ES River and Mercantile UK Dynamic Equity Fund

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Quarterly Report to 31 December 2019

UK Equity Unconstrained Fund I Monthly Report Month 2008

For unitholders only R&M UK Dynamic Equity | 0 ES R&M UK Dynamic Equity Fund Quarter 4, 2019

Fund Objective

The investment objective of the Fund is to grow the value of your investment (known as “capital growth”) in excess of the MSCI United Kingdom Investable Market Index (IMI) Net Total Return (the “Benchmark”) over a rolling 5 year period, after the deduction of fees.

Performance

B share class Fund Benchmark Difference 3 months 6.2% 3.6% 2.6% 1 year 22.6% 18.4% 4.2% 3 years (p.a.) 6.7% 6.5% 0.2% 5 years (p.a.) 8.3% 7.2% 1.0% Since Inception (p.a.) 11.1% 8.4% 2.8%

25%

20%

15%

10%

0% 3 Months 1 Year 3 Years 5 Years Since Inception p.a. p.a. p.a.

Fund Benchmark Difference 3 years (cumulative) 21.4% 20.7% 0.6% 5 years (cumulative) 48.7% 41.8% 7.0% Since inception (cumulative) 112.0% 77.0% 35.0%

Source: River and Mercantile Asset Management LLP. Benchmark is the MSCI UK Investable Market Index, net GBP. Fund performance shown is of B share class (accumulation units) and is calculated using the midday published price, net of an annual management charge of 0.75% per annum. Please note that the benchmark performance is calculated using close of business mid-market prices. Other share classes may be available. Past performance is not a reliable indicator of future results.

Portfolio Summary & Key Risk Characteristics

Fund AUM £73m Tracking Error 4.29 % Strategy Capacity £2bn Active Money 69.77 % Number of stocks 54 Largest Holding GlaxoSmithKline 4.3 %

The Synthetic Risk and Reward Indicator (SRRI) is based on how much the returns of the shares have varied over the last five years, or since launch (whichever is the shorter period). The higher the rank the greater the potential reward but also the greater the risk of losing money. For more details please refer to the Key Investor Information Document.

R&M UK Dynamic Equity | 1 Investment commentary

The information contained in this report does not constitute as investment advice and should not be treated as a recommendation to invest in any security. The information is based on the historical performance of the ES R&M UK Dynamic Equity Fund and may no longer be current. Any references to securities are for illustrative purposes only and these securities may no longer be held. The information should not be used as the basis for any investment decision. Any opinions expressed are opinions of the relevant portfolio manager and are given in good faith as of the date of the report but should not be considered operative at any date thereafter.

Quotations for the quarter “What if I were to tell you there’s a Republican president but a better version and you had two- thirds Republican majorities in both houses of Congress… and you have a deficit-to-GDP of two, not four-and-a-half… and you have a debt-to-GDP lower than the United States… and 12-times earnings and a 4 per cent yield… sounds like a decent place to invest to me!” Stanley Druckenmiller (Duquesne Capital founder), on the UK "No multiples of GMV (gross merchandise volume), or revenue, or subscribers, those are difficult to justify... What is the valuation of the company? It's the cash-flow multiple at the steady state." Mayashi Son (Softbank founder and CEO) “[O]ur quantitative screens as well as our fundamental due diligence continues to uncover good companies trading at bad prices because of poor capital structures, earnings misses, or lack of investor understanding. Hence, the opportunity to buy complexity at a discount, fix it up, and return it to the public market in a more simplistic format has – frankly – not been this good in two decades.” KKR Global Macro Team "The first 50 is the most difficult; you've got to get through that vulnerable period, you've got to get into your rhythm, you've got to get the pace of the wicket. The second 50 you should be 'in your game': moving well, seeing it nicely and just keeping your game going. From then it should just get easier and generally the only one that gets you out at that stage is yourself." Graham Gooch (former England cricketer) “Let's get Brexit done but first, my friends, let's get breakfast done.” Boris Johnson (UK Prime Minister)

Introduction December saw two important pieces of geopolitical news which reduced a couple of the tail-risks that had roiled both global and UK domestic investors, in the form of a détente in the US-China trade war and a convincing majority for Prime Minister Boris Johnson’s Conservative Party in the UK general election. When combined with a bottoming in global economic lead indicators and an inventory correction plus accommodative monetary policy around the globe, the current set-up suggests taking a positive view on risk assets like UK equities over the intermediate term. In the UK, it had become clear from election manifestos that whichever party formed a government there was going to be a period of fiscal stimulus in the UK. However, the clear political swing to the left embodied by Labour’s manifesto – with its somewhat troubling moves for investors towards property appropriation – had undoubtedly upped the stakes on the result in the eyes of many investors, regardless of whether some of the more extreme policy elements were deliverable legally or politically. As such, a Conservative majority – and in the end a more convincing one than most had anticipated – is a strong positive for UK businesses and their equity investors. There is a wonderful opportunity for the government to inject some optimism into an economy that has found itself facing the burden of uncertainty (with impressive levels of resilience) since the EU referendum in June 2016 and to provide a stable platform that allows some of the pent-up demand and investment, from both domestic and foreign sources, to be unleashed. Investor anxiety over an imminent US recession has reversed as the US have de-escalated the China trade and technology war, while the Federal Reserve (Fed) and other global central banks have further loosened monetary policy to offset the souring corporate sentiment, particularly in the manufacturing sector (as indicated by PMIs below 50), that we highlighted last quarter. We see an inventory correction and improving order trends as supportive data-based evidence that global economic growth will improve. The risk of a recession materialising in 2020 under the current conditions appears low but, equally, we should not necessarily conflate this with a sharp inflection or high aggregate global growth. Your portfolio is well positioned to deliver attractive returns in this environment. I was more active than usual in adding new names to the portfolio this past quarter, with a combination of macro / geopolitical and stock specific fundamental catalysts providing timing factors to support our entry points. I am enthusiastic about the outlook for the Fund based on the strong operational delivery of its holdings, their wide range of shareholder value drivers and the fact we are at an early stage of what should be an extended phase of capital flows back into UK assets.

