Fund Update

For professional investors and advisers only
Schroder ISF* US Smaller Companies
Fund Update
Covering August 2016
Overview
US equities ended the month higher as confidence grew about the growth outlook on the back of positive jobs data and despite
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increased expectations of an imminent rate rise. The fund underperformed its Russell 2000 benchmark. Our investment approach
continues to target three types of opportunities: “mispriced growth stocks” – stocks where we think the market continues to
undervalue a company’s growth prospects; “steady eddies” – strong companies with recurring revenues and/or cashflows; and
“turnarounds” – firms that are addressing their problems, often with new management, which are likely to outperform over time.
The market and the drivers of fund performance
August began well thanks to a better-than-expected July employment report that helped to ease growth concerns surrounding the
weaker-than-forecast second-quarter GDP print. However, momentum quickly stalled as investors began to digest a potential rate
hike in the back half of 2016, as well as disappointing productivity and retail sales data. Federal Reserve chairwomen Janet Yellen
struck a hawkish tone in a speech at the Jackson Hole annual symposium of central bankers, noting that the case for a rate hike had
strengthened in recent months. Consensus anticipated that any rise would be deferred until December and after the presidential
elections. All major large and small-cap benchmarks were higher, with value indices outperforming growth within the large and smallcap space. Within the S&P 500 the top-performing factors were price volatility, expected growth, and earnings risk. The bottomperforming factors were price momentum, historical growth, and profit trends. Within the Russell 2000, expected growth, price
volatility, and traditional value led, while the weakest-performing factors were historical growth, price momentum and profit trends.
The fund underperformed the Russell 2000. Stock selection was strongest in utilities, with strong returns from our stocks in the gas
distributors and water utilities and an absence in the telecommunications industry. We had continued outperformance in the energy
sector. The fund also benefited from underweights in the rate-sensitive real estate investment trusts and utilities, the weakest sectors
in the Russell 2000 this month. Stock selection detracted most in health care and producer durables in August. Much of the lag in
healthcare was due to the medical equipment industry (specifically VWR, see below). In terms of our alpha sources, all three types
lagged the Russell 2000 in August. “Mispriced growth stocks” were the strongest performers returning 1.7% led by a number of our
bank holdings. “Steady eddies” were modestly positive however turnarounds finished the month in the red.
Key stock contributors were led by Western Alliance Bancorporation, Chemical Financial and PDC Energy. Arizona-based bank
Western Alliance rose on the increasing prospects of a rate hike. Chemical Financial, a Michigan bank, continues to outperform as
the street is now recognising the value that will be created when it closes its acquisition of Talmer Bank. Main detractors included
Surgical Care Affiliates, VWR and Advanced Drainage Systems. Surgical operates hospitals and surgical centres and traded
lower due to concerns over staffing costs of peer companies, despite reporting a strong second quarter. It does not employ their
surgeons so fears over staffing shortages and costs are misplaced. Laboratory supply distributor VWR reported a strong second
quarter but pulled back over worries about a distribution contract renewal with Merck. Advanced stumbled as it worked through a
major accounting project of capitalising truck leases onto the balance sheet, resulting in late filing of several key financial reports.
The market outlook and portfolio strategy
We have a natural buffer in the wake of the Brexit vote in that the US small and mid-cap space is heavily domestically oriented
(approximately 80% of revenues are generated in the US). Our exposures to EU revenues at the portfolio level are relatively modest
at approximately 9% of total revenues. As one would expect from a bottom-up manager we are reviewing our holdings to assess
situations where companies have higher exposures to non-US dollar revenues and/or US-dollar expenses. We remain positive on
the housing sector, where the uptrend in home starts appears to be on a sustainable path and importantly it does not show any of
the frenetic and speculative characteristics of a bubble. Given the importance of housing in the overall US economy we find this a
fruitful area for investment and one that disproportionately favours small and smid-cap companies over large caps.
Important Information: This document does not constitute an offer to anyone, or a solicitation by anyone, to subscribe for shares of Schroder International
Selection Fund (the “Company”). Nothing in this document should be construed as advice and is therefore not a recommendation to buy or sell shares.
Subscriptions for shares of the Company can only be made on the basis of its latest Key Investor Information Document and prospectus, together with the
latest audited annual report (and subsequent unaudited semi-annual report, if published), copies of which can be obtained, free of charge, from Schroder
Investment Management (Luxembourg) S.A. An investment in the Company entails risks, which are fully described in the prospectus. Past performance is not
a reliable indicator of future results, prices of shares and the income from them may fall as well as rise and investors may not get the amount originally
invested. Schroders has expressed its own views and opinions in this document and these may change. This document is issued by Schroder Investment
Management Ltd., 31, Gresham Street, EC2V 7QA, who is authorised and regulated by the Financial Conduct Authority. For your security, all telephone calls
are recorded. Risk Considerations: The capital is not guaranteed. Investments denominated in a currency other than that of the share-class may not be
hedged. The market movements between those currencies will impact the share-class. Investments in small companies can be difficult to sell quickly which
may affect the value of the fund and, in extreme market conditions, its ability to meet redemption requests upon demand. The fund will not hedge its market risk
in a down cycle. The value of the fund will move similarly to the markets.
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Source: Schroders, FactSet, gross of fees in US dollars
* Schroder International Selection Fund