MARKET OVERVIEW

Global equities climbed higher last month, despite grumblings that gains were outpacing fun-

damentals. The S&P 500 rose 3.6%, its best August performance in nine years and sixth con-

secutive monthly advance. From the ashes of early March, the benchmark has soared 53%.

Reports showed Japan, Germany, France and at least five other countries officially exited

recession in the second quarter.

The U.S. manufacturing sector stirred back to life. Invigorated by vehicle sales and the gov-

ernment’s “cash for clunkers” program, industrial output rose for the first time since October.

Factory gauges for the New York and Philadelphia regions cranked back to pre-recession

levels. Americans traded in just under 700,000 gas-guzzling cars and trucks between July 27

and August 24 at a taxpayer cost of $2.9 billion. The impact was evident in July retail sales

figures. Although broader spending fell 0.3%, the first decline in three months, receipts at

dealerships and parts vendors rose 2.4%.

Opposing reports highlighted hope and fear in the housing market. Bulls were encouraged

by a 7.2% month-over-month spike in July existing home sales, the largest increase since

1992. Bears noted a record 13.2% of U.S. mortgages were either delinquent or in foreclo-

sure in the second quarter. Absent sup-

port from Washington, the market would

likely be in rougher shape. The Federal

Reserve is keeping mortgage rates low by

purchasing $1.25 trillion in housing-related

debt, while Congress’s $8,000 first-time

home buyer tax credit spurs demand. The

credit is set to expire November 30.

From an earnings standpoint, August was

a period of relative calm. Second quarter

S&P 500 profit estimates improved mod-

estly from -29.5% to -27.3%, according to

Thomson Reuters. The third quarter

earnings season kicks off October 7 with

bellwether aluminum producer, Alcoa. Led

by declines in the materials and energy

sectors, overall S&P 500 profits are

expected to drop 20.8%. The financials

sector should do best, with profits

bouncing 371% off crisis-ravaged year-

over-year comparables.

by Greg Meier

A U T U M N 2 0 0 9

AT THE MARGIN

IN THIS ISSUE

Market Overview . . . . . . . . .1

Perspective . . . . . . . . . . . . .2

Equity Update . . . . . . . . . . .2

Firm Update . . . . . . . . . . . . .3

Portfolio Manager Insights:

Quantitative’s

Complementary Role in

Portfolios . . . . . . . . . . . . . .4

Feature:

The U.S. Federal

Reserve — Post-Crisis

Policy . . . . . . . . . . . . . . . .6

Focus:

Risk Management . . . . . . .8

Chartbook . . . . . . . . . . . . .12

August YTD

S&P 500 3.6 15.0

NASDAQ Composite 1.5 27.4

Dow Jones Industrials 3.8 10.6

MSCI EAFE 5.5 24.8

MSCI EAFE Growth 3.2 19.7

MSCI EAFE Value 7.6 30.0

MSCI EM -0.3 51.1

MSCI ACWI xUS 3.7 30.2

MSCI Europe 6.3 26.6

MSCI Japan 3.9 11.3

Russell 1000 3.6 16.4

Russell 1000 Growth 2.1 21.9

Russell 1000 Value 5.2 10.6

Russell Midcap 4.9 25.5

Russell Midcap Growth 3.1 29.7

Russell Midcap Value 6.6 20.8

Russell 2000 2.9 15.8

Russell 2000 Growth 1.0 21.2

Russell 2000 Value 4.7 10.8

ML High Yield Master II 2.0 40.2

As of 31-Aug-09

Market Performance (USD)

VOL. 13 NO. 8

PERSPECTIVE

Christopher A.Herrera

Senior Vice President,Portfol io Manager

EQUITY UPDATE

STYLE AND MARKET CAPITALIZATION

Mid-cap stocks were top performers last month.

Mid caps have led just three times in 2009, yet

for the year retain a considerable lead. The

Russell Midcap Index is up 25% since January 1.

That compares with 16% gains in the large-cap

Russell 1000 and small-cap Russell 2000

indexes. From a style standpoint, investors again

favored value over growth in August. Growth

stocks still hold a solid lead for the year.

