NOV 16

Mark Mahaffey Ben Davies Aalok Sathe

“Wir können das schaffen” (“We can do it”) ― Angela Merkel

OVERVIEW

In late-September for the last 20 odd years, I have made the three-day trip to the famous Munich beer festival, ‘Oktoberfest’. Ex-colleagues and friends have made the trip over the years, with differing rotation, and many people still tell me it is on their bucket list. The Oktoberfest is the world’s largest festival, with 6 million visitors attending the 16-18 day event, which runs from late-September to early October. Originating from the royal wedding celebrations in 1810 between Crown Prince Ludwig and Princess Therese of Saxe-Hildburghausen, the festival has been an annual event almost ever since. In over 200 years, the festival has only been cancelled 24 times, usually as a result of war. Obviously, beer is an attraction for the largely German attendance (some 75% usually) but the pantomime party atmosphere of historic Bavaria is like a journey back in time. Only beer that has been brewed from the six breweries in the city limits can be sold as Oktoberfest beers – Augustiner-Brau, Hacker-Pschorr-Brau, Lowenbrau, Paulaner, Spatenbrau and Staatliches Hofbrau-Munchen. The belief is that Oktoberfest beer is brewed only for the festival, so it is fresh and without multiple preservatives, thus reducing its hangover potential!!! While our capacity for beer is far less in our 50s, than it was in our 20s and 30s, an enjoyable time was still had by all.

HINDESIGHT DIVIDEND UK LETTER / NOV 16 1

Last year’s trip to Munich in September 2015 coincided with Germany opening their arms to refugees, the majority of them arriving at Munich’s main railway station right in the centre of town, as their first step on German soil. The suspension of the Dublin agreement meant that refugees no longer had to be repatriated to their first port (country) of entry. Germany had become the ideal destination for many. The terrible tragedies of the war in Syria were becoming apparent, as well as the harsh reality of the dangers of making the trip across the Mediterranean Sea. The picture (below) of the drowned three-year old boy was a pinnacle in the crisis.

It has been said that the Germans were more welcoming to the refugees than other European countries because of their guilty past, but I think that all human beings, in general, want to help people who are in genuine distress and are prepared to offer sanctuary and aid.

Germany needs immigrants more than most. Its fertility rate is one of the worst in the world and the population is ageing and on the decline. Without immigration, Germany will lose 10% of their population in the coming decades and even more of the workforce. Angela Merkel, Germany’s Chancellor, understands that only too well. Unfortunately, taking 1.5m in less than two years has created more problems than solutions at this point. At next year’s elections, she might pay the price for her seemingly well-intended actions.

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This September, Munich and indeed Germany seem to be struggling to come to terms with the mass influx. Both political correctness and the rise of right-wing support are potentially guilty of making it difficult to understand the real story. The refugees seem to consist of a disproportional amount of young Muslim males, far too many from Albania, Kosovo and Sub-Saharan Africa, which suggests economic migration, rather than war refugees.

We arrived to find the poorest attended Oktoberfest in many years, as terrorism concerns were rife. Fences encircled the huge fairground and beer tent site for the first time to control access. Our observations were of a visibly significant increase in the Muslim population. In Germany as a whole, it is rising dramatically, although still lower in percentage terms than France. As reality has set in Munchner, as the inhabitants of Munich call themselves, have changed in a year. For them, there seem to be only negative stories:

 Muslim men, under the auspices of polygamy (banned in Germany), are routinely taking advantage of the social welfare system with multiple benefits for their ‘wives’  The rapid increase of mosques with their call to prayers is making many German towns sound like they are in the Middle East  Every female seems to have a story about unwelcome Muslim male attention, reminding us of the New Year’s Eve stories of mass sexual assaults, especially in Cologne.

Germans seem generally to view that the Muslims do not desire to integrate into German society, obey German laws or, more importantly, its Christian values but to seek to take control and grow a new Mecca in Germany. A recent report stated that 138,000 German families had emigrated to Hungary in the last two years, unhappy with the changes to German society. Last year, the President of Hungary said:

“For us today, what is at stake is Europe, the lifestyle of European citizens, European values, the survival or disappearance of European nations, and more precisely formulated, their transformation beyond recognition. Today, the question is not merely in what kind of a Europe we would like to live, but whether everything we understand as Europe will exist at all.”

As a liberal and pragmatic person, I usually stand on opposite sides of the debate to any right wing politics. So, it is naturally a real concern to see first Brexit, then Trump, followed potentially by Le Pen’s rise to the forefront. One of our favourite drinking spots in Munich is the Hofbrauhas, famous for being the first meeting place of Adolf Hitler and his national socialists in 1920. In light of the current rise of nationalism once again, this year’s visit was far more thought provoking than usual.

I have merely made observations without any answers as to why multiculturalism is failing, but it is. Whether we can thwart the current and rapid rise to the right will depend on all parties. Muslim societies, in Europe as a whole, need to understand that the welcoming arms of the inhabitants last year came with a belief that there would be an assimilation of values and adherence to established local laws. On the other side, we can strongly object to ‘racist’ language that is winning the popular vote. Unfortunately, we are going down the opposite path to co-existence today and well trodden in history. The outcome is far from what we should be looking for in the 21st century.

