March market overview

Twelve months ago in early March 2009 markets hit their nadir for this cycle and promptly began to rebound from
the multi decade lows. At that time Viewpoint quoted Mark Twain who once remarked that history does not repeat
itself but it does rhyme. One year on and this quote is no less appropriate – the world did not end but the recession
did in most countries and markets aggressively rebounded from their lows. This is the same pattern as seen in
previous recessions with one main difference being the magnitude of the bear and bull phases in the cycle. Of
course the path from here remains unknown and the rhyme may yet peter out, but in the interim at least, markets
have not deviated significantly from past habits. The chart below shows the cumulative returns of several major
asset classes over the past twelve months and highlight that the returns have indeed been significant but also that
markets have moved sideways for the last four months. The S&P 500 index ended February at approximately the
same level it reached in mid October last year and investors have suffered volatility along the way with several
swings of +/- 5%. This is despite generally strong economic data over the period as well as impressive corporate
earnings. One reason to be positive is that if the markets were comfortable with equity valuations in October, there
should be greater confidence now as the price has stayed stable but the visibility of the macro economic outcome
is slowly clearing. Into 2010, however, investors should beware hubris as historical data for the S&P 500 suggests
that the twelve month returns following such a strong rally are slightly negative. Investors should never forget the
benefits of diversification especially in an environment where uncertainty is high and may wish to consider other
risk assets aside from pure equity exposure to provide a degree of protection, such as areas of the fixed income
markets.

Fig.1 Indexed market returns (rebased to 100)

From a debt perspective, there is a chance that the historical norms should not be taken as a given. In most previous cycles Western governments were not as stretched as they are today. The size of the credit-related boom and subsequent bust led to such massive fiscal and monetary stimulus that many governments are already at their limit and are having to reign in expenditure. It is now apparent that the gigantic stimulus projects which began over a year ago have stabilised the system, but concern remains regarding what happens next. Sovereign risk is a real Viewp int March 2010 Performance rebased to 100 2 issue in this cycle and is commanding the attention of markets. For the past few months the spotlight has been firmly on Greece due to the sheer size of their fiscal deficit and refinancing requirements. However, the past few weeks have been good for the country following several comments suggesting implicit support from the EU and successful bond issues that cover a small part of their 2010 refinancing needs. Greece has already announced several measures to reduce their fiscal deficit, such as public sector wage cuts and a two per cent increase in VAT, and the market has responded well to what is a more credible package than those previously announced. The measures are still somewhat short of the Irish austerity package, however. The spread between Greek 10 year bonds and German Bunds has now fallen from a peak of 396 bps to around 300 bps. Although Greece is a relatively small economy other peripheral EU countries are facing similar issues, and given Greece really represents the extremes of what the market is concerned about then if it can convince the market that it can weather its storms then it is perhaps difficult to see another country failing to do so. The UK is one such country that has seen a heightened degree of credit analysis undertaken as the nation has embarked on an expensive life support system for the past 12 months. In FOCUS below the state of the UK’s finances are addressed in the context of the risks posed by the impending UK General Election.

Asset class performances displayed a modest amount of divergence in February, particularly when comparing the US and UK to Europe. Looking at equities, the S&P 500 and FTSE All Share gained 3.0% and 3.4% respectively in local currency terms, while continental European equities posted a loss of -0.4%. This resulted in the MSCI World Index gaining 1.4% in US Dollar terms and outperforming emerging markets which gained 0.4%. The returns in local currency terms were reasonable, but the strong US Dollar provided a headwind to performance. Concerns surrounding the fiscal positions of peripheral euro-zone countries including Greece and Portugal may well have contributed to the poor relative performance of this region, and corporate earnings results may have been another contributor.

