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COLUMBIATHREADNEEDLE.COM GLOBAL ANNUAL PERSPECTIVES 2016

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Page 1: GLOBAL ANNUAL PERSPECTIVES 2016 - Columbia Threadneedle · 2016-01-20 · market backdrop into a smoother path towards one’s investment goals. In the following pages, our investment

COLUMBIATHREADNEEDLE.COM

GLOBAL ANNUAL PERSPECTIVES 2016

Page 2: GLOBAL ANNUAL PERSPECTIVES 2016 - Columbia Threadneedle · 2016-01-20 · market backdrop into a smoother path towards one’s investment goals. In the following pages, our investment
Page 3: GLOBAL ANNUAL PERSPECTIVES 2016 - Columbia Threadneedle · 2016-01-20 · market backdrop into a smoother path towards one’s investment goals. In the following pages, our investment

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Global Annual Perspectives 2016

CONTENTSINTRODUCTION AND OVERVIEW Robert McConnaughey, Global Head of Research ......................................................................................3

2016: A YEAR OF POLICY DIVERGENCE Mark Burgess, CIO EMEA and Global Head of Equities ..............................................................................4

EQUITY VIEWPOINTS

OPTIMISM IN CAUTIOUS TIMES William Davies, Head of Global Equities ....................................................................................................7

STAYING ADAPTABLE AS MARKETS EVOLVE Leigh Harrison, Head of Equities, Europe ................................................................................................10

ASIAN EQUITY OUTLOOK Soo Nam NG, Head of Asian Equities ......................................................................................................13

ACTIVELY BUILDING PROFITABLE PORTFOLIOS Melda Mergen, Director US Equities ........................................................................................................15

ARE ENERGY STOCKS HEADED FOR A FIFTH YEAR OF UNDERPERFORMANCE? Jonathan Mogil, Portfolio Manager and Senior Analyst ............................................................................ 17

FIXED INCOME VIEWPOINTS

2016 – A YEAR FOR TREADING CAREFULLY Jim Cielinski, Global Head of Fixed Income .............................................................................................19

DURATION, LIQUIDITY, AND DEFAULTS, OH MY! Colin Lundgren, Head of US Fixed Income and Gene Tannuzzo, Senior Portfolio Manager .......................22

ASIAN FIXED INCOME OUTLOOK Clifford Lau, Head of Fixed Income, Asia Pacific ...................................................................................... 24

EMERGING MARKETS STARTING TO LOOK ATTRACTIVE Jim Carlen, Senior Portfolio Manager .......................................................................................................26

MULTI-ASSET/ALTERNATIVE AND OTHER VIEWPOINTS

WILL OUTCOMES IMPROVE FOR DIVERSIFIED INVESTORS IN 2016? Jeff Knight, Global Head of Investment Solutions, Co-Head of Global Asset Allocation ...........................28

ALTERNATIVE BETA AS TRUE DIVERSIFIERS William Landes, Deputy Head of Global Investment Solutions and Head of Alternative Investments ....... 31

AN UNDERAPPRECIATED OPPORTUNITY FOR INCOME INVESTORS David King, Senior Portfolio Manager ......................................................................................................34

CAPITALIZING ON DISRUPTIVE TECHNOLOGIES Robert McConnaughey, Global Head of Research ....................................................................................36

DC WORKPLACE PENSIONS: TARGETING GOOD FINANCIAL OUTCOMES Chris Wagstaff, Head of Pensions and Investment Education ..................................................................38

SUNNY DAYS AHEAD FOR CLOUD COMPUTING John Golden, Senior Analyst ....................................................................................................................40

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MARKET CONTROVERSY + SKILLED INVESTMENT TEAMS = OPPORTUNITY

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Global Annual Perspectives 2016

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INTRODUCTION AND OVERVIEW

THERE IS NO SHORTAGE OF THINGS TO WORRY ABOUT, BUT INVESTORS WILLING TO LOOK BEYOND THE HEADLINES MAY FIND OPPORTUNITIES IN 2016

n �Seven�years�after�the�depths�of�the�financial�crisis,�macroeconomic�growth�rates�are�stubbornly�low�despite�unprecedented�central�bank�interventions�and�increased� global�leverage.

n ��Interest�rates�are�rising�for�the�first�time�in�almost�10�years.�

n �Technological�change�and�globalization�are�challenging�traditional�patterns�of�pricing�power�across�many�industries.�

n �Emerging�markets,�having�played�such�a�large�role�in�boosting�global�growth�rates,�have�shown�signs�of�weakness.

n �Commodity�prices�have�plummeted�with�no�clear�path�towards�recovery.

n �All�of�this�has�elevated�levels�of�fear�and�uncertainty�about�economic�prospects,�feeding�geopolitical�tensions.

2015�was�a�challenging�overall�market,�and�we�do�not�see�a�rising�tide�changing�that�dynamic�to�lift�all�boats�in�2016.�If�anything,� we�suspect�there�will�be�increased�volatility�in�the�year�to�come.� But,�ultimately,�investing�is�about�gauging�the�magnitude�of�market�fears�and�optimism�to�find�situations�where�the�reality�is�different�to�the�embedded�market�assumptions.�Despite�the�doom�and�gloom�headlines,�there�is�actually�a�fairly�rich�array�of�opportunities.� We�believe�that�skilled�teams�can�attack�those�areas�of�uncertainty�in�order�to�take�prudent�risks�and�gain�exposure�to�exploitable�market�inefficiencies.�

A�portfolio�that�uses�a�diversified�palette�of�specific,�rigorously�researched�positions�(including�alternative�strategies)�can�find� ways�to�turn�what�might�appear�to�be�a�confusing�and�intimidating�market�backdrop�into�a�smoother�path�towards�one’s�investment�goals.�In�the�following�pages,�our�investment�team�provides�insights�into�where�we�see�some�of�those�opportunities�as�well�as�risks.� As�always,�our�priority�is�the�investment�success�of�our�clients,� and�we�hope�these�articles�help�you�hone�your�investment�strategy�for�2016�and�beyond.

Finally,�on�behalf�of�everyone�at�Columbia�Threadneedle�Investments,�thank�you�for�your�interest�and�continued�support.�Best�wishes�for�a�healthy�and�prosperous�2016.�

Robert McConnaughey Global Head of Research

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Global Annual Perspectives 2016

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2016: A YEAR OF POLICY DIVERGENCEPolicy�divergence�will�continue�to�dominate�in�2016.�Interest�rates�will�move�away�from�emergency�settings�in�the�US�but�monetary�policy�in�Europe�and�Japan�will�remain�very�accommodative,�and�the�European�Central�Bank�and�Bank�of�Japan�may�decide�to�do�more�to�support�growth.�In�the�UK,�current�pricing�in�the�bond�market�suggests�that�we�won’t�see�any�interest�rate�rises�before�2017.�

2016�will�see�a�low�growth,�low�return�world�with�corporate�margins�pressured�by�weak�end�demand�and�overcapacity�in�a�number�of�industries.�Successful�investors�will�be�those�that�can�find�companies�with�the�ability�to�demonstrate�organic�growth�–�these�prized�stocks�should�trade�at�a�premium�to�their�peers.

The�outlook�for�the�emerging�markets�(EM)�remains�challenging,�particularly�for�those�countries�that�have�built�their�economies�to�serve�Chinese�demand�for�commodities.�The�outlook�for�these�countries�is�downbeat,�and�weaker�currencies�may�not�help�to�lift�demand�for�EM�exports�where�consumer�and�corporate�demand�is�subdued.�A�world�where�the�US�tightens�policy�but�other�central�banks�retain�an�accommodative�stance�should�mean�a�stronger�dollar,�all�else�being�equal.�That�is�likely�to�be�a�further�headwind�for�EMs,�as�there�is�a�strong�inverse�correlation�between�the�dollar�and�emerging�markets.

In�terms�of�valuations,�we�still�regard�equities�as�more�attractive�than�bonds�and�expect�to�retain�that�positioning�for�now�in�our�asset�allocation�portfolios,�although�with�less�conviction�than�we�have�done�for�some�time.�However,�compared�to�their�longer-term�history,�equities�still�offer�better�value�than�bonds.

Mark Burgess CIO EMEA and Global Head of Equities

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Global Annual Perspectives 2016

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A time for active investors where fundamentals will prevailIn�2016,�we�expect�opportunities�for�active,�discerning�investors�to�increase�–�the�rising�tide�of�global�QE�that�had�lifted�all�boats�will�begin�to�ebb,�and�in�that�environment�it�will�make�sense�to�differentiate�within�and�across�asset�classes.�In�this�world,�a�focus�on�valuations�and�fundamentals�–�‘old�school’�investing�if�you�like�–�should�be�more�important�than�it�has�been�in�recent�years,�when�markets�were�backstopped�by�abundant�and�growing�liquidity.

M&A continuesCompanies�remain�reluctant�to�commit�to�large-scale�or�long-term�investment�capital�expenditure,�and�as�a�result�companies�that�do�have�spare�cash�are�likely�to�return�it�to�investors�or�use�it�to�fund�M&A,�as�they�have�been�doing�recently.�In�a�low-growth,�low-return�world,�it�may�make�more�sense�for�companies�to�buy�or�eliminate�their�competition,�rather�than�pursue�organic�growth,�which�is�hard�to�find.�M&A�is�generally�supportive�of�equities�and�other�‘riskier’�assets�such�as�high�yield,�but�it�is�usually�negative�for�investment-grade�companies�as�it�often�involves�some�re-leveraging�of�investment�grade�corporate�balance�sheets.�For�that�reason,�we�have�been�adjusting�our�exposure�to�corporate�credit�in�our�asset�allocation�portfolios,�with�a�preference�for�European�high�yield�over�investment�grade.

At�a�regional�level,�we�continue�to�see�good�opportunities�in�Japanese�equities�and�we�have�also�reflected�this�in�our�asset�allocation�portfolios.�Japan�has�delivered�good�levels�of�earnings�growth�and�this�has�meant�that�equity�valuations�have�remained�attractive,�even�though�the�stock�market�has�performed�strongly.�This�contrasts�with�the�rest�of�the�world,�where�equity�valuations�are�no�better�than�fair�in�most�instances�and�where�corporate�news�flow�is�deteriorating�at�the�margin.

Conditions turn favourable for European equitiesQE,�lower�energy�prices,�euro�weakness�and�loosening�credit�conditions�are�all�enhancing�the�trading�environment�for�European�companies.� There�are�now�signs�of�improvement�in�several�eurozone�economies,�

and�we�anticipate�that�domestic�European�earnings�will�continue�to�contribute�strongly�to�overall�corporate�profitability.�On�the�international�front,�we�are�monitoring�the�economic�outlook�for�China,�and�evaluating�the�potential�impact�on�European�exporters�and�global�growth.�

Many�companies�in�Europe�(outside�the�financial�sector)�have�strong�balance�sheets�and�cashflow,�leading�to�the�likelihood�of�further�dividend�growth,�cash�returns�and�M&A�activity.�We�continue�to�favour�companies�with�robust�earnings�prospects�and�pricing�power.�Heightened�volatility�in�equity�markets�is�providing�us�with�attractive�investment�opportunities.

The unknown consequences of raising rates in a low growth environment Perhaps�the�biggest�threat�for�2016�is�that�the�macro�and�company�indicators�that�we�are�seeing�at�the�moment�–�subdued�growth�and�inflation,�soft�final�demand�and�a�deteriorating�outlook�for�corporate�earnings�–�are�not�the�kind�of�the�things�that�one�would�expect�to�see�when�the�world’s�most�important�central�bank,�the�US�Federal�Reserve,�is�starting�an�interest-rate�tightening�cycle.�It�is�clear�that�the�Fed�is�very�keen�to�start�normalising�interest�rates,�but�if�one�simply�looked�at�the�data�in�isolation,�it�is�hard�to�come�to�the�conclusion�that�the�Fed�needs�to�raise�rates�quickly�or�aggressively.�The�recent�US�jobs�data�releases�have�been�strong,�but�they�need�to�be�set�in�context�–�labour�participation�rates�in�the�US�are�still�at�40-year�lows.�

Markets�do�expect�the�Fed�to�act,�and�we�expect�the�FOMC�to�raise�rates�in�a�controlled�and�sensible�manner.�Nonetheless,�given�the�heavy�emphasis�that�markets�have�put�on�forward�guidance�and�the�Fed’s�‘dot’�plots,�there�is�still�the�risk�that�the�Fed�could�lose�control�of�its�own�narrative,�as�it�has�done�at�some�points�in�2015.�Markets�tend�to�become�unsettled�when�policymakers�flip�flop,�and�for�that�reason�it�is�important�that�the�Fed�remains�in�control�of�its�messaging�in�2016.

