Commentary: First Quarter 2010 Market and Performance Update

Summary

• Global equity markets rose, as manufacturing helped drive economic growth
• Concerns lessened about possible sovereign debt default in Greece, as European Union leaders agreed on a bailout plan
• Labor markets and consumer spending remained weak

At the end of the first quarter, investors were generally less concerned about possible government bond defaults as European nations decided on a plan of action to assist Greece if necessary. Central banks in both developed and emerging markets began to tighten monetary policy in order to curb inflation. China’s central bank raised bank reserve requirements twice, and India raised its interest rates after inflation reached a 16-month high. In the U.S., the Federal Reserve (Fed) raised its discount rate, which is charged to banks that borrow from the central bank.

For the quarter, the Dow Jones Industrial Index returned 4.82%, while the S&P 500 Index returned 5.39% and the NASDAQ Composite Index returned 5.91%. The MSCI AC World Index rose 3.23% for the quarter, as optimism prevailed about the global recovery. However, it is our view that global economic growth will continue to be sluggish, as governments and central banks carefully remove policies put in place during the recession. The Barclays Capital Global Aggregate Bond Index was roughly flat, returning -0.27% for the quarter. Corporate bonds continued to see strong gains due to better-than-expected earnings reports and improving profits from cost-cutting programs.

Stocks

The global economy is gradually improving, but the Fed and other central banks have reiterated that policies will remain accommodative for some time to come. In the U.S., corporate earnings continued to be positive, instilling more confidence in the recovery. However, market participants worried that the debt crisis in Greece and other European nations might stall eurozone economic recovery and put pressure on the still-nascent U.K. recovery. European leaders announced they would work with the International Monetary Fund to provide assistance to Greece, which eased fears early in the quarter that sovereign debt troubles would spread to other European nations.
Sector performance within the MSCI AC World Index reflected investors’ willingness to look beyond weak labor markets and concerns over possible government bond defaults and focus on global economic recovery instead. For the quarter, top performers were sectors that are more responsive to shifts in the broader markets, such as Information Technology, Industrials and Materials. More defensive sectors, such as Utilities and Telecommunications, lagged the broader market.

The Chicago Board Options Exchange Volatility Index (VIX), a measure of implied volatility in the S&P 500 Index that is also known as the “fear index,” began the quarter above 21 but then fell to a little over 17 at the end of March, as a calmer tone prevailed in the market.

Bonds

Performance in the fixed-income markets was mostly flat for the quarter, and non-government bonds generally outperformed government bonds. Earlier in the quarter, investors looked for safe havens, such as shorter-maturity U.S. Treasuries, as speculation about defaults in other countries continued to make headlines. However, towards the end of the quarter, positive news about corporate earnings and increases in manufacturing pushed demand for corporate bonds higher.

Greek sovereign debt sparked investor concern, as several of its banks were downgraded by credit-rating agencies and its government has been slow to implement spending cuts. Although the European Union developed a plan to assist Greece as necessary with its financial difficulties, questions remain about what will happen if other European peripheral nations experience similar issues.

Economy

Economic data continued to be mixed throughout the quarter, but there was marked improvement in U.S. corporate balance sheets and growth in manufacturing and services. The Fed, the Bank of England and the European Central Bank all kept interest rates at record-low levels. However, the Fed increased the discount rate from 50 basis points to 75 basis points.

We believe the economy is steadily rebounding, but hurdles remain ahead. Initial jobless claims began to decline at the end of the quarter, but the unemployment rate remained high at 9.7%. The housing market continued to suffer, as housing starts and building permits both declined in February. Inflation remained benign, as the Consumer Price Index was flat and the Producer Price Index fell slightly.

Oil prices rose for the quarter, with WTI Cushing crude oil prices (a key indicator of movements in the oil market) ending at around $83.76 per barrel. The increase in prices was due in part to harsh winter weather in February, but the gain could also be attributed to gradual improvements in the global economy.

