Global Outlook

Global Outlook
Second Quarter 2011
In this issue, we examine the outlook for corporate profits given our
expectations of a deceleration in economic activity during 2011. This
quarter’s Focus on Change article examines the key drivers supporting
global real estate.
Global Outlook 1

Summary
06 Global Overview
Turbulence is building up
The House View forecasts that the pace of corporate
profits growth will decelerate through 2011, as
companies face a squeeze from both revenues and
especially costs. Investment risks will remain high,
reflecting both political and geo-political events, on
top of the normal cyclical issues facing investors.
08 Focus on Change
Investing in commercial real estate
Real estate benefits from a relatively secure and
sustainable yield at this stage of the economic
cycle. This is underpinned by ongoing global
economic recovery, generally constrained supply and
improvements in business and occupier confidence.
10 Global Sectors
Mining for value
The global recovery may remain muted but there are
attractive opportunities for those firms with exposure
to the engines of growth.
11 US Equities
Giving business a boost
Drug distributors are benefiting from the move to
generics, while energy drinks pick up the pace in
consumer staples.
12 UK Equities
Refocusing builds competitiveness
Industrial manufacturers and infrastructure
companies are adapting to meet fresh challenges,
leaving them well-positioned for strong and sustained
earnings growth.
13 European ex-UK Equities
Slick operators
Certain oil services holdings could gain from the move
to offshore, while rising food prices prove no bad thing
for some firms.
14 Japanese Equities
It pays to have social skills
The impact of social media is proving fruitful for some
retail and technology firms, while rising input costs are
less of a problem for our favoured chemical stock.
15 Emerging Market Equities
A new horizon
Asian companies are responding to a need for greater
efficiency. IT services companies and environmental
technology firms are set to benefit.
16 Government Bonds
A balancing act
We examine the prospects for government bond
markets against a backdrop of rising inflation and
prospective rate hikes.
17 Corporate Bonds
Highlighting high-yield opportunities
With investors faced by turmoil in Japan and the Middle
East as well as concerns over inflation and a weaker
economic growth outlook, we examine the prospects
for high yield in the months ahead.
2 Global Outlook

18 Money Markets
Entranced by the exit signs
Some central banks seem close to an exit strategy –
it may be the wrong choice.
19 Currency
Anticipating policy decisions
Exchange rate markets are destined to remain volatile
until the economic outlook becomes clearer.
20 Real Estate
Accessing China
Many investors are looking at Chinese property as an
investment destination. How do international investors
access the commercial real estate market in China and
what are the barriers to entry?
21 Global Index-Linked Bonds
Diverging inflation paths create opportunities
With the shockwaves of the financial crisis still
rumbling around the markets, a growing theme
is the divergence of inflation prospects across
different economies. Before the crisis, the degree of
homogeneity of outlook was remarkable; now, the
opposite is the case.
Global Outlook 3

Standard Life Investments is one of the world’s major
investment companies. Responsible for investing
funds on behalf of over five million retail and corporate
customers including the Standard Life Group, we offer
global coverage of investment instruments and markets.
We are active fund managers, who place significant emphasis
on research and teamwork. After in-depth analysis, our Global
Investment Group forms a view of where to allocate assets,
based on the prevailing market drivers and on forecasts of
future economic indicators. The Global Investment Group is
made up of senior investment managers from the Strategy
and Asset Class teams and is responsible for providing the
overall strategic focus to the investment process.
The House View delivers a consistent macro-economic
framework to our investment decisions. It generates the
market and thematic opportunities for us to add value to
our customers over the timescales they use to measure our
success. It is formulated in such a way as to make timely
investment decisions but to also allow all members of the
investment teams to influence its conclusions.
Standard Life Investments is a dedicated investment
company with global assets under management of
approximately £156.9 billion (as at 31 December 2010)
– this equates to $245.6 billion, C$244.0 billion, A$238.4
billion and €183.0 billion.
In a diverse, dynamic world we use our insight and intellect to seek out investment
opportunities. Our ability to predict, react and adapt rapidly helps us to maintain our
position as a leading investment house.
4 Global Outlook

Foreword
Keith Skeoch
Chief Executive
Recent weeks and months have seen a number of major
shocks to the global economy, most notably the earthquake
and tsunami in Japan but also the tragedies in Australia and
New Zealand as well as the effects of the recent political
developments in the Middle East and North Africa. In our
view, the world economy is strong enough to withstand the
cumulative impact; indeed the relative resilience of markets
year to date reflects this. Analysis from our fund manager
teams shows that most companies that faced financial
difficulties have rebuilt their balance sheets considerably,
and indeed are in a position where new business investment
and hiring makes sense. However, as Andrew Milligan
describes in more detail in the Overview article below, we do
forecast a deceleration in economic activity into the autumn.
We have warned that global growth will oscillate for some
time, finding it difficult to make strong headway. A number
of short-term factors are squeezing both consumer incomes
and corporate profitability. The House View has taken some
risk out of portfolios while we await some stronger valuation,
behavioural and macro triggers to re-enter the market.
The geo-political shocks and the natural disasters have
caused many clients to question the outlook for inflation in
the next phase of the cycle. This, indeed, is an important
topic, which the Global Investment Group has analysed in
much detail. The good news for investors is that our research
shows that core inflation should remain under control
into 2012. While the key drivers, namely wages growth,
unemployment levels, commodity and money supply
trends and exchange rate movements, do suggest some
upward tendencies over the coming 12-18 months, our
models do not suggest that core inflation will reach levels
which would unduly worry central bank governors. Pricing
power is being seen for many companies who operate in
a business-to-business environment, an issue explored in
more detail in the individual equity articles below. However,
for those firms operating in a consumer environment then
pricing power is much more restrained, especially outside of
emerging market economies.
Nevertheless, we are reaching a stage in the investment cycle
where investors are understandably looking more for real than
paper assets in order to protect themselves from the upwards
drift in inflation. In the Focus on Change article, Simon Kinnie
from our Real Estate research team examines some of the key
drivers supporting the global real estate markets. Similarly,
later in this Global Outlook, Jonathan Gibbs considers the
backdrop for the global inflation-linked bond markets.
Although the House View is Heavy in commercial property
and Neutral in inflation-linked debt, these are tactical calls.
Investors need to consider when their strategic exposure to
such asset classes should be raised consistently over time.
Global Outlook 5

Global Overview
Turbulence is building up
The House View warns that the pace of corporate
profits growth will decelerate into 2011, as
companies face a squeeze from both revenues
and costs. Portfolio values will swing reflecting
political, geo-political and climatic risks, on top of
the normal cyclical issues facing investors.
Chart 1
Oil is a worry
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Brent oil $ per Barrel (L.H. Scale)
12 month % change in the price (R.H. Scale)
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Andrew Milligan
Head of Global Strategy
Introduction
While a number of economists were significantly raising their
global GDP forecasts for 2011-12, in the previous edition of
Global Outlook we advocated a more balanced approach,
suggesting that for some years the global economy would
struggle to achieve above-trend growth. Indeed, various
factors such as surging oil prices should bring about more
moderate activity into the autumn. Despite this, corporate
earnings can grow apace; however, margin pressures should
not be under-estimated, while geo-political events may
periodically hurt investor sentiment. On balance, the House
View continues to favour exposure to corporate cash flows
as the primary theme for asset allocation, through a number
of income opportunities – which we define as sustainable
yield – from real estate, corporate bonds and equities. These
provide some income insulation from the limited interest rates
tightening cycle we are forecasting in 2011-12.
Events piling on events
Successful asset allocation calls require a good understanding
of numerous risks in spring 2011: inflation in emerging
economies, geo-political developments in the Middle East and
North Africa (MENA), the Euro-zone debt problems, and the
natural disasters in Japan and other parts of Asia. We address
each of these in turn.
China is just one example of an emerging economy facing
a conflict between growth and inflation targets. We expect
headline inflation to roll over later in 2011, on the major
assumption that there will be no further significant shocks to
food production. However, we are concerned by longer-term
inflation pressures appearing in wages and property markets.
Wages are generally growing 10-15% a year, sufficient to
cause difficulties for low value-added sectors such as textiles.
The causes - a complicated mix of demographics interacting
with the latest Five Year Plan’s aim of boosting consumer
spending, plus the inherent conflicts in government policy to
ensure growth is sufficiently strong to relieve social tensions –
are not expected to disappear quickly. We expect to see some
further monetary tightening, and other measures aimed at the
real estate market.
Turning to MENA, while we cannot forecast geo-political
developments precisely, we can analyse the impact on
the oil price. Events in Libya have largely withdrawn 1.0-
1.5mbpd from global oil supply. So far, this is manageable,
Source: Bloomberg
through a combination of increased OPEC supply, as well as
greater use of strategic stockpiles. Hence, any further, major,
supply side disruption could have significant consequences
in terms of much higher oil prices. Conversely, oil prices
are not likely to fall back far, as many governments in the
region have tried to calm down opposition through increased
largesse, which in turn requires higher oil revenues. Changes
in oil prices matter considerably; Brent oil prices reaching
$130-150pb (see chart 1) would mean a much bigger realterm
squeeze on consumers’ incomes, as well as corporate
profits, than seen so far, with the knock-on effects of rather
slower global activity.
There has been somewhat better news on the Eurozone debt
crisis. The threat of ever-wider bond spreads for peripheral
European countries, leading to a vicious circle of debt
servicing problems, has forced European politicians to
announce some helpful steps, such as increasing the size of
the emergency lending facilities, lowering interest rates for
some countries, and opening the door for bond purchases
to lower debt burdens. However, these arrangements still
do not go far enough – our concern is that they represent a
liquidity, not a solvency, solution. The next major trigger will
be the bank stress tests and capital raising in the summer,
and whether markets have any confidence in the results.
Longer term, investors are monitoring the extent to which
government measures can actually control spending and
boost the private sector at the same time, so bringing fiscal
deficits under control.
The recent earthquake and tsunami have economic
consequences serious not only for Japan but also the wider
Asian region. The Bank of Japan is supporting the financial
markets through liquidity injections and enhanced QE, while
the government is planning a major reconstruction package
which should help push the economy back onto a growth path
from Q3/Q4 onwards. We expect further yen intervention, if
required, to prevent the currency appreciating too quickly.
Initial analysis suggests several months of sharply lower
output. The impact could be longer, partly due to rolling power
cuts, as so much infrastructure has been damaged, and partly
to disruptions to just-in-time production schedules, especially
for auto or technology companies.
Global growth is slowing
Such shocks were unfortunately timed, as parts of the world
economy were already starting to show early signs of a
6 Global Outlook

