M&G North American Value Fund Fourth quarter 2016

Fund manager – Daniel White

Quarterly Review

Overview

US equities ended the year on a high note as investor confidence was lifted by the election of Donald Trump as

US president and the prospect of stronger economic growth. ‘Value’ as a style outperformed ‘growth’ and the

broader market, helping value stocks to outperform for the whole of 2016.

The fund was ahead of the S&P 500 Index during the quarter and over the year, with stock selection in most

sectors adding value.

During the quarter, we started a new position in Extended Stay America, an operator of extended stay hotels.

Pharmaceutical firm Shire and Ingram Micro, a distributor of computer and technology products, which was taken

over during the period, left the portfolio.

Performance, attribution & positioning

Fund commentary

US stockmarkets ended the year on a positive note,

climbing to record highs. Over the course of 2016, the

US was the best-performing major market, ahead of

the index of global equities.

Investor confidence was buoyed by the surprise

election of Donald Trump as US president and the

prospect of supportive policies such as tax cuts and

infrastructure spending that could boost the US

economy.

As was widely expected, the US Federal Reserve

(Fed) raised interest rates for the first time in a year in

response to the ongoing US economic recovery, in

particular the robust jobs market. A more surprising

development during the quarter was a deal between

oil-producing nations to cut output in an attempt to

boost oil prices.

As investors’ optimism about global growth increased,

there was a notable rotation from defensive sectors,

which have been in favour lately, towards more

economically sensitive areas. Financials led the way,

buoyed by higher interest rates, while industrials also

outperformed. Energy stocks climbed as oil prices

rose. In contrast, consumer staples, healthcare and

utilities were notable laggards.

In terms of market capitalisation, small-cap stocks

were the best performers. In terms of style, there was

a powerful shift to ‘value’, which outperformed the

broader market and ‘growth’ stocks; this rotation

helped ‘value’ outperform over the whole of 2016. It

also provided a tailwind for the fund, which was ahead

of the S&P 500 Index and the Russell 1000 Value

Index over the quarter and 2016.

During the fourth quarter, at the portfolio level, asset

allocation and stock selection both added value.

Stockpicking was positive in all sectors except in

telecommunications.

The fund’s above-index position and stock selection in

financials made the biggest contribution to relative

performance. The fund’s holdings in Goldman Sachs,

JP Morgan and Citigroup were among the leading

contributors to performance. The financial groups’

share prices gained after reporting robust corporate

results, with revenues boosted by increased trading

activity. The stocks received further support when the

Fed raised interest rates, a move that is expected to

boost their profitability. They also gained on the

prospect of lower regulation.

Stock selection in the energy sector added value as

well. Higher oil prices boosted the shares of

McDermott International, an engineering and

construction company in the offshore oil & gas

industry, as well as ConocoPhillips and Hess, two oil

exploration companies.

Eagle Materials, a building materials firm, was another

notable contributor as the shares climbed to their

highest level in two years on the prospect of increased

infrastructure investment after Trump’s victory.

Conversely, the leading detractors were stocks in

defensive sectors which underperformed when investor

sentiment shifted in favour of cyclicals. The fund’s

holding in Livanova, a medical technology company,

detracted after its latest results disappointed.

In the consumer staples sector, Tyson Foods, a meat

producer, also weighed on performance. The

company’s results were weaker than expected and it

announced that it was replacing its chief executive.

Molson Coors was another notable detractor. The

brewing company’s share price retreated after recent

gains following the multi-billion merger between

Anheuser-Busch InBev and SABMiller. As a result of

the deal, Molson acquired SABMiller’s stake in

MillerCoors, the joint venture between the companies.

2016 performance In 2016, the fund delivered positive returns ahead of

the S&P and the value indices. Returns on the sterling

share classes were boosted by the weakening of the

pound during the year.

Stock selection in a range of areas added value, most

notably in the healthcare and materials sectors.

Newmont Mining, a gold producer, was the leading

contributor, helped by rising gold prices in the first half

of the year. Not holding a number of biotech stocks

helped relative performance as they declined on

concerns about potential controls on drug prices.

Shares in Oshkosh, a manufacturer of specialty

trucks, climbed on solid results, driven by increased

sales of military vehicles. McDermott and Eagle

Materials were also notable contributors.

The leading detractor was Cobalt International, an oil

& gas explorer. The company was hurt by low oil

prices and uncertainty surrounding its proposed sale

of an oil-producing asset to the Angolan government.

Elsewhere, the holdings in Alphabet, the parent

company of Google, and Livanova also cost some

performance.

Portfolio activity The fund’s allocation to financials and energy

increased slightly during the quarter, partly as a result

of robust share price performance in both areas.

Financials is the fund’s largest overweight. In contrast,

the fund’s weighting in the healthcare and information

technology sectors was reduced. The industrials

sector is the fund’s biggest underweight.

There was one new purchase during the quarter:

Extended Stay America, an operator of extended stay

hotels. We believe the stock is attractively valued as it

is trading at a discount to the value of its property. The

company is realising some of this value by selling and

franchising a number of its hotels. Moreover, following

a period of heavy investment, cashflows are expected

to increase.

In terms of sales, pharmaceutical firm Shire and

Ingram Micro, a distributor of computer and

technology products that was taken over during the

period, left the portfolio.

Outlook

We believe the outlook for value investing in the US

remains positive. We believe value’s outperformance

can continue – we note that the recent style reversal

is modest in light of the prolonged underperformance

of value stocks over the past few years. The spread

between the cheapest part of the market and the most

expensive remains wide – ‘value’ has further to go

before it has narrowed the gap with ‘growth’.

While we are optimistic that value stocks can continue

to outperform, we recognise that there may be some

headwinds. The value style has experienced a very

strong recovery and future outperformance may not

necessarily continue in a straight line.

There are plenty of uncertainties that could unsettle

investors – not least President Trump’s policies. We

therefore believe it is prudent to remain selective and

construct a well-diversified portfolio.

Looking ahead, we believe the fund is well positioned

for this environment. The fund has demonstrated its

ability to capture the upside when value outperforms

yet keep pace with the broader market when the value

style is out of favour.

Long-term performance

Please note that 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.

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