Market background The fourth quarter mirrored a strong overall year for major financial assets with 34 out of the 38 non-currency global assets monitored by Deutsche Bank (DB) showing a positive return in US dollar (USD) terms in the quarter and all 38 delivering positive returns for 2019 overall in both local currency and USD terms. Risk assets led the way in Q4,

R&M UK Dynamic Equity | 2 with emerging market (EM) equities (especially Russia and Brazil), European banks, US technology and commodities (notably oil and copper) all particularly strong. The best performing currency pair in DB’s rankings over Q4 was GBP/ USD, with sterling ending the quarter +7.9% against the dollar. Much of sterling’s gains came after Prime Minister Johnson and the EU agreed a new Brexit deal in October, and the gains in GBP/USD over the last three months mark the strongest quarterly performance since Q2 2009. Returns from sovereign debt and credit markets were more subdued. The table below shows the factors driving UK equity market performance over the quarter. Growth, Quality and Recovery (return change) Potential factors were all broadly supportive. Momentum factors were modestly supportive while Value factors were modestly negative (with the most ‘deep value’ measure the weakest) in a reversal of the previous quarter. The small-cap factor was a tailwind: Numis Smaller Companies plus AIM (ex ICs) index returned +12.6% versus MSCI UK which returned +2.3%. UK factor performance (L to R: 1 week, 1 month, 3 months)

Source: Canaccord Genuity Quest. Return spread = Q, Asset Growth / Equilibrium Growth = G, Return Change = R, Quest Mkt-Book = AB

How did we perform and why? (Fund performance references the B share class and is calculated net of a 0.75% p.a. annual management charge) The strategy returned 6.2% during the quarter; for comparison, the MSCI UK Investable Market index (IMI) returned 3.6%. That put returns for the 2019 calendar year at +22.6% (MSCI UK IMI +18.4%), a pleasing recovery after a disappointing 2018. Performance over the long term remains solid in absolute and relative terms, returning +11.1% per annum since inception (of the B share class in 2012) versus a benchmark return of +8.4% and ahead of the comparator benchmark over three- and five-year periods. Prudential (+0.6%) was the largest absolute contributor to performance in Q4, rising 14% as the market re-rated the stock based on both fundamental (de-merger of M&G highlighting value in the Asian franchise) and more top-down (steepening yield curves and more supportive EM (emerging market) sentiment) elements. Investors continued to reappraise Smart Metering Systems’ (+0.5%) prospects, about which we wrote last quarter following a well-timed top- up to the Fund’s position. New holdings Flutter Entertainment (+0.4%) and Helios Towers (+0.4%) both got off to strong starts, with the former continuing to deliver very strong revenue growth in the US and the latter the beneficiary of index flows post-IPO.Avast , an addition to the portfolio last quarter, continued its strong start; it delivered another strong trading update and had research initiated on it with a positive recommendation by a well-regarded sell-side analyst, which likely brought the attractions of this undervalued compounder to a broader audience. Our domestic-facing UK companies performed well following the Brexit deal in October and the Conservative general election victory in December. Polypipe (+0.5%), easyJet (+0.4%), Galliford Try (+0.3%) and Legal & General (+0.3%) all rose over 20% in the quarter, while banks Lloyds (+0.4%) and Royal Bank of Scotland (+0.3%) both added over 15%. An underweight in Royal Dutch Shell and zero weights in HSBC and Diageo added 1.0% to relative returns. Tullow Oil was the Fund’s only materially negative contributor but is worthy of detailed comment. Its share price fell 70% (-0.8% absolute contribution) after two pieces of negative news. Firstly, having announced a large oil find in Guyana, a region for which there are elevated expectations following Exxon’s major discoveries there, Tullow announced that its own discovery (Oriniduik) was so-called ‘heavy oil’ and therefore its commercial viability is marginal. Secondly, in a joint announcement we were told that the CEO and Head of Exploration were leaving the company but also that production forecasts from its West African fields were being materially reduced as a result of persistent operational issues. Although capital expenditure on these fields is also being reduced to preserve cash, due to Tullow’s debt profile the equity valuation is highly sensitive to the cash flow generation and debt paydown, which have clearly been compromised. Having confirmed production forecasts not long before, communication on these issues was disappointing. Although we halved our position on the initial exploration disappointment and were, consequently, more insulated from the sharper later share price falls, on reflection I am disappointed that I did not react more decisively to a production downgrade earlier in the year, which could justifiably be seen as a violation of my original investment thesis (cash generation and deleverage plus exploration optionality). These are the sort of tough lessons that the market can teach you – lesson learnt. We exited the remainder of our position shortly after the quarter-end when the remaining short-term share price catalyst – drilling results for the Carapa exploration well in Guyana – failed to play out as expected (see ‘Activity’ below). Vodafone (-0.3%) fell -7%. Like other UK companies with significant overseas operations it was, at least to some extent, a victim of sterling’s strength reducing the spot value of its cash flows in GBP terms, but it did also announce a write-down on its Indian investment which took the shine off improved results from the core (see ‘Top five holdings’ for our running investment thesis). Stock Spirits (-0.2%) earns 100% of its revenues outside the UK, but its 11% decline was more related to some negative forecast revisions by some analysts ahead of the imposition of higher duties in its key markets of Poland and Czech Republic. Having met with management recently, I believe the company to be well-positioned to trade through any initial volume impacts – and could even benefit competitively in the long

R&M UK Dynamic Equity | 3 run – meaning these downgrades may turn out to have been hasty, but we are on alert to act should this confidence prove unfounded. Finally, Rolls-Royce (-0.2%) saw negative revisions to its near-term cash flow forecasts due to ongoing issues with the Trent 1000 engine. While this engine’s travails are evidently having an outsized impact on current financials and investor sentiment, our focus is much more on the Trent XWB platform as a driver of future value. We await validation of our thesis this year once the first engines come in for servicing. In the meantime, the attractive valuation (100%+ upside potential if they deliver medium-term cash guidance) for such a fundamentally robust franchise is enough to keep us invested, counteracting weaker timing.

