Commentary: August 2009 Market and Performance Update

The recovery continued, albeit at a slower pace 

• Further evidence of a mending global economy boosted stocks and bonds 
• After extraordinary gains, global stock markets were more subdued 
• The U.S. job market showed improvements while Germany and France emerged from recession 
• Riskier assets continued to outperform

Evidence mounted in August that the global economy has turned the corner from recession to recovery, as many companies continued to report better-than-expected profits.The Dow Jones Industrial Average gained 3.96%, the S&P 500 Index rose 3.61%, the NASDAQ Composite Index finished up 1.67%, and the MSCI AC World Index closed 3.58% higher. In the bond markets, the Barclays Capital U.S. Aggregate Bond Index gained 1.04%, and the Barclays Capital Global Aggregate Bond Index gained 1.76%.

The Chicago Board Options Exchange Volatility Index (VIX), a barometer of market volatility, was little changed over the month, ending August at 26.01. However, volatility remained higher than the long-term average and there continued to be large gaps between the best- and worst-performing stocks and sectors in the global markets.

Stocks

The trend of encouraging economic news and generally better-than-forecast corporate profits extended for another month. The Financials sector was by far the main driver of returns in August, posting gains of nearly twice the Industrials sector, the next best performing area within the MSCI AC World Index. In the U.S. equity markets, other higher-beta sectors, such as Industrials and Consumer Discretionary, also performed well in addition to Financials.

Despite the economic optimism, Energy was the second worst-performing sector in global equity behind Telecommunications. WTI Cushing crude oil prices were roughly unchanged over the month, finishing at $69.96 per barrel, compared to $69.45 at the end of July. Still, that was more than double the low of near $30.00 reached in December last year.

Bonds

Agency mortgage-backed securities (MBS) outperformed Treasuries, as prepayments have not been as fast as previously forecast. Commercial mortgage-backed securities had a robust month as spreads narrowed; however, delinquency rates are still on the rise and ratings actions have increased. Despite a continued deterioration in the commercial real estate market, growing appetite for risk helped CMBS sustain its impressive rally. The sector also continued to be among the best-performing in the overall bond markets year to date, with gains of around 20% as measured by the Merrill Lynch CMBS Fixed Rate A-AAA Rated Index. Emerging-market debt, another sector considered to be among the riskiest, also continued to be among this year’s top performers, with year-to-date gains of over 20% in the JPMorgan EMB Global Diversified Index.

Government bonds, which tend to react negatively to strengthening economic data, also posted moderate gains in August amid expectations that inflation pressures would remain subdued and interest rates would remain very low for the foreseeable future. Long Treasury yields fell slightly, with 10-year and 30-year Treasury yields falling to 3.40% and 4.18%, down 8 and 12 basis points, respectively.

The Economy

The month got off to a strong start with a larger drop in job losses than forecast and the first dip in the unemployment rate since last April. The news fanned hopes that the fragile labor market was on the mend and that the world’s largest economy was stabilizing. The housing market showed signs of improvement, as the S&P Case-Shiller Home Price Index moved higher for the second straight month. Home prices were also higher by a modest amount in the second quarter when compared to the first, which was the first quarterly gain in three years.

Retail sales indicators in the U.S. remained weak; this is a concern since consumer spending is by far the main driver of growth. However, in a sign of hope for an improving trend, figures released in the last week of the month showed the Conference Board’s Consumer Confidence Index climbed in August amid surging equities and signs of improvement in the housing market.

Figures released early in the month showed the euro zone economy contracting by a smaller-than-expected 0.1% in the second quarter, surprising the majority of forecasters. Its two largest members, France and Germany, both pulled out of recession and posted growth in gross domestic product (GDP) of 0.3% in the second quarter. The second estimate of UK second-quarter GDP showed a smaller drop than the first estimate, but at 0.7%, it was still a substantial decline.

In the currency markets, mounting recovery hopes meant that the dollar continued to lose its appeal as a “safe haven” in times of global turmoil. It fell a little over 1% against the euro to end the month to about $1.44, while declining 2.5% to around 93 yen. Sterling fell against all major currencies, including the dollar, amid relative weakness in the UK economy.

Portfolio Review

In the global equity markets, value stocks outperformed growth stocks across all market capitalizations. Because value stocks are perceived to be more vulnerable to losses, they have tended to sell off more during down markets compared to growth stocks, and also have led historically when markets rebounded during a recovery. For U.S. equities, large caps outperformed small caps; mid-cap stocks were the best performers.

Non-U.S. equity markets continued to rally for the month; however, their performance was more subdued that it was in July. Europe returned 6% during the month, and it has now outperformed the world index in four of the last five months. Emerging markets trailed developed markets for the month, but they continue to outpace developed markets year to date.

Investment-grade fixed-income markets reacted positively to improving fundamentals and better corporate earnings. High-yield fixed income also had positive returns for the month, as corporate earnings improved due to increased sales and cost-cutting measures. Emerging-markets debt posted positive returns for the sixth straight month, and higher-yielding credits led, particularly those of Pakistan and Ukraine, which posted double-digit returns for the period.