I came across this link in September while looking up news about Oktoberfest. Whether it is true or a right-wing hoax is unknown, but it seemed to sum up the breadth of the gap to be filled. http://100percentfedup.com/muslim-petitions-to-cancel-oktoberfest-in-germany-as-munich-police-plan-to-keep- refugees-and-revelers-apart/

HINDESIGHT DIVIDEND UK LETTER / NOV 16 3

Our main investment ideas this month are: 1. Britvic PLC

CONTENTS

Inside this edition of the UK Dividend Letter you’ll find:

OVERVIEW 1

INVESTMENT IDEA #1 BRITVIC PLC 5

INVESTMENT INSIGHTS 12

HINDESIGHT DIVIDEND PORTFOLIO UPDATE 17 PORTFOLIO UPDATE - WHAT HAPPENED? MARKET & SECTOR ANALYSIS 20

HINDESIGHT DIVIDEND UK PORTFOLIO # 1 (NOVEMBER 2016) 22

APPENDIX I THE WAY WE THINK 24

APPENDIX II HOW WE THINK 25

HINDESIGHT DIVIDEND UK LETTER / NOV 16 4

INVESTMENT IDEA #1 BRITVIC PLC by Mark Mahaffey

Sky PLC

Price (£) 558.0 Turnover (£mm) 1,300.1 Net Income (£mm) 103.8 Market Cap (£mm) 1,459.1 Fwd P/E Ratio 12 Dividend Yield (%) 4.10% Payout Ratio (%) - Total Debt to Total Equity (%) 280.1% FCF to Market Cap (%) 4.0% ROIC (%) 15.6%

Britvic PLC (BVIC: LSE) is a leading producer of soft drinks that are distributed across the world. The company is based out of (Greater London). It is one of the two largest soft drinks producers in the and one of the largest across the world by volume. Britvic has a large feather in its cap as it produces soft drinks under its own name but also has the rights to sell other drinks, such as those produced by Pepsi (within the UK). Britvic is a global company, however, its core focus is on Great Britain, Ireland, France and Brazil, while also making inroads into North America, employing over 4500 individuals.

The soft drinks producer was initially listed on the in 2005. It is currently a member of the FTSE250 with a market capitalisation of over £1.4bn, led by Mr. Simon Litherland. The company was founded in the mid-19th century by the chemist H D Rawling, who began making vitamin drinks and tonics from his pharmacy in (Essex). The British Vitamin Product Company was later purchased by Ralph Chapman, who produced fruit juices. As the popularity of their produce started to gather pace, it was bought out by Vine Products, and eventually became a subsidiary group of Allied Breweries, 30 years after being founded. Given its popularity, this eventually led to the whole firm being rebranded and it started trading under the name Britvic. Over the years it has navigated through several periods of M&A activity during which the drinks company acquired brands, such as , J20 and , and eventually bought the UK franchises of Pepsi and 7Up.

Britvic’s initial large name investors were Intercontinental Group, and Pernod Ricard, who all saw their investment being realised when the company became public in December 2005. Intercontinental Hotel Group and PepsiCo are both still large long-term owners.

Most recently, Britvic attempted to merge with the Scottish soft drinks producer A.G. Barr in 2012. The deal would have created one of the largest drinks producers in the world. The Office of Fair Trading referred the deal to the Competition Commission and eventually it was abandoned. This was an unfortunate result, as the deal would have created significant value for shareholders on both sides.

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The company was formed during the Victorian period. This was at a time when there was a large amount of hostility towards alcoholic beverages and it was this resentment that led to the development of a new range of drinks called ‘soft drinks’. Many of these drinks used carbon dioxide, which was injected into water, a method developed by at the end of the 18th century in London. ‘Fizzy’ drinks became popular very quickly and Britvic’s early advertising methods enabled many of their beverages to achieve a certain degree of recognition across the nation.

The British Vitamin Products Company (Britvic), as it was initially known, developed a significant number of soft drinks over the years and has always been at the forefront of this industry. The company can lay claims to developing the ever-popular Lemonade, its own tonic recipes and some non-alcoholic ales that people still drink. It has always shown an entrepreneurial side and this was demonstrated by the former leader Ralph Chapman, whose eagle eye noticed that during the Depression era many customers were suffering health issues. HD Chapman showed his endeavour and devised a means of bottling fruit juices that helped to supply its customers with much needed vitamins at an affordable price.

Chapman at the time mastered the technique of packaging fruit juices in small bottles, without the need for preservatives. The popularity of its fruit juices gave Chapman and his team the impetus to roll out their bottled juice; however, this was hampered by World War II breaking out. Restrictions were put into place on most food groups as part of the government’s rationing efforts. During the war, the government rationalised the newly formed soft drinks industry, establishing a narrow field of six permitted ‘standard’ drinks. As the war ended, the management team was able to roll out their original planned line and the company became the first in to bottle fruit juices and introduce their small-format bottles. The new drinks range was marketed under the Britvic brand name, becoming the popular soft drink of choice.

Soft drinks consumption has risen steadily over the years and Britvic has greatly benefitted by having first mover advantage. The company has gone on to branch out, developing diet drinks, which they launched with their Slimsta product line in the 1970s. Britvic has always been at the forefront of the soft drinks business, looking for new brand formulas to keep consumers attracted.