S&P 500 SECTORS AND INDUSTRIES

Prodigal sons of Wall Street, banks outperformed

again in August. In the past six months, banks

have led the overall market four times, up 137%,

on average, since March 9. Some of the most

beaten-down names have become unlikely star

performers. American International Group, 80%

owned by the U.S. government, returned 245%

last month. Citigroup, 34% government owned,

gained 58%. Both issues are still trading more

than 70% lower than a year ago. Credit crisis-

related losses and writedowns now total $1.6

trillion, according to Bloomberg.

INTERNATIONAL EQUITY

Foreign investors dialed up a second monthly

advance in August, amid fresh signs the Great

Recession was easing. Developed world stocks

captured the lion’s share of gains, bolstered by

strong results in Europe and a falling dollar.

Emerging markets shares trended lower, under-

performing developed markets for the second

time in 2009. Reports showed Japan, Singapore,

Hong Kong, Germany, France, Norway, Thailand

and Israel returned to economic growth in the

second quarter, officially exiting recession.

Chinese shares tipped into a bear market, as a

prime mover behind a local rally — unfettered

bank lending — tightened up.

2

Global equities have rebounded significantly

from the low in March. As of the end of

August, the MSCI All Country World Index

was up 23.6% year to date. The rebound

from the low was driven by a combination of

improving economic news and positive

earnings announcements. Global equities

now trade at 14.6x next twelve month’s

expected earnings, a significant re-rating

from the 9.0x low over the last year.

In aggregate, the positive earnings season

was mostly driven by better-than-expected

cost cutting by companies. Sales growth

was not as prominent a factor in the out-

come versus expectations. In response,

analyst expectations for future earnings

have been revised up significantly over the

last few months. The key to sustaining the

recent rally will be a continued positive

earnings outlook driven by improving eco-

nomic and company-specific fundamentals.

Over the next few months, the market’s

focus will move to the potential recovery in

2010 earnings.

At Nicholas-Applegate, we focus on identi-

fying those companies that are experiencing

positive change that will drive an improve-

ment in their earnings power. In our tradi-

tional global equity portfolios, we favor Asia

ex-Japan equities which benefit from

strength in Chinese demand and improving

domestic economies. In addition, we are

overweight Europe, with an emphasis on

those companies that have a global focus in

their respective businesses. In terms of sec-

tor exposure, we are seeing the most posi-

tive changes in materials and industrial com-

panies. These sectors have high exposure

to demand from emerging markets as well

as positive sensitivity to an expected upturn

in the inventory cycle. As the market's focus

moves from valuation re-rating to earnings

delivery, our focus on bottom-up stock

picking should be an advantage.

Copyright 2009

....Nicholas-Applegate

....Capital Management

FIRM UPDATE

AT THE MARGIN is a

monthly publication of:

Nicholas-Applegate

Capital Management

600 West Broadway

San Diego, CA 92101

PHONE (800) 656-6226

(619) 687-8000

FAX (619) 645-4069

3

This quarter, we welcomed the following professional to our Marketing team:

Clifton A. Wedington — Senior Vice President, Public Funds — Clifton Wedington is respon-

sible for Public Funds marketing on the West Coast. Prior to joining the firm, Clifton was Vice

President, Institutional Advisory Group, with Morgan Stanley Investment Management; Vice

President, Global Wealth Management; Chairman of the Board of Trustees, Contra Costa

County Employees’ Retirement Association; Vice Chairman of the Executive Board of

Directors and Chairman of the Education Committee for the State Association of County

Retirement Systems; and Managing Partner, Computer Audit Systems. He has lectured for

the California Association of Public Retirement Systems conference and the Trustee

Education Program. Clifton earned his B.S. in Business Management from the University of

Maryland, and Certificate in the Advanced Investment Management Program, the Wharton

School, University of Pennsylvania. He has twenty years of investment industry experience.

NICHOLAS-APPLEGATE HOSTS THE MONARCH SCHOOL

On September 8, Nicholas-Applegate hosted the Monarch School at the La Jolla Playhouse

for a student matinee of the play, “The 39 Steps,” an adaptation of Alfred Hitchcock’s 1935

film.The La Jolla Playhouse provided a teaching artist and enrichment guide, which they used

to prepare and engage the students prior to their arrival at the theater. Founded in 1988, the

Monarch School is dedicated to providing homeless and at-risk children with an accredited

education while caring for their basic needs. Today, more than 100 students between the ages

of 7 and 18 are enrolled at the Monarch School. Nicholas-Applegate is a corporate sponsor

of the La Jolla Playhouse.

