Having delivered another year of strong performance in 2017, global equity markets' 15-month run of positive returns finally came to an end in February. While the concentrated market of the previous year initially continued into 2018, the macroeconomic downturn proved less supportive for equities as economic and geopolitical concerns alarmed investors. Momentum remained the strongest style (followed by growth) through the quarter, but the latter two months saw a noticeable return of volatility to the market and global equities generated two months of negative performance.

Against this volatile turn of events, the strategy underperformed the benchmark in Q1 2018, driven by our holdings in the consumer discretionary, healthcare and consumer staples sectors, notably in the US. Offsetting this underperformance to an extent, the fund benefitted from positioning in the technology sector and the auto parts industry.
Global equity markets declined in Q1, despite getting off to a strong start. Markets were initially unnerved by higher-than expected inflation data in the US in February, which prompted concerns that the Federal Reserve could raise interest rates more quickly than expected. That was before fears over US-China trade sanctions, as well as mounting regulatory pressures for the technology sector, added to instability. Technology and consumer discretionary stocks were the only sectors to post positive performance over the quarter.

US equities began 2018 strongly, buoyed by ongoing strength in economic data, robust earnings and the confirmation of a major tax reform package. Indeed, macroeconomic prints remained broadly positive throughout Q1. However, February and March saw a marked increase in volatility as investors digested the destabilising potential of elevated US inflation prints and US-China trade sanctions. Overall, US equities declined over the period. The weakest performance was in telecoms, energy and consumer staples although most sectors fell.

Continental European equities also fell in the first quarter, driven by worries about the path of US interest rates and the outlook for global trade despite an encouraging economic backdrop in the Eurozone. UK equities were negatively impacted by sterling strength, which was in turn driven by progress with Brexit negotiations, better-than-expected macroeconomic data and growing expectations that base rates could rise faster than previously anticipated.
Amidst the rise in market volatility stemming from global trade tensions, emerging market equities suffered less than the developed markets. Elsewhere, on the whole, developed Asian markets declined.

Looking at the strategy, underperformance was driven by the consumer discretionary, healthcare and consumer staples sectors, most notably in the US. Within the consumer discretionary sector, our retail exposure detracted, coming from a mixture of our underweight position in Amazon and not holding Netflix, both stocks that we do not favour on account of our business quality and valuation metrics. We also suffered from our overweight in more traditional retailers. However, this was offset to some extent by our overweight in the auto parts industry, specifically in UK company GKN Plc which rose on takeover talk early in the period.

Within healthcare, the fund suffered from positioning in the pharmaceuticals and health equipment industries. Our overweight positions in pharmaceuticals detracted from performance while not holding a number of health equipment names in the US also weighed on performance as the industry performed well through the quarter. Stock selection in consumer staples also detracted, again notably in the US, where our favoured holdings in the food & drink and home products industries suffered over the quarter.
Technology, where our preferred areas remain high quality "boring" companies with strong balance sheets, offset some of the underperformance from elsewhere in the portfolio. Notable contributions came from our overweight positions in semiconductors, IT services and hardware. At the regional level, stock selection in Japan and the UK was positive.

Source: Schroder QEP Global Core quarterly fund update - First quarter 2018

Global equities delivered another year of strong performance in 2017, as markets across the globe reached successive new highs.

Against this backdrop, the strategy underperformed the reference benchmark in 2017. In the information technology sector, our focus on attractive valuations was not rewarded, while being underweight expensive growth names detracted. Our consumer discretionary holdings also weighed on returns. Underperformance earlier in the year was offset somewhat by fourth quarter performance, which saw strong stock selection in healthcare, industrials and financials sectors

2017's macroeconomic backdrop was generally supportive for equities, with low interest rates, stable economic expansion, benign inflation, and generally positive earnings releases allowing investors to overlook a comparatively turbulent geopolitical picture. As a result, global equity markets delivered 12 successive months of positive performance, in local currency terms, a feat that has not been seen over the past 30 years. The year began with markets buoyed by President Trump's plans for tax cuts, deregulation and infrastructure spending, and their implications for growth. Whilst his ability to deliver on pre-election promises soon came into question, economic data remained supportive and US markets reached a series of new milestones over the course of the year.

In Continental Europe, the populist movement continued to dominate politics, while in the UK there remained the question of Brexit and the triggering of Article 50. Concerns on the continent eased following market-friendly election results in Holland and France, with equity markets also responding positively to an extension of quantitative easing (QE) and an improving growth outlook. However, while the Bank of England raised interest rates for the first time in over ten years, UK growth slowed and the uncertainty surrounding Brexit negotiations lingered on.

Across the emerging markets, improving commodity prices and a more positive growth outlook successfully diverted attention away from political instability and growing tensions on the Korean peninsula. As a result, emerging markets outperformed developed markets by a significant margin.

The technology sector dominated, comfortably outperforming all other sectors and leading to a highly concentrated market driven by a narrow cohort of growth stocks trading on ever-more extended valuations. Consequently, growth and, to an even greater extent, momentum, dominated market returns over the course of the year. While, to some extent, this momentum has been justified by improving fundamentals and the quality of many of these companies cannot be denied, we believe that it is important not to overpay for quality. Therefore, where we might typically expect our focus on quality to provide some diversification under normal market conditions, the market's fixation on expensive high quality stocks has seen the slower growing but equally high quality stocks somewhat left behind. Combined with record low volatility levels, such a narrow market presented a challenging environment for our diversified, valuation-aware approach.

With the valuations of the current market leaders looking ever more stretched, the question must be whether they can maintain such high levels of growth in future. This will be reliant on the continuation of more good news and the potential for disappointment is high. Therefore, as many of these names are widely owned, if the market does rotate, we would fully expect volatility to spike higher which would favour our diversified approach.

Looking at the strategy, underperformance was driven by the technology and consumer discretionary sectors, most notably in the US. Within technology, our preferred names, specifically attractively-valued companies such as Qualcomm and IBM, weren't rewarded, as investors focused on companies with exposure to topical secular growth themes.

Within the consumer discretionary sector, our retail exposure detracted, coming from a mixture of underweight positions in Amazon and Home Depot and overweights to more traditional retailers. Our Japanese exposure also weighed on returns over the course of the 2017, led by overweight positions in healthcare and wireless telcos.

The final few months of the year, however, provided a better environment for the strategy and it finished the fourth quarter ahead of the reference benchmark. The quarter's outperformance was driven by strong stock selection across both region and sector, with some of our favoured holdings adding value. Within healthcare, our longstanding overweight in healthcare providers had a positive impact on returns, whilst not holding certain US pharmaceutical names was also beneficial.

Within financials, our holdings in consumer finance, life & health insurance and complex banks proved profitable, whilst not holding certain European banks also provided a boost. Industrials benefited from a mix of over- and underweight positioning. Our longstanding underweight to GE, which cut its dividend during the quarter, finished as the top positive contributor over both the quarter and the year. Holdings in machinery companies 3M and Snap-on added value, as did selective holdings across Continental Europe. Our underweight allocation to utilities, the top contributing sector for the year, supported performance again in Q4.

Source: Schroder QEP Global Core quarterly fund update - Fourth quarter 2017