Global equities came under pressure, triggered by the collapse of sub-prime debt and the subsequent reduction in investors' risk appetite. The Eurozone was not immune, with the DJ Euro $ Stoxx 50 down 0.65% for the quarter vs being up 8.6% for the previous quarter. The high exposure to financial stocks in the index - 34% - impacted badly on the performance of the fund as this sector was hard hit by the sub-prime fallout. Stocks like BNP Paribas, Societe Generale, Barclays and UBS to name but a few, were all down over 14% at the time of the crisis. With the central banks pumping in over $400bn in liquidity during the crisis, the sector has recovered to some extent but remains jittery. The FTSE 100 also did not fare well, losing 2.28% after returning 4.56% in the second quarter.

Emerging Europe was not immune either as investors bailed out of emerging markets. This is reflected in the performance of the Aviva Convergence Fund where the relative regional losers were Hungary and Poland, which returned -1.44% and 0.65% respectively for the quarter. Together they form 28% of the convergence fund. To a large degree the Polish market reflected the collapse of the ruling political coalition as opposed to economic concerns as earnings continued to beat expectations. In contrast, Cyprus, which makes up 19.4% of the fund, rose by 4.85% for the quarter as corporate results remained strong. This follows a 6.2% return in the second quarter.

Eurozone fundamentals remain firm, with GDP growth expected to be 2.7% for the year. Fuelling growth is an improvement in the business competitiveness that is countering the impact of a stronger euro. European exports are also more insulated from a slowdown in the US given the emerging markets closer to home and the relatively firm growth of the BRIC economies. These economies are now greater contributors to global growth than the US. The consumer sector remains upbeat, with unemployment declining across the region. This positive growth is translating into strong profit growth and upward earnings revisions that should underpin the market in the months ahead. The one risk remains the hawkish tone of the ECB, which could result in another rate hike once the impact of the sub-prime debt fallout dissipates.

Overall the blend of funds is working well and offers investors a well-diversified portfolio covering both developed and emerging markets in the region. As such no significant changes where implemented during quarter.

European equities continued their strong performance, with the DJ Euro Stoxx 50 delivering 8.7% for the quarter in dollar terms. Better-than-expected first-quarter earnings and further evidence of economic strength in Europe, particularly in Germany, have lead to earnings upgrades for 2007. Merger and acquisition activity coupled with news of share buybacks and corporate restructuring bolstered sentiment. Against this backdrop the 25 basis point rate hike by the Bank of England and the ECB had little impact on equity performance. The Dax Index had a stellar performance, up 17.2% in dollar terms, while the FTSE 100 lagged the European region and only delivered 6.8%.

In order to diversify some exposure away from the developed markets in the region and to take advantage of the growth story in emerging Europe, a new fund - the Aviva Convergence Fund - was added to the fund. This fund invests in equities in those countries that were approved for entry into the European Union on 1 May 2004. It can also invest up to 20% in companies that derive a meaningful proportion of their revenues from countries participating in the EU enlargement process. This fund has exposure to diverse economies such as Poland, Cyprus, the Netherlands, Turkey and Hungary, which are not accessible through traditional European funds. Given the divergent equity drivers offered by this region, we believe that this addition will add value going forward. To accommodate the 10% holding in this fund we sold out of the Sanlam UK Equity Fund (5.5%) and reduced our exposure to the Fidelity Blue Chip Fund by 4.5%. Despite this the fund still has a large exposure to both these regions due to the 78% holding we have retained in the Merril Lynch index tracker fund. As a result the top three regional exposures remain - the UK, Germany and France.

Global equities yielded 2.1% in USD terms over the past quarter, significantly lower than the 8.0% reported in the forth quarter of 2006. Performance in the Pan European region followed similar trends, with Europe and the UK having returns of 1.5% and -0.3% respectively. These are way down from the 8.5% and 10.8% achieved in the fourth quarter and reflect the pullback in late February/early March with the global correction. In addition the fall in oil prices in January impacted on the UK market given its relatively large oil sector.

Growth in the region is firm although the momentum is slowing under the impact of four rate hikes - the last having occurred during the quarter. Merger and acquisitions (M&A) continue to dominate the region, driven by the cheap cost of debt financing that is used to buy listed equities. There are few signs of this changing; in fact, there were some highly leveraged deals during the quarter. Speculation on these deals has also supported the market.

Corporate activity such as share buybacks and special dividends are still playing a role. Our managers have started focusing on opportunities in the large-cap area of the market as the M&A activity is starting to move up the capitalisation scale. The underlying structure and manager exposure of the fund have not changed during the quarter and the biggest regional bet remains the overweight position to the UK market. This market is expected to do well given that interest rates are at their peak, the M&A activity remains relentless and firm earnings growth is still expected.

The welcome mollification of global inflationary fears around mid-2006 led to lower bond yields and higher equity prices in the second half of the year. Credit spreads narrowed again after widening in the middle of the year, volatility stabilised and emerging markets recovered strongly along with developed equity markets. All eyes remained on the next step of the US Fed, and the end of US interest rate hikes was heralded by many market commentators. Judging by the latest statement early in the fourth quarter, this expectation appeared to be on track.

However, strong economic performance in many major areas around the globe during the last quarter has served to shift expectations again, and longterm interest rates rose towards the end of the quarter and into the new year, albeit not back to the June peak. The question of "whether" rather than "when" the US interest rate cycle will peak in 2007 is once again being asked. During 2006 European markets fared well relative to the MSCI, as growth in the region was better than expected. Germany and France did particularly well among developed European markets. Given the economic growth seen in 2006 for the region, the outlook for lower short-term interest rates seems less optimistic than before, but the equity markets in the region should continue to benefit from the continued positive outlook for growth. During the past quarter the exposure to the UK was reduced in favour of exposure to European blue-chip shares via the Fidelity Euro Blue Chip Fund.

This decision was based on our view that the strength in the British pound was unlikely to be sustained at levels seen in 2006, and the improved outlook for European growth favoured higher non-UK exposure. The core manager (Merrill Lynch) continues to do well and the managers in the UK Equity Fund continue their excellent track record of outpacing the FT All Share Index.