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Global Annual Perspectives 2016

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The China slowdown – a continuing challenge for some emerging marketsThe�other�big�unknown,�from�our�perspective,�is�China.�An�economic�slowdown�is�ongoing�but�no-one�can�judge�with�any�certainty�in�terms�of�how�long�or�how�bad�it�could�be.�Our�own�assessment�is�that�economic�growth�will�be�below�the�7.5%�level�seen�in�prior�years,�but�will�remain�in�positive�territory,�supported�by�domestic�consumption.�For�growth�to�slip�below�0%�would�require�a�collapse�in�consumption�and�the�government�choosing�to�stand�aside�and�do�nothing�to�support�the�economy.�That�is�not�likely,�in�our�view.�Nonetheless,�the�slowdown�in�China�is�likely�to�be�challenging,�particularly�for�some�of�China’s�EM�peers,� and�there�are�no�examples�in�history�of�the�kind�of�credit�expansion�that�we� have�seen�in�China�having�a�happy�ending.

Are we closer to the next crisis than the last?The�main�issue�that�I�think�investors�need�to�consider�is�that�of�economic�growth,�and�why�it�is�still�so�low.�The�Lehman�crisis�was�more�than�seven�years�ago,�and�yet�outside�of�the�US,�growth�is�elusive.�In�2016,�we�think�that�investors�will�begin�to�question�some�of�the�policies�enacted�by�central�banks�and�whether�those�policies�are�helping�growth�or�hindering�it.�

There�is�a�growing�body�of�opinion�which�suggests�that�while�QE�has�created�the�conditions�for�companies�to�borrow�and�invest�in�their�businesses,�it�has�also�meant�that�‘zombie’�companies�that�should�have�failed�a�long�time�ago�have�been�kept�alive.�To�put�this�another�way,�the�process�of�‘creative�destruction’�has�not�been�allowed�to�run�its�usual�course�following�the�Great�Financial�Crisis,�and�as�a�result�the�world�now�finds�itself�awash�with�excess�capacity.�The�adverse�effects�of�this�are�being�amplified�by�the�ongoing�macroeconomic�slowdown�in�China.�Companies�with�differentiated�products�and�high�barriers�to�entry�can�still�prosper,�but�for�everyone�else�life�is�very�difficult.�The�fact�that�Lehman�occurred�over�seven�years�ago�also�means�that,�in�all�likelihood,�we�are�closer�to�the�next�crisis�than�we�are�to�the�last�one.�That�is�something�investors�should�keep�in�mind�when�they�are�building�portfolios�for�2016.

Continued low oil price may mean that some producers start to failOne�thing�that�we�can�say�for�certain,�assuming�that�everything�remains�the�same,�is�that�the�downward�pressure�on�headline�inflation�from�low�oil�prices�should�drop�out�of�the�reported�numbers�in�2016.�Indeed,�inflation�and�whether�it�moves�closer�towards�the�level�targeted�by�central�banks�will�be�crucial�as�that�is�likely�to�determine�whether�or�not�we�see�further�policy�support�from�the�Bank�of�Japan�and�European�Central�Bank.�

We�will�continue�to�monitor�the�oil�price�closely.�At�current�prices,�higher-cost�producers�and�some�of�the�more�marginal�shale�producers�are�losing�money,�but�some�will�keep�producing�in�order�to�generate�cash�flow.�While�these�producers�had�been�able�to�hedge�production�for�delivery�in�a�year’s�time�at�levels�materially�above�the�spot�price�(on�the�basis�that�oil�prices�would�bounce�back),�that�is�no�longer�the�case.�Indeed,�you�have�to�look�quite�a�long�way�along�the�oil�curve�to�find�prices�for�future�delivery�that�are�materially�above�where�prices�are�today.�It�is�therefore�likely�that�we�will�see�some�of�the�weaker�and�higher-cost�producers�fail�in�2016.�Energy�is�a�meaningful�component�of�the�US�high�yield�universe,�so�this�is�something�that�investors�need�to�watch.

Brexit uncertainty may increase volatilityOne�subject�that�will�occupy�more�airtime�in�2016�is�that�of�‘Brexit’�–�the�UK’s�potential�exit�from�the�European�Union.�Markets�are�currently�very�relaxed�about�this�issue.�As�we�saw�with�Scotland’s�referendum�on�its�membership�of�the�UK,�markets�can�become�complacent�in�the�run-up�to�a�referendum�and�this�can�create�short-term�volatility�when�investors�begin�to�realise�that�a�‘good’�outcome�is�no�longer�as�certain�as�it�once�seemed.�At�the�moment,�polls�suggest�that�most�Britons�would�vote�to�stay�in�the�European�Union,�but�such�an�outcome�cannot�be�taken�for�granted.�

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Global Annual Perspectives 2016 | EQUITY VIEWPOINTS

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EQUITY VIEWPOINTS

William Davies Head of Global Equities

EQUITY VIEWPOINTS

OPTIMISM IN CAUTIOUS TIMESCaution aboundsMarkets�enter�2016�with�expectations�for�equities�generally�low.�Investors�appear�fearful�that�valuations�are�not�particularly�cheap,�industrial�spending�is�under�pressure�(due�to�the�low�oil�price)�and�there�is�growing�discussion�about�2017�heralding�an�albeit�mild�US�recession.�

In�emerging�markets,�commodity�exporters�have�been�pummelled�by�the�rout�in�the�commodity�markets�and�although�the�worst�fears�about�the�Chinese�slowdown�have�not�yet�been�realised,�concerns�remain.�Politically,�the�Middle�East�remains�the�proverbial�‘riddle,�wrapped�in�a�mystery,�inside�an�enigma’.� We�appear�no�closer�to�any�solution.�However,�in�Europe,�we�were�hypothesising�about�Greece�leaving�the�eurozone�a�year�ago.�This�now�seems�less�likely�although�nationalism�remains�a�threat.

Hence�there�are�many�reasons�to�be�cautious.�However,�I�am�of�the�view�that�whilst�the�global�economy�has�not�yet�reached�‘normality’�following�the�deep�recession�of�2008/9,�there�are�signs�of�normalisation�and�even�reasons�to�be�cheerful.�

USWhat�if�the�US�Fed�has�actually�‘played�a�blinder’�since�the�depths�of�the�recession?�QE1�provided�liquidity�and�financials�were�recapitalised.�QE3�helped�provide�stimulus�to�the�housing�market,�the�announcement�of�tapering�raised�yields,�and�actual�tapering�dampened�economic�growth�without�inducing�a�recession.�Now�interest�rates�have�started�to�rise.�I�would�expect�the�Fed�under�Janet�Yellen�to�do�as�it�says�and�only�raise�rates�whilst�the�US�economy�can�stand�it.�There�are�those�who�believe�that�the�Fed�will�need�to�reverse�its�December�2015�rate�rise�in�2016�and�those�who�believe�the�further�rate�rises� in�2016�will�help�bring�about�a�slowdown�and�potential�US�recession�in�2017.�

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Global Annual Perspectives 2016 | EQUITY VIEWPOINTS

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EQUITY VIEWPOINTS

Perhaps�my�view�is�somewhat�Panglossian�but�I�believe�the�central�and�most�likely�scenario�for�the�US�economy�is�of�gentle�rate�rises�and�of�growth�somewhere�between�1.5�and�2.5%�over�the�next�couple�of�years,�fuelled�by�a�consumer�benefitting�from�lower�commodity�prices�(akin�to�a�tax�cut).�I’m�sure�there�will�be�bumps�along�the�way�but�this�central�scenario,�along�with�mild�inflation,�should�be�a�pretty�supportive�environment�for�equities.�Maybe�the�US�presidential�election�of�2016�will�provide�one�of�those�‘bumps’,�but�I�presume�the�more�radical�policies�mooted�to�get�candidates�elected�for�their�respective�parties�will�be�diluted�in�order�to�appeal�to�the�centre�and�therefore�makes�candidates�electable.�Hence�the�US�economy�seems�to�me�the�most�advanced�towards�‘normality’.�In�the�context�of�previous�cycles,�the�recovery�is�gentler,�interest�rates�will�be�lower�and�earnings�growth�will�be�more�modest,�but�on�the�flipside�the�pressures�of�higher�labour,�interest�and�commodity�costs�are�likely�to�be�less�severe,�so�maybe�in�this�cycle�current�elevated�profit�margins�can�stay�higher�for�longer.��

EuropeIf�the�US�economy�is�heading�towards�a�more�‘normal’�state,�other�developed�regions�lag.�In�the�eurozone�QE�continues,�but�at�least�there�is�now�positive�economic�growth,�i.e.�progress�from�2012/13.�This�growth�is�expected�to�continue,�although�probably�only�around�the�1.5%�rate,�and�that’s�with�the�help�of�QE�and�negative�interest�rates.�Politically,�the�EU�remains�a�mess,�but�the�mid-year�change�to�label�‘immigrants’�as�‘refugees’�helped�improve�acceptance�of�the�current�situation.�One�of�Europe’s�challenges�remains�the�demographic�headwind.�Immigration�has�helped�reverse�this�in�2015�and�this�trend�can�be�expected�to�continue�in�2016�and�beyond.�Although�improving�GDP�is�not�the�same�as�GDP�per�head,�it�nonetheless�helps�economic�activity�in�the�region�and�European�nominal�growth�in�aggregate.�Nevertheless,�although�acceptance�of�immigration�has�improved,�it�still�divides�opinion�and�helps�drive�support�for�more�nationalistic�and�less�inclusive�political�parties.�Globalisation�and�inclusivity�have�been�significant�contributors�to�global�economic�growth�over�the�past�decades.�It�would�be�disappointing�were�this�to�reverse.�Britain’s�vote�to�remain�in�the�European�Union�will�be�a�test,�as�could�elections�in�France�and�Germany�in�2017.�

JapanIn�2015�US�earnings�growth�failed�to�meet�expectations,�and�although�Europe�ex-UK�earnings�growth�will�probably�be�in�double�digits,�it�failed�to�meet�some�of�the�loftier�forecasts�made�mid-year.�Currency�factors�helped�in�Europe�and�hindered�the�US.�However,�in�Japan,�the�stock�market�enjoyed�a�third�year�of�strong�earnings�growth.�Obviously�the�weakness�of�the�yen�and�lower�commodity�prices�have�helped�over�that�time�but�more�recently�the�currency�tailwind�has�been�less�pronounced,�yet�companies�have�continued�to�deliver,�helped�by�improved�corporate�governance.�Japanese�valuations�do�not�look�stretched,�growth�is�expected�to�continue�and�the�outlook�appears�good.

Growth countriesEmerging�economies�have�attracted�much�attention�over�the�last�year.�The�commodity�exporters�such�as�Russia,�Brazil�and�South�Africa�have�been�under�extreme�pressure,�whilst�importers�such�as�India�have�enjoyed�a�better�time.�China�has�attracted�much�attention.�The�stock�market�boom�and�bust�added�to�instability�but�the�worst�fears�of�slowdown�failed�to�materialise.�The�authorities’�move�to�an�economy�less�driven�by�fixed�asset�investment�but�with�a�continued�strong�consumer�appears�to�be�under�control,�but�there�remain�fears�that�this�‘control’�is�illusory�and�the�decline�in�real�estate�investment�in�particular�will�lead�to�a�sharper�economic�slowdown�than�anticipated.�The�managed�decline�in�the�value�of�the�yuan�also�prompts�excitement.�My�view�is�that�its�value�versus�the�dollar�is�likely�to�decline�further,�but�not�at�a�rate�which�will�meaningfully�impact�stability.�Hence�the�slowdown�in�China�will�continue,�but�not�alarmingly�so,�and�consumption�growth�should�remain�strong.

So�my�view�of�the�world�is�that�economically�2016�will�bring�more�of�the�same�in�aggregate�–�gentle�growth�with�benign�inflation�and�low�interest�rates,�but�now�rising�in�the�US.�Not�terribly�exciting�really,�but�this�will�provide�support�for�equities�which�are�likely�to�enjoy�positive�but�not�excessive�returns.�To�my�mind,�this�is�a�more�constructive�view�than� that�of�many�market�participants.

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RisksSo�what�could�derail�Pangloss?�Many�cite�the�decline�in�energy�and�more� broadly�commodity-related�capital�expenditure�as�being�an�indication�that� further�downward�economic�pressures�are�to�come.�I�agree�that�within�this�sector�there�will�continue�to�be�pressures.�I�also�agree�that�in�2016�this�will�likely�spread�so�that�bankruptcies�in�this�area�will�infect�a�number�of�banks�and�supporting�industries.�Nonetheless,�I�still�can’t�get�out�of�my�mind�that�for�developed�economies�which�are�generally�importers�of�commodities,�lower�commodity�prices�are�a�net�benefit.�Admittedly,�if�the�declines�were�gentler�the�destabilising�effects�of�the�hits�to�parts�of�the�economy�would�be�less�extreme,�but�the�consumer�is�undoubtedly�a�beneficiary.