Current outlook and portfolio positioning As we stand, UK plc is in a similar position as the end of last quarter in terms of the profit cycle and valuation, i.e. recovering and low/attractive in absolute and relative terms (to its own history, other global equity markets and alternative asset classes). This leaves ongoing shareholder value growth Potential for the UK equity market over the medium term and we now have increased confidence that this can be delivered, due to the removal of a large element of political uncertainty and an improvement in the global trade environment. UK market (ex. financials and utilities) cash flow return on investment (CFROI)

Source: Credit Suisse HOLT Composite valuation dispersion remains above average but has receded from the heights witnessed at the end of the last quarter. The share prices of companies with either UK domestic-facing and/or more cyclically-exposed earnings streams, which formed a large part of the ‘cheap’ cohort, performed well, thus closing some of the gap previously identified. UK cyclicals vs defensives relative price and estimates momentum Forecast momentum for cyclicals relative to defensives remained negative in Q4. In isolation this suggests tactical caution is warranted over the shorter term1. I have tried to balance this within portfolio construction with our view on improving economic lead indicators and better conditions for UK domestic cyclicals – both parts of the market with weak current earnings revisions – which is discussed in more depth below.

Source: Redburn, Thomson Reuters

1 See previous reports for definitions and further detail on these measures.

R&M UK Dynamic Equity | 4 Does the portfolio reflect our philosophy and process? We hold investments across our four categories of Potential, but these are currently dominated by the Quality (51%) and Recovery (31%) categories. The weightings between the four life cycle categories have remained relatively stable over the last quarter, though within these categories (and since the start of the new year) I have added more cyclical Growth while a couple of investment cases have migrated from the Recovery phase to Quality. Category and MoneyPenny skews

60% 25 25% 14

50% 12 20 20%

10 40% 15 15% 8 30% Count Count Percent

Percent 6 10 10% 20% 4

5 5% 10% 2

0% 0 0% 0 Growth Quality Recovery Asset Backed 1 2 3 4 5 6 7 8 9 10 Weight 9.5% 50.6% 30.5% 7.9% Weight 22.94% 14.36% 15.03% 15.80% 16.12% 5.25% 2.90% 4.90% 0.00% 0.00% Count Count 6 22 21 4 12 8 7 8 10 3 1 3 0 0

Source: River and Mercantile Asset Management LLP The portfolio is attractively valued, even after strong absolute returns in 2019, still pricing in a lower return on capital than the portfolio’s companies are forecast to deliver in aggregate2. Earnings momentum characteristics of the Fund overall are broadly in line with the benchmark despite a conscious tactical shift into some companies where we believe future earnings prospects to be better than the recent earnings revisions would suggest (UK domestics and global cyclicals – see ‘Key debates’ and ‘Activity’ below). R&M UK Dynamic Equity relative valuation versus global equity benchmarks

Source: Credit Suisse HOLT In terms of the drivers of future return: the Fund currently delivers a 17% cash return on invested capital (CFROI), and offers a ~4% dividend yield plus sustainable growth of over 6% (forecast earnings growth 8-12% over short to medium term) or an 8% earnings yield3. This triangulates between a high single-digit to mid-teen future return per annum, which is in line with the weighted average returns indicated by our bottom-up valuation analysis. I remain confident that a portfolio of companies with these characteristics should provide attractive absolute and relative returns for investors over the medium term. Style Skyline Our valuation exposure is, at the margin, more neutral (relative to the benchmark) than last quarter on StyleAnalytics’ data. This is consistent with our observation that valuation dispersion spreads are no longer as wide as at the end of August and is compensated by superior fundamentals (returns and growth) relative to our previous positioning. It is worth repeating, however, that based on our bottom-up fundamental work I am confident that the shares in which the portfolio is invested offer attractive value characteristics and, therefore, a wide margin of safety.

Source: StyleAnalytics 2 Source: Redburn IDEAS 3 Sources: Bloomberg, Credit Suisse HOLT and StyleAnalytics

R&M UK Dynamic Equity | 5 The key debates driving fund positioning “Let me warn you, Icarus, to take the middle way, in case the moisture weighs down your wings, if you fly too low, or if you go too high, the sun scorches them. Travel between the extremes.” Daedalus and Icarus, Ovid (Metamorphoses, Book VIII) There are two important top-down considerations from the last quarter which shaped thinking around portfolio construction more than usual. One of these I think is likely to be more tactical, that is on a shorter term (6-12 month) horizon, the other potentially more strategic and longer term (3-5 years). The tactical opportunity is presented by an improvement in activity in trade and manufacturing exposed parts of the global economy, which had effectively fallen into recession in the middle of 2019 and risked spillover to services and consumer-facing segments. Economic expansions usually end with tight monetary policy or credit problems and there is no obvious ‘smoking gun’ today (rates seem unlikely to increase in 2020 as Powell shifts the Fed to average inflation targeting), so to quote legendary investor Stanley Druckenmiller’s recent interview, “Once the fed shifted from their QT and tightening programme, our biggest problem was global trade... and on a rate-of-change basis... if anything there’s a de-escalation” in the US-China trade and technology war. This appears to have had a positive effect on C-level optimism. Economic expansion can continue, primarily because the period since 2008-9 has been characterised by a degree of caution among households and companies that has left discretionary spending for consumers and corporates still below its historical average – highly atypical compared with this stage of previous cycles (when considering length of time, employment conditions, etc.). A number of indicators of ‘animal spirits’ in the US economy remain relatively subdued, such as housing activity (top left below) and discretionary spending among both consumers and corporates (top right below); this suggests some pent-up demand remains to be released by an improvement in consumer and business confidence. Single-family starts and permits lifted by lower mortgage rates and low unemployment rate (left) and Discretionary spending*, % of GDP (right)

Substantial pent-up demand for housing: almost 1/3 of 18-34 year olds living with their parents (left) and December CFO survey shows rebound in corporate sentiment

Source: Deutsche Bank Research. *Note: Discretionary spending defined as consumer durable goods plus business capex plus residential investment. This provides an overall supportive backdrop for equities and, more specifically, presents an opportunity to selectively buy higher quality cyclical franchises at attractive prices, which may have been punished for an earnings miss or forecast cut which has more to do with the difficult macro environment than any company-specific issues. There is a particular attraction to these ideas if, like recent purchase Electrocomponents, they are structurally improving the business model and consequently taking market share, or they can accelerate shareholder value via sensible capital allocation (including M&A) from a position of excess balance sheet capacity, as in Intertek’s case. All this said, it does not strike me as the time to be ‘flying too close to the sun’ in terms of positioning. Relative to other global ‘mid-cycle’ PMI inflections in history, valuations are overall higher, the US consumer is already relatively