Chart 2
The next M&A cycle begins
US$bn
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Value of M&A deals, Western Europe
Value of M&A deals, Asia
Source: ASR, Datastream
Value of M&A deals, North America
Chart 3
Margins under pressure
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US Consumer price inflation less US producer price inflation (12 month % change)
advanced by 12 months
Year on year % change in EBIT margins
Source: MSCI, Worldscope, IBES, OECD, Statistical Office of the European
Communities, ECB, Morgan Stanley Research
slowdown. Certainly, there are areas of strength, for example
German export orders. However, the combination of higher
commodity prices, the impact of monetary tightening in
Asia, and fiscal tightening across US states and European
economies, are all making themselves felt. In recent Global
publications, we have documented the dangers of China
beginning to export inflation to other economies, which in
turn will both squeeze margins for some companies but also
cause difficulties for central banks as core inflation rates come
under pressure.
On balance, we see global economic activity growing about
4% a year in 2011-12, with the larger OECD economies
closer to 2% and the global emerging markets (GEM)
running about 5-6% p.a. Consensus forecasts for US GDP
growth in 2011 were raised from 3% to 4% after the Obama
package last autumn, but have retreated again towards 3%.
Slow OECD growth means excess capacity restrains core
inflation. A number of GEMs do face inflation problems
stemming from a series of climatic and natural disasters
as well as rising production costs for raw materials when
demand has been so strong. Detailed analysis from the
Global Investment Group (GIG) indicates that, in the OECD,
the pass through of higher raw material costs into core
inflation is limited in an environment where excess capacity
limits wages growth and problems in the financial system
still limit money supply growth.
Accordingly, monetary policy is set to move slowly from
extremely easy back towards neutral. The ECB and MPC are
both worried about deteriorating inflation expectations, but
the ECB is expected to raise its benchmark rate first. The US
Federal Reserve may wish to withdraw from its exceptional
quantitative easing policy stance but an interest rate rise
will probably not happen until later in 2012. Asian central
banks, led by the PBOC, face inflation headwinds at this
point in the cycle; interest rates have been structurally too
low across the Asian ex Japan region. There is certainly a
risk that markets extrapolate any rate move out too far and
probably too fast; hence we are anticipating that bond
market volatility is set to continue.
Where next for profits?
Consensus estimates are for profit margins in the nonfinancial
S&P 500 companies, using these as a global proxy,
to rise to about 9% this year, which would be an 18-year high.
Where next? We expect the combination of a deceleration
in top-line earnings growth and some increase in costs will
dampen margins (see chart 3). We are certainly not expecting
a collapse in profits but the growth rate is expected to slow,
from 30-35% pa in 2010 towards 5-15% pa in 2011. The risk
to consensus expectations is to the downside.
Businesses are expected to react through measures to
boost growth and cut costs. We have surveyed our fund
managers who confirm that companies are looking for
growth opportunities, especially in GEM, often preferring
M&A to organic investment (see chart 2). As companies
generally have exceptionally low leverage, with large
amounts of cash on their balance sheets, this opens
the door for more M&A activity as well as investment in
technology to lower unit labour costs. Elsewhere there are
some important trends for share and bond holders; those
sectors which have finally stabilised their balance sheets
are putting cash to work through share buy backs, dividend
increases and debt repayments. US firms are reported to
have bought back $326bn of stock in 2010, more than
double 2009’s repurchases.
As higher commodity prices are, in effect, a wealth transfer
from consumers to producers, they have a rather different
impact on the wider economy than on the stock market. Most
macro-economic models suggest a sustained $10 per barrel
rise in the oil price would dampen real OECD GDP growth by
0.25-0.5% pa over a 2-year period. This figure could be double
for emerging economies as energy costs in, say, household
spending are more significant.
The House View
There have been some changes to the House View since
the start of the year. We have become more concerned
about Asian assets in relation to the continued monetary
tightening, and hence we have a Light position in Asia offset
by a Heavy position in the US. Valuations of corporate bonds
have become less positive and hence we have begun to
lower those positions towards Heavy/Neutral for high-yield
and investment-grade debt, respectively. We still prefer risk
assets related to the corporate cashflow and hence the House
View is Heavy in real estate, corporate bonds and selected
equities, where valuations are more attractive. We warn about
turbulence in financial markets relating to policy and other
event risks; this is something which investors can use to their
advantage. Hence we took the opportunity after the plunge in
the Japanese stock market, following the earthquake, to move
back from Light to Neutral in our portfolios.
Global Outlook 7

Focus on Change
Investing in commercial real estate
Real estate benefits from a relatively secure and
sustainable yield at this stage of the economic
cycle. This is underpinned by ongoing global
economic recovery, generally constrained supply
and improvements in business and occupier
confidence.
Chart 1
UK real estate initial yields compared
%
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1
Simon Kinnie
Senior Investment Analyst
The yield on real estate
Our investment process is based on a foundation of rigorous
research, guided by our Focus on Change investment
philosophy. Central to this is our Common Investment
Language, which we use to validate all our investment
decisions. In previous editions of Global Outlook, we
examined how Focus on Change drives specific asset
allocation decisions and helps navigate economic recovery, as
well as demonstrating our stock and sector picking decisions.
In this edition, we examine commercial real estate. In doing
so, we consider five key questions:
¬ What are the key drivers?
¬ What is changing?
¬ What expectations are priced into the markets?
¬ Why will the market change its mind?
¬ What are the triggers?
Our analysis predicts close to double digit annual returns for
global commercial real estate markets over the medium term.
Our expectations are that returns on a global basis are likely
to be similar across most regions and will comfortably beat
cash, underpinned by the resilient income yield component. In
an environment of low interest rates and a moderate economic
recovery, the relatively secure yield remains attractive.
What are the drivers of real estate’s
performance?
¬ Income yield margin – typically commercial real estate’s
income yield over bond yields or 5-year interest rates (as
a proxy for a risk free rate) provides an indicator of its
attractiveness relative to other asset classes (see Chart 1).
Over the last 35 years, the net margin has averaged around
2%. Although the modest recovery in prices has reduced
the margin available over the risk free rate, at close to 2%
on average it remains compelling.
¬ Capital flows - weight of money is a key determinant of
capital value moves in commercial real estate. The illiquid
nature of assets and the finite amount of supply can mean
capital is less easily placed into and withdrawn from the
market during cyclical moves in sentiment. Therefore,
volumes of equity raised for investment give a good lead
indicator for prices.
0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
IPD Initial yields (time weighted) UK (GBP IR swap 5-year - middle rate)
UK benchmark govt bond 10-year
AAA GBP corp bond yields
Source: Datastream
¬ Tenant demand – performance of real estate is inherently
linked to that of the underlying economy and occupier
activity. Business investment, employment growth and
consumer spending are all key forward indicators of tenant
demand for new and additional space, which in turn drives
rental growth.
¬ Construction activity – supply of new real estate is uneven.
Levels of building and new construction are crucial to
rental trends. Significant undersupply is likely to lead
to rents rising rapidly, while substantial oversupply will
dampen rental growth. Even in an environment of strong
tenant demand, excess levels of construction could
suppress any potential growth in rents.
What is changing?
3m GBP interbank rates
Recovery is materialising in most global real estate markets
(see Chart 2). This is consequently leading to tenant demand
improving as occupier confidence and business investment
increases. Vacancy rates are falling as a result, and strong
rental growth is being recorded in some of the highly cyclical,
supply-constrained office markets, such as Hong Kong,
Central London and Paris. The market is also becoming more
polarised between the Asian markets, which have strong
economic growth as a foundation, and the weaker Western
markets which, excluding the previously mentioned cyclical
office markets, are not driven by global factors and where
economic recovery remains slow. Globally, prices look to be
stabilising, as are rents. However, there is a broad spread of
rental movements across the markets, from the strong growing
cyclical office markets to the weaker peripheral European
markets where oversupply and weak demand continue to put
downward pressure on occupier rents.
Globally, liquidity has picked up in most regions from the
relatively low levels recorded in 2009. In Western Europe,
volumes in 2010 were 56% higher than the previous year
(according to Cushman and Wakefield), while in North America
they were a sizeable 127% up on the levels recorded in 2009
(Cushman and Wakefield data). Investor appetite for risk has
increased, as a result of the limited availability of good quality
prime assets. Investors are now willing to invest in reasonable
quality, secondary assets, particularly if there is an asset
management angle. Furthermore, international investors are
also looking outside core markets to source quality stock.
There is still a significant amount of capital targeting global
real estate markets according to agents. DTZ estimates that
the amount is up 17% on the level of investment in 2010.
8 Global Outlook