We�have�discussed�rising�nationalism�and�populism�as�being�a�threat�to�economic�growth.�Certainly�rising�immigration�touches�nerves�in�certain�countries.�Over�the�past�year�global�trade�growth�has�come�under�pressure.� The�relationship�between�demand�for�commodities�and�trade�volumes�has� been�important�as�China’s�place�in�world�trade�has�ballooned�over�past�decades.�I�believe�the�shift�towards�a�more�balanced�Chinese�economy�is�depressing�the�growth�of�world�trade�volumes�versus�expectations�a�couple�of�years�back.�However,�whilst�in�2014�we�saw�the�breakdown�of�WTO�talks,�in�2015�we�saw�the�Trans-Pacific�Partnership,�Japan�improving�its�relations�with�China�and�South�Korea,�and�India�in�talks�to�boost�trade�with�many�nations.�Hence�whilst�OPEC�may�be�struggling�and�certain�nations�may�seem�increasingly�nationalistic,�there�has�also�been�evidence�of�improving�trade�relations�in�2015,�a�welcome�trend.

Linked�to�trade�are�political�risks.�They�remain�elevated�as�we�enter�2016,�especially�in�the�Middle�East.�In�Syria,�Bashar�al-Assad’s�government�battles� with�IS,�other�opposition�forces�and�the�Kurds.�It�used�to�be�said�that�your�enemy’s�enemy�is�your�friend.�However,�the�level�of�complication�in�the�Middle�East�is�extreme.�The�US�would�not�have�been�happy�with�Russia’s�annexation� of�Crimea�in�2014,�nor�Russia’s�support�of�the�Syrian�government,�which�Obama�asked�permission�to�fight�previously.�However,�the�US�would�support�Russia’s�fight�against�IS,�whom�the�US�is�also�at�conflict�with,�and�whom�the�Syrian�government�forces�battle.�The�Turks�battle�with�the�Kurds�and�IS,�but�shot� down�a�Russian�fighter�jet.�The�potential�for�escalation�remains,�but�if�anything�one�common�theme�is�emerging:�IS�is�the�common�enemy.�No�doubt�there�will�

be�many�twists�and�turns�in�2016,�and�there�remains�the�possibility�that�further�Paris-type�atrocities�will�occur�and�derail�confidence.�Thus�far�people�have�been�most�resilient�and�the�economic�impact�limited.

Rising equitiesHence�there�are�risks�to�my�somewhat�benign�view�that�equities�can�rise�in�2016.�Geopolitical�risk�will�not�disappear�and�it�remains�possible�that�the�Fed�‘gets�it�wrong’�and�growth�stalls�in�the�US�or�maybe�in�China,�Europe�or�Japan.�Nonetheless,�I�believe�a�central�view�that�growth�in�the�major�economies�remains�intact�and�that�earnings�can�also�grow�is�perfectly�credible.�Given�the�low�cost�of�debt,�companies�will�continue�to�buy�their�own�shares�and�each�other.�Consensus�2016�earnings�growth�forecasts�of�8%�in�the�US,�6%�in�Europe�as�a�whole,�11%�in�Japan�and�5%�in�Asia�ex-Japan�do�not�look�especially�demanding,�leaving�2016�PE�multiples�of�16.5x�in�the�US,�15.0x�in�Europe,� 14.0x�in�Japan�and�12.5x�in�Asia�ex-Japan,�or�15.2x�for�global�equities�as�a�whole�–�not�eye-wateringly�cheap�nor�especially�expensive.�In�my�view,�this�leaves�room�in�2016�for�high-single-digit�upside�for�global�equities,�giving�a�total�return�of�around�10%�(including�dividends)�on�the�back�of�my�expectation�that�the�central�case�of�gentle�economic�growth�should�be�delivered.

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STAYING ADAPTABLE AS MARKETS EVOLVEOpportunitiesAs�Mark�Burgess�has�discussed�in�his�article,�we�think�that�2016� should�provide�further�opportunities�for�active�investors.�In�2015,� active�managers�were�able�to�add�value�for�their�clients�by�avoiding� areas�such�as�mining�and�energy,�which�were�hit�hard�by�the�weakness� in�commodities�markets�and�the�economic�slowdown�in�China.�

Concerns�about�China�will�continue�into�2016,�as�the�slowdown�there�is�a�multi-year�phenomenon.�This�will�pose�further�challenges�for�the�mining�companies�and�other�commodity-related�firms.

One�thing�that�we�have�seen�return�with�a�vengeance�is�idiosyncratic�or�stock-specific�risk�–�Glencore�and�VW�are�just�two�recent�examples�in�Europe,�but�there�are�plenty�of�others.�Owning�the�broad�market�has�been�very�rewarding�over�the�past�few�years�as�US�and�UK�asset�prices�have�been�boosted�by�QE,�but�we�think�that�story�has�run�its�course.

To�put�this�another�way,�we�think�that�investors�will�have�to�work�very�hard�to�find�‘winners’,�as�organic�growth�is�likely�to�be�very�scarce�in�2016,�but�equally�investors�will�need�to�make�sure�that�they�avoid�company-specific�disappointments.�

Threats2016�is�likely�to�represent�a�transition�point�for�the�global�economy�as�the�US�Federal�Reserve�raises�interest�rates�from�extremely�low�levels.�Such�transition�points�are�usually�accompanied�by�a�pick-up�in�volatility,�and�that�is�why�we�are�relatively�cautious�about�the�outlook.�Cynics�say�that�the�Fed�is�only�raising�rates�so�that�it�has�room�to�cut�them�again�when�the�next�slowdown�arrives,�but�that�is�a�topic�for�another�day.

In�China,�the�authorities�will�have�their�work�cut�out�to�mitigate�the�effects�of�the�economic�slowdown.�In�the�interim,�Chinese�firms�will� try�to�export�their�excess�capacity�to�the�rest�of�the�world,�resulting�

Leigh Harrison Head of Equities, Europe

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in�a�tough�pricing�environment�for�many�companies�across�a�range�of�industries�and�sectors.�This�will�put�downward�pressure�on�companies’�earnings�and�profit�margins.�There�has�been�a�huge�credit�boom�in�China�and�the�way�in�which�the�authorities�deflate�the�credit�expansion�is�likely�to�have�a�significant�impact�on�how�financial�markets�perform�in�2016.�It�also�remains�to�be�seen�whether�China�will�maintain�its�currency�peg�to�the�US�dollar.�Concerns�that�China�could�further�devalue�its�currency�may�cause�some�uncertainty,�which�is�likely�to�be�unhelpful�for�stock�markets.

We’ve�already�seen�the�adverse�effects�of�China’s�slowdown�on�companies�that�produce�equipment�for�the�mining�industry,�but�now�the�weakness�is�spreading�out�to�other�industrials.�Indeed,�some�analysts�are�talking�about�a�recession�in�industrial�profits.�This�is�not�the�same�thing�as�an�economic�recession,�but�it�does�show�that�the�environment�for�some�companies�is�extremely�difficult.

As�William�Davies�and�others�have�noted�in�their�outlooks,�geopolitical�risks�are�rising�and�we�believe�that�they�are�likely�to�play�a�part�in�determining�the�performance�of�markets�in�2016.�There�is�a�growing�consensus�that�more�needs�to�be�done�to�tackle�terrorism�and�extremism�but�it�is�hard�to�see�any�quick�or�easy�solutions.�Markets�like�some�degree�of�certainty�and�that�is�something�that�the�current�geopolitical�environment�cannot�provide.�There�will�be�a�US�presidential�election�in�2016�and�that�may�also�unsettle�markets.

Other things to watch for in 2016The�one�thing�that�2015�has�shown�is�that�even�highly�respected�companies�can�come�unstuck.�Technology�is�changing�at�a�rapid� pace�and�affecting�industries�in�a�manner�that�few�of�us�would�have� been�able�to�anticipate�just�two�or�three�years�ago.�For�example,�the�flipside�of�the�emissions�scandal�in�the�autos�sector�is�that�it�could� lead�to�a�whole�new�range�of�products�and�innovations�that�allow� auto�manufacturers�to�meet�ever-tightening�emissions�requirements� without�them�having�to�resort�to�subterfuge.�That�could�throw�up� some�interesting�investment�opportunities.

Unfortunately,�assessing�the�impact�of�technological�change�is�far�from�straightforward;�‘killer’�and�ground-breaking�technologies�will�emerge,�but�there�will�also�be�failures,�and�it�is�difficult�to�identify�these�with�certainty.�Moreover,�there�may�be�longer-term�dynamics�–�such�as�the�advent�of�self-driving�cars�–�which�will�change�industries�in�a�manner�that�is�very�hard�to�judge�accurately.�For�example,�self-driving�cars�won’t�just�affect�car�manufacturers,�but�a�whole�raft�of�associated�industries�such�as�electronic�and�safety�equipment�manufacturers,�battery�and�power�supply�manufacturers�and�insurers.�The�perfect�driver,�from�an�insurer’s�perspective,�is�one�who�always�pays�his�or�her�premium�on�time�and�never�has�an�accident.�In�future,�cars�could�be�regarded�in�much�the�same�way�that�taxis�or�other�private�hire�vehicles�are�now,�and�older�drivers�who�would�have�had�to�give�up�their�driving�licence�altogether�will�be�able�to�get�around�more�easily�(and�more�safely)�than�they�do�now.�

Climate�change�is�another�subject�where�the�long-term�investment�consequences�could�be�profound.�The�coal�industry�is�feeling�the�full�force�of�climate�change�legislation�and�institutional�reluctance�to�hold�assets�related�to�coal�mining�and�hydrocarbons�at�the�moment,�but�it�won’t�be�the�only�area�to�be�affected.

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Of�course,�some�of�the�companies�that�will�change�the�investment�landscape�in�the�future�won’t�be�investable�for�equity�investors�yet�–� a�lot�of�them�are�start-ups�and�not�traded�on�any�stock�exchange.�However,�there�will�be�opportunities,�as�well�as�winners�and�losers� as�the�process�of�change�occurs.�This�is�where�an�active�and�selective�investment�approach�can�make�a�difference,�in�our�view.

What else should investors consider?Investors�must�keep�their�eyes�and�ears�open�and�be�able�to�differentiate�between�what�is�important�and�what�is�just�market�‘noise’.�Unfortunately,�we�live�in�an�age�of�information�overload�where�crucial�pieces�of�information�are�sometimes�buried�in�other�pieces�of�information�that�may�have�little�or�no�consequence�from�an�investment�perspective.�Investors�need�to�work�out�what�is�important�and�then�position�themselves�appropriately,�and�crucially�it�is�best�if�this�can�be�done�before�other�investors�have�adopted�the�same�positioning.�For�example,�growth�and�momentum�strategies�have�worked�very�well�in�2015,�but�that�may�not�be�the�case�in�2016.�At�the�moment,�it�appears�that�companies�with�strong�balance�sheets�and�good�earnings�visibility�will�be�in�demand�in�2016�as�we�move�into�a�more�uncertain�economic�environment�where�growth�remains�challenged.�At�the�same�time,�however,�investors�still�need�to�think�about�what�a�business�is�likely�to�be�worth�in�the�longer�run�so�that�they�don’t�overpay�for�the�shares.

In�short,�investors�need�to�be�adaptable�and�realise�that�financial�markets�evolve�continuously.�Working�out�when�things�are�about�to�change,�and�being�positioned�for�those�changes�before�the�wider� market�has�reacted,�is�very�important.�The�English�economist,� John�Maynard�Keynes,�summed�up�this�challenge�very�well:� “It�is�largely�fluctuations�which�throw�up�the�bargains�and�the� uncertainty�due�to�fluctuations�which�prevents�other�people�from� taking�advantage�of�them.”

Thus in a nutshell, 2016…Overall,�we�believe�that�2016�could�be�quite�a�challenging�year,�as�earnings�and�dividend�growth�are�likely�to�be�quite�modest.�Discount�rates�will�rise�as�the�Federal�Reserve�increases�interest�rates,�reducing�the�nominal�value�of�future�cash�flows�and�profits.�However,�by�taking�a�considered�investment�approach,�we�believe�it�should�be�possible�to�generate�reasonable�risk-adjusted�returns.�

“�It�is�largely�fluctuations�which�throw�up�the�bargains�and�the� uncertainty�due�to�fluctuations�which�prevents�other�people� from�taking�advantage�of�them.”

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Soo Nam NG Head of Asian Equities

ASIAN EQUITY OUTLOOKWhile�much�coverage�is�devoted�to�China’s�economic�slowdown�and�to�Asian�equity�market�volatility,�investors�can�find�value�in�sectors�that�play�on�growth�in�the�region’s�fast-transitioning�economies.

Asia�continues�to�be�misunderstood�as�it�goes�through�a�process�of�economic�transition.�China�is�still�the�key�driver�for�the�region�because� of�the�size�of�its�economy�and�because�a�lot�of�markets�in�the�region�have�exposure�to�China.�India�is�an�economic�power�in�its�own�right� but�is�more�insular.

The�slowdown�of�the�Chinese�economy�(from�10.6%�growth�in�2010�to�7%�this�year)�has�been�extensively�analysed.�However,�Asian�companies�have�been�adjusting�to�this�more�modest�rate�of�expansion�for�a�number�of�years�and�corporate�strategies�and�cost�bases�have�been�recalibrated.

