The World Health Organization (WHO) on Monday evening, April 27, raised the level of the influenza pandemic alert to “Phase 4.” This means that while a pandemic is not inevitable, the risk that one will occur is “significant”. A WHO spokesman indicated that any attempts to contain its spread have been abandoned and they are stressing instead the need to mitigate its effects.

Earlier in the day on Monday, global equity markets reacted negatively to the swine flu worries. At this point there is insufficient information to judge whether a pandemic serious enough to impact global economic activity will develop.  If, as we hope, this can be avoided, negative market effects would prove to be transitory.  On the other hand, should a serious global pandemic occur, the prospects for the recovery of an already fragile global economy would be dealt a heavy blow. As long as the current uncertainty about this global threat continues, equity markets are likely to be volatile and experience a reduction in the readiness of investors to take on additional risk.

As a precautionary measure, we have decided to build up a cash reserve in our International, Emerging Market, and Global Multi-Asset Class portfolios.  In doing so, we have given emphasis on taking some of the profits from the recent sharp run-up in emerging-market equity markets. We continue to believe that over the course of 2009, the emerging-market equity markets will outperform the global average, but they may have gotten a bit ahead of themselves.

In recent years, the months November through April have typically been the strongest period for emerging-market equities, followed by pullbacks. Also, any general increase in risk aversion on the part of international investors is likely to hit the emerging markets hardest.  If the risk of a pandemic becomes an actuality, many emerging-market economies are likely to suffer from having less advanced medical systems. The ongoing experience of Mexico in comparison with that of the United States may serve as an illustration of the importance of this systemic difference in ability to address such a medical challenge.

We recognize that raising cash in portfolios as a precaution in such times can mean foregoing some of a future market advance in the absence of adverse developments.  The move, however, will cushion portfolio performance if the markets fall. Capital preservation is Cumberland’s overriding priority in managing portfolios.