MORPHIC ETHICAL EQUITIES FUND LIMITED — Fund Information / Factsheet 2017

Aug 9, 2017

Focussed | Vigilant | Agile

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Ethical Investing in Focus

Fund Objective

During July Morphic Asset Management, as manager of the Morphic Ethical Equities Fund (ASX: MEC) became a signatory to the United Nations Principles for Responsible Investing (UN PRI), joining over 1,700 signatories with $68tn of Assets Under Management.

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 PRI are six principles that Asset Managers agree to abide by, centred on incorporating Environmental, Social and Governance (ESG) issues into decision making and promoting better ESG with the companies we own shares in. The MEC is now a signatory of both PRI and Responsible Investment Authority of Australia.

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.

Performance Report

The Fund fell 1.2% in July, as the strong rise in the Australian Dollar offset the 2.7% rise in global markets in US Dollar terms. The Fund outperformed global markets over the month. Since inception (May 2017) the Fund is down 2%.

Market Recap

The enthusiasm for all things risky in 2017 continued, with yet another strong month for global markets. The love of risk extended to the Australian Dollar. It’s all very different from a year ago where investors fretted about recession risk.

Emerging Markets continue to be the favourite destination for capital and rose 5.5% for the month, led by Brazil (10.8%) and China (8.3%). The USA (1.9%) and Japan (2%) were the laggards. The love of technology shows no sign of abating. Software was up 5.4% for the month and 27% YTD. Lagging over the month were defensive sectors such as Health Care (0%) and Consumer Staples (0.6%).

After last month’s sell off in bonds, buyers returned to drive yields down. This led to broad based falls in the US Dollar. A more dovish outlook from the US Federal Reserve was cited, yet our read was nothing changed: The Federal Reserve remains on track to reverse its Quantitative Easing program of 2008-14 and kept the option open for another rate hike in December.

Portfolio Review

The Fund outperformed global markets over July. Hedges added value over the month. Stocks were a positive contributor; outright shorts detracted value. The MEC’s mandated zero exposure to negatively screen stocks was a headwind over the month.

The largest contributor was our long-short pair in European Freight companies, DSV (long) and Panalpina (short). Panalpina reported a disappointing set of results towards the end of the month, which saw the stock fall heavily. Analysts’ earnings expectations still seem too optimistic due to their misplaced focus on the potential for rising freight volumes from improving global growth while ignoring what we believe will be continuous margin pressure in the industry.

Performance

	Name	Fund1	Index2
	1 Month	-1.22%	-1.24%
	Since Inception (p.a.)	-2.03%	-1.13%
		Key Facts
	ASX code / share price		MEC / 1.125
	ASX code / option price		MECO / 0.032
	Listing Date Management Fee Performance Fee3		03 May 2017 1.25% 15%
	Market Capitalisation		$51m
	Shares Outstanding		45,315,627
	Options Outstanding		43,565,626
	Options Exercise price		$ 1.10
	Options Expire		30 November 2018

Net Tangible Assets (NTA)

Net tangible asset value before tax[4] $ 1.0405 Net tangible asset value after tax[4] $ 1.0567

Top 10 Holdings

Long Stocks(Shorts)	Theme	Region	Weighting
Power Grid	Indian Infrastructure	Central Asia	3.8%
Alstom	Global Rail	Europe	3.1%
SES	Global Satellite	Europe	2.7%
Wells Fargo	US Quality Banks	North America	(2.6%)
Service Corp	US Deathcare	North America	2.5%
Samsung Electronics	Global Tech	Asia Pacific	2.3%
Rural Electrification	Indian Infrastructure	Central Asia	2.3%
DSV	Global Freighters	Europe	2.1%
Panalpina	Global Freighters	Europe	(2.1%)
Bank of Internet	US Quality Banks	North America	1.8%

VISIT US: www.morphicasset.com CALL US: +61 2 9194 6707 EMAIL US: enquiries@morphicasset.com

Focussed | Vigilant | Agile

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Analyst estimates imply Panalpina will have its best two quarters in the last seven years. We remain sceptical and short.

