Q2 2023 Investment Outlook

Navigating the polycrisis: Part II

FIL Investment Management

March 2023

For investment professional use only and not for general public distribution
Navigating the polycrisis: Part II
Three themes for Q2 2023

▪ The aftershocks of Covid and the war in Ukraine continue to reverberate, with fissures in the global banking system opening on
the back of the fastest rate hiking episode in history. DM financial stability risks return with a vengeance.
Hard vs. soft ▪ With inflation having peaked, yet remaining well over target, the polycrisis continues to seriously challenge the Fed and other
landing CBs. Every path in policymakers‘ decision tree entails trade-offs in managing growth, inflation, moral hazard risk, and more.
▪ The most extreme policy cycle since the 1980s has yet to conclude; we still see a hard landing recession in DM as the most
logical outcome. Meanwhile, China’s reopening and Japan’s incoming policy regime introduces both risks and opportunities.

▪ Up until March, the investment landscape showed a contrasting picture of near-term resilience and strong balance sheets, and
risk of a recession eventually triggered by the higher cost of capital. This landscape has quickly darkened.
Risks and ▪ In this context, our investment teams are focused on opportunities with resilient profiles. Sectors and regions with structural
opportunities tailwinds and defensive characteristics, balanced with attractive valuations, present better risk-reward at this juncture.
▪ In the near-to-medium term, China’s re-opening is a boon for China and EM risk assets. Over the longer-term, the themes of
sustainability, demographics, and reshoring/near-shoring continue to be sweet spots.

▪ The message from China’s Two Sessions meeting is one of sustainable growth and a commitment to reopening. The
government set a 5 per cent growth target in 2023 as an achievable goal, supported with moderate fiscal stimulus.
China reopening ▪ Domestic mobility has rapidly returned, a positive sign. That said, stronger consumer confidence will be key as well as property
sector activity. The latter is showing early signs of recovery.
▪ We are focused on second derivative reopening beneficiaries, onshore assets, and the strategically important digital economy.
Growth spillovers to neighbouring Asian markets and EM offer additional opportunities for alpha generation.

Source: Fidelity International, March 2023.

2
Key themes and their investment implications for Q2 2023

Asset Private
Allocation Equities Fixed income markets Real estate

▪ Currently, the fallout from SVB has not
changed our medium-term outlook. We
still expect a hard landing but at a later
date. We are defensively positioned,
underweight credit and overweight cash.
Hard vs. ▪ We think markets are under-pricing the risk
of a recession in DM and that credit will be
the first to come under pressure. Equities
soft landing are supported by sentiment and strong
labour markets for now.
▪ Within credit, we prefer IG for its higher
quality, defensive characteristics.
▪ This quarter could be volatile amid
issues in the banking sector alongside
ongoing uncertainty over the future
path of the global economy and
interest rates.​
▪ Equity markets are yet to fully reflect
the potential hit to earnings from a
faltering global economy.​
▪ For companies, the near-term pain
is evident in our survey’s wide range
of data points. Our analysts expect
a rise in debt defaults over the next
12 months.
▪ The risk of a hard landing is not yet
fully priced into HY spreads. Credit
conditions are tightening, the
weighted average cost of capital is
increasing. High yield bonds offer
high all-in yields, but spreads still
don’t provide adequate protection
for a hard landing.
▪ Private debt less impacted by dichotomy
of hard vs soft landing – both suggest
challenges, but even in the hardest
landing scenario, the private debt
product retains protections at the
most senior secured position of the
capital structure, while floating rate
nature mitigates impact of volatile
rates backdrop.
▪ In a soft-landing scenario, the recent
repricing in real estate should provide a
good foundation for performance
driven by a combination of rental
growth and attractive yield. ​
▪ In a hard-landing, higher inflation and
or interest rates could cause a further
wave of repricing and reduced liquidity
and reduced confidence.​
▪ Real estate related debt and bond
exposure could create a crisis in
confidence in the broader sector.

▪ SVB highlights the risks involved with
today’s fast pace of tightening. The Fed
has been amongst the most aggressive
– one reason why we favour a relative
underweight in US equities. Now, the
fallout looks to be contained but we
will continue to monitor the situation
Risks and as it unfolds. ​
opportunities ▪ European small caps have lagged the
broader recovery in Europe equities,
creating the opportunity for a catch
up. They are priced for a deep
recession while the outlook is for
a milder recession.
▪ We believe an earnings correction will
occur this year. Corporate profit margins
are under pressure, and rising funding
costs are also adding risk.​
▪ US earnings woes are likely to be
extended, driven by multiples
compression, with a strong labour
market weighing on margins. ​
▪ China’s re-opening is a significant boost
for equities within Asia. Regional
earnings for 2023 remain encouraging
vs global markets.​
▪ Refinancing is becoming more expensive
for companies and rising interest rates
are already having an effect on the
residential mortgage market and auto
loans. This is normally the time to gain
duration exposure: government bonds
typically outperform higher-risk assets
at this point in the cycle. ​
▪ The next maturity wall occurs in 2025.
However, at the margin there will be
companies that do need to refinance and
this will be expensive.​
▪ The sectors that dominate the
European private debt market are
predominantly stable – services etc. –
with limited exposure to Russia or
inflated energy prices.
▪ Europe offers more mature market
than U.S. with more experienced
borrowers and fewer names from
more stressed subsectors​.
▪ Limited exposure to energy,
banking, and tech sectors. ​
▪ Structural changes in supply
chains continue to create demand
for logistics.
▪ Acute shortage of supply and
abundance of demand in
sustainable buildings. Linked
carbon ambitions.

