QUARTERLY REPORT

30 September 1997

Investment Manager's Report

Performance
It has been a quarter of significant divergence with large markets like Japan falling 12.8%, some Asian markets by as much as 42%, contrasting with rises in the US of 7%, Italy 18% and UK 12%. The wash-up of all this was a 2.8% advance in the FT World Index and a rise in our portfolio of 0.6%. For the present, our low representation in the US market, with its 47% weighting in the MSCI, makes for difficult comparisons - more of that later.

PFL Cumulative Performance Versus FT World Accumulation Index

Changes To The Portfolio
The significant changes in the portfolio included the addition to our interests in Banking and Finance companies in Italy and France. Coming off a low base, this sector is starting to experience the winds of change that have swept North America and elsewhere. We have added further to our holdings in Rinascente (principally hypermarkets in Italy), where the benefits of a new management/ownership structure is having a significant impact. Elsewhere in Europe, we have continued to add to smaller holdings while selling out of Deutsche Bank and Daimler Benz - both of which have delivered the best part of their potential. In North America, we have added to Great Lakes Chemical and introduced King World Productions while eliminating several smaller holdings.

Our experience in Asia has been fortunate, having sold down Indonesia ahead of the crisis, we have been able to cherry pick some bargains in the subsequent panic. In Japan, our stocks which were picked on the basis of their world competitive qualities and improving profitability have been left largely unscathed by that market's continuing downward re-rating. We are cautiously collecting holdings in some domestic orientated issues.

Top Ten Holdings (as at 30 September 1997)

Stock	Country	Industry	% Holding
Fuji Photo Film	Japan	Photographic Equipment	4.1%
Rinascente	Italy	Retailer	3.5%
Yamanouchi Pharm.	Japan	Pharmaceutical	3.4%
Siemens	Germany	Industrial Conglomerate	3.1%
Schindler	Switzerland	Construction	3.1%
Lagardere	France	Media/Defence	3.0%
Canon	Japan	Office Equipment	2.8%
Nintendo	Japan	Home Entertainment	2.7%
Samsung Electronics	Korea	Electronics	2.6%
Daiichi Pharm.	Japan	Pharmaceutical	2.5%
TOTAL			30.8%

Disposition Of Assets

Region	30 September 1997
Western Europe	36.0%
Japan	31.2%
South America	7.3%
Other Asia	6.7%
North America	3.9%
Australia	1.3%
Cash	13.6%

Current Developments
The precipitous decline in many of the markets of the Pacific Rim reminds us how confidence can shear. The break in confidence is explained by the realisation that the honeymoon period of huge inward investment flows are over for now. These flows in large part originated out of the desire by multinationals to tap low production costs as they adapted their businesses to the new paradigm. Further, it is apparent that these countries will no longer be able to bask in the comfort of low interest rates which resulted from their currencies being tied to the US$. With interest rates now likely to be driven by domestic needs, in particular to attract funds to stabilise their exchange rates, we can expect rates to remain at higher levels than hitherto. This has clear adverse implications for corporate profits and the valuations thereof. (It should also be said that the great surge in these markets in the last 10 years was driven more by a revaluation of earnings than their growth rate, which at around 15% pa, was good but not spectacular).

Going forward, we believe the economies of Thailand and Malaysia face significant restructuring. Interestingly, large company valuations do not seem to fully reflect the damage that has been wrought. Many now have considerably increased indebtedness because of the translation effect of their large foreign currency borrowings. Combine this with recent additions to capacity, in a world where traded goods are in abundance, and it is clear that deteriorating domestic demand and confidence simply adds to their woes. That the smaller specialised companies are relatively cheap is a reflection of investor emphasis on liquidity and concerns about fair treatment of minorities.

We feel that Indonesia has handled the crisis in a more pro-active manner than their neighbours, although their banking system is impaired. The removal of foreign ownership restrictions that coincided with a panic sell-off has driven down the value of several very attractive Jakarta listed multinationals. Though their growth rates will in the near term decline, their longer term prospects as purveyors of household necessities to a growing population is essentially unaffected. On valuations similar to their inherent growth rates, these are some of the cheapest companies that we have recently found.

The deterioration in the Pacific has important consequences for Japan and China. In the case of China, almost overnight a group of countries with a population total of some 350 million people have taken a "wage cut" varying between 20-50% due to currency devaluations. For a country in the midst of economic transformation, as it attempts to raise the efficiency of State owned enterprises and remove an overhang of surplus capacity, this is an unhelpful development.

For Japan, the deterioration of exports to the region adds to the burden of an economy already writhing under the burden of the higher consumption tax introduced in April. This shock has acted as a catalyst to devalue large segments of the Japanese stock market which had hitherto levitated on hope and history. Broad categories of companies that have paid little heed to profitability for a long time are now being sold down mercilessly to below book value. This process may involve a prolonged period of investor scepticism. However, it can be viewed in a positive light because the correct pricing of risk is a necessary pre-condition for the broader restructuring that the economy needs. If one juxtaposes these massive deratings with the actions already instituted by the leading companies in the form of a cautious adoption of share buy-backs and the introduction of executive share option schemes, it is clear that impetus is being added to the Japanese restructuring story.

However, the Japanese stocks we hold were chosen precisely because they were either already internationally competitive or as domestic-orientated companies had began to emphasise profitability rather than market share alone. In the last 12 months for example, our Japanese stocks have returned 18% against a market that has declined 15%. (Over two years, the return was 74% versus 16% respectively). As the Yen has been fully hedged, this translates as a similar gain in US$ terms.

Europe contrasts starkly with Asia with valuations improving against a background of low inflation, low interest rates and accelerating activity. Trailing the US by a good 5-7 years, the benefits of restructuring are gradually coming through. We feel our European stocks offer better prospects than the many wonderful companies we have researched in the US which have already seen an extraordinary expansion of their profit margins over the last ten years. For example, the after-tax return on sales of the "Nifty Fifty" group has risen from 8.6% in 1987 to a projected 11.8% for the current year, an improvement of all of 37%. However, as noted in earlier correspondence, the sharp intra market rotations do periodically throw up interesting prospects. (Please do not interpret this as a change in our fundamental view regarding valuations).

Outlook
Plentiful liquidity and the prospect of low inflation with some recovery in growth, particularly in Europe, continues to support markets. The recent recovery in bond prices reveals the underlying market view that the dangers of a rise in inflation are small. Our view is that a weary eye should be kept on aggregate demand as the US is at present the principal driver to world growth (as evidenced by the current account deficit of some $200bn). At present, the market is treating the improvement in bond prices (lower yields) as a positive factor for markets and this relationship should be monitored closely. The presumption that inflation is the main risk facing markets is not one we subscribe to.

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