Fixed income securities also produced mixed returns for the month with European government bonds returning 1.2%, compared to 0.4% and -0.4% for the US and UK respectively. These returns were significantly influenced by a flight to quality in the last week of the month which saw most fixed income instruments posting positive returns. Investment grade debt posted solid returns for February and more or less matched the return of government debt except in Europe where investment grade underperformed by 0.6%. Emerging market debt also rallied strongly in the last week of the month to produce a total return of 1.6% in US Dollar terms. High yield bonds produced small positive returns of 0.2% and 0.1% in Europe and the US respectively. It appears that the peak in high yield defaults has passed already as the global default rate calculated by Moody’s fell for the third consecutive month in February, to 11.6% versus a peak of 13.5% in November 2009. Notably Moody’s also revised their forecast for the end 2010 default rate to 2.9% from 3.4% last month.

Within currencies the US Dollar continued its recent strong run with further appreciation versus the euro, Sterling and South African Rand. This increased the outperformance of US asset classes when viewing returns in US Dollar terms, particularly within equities. As was also the case in January the Japanese Yen remained one of the main exceptions to the rule and gained a further 2.0% versus the greenback in February.

Soft and hard commodities proved to be the standout asset class for the month. The Rogers International Commodity Index returned 5.4% for the month, led largely by 7.3% rise in the oil price, whilst the equivalent agricultural index returned 4.1%. Property security returns were similar to the broader equity markets, with the global index returning 2.7% in US Dollar terms. Year to date these assets are in negative territory, with a return of - 3.4%. For February, US property securities stand out, returning 5.5%.

Source: RMB Asset Management / Bloomberg / Lipper Hindsight. March 2010.

Source: Lipper Hindsight,March 2010

FOCUS – Britain’s Greek Tragedy3

In the months following Lehman’s collapse, the mass of government financed economic stimulus was both deep and widespread. Indeed, this concerted policy response was one of the few things over the period that might truly be referred to as ‘unprecedented’ at the time. These actions are understandable as this concerted effort introduced a degree of comfort to markets that was otherwise lacking. The potential for failing banks to topple into each other like a set of dominos seems perhaps somewhat alarmist now, but at the time, with AIG, Lehman and other major financial institutions on the brink, with immense amounts of impaired or potentially defaulting debt to deal with, these concerns were not unfounded. With hindsight, therefore, the actions of central banks and treasuries was rational, but it was not costless.

The symptoms of overstretching may be found in many parts of the world. In the first instance the global banking collapse stemmed from leverage and assumptions about the risk that this entailed. Now the secondary effects are being felt, which may be less dramatic, but all the more important. For example the US property market (the epicentre of the primary crisis) has suffered significantly as consumers have had their excesses quickly reigned in. The Mediterranean nationals also have to rapidly adjust to a world where cheap credit is no longer freely available. Another example that is growing in significance is the UK. With a falling currency, blossoming public debt and political concerns, the risk is that the UK starts to fulfil the negative prophecies. The UK consumer went into the crisis amongst the most geared in the world and this relied largely on the ability to refinance unsecured debt by rolling from one zero interest credit card deal to another and by withdrawing equity from “perpetually” rising housing prices. It is clear from Fig. 1 that the UK household savings rate has improved materially from the negative position in 2008. This is a positive sign for the individuals involved, but it does cast a pall over the potential for the UK’s economic growth. The UK’s growth in Gross Domestic Product (GDP) is significantly impacted by consumer spending. This is usually fairly stable, but the retraction of hitherto freely available credit has impacted consumer spending severely. Given the levels of public debt outstanding in the UK, it is clear that the UK is utterly reliant on GDP growth as deflation is torrid for the over-indebted.

