Investment Report

The purpose of this report is to advise Members of the Trustee's investment policy and provide an outline of the general economic background prevailing during the year under review.

Investment Objectives

The Scheme's funding objective is to achieve full funding on a gilts-basis (least risk) over a 20 year time horizon. This is to be achieved through a combination of payments into the Scheme and investment returns.

Therefore, the investment objective is to achieve a return on assets over the longer term that exceeds the growth of liabilities on a gilt matched basis with an acceptable degree of risk measured in terms of fluctuation in this funding level (defined as assets divided by liabilities).

This objective is subject to annual monitoring by the Investment Committee with a triennial review following the completion of an actuarial valuation.

The objectives form the basis from which the Investment Committee develops a strategy approved by the Trustee Board, which is discussed with the principal employer. It is then for the Investment Committee to implement that strategy in terms of asset allocation and the appointment and monitoring of the appropriate managers.

The Scheme's funding and investment objectives, together with full details of the relevant processes, are set out in the 'Statement of Investment Principles', copies of which are available by writing to the Group Pensions Department at the address shown on page 43 of the full Report and Accounts PDF.

The charts on pages 20 to 22 of the full Report and Accounts PDF illustrate the current allocations by asset type, investment manager and geographical spread. Further details of the investment objectives and performance of each manager can be found on pages 23 to 24.

In respect of the Money Purchase Section, the Scheme's long-term investment objective can be stated as being to consider members' circumstances, protect their interests and to make available a series of funds designed to enable appropriate decisions to be taken.

Socially Responsible Investment

Under the 1995 Pensions Act, from July 2000 trustees of occupational pension schemes must state in their Statement of Investment Principles (SIP) whether or not they operate an ethical investment policy. The law requires that trustees should act in the best interests of all beneficiaries, which generally means their best financial interests.

The Trustee Board believes that all companies should be run in a socially responsible way as in the long run this will contribute to the success of those companies, but equally recognises its fiduciary responsibility to act in the best financial interests of the Scheme's members. Therefore, the Trustee Board's policy is that the investment managers should take account of social, environmental and ethical considerations to the extent that they may have a financial impact on investment performance. With this in mind, the Trustee Board also encourages managers to pursue policies of engagement with the companies in which they invest funds.

The Trustee Board, however, recognises that because of the need to closely track the Index benchmarks, it is not appropriate for the Scheme's passive managers (see pages 23 to 24 of the full Report and Accounts PDF for details of the investment managers) to take account of social, environmental or ethical considerations in the construction of their portfolios. However, the Trustee Board also encourages its passive managers to pursue policies of engagement with the companies in which they invest funds.

Corporate Governance

The Scheme has instructed its investment managers to, whenever possible, exercise voting rights attaching to investments. While in the majority of circumstances the managers are instructed to exercise their professional judgment on how the 'vote' is exercised, in potentially contentious situations the Investment Committee is consulted.

The Investment Committee regularly reviews how the investment managers exercise the Scheme's voting rights and continues to monitor the debate on corporate governance and the role shareholders should play.

Custody of Assets

In respect of the Final Salary Section, although the Trustee Board has delegated day-to-day management of the Scheme's investments to external managers, the custody (safekeeping) of most of these assets is presently carried out independently of the managers by State Street Bank and Trust Company Limited.

In respect of the Money Purchase Section, the custody (safekeeping) of these assets is carried out by the manager, Standard Life Investments.

Investment Strategy - Final Salary Section

The Trustees will seek to achieve the investment objectives through investing in a suitable mixture of return seeking (e.g. UK and overseas equities and property) and matching (e.g. bonds and derivatives) assets. It is recognised that the income or profits on return seeking assets, while expected to be greater over the long term than those on matching assets, are likely to be more volatile and that asset allocation is one of the key decisions of pension fund investment with significant implications for long term investment return.

The asset allocation strategy is to have 100% investment in an appropriate bond portfolio by 2024. The Trustees wish to move to the target asset allocation in a cost efficient manner that is also mindful of the assumptions within the actuarial valuation. To this end, a switching strategy is in place to facilitate the transfer from the existing asset allocation to the target asset allocation. The pace and magnitude of switches from the return-seeking assets to the matching assets will be decided upon based on the monitoring of the Scheme's solvency position and the implied contribution level.

The intention is for future contributions (net of relevant payments and expenses) to be invested in bonds and for sufficient switching to occur so that the Scheme is holding no more than 20% return-seeking assets by 2014.

This strategy will, as in previous years, involve the Scheme's asset classes and geographic areas. This diversified spread is designed to deliver the Scheme's required investment performance in a risk controlled manner.

The Scheme has entered into derivative interest rate and inflation swap contracts to alter the duration and inflation exposure of the bond assets to better reflect the Scheme's liabilities and cash flow profile in order to ensure that the investment manager's are able to cover exposed positions (e.g. risk reduction) and to increase or decrease exposure to markets, other than by direct investment, following asset allocation decisions.

Derivatives

Restrictions are imposed on the use of derivatives and will be used by the Scheme for risk management purposes, as part of the strategic asset allocation policy. The Scheme is currently involved with the following types of derivatives;

Futures contracts are contracts to sell or buy a standard quantity of a specific asset at a pre-determined future date, at a price agreed by and traded through an exchange.
Forward foreign exchange contracts are contracts whereby two parties agree to exchange currencies on a specified future date at an agreed rate of exchange.
Options are contracts that give the purchaser, the right, but not the obligation, to buy (call option) or sell (put option), from/to the seller of the option, a specified quantity of a particular product at a specified price.
Swaps are over-the-counter contracts where the parties to the contract agree to exchange cash flows, the amount of which is determined by reference to an underlying asset, index, instrument or notional amount. One party pays to the other a fixed rate of interest on the notional capital amount and receives in return the floating rate of interest on the same notional amount.

