Market review
In financial markets good news can sometimes become bad news. This proved true in the second quarter of 2013. The good news - better economic data - prompted the US Federal Reserve (Fed) to indicate that it may start to wind down its quantitative easing (QE) programme. The bad news was the reaction by markets. Fears that such a withdrawal would drain some of the liquidity currently supporting markets, led to a massive sell-off in the bond market. Fed Chairman Ben Bernanke's announcement that the central bank could begin to slow the pace of its asset purchases if unemployment drops as projected, led to a sharp upward move in bond yields. The period witnessed large outflows from fixed income funds. As panic spread, global equity markets were also impacted as anxious investors rushed to sell their holdings. This pushed down all markets, with emerging market equities particularly hard hit. The MSCI AC World NR Index returned -0.4% in dollars over the quarter. Emerging market equities underperformed developed market equities, with the MSCI Emerging Markets NR Index losing 8.1% over the quarter.

Portfolio review
The portfolio produced positive returns over the quarter, ahead of the MSCI AC World NR Index. The best performing sector over the quarter was consumers, driven mainly by healthcare equipment & services and pharmaceutical stocks. Global health service company Cigna outperformed on better than expected earnings growth, while Valeant Pharmaceuticals was boosted by its recent acquisition of eye care company Bausch and Lomb. Elsewhere, personal care provider Nu Skin continued to deliver strong operational results. The financial sector also performed well. Although Brazilian banks Banco do Brazil and Itau Unibanco were impacted by civil unrest in the country, good stock selection in diversified financials contributed to returns. ING Groep benefited from its IPO and good investment returns within its life insurance business, while Moody's and JPMorgan also performed well. The resources sector was the largest detractor over the quarter due to our energy holdings. US refiners, including Valero Energy and Marathon Petroleum, fell on concerns that narrowing oil price differentials might affect their profitability. The services sector also dragged on performance. Despite consumer durables & apparel adding to returns, we suffered from not holding a number of Japanese automobile stocks, such as Toyota Motor, Fuji Heavy Industries and Mazda Motor, which benefited from a weaker yen.

Portfolio positioning
Talk of a wind down in QE, as a result of an improvement in US employment and leading economic indicators, has sparked a material shift in the investment landscape. A sharp upward shift in yield curves around the globe implies that the easing policy, which has seen 520 cuts in interest rates around the globe over the past six years, has been a success. Inflationary expectations have been raised and the global economy is moving towards a renewed growth trajectory. However, evidence of this, as yet, is rather scarce on the ground. Quarter after quarter, equity investors have seen companies beat earnings expectations, but only through cutting costs. Sales estimates have been reduced and outlook statements have been broadly pessimistic. With the second quarter earnings season approaching, it will be interesting to see if the central banks are right to shift the rhetoric from "we will do whatever is needed" to a tapering down of QE. Either way, the sell-off in bond markets has been particularly severe as sellers rushed to be first out of the door and the fear factor pushed through, perhaps unfairly, to equities. Inflection points of any kind do tend to be accompanied by a jump in volatility, but the stock market sell-off seemed a little contradictory, given that a QE pullback was driven by higher growth expectations. Despite renewed uncertainty, stock markets generally seem well supported. If growth does not materialise we get more QE; if growth does pick up the outlook for profits improves. If inflation rises then equities are a more attractive asset class than fixed income. So, besides the recent volatility, what is there not to like?

Market review
Equity markets generally gained strongly over the first quarter, with the MSCI AC World NR Index adding 6.5% in US dollars. Developed markets equities, led by stellar returns in the US, outperformed. The MSCI Europe NR Index recorded gains of 2.7% and the MSCI Japan NR Index added 11.6%. Emerging markets were weaker, with the MSCI Emerging Markets NR Index losing 1.6% over the quarter. Returns, however, varied greatly across countries and regions.