By Cathleen Bramlage

A scene from the play, "The 39 Steps," produced by the La Jolla Playhouse.

4

Modern portfolio theory stresses the impor-

tance of investment diversification to reduce

portfolio risk and smooth investment returns

throughout various market cycles. The back-

bone of portfolio diversification is investment

in uncorrelated assets, which most typically

includes a blend of fixed income and equity

assets, with those further diversified by

quality and duration in the case of fixed

income, and country, market capitalization,

and style tilt in equities. Beyond these tradi-

tional equity diversifiers, research suggests

that the inclusion of quantitatively managed

strategies as a complement to fundamentally

managed ones also reduces risk and

results in a more efficient total portfolio. The

correlation of excess returns of quantitative

versus fundamental managers over the past

five years has been quite low. Please see

Exhibit 1.

Investors have often shied away from quanti-

tatively managed strategies because their

seemingly complex nature violates one of

Warren Buffett’s top investment principles:

“Never invest in a business you cannot under-

stand.” The reality, however, is that most

quantitative strategies are not managed as

black boxes of fancy math, but rather are

simply formulaic representations of finan-

cial theory, supported

by sound economic

principles. These fac-

tors include meas-

ures such as increas-

ing earnings, positive

guidance by man-

agement, and strong

balance sheet ratios.

Although a formulaic

approach eliminates

the stock story ele-

ment that is often part

of qualitative investing, it also removes the

behavioral and emotional bias of stock selec-

tion in favor of an objective and disciplined

process of risk-controlled investing.

As with all investment styles, quantitative

investing will not always be in favor and fully

rewarded by the market. Indeed, at times in

the investment cycle when sentiment is driv-

ing stock prices, fundamental managers often

are better rewarded than the disciplined,

objective investment process of quant man-

agers due to their process allowing for subjec-

tive adaptations in response to current market

trends. Further, during periods of rapidly

changing information quant managers will

also have difficulty. We’ve experienced such

inflection points twice in the past year, first in

the summer of 2008, then again in the second

quarter of 2009. During these periods of

inflection when, for instance, commodity

prices are falling but earnings estimates

reflect their previous highs, quantitative

models will be at a disadvantage as they

objectively rely on data that fundamental man-

agers are instead able to alter according to

changing information. However, the inverse is

also true, with quantitative managers having a

keen advantage during periods when stock

prices follow a company’s underlying valua-

Blair E. Vaughan, CFA

Product Manager,Systematic

PORTFOLIO MANAGER INSIGHTS: QUANTITATIVE'SCOMPLEMENTARY ROLE IN PORTFOLIOS

Exhibit 1

Correlation of Quantitative vs. Fundamental Active Managers’Excess Returns

US Small Cap Core US Large Cap Core Global Equity

5-year

correlation* 0.45 0.33 0.23

*Quarterly median performance within eVestment asset class universes; Fundamental vs.

Quantitative style is manager-defined; Excess return is the difference between the median

manager return (separate account composite, gross of fees) and the asset class benchmark: US

SCC: Russell 2000; US LCC: S&P 500; Global Equity: MSCI World; Average universe size of man-

agers during the period: US SCC – Fundamental: 71 Quantitative: 41; US LCC – Fundamental: 157

Quantitative: 83; Global Equity – Fundamental: 197 Quantitative: 41.

Source: eVestment Alliance

As of 30-Jun-09

tions, as their models are able to scour the

entire universe for such opportunities effici-

ently and objectively, sometimes identifying a

trend before it has been identified by analysts

who are often the source of ideas for funda-

mental managers. Additionally, we believe that

over the long-term, equity market prices must

trade according to fundamental valuations, and

as such, constructing portfolios according to

such principles in a disciplined fashion will pay

off over a full market cycle.