R&M UK Dynamic Equity | 6 confident, unemployment is at 3.5% and borrowing rates are already accommodative. From an equity investor’s point-of-view there is the fundamental issue that, when looking at the most sensitive corporates to an uptick, in many cases operating margins are already at cycle highs and are matched by high through-cycle valuation measures, so the opportunity-set in these shares is not the same as, say, early 2016. US inventories have corrected 20% from peak (below left) and the German economy’s book-to-bill has improved at a record pace ex-2009 (below right)

Source: Liberum Industrial production within the global economy has scope to pick up (below left) but some caution is warranted as margins and valuations are already at cycle highs in some areas of the UK market such as the capital goods sector (below right)

Source: J.P. Morgan Chase & Co, Copyright 2019 [chart as of 9 December 2019], Canaccord Genuity Quest The potentially strategic portfolio construction opportunity is positioning more aggressively in domestically-facing UK stocks. I wrote last quarter that the UK equity market as a whole looked attractive in a global context and I would reiterate that today with renewed vigour. The valuation discount to developed market peers is still as wide as at any point since the late 80s / early 90s and many overseas investors have been running underweights, so positioning is light (the two are clearly linked). The ability to add value via active stock picking is wide-ranging – there are plenty of UK-listed but highly international companies trading on material discounts to lookalike overseas peers (Prudential and BAE, for example) – but particularly acute in domestics which, despite 17% outperformance for since bottoming in August 2019, still trade close to a relative low P/E (price to earnings) versus international earners compared to a 10 year history. In general, these companies will see the largest benefits from improved confidence for consumers and business leaders alike (I noted with interest the New Year’s Day Times headline “Britain sees in new year on a wave of optimism”) – manifesting itself in areas such as a demand boost for construction and building products companies as delayed projects get the go-ahead, or improving loan volumes for banks both to small businesses, which have typically borne the brunt of uncertainty, and housing-related consumer lending. I am particularly interested by those companies – such as Polypipe, DFS and easyJet within the portfolio – that have managed to use the challenging conditions to increase market dominance. The UK equity opportunity is underpinned by the fact it remains a favourable jurisdiction for investors, contains a broad array of attractive corporate franchises and now has five years of political stability ahead (in relative terms, at the very least!) – all of which means we should expect UK corporates to remain acquisition targets for overseas corporates and private equity buyers alike, particularly if valuations do not move higher. In this regard, the ‘party’ seen in 2019 may just be getting started.

R&M UK Dynamic Equity | 7 The discount for the UK market relative to other developed markets is wide (top left) and the opportunity set is broad, but we believe particularly attractive in laggards such as small caps and domestically-exposed companies (top right) who can benefit from dynamics such as an improvement in consumer confidence from a low level relative to history and other regions (bottom left) and corporate optimism (bottom right) reviving business investment. UK vs. MSCI World Average Valuation Premium (left) and Valuation discount for UK domestics vs. Global earners (right)

UK Consumer Confidence (economic situation next 12 months) (left) and US CEO vs. UK CFO business optimism surveys (right)

Source: Bloomberg, Exane BNP Paribas, Morgan Stanley research, European Equity Strategy, 2019

Portfolio activity “Around here… we don’t look backwards for very long. We keep moving forward, opening up new doors and doing new things. Because we’re curious. And curiosity keeps leading us down new paths.” Walt E. Disney Key purchases We purchased Barrick Gold, the world’s largest gold miner, as a high-quality name and relative outperformer (operationally and in share price performance terms) within the precious metals sector after exiting Fresnillo (in line with commentary in our last quarterly report). Following its merger with Randgold Resources in September 2018, it boasts a regionally diverse portfolio of quality assets, spanning five continents and including five of the top ten Tier One gold resources globally. This enables low costs of production relative to its senior peers. Portfolio optimisation under the new CEO coupled with a supportive gold price environment and merger-related cost synergies underpin an improving returns profile, with strong cash generation enabling balance sheet deleveraging and capital allocation towards accelerating development of higher-return growth projects within the pipeline, mine-life extending exploration and additional value-adding M&A (supported by the $1.5bn-plus of non-core asset sales they are targeting). A premium rating versus peers is justified by Barrick’s strong operational track record, significant resource backing and management’s history of value creation. At the current spot gold price ($1,550/oz) we see potential for in excess of $8bn cumulative operational free cash flow between 2020-24 which, combined with the improving balance sheet, will enable a positive re-appraisal of the shareholder return policy. We acquired shares in Capital & Counties Properties (CapCo) in the wake of its sale of the troubled Earl’s Court project. After multiple write-downs to its value, this project had become a relatively small part of CapCo’s overall value but took up a disproportionate amount of investor and analyst attention due to persistent negative headlines. In achieving a relatively clean exit from the project at a valuation above what many analysts had forecast, the company has drawn a line under this failure and is left with an attractive Covent Garden portfolio, primarily consisting of premium retail and restaurants, and low levels of financial gearing. With the shares available at a 20 per cent discount to the stated net asset value (NAV), the larger than expected Conservative election victory and line-of-sight to the Brexit end-game are likely support a re-rating of the shares towards NAV and bring into play the prospect of an acquisition of these highly strategic prime London assets by a foreign buyer. ConvaTec is a leading provider of specialist medical products, with a focus on chronic care therapies. Historic underinvestment in R&D and poor execution resulted in market share losses and caused the company to significantly underperform its IPO expectations. Despite this, it has consistently delivered operating margins in excess of