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Today, Britvic manages over 30 brands across the world and has continually delivered a strong financial performance, seemingly always able to generate strong free cash flow throughout the business cycle. Last year, the company continued to grow its sales – generating over £1.3bn in revenues – as it has always done, year after year. As mentioned earlier, the company generates its core business from the following geographies:

 Great Britain  Ireland  France  Brazil  Rest of the world

 These geographic revenues are then split across two groups:  Carbonated drinks  Non-carbonated drinks

Britvic’s share price has suffered over the past 12 months, trading negatively, with similar issues to many stocks because of fears generated by Brexit and the US elections. Aside from these fears, there has been a lot of negativity towards the stock, driven by worries over the level of competition that Britvic is due to face given the aggressive food retail environment. Shareholders are particularly worried about the formation of CCEP (Coca-Cola European Partnership), which will attempt to regain its market share from Pepsi (Britvic). To add further pressure, analyst worries have weighed down on the firm's share price, as they have shown their fears over the rise in input costs and the impact that it will have on Britvic’s costs. Many have voiced their concerns over the rising costs of a basket of raw materials that consist of sugar, concentrate, orange juice and oil, all of which have a significant effect on Britvic’s growth. Finally, the UK government announced the ‘sugar tax’, which has created the perfect storm of fear for Britvic. Despite all the bad news, the soft drinks firm continues to produce strong numbers, growing its topline year-on-year. Furthermore, the company has always reported positive free cash flow numbers throughout the business cycle and once again reported strong data. With many investors on edge, Britvic has seen its share price trade down more than 20% over the past 12

HINDESIGHT DIVIDEND UK LETTER / NOV 16 7 months, and more than 28% relative to the FTSE100. Britvic plc has significantly underperformed and, in dollar terms, is trading at its 2013 level. Since its high in 2014, Britvic is now down over 44% in dollar terms.

Britvic plc enters the HindeSight Dividend portfolio this month. We believe the negative factors that have concerned the market are built into the firm’s low share price. Being a leading soft-drinks supplier, the firm’s management team has the experience to navigate it through this tough period of time. It currently trades with a forward P/E of 12x and offers a strong dividend yield of 4.1%. Given how significantly Britvic has lagged behind its competitors in recent months, the soft drinks producer offers not only good value, but also a defensive aspect to any portfolio, at current levels.

The underperformance in its share price can be attributed to:

 Rising input costs, as a result of GBP weakness  Intense competition  International Strategy/Supply Chain  Worries over the sugar tax.

Rising Input Costs & Competition With Britvic being a soft drinks producer, the company has to continually manage their input costs. With the price of key raw materials continuing to rise, analysts this year have estimated that certain parts of the firm’s input cost basket have gone up at least approximately 25%. This has been as a result of the depreciation of sterling. With this feeding into Britvic’s costing environment, it is feared that this will more than likely feed into bottom line financials.

The company has faced this situation before. In 2011, Britvic saw its input costs rise rapidly as the BP plant failure saw oil prices rise and a surge in sugar prices due to a lack of supply, along with various other rises. Despite the issues, Britvic was able to quickly adapt its prices structure to cover their rising costs. The current situation is nowhere near the level of inflation that was seen in 2011. However, given the competitive environment within the food industry, analysts are worried that Britvic may not be able to pass on these costs to the end user, as they had previously done.

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Despite the rising input costs, Britvic’s management team has shown in the past that it is more than capable of managing this sort of situation, with great success. It is hoped that the management team will once again demonstrate this experience to aid the firm through its current issues. They have already shown their awareness of the issue at hand, announcing that they would be moving their hedging strategy from a 12-month basis to an 18-month period, with the hope that this would help smooth the impact of their rising costs.

Furthermore, the company has suggested that they are in a position to adjust their fixed costs in order to help negate any headwinds that it may face from raw material inflation, something that it is already starting to see.

It is important to realise that these rising costs are an industry-wide issue and not specific to Britvic as a company. With the company changing its hedging policy and being flexible enough to manage its fixed costs, it is hoped that this will help guide the soft drink producer’s market capitalisation higher, with better than expect results going forward.

Competition: Coca-Cola Bottling (CCEP) In the past five years, Britvic, with its Pepsi bottling contract, has gained significant market share within the United Kingdom. Its performance can be largely attributed to the UK carbonated market. Unfortunately, this year Coca-Cola formed its European Partners Group (CCEP) in the hope of regaining some of the market share that it lost to Britvic over the past few years. The new partnership has relaunched its Coca-Cola Zero Sugar drink within the UK market, backed by a healthy marketing budget that is aiming to take back some of its former customers from Britvic. This has alarmed many existing shareholders, adding to the stocks underperformance, as many feel that this could hinder the firm’s margins going forwards.

Britvic’s shareholders should not be too concerned, however, as the firm has shown its ability to price its products competitively, throughout its history. Its pricing strategy across all its brands, including Pepsi, has been one of its key drivers as it gained market share over the past few years. Research has shown that Britvic’s pricing strategy has seen its products being on average 25% cheaper (on a per litre basis) relative to its competitors. Industry analysts are confident that the firm will continue to do this, despite Coca-Cola’s renewed interest in the UK market, helping Britvic to continue its strong performance. To further support the situation, Britvic’s management team has committed further funds to its branding and market strategy to help counteract any threats from its rivals. It is believed that the measures being taken will eventually show that Britvic is currently undervalued and will help to regain its share price momentum.

International Strategy/Supply Chain Program With Britvic’s growth over the past five years, they have not always had the capacity, hindering its performance and suppressing its share price. The soft drinks giant recently stated that its supply chain program is due to be completed over the next two years, helping to strengthen and address the firm’s capacity constraints. Completion of the firm’s project will help to add further flexibility, enabling Britvic to target new revenue streams, primarily through the addition of extra production lines, augmenting its existing output. The increased capacity will also be beneficial, as their warehousing abilities will be strengthened. This will allow Britvic to distribute their products more efficiently and, in turn, lower their logistical costs, all of which will help the firm’s margin expansion.

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Britvic has also announced that it will be exiting from Indian operations to help refocus and solidify its efforts within the Western market. The firm’s strategy is to create a lighter asset model by having local partnerships, rather than heavily invested programs across the world.