▪ We prefer EM equities to DM
equities. We also expect EM
currencies to be supported.​
▪ Other beneficiaries of China’s
reopening include the Thai baht,
the Australian dollar, and
China Indonesian and Chinese
A-Shares equities.​
reopening ▪ We prefer Asia high yield to that of
Europe and the US.​
▪ The rapid reopening has resulted in
a spike in valuations among Chinese
equities. The next stage will be a
switch to earnings as the main driver
for future gains.​
▪ Earnings per share (EPS) still has a
long way to go to catch up with the
historical average peak increase.​
▪ Chinese corporates enjoy favourable
tailwinds. Monetary and fiscal policies
are both accommodative and inflation
remains benign.​
▪ The macroeconomic backdrop
remains supportive in China, with
Covid cases having peaked, easing
monetary policy from the People’s
Bank of China (PBOC), and
increasing fiscal support. This will
be expensive.​
▪ Europe currently enjoying the economic
tailwind from China reopening, but this
is likely to have postponed any expected
recession rather than resolving the
risk completely​.
▪ Economic buoyancy seen in borrowers’
input costs decreasing, but wage
pressures persist and this continues to
weigh on operating cash flow.

This is for investment professionals only and should not be relied upon by private investors

3
Global Macro
The scenario probability tree
Recent banking stresses in the US strengthen our conviction that a hard landing is ahead

Scenario probability tree over the next 12-18 months Cumulative scenario probabilities

T=0 12M 18M

Probabilities after 12 months
0.1
Soft landing/policy
miracle Soft landing 5% (30%)
(UR = 3.5% – 4.4%)
5% 5%

Recovery Cyclical recession 80% (55%)

(UR = 3.5% – 4.4%)

Labour market strength

Hawkish reaction Balance sheet recession 15% (0%)
1
80%
Cyclical Recession Sum of recession probs. 95% (55%)
(UR = 4.4% – 6.5%)
80%

0%
Policy Induced
Balance Sheet
Recession
(UR > 6.5% )

Policy Induced
Balance Sheet
Recession
(UR > 6.5% ) 15%
15% 0%

Note: Probabilities are shown for each branch. Note: Previous probabilities shown in brackets
Source: Fidelity International, March 2023. Source: Fidelity International, March 2023.

5
Our quant models have been signalling a high probability of US recession…
…even before the rise in banking stress. Now it’s becoming even more likely

Recession prob. from US future activity trackers (1Q ahead) Recession prob. from various yield curve inversions (2Q ahead)

100% 1.0

90% 0.82

80% 0.8
0.76
70%
58%
60% 0.6

50%

40% 0.4

30%

20% 0.2

10%

0% 0.0
Q1 1969 Q1 1978 Q1 1987 Q1 1996 Q1 2005 Q1 2014 Q1 2023 1972 1979 1985 1992 1999 2006 2013 2020

Actual Fitted Recession 10Y3M Combined Curve

Note: combined curves looks at the spread of 28 different nominal curves which gives us the best success rate of
predicting a recession historically. Data as on end December 2022
Source: Fidelity International, Fidelity Global Macro Team calculations, March 2023. Source: Fidelity International, Fidelity Global Macro Team calculations, March 2023.

6
Bank lending channel and Fed policy implications
Focus now on the bank lending channel which is the key transmission mechanism for ongoing stress

Market now pricing in significant cuts by year end Credit standards have already tightened meaningfully, implying
USD OIS 1M implied forward rates flat credit growth going forwards
6 -10% 110%

5.5 90%
-5%
5 70%

4.5 50%
0%

% Balance
4 30%

5%
3.5 10%

3 -10%
10%
2.5 -30%

2 15% -50%

Jan-1987

Jan-1990

Jan-1993

Jan-1996

Jan-1999

Jan-2002

Jan-2005

Jan-2008

Jan-2011

Jan-2014

Jan-2017

Jan-2020

Jan-2023
Jun-2023

Dec-2023

Jun-2024

Dec-2024
Mar-2023

Mar-2024

Mar-2025
Sep-2023

Sep-2024

Loan growth from commercial banks (%YoY, Inverted, 12M lag)

Pricing on 17th March Pricing on 8th March Banks Tightening C&I Loans to Large Firms (% balance of banks tightening, RHS)

Source: Fidelity International, Bloomberg, March 2023. Source: Fidelity International, Haver Analytics, March 2023.

7
Bank lending channel and Fed policy implications
Falling bank deposits, market turmoil will lead to further tightening in financing conditions

Gap between money market fund yields and bank deposit rates Impact on lending standards for large/med sized firms from
highlights deposit flight risk regressing lending standard
6% 12.0 11.6

5%

4%
8.0

Percentage points
7.1
3%

2%

4.0
1%

0%
Jan-2003

Jan-2005

Jan-2007

Jan-2009

Jan-2011

Jan-2013

Jan-2015

Jan-2017

Jan-2019

Jan-2021

Jan-2023
0.0
50 bps increase 100 bps increase
FFR target upper bound Money Market Fund average yield in avg US Bank CDS in Fed Funds Rate
FDIC National Average savings rate Note: Above are estimates based on regressing lending standards on Fed funds rate and average US Bank 5Y CDS spreads.
Equal weighted average of six US Bank 5Y CDS spreads are used for calculating average US bank CDS (MS, GS, JPM, BofA,
WF and Citi). Lending standards are net % of tightening standards from the Senior Loan Officer Opinion Survey. All the
Note: MMF yields are approximated via an average of 4 US money market fund yields.
independent variables are statistically significant at < 5% and the model R2 is 40%.
Source: Fidelity International, Bloomberg, Haver Analytics, March 2023.
Source: Fidelity International, Fidelity Global Macro Team calculations, Bloomberg, Haver Analytics, March 2023.