Chart 2
Returns across asset classes
% Return p.a.
20.0
Chart 3
IPD UK real estate capital values and rents
Index Level
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Annual % returns for each time period for:
Gilts Equities - All Real Estate Equities Direct Real Estate
Source: IPD Quarterly and Monthly Index
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Capital and growth value indices
Capital Value Index Rental Growth Index
Source: IPD Monthly Index
Broadly, given that development financing disappeared
rapidly as a result of the credit market problems, supply of
good quality new space is at low levels in most markets.
Similarly, as development financing remains constrained and
the development pipeline remains muted, limited supply has
fallen further in the highly responsive cyclical office markets.
Future global development is generally focused on Asian
markets; two-thirds of the global development pipeline is in
this region. In Europe, office development is at a 30-year low,
with only a quarter of the global development pipeline directed
at Western markets. Bank appetite for development financing
has improved marginally, although banks are likely to insist
that pre-lets are in place before construction begins. There
are now several large tower buildings planned for delivery,
including the Unibail Rodamco Tour Phare (or Lighthouse
Tower) in Paris; the Tour Generali in La Défense; the Tishman
Speyer and Commerz Real TaunusTurm development in
Frankfurt and in London British Land’s “Cheesegrater” building
at Leadenhall, Land Securities “Walkie Talkie” at Fenchurch
Street and the Arab Investments Pinnacle building. Despite
these towers, the future developments are unlikely to tip
the market over into significant oversupply, unless occupier
demand goes into reverse.
As investors have become more concerned about inflationary
pressures they are increasingly looking to real estate to
provide a hedge; hence allocations to the asset class are
increasing. Although historically real estate has provided
inflation hedging characteristics, this has been in periods of
above–average economic activity. In the period ahead, real
estate returns are expected to provide a degree of inflation
protection, but this is underpinned by below average supply
of space.
What is priced in?
A key question for commercial real estate investors attracted
by a relatively high income is how resilient is the yield in an
environment of modest growth? Furthermore, how does the
yield compare to that on other assets and does the additional
margin compensate for the limited liquidity associated with
investment in bricks and mortar? The answer is favourable.
US offices currently yield 6.2%, which compares favourably to
the US 10-year government bond yield of 3.3%, a proxy for a
“risk free” asset. This is a 2.9% margin, so a reasonably high
additional return. As real estate is a real asset, depreciation
should also be accounted for. Typically this is 0.8% p.a.,
according to the academic literature, reducing the margin to
2.1%. UK and European markets show similar trends.
How resilient is the income? Income generally follows the
same pattern as rents, which are stabilising (see Chart 3).
Our view is that there will be a modest increase in income
over the medium term. Adding on the additional contribution
from income growth provides a margin over the risk free rate
of some 2%. We see this as a reasonable compensation for
the limited liquidity of this asset class. Two key assumptions
lie behind such pricing – a controlled sale of “non core”
assets by the banks and interest rates rising but remaining at
relatively low levels historically.
Why will the market change its mind?
Real estate pricing currently reflects a relatively weak
economic recovery. If this were to falter significantly and
another recession materialised, prices would adjust sharply
downwards to reflect the weaker occupier markets and
depressed demand. On the other hand, if economic growth
is stronger than anticipated then real estate markets will
re-price to take account of more significant occupier demand
and rental growth materialising more forcefully. Strong rental
growth would be underpinned by the comparatively subdued
levels of new development since 2001.
Investors are becoming more concerned with inflationary
pressures and in the past this has typically led to a higher
allocation to real estate. We would expect this cycle to be
no different and the volume of capital targeting real estate
is likely to increase if inflationary pressures persist. This
may mean that the soft patch for real estate prices which we
expect later this year could be shallower. Indeed, it may not
materialise until towards year-end if sentiment increases
sharply as a result of inflationary concerns and more capital
is allocated to the sector.
The soft patch for prices mentioned earlier predominantly
relates to poorer quality stock. The modest reduction in prices
which we expect is due to an increase in supply from the
main lending banks as they work through their problem stock.
There has been a steady increase in this type of asset brought
to market. Over the past year, more banks now have expert
teams in place, know and understand the breadth and depth
of this stock, and generally have better work-out strategies to
deal with these assets. We expect the controlled measured
approach adopted to date to continue, although the pace of
release is likely to be stepped up. On that basis, our analysis
predicts close to double digit annual returns for global
commercial real estate markets over the medium term.
Global Outlook 9

Global Sectors
Mining for value
The global recovery may remain muted but there
are attractive opportunities for those firms with
exposure to the engines of growth.
Chart 1
Engineers rewarded
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Weir Group (L.H.Scale)
Sandvik (R.H.Scale)
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Lance Phillips
Head of Global Equities
Déjà vu
There is currently a remarkable sense of déjà vu within global
equities markets. Macro economic worries contend with
strong company fundamentals, a pattern that is similar to the
first quarter of 2010. However, while macro events dominate
headlines, those companies that continue to deliver solid
operational results should eventually see market recognition
and share price outperformance. We employ a fundamental
bottom-up approach, selecting individual stocks that are wellplaced
to cope with the challenging business environment.
Our largest holdings are in those stocks where we feel we
have strong insights that are generally unrecognised by the
wider market.
A resourceful approach
Despite recent macro headwinds, resource companies have
continued to deliver consecutive quarters of growth as
commodity prices remain elevated and demand from Asian
economies remains robust, despite recent events in Japan.
The positive earnings story demonstrates the remarkable
resilience of the resources sector to the global downturn and
bodes well for future investment in capital projects within the
industry. Our bottom-up approach to stock-picking means
that we are well-placed to benefit from a pick-up in capital
expenditure within the mining and oil industries.
One of the primary beneficiaries of this pick-up in resource
spending has been UK engineering firm Weir Group. The firm
has significant exposure to a number of resource-related
segments, with 90% of sales going to the oil, gas, mining,
power generation and nuclear markets. The company’s
exposure to mining machinery is particularly attractive as
the recent surge in commodity prices has meant that major
resources companies are once again dusting off plans for
volume expansion. Xstrata and Rio Tinto have both recently
doubled capital expenditure plans that were set at the time
of the firms’ rights issues in the first half of 2009. Consensus
from mining analysts suggests that capital expenditure,
globally, will pick up by over 30% next year as green-field
expansion projects are brought back on line. This growth
dynamic in the mining sector is also likely to present
opportunities for Swedish industrial group Sandvik AB.
The firm generates 45% of its revenues from its mining and
construction business and is well-positioned to profit from the
ongoing infrastructure/commodity super cycle.
Source: Datastream
There are also encouraging signs that recent high resources
prices are being translated into significant capital investment
in the oil and gas industry. This is presenting appealing
opportunities for those firms with exposure to the energy
industry, such as Korean ship-building giant Samsung Heavy
Industries. A significant portion of the firm’s revenue is
generated from liquid natural gas (LNG) carriers and drilling
ships, which are expected to see strong demand on the
back of rising capex spending. The firm’s exposure to the
LNG market is particularly appealing in light of the recent
earthquake in Japan. The Japanese LNG market accounts for
35% of the global market and this is likely to increase rapidly
as the country reviews its nuclear power requirements in the
aftermath of the recent disaster.
Stacking the chips in your favour
The highly cyclical semiconductor industry has recently
witnessed a period of instability, with DRAM prices sliding
and weak TV sales hitting demand. However, on a companyspecific
level, there are a number of developments that
present an opportunity for bottom-up stock pickers.
One such opportunity is ASML Holding, the world’s leading
maker of lithography systems for the semiconductor industry.
Its customers in the semiconductor foundry sector are
engaged in an arms race, with several players competing for
leadership. It also stands to benefit from growth in demand
for NAND ‘flash’ memory, which requires additional capital
investment. As the industry moves to smaller manufacturing
‘nodes’, making semiconductors smaller and more costefficient
to make, capital intensity increases and ASML is
expected to strengthen its competitive position and pricing
power.
Another preferred stock is Samsung Electronics. It derives a
large proportion of its earnings from memory semiconductors,
where it is a volume and cost leader. In particular it benefits
from demand for the aforementioned NAND memory – driven
by continuing growth in smartphones and tablet computers.
Further upside will come from notebooks replacing hard drives
with NAND memory, as evidenced by the success of MacBook
Air. The firm is also likely to retain its technological lead and
continue to take greater market share.
10 Global Outlook

