Economic and Market Perspectives Simon Doyle – Head of Fixed Income and Multi-Asset A world of uncertainty or a world of opportunity?

Why? Seeds sown early this decade US monetary policy Leverage Sub-prime Financial engineering

Financial market failures Bring out your dead! Re-incarnated Wounded Dead!

Risky assets have suffered Balanced AssetsDefensive Assets Gross 12 month returns by asset class as at 31 October 2008 Source: Schroders/Datastream. 1. S&P ASX 200; 2. MSCI World; 3. S&P ASX300 Property Trusts; 4. Merrill Lynch Global High Yield Index; 5. Schroder Hybrid Securities Fund; 6. UBS Credit Index; 7. UBS Bank Bill Index 8. UBS Treasury Index Big losses in equities, REITs and higher yielding credit Growth Assets

The pointy end… Source: CBA, Schroders Indicative market CDO Indicative market US residential mortgage backed 2007 AAA structured product and mortgage backed security prices Shanghai SE Composite Index Chinese stock market Excesses coming home to roost

US recession is inevitable Source: Datastream US GDP and Conference Board Leading Index It will be an extended slump

Recession is also likely in Europe and Japan Eurozone GDP and Whole Economy PMJapanese GDP and Econ Watchers Outlook Eurozone GDP – yoy% Weighted ISM (RHS) Japanese GDP – yoy% Eco Watchers Outlook – Lead 2 months (RHS) Surveys indicate sharp slowdown

Inflation is no longer an issue Source: Datastream G7 economic activity and change in inflation G7 annual change in inflation G7 GDP – yoy% change, lead 2q (RHS) Inflation follows economic growth down

Terms of Trade are reversing Source: UBS, Datastream Terms of Trade and Base Metal Prices Australian terms of trade MG Base Metal Index (RHS) Tailwind to headwind

Australia will flirt with recession Source: Datastream Weak sentiment is flowing through to activity Australian non-farm product and leading index %

We have high household debt levels like the US Source: GSJBW Research Estimates, Goldman Sachs Research Estimates Household sector debt as % of GDP Aggressive household credit build up across most western economies Australia UK USA

Global Equities are looking attractive Source: Schroders, Datastream P/E ratio average +1 std deviation -1 std deviation Trailing PE MSCI World vs 25 year historical average Global market is cheap

BHP Billiton Commodity prices have driven profits Source: Merrill Lynch 31 August 2008 This is illustrative only and does not represent Schroders’ recommendation on these stocks Earnings driven by increased prices - volume increase offset by higher costs Increased prices Increased volume offset by increased costs Underlying EBIT analysis: FY08 vs FY02

Something positive from the credit crisis… Source: Schroders, Datastream US high yield Return Spread (RHS) Credit markets will provide attractive returns %

Source: Morgan Stanley, * Includes public sector Corporate gearing is low Corporates Households Financials Total* US debt as a percentage of GDP

Yields from Hybrids are looking attractive Source: Schroders, Datastream Australian hybrid yield and cash rate Cash rate Hybrid option adjusted yield Hybrids are cheap now!

Cash looks good now… Source: Schroders/Datastream Australian cash rate vs US federal funds rate: US federal funds rate Australian cash rate ? …but look what happened in the US

Source: Schroders/Datastream Returns of Australian Cash, Government Bond Too much cash – too little bonds High cash rates + fear = poor long term portfolio construction decisions

Source: Schroders Cycle vs. asset class performance Slow downRecession Recovery Expansion Cash Govt bonds High Yields Bonds Equities High Yields Bonds Equities Commodities Property Australia Preferred asset class and the economic cycle US Europe Japan Asia

Our approach hasn’t changed We like; Transparency Liquidity Value for money True economic diversification Appropriate leverage Unlisted assets and hedge funds do not provide this!

June 2007 What have we been doing? Remove risk in 2007

December 2007 What have we been doing? Remove risk in 2007

What are we doing? Selectively adding risk October 2008

Conclusions Economic concerns warrant caution “Risky” assets now have a risk premium Its not the time to sell risk Like higher yielding assets - hybrids Cash was king – but being too defensive could be costly A world of uncertainty…but with selective opportunity

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