R&M UK Dynamic Equity | 8 20% - testament to the strength of its chosen verticals and high gross margins. Recovery Potential is driven by a restructuring plan under a new leadership team, where we believe cost-base rationalisation can drive both an acceleration in organic sales growth and an improvement in margins towards the industry standard. ConvaTec’s valuation is particularly compelling, trading on a ~50% discount to its major listed peer, Coloplast. Whilst it will take time for the largest benefits from the turnaround to materialise, the market gives little credit for management’s actions, therefore offering upside risk to conservative analyst forecasts (which have started to be beaten and upgraded). We initiated a position following a positive trading update and the arrival of the well-respected new CEO from Genus, linking up with the new Chair who has overseen a similar turnaround at Rentokil. We have high hopes this duo can repeat their previous delivery of strong shareholder value. ‘The strong getting stronger’ has been a recurring theme for UK retail over the past few years but the share price of furniture retailer DFS has lagged that of peers such as Dunelm, Pets at Home and JD Sports, with which we believe it shares fundamental attributes. Its equity multiple belies the risks investors see in retailers with balance sheet gearing, but DFS’s cash generative model (its sofas are built to order so they hold little inventory) and ability to flex the cost base, notably its ~£100m advertising budget, does give room to offset negative operational gearing effects in a slowdown. Its scale, vertical integration and experience in the delivery model appear to bestow competitive moats which have not allowed disruptors to gain any material foothold in its core market – DFS remain three times larger than its closest competitor in sofa market share. We bought the stock around the UK general election, as we believe that increased certainty can deliver a boost to housing transactions and sales of big-ticket consumer discretionary items, both of which are likely to be a tailwind for DFS’s like-for-like (LFL) sales. Analyst expectations are currently for a relatively modest +1% but previous upswings have delivered mid-single digit growth and each 1% of LFL sales is a ~8% swing to profit forecasts. Looking further out, the management team has identified a £40m+ profit opportunity which assumes little market recovery. This is clearly material versus a starting point of £50m profit before tax (PBT) and, should it be delivered, we will have purchased a structural winner on ~5x earnings. Electrocomponents is a high service global industrials and electronics distributor with an increasingly strong market position in a highly fragmented market as evidenced by recent market share gains. Growth potential and high through-cycle gross margins are underpinned by a broad range of stock with very high availability (‘the fourth emergency service’) coupled with technical sales advice. Sales and earnings growth expectations are modest relative to recent history and in the context of a material step-up in investment and structural growth tailwinds. Balance sheet strength offers optionality in terms of value accretive bolt-ons and/or capital returns. Short-term cycle related downgrades, which we believe are backwards looking compared with more supportive trading conditions in prospect (outlined above in ‘Key debates’), as well as some share price weakness around what we hope is a short-term sickness leave for the well-respected CEO, presented an attractive opportunity to initiate a position in a high-quality cyclical company with an attractive margin of safety to our through-cycle earning power valuation. Flutter Entertainment operates a highly profitable online gambling model (23-25% EBITDA margins / 30% CFROA average over the last five years), has geographically diversified earnings, a rock-solid balance sheet, strong management team and has a highly desirable early mover strategic position in the US sports betting market offering longer term earning power optionality. 20% market share of US sports betting (vs. 45-50% today in key states) with 25% of the total market opened up would double today’s EBITDA. This is the sort of opportunity the market typically finds hard to price correctly. We believe that the regulation-driven earnings downgrade cycle of the last 12-18 months has bottomed-out; this is reflected by share price performance which has started to trend positively. Solid underlying growth characteristics (+15% YoY in 2019) with low capital requirements and its US positioning underpins a premium multiple in the sector. Based on our assessment of the long-term value of the US, which is currently loss-making, the core business was available on an attractive 10x EBITDA as opposed to the headline 14x, which is more in line with the historic average. In 2020 we expect Flutter’s merger with The Stars Group to close, which will produce the scale player in the industry and provide multiple synergy opportunities. Intertek is a high margin, capital light business compounding attractive 15-20% CFROI at mid-to-high single digit growth rates thanks to its leading position with the $250bn global quality assurance market. Its position particularly within products testing and assurance confers access to structural mega-trends such as product traceability and ethical sourcing or global uniformity of quality in increasingly complex supply chains and distribution networks. The stock is anti-consensus on the sell-side – only 2 buyers out of 21 – due to its relatively elevated valuation multiples, but we believe this misses two points: firstly, its attractive fundamentals mean the shares can maintain a premium multiple as indicated by industry peers; secondly, the balance sheet is currently under-geared at 1.0x versus the targeted 1.5- 2.0x net debt / EBITDA and as it deploys this on acquisitions the valuation multiple will come down. The shares had declined due to fears around the impact of a US-China trade war on the testing business, but any disruption would be temporary in nature as Intertek are well positioned across Asia-Pacific and ultimately more complexity in the supply chain is a good thing for its business. Finally, the margin recovery opportunity in the Resources division – with high operational gearing to a cyclical improvement in revenues – is overlooked by many investors due to the division’s small current contribution to group profits but can make a meaningful contribution to growth over the next 1-2 years. Unilever is a global consumer staples quality compounder with a strong economic moat. Over 80% of the group’s ~€50bn turnover is from products and brands with number 1 or 2 market positions. Although barriers to entry are eroding, barriers to scale are growing, supporting sustainable low-to-mid single digit sales growth and high returns. With organic growth expectations now below the mid-point of the group’s multi-year target range (+3-5%), we took the view that risk is to the upside as emerging markets sales (> 60%) have suffered from transitory country-specific issues. Developed market growth has been anaemic in recent years, but expectations of nil growth look modest at a time when the group is making meaningful changes to the rate of innovation, new product launches and marketing efficacy. Although Unilever’s operating margin targets of ~20% in FY20 are ambitious and revenue investment ratios are falling, our new analysis leads us to no longer believe they are inconsistent with mid-term revenue growth targets as they mask the significant scale of reinvested cost savings and the increasing efficiency of investment. For example, Unilever is investing in innovative digital methods to capture and utilise first-party consumer data on a massive scale for