The U.S. dollar continued its rally, ending the quarter at $1.52 per British pound and $1.35 per euro. The dollar was also slightly stronger versus the Japanese currency, ending at around 93 yen.

Portfolio Review

This volatile quarter resulted in mixed performance for SEI’s Funds. In large-cap equity, positioning in smaller, deeper-value names helped performance, while a high-quality bias was challenging. In small-cap equity, overall stock selection in the Energy sector hurt performance. In international equity, an overweight to Canada and Europe helped performance, while an overweight to emerging markets slightly detracted.

An overweight to commercial mortgage-backed securities (CMBS) for core fixed income contributed positively to performance, as investors increased their risk appetites and felt more certain that the economic recovery would continue to take hold. In high-yield bonds, an allocation to collateralized loan obligations continued to be beneficial, as these investments benefited from improving company fundamentals and a favorable technical environment, where demand outpaced supply. In emerging-market debt, security selection in peso-denominated assets in Mexico added to performance.

Contributors	Detractors
Overweights to Financials and Consumer Discretionary in large-cap equity – these sectors outperformed for the quarter	Weak stock selection in large-cap equity – especially in Information Technology
Stock selection in international equity – particularly in the U.K	Underweight to Consumer Discretionary in small-cap equity – selection in this sector also detracted
Overweight to corporate bonds in core fixed income – corporate earnings continued to improve	Stock selection in emerging-markets equity – particularly in Korea, Taiwan and Russia
Underweight to Electric Generation in high-yield bonds – weak demand for power and natural gas hurt the sector	Underweight to Banking in high-yield bonds – positive news caused many bank bonds to soar

Manager Positioning and Opportunities

SEI’s portfolio managers remain focused on finding managers that provide consistent returns over time. For large-cap equity, our Funds’ underlying investment managers remained positioned in high-quality securities, as they believe these companies should continue to benefit as the recovery takes hold. In small-cap equity, managers are currently underweight to Healthcare and Financials. In non-U.S. equity, Fund managers are overweight to Information Technology while maintaining underweight positions in Financials and Utilities.

Our investment-grade fixed-income managers remain overweight to non-agency mortgage-backed securities and residential asset-backed securities. High-yield managers are gradually reducing their allocations to bank loans as better opportunities arise. In emerging-market debt, the search for higher-yielding bonds continues but security selection will be integral to adding value going forward.

Our View

In SEI’s view, the global economy should continue to improve, but growth will not be uniform across all regions. Emerging markets are the clear leaders so far. The outlook remains uncertain for how the European recovery will progress, as uncertainty around how to handle problems with Greek sovereign debt revealed weaknesses in the structure of the eurozone. Developed countries face a delicate balancing act. There is growing pressure on high-deficit nations to rein in government spending, but it is necessary to maintain sufficient fiscal support in order to prevent a relapse into recession.

We continue to hold a positive view toward equities, although year-to-date performance has been choppy. Fixed-income markets are being pulled in different directions. Developed-market sovereign debt has been hurt by deficit concerns, but helped by the slow recovery and generally low inflation. Emerging-market debt has been relatively strong, as investors continue to re-evaluate the relative riskiness of the asset class. Opportunities in investment-grade (bonds with relatively better credit quality) and high-yield (rated below investment grade and perceived to be riskier) credit also remain strong, reflecting robust corporate financial positions and expectations of continued economic expansion.

The key concern, in our view, continues to be the exit from governmental stimulus packages. A big increase in government spending was certainly the correct response as private-sector demand fell away in the latter part of 2008 and early 2009, but it may reduce economic growth potential over the long term, as stock prices usually fall during times when government spending rises substantially. We still believe that the key central banks—the Fed, the Bank of England and the European Central Bank—will be slow to remove economic stimuli. While we continue to see balanced opportunities in equities and fixed income, we remain cautious regarding the economic and market risks for the near term.

Global indexes and investing terminology

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 can 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. High yield bonds involve greater risks of default or downgrade and are more volatile than investment grade securities, due to the speculative nature of their investments.

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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