.‧‧ Despite a moderate recovery in domestic Europe, the macroeconomic headwinds means that we expect lower equity returns in Europe than in 2015.‧‧ Valuations appear more attractive in the UK with higher potential upside but Brexit is likely to depress potential UK returns until the uncertainty around the referendum is resolved.29 Global Macro & Market Outlook Second Quarter 2016

‧‧ However, on a longer term view, Brexit fears may create GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEW good opportunities in high quality UK companies. CONCLUSION‧‧ Overall for Europe, our focus remains on international franchises which have exposure to higher global growth.Japan‧‧ Japan was one of the worst performing major equity markets in the first quarter of the year.‧‧ Inaction by the BoJ resulted in a strong appreciation of the Yen which dented the competitiveness of exporters.‧‧ Longer term the competitive position of Japan does look challenging with high levels of competition in emerging Asia and South Korea which are moving up the value chain.‧‧ Although the valuation of the market appears optically cheap a through cycle approach tells a very different story and unless the stagnant domestic economy turns around the equity returns will be wholly dependent on monetary or fiscal stimulus.Emerging Markets‧‧ EM equities finally outperformed Developed Market equities after a period of significant declines.‧‧ A weaker US Dollar and a stabilisation in commodity prices helped EM returns.‧‧ However, the sustainability of the bounce in commodities is questionable and it is expected that in many countries a long fiscal drag is required to restore sovereign finances.‧‧ We prefer EM equities that are driven by consumption and development. In geographic terms, Asia is still the focus area.‧‧ Valuations remain attractive in EM equities but a prolonged stabilisation in currencies, fiscal positions and foreign direct investment is required for the equity outlook to become more positive.30 Global Macro & Market Outlook Second Quarter 2016

Fixed Income GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEWTo the untrained eye, the first quarter of 2016 may look CONCLUSIONa relatively uneventful period for most fixed income creditmarkets as yield spreads closed near to where they had ended2015. On closer inspection, it was one of the most volatilequarters for quite a few years and was accompanied by astrong rally in government bonds. The laggard for the periodwas subordinated financial debt, though this comes after along period of superior performance to other credit sectors.Government Bonds‧‧ The most recent FOMC attestations have created a rush for real-return bonds as some investors feel that the Fed will get “behind the curve” with its prolonged softly-softly approach to monetary policy. The conundrum is that most domestic economic data is pointing to a reasonably steady picture for demand (see the Macro piece). With the 10-year real yield close to zero, the nominal Treasury bond yield is pretty much at the implied (“breakeven”) inflation rate of 1.6%. CPI may drift higher over the months ahead but not excessively so – this should limit any substantial moves higher in Treasury bond yields.‧‧ The story in the Eurozone will continue to be heavily influenced by the ECB’s asset purchase scheme, spurned by the powerful combination of negative net supply in many regions (more bonds redeeming than are being issued) and a shrinking universe of qualifying maturities that can be bought. By way of an example, the ECB can now only purchase German Bunds longer than 2024 maturity because all shorter issues yield less than the cap of -0.2%. Expect the long end of the yield curves to continue to be the greatest beneficiaries of ECB action.‧‧ Elsewhere, much of the short-term outlook for UK Gilts hinges on the outcome of the June EU referendum. The polls are suggesting a close contest: a vote to exit should ultimately be supportive of the gilt market due to growth concerns, while continuing with the status quo may lead to some underperformance to Bunds.31 Global Macro & Market Outlook Second Quarter 2016