8
US labour market remains at its tightest levels in decades
The Fed is pursuing tool separation to address financial stability and inflation targeting but the trade-off is
getting sharper
Labour market tightness inconsistent with soft landing… … and keeping underlying inflation high and sticky.
Fidelity Labour Market Tightness Indicator (FLMTI)
100 1 9%
85.7 8%
90 0.9
7%
80 0.8 6%
5%
70 0.7
4%
60 0.6 3%
Percentile

50 0.5 2%
1%
40 0.4
0%
30 0.3 -1%
-2%
20 0.2

Oct-2020

Oct-2021

Oct-2022
Jan-2020

Jul-2020

Jan-2021

Jul-2021

Jan-2022

Jul-2022

Jan-2023
Apr-2020

Apr-2021

Apr-2022
10 0.1

0 0
1955
1958
1961
1964
1967
1970
1973
1976
1979
1982
1985
1988
1991
1994
1997
2000
2003
2006
2009
2012
2015
2018
2021
2024
Headline PCE (6M ann %)
NBER recession periods Soft landing periods FLMTI PCE Core services ex housing (6M ann %)
Inflation target

Note: Calculated as the average percentile of indicators above their median.

Source: Fidelity International, Fidelity Global Macro Team calculations, March 2023. Source: Fidelity International, Haver Analytics, March 2023.

9
ECB policy implications
Bank lending channel plays an even more important role in the policy transmission in Europe vs US

Markets still pricing rate hikes Credit standards in the Euro area have tightened meaningfully
EUR OIS 1M implied forward rates Change in credit standards, past 3M
4.5 70%

4.3 60%

4.1 50%

3.9
40%
3.7

Net % Balance
30%
3.5
20%
3.3
10%
3.1

2.9 0%

2.7 -10%

2.5 -20%
Mar-2023 Jun-2023 Sep-2023 Dec-2023 Mar-2024 Jun-2024 Sep-2024 Dec-2024 Mar-2025 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023

Pricing on 17th March Pricing on 8th March Business Loans Loans for house purchase Consumer credit and other lending

Source: Fidelity International, Bloomberg, March 2023. Source: Fidelity International, Haver Analytics, March 2023.

10
Waiting for the BOJ exit
Annual wage negotiations surprised on the upside but market turmoil puts near-term YCC exit in question

BOJ interventions to defend YCC have started falling back from Japan is the world’s largest creditor with a positive net
previously very elevated levels international investment position (NIIP) of $3.5 trillion
Rolling 2yr Z-score of JGB purchases by the BOJ International holdings of US Treasuries
1200 18%
8
16%
1000
6 14%

800 12%
4

USD bn
10%
600
8%
2
400 6%

0 4%
200
2%

-2 0 0%

Luxembourg
UK
Japan

Belgium

Ireland
China

Cayman

Switzerland
-4
Mar-17 Mar-18 Mar-19 Mar-20 Mar-21 Mar-22 Mar-23
Total bond purchase (60D rolling sum) US Treasury foreign holders % share of foreign holdings (RHS)

Source: Fidelity International, Bloomberg, March 2023. Source: Fidelity International, Bloomberg, March 2023.

11
Global Investment Research
178 responses from 151 analysts

Region Sector

Materials Utilities
12 7
Communication
Services
6
Asia Pacific (ex
China, ex Japan) Consumer
North America 29 Discretionary
42 27
Information
Technology
21
Consumer
China Staples
Japan 31 16
10
Energy
Industrials 9
34
EMEA / Latin
America
11 Financials
Europe 30
55 Healthcare
16

Analysts that cover more than once sector, or whose sectors have significant variation between subsectors, answer the survey more than once to provide greater granularity. Charts show number of responses.
Source: Fidelity International, March 2023

13
 Both management sentiment and leading indicators turned up, driven by China’s
reopening; labour costs remain sticky while non-labour cost pressures ease

FIL analyst survey corporate leading indicators and FIL analyst survey corporate leading indicators and
management sentiment, March 2023 management sentiment, March 2023
1.00 1.20

0.80 1.00
Weighted average of responses

0.60 0.80

0.40 0.60

0.20 0.40

0.00 0.20

-0.20 0.00

-0.40 -0.20

-0.60 -0.40

Jul-20

Jan-21

Jul-21

Jan-22

Jul-22

Jan-23
Mar-21

Mar-22

Mar-23
Sep-20

Nov-20

Sep-21

Nov-21

Sep-22

Nov-22
May-21

May-22
Oct-20

Oct-21

Oct-22
Jun-20

Dec-20

Jun-21

Dec-21

Jun-22

Dec-22
Feb-21

Feb-22

Feb-23
Apr-20

Apr-21

Apr-22
Aug-20

Aug-21

Aug-22

Leading indicators Management sentiment Total labour costs Total non-labour costs

Source: Fidelity International Global Investment Research, March 2023 Source: Fidelity International Global Investment Research, March 2023

14
Sentiment and leading indicators diverging between DM and China
The picture elsewhere remains split

Management Sentiment by region Leading Indicators by region

Sentiment Sentiment Sentiment Sentiment
decreasing increasing decreasing increasing

Global Global

North America North America

Japan Japan

Europe Europe

EMEA/Latin America EMEA/Latin America

China China

Asia Pacific (ex China ex Japan) Asia Pacific (ex China ex Japan)