There�is�considerable�evidence�to�suggest�that�the�Chinese�economy�can�achieve�a�soft�landing�through�a�combination�of�fiscal�and�monetary�measures.�The�government�is�talking�about�GDP�growth�of�approximately�6.5%�over�the�next�three�years�and�the�consensus�numbers�reflect�that�expectation.�

The�IMF’s�decision�to�classify�the�renminbi�as�a�freely�usable�currency�from�1�October�2016�is�further�testament�to�the�progress�of�reform�over�recent�years.

On�the�macro�front�we�are�looking�at�a�relatively�benign�environment,�which�anchors�a�positive�case�for�investing�in�Asia�ex�Japan.�In�fast-transitioning�economies�it�is�important�to�look�beyond�averages/aggregate�figures�into�sectors�that�are�growing�faster�than�the�overall�economy.

In�Asia,�this�is�linked�to�the�rise�of�services�for�the�middle�class�–�such�as�insurance�–�and�the�growth�of�the�online�economy.�Ping�An�Insurance,�AIA�Group,�Baidu�and�Alibaba�are�examples�of�interesting�companies�in�these�sectors.�

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Another�sector�we�like�across�both�developing�and�emerging�Asian�economies�is�healthcare.�There�are�some�strong�healthcare�and�pharmaceutical�names�in�Australia�(Healthscope,�Ramsay�Health�Care,�CSL)�and�China�(China�Biologic�Products)�who�are�tapping�into�the�requirements�of�an�ageing�population�across�Asia�and�the�rising�demand�for�quality�healthcare.

Infrastructure�companies�should�benefit�if�the�Chinese�government�invests�in�major�projects�to�boost�growth�–�CRRC�(China�Railway�Rolling�Stock�Corporation)�plays�well�into�this.�

Domestic�consumption�and�investment�demand�will�therefore�drive�growth�in�Asia.�There�are�a�number�of�Asian�companies�at�the�forefront�of�technological�innovation,�for�example�selective�chip�makers�and�electronic�components�manufacturers�in�Taiwan�and�South�Korea,�who�will�continue�to�excel�on�the�export�front.

We�continue�to�be�underweight�natural�resources�because�demand�and�supply�will�remain�challenging�in�2016.�Mid-market�products�including�those�in�the�electronics�and�automotive�sectors�may�face�an�intensified�squeeze�by�competition�from�high-end�brands�and�entry�level�‘value-for-money’�products.�

The�quality�of�companies�in�Asia�is�improving�through�greater�focus�on�competitive�advantages,�sustainable�profitability�and�corporate�governance,�which�in�turn�delivers�more�resilient�earnings�and�dividend�streams.�

It�is�therefore�important�that�investors�do�not�become�fixated�with�macro�developments.�While�recent�events�such�as�the�Chinese�domestic�market�rout�and�the�mini-devaluation�of�the�renminbi�have�led�to�increased�market�volatility,�they�have�also�created�opportunities�for�investors�to�look�beyond�the�headlines�into�individual�stocks�to�find�exceptional�value,�while�Asian�equities�are�still�generally�cheap.

Quick view: What to expect from Asian equity markets in 2016

n Opportunities:�The�rise�of�the�middle�class�is�boosting�providers�of�services�such�as�healthcare�and�insurance.

n Threats:�Rapidly�transforming�consumer�behaviour�and�aggressive�competition�in�selective�sectors.�

n General outlook:�Market�participants�have�adjusted�to�the�slower�pace�of�economic�growth,�offering�a�cleaner�slate�to�assess�the�forward-looking�merits�of�Asian�equities.

n What should investors look out for?�Companies�that�are�undervalued;�higher�growth�sectors�in�China;�progress�in�policy�reforms/implementation�in�Indonesia�and�Thailand.�

n What should investors consider?�Opportunities�to�tap�into�volatility.

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Melda Mergen Director US Equities

ACTIVELY BUILDING PROFITABLE PORTFOLIOS

“�Although�higher�volatility�means�higher�risk,�it�also�provides�active�managers�with�opportunities�to�produce�higher�returns.”

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Return spreads between outperforming stocks and the overall market are still substantial

0

10

20

30

40

50

60

70

80

0

20

40

60

80

100

90 120Ja

n 89

Jan

90

Jan

91

Jan

92

Jan

93

Jan

94

Jan

95

Jan

96

Jan

97

Jan

98

Jan

99

Jan

00

Jan

01

Jan

02

Jan

03

Jan

04

Jan

05

Jan

06

Jan

07

Jan

08

Jan

09

Jan

10

Jan

11

Jan

12

Jan

13

Jan

14

Jan

15

Nov

15

Return spreadOutperformers Underperformers

Prior 12-month total return

Sources: Columbia Threadneedle Investments and S&P Capital IQ ClariFi, 11/15

Out

perfo

rmer

s/un

derp

erfo

rmer

s (%

)

S&P

500

retu

rn s

prea

d (%

)

Return spreads between outperforming stocks and the overall market are still substantial

Prior 12-month total return.Source: ColumbiaThreadneedle and S&P Capital IQ ClariFi, November 2015.

Building�a�well-diversified�portfolio�can�be�a�daunting�task.�With�so�many�strategies�to�choose�from,�a�challenging�market�environment,�and�the�fact�that�all�portfolio�managers�are�not�expected�to�outperform�all�the�time,�it’s�not�easy�finding�the�right�mix�of�investments�to�meet�your�financial�goals.�Investors�are�no�longer�prepared�to�reward�active�managers�for�market-driven�beta�performance,*�but�expect�these�managers�to�prove�their�skill�by�producing�positive�alpha.**

As�portfolio�managers,�we�face�the�same�dilemma�every�day,�namely�finding�and�managing�the�right�combination�of�investments�to�help�our�clients�reach�their�desired�outcomes.�Did�you�know�that�only�49%�of�S&P�500�stocks�on�average�have�outperformed�the�market�since�1989?�Despite�generally�low�hit�rates,�there�is�still�significant�return�spread�between�outperforming�stocks�and�the�market.�With�the�help�of�portfolio�construction�techniques,�we�can�seek�better�risk-adjusted�returns�by�balancing�stock�characteristics�at�the�portfolio�level.�

Producing repeatable outcomesConsistency�is�very�important�when�choosing�active�strategies.� We�believe�that�a�consistently�applied�investment�philosophy� to�identify�and�exploit�mispriced�stocks�can�produce�repeatable� investment�outcomes�over�time.�Investing�in�active�managers� with�dependable�styles�can�help�you�to�build�a�portfolio�with� reliable�investment�performance.�

Diversification�remains�a�cornerstone�of�portfolio�construction.� We�believe�that�picking�active�strategies�with�lower�excess�return�correlations�is�a�better�approach�than�looking�at�each�manager’s�performance�and�volatility�separately.�

* The beta of an investment portfolio is a measure of the amount of risk inherent to its exposure to the broad market. ** Alpha is the idiosyncratic component of an investment’s return not explained by the relationship to the broad market.

Separating the winners from the losersThe�tide�will�not�raise�all�boats�in�2016.�With�diverging�monetary�policies�around�the�globe,�secular�headwinds�in�commodity�markets,�increased�geopolitical�risk�and�slowing�global�growth,�investors�will�continue�to�rely�on�active�managers�who�can�identify�the�winners�from�the�losers.�

We�expect�market�volatility�to�remain�high�in�2016.�Although�higher�volatility�means�higher�risk,�it�also�provides�active�managers�with�opportunities�to�produce�higher�returns.�Particularly,�when�secular�changes�similar�to�what�we�are�experiencing�today�push�return�spreads�wider,�the�market�indices�are�designed�to�include�both�the�winners�and�the�losers.�Active�managers�have�the�opportunity�to�invest�only�in�the�companies�that�benefit�from�these�changing�trends.

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ARE ENERGY STOCKS HEADED FOR A FIFTH YEAR OF UNDERPERFORMANCE?Four years and counting Energy�stocks�have�underperformed�the�broader�market�for�a�fourth�consecutive�year.�They�have�also�posted�the�lowest�returns�among�the�10�S&P�500�sectors�over�both�a�three-�and�five-year�time�horizon,�and�rank�second�lowest�(above�only�financials)�over�the�past�10�years.

Oil prices are only part of the problemThe�long-term�relative�performance�of�energy�stocks�versus�the�broader�market�typically�correlates�with�the�price�of�oil.�Energy�stocks�performed�very�well�during�both�the�1970s�and�2000s�when�oil�prices�rose�and�underperformed�during�most�of�the�1980s�when�oil�prices�declined.�

“�Outperformance�of�energy�stocks�in�2016�will�require�an�earlier�than�expected�oil�price�recovery.”

Jonathan Mogil Portfolio Manager and Senior Analyst

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The close correlation between energy stocks’ relative performance and oil prices

Source: Ned Davis Research, Bloomberg, 11/25/15

Annual relative performance of energy vs. the market (1973-2015)

The close correlation between energy stocks’ relative performance and oil prices

5-ye

ar c

umul

ativ

e (%

)

Annu

al re

lativ

e re

turn

(%

)

-60

-40

-20

0

20

40

60

80

100

120

0

20

40

60

80

100

120

100

150

200

250

300

-30

-20

-10

0

10

20

30

40

50

60

Annual relative performance

Rolling 5-year relative performance

Source: Bloomberg, 12/09/15Data for 2015 is year-to-date average up to December 9.

Average Brent Crude oil priceS&P energy vs. market

73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15

Tota

l ret

urn

($)

Pric

e pe

r bar

rel (

$)

1973

2015

2013

2011

2009

2007

2003

1999

1993

1995

1989

2005

2001

1997

1991

1987

1985

1983

1981

1979

1977

1975

Source: Bloomberg, December 2015 Data for 2015 is year-to-date average up to 9 December.

The�sharp�contraction�in�oil�prices�is�largely�responsible�for�energy’s�weak�recent�performance,�although�many�other�factors�are�to�blame,�some�of�which�have�been�in�place�for�several�years.

Corporate�returns�have�been�steadily�deteriorating�since�the�middle�of�the�last�decade�as�a�result�of�record�levels�of�capital�spending�and�easy�access�to�capital.�With�oil�prices�recently�below�$40�per�barrel,�the�energy�sector�is�being�forced�to�focus�on�lowering�its�cost�structure,�improving�operational�and�capital�efficiencies�and�spending�within�its�means.�

Can�the�underperformance�continue? Statistically�speaking,�a�losing�run�of�five�or�more�years�for�any�sector�is�par�for�the�course�and�has�occurred�on�numerous�occasions�over�the�past�50�years.

Reversing energy’s losing streakFor�energy�shares�to�outperform�the�broader�market,�higher�oil�prices�and�a�more�disciplined�business�model�must�emerge.�Sentiment�towards�oil�prices�remains�negative.�The�lower-for-longer�view�is�widely�accepted�throughout�the�investment�community,�and�the�prospect�for�an�oil�price�recovery�before�late�2016�or�early�2017�seems�unlikely.�Equity�investors,�however,�appear�to�be�an�optimistic�group.�Valuations�today�look�beyond�the�current�downturn�to�a�time�when�oil�prices,�earnings�and�cash�flows�will�all�be�higher.�

The�timing�of�oil’s�recovery�will�likely�dictate�how�energy�stocks�will�fare�versus�the�broader�market�in�2016:

n Early surprise:�An�oil�price�recovery�in�early�to�mid-2016�will�likely�catch�the�market�off�guard,�providing�a�positive�catalyst,�especially�if�the�higher�prices�are�perceived�to�be�sustainable.�

n A 2017 recovery:�Expectations�for�a�gradual�recovery�in�2017�will�likely�not�be�enough�of�a�catalyst�to�move�the�stocks�higher�during�2016.

n Lower for even longer:�Should�oil�market�imbalances�persist�throughout�2016,�pushing�out�the�recovery�out�beyond�2017,�energy�stocks�will�most�likely�face�another�difficult�year.

Oil�markets�will�likely�remain�oversupplied�for�most�of�2016,�although�signs�of�the�next�oil�cycle�are�already�starting�to�emerge.�Declining�US�shale�activity�(a�positive)�and�the�continued�market-share�war�within�OPEC�(a�negative)�are�only�two�parts�of�the�supply�equation.�Sharp�declines�in�capital�spending�outside�of�these�two�regions�have�been�underway�for�almost�two�years�and�should�continue�in�2016,�further�delaying�future�supplies�to�accommodate�modest�demand�growth�and�natural�decline�rates.�While�it�is�difficult�to�predict�exactly�when�the�supply/demand�imbalance�will�reverse,�a�gradual�recovery�in�2017�remains�the�most�probable�outcome�–�one�that�is�unlikely�to�provide�enough�of�a�catalyst�for�energy�stocks�to�outperform�the�broader�market�during�2016.�

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2016 – A YEAR FOR TREADING CAREFULLYWe�face�a�year�where�interest�rates�will�rise,�where�the�US�and�European�economies�will�continue�to�grow�and�where�the�financial�world�will�need�to�contend�with�historically�low�energy�prices,�heightened�geopolitical�risks�and�a�Chinese�economy�which�is�rebalancing�from�an�industrialised�nation�to�a�more�consumption-led�economy.�Many�of�these�background�features�remain�interlinked.

