Portfolio overview

Money market securities on the whole had a mixed quarter, with the broader index pulling up from the lows seen in June on the back of the Eurozone sovereign crisis. While spreads tightened on corporate paper, the underlying money market rates moved very differently across regions. In the UK there was little change over the quarter in three-month LIBOR funding; in fact it started and ended the quarter at 0.73% with little volatility in the interim. In the US three-month LIBOR fell from 0.53% to 0.29% as fears over deflation pushed yields lower. In Europe, however, it rose from 0.71% to 0.85% and this could probably in part be attributed to some withdrawal of liquidity by the European Central Bank (ECB) through its 12-month lending facility and lingering concerns over sovereign risk. Despite less media attention, spreads on Irish debt exceeded the levels reached in second quarter. Absolute yields in Greece and Portugal also shot higher. However, it was not a bad period for the euro and this will have helped investors in euro exposed products. Although the risks are still out there in Europe, the devaluation effects of another round of quantitative easing (referred to as QE2) in the US, Japan (through the currency intervention) and possibly the UK, have combined to squeeze the euro higher. Time will tell, and recent history suggests that the ECB may join the game at a later stage when a renewed fall in the euro may materialise.

Portfolio activity and positioning

We bought a lot of paper in the RMB International Income Fund over the quarter, which ranged from US and European bills through to a number of different investment grade issuers. Names such as Iberdrola offered a healthy premium being a Spanish issuer, but the cashflow generation of this utility is sufficient to cover their debt servicing. Other names we bought included EDF, BP (still offering a good spread after the problems related to the deepwater oil spill), Astrazeneca, Goldman Sachs and Barclays. The regional split remains broadly neutral. The fund yields 0.69% and has a modified duration of just 0.13 years.

Economic overview
The second quarter of 2010 started strongly enough as growth expectations of 3.5% in the US for the full 2010 appeared realistic against a backdrop of rising private sector payrolls and low inflation. However, the US recovery risks running out of steam in a domestic market where low capacity utilisation holds back investment and credit remains tight at household and corporate levels. Consumer participation in the recovery remains fragile, as house prices look set for further softening. The compounded problems of a weakening European export market added to fears of a double dip. Asia continues to lead global growth with a strong rebound in Japanese exports and bullish growth expectations in China and India. The UK saw a new government coalition formed which, to date, has held up well and wasted no time in instigating budgetary cuts and austerity measures. These have been well received. Undoubtedly it was the European economy which dominated headlines throughout the quarter as sovereign funding issues reached a point of capitulation and forced a concerted effort between the Eurozone member governments, the European Central Bank (ECB) and the International Monetary Fund (IMF) to provide a backstop to the funding crisis.

Portfolio overview
Money market securities, unsurprisingly, came under pressure during the second quarter. Conditions worsened against a backdrop of a rapidly deteriorating outlook in Europe as the sovereign funding issues escalated. There was no change to the ECB policy rate during the quarter, which remained at 1%. However, there was a noticeable move higher in interbank financing rates during the quarter, with short-term providers of US dollar liquidity earning nearly twice as much at the end of the threemonth period than at the start. Ultimately, this all stemmed from the peripheral Eurozone sovereign risk that had permeated the region's banks. Speculation mounted that French and German banks, amongst others, had substantial holdings of Greek debt which saw two-year yields spike to as much as 18% in early May. A €750bn bailout package helped stabilise the markets, after which the ECB committed to a sterilised bond buying program. As the ECB's 12-month Long-Term Refinancing Operation (LTRO) neared maturity, the wider investment community feared a funding crisis amongst the European banks and the ECB introduced a three-month LTRO in an effort to reduce the strain. As it turned out, banks rolled over less than expected and the quarter ended with some level of stability being achieved.

Portfolio activity and positioning
During the quarter, spreads on floating rate notes widened from 30bp over LIBOR to 50bp, a reflection of the risk aversion and funding issues that increased during the quarter. We continue to reinvest maturing bonds into government bills and high quality corporate paper including Santander, GE, Bank of America and Total. Spread duration remains low and over the next quarter we will continue to look for short maturity bonds with attractive spreads, and will use government bills to manage the liquidity. The regional split remains broadly neutral.

