Core portfolio quarterly report

Strategic asset allocation service (Core portfolio) - Sterling quarterly report - 30 June 2008

This review will include an insight into each asset class including the bank's view of the asset and its anticipated return. It is these anticipated returns, coupled with the historic twelve-month risk or volatility attached to each asset (expressed as a 'standard deviation' figure), that the bank uses to determine the appropriate allocation to each asset class.

Cash: Despite mounting evidence of a slowing economy during the second quarter of 2008, the prospect of the Bank Of England cutting interest rates in the foreseeable future is remote following surging inflationary pressures during June. As oil prices top $140 per barrel and natural gas prices continue to move higher, further increases in utility bills later in the year are likely to provide additional upward pressure on inflation. The Bank Of England base rate now stands at 5.00% following a 25 basis point reduction at their April meeting.

Actual return in 2008 YTD 2.49%
Standard deviation^ 0.11%
Current weighting 21.51%

Bonds: The divergence in interest rate sentiment during the quarter created difficulties for fixed income investors, with some capital flowing into government debt as a safe haven and other managers buying what they consider undervalued corporate credits. Our own position was switched from government debt to investment grade corporate exposure in early May, as we felt the government debt had been over bought by the market and offered little value to investors. Through June, however, spreads widened as investor risk appetite diminished and the spectre of rising default rates came firmly into view. Several sectors in the UK, such as banks and general financial institutions, came under pressure and debt issued by corporates in these sectors were repriced by the market. Inflation has also been an increasingly important theme and this has restricted the progress of bonds. The Monetary Policy Committee faces its most difficult time since formation, balancing the lagging economy with the rising price of commodities, such as oil, pushing inflation higher. Our overall cautious stance will no doubt result in the portfolio maintaining its current weighting to bonds, supporting an overweight cash position as markets ponder the forthcoming data releases, which we fear may continue to reflect a struggling economy.

Actual return in 2008 YTD -8.40%
Standard deviation^ 3.92%
Current weighting 14.27%

Equities: Equity markets fell sharply during the second quarter and the MSCI World Index was down 11.73% in sterling terms for the year to the end of June. In the US and the UK the collapsing housing and construction sectors, the withdrawal of credit and deteriorating economic growth conditions all combined to hit sentiment hard. At the start of May, we reduced our already underweight position by a further 5% down to 22% as the markets continued to take on board data pointing to slowing growth and increasing inflationary concerns. As we have outlined in earlier reports, the central banks are facing a dilemma but during the quarter we witnessed a significant shift in monetary policy as both the Federal Reserve and the European Central Bank adopted a more tightening stance. At current valuations, it could be argued that equity markets appear cheap but much will depend on the extent to which corporate profits are impacted by the deteriorating growth picture. It is likely that earnings forecasts will have to be downgraded making market valuations less attractive. We continue to believe that the immediate outlook for equity markets will be very challenging. Accordingly, we plan to maintain our underweight position.

Actual return in 2008 YTD -14.17%
Standard deviation^ 14.92%
Current weighting 21.68%

Property: The investment committee has not been invested in property since the beginning of the year, as we do not expect returns to exceed cash in the short term. Property, both commercial and residential, has performed weakly over the past few months and, with the expectation of potential interest rate increases to try to fight inflation, the outlook remains poor. We do not plan reinvestment into mainstream sectors in the near future, but continue to look for countries or sectors in property we believe will outperform cash. In the meantime, we will allocate the holding to cash or other assets we believe will perform more strongly.

Actual return in 2008 YTD -0.24%
Standard deviation^ 11.72%
Current weighting* 0.00%
* Asset class exited on 19 February 2008

Alternative investments: Hedge funds: The general hedge fund space started to deliver in line with its reputation through the second quarter by protecting against drawdowns seen in equity markets and showing lower correlation compared to the recent past. Specifically, the HFRX Global Hedge Fund Index added 2.50% in sterling terms from the end of March to the end of June, recovering all the losses sustained in the first quarter. This compares favourably to global equities, as represented by the MSCI World Index, which has posted sterling-based losses in excess of 11% for the year to the end of June. Given the environment faced by managers, the broad multistrategy hedge fund investor has generally been well sheltered from the dislocation in capital markets. At the individual strategy level, a wide dispersion of returns has emerged with dedicated short bias managers and global macro funds delivering versus the various arbitrage strategies that rely on gearing to magnify returns. Some star managers who closed their funds to new investors for a number of years have recently reopened for business as they seek new capital to take advantage of undervalued assets in particularly distressed sectors. We remain fully weighted to this asset class.

