MORPHIC ETHICAL EQUITIES FUND LIMITED — Fund Information / Factsheet 2017

Nov 7, 2017

==> picture [53 x 46] intentionally omitted <==

==> picture [109 x 41] intentionally omitted <==

Fund Objective

Monthly Report October 2017

The Morphic Ethical Equities Fund Limited (the Fund) seeks to provide investors a way to grow their wealth and feel confident they do so without investing in businesses that harm the environment, people, and society.

The Fund excludes direct investments in entities involved in environmental destruction, including coal and uranium mining, oil and gas, intensive animal farming and aquaculture, tobacco and alcohol, armaments, gambling and rainforest and old growth logging.

Investment returns

	1 Month	3 Months	ITD p.a.
Morphic Ethical Equities Fund1	5.51%	9.05%	7.00%
Index2	4.46%	8.75%	7.52%

Ethical Investing in Focus

Last month, the Fund initiated a position in China Everbright International (CEI). CEI is an attractively priced Hong Kong listed company which operates waste-to-energy plants in China. Like developed countries, China is trying to reduce its reliance on landfill. There is growing awareness that landfill causes environmentally damaging emissions and water pollution. CEI’s incineration plants are a better environmental solution by taking the waste for electricity generation. The company also operates biomass-to-energy and water treatment.

Chinese environmentally related stocks are starting to get renewed attention after the Communist Party Congress reemphasised the need for the country to focus on cleaning up pollution. CEI has also recently announced an increase in their dividend payout, a key validation of improving cash flows.

Portfolio review

The Fund consolidated on its September gains, outperforming the market by 1.05% with a return of 5.51%. Global markets were up 2% in USD terms and a falling AUD was a tailwind.

Long stock selection was again the primary driver of outperformance over the month. Market neutral pairs were a positive contributor and hedging decisions were a small detractor.

The largest contributor for the month was Japanese advertising business, Macromill. We have written before about this stock and as time post-IPO has passed, more analysts have picked up coverage. After surging by more than 30% in October, we have trimmed our position on two grounds: firstly, while the stock still has upside, it isn’t as cheap as it was; and secondly, private equity firm Bain, which sold in the IPO, is now out of lock-up on the stock, and with the price well above IPO levels, seems likely to monetise more of its investment.

The second largest contributor was Japanese construction firm, Hazama Ando, which is relatively large (US$1.5bn market cap) but has hardly any sell-side coverage. The stock trades at a PER of less than 8x. We see further gains if it just closes the valuation gap with its peer, Kumagai Gumi, which has broad broker coverage and trades on a still cheap PER of 9x.

One of the largest detractors came from French satellite operator SES Group. We often talk about our stop loss rules being a good circuit breaker for calls that aren’t working. So it proved here when we were stopped out during the month. Soon afterwards, the stock reported weak results and downgraded its outlook, with our rules having protected investors from worse losses.

==> picture [88 x 42] intentionally omitted <==

Outlook

We wrote about our Q4 outlook recently. Our view is ‘onwards and upwards until Christmas’. It has been a good year already, but it is worth noting that for the last 30 years, on average, two-thirds of equity returns occur between October 12[th] and December 31[st] .

Global trends in economic data are good and also broadly based rather than being just driven by China or the US. ‘Animal spirits’, as measured by consumer confidence, are at their highest in 17 years.

Perhaps the biggest thing to fear is the lack of fear itself. Often things go wrong when so little is priced in, but trying to predict an unknown event at an unknown point for an unknown outcome is tough. We prefer to adapt to new news quickly when it arrives.

Hedges remain minimal. Our aim is to give investors the highest level of upside participation in this old but still bull market. That said, the Fund has some cheap insurance for a December pick up in volatility. It also has some protection against the market pricing faster US interest rate hikes to reflect the good data.

Key Facts

ASX code / share price	MEC / 1.09
ASX code / option price	MECO / 0.016
Listing Date	3 May 2017
Management Fee	1.25%
Performance Fee3	15%
Market Capitalisation	$ 50m
Shares Outstanding	45,466,227
Options Outstanding	43,415,026
Options Exercise price	$ 1.10
Options Expire	30 November 2018

Net Tangible Assets (NTA)
Net tangible asset value before tax4	$ 1.1326
Net tangible asset value after tax4	$ 1.1236

Focussed | Vigilant | Agile

Top 10 Holdings

Top three contributors[5 ] (bps)

Stocks (Shorts)	Theme	Region	Position Weighting
Alstom	Global Rail	Europe	3.8%
Service Corp	US Deathcare	North America	3.0%
Samsung Electronics	Global Tech	Asia Pacific	3.0%
Ateam	Japanese E-Commerce	Asia Pacific	2.9%
Western Alliance	US Quality Banks	North America	2.6%
Open House	Japanese Homebuilders	Asia Pacific	2.4%
Iida Group	Japanese Homebuilders	Asia Pacific	(2.2%)
Wells Fargo	US Quality Banks	North America	(2.1%)
Macromill	Global Research	Asia Pacific	2.0%
Hazama Ando	Japanese Homebuilders	Asia Pacific	2.0%

