Global equity markets experienced a continuation in the rally that took hold towards the end of the first quarter. During the three-month period, the MSCI World (Developed Markets) Index rose by 17.45% in dollars. While not as substantial as the market gains seen during the second quarter, this was still a significant return for a quarterly period. After a slight pause in June, the market roared back in July by 8.5%. In August and September, the market rose by 4% in each month. Despite a torrid start to the year, the market is now up almost 25% year to date, having risen in six of the past seven months.

All regions posted positive absolute returns, with the MSCI Pacific excluding Japan leading the way, up more than 27% for the quarter. Europe followed, rising nearly 23% during the period, while the US delivered just less than 16%. Japan was the clear laggard, rising only 6.51%. Emerging markets continued to outperform their developed counterparts during the third quarter.

The market has clearly rallied substantially off its market lows, and whilet this may not have been totally justified at the end of the second quarter, the stabilising and even improving economic news definitely supports a significant move off the market lows. The macroeconomic threat of financial meltdown a year ago has mainly passed, although significant challenges still remain. Central banks continue to pump liquidity into financial markets in an effort to reignite the global economy and economic growth. While many economies are still experiencing negative or sluggish economic growth, conditions do appear to be improving and attention has now sharply turned to focus on the nature of the economic recovery, including the potential threat of a double-dip recession.

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

The second quarter of 2009 saw global equity markets rise for the first time on a quarterly basis since the third quarter of 2007 - when the credit crisis first started to emerge. For the period, the MSCI World (Developed Markets) Index rose 20.75%[1], making it one of the best quarters in the history of the MSCI World Index, and the best for over 10 years. Even more astonishing was the three month period to the end of May, which saw the MSCI World Index rise by more than 30%! Returning to the quarter itself, April saw the rally which began in late February continue with a monthly return of over 11%, and May was little different to April as the market rose by over 9%. However, in June a period of reflection took place as equity markets fell very slightly, but by less than -0.5%. This potential 'pause for breath', was certainly required given the strength of the rally, on what many have viewed as fairly flimsy support, and evidence of this concern re-emerged during June as the on-going debate about the future direction of the global economy and market continued. In light of the strength of the market rally it will come as no surprise that all regional markets participated. In dollar terms the markets were led from the east, with the Pacific excluding Japan region rising by nearly 32%, while Japan rose by over 23% and Europe by over 25%. North America posted a relatively modest return of just under 17%. However, it was in the emerging markets where the highest returns were delivered, with the MSCI Emerging Markets Index rising nearly 35% over the quarter. At the country level, within the Developed Markets arena, Singapore was the stand-out performer rising a shade under 46%, while Greece, Hong Kong and Spain all managed to rise by over 35%. In sharp contrast, although what under normal conditions would be a very respectable return, was Ireland rising by only 6.61%. This was the clear laggard, with the next worst performer being the USA rising a little over 15%. Switzerland, with a gain of 16.30% was the only other Developed Market that did not rise by at least 20%. In the emerging markets a divergence of performance was observed with Israel not quite gaining 16%, while the likes of China and Brazil gained nearly 36% and nearly 41% respectively. However, even these were outshone by the likes of India rising almost 60% and Hungary by slightly shy of 70%! No changes were made to the composition of the underlying managers during the quarter.

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

The first quarter of 2009 was characterised 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 stabilisation in the global economy helped lift 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 designed to force down longterm interest rates, unfreezing of credit markets and removal of 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 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 in this regard during the quarter.

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 Brothers' collapse and recessionary conditions evident across developed markets. Emerging markets fared worse as risk appetite disappeared, and were 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 bailout packages and aggressive rate cuts.
These measures triggered a New Year rally, but this is likely to be a rocky path given the headwinds in 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 of the year, 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 Purchasing Managers 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.
The fund underperformed its benchmark for the year as the underlying managers delivered disappointing 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.