R&M UK Dynamic Equity | 9 precision marketing. This is significantly more cost effective than using third-party data. A period of underperformance relative to consumer staples peers provided an opportunity to initiate a position at a valuation discounting long-term growth and margins below our expectations. We acquired shares in African mobile towers operator (‘towerco’) Helios Towers at IPO. Helios operates a Quality business model, playing a key role in the economic growth prospects of the five countries in which it currently operates by providing critical infrastructure for the mobile network operators (MNOs). It is in the sweet-spot of a towerco’s corporate lifecycle because they are already earning above cost of capital returns but have a long runway to compound out via growth in its invested capital base (organic and via M&A). Africa is still an immature market, both in the sense that MNOs are still early in the process of outsourcing infrastructure ownership to dedicated towercos (only a quarter of African towers are owned by towercos, like Europe but with the kicker of superior contract structures) and in terms of overall mobile penetration and data usage. The capital deployment necessary to deliver this future growth is covered by organic cash generation. Although margins are high today (55% EBITDA margin on a trailing 12 month basis), they can go higher yet as the tenancy ratio (i.e. the number of mobile operators with equipment on each tower or mast) is still low at 2.05x across the group; revenues from each additional tenant come with a very high drop-through to the bottom line, meaning that at its target of ~2.3-2.5x tenancy ratio the business would be expecting to make 60-65% margins with clear benefits to cash generation and return on capital ratios. There are likely two main reasons that the shares are mispriced and in both cases the passage of time and greater investor education can shift perception closer to reality and help close the anomaly. The first is that P&L accounting does a poor job of representing the true economics of the business; depreciation and amortisation (D&A) should roughly equate to maintenance capex yet here D&A is $136m while, according to the company, maintenance and upgrade capex is only ~$40m (total capex including growth capex is expected to be $130m in 2019). This is largely because Helios is forced to depreciate its main asset over 20 years when the typical useful life of a mobile tower is closer to 40. Underlying free cash generation is therefore materially better than the P&L would have you believe. Secondly, the market misperceives the level of political risk that needs to be priced into the shares. Towerco peers in the US and Europe trade on more than 20x EV/EBITDA yet Helios IPO’d at less than 9x and today trades at 11x even after a 37% share price increase. While the level of risk to operating in a country such as the Democratic Republic of Congo (DRC) should never be outright dismissed, I gain confidence from four sources: i) the tight contract structures, including inflation pass-throughs which mitigates currency risk; ii) the company’s track record, with no towers lost due to political issues and tax rates barely changed – including going down in DRC; iii) that the main targets for ‘left-field’ actions such as fines, tax levies or appropriation of property have typically taken place in extractive industries such as mining or consumer-facing entities (the mobile operators themselves), whereas mobile infrastructure is clearly a growth enabler in the continent; and, perhaps most crucially, iv) from the fact that the largest towerco in the world, American Towers, recently invested $1.9bn in acquiring Eaton Towers, which operates in West, East and Southern Africa. Interestingly, it did so at a 13.7x EBITDA multiple (pre-synergies). We increased the weighting in quality UK domestic cyclicals Lloyds Banking Group and Polypipe, consumer-facing recovery thesis Wm Morrison Supermarkets (funded by reducing some of our Tesco position to buy the sector laggard), as well as quality compounder RELX on more positive news around contract renewals in the academic journals division which we expect will underpin revenue growth and support a re-rating. Key sales and reductions Three stocks were sold because they reached our fair value estimate and we saw less scope for positive earnings surprises or sentiment shifts for these now relatively well-liked stocks when compared with other opportunities – new and existing – within the portfolio. Melrose now has analysts forecasting operating margins in line with management targets (although typically with a slightly different mix – Aerospace higher and Driveline lower than guidance), so they require outperformance which is certainly possible but already well-priced on a sum of the parts analysis. National Grid’s share price now offers a mid-single digit total return based on our analysis and therefore provided a source of cash to invest in the names above that are more closely aligned with the tactical views outlined. Qinetiq has seen the re-appraisal of its organic growth prospects by the market that we had anticipated, re-rating to nearly 20x current year earnings. Prospects for revenue growth look well underpinned by the order book but we expect there will be a hiatus period in the return on capital improvement (Quality thesis), suggesting that the share price is embedding a lot already. We exited our position in BHP Billiton to concentrate our mining investments in Anglo American (to which we allocated more capital), where we see greater upside based on our through-cycle valuation methodology, as well as more fundamental catalysts to unlock upside optionality (e.g. South African assets being spun-off). As discussed above, we initially halved our position in Tullow Oil before exiting at a disappointing loss shortly after the quarter-end due to negative news flow, which compromised our original Recovery investment thesis based on producing assets delivering cash generation for deleveraging, plus attractive optionality from the Guyanese exploration portfolio. We accept that the shares now carry little in the price for future exploration success and may become a strategic target for Total, but valuation as a single strand is never sufficient to build a thesis and we do not have evidence at present to support a fundamental investment case. We sold our ‘stub’ holding in M&G following its spin-out from Prudential as well as the remaining sub-scale position in Fevertree Drinks, where I could not build enough confidence in either an improvement in UK trading or US revenue growth accelerating to a level that could offset the softer numbers in the UK. Growth companies receiving forecast downgrades (and without valuation support) is a key sell discipline and it was adhered to. We also materially decreased the Fund’s weighting in JD Sports after a more than 100% increase in the share price during 2019. Having entered the FTSE 100 during the third quarter re-balancing, the shares have now both received increased passive flows and come onto the radar of more investors. A high valuation multiple is no less than the company deserves for its excellent execution of the Growth investment case but does bring with it increased risks on any disappointment. For now, we still see scope for earnings to exceed expectations and the shares have not yet

R&M UK Dynamic Equity | 10 breached our ‘bull case’ fair value so I remain content to hold the stock at a lower weight. Finally, we reduced our position in 888 to help fund a high conviction weight in new holding Flutter. We maintain a 2% weighting in 888 and see strong underlying growth (which we believe the market is missing) and clear strategic value, but chose to diversify the skew of our online gambling companies’ revenues away from the UK due to i) exciting opportunities in the US, on which Flutter is best positioned to execute, ii) the reappearance of regulatory ‘noise’ in the UK surrounding online casino, and iii) an increase in UK-facing revenues elsewhere in the portfolio, as described at length in this report.