US Equities
Giving business a boost
Drug distributors are benefiting from the move to
generics, while energy drinks pick up the pace in
consumer staples.
Chart 1
Responding to food and energy demand
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AmerisourceBergen (L.H. Scale)
Hansen Natural (R.H. Scale)
Euan Sanderson
Senior Vice President, US Equities
A cliff face for branded drugs
Health issues are always important in the United States,
a country which spends more on medical care than any
of the other major economies. A generic drug wave starts
in 2011 with an estimated $15 billion worth of branded
drugs coming off patent this year, expanding to some $75
billion by 2015. This includes Pfizer’s Lipitor, the world’s
largest-selling branded drug which has annual sales of
$7.2 billion. Generic drugs often offer higher gross margin
dollars to the distributors than branded drugs, and at the
same time are priced lower for consumers. The conversion
from branded drugs to generic drugs usually occurs quite
swiftly. Furthermore, demand for speciality drugs in areas
like oncology is increasing rapidly and should continue to
do so given demographic trends. With the country’s largest
generation now reaching retirement age, spending on
essential medical needs is set to increase.
In our view, the stock market has underestimated the benefits
of generic and speciality drugs to large supply chain drug
distributors, such as AmerisourceBergen and McKesson.
Along with Cardinal Health, these companies provide 94%
of US and 35% of worldwide third-party drug distribution.
AmerisourceBergen’s exposure to independent pharmacies
positions it well for generic launches since these customers
have no ability to source generics directly. In addition,
AmerisourceBergen is the largest speciality drug distributor,
which is the fastest-growing area of drug spend in the US.
There is scope for share price upside once greater clarity on
the generic and speciality opportunity is taken on board by
the market.
McKesson holds some 36% of the US market and 14% of the
worldwide market. Its generics programme is broadly seen as
the strongest, with even large chain drug retailers choosing to
use McKesson instead of buying directly from manufacturers.
We remain positive on McKesson’s acquisition of US Oncology
in late 2010, which provided the company with a meaningful
speciality drug business. This acquisition gives us greater
comfort about the long-term sustainability of growth for the
company.
Energy drinks – a category with growth
Consumer staples companies are generally facing challenges
when it comes to volume growth. Energy drinks are one of the
exceptions within this sector, having achieved a compound
Source: Bloomberg
annual growth rate of 15% between 2000 and 2010,
compared to global beverage/snack sector growth of about
5%. In the US marketplace, growth numbers for energy drinks
are significantly higher (estimated at about 22%).
We believe Hansen Natural is well-placed in this category.
The company is a manufacturer of natural soft drinks, fruit
drinks, energy drinks and iced teas. Its primary brand is
Monster energy drinks. Having been a leading natural soda
brand in California for 30 years, Hansen Natural is expanding
around the world. Its products are currently distributed in 58
countries outside the US. International sales rose to $240
million in the year ended 31 December 2010, compared with
$168 million in the previous year. The company is also taking
steps to improve profit margins on sales outside the US with
some local plant infrastructure coming on line. Hansen Natural
will launch Worx Energy in 2011 to compete in the market for
5-hour energy products, which offers further opportunity for
growth. Consensus estimates for revenue growth look overly
conservative given the current growth trend for energy drinks
in the US and international expansion.
Traditional beverage players like Coca-Cola and PepsiCo have
been unable to develop an energy drink that has sold well.
Acquisition of a successful energy drink business would
provide revenue and margin synergies, and Hansen Natural
already has links with PepsiCo in distribution agreements. We
believe the market does not fully appreciate Hansen Natural’s
organic growth opportunities, and its potential acquisition is
an incremental positive.
Our strategy within US equities
We purchased Charles Schwab, which is an online broker with
good medium-term prospects. Sales of equity mutual funds
have increased following improvements in investor sentiment
and recovery in the US and global stock markets. As interest
rates slowly return to more normalised levels in coming
years, Charles Schwab will be able to eliminate current fee
waivers on money market products. Another stock we have
bought recently is Foster Wheeler. This is an engineering and
construction company which has exposure to the oil and gas
industry activity. Recent investment updates comment on
a material increase in bidding activity from this sector and
Foster Wheeler should benefit significantly from increased
capital spending by the oil majors.
Global Outlook 11

UK Equities
Refocusing builds competitiveness
Industrial manufacturers and infrastructure
companies are adapting to meet fresh challenges,
leaving them well-positioned for strong and
sustained earnings growth.
Chart 1
UK manufacturing expands
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Premeir Farnell (R.H. Scale)
David Cumming
Head of UK Equities
The UK economy continues to recover, with many companies
reporting strong earnings growth. We are seeing opportunities
emerge across the market, with an increasingly sharp
divergence in individual stock performance within sectors.
This is rewarding our bottom-up, stock-picking approach.
Moving up the value chain
Notwithstanding the global shift towards lower-cost
manufacturing centres in developing markets, the UK remains
the sixth-largest manufacturing economy in the world. Many
UK manufacturers have had to adapt and reposition their
businesses to compete globally. Much UK manufacturing is
now high tech, research and development (R&D) and designoriented.
We see promising investment opportunities among
those players with global operations offering high-quality
products within a specific niche and where an increasing
proportion of sales go to emerging markets.
One such example is Premier Farnell, which markets and
distributes specialist products to the electronic maintenance,
repair and operations industry. It is shifting its strategic focus
to R&D customers, as opposed to lower-margin maintenance
and repair businesses, in turn driving improvements in its own
operating margins. Premier Farnell is not only shifting to higher
value-added products, but is also developing lower cost routes
to market. This includes the element14 website, specifically
targeted at the R&D community and positioned as a ‘Facebook’
for engineers. As a result of this targeted customer and
strategic focus, the group continues to report good sales
momentum in emerging markets, particularly China.
We also favour industrial engineer IMI. Like Premier Farnell,
it continues to reap the benefits of strategic repositioning as
it moves away from commoditised products towards higher
value-added sectors, as well as capitalising on increasing
demand from emerging markets.
Structurally sound
The construction sector continues to face considerable
headwinds, with the stock market’s main concern being the
likely impact of government spending cuts. However, this
overlooks the significant change in the shape of the UK’s
construction and infrastructure groups. They have responded to
the challenging domestic backdrop by increasing their exposure
to global infrastructure spending and by diversifying into greater
professional services and facilities management provision.
Source: Datastream
Names we favour include Balfour Beatty and Carillion. Balfour
Beatty is the UK’s biggest infrastructure group. While the market is
fixated on the 20% of its revenues that stem from UK government
capital expenditure, this overlooks the fact that 50% of its
revenues are generated overseas. In addition, the acquisition of
Parsons Brinkerhoff has significantly raised the group’s exposure
to professional services and international earnings.
Construction and infrastructure services group Carillion is
also well-positioned for overseas earnings to provide a buffer
against cuts in UK public-sector construction. Moreover,
Carillion looks well-placed to pick up business as a result
of increasing government outsourcing. A key strand of the
government’s Comprehensive Spending Review (CSR) is the
greater autonomy that will be given to local authorities in
their management of budgets. This shift suggests a need for
dramatic re-engineering of service delivery at both the central
and local levels, which is likely to be helpful for support
services firms. Around 55% of Carillion’s earnings stem from
its support services business; our analysis suggests that it
is likely to prove one of the major beneficiaries of the trend
towards more public sector outsourcing.
Our strategy within UK equities
Many of our largest positions are concentrated in so-called
‘early cyclicals’ – stocks with particularly strong scope for
earnings growth because of their exposure to the initial
stages of economic recovery. Industrial manufacturers and
infrastructure companies both fall within this category. In
contrast, we are underweight more purely defensive areas of
the stock market, notably consumer staples, including food
producers and manufacturers of household necessities.
These businesses are facing sharply higher raw material costs
– with the prices of metals, oil, foodstuffs and other inputs all
rising. However, the fragility of consumer demand means that
many companies are striving to absorb these higher costs. This
is inevitably impacting on their profitability, with profit warnings
already coming through from some of the smaller players. We
prefer to take our exposure to the consumer through particular
consumer discretionary stocks, which are well-placed for
stock-specific reasons. Names we like include car distributor
and retailer Inchcape. It continues to benefit from its marketleading
position in premium brands in the UK, its resilient and
higher margin after-sales capabilities, and from its international
exposure, particularly in emerging markets.
12 Global Outlook

European ex-UK
Equities
Slick operators
Certain oil services holdings could gain from the
move to offshore production, while rising food
prices prove no bad thing for some firms.
Chart 1
Pressures on retailers
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Casino Guichard (L.H.Scale) Delhaize group (R.H. Scale)
Chris Haimendorf
Investment Director, Europe
A site for sore eyes – opportunities in
offshore
We have been anticipating for some time that major oil
companies would find renewed confidence in committing to
capital spending decisions. Oil majors are indeed stepping
up efforts to prevent a decline in volumes, whether through
investing in exploration or by acquiring other companies.
Recent events in the Middle East make offshore oil exploration
an even more strategically attractive option. Although there
is a higher associated cost, such sites are less vulnerable to
domestic civil unrest.
We have been increasing our position in various oil services
companies set to benefit from this trend. Subsea 7, which
was acquired by Acergy in 2010, is one such example.
The company designs, fabricates and installs offshore oil
equipment. Strong full-year results have led to earnings
upgrades. Subsea 7’s geographic exposure is favourable,
with the firm generally less exposed to countries presently
experiencing political unrest. We believe it is well-positioned
to take advantage of oil companies’ growing preference
for offshore projects. In addition, the stock’s valuation is
relatively appealing in comparison with its peers.
We have also added oil services company Fugro to several
of our funds. It has a wide spread of businesses, with three
quarters of its turnover relating to the oil and gas industry.
Many of its customers are national oil corporations; a group
which are notably increasing spending in 2011 on offshore
projects. Trading statements look positive, and we expect to
see revenues grow considerably over the remainder of this year.
Passing on the pain in food retail
As the cost of agricultural commodities trends higher, those
markets with a less aggressive competitive environment
present an easier opportunity for food retailers to pass on
higher food prices. This is especially the case where there
is strong GDP growth, as customers are more willing and
able to absorb higher prices. In the US, food price inflation
at supermarkets looks likely to be rampant given that food
retailers have limited buying power. US food retailers are trying
to pass on higher prices, but the competitive environment and
presence of large players who appear willing to invest to keep
prices down make this very difficult. For this reason, we do not
own European food retailers Ahold or Delhaize, both of which
have substantial exposure to the very fragmented US market.
Source: Bloomberg
In contrast, we favour French retailer Casino Guichard.
Approximately 40% of its profits come from emerging markets,
and Latin America in particular, where it continues to take
market share from the independent sector. It has an excellent
footprint in Brazil, owning almost 34% of the country’s largest
food retailer, Grupo Pão de Açucar, with an option to increase
this to a majority stake in 2012. The firm has also expanded
its emerging market presence with the purchase of Carrefour’s
Thai business, which doubles the size of its Thai operations. We
believe Casino’s structural growth in emerging markets will help
drive growth ahead of the sector, which is not reflected in the
stock’s current valuation.
We also continue to favour Portuguese-listed food retailer
Jerónimo Martins. Three quarters of its profits are derived
from its Polish Biedronka business; a discount format that
offers cheap, good-quality, own-label products. At the moment
Biedronka’s market share sits at 10%, but there are structural
changes here as the business wins market share from the
independent sector. Within the very fragmented Polish market,
Jerónimo enjoys the strongest competitive position, and should
find it relatively straightforward to pass on higher prices to
consumers.
Our strategy within European equities
Although European banks often face difficulties, especially
in some of the smaller or peripheral European countries,
we can use our Focus on Change approach to find attractive
opportunities. We have recently initiated a position in
Belgium’s largest bank and insurer, KBC Group. In our view,
its efforts to rebuild its capital position through the partial
sale of its Czech bank CSOB are underestimated by the wider
market. We also expect KBC to benefit from the contraction in
European peripheral spreads and the reversal of writedowns
on collateralised debt obligations. Elsewhere, we are buyers of
HeidelbergCement, which should see share price appreciation
as US construction starts to improve. We have sold Swedish
retailer H&M, given the risk of a further squeeze to its margins
as the company cuts prices to compete more aggressively. In
addition, cotton prices and Chinese labour costs are rising,
presenting further headwinds for the firm.
Global Outlook 13

