PERFORMANCE SUMMARY

Strong performance this quarter driven by structural growth stories

The Legal & General UK Equity Income Trust performed well during the fourth quarter of 2011. It returned +8.76%, compared to +5.89% for the IMA UK Equity Income sector average and +8.39% for the FTSE All-Share Index.*

Our positive view on industrial stocks that are focused on structural, rather than cyclical, growth helped drive performance as some of these (particularly in the mid cap area) performed very strongly in the fourth quarter.

On a stock specific level the key drivers of positive performance included Weir Group, which rebounded strongly after being sold off in the third quarter as the company produced results that were ahead of expectations, with strong earnings and an encouraging new business pipeline. Meanwhile Petrofac also performed strongly on the back of better numbers than the market was anticipating.

Elsewhere, Compass Group performed very strongly. In part we see this as being part of growing recognition within the market that equities offer value from an income perspective. The yield on some of these stocks is particularly attractive and offers an incentive to move up the risk spectrum out of sovereign bonds and into equity income.

On a relative basis, the fund also benefited from being underweight in areas of the market that struggled during the period. One of these was domestic financials, particularly banks, which experienced another quarter of poor returns. In the case of Lloyds, for example, a disappointing update that forced management to move away from their medium-term targets after just five months weighed heavily on the shares.

Other than real estate company London & Stamford Property, the only domestic financial stock we hold in the portfolio is Hargreaves Lansdown, which was one of the few notable negative contributors to performance during the quarter. Other detractors from relative performance included our underweight in the resources sector, which contains stocks that tend to be too low-yielding and high-beta for inclusion in the portfolio. Additionally, Staffline Group fell during the period as small cap stocks continued to be out of favour with the market in general.

It is pleasing to note that there have not yet been any dividend cuts to stocks held in the portfolio. It is a key part of our investment strategy to identify companies that have robust, defendable profits and can sustain cash flow and dividends.

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

POSITIONING

Finding opportunities across the spectrum of the UK market

At present approximately 45% of the portfolio falls into what we call our 'Sustainable High Yield' category with 35% in 'Dividend Growth' - we believe that both styles represent compelling value at the moment.

The rest of the portfolio consists of special situations from across the market cap spectrum. The most notable of these during the fourth quarter was Lancashire Holdings, a specialist insurance underwriter that fared well during a year with many natural disasters and is now able to write new business at a higher level. The company paid a substantial special dividend during the fourth quarter, from exceptional profits.

The stock that best encapsulates the spirit of our 'Sustainable High Yield' element is Vodafone, which is the largest holding in the portfolio. Our view is that this is a strong, defensive, global company that is highly cash generative and with a superb dividend history – the fact that it yields in the region of 7.5% makes it especially attractive at present. The differential between the yield on its equities and its bonds (and, indeed, government bonds) suggests that at least one of the assets is fundamentally mispriced. While we do not know if or when these valuations will revert, we believe they will and in the interim are confident of compounding our 7.5% dividend yield.

Our 'Dividend Growth' stocks are focused more on structural than cyclical growth in the current market environment. Examples of the stocks that we are looking for include Weir Group and Petrofac (mentioned above) as well as Senior. The latter is a small cap industrial company that is geared into the production of the Boeing 787 'Dreamliner', which has a large order backlog which underpins earnings over the medium term; this is not particularly cyclical because it is a long lead time business.

We try to have a broadly diversified portfolio and at present are near the top end of our typical portfolio size of 30 to 40 stocks. We relish running a concentrated portfolio as it allows us to back our best ideas so that every stock has a material impact on performance.

OUTLOOK

Positive on the outlook for equity income stocks, albeit in a challenging market

Our broad outlook for the market is that Europe will continue to dominate news flow. This will probably be more of a negative influence than positive on the UK market, but the situation is complex enough that nobody can be certain of how it will develop. All we can do is have a good understanding of the types of risk we have in the fund and focus on picking fundamentally strong stocks that in our opinion offer exceptional value.

Fortunately there are plenty of investment opportunities for us in the market at the moment, and in our opinion stocks with strong sustainable high yield or dividend growth characteristics are well positioned to outperform. In general we believe that equity income will continue to be a strategy that finds favour with investors, given that good sources of income are harder to find (especially with uncertainty over the credit-worthiness of European sovereigns).

Our expectation is that the yield on the fund is likely to rise over the next year (due to growing dividends rather than capital falls), and our forecast for dividend growth in the UK equity market is around 5 to 10% for 2012, although of course there is no guarantee that either of those predictions will prove true.

In summary, we are cognisant of the risks that face the UK economy and the financial system from what's going on in Europe, but we're not overly depressed. The UK has a large trading relationship with the US, which is farther down the route of deleveraging and purging of its financial system. Furthermore, the UK market isn't a pure reflection of the UK economy; we will continue to focus on companies with strong franchises and cash flows, which can support sustainable and growing dividends.

Richard Black - 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 Equity Income 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.

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.