The past two years have exemplified a period

when quantitative money management styles

have been out of favor, and quant managers

have struggled. According to research pub-

lished by the Research Foundation of CFA

Institute, in 2007, U.S. large-cap quantitative

strategies were the only asset classes to out-

perform their fundamental peers.1 Given this

seemingly long period of underperformance, it

is reasonable to question whether these

returns signal that quantitative management

has lost its advantage. Similar to how funda-

mental managers lagged quantitative ones

through the 2001-2005 period, only to cycle

back into favor, we believe the ability of quants

to produce alpha will return as the market

again consistently trades on underlying com-

pany valuations. This cycle of how the broader

market rewards different investment styles

makes a compelling case for fundamental and

quantitative managers complementing rather

than competing with each other in a client's

portfolio.

5

THE BENEFITS OF QUANTITATIVE INVESTING

Quantitative processes are defined by their objective application of investment principles

across their investment universe. Beyond removing emotional and behavioral biases, these

models inherently lend themselves to sophisticated risk controls and trade-cost management

as part of the portfolio construction process. While fundamental processes necessitate an

allocation of intellectual capital by the portfolio manager, limiting breadth both in universe cov-

erage and portfolio impact due to finite resources, quantitative ones lend themselves to appli-

cation of robust selection criteria across a wide universe. During rational market cycles when

company valuations and stock prices align, a manager’s ability to quickly and efficiently canvass

the entire investment universe for mispricing opportunities is advantageous to clients.

The ability to incorporate risk estimates, including interaction effects with other holdings, and

trading costs into the process maximizes coverage breadth while ensuring a consistent appli-

cation of the investment philosophy. This process lends itself to quantitative managers

having an advantage in customizing and researching specialty mandates according to client

needs. Whether client mandates dictate a finite holdings concentration, portfolio targeted

tracking error, or regional or style focus, quantitative managers need merely to alter con-

straints within the model to deliver a portfolio according to the customized specifications, and

can do so with precision. Further, these specialized portfolios can then be back-tested to gain

insight on such a construction’s behavior over time through various market cycles. Back-

testing altered constraints or model specifications provides a valuable research tool when

analyzing how a similar portfolio may behave and is a particular strength for quantitative

managers.

1F. Fabozzi, S. Focardi and C. Jonas, “Challenges in Quantitative Equity Management,” Research Foundation of CFA Institute,

July 2008.

6

FEATURE: THE U.S. FEDERAL RESERVE — POST-CRISIS POLICY

The global recession is over, according to

Olivier Blanchard, top economist at the

International Monetary Fund. He may be

right. Economic uncertainties have dimin-

ished markedly, and the deep contractions

witnessed during the heat of the financial

crisis shouldn’t be repeated. Behind this

argument stands a wall of government stimu-

lus money, dramatically narrowed bond

spreads, a historic equity rally and unprece-

dented monetary easing. The U.S. economy

will return to growth during the current quar-

ter, according to Bloomberg News. Corporate

earnings expansion is expected next.

At their annual symposium in Jackson Hole,

Wyoming in August, central bankers world-

wide congratulated one another on a second

Great Depression averted. They deserve

unabashed credit for a battle well fought. But

the war isn’t over. Without an effective exit

strategy, Federal Reserve policies risk

igniting a conflagration that could rival the

financial crisis in destructive tenacity.

DECONSTRUCTING POLICY

The U.S. economy is stabilizing, but far from

healthy. Fear of a Japan-style deflationary

spiral persists in some circles. Deflationists

note that the Consumer Price Index (CPI)

fell 2.1% in July, the most since 1950.

Worker wages plunged a record 5.1%.

Unemployment, at decades’ highs, will prob-

ably climb further. More than a third of U.S.

factories sit idle.

Policymakers at the Fed recognize these

issues. Chairman Ben Bernanke, in parti-

cular, is learned in the Great Depression and

keen to avoid a repeat. To this end, he has

kept the monetary throttle wide open,

launching liquidity facilities and asset pur-

chase programs, and maintaining overnight

rates at a record low 0.00%-0.25%.

Commenting on the bank’s strategy of

“exceptionally low" rates for “an extended

period,” on August 21, St. Louis Federal

Reserve President James Bullard said, “I

don't think markets have really digested what

that means.”