Investment Strategy - Money Purchase Section

The strategy to achieve the investment objectives of the Money Purchase Section involves the Scheme's assets being spread across a number of asset classes and geographic areas. The assets are invested in unit linked arrangements, wrapped in insurance policies, managed by Standard Life Investments.

The Trustees make available a range of investments via pooled funds, which seek to:

Establish a financially efficient scheme that provides attractive and robust long term investment options to members that recognise their investment challenge and incorporate institutional best practices
Enable members to protect their benefits as they approach retirement
Limit the scope of members to need to take detailed investment decisions.

Currently the Trustees offer three Lifestyle strategies which involve automatic switches from predominantly equities to fixed interest and cash funds as the target retirement date approaches. In addition, the Trustees offer a number of funds offering specific equity, bond or cash investments which may be selected by members instead of the Lifestyle options.

The Money Purchase Section does not hold shares directly in Kingfisher plc.

Investment Background

Final Salary Section

Equities
Over the Scheme year economic growth continued apace and although inflation became a greater concern, equity markets generally produced good returns.

Equity markets were weak at the start of the period, with performance globally being dominated by concerns over central bank tightening and its impact on economic growth. All regions were impacted, but those most exposed to global growth were worst affected. As the year progressed, increased tension in the Middle East saw further weakening in the equity markets, which then reversed in the summer due to the strength in corporate earnings and encouraging statements from the US Federal Reserve on the outlook for inflation, leaving interest rates unchanged and the oil price fell. High levels of corporate activity in mergers and acquisitions provided further support to the markets. Strong equity market performance continued during the final months of 2006, although it was volatile. The US maintained its interest rates, but the Bank of England and the European Central Bank increased theirs as did Japan in the new year.

The first quarter of 2007 saw a continuation of generally strong equity performance along with a significant increase in volatility. Modest January rises were followed by sharp falls at the end of February as a result of concerns over the tightening of government controls in the Chinese equity market and a rebound in March with investors fears being allayed, although tempered with concerns over the US sub-prime mortgage market. UK and European markets proved resilient with sustained economic and corporate earnings growth, improved business sentiment and the continuing strength of mergers and acquisitions activity.

Bonds
Bond markets were broadly flat or negative, as rising interest rates pushed up bond yields leading to losses of capital value. The situation was exacerbated for overseas bonds by the falling of the US dollar and yen against sterling. UK Index linked faired better than conventional bonds and corporate bonds remained well supported due to robust fundamentals.

Property
Investor demand has been the key driver of property returns over the period. Retail activity continued to improve despite the muted sales background, with rental growth holding up. Offices showed strong growth as demand conditions improved, particularly in Central London. Vacancy rates declined leading to acceleration in rental growth. Availability in the Industrial sector remained high as the recovery in the manufacturing sector appeared to ease by the end of 2006. Rental growth remained modest and is unlikely to strengthen in the short term due to modest occupier demand, high availability and continued high levels of development.

Investment Performance

Final Salary Section

The performance of the Scheme's investments is measured against the scheme specific benchmark and other UK pension schemes of various sizes by an independent external measurement service, Mellon Analytical Solutions. Taking all portfolios together, the return achieved by the Scheme during the year to
31 March 2007 was 6%, matching the scheme specific benchmark.

Reviewing performance over the longer periods is more relevant to the Scheme's long-term objectives. Over three and five year periods, the annual returns were 12.8% and 7.3% compared to 12.3% and 5.1% respectively.

Current Managers' Objectives and Achievements
As part of the Scheme's investment strategy, its assets are allocated to a number of investment managers in specific asset classes. The investment managers are given performance objectives which, when combined, are intended to enable the Scheme to achieve its overall investment objectives (see page 19 of the full Report and Accounts PDF).

UK Equities
AXA Rosenberg's UK Equity portfolio objective is to out-perform the FTSE All-Share Index by 2% per annum (net of base fees) over rolling three year periods. Over the rolling three year period AXA Rosenberg underperformed its objective. AXA Rosenberg's fees are market-value based with a performance related element. AXA Rosenberg did not receive a performance related fee.

Global Equities
Wellington Management's objective is to out-perform the MSCI World Index return by 2% per annum (net of base fees) over rolling three year periods. Over the rolling three year period, Wellington underperformed its objective. Wellington Management's fees are market-value based with a performance based element.

State Street Global Advisors' objective is to deliver a return to within 0.5% of the rolling annual total return and within 0.25% per annum over rolling three-year periods of its 'benchmark'.

The 'benchmark' is made up of UK and Overseas Equity securities and comprises the following indices: 43.4% FTSE-All Share Index; 24.4% FTSE-All World North America; 19.3% FTSE-All World Europe ex-UK; 5.6% FTSE-All World Japan and 7.3% FTSE-All World Pacific Basin (ex Japan). Over the year State Street Global Advisors achieved their objective. State Street is remunerated on the basis of a fixed fee.

Bonds
European Credit Management's objective is to out-perform by 2% over three year rolling periods (net of fees) 1 month LIBOR, the first three year rolling period will be completed in 2009.

Goldman Sachs' fixed interest portfolio has the objective of out-performing its benchmark by 1.5% over rolling three year periods (net of base fees). 70.0% Merrill Lynch Sterling Non-Gilts Index and 30.0% FTSE-A All Stocks UK Gilts Index, the first three year rolling period will be completed in 2009.

PIMCO's fixed interest portfolio has the objective of out-performing its benchmark by 1.5% over rolling three year periods (net of base fees). The benchmark is made up of 70.0% Merrill Lynch Sterling Non-Gilts