Morningstar Quarterly European Fund Research Report (3Q2008)

e Third Quarter
The third quarter of 2008 was characterised by a sharp increase in volatility and losses across emerging and developed markets. Four key factors drove market activity:

(1) The ongoing credit crisis,

(2) Falling resources prices,

(3) Strengthening of the US Dollar, and

(4) Slowing growth and increasing political risk in key emerging markets.

The credit crisis continued to weigh heavily on global markets, particularly at quarter-end as broad market indices gyrated in response to bank failures and government intervention (and the lack thereof) in the US, the UK, and Europe. In the last weeks of September, major indices such as the S&P 500 and FTSE 100 moved as much as 8.8% in a single day. Earlier in the period, the MICEX in Russia moved up to 23% in a day amid multiple trading halts.

Whilst the failure or near failure of major financial institutions such as Freddie Mac, Fannie Mae, Lehman Brothers, Washington Mutual, Wachovia, Fortis, and Bradford & Bingley grabbed the headlines and roiled markets, financials in general were not the worst-performing area of the market as of 29 September. Natural resources issues fared considerably worse in the quarter as commodity prices slumped amid fears of slowing global demand. Oil prices fell from US$146/per barrel for Brent Crude in early July to US$91/per barrel at 29 September, declining nearly 10% on the 29 September alone, and industrial and precious metals also dropped. This decline fed into weakness in markets heavily dependent on commodities income, including Russia, Latin America and Norway. In equity markets, investors reacted by shifting into the perceived stability of large-cap issues, leading to broad small-cap underperformance. Investors reacted similarly in credit markets, avoiding credit risk in favour of government debt. Indeed, at one point on 17 September, the three-month T-bill's yield turned negative, implying that investors were so uncertain about the future that they believed locking in a certain, but small, loss was preferable to taking even a small amount of incremental risk in the market.

Specialty Equity Fund Trends
There was a clear division between winning and losing specialty fund categories in the third quarter. Despite an end -of-quarter resurgence, funds in the Morningstar Sector Equity: Precious Metals category fell 26.15% QTD, reflecting the downward trend in gold prices in the period. Funds in the Sector Equity: Industrial Materials and Sector Equity: Energy categories were also hard hit, losing 26.26% and 25.6%, respectively reflecting lower commodity prices. Despite the drama in the area, Sector Equity: Financial Services funds lost a relatively small 6.16%. The strongest areas reflected their perceived defensive traits and a distinct lack of correlation with global economic health. Sector Equity: Healthcare funds rose 4.3% on average, whilst Sector Equity: Biotech offerings returned 9.92%.

Regional Equity Fund Trends
From worst . . .
The Morningstar Russia Equity category was by far the worst performing fund peer group in the quarter, both in Europe and globally. The average fund in the category lost 40.71% through 30 September as Russian shares slid on falling energy prices and as concerns mounted regarding Russia's political environment. The average fund in the sector held 43% in energy and 26% in industrial materials based on complete holdings data gathered by Morningstar. Funds in the Morningstar Emerging Europe Equity category were also hit by their large Russian stakes, and lost 20.42% in the period. The average Norway Equity fund, which held 35% in energy and 23% in industrial materials, dropped 30.16%.

. . to First
The best performing European equity categories in the period were a diverse group. Switzerland Large-Cap Equity funds registered the smallest loss, down 3.1% for the period. According to Morningstar's European research team, Swiss equity funds limited losses due to defensive mega cap stocks like Nestlé, Novartis and Roche. The average fund in the category features a weight of 30% in the health-care sector. That group was followed loosely by France Large-Cap Equity (-6.52%), Switzerland Small/Mid-Cap Equity (-6.54%), and Spain Equity (-7.65%).

Large-Caps Rule
Among Morningstar's broad Europe Equity categories, the three style-based large-cap categories dropped the least, reflecting investors' preferences for relatively defensive large-cap issues. Funds in the Morningstar Europe Large-Cap Blend Equity category fell 11.45% on average, whilst funds in the Europe Large-Cap Value Equity and Europe Large-Cap Growth Equity categories fell 11.13% and 12.76%, respectively. Reflecting their higher risk levels, funds in Morningstar's Europe Mid-Cap Equity and Europe Small-Cap Equity categories dropped 14.51% and 17.12%, respectively.