-0.5 -0.2 0.1 0.4 0.7 -0.8 -0.3 0.2 0.7

Weighted net responses
Dec-22 Jan-23 Feb-23 Mar-23 Dec-22 Jan-23 Feb-23 Mar-23
Chart shows proportion of responses reporting management sentiment is positive minus those reporting management
sentiment is negative; strong negative and strong positive receive a higher weighting. Question: “Based on your recent Chart shows proportion of responses reporting leading indicators are positive minus those reporting leading indicators
research and interactions with companies, to what extent, if at all, has your perception of management sentiment over are negative; strong negative and strong positive receive a higher weighting. Question: “What is the outlook for leading
the next 6 months changed?” indicators over the next 6 months at your companies?”
Source: Fidelity International Global Investment Research, March 2023 Source: Fidelity International Global Investment Research, March 2023

15
Sentiment by Region
China takes off

1.50

1.00

0.50

0.00

-0.50

-1.00
Jul-20 Sep-20 Nov-20 Jan-21 Mar-21 May-21 Jul-21 Sep-21 Nov-21 Jan-22 Mar-22 May-22 Jul-22 Sep-22 Nov-22 Jan-23 Mar-23

Asia Pacific (ex China ex Japan) China EMEA/Latin America Europe Japan North America Global

Source: Fidelity International, March 2023

16
Supply chain disruptions easing but labour costs will keep pressure on services

Labour costs by region Non-labour costs by region

1.40 2.00
1.20
1.50
1.00
0.80
1.00
0.60
0.40 0.50

0.20
0.00
0.00
-0.20 -0.50
-0.40
-0.60 -1.00

Jul-20

Jan-21

Jul-21

Jan-22

Jul-22

Jan-23
Mar-21

Mar-22

Mar-23
Sep-20

Nov-20

Sep-21

Nov-21

Sep-22

Nov-22
May-21

May-22
Jan-21

Jan-22

Jan-23
Jul-20

Jul-21

Jul-22
Mar-21

Mar-22

Mar-23
Sep-20

Nov-20

Sep-21

Nov-21

Sep-22

Nov-22
May-21

May-22

Asia Pacific (ex China ex Japan) China Asia Pacific (ex China ex Japan) China
EMEA/Latin America Europe EMEA/Latin America Europe
Japan North America Japan North America
Global Global
Chart shows proportion of responses reporting costs are increasing minus those reporting costs are decreasing; significant Chart shows proportion of responses reporting costs are increasing minus those reporting costs are decreasing; significant
increases and significant decreases receive a higher weighting. Question: “What are your expectations for total labour increases and significant decreases receive a higher weighting. Question: “What are your expectations for total non-labour
costs over the next 6 months compared to current levels?” costs over the next 6 months compared to current levels?”
Source; Fidelity International, March 2023 Source; Fidelity International, March 2023

17
Is this Global Financial Crisis 2.0?
…..we don’t think so, but the situation could deteriorate further

US banks' capital levels are twice those in 2008 European banks also exhibit stronger capital levels

Top 11 banks CET1 6.0% 16%

12
5.5% 14%
10 5.0%
4.5% 12%
8
4.0% 10%
6 3.5% 8%
4 3.0%
2.5% 6%
2
2.0% 4%
0

1990
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
2018
2019
2020
2021
2022E
2023E
2024E
2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022
Leverage Ratio CET1 ratio (RHS)
Source SNL Financial, 31st December 2022 Source: SNL Financial, JP Morgan, 31st December 2022

US banks are much more liquid than before And liquidity... as illustrated by liquidity coverage ratios
US Banks: Cash at Fed
1,600
180%
1,100 170%
Billions $

160%
600 150%
100 140%
130%
-400 120%
WFC
BAC

USB

RF
COF

PNC

Total
TFC

STT

Q3 2016
Q4 2016
Q1 2017
Q2 2017
Q3 2017
Q4 2017
Q1 2018
Q2 2018
Q3 2018
Q4 2018
Q1 2019
Q2 2019
Q3 2019
Q4 2019
Q1 2020
Q2 2020
Q3 2020
Q4 2020
Q1 2021
Q2 2021
Q3 2021
Q4 2021
Q1 2022
Q2 2022
Q3 2022
JPM

NTRS
MTB

2000q4 2008q4 2022q4

Source: SNL Financial, JP Morgan, 31st December 2022 Source: ECB, December 2022

18
Multi Asset
Multi Asset: Key takeaways
Solutions & Multi Asset key
view
No ‘Goldilocks’: The inflation
battle will continue but with
growing divergence
Banking crisis: Tighter financial
conditions, possible credit
crunch
China is resurgent
Source: Fidelity International, as of March 2023. Views reflect a typical time horizon of 12–18 months and provide a broad starting point for asset allocation decisions. However, they do not reflect current positions for investment strategies, which will
be implemented according to specific objectives and parameters.
20
Reasoning
Central banks are facing an increasingly high
stakes trade-off between financial stability and
controlling inflation. There is a growing divergence
between different central bank policy that may
present opportunities.
Higher bank funding costs will accelerate the
withdrawal of credit from the economy, raising the
risks of a hard landing in the next 12-months. The
regional banking crisis in the US is not yet
contained and could still become a systemic
problem.
China is emerging from Zero Covid far faster than
expected, accompanied by a broadening package ▪ Allocate to EM equities over DM
of growth-positive policy announcements. Many
other Emerging Markets are benefitting from falling ▪ Allocate to local currency EM debt
inflation, peak monetary tightening, and attractive
valuations. This may prove a potent mix.
Investment implications
▪ Allocate away from corporate credit
▪ Allocate to South African and Brazil local
▪ Maintain overall neutral duration rates
across portfolio
▪ Tilt to US Renewables equities
▪ Prefer Gilts over Bunds and JGBs
▪ Avoid US Homebuilders equities
▪ Avoid GBP
▪ Cautious on US due to on-going
banking stress ▪ Prefer IG over HY
▪ Allocate to min-vol equities
▪ Higher dollar funding costs are a
headwind for EM FX ▪ Allocate to ‘long equity volatility’ strategies
▪ Move up in quality across equities and
credit
▪ Allocate to Asia High Yield out of Europe,
US HY
equities
▪ Buy Thai Baht
(currency hedged) over hard currency ▪ Buy Indonesia and China A-Shares
equities
The inflation battle will continue but with growing divergence
Remain cautious, expect credit to come under pressure before equities; avoid GBP

