Market Outlook - Global Financials - Guy de Blonay

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As the turbulence of the third quarter subsides a degree of clarity has returned to the global financials universe. The New Star Global Financials Fund is AA rated by Standard & Poor's* and is managed by Guy de Blonay. Below Guy explains how he successfully negotiated the volatility to take the fund to a new high and where he sees opportunities in the remainder of 2007 and into 2008.

After a period of weakness, equity markets recovered their composure during late August and September as facts replaced rumours about the extent of the fallout from the US sub-prime mortgage crisis. In such circumstances, the New Star Global Financials Fund erased losses sustained over the summer and its share price reached a new high on 8 October. This was largely because the fund cut its holdings in investment banks that rely on capital markets trading income and selectively increased its holdings in retail banks, asset management groups, derivative product providers and financial exchanges.

The sub-prime crisis and consequent fears of an economic slowdown in the US contributed to the continued volatility of global stocks during early September. Pressure in the credit markets, slowing housing markets in Ireland and Spain and concerns that earnings growth was peaking also hindered many European banks. The half-point fed funds target rate cut by the US Federal Reserve in the middle of the month, however, triggered a relief rally in the financial services sector, with many stocks found to be immune from the sub-prime fallout regaining their previous highs.

Through September and early October there were a number of portfolio changes to reflect the changing market conditions. Holdings in investment banks such as Credit Suisse, which derive much of their revenue from capital markets, were reduced. The fund's exposure to investment banks in general was also reduced while geographically, the fund generally avoided the US and Japan.

Instead the fund focussed on Europe, Asia and increasing its weighting in emerging markets. In Europe, it maintained its focus on asset management groups, derivative product providers and financial exchanges. Turkey, in particular, offers potentially attractive opportunities and the fund increased its holdings, benefiting in the process from the impetus given to valuations by a surprise Turkish interest rate cut. Retail banks in Greece and Cyprus, such as National Bank of Greece and Hellenic Bank, are also benefiting from strength within their local economies and liquidity flows have remained relatively unaffected by the problems in the US.

In Asia, the fund bought Hong Kong-listed companies with good exposure to China. Banks and property investment companies in particular performed well after the Chinese government relaxed rules governing domestic investment abroad. Other recent additions were made in India, including State Bank of India. While the Indian Reserve Bank has been tightening monetary policy, a 10% gross domestic product (GDP) growth rate is still considered achievable by 2011.

In emerging markets outside Asia, the fund made additions in Russia and Brazil. Russian holdings continue to be increased while in Brazil, where economists have lifted their GDP forecast for this year from 4.3% to 4.5%, the fund added Banco do Brasil and Redecard.

Over the coming months, banks with international businesses should be cushioned from any US economic growth slowdown. Banks that look particularly interesting include those operating in countries where there is stronger underlying growth in capital market activity such as China or India. The fund is also likely to focus on countries where the domestic economies are buoyed by strong oil prices such as Russia and the Middle Eastern states. In general, the fund will seek to identify companies that have above-average growth prospects yet are attractively valued.

Stock specifics

Standard Chartered

This international bank derives much of its growth from Asia and should benefit from a decoupling of Asia from US economic trends. So far, its Asian focus has allowed it to escape relatively unscathed from US sub-prime related problems. Strong prospects for the Asia-Pacific debt capital markets add to the potential growth story within its wholesale bank. This should keep core revenues compounding at 20-25% a year.

National Bank of Greece

At the end of 2006, National Bank of Greece had an 18.9% share of assets in its home market. It has good margins and is expanding into Turkey through its $2.7 billion controlling stake in Finansbank, which has a 6.3% lending market share. The company is also expanding into south-eastern Europe and has attractive medium-term earnings growth potential.

Shenzhen Investment

Shenzhen is a mid-market property developer in southern China. It has diversified into 15 cities and its land bank comprises more than 15 million square metres of land. This growing land bank should enable it to increase development and generate stronger earnings growth over the next few years. In early October, Shenzhen was trading on a 29% discount to its net asset value. With other major players trading at a premium, the company could be due for a re-rating.

* At 28 September 2007

Past performance is not necessarily a guide to future performance. The opinions expressed here represent the views of the fund manager at 17 October 2007 and should not be interpreted as investment advice.

The value of investments in the fund may fall as well as rise as a result of market or exchange rate movements. This document is for professional advisers, professional investors and financial institutions only and is not to be relied upon by private investors. Issued by New Star Investment Funds Limited.