I N V E S T M E N T M A N A G E R S U R V E Y R E P O R T T H I R D Q U A R T E R

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1 Nor thern Trust I N V E S T M E N T M A N A G E R S U R V E Y R E P O R T T H I R D Q U A R T E R October 2009 Christopher Vella, CFA Global Director of Manager Research Northern Trust Global Advisors cv11@ntrs.com Janet Yang, CFA Investment Product Manager Northern Trust Global Investments jy15@ntrs.com M A N A G E R S E X P R E S S O P T I M I S T I C E X P E C T A T I O N S F O R C O R P O R A T E E A R N I N G S A N D G L O B A L G R O W T H In a marked changed from previous quarters, the third-quarter 2009 Northern Trust Global Advisors (NTGA) manager survey showed a significant majority of managers expressing optimistic expectations for corporate earnings and global growth. Fully 83% of managers expect corporate earnings to increase in the next quarter and 84% of managers expect global growth to accelerate in the next six months. Still hesitant to call a buoyant V-shaped recovery, managers see potential fragility in the system. Of respondents, 76% expect interest rates to hold steady, reflecting a view that central banks will hesitate to raise interest rates for fear of choking off early signs of recovery. MANAGERS SURVEY SUMMARY A number of noteworthy themes became apparent in this quarter s survey of external managers used by NTGA. First, managers generally seem to have reached an equilibrium point in their portfolios. After multiple quarters of marginally increasing risk and decreasing cash allocations, managers have expressed their satisfaction with the current levels of risk and cash in their portfolios. Second, earnings and growth expectations are at an all-time high since we began compiling survey results in early 2008, and managers still see more potential for market improvement. These optimistic expectations are somewhat tempered by the final theme: Survey participants still see some vulnerability in the system and are hedging any buoyant recovery expectations. Fully 84% of managers surveyed foresee global economic growth accelerating in the next six months. With global expansion back on track, a comparable portion of managers surveyed (83%) expects corporate earnings to improve in the next three months. Meanwhile, a mere 7% of managers expect corporate earnings to weaken in the next quarter. This marks a major shift in manager sentiment from our second quarter survey, where earnings bulls and bears were more evenly balanced, with 39% expecting improvement and 32% expecting weakening. Yet, this is not to say that all managers necessarily foresee a buoyant V-shaped recovery. Rather, survey participants observe a degree of fragility in the situation. Consequently, the majority (76%) expect interest rates to hold steady in the coming months, reflecting a view that central banks will hesitate to raise reference rates for fear of choking off early signs of recovery. The following pages summarize the most notable responses from this quarter s survey. The results show generally optimistic expectations, though with a cautious bent. Economic expectations in the form of corporate earnings and global growth expectations are the highest we ve seen in a while. Though an increasing number of managers believe that these positive expectations are already priced into the markets, a significant plurality believe there is still room for market improvement. On the other hand, the current general debate about whether the economy is heading for an inflationary or deflationary environment does not seem to be raging among managers within NTGA s lineup, with the deflationary sentiment barely registering any of the 83% of managers expect corporate earnings to increase in the next three months. 84% expect global growth to accelerate in the next six months. 46% of managers still see room for market appreciation. continued

2 votes. Instead, judging by written commentary on the subject, many believe that excess production capacity will counteract future growth on the inflationary side and government stimulus money will continue to counteract any significant deflationary pressures. MARKET VALUATION The gradual change in manager sentiment regarding the valuation of the U.S. market, using the Standard & Poor s (S&P) 500 index as a proxy, is unsurprising given the 2009 increase in the S&P 500 of almost 5 between the March low and September high. In the first quarter, 79% of managers believed the S&P 500 was undervalued MANAGER PERCEPTION ABOUT S&P % 19% UNDERVALUED by more than % UNDERVALUED by to 1 compared to 46% of managers this quarter. However, this 46% still represents a significant plurality, suggesting that managers still see the potential for additional market improvement. More than twice the number of managers believe the market has room for growth compared to the 2 of managers who believe the market is overvalued. RISK AVERSION Following two surveys in a row where many managers implied plans to take on more portfolio risk, the majority of managers now seem satisfied with the current risk levels of their portfolios. Fully 53% of managers now express a stable no change in risk aversion sentiment. Whereas 48% of managers were less risk-averse last quarter, only 29% of managers share the same view this quarter. 4 34% APPROPRIATELY VALUED 9% 17% OVERVALUED by to 1 3% OVERVALUED by more than 1 CASH LEVEL VS. 3 MOS. AGO MANAGER RISK AVERSION VS. 3 MOS. AGO % 88% % 29% % 53% 2 4% 2% 19% 1 AT MAX or over norm WITHIN NORM AT MIN or under norm 2 21% LESS RISK-AVERSE 19% NO CHANGE IN RISK AVERSION MORE RISK-AVERSE 2