Jim Cielinski Global Head of Fixed Income

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We�question�(yet�again)�the�low�level�of�government�bond�yields,�ponder�the�performance�of�corporate�credit�markets�as�we�near�the�end�of�the�corporate�credit�cycle�and�ask�whether�we�are�at�a�turning�point�for�emerging�markets�economies�after�a�turbulent�four-year�period.

Against�a�background�littered�with�so�many�risks,�are�potential�returns�sufficient�to�persuade�investors�to�recycle�or�indeed�add�to�their�fixed�income�exposures,�and�if�so,�where?

The economic outlook and the policy response We�expect�to�see�reasonable�rather�than�robust�ongoing�recovery� in�developed�market�economies�as�we�head�into�2016.

Economic�performance�will�remain�supported�by�expansionary�policy�conditions�and�an�encouraging�environment�for�the�consumer�(including�much�lower�unemployment,�decent�real�wage�growth�and�the�dividend�of�lower�energy�prices).�Meanwhile,�for�US�and�UK�manufacturers,�the�currency�strength�mixed�with�a�more�depressed�external�demand�environment�provides�a�form�of�negative�offset�for�growth�as�a�whole.� The�collateral�damage�from�the�global�commodity�and�energy�shocks�includes�collapsing�investment,�job�cuts�and,�undoubtedly�for�some�companies,�bankruptcy.

The�present�very�low�headline�inflation�rate,�suppressed�in�the�near�term�by�this�global�energy�shock�and�declining�commodity�prices,�comes�at�a�time�of�non-existent�wage�pressures.�This�has,�to�an�extent,�bailed-out�central�banks�from�being�seen�as�being�‘behind�the�curve’�in�the�eyes�of�the�financial�markets.�The�lack�of�wage�pressure�is�also�perhaps�explained�(in�a�circular�sense)�by�relatively�decent�real�wage�growth,�which�will�be�undone�in�coming�months�(as�year-on-year�comparisons�become�less�favourable)�unless�fuel�and�commodity�prices�continue�to�decline�meaningfully.�It�seems�then�that�the�downside�surprises�to�inflation�are�gradually�drawing�to�a�close.

We�sit�at�a�well-signposted�crossroads�in�terms�of�monetary�policy� with�the�US�Federal�Reserve�raising�rates�for�the�first�time�since�2006,� to�be�followed�by�the�UK�in�the�second�half�of�2016�or�later.�In�Europe,�

in�the�face�of�an�inflation�rate�that�is�below�the�ECB’s�mandated�target,�the�ECB�has�enacted�the�opposite�policy�and�lowered�rates�into�deeply�negative�territory�and�extended�QE.�We�must�question�whether�‘that�is�it!’�in�terms�of�policy�stimulus.

Given�our�own�forecasts�for�growth�and�inflation,�the�threshold�for�additional�easing�from�the�ECB�or�Bank�of�Japan�is�very�high.�There�is�a�good�chance�then�that�the�developed�market�easing�cycle�is�now�behind�us.

Government bond marketsWe�started�2015�pondering�the�possibility�of�a�material�correction�in�government�bond�markets�and�so�it�is�with�a�sense�of�déjà�vu�that�2016�will�begin�with�the�same�concerns.�Can�markets�shake�off�rising�interest�rates�and�US�economic�strength�and�be�‘reassured’�by�the�dollar’s�strength�and�the�collapse�of�energy�and�metals�prices?

Perhaps�without�a�(potentially�dangerous)�belief�that�‘this�time�is�different’�it�is�hard�to�find�any�real�value�in�either�nominal�or�real�yields� in�major�markets.�This�comes�at�a�time�when�central�banks�have�become�owners�of�such�large�swathes�of�bonds�that�they�have�in�some�senses�‘robbed’�most�of�the�returns�from�investors�going�forward�–�in�a�clear� and�deliberate�strategy.�

In�a�repeat�of�where�we�were�at�the�start�of�last�year,�it�appears�that�core�government�bonds�yields�offer�a�poor�investment�prospect�in�both�nominal�and�inflation-adjusted�terms.�As�mentioned,�real�yields�have�been�suppressed�by�global�policy�action�and�as�we�turn�that�corner,�there�will�be�heightened�pressure�for�normalisation.�Hence,�we�forecast�yields�that�are�a�shade�higher�by�the�end�of�2016�but�against�a�background�of�such�low�inflation�that�the�correction�is�not�expected�to�be�the�material�one�many�keep�expecting.

Emerging market debt It�is�likely�to�be�another�year�in�which�weaker�economic�growth�will�weigh�on�emerging�market�sentiment,�though�we�expect�spreads�to�stabilise�somewhat�after�the�Fed’s�rate�rise.�

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China�in�particular�will�show�more�signs�of�running�at�a�slower�growth�rate�but�we�see�a�so-called�‘hard�landing’�as�unlikely�given�the�policy�tools�available.�In�practice�we�think�a�further�currency�devaluation�of�around�10%�might�be�expected.�But�the�use�of�these�tools�will�create�further�turbulence�in�emerging�markets.

In�2016,�we�feel�that�there�will�be�opportunities�for�investment�between�individual�countries�and�in�terms�of�overall�macro�positioning.�As�at�the�start�of�2016,�we�were�invested�with�overweights�in�Argentina,�Serbia�and�Hungary,�and�underweight�positions�in�Brazil,�China�and�commodity-linked�Latin�American�countries�including�Chile�and�Peru.�We�are�not�out�of�the�woods�yet!

Corporate credit marketsPolicy�conditions�will�remain�accommodative�and�supportive�for�corporate�credit�markets�in�general�during�2016.�The�benign�environment�of�relatively�low�growth�and�low�inflation�will�help�rein�in�the�nascent�‘animal�spirits’�stalking�corporate�boardrooms�and�that�in�turn�will�ease�the�risk�of�higher�corporate�default�rates.�Defaults�will�rise,�though�we�expect�these�to�remain�relatively�isolated�to�the�US�commodity�and�energy�sectors.�This�will�not�be�such�an�issue�in�Europe�given�the�very�different�market�composition.�However,�the�corporate�credit�improvement�story,�long�a�positive�feature�of�credit�markets,�is�told�and�we�are�in�the�final�chapters�of�this�present�cycle.�

This�would�make�us�more�pessimistic�about�the�asset�class�were�it�not�for�the�fact�that�valuations�or�spreads,�expensive�in�the�spring�of�2015,�have�revalued�to�levels�that�are�attractive�compared�to�history�–�especially�in�the�US.�

Hence�we�retained�a�neutral�to�modest�overweight�in�corporate�bonds�into�2016.�For�European�high�yield,�the�heightened�M&A�activity�could�actually�prove�positive�with�a�number�of�such�companies�being�the�target�for�their�better-rated�investment-grade�cousins.�For�developed�market�banks,�the�lengthy�period�of�credit�rehabilitation�is�coming�to�a�close�at�a�time�when�spreads�are�at�similar�levels�to�corporate�issuers.�

Conclusions and expected market returnsMarket�risks�persist�without�the�realistic�prospect�of�meaningful�investment�reward.�The�risk�of�rising�corporate�defaults,�the�oil�price�shock,�heightened�geopolitical�and�economic�risks�coming�together�at� a�time�of�policy�shift�provide�plenty�to�concern�investors,�especially�in� a�time�of�questionable�market�liquidity.

Against�these�challenges,�yields�and�potential�returns�appear�low�and�bond�markets�may�not�be�able�to�provide�the�traditional�diversification�benefits�that�they�once�did.�

So�where�should�investors�look�for�income?�We�continue�to�prefer�shorter-duration�asset�classes�where�interest�rate�risk�in�limited,�including�cash-benchmarked�absolute�return�strategies�as�well�as� some�exposure�to�spread�markets,�including�investment�grade�and�European�high�yield�corporate�bonds.�Mind�your�eye!

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Colin Lundgren Head of US Fixed Income

DURATION, LIQUIDITY, AND DEFAULTS, OH MY! Duration-bitten�portfolio�managers�may�be�capitulating�on�US�interest�rates�at�just�the�wrong�time.�Positioning�surveys�suggest�professional�investors�are�less�afraid�of�higher�rates�than�retail�investors.�Also,�the�market�is�priced�well�below�the�US�Federal�Reserve’s�current�guidance�for�the�path� of�the�federal�funds�rate.�In�other�words,�the�interest�rate�market�is�not�well�set�up�for�a�stronger�economy,�higher�inflation�or�anything�more�than�a�few�Fed�rate�hikes.

The market is priced below the Fed’s interest rate projectionsSh

ort-t

erm

inte

rest

rate

(%

)

The market is priced below the Fed’s interest rate projections

-1

0

1

2

3

4

2015

Projected SEP median* Market expectations

Source: Bloomberg, 12/15*Median based on the Fed’s Summary of Economic Projections (SEP), 12/15

2016 2017 2018 Longer term

Source: Bloomberg, December 2015.*Median based on the Fed’s Summary of Economic Projections (SEP), December 2015.

Gene Tannuzzo Senior Portfolio Manager

22

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Dealer inventory slump threatens bond market liquidity

Dea

ler i

nven

torie

s of

cor

pora

te b

onds

Dealer inventory slump threatens bond market liquidity

Apr Jun Aug Oct Dec AprFeb Jun Aug Oct Dec AprFeb Jun Aug Oct Nov

Investment grade money market High yield money market

Source: Federal Reserve Bank of New York, 11/15

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

20,000

2013 2014 2015

Source: Federal Reserve Bank of New York, November 2015.

Bond market liquidity: From bad to worse?Liquidity�will�continue�to�nag�the�bond�market,�and�not�just�in�risk-off�environments.�Regulatory�changes�help�explain�why�dealer�inventories�are�at�or�near�all-time�lows,�and�they�are�no�longer�the�source�of�liquidity�they�once�were.�Also,�we�can’t�necessarily�take�comfort�in�size.�Mega�funds�may�be�especially�challenged�to�navigate�changing�market�conditions,�respond�to�large�flows�or�invest�in�cash�bonds.�Morningstar’s�non-traditional�and�multi-sector�fixed-income�categories�include�six�mutual�funds�with�more�than�$15�billion�in�assets,�and�two�funds�that�exceeded�$30�billion�as�of�November�30,�2015.�Unfortunately,�the�surprise�may�be�bond�market�liquidity�going�from�bad�to�worse.

Beyond the headlines Defaults�are�on�the�rise,�but�the�headline�number�masks�the�real�story.�High-yield�spreads�are�currently�compensating�investors�for�a�5%�default�rate,�well�above�the�current�rate�and�slightly�higher�than�the�long-term�average.�Our�internal�default�forecast�is�5.5%�in�2016�and�6.4%�in�2017.�But�the�increase�in�defaults�is�expected�to�be�largely�concentrated�in�

energy,�metals�and�mining.�We�expect�energy�defaults�to�exceed�20%�in�2016�and�be�close�to�that�level�in�2017.�Excluding�those�troubled�areas,�we�think�defaults�will�be�less�than�3%�in�2016�and�under�5%�in�2017.�

Therefore,�higher�defaults�should�warrant�some�caution�and�careful�security�selection,�but�a�broad�repricing�of�the�high�yield�market�may�provide�more�than�enough�yield�compensation�to�produce�attractive�risk-adjusted�returns�in�2016.�Indeed,�based�on�our�proprietary�model�of�default�rates,�current�credit�spreads�already�price�in�rising�defaults�throughout�2016�and�2017.

Default rates expected to rise in 2016–2017Default rates expected to rise in 2016–2017

Def

ault

rate

(%

)

Moody’s global speculative-grade default rate Model default rate

Sources: Moody’s, Columbia Threadneedle Investments proprietary research, 11/15

0

2

4

6

8

10

12

14

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Sources: Moody’s, Columbia Threadneedle Investments proprietary research, November 2015.

“�High�yield�may�produce�some�of�the�most�attractive�returns�in�fixed�income,�despite�higher�defaults.”

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FIXED INCOME VIEWPOINTS

ASIAN FIXED INCOME OUTLOOKWith�limited�issuance�and�strong�demand�set�to�fuel�outperformance�in�Asian�bond�spreads,�investors�should�be�able�to�look�forward�to�favourable�returns�from�debt�markets�in�the�region�over�the�coming�months.

Given�expectations�both�on�global�interest�rate�movements�and�currency�volatility�for�2016,�our�investment�strategy�continues�to�favour�US�dollar�denominated�Asian�fixed�income�markets.

Clifford Lau Head of Fixed Income, Asia

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There are several reasons for this: n With�the�US�dollar�being�an�outperforming�currency�across�different�markets�and�regions,�investing�in�US�dollar�denominated�Asian�bonds�would�be�on�the�right�side�of�the�trade.

n We�believe�Asian�economic�fundamentals�and�overall�corporate�health�indicate�that�the�region’s�economies�are�broadly�well-financed.

n GDP�growth�has�been�underwhelming�in�2015,�but�we�don’t�expect�any�individual�economy�to�experience�serious�fiscal�difficulties.