UK Equity Funds
Funds focused on UK equities reflected the overall trends across economic sectors and investor preferences for the perceived safety of large-cap issues, excluding banks. The Morningstar UK Large-Cap Blend Equity and UK Large-Cap Value Equity categories fell 13.05% and 9.6%, respectively. The UK Mid-Cap/All-Cap Equity and UK Small-Cap Equity categories dropped further, however, losing 13.04% and 14.24%, respectively. In the case of the UK Large-Cap Growth Equity category, the relative strength of large caps was overwhelmed by the group's penchant for resources issues: It fell 16.86% on average--the worst loss of the five UK equity peer groups tracked by Morningstar.

Asia– Broad Asian Markets Still Coupled with Global Peers; India Sees Recovery
Asian equity markets rode a roller coaster along with developed markets this quarter, proving that their markets have not yet decoupled from their global peers. Financials stocks suffered along with their Western peers. ICBC and Bank of China have disclosed, with three other listed Chinese banks, a combined exposure of around US$454 million to Lehman Brothers. These troubled assets are not significant in terms of the companies' asset bases, but they were significant enough to trigger a massive sell-off of Asian financials. Uncontained inflation and slowing economic growth also smothered Asia equity markets, despite easing in Energy prices. The broad Morningstar Asia-Pacific ex Japan Equity category dropped 14.8% in the period, whilst the Asia-Pacific with Japan category fell 11.5%.

China saw a reversal of its longer-term inflation trend, and became the first country among its Asian peers to start easing monetary policy. The People's Bank of China surprisingly cut the benchmark lending rate by 0.27 percentage points and lowered the reserve requirement ratio by 1 percentage point for small banks in mid-September. Despite this, the average fund in the Morningstar China Equity category dropped 16.67% QTD, reflecting ongoing concerns about the sustainability of economic growth in the face of the global slowdown. India bucked the general trend in Asia: In the face of lacklustre growth and high inflation, the average India Equity fund lost just 4.52% in the period. These funds are down 48.15% YTD.

US Funds – QTD Returns Solid Despite Volatility
Wall Street was at the epicentre of the financial crisis. The third-quarter drama included: the fall and consolidation of several financial giants, US mortgage lenders Fannie Mae and Freddie Mac becoming government entities, AIG receiving an US$85 billion cash infusion, Goldman Sachs and Morgan Stanley becoming regulated commercial banks, Washington Mutual becoming the biggest bank failure in US history, and Warren Buffet injecting capital into Goldman Sachs.

Despite an action-packed conclusion to the period, third quarter fund returns were not dramatic, with the average US equity fund shedding just 4.4%. The Morningstar US Large-Cap Value Equity and US Small Cap Equity categories posted moderate losses of 2.64% and 0.9%, respectively. This can be attributed to the fall of commodity prices, relatively light exposure to mining issues, and the strengthening of the dollar from its record lows. The US Dollar gained over 9% against the Sterling from 1 July to 30 September 2008.

Fixed-Income Fund Trends
Investors shunned credit risk in the quarter, searching for safety in high- quality issues. Across Morningstar's currency-based fixed-income categories, high-yield peer groups lost the most, whilst corporates followed close behind. In contrast, government bond categories were markedly strong. In local currency terms, the average fund in the Euro Government Bond category gained 4.17%, whilst the average Euro High-Yield Bond fund lost 4.63%, reflecting an extreme widening of credit spreads over the past year. The patterns were identical in the Morningstar Sterling and Dollar bond fund categories as can be seen in the fixed income table further below.

Notes to Editors:
The analysis contained in this report is based on an assessment of all European open-ended funds tracked by Morningstar. The company tracks approximately 60,000 European open-end funds.

Performances are based on the latest available data as at October 1, 2008.

The Morningstar Quarterly European Fund Research Report is written by Morningstar's team of European fund analysts. The company employs more than 220 experienced and qualified researchers and investment analysts globally, with 28 based in Europe, and has published detailed analysis on more than 4,000 funds and stocks worldwide. The company's reputation for independence is driven by its “investors first” mission to create great products that help investors reach their financial goals. Morningstar does not charge fund companies to issue qualitative opinions on their funds, and analysts have complete freedom to state an opinion, positive or negative, on any fund they cover. The company's analysts base their opinions on their individual comprehensive analysis of fund holdings and performance data, interviews with portfolio managers and key fund group executives, and proprietary analytical tools.

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Third-Quarter 2008 Fund Performance Tables: Morningstar Category Performance Denoted in Euro, Sterling and Swiss Franc