Another contributing element for GDP is exports to foreigners. Sterling has fallen materially against the currencies of its trading partners, as the trade weighted GBP figures will attest. Fig. 2 demonstrates clearly the impact that the banking crisis had on sterling. On a trade weighted basis the pound has fallen by a quarter from the peak in 2007. This has resulted in sterling priced assets and services becoming cheap for foreign investors. This ability for a currency to weaken is a real benefit in that it makes the UK’s exports at a stroke very competitive. Purchasers who have elastic demand characteristics can substitute the UK’s products and services where the price in sterling is advantageous. Thus far the inflow of foreign capital has registered in the current account (see Fig. 3), but inflation is not at a level which would cause the Bank of England particular inflation concerns at the moment. Another inflation risk is the fall in sterling’s value as this results in any imported good becoming more expensive. The UK, with a negative current account balance, would expect to be impacted by this phenomenon, but thus far the uptick in inflation has been muted compared to countries such as the US (Fig. 4). This is useful as it gives central bankers time to hold off any potential interest rate increases which could stifle a fledgling recovery.

Prior to the credit crunch the UK was booming. GDP growth was stable, inflation contained, employment rates high, sterling strong and both real and financial assets continually being revised up. The powerhouse of postindustrial Britain’s apparently benign economic paradise was the services sector and perhaps most importantly the financial services industry. These businesses have prospered in London following the highly successful Big Bang of the 1980s. Subsequent governments have promoted London’s prominence as a financial centre and reaped significant rewards in terms of taxation, a cultural explosion and the cementing of London as a key city globally. With hindsight, the level of indebtedness that stoked these price rises is eminently clear. London became ‘top heavy’ both in a literal sense as banks added to their human capital and real estate and in a metaphorical sense, as debt ballooned within the financial industry and later the government finances. The market is becoming increasingly aware of the potential risks swelling within the UK’s debt profile. These risks are well reflected in the Credit Default Swap (CDS) markets. The CDS is effectively a form of insurance against default of an issuer. The wider the CDS spread, the greater the anticipated risk of default. The UK’s CDS is now comparable to stable corporate names such as Tesco (Fig. 5). The spread is wider than many other developed nations that have analogous economic circumstances such as the US. (Fig. 6)

The UK’s debt burden is large, but well structured when compared to Greece and even the US. The debt distributions below (Fig 7-9) demonstrate the front loaded nature of the Greek debt distribution which makes the funding requirements more pressing in the short term. The UK, on the other hand, has issued debt of such a nature that has little impact on the immediate refinancing needs of the country, however, this delays the inevitable for then UK.5

Deleveraging is going to be a long and painful process for the UK consumer and government. The corporate sector responded quickly to the economic slow down and therefore is on average in better shape. In fact, many corporations have taken the recent thaw in credit markets as a good opportunity to refinance much of their debt. Large deficits to GDP are not in and of themselves a disaster for developed countries, Japan’s continued indebtedness is a testament to this. The UK has issued a significant amount of debt, but this has largely been absorbed through quantitative easing. So far it appears that the difficult and meaningful steps to reduce the debt burden have not been taken. Much of the reason for this is the impending general election. The UK has to have a general election by the middle of this year and it is currently assumed that it will take place on May 6. The politicking which takes place during the run up to the general election is likely to result in noncommittal fiscal and monetary statements from all of the three main parties as they seem to feel that any party whose manifesto is steeped in austerity will lose. As a result, politicians are presently espousing policies that are insipid. Such is the reluctance of the opposition to provide clear guidance on their likely approach that it renders them toothless in their ability to tackle the incumbents. In fact, the ruling Labour party are enjoying something of a renaissance as a recent poll put the Tory lead as a mere two points. This result, released early in March, was greeted by market jitters. It is clear, therefore, that the markets are anxious for any new government to have a solid mandate and an ability to confront the issues facing the UK head on and are taking the threat of a hung parliament (i.e. no single party with overall control) very seriously. The chance of any party earning an outright majority seems to be diminishing and the market must be prepared for a minority government in the UK barring any significant shift on polling day.

A shared mandate, or ‘hung’ parliament, could be a problem for the markets due to the lack of a single dominating party. The perceived wisdom is that a hung parliament results in compromise and horse trading that stymies the decision making process. This is not always the case, however, as in extremis such as conflicts, the parties put their differences behind them. As the economy moves away from an obvious and proximate crisis such as the days following Lehman, it is likely that the coordination will wane. This pessimistic scenario is becoming commonplace however and this leaves room for a contrarian view. The UK has a history of making the best of adversity and the years ahead may provide an opportunity for an invigorated and better diversified British economy to flourish.