WHAT ‘THAT’ MEANS

Even before Mr. Bullard’s comments, expec-

tations for belt tightening had collapsed. On

June 5, when the Labor Department’s

monthly nonfarm payroll report showed the

fewest job losses in eight months, investors

gave a 67% chance for a rate hike to 0.75%

by November. As of August 28, odds for no

change stood at 98%. Further out, investors

price a 31% chance the current policy will

remain intact through at least June 2010.

If peak unemployment is a reference for pre-

dicting post-recession tightening, the Fed’s

first move could come substantially later. The

Fed didn’t raise rates for a full year after

unemployment crested after the last reces-

sion. The Fed waited twenty months after

peak joblessness during the 1990-91 down-

turn. By White House estimates, joblessness

will breach 10% in late 2010. If the govern-

ment raises tax rates, peak joblessness will

probably arrive even later, according to

Horacio Valeiras, CFA, Chief Investment

Officer. In either case, Mr. Bernanke may be

hoping to keep policy loose well into 2011.

Greg Meier

Financial Writer

“Recent increases in the monetary base are far greater than any previously in

American history… Will these policies be successful without accelerating inflation?

The epitaph to this curious case of monetary base expansion is yet to be written.”

Richard G. Anderson, Vice President, Federal Reserve Bank of St. Louis, July 2009

7

THE THREAT WE FACE

With little room for further cuts, the Fed’s primary tool

for firing up growth isn’t interest rates. It is quantita-

tive easing – asset purchases. Purchase programs

launched in the wake of the financial crisis include

$300 billion in Treasuries, up to $1 trillion in securities

backed by student, auto, credit card and commercial

real estate loans and $1.25 trillion for residential

mortgages. This buying spree has exploded the Fed’s

balance sheet.

At $929 billion at the end of 2007, the Fed’s balance

sheet increased to $2.29 trillion last December. It has

since fallen, but the decline should be temporary. In a

July 29 speech, New York Federal Reserve President

William Dudley reckoned the balance sheet would

“grow to roughly $2.5 trillion.” That equates to near 20% of

annual U.S. economic output.

In economic terms, the balance sheet expansion is essen-

tially an increase to the U.S. money base. As the Fed buys

private sector assets it simultaneously injects new cash into

the economy.

In historical terms, what we are witnessing is unprece-

dented. According to economist Dr. Arthur Laffer, the rise in

the U.S. money base is larger than anything ever at-

tempted by a factor of ten. Please see Exhibit 2. The result

could be highly inflationary. The previous record for mone-

tary base expansion occurred during preparations for the

Y2K millennium rollover. Between October 1999 and

January 2000, the Fed’s balance sheet grew from $572 bil-

lion to $639 billion. Within five months, the CPI spiked from

2.6% to 3.8%. Commenting on the dangers of quantitative

easing this summer, Mr. Bullard noted "permanently dou-

bling the money supply eventually doubles the price level…

This gives a rough idea of the type of threat we face."

The Fed’s balance sheet problem is multidimensional.

According to Banc of America-Merrill Lynch, the Fed’s port-

folio has hardened substantially since the start of the crisis.

As asset purchase programs ramp up and liquidity facilities

wind down, the illiquid component of the Fed’s portfolio has

more than doubled to $1.4 trillion. This structural shift is

expected to quicken as the Fed’s portfolio grows, making it

increasingly difficult to unwind policy. Once the economy

regains traction, if the Fed can’t pull back quickly, a desta-

bilizing spike in inflation becomes likely.

PAYING DEBT WITH DEVALUED DOLLARS

Victor Canto, Ph.D., Founder, La Jolla Economics, and

Steve Sexauer, Chief Investment Officer, Allianz Global

Investors Solutions LLC, reviewed potential Fed exit strate-

gies in a May 2009 paper. Their conclusion was, because

fear of a Great Depression outcome is so intense, the Fed

will hold policy loose for too long.

Such a result could be politically expedient in Washington.

The White House forecasts deficit spending will cause a

near doubling in the national debt to almost $20 trillion by

2019. The U.S. debt to GDP ratio will surge from 48% to

69%. Servicing the debt will be costly. It could force tax

hikes, service cuts or both. A ratcheting up in price levels

would allow the U.S. government to pay debts using de-

valued dollars.

