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Week In Review

83% of Fund Managers Expect Earnings To Increase Sharply in Third Quarter

Eighty-three percent of the 60 institutional managers that Northern Trust surveyed expect corporate earnings to increase in the third quarter, and 84% expect the world economy to improve. Seventy-six percent expect banks will continue to keep interest rates low, for fear of choking off the recovery, and 46% think stocks in the S&P 500 Index are undervalued. In addition, 88% said they have returned to their normal level of cash holdings.

Asked what they think are the five most attractive investment sectors, the fund managers cited technology, energy, industrials, healthcare and materials. The findings were the most optimistic since Northern Trust began the poll a year ago.

"We found it interesting that managers expressed strong optimistic expectations for global growth and corporate earnings while at the same time expressing expectations for a stable inflationary environment," said Chris Vella, global director of research at Northern Trust. "Though growth and inflation generally arrive hand-in-hand, multiple managers cited the express production capacity as counteracting any inflationary pressures."

Wealthy More Discerning About Hedge Funds

Despite the steep losses that hedge funds suffered in 2008, defying their supposed absolute returns, many wealthy investors continue to invest in them, but with strings attached, executives said at the Reuters Global Wealth Management Summit in Boston.

"We see continued dedication to hedge funds," said Catherine Keating, chief executive of JP Morgan Chase's private bank. "The things our clients are focused on are how does that hedge fund generate its returns? How much is correlated to the market? Clients care about transparency-what fees are they getting charged? They don't mind paying fees as long as they're getting value."

Moffett Cochran, CEO of Silvercrest Asset Management, added, "The events of last year may have forever changed attitudes toward investing. It may be that their allocations to growth and equities will be lower. The vast majority of hedge funds had negative returns. The whole concept of absolute returns embedded in the hedge fund rationale was thrown out of the window."

While the trauma that most investors seemed to feel through the middle of this year has abated, they are far more cautious than ever before, particularly with respect to market volatility, liquidity and overall risk, speakers said.

More Funds Expand Cash, Fixed Income Capabilities

While most funds strictly adhere to their investment mandates, more are permitting their managers to move into cash and bonds as a defensive play. And the strategy proved to be extremely wise as a hedge against last year's steep declines.

The Stadion Managed Fund, a large blend fund, began moving more of its assets into cash as early as the end of 2007. Over the past three years, it has returned an average of 3.9%, beating 99% of its competitors.

But the manager of the fund, Tim Chapman, admitted that the 15 indicators he uses, including market volatility, don't always work. He sat in cash earlier this year as the market rallied, for instance.

Still, he defends he conservative approach: "We are not trying to beat the market every year. The goal is to get decent returns in good years and avoid big losses in bad times."

Another fund that permits its manager to move heavily into cash is the Capital Advisors Growth Fund, delivering an annual average return of 2% over the past five years, outpacing 75% of its large-cap growth peers. When the markets collapsed in the fall of 2008 and the spread between Treasuries and junk bonds widened, which the fund's managers view as poor consumer confidence, the fund moved 25% of its assets into cash.

Yet another fund that invests heavily in bonds, the Madison Mosaic Balanced Fund, will move as much as 30% to 50% of its assets into fixed income.

Investors Continue to Favor Bonds Despite Returns

Flows into equity funds have remained flat ever since the market bottomed out on March 9, an indication that investors remain spooked by the market's sharp decline last year-despite the S&P 500's year-to-date 59% gain.

In fact, in September, investors withdrew $11 billion from equity funds, according to TrimTabs Investment Research.

Many believe that investors' continued pessimism in the face of such strong profits shows a historic change in their attitudes toward investing.

Vanguard Closes Top-Performing Value Fund

Vanguard is temporarily closing its top-performing Vanguard Capital Value Fund, a $742 million fund that rose 68.5% year-to-date through the end of September and whose assets have tripled in that period of time.

"Despite our efforts, at both a company and an industry level, to educate investors about the perils of performance-chasing, we continue to be concerned about this behavior," said Vanguard CEO Bill McNabb.

"Closing the fund for a cooling-off period protects existing shareholders from higher transaction costs from short-term-oriented investors [and] protects prospective investors from themselves, as high-performing funds will almost certainly drop off at some point," McNabb added.