3 C ASH HOLDINGS Echoing the risk aversion results, managers also seem largely content with the cash positions in their portfolios. Now, 88% of managers are at their normal cash range, with only approximately 12% of managers over or under that normal range. RANKED BROAD INVESTMENT OPPORTUNITIES In contrast to last quarter s results, U.S. large cap equities now top U.S. small cap equities, and MSCI EAFE investments now top MSCI emerging markets investments. Given the recent run-up in prices of U.S. small cap and emerging markets companies, the relatively increasing attractiveness of U.S. large cap and developed international market companies makes sense. CURRENCY EXPECTATIONS Similar to recent surveys, the commodity theme again manifested itself when managers were asked to pick the currencies that they expected would appreciate relative to the U.S. dollar. The relative rank and magnitude of managers picking the Canadian dollar, Brazilian real, and Australian dollar three countries whose currencies strongly correlate with commodity prices, are consistent with rising commodity prices from continued strong demand. The ranking and relative magnitude of manager currency expectations this quarter changed very little from the previous quarter. RANK RELATIVE RANK INVESTMENT TO 1 U.S. Large Cap Equity Higher 2 U.S. Small Cap Equity Lower 3 MSCI EAFE Lower 4 MSCI Emerging Markets Lower 5 Commodities No change 6 Emerging Market Debt Higher 7 Governments TIPS Lower 8 Non-U.S. Bonds No change 9 Private Equity Higher 10 BC Aggregate Bond Lower 11 Other No change 12 Hedge Funds No change 13 Private Real Estate No change 14 U.S. Treasury (Cash) No change CURRENCIES EXPECTED TO APPRECIATE VS. U.S. DOLLAR IN THE NEXT 6 MOS.* % 75% CANADIAN DOLLAR 54% BRAZILIAN REAL 67% 67% 65% AUSTRALIAN DOLLAR 37% 5 EURO 33% 44% SWISS FRANC 37% 33% 3 27% JAPANESE YEN BRITISH POUND * Percentages do not add to 10, as respondents were allowed to pick multiple currencies. 3 continued

4 MOST ATTRACTIVE MARKET SEGMENTS TOP FIVE RANK 1. TECHNOLOGY 2. ENERGY 3. INDUSTRIALS 4. HEALTHCARE 5. CONSUMER DISCRETIONARY TOP FIVE RANK 1. TECHNOLOGY 2. ENERGY 3. INDUSTRIALS 4. HEALTHCARE 5. MATERIALS CORPORATE EARNINGS EXPECTATIONS FOR THE NEXT 3 MOS % 29% 83% MOST ATTRACTIVE MARKET SEGMENTS Digging deeper to more specific investment opportunities, when asked to cite their top most-attractive market segments, managers answers remained fairly stable from the previous quarter s survey to the current quarter s survey. Materialsrelated companies appeared for the first time in the top five rank, replacing consumer discretionary companies, a perennial top five favorite in past surveys. The stability of responses between quarters is even more remarkable given that managers have free rein to cite their best investment opportunities instead of picking from a pre-determined list. CORPORATE EARNINGS Whereas a plurality of managers in last quarter s survey were correct when they expressed the belief that corporate earnings would increase in the coming quarter, now a significant majority 83% of managers surveyed this quarter believe that corporate earnings will again increase in the coming quarter. Meanwhile, a mere 7% of respondents expect corporate earnings to weaken in the next three months. GLOBAL GROSS DOMESTIC PRODUCT While managers were already optimistic toward global growth in the previous survey, that sentiment became more pronounced this quarter. Fully 84% of managers in this quarter s survey expect global growth to increase in the next six months, compared to 65% of manager in the second quarter. Notably, the survey also showed that of managers expect global growth to decelerate in the coming months. 2 32% INCREASING DECREASING 1 7% REMAINING THE SAME GLOBAL INFL ATION EXPECTATIONS The proportion of managers expecting global inflation to increase in the next six months declined to 43% this quarter versus 58% last quarter. Instead, the majority of managers expect inflation to remain unchanged in the coming months. Though seemingly paradoxical when viewed in light of manager sentiment favoring accelerating global growth and increasing corporate earnings, the excess production capacity issues cited multiple times in manager comments may explain the apparent contradiction. As one manager wrote, capacity utilization remains at very low levels and until demand picks up, activity picks up, and inventory levels rise, we don t see an inflationary threat. 4

