The mood and tone of financial markets was very different in the second quarter of 2018 to the first. A challenging first three months of the year for equity and bond markets gave way to a much stronger quarter for risk assets.

Both US and UK equities recorded near double-digit gains in sterling terms, buoyed by strong corporate earnings, higher commodity prices and improving economic data.

It was the strong US economy which provided the impetus for the US Federal Reserve to raise interest rates in June, and signal two more hikes in 2018. Closer to home, the European Central Bank (ECB) announced that interest rates will not be going up until at least the summer of next year, but that its QE programme would end in December.

Another key driver of markets was the strong dollar and consequent sell-off in emerging markets. The impact was significant, and the divergence in returns between the two was large (12%). Emerging market bond markets were also hit, and at the index level, real yields have risen to 4% which are considerably higher than in developed markets.

It was a quieter month for developed market fixed income markets. Gilt yields were flat although corporate spreads widened, leading to small losses for UK credit.

Portfolio Review The Flying Colours: Core Defensive portfolio returned 2.00% in the second quarter of 2018. This was ahead of the ARC Cautious PCI category average return of 1.10%.

Top Contributors: Vanguard US Equity Index - US equities returned 10.3% in the quarter buoyed by a combination of a strong US Dollar, excellent corporate earnings and a continued run of good economic data.

Fidelity Index UK Equity - UK equities recovered well after disappointing first-quarter returns. A weaker sterling boosted earnings for Britain's multinationals, which derive much of their profits overseas. A rebound in commodity prices also helped the UK's oil and mining firms.

Fidelity Index Japan Equity - In local currency terms, the Japanese market rose just 1.1% but returns for UK investors were boosted a further 4% by the strengthening Yen.

Top Detractors: Fidelity Index Emerging Markets - Trade concerns and a strong US Dollar weighed on sentiment towards emerging market equities and this drag was particularly prevalent for Chinese stocks.

Vanguard US Government Index - US Treasuries yields rose in the quarter in reaction to the US Federal Reserve's interest rate hike in June. This led to a small loss for the fund. Vanguard UK Investment Grade Bond Index - UK credit spreads widened in the quarter leading to underperformance of UK corporate bonds relative to UK gilts.

The Flying Colours: Dynamic Defensive portfolio returned 1.21% in the second quarter of 2018. This was marginally ahead of the ARC Cautious PCI category average return of 1.10%.

Top Contributors: Threadneedle UK Equity Income - Excellent returns from the fund's consumer defensive and consumer cyclical names helped the fund outperform the FTSE All Share by 2.6% in the quarter. As a result, the fund placed in the 3rd percentile in its Morningstar category

Majedie UK Equity - The fund's overweights to the supermarket, and oil & gas sectors boosted relative returns. The outperformance of the FTSE All Share was 1.6%.

Dodge & Cox US Stock - The fund benefitted from the overall strength of the US equity market, while its energy and healthcare holdings helped relative returns.

Top Detractors: Legg Mason Western Asset Macro Opportunities Bond - It was a challenging quarter for the fund following outsized losses from its emerging market fx positions, and long duration stance as yields rose over the quarter.

Fidelity Index Emerging Markets - Trade concerns and a strong US Dollar weighed on sentiment towards emerging market equities, and this drag was particularly prevalent for Chinese stocks.

Legg Mason Brandywine Global Fixed Interest - The fund's Mexican and Brazilian debt and foreign exchange holdings dragged on returns. Less exposure than the benchmark to the US Dollar and Japanese Yen also detracted. ------ The Flying Colours: Core Conservative portfolio returned 3.41% in the second quarter of 2018. This was ahead of the ARC Balanced Asset PCI category average return of 2.10%.

Top Contributors: Vanguard US Equity Index - US equities returned 10.3% in the quarter buoyed by a combination of a strong US Dollar, excellent corporate earnings and a continued run of good economic data.

UK Equity Trackers - UK equities recovered well after disappointing first-quarter returns. A weaker sterling boosted earnings for Britain's multinationals, which derive much of their profits overseas. A rebound in commodity prices also helped the UK's oil and mining firms. Fidelity Index Japan Equity - In local currency terms, the Japanese market rose just 1.1%, but returns for UK investors were boosted a further 4% by the strengthening Yen.

Top Detractors: Fidelity Index Emerging Markets - Trade concerns and a strong US Dollar weighed on sentiment towards emerging market equities, and this drag was particularly prevalent for Chinese stocks.

Vanguard US Government Index - US Treasuries yields rose in the quarter in reaction to the US Federal Reserve's interest rate hike in June. This led to a small loss for the fund.