The company is looking to build upon its success in the US with its Fruit Loops brand. They are looking to distribute a wider range of flavours to a wider number of states. With Donald Trump being voted in, and his first order in business being to lower corporate taxes, greater revenue generation will only see a rise in the firm’s bottom line reporting.

Worries over Sugar Tax The sugar tax, which is the nickname given to the Soft Drinks Industry Levy (SDIL), was announced by the UK government this year (2016). It is not a tax on all sugar but, in fact, a levy directly targeting the producers and importers of sugar-based soft drinks, encouraging them to remove as much sugar from their drinks as possible.

The announcement of the levy saw Britvic and its peers trade down very quickly and investors were afraid as to how these businesses would cope. Soft drinks have been targeted in particular as ‘it has been found that there are approximately nine teaspoons of sugar in a 33ml can of cola’. This level of sugar immediately takes children beyond their daily recommended limits. Despite the announced tariff, Britvic has not given any reason for investors to fret. In fact, the management team has moved to reassure investors that many soft drinks could easily be reformulated to contain less sugar. Furthermore, it has been reported that companies like Tesco, Robinsons (which is a Britvic brand) and The Co-Operative have already taken steps to reformulate their drinks.

Over the course of history, the food and drinks industry has been hit by a number of levies and the most recent one is no surprise. Not too long ago, many companies were hit by the salt levy, and once again the firms involved had to reformulate their products. Over the last decade, salt intake is down 15% in the UK as a result of the action taken by industry producers.

Ultimately, Britvic has already started to make changes to its products to meet stricter guidelines. The sugar tax may have startled investors but, in reality, it is not something the industry has not faced before. In fact, having learnt from previous situations, soft drink producers can adapt quickly this time, having observed the changes that their food group peers made previously when the salt levy was implemented.

Insider Buying Britvic’s market capitalisation has suffered severely over the past year, but there are significant reasons for its share price to rerate to the upside, as stated above. This confidence could recently be seen with a number of senior Britvic directors, including the CEO, purchasing shares in the open market. Insider buying is a strong indicator of the value that management sees in the firm and reaffirms that they believe the stock is currently undervalued at these levels.

HINDESIGHT DIVIDEND UK LETTER / NOV 16 10

Source: Bloomberg

Analysts’ Corner Britvic plc is a leading soft drinks provider with a global footprint. It has a strong presence across Europe, South America and is making strong inroads into the United States. The stock offers investors with a strong dividend yield. It is well covered by the analyst community, with 19 out of 20 individuals giving the stock a buy or hold rating. Our scoring system suggests that the stock has an average 12-month target price (TP) of 730p, representing an upside of over 15%.

Summary Britvic’s share price has taken a hammering over the past 12-24 months and currently trades at a discount to itself and its peers. It has traded down due to the general global political landscape, while investors also worried about the introduction of new levies and input inflation. The soft drinks producer is still a strong and high quality business that has shown its ability to weather difficult situations throughout its history. It is a business that generates high quality returns and produces significant free cash flow throughout the economic cycle. The current level at which it trades and the firm’s leading position within the global soft drinks market makes Britvic a highly attractive prospect.

HINDESIGHT DIVIDEND UK LETTER / NOV 16 11

INVESTMENT INSIGHTS

We have been harping on for months about our concerns in the bond and fixed income markets. (Still time to get out!!) The long bull market since 1980 in bonds is over. Fixed income investments have sat at the bedrock of most portfolios, institutional or individual for the last three odd decades, offering solid dependable returns with limited risk. Now, they offer miniscule returns with a huge risk of capital losses.

Inflation anyone? Some of the recent headlines in the UK have a common theme.

 Apple raises computer prices in the UK  raises Marmite’s price by 12.5%  Typhoo Tea: the cost of a cuppa to go up  Britain’s biggest crisp maker, Walkers, hikes prices after Brexit  Microsoft to raise prices after post-Brexit pound slump

The post-Brexit GBP slump has brought obvious economic consequences. As we import everything from foodstuffs to computers, we are clearly going to have to pay more as our currency weakens. We should expect to see more of this in the future. While economists argue that these price rises are a ‘one-off’ re-adjustment for our importing nation, due to a sharply lower currency, this does actually represent a substantial cost of living deterioration to the average family, with wages in the short term not likely to rise anywhere near enough to compensate.

Zero interest rates and money printing in the name of quantitative easing for the last several years have been responsible for this current calamity in waiting. However, the touch paper may well have been lit by the shock US election result. In Trump’s election triumph speech, there was a clear focus on fiscal spending with countless references to improving US infrastructure. In the minds of the investors, more fiscal spending means more inflation, with less need for monetary stimulus. With the quantity of excess money floating around the global system these days, inflation is theoretically only a matter of time. The only problem is knowing when. In the UK, with the collapse in the currency, inflation is staring us in the face, but for other countries it is less clear. The Japanese conundrum – the inability to create inflation, regardless of how much infrastructure spending and money printing they do – is often debated as the new world, where deflationary forces have a much stronger hold than historically. Obviously, the potential arguments to that may be, NOT YET, but expect hyperinflation in spades when it comes, or maybe Japan with its debt load and rapidly dwindling population is an oddity. Time will tell.

The current sell-off in bond prices with yields rising might not look dramatic on the charts, but in terms of where we have come from since 1980, the potential for future substantial movement is clear.

HINDESIGHT DIVIDEND UK LETTER / NOV 16 12

Since August 2016, a holder of the 30-year UK gilt of has lost 16%.

