SEI Stability-Focused Strategic Portfolios

Brexit dominates headlines in Q2 2016; fixed income rallied while global equity markets stabilised after initial shock of a ‘leave’ vote

• Following the relative calm of April and May, June ended raucously as markets digested the at least partially unexpected outcome of the UK EU referendum vote. Fixed income yields fell in a ‘flight to safety’ response from investors, while equity markets initially declined modestly and then rallied on the expectation of central bank support.
• Overall, the SEI Strategic Portfolios delivered strong absolute returns across the range, beating broad market indexes over the quarter*. UK investors with globally diversified investment strategies, such as those inherent to the SEI Strategic Portfolios, generally benefitted from the decline in sterling, as the value of unhedged non-sterling holdings in equities appreciated in GBP terms.
• Within the Stability-Focused SEI Strategic Portfolios (the Defensive, Conservative, and Moderate Funds), the investments in the fixed income asset classes appreciated in absolute terms and many outperformed their individual benchmarks. Allocations to Global Short Duration Fixed Interest presented less volatile returns when compared to the medium-duration fixed income allocations within the Strategic Portfolios. Generally speaking, credit and currency positions outweighed headwinds from short duration in the face of generally falling yields.
• Additionally, significant benefit was felt from the investments in the Global Managed Volatility asset class, which outperformed significantly over the period, justifying its application as defensive equity exposure for investors with shorter time horizons and more conservative investment goals. Asset allocation often shows its strongest hand during times of crisis; SEI’s approach to asset allocation provided meaningful benefit to Strategic Portfolio investors over the period.

Market Overview

• The second quarter’s most prominent event, a vote by UK citizens in favour of leaving the European Union (EU), took place with roughly a week left in June. Market volatility had increased markedly ahead of the referendum, but not by enough to compensate for the unexpected outcome, as polls and bookmakers, while split, generally projected a victory for the Remain campaign.
• A sharp spike in global stock-market volatility ensued; yields were driven downward to record levels on perceived safe-haven investments like developed-market government bonds, and sterling and the euro, the currencies at the centre of the developments, weakened substantially relative to the US dollar and Japanese yen. Much of the stock-market losses were recovered within a week’s time, suggesting the impending multi-year uncertainty may not be as detrimental to global economic health as initial reactions implied.
• The preceding 11 weeks of the quarter were largely uneventful and major central-bank policies were essentially on hold through April and May. The ECB commenced two stimulus measures in early June that been announced in March: corporate-bond purchases and targeted long-term repo operations. Oil prices advanced for much of the quarter then levelled off in June as OPEC failed again to agree on a production freeze, while the yen strengthened relatively steadily against most other major currencies.
• In terms of economic data, US manufacturing growth accelerated to healthier levels in June, with new orders a key source of strength. Labour productivity dropped by 0.6% in the first quarter but year-over-year productivity advanced by 0.7% as output gained by more than hours worked, suggesting seasonality might have contributed to weakness.
• Eurozone services sector growth softened modestly in June, while an increase in manufacturing growth compensated, keeping the composite level mostly steady going back to February. Producer prices jumped 0.6% in May, more than offsetting April’s decline, but still deeply negative year over year. Eurozone unemployment remained high in May, declining by 0.1% to 10.1%. However, a 1% drop from a year earlier demonstrates some improvement in the labour market. First quarter economic growth for the EU was revised upward, to 0.6% and 1.7% year over year.
• UK construction activity contracted with some intensity during June, its first decline since early 2013. Services sector activity decelerated to its slowest level in more than three years, albeit still in growth territory. A final reading of economic growth registered 0.4% for the first quarter and 2.0% year over year. Looking forward, clearly much will depend on the effect of the Brexit vote on consumer confidence and business investment.

Selected Asset Class Commentary

• Global Short Duration Fixed Interest asset class: Off-benchmark exposure to corporate credit was beneficial over the quarter, while active currency exposure to AUD and EUR added value. The underweight duration stance was a slight detractor from relative returns, however this was partly offset by being overweight to higher yielding markets. At the manager level. AllianceBernstein and Schroder Investment Management both outperformed during the quarter, while Colchester Global Investors lagged.
• Global Government Fixed Interest asset class: Global bonds benefitted from the Brexit vote as government bonds in G4 countries were purchased by investors seeking to reduce risk. Expectations are now that the US Federal Reserve will hold off on raising rates for some time. Duration positioning detracted overall due to the fund’s underweight, although this was partly offset by an overweight to higher yielding markets. Off-benchmark exposure to corporate credit was marginally positive. AllianceBernstein and Schroder Investment Management both outperformed, while Colchester Global Investors and Brandywine Global Investment Management both lagged mainly due to underweights in the core markets which rallied strongly.
• Global Credit Fixed Interest asset class: Global corporate bonds also performed well in the aftermath of the Brexit vote which drove yields lower. Duration and yield-curve positioning were largely neutral. An overweight to corporate credit, particularly US corporates, contributed, as did off-benchmark high-yield exposure. Active currency positioning, mostly in the form of an underweight to the euro, was also positive. With the exception of JP Morgan Investment Management, all fund managers outperformed during the quarter.
• Emerging Markets Fixed Interest asset class: Local currency bonds from emerging-Europe countries struggled in the post-Brexit landscape; meanwhile, US dollar-denominated issuers, commodity exporting countries and other regions, such as Latin America, performed well. Stone Harbor Investment Partners contributed as an underweight to Hungarian local debt and overweight to Venezuelan debt helped relative performance. The fund is neutral weight in local currency debt. An underweight to external debt remains; however, this is in conjunction with an overweight to corporate bonds. The higher yields and lower interest rate sensitivity of corporates are attractive. The remaining allocation is a modest exposure to cash.
• Global Managed Volatility asset class: through its natural focus on lower volatility names, this asset class is significantly biased towards defensive sectors. As a result it was underweight (compared to the MSCI World Index) to some of the areas most affected by the Brexit outcome, including homebuilders and banks. As the primarily equity implementation in the Stability-Focused SEI Strategic Portfolios, this asset class played a significant role in ensuring that the Strategic Portfolios performed to expectations in a challenging environment. Additionally, the global diversification present within the asset class itself also contributed as the value of non-sterling exposures appreciated in GBP terms.
• Commodities asset class: Commodities as a whole performed well for the quarter. Oil performance was very positive as supply outages in Canada, Nigeria and Libya aided returns. Soybean returns were also strong, driven by poor weather in key South American growing regions. Active positioning in base metals and grains benefitted the fund on a relative basis while energy positioning modestly detracted.