Allocate away from corporate credit: HY spreads not yet pricing Avoid GBP: UK’s chronic deficit remains, whereas the
the required tightening in financial conditions Eurozone’s current account reverting back into surplus
30 15
80 2500

20 10
60
2000

40
10 5

1500

20 0 0

1000
0 -10 -5

500
-20 -20 -10

-40 0 -30 -15

1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 Jan 04 Jan 06 Jan 08 Jan 10 Jan 12 Jan 14 Jan 16 Jan 18 Jan 20 Jan 22
Fed Senior Loan Officers Survey: Banks Tightening Lending to Small Firms (%) - LHS Eurozone: Current Account (SWDA, Bil.EUR)
BofAML High Yield Corporate: OAS - RHS U.K.: Trade Balance: Goods and Services (SA, Bil.Pounds)

Source: Haver Analytics, March 2023. Source: National sources; Haver Analytics, February 2023.

21
Banking crisis: Tighter financial conditions, possible credit crunch
Prefer IG to HY for defensiveness; cautious on the US as lending likely to contract

Difference between US HY and IG spreads will likely widen Tighter lending standards in the US are likely to significantly
further given higher risk of hard landing reduce bank loans
65 -100 -25% 100

63 -150 -20%
80
61 -200 -15%

-10% 60
59 -250

57 -300 -5%
40
0%
55 -350
20
5%
53 -400
10% 0
51 -450
15%
49 -500 -20
20%
47 -550
25% -40
45 -600
2013 2015 2017 2019 2021 2023
NBER recession periods
ISM Composite Index (SA, >50=Increasing) (LHS) C & I Loans in Bank Credit: All Commercial Banks (%yoy, inverted) (LHS)
US IG spread - US HY spread (RHS) FRB Sr Officers Survey: Banks Tightening C&I Loans to Large Firms (%bal, leading 12M, RHS)

Ice BofA indices. Source: Refinitiv, Fidelity International, March 2023. Source: National sources; Haver Analytics, February 2023.

22
China is resurgent
Prefer EM equities to DM equities, especially the US

The de-rating in US and DM equities is now very small compared China’s rapid normalisation and stimulative policy stance makes
to pre-COVID, leaving EM and FTSE 100 more attractive us positive on cheap Emerging Market equities

Forward P/E by major equity markets (January 2020 = 100) China: High Frequency Activity Index (2019 = 1)
1.4
140

1.2
130

120
1
110

0.8
100

90
0.6
80

70 0.4

60
Feb-19 Aug-19 Feb-20 Aug-20 Feb-21 Aug-21 Feb-22 Aug-22 0.2

0
S&P 500 - Forward P/E MSCI World Index - Forward P/E 01/01/2020 01/07/2020 01/01/2021 01/07/2021 01/01/2022 01/07/2022 01/01/2023
MSCI Emerging Markets Index - Forward P/E FTSE 100 Index - Forward P/E

Source: Bloomberg, January 2023. Source: Haver Analytics, March 2023. The Yicai HFEAI tracks congestion, subway usage, home sales etc.

23
Our asset allocation views at a glance

Equity region Government bonds

View Change Rationale View Change Rationale
The US economy is slowing from a high level. However, the recent
US 
 
- banking sector turmoil could further tighten financial conditions.
US Treasuries 
 
▲
Tighter lending standards mean that US hard landing risks have
increased. We therefore prefer nominal rates to TIPS.
Activity continues to recover. However inflation is still high and
Europe ex. UK 
 
-  Fundamentally, the Euroarea is likely to end up with higher inflation
sticky. Banking sector uncertainty could tighten credit conditions. Euro core (Bund)  
- and a more hawkish central bank than either the US or UK.
The internationally focused large cap index is cheap on a range of
UK 
 
- valuation metrics. Recent data has provided some positive news on inflation and
Manufacturing activities are impacted by slowing global activity and UK Gilts 
 
- there are signs of labour market slock. The BoE has a dovish bias
Japan 
 
- cost pressures, albeit the service sectors are supported by tourism despite the recent hike.
related reopening demand. A new era dawns at the BoJ. We continue to believe that the
Japan govt bonds 
 
- current YCC policy is unsustainable.
The China re-opening should continue to support the region.
Emerging markets 
 
- However, USD flows could impact short-term EM performance. The banking crisis has raised the risks of a disinflationary hard
Inflation linked bonds
The region could benefit from China reopening and the associated

 
▼ landing coming sooner and being more severe than previously
Asia-Pacific ex. Japan 
 
- trade and commodity demand in 2023.
(US TIPS)
expected.

Credit FX
View Change Rationale View Change Rationale
USD is typically a risk-off asset. However the banking sector stress
Investment grade (IG) 
 
- Given the recent banking stress, we prefer to stick to our USD 
 
- means the outlook is mixed.
bonds defensive bias, even though spreads have widened meaningfully.
We maintain our cautious view on HY vs IG given deteriorating Rate differentials look positive for the euro given the relatively
Global high yield 
 
- rating trends and tightening lending standards. EUR 
 
- hawkish outlook for the ECB, although things have been
complicated by banking stress.
China reopening helps with EM fundamentals, but recent risk-off
Emerging market debt 
 
- sentiment and tightening dollar liquidity could hurt near-term  JPY is cheap and we see optionality from hard landing risks as
(EMD, hard currency)
performance.
JPY  
- global rate differentials compress.

