Letter from the CIO

Given the excitement in the markets during 2016, I wanted to give a quick summary of investment performance last year, cover some key initiatives within Russell Investments, and provide a brief glimpse ahead for markets in 2017. We remain committed to accomplishing our mission of “Improving Financial Security for People.” The competitive industry and the difficult markets we face require us to be sharper than our peers in generating results. We are more vigilant than ever in managing the assets you have entrusted to us and look forward to continuing to help you achieve your objectives.

PERFORMANCE

At the beginning of the year, we forecast low to mid-single digit returns for global equities and expected that global interest rate policies would start to normalize as rates rose. More granularly, we preferred European equities over U.S. equity markets and shorter term bonds. Additionally, we were aware that with the potential rate rises, expensive defensive stocks and stocks valued primarily for income generation (aka proxy yields) within the equity market were likely to underperform. Basically, we expected that the strong demand for yield would be less important as rates normalized. We continued to believe that owning a diversified multi-asset portfolio would help smooth overall volatility.

There are always unanticipated events and 2016 was not short of them. This includes Brexit and the election in the United States. At the start of the year, we did not plan for strong reflation with double digit returns in U.S. equities and positive returns in major commodities.

Despite the unanticipated events, we were able to tactically adjust from our early 2016 views to provide solid value for investors as we ended the year. Globally, our performance was generally in line and exceeded objectives in certain areas. Certainly, higher nominal returns were generated across a variety of multi-asset products, often done while being lighter in equity risk due to our single digit forecast for stocks. Good substitutes for stocks such as high yield, bank loans and preferred securities helped achieve strong returns, while protection strategies allowed us to hold onto equities that we otherwise would not given volatility concerns.

Within asset classes, our equities team had a good second half of the year as expensive defensive securities and other yield-oriented sectors (where we were underweight) and securities lagged during the “reflation trade.” Within fixed income, our portfolio managers generally exceeded benchmarks by using unique country and currency strategies despite smaller exposures than our peers to riskier credits. Lighter credit risk hurt our riskier bond funds although the nominal results generated were mostly double digit as the asset class performed well led by energy securities.
2016 was a tough year for many active stock-pickers, nevertheless our manager selection was overall again positive, in particular equities. The table on the next page shows the percentage of our EMEA Funds that have beaten their respective benchmarks gross of fees over one, three, and five year periods and since inception. Our EMEA range of multi-asset Funds performed strongly against their respective objectives.

Our single asset-class EMEA Funds had an overall positive year relative to their respective benchmarks, with 68% outperforming over one year and 90% outperforming over five-years. Our Fixed Income Funds, Global Equity Funds and Emerging and Frontier Markets Equity Funds posted particularly strong 2016 benchmark-relative returns.

Percentage of Russell EMEA funds outperforming their benchmark

January 2014 to 31st December 2016

Percentage of Russell EMEA funds outperforming their benchmark

Source: Russell Investments. Calculations based on Confluence. Data as at 31st December 2016. Gross of fees stated in USD. Calculations do not include discretionary mandates or Funds not measured primarily against a stockmarket benchmark. Please note that the value of your investments may fluctuate. Results achieved in the past do not offer any guarantee for the future.

1In sterling terms, gross of fees
2In sterling gross of fees

NEW AND ONGOING INITIATIVES

In this incredibly competitive industry, we cannot stand still. We have heard your requests and are creating new solutions and modifying existing ones to help better achieve your objectives by recognizing your preferences, constraints and circumstances. The market environment is also creating huge challenges that necessitate change. Specifically, our capital markets forecasts are calling for very low returns across asset classes over the next 7-10 years. This challenging environment creates a simple low-return imperative for investors: when expected future market returns are likely to be lower than the required rate of return, we believe an investor cannot afford to ignore any investment strategy that may offer incremental return, take on risks they do not expect to get paid for, or disregard implementation efficiency. As a result, we are expanding our fund range to offer a wider range of solutions across the risk spectrum.

In September 2016, we made available a new Unconstrained Bond strategy to address investors’ needs for consistent returns over shorter time horizons with moderate risk. This will be complemented in 2017 by the launch of our Multi-Asset Credit (MAC) strategy, based on a portfolio we have successfully managed in a segregated client mandate. Our MAC strategy targets a higher return with modestly higher risk than our unconstrained strategy. We see these two new strategies as part of a spectrum of multi-asset solutions.

Our Implementation Services team (RIIS) unveiled the Informed Dynamic Currency Hedging (IDCH) model. This cutting-edge model is designed to provide additional investment return while improving the risk-return profile of international currency exposure. RIIS saw continued growth globally across all products (Transition Management, Overlay Services, FX and Execution Services). RIIS’s excellence as a global broker was evidenced by their top ranking, for the second successive year, in the Institutional Investor Trading Cost Analysis survey.

In addition to developing new ideas to offer to our clients, it is important that Russell Investments continues to ensure our portfolio managers have the right tools. That could mean owning factors in a dedicated portion of the strategy, or using CDX, futures or options to manage risk. The evolution of our process over the past few years has allowed us to provide precise tools and strategies for our portfolio managers to adjust portfolios alongside our underlying managers as opposed to simply varying manager weightings or changing out manager portfolios. As an example, even though not well anticipated by the market, I am pleased with the way our team was able to nimbly deal with the environment around Brexit and the U.S. election given the more advanced tools they had relative to five years ago.

We have also built stronger modelling capabilities to better understand risk and align our positioning across asset classes. For example, the global equity team greatly refined their dynamic positioning process by creating more robust models that leverage our decision-making framework based on cycle, value, and sentiment (CVS) to determine where to overweight and underweight equity factors.

ESG INITIATIVES

Environmental, social and governance (ESG) issues are becoming more important for many of our clients, and we are responding with a range of new initiatives. For instance, in 2016 we launched a ground-breaking decarbonisation strategy to reduce the CO2 footprint of a portfolio whilst managing both active risk and the overall portfolio ESG rating. This strategy has also been incorporated in two new actively managed strategies with wide-ranging ESG briefs that we have launched for a Belgian client early this year.

LOOKING AHEAD TO 2017

  • The new regime in the US, in particular the ability of the new President to meet elevated market expectations
  • The potential for further political and economic upheaval, particularly in the Eurozone, as populists continue their battle against elitists and as the merits of globalization are called into question
  • Wider interest rate and inflation trends, as the long disinflationary tide begins to turn and as world economies return to growth

More broadly, we remain committed to ensuring we have the right people, process and infrastructure to get the absolute best for our clients. We are continuing to make significant improvements to our products and evolve our process and toolkit to ensure we generate the best possible outcome. On behalf of Russell Investments, we thank you for your continued commitment and partnership.
Happy New Year,


Jeff Hussey

Global Chief Investment
Officer

Gerard Fitzpatrick

Chief Investment Officer,
EMEA and Fixed income

Please note that the value of investment and the income derived from them may go down as well as up and an investor may not receive back the amount originally invested. Any past performance figures are not a guide to future performance