Whether bankers have the inclination or ability to unwind

policy before inflation entrenches is unclear. The Fed hasn’t

been stress-tested on inflation in years. The core CPI

hasn’t pierced 3% since 1995. The core PCE hasn’t since

1992. In a 2002 speech, Mr. Bernanke touched on the topic

of government debt and inflation, saying, "People know that

inflation erodes the real value of the government's debt and,

therefore, that it is in the interest of the government to

create some inflation."

continued on page 10

Exhibit 2

8

FOCUS: RISK MANAGEMENT

In June of this year, the research group at

MSCI Barra published a report entitled “Best

Practices for Investment Risk Management”

that proposed a framework which included:

n analyzing multiple aspects of risk, not just

one measure,

n investigating factors that affect risk across

an entire firm,

n scrutinizing risk during normal time periods

versus risky time periods and

n aligning risk management with the invest-

ment goals of the firm.

Nicholas-Applegate’s Research and Risk

Management team had already created a risk

management system that parallels the frame-

work set out by the consultants at MSCI

Barra. Many investment managers, how-

ever, refer to tracking error as the single gold

standard for risk management. In the 1980s,

standard deviation of the portfolio returns was

considered the ne plus ultra of risk analysis.

Our risk management program began in the

late 1990s during the heyday of the tech-

nology bubble. It began as a series of printed

reports — one report for each investment

strategy based on a fundamental factor risk

model. We later expanded it by looking not

just at the most recent portfolio statistics but

also at how the statistics evolved over time.

Above all, though, we took to heart the idea

that investment risk is multi-faceted. One can-

not look at one or two statistics and know the

risk of a portfolio: one must look at many risk

measures.

Beginning in the fall of 2001, we developed

and implemented an automated system of risk

management. Our goals were threefold. First,

we recognized that risk could be measured in

many different ways. Second, we wanted the

risk system to produce timely and accurate

daily reports. Third, we wanted everyone on

the investment staff to have access to the

results. We created a system that produces

approximately 1,600 charts, tables, and

reports. Some of these are based on daily

data and some on monthly data. The system

includes reports on:

n tracking errors and information ratios —

both long-term and short-term

n the split between systematic risk and stock-

specific risk

n performance in up and down markets

n returns-based style analysis

n capitalization distribution of the portfolio

versus the benchmark

n a quality control measure

n stock-specific volatility through time

n active risk factor bets through time

n several analyses based on the work of

Eugene Fama and Kenneth French

n Value-at-Risk analyses for portfolios with

the potential for non linear returns

n liquidity

We meet quarterly with each of the portfolio

teams to review the intended and unintended

risks in the portfolios and to review the multi-

faceted risk analysis of each strategy. The

reports can be viewed on an Intranet site by

each of the portfolio teams. In addition, we've

developed software to analyze risks that could

affect the entire firm and have researched

what may happen to our strategies during

extreme risk events.

While our risk system predated MSCI Barra’s

best practices research, we are always

looking for new measures or new statistical

techniques that will enable our investment

teams to have a better understanding of risk

and to integrate risk management into the

investment decision process.

Douglas B. Stone

Senior Vice President,Director of Researchand Risk Management

Exhibit 5 shows the results of running Ordinary Least

Squares (OLS) regression over 114 months ending in June

2009.

OLS regression models provide coefficient estimates for

the average of the dependent variable. In this example, I

use the Fama-French, three factor model which is an

extension of the Capital Asset Pricing Model (CAPM). In

addition to a constant, often referred to as alpha, there is a

market variable, commonly known as beta, a size variable

calculated by subtracting returns on large stocks from the

returns on small stocks, and a variable measuring value,

which is calculated as the returns on low book-to-price

stocks subtracted from high book-to-price stocks. We use a

regression model to estimate a portfolio’s sensitivity to

these factors. One might ask an additional question: what

are the sensitivities when the portfolio’s performance is

poor or when it is good?

While the adjusted r squared is somewhat low at 64 per-

cent, the analysis indicates a relatively high beta to the

market and a risk adjusted return of 20 basis points per

month. The size coefficient indicates that this is a small-cap

portfolio and the value coefficient indicates that this is a

growth portfolio.