The BOE remains one of the more dovish central banks, despite
GBP 
 
- the hike in March.

Tighter financial conditions as a result of banking stress are a

EM FX 
 
▼ headwind for EM FX.

Source: Fidelity International, as of March 2023. Change reflects directional difference in view versus previous month. Views reflect a typical time horizon of 12–18 months and provide a broad starting point for asset allocation decisions. However,
they do not reflect current positions for investment strategies, which will be implemented according to specific objectives and parameters.

24
Equities
 Equities: Key takeaways
We remain cautious on global equities Diverging regions create selective entry points
▪ Market volatility remains high amid ongoing uncertainty ▪ US - earnings woes remain, driven by multiple
over the future path of the global economy/interest rates. compression, with a strong labour market weighing on
margins. However, corporates remain higher return
▪ Potential tail risks could send markets even lower if left prospects, given the effects of a strong domestic
unchecked. Silicon Valley Bank’s collapse has led to competitive environment.
deposit outflows from regional banks and tighter financial
conditions. The crash of Credit Suisse has increased ▪ Europe - tightening financial conditions to have a
fragility in the European banking sector. negative impact on earnings prospects for European
companies as well.
Earnings are set for a correction
▪ Expect an inflection point in earnings this year amid ▪ China - improving corporate earnings are likely to take
recessionary fallout for top line earnings growth, an over from cheap valuations as the main driver in the
inflationary hit on costs and higher borrowing rates next stage of the rebound.
resulting in greater interest expense.
▪ Companies have begun to give more cautious guidance,
with sectors, like consumer discretionary, beginning to
issue profit warnings.
▪ However, readjustment of earnings expectations in
the months ahead can turn caution into opportunity.

26
Valuation gaps leave ample room for stock picking once volatility calms down
Valuation gaps already narrowing globally (US) but still near peak in Europe

Premium of most vs least expensive (based on FCF, sector 12m forward P/E premium (Growth vs Value)
neutral basis)
200% 160%

140%
150%
120%

100%
100%

80%

50%
60%

40%
0%
20%

-50% 0%
May-92

May-99

May-06

May-13

May-20
Mar-91

Jul-93

Mar-98

Jul-00

Mar-05

Jul-07

Mar-12

Jul-14

Mar-19

Jul-21
Sep-94
Nov-95

Sep-01
Nov-02

Sep-08
Nov-09

Sep-15
Nov-16

Sep-22
Jan-90

Jan-97

Jan-04

Jan-11

Jan-18

Mar-04

Mar-07

Mar-10

Mar-13

Mar-16

Mar-19

Mar-22
Dec-04
Sep-05

Dec-07
Sep-08

Dec-10
Sep-11

Dec-13
Sep-14

Dec-16
Sep-17

Dec-19
Sep-20

Dec-22
Jun-03

Jun-06

Jun-09

Jun-12

Jun-15

Jun-18

Jun-21
MSCI Europe MSCI World

Source: Exane BNP Paribas estimates, January 2023 Source: FactSet, January 2023

27
China - Consumption will likely continue to lead recovery
Consumption recovery will stay strong in H1, supported by savings and possible policy easing, but long-term sustainability of the recovery
depends on the policy settings and households’ income expectations

China's household deposits vs loans, net yearly change China CPI and PPI
20 10 15

15
8
cny Trillions

10
10
5
6
0
2008
2008
2009
2009
2010
2010
2011
2011
2012
2012
2013
2013
2014
2014
2015
2015
2016
2016
2017
2017
2018
2018
2019
2019
2020
2020
2021
2021
2022
2022
2023
5
4
Household loans Household deposits

2
Source: Bloomberg, Fidelity International, March 2023 0

180
170 0
160
150 -5
140
130 -2
120
110
100
90
80 -4 -10
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023

Headline CPI Core CPI PPI

China real retail sales index US real retail sales index

Source: Bloomberg, Fidelity International, March 2023 Source: Bloomberg, Fidelity International, March 2023

28
China - Long term growth will pivot from property-driven to “high-quality growth”
The shift away from relying on property sector to boost growth is clear, but in the short-term property sector
stabilisation is still crucial for China to move towards the new growth model.
Fixed assets investments indicate the shift in growth priorities Global implications will be different: less commodities driven,
more consumer and manufacturing sectors growth
China fixed assets investment (% cumulative) China tourism outflow
50 0

40 -50

30 -100

20 -150

CNY bn
10 -200

0 -250

-10 -300

-20 -350

-30 -400

-40 -450
2015 2016 2017 2018 2019 2020 2021 2022 2023 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

FAI Manufacturing Real Estate Infrastructure

Source: Bloomberg, Fidelity International, March 2023 Source: Bloomberg, Fidelity International, March 2023

29
Fixed Income
Fixed Income: Key takeaways
Time to be defensive
▪ Investors should prioritise protection in this
recessionary environment. We favour IG bonds, where
investors at least get some risk premium as protection
for any default risk.
Long US and EU duration
▪ Europe and the US are on the brink of recession. We
believe the Fed and the ECB will need to pivot at
some stage (which includes ending QT), meaning US
Treasuries and Bunds should find support. Now is the
time to add interest rate risk by adding duration.
31
High yield (HY) not offering enough recession
protection
▪ The risk of a hard landing is not yet fully priced into HY
spreads. Credit conditions are tightening, the weighted
average cost of capital is increasing. High yield bonds
offer high all-in yields, but spreads still don’t provide
adequate protection for a hard landing.
The saving grace is that there is no immediate
refinancing cliff
▪ Companies termed out their debt and refinanced at
low rates, so there is no immediate refinancing cliff
before 2025. However, at the margin there will be
companies that do need to refinance and this will be
expensive.
Bank reserves have fallen significantly
High powered money is declining as deposits have fallen. Meanwhile the cost of capital in increasing.

