Quarter Ended 30 June 2011

Global Macro and Markets Overview
Equity and currency markets remained heavily influenced by macro economic issues.  These issues included (1) US debt ceiling (2) Eurozone sovereign issues (3) commodity prices (4) China slowdown (5) the end of QE2 and (6) Japanese supply chain disruptions.  Outlined below is a brief synopsis of these issues.

A US debt ceiling has been in place since 1917.  Presently it is capped at $14.3tr which is likely to be reached by 2 August.  Democrats and Republicans in the year before the election are using the debt ceiling to outline their future fiscal policy initiatives.  Investors believe, based on the fact that the debt ceiling has been raised 74 times since 1962, that it will be increased prior to 2 August.  However, continued speculation of a possible US default is making markets very nervous. 

Our confidence in the Eurozone project has been severely tested as politicians remain permanently behind the curve.  The bond market, despite political protestations about the rating agencies, has indicated its thoughts with regard to the handling of this issue.  At the time of this letter 10 year bond yields for Greece (17.10%), Portugal (12.28%), Ireland (13.69%), Italy (5.86%) and Spain (6.21%) had spiked significantly over their German (2.64%) counterpart.   Based on these bond yields the market is pricing in a series of defaults and hopefully forcing European politicians into enacting appropriate corrective action that Appian has long advocated.  We continue to remain acutely aware of the risks associated with this issue. 

Commodity prices spent most of Qtr 2 at elevated levels.  This remains a concern for us as Corporations begin to report Q2 earnings and analysts have expectations of record margins.  We think there will be greater margin pressure and hence analysts may have overestimated their expected earnings.  However, the recent release of emergency oil supplies from the IEA will provide some short term relief. 

Chinese politicians are attempting to construct a soft landing of the economy.  There is a concern amongst the ruling class that there may be a property bubble and high food prices provide a timely reminder that social unrest remains a continuing concern.  The authorities wish to slow the level of investment in the economy and at the same time encourage consumer spending.  This slowdown will not only effect neighbouring emerging market countries but also those countries that are rich in natural resources. 

The benefits of QE2 are difficult to evaluate but in all likelihood it was beneficial for risk assets such as equities.  QE2 was the $600bn purchasing program of US treasuries by the Federal Reserve as the Fed Funds rate had been lowered to close to 0%.  It enabled bonds yields to remain artificially low and may have provided US exporters with a weaker dollar.  This program ended on 30 June and whilst this should be considered a relative negative we believe the Federal Reserve will keep interest rates at historically low levels until there is sustainable  growth in employment.  The possibility of QE3 should not be discounted. 

The after effects of the Japanese Tsunami and earthquake have been more negative in disrupting global manufacturing than originally anticipated.  However, we suspect the fiscal stimuli provided by the Japanese government will be beneficial for global growth in H2. 

In the short term we remain comfortable with a suitable exposure to appropriate equities (as outlined below) based on their relative valuation to other asset classes and continuing monetary support.  Highly rated bonds, whilst outperforming in the short term, remain overvalued.  Appian remains wary of the effects of future inflation on the real return for bonds.  The security of our cash holding remains a serious consideration as we move funds from commercial bank deposits to short dated German government bonds.  We remain hesitant in materially increasing our clients risk exposure until we get greater transparency on the issues discussed. 

Henkel
Even in times of difficult conditions there are some individual stocks that perform well.  One such stock in Appian's equity portfolio is Henkel, the German producer of household products (Persil), personal care goods (Schwarzkopf) and adhesives (Loctite).  We invested in Henkel in Q3 of last year as we were attracted by its management's determination to generate efficiences and to impose more rigorous systems to boost sales growth and profit margins in its business.  Since then management has delivered - margins have expanded as significant cost savings have been realised and sales growth rates improved.  The company has so far exceeded its targets giving confidence it can achieve the medium-term goals it has set itself.  Consequently, the share price has benefited, rising by 10% over Q2 and it is now approximately 20% above our entry point. 

