Global equities declined during the second quarter after reaching a peak in late April, as investor fears mounted over Europe's escalating fiscal troubles and a potential slowdown in the world's economic recovery. Heightened anxiety in the financial markets saw the MSCI World Index finish the quarter 12.7% lower in US dollar terms. No region or sector was spared the flight from risk. Industrial stocks were hardest hit due to concern that a relapse into recession might undermine demand. Financials were seen as potential victims of a double-dip recession and regulatory reform. Weak stock selection in both sectors hurt relative returns and our portfolios underperformed the benchmark during the quarter and year to date returns, date.

Markets were extremely volatile as investors reacted to the concerns that sovereign-debt problems in Europe might spread and undermine economic growth in other economies. This was accompanied by a host of other new uncertainties: from the oil spill in the Gulf of Mexico to signs of a softening in US consumer confidence. Stocks fell in both developed and emerging markets, and credit spreads widened. But while risk aversion increased, it remains far below the levels seen during the recent financial crisis. For example, interbank lending rates are still in line with pre-crisis historical norms.

Emerging market economies are leading the recovery, thanks to booming domestic demand. Within the developed world, the euro-area recovery is lagging, as fiscal austerity measures in Greece and other high-deficit nations challenge economic growth. But not all Europe is in the same boat, core euro-area countries such as Germany are recovering steadily thanks to a weaker euro and historically low interest rates.

Risk aversion and deflationary fears, together with a vigorous short covering rally, saw global intermediate interest rates decline between 50 and 85 basis points (bps) lower, led by the 10-year US Treasury yield, which fell 85 bps to 2.93%. Global corporate credit indices underperformed treasuries by about 2.5 percentage points, giving back more than their first quarter excess returns, but still delivering positive absolute returns, especially in the US market.

Global equities declined during the second quarter after reaching a peak in late April, as investor fears mounted over Europe's escalating fiscal troubles and a potential slowdown in the world's economic recovery. Heightened anxiety in the financial markets saw the MSCI World Index finish the quarter 12.7% lower in US dollar terms. No region or sector was spared the flight from risk. Industrial stocks were hardest hit due to concern that a relapse into recession might undermine demand. Financials were seen as potential victims of a double-dip recession and regulatory reform. Weak stock selection in both sectors hurt relative returns, and our portfolios underperformed the benchmark during the quarter and year to date.

Markets were extremely volatile as investors reacted to the concerns that sovereign-debt problems in Europe might spread and undermine economic growth in other economies. This was accompanied by a host of other new uncertainties: from the oil spill in the Gulf of Mexico to signs of a softening in US consumer confidence. Stocks fell in both developed and emerging markets, and credit spreads widened. But while risk aversion increased, it remains far below the levels seen during the recent financial crisis. For example, interbank lending rates are still in line with pre-crisis historical norms.

Emerging market economies are leading the recovery, thanks to booming domestic demand. Within the developed world, the euro-arearecovery is lagging, as fiscal austerity measures in Greece and other high-deficit nations challenge economic growth. But not all Europe is in the same boat, core euro-area countries such as Germany are recovering steadily thanks to a weaker euro and historically low interest rates.

Risk aversion and deflationary fears, together with a vigorous short covering rally, saw global intermediate interest rates decline between 50 and 85 basis points (bps) lower, led by the 10-year US Treasury yield, which fell 85 bps to 2.93%. Global corporate credit indices underperformed treasuries by about 2.5 percentage points, giving back more than their first quarter excess returns, but still delivering positive absolute returns, especially in the US market.

All performance figures are quoted in US dollar terms unless stated otherwise.

Financial markets made fitful progress during the first quarter, as credit spreads narrowed further and stocks recovered from January's steep decline to end the quarter higher in most developed markets. Investors gained confidence from increasing signs that the global economic recovery was continuing to gain momentum, although concerns lingered about the sustainability of the recovery and the likely impact on the global economy of soaring public debt levels. The MSCI World advanced 3.24% in total dollar-based returns for the quarter.

The quarter itself was a tale of two halves: after an initial rally at the start of the year, the market sold off from mid-January to mid-February, and then rallied strongly, recovering earlier losses and moving to new recent highs. On a monthly basis, the market fell by more than 4% in January, rose by almost 1.5% in February and by over 6% in March. The market's concern in the first part of the quarter related primarily to sovereign risk issues, particularly in Greece. These fears were not limited to Greece, but extended to Portugal, Spain, Ireland, Italy and the UK. Other market concerns were on the strength and sustainability of the economic recovery, while the possible threat from inflation appeared to have attracted less attention from the middle of the quarter.

Major global central banks delivered solemn warnings about the fragility of the incipient recovery during the quarter, while taking practical steps toward policy normalisation. For instance, the US Federal Reserve increased its discount rate; stopped buying agency mortgage-backed securities (MBS); tested reverse repos and created a 'term deposit facility' designed to reduce excess liquidity The European Central Bank began phasing out its long repos, term-facility liquidity. term repo operations and moved back toward variable rate tenders, with limited amounts offered in its three-month operations. Meanwhile, The Bank of England suspended its asset purchase program in February.

[1] All performance figures are quoted in US dollar terms unless stated otherwise.

Equity markets extended their rally through a third straight quarter at the close of 2009. During the final three months of the year, the MSCI world index rose by 4% in US dollars while the equivalent index of Emerging Markets rose by 8%.

Companies have focused strongly on reducing costs over this period, with initiatives to reduce capital expenditure, raise productivity and keep inventories at historically low levels. This trend was the main reason for the better-than-expected earnings figures reported for the third quarter of 2009. Most of the pleasant surprises came from lower-than-expected costs, rather than higher sales. In the financial sector, balance sheets and capital ratios were generally stronger but the process of reducing leverage still has further to run stronger, run.

Corporate earnings are expected to be strong on a year-on-year comparison for the first quarter of 2010, given the economic weakness a year ago. However, as 2010 progresses earnings comparisons are going to be tougher to beat given the stimulus packages seen and corporate cost cutting that took place during 2009. Consequently year-on-year corporate earnings comparisons for later in 2010 are likely to look significantly less favourable to those of the first quarter of 2010. The hope is that top-line growth will lead to corporate earnings continuing to rise throughout 2010.

Investment appetite for riskier appetites continued to grow during the fourth quarter, despite a rise in Treasury yields due to improving economic news and concerns about much greater government bond issuance. The Barclays Capital US Treasury Index returned -1.3% and -3.6% for the quarter and year respectively. In contrast, the strongest performing sectors during the period were high yield, up 6.2% (58.2% for the year) and collateralised mortgage-backed securities (CMBS), up 3.3% (28.5% for the year). Another measure of demand for risk assets was the S&P500's 6.0% quarterly return. This performance was impressive not only against a backdrop of higher interest rates, but also in the face of the Dubai World default scare; an Austrian bank failure and sovereign credit quality concerns, particularly regarding Ireland, Spain, and Greece.

Investors continue to speculate as to what the Federal Reserve's "exit strategy" will be from the unprecedented combination of traditional and nontraditional support of the credit markets.


All performance figures are quoted in US dollar terms unless stated otherwise.