Top five holdings GlaxoSmithKline (4.3% of NAV) – Quality GlaxoSmithKline (GSK) is a globally and structurally diversified healthcare company with a major global presence in vaccines, consumer health, and respiratory/HIV – all of which have attractive medium-term growth prospects – plus an increasingly scaled platform in oncology. There is evidence that a corporate culture shift has happened which has made the company more shareholder value focused: i) It has reduced R&D programmes in Pharma business to focus on blockbuster potential, improve returns and cash flow before rebuilding its pipeline (organically and inorganically) under its new Chief Scientific Officer (ex Genentech, Roche and Calico); ii) It has increased collaboration (“externalisation of non-core pipeline” in industry speak) and built scale in the Consumer Health (CH) division via buyout of the Novartis JV followed by a Pfizer JV (2H19 close); iii) It will demerge CH via spin-out on a three year horizon with the CH standalone able to support higher leverage, thereby deleveraging Pharma and Vaccines and enabling investment for growth. The first stage has been a success – CFROA has doubled from 7% to 15% and FCF (free cash flow) conversion has improved to 100%. Vaccines are currently the key growth driver for the business and Shingrix (shingles) has a good opportunity to deliver sales (with attractive economics) that continue to beat consensus expectations as the business increases manufacturing capacity. Within the key debates, Generic Advair looks lower risk given lead times and the incremental nature of competitor entry; consensus forecasts have been revised up. GSK will not be immune from shifts in the US drug pricing landscape, but management has been robust in its view of GSK as a relative winner. The biggest risk is around the HIV franchise given its importance to current earnings; nonetheless GSK does have some offsetting strategies relating to Gilead’s competitor product. Early evidence from the ESMO (European Society for Medical Oncology) Congress on the likely success of its pipeline replenishment strategy provides timing support. Our DCF (discounted cash flow) and SoTP (sum of the parts) valuations still point to a healthy margin of safety despite strong share price performance since our purchase last year. Prudential (3.9% of NAV) – Quality Prudential is a genuine Quality compounder, delivering a 25% return (CFROE) while growing its equity base at 5-10% every year since 2009, and with a track record of ~15% CAGR (compound annual growth rate) in operating earnings since 2004. The engine for sustained growth is its leading Asian franchise, with an agent base that would be impossible for a competitor to replicate from scratch selling into structurally growing demand, propelled by lower insurance penetration, lack of state benefits and favourable demographics. The CEO of Asian operations believes this business can double earnings over the next 5-7 years, i.e. 10-15% CAGR, though growth has been under pressure in the short term from disruption caused by the Hong Kong protests. It also has a market-leading US variable annuities (VA) business (Jackson National) which can benefit from baby boomers heading into retirement, driving demand for its products. In Q4 2019 they completed the spin-out of M&G, one of the largest UK life insurers and asset management businesses. We see this as a positive step to generate shareholder value, acting to shine a light on the compelling valuation opportunity in the Asian business particularly. The group trades on 10x earnings, which is low considering the growth potential and return profile, but the implied discount on the Asian business versus close peer AIA trading on 19x – even assuming a relatively low multiple for Jackson National – looks stark. We think it is possible that the board looks to sharpen the focus on the Asian franchise further in due course by selling or IPO’ing Jackson, which would materially alter the risk profile by reducing shareholders’ exposure to financial assets. Tesco (3.8% of NAV) – Recovery Tesco is delivering a well-executed turnaround, with the core food retail business targeting a Recovery of 3.5% to 4.0% operating margins in 2020 underpinned by £1.5bn in cost reductions. There is evidence that its self-help strategy is gaining traction, with LFL sales having been at the high end of the peer group and margin improvement on track for the high end of original guidance. The Booker acquisition is an attractive strategic addition with conservative synergy guidance. The wholesale improvement in stakeholder relationships (employees, customers and suppliers, as well as shareholders) helps build conviction in the sustainability of the recovery. Our analysis suggests that the core business currently accounts for the bulk of the current enterprise value, based on achieving the middle of the targeted margin range, suggesting there is a healthy margin of safety provided by the value of the Booker wholesale business (acquired for £3.7bn) and overseas businesses. We also take comfort from the explicit cash generation targets; we calculate that management will have the flexibility to return excess cash flow of up to 5% of the current market cap per annum above and beyond the ordinary dividend. Tesco continues to execute sensible strategic capital allocation decisions, such as the bank disposal and the news that it is likely to dispose its Asian business at an attractive profit multiple, but recent softer industry sales growth – to which it is not immune – has opened an attractive gap between the price and longer-term intrinsic value once again. While CEO Dave Lewis’s departure is unfortunate given his many qualities and the excellent job he has done, it had been broadly expected and we welcome the orderly transition process evident from his departure date in summer 2020 and the appointment of his successor being announced simultaneously. Vodafone (3.2% of NAV) – Asset-backed Vodafone (VOD) is a deep value Asset-backed investment case trading at ~40% discount to replacement cost, which has a clear self-help strategy focused on cost efficiencies and asset utilisation that is consistent with its lifecycle stage and will drive margins and returns higher over the medium term. It targets a net cost saving of €1.2bn over three

