PERFORMANCE SUMMARY

Performance was slightly behind the peer group average

The performance of the Legal & General Dynamic Bond Trust over the three months to the end of December was +2.26%, compared to a rise of 2.88% in the IMA £ Strategic Bond sector average.

With the Euro-zone sovereign debt slow-motion car crash dominating investors' thoughts, the lack of political progress towards a comprehensive solution added to concerns that the crisis could push Europe back into recession. With even the powerhouse German economy showing signs of faltering, and with Greece lurching ever closer to an uncontrolled default, investors' appetite for risk showed only sporadic signs of recovery amid fresh worries over the impact of peripheral sovereign debt losses on the banking system. Although the Chinese economy showed further signs of cooling, the US gave investors greater grounds for optimism as relatively resilient levels of economic growth and the improving jobs market fed through to boost retail sales.

 Attribution over the quarter

The fund was positioned to benefit from falling bond yields (via a long duration position) over the quarter, which contributed to positive returns as UK yields fell and prices rose – particularly at longer maturities where a significant proportion of the fund's UK government bond holdings were focused.

Allocations to higher yielding assets – financial sector bonds and high yield bonds – also made positive contributions over the period. Several banks repaid their subordinated bondholders, the market responded well to broadly constructive headlines around potential write-downs of Greek government debt and a stabilisation in global macro-economic growth data helped support investors' risk appetite.

Positioning

In keeping with our view that the market's appetite for risk would decline as the global economic outlook became increasingly unclear, we pared back the portfolio's level of risk during volatile market conditions during the quarter. We reduced our net exposure to high yield while adding to our weightings in core government bond markets, particularly long-dated gilts as we believed that these would be among the key beneficiaries of investors nervousness and quantitative easing-related buying. We have also continued to move up in quality among financial sector bonds, paring our holdings in subordinated bank bonds in favour of those at the top of the capital structure.

Key buys and sells this quarter

Given our view that rising levels of global economic uncertainties would erode investors' appetite for risk, we reduced our net high yield exposure, partly through the use of index-based credit default swaps as there was only intermittent liquidity in some underlying cash bonds during volatile market conditions.

The rising level of exposure to core sovereigns, chiefly through longer-dated gilts, was another significant change to the portfolio over the quarter. While helping to extend the fund's interest rate risk exposure (duration), this also helped to cushion the portfolio from market volatility.

During the quarter we also took advantage of a spate of redemptions in bank debt; with Europe's banks required to boost capital by over €100bn over the next few months, many banks offered to repurchase or exchange subordinated debt at attractive levels. We capitalised on this trend by taking tactical positions in Lower Tier 2 Nationwide and BNP Paribas bonds, and a Tier 1 issue from Société Générale– all of which were subsequently called at par – and a Lower Tier 2 issue from Northern Rock that was tendered for at a healthy premium to the prevailing market price. By no means all tender offers were attractive, however, as we declined to participate in a debt exchange offer from Santander.

Given the relatively low levels of market liquidity during a quarter marked by high levels of volatility, we made frequent use of new issues to put some of the fund's cash to work. Among the issues we participated in were oil rig operator Transocean, Italian power firm Enel and Swedish bank Svenska.

Outlook

Until such time as European political leaders finally take decisive action to resolve the debt crisis, we believe that the burden of managing the situation will be left to the European Central Bank through measures such as providing further liquidity to banks and additional purchases of peripheral debt.

In the meantime, we do not believe that market conditions are likely to reward investors choosing to take aggressive risk positions, though we remain more optimistic that sentiment could take a turn for the better later this year if investors regain confidence in the banking sector via measures such as state-backed recapitalisations.

Richard Hodges, Fund Manager
Legal & General Investment Management January 2012

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The views expressed within this document are those of Legal & General Investment Management, who may or may not have acted upon them. Legal & General Investment Management is authorised and regulated by the Financial Services Authority and is the Investment Adviser to Legal & General Dynamic Bond Trust, a UK authorised unit trust. This document should not be taken as an invitation to deal in any Legal & General investments or any of the stated investments. Remember, the value of investments and any income taken may fall as well as rise, are not guaranteed and investors may get back less than they invest. Past performance is not a guide to future performance. Exchange rate changes may cause the value of any overseas investments to rise or fall. Details of the specific and general risks associated with the fund mentioned are contained within the Key Information including the Simplified Prospectus.

Legal & General (Unit Trust Managers) Limited. Registered in England No. 1009418. Registered office: One Coleman Street, London EC2R 5AA. Authorised and regulated by the Financial Services Authority.