Second Quarter 2010 Market and Performance Update

Summary:

• Global equity markets slumped on sovereign debt troubles and doubts about economic recovery.
• Investor caution was reflected in heightened demand for assets considered to be safer, such as U.S. Treasuries.
• Economic data was mixed, adding to doubts about the direction of the global economy.

Optimism in the first quarter turned to skepticism in the second quarter, as the sovereign debt crisis in peripheral Europe and a mixed bag of economic data raised questions about the sustainability of a global economic recovery. The second quarter was also characterized by higher market volatility, epitomized by the "Flash Crash" on May 6, when the Dow Jones Industrial Average slid 700 points in just 10 minutes. Pending financial reform legislation, proposed government austerity measures and weak labor markets added to a general lack of confidence on the part of market participants.

For the quarter, the Dow Jones Industrial Index fell 9.36%, while the S&P 500 Index fell 11.43% and the NASDAQ Composite Index declined 11.82%. The MSCI AC World Index dropped 12.12% for the quarter, as investors avoided riskier assets on worries that the global economic recovery might stall. It is SEI's view that global economic growth will continue over the long term, although concerns about the level of government debt in peripheral Europe is still an issue. The Barclays Capital Global Aggregate Bond Index was nearly flat, decreasing 0.04% for the quarter. Government bonds from countries with relatively stable financial situations (such as the U.S., the U.K. and Germany) were the top performers, as concerns about economic growth hampered investors' willingness to take on additional risk.

Stocks

European government austerity measures were implemented to reduce debt burdens but raised concerns that the global economy may begin to contract as a result of these actions. Although European leaders and the International Monetary Fund introduced a bailout plan for Greece totaling €110 billion in exchange for increased fiscal tightening on the part of the Greek government, investors worried that sovereign debt troubles would spread to other European nations.

From a sector perspective, performance was negative for all sectors in the MSCI AC World Index, with investors' lack of confidence reflected in the avoidance of riskier assets and increased demand for more defensive assets. For the quarter, top performers were Consumer Staples, Telecommunications and Utilities, while Financials, Information Technology, Materials and Industrials lagged the broader market. BP's difficulties in handling the oil spill in the Gulf of Mexico added to downward pressure in the equity markets.

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 at around 17 but then rose to over 34 at the end of the quarter, as investors became increasingly nervous.

Bonds

Performance in the global fixed-income markets was flat for the quarter, with a continuation of demand for shorter-maturity government bonds of developed-market countries that are considered to be relatively stable. Sovereign debt worries caused investors to avoid riskier assets such as corporate bonds and high-yield bonds. The three-month London Interbank Offer Rate (Libor) rose over 0.5%, its highest level since the summer of 2009.

The Federal Reserve, the Bank of England and the European Central Bank (ECB) all kept rates at record lows in order to encourage economic growth in a sluggish environment and it is likely that rates will remain at these lows for the rest of the year. The ECB worked to mitigate fears in the bond markets by purchasing Greek debt, as well as government bonds issued by Portugal, Spain, Italy and Ireland. During the quarter, credit-ratings agencies downgraded sovereign debt issued by Greece, Portugal and Spain, putting negative pressure on the euro.

Economy

Economic data was mixed and marked by the introduction of austerity measures by European governments, which were met with opposition in the form of protests and strikes in Greece, Italy and Spain. In the U.S., both the housing and labor markets experienced setbacks. At the end of the quarter, U.S. initial jobless claims were higher than anticipated, and mortgage applications and refinancing activity fell after the first-time homebuyer tax credit ended. Further economic weakness was reflected when gross domestic product for the first quarter was revised downward. However, manufacturing activity continued to expand, and inflation did not pose a near-term threat. The Chinese government made efforts to rein in the nation’s fast growth, causing worries that global growth would suffer as a result.

Oil prices fell for the quarter, with WTI Cushing crude oil prices (a key indicator of movements in the oil market) ending at $75.63 per barrel. As a result of the flight to safety, the U.S. dollar was stronger versus the British pound at $1.51 and also strengthened against the euro at $1.22. However, the Japanese currency continued to appreciate against the dollar, ending at around 88 yen.

Portfolio Review

Investors' risk aversion and highly volatile markets posed hurdles for SEI's Funds. While equity Fund performance was negative, SEI's large-cap equity Funds were helped by the success of value-oriented factors. In small-cap equity, the Information Technology sector was the most significant detractor from performance. In international equity, emerging-markets exposure was beneficial, as were overweights to China and Canada.

Although bond markets fared better than equity markets, riskier fixed-income assets were punished for the quarter. In core fixed income, allocations to non-agency mortgage-backed securities helped performance, while allocations to corporate bonds and commercial mortgage-backed securities had negative impacts. In high-yield bonds, collateralized loan obligations were helpful, as these securities tend to lag their underlying collateral in terms of performance when there are sharp changes in market direction. In emerging-market debt, security selection in Argentina and Mexico was beneficial.

Contributors 

• Selection in Information Technology in Large Cap Equity – especially the software & services industry
• Underweight to peripheral European countries in International Equity – such as Italy, Spain and Greece 
• Underweight to Hungary in Emerging Markets Debt – the country was hurt by its fiscal problems over the quarter

Detractors 

• Selection in Small Cap Equity – especially in Information Technology and Consumer Staples 
• Underweight to agency debt in Core Fixed Income – this sector outperformed Treasuries 
• Security selection in High Yield Bonds – especially in the Basic Industry sector

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 companies with solid growth characteristics, as they believe these companies should continue to benefit from economic recovery. In small-cap equity, managers remain underweight to Healthcare and Financials, while the largest overweight is in Information Technology. In non-U.S. equity, the managers have increased exposure to emerging Asia, emerging Latin America and Europe ex-U.K.

Our investment-grade fixed-income managers still see opportunities in non-agency mortgage-backed securities, and the overweight to agency mortgage-backed securities has been reduced to an underweight, as managers are finding better value in other sectors. High-yield managers have maintained an allocation to bank loans due to their more defensive positioning and event-driven opportunities. In emerging-markets debt, managers have added to corporate names but have marginally reduced exposure to local assets due to poor sentiment and looming uncertainty, which they believe may lead to further risk aversion by market participants.

Our View

In SEI's view, the global economy should continue to improve, but there are concerns that the European sovereign debt crisis will hinder the recovery. Emerging markets are the clear leaders so far, and better economic activity has been reported for the U.S. and core countries in Europe, namely France and Germany. Asian markets performed well last year but are struggling in the near term as central banks are implementing tighter controls on lending in order to cool down rapid economic growth. The euro has continued to fall, raising questions about the cohesiveness of the European Union and the viability of the common currency.

We continue to hold a positive view toward equities, and we believe developed-markets equity looks more attractive than emerging-markets equity from a pricing perspective. Opportunities in investment-grade and high-yield credit are still attractive, but these market segments are likely to experience volatility until peripheral European nations resolve their debt problems. All in all, SEI's long-term outlook for growth is positive, although setbacks along the way are expected. In general, we continue to have a favorable outlook, particularly toward high-quality assets in both the fixed-income and equity markets.

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.

• Not FDIC Insured 
• No Bank Guarantee 
• May Lose Value