Source: Bloomberg

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The Global Bond Index Market value lost $1tr on election week.

History tells us that the reflation/inflation scenario, especially from increased fiscal spending, will be bad news for bondholders but great for stocks, as all the new government money flows into businesses. I’m sure that is still in Economics 101. Unfortunately, I am not certain that it is that straightforward at this juncture in valuations and time.

Over the summer we saw negative yields on bonds issued by non-state backed corporates for the first time in history. A financial insanity if ever there was one. It occurred because of the quantity of money in the system looking for an investment home, with Central Banks pinning overnight rates at zero and buying back bonds of all maturities. With the return streams available in fixed income investments potentially negative, investors have piled into equities, especially stocks offering reasonable dividends potential, believing them to be bond proxies. We view the current general valuations in most developed equities as the highest in history, and like bonds, offering very little in the way of returns but plenty in the way of huge potential capital losses.

Still, one of the best charts I have seen recently shows the valuations of the cross section of US stock market components by John Hussman. Most people are aware equity market valuations were extremely high in 2000 at the height of the world changing internet boom, perhaps the highest in history? In reality, the average was indeed high, dragged up by the super high valuations of tech, of two or three deciles of stocks. There were, in fact, many deciles of stocks that were trading at fair valuations or even cheap, such as the old industrials of the past. Today, every decile of stock appears to be trading at historically high valuations. This is not a good time to start investing on a reflation argument.

HINDESIGHT DIVIDEND UK LETTER / NOV 16 14

The excerpt above is from the weekly Hussman report, available at: www.hussmanfunds.com

It won’t be the first time that rising bond yields have triggered a stock market crash. The great stock market crash of 1987 may have come about as a result of interest rates rising above 10%. Stock prices are high today because businesses have been able to borrow money cheaply, often to buy back their own stock. Higher bond yields, making business financing more costly, is not good for stocks. How could it be and at this level of equity valuations, it might well be the straw that finally breaks the camel’s back. Its early days, but the ‘feel good’ factor of fiscal spending, unfortunately, comes with adding to the already burgeoning debt pile, which has been primarily financed by China’s excess dollar reserves over the last decade. With Trump threatening a trade war with China, I’m not certain how well that is going to work out. Ladies and gentlemen, please fasten your seatbelts as we are entering a period of turbulence!

HINDESIGHT DIVIDEND UK LETTER / NOV 16 15

HINDESIGHT DIVIDEND UK LETTER / NOV 16 16

HINDESIGHT DIVIDEND PORTFOLIO UPDATE

The excerpt below is from our May newsletter, detailing the methodology we use for tracking the performance of the HindeSight letter. We have updated the results until the end of October 2016. The bar chart showing the % portfolio allocation shows that we are running roughly 50% cash balance of the introduced money at this juncture, reflecting our concerns about high valuations.

 Winners to Losers ratio: 28:23  Average total returns (including dividends) and total relative returns of closed portfolio: 8.49%/12.75%  Average total returns (including dividends) and total relative returns of open portfolio: 0.11%/(7.77%)  Current NAV of HindeSight portfolio versus current NAV of ETF portfolio: 115.8/106.3  Worst drawdown: HSL (9.5%), ETF (13.0%), from May 2015 to October 2015.

HINDESIGHT DIVIDEND UK LETTER / NOV 16 17

The HindeSight Dividend Letter and its portfolio have been live since September 2014. Since then until April 2016, we have recommended 44 stocks, out of which 25 have been sold from the portfolio. Some have hit profit targets, others have hit stop losses (each recommended stock has a 25% maximum loss risk – the stop loss and is exited if that is breached). The peak stock portfolio was 27 stocks in Aug 2015 and we currently (end of April 2016) hold just 17. As with any stock advisory newsletter, it is important to demonstrate a system to the readers and monitor both its progress and its recommendations. The whole point is to help readers to invest their hard-earned monies wisely and hence profitably. Most readers will not follow our advice completely as regards to stock selections or timing, as investing depends on everyone’s personal circumstances and opinions, but a methodology for recording your track record is key to continued success.

There are many ways to measure an investment track record. Most stock advisory services focus on the winners to losers’ ratio and the average percentage gains per recommendation. At the back of each newsletter, we show the total return of each open and closed recommendation accordingly. Our record on these metrics is as follows: winners to losers’ ratio 25:17; average total return gain 3.12%; average total return gain compared to Index 7.96%.

However, we feel that the best way for anyone to look at an investment track record is to record the monthly returns exactly in the same way you would an investment fund with the % change in Net Asset (or Liquidation) value being between the start of the month and the end of the month. An investment fund that offers monthly dealing will see new monies enter the fund (as new capital is introduced) or monies redeemed on any month end that will have to be accounted for.

From the inception of our HindeSight dividend portfolio, we have recommended introducing new money into ‘your own fund’ over a period of several months in order to build up to a total portfolio size of 25-30 stocks, which would be the maximum size, and then rotating the stock selection. Sometimes, like at present, the portfolio would have less equity exposure and higher cash allocations. The reasons for this will depend on the stock level targets or stops being reached, as well as the intra-year seasonality. We will always tend to hold more cash and have more defensive stocks in the summer months and vice versa in the winter, according to normal equity investing patterns.

