Lincoln Financial Group, investment in emerging markets, excluding China, is the area of biggest growth in adviser interest, with the frequency of recommendations almost doubling from 5 to 9 per cent since October 1, 2004. What has been your experience?Mullins: We have always recommended exposure to emerging markets in our client portfolios as this sector provides substantial diversification benefits. We believe that a diversi- fied portfolio of emerging markets equities complements a well structured developed markets’ portfolio. However, we recommend pre-defined asset allocation strategies and do not alter these in light of market trends. Yearsley: I agree with Lincoln that emerging markets are a popular area for investment at the current time. With developed markets giving returns in the high single digits, investors seem prepared to accept higher-risk investments in order to achieve higher returns. Emerging markets have favourable demographics, with young and eager populations. The prospects look good for the long term. Davidson: Yes, we have found an increase in interest in emerging markets over the past year, with particular focus on emerging Europe and India. The reason is the growth potential of these markets and investor excitement over expanding Europe. The past month has witnessed even more fund manager moves, notably from SVM and Credit Suisse. Recent research found that only one in four managers has been in charge of their portfolio for four years or more. Will the fund managers’ merry-go-round ever slow down? Mullins: We pay very little attention to fund manager moves as we choose our funds on the basis of wanting to capture market returns, rather than trying to find a manager who tries (and usually fails) to beat the market. We do not believe the cost of active fund management is worth paying for. Yearsley: I do not think the fund managers’ merry-go-round will ever slow down. Fund management group A will always try and poach a decent fund manager from fund management group B and offer him more money. That is the way of the world. I think the advent of fund supermarkets over the last four or five years means that fund managers moving is not a massive problem. It is cheap, quick and easy to switch funds these days, so if you want to follow a departing manager you can do. I am not sure that managers are moving more now than in the past, it is just that it is reported more widely. Davidson: No, it is the nature of the beast. It is disconcerting for investors but they need to be reminded that the process of the fund management group and the team approach are components in providing consistency. Are you expecting a recession in the bond market as a result of rising inflation? Mullins: We do not prom- ote marking timing and believe that clients should stay invested even during periods of uncertainty. Because equity, bond and property markets are negatively correlated, any uncertainty regarding overall returns can be minimised. Yearsley: I expect continued volatility in the bond market over the coming year. Interest rates will probably peak in the New Year and possibly start falling after that. Obviously, falling interest rates mean that bond prices should increase. I have to be honest and say the outlook for bonds does not look that exciting at the current time. However, I am not expecting a recession in the market. Davidson: We are not expecting a recession but a slowdown. In addition, equity investments are proving more popular as confidence returns. Do you believe that without sweet equity in co-invest- ment schemes, venture capital trust managers lack an incentive to perform? Mullins: It is disappointing but probably true to say that unless an active fund manager has his or her own rewards correlated with those of the investor, then investment returns may suffer. Suffice to say that aligning manager and investor rewards is not that straightforward and investors should be aware of potential conflicts which could influence a manager’s decision. Yearsley: I think that sweet equity deals for VCT man- agers on top of performance fees is too much. VCT man- agers already get paid 2 to 2.5 per cent a year, they receive monitoring and arrangement fees, they have traditionally always had performance fees and now they want sweet equity. Is this going to be the straw that broke the camel’s back? They should either have performance fees or sweet equity. Northern Venture Managers has just announced on its new offering of shares that it will only have sweet equity and it is abolishing the performance fee. I think this should be applauded and should be encouraged. Anything that aligns investors and managers is great. However, some recent deals look greedy. Davidson: Incentives can be offered in many ways, not just sweet equity. Sweet equity can focus the mind but it is the duty of the manager to manage for the benefit of all clients, not just themselves. Would you agree that Europe is displaying better investment opportunities right now compared with the UK? Mullins: Our investment philosophy dictates that we neither try and time markets nor use momentum investing as a means for capturing returns. Investing is always a process of making definitive choices in an uncertain environment. In reality, it is simply not possible to predict reliably where markets will be next week, next month or even next year. Yearsley: I think there are some interesting opportunities in Europe at the current time. Investors have ignored Europe over the last few years as they see it as bureaucratic and politically a nightmare. However, there are some very dynamic companies and countries included. Restructuring is going on in Germany, productivity has been increasing and the stockmarkets have improved on the back of this and also the Eastern European story. I think it is definitely time that investors started looking at investing in Europe again. Davidson: Europe is a bigger market so there are more anomalies to exploit. However, any balanced portfolio will contain a mix of geographical areas in order to spread risk. Do you expect the New Star flotation to lead to departures from the firm over the short to medium term? Mullins: There will always be speculation about fund manager moves. Given the volumes of managers operating in the market and, more important, how they are remunerated, I am sure that there could be some fallout. Yearsley: I do not think that the flotation of New Star will lead to many departures. Only a small amount of equity can be taken out by employees at float, with most locked in until, I believe, 2009. Therefore, it is unlikely that many will leave. I think more of a concern for New Star at the current time is mediocre performance from some of its funds. Has the impending float meant that some fund managers have taken their eye off the ball? Davidson: We doubt it. Staff are tied in longer term and can only cash in parts of their equity. We believe that most will wait for the longer-term benefits.