Global�growth�rates�have�impacted�the�profitability�of�many�Asian�corporates,�particularly�those�trading�internationally�or�dependent�on�export�growth.�However,�corporates�in�the�region�have�been�actively�refinancing�maturing�debts,�which�in�a�low�interest�rate�environment�has�helped�bring�down�overall�leverage�ratios.�As�a�result,�global�investors�on�the�hunt�for�yield�are�expected�to�look�east�in�2016.

Fewer�Asian�companies�tapped�bond�markets�for�money�in�2015�and�this�trend�is�set�to�continue�while�demand�is�expected�to�remain�high.�We�believe�that�management�of�Asian�companies�will�remain�cautious�about�new�issuance�until�they�see�evidence�of�growing�demand�in�their�sectors.�Similarly,�we�don’t�expect�many�major�mergers�or�acquisitions�to�take�place�in�2016.

Reduced�issuance�could�be�constructive�for�Asian�bond�markets�by�driving�the�sector�to�outperform�and�there�has�been�increasing�demand�for�reallocating�assets�to�invest�in�Asian�bonds.�We�have�been�working�with�a�number�of�clients�from�within�and�outside�the�region�who�believe�Asian�markets�are�well�placed�for�asset�allocation.

There�is�much�talk�of�interest�rate�divergence�between�the�US�and�Japan�versus�Europe,�where�the�debate�has�been�whether�to�extend�QE.� While�there�is�not�the�same�discussion�taking�place�in�Asia�on�the� merits�of�injecting�liquidity�into�markets,�interest�rates�will�head�in� different�directions.

Looking�ahead,�there�are�likely�to�be�some�interesting�developments�in�China.�The�devaluation�of�the�renminbi�caught�the�FX�market�off-guard�and�Chinese�stocks�are�experiencing�volatility,�so�we�expect�the�Chinese�government�will�use�whatever�tools�are�at�its�disposal�to�suppress� market�volatility.

Quick view: What to expect from Asian fixed income markets in 2016

n Opportunities: The�ability�to�express�an�investment�opinion�in�a�single�market�in�different�ways�(for�example,�in�Indonesia�through�the�US�dollar�denominated�Indonesian�sovereign�bond�market;�the�local�currency�government�bond�market;�or�the�FX�market).

n Threats:�Uneven�economic�growth�across�Asia�leading�to�divergence� in�interest�rate�policy;�sluggish�global�economic�growth�impacting� Asian�exporters.

n General outlook:�Expectations�are�for�strong�relative�performance�in�the�Asian�bond�market�as�an�imbalance�between�supply�and�demand�drives�the�spread�to�outperform.

n What should investors look out for?�Surprises�in�Chinese�monetary�policy�as�the�country’s�government�seeks�to�quell�market�volatility�and�sustain�economic�growth.

n What should investors consider?�Strategies�designed�to�take�advantage� of�the�long�and�short�side�of�the�market.

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EMERGING MARKETS STARTING TO LOOK ATTRACTIVEAfter�the�turbulence�of�the�past�few�years,�emerging�markets�(EM)�look�poised�for�a�rebound�in�2016.�Here’s�why:

n Key commodity prices should modestly recover:�Low�expectations�for�commodity�prices,�plus�commodity-dependent�EM�countries�that�have�largely�adjusted�to�lower�prices,�mean�even�a�modest�recovery�would�become�a�terms-of-trade,�growth�and�fiscal�tailwind�for�much�of�the�sector.

n Global growth has bottomed and should finally show year-on-year improvement:�EM�growth�in�particular�should�show�its�first�acceleration�in�five�years�and�is�expected�to�improve�from�about�4%�to�4.6%.�While�the�improvement�would�be�modest,�it�is�an�inflection�point�and�is�critical�to�improving�the�narrative�for�emerging�markets.

n The Federal Reserve rate-hiking cycle is a sign of confidence in US growth and comfort with the global economy:�A�low�trajectory�hiking� cycle�should�not�derail�EM�growth�and�investment,�and�it�could�help�reduce�uncertainty�if�accompanied�by�easing�from�the�European�and� other�central�banks.

Jim Carlen Senior Portfolio Manager

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Emerging market countries show improvementOver�the�last�decade,�the�investment�thesis�for�EM�has�been�better�balance�sheets,�better�growth�and�attractive�investment�opportunities.�The�commodity�collapse�was�a�setback�to�many�EM�growth�stories�and�exposed�weak�macroeconomic�policies�in�some�countries.�However,� a�critical�mass�of�EM�countries�is�turning�the�corner�with�policy�adjustments,�better�leadership�and�some�recovery�in�growth�(and�in� some�cases�all�three).

Russia�is�set�to�restart�growth�in�2016,�Turkey’s�new�market-friendly�government�will�address�some�long-delayed�structural�issues,�and�Indonesia�has�implemented�a�number�of�modest�structural�reforms�that�should�help�boost�growth.�Argentina�has�elected�a�market-friendly�president,�and�Brazil�may�finally�start�to�take�concrete�steps�toward�fiscal�adjustment,�which�could�spur�better�confidence�and�growth.�This�sample�of�improvement�stories�makes�up�more�than�40%�of�the�EM�bond�index�(JPM�EMBI�Global).

Emerging markets are not a monolithic sectorThere�are�still�some�tough�stories�in�the�sector,�and�the�market�is�less�likely�to�simply�hope�for�the�best�–�and�buy�the�cheapest�bond�–�than�may�have�been�the�case�in�other�recovery�years.�We�expect�the�EM�tailwinds�cited�above�to�be�quite�modest,�and�the�overriding�theme�for�the�foreseeable�future�will�be�the�level,�quality�and�sustainability�of�policies�and�economic�growth.�The�end�of�some�of�the�more�populist�EM�regimes,�or�at�least�their�neutralization,�signals�that�more�countries�should�get�their�policies�on�track.

Potential opportunity in Emerging Markets Foreign Exchange (EMFX)EMFX�and�local�debt�might�be�one�of�the�better�investment�opportunities�in�the�sector�in�2016.�With�attractive�valuations�and�the�reduction�in�EM�gloom�and�doom,�EMFX�should�benefit�from�better�investment�flows�as�investors�seek�to�tap�into�better�growth�and�reform�stories.�Given�how�far�the�US�dollar�has�rallied,�it�is�also�expected�to�be�less�of�a�headwind�to�EMFX�than�in�the�past.�

“�Emerging�markets�should�become�more�attractive�as�fundamentals�improve�and�investors�seek�to�tap�into�better�growth�and�reform�stories.”

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MULTI-ASSET/ ALTERNATIVE AND OTHER VIEWPOINTS

MULTI-ASSET/ALTERNATIVE AND OTHER VIEWPOINTS

WILL OUTCOMES IMPROVE FOR DIVERSIFIED INVESTORS IN 2016? Investment strategy is all about decisions and outcomesEven�for�investors�who�are�sceptical�of�the�efficient�market�hypothesis,�there�is�no�denying�that�investing�is�difficult.�We�make�decisions�under�tremendous�uncertainty,�not�only�about�what�real�world�events�will�transpire�but�indeed�about�how�market�prices�will�react�to�these�events.�We�investors�must�make�decisions�in�the�presence�of�this�uncertainty,�knowing�that�not�all�of�them�will�pay�off.�Sometimes�good�decisions�are�met�with�bad�outcomes,�and�sometimes�bad�decisions�are�met�with� good�outcomes.�We�can�only�control�our�decisions�and�expect�that� the�good�ones�will�pay�off,�on�average,�over�the�long�run.

Jeff Knight Global Head of Investment Solutions, Co-Head of Global Asset Allocation

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“�We�believe�diversified�portfolios�will�fare�better�in�2016�than�in�2015”

Diversification is a good decision Diversification�offers�one�of�the�best�opportunities�in�all�of�investing.� By�combining�dissimilar�investments�in�our�portfolios,�we�earn�the�weighted�average�of�the�returns�of�these�investments.�However,�we�do�not�retain�the�weighted�average�volatility�(risk)�of�these�investments.�Because�we�can�usually�expect�some�of�our�investments�to�pay�off�even�while�others�struggle,�we�generally�see�that�diversification�reduces�some�of�the�ups�and�downs�of�investing�at�the�overall�portfolio�level.�For�this�reason,�diversified�portfolios,�over�time,�can�offer�more�return�per�unit�of�risk�than�concentrated�ones.

Diversified portfolios struggled in 2015, but 2016 should be better

Portf

olio

retu

rn (

%)

Diversified portfolios struggled in 2015, but 2016 should be better

Source: Columbia Threadneedle Investments, 12/15Equal weighted average of 10 major markets, 1970–2015: U.S. stocks represented by S&P 500 Index, international stocks represented by MSCI EAFE Index, U.S. government bonds represented by Barclays U.S. Treasury Index, international government bonds represented by Citigroup World Non-U.S. Government Bond Index, high yield represented by Barclays High Yield Index, investment grade represented by Barclays U.S. Corporate Bond Index, securitized represented by Barclays U.S. Mortgage-Backed Securities Index, TIPS represented by Barclays Global Inflation-Linked Index, commodities represented by Dow Jones-UBS Commodity Index and REITs represented by FTSE/NAREIT Index. If a particular index did not have a sufficient track record back to 1970, a representative index of similar risk/return characteristics was used.

-20

-15

-10

-5

0

5

10

15

20

25

30

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

2015

Source: Columbia Threadneedle Investments, December 2015.Equal weighted average of 10 major markets, 1970–2015: US stocks represented by S&P 500 Index, international stocks represented by MSCI EAFE Index, US government bonds represented by Barclays US Treasury Index, international government bonds represented by Citigroup World Non-US Government Bond Index, high yield represented by Barclays High Yield Index, investment grade represented by Barclays US Corporate Bond Index, securitized represented by Barclays US Mortgage-Backed Securities Index, TIPS represented by Barclays Global Inflation-Linked Index, commodities represented by Dow Jones-UBS Commodity Index and REITs represented by FTSE/NAREIT Index. If a particular index did not have a sufficient track record back to 1970, a representative index of similar risk/return characteristics was used.

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Spreading investment portfolios across numerous asset classes has a great track record A�simple,�diversified�portfolio�strategy�has�produced�a�positive�return�in�the�vast�majority�of�years�(see�previous�chart).�Note�that�since�1970,�a�diversified�approach�has�produced�a�positive�return�in�most�years,�and�that�these�returns�can�be�quite�meaningful�much�of�the�time.�In�fact,�the�example�portfolio�would�have�produced�an�average�return�of�9.8%�through�2014,�with�only�three�down�years�over�that�span.�

Yet 2015 delivered very bad outcomes for diversified investors Glancing�at�the�chart,�we�can�easily�see�that,�in�context,�2015�was�a�horrible�year�for�diversified�investors.�In�fact,�with�the�exception�of�the�great�financial�crisis�of�2008,�2015�delivered�the�worst�outcome�to�diversified�investors�since�1974.�This�simple�observation�was�nearly�absent�from�most�market�commentary�last�year.�But�let’s�be�clear,�2015�was�a�historically�awful�year�for�diversified�portfolios.

2016 should be better. It seems a fairly safe presumption that diversified portfolios will fare better in 2016 than in 2015 Historically,�after�each�of�the�prior�three�negative�years,�the�following�year�delivered�firmly�positive�returns.�More�to�the�point,�however,�we�note�that�many�of�the�asset�classes�reflected�in�this�chart�experienced�a�meaningful�reset�of�their�forward-looking�risk�premia�(in�other�words,�their�expected�returns).�High-yield�bonds,�for�example,�offered�yields�277�basis�points�higher�than�in�the�middle�of�2014.*�Commodities�too�must�have�a�somewhat�more�limited�downside�with�oil�at�$40�per�barrel�than�with�oil�at�$100�per�barrel.�

Diversification�almost�always�works.�For�investors�frustrated�by�performance�in�2015,�we�confidently�recommend�that�you�stay� diversified�with�a�keen�eye�on�how�your�risks�are�allocated.

* The high-yield option-adjusted spread (OAS), a measurement of the spread of a fixed-income security rate and the risk-free rate of return, had a low of 3.23 on June 23, 2014 vs. 6.00 on December 7, 2015.

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MULTI-ASSET/ ALTERNATIVE AND OTHER VIEWPOINTS

William Landes Deputy Head of Global Investment Solutions and Head of Alternative Investments

ALTERNATIVE BETA AS TRUE DIVERSIFIERS Alternative�betas�can�play�the�role�of�a�true�diversifier�in�a�broad-based�portfolio.�They�include�various�equity�style�factors�and�can�be�found�across�asset�classes�such�as�stocks,�bonds,�credit,�currency�and�commodities.�While�alternative�betas�have�always�been�embedded�in�markets,�they�weren’t�always�identified�as�such.�In�the�early�1990s,�academics�and�investors�first�recognized�the�persistence�of�certain�equity�factors*�and�hedge�fund�managers�began�investing�based�on�momentum�bias,�value�bias�and�other�alternative�betas.�What�used�to�be�called�alpha�in�the�hedge�fund�space�was�really�rules-based,�replicable�beta.�Today�our�understanding�of�alpha�and�beta�in�the�return�stream�has�evolved.�

*Fama and French formalized equity style investing with the three-factor model (“The Cross-Section of Expected Stock Returns,” Journal of Finance (1992), with Eugene Fama) and have written extensively on various equity style premia.