The table below shows the details of the investment process. We have assumed that each stock allocation will be £1000, but obviously any amount can be used. New monies were introduced to the fund each month until October 2015 and these were fully invested into the recommended stocks. The monthly return is then calculated as the difference between the month’s net asset values. The total amount of money introduced into the fund and invested was £29,000. Clearly, the account balance of £31,148 at the end of April 2016 would suggest that the total % profit is 7.4%, which is different from the 14.2% that we have as the NAV. It is not the easiest concept for people to get their heads around, but one way to look at it is to only think of the invested capital in the fund. Any money that has not been invested into the fund, either as cash or equity holdings, is outside of the fund and potentially earns a return independently. For many months, until Sept 2015, most of the total introduced capital of £29,000 was outside of the fund and hopefully earned elsewhere. You can only record a return on total capital that is available to actually invest in the fund.

In order to compare the change in NAV of the HSD fund over the last 18 months with relevant benchmarks, we recognise that any comparison is fraught with debatable issues.

Sadly, cash on deposit or in the best interest bearing account will earn a negligible amount these days, and so we have an easy benchmark of £29,000 cash saved over the last 18 months. The value of the account today is also £29,000. A more relevant benchmark, especially in these days of much touted passive investing, is to assume that each time that you invested in one of the recommended stocks you had the choice to buy a generic UK equity Exchange traded fund instead for your equity exposure, and each time you sold a fund stock you sold the equivalent ETF pair amount. So, instead of choosing a cheap value stock that was chosen by a tried and tested model, you chose to take the equivalent equity exposure in a wide group of 100 stocks of the FTSE100. There is nothing wrong with this approach and there are multiple papers written about how passive investing beats most active investing and there is some truth in that, but it is once again hugely debatable.

Yes, it is true the average fund manager over the last 15 years has probably underperformed the index by some margin. This is partially as a result of the high fees, which have declined in recent years, but you often find fund managers who are naturally more defensive and others that are more aggressive. Neil Woodford, one of the best- known equity managers, appears to significantly outperform indices over the long term, usually as a result of being defensive before a crisis. Unfortunately, he tends to lag his more aggressive peers on equity recovery rallies, such as those seen since the 2009 lows. Most managers who focus especially on smaller companies have done extremely well over the last 5 years, as the FTSE 250 has outperformed the FTSE100 considerably. Unfortunately, it seems difficult for many fund managers to outperform a bear market decline and outperform a bull market rally over the cycle.

Personally, I would like to make the best risk adjusted return and avoid catastrophic losses. There is not much joy in announcing that you have lost ‘only’ 20% when the index is down by 30% and you cannot expect many congratulations.

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The HDVS targets an outperformance to the FTSE100 index of 10% per annum in NAV change. If the FTSE100 is up 10% we would hope to make 20%, and if the FTSE100 is down 10% we would like to be flat but we are very focussed on the downside protection when stocks are very overvalued, as they are currently. We would also like to see lower quarterly volatility within that target than the index, especially in down drafts in the index price, as we witnessed last August, as well as this January and February. One of the first observations that many investors make after a bear market decline is how much more in % terms they have to make on the way back up in order to break even. When people saw 40% portfolio declines in the 2008 crisis, they had to make 66% gains so as to get back to pre-crisis levels. Avoiding these large drawdowns is the best way to take advantage of the next upswing and it is crucial to staying in the game.

We have in effect 3 different investment strategies, as both the table and charts show, maybe made by three brothers. Brother 1 believes that cash is king and saves it to get £29,000 and hold it safe in his pot. Brother 3 decides to invest according to the HDVS.

Since September 2014, the NAV increase in return terms for the cash investor is close to zero. The ETF investor is - 3.8%, while the HDVS investor is up 14.2%. The index itself has dropped by -5.76% over this period.

These numbers are totally in line with the strategy. The outperformance is marginally better than the 10% index outperformance per annum, while the volatility on drawdowns has been less.

This is the portfolio that we will be tracking in the monthly issues of HSL, but naturally many of our new or existing subscribers will wonder how they can start now, if they didn’t start at the beginning. The answer is simply to assume that the new month’s selections are the start of your portfolio and you then you can build from there, exactly as we have done since our inception. The concept is the same – drip feed into a stock portfolio and then build this up to a desired size, before rotating it accordingly. Most research suggests that part of poor equity investing comes from having either too few or too many stocks, and somewhere between 20-35 is optimal. The HDVS will tend to average around 25 stocks over the course of a year.

To round up our current performance from inception to April 2016, these are the important numbers for us:

 Winners to Losers’ ratio: 25:17  Average total returns (incl dividends) and total relative returns of closed portfolio: 4.66%/10.40%  Average total returns (incl dividends) and total relative returns of open portfolio: 1.34%/4.36%  Current NAV of HindeSight portfolio versus current NAV of ETF portfolio: 114.2/96.7  Drawdown history of both the HSD and ETF portfolio (drawdown relates to the declines in value of the NAVs, from prior peaks to the troughs, i.e. what you thought you had in the bank compared to what it went down to, before springing back up again in value).  Worst drawdown: HSL -9.41%, ETF -13.21%, from May 15 to Sep 15.

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PORTFOLIO UPDATE - WHAT HAPPENED? MARKET & SECTOR ANALYSIS

UK Market Valuations

UK INDICES PRICE/EARNINGS PRICE/BOOK DIVIDEND RATIO RATIO YIELD (%)

FTSE 100 INDEX 52.41 1.83 4.04% FTSE 250 INDEX 21.33 2.11 3.09%

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HINDESIGHT DIVIDEND UK LETTER / NOV 16 21

HINDESIGHT DIVIDEND UK PORTFOLIO # 1 (NOVEMBER 2016)

Portfolio Update and Construction

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PORTFOLIO UPDATE

Dunelm Group PLC Dunelm PLC had an ex-dividend date on 3rd of November 2016 for 19.10p.