Falling trend in US bank reserves US M2 growth is now in negative territory

4500 30

4000
25

3500
20
3000

2500 15

2000 10

1500
5
1000

0
500

0 -5
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021

Total Reserves of Depository Institutions ($bn) US M2 YoY (%)

Source: Fidelity International, Federal Reserve, as of 1 January 2023. Source: Fidelity International, Bloomberg, 31 January 2023.

32
Senior Officer Loan Survey shows tightening credit conditions
Yet spreads across IG & HY indices show no sign of widening

US senior loan officer survey for large corps vs US IG spreads US senior loan officer survey for large corps vs US HY spreads
700 100 2500 100

% %
600 tightening standards 80 tightening standards 80
2000

500 $ IG 60 $ HY 60
Spreads (bps) Spreads (bps)
1500
400 40 40

300 20 20
1000

200 0 0

500
100 -20 -20

0 -40 0 -40
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022

1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
USD IG Senior Officer Loan Survey - C&I Loans for Large/Medium USD HY Senior Officer Loan Survey - C&I Loans for Large/Medium

Source: Fidelity International, Bloomberg, 28 February 2023. USD IG = C0A0, USD HY = H0A0. Net % of domestic respondents tightening standards for C&I Loans for Large/Medium used.

33
The maturity wall for US corporates starts hitting from 2023-25 – but thankfully no
immediate refinancing cliff
The maturity wall for HY corporates reaches its nadir in 2027

USD IG bond maturity wall % total market value USD HY bond maturity wall % total market value
18% 25%

16%

14% 20%

12%
15%
10%

8%
10%
6%

4%
5%
2%

0% 0%
23 24 25 26 27 28 29 30 31 32 33 34 35

Bonds Leveraged Loans

Source: Fidelity International, GS, 31 December 2022. Source: Fidelity International, GS, 31 December 2022.

34
Private Credit
Private Credit: Key Takeaways
Valuations suggest longstanding resilience
▪ Private debt less impacted by dichotomy of hard vs soft
landing – both suggest challenges, but even in the hardest
landing scenario, product retains protections at the most
senior secured position of the capital structure, while
floating rate nature mitigates impact of a volatile rates
backdrop
▪ Market technicals suggest there’s no steep uptick in
returns for taking an aggressive position – rather cautious
credit selection remains key
Under pressure, but not to breaking point
▪ While we anticipate default rates will increase, these
are likely to be limited. Ratings downgrades - and
therefore a greater dispersion of ratings – expected
▪ Borrowers facing higher debt servicing costs than
typical, and even as input costs have fallen, wage
pressures persist to weigh on earnings
▪ Competing against an increasingly attractive cash market
36
Strong, well-positioned market fundamentals
▪ Refinancing wall in the near term is being chipped away.
The loan market has found solutions for some of the
chunkier and more complex upcoming maturities. Around
€47.8B of debt maturing before 2026, of which €19.5B is
rated single B or below
▪ Sectors that dominate private debt have limited exposure
to Russia or inflated energy prices
▪ Europe enjoying economic tailwinds from China reopening
and remains attractive for long term investors given
current valuation entry point, more mature borrower
profile, and reduced exposure to subsectors now
undergoing stress
Outlook only limited by supply
▪ Pipeline of largescale leveraged buyouts
curtailed primarily by the mismatch in valuations between
buyers and sellers
▪ This limits the new issue supply available to
ramping CLOs, which in turn rely upon the secondary
market to source assets.
Loans continue to offer a premium to high-yield bonds
Adjusted for ratings and seniority, loans continue to be more attractive on a relative basis. But the story goes
further than just the margin on offer: the loan market is less volatile, more likely to be covenanted (in the case
of direct lending), and PE sponsors have demonstrated willingness to support stressed borrowers
EUR Loans vs HY - Senior Secured - BB EUR Loans vs HY - Senior Secured - B
1,200 1,200

1,000 1,000

800 800

600 600

400 400

200 200

0 0

-200 -200

-400 -400

-600 -600
Mar-13

Mar-14

Mar-15

Mar-16

Mar-17

Mar-18

Mar-19

Mar-20

Mar-21

Mar-22

Mar-23

Mar-13

Mar-14

Mar-15

Mar-16

Mar-17

Mar-18

Mar-19

Mar-20

Mar-21

Mar-22

Mar-23
Spread 1L Loans BB Senior Secured BB Spread 1L Loans B Senior Secured B

Source: Credit Suisse Western European Leveraged Loan Index, EUR only; ICE BofA High Yield; Bloomberg; Fidelity International, March 2023

37
Spreads across European loans attractive versus other asset classes
With current discount margin in the European loan product current around the 69th percentile, the product offers a
great deal of value versus historical averages

Spreads across Credit - March 2006 to March 2023

2,500
Discount Margin / OAS to Swap (bps)

2,000

1,500

1,000
69th 67th 74th 70th
56th
51st
500
73rd 75th 80th
62nd

0
EUR Loans Euro HY EUR IG EUR CLO AAA EUR CLO BBB USD Loans USD HY USD IG USD CLO AAA USD CLO BBB

Source: Credit Suisse Western European Leveraged Loan Index, Eur only, discount margin to maturity; Credit Suisse Leveraged Loan Index, discount margin to maturity; ICE BofA Euro High Yield, OAS to Swap
(OAS to Gov for 2006 & 2007); ICE BofA US High Yield, OAS to Swap (OAS to Gov for 2006 & 2007); ICE BofA Euro Corporate Index, OAS to Swap (OAS to Gov for 2006 & 2007); ICE BofA US Corporate
Index, OAS to Swap (OAS to Gov for 2006 & 2007); JPM Secondary Discount Margins for pre-crisis CLOs; Citi Secondary Discount Margins for post-crisis CLOs; Fidelity International, March 2023