Japanese Equities
It pays to have social skills
The impact of social media is proving fruitful for
some retail and technology firms, while rising
input costs are less of a problem for our favoured
chemical stock.
Chart 1
Early adopters
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Softbank (L.H. Scale)
Start Today (R.H. Scale)
Matt Harris
Investment Director, Asia Pacific
Socially adept
Social networking services (SNS) are increasingly viewed as
essential for internet users. As such, there are significant
growth opportunities for companies that can harness social
marketing techniques as a means to connect directly with
customers. One of our favoured stocks, which successfully
combines Japanese consumers’ love of fashion and
technology, is Start Today – Japan’s fastest growing highfashion
e-commerce site. The firm operates the Zozotown
website, which styles itself as a shopping mall in cyberspace
and offers subscribers access to major brand names, as well
as new fashion labels. Retailers simply set up shop on the site
and generally sell on consignment. But where Zozotown differs
from other online retailers is that subscribers can use social
media, such as Twitter and Facebook, to share their opinions
on products – something which consumers increasingly trust
more than traditional search engine results.
Japan has long been an early adopter of trends and we believe
Zozotown, with its community-based feel, is a good platform
for creating excitement around brands; a marketing technique
that retailers undoubtedly welcome. In a relatively short
space of time, the firm has achieved high recognition for the
Zozotown name, which is well on its way to having 2.5 million
subscribers. It has enjoyed strong sales transactions following
both aggressive TV advertising and an increase in the number
of brands available on the website. Its proprietary technology
and applications can also be used on smartphones and
tablets, and Start Today is working on other ways to expand
its pioneering e-commerce offering. We are confident that
there are opportunities for Start Today to expand its franchise
overseas, as well as into new segments, such as luxury. It also
plans to target new demographics, introduce diffusion brands,
and leverage its strong alliances with companies such as
Yahoo Japan - all of which bode well for future profitability.
Another firm that is successfully harnessing internet and
mobile technology is integrated telecoms services firm
Softbank. The Japanese mobile industry is structurally unusual
in that it is dominated by the network operators, not the
handset manufacturers. This has resulted in what is known
as the ‘Galapagos’ effect where Japanese mobile phones are
very different from their overseas counterparts, and where
the network operators control phone features and design.
Source: Bloomberg
However, with the rapid spread of smartphone technology,
Japanese network operators are having to adapt to the
changing demands of their customers, and Softbank is one
stock that looks to be doing this relatively successfully. The
company has significantly increased its subscriber numbers
on the back of strong marketing campaigns, and, more
importantly, is the exclusive provider of the iPhone and iPad in
Japan. It is also a majority stakeholder in Yahoo Japan and has
exposure to the rapidly expanding Asian market, investing in
Chinese online TV service PPTV, which has exceptional growth
potential. Given its strong relationship with Apple, we have
also increased our exposure to mobile phone and electronics
component maker Dai-Ichi Seiko. Following its secondary
stock offering, we are encouraged by the company’s improved
liquidity.
Good chemistry
As commodity prices spiral ever-higher, the chemicals sector
is an area that looks vulnerable to increasing input costs.
However, we believe the market is overly pessimistic on the
sector, and have a positive view on Mitsubishi Gas Chemical
(MGC), one of the largest methanol producers in the world.
MCG produces methanol from natural gas, rather than coal.
This leaves MGC less exposed to rising commodity prices than
coal-based producers who are seeing their margins contract.
In addition, methanol’s applications are diverse, from use
in paint, adhesive and varnish manufacture, to agricultural
chemical production, but mainly as a gasoline additive. We
believe this stock has a positive outlook, given the sustained
and strong demand for methanol from emerging economies
such as China, and its application as a ‘clean’ fuel of the
future.
Our strategy within Japanese equities
We have recently been increasing our position in Japan
Tobacco, as fears over a decline in domestic consumption
following the tax increases last year have proved unfounded.
In addition, we expect the company’s profits from its
overseas business to increase going forward, while we also
believe there is scope to restructure its business in Japan
itself. Elsewhere, we have a positive view on Bridgestone
Corporation on the back of recovering tyre sales and
projections that rubber prices will decrease.
14 Global Outlook

Emerging Market
Equities
A new horizon
Asian companies are responding to a need for
greater efficiency. IT services companies and
environmental technology firms are set to benefit.
Chart 1
Benefiting from IT spending
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51Jobs (L.H. Scale)
Kingdee International (R.H. Scale)
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Ronnie Petrie
Head of Emerging Market Equities
China’s new growth phase
Having delivered nearly three decades of impressive growth,
China’s policymakers are gearing up for a shift in emphasis.
The nation’s 5-year plan is expected to focus less on growth
rates and more on structural adjustments. This is likely to have
far-reaching consequences for the corporate sector and also
generate significant investment opportunities.
One area that we believe has significant growth potential
is the information technology sector. Chinese companies
are estimated to spend around 10% of the levels of US
firms, in terms of IT budgets. However, that is expected to
change significantly as companies focus more on boosting
productivity and improving efficiency.
Enterprise software firm, Kingdee International, is a key
beneficiary of this trend. The firm is the second largest
Enterprise Resource Planning (ERP) solution provider in China
and has already proved capable of out-competing international
rivals such as SAP and IBM. In addition, while Chinese banks
and online gaming stocks are already bigger than their global
peers, enterprise software giants such as IBM and Oracle, are
in aggregate 64 times bigger than the top Chinese players in
terms of market cap. This gap is likely to narrow significantly as
firms such as Kingdee see significant growth.
Another firm that is set to gain from an increasing focus on
IT-related efficiency improvements, is 51jobs. The integrated
human resource services provider connects millions of
job seekers with employment opportunities, as well as
streamlining the recruitment process and human resource
administration for tens of thousands of companies in China.
The online recruitment and HR services markets are still
very fragmented and penetration rates are low. According
to iResearch, only about 8% of enterprises in China used
online recruiting services in 2009. In addition, there are 43
million SMEs in China, though only around 2 million websites
for the whole country. With Chinese companies looking to
significantly boost productivity, we believe that firms like
51jobs are well positioned to gain market share in the rapidly
expanding IT services segment.
Environmental opportunities
Demand for environmentally efficient technology is creating
opportunities for those Chinese firms that have the scale and
Source: Bloomberg
engineering ability to meet international quality standards.
One such firm is GCL Poly. The Chinese firm is currently one of
the top five polysilicon producers globally but its significant
cost leadership means that it is set to rapidly increase its
share of the solar wafer market. Our analysis indicates that its
high and sustainable profitability is not fully reflected in its
share price and there are a lot of incentives for the company to
continue to power ahead.
Another firm that is set to profit from an improvement in the
environmental credentials of its product is Chinese plastic
injection moulding equipment manufacturer Haitian. The
firm has developed a range of new model releases that are
significantly more energy efficient than its domestic rivals,
while retaining a major cost advantage over international
competitors. This is likely to be a compelling combination for
its customers and the firm’s 5% share of the global market
has the potential to be materially higher given Haitian’s price/
quality/cost ratio.
And it is not just in China where manufacturing firms are
benefiting from a pick-up in demand for environmentally
friendly products. Chroma ATE, a Taiwanese firm that
specialises in power test instruments and systems, is wellplaced
to profit from a growing shift to electric vehicles.
The firm’s revenues from clean technology sectors already
represent 31% of its total revenues and these eco-products
are likely to remain the main growth driver going forward.
Our strategy within emerging markets
In an environment of heightened market volatility, we
are looking to invest in stocks that are executing well in
sustainable growth areas and delivering on operational
improvements to expand margins despite the pressures
from higher raw material costs. We believe that corporate
fundamentals remain relatively healthy for many companies,
even though the regional economic backdrop is becoming
more difficult. We remain Heavy in consumer-related areas,
reflecting for example the efforts by the Chinese authorities
to raise household incomes and support real wages by
capping inflation pressures. We are Light in the financials
sector generally. The valuations of many such stocks are not
attractive against a backdrop of monetary tightening in many
countries in the region.
Global Outlook 15