Hedge Positions

Key	Facts3 Name Short Yen vs. Euro	Risk Limit Utilisation (%)* 0.4%
	Short Global Bonds	0.3%
	Long French Bonds vs. Germany	0.3%
	Long AUD	0.3%

The second best contributor came from Bank of Internet. Investors are divided between optimists and sceptics on the bank’s business model. The quarterly results showed earnings remain on track, and gave the clearest statement yet that rumours of regulatory issues are baseless, giving the sceptics pause for thought. After a 20% rally last month, we have taken profits on part of the investment.

• As a percentage of the Fund’s Value at Risk (VaR) Limit

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Risk Measures
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Remaining on the theme of divisive stocks, our largest detractor for the month came from our long Magellan, short Platinum Asset Management pair. Despite Platinum reporting very large outflows in May of $500m and a larger than expected (forced) outflow of over $1bn in June, the stock has rallied over 30%. The stock is now trading on over 20x earnings, up from 15x, pricing Platinum as a growth stock, and indeed one of the most expensive listed Fund management businesses in the world.

Net Exposure5	101%
Gross Exposure6	144%
VAR7	1.02%

T Top 5 Contributors[8] (bps) Top 5 Detractors[8] (bps)

Panalpina	37	Platinum Asset Mgmt.	-26
Power Grid	29	D.G. Khan Cement	-25
Bank of Internet Macromill Wells Fargo	23 17 15	HCA Bank of the Ozarks People’s Insurance	-20 -15 -9

A common explanation for this is improved performance in the main International Fund, and the belief that with this, flows will go from negative to positive. Our issue with this thesis is that the correlation between flows and performance is tenuous. Flows are driven by a number of factors, of which performance is just one. We remain in the position but have reduced our short position sizing based on our risk rules, and await the earnings results.

By Region

Fund Equity Exposure Summary

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44.0%
North America
Asia Pacific 24.4%
Western Europe 18.1%
Central Asia 10.8% Morphic Ethical Equities
Fund
Africa / Middle East 1.1%
Benchmark
South & Central America 1.0%
Eastern Europe 0.7%
0.0% 20.0% 40.0% 60.0%
By Sector
Consumer Discretionary 18.3%
Financials 18.1%
Information Technology 17.1%
Industrials 10.9%
Health Care 10.4%
Consumer Staples 6.4% Morphic Ethical Equities
Materials 5.8% Fund
Utilities 5.7%
Benchmark
Real Estate 4.9%
Telecommunication Services 2.5%
Energy 0.0%
0.0% 10.0% 20.0% 30.0%
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Outlook

Our confidence last month that a surging Australian Dollar had reached its limits again proved premature. Fool me once, shame on you, fool me twice, shame on me. Interest rate differentials can’t account for the move, so we are left with speculative positioning as the most plausible explanation. Though a bit chastised, we still think that the second half will be tougher for Australian Dollar bulls and US Dollar bears, but with lower conviction!

Our main hedges are focused on hedging Japanese Yen risk against the Euro along with hedging out some risks associated with rising interest rates globally.

The Fund remains fully invested, although optimistically cautious, rather than cautiously optimistic best describes our stance. Our emerging market overweight remains but has been reduced reflective of the less compelling value proposition caused by recent gains. This is funded through a US market underweight.

Jack Lowenstein, Chad Slater, Geoff Wood, James Tayler, Cameron Halkett, Claudia Kwan, Lucina Martin, Daniel Hayman, Irene Kardasis, Nadeem Ali

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.

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] Includes Equities and Commodities

• longs and shorts are netted;[6 ] Includes Equities, Commodities and 10 year equivalent Credit and Bonds - longs and shorts are not netted;[7 ] VAR is Value at Risk based upon the 95[th] percentile with a 1 day holding period using a 1 year look back;[8] Attribution; relative returns against the Index excluding the effect of hedges.

VISIT US: www.morphicasset.com CALL US: +61 2 9194 6707 EMAIL US: enquiries@morphicasset.com