38
Underlying sectors of private debt world relatively strong
Euro loans remain defensively titled compared to High Yield

70%

61%
60% 59%

50% 50%
50%

41%
39%
40%

30%

20%

10%

0%
Cyclicals Defensives
EUR Loans EUR HY EUR HY ex Perps

Source: Credit Suisse Western European Leveraged Loan Index, Eur only; ICE BofA Euro High Yield. Defensive/Cyclical split based on Credit Suisse sector type classifications; Fidelity International, March 2023

39
Real Estate
Real Estate: Key takeaways
H2 22 re-pricing provides good foundation for sector
▪ A soft landing scenario is a ‘goldilocks’ scenario for
real estate. The recent re-pricing should provide a
good foundation for attractive performance, driven by
a combination of attractive yields (now at least 100
bps higher than in Q2 22), rental value growth and
ongoing indexation of rents.
Sustainability provides opportunities
▪ An acute shortage of supply and an abundance of
demand for sustainable buildings is supporting a large
‘green’ premium. High energy costs and corporate Net
Zero Carbon targets are focusing occupiers attention
on the energy efficiency and carbon footprint of their
real estate, while SFDR is focusing investors attention
on the environmental qualities of their portfolios
41
A hard landing exposes a number of ongoing risks
▪ Higher interest rates and/or higher inflation could
cause another wave of re-pricing, reduce liquidity and
further damage confidence in the sector, particularly if
there are further headlines around closure of funds to
redemptions or defaults on CMBS. Tenant failures
could also damage income returns.
Exposure to higher risk sectors could hit income
▪ High levels of exposure to tenants in sectors such as
energy, banking and technology where volatility is high
and there are increased default risks, could be
damaging to performance. Within the FIL real estate
portfolios we only have 7.5% of income exposed to
these sectors.
UK well placed for recovery; Eurozone more vulnerable to further corrections in
hard landing scenario

UK values down 20% since July; pace of correction slowing European values also down, but correction (so far) more modest
4.0 6.0
UK all property - components of monthly total return (%)

2.0 4.0

Asset level all property components of

2.0

quarterly total return (%)

0.0

0.0
- 2.0

-2.0
- 4.0
-4.0

- 6.0
-6.0

- 8.0
-8.0
Feb-22

Mar-22

Apr-22

Oct-22
Jan-22

Jun-22

Aug-22

Sep-22

Nov-22

Dec-22

Jan-23
Jul-22
May-22

Q1 2006

Q1 2007

Q1 2008

Q1 2009

Q1 2010

Q1 2011

Q1 2012

Q1 2013

Q1 2014

Q1 2015

Q1 2016

Q1 2017

Q1 2018

Q1 2019

Q1 2020

Q1 2021

Q1 2022
Income Return Market rental value growth Yield impact Total Return Income Return Capital Growth Total Return

Source: MSCI UK Monthly Index, February 2023; MSCI Pan-European Balanced Property Fund Index, Q4 2022. Source: MSCI Pan-European Balanced Property Fund Index, Q4 2022.

42
Repricing reflects more than interest rate moves – structural headwinds impacting
secondary offices and retail

Relative pricing looks tight, but rental growth and indexation are Repricing has been particularly sharp for secondary offices
supporting values
9 9.0

8
8.0
7
Core Eurozone prime yield (%)

6 7.0

Yield (%)
6.0
4
5.0
3

2 4.0
1
3.0
0

-1 2.0

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Sep-12

Sep-13

Sep-14

Sep-15

Sep-16

Sep-17

Sep-18

Sep-19

Sep-20

Sep-21

Sep-22
2008-01
2008-07
2009-01
2009-07
2010-01
2010-07
2011-01
2011-07
2012-01
2012-07
2013-01
2013-07
2014-01
2014-07
2015-01
2015-07
2016-01
2016-07
2017-01
2017-07
2018-01
2018-07
2019-01
2019-07
2020-01
2020-07
2021-01
2021-07
2022-01
2022-07
2023-01
All property spread over bond yields Logistics Shops - prime Shops - secondary
Office Retail Offices - prime Offices - secondary CBD
Eurozone 10y govt bond yield Industrial - distribution Industrial - industrial estates

Source: Fidelity International, CBRE, February 2023. Source: Refinitiv Eikon, March 2023.

43
Focus on sustainability – green premium set to provide downside protection and
considerable upside

Office occupiers show willingness to pay a green premium Investors are paying an increasing premium for green offices
30
Q: how open is your organisation to paying a premium to

Difference in pricing* between buildings with and without

occupy space with leading sustainability and green credentials?
25

environmental ratings from BREEAM/LEED

20

15

10

22% 34% 18% 18% 7% 5

-5

-10

-15

Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
2013 Q1

2014 Q1

2015 Q1

2016 Q1

2017 Q1

2018 Q1

2019 Q1

2020 Q1

2021 Q1

2022 Q1
0% 20% 40% 60% 80% 100%

Have already Likely to by 2025

Likely to but after 2025 Not on our radar, but would consider
Would never consider Don't know London green office price differential

* Pricing difference is based on hedonic analysis of London office prices, controlling for factors that impact building value such as age, size and sub-market
Source: Fidelity International; JLL, The Future of Work Survey, July 2022. Source: Real Capital Analytics, October 2022.

44
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ED23-066

45