R&M UK Dynamic Equity | 11 years to 2021, created by ongoing digitisation of the cost base and a particular benefit from reduced customer churn; this is equivalent to 8% of group EBITDA (both FY18). Improved asset utilisation will be delivered via a combination of partnering and sales of non-strategic tower assets; recent announcements on the latter have provided a positive timing catalyst for the shares. Last quarter delivered an inflection to positive mobile service revenues (MSR) as we had forecast; signs that competition is easing in some trickier European markets and interesting commercialisation strategies for 5G (e.g. ‘speed tiering’) provide encouragement on the sustainability of the improving trend. Finally, last year Vodafone completed the acquisition of Liberty Global’s German and central/eastern European cable and fibre assets, which offer cost synergies to the combined group and have attractive cash generative characteristics. Future cash earning power in excess of €6bn is not priced into the shares, which may be in part due to the company’s complex structure – stripping out the value of publicly-listed entities (e.g. Vodacom), JVs and its tower assets (analysts had valued the towers portfolio at €12 billion but we calculate they could be worth as much as double this based on new financial disclosures4) suggests the core European business is available for less than 4x EBITDA, which compares to European incumbents on 6-8x and recent private market transaction multiples in the sector typically at 8x or higher. There is a material implied equity risk premium between the double-digit free cash flow yield and the debt yielding closer to 2%, which can close with the improved operational execution outlined above. Lloyds Banking Group (3.0% of NAV) – Quality Lloyds (LLOY) has transitioned from retrenchment and restructuring in the Recovery phase to a Quality investment case where returns above cost of capital are underpinned by its ~25% market share of deposits and mortgages. Banks are rarely thought of as good ‘quality’ businesses in the post financial crisis era, but those that control a large share of a local deposit base are often exactly that as they have a cost advantage and can finance a large pool of assets with low cost deposits and dilute administrative costs over a large base – classic lowest cost producer and economies of scale ‘moats’, in other words. Dominant banking franchises are ultimately able to achieve higher returns than competitors for the same balance sheet risk. A sentiment-toxic combination of ongoing PPI remediation costs (now in the rear-view mirror), higher regulatory capital requirements (still an issue) and political risk – as a totally domestic UK-exposed bank and liquid share LLOY has been particularly impacted by swings in investor sentiment around Brexit and the UK general election – means the shares trade on 1.1x tangible book value and 8x earnings, offering a 5.5% ordinary dividend yield (before distribution of meaningful excess capital), despite being forecast to earn a 12% real return on equity this year (at the top end of European banks) with far more headwinds than tailwinds for its business. It is rare to find such a dominant banking franchise globally, let alone in a developed market like the UK; it is rarer still to find them at such attractive valuation multiples. The paralysis of the UK economy amidst the heightened political uncertainty has provided a highly challenging environment for UK banks but just as investors have often underestimated LLOY’s net interest margin and earnings resilience (which protects our downside), we also believe they are not pricing the benefits of increasing business and consumer lending activity (from a low base) in the wake of the Conservative election victory. Analysis suggests this could provide a ~10-15% boost to profits versus the current flat earnings profile forecast out to 2022 (7p EPS); a move back towards forecast upgrades would act as a supportive catalyst for the market to reappraise the risk premium they are currently attaching to Lloyds (and other UK banks). Over the very long term5, investors have on average applied an 8% cost of equity to UK bank earnings, so there is potentially a large value gap to close from 8x to 12.5x earnings on top of other capital distributions.

4 FY19 Vodafone ‘European TowerCo’ proportionate financials: revenues €1.7bn, EBITDA €900m, CapEx ~€200m; total Tower EBITDA (including emerging markets) €1.3-1.4bn. I intend to go into more depth on the thesis underpinning our two towerco investments, Vodafone and Helios Towers, in the next quarterly report. 5 Data on Barclays goes back over a century.

R&M UK Dynamic Equity | 12 Final word Post strong absolute returns from the Fund and the UK benchmark over the last 12 months it is inevitable that we ask, ‘what now?’. Some short-term sentiment indicators flag over-bought conditions in global equity markets but by no stretch are these measures universal. Over the intermediate term, as well as very supportive monetary policy there is a large equity inflow required to make up for the unprecedented selling of the asset class since 2018. History suggests there is a limit to support from lower rates – US investment firm KKR suggests that if real rates go much more negative than current levels investors place a discount on the multiple they are willing to pay because they worry about lower rates signaling about prospects for growth and profitability – and equity multiples in the US are unlikely to provide much cushion in the event of an earnings downgrade cycle, but for now a macro improvement environment, which is typically favourable for risk assets, seems more probable. There are many more reasons to be optimistic about returns from UK equity strategies than there are to be pessimistic. On top of the broader global macro support, the relative political stability of a five-year Conservative government with a large majority should provide encouragement for global investors to return to market in which they have largely been ‘M.I.A.’ for the last two to three years. While we are still not clear about the nature of the UK trading relationship with the EU post-2020, this trade negotiation does not compare to the binary nature of a ‘no-deal’ exit and therefore brings with it a very different (reduced) risk profile. It would be unsurprising were financial markets to periodically worry about these negotiations over the coming year, providing opportunities for the active investor. In the meantime, there is early evidence from surveys of a UK confidence boost, with the planned March budget also set to deliver a positive fiscal impulse into the economy. Do not expect this to be reflected in company trading statements released during the first quarter (we have already seen several subdued performances) but prospects for corporate profitability and, critically, the range of outcomes are much improved. What is more, there is still a wall of private equity cash ready to be deployed and ‘complexity’ – of which there is plenty in the UK today, under KKR’s definition in my ‘Quotations for the quarter’ – is cheap, so expect ‘de-equitisation’ to remain a feature of the investment landscape in the UK. Our active approach has ensured that the Fund has attractive capital growth potential but is also balanced enough to not be purely focused on all-out offence – a prudence that I continue to think is appropriate at a more mature phase in the stock market cycle. I judge each stock on its own merits against our philosophy, focused on finding firms with the Potential to create significant shareholder value from various stages of the corporate lifecycle (with many opportunities today in Recovery), when bought at a Valuation offering a margin of safety with Timing support. Our portfolio companies have a wide range of earnings drivers, reflecting the broad opportunity set in the UK, and I have conviction that the Fund’s holdings have the balanced PVT characteristics that will deliver attractive absolute and relative returns for us over the medium term. Thank you for your patience, ongoing support and partnership while the material anomalies we are exploiting correct themselves.

William Lough Portfolio Manager January 2020

R&M UK Dynamic Equity | 13 Fund Information

Launch date 22 March 20071 Fund manager: William Lough (from 3 April 2018) IA sector: UK All Companies Benchmark: MSCI UK IMI (Total Return, net GBP) Tracking error range: N/A Strategy capacity: £2bn (pooled & segregated) XD dates: 1 April & 1 October Dividend/Accumulation payment date: 31 May and 30 Nov

Share class: A B Z

Launch price (shares): 100.00p 250.00p 500.00p

Share classification: Retail Retail/Institutional Institutional

Type of shares: Income Accumulation Accumulation

Fund charges:

Annual 1.50% 0.75% As agreed*

Initial (up to) 5.25% 5.25% 5.25%

Ongoing Charge Figure (OCF) (incl. AMC) 1.67% 0.91% AMC* + 0.17%

*Z class AMC is charged outside the Fund

Minimum investment

Initial £1,000 £2.5 million £5 million

Subsequent £500 £25,000 £50,000

Sedol B1NG829 B7H1R58 B1NGCT4

ISIN GB00B1NG8296 GB00B7H1R583 GB00B1NGCT49

Bloomberg RIVMERALN RIVMERB LN RIVMERZ LN

1 B share class launched 21 November 2012

R&M UK Dynamic Equity | 19 Important disclosures

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R&M UK Dynamic Equity | 20