What Worked in Our Portfolios	What Didn’t Work in Our Portfolios
Superior stock selection in Large Cap Equity – Particularly in Consumer Discretionary and Utilities	Quality growth exposure in Large Cap Equity – This drove poor stock selection in Financials and Information Technology
Stock selection in China and Brazil for Emerging Markets Equity – Especially Chinese financial companies and Brazilian textiles and retail	Stock Selection in Small Cap Equity – Especially within Consumer Discretionary, Financials and Materials
Allocation to Credit in Core Fixed Income – This sector outperformed on better corporate outlooks	Underweight to Financials in International Equity – The rally in Financials continued in August, led by banks
Allocation to collateralized loan obligations (CLOs) in High Yield – CLOs outperformed the broader high-yield market for the month	Underweight to AIG bonds in High Yield – Bonds rallied after its management announced that funds would be left over for shareholders after the firm pays back the government
Overweight to Venezuela in Emerging Markets Debt – Economic reforms were announced in Venezuela aimed at fighting inflation and boosting economic output

Manager Positioning and Opportunities

Large-cap managers are focusing their attention on companies with sound fundamentals and sustainable business models, which should benefit as economic recovery takes hold. Growth managers are positioning in companies with higher price-to-earnings ratios and expected earnings growth. Turnover levels are moderating, and we remain confident that compelling valuation opportunities remain available. This should be a strong active management environment, and our managers are looking to benefit from historically wide value spreads that have existed as a result of the market dislocation.

International equity managers remain overweight toward the Asia Pacific ex-Japan region, where they expect higher growth over the long term. They have also recently increased an underweight to Europe while reducing an underweight to Japan. Sector allocation is a product of security selection, but overweights to Information Technology, Telecommunications and Consumer Discretionary are maintained because managers believe they will benefit most from continued improvements in the economy.

Core fixed-income managers are overweight to non-agency MBS, and this is expected to continue since these securities are substantially over-collateralized and are located at the top of the capital structure, meaning that they get paid first. Overweights also exist for agency MBS, which has responded well to the government’s direct purchase programs; however, managers are reducing this overweight at the moment because they are seeing better opportunities in other sectors. There are opportunities currently in corporate bonds, especially Financials, and several managers are increasing their exposure. Managers are also investing in senior tranches of commercial mortgage-backed securities and residential asset-backed securities with superior collateral and structural characteristics.

High-yield fixed-income managers have maintained an allocation to bank loans, citing their seniority in the capital structure and historically high recovery rates. Collateralized loan obligations have also presented an expanded opportunity set. Investments in banks are being concentrated toward those in which the managers have highest conviction. Emerging-market debt managers are confident that there is still room for sovereign credit to move higher. They are trading into shorter-duration bonds as well as high-quality names such as Poland and Brazil. Managers have also expressed interest in Asian bonds, as Asia is expected to lead the global economy out of recession and into recovery; however, no significant changes have been made to this region just yet.

Outlook

In SEI’s view, global equity markets should be able to extend their rally through the rest of this year, as long as there continues to be supporting evidence that the global economy is improving and corporate profits are rising. However, we believe it is unlikely that the pace of gains witnessed over the past five months can be sustained through the rest of the year.

SEI believes the global economy is going through a healing process, with growth continuing in the developing economies of the world and signs of improvement in developed economies. Over the next year, SEI expects to see decent economic growth across the globe and a rebound in corporate profits. However, as we approach 2010, there will be some headwinds, such as the massive debts that governments have taken on in the U.S. and Europe in efforts to stimulate growth. Further increases in oil and other commodity prices could also put a dent in consumers’ discretionary spending.

We remain optimistic regarding the corporate bond markets. Although high-yield corporate bonds have appreciated strongly, yield spreads (the difference between the higher yields available in this sector compared to equivalent government bonds) remain attractive. We expect non-government bonds to continue to outperform government debt if economic growth turns positive and corporate cash flows improve.

This material is for educational purposes only and is not meant to be investment advice. The reader should consult with his/her financial advisor for more information. This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. To determine if the Fund(s) are an appropriate investment for you, carefully consider the investment objectives, risk factors and charges and expenses before investing. This and other information can be found in the Fund's prospectus, which may be obtained by calling 1-800-DIAL-SEI. Read it carefully before investing.

SEI Investments Management Corporation (SIMC) is the adviser to the SEI Funds, which are distributed by SEI Investments Distribution Co (SIDCO). SIMC and SIDCO are wholly-owned subsidiaries of SEI Investments Company.

Diversification may not protect against market risk. Current and future portfolio holdings are subject to risks as well. In addition to the normal risks associated with equity investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Narrowly focused investments and smaller companies typically exhibit higher volatility. REIT investments are subject to changes in economic conditions, credit risk and interest rate fluctuations. Bonds and bond funds will decrease in value as interest rates rise. Index performance returns do not reflect any management fees, transaction costs or expenses. One cannot invest directly in an index. Past performance does not guarantee future results.

For those SEI Funds which employ the 'manager of managers' structure, SEI Investments Management Corporation has the ultimate responsibility for the investment performance of the Fund due to its responsibility to oversee the sub-advisers and recommend their hiring, termination and replacement.

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