==> picture [223 x 93] intentionally omitted <==

----- Start of picture text -----

Macromill 65 bps
Hazama Ando 23 bps
Open House 15 bps
----- End of picture text -----

Top three detractors[5 ] (bps)

==> picture [223 x 93] intentionally omitted <==

----- Start of picture text -----

SES -24 bps
Alstom -24 bps
Kusuri No Aoki -11 bps
----- End of picture text -----

Hedge Positions

Name	Risk Limit Utilisation (%)6
Short 10Y US Bonds	1.0%
Short Euro Long Yen	0.6%
US Curve Flattening	0.3%
Long Volatility (VIX)	0.1%

Equity Exposure Summary By region

	Risk Measures
Net Exposure7		103%
Gross Exposure8		157%
VAR9		1.06%

Equity Exposure Summary By sector

==> picture [474 x 167] intentionally omitted <==

----- Start of picture text -----

North America 44.1% Information Technology 21.4%
Financials 17.6%
Asia Pacific 30.9% Industrials 16.7%
17.6% Consumer Discretionary 12.7%
Western Europe
Health Care 9.1%
Central Asia 4.9% Morphic Ethical Real Estate 6.4% Morphic Ethical
Equities Fund Equities Fund
Consumer Staples 4.7%
South & Central America 1.0%
Benchmark Materials 4.6% Benchmark
Africa / Middle East 0.9% Utilities 3.8%
Telecommunication Services 2.6%
0.7%
Eastern Europe 0.3%
Energy
0.0% 20.0% 40.0% 60.0% 0.0% 10.0% 20.0% 30.0%
----- End of picture text -----

This communication has been prepared by Morphic Ethical Equities Fund Limited (“MEC”) (ACN 617 345 123) and its Manager, Morphic Asset Management Pty Ltd (“Morphic”) (ACN 155 937 901) (AFSL 419916). The information contained in this communication is for information purposes only and is not investment or financial product advice and is not intended to be used as the basis for making an investment decision. Please note that, in providing this communication, MEC and Morphic have not considered the objectives, financial position or needs of any particular recipient. MEC and Morphic strongly suggest that investors consult a financial advisor prior to making an investment decision. No warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information, opinions and conclusions contained in this communication. To the maximum extent permitted by law, none of MEC, its related bodies corporate, shareholders or respective directors, officers, employees, agents or advisors, nor any other person accepts any liability, including, without limitation, any liability arising out of fault or negligence for any loss arising from the use of information contained in this communication. If this communication includes “forward looking statements”, such forward-looking statements are not guarantees of future performance and involve known and unknown risks, uncertainties and other factors, many of which are beyond the control of MEC and its officers, employees, agents or associates that may cause actual results to differ materially from those expressed or implied in such statement. Actual results, performance or achievements may vary materially from any projections and forward-looking statements and the assumptions on which those statements are based. MEC and Morphic assume no obligation to update such information. This communication is not, and does not constitute, an offer to sell or the solicitation, invitation or recommendation to purchase any securities and neither this communication nor anything contained in it forms the basis of any contract or commitment.

The Certification Symbol signifies that a product or service offers an investment style that takes into account environmental, social, governance or ethical considerations. The Symbol also signifies that Morphic Ethical Equities Fund adheres to the strict disclosure practices required under the Responsible Investment Certification Program for the category of Product Provider. The Certification Symbol is a Registered Trade Mark of the Responsible Investment Association Australasia (RIAA). Detailed information about RIAA, the Symbol and Morphic Ethical Equities Fund’s methodology, performance and stock holdings can be found at www.responsibleinvestment.org, together with details about other responsible investment products certified by RIAA. The Responsible Investment Certification Program does not constitute financial product advice. Neither the Certification Symbol nor RIAA recommends to any person that any financial product is a suitable investment or that returns are guaranteed. Appropriate professional advice should be sought prior to making an investment decision. RIAA does not hold an Australian Financial Services Licence.

1 Performance is net of investment management fees, before company admin costs and taxes; 2 The Index is the MSCI All Countries World Daily Total Return Net Index (Bloomberg code NDUEACWF) in AUD; 3 The Performance Fee is payable annually in respect of the Fund’s out-performance of the Index. Performance Fees are only payable when the Fund achieves positive absolute performance and is subject to a high water mark;[4] The figures are unaudited;[5] Attribution; relative returns against the Index excluding the effect of hedges;[6] As a percentage of the Fund’s Value at Risk (VaR) Limit;[7] Includes Equities and Commodities - longs and shorts are netted;[8] Includes Equities, Commodities and 10 year equivalent Credit and Bonds - longs and shorts are not netted;[9] VAR is Value at Risk based upon the 95[th] percentile with a 1 day holding period using a 1 year look back.

==> picture [88 x 42] intentionally omitted <==

Focussed | Vigilant | Agile