FOR INVESTMENT PROFESSIONALS ONLY

M&G European Strategic Value Fund First quarter 2018 Fund manager – Richard Halle

Quarterly Review

Past performance is no guide to future performance.

Highlights

• European equities fell in the first quarter as investors were unsettled by the prospect of higher interest rates in the US and a potential global trade war. Value as a style was in line with the market.

• The fund declined but was ahead of the MSCI Europe Index, with stock selection adding value, most notably in the telecoms sector. Danish telecoms operator TDC was the leading contributor following a takeover offer.

• We invested in five new holdings: Spanish financial group CaixaBank, Dutch supermarket chain Ahold Delhaize, Austrian fibres producer Lenzing, logistics firm AP Moller-Maersk, and Qinetiq, a UK provider of technology and solutions to the defence industry. The stakes in H Lundbeck and Bovis Homes were sold.

Performance, attribution & positioning

Past performance is no guide to future performance.

Risks associated with this fund: For any past performance shown, please note that past performance is not a guide to future performance. The value of investments and the income from them will rise and fall. This will cause the fund price, as well as any income paid by the fund, to fall as well as rise. There is no guarantee the fund will achieve its objective, and you may not get back the amount you originally invested. Changes in currency exchange rates will affect the value of your investment. Further risk factors that apply to the fund can be found in the fund’s Key Investor Information Document (KIID). Things you should know: The fund invests mainly in company shares and is therefore likely to experience larger price fluctuations than funds that invest in bonds and/or cash.

Fund commentary European equities fell in the first quarter as volatility returned to financial markets. After a positive start to the year, share prices retreated amid worries about higher interest rates in the US and a potential global trade war. The threat of regulation being imposed on giant technology companies following the Facebook data scandal also contributed to the negative sentiment.

These concerns outweighed some encouraging corporate results and continued robust economic growth in the eurozone.

In terms of sectors, investors rotated away from defensive areas and consumer staples and telecoms were notable laggards. The prospect of higher interest rates arguably dampened investor enthusiasm for so-called ‘bond proxies’. Materials also underperformed.

In contrast, consumer discretionary was the best-performing area, closely followed by utilities. Energy stocks outperformed as oil prices climbed to the highest level since 2014. Recent production cuts appear to have been successful in reducing the global supply glut.

Small-cap stocks continued to outperform their larger counterparts over the period, while ‘value’ as a style was in line with the broader market and ‘growth’.

Against this background, the fund outperformed the MSCI Europe Index, with stock selection adding value, most notably in the telecoms sector. The fund’s holding in Danish telecoms company TDC was a leading contributor as the shares climbed after the company accepted a takeover offer.

Similarly, shares in German renewable energy company Innogy climbed on the news that it would be acquired by German utility firm EON.

Stock selection in information technology was also successful. Finnish mobile network equipment firm Nokia rose on better-than-expected results and the prospect of improving market conditions. Nokia has struggled lately as investment in the 4G mobile network has come to an end. However, the company is optimistic about new investment in mobile infrastructure as telecoms firms appear to be planning the roll-out of 5G networks sooner than expected.

In materials, Finnish pulp and paper company UPM-Kymmene made a positive contribution. As a leading producer of raw materials used in cardboard, UPM has benefited recently from expectations of increased

demand for packaging, driven by the growth of e-commerce and consumer trends in Asia.

On the other hand, stock selection in materials detracted, with shares in Finnish stainless-steel maker Outokumpu declining on concerns about the impact of US tariffs on steel imports. We believe the market’s fears are excessive and Outokumpu will be able to cope with the measures.

Stocks selection in healthcare also cost some performance. Shares in pharmaceutical firm Vectura declined after the company failed to gain US approval for its generic asthma treatment.

Wereldhave, a Dutch property company, was another detractor as the shares fell on weak results and a lower dividend payout. Wereldhave operates shopping centres in Northern Europe and the management team is taking corrective action, including investing in its properties.

Another Dutch holding, Boskalis, cost some performance. The maritime services firm’s share price fell as investors were disappointed by its forecast that market conditions would remain tough for a couple of years.

Elsewhere, the holding in German airline Deutsche Lufthansa detracted, as the stock retreated after an impressive run of gains. We believe the shares remain attractively valued.

Portfolio activity There was a noticeable increase in the number of purchases during the period, as we took advantage of the market turbulence. We started a position in AP Moller-Maersk, a Danish logistics firm specialising in container ships. We believe Maersk should benefit from recent corporate restructuring as well as industry changes.

Lenzing, an Austria-based producer of cellulose fibres, also joined the portfolio. Lenzing creates fibres from pulp using a less water-intensive, more sustainable process. In our view, the company’s technological expertise is not being fully valued.

In Spain, we bought shares in financial group CaixaBank. We believe the Spanish banking sector is attractive, as it has been through a period of consolidation and the Spanish economy has undergone a thorough cleansing after the financial crisis of 2007/8.

Dutch supermarket chain Ahold Delhaize, which has a leading position in Benelux as well as large operations in the US, also joined the portfolio. In our opinion, the company has shown the capability to deal with discount supermarkets, and investors’ fears about the potential threat from Amazon are excessive.

The final newcomer was Qinetiq, a UK provider of technology and solutions to the defence industry.

In terms of disposals, we sold the holdings in H Lundbeck, a Danish pharmaceutical firm, and Bovis Homes. Both stocks have performed well since we purchased them and they were sold as they could no longer be considered undervalued.

In terms of positioning, there was no significant change to the fund’s allocations over the quarter. Energy remains the fund’s largest overweight. Industrials is another notable above-index position.

In contrast, consumer staples is still a large underweight as we consider stocks in this area expensive. The fund’s allocation to healthcare was reduced with the sale of H Lundbeck and is another underweight position.

Outlook

We remain positive about the outlook for European equities in light of the improving economic backdrop, which has helped companies deliver healthy earnings results.

In particular, we believe value stocks look attractive on both an absolute basis and relative to growth stocks, which have been in favour for most of the past decade.

Volatility increased during the quarter and we think it is likely to remain elevated in the near future, particularly compared with the relative calm of recent years. Uncertainty about the introduction of trade tariffs, the withdrawal of economic stimulus measures by central banks and geopolitical tensions are just some of the factors that could unsettle investors in the coming months.

Nevertheless, we believe increased market turbulence could be beneficial for long-term, value-focused investors: sudden and extreme sentiment-driven stockmarket sell-offs can often result in stocks becoming mispriced. As we did during the first quarter, we will look to take advantage of any opportunities that are created by market movements.

Despite the current concerns, we feel there are some encouraging underlying trends in Europe. The economy is relatively robust and there is potential for demand to increase. Importantly, from an investment point of view, we think valuations are reasonably attractive. In this environment, we will continue with our current strategy, using careful stock selection to identify mispriced opportunities.

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