The importance of Asset AllocationMirko Cardinale

Strategic Asset Allocation Specialist

Milan, 8 November 2007

This document is for professional advisers and market counterparty or intermediate customers only. The content is not approved for use with private/retail investors or pension scheme members.

Agenda

Importance of Asset Allocation

Evolution of Tactical Asset Allocation

Morley’s Tactical Asset Allocation process

Current outlook and positions

Performance and risk

Summary

Q & A

Importance of Asset Allocation

Most significant driver of portfolio returns

Academic studies agree asset mix is crucial

Combines assumptions on expected returns, volatility, and correlations

Asset allocation needs to exploit asset-class diversification

Source:Morley/ Gary P. Brinson, L. Randolph Hood, and Gilbert L. Beebower, Determinants of Portfolio Performance, The Financial Analysts Journal, July/August 1986 Blake D, Lehmann, B Timmermann, A (1999) Asset Allocation Dynamics and Pension Fund Performance Journal of Business 72 , 429-62

Efficient Frontier

Individual Asset ClassesEx

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etu

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Risk

Co

rrel

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Time

Efficient Frontier with Alpha

Page 5

Long-term beta-return forecasts

Long-term asset class returns are far more predictable

Fundamental economics & empirical research create building blocks of “sustainable returns”

Equity return prospects now modest

2.8

2.3

2.5

0

2

4

6

8

10

12

14

16

18

20

1981 1986 1991 1996 2001 Present

0

2

4

6

8

10

12

14

16

18

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Yield Expected Growth

Expected Inflation Subsequent 10 Year Return

Source: Morley Strategy Team, June 2007

The content of this slide is designed to illustrate the results of a research strategy employed by Morley Fund Management Limited for its internal use only.  It is not to be relied on by anyone else for their investment decisions.

Sustainable returns vary significantly over time and assets

Sustainable returns combined with historical volatility

Risk and return of conventional asset groups

Source: Morley Strategy Team, illustrative example as at 18 September 2007

Japan Equities (hedged)

Asia Pacific Equities (hedged)

UK Corporates

Global Aggregate Bonds

UK Property

Convertibles Commodities

Global REITs

EU Equities

US Equities

EM Equities

UK Gilts

UK Index-Linked Gilts

Emerging Market US$ Debt (hedged)UK Cash

Diversified StrategyFund (beta only)

Diversified StrategyFund (incl. alpha)

3.5%

4.5%

5.5%

6.5%

7.5%

8.5%

9.5%

10.5%

2% 7% 12% 17% 22% 27% 32%

Risk

Ret

urn

UK Equities

Emerging Market Local Debt

Sustainable returns demonstrate sensible order; but vary over time

Extending the asset allocation framework

Theory and practice show the benefits of a Strategic Asset Allocation framework

But is there any value in shorter-term market opportunities?

Incorporating short-term opportunities is known as Tactical Asset Allocation

TAA exploits short-term asset allocation opportunities

Origin of Tactical Asset Allocation (TAA)

First used to inform “asset-timing” decisions in the 1970s

A “top down” investment process

Captures shorter-term opportunities

TAA added “flexibility” to the strategic benchmark

Bonds30%

Cash10%

Equities60%

Bonds30%

Cash10%

Equities60%

Evolution of Global Tactical Asset Allocation (GTAA)

TAA becomes a broader, standalone investment

Empirical studies highlight asset

class inefficiencies

Single country TAA

Cheap index futures available

Futures markets broader and more

liquid

Multi-country models find regional inefficiencies

Multi-country GTAA

Currency market predictability

found

Multi country / currency GTAA

Pooled funds developed under

UCITS III

1980s 1990s 2000s

A modern GTAA process

Diversified range of long/short positions

Exploits market inefficiencies

Cheap and efficient execution

Low correlation with traditional asset classes

Bond Market Selection

Equity Market Selection

Asset Class Selection

Currency Selection

Global TAA has become more diversified and consistent

Source: Morley as at 30th September 2007.

Characteristics of GTAA returns

Can be considered as a way to reduce overall fund volatility or boost returns

Interest in GTAA driven by surge in demand for uncorrelated returns

Uncorrelated, absolute returns

FTSE All Share-0.40

MSCI World -0.45

FTSE World Eur ex UK -0.34

Lehman Global Agg +0.06

FTA All Stocks +0.05

3 Month Libor +0.05

-0.5 -0.4 -0.3 -0.2 -0.1 0 0.1 0.2

Correlation of GTAA Returns

Data uses >8 years of performance data from MPPL Balanced Managed Overlay (Q4 98-Q2 07)

Risk

Ret

urn

Efficient Frontier with TAA

Efficient Frontier without TAA

Initial portfolio with optimised strategic allocation

Improved return expectations for the same level of risk

Improved risk profile for an identical level of return

Philosophy

Inefficiencies between markets more significant than those within markets

Inefficiencies are persistent & exploitable, from

Investor sentiment

Structural anomalies between markets

Non profit-maximising participants

Transactions in futures and forward markets are quick and cheap enough to exploit these opportunities

Morley’s process can exploit these opportunities with the high degree of consistency that our clients desire

Investment process

A robust process that aims to deliver consistent, excess returns

Economic scenario analysis

Forecasting returns

Optimal portfolio analysis

Portfolio selection

Implementation

Why asset allocation?

Asset allocation is the most significant driver of portfolio returns

GTAA takes advantage of short-term asset allocation opportunities

Generates returns from diversified long/short positions across global equity, bond, and currency markets

Represents an excellent source of uncorrelated absolute-returns

Q&A

Important information

This document is intended for institutional or professional investors and experienced advisers only.

Except where stated as otherwise, the source of all information is Morley as at 31 October 2007.

Where past performance has been illustrated it is not intended to be a guide to the future.

The value of an investment and any income from it may go down as well as up, and the investor may not get back the original amount invested.

Any future returns and opinions expressed are based on our internal forecasts and should not be relied upon as indicating any guarantee of return from an investment with Morley. No part of this document is intended to constitute advice of any nature nor should any part be construed as a recommendation to purchase or sell stocks.

Morley is a business name of Morley Fund Management Limited, registered in England No. 1151805. Registered Office: No. 1 Poultry, London EC2R 8EJ. Authorised and regulated in the UK by the Financial Services Authority and a member of the Investment Management Association.

Morley Fund Management is also a business name of Morley Fund Services Limited and Morley Fund Management International Limited. All are Aviva companies.

Contact us at Morley Fund Management Limited, No. 1 Poultry, London EC2R 8EJ.

MFM 07/941