Vanguard UK Investment Grade Bond Index - UK credit spreads widened in the quarter leading to underperformance of UK corporate bonds relative to UK gilts.

The Flying Colours: Dynamic Conservative portfolio returned 2.94% in the second quarter of 2018. This was ahead of the ARC Balanced Asset PCI category average return of 2.10%.

Top Contributors: Threadneedle UK Equity Income - Excellent returns from the fund's consumer defensive and consumer cyclical names helped the fund outperform the FTSE All Share by 2.6% in the quarter. As a result, the fund placed in the 3rd percentile in its Morningstar category.

Majedie UK Equity - The fund's overweights to the supermarket and oil & gas sectors boosted relative returns. The outperformance of the FTSE All Share was 1.6%.

Vanguard US Equity Index - US equities returned 10.3% in the quarter buoyed by a combination of a strong US Dollar, excellent corporate earnings and a continued run of good economic data.

Top Detractors: Legg Mason Western Asset Macro Opportunities Bond - It was a challenging quarter for the fund following outsized losses from its emerging market fx positions, and long duration stance as yields rose over the quarter.

Fidelity Index Emerging Markets - Trade concerns and a strong US Dollar weighed on sentiment towards emerging market equities, and this drag was particularly prevalent for Chinese stocks.

Legg Mason Brandywine Global Fixed Interest - The fund's Mexican and Brazilian debt and foreign exchange holdings dragged on returns. Less exposure than the benchmark to the US Dollar and Japanese Yen also detracted.

The Flying Colours: Core Balanced portfolio returned 4.22% in the second quarter of 2018. This was ahead of the ARC Steady Growth PCI category average return of 3.41%.

Top Contributors: Vanguard US Equity Index - US equities returned 10.3% in the quarter buoyed by a combination of a strong US Dollar, excellent corporate earnings and a continued run of good economic data.

UK Equity Trackers - UK equities recovered well after disappointing first-quarter returns. A weaker sterling boosted earnings for Britain's multinationals, which derive much of their profits overseas. A rebound in commodity prices also helped the UK's oil and mining firms.

Fidelity Index Japan Equity - In local currency terms, the Japanese market rose just 1.1% but returns for UK investors were boosted a further 4% by the strengthening Yen.

Top Detractors: Fidelity Index Emerging Markets - Trade concerns and a strong US Dollar weighed on sentiment towards emerging market equities and this drag was particularly prevalent for Chinese stocks.

Vanguard US Government Index - US Treasuries yields rose in the quarter in reaction to the US Federal Reserve's interest rate hike in June. This led to a small loss for the fund.

Vanguard UK Investment Grade Bond Index - UK credit spreads widened in the quarter leading to underperformance of UK corporate bonds relative to UK gilts.

The Flying Colours: Dynamic Balanced portfolio returned 4.00% in the second quarter of 2018. This was ahead of the ARC Steady Growth PCI category average return of 3.41%.

Top Contributors: Threadneedle UK Equity Income - Excellent returns from the fund's consumer defensive and consumer cyclical names helped the fund outperform the FTSE All Share by 2.6% in the quarter. As a result, the fund placed in the 3rd percentile in its Morningstar category.

Majedie UK Equity - The fund's overweights to the supermarket and oil & gas sectors boosted relative returns. Outperformance of the FTSE All Share was 1.6%.

Vanguard US Equity Index - US equities returned 10.3% in the quarter buoyed by a combination of a strong US Dollar, excellent corporate earnings and a continued run of good economic data.

Top Detractors: Legg Mason Western Asset Macro Opportunities Bond - It was a difficult quarter for the fund following outsized losses from its emerging market fx positions, and long duration stance as yields rose over the quarter.

Fidelity Index Emerging Markets - Trade concerns and a strong US Dollar weighed on sentiment towards emerging market equities and this drag was particularly prevalent for Chinese stocks.

Legg Mason Brandywine Global Fixed Interest - The fund's Mexican and Brazilian debt and foreign exchange holdings dragged on returns. Less exposure than the benchmark to the US Dollar and Japanese Yen also detracted.

The Flying Colours: Core Growth portfolio returned 5.25% in the second quarter of 2018. This was ahead of the 50:50 blend of the ARC Steady Growth PCI and ARC Equity Risk PCI category averages, which returned of 4.13%.

Top Contributors: Vanguard US Equity Index - US equities returned 10.3% in the quarter buoyed by a combination of a strong US Dollar, excellent corporate earnings and a continued run of good economic data.

UK Equity Trackers - UK equities recovered well after disappointing first-quarter returns. A weaker sterling boosted earnings for Britain's multinationals, which derive much of their profits overseas. A rebound in commodity prices also helped the UK's oil and mining firms.