William Hill PLC William Hill PLC had an ex-dividend date on 20th of October 2016 for 4.10p.

Capita PLC PLC had an ex-dividend date on 20th of October 2016 for 11.10p.

Prudential PLC Due to its good performance, we decided to sell our holding in Prudential, as it was up over 29% (in relative terms) and 17% (in absolute terms) respectively.

HINDESIGHT DIVIDEND UK LETTER / NOV 16 23

APPENDIX I

THE WAY WE THINK

We passionately believe that dividends really, really matter.

William Thorndike in his fascinating book ‘The Outsiders - Eight Unconventional CEOs and Their Radically Rational Blueprint for Success’ examined one of the most important aspects of running a business a CEO must undertake: Capital Allocation. He summarised how a CEO deploys capital in order to best utilise cash flow generated from his or her business operations. Essentially, CEOs have 5 ways of deploying capital:

 Investing in existing operations  Acquiring other businesses  Repaying debt  Repurchasing their own stock (buybacks)  Paying dividends

Dividend payments are a crucial operation in creating stakeholder wealth. It is this aspect of a business that we are so fixated by – the propensity for a company to produce and continue to grow dividends so that we may accrue wealth over a generation. But as readers will know we can’t just grab stocks with the highest yield for fear that this signals some cash flow or even solvency issues for the firm. So it is with this very real threat in mind we explore only well- capitalised FTSE 350 companies.

This letter’s purpose is to help inform readers on dividend investing so that they can construct a portfolio of sound UK dividend stocks based on our recommendations.

Our prerequisite is that any stocks selected for this letter must be liquid, well-capitalised with a strong free cash flow and a progressive dividend policy.

Our System

 Every month we will provide a write up of 3 to 4 stocks until we create a portfolio of 25 UK dividend stocks. This will be the HindeSight UK Dividend Portfolio #1  You will be alerted by subscriber email intra-month when these stocks become a buy. Timing is critical to the strategy, not only buying quality stocks but buying them at the right time  The entry points will then be recorded in the next monthly in the HindeSight UK Dividend Portfolio section and the stock(s) written up in full  We will run our winners but tend to rotate every 6 months depending on specific criteria which would elevate cheaper companies into the portfolio relative to stocks that had performed  The basis for stock and portfolio selection is derived from our quantitative systematic methodology which screens these companies using the Hinde Dividend Value Matrix®, (HDVM®), a proprietary stock-rating system  In the section on ETPs we will highlight our investment philosophy and the investment process behind our stock selections. This is the basis of our dynamic risk and money management in our portfolio construction for you. You can also read the stand-alone Hinde Dividend Value Strategy document to see the methodology behind our stock selection

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APPENDIX II

HOW WE THINK

“We have met the enemy, and he is us.” Walt Kelly

Our key to long-term performance investing is premised on the following:

 Systematic rule-based strategy  Systematic risk and money management  Occam’s razor, aka ‘K.I.S.S.’, Keep It Simple Stupid  Consistency  Discipline

All our investment ideas are rule-based methodologies driven by systematic and quantitative models.

Hinde Dividend Value Strategy Hinde Dividend Value Strategy seeks to generate a total return from an actively managed basket of UK dividend- paying stocks. The strategy selects 20 highly liquid, mid-to-large capitalised stocks on an equally-weighted basis, which offer the highest total return potential. The 50% Hedge version of the strategy would then be subject to a strategic Beta Hedge*, which is designed to cover 50% of the value of the UK stock basket at all times.

The 50% hedge is maintained using UK equity benchmark indices to reduce exposure to overall market volatility, but without reducing overall total returns to the market over the long run. The Hinde Dividend Value Strategy (100% Hedge) would deploy a full beta hedge at all times.

Hinde Dividend Value Matrix® The strategy employs a quantitative, systematic methodology, whereby FTSE 100 and FTSE 250 constituent stocks are screened using the Hinde Dividend Value Matrix®, a proprietary stock-rating system. We use the same system to select stocks for any of our strategies, long-only, 50% Hedge or 100% Hedge. The only difference is clearly the extent of the hedge on the exposure to the overall market.

The basic premise of the strategy is to accelerate returns by selecting relatively high yielding stocks which offer the highest potential for capital revaluation. The dynamic rotation of stocks each quarter enables us to sell stocks where the capital revaluation and dividend has been captured, and use this additional capital to invest in more undervalued quality companies. If successful, this cycle of capture and re-investment offers the chance to significantly improve the total return generated by the Dynamic Portfolio.

The basis of the stock selection process is the Hinde Dividend Value Matrix®, which is a derived process that looks at 3 crucial variables:

* Beta is the stock’s sensitivity to market movements, e.g. if a share has a beta of 1.5 its price tends to move by 1.5% for each 1% move in the index

1. Dividend Screen The top ranking stocks will be those offering a relatively high dividend. A composite of the following criteria comprises the Dividend Rank:

 Relative Dividend Yield  Dividend Capture  Payout ratios

The Relative Dividend Yield assesses if a company pays a higher dividend than the Index it derives from (the FTSE 100 or FTSE 250). The Dividend Capture criteria explain how quickly and how much of the dividend is paid at any point in time. The Payout Ratio gives a snapshot of whether a company will be able to maintain and grow its dividend. It helps us to assess how much of a company’s revenue, profit or cashflow is paid out in dividends.