Source: RMB Asset Management / Bloomberg / Lipper Hindsight. March 2010.

RECENT MANAGER MEETINGS

INDUSTRY NEWS

SENIOR MANAGEMENT

Roger Yates has joined Pioneer Investments as chief executive officer. He was most recently at Henderson Global Investors..

Gregory Fleming has joined Morgan Stanley Investment Management as president and head of investment management. He joins from Merrill Lynch.

Arne Lindman has joined Fidelity International as chief executive officer for Asia. He joins from Prudential.

Changhong Zhu has joined China’s State Administration of Foreign Exchange as chief investment officer. He joins from Pimco.

David Urch has joined Oriel Asset Management as chief investment officer. He was previously at Fidelity.

Gary Steinberg has joined the International Monetary Fund to lead its investment unit. He was previously with John Woods and Associates.

Richard Weil has joined Janus Capital as chief executive officer. He joins from Pimco.

Piers Hillier has joined LV Asser Management as chief investment officer. He was previously at WestLB Mellon Asset Management.

Stephen Jones has joined Principal Investment Management as chief investment officer. He joins from Gartmore Investment Management.

Hans Fahlin is joining AP2 as chief executive officer. He joins from Fortis Investments.

Tim Roberts has joined Ignis Asset Management as chief operating officer. He joins from McKinsey & Company.

ALTERNATIVES

Karl Bergquist has joined Arrowgrass Capital Partners as credit portfolio manager. He was previously at Gartmore Investment Management.

Jean-Phillipe Blochet has joined Moore Capital as a senior portfolio manager. He joins from Brevan Howard.

Lev Mikheev and Tom Hickey have founded Salute Capital, a global emerging markets boutique. They join from Moore Capital.

Maxime Carmignac and Kenneth Ginsburgh have launched Althea Capital, a global emerging market fund. They join from Tudor Investment Corporation and SAC Capital Advisors respectively.

Roni Laserson has joined Henderson Global Investors as director of hedge fund business development for the Americas. She was most recently with Citadel Investment Group.

Tom Wiggin has joined Cheyne Capital as head of UK marketing. He joins from Deutsche Bank.

William Marr has joined Ramius Alternative Solutions to manage a fund of hedge funds. He joins from Merrill Lynch. Alexander Rudin and Nadine Haidar also join from Merrill Lynch as a director of investment research and head of business due diligence.

Julien Frazzo has joined De Putron Fund Management as an event driven portfolio manager. He was previously at Citadel Investment Group.

Laurent Chevellier has joined from Eurofin Capital as head of alternatives research and portfolio management. He was previously with Unigestion.

Sam West has joined Matrix Group as a portfolio manager for Asian equities. He joined from Cantillon Capital Management.

Jan Smorczewski has joined Caxton Europe as macro portfolio manager. He was previously at Barclays Capital.

Nandita Singh has joined Tudor Capital as a currency strategist. He joins from JP Morgan.

Minh Tran has joined SAC Global Investors as a vice president. He joins from Atticus Capital

Geoffrey Houlot has joined Brevan Howard Asset Management as a portfolio manager. He joins from Morgan Stanley.

Janine Guillot is joining the California Public Employees Retirement Systems as head of alternatives and property. She joins from Barclays Global Investors.

Mario Frontinu and Sam Myhram have joined Sator SpA as chief investment officer and senior analyst respectively. Frontini was previously at Fidelity and Myhram was previously at Didner and Gerge.

EQUITY8

Laurent Douillet has joined Lazard Asset Management as a global technology analyst. He joins from AllianceBernstein. In additional Elias Chrysostomou is joining as global financial analyst. He joins from UBS Global Asset Management.

Andrew Parry and the team at Sourcecap have joined Hermes to form a European equity team.

