Graham Kitchen Henderson UK Equity Fund Manager Can Megacaps ever perform?

1. Graham Kitchen Henderson UK Equity Fund Manager Can Megacapsever perform? Thursday 1 March 2007

2. What are Megacaps? FTSE All Share market capitalisation = £1.85 trillion Information ratio = Source: Citigroup. As at 31 December 2006 Top 10 stocks account for almost 40% of the UK Market

3. UK market performance since 1995 FTSE100 has lagged the FTSE 250 in recent years Source: Datastream Total Returns in Sterling rebased to 100. Mid-caps have significantly outperformed

4. Megacaps have been a drag on market performance FTSE 100 impacted in 2006 by poorly performing Megacaps Source: Citigroup (01.01.2006 to 31.12.2006) Based on Top 10 stocks at the start of 2006 rebased to 100. Megacap returns have disappointed

5. Megacaps have underperformed the FTSE 100 Performance of Megacaps relative to FTSE 100 (excl. top 10 stocks) Source: Morgan Stanley. Rebased to 100. Megacap returns have disappointed

6. Megacaps have become more dominant Top 10 stocks as a percentage of the FTSE All Share % Source: Citigroup Concentration rose dramatically in the late 90’s

7. Why have they underperformed? Valuations were too expensive in 2000 Megacaps trade at a discount to the rest of the market Price/Earnings 27x 18x 14x 11x Source: Citigroup based on 12 month forward earnings. Megacaps are now more attractively valued

8. Why have they underperformed? Merger & Acquisition activity focused in mid-caps % of index acquired % Source: Citigroup. M&A has helped drive FTSE 250 outperformance

9. Why have they underperformed? Disappointment from some stocks: • Earnings downgrades (HSBC) • Poor newsflow (BP) • US dollar exposure (GlaxoSmithKline) US$ exposure has also been an issue % Source: Citigroup. Sales exposure to key regions. Megacap earnings have not been supportive

10. Megacap performance has been mixed Megacap performance in 2006 (%) % Source: Datastream. Price returns for 2006. Stock specific issues have driven performance

11. Performance driven by fundamentals • Barclays was a strong performer in 2006 • Low valuation – 9x Price/Earnings • Upgrades to earnings forecasts • Strength at BGI and Barclays Capital offset concerns about rising default rates at Barclaycard Barclays share price in 2006 pence Interim results beat the market’s expectations Source: Datastream. Analysts forecasts were too pessimistic

12. Megacaps now look cheap Megacaps trade at a discount to the rest of the market Price/Earnings 14x 11x Source: Citigroup based on 12 month forward earnings. Megacaps are now more attractively valued

13. Can Megacaps ever perform? • Valuations are cheaper • Balance sheets are stronger • Larger M&A deals ... • … but earnings remain under pressure Source: Citigroup and Henderson Global Investors Lower earnings growth forecast for Megacaps

14. Can Megacaps ever perform? YES especially if …… • Mid-cap M&A slows • Stop producing disappointing news • Become more shareholder friendly

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