The lower the amount of dividends paid out as a percentage of profits, the healthier future dividend potential will be. History is for once a good guide as to whether companies will continue to pay and grow their dividends. A stock with an excessively high yield relative to its sector or the overall market is invariably showing signs of heightened risk to its dividend sustainability and often the viability of the company itself. The screen incorporates a limit on yield dispersions from the overall market.

The strategy is emphatically not a yield chaser. It is the Performance and Value screens that are used to assess the total return potential of a stock by analysis of how undervalued it is relative to its fundamentals, sector and overall market index.

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2. Performance Screen The top ranking stocks have the poorest relative performance to their index over multiple time horizons.

A composite rank of the following criteria provides the Performance Rank:

 Stock relative performance ranked over multiple time periods  Average of time periods taken to select rank of stocks

3. Value Screen The top ranking stocks by key fundamental criteria show stable fundamentals and exhibit upside momentum growth potential. The following are some of the criteria that provide the Value Rank:

 Value - Price to Book (intangible book adjustment), Free Cash Flow metrics  Quality - Return on Investment and Earnings metrics  Financial Stability - Debt levels, Coverage and Payout ratios  Volatility - Stock variance, Dividend variance  Momentum - Sales Growth, Cashflow metrics  Liquidity - Minimum market capitalisation relative to index, Shares outstanding

Implementing the Hinde Dividend Value Matrix® The FTSE 100 and FTSE 250 stocks are ranked using the Dividend, Performance and Value screens. An equally- weighted composite rank is then taken of these 3 ranks, which provides a final ranking from which a selection of 20 stocks is made for the portfolio.

The stocks with the highest ranking are compiled for the FTSE 100 and the FTSE 250. The top 10 from each index are then taken, subject to diversification rules, which entail that normally only 1 stock per sector per index can be invested in. For example, if the top 10 stocks are all mining companies, the selection process would take the first of these and then move on to select the next top stock from another sector. As long as a stock has the highest score in its sector, the fact that it has appeared in the final ranking means it is already eligible for investment. In exceptional circumstances, it may be that more than one stock has to be selected from an individual sector.

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External Analyst Score (EAS) This score is derived from 3 inputs that have been obtained from all the external analysts at leading institutions who are covering the stock:

1. The 12 month target price in relation to current price

2. The number of analysts covering the stock

3. The recommendation analysis, e.g. STRONG SELL, SELL, UNDERPERFORM or HOLD

This score is used to observe the other analysts’ view of the stock and is helpful when understanding the methodology that other analysts use to determine their 12-month target price. We ultimately get a blend of price targets that is based on different valuation metrics.

EAS Score Output: 1. The combined score will vary from 30-70

2. A stock with a lowest score of 30 shows the majority of analysts not only have a full sell/underweight recommendation, but also a low 12-month target price in relation to current price.

3. A stock with the highest score of 70 shows the majority of analysts not only have a full buy/overweight recommendation, but also a high 12-month target price in relation to current price.

Note:

- On a standalone basis, the EAS score must be viewed in the following context:

 Equity analysts issue far more positive recommendations than negative  If all analysts are overwhelmingly bearish or bullish, then this can signal a contrarian position be held, but this is determinate on the where the stock is valued.

- However, in conjunction with the HDVM®, we have found the score to be useful when it is high or momentum is turning higher, as this suggests that the stock offers deep value.

Disclaimer This newsletter is intended to give general advice only on the importance of dividends within the equity space. The investments mentioned are not necessarily suitable for any individual, and you should use this information in conjunction with other advice and research to determine its suitability for your own circumstances and risk preferences. The value of all securities and investments, and the income from them, can fall as well as rise. Your investments may be subject to sudden and large falls in value and you may get back nothing at all. You should not buy any of the securities or other investments mentioned with money you cannot afford to lose. In some cases there may be significant charges which may reduce the value of your investment. You run an extra risk of losing money when you buy shares in certain securities where there is a big difference between the buying price and the selling price. If you have to sell them immediately, you may get back much less than you paid for them. The price may change quickly, particularly if the securities have an element of gearing. In the case of investment trusts and certain other funds, they may use or propose to use the borrowing of money to increase holdings of investments or invest in other securities with a similar strategy and as a result movements in the price of the securities may be more volatile than the movements in the price of underlying investments. Some investments may involve a high degree of ‘gearing’ or ‘leverage’. This means that a small movement in the price of the underlying asset may have a disproportionately dramatic effect on your investment. A relatively small adverse movement in the price of the underlying asset can result in the loss of the whole of your original investment. Changes in rates of exchange may have an adverse effect on the value or price of the investment in sterling terms, and you should be aware they may be additional dealing, transaction and custody charges for certain instruments traded in a currency other than sterling. Some investments may not be quoted on a recognised investment exchange and as a result you may find them to be ‘illiquid’. You may not be able to trade your illiquid investments, and in certain circumstances it may be difficult or impossible to sell or realise the investment. Investment in any of the assets mentioned may have tax consequences and on these you should consult your tax adviser. The opinions of the authors and/or interviewees of/in each article are their own, and are not necessarily those of the publisher. We have taken all reasonable care to ensure that all statements of fact and opinion contained in this publication are fair and accurate in all material respects. All data is from sources we consider reliable but its accuracy cannot be guaranteed. Investors should seek appropriate professional advice if any points are unclear. Ben Davies and Mark Mahaffey the editors of this newsletter, are responsible for the research ideas contained within. They or any of the contributors or other associates of the publisher may have a beneficial interest in any of the investments mentioned in this newsletter.

Disclosures of holdings: None relevant to any content discussed within this issue of the newsletter

HINDESIGHT DIVIDEND UK LETTER / NOV 16 27