Anne Gudefin and Charles Lahr have joined Pimco as global portfolio managers. They both join from Franklin Resources.

Dirk Enderlein has joined Wellington Management as a European equity portfolio manager. He joins from Allianz RCM Global Investors.

Klaus Bockstaller has joined Pictet Asset Management as head of EMEA and Latin America and co-head of global emerging markets portfolios. Hugo Bain has also joined as senior investment manager for Eastern Europe. They both join from Fleming Family Partners Capital Management.

Samir Patel has joined Hermes Investment Management as an emerging markets portfolio manager. He joins from Polar Capital.

Simon Brazier has joined Threadneedle as co-head of UK equities. He joins from Schroder Investment Management. Richard Colwell is joining as UK income equity manager from Aviva Investors and James Thorne is joining as UK smaller companies portfolio manager. He joins from Baring Asset Management.

Dan Harlow has joined AXA Framlington as a UK equity portfolio manager. He joins from Montanaro Asset Management.

Danila Gallarto, Carmel Peter and Chris Shale have joined the Universities Superannuation Scheme in the global emerging markets and Asia team. Peter and Shale join from RWC Partners and Gallarato joins from the Abu Dhabi Investment Authority.

Bosworth Monck, Gabriel Montana and Richard Smith have joined Earth Capital Partners to manage agriculture, forestry and biodiversity investments. They join from Ibis Asset Management.

Pauline McPherson has joined Alfred Berg as chief investment officer and portfolio manager for quantitative strategies. He joins from Wellington Management. Amitahb Dugarhas also joined Alfred Bergg as US and international equity portfolio manager. He joins from Mellon Capital Management.

Roberto Lampl has joined Baring Asset Management as head of Latin American equities. He joins from ING Asset Management. Also Colin Ng has joined from Baring Asset Management as head of Asian equities. He joins from MFC Global Investment Management.

Barry Dargan has joined Artisan International as a global equity portfolio manager. He joins from MFS Investment Management.

Stuart McPhereson and Ward Griffiths have joined MFS Investment Management asglobal analysts. They join from Goldman Sachs Asset Management and Citibank respectively.

Nick Mottram has joined Dalton Strategic Partnership as a global equity portfolio manager. He joins from Origin Asset Management.

Emery Brewer and Ivo St Kovachev have joined JO Hambro Capital Management to manage a global emerging market fund. They were previously with Driehaus Capital Management.

David Cornell has joined India Investment Partners as a global emerging markets portfolio manager. He joins from Henderson New Star.

Reza Mahmud has joined from Aviva Investors as a multi-asset strategist and portfolio manager. He joins from Brunei Investment Agency.

FIXED INCOME

Chris Fellingham has joined Ingnis Asset Management as chief investment officer for fixed income. He joins from Soros Fund Management.

Neel Kashkani has joined Pimco as head of new investment initiatives. He joins from the US Troubled Asset Relief Programme.

Mark Connolly has joined Scottish Widows Investment Partnership as director of fixed income. He joins from Standard Life Investments.

Dahlia Verjee has joined Thames River Capital as a senior trader for global credit. She joins from Deephaven Capital Management.

Fred Cleary has joined Hermes Fund managers as a government bond portfolio manager. He joins from UBS.

Charles Zerah has joined Carmignac Gestion as fixed income portfolio manager. He joins from Credit Agricole Asset Management.

John Lupton and Cian O’Carroll have formed a partnership with Hermes Fund Managers to manage credit portfolios. They join from Fortis Investments.

Kevin Corrigan has joined Lombard Odier as head of credit. He joins from Goldman Sachs Asset Management.

Leah Parento has joined Investec Asset management as a specialist credit analyst. She joins from RBS.

Sanjay Joshi has re-joined London and Capital as a senior income portfolio manager. He joins from F&C Asset Management.

Brigid Jackson is joining Henderson New Star as a director in fixed income. She joins from Blackrock.

Important Notes

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