Global equity markets rallied in December, as worries about the eurozone debt crisis and the fear of a prolonged period of low growth for the Chinese economy continued to recede. Instead, the US fiscal cliff became the dominant global macro concern, causing some weakness in consumer confidence, although economic data remained positive. The cliff was partly addressed through the agreement passed by Congress on 1 January 2013. Due to this uncertainty, US markets underperformed, with the S&P 500 up 0.7%, compared to the Eurostoxx 50 up 2.4% (both in local currency). Japanese markets performed best, with the Topix gaining over 10% in local currency terms, as elections in that country saw the return of Shinzo Abe as Prime Minister with a mandate for economic stimulus to reflate the Japanese economy through fiscal packages and more aggressive inflation targeting. In the currency markets, the prospect of looser monetary policy caused the yen to fall to a two-year low against the dollar. Yields on peripheral European debt remained stable, with the Italian government successfully selling debt into the market in December.

Against this backdrop, the Fund maintained a delta at the upper end of its range, as our Global Strategy Team (GST) maintained a constructive view on risk assets. Relative to the MSCI World, our stock selection module was short the US and long Europe, which benefited the Fund. The US, however, continues to be the largest regional allocation. Over the course of the month we increased our positions in Japan as we believe there is a very real prospect of this country outperforming given the changing political landscape. At a sector level, our biggest contributors were overweights to the financial and consumer discretionary space, while the biggest detractors were underweights in information technology and industrial stocks.

Within fixed income, we maintained our core position in Australian 10-year bond futures and switched some of our Australian inflation-linked bond position into the higher yielding New Zealand equivalent. While our core US Treasury holdings detracted from performance, we maintained a short 10-year Treasury future, which added value; we took some profits on this position towards the end of the month. We added a small position in the 5-year part of the UK curve and with bond yields across Europe stabilising, we added to duration in Italy where roll and carry remains attractive. Duration in sovereign bonds ranged between 1.4 and 2.4 years for the month and despite some small relative outperformance from Australia, fixed income performance in a falling market was negative. We continue to hold a convertible bond allocation and in the recent positive environment this provided alpha for the Fund.

Looking ahead we remain positive on the outlook for risk assets going into 2013, as the macro environment slowly improves, central banks continue to add stimulus and positioning in equities remains modest. While risks remain within Europe, we are comfortable holding Italian debt. Although there remains much more to be done for the US to get onto a sustainable spending path, we were encouraged that a Republican Congress agreed to tax rises as this was a sign that co-operation and compromise can be achieved. We believe a portfolio with a core allocation to high-yielding equity stocks and a modest allocation to core fixed income captures dividend yield as well as further potential upside from equity markets, with highly rated fixed income instruments providing diversification benefits

Developed equities outperformed emerging markets in March and Japan continued to lead the way with the Nikkei rallying more than 7%. There was significant divergence within the developed world though, with the S&P gaining 3.6%, while the Eurostoxx posted losses of 0.4% and Spain’s IBEX fell more than 3.7%. Much of the relative underperformance can be attributed to concerns about the bailout in Cyprus, despite the country accounting for less than 0.5% of Eurozone GDP and the package being much smaller in absolute terms than the ones implemented in Greece or Ireland. The reason the bailout was so important was that the original terms contained a “tax” on all bank deposits, including those under 100,000 Euros, the threshold size of deposit that should be protected under the Eurozone deposit insurance scheme. After the initial proposal was rejected by the Cypriot parliament, the final bailout safeguarded these smaller depositors at the expense of those with holdings greater than 100,000 Euros. While the Troika have insisted that the Cypriot banking system needed to shoulder some of the burden, having benefitted from its "no questions asked" approach to potentially suspect Russian money, the consequences of asking depositors to bear the cost of the bailout may reverberate for some time. Deposit flight from Portugal, Spain or even Italy could put pressure on the periphery and undo much of the good work that the OMT backstop has done in restoring investor confidence in the region.

Over the course of the month, the Fund maintained a delta towards the upper end of the range and continued to hold significant positions in Japan and the US, the two regions favoured within our asset allocation framework. Within equities, we prefer consumer discretionary and financial stocks in the US and Japan, a combination that outperformed the broad MSCI World Index significantly over the month. We continue to hedge some of the US exposure with a short in US small-cap equities. We also have a small short in Chinese equity futures with a view that inflation and the country’s property bubble will provide strong headwinds for the banking sector. This trade added value over the month as the H-Shares Index fell just over 4.7%. Within convertible bonds, we trimmed some names, but maintained close to a 20% allocation that provided significant carry to the Fund and some modest capital gains, despite increased volatility towards the end of the month. Our fixed income allocation contributed positively to performance in March and we maintained an average duration of 1.2 years of high quality government bonds. We continue to hold a long position in Australian 10-year government bonds as well as our strategic positions in inflation-linked bonds in Australia and New Zealand. A short position in short-dated Australian nominal bonds added value as the prospect of rate cuts from the RBA became overextended. We added duration in Europe on the back of events in Cyprus and the flight to quality bid that ensued saw this trade add to performance, while our inflation swap in the UK also did well.
We remain comfortable with the current level of risk in the Fund given the level of global monetary easing, which has provided significant liquidity and forced investors up the risk spectrum. In the short term, we are monitoring events in Japan carefully and are wary of the potential for disappointment given heightened expectations for the BoJ’s meeting in April. Events in Europe have once again demonstrated that risks remain and while we have little exposure to Europe and are short the currency, another crisis in the periphery does have the ability to affect sentiment in markets where we are constructive and where the data has been encouraging, notably the US.

The fund changed sectors from Global--Multi Asset--Low Equity to Global--Multi Asset--Flexible on 05 Feb 2013