Global Real Estate followed the broader market higher during the third quarter of 2012, albeit at a slightly subdued pace. Whilst valuations of prime commercial property assets have been firm, occupancy levels remain vulnerable to contraction, most notably in the retail sub sector which continues to struggle with flat sales figures and store closures. Of course, prime commercial property sites are so called because of their location and the majority of businesses in our real estate portfolio own tracts of land and buildings in some of the best sites in the world which, if not entirely immune to economic slowdown, are at least shielded from the worst of any impact.

The largest component of the portfolio is located in the US and Canada which, we continue to believe, offer the best prospect for recovery from the fallout of the 2008 banking crisis. With the US housing market showing tentative signs of recovery and unemployment levels stabilising, prospects for growth in certain regions remain reasonable. In the UK, the focus remains very much on the central London market which is effectively in a housing bubble although demand from wealthy immigrants shows little sign of easing. This effect has a natural impact across all sub sectors of the central London market where nearly all of our UK holdings have good exposure. Europe, on the other hand, remains depressed although valuations are low. We do not expect an early turnaround in this area, however, which remains a relatively underweight part of the Fund portfolio.

Not all parts of the portfolio operate in such difficult and often stagnant markets. Our only Asian equity, The Link REIT in Hong Kong, which is the largest quoted REIT in Asia, continues to benefit from a strong trading performance from its portfolio of shopping malls and car parks. Land in Hong Kong, where The Link carries out most of its business, is underpinned by scarcity value making this an ideal investment and one which the Fund has held for several years. As an investment, in addition to the rising value of the company's land and assets, The Link has always pursued an active dividend policy and avoided the dividend cuts incurred by other parts of the industry in the wake of the banking crisis. The current yield of 3.5% is paid gross to investors and distributions have grown since the first dividend was paid in August 2006.

International Real Estate has held up remarkably well in 2012 to date. The Fund returned 11% over the first half of the year which was an improvement on the returns from global equities (+6%) and global bonds (+0.4%) which have struggled to make much headway against a backdrop of difficult market conditions. The company visits we have made over the course of the last quarter have highlighted why this level of outperformance has occurred and why it is likely to continue in the near future if, as we expect, markets remain choppy pending a resolution to the Eurozone crisis.

Firstly, most of the securities in the underlying Fund portfolio have a strong tenant base. This is absolutely critical to the success or otherwise of a commercial property portfolio as it enables landlords to look through short term weaknesses in the market place and to build up cash balances either for acquisitions, refurbishments or return of cash to shareholders by way of dividends. Secondly, and not unrelated to the first point, property portfolios need to be centrally located in areas of above average growth. In the UK this currently means London although a number of our property companies have sites out of London where returns have been robust, if not spectacular. This leads to the third criteria that management teams must be able to add value in falling as well as rising markets. Whilst age and experience is often considered to be a barrier to entry in more hi-tech markets, in property it is almost a prerequisite for success. That is not to say that younger management teams cannot do as well as their more experienced colleagues. It is just that successful property investing is a longer term, cyclical business and we are generally reassured by the longevity and track records of the management teams running the businesses in which we invest.

It has been a good start to 2012 with the Fund up by nearly 11% in Dollar terms in the first quarter. To a greater extent, this move reflected the ongoing recovery in the US commercial property market where the fund has a near 50% exposure. Much of the stock-market gains in the quarter were driven by a recovery in financial and technology stocks, many of which carried on their ascendancy from the depths reached in the third quarter of 2011. Nonetheless, the pattern of recovery in the major commercial property sector is well underway and the fund price has now doubled over the last three years.

Improving economic conditions translate into improved profitability for the companies in the Fund portfolio, most of which have a high correlation with the wider economy. Better GDP growth means a more secure tenant base and provides scope for rental growth as well as a reduction in tenant failure, something which has hurt UK high street retailers in recent years. Despite the difficult conditions in this market, our holdings have proved to be generally resilient with the exception of those exposed to the UK industrial sub sector which has suffered as economic growth in the region has failed to gain meaningful traction. Elsewhere, however, the Canadian market, which represents our third largest regional exposure (after the UK) has fared well whilst our European holdings have been resilient despite the ongoing Euro zone crisis.

We do not expect to shift asset allocation significantly within the portfolio in the short term. The large weighting in North America has worked in our favour and the US is now some way ahead of other major economies in terms of recovery from the banking crisis, in part thanks to its relatively limited exposure to Europe (from an export/import perspective). We also remain diversified across a range of sub sectors and we expect the ongoing recovery to filter through to investors in the form of improved dividend payouts as the year progresses. The commercial property sector remains divided between the 'haves' and the 'have nots' with the best opportunities being found in the more significant players with financial muscle and deeper pockets. From our perspective, this means a focus on top end city centre properties rather than second tier businesses where conditions are far more difficult. Inevitably, it also means a focus on the leading Real Estate Investment Trusts where dividends are robustly covered by rental income streams and liquidity is ample.

The global real estate sector had a tough 2011, falling by 8% in Dollar terms. The International Real Estate Fund fell by 3.8% over the course of the year, due in part, to its large exposure to the US Real Estate Investment Trust (REIT) sector, which was the only major global property market to record a meaningful total return over the year. Australia, where we also have an overweight position, performed reasonably well but the UK and especially Europe were both disappointing as their respective economies spent most of 2011 grappling with the fallout from the euro zone crisis and fears of a double dip recession.

Within the portfolio, shopping malls performed well. Apartment companies also performed well as the shift from home ownership gathered momentum but it was another poor year for the hotel sector. This helped our relative performance as we typically avoid this part of the market. Elsewhere, the office sector performed indifferently thanks to weakening employment trends whilst industrials too lagged the market thanks to their correlation with the wider economy. Interestingly, emerging market property, where we have a very low weighting, performed badly as risk aversion prevailed, liquidity dried up and economic growth sagged.

We do not expect to alter our asset allocation significantly in the first half of 2012. Growth in the US is forecast to be the highest in major markets, at least in the first half of 2012, and the US has relatively low exposure to Europe. We may reduce our holdings in this region as, Germany aside, it will be some time before the euro zone crisis abates although yields are attractive and dividend payouts are secure thanks to the widespread financial restructuring which took place in the wake of the 2008 credit crisis. Central London prices are holding up well, but outside this area the UK is suffering from anemic economic growth and high unemployment, neither of which is likely to improve in the near term. However, from a yield perspective, the UK market is attractive and withholding taxes are generally lower than in other parts of the world.