Benchmarks are critical to the analysis of portfolios. In

addition to analyzing returns, we use benchmark holdings

to compute active sector bets. We look at the portfolio’s

sector weights and the benchmark sector weights and cal-

culate the active exposures (portfolio minus benchmark).

We compute the active exposure for every month over the

last three years, and then we create a display showing the

median exposure, the interquartile range which is the 75th

percentile minus the 25th percentile, and the individual sec-

tor exposures for the last three months.

Exhibit 6 shows active sector weights for a hypothetical

large-capitalization portfolio that is benchmarked to the

Russell 1000 Growth Index. First of all, the zero line repre-

sents the benchmark. The solid line inside each box is the

median active exposure and the length of the box is the

9

OLS Estimate of a Hypothetical Small-Cap Growth PortfolioVariable Coefficient

Alpha 0.2083

Beta 1.3633

Size 0.1901

Value -0.0343

Adjusted R Squared 64%

Source: MSCI Barra; Nicholas-Applegate

As of Jun-09

Exhibit 6

Exhibit 5

continued on page 11

10

Feature: The U.S. Federal Reserve –

Post-Crisis Policy

continued from page 7:

The largest buyer of U.S. debt, China is growing anx-

ious. If U.S. inflation spikes, the greenback could sink in

currency markets, damaging the value of China’s

holdings. In March, Prime Minister Wen Jiabao made

public his concerns “about the safety of our assets.” He

is not alone. Officials in Japan, France, India, Russia

and Brazil have also voiced unease. The greenback is

already weakening, down 12% against a basket of cur-

rencies since March. Mr. Valeiras expects this trend to

continue.

FLASHBACK TO THE 1980s

Viewed through the lens of a soft dollar, government debt

and the Fed’s asset purchases, the case for inflation comes

into focus. Recently rising energy prices could add another

complication. Some of America’s worst post-war recessions

revolve around oil crises. When crude jumped from $16/bbl

to $40/bbl between 1979 and 1980, core inflation cracked

13%. To force prices down, then-Fed Chairman Paul Volcker

took the fed funds rate to an all-time high of 20% twice.

Please see Exhibit 3. Economic output plunged 7.9%, the

most since 1958.

Crude is up more than 60% in 2009. While energy markets

are notoriously volatile and highly seasonal, this occurred at

a time when U.S. demand decreased. American oil import

volumes are down 12% this year. By the same token, imports

to China, the world’s second-largest energy market,

are up 6% in 2009 and 42% in the past year.

DEFLATION IS DEAD

As a matter of straight math, the epitaph on defla-

tion has already been written. Recall the CPI was

-2.1% in the year to July 31? The 2008 commodi-

ties bust is about to roll off trailing twelve-month fig-

ures. When it does, forthcoming calculations will

have lower year-over-year comparisons. If prices

simply hold steady on a monthly basis through

December, an unlikely but reasonable assumption,

the annual change in the CPI will approach 2.5%.

Please see Exhibit 4. The same process applied to

the PCE results in a move from -0.8% to 1.1%. A similar

increase will be seen in Europe.

Forward-looking indicators are rising. The breakeven

between nominal 10-year Treasuries and inflation protected

Treasuries (TIPS), a gauge for future inflation, shot from

0.9% in January to 1.9% in August. TIPS have gained 6.5%

this year, while nominal Treasuries have fallen -3.5%,

according to Banc of America-Merrill Lynch.

At last month’s Jackson Hole convention, Fed officials paid

lip service to the issue of unwinding policy. This was an

opportunity lost. Plotting a clear exit strategy would have

sent a vital and timely message to investors that inflation will

be addressed before it becomes unhinged.

Exhibit 4

Exhibit 3

Securities and sectors discussed herein reflect general market

commentary and should not be construed as a recommendation

(current or past) of the company or any of its portfolio managers.

There is no guarantee that any opinion, forecast, or objective will be

achieved. The information herein is provided for informational

purposes only and should not be construed as a recommendation of

any security, strategy or investment product.