Government Bonds
A balancing act
We examine the prospects for government bond
markets against a backdrop of rising inflation and
prospective rate hikes.
Chart 1
Peripheral spreads widening
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Philip Laing
Investment Director, Government Bonds
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Not a normal recovery
For many fixed income investors, the prospect of rising
interest rates is an alarming one. As with previous economic
cycles, central banks are walking the tightrope between
growth and inflationary concerns. This time round, however,
inflationary pressures are becoming apparent much earlier
in the economic cycle, at a time when unemployment levels
generally remain high and industry appears to still have
adequate levels of spare capacity. Part of the problem is
that commodity price pressures in developed economies are
increasingly a function of geo-political tensions and climatic
events affecting producers in the emerging economies, but
there are complex questions as well about the pricing power
which many firms appear to have.
Central banks need to weigh up whether these pressures are
transitory or if inflation is going to be structurally higher in
the medium-term. In the UK, US, and Europe, monetary policy
has reached a turning point: should the authorities consider
hiking interest rates to dampen inflation expectations and risk
aborting an economic recovery that has yet to become selfsustaining?
While on the surface this would be negative for
bond investors, the finely balanced risks heighten the perils of
a policy mistake in more than one major developed economy.
Clinging on to credibility
The case for interest rate hikes is arguably strongest in the
UK, where CPI inflation is double the Bank of England’s
official target. In our view, a hike is not required on the basis
of growth as the recovery remains fragile. However, some
members of the Monetary Policy Committee consider that
the Bank needs to repair its inflation-fighting credibility by
tightening policy. It is not clear how effective such a rate
rise would be; indeed it would more likely be intended as a
signal to financial markets. Thus far, hikes of 0.5-0.75% have
been priced in to the front end of the yield curve. We were
positioned for this move, but more recently we have been
buying bonds with a 4-5 year maturity on the grounds that
these are now reasonably valued and should show resilience
in the light of any policy mistakes arising from premature
monetary tightening.
European hawks squawk
The European Central Bank has historically been more
hawkish than its UK and US counterparts, with price stability
its sole, key concern. Recent comments from ECB president
Trichet indicated the strong probability of a rate hike at its
April meeting. In our view, this would be a policy mistake;
while some countries are exhibiting strong growth, most
of the region is only just beginning to see unemployment
levels peaking. The ECB’s determined language may prompt
European politicians to make a greater effort to try to reconcile
the conflicting interests of the core and periphery economies.
The latter wants cheaper and greater funding access, while
the former is a strong proponent of structural reform. Until
these issues are resolved, or we are more comfortable with
solvency issues, we maintain a Light position in peripheral
European debt.
All eyes on inflation
In the US, a notional rate hike is priced in over the next year,
although this is arguably a token gesture as the US maintains
an accommodative bias. The second round of QE was
introduced partly to quell deflationary fears, which have now
all but dissipated, but inflation is not yet a concern. The US
economy is seeing pockets of higher inflation, most notably
in food and energy costs, while demand for rented property is
putting pressure on the rental component of inflation. Overall,
however, prices remain quiescent, and US economic growth
prospects are far from certain. There are signs that the pace of
economic growth is decelerating into the summer on the back
of higher gasoline prices, mortgage rates and state taxes,
to name a few of the headwinds. Against that backdrop, we
prefer US Treasuries to German bunds in our portfolios.
Our strategy within government bonds
In the long-term, interest rate hikes will prove negative
for bond investors. In the short-term, however, there are
opportunities to add value where negative growth shocks
unsettle investors. Our approach to portfolio construction
remains flexible. In the UK, gilts look overvalued given the
current and expected levels of inflation, but there is evidence
of foreign investors buying gilts. Hence, despite this apparent
overvaluation, we are reluctant to take an overly short
position. Across our portfolios, we have increased exposure,
where appropriate, to index-linked gilts as a defensive move.
This position, plus exposure to US inflation-linked TIPS, has
added value to our portfolios as inflation expectations have
increased. Within the Euro-zone, although we remain Light in
peripheral European debt, we are Heavy in Italian government
bonds as a higher quality proxy.
16 Global Outlook

Corporate Bonds
Highlighting high-yield opportunities
With investors faced by turmoil in Japan and the
Middle East as well as concerns over inflation and a
weaker economic growth outlook, we examine the
prospects for high yield in the months ahead.
Chart 1
Valuations still helpful
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Arthur Milson
Investment Director
High yield – attractive despite headwinds
At the start of the year we predicted that high yield’s
positioning, above investment grade bonds but below equity
in the risk spectrum, would be well suited to the prevailing
investment conditions. Indeed, high-yield has performed
year to date, with total returns comfortably surpassing that
of lower yielding investment grade while largely avoiding the
volatility seen in the equity markets. Looking forward, we
believe that the positive drivers of high-yield performance in
2011 remain intact. Since 2007, companies have focused on
improving the strength of their balance sheets, rather than
chasing growth prospects. A focus on cost-cutting to boost
earnings and a reduction in capital expenditure to conserve
cash flow, improved their debt servicing capabilities. The
trailing 12-month default rate from Moody’s has shown a
clear downward trend; 2010 started the year with defaults at
11.3%, falling to 2.3% by the end of the year. Moody’s base
case scenario predicts a continued decline to 1.2% by the end
of 2011, a factor that should underpin the high-yield market
going forward.
Recent events have led some forecasters to revise downwards
their earnings projections. These include not only the
deceleration being seen in some economies, such as the US
and China, but also the impact of the recent events in the
Middle East and the natural disasters in Japan. While certain
industry sectors will clearly be impacted more than others, our
overriding view is that any slowdown looks to be too moderate
to have much of an impact on the default cycle. Additionally,
a range of major risks, such as sovereign debt concerns in
Europe or uncertainty about the degree of bank regulation,
still encourage companies to remain focused on their balance
sheets and retain conservative financial policies.
New issue trends
European high-yield new issuance reached €47 billion in
2010, due to a combination of refinancing existing bonds
and new companies coming to the market for the first
time. We expect such trends to continue in 2011, further
augmenting the investment universe and creating compelling
opportunities across our high-yield portfolios. Issuance
has proven positive to date, as companies can proactively
manage their balance sheets and extend the term of their
Source: Thomson Datastream
debt maturity, reducing near-term refinancing risk. With the
certainty that there is not a large debt repayment looming,
rating agencies look favourably on companies that have
managed their balance sheets. New issuance has been seen
across a wide range of industry sectors, enhancing both the
size and diversity of the European high-yield market.
Relatively attractive yield
Central banks such as the MPC and ECB have hinted at
interest rate increases later this year. A key concern for
many bond investors is the subsequent effect on their bond
portfolios. Although rate moves look increasingly likely, our
House View expects them to remain at historically low levels.
This is particularly the case if oil prices climb and remain at
elevated levels, as central banks will wish to avoid derailing
the recovery. An important feature of high-yield bonds is that
they are short duration, i.e. less sensitive to rate moves in
nature, averaging only 3.5 years on the Merrill Lynch Euro Non
Financial High Yield Constrained Index. This makes such debt
relatively attractive to yield-hungry investors.
Our strategy within high-yield bonds
Our investment strategy for 2011 reflects our positive outlook
for high yield. We believe strong stock and sector selection
will drive outperformance. The backbone of our high-yield
portfolios consist of companies within the packaging and
cable & telecoms sectors. A preferred name is Ardagh Glass,
one of the largest glass packaging companies in Europe and
a leading global metal packaging business. It has leading
positions in defensive food and beverage markets, strong
and stable cash flows, a blue chip customer base and a
proven ability to pass through raw material price increases.
Cable companies such as Virgin Media have a technological
advantage in delivering high-speed internet connections,
and bundling up this product offering with cable TV,
telephone lines and mobiles, helping to drive strong earnings
performance and balance sheet deleveraging. Within our
portfolios, we have a preference for ‘B’ versus ‘BB’ rated debt,
since the former enhances yield income and is less vulnerable
to interest rate increases. Looking ahead, we will continue to
invest in well-priced new issues, as well as identifying trading
opportunities during periods of volatility.
Global Outlook 17

