Portfolio Commentary

Quarterly Investment Update for Q4 2009

U.S. Market Environment

The U.S. stock market moved higher in 2009 in part because the big banks at the heart of the 2008 financial crisis started making money again. But much of their ability to do so was dependent on the Federal Reserve, which aided them with ultra-low borrowing costs. Investors are uncertain how banks and the rest of the economy will fare as policymakers begin to withdraw some of those emergency supports from the economy this year. As 2009 closed, consumers appeared more optimistic about the future, though their mood remains gloomy relative to historical measures of sentiment. Undoubtedly supporting the upturn in consumers’ outlook is an economy that ended the year stronger than it began. The year included a remarkable stock-market turnaround: 2008’s bear market (in which the Russell 3000 Index – a proxy for the U.S. stock market – returned about -37%) spilled over into the first quarter of 2009. But beginning in early March, the Russell 3000 Index rallied robustly to produce a year-to-date total return of about 28%, the highest since 2003.

The final quarter of 2009 represented the third consecutive quarter of positive returns (as measured by the Russell 3000 Index). Although improving, the U.S. economy is still fragile with unemployment posting double digit rates during the quarter and large public and private debt levels adding an additional level of concern. The coming months will begin to determine whether the recovery of private demand will lead to expansion or whether market impediments will contribute to a leveling off of the growth in economic activity.  Nevertheless, the Federal Reserve’s purchase of mortgage and Treasury securities, the government’s support for consumer finance markets and near-zero short term rates continued to help revive risk appetites and were also the major factors behind the enhanced stability and the reduction in the VIX (Chicago Board of Options Exchange Volatility Index).

For the quarter, growth-related U.S. stocks outperformed value-related U.S stocks across all market capitalizations. Additionally, large-capitalization stocks provided the best returns followed by mid and then small capitalization stocks.

International Market Environment 

Economic indicators suggest that the recovery process, which began in late summer, continued in the fourth quarter. In fact, the probability of a double-dip recession has diminished significantly and growth is expected to remain positive in the first quarter of 2010. The free fall in economic activity has fortunately moderated, and in the second half of 2009 most international economies have attained positive growth rates. This reversal is attributed to the success of stimulus measures adopted on a global scale, both on the monetary and fiscal front. Given the role played by economic policies in stabilization, the main risk for the global economy in the short-term lies in the appropriate timing and design of the unwinding of these measures. Doubts remain about whether private demand can take over the lead as the driver of the recovery.

Ending two consecutive quarters of outperformance, growth-related non-U.S. developed market stocks outperformed value-related non-U.S. developed stocks across all market capitalization ranges for the quarter.  Non-U.S. developed market large capitalization stocks provided the best returns relative to non-U.S. developed mid and small capitalization stocks.

In developed markets, performance continued to post positive results. Within Western Europe, Norway (+14.93%), the United Kingdom (+6.98%) and Switzerland (+3.83%) posted the best returns. Greece (-22.39%), Austria (-9.78%), and the Finland (-3.49%) had the weakest returns. Within the Pacific region, Singapore posted the best return (+9.76%), while Japan (-2.76%) experienced the weakest performance.

Emerging markets outperformed the developed world during the fourth quarter of 2009. Performance of the MSCI Emerging Market Index (+8.58%) finished in positive territory for the fourth consecutive quarter with growth stocks (+8.92%) modestly outperforming value stocks (+8.24%). While the “BRIC” countries saw positive results, Brazil (+13.05%), Russia (+10.47%), China (+9.56%) and India (+7.70%) lagged behind Chile (+15.43%), Israel (+14.14%) and Mexico (+13.66%) as the top performers in the emerging market region during the quarter. Morocco (-7.05%), Czech Republic (-6.89%) and Egypt (-6.24%) experienced the weakest performance in the emerging markets.

NOTES

Sources: Driehaus Capital Management LLC, FactSet, Morgan Stanley Capital International and Standard & Poor’s Global Industry Classification Standard, Russell Indices, and the Wall Street Journal.