The asset and industry reports contained herein are unaudited. The

summation of dollar values and percentages reported may not equal

the total values, due to rounding discrepancies. Unless otherwise

noted, Nicholas-Applegate is the source of illustrations, performance

data, and characteristics. Unless otherwise noted, equity index

performance is calculated with gross dividends reinvested and

estimated tax withheld, and bond index performance includes all

payments to bondholders, if any. Indexes may not represent the

investment style of any Nicholas-Applegate strategy. Index calcu-

lations do not reflect fees, brokerage commissions or other expenses

of investing. Investors may not make direct investments into any index.

This is not an offer or solicitation for the purchase or sale of any

financial instrument. It is presented only to provide information on

investment strategies and opportunities. The material contains the

current opinions of the author, which are subject to change without

notice. Statements concerning financial market trends are based on

current market conditions, which will fluctuate. Forecasts are inherently

limited and should not be relied upon as an indicator of future results.

References to specific securities, issuers and market sectors are for

illustrative purposes only. This presentation should not be construed as

a general guide to investing, or a recommendation regarding any

investor’s specific circumstances. Although the manager attempts to

limit portfolio risk, risk management does not imply low risk. All

investments are subject to some degree of market and investment-

specific risk. The value of investments can go down as well as up, and

a loss of principal may occur. No part of this material may be copied

or duplicated, or distributed to any third party without written consent.

Small- and mid-cap stocks may be subject to a higher degree of risk

than more established companies’ securities. The illiquidity of the

markets for these stocks may adversely affect the value of these

investments. Investments in overseas markets may pose special risks,

including currency fluctuation and political risks, and the portfolio is

expected to be more volatile than a U.S.-only portfolio. These risks are

generally intensified for investments in emerging markets.

Discussion of individual securities is presented solely to aid general

discussion of the economy and sectors thereof. No single recommen-

dation or subset of recommendations is representative of the

composition or performance of any client portfolio. Investors should not

assume that any investment discussed herein was or will be profitable;

actual accounts may vary, and there is no guarantee that a particular

client’s account will hold any or all of the securities listed.

11

DISCLOSURE:

interquartile range. The small dot is the active exposure

three months ago, the slightly larger circle is the active

exposure for two months ago and the largest circle repre-

sents the most recent month. In Exhibit 6, the manager on

average has been more heavily invested in energy, health

care, industrials, information technology and materials than

the benchmark. If we focus on industrials, we can see that

the manager has overweighted this sector for the last two

months vis-à-vis the benchmark. This would be a discus-

sion point during a portfolio review. This type of chart is also

useful in analyzing risk factors versus a benchmark.

These exhibits, along with the many other types of analysis,

allow our investment teams to monitor risks. We take as a

given that analyzing multiple risk factors is our main focus.

Our processes and determination to make the results avail-

able and understandable both in a quantitative and in a

visual sense have helped our portfolio management teams

to understand risk and to embrace the concept of risk

management.

Focus: Risk Management

continued from page 9:

12

Credit markets have opened and companies are

accessing capital evidenced by robust new

issuance and falling spreads. In addition to

access to capital, a company's cost to borrow has

become less prohibitive due to significantly tighter

spreads, which rose as high as 21% in December

2008. Fast forward eight months and high yield

spreads have narrowed to 912 basis points above

comparable U.S. Treasuries and are back to

levels not seen since September 2008, according

to Banc of America-Merrill Lynch.

Industrial production, a measure of output which

includes manufacturing, mining and utilities, has

been rising globally. Specifically, the three largest

developed economies of the United States,

Germany, and Japan have seen swift increases in

production in recent months. Skeptics point to

government programs such as "cash for clunkers"

for providing a non-recurring boost to production.

In the U.S. alone, motor vehicle assemblies

jumped nearly 42% in July. However, excluding

motor vehicle and parts, manufacturing production

in the U.S. still rose by 0.2%.

CHARTBOOK — RESEARCH FROM THE FIELD

July sales of existing homes rose 7.2% over June

and 5% over July 2008, marking the fourth con-

secutive month of sales growth and the biggest

monthly jump since the National Association of

Realtors began tracking the data in 1999.

Despite the increase in sales, prices remain

15.1% below year-ago levels, with the median

price coming in at $178,400 in July. Price com-

pression has been caused by the increase of dis-

tressed properties on the market, evidenced by

31% of the month's transactions stemming from

foreclosures and short sales.

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