Money Markets
Entranced by the exit signs
Some central banks seem close to an exit strategy
– it may be the wrong choice.
Chart 1
Interest rates set to rise only modestly
%
5.0
4.0
3.0
2.0
1.0
0.0
Gordon Lowson
Head of Money Markets
US
Whether the Fed really believes its more upbeat assessment
of the state of the economy, it seems in no hurry to change
its current policy stance. For the record, the minutes of the
latest FOMC meeting concluded that the economy was now
on a ‘firmer footing’ and that conditions in the labour market
‘appear to be improving gradually’. The committee also left
out references to previous concerns such as ‘high levels of
unemployment’ and ‘modest income growth’. Nevertheless,
they seem to be content to continue QE2 bond purchases until
the programme formally ends in June.
If this improved perception of the economy has so far been
insufficient to elicit a change of tack, what would trigger a
change in Fed policy? Chairman Bernanke has stated that, for
the Fed to move towards the exit, there would have to be signs
that the economic recovery was becoming self-sustaining,
that labour demand was on a clear improving trend and that
core inflation should be approaching 2.0%. At present, none
of these triggers have been activated. Consequently, the Fed
seems comfortable to keep interest rates at ‘exceptionally low’
levels for an ‘extended period’. The first step towards the exit
is likely to be the cessation to re- investing bond redemptions
back into the market, rather than a rise in interest rates.
UK
Despite the bearish interest rate momentum that has built up
since the beginning of the year, it is still far from ‘done and
dusted’ that UK interest rates are about to rise. It is certainly
true that reported levels of inflation have continued to lurch
higher on the back of commodity price pressures and tax
increases. Increasingly, this has been associated with rising
levels of inflation expectations over both the near-term and
medium-term time horizons.
However, there are two key considerations that suggest that
the Monetary Policy Committee (MPC) could, and should,
resist the call for much higher rates – at least in the near-term.
Firstly, despite the deterioration in inflation expectations,
there has still been no meaningful manifestation of these
expectations in the form of higher wage settlements.
Secondly, all the signs are that the economic recovery is very
slow, making it possible that a rise in interest rates could tip
the economy back into recession, without seriously clamping
down on headline inflation which is being driven more by
external factors.
-1.0
Europe
The European Central Bank (ECB) has a track record of acting
decisively, if not always appropriately. Back in July 2008, it
responded to upward commodity price pressures by raising
interest rates just at the time when recessionary forces
were gaining the ascendancy. That move was subsequently
reversed, and more, within just three months. The Bank
misread the outlook for inflation and acted upon the
prevailing price pressures. It looks like it could be about to
commit a similar policy error.
By changing its policy stance to ‘strongly vigilant’ the Bank
has signalled an imminent rise in interest rates. Most market
participants take that to mean a hike at the next meeting
in April. While inflation is above target, conditions are far
from inflationary, apart from in Germany. The ECB has always
claimed that its policy decisions were governed by the
economic health of the region as a whole, rather than by what
is going on in any particular part of Europe. That may well be
the case, but it will also be cognisant that its policy changes
will not have a homogeneous impact across the region. A
rate rise will hit the peripheral economies more forcefully,
as well as those other countries that are imposing a fiscal
retrenchment squeeze. All in all, we do not expect to see as
many interest rate increases as are currently priced into the
money markets.
Japan
2007 2008 2009 2010 2011
December 2011 interest rate expectations less benchmark policy interest rates for:
US Europe UK
Source: Bloomberg, Thomson Datastream
Following the natural disasters that have recently ravaged the
Japanese economy, it is inevitable that near-term monetary
policy decisions will be determined by emergency needs. For
the Bank of Japan (BOJ) this has meant ensuring that ample
credit is available. Consequently, the first priority has been to
make sure that the banking system has sufficient short-term
funds to help cope with the crisis; hence a series of liquidity
injections have taken place. Ostensibly, this has been done
on a temporary basis, but needs will dictate just how long
this lasts. Meanwhile, the BOJ will continue its ongoing QE or
bond-buying programme. Even before the recent crisis, the
BOJ seemed to be the central bank that was furthest from the
exit. That has not changed.
18 Global Outlook

Currency
Anticipating policy decisions
Exchange rate markets are destined to remain
volatile until the economic outlook becomes
clearer.
Chart 1
Currencies diverging
180
160
140
120
100
80
60
2007 2008 2009 2010 2011
Bank of England trade-weighted currency performance for:
Ken Dickson
Investment Director, Currency
US Dollar
The US dollar continues to trade poorly relative to most other
currencies. On a broad trade-weighted basis it is close to the
bottom of its recent range and not far off its all time lows.
Investors are very focused on the mounting fiscal deficit
and the apparent lack of any policy initiative to address
the problem, in contrast to most other major developed
economies. The US dollar has also not been a beneficiary of
any safe haven flows resulting from the increased political
tensions in the Middle East, with investors preferring other
perceived safe haven currencies such as the Swiss franc.
While the Fed seems to be getting a bit more optimistic about
the state of the economy, it is still some way from considering
a withdrawal from the present very accommodative policy
stance. The economy has yet to demonstrate that it has
entered a self-sustaining period of growth, while inflation
remains relatively muted. In the short-term, at least, the US
dollar is likely to remain relatively under-owned. As soon as
exit strategies start to be publically mentioned by American
central bankers, buyers will return in anticipation of US
interest rates moving higher.
Euro
The euro continues to trade well, despite the ongoing
peripheral sovereign woes. This is largely due to increasingly
hawkish ECB comments and continuing strong economic data,
albeit largely down to strength in Germany. The market had
already started to factor in some ECB tightening during 2011,
but Trichet’s “strongly vigilant” statements in early March
altered investors’ thoughts on the timing of the first rate rise,
bringing it from the third or fourth quarter into the second
quarter, and raised the issue of how far rates may eventually
rise. This is likely to keep interest in buying the euro currency
in the short-term, despite its already overvalued status on
most measures. However, the peripheral debt issues remain
and in certain instances have actually deteriorated. Bond
yield spreads of several peripheral countries continue to hover
around record wides against German bond yields. There are
no solutions likely in the near term; this ongoing impasse may
undermine the potential interest rate advantage of the euro,
leading to periodic falls.
Sterling
Euro Yen USD GBP
Source: Thomson Datastream
Sterling has been relatively stable over the past quarter and,
although trading at fair value levels against the US dollar, still
looks cheap against many other currencies, particularly the
euro. However, we look to be entering a much more volatile
period. Persistently higher-than-expected inflation in the
UK has led to increased market expectations of potential
rate hikes in the not too distant future. This has given
sterling some support in the currency markets. There is still
considerable doubt as to whether the MPC will hike at all this
year, as the majority on the committee still regard the rise in
inflation as temporary, arguing it should fall back towards the
2% target in 2012. On top of this, despite a slow UK economic
recovery, the fiscal tightening announced in 2010 is only
starting to bite. There is a chance that the MPC may make a
policy mistake by hiking rates into a weakening economic
backdrop in an attempt to correct what is just a temporary
inflation problem. Initially, this would be sterling supportive
but as the mistake became obvious any gains would reverse.
Despite these risks, the fundamentals for sterling still look
relatively sound. A stable political situation combined with
the clear budget deficit reduction plan should provide the
currency with good overall support over the next quarter.
Japanese Yen
The yen had a quiet quarter before the earthquake struck in
early March. The initial response was a sharp appreciation of
the yen, but subsequent G7 intervention pegged the currency
back close to previous levels. More intervention is likely if
the currency appreciates too quickly. Looking forward, the
currency is being driven by multiple factors. On the one
hand, the currency has been supported by repatriation,
safe haven flows and positive real interest rates. On the
other hand, the country’s political, deflation, budget deficit
and demographic problems remain, while the yen is still
overvalued against most other currencies. In coming months,
the yen will continue to be supported by repatriation due
to Japanese year-end effects and as insurance companies
liquidate overseas assets to cover claims following the
March earthquake and floods. However, we anticipate that
the currency will start to weaken later in 2011 on mounting
concerns about the impact of the economic reconstruction
plans on the budget deficit.
Global Outlook 19

Real Estate
Accessing China
Chart 1
Asia Pacific sales volume 2010
The attractiveness of China as an investment
destination is well known. But how do
international investors access the commercial
real estate market in China and what are the
barriers to entry?
Singapore, (11%)
Other, (13%)
China, (14%)
Australia, (16%)
Hong Kong, (17%)
Japan, (29%)
* US Dollar Millions - Based on independent reports of properties and portfolios
USD10m and greater. Excludes development sites.
David Paine
Head of Real Estate Investments
Real estate market
The real estate market fundamentals in China are mixed:
while some parts are healthy, demonstrating rental growth,
attractive yields and low vacancy rates, other aspects require
more careful analysis. The office markets of the east coast
cities of Shanghai, Beijing, Guangzhou and Shenzhen are
relatively mature and new office buildings continue to come
on stream. However, an acute lack of modern office space
is apparent in the rest of the country and demand for new
office space outstrips supply by a large margin. The retail real
estate market is less mature, with low provision that is not
commensurate with retail sales, which are growing at double
digit rates on the back of rising personal incomes. While
luxury brand suppliers have been flocking to China to take
advantage of the growing wealth and aspirations, anecdotal
evidence suggests that the bulk of consumer purchases
are still made in street markets. A reliable supply chain to
move finished goods from the factories to consumer markets
is crucial to the development of the retail sector, and the
logistics sector is still in its infancy. The industrial sector is the
most mature and has grown in tandem with a strong economy
focused on manufacturing and exports.
The real estate investment market in China has seen solid
volumes, driven by robust economic growth, relatively low
interest rates and attractive yields (see chart). However,
domestic investors dominate due to the limited routes open to
international investors and the barriers to entry.
Barriers to entry
The commercial real estate market in China is characterised by
a dearth of free-flowing, high-quality market information, the
need for robust regulatory enforcement and the absence of fair
transaction processes. The lack of transparency is a significant
barrier to entry and requires significant effort to gain local
knowledge and forge relationships on the ground.
Furthermore, the capital markets in China lack depth and
breadth. The range of financial instruments available to
international investors is limited at best and virtually nonexistent
for real estate. Restrictions on foreign company
listings are in place, there is no REIT structure in China, the
listed real estate sector is dominated by developers and the
corporate bond market is in its infancy. International investors
are required to access the real estate market via joint ventures
and partnerships, or invest time and resources to establish a
local presence.
Source: Real Capital Analytics
Possibly the most significant barrier to entry is the financial
system. Capital flows are restricted by the government and
a series of regulations aimed at foreign flows into the real
estate market and foreign borrowing has been promulgated
in the last few years. Regulation 171 limits the market
access of foreign investors to own usage unless it is a locally
incorporated entity registered as a Foreign Invested Real
Estate Enterprise (FIREE). There are limitations on debt-toequity
ratios, total investment and the activities of the FIREE,
with no distinction made between residential and commercial
real estate. Other barriers to entry include a currency that
is not freely convertible, foreign exchange controls and a
complex tax system. Not surprisingly, the number of FIREE
approved by the central government is declining.
However, changes are afoot. There has been talk about
launching a Chinese REIT sector and permitting insurance
companies to invest in office properties, which would both
stimulate investment activity and ease entry into the market.
The central government has shown commitment to the
liberalisation of the currency and the most recent move by
State Administration of Foreign Exchange to introduce renminbi
option trading underscores this. This move will enable banks
to offer renminbi options to enable financial institutions and
enterprises to hedge their foreign exchange exposure.
Investors and developers alike recognise that China’s
commercial real estate market fundamentals are attractive, but
at the moment the barriers to entry are too high and the routes
to access the market are limited.
Our strategy within property
Globally we favour core prime locations and we see the best
resilience in better quality assets in supply constrained
markets. We continue to have a strong bias for Central
London offices in the UK, based on the ongoing supply and
demand imbalances. We believe the European commercial
property markets to be further into the recovery and favour
the Paris office market and high-yielding logistics markets
across the Continent. In Asian markets we hold a preference
for office markets with the tightest supply pipelines such
as Sydney. Across North America we see value in underdeveloped
industrial locations in Canada and we favour the
cyclical office markets in the US. Taking a three-year view, we
still anticipate healthy outperformance against cash from the
market as a whole.
20 Global Outlook