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Low correlations make alternative betas powerful diversifiersBased�on�our�research,�returns�of�a�diversified�basket�of�alternative�betas�have�a�low�correlation�of�return�to�each�other�and�to�the�overall�market��–�an�average�of�0.04.�Financial�theory�tells�us�the�best�way�to�reduce�portfolio�volatility�and�protect�from�downside�risk�is�to�own�negatively�correlated�assets�that�generate�positive�return�payoffs.�

Tapping into alternative betasThe�two�ways�to�access�alternative�betas�are�through:�1)�a�counterparty�who�manufactures�an�index�seeking�to�capture�a�specific�risk�premia;�or�2)�an�asset�manager�who�can�manufacture�an�index�itself.�For�example,�a�quantitative�equity�group�such�as�ours�could�build�momentum�and�value�risk�premia�using�internal�quantitative�tools.�An�index�designed�to�capture�the�value�equity�risk�premia�would�take�a�benchmark�such�as�the�Russell�1000,�rank�the�securities�within�by�some�valuation�measure,�and�then�go�long�the�top�quintile�of�cheapest�stocks�and�short�the�bottom�quintile�of�the�most�expensive�stocks.�This�extracts�the�value�premia�and�insulates�the�investor�from�most�general�market�beta.�

Specifically�targeting�an�isolated�alternative�beta�allows�an�investor�to�directly�own�the�value�risk�premia�described�above�with�little�to�no�market�directionality.�This�technique,�applied�across�a�range�of�diverse�alternative�beta�factors,�offers�many�of�the�same�exposures�investors�would�get�from�owning�a�multi-strategy�hedge�fund,�but�with�daily� liquidity�and�much�lower�fees.�

Alpha vs. beta: Scarcity, contribution to return and pricing

Source: Columbia Threadneedle Investments

Scarcity

Pric

e

Manager skill High costand elusive

Lower costand harderto replicate

Low costand prevalent

StyleTrendValueCarryCurveVolatility

EquityCreditCommoditiesRatesCurrency

ALPHA

TRADITIONAL BETA

Illustrative pricing curve overlaid on investment strategies

SMART BETA:Multi Factor

SMART BETA:Single Factor

ALTERNATIVE BETA

Equity

Fixed Income

Source: Columbia Threadneedle Investments.

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Capturing value premia

n Buy currencies that are undervalued according to purchasing power parity

n Sell currencies that are overvalued according to purchasing power parity

Equity

Value

Fixed income

Currency

n Buy cheapest 20% of stocks ranked on price-to-bookn Sell most expensive 20% of stocks ranked on price-to-book

n Buy government bonds whose real rates are above historical averagen Sell government bonds whose real rates are below historical average

The growing appeal of alternative betasThe�opportunity�to�access�these�sources�of�return�in�a�transparent,�liquid�and�low-cost�manner�has�made�the�subject�of�alternative�betas�compelling�for�many�investors.�We�believe�this�interest�will�only�grow�as�investors�seek�ways�to�limit�the�impact�of�higher�volatility�on�their�overall�asset�allocation.�It�is�important�that�investors�recognize�that�alternative�betas,�while�not�directional�in�nature,�are�subject�to�capital�market�influences�and�require�active�management�of�positions�and�risks.�

“�More�investors�will�use�alternative�betas�to�obtain�the�same�exposures�they�would�get�from�owning�a�multi-strategy�hedge�fund,�but�with�daily�liquidity�and�much�lower�fees.”

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AN UNDERAPPRECIATED OPPORTUNITY FOR INCOME INVESTORS2014�was�a�big�year�for�Wall�Street’s�financial�engineering�efforts.�A�major�revival�of�master�limited�partnerships�(MLPs)�and�the�development�of�YieldCos�were�efforts�to�satisfy�the�yield�hunger�of�investors�displeased�with�historically�low�coupons�on�quality�bonds.

By�the�fall�of�2014,�the�first�YieldCo�had�done�a�secondary�offering�at�double�its�initial�public�offering�(IPO)�price,�and�the�average�MLP�IPO�was�trading�up�20%–30%�on�the�first�day.�But�two�things�happened�to�cool�the�market�for�these�securities.�First,�crude�oil�prices�unexpectedly�declined�by�60%.�Since�the�businesses�underlying�MLPs�and�YieldCos�must�be�linked�to�energy�production,�the�outlook�soured�for�some�of�these�entities.�Second,�the�broader�stock�market�became�more�volatile�and�its�trend�flattened.�This�appears�to�have�been�caused�by�the�kind�of�political�and�macroeconomic�events�that�lead�to�measured�caution�by�professionals�but�can�result�in�panic�by�individual�investors.

In�perfect�hindsight,�the�30%–70%�declines�in�price�for�most�MLPs� and�YieldCos�in�2015�may�be�understandable.�However,�large�and� rapid�changes�in�security�prices�present�the�possibility�that�the�market�has�overreacted.�

David King Senior Portfolio Manager

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Fundamentals remain soundIt�appears�impossible�for�new�MLPs�to�go�public�in�the�current�energy�glut,�and�the�consensus�view�is�that�the�YieldCo�business�model�is�broken�due�to�the�high�cost�of�capital.�These�sentiments�are�remarkably�short-sighted.�While�oil�will�be�plentiful�in�the�near�future,�production�is�starting�to�fall�while�demand�growth�responds�to�current�low�prices.�Industry�experts�believe�that�world�production�will�fall�short�of�world�demand�by�next�summer.�Prices�will�eventually�respond�positively�to� this�imbalance,�even�if�inventories�result�in�no�lack�of�current�supply.�

As�for�the�capital�cost�of�YieldCos,�the�bearish�argument�has�a�heavy�dose�of�circular�reasoning:�the�stocks�cannot�be�more�attractive�at�higher�prices�and�less�attractive�at�lower�ones.�The�weak�performance�of�YieldCo�equities�is�more�likely�a�function�of�market�volatility�and�the�short�trading�history�of�these�stocks�than�a�sudden�realization�that�their�business�models�are�becoming�dysfunctional.

A breakout year ahead?There�is�historical�precedent�for�a�significant�recovery�in�the�MLP/YieldCo�universe.�Today,�real�estate�investment�trusts�(REITs)�are�an�accepted�part�of�a�high-quality,�income-oriented�investment�strategy.�Twenty�years�ago,�the�group�was�excluded�from�major�market�indices�and�viewed�with�scepticism.�The�stocks�traded�in�a�volatile,�undisciplined�manner.�REITs�faced�the�same�questions�about�business�model�viability�and�dependence�on�one�commodity�that�now�plague�MLPs�and�YieldCos.� As�time�passed,�however,�the�functionality�of�the�REIT�structure�was�proven,�real�estate�cycles�went�up�as�well�as�down,�and�investors�in�the�leading�REITs�enjoyed�attractive�total�returns�with�a�strong�income�component�and�only�moderate�price�volatility.�Our�view�is�that�the�leading�MLPs�and�YieldCos�will�follow�a�similar�path.�If�2016�is�a�break-out�year� for�these�entities,�it�is�not�too�soon�for�investors�to�position�themselves��to�take�advantage�of�the�trend.

The benefits and risks of MLPs, YieldCos and REITs

nCombination of dividend yield and dividend growthnTax-efficient structures with no corporate level income taxnLong-term contracts provide visibility into future cash flownParticipation in the US infrastructure buildout (e.g., shale gas pipelines,

wind farms, telecom towers)

Benefits to income

investors

nRequire periodic access to capital markets due to high payout ration Sponsors have significant influence over MLPs, YieldCos and externally

managed REITsn Overhang of rising interest rates on companies that are viewed as bond

alternativesnEnergy prices may effect MLPs’ earnings and growth prospects

Potential risks

n Mostly-fee based activities in mining, refining, and transportation of oil and gasn Growth through organic development or acquisition from sponsor/third-partyn Oil & Gas MLPs: pipelines, storage terminals, refineries, propane distributionn Non-Oil & Gas MLPs: coal mines, wood pellets, nitrogen fertilizers, soda ash

MLP

n Solar and wind power plants and other assets with long-term contractsn Growth through acquisition from sponsor/third-partyn Not a tax-exempt entity under IRS; tax shelter dependent on tax credits

and depreciation

YieldCo

n Earnings through direct real estate investments or mortgage interestn Growth through organic development or acquisition from third-partyn Traditional REITs: office buildings, apartments, shopping malls, storage facilitiesn Specialty REITs: telecom towers, timber, data centres, advertising structures

REIT

Definitions

“�If�2016�is�a�break-out�year�for�MLPs�and�YieldCos,�it�is�not�too�soon�for�investors�to�position�themselves�to�take�advantage�of�the�trend.”

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CAPITALIZING ON DISRUPTIVE TECHNOLOGIES A�growing�piece�of�the�global�profit�pie�is�accruing�to�the�brains�behind�the�systems,�whether�that�is�elite�human�talent,�software�and�systems�that�enable�business�processes�or�–�most�powerfully�–�the�two�together,�where�elite�human�talent�leverages�the�strengths�of�cutting-edge�machine�systems.�This�dynamic�makes�it�different�this�time�in�terms�of�the�drivers�of�economic�success�and�business�cycles�that�many�market�participants�learned�in�school.�Countries,�companies�and�individuals�that�lack�differentiated�intellectual�property�will�struggle�to�compete.�Simple�labour�cost�arbitrage�and�capital-intensive,�low-value-added�manufacturing�will�be�increasingly�revealed�to�be�ineffective�paths�toward�sustainable�prosperity.

Robert McConnaughey Global Head of Research

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Embracing the power – and weighing the cost – of artificial intelligence2016�will�be�the�year�that�the�real-world�use�of�artificial�intelligence�tools�grows�to�a�level�that�raises�market�and�public�awareness�of�the�profound�implications�of�its�power.�This�reinforces�the�issues�raised�above.�For�example,�even�the�overseas�information�technology�(IT)�services�companies�that�have�thrived�on�labour�arbitrage�to�attract�outsourcing�business�are�rapidly�adding�machine�learning�systems�that�can�replace�human�programmers�and�analysts.�Just�as�robots�have�begun�to�replace�human�workers�in�manufacturing,�services�–�even�white�collar�services�–�will�increasingly�be�automated.�

While�these�developments�are�threatening�for�many�traditional�avenues�for�growth�in�the�emerging�markets,�it�is�not�all�bad�news.�For�example,�we�see�technology�as�a�key�enabler�of�impactful�reforms�in�countries�like�India,�where�simply�moving�paperwork�processes�online�is�having�a�huge�effect�in�reducing�corruption.�Also,�the�biometric�registration�of�that�massive�nation’s�citizens�is�allowing�for�big�leaps�forward�in�the�delivery�of�government�services�and�the�expansion�of�the�banking�system�to�the�previously�disenfranchised.

Darwinian�evolution�is�a�nasty�business�for�those�on�the�negative�side�of�the�equation.�Industries�and�companies�undergoing�disruptive�attacks�may�behave�very�differently�to�how�investors�are�accustomed�to,�as�historical�valuation�frameworks�and�cycles�may�prove�of�little�support.�Beware�the�value�trap�of�investing�in�apparently�cheap,�buggy-whip�companies.

Playing offence: The best defence in 2016The�implications�of�the�above�will�feed�a�growing�feeling�of�helplessness�among�the�many�in�the�world�rendered�uncompetitive.�This�increasing�angst�will�likely�fuel�the�continued�rise�of�political�polarization�and�populism�around�the�world.�

On�the�flip�side,�the�concentration�of�wealth�among�the�individuals,�companies�and�nations�that�can�embrace�and�lead�the�digital�revolution�will�be�extraordinary.�It�is�crucial�that�investors�maintain�meaningful�exposure�toward�innovation�to�capture�these�benefits�and�to�hedge�against�the�disruptive�downside.�This�may�be�counterintuitive�to�some�during�periods�of�volatility,�as�innovation�can�appear�to�be�expensive� and/or�risky,�but�the�best�defence�in�this�case�may�be�to�be�proactive� by�participating�in�the�success�of�leading�disruptors.�

Harnessing the speed and power of technological innovation Mobile Robot Technology Roadmap, Global, 2000 and Beyond

Source: Frost & Sullivan.