‧‧ In Japan, the bellwether 10-year bond has finally broken GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEW below the zero yield barrier, a testimony that any further quick or structural fixes by the Ministry of Finance/BoJ to bolster CONCLUSION demand and inflation will most likely prove ineffective.Investment Grade‧‧ US Investment Grade (IG) spreads had widened to levels that are historically associated with an imminent recession. This has come despite a massive outperformance by the interest rate swaps market versus Treasuries. High quality IG debt normally tracks the swaps market but additional pressures such as lower secondary market liquidity contributed to spreads hitting the widest levels for almost 4 years in mid- February before staging a long overdue recovery. Balance sheets have become more robust over the past 2 years from a credit perspective, which should allow the sector to build on the recent revival of interest.‧‧ The long-awaited announcement by the ECB to include corporate IG debt issued by Eurozone-based borrowers has resulted in both a scramble by investors to buy qualifying issues (in part, as a replacement to government bonds already sold to the ECB), as well as fuelling a surge in IG debt issuance to take advantage of this extraordinary environment we find ourselves in. The outlook for this sector is that because there are two significant sources of demand (ECB and private investors) that need to invest into high grade paper, the sheer weight of money will continue to support bonds issued by both domestic and overseas borrowers (which should from a substitution effect to domestic paper).‧‧ As with gilts, the period until 23rd June (EU referendum voting day) may hold investors back from over-allocating to GBP IG credit, especially to UK names. The overall state of the UK economy is in reasonably sound shape, as are the vast majority of corporate balance sheets, so fundamentally there continues to be a strong case to expect further spread compression.32 Global Macro & Market Outlook Second Quarter 2016

Financials GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEW‧‧ One of the stark features of the first half of the 1st quarter CONCLUSION was the significant underperformance of financials against other competing fixed income asset classes. Whilst most other credit sectors managed to recover from the wide spread levels, financial spreads remain wider than end-2015 levels.‧‧ Concerns over bank earnings following a few quarters of tough trading conditions has forced some of the larger banks to scale back investment banking operations, and focus on retail and wealth management which have a much more stable revenue stream. This change of employing bank capital is a big positive from a credit viewpoint, as it reduces the amount of risk-weighted assets from the balance sheet, and should therefore raise the capital ratios that are followed by so many. This will build on the overall trend recorded over the past few quarters that have recorded a material fall in risk-weighted assets.‧‧ We may well need to get through the Q1 earnings season before the spreads on financials catch up with the recovery seen in corporate credits since the mid-February widening.High Yield‧‧ Much of the negative performance recorded by US High Yield (HY) in 2015 was attributed to the poor showing by the energy sector, which had been hit hard by the relentless fall in oil and gas prices. Many of the borrowers in the HY space have little or no links to energy, but their performance was nevertheless tainted by investors wanting to reduce exposure to the sector as a whole.‧‧ US non-energy borrowers’ balance sheets remain in a relatively sturdy state, with most of the favoured credits not needing to come to the market for some time, mainly because of the opportunistic extension in the debt maturity profile. Balance sheet cash remains high, and despite the smart recent rally, spreads still have a reasonable amount to come in over the months ahead.33 Global Macro & Market Outlook Second Quarter 2016

‧‧ The relatively smaller EUR HY market has a slightly different GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEW backdrop as despite not being on the ECB’s buying list, a proportion of the flood of money swirling around the Euro CONCLUSION area will find its way to the HY sector. A similar effect was witnessed in the US when the Fed opened the floodgates with its own QE.Emerging Markets‧‧ Quietly in the background, both hard currency sovereign EM debt and IG EM debt has been among the most stable performers over the past few months. This comes despite countless threats from many sources that the combination of slowing China demand, the threat of higher US rates and a surging US Dollar would all come together to undermine debt issued by most developing nations.‧‧ Certain geographical regions are of course very reliant on a stable order book from China, but the most attractive/stable areas continue to be in Indian corporates and state-owned banks, high quality Chinese property companies and selected LATAM names that earn much of their revenue in hard currency.Hedge FundsThe broad hedge fund industry has been impacted by thesignificant market volatility being witnessed in world marketsand has disappointingly traded with a high correlation togeneral risk assets, albeit with a low beta and therefore lowervolatility. This has strengthened our case for a highly selectiveapproach among upper quartile hedge fund managers with astrong track record of alpha generation.Overall industry fund flows have essentially ground to a haltwith most activity among market participants now focusedaround a shuffling of the pack; reallocating to recent winnersand less correlated names. This is a trend we expect tocontinue in the coming months as investors adjust to a highervolatility market regime.34 Global Macro & Market Outlook Second Quarter 2016