Portfolio review
The best performing sector over the quarter was financials, as a number of our holdings performed well. Swedbank announced a new minimum dividend payout ratio, driving a rerating of the stock, while US insurance companies such as Lincoln National and MetLife were supported by buoyant equity markets and rising yields on ten-year government bonds. Elsewhere, US energy holdings Valero and Marathon Petroleum rose on strong fourth quarter results, as both companies reported increasing refining margins. The portfolio also benefited from good stock selection within media, as ValueClick posted results that showed the strength of its core business and recent acquisitions, while news that CBS intended to increase its share buyback and convert CBS Outdoor to Reit status was well received by investors. On the negative side, the technology sector detracted from returns, as EMC and Apple underperformed. Despite the overall positive contribution from the resources sector, China Shenhua Energy, BHP Billiton and Cliff Natural Resources were weak over the quarter, due to concerns over falling demand for commodities, while CNOOC posted weaker than expected results.

Portfolio positioning
With a decent dose of fear returning to equity investors, the current level of world equity prices cannot be said to contain the 'irrational exuberance' claimed by the pessimists earlier in the quarter. But there are still plenty of headlines for the bears to feed on: Chinese growth faltering, North Korean sabre rattling, and more euro-zone problems surrounding Cyprus, to name but a few. However, focusing on the bottom line of companies shows they continue to perform above expectations and that dividend increases and share buybacks are ongoing. The US banking stress tests, released in early March, saw only one prospective failure and the whole US system is generating new reserves at a prodigious rate. Europe lags behind in this process and attempts by China to rein in credit creation may not be conducive to growth. However, only a short time ago it was the fear of a potential systemic implosion which saw investors become extremely risk averse, rather than the fear of an anaemic rate of economic expansion. The recovery process is steadily pushing investors towards riskier assets, supported by the world's central bankers who have ensured that - systemic problems aside - investors will not be rewarded for caution. Evidence pointing to a recovery in the US housing market remains largely ignored as investors are still nervous, following their experiences in 2008. Corporate executives are as susceptible as anyone else to the general malaise and, perhaps, in an environment concerned with short-term quarterly reports and annual guidance from the corporate sector, it is unlikely that any underlying improvements in the business environment will be communicated until the forecast period is almost complete. This may not happen in the upcoming first quarter reporting season, but the performance of global equity markets seems to indicate that some more optimism may come from the corporate sector as we move through 2013.

Market review
Risk assets seemed to shrug off continued concerns about the fragile global economy, with equity markets posting strong returns over the last quarter of 2012. Very low global interest rates coupled with unconventional policy support provided an attractive backdrop for risk-taking. The MSCI World Index added 2.6% in US dollars over the quarter, with Germany (+8.1%), France (+11.6%) and the emerging market composite (+5.6%) showing particularly strong gains.

Portfolio review
The largest contribution to the portfolio's performance over the quarter came from the resources sector, where a number of our holdings posted strong returns. China Petroleum & Chemical Corp and LyondellBasell Industries rose on strong petrochemical margins. Fortescue Metals benefited from the bounce back in iron ore prices, while Rosneft acquired BP's stake in the BP-TNK joint venture. The telecommunications & utilities sector also added to relative returns. This was thanks to good stock selection decisions. Telstra was a notable performer, but we also benefited from not owning AT&T and holding our underweight position in utilities companies. On the negative side, financials detracted from relative returns as MSCI Inc fell, following Vanguard's decision to no longer use the company's indices for a number of its exchange traded funds. We also suffered from not holding a number of companies that performed well over the period, including Bank of America and HSBC. Elsewhere, Apple struggled on concerns about slowing growth as a result of increased competition in the tablet and smartphone space. Direct selling company, Herbalife fell after questions were raised about its business model by a US hedge fund. In recent years it has generated high returns and strong cash flows. We will be encouraging the company to improve its disclosure practices.

Portfolio positioning
While the last minute tax compromise in the US helped markets rise sharply in early 2013, we are mindful that further decisions on spending cuts need to be made by the end of March. Therefore, there may be further volatility in the near term. With the weak economic recovery likely to persist, the attraction of equity as an asset class relative to fixed income looks compelling. However, for sustainable absolute returns we would like corporate cash to be put to work in investments or dividends. We will continue to urge companies, where we believe balance sheets are inefficient, to return surplus cash to shareholders. Equity markets continue to offer compelling value compared to other asset classes. This is apparent in good companies as well as those that are poorly managed. We believe that as equity markets regain popularity among investors, good stock picking will be increasingly rewarded.