2000 2005 2010 2015 >2020

FULL AUTONOMYPARTIAL AUTONOMYHUMAN ASSISTED

Unmanned machines (e.g., automated guided vehicles [AGVs])

Controlled by warehouse-management systems

Wearable technology(e.g., exoskeletons)

Machines controlled remotely by telepresence

Semi-autonomous machines(e.g., remotely operated vehicles)

Machines that make basic decisions

Initial stages ofcognitive systems

Limited interaction between humans and machines

Autonomous machines (e.g., collaborative robots)

Intelligent machines with human emotions that can converse

fluently and adapt to their environment

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DC WORKPLACE PENSIONS: TARGETING GOOD FINANCIAL OUTCOMES Britons�aren’t�saving�enough�and,�when�they�are,�most�aren’t�allocating�their�capital�efficiently.�A�minority,�however,�are�taking�advantage�of�opportunities�created�by�astute�asset�allocation�and�active�fund�management�to�generate�good�financial�outcomes.�

Most�working-age�Britons�are�oblivious�to�what�lies�ahead�for�them�at� and�in�retirement.�That�much�is�clear�from�the�recent�launch�of�the�Pensions�Policy�Institute�(PPI)�report�The Future Book: Unravelling workplace pensions1,�a�longitudinal�study�of�the�UK�Defined� Contribution�(DC)�workplace�pensions�landscape.�

Commissioned�by�Columbia�Threadneedle,�this�research�points�to�a�national�rate�of�saving�into�DC�workplace�pensions�that�is�woefully�inadequate,�resulting�in�financial�outcomes�at�and�in�retirement�far�below�OECD�averages.�Indeed,�the�gross�replacement�rate�(gross�income�in�retirement�relative�to�gross�earnings�when�working)�for�a�median�earner�in�the�UK�without�retirement�savings�(around�50%�of�the�UK�working�population�don’t�have�pension�savings)�is�29.7%.�While�for�those�with�pension�savings�and�assumed�‘full�careers’,�this�rises�to�a�more�respectable�60.8%,�this�is�much�lower�than�exemplars�such�as�the�Netherlands�(90.5%)�where�nearly�90%�of�the�working�population�have�pension�savings2.�

In�fact,�based�on�current�trends,�The�Future�Book�suggests�that�the�average�Briton�retiring�in�20�years’�time�could�deplete�their�DC�pensions�pot�within�just�six�years�and�might�have�to�rely�solely�on�a�modest�state�pension3.�Given�continued�improvements�in�longevity,�unless�individuals�are�able�to�plug�this�shortfall�with�other�savings�or�income,�there�is�a�very�real�danger�of�experiencing�a�lower�standard�of�living�in�retirement�than�working�life.�Enter�auto�enrolment�(AE).�In�its�three-year�history,�AE�has�had�an�unprecedented�impact�in�shaping�the�DC�landscape�by�boosting�the�number�of�people�saving�into�a�workplace�pension�scheme�by�nearly�5.5m4.�However,�at�2%,�current�AE�contribution�levels�are�far�from�

Chris Wagstaff Head of Pensions and Investment Education

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MULTI-ASSET/ ALTERNATIVE AND OTHER VIEWPOINTS

adequate�and�there�are�more�than�six�million�working�people�who�aren’t�eligible�to�participate,�by�virtue�of�their�age�and/or�income5.�

Not�that�the�median�employer�and�employee�contribution,�into�DC�workplace�pension�schemes�per�se,�for�the�average�earner�totalling�a�meagre�6%�is�much�better.�Both�point�to�a�particularly�uncomfortable�retirement.�Indeed,�as�a�rule�of�thumb,�median�earners�need�to�contribute�11%�-�14%�of�their�band�earnings�from�the�age�of�22�to�State�Retirement�Age�(SRA)�to�have�a�two-thirds�chance�of�retiring�comfortably6.�Of�course,�the�longer�people�put�off�saving,�or�set�aside�an�inadequate�proportion�of�their�income,�the�less�likely�it�is�their�pensions�pot�will�provide�for�a�sufficient�income�in�retirement.

However,�factors�other�than�a�low�rate�of�saving�conspire�to�compromise�achieving��good�financial�outcomes.�Foremost�amongst�these�is�how�pension�savings�are�invested.�

The�Future�Book�points�to�the�overwhelming�majority�of�DC�scheme�members�investing�in�predominantly�one-size-fits-all�(and�arguably� unfit-for-purpose)�default�funds,�with�a�small�minority�investing�in� assets�capable�of�generating�inflation-beating�returns�in�the�long�run7.�

However,�given�the�prospect�of�more�modest�and�more�volatile�real�returns�from�hereon,�if�good�financial�outcomes�are�to�be�achieved,�the�imperative�should�be�to�invest�in�actively�managed,�well�diversified,�multi-asset�funds.�With�astute�asset�allocation�and�good�risk�management,�such�funds�are�well�positioned�to�combine�long-run�real�returns,�robust�against�a�multitude�of�economic�scenarios,�with�low�levels�of�volatility.�

Indeed,�as�an�active�manager�with�both�strong�multi-asset�capabilities�and�DC�credentials�and�a�keen�focus�on�providing�value�for�money,�we�are�well�placed�to�not�only�help�DC�savers�and�investors�achieve�a�financially�secure�and�comfortable�retirement,�we�arguably�have�a�responsibility�to�do�so.1The Future Book: unravelling workplace pensions. Daniela Silcock, Tim Pike and Shamil Popat. Published by the Pensions Policy Institute, October 2015. ISBN: 978-1-906284-34-3.2OECD Pensions at a Glance 2015, p.141 and p.187. A ‘full career’ is defined as working from age 20 to state retirement age without a career break.3The Future Book. Ibid p.40.4The Automatic Enrolment (AE) Evaluation Report 2015. Department of Work and Pensions. November 2015.

Quick view: DC workplace pensions in 2016 n Opportunities:�Well�diversified,�actively�managed,�multi-asset�strategies�tend�to�offer�stable�and�robust�real�long-run�investment�returns.�

n Threats:�Inadequate�saving;�underestimating�longevity;�unfit-for-purpose�default�funds;�prioritising�cost�containment�over�value�for�money.

n General outlook:�More�modest�real�returns,�continued�market�volatility,�interest�rates�lower�for�longer.�

n What should investors look out for?�Be�wary�of�investing�in�apparently�low-risk�funds�unlikely�to�generate�real�returns�and�relatively�undiversified�passive�funds�that�cannot�be�positioned�to�take�advantage�of�market�conditions�or�dampen�market�volatility.

n What should investors consider?�Actively�managed,�well�diversified,�multi-asset�funds�that�employ�astute�strategic�and�tactical�asset�allocation.�

5To be automatically enrolled an employee must be aged between 22 and SRA with an income from any one employer over £9,984 per annum. Minimum total employer and employee contributions are currently 2%, rising to 5% in March 2018 and 8% in March 2019. 6Source: The Future Book. p.24. Band earnings are between £5,824 and £42,395 in 2015/16. This assumes that at SRA the state pension will still benefit from “triple lock” indexation. 7Source: The Future Book. Ibid p.23.

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John Golden Senior Analyst

SUNNY DAYS AHEAD FOR CLOUD COMPUTING What is cloud computing?Cloud�computing�lets�enterprises�choose�between�owning�their�infrastructure�and�renting/subscribing�to�the�same�capabilities�from�third-party�providers.�The�two�major�types�of�cloud�computing�are�Software�as�a�Service�(SaaS)�and�Infrastructure�as�a�Service�(IaaS).�With�SaaS,�enterprises�outsource�the�development�and�hosting�of�software�to�third�parties�such�as�Salesforce.com�and�Workday.�With�IaaS,�enterprises�write�software�internally�and�host�the�application�in�third-party�data�centres�such�as�Amazon�Web�Services�(AWS)�and�Microsoft’s�Azure.

The cloud-based software market is projected to grow

SaaS On-premise SaaS as % of software Forecast

Forecast

Sources: Gartner/IDC, Columbia Threadneedle Investments, 12/15

IaaS

On-premise

CTI IaaS as % of TAM

Gartner IaaS as % of TAM

Sources: Gartner/IDC, Columbia Threadneedle Investments, 12/15

Gartner and Columbia Threadneedle Investments projected IaaS share of total addressable market (TAM).

Reve

nue

($ b

illio

ns)

SaaS

por

tion

of s

oftw

are

reve

nue

(%)

Reve

nue

($ b

illio

ns)

IaaS

por

tion

of s

oftw

are

reve

nue

(%)

The cloud-based software market is projected to grow

Significant growth expected in outsourced infrastructure

2012

2013

2014

2015

2016

2017

2018

2019

0

100

200

300

400

500

600

700

2012

2013

2014

2015

2016

2017

2018

2019

0

2

4

6

8

10

12

0

100

200

300

400

500

600

02468

101214161820

Sources: Gartner/IDC, Columbia Threadneedle Investments, December 2015.

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MULTI-ASSET/ ALTERNATIVE AND OTHER VIEWPOINTS

The cloud-based software market is projected to grow

SaaS On-premise SaaS as % of software Forecast

Forecast

Sources: Gartner/IDC, Columbia Threadneedle Investments, 12/15

IaaS

On-premise

CTI IaaS as % of TAM

Gartner IaaS as % of TAM

Sources: Gartner/IDC, Columbia Threadneedle Investments, 12/15

Gartner and Columbia Threadneedle Investments projected IaaS share of total addressable market (TAM).

Reve

nue

($ b

illio

ns)

SaaS

por

tion

of s

oftw

are

reve

nue

(%)

Reve

nue

($ b

illio

ns)

IaaS

por

tion

of s

oftw

are

reve

nue

(%)

The cloud-based software market is projected to grow

Significant growth expected in outsourced infrastructure

2012

2013

2014

2015

2016

2017

2018

2019

0

100

200

300

400

500

600

700

2012

2013

2014

2015

2016

2017

2018

2019

0

2

4

6

8

10

12

0

100

200

300

400

500

600

02468

101214161820

Sources: Gartner/IDC, Columbia Threadneedle Investments, December 2015.Gartner and Columbia Threadneedle Investments projected IaaS share of total addressable market (TAM).

What is driving the growth of cloud computing?Market expansion:�Hundreds�of�thousands�of�small�businesses�and�start-ups�now�have�broader�access�to�information�technology�resources.�According�to�venture�capital�firm�Upfront�Ventures,�entry�IT�costs�for�a�start-up�or�small�business�decreased�to�$5,000�in�2011�from�approximately�$50,000�in�2009,�significantly�expanding�the�market.

Ease of use/service on demand:�While�in�the�past�a�company�might�wait�days�or�even�months�for�traditional�IT�departments�to�procure,�set�up,�monitor�and�secure�infrastructure,�today�developers�can�now�spin�up�a�server�in�minutes.�Businesses�can�buy�computing�power�and�storage�capacity�to�meet�spikes�in�demand�driven�by�seasonal�periods,�events�or�even�time�of�day.

Lower cost of ownership: Cloud�computing�is�considerably�cheaper�than�traditional�infrastructure�for�most�applications.�Large�cloud�providers�run�their�mega�data�centres�much�more�efficiently�than�traditional�providers.� For�example,�AWS�can�manage�over�1,000�servers�with�a�single�engineer,�while�traditional�enterprises�manage�approximately�50�servers�per�engineer.

Shifting buyer base from central IT:�Today,�non-traditional�IT�buyers�(such�as�line�of�business�leaders�and�marketing)�control�as�much�as�25%�of�IT�purchases.�According�to�Gartner,�this�percentage�will�grow�to�50%�by�2018.�These�buyers�have�limited�lock-in�from�incumbent�technology�vendors�and�are�free�to�choose�the�best�solution�to�meet�their�business�objectives.

Cloud computing: A minor but growing segment of today’s IT market We�believe�the�IT�market�is�in�the�very�early�stages�of�the�cloud�adoption.�Our�historical�S-curve�analysis�suggests�that�cloud�computing�could�continue�to�grow�at�a�40%�compound�annual�growth�rate�(CAGR)�for�the�next�several�years,�above�industry�forecasts�of�28%�CAGR.�In�the�most�recent�quarter,�AWS�grew�78%�year-over-year�(YoY),�reaching�an�$8�billion�run�rate,�while�Microsoft’s�Azure�grew�135%�YoY,�far�ahead�of�expectations.�SaaS�providers�continue�to�grow�rapidly�as�well.�For�example,�Salesforce.com�and�Workday�grew�24%�YoY�and�50%�YoY,�respectively.�This�performance�is�in�stark�contrast�with�legacy�client/server�infrastructure�vendors,�which�have�reported�little�revenue�growth�or�even�revenue�declines.

Legacy client/server infrastructure players reacting, but profit pools will compress IBM,�Oracle,�EMC�and�Hewlett-Packard�all�have�newer�technology�and�as-a-service�segments�growing�in�the�20%–50%�year-on-year�range.�However,�this�growth�is�masked�by�declines�in�traditional�business�lines,�and�the�cost�of�investing�in�these�growth�areas�is�weighing�on�their�overall�earnings�growth.�Microsoft�is�the�one�legacy�IT�provider�where�the�transition�appears�to�be�further�along.�The�company’s�as-a-service�businesses�are�now�at�an�$8�billion�run�rate�and�the�company’s�overall�margins�have�begun�to�expand.�Over�the�next�several�years,�we�expect�the�newer�as-a-service�offerings�to�continue�to�take�share�from�legacy�products.

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Our Global Presence

Amsterdam

Luxembourg

Copenhagen

Zurich

Frankfurt

Stockholm

Dubai

Geneva

Minneapolis

Chicago

Milan

Vienna

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London

Los Angeles

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Portland

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