PERFORMANCE SUMMARY

Maintaining our high conviction process in challenging and volatile markets

The fourth quarter of 2011 saw a challenging market environment for the Legal & General UK Alpha Trust, which returned -3.50%, underperforming both the FTSE All-Share Index (+8.39%) and the IMA UK All Companies sector average (+6.07%).*

Markets are so risk averse that in many cases fundamentals have not been the primary drivers of stock prices. If it's not a large cap that yields at least 4% then investors aren't interested, which has led to some exceptionally cheap valuations elsewhere in the market. Some of the companies we hold, financially sound and with good long-term growth prospects, have been sold off indiscriminately. No doubt this is as frustrating for our investors as it is for us.

On the other hand, in many ways now is an exciting time to be an investment manager, especially if like me your instinct is to be contrarian. We are topping up the positions in some of our highest conviction stocks as they fall, a strategy we have employed successfully before, notably in 2008, and which has been a key driver of the UK Alpha Trust's strong historic performance. Over three years, for example, the Trust has returned +120.40% compared to +43.85% for the FTSE All-Share and +42.07% for the IMA UK All Companies sector average**, although of course there is no guarantee of this being repeated in future.

We believe it is a mistake to look at a portfolio on a weekly (or even daily) basis and just sell whatever is hurting you the most. It feels, however, as though most investors are doing exactly that. We take a longer-term view and our unconstrained mandate means we only hold stocks in which we have high conviction.

* Source: Lipper, % Growth Cumulative (GBP), net of fees, from 30/09/11 to 31/12/11
** Source: Lipper, % Growth Cumulative (GBP), net of fees, from 31/12/08 to 31/12/11

POSITIONING

Identifying undervalued areas of secular growth

In general, our strategy over the last few months has been to take profits in some of the portfolio's winners and redistribute this capital into stocks that have fallen to what we believe are attractive valuations. At present we favour stocks with a good degree of asset-backing, where the share price is trading around (or even below) the value of these assets. As markets fall there are more and more of such opportunities.

On a sector level we are finding value in technology, which is generally considered to be cyclical, but in fact there are parts of the sector with more resilient earnings. Data centres are one example, as there is a clear secular growth trend in both developed and emerging markets for storage capacity and managing traffic of data. Our favoured stocks in this area include Iomart, based in the UK, and CSF Group, which is UK listed but operates in South East Asia. We have also added to our holding in Optimal Payments, which runs integrated online and mobile payment systems.

Mining stocks have sold off aggressively in a market environment that shuns anything with a whiff of risk or cyclicality. Here too, however, the supply/demand balance seems supportive of long-term revenue growth and we are adding to our positions on a selective basis, with a focus on well-managed companies with good reserves.

As for the areas we are avoiding, anything that seems close to fully valued is not attractive at present. There are plenty of cheap stocks in which we have conviction, so there is no need for us to stretch further up the valuation scale in search of ideas. Worse than a high valuation, however, is high debt. While credit markets continue to experience turmoil we don't want to expose our investors to firms with a lot of debt on the balance sheet. Hence why we still hold no banks in the portfolio despite what may appear to be low valuations.

When the market doesn't recognise the value of your stocks, there is always the potential for bids. For example Mecom, a European newspaper business, has received approaches for its Norwegian division that have boosted the share price. We never buy into a stock purely on the expectation of M&A activity, but it is often a useful by-product of a strategy that looks for undervalued assets.

OUTLOOK

"Be fearful when others are greedy, and greedy when others are fearful." (Warren Buffet)

In the months ahead we will continue to stay true to our core investment principles, namely to invest only when we have high conviction and to choose fundamentally strong stocks with a compelling long-term story. Our ability to invest across the full range of the UK main market and AIM, coupled with the size of the Trust, means we can make a substantive investment in almost any stock in the universe – so we can go wherever we see the best value or growth potential.

Like most people we do not have a particularly bullish view on the UK economy however the UK stock market is a highly international one and over half our portfolio is tilted towards overseas earnings. In general the portfolio continues to have a slant towards companies exposed to growth in emerging markets, with a focus on positioning ourselves to take advantage of strong secular growth trends.

Indeed we consider that on aggregate equities look reasonably cheap when measured against historic valuations and we are finding many attractive investment ideas. I cannot pinpoint a date when the market will wake up to how much it has overlooked a large number of fundamentally strong businesses, but we are excited about the opportunities to accumulate cheap stock in our highest conviction ideas.

Richard Penny, Fund Manager
Legal & General Investment Management

This is not a consumer advertisement. It is intended for professional financial advisers and should not be relied upon by private investors or any other persons.
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 UK Alpha Trust, a UK authorised unit trust.
This document should not be taken as an invitation to deal in 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.
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