Novartis
A recent new addition to the equity portfolio was Novartis, the Swiss based global pharmaceutical giant.  The pharma sector is one where we have been underweight and after a consistent de-rating of the valuations of pharma stocks over the past decade we are beginning to sense value - particularly as it is value in a defensive sector against a background of growing macro-economic threats.  We were attracted to Novartis in particular because it has a strong balance sheet, a better than sector average dividend yield (4.5% versus 3.5% for the sector), a well diversified business and an interesting pipeline of potential new products spread across four new emerging franchises.  Simply put, a candidate that matches Appian's preference for high quality, large cap stocks which have defensive growth characteristics at attractive valuations. 

Northern Trust
Post the acquisition of Bank of Ireland Securities Services by Northern Trust client assets will now be held under the custodial stewardship of Northern Trust.  Northern Trust is a global leader in custodial duties with circa $4.4trillion in assets under custody.  As with every aspect of a clients portfolio Appian will continue to review and seek the most appropriate structure and custodian for your assets.

Pat Kilduff
Investment Manager
July 2011

Quarter Ended 31 March 2011

Global Macro and Markets Overview
Equity and currency markets suffered significant volatility in the first quarter of 2011.  Initially the equity market benefited from better than expected earnings in Q1.  This combined with PMI and ISM figures showng a significant expansion in the service and manufacturing sectors provided impetus to the equity market.  Equities also benefited from on-going mergers and acquisition activity and improving employment figures.  However, in the latter half of the quarter equity markets suffered as a result of geopolitical volatility in North Africa and the Middle East and the natural disasters that struck Japan.  As a result of the problems in the Middle East and North Africa the price of a barrel of oil spiked to $115.  Inflationary pressures increased as a result of higher energy costs and food prices.  Higher food prices have proven to be the catalyst for the geopolitical concerns in the Middle East and North Africa. 

Risks associated with the Eurozone sovereign government debt continue to materialise with little impetus from the ECB or European Commission in implementing a practical medium to long term solution.  As a result of inflationary pressures the ECB has signaled to the market that it will begin the process of increasing interest rates.  This is a reflection of higher than expected inflation in the Eurozone and continued above par growth in core European countries.  The signposted increase in interest rates in the Eurozone has seen the Euro significantly strengthen versus the US Dollar. 

There remain significant risks with regard to the macro economic environment.  These include:  (1) the possibility of a hard landing in emerging markets; (2) continued currency volatility; (3) the difficulty in ultimately quantifying the issues surrounding Japan, North Africa and the Middle East; (4) continued weakness in the property market in the US and the effect that has on consumer spending; and (5) the possibility that QE2 (US quantitative easing, round 2) will cease at the end of June and the effects this might have on asset values.

Pfizer and Humana
Two US health related stocks common among our equity holdings, Pfizer and Humana, performed strongly in the first quarter.  Both companies have strong balance sheets and were lowly valued (at less than 10 times earnings) at end 2010, reinforcing our view that attractively valued companies, with sustainable business models and low financial risk provide attractive and sensible investment opportunities.

US pharma giant Pfizer rose 16% helped by two developments.  FIrstly, it raised its target for annual cost savings from the $68bn acquisition of Wyeth just a year earlier to $4bn, implying that the cost savings alone from this deal represent a return of 6% on the investment.  Secondly, Pfizer's management concede that it is sympathetic to the idea of possibly separating out the group's consumer products and pharmaceutical business which investors believe may allow each division to be better valued by the market.

Humana is a provider of healthcare services and other health insurance products in the US.  Its shares gained 28% in the first three months of 2011 as investors recognised that the various healthcare reforms championed by either political bloc in the US are likely to be favourable to its business.  Meanwhile it continues to successfully enroll new customers, highlighting the existing positive trends it is benefiting from.

Pat Kilduff 
Investment Manager
March 2011