Quarter Ended 30 September 2011

Global Macro and Markets Overview
Global equity markets weakened materially as yields in government bonds hit historical lows.  Investors' concerns focused on a global slowdown and continued European sovereign risk issues.  The Federal Reserve became more bearish with regard the future outlook as it announced that it would keep interest rates at exceptionally low levels until 2013.  It initiated "Operation Twist" which is the buying of longer dated US government treasuries.  It is hoped this will reduce the borrowing rates associated with long term debt. 

In the US negative headlines surrounded the lack of progress on introducing a long term deficit reduction plan.  The solution which transpired in early August was seen as a short term fix.  Due to the political ramifications with regard the budget deficit S&P downgraded its long term credit rating of the US from AAA to AA+ with a negative outlook.  We do not expect much more progress on this particular issue prior to the election of next year. 

The ECB downgraded growth forecasts for 2011 and 2012.  Meanwhile the Troika experienced conflict with the Greek government and the introduction of an appropriate fiscal policy.  During Q3 a number of European countries voted for the approval of increasing the EFSF.  Some commentators suggested that this fund would have to be leveraged.  It is ironic and worrying that the credit crisis, which resulted from excessive leverage, may need a solution which will entail leveraging the rescue fund. 

The concerns with regard asset values and sovereign debt concerns ensured a flow of funds into gold and what is perceived as defensive currencies.  However, as emphasised by the move from the Swiss National Bank to peg their currency to the Euro at 1.20 investing in currencies remains a volatile exercise. 

The drip feed of negative headlines with regard the European solution continued unabated throughout the quarter.  These included the necessary approval of the EFSF by the German Federal Constitutional Court, the reluctance of the Berlusconi government to introduce an austerity package and the forcing of the Greek government in introducing a property tax.  Italian and Spanish government bond yields increased to worrying levels with the ultimate arrival of the ECB as a buyer of last resort.  The lack of political leadership and the extended time taken for any proposed solution to the European sovereign debt crisis will ensure that markets will remain volatile in the near future.

Nestlé and Unilever
Two consumer staple companies which are Appian equity holdings are Nestlé and Unilever.  High quality consumer staple stocks are strong fits for our preference for companies with 'defensive growth' characteristics.  As the prospects for both of these companies are not overly dependent on the vagaries of the economic cycle, their defensive aspects pay off in turbulent equity markets (for example, in Q3 Nestlé's share price fell by 4% while Unilver's actually gained 5%).  Moreover, both companies have sustainable business models that will generate growth and have strong balance sheets to support this growth.  Both are well placed to grow sales organically by a low to mid single percentage annual rate over the medium to longer term.  Much of this will be volume growth - developing sales in emerging markets, winning market share and expanding their product ranges in all markets.  Some of the revenue expansion will be value growth, partly through higher prices (to reflect higher commodity costs) and partly through mix as higher value added products are focused on.  Furthermore, continual efficiency and cost savings programmes will not only absorb the element of rising commodity costs that cannot be recovered in pricing but will allow margin expansion, reinforcing the prospects for profit growth.  Finally, while investors wait for this potential to be realised they will be rewarded by a dividend yield of 4%. 

As always, if you have any queries in relation to your investment or portfolio, please feel free to contact me or my colleagues.  If you feel it to be beneficial, please do not hesitate to contact us to organise a meeting where we can discuss our investment views in greater detail. 

Pat Kilduff
Investment Manager
October 2011