Fidelity Index Japan Equity - In local currency terms, the Japanese market rose just 1.1% but returns for UK investors were boosted a further 4% by the strengthening Yen.

Top Detractors: Fidelity Index Emerging Markets - Trade concerns and a strong US Dollar weighed on sentiment towards emerging market equities and this drag was particularly prevalent for Chinese stocks.

Vanguard US Government Index - US Treasuries yields rose in the quarter in reaction to the US Federal Reserve's interest rate hike in June. This led to a small loss for the fund.

Vanguard UK Investment Grade Bond Index - UK credit spreads widened in the quarter leading to underperformance of UK corporate bonds relative to UK gilts.

The Flying Colours: Dynamic Growth portfolio returned 5.32% in the second quarter of 2018. This was ahead of the 50:50 blend of the ARC Steady Growth PCI and ARC Equity Risk PCI category averages, which returned of 4.13%.

Top Contributors: Threadneedle UK Equity Income - Excellent returns from the fund's consumer defensive and consumer cyclical names helped the fund outperform the FTSE All Share by 2.6% in the quarter. As a result, the fund placed in the 3rd percentile in its Morningstar category.

Majedie UK Equity - The fund's overweights to the supermarket and oil & gas sectors boosted relative returns. The outperformance of the FTSE All Share was 1.6%.

Vanguard US Equity Index - US equities returned 10.3% in the quarter buoyed by a combination of a strong US Dollar, excellent corporate earnings and a continued run of good economic data.

Top Detractors: Legg Mason Western Asset Macro Opportunities Bond - It was a difficult quarter for the fund following outsized losses from its emerging market fx positions, and long duration stance as yields rose over the quarter.

Fidelity Index Emerging Markets - Trade concerns and a strong US Dollar weighed on sentiment towards emerging market equities and this drag was particularly prevalent for Chinese stocks.

Legg Mason Brandywine Global Fixed Interest - The fund's Mexican and Brazilian debt and foreign exchange holdings dragged on returns. Less exposure than the benchmark to the US Dollar and Japanese Yen also detracted.

The Flying Colours: Core Aggressive portfolio returned 6.12% in the second quarter of 2018. This was ahead of the ARC Equity Risk PCI category average return of 4.84%.

Top Contributors: Vanguard US Equity Index - US equities returned 10.3% in the quarter buoyed by a combination of a strong US Dollar, excellent corporate earnings and a continued run of good economic data.

UK Equity Trackers - UK equities recovered well after disappointing first-quarter returns. A weaker sterling boosted earnings for Britain's multinationals, which derive much of their profits overseas. A rebound in commodity prices also helped the UK's oil and mining firms. Fidelity Index Japan Equity - In local currency terms, the Japanese market rose just 1.1% but returns for UK investors were boosted a further 4% by the strengthening Yen.

Top Detractors: Fidelity Index Emerging Markets - Trade concerns and a strong US Dollar weighed on sentiment towards emerging market equities and this drag was particularly prevalent for Chinese stocks.

Vanguard US Government Index - US Treasuries yields rose in the quarter in reaction to the US Federal Reserve's interest rate hike in June. This led to a small loss for the fund.

Vanguard UK Investment Grade Bond Index - UK credit spreads widened in the quarter leading to underperformance of UK corporate bonds relative to UK gilts.

The Flying Colours: Dynamic Aggressive portfolio returned 6.40% in the second quarter of 2018. This was ahead of the ARC Equity Risk PCI category average return of 4.84%.

Top Contributors: Threadneedle UK Equity Income - Excellent returns from the fund's consumer defensive and consumer cyclical names helped the fund outperform the FTSE All Share by 2.6% in the quarter. As a result, the fund placed in the 3rd percentile in its Morningstar category.

Majedie UK Equity - The fund's overweights to the supermarket and oil & gas sectors boosted relative returns. Outperformance of the FTSE All Share was 1.6%.

Vanguard US Equity Index - US equities returned 10.3% in the quarter buoyed by a combination of a strong US Dollar, excellent corporate earnings and a continued run of good economic data.

Top Detractors: Legg Mason Western Asset Macro Opportunities Bond - It was a challenging quarter for the fund following outsized losses from its emerging market fx positions, and long duration stance as yields rose over the quarter.

Fidelity Index Emerging Markets - Trade concerns and a strong US Dollar weighed on sentiment towards emerging market equities, and this drag was particularly prevalent for Chinese stocks.

Vanguard US Government Index - US Treasuries yields rose in the quarter in reaction to the US Federal Reserve's interest rate hike in June. This led to a small loss for the fund.

Guy Myles Chairman, Flying Colours Investment Committee