Global Index-Linked
Bonds
Diverging inflation paths create opportunities
With the shockwaves of the financial crisis still
rumbling around the markets, a growing theme
is the divergence of inflation prospects across
different economies.
Chart 1
Inflation expectations compared
bps
90
80
70
60
50
40
30
20
10
0
Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar
Basis points spread between UK 5-year 5-year forward inflation swaps and
US 5-year 5-year forward inflation swaps.
Johnathan Gibbs
Investment Director
Inflation is diverging
In the 1990s-2000s, now known as the Great Moderation,
a noticeable feature of the economic landscape was that
inflation was low across most countries despite consistently
strong economic growth. In recent years, the inflation path has
looked rather different from one economy to another. Compare
for example the US and the UK. The UK’s inflation data has
stubbornly exceeded expectations ever since the crisis,
whereas in the US core inflation has tracked obdurately lower.
Policy makers in both countries allege the existence of large
output gaps, yet only the US displays the classic symptoms.
In the UK, unemployment may be high, but it is not at levels
implied by output gap estimates. Inflation is stubbornly higher
than it should be, even when all of the temporary factors
such as tax increases and the impact of a lower currency are
removed, and even when capacity utilisation indicators are
largely around cyclical averages rather than at peak levels.
Similarly for Europe, there is a marked heterogeneity of
economic performance. Core Europe has recovered well from
the crisis, led by Germany where some wage pressures are
starting to appear. Conversely, the plight of the peripheral
EMU countries needs little further description. The dilemma
for the ECB in terms of policy making is plain to see. Indeed,
with the Fed still easing quantitatively, the Bank of England
split on the timing of a tightening and the ECB chairman
making it abundantly clear that action is coming soon, this
creates a further degree of difference.
While such divergence may complicate matters for policy
makers, it does throw up opportunities for investors to add
value in bond portfolios. Having emerged from a period where
the world generally thought inflation was tamed, through
one where deflation was seen as much more of a threat, the
upswing in inflation pressures, partly in the US and Europe
but especially across many emerging market economies,
has brought inflation-linked bonds to the forefront of many
investment discussions.
In recent months, inflation expectations have risen markedly
across major markets. This move has been highly correlated
with the changes in the price of oil and other major
commodities. However inflation expectations over the coming
five years are only at comparable levels to those experienced
prior to the crisis. In that period, the consensus was that
the authorities had inflation under control, permanently.
Source: Bloomberg
Questions have to be asked, therefore, about why inflation
insurance is no more expensive now than then, given the
much higher levels of uncertainty.
At this stage of the economic cycle, we would expect in
normal circumstances that investors should favour real
assets, i.e. those with an implicit or explicit link to inflation.
However, this is far from a normal recovery, after a far from
normal recession. Hence it is expected that investors will wish
to own a more cautious mix of real assets than in more normal
circumstances. This may mean a greater weight in inflationlinked
bonds, and lower weightings in riskier real assets,
than would be normal at this stage of the cycle, to provide a
significantly better diversified portfolio. Global inflation debt
has proved a powerful diversifier in the last decade, both
within bond portfolios and within balanced funds. Holdings
in this asset class allow investors to move closer to their
efficient frontier.
A historical problem with UK inflation-linked bonds was
that they were expensive compared to other assets. This is
less obvious nowadays, as spreads with other markets have
narrowed. However, there are still clear opportunities in other
inflation-linked markets such as the US and Australia, where
real yields are higher. For this reason, a global portfolio is
more attractive than a domestic one, providing higher real
yields and better diversification.
We expect significant opportunities within global inflationlinked
bonds arising from the divergence in growth and
inflation outlooks. The attached chart shows that, despite
the clearly different output gaps in the UK and US, ten-year
inflation expectations between the two countries moved
almost to parity in Autumn 2010. We identified this as a
strategic opportunity, and using the inflation swap market
took exposure to rising UK inflation expectations relative to
those in the US. This strategy has already begun to add value
for our funds.
To conclude, we see the divergence of outlooks across global
economies as likely to provide both risks and opportunities for
portfolio managers. Within global inflation there will be more
relative value opportunities than for some time. At the multiasset
level, global inflation forms a key part of a diversified
portfolio of real assets, helping to enhance the risk-return
characteristics of the wider portfolio.
Global Outlook 21

Global Outlook Team
The production of Global Outlook draws on the ideas
and insights of many of our investment professionals
around the world within the framework of our Focus
on Change investment philosophy. Below are the
contributors to the publication, in addition to those
mentioned within the document.
Contributors
Editor
Sub-Editors
Chart Editor
Frances Hudson
Andrew Milligan
Richard Batty
Jason Hepner
Douglas Roberts
Richard Batty
Additional Contributors
Copywriters
Dominic Byrne (Global equities)
Magdalene Miller (Global emerging markets)
Helen Driver (UK equities)
Masaru Okubo (Japanese equities)
Takeshi Wada (Japanese equities)
Simon Wood (Foreign exchange)
Govinda Finn
Robert MacDonald
Lorna Malone
Kathryn Robertson
Julie Sheridan
David Turner
Isobel Walder

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House View
The following portfolio is based upon a global investor with access to all the major asset classes. For regional versions of the House View, please
contact your Standard Life Investments representative.
Risk
Government Bonds
US Treasuries
European Bonds
UK Gilts
Japanese Bonds
UK Inflation-
Linked Debt
Corporate Bonds
Investment Grade
High-Yield Debt
Equities
US Equities
European Equities
Japanese Equities
UK Equities
Developed Asian
Equities
Emerging Market
Equities
Property
UK
European
North America
Asia Pacific
Other Assets
Foreign Exchange
Global
Commodities
Cash
April 2011 House View
The Global Investment Group has concluded that portfolios will take on moderate levels of risk, focusing
on assets with high, yet sustainable, yield and looking for relative value opportunities in view of continued
economic and market volatility.
Yields are supported by a backdrop of muted inflation pressures and further quantitative easing, but
valuations and the deteriorating fiscal outlook are becoming more of a concern.
Core European bond markets are supported by moderate levels of inflation and safe haven flows but
investors remain concerned about the fiscal outlook in a number of Euro-zone countries.
The muted economic recovery and significant fiscal tightening provide strong support for the bond market,
while inflation risks reflecting commodity prices and taxes should start to ease.
Japanese government bonds are not experiencing the same levels of volatility as in other markets,
although low levels of yield are deterring some global investors.
There are inflation risks in the medium-term from central bank quantitative easing, but valuations of
inflation-proofed debt need to be examined carefully.
The decline in the yield spread is expected to continue, but the volatility of the underlying government
bond markets is growing significantly and adversely affecting total returns in investment grade debt.
Still benefiting from an attractive carry, strong corporate cash flows and further improvement in the default cycle
as economies recover, but valuations are not as supportive as they were last year.
Good cost control and better economic prospects are supporting strong corporate cash flows, although
the upside is limited by the consumer debt, government debt and housing market overhangs.
Although strong emerging market demand support many exporters, the corporate sector faces margins
pressure while the peripheral economies would be affected by any ECB monetary tightening.
Valuations have improved considerably while the Bank of Japan is taking more steps to stabilise the
currency. The success of the government in helping the economy restructure after the series of natural
disasters remains very uncertain.
The market can make headway supported by valuations and the benefits of sterling’s depreciation on
overseas earnings, but faces headwinds from weak real income growth and fiscal tightening.
Strong economic growth is increasingly translating into inflationary pressures, bolstered by commodity
price shocks, in turn requiring more aggressive monetary tightening.
Selection is increasingly required; while some benefit from strong commodities demand and upgrades to
sovereign debt ratings, others face growing inflationary pressures and valuation concerns.
Despite short-term yield pressures, we continue to expect strong relative returns over cash on a three-year
holding period.
Key centres, such as Paris and Stockholm, are benefiting from the same positive demand and constrained
supply factors as supported London’s earlier yield rally.
We see the best prospects in under-developed industrial locations in Canada and the cyclical US office
markets where future supply is at 30-year lows.
Excessive supply in certain markets, e.g. China, will hold back growth, but office markets in other markets,
e.g. Australia, remain supported by a good demand/supply balance.
The dollar and yen are being driven by divergent growth prospects for the coming year. Sterling and the
euro will reflect the success of policy makers in capping inflation and fiscal pressures.
Strong demand for industrial commodities, led by infrastructure projects in emerging economies, but oil
and soft commodities will eventually see new supply come on stream.
Central banks in the major economies will keep monetary policy very loose into 2011 as inflation
pressures remain weak, due to excess capacity and high levels of unemployment.
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