5 GLOBAL GDP EXPECTATIONS FOR THE NEXT 6 MOS. 10 GLOBAL INFL ATION EXPECTATIONS FOR THE NEXT 6 MOS % 84% % 43% % 2 26% 2 42% 9% 16% 3% ACCELERATING REMAINING THE SAME INCREASING REMAINING THE SAME DECELERATING DECREASING INTEREST RATE EXPECTATIONS Largely presaging the September 23 unanimous decision by the Federal Reserve to keep the main interest rate unchanged and its reiteration to keep rates low for an extended period, survey respondents measurably shifted their interest rate expectations. More than 75% of managers now expect interest rates in the next three months to remain the same, compared to only 45% of managers who had similar expectations last quarter. INTEREST RATE EXPECTATIONS FOR THE NEXT 3 MOS % 24% % 2 45% 4% INCREASING DECREASING REMAINING THE SAME 5 continued

6 MANAGER PERSPECTIVES Given the amount press coverage speculating about unprecedented inflation and the recurring commodities theme in the past few NTGA surveys, we asked managers for their thoughts on whether or not the economy was heading for an inflationary or deflationary environment and what, if any, role commodities played in those expectations. The following represent a selection of responses from managers: We believe the most likely scenario is an inflationary environment over the coming years, given the loose monetary policy and extraordinary levels of stimulus currently fueling the global economic stabilization. We typically do not allow macroeconomic forces to dictate our fundamental, bottoms-up selection process; there must exist a secular/ sustainable theme to each holding. In the face of extraordinary inflation, we have been careful to thoroughly scour our universe for holdings which have the ability to neutralize the effect of a significant commodity run related to either the perceived or real inflationary pressures. Consequently, we have invested in names that should capitalize on the trend without being subject to the same amount of volatility as the underlying commodity prices. Grant Brown, portfolio manager, Chinook Capital Management With continued reduced bank lending, particularly in the U.S., it is unlikely that inflation will be a problem in the foreseeable future. Commodity prices as a result will also experience lower pricing pressures until world demand, mainly led by developed economies, will recover. Cynthia Tusan, president, Strategic Global Advisors, LLC Managers also shared their general thoughts on the markets and economy. The following represents a selection of their responses: In our recent meetings with companies, we have been surprised by: 1. The unusually strong incremental margins they are expecting when growth resumes. We knew companies had very effectively managed their cost structure, but are surprised by the degree to which those efficiencies are sustainable even if growth resumes (or so company managements claim). If this is true, this could be a very strong profit cycle despite likely high structural unemployment and lackluster growth. 2. We are already hearing supply bottlenecks emerge with only marginal increases to demand, because companies have cut so much high-cost capacity, which is unlikely to ever be restarted, and have been so unwilling to invest working capital or expansion capital. Mike Utley, corporate communications, TCW The market has picked up on the fact that the economy has bottomed. However, the expected growth from the bottom is much lower from historic norms. Combined with the prospect of taxes moving higher, causing margins to fall, earning growth prospects are very low. Bob McGee, portfolio manager, C.S. McKee Investment Managers 6

7 ABOUT THE SURVEY For its survey, NTGA polled a select group of respondents, including fixed income and long-only equity managers across value and growth styles, with a bias toward fundamental, bottom-up stock picking strategies. Invitations to complete the survey were only sent to investment managers that currently manage a mandate for NTGA and its clients. As a result, the survey responses should reflect the beliefs of only the managers in which NTGA maintains a high conviction. The survey is conducted quarterly so that NTGA and participating managers can examine trends in attitudes and allocations. ABOUT NORTHERN TRUST GLOBAL ADVISORS Northern Trust Global Advisors is a leading provider of multi-manager investment solutions, with $26 billion under management for institutional and personal clients. Having investments with more than 200 external managers worldwide, NTGA solutions range from retail mutual funds and alternative asset classes to Emerging Manager programs and total investment program management for institutions and affluent individuals and families. 7

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