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Market review

Quarter one 2010 review

A review of markets and the prevailing macroeconomic environment during the first quarter of 2010 has served to highlight that the role of an asset manager is far from easy. The headline news has centred on the spectre of sovereign risk and the difficulties faced, particularly in Greece, by governments trying to finance and service borrowing requirements in the wake of collapsing tax receipts. The contagion effect this has created across the euro-family of countries has unfolded before our eyes and this, in turn, has spread to geographies further afield. The size of the fiscal deficits, relative to their economies, in both the US and the UK are considered by many to be unsustainable and the drag on future economic performance - caused by higher taxes and spending cuts - will be an issue for years to come. Returning to Europe, the absence of a blueprint describing how to support a member state facing default, or how any of the burgeoning deficit will be controlled, let alone repaid, serves to expose the lack of clear leadership across Europe and has unsettled investors around the world.

Against this backdrop, however, broad economic and corporate news flow, particularly from the US, has cemented a view the global recovery is firmly underway. Earnings growth has generally exceeded expectations, consumer confidence is on the rise and unemployment data towards the end of the quarter suggests sustained job creation is just around the corner. Looking to the East, the Chinese economy is growing at a faster rate than forecast and this is bringing demonstrable benefits to the wider region as a whole. Western demand is clearly below that enjoyed in the past, however, local central bank stimulus has boosted demand across Asia and Latin America leading to a reversal in the trade imbalances we grew used to before the financial crisis began. China posted a trade deficit in March, a clear signal of the growing impact domestic consumption is having on the economy.

While being understandably pre-occupied with the structural headwinds prevailing across Western economies, investors have not ignored attractive valuations, strong earnings momentum, rising global growth forecasts, benign inflationary pressures and low interest rates to push equities, and other asset classes, higher through the quarter. This does mask periods of heightened risk aversion and, in our view, is a reflection of the ‘fragility of mindset’ across the investment community. The MSCI World Index was down 4.2% in January, posted a positive return of 1.2% in February and rallied 5.9% in March, delivering 2.7% over the quarter. The return profile of the major equity markets was very similar, but ultimately the S&P 500 has risen 4.9%, the FTSE 100 4.9% and the FTSE Europe ex-UK 3.7%. Emerging markets posted a 2.1% gain for the quarter. Corporate bonds, commercial property and commodities all rewarded investors over this reporting period.

Investment strategy

Our portfolios are positioned to benefit from what we believe are the relative certainties investors can allocate risk capital to during these uncertain times. We believe these to be the shift in economic power from the West to the East, the growing demand for commodities to service this rise in economic prosperity, and the growth in importance and contribution the developing world consumer will have on the profits of the corporate sector, across developed and developing economies. In our view, these are secular trends which will deliver attractive investment returns over the long term. Notwithstanding these secular trends, tactical strategies are also employed to take advantage of what we see are windows of opportunity with a shorter shelf life. For example, some metrics have highlighted equities across emerging markets have returned to pre-crisis valuation levels and, having taken some profits, we have used a bout of risk aversion to enter into a contract to enhance the yield on our US dollar cash to 10% per annum, while reserving the right to reinvest into equities should markets fall. Another example has been our allocation to investment grade corporate bonds allowing us to capture capital gains, in addition to coupon payments, as credit spreads have narrowed driven by improving balance sheet fundamentals.

As this quarter has ended and the early reporting season has begun, it is apparent the corporate sector in the US has adapted well to the acute collapse in world trade suffered 12 months ago, and has emerged stronger and leaner. By controlling their cost base, successful companies have been able to benefit from this operating leverage and delivered impressive earnings growth, even if demand is sub-trend by historic standards.