Global equity markets rose on a quarterly basis for the first time since the third quarter of 2007, when the credit crisis first took hold. During the second quarter the MSCI World (Developed Markets) Index rose by 20.75%[1], making it one of the best quarters in the history of the Index. Even more astonishing was the three-month period to the end of May, which saw the MSCI World Index rise by more than 30%!

During April and May stock markets delivered a monthly return of over 11% and 9% respectively. However, there was a period of reflection in June, as equity markets fell by less than 0.5%. This 'pause for breath' was probably necessary given the strength of the rally based on what many have viewed as fairly flimsy support. During June, the ongoing debate continued about whether or not the global economy andmarkets are in the midst of a stabilisation and prospective recovery. All regional markets participated in the stock market rally. In dollar terms, the markets were led from the East, with the Pacific excluding Japan region rising by nearly 32%, Japan advancing by over 23% and Europe up 25%. The US posted a relatively modest return of just under 17%. However, it was the emerging markets that delivered the highest returns, with the MSCI Emerging Markets Index rising by nearly 35% over the quarter. At an emerging-market country level, Singapore was the strongest performer rising by just under 46%. China and Brazil experienced gains of almost 36% and 41% respectively, while India and Hungary outshone these emerging-market stalwarts, delivering returns of about 60% and 70% respectively. Within the Fund, no changes were made to the composition of the underlying managers during the quarter.

The first quarter of 2009 was characterized by extreme volatility in equity markets with a sharp pull back in January and February followed by an extremely strong recovery in March. Reflecting this, the MSCI World Index was down 12.5% for the quarter masking a 7.2% recovery in March. Emerging markets fared better up 0.5% for the quarter and 14.2% up for year to date. Signs of economic stabilization in the global economy helped lifted sentiment in March. Economic catalysts for the rally included an upturn in China's leading economic indicator, a rebound in Chinese and Japanese purchasing manager indices, a V-shaped rebound in ISM new orders, better than expected US housing data, buoyancy in mortgage refinancing and ongoing destocking of inventories in most major regions across the world.

In the Eurozone, the ZEW expectations index pointed to a recovery in GDP growth later in the year although the coincident index suggested the recession would still deepen in the short term. Although visibility in the global growth outlook is improving, headwinds remain such as - benign consumption expenditure on rising unemployment, massive declines in export growth, especially in Asia and Japan, and still high real yields on corporate bonds and mortgage backed securities. Financial catalysts also boosted sentiment this quarter, these included quantitative easing in the US, Japan and the UK all designed to force down long term interest rates, unfreeze credit markets and remove toxic assets from bank balance sheets. That these measures have had some success is borne out by the declines in nominal borrowing rates, and the beginnings of a narrowing in corporate bond spreads. In the US, the introduction of the TALF programme (Term Asset Backed Securities Lending Facility) saw the Federal Reserve commit some USD300bn to purchases of US Treasuries, a further USD750bn in purchases of mortgage backed securities and a further USD100bn for purchases of GSE debt. In total some USD1.15trillion was committed over and above the USD750bn announced under the Tarp programme (Troubled Asset Rescue Package). The UK's quantitative easing programme was less spectacular at GBP75bn, while Japan's spend was a more muted USD100bn.

The stimulus packages announced to date, along with multi-trillion USD guarantees, have partially allayed market concerns about the likelihood of a global economic recovery going forward. Questions still remain about the shape of the recovery i.e will it be a U, L, W, V or J-shaped recovery? SMMI favours the latter believing that consumer behaviour has changed following the credit crisis, at least in the developed world, and that savings will be ramped up in anticipation of higher future taxes needed to fund the mushrooming fiscal deficits as well as providing a cushion against an expected surge in inflation over the next few years. Given this scenario, corporate profits will recover but growth will likely remain muted for some time to come. Against this backdrop then one needs to ask whether equity markets will continue to rally or whether they have run ahead of themselves. We are happy with the blend and diversification of the underlying managers and as such no changes where made during the quarter in this regards.

Market review
Deleveraging, correlation and eventual capitulation were all evident in 2008 and produced a roller coaster ride for global equities. The MSCI World Index ended the year down 42.1% in dollar terms and 22.1% down in the fourth quarter in the wake of Lehman Brother's collapse and recessionary conditions evident across developed markets. Emerging markets fared worse as risk appetite disappeared, down 27.9% in the quarter and 54.5% for the year. Global recessionary fears pushed policy makers to unprecedented policy reaction. In the US, President-elect Barack Obama announced a $775bn package with some $310bn in tax cuts and the balance in infrastructural projects. In addition, the Fed cut interest rates to 0-0.25% - an all time low. Other central banks followed suit, announcing bail out packages and aggressive rate cuts. These measures triggered a New Year rally but this is likely to be a rocky path given the headwinds over the coming quarters. Economic recession in the developed world is expected to deepen, with earnings growth likely to contract further. Given the lead and lag between US earnings and those in the Eurozone, Japan and emerging markets, the outlook for earnings remains depressed. With corporate spreads also likely to remain at elevated levels at least in the first half, a second half recovery in US earnings will need to be accompanied by an easing in corporate spreads. A further catalyst will need to be a broad-based turnaround in leading economic indicators, particularly in PMI indices. Any recovery will be driven by huge fiscal expenditure and policy initiatives aimed at normalising the credit markets. Investors expecting a miraculous global economic recovery in 2009 are likely to be sorely disappointed, with many of the challenges evident last year continuing to weigh on markets for most of this year.

What SIM did
The fund underperformed its benchmark for the year as all the underlying managers performed poorly. Particularly disappointing was the Alliance Bernstein Value-Growth blend. SIM's High Conviction fund's exposure to emerging markets also hurt performance. No significant change was made to the strategy of the fund over the quarter as the fund is well diversified and has a good blend of different equity styles.