Outlook

• UK’s vote to leave the EU is a major political and economic event that will likely weigh on international financial markets, not just for weeks and months, but perhaps for years. The leap into the unknown will likely depress UK economic growth as business spending gets frozen until some clarity re-emerges on the country’s trading relationships. Sterling’s plunge immediately following the Leave voteshould provide a much-needed offset to the mostly negative impact of all the uncertainty, as UK exporters find themselves in a more competitive position.
• Britain’s growth prospects were decent prior to Brexit; by contrast, continental Europe was already struggling to improve. Of the many economic imbalances that exist in the world, among the greatest is the huge trade surplus run by the eurozone. In the aftermath of the Leave vote, nationalist parties in various countries are lobbying for their own referendums on continued membership in the EU, which adds to the uncertainty facing investors. The fragility of the eurozone recovery going into this crisis is a matter of concern. The fact that bond yields did not bounce higher even as stock prices rallied post-Brexit is a divergence worth noting.
• SEI believes that the US remains the cleanest shirt in the laundry bag, staying resilient despite numerous shocks over the past seven years. This puts the Federal Reserve in something of a quandary, since the Brexit shock has seemingly upended any possibility of a near-term rise in the funds rate. Market-implied expectations for the next policy-rate move have been pushed out to late-2017; in fact, futures traders have priced in the mild possibility of a rate cut in the near term.
• However, there is a growing sense of that the US central bank may be a falling behind the inflation curve. Soggy global economic growth and the shock delivered by the UK vote argue for a very cautious process of interest-rate normalization. But if the upward trend in labour costs is sustained, a more aggressive response by the US central bank eventually will be justified. In the months immediately ahead, investors’ attention mostly will be focused on the US presidential election. Like recent and upcoming contests in Europe and elsewhere, the US contest will contentious.
• SEI expects challenges for the UK and eurozone economies and their currencies, but a repeat of the 2008 global financial crisis appears improbable. The global economy would largely seem resilient enough to push through. During the times of greatest uncertainty, sticking to an investment plan and philosophy can seem like the hardest thing to do; SEI and the underlying managers intend to do so and would strongly suggest that where possible investors to continue to take a similar approach.

Important Information on Performance
Past Performance is not a guarantee of future performance. Standardised performance is available upon request. All data is as at 31 March 2016.
Asset class performance discussed is based on the majority SEI fund underlying the asset class. This does not include analysis of the manager pools, hedged share class investments within SEI Funds, additional SEI funds or any third-party funds within the Strategic Portfolios. As a result, performance for the total asset class allocation may vary. Not all asset classes discussed are included in all Strategic Portfolios.

Important Information
This document and its contents are directed only at persons who have been classified by SEI Investments (Europe) Limited as a Professional Client for the purposes of the FCA Conduct of Business Sourcebook.
This information is issued by SEI Investments (Europe) Limited, 1st Floor, Alphabeta, 14-18 Finsbury Square, London EC2A 1BR, which is authorised and regulated by the Financial Conduct Authority.
The SEI Strategic Portfolios are a series of the SEI Funds and may invest in a combination of other SEI and Third-Party Funds as well as in additional manager pools based on asset classes. These manager pools are pools of assets from the respective Strategic Portfolio separately managed by Portfolio Managers which are monitored by SEI. One cannot directly invest in these manager pools.
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This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any stock in particular, nor should it be construed as a recommendation to purchase or sell a security, including futures contracts.
Investments in SEI Funds are generally medium- to long-term investments. The value of an investment and any income from it can go down as well as up. Investors may not get back the original amount invested. The risks described below may apply to the underlying assets of the products into which the Strategic Portfolios invest:

• Investment in equity securities in general are subject to market risks that may cause their prices to fluctuate over time.
• Fixed income securities are subject to credit risk and may also be subject to price volatility and may be sensitive to interest rate fluctuations.
• Absolute return investments utilise aggressive investment techniques which may increase the volatility of returns. If the correlation between absolute return investments and other asset classes within the fund increases, absolute return investments’ expected diversification benefits may be decreased.
• International investments may involve risk of capital loss from unfavourable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations.

The Funds are denominated in one currency but may hold assets priced in other currencies. The performance of the Fund may therefore rise and fall as a result of exchange rate fluctuations.
Whilst considerable care has been taken to ensure the information contained within this document is accurate and up to date, no warranty is given as to the accuracy or completeness of any information and no liability is accepted for any errors or omissions in such information or any action taken on the basis of this information. SEI sources data directly from FactSet, Lipper, and BlackRock, unless otherwise stated.