Quarterly investment commentary – second quarter 2007

Steady progress

Over the second quarter, global equity markets continued to move higher with the MSCI World Index* achieving a total return of 6.7% in US dollar terms and 5.0% in sterling terms. However, towards the end of the quarter, markets dipped on profit-taking and concerns over the prospects for US inflation and interest rates. In the US, both the Dow Jones Industrial Average and the S&P 500 Index reached record highs during the period. Elsewhere, markets in Asia were particularly strong with the regional MSCI Index setting an all-time high in June. The continuing strength of the Chinese economy is benefiting countries throughout Asia.

Overall, it was a difficult quarter for government bond markets. UK and European bonds continued to face the headwind of higher interest rates as central banks sought to combat inflationary pressures. It was also a disappointing quarter for US Treasury bonds. Until recently, many investors had been expecting US interest rates to move lower in the second half of 2007, given the protracted slowdown in the US housing market. It now appears likely US rates will remain unchanged over the second half of 2007.

The robust level of global economic growth has been a key factor contributing to the upward pressure on both consumer and producer prices, and the consequent tightening of monetary policy in the UK and Europe. Both the Bank of England and the European Central Bank increased rates by a quarter point during the period – UK interest rates raised to 5.5% on 10 May and eurozone rates increased to 4.0% on 13 June.

While the upward course of interest rates in the UK and Europe proved unhelpful for government bond markets, equity investors have tended to focus on the beneficial impact of stronger economic growth. This is helping to boost the level of corporate earnings and allowing companies to pay out higher dividends to shareholders. In the UK and Europe, investors have also shown more interest in larger companies at the expense of small and medium-sized stocks. For much of 2007, blue-chip stocks had lagged the gains seen in their smaller counterparts and the comparative valuations of larger companies have become increasingly attractive.

The high level of takeover activity, both by other companies and private equity firms, has been a key factor helping to drive equity markets higher. During the second quarter companies such as Hanson and Reuters in the UK were on the receiving end of takeover bids, while private equity firm KKR has completed its acquisition of Alliance Boots.

* MSCI World Index:
The Morgan Stanley Capital International World Index is a market capitalization-weighted benchmark index made up of equities from 23 countries, including the United States.

Index returns source: Thomson Financial Datastream. All returns shown are total return to the end of June 2007.

This table shows how different indices, representing different geographical regions, have performed over various time periods to 30 June 2007.

We’ve sourced the index figures, in sterling terms, from Financial Express to 30 June 2007. The indices mentioned above are measures of the markets they represent. For example, The FTSE All-Share Index represents 98-99% of the UK market capitalisation. It is the aggregation of the FTSE 100, FTSE 250 and FTSE Small Cap Indices.

You shouldn’t take past performance as a guide to future performance or as the main or sole reason for deciding to invest. It may have been achieved in a more favourable economic period that may not happen again, and tax conditions are unlikely to be the same. We don’t guarantee the value of your investment and any income, both of which can go down as well as up.

A long-term commitment

We believe it’s important, where possible, to take a long-term view when investing. Looking back over the years, volatility has always been a feature of world stock markets, with each setback followed by a recovery – some taking longer than others. One of the best and most accepted ways to deal with volatility is to invest for the medium to long term – a period of at least five to eight years.

It’s important to invest in the right funds, and this depends on your investment objectives and attitude to risk. If either has changed, your adviser will help you review your investment to make sure it continues to meet your needs. Although we can’t give you investment advice, we do offer a wide range of funds suitable for almost all investment objectives and attitudes to risk.

We’ve written this commentary assuming you have some experience of investing in stocks and shares. This means that although we have tried to write as much as possible in plain language, we may have used certain words or phrases that might not be familiar to anyone new to investing. If you don’t understand any part, please contact your adviser.

We strongly recommend you speak to your adviser before making any changes to your plan.