The broad London & Capital hedge fund selection now GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEWcontains a core of uncorrelated strategies combined with somehigher/risk return opportunistic funds, which we believe will CONCLUSIONprovide the optimal approach moving forward. We continue tosee good opportunities for alpha generation moving forwardand we will look to take advantage multiple strategies acrossthe asset class:‧‧ Equity Long/Short: We continue to focus on sector specific strategies in financials, technology, healthcare and biotech. Increasing intra- and inter-market dispersion is creating strong opportunities for those with specialist knowledge that can take advantage of both long and short opportunities.‧‧ Equity Market Neutral: Both discretionary and systematic market neutral strategies have exhibited strong alpha and we believe this will continue in a bifurcated market. In addition, the low risk profile of neutral strategies ensures a focus on capital preservation in volatile markets.‧‧ Macro/Commodity Trading Advisors (CTA): Will continue to benefit from diverging global macroeconomic performance and policies. In addition, CTAs are poised to benefit from any extended periods of risk off sentiment as evidenced by Q3 2015 and Q1 2016 performance and therefore we believe these strategies provide a complimentary hedge to traditional asset classes.‧‧ Opportunistic: we continue to favour niche high risk/ return strategies in power, agriculture and volatility trading. We believe the uncorrelated nature of these strategies is extremely attractive in the current environment.35 Global Macro & Market Outlook Second Quarter 2016

Conclusion GLOBAL MACRO OVERVIEW ASSET MARKET OVERVIEW2016 is the year of consolidation as the global economy enters CONCLUSIONa period of more restrained growth coupled with higher marketvolatility. Central banks will remain the centre of attention as theECB, BoJ and the main EM banks continue to loosen monetarypolicy whereas the US Federal Reserve follows a gradualtightening path. The spike in volatility in the early part of Q1 wasunnerving for many investors and has led to some changes inasset allocation amongst certain investors particularly withinthe riskier spectrum of financial markets. We entered the NewYear with slighter higher cash balances than normal and havereduced this overweight gradually. We still retain a slightlycautionary stance on equities and remain overweight withinfinancials in and European corporate debt. There are selectivepicks within EM debt as well.36 Global Macro & Market Outlook Second Quarter 2016

About London & CapitalLondon & Capital was established in 1986. A leading firm ofinvestment advisers and asset managers, with an internationalclient base, the Company provides private individuals, familyoffices, institutional investors, intermediaries and charities fromacross the globe with expert advice on offshore and onshoreinvestment strategies. Operating with a boutique culture, London& Capital places a strong emphasis on capital preservation andthe delivery of a tailored client service.London & Capital is an independently-owned company,with some 100 employees worldwide. London & Capital isheadquartered in London, with Group affiliate ‘London & CapitalAsia’ servicing the rapidly developing Asian markets from itsbase in Hong Kong, and 'London and Capital Caribbean',situated in Barbados where it provides support to ourInstitutional clients in the area. The Company is regulated by theFCA (UK) the SEC (US) and SFC (HK).London & Capital Asset Management Limited7 Triton Square T +44 (0)20 7396 3200Regent’s Place F +44 (0)20 7396 3201London NW1 3HG E [email protected] Kingdom W londonandcapital.comLondon & Capital Asia Limited23rd floor, unit 6 T +852 2279 7888Henley Building F +852 2279 78985 Queens Road Central E [email protected] KongLondon & Capital Caribbean LimitedPort St Charles T +1 (246) 271 1332St Peter F +44 (0)20 7396 3201Barbados E [email protected] W londonandcapital.comDisclaimer: London & Capital Asset Management 143286, of 7 Triton Square Regent’s Place is authorised and regulatedby the Financial Conduct Authority, 25 The North Colonnade, Canary Wharf, London, E14 5SH. This document does notrepresent primary research; it provides the views of the London & Capital investment team examining the fundamentalbackground, economic outlook and possible effect on asset markets. This document is not an invitation to subscribe and isby way of information only. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be solelyrelied on in making an investment or other decision. If you are considering investing, you should consult your London &Capital adviser. The views expressed herein are those at the time of publication and are subject to change.Correct at time of going to press.