Economic overview
During the quarter, the US Fed chairman Ben Bernanke reaffirmed that US interest rates would remain exceptionally low for an "extended period" despite the "nascent" economic recovery, leaving interest rates unchanged at 0.25%. In the UK, the Bank of England governor, Mervin King, kept interest rates at 0.50%, and confirmed he would maintain ultra-low interest rates for a protracted period after the Monetary Policy Committee (MPC) tempered optimistic growth forecasts in its quarterly inflation report. In addition, the MPC voted to pause its quantitative easing programme, while signalling a "wait and see" stance to judge the effects of the policy. The European Central Bank (ECB) left interest rates unchanged at 1.00% and, despite the European Union (EU) member states, ECB and International Monetary Fund (IMF) striving to find a happy ending to the Greek tragedy, the market continued to discount future concerns.

Market overview
Money market securities enjoyed renewed popularity with investors in the last part of 2009 and liquidity continued to improve in the first quarter of 2010. Despite negative news on banks at the end of January and downside in February when sovereign risk fell under the spotlight with the Greece crisis, spreads on corporate floating rates notes rallied another 10bp over the quarter. In March, both euro and dollar short-term money markets broke their respective records - but for very different reasons. On the one hand, the cost for banks to borrow money over three months in euro, LIBOR fell to a record low of 0.58% due to weaker demand from traders. On the other hand, the cost of borrowing over three month in US dollar hit a 6-month high of 0.29% ahead of the end of the US Federal Reserve's quantitative easing programme.

Portfolio activity and positioning
During the quarter, floating rate note market spreads continued to tighten from 58bp over LIBOR to 48bp, giving a modest capital appreciation on the top of the quarterly income. At the fund level, we maintained its low spread duration risk. We continued to run our conservative strategy by reinvesting any maturities into a combination of quality short-term corporate paper with attractive spread and government bills in order to keep the fund liquid. We also maintained the allocation of the fund close to the benchmark: 1/3 in US dollar, 1/3 in euros and 1/3 in sterling.

Economic review
During 042009 the US Federal Reserve kept interest rates at 0.25%. While officials have expressed concerns that near zero interest rates could lead to a new speculative bubble, the possibility in their opinion is "relatively low". The Bank of England held interest rates at 0.5% but extended its programme of quantitative easing, pumping another £25bn into the economy in what was described as "one last heave" to stimulate growth. However, the Bank indicated that it will slow the pace of cash injections under its OE programme over the next three months, in line with its slightly improved economic outlook. The extension will bring the total cost of the programme to £200bn. The move follows tentative signals from the Fed and ECB of an end to their ultra-loose monetary policy. The European Central Bank kept interest rates on hold at 1.0%, warning Greece to bring public finances back under control. In addition the IMF's managing director warned about the risks of an early exit, saying that the global economy was on the verge of recovery but remained vulnerable to shocks and policy mistakes, and that fiscal and monetary stimulus programmes should not be stopped too soon.

Market overview
Money market securities continued to rally during the final quarter of 2009 with spreads having largely normalized from the extremes reached one year ago. Despite some concerns about continuing problems in consumer credit and commercial real estate, the major US banks reported good 03 results. In fact, US corporates in general surprised the market with better than expected quarterly numbers, showing how they managed to cut costs faster than revenues fell. Overall, banks and commodity-linked companies continued to consolidate their balance sheets through sales of assets, mergers and acquisitions. However, state leaders of the developed nations reaffirmed their willingness to make bankers pay back the cost of their bail-out funds through a tax increase on profit and bonuses. In the Middle East, Dubai World announced they where seeking a debt standstill on approximately $22bn of debt, which had a minor impact on global credit spreads but money market securities generally escaped any pain.

Portfolio activity and positioning
Over the quarter spreads on floating rate notes continued to narrow - albeit at a slower pace than previously - contracting from 75 basis points over Libor to 58bps. Money markets have now largely normalized and spreads should continue to tighten at a lower pace. At a fund level, we maintained low fund's spread duration risk and continued to reinvest any maturities into a combination of quality short term corporate paper with attractive spread and government bills. We also maintained the allocation of the fund close to the one of the benchmark: 1/3 in US Dollar, 1/3 in Euros and 1/3 in Sterling.