Commodities: The 28.48% rise in the S&P Goldman Sachs Commodity Index in sterling terms from the end of March to the end of June suggests that these markets have been a general one-way bet. However, the index is production-weighted with energy being by far the largest sector allocation and the attribution of this return is clearly in large part down to the rising price of oil. Brent crude saw a 35% rise through the second quarter, finishing at $138 per barrel. The global economy is struggling to control the inflationary impact created by high energy costs, and geopolitical concerns related to Israel's rumoured attack on Iranian nuclear installations are creating further upward pressure on the oil price. On the face of it, the flat performance of gold - as the classic safe haven - over the quarter reveals little. However, the end of March coincided with heightened risk aversion in asset markets so a return to that price level ($932 per troy ounce at end June) after a mid quarter dip shows that fear has returned.

Actual return in 2008 YTD -2.10%
Standard deviation^ 5.19%
Current weighting 42.54%

Manager's comment: Investors with cash committed to capital markets face a slowing global economy, rising inflation, rising unemployment, interest rate uncertainty, a weakened banking sector and the effects of a credit crunch which are only beginning to impact the consumer. This is not a favourable landscape and the asset allocation within the portfolio, particularly the overweight position in cash and the full weighting to alternatives, reflect this. At the centre of the world's problems is the spectre of rampant inflation caused by surging commodity prices and government policies, particularly in the developing world, which have worsened a problem they were designed to remedy. A recently published report from Morgan Stanley highlights six of the ten most populous nations in the world are living with an inflation rate in excess of 10%. Global economic progress is currently being held to ransom by the high cost of oil and the environment is likely to remain difficult until investors see a moderation in this price, together with a clear indication the banking crisis is over. We do not see either of these issues being resolved in the near term and will continue to maintain a defensive asset allocation within the portfolio.

Performance versus benchmark:

	2005	2006	2007	2008 YTD	Rolling 12 months return	Since inception**
Total model portfolio performance	10.21%	8.58%	2.01%	-5.30%	-7.94%	17.72%
Cash rate* (benchmark)	4.49%	4.48%	5.39%	2.49%	5.36%	18.36%
Standard deviation^	4.15%	3.56%	5.46%	7.06%	6.20%	5.05%

Performance figures are for the sterling SAAS (core) model portfolio (based on income reinvested and gross of fees).

* Cash rate is based on 3 month LIBID

** Launch date - 1 December 2004

^ Standard deviation is a measure of how widely "spread out" the returns of an investment are. The more spread out the returns are, the bigger and more frequent the losses on that investment. An investment's return over a year will be within one standard deviation of its expected return roughly two-thirds of the time, and within two standard deviations roughly 95% of the time. So, for example, if an investment has an expected return of 10%, with a standard deviation of 2%, then its return should be between 8% and 12% two-thirds of the time; and between 6% and 14%, 95% of the time. From November 2006 this is the annualised standard deviation of the returns for the SAAS (core) model portfolio.

Disclaimer: We accept no liability for any loss arising from the use hereof nor make any representation as to the accuracy or completeness of this information. The information and opinions above have been compiled or arrived at from sources believed to be reliable. They replace any previous monthly communication provided to you by us. Any underlying research or analysis has been procured by us for our own purposes and may have been acted upon by us for our purposes, or an associate for their own purposes. Please note that figures where quoted have been rounded up or down to the nearest decimal place and this may result in slight rounding differences. This information should not be construed as a solicitation to invest or be relied upon for the purpose of making an investment in this service. Where daily prices are not available for valuation or performance measurement purposes, individual holdings within the SAAS (core) portfolio will be valued using the last available price.

Notice: The value of your investments and the income from them can fall as well as rise and you may not get back the original amount invested. Exchange rate changes may affect the value of investments. Past performance is not necessarily a guide to future performance.

Fairbairn Private Bank is a registered trade name of Fairbairn Private Bank (IOM) Limited and Fairbairn Private Bank Limited.

Fairbairn Private Bank (IOM) Limited is licensed by the Isle of Man Financial Supervision Commission to take deposits and provide investment services. Registered office: St Mary's Court 20 Hill Street Douglas Isle of Man.

Fairbairn Private Bank Limited is regulated by the Jersey Financial Services Commission to carry on deposit-taking and investment business. Registered office: Fairbairn House 31 The Esplanade St Helier Jersey. Latest audited accounts are available on request.

Source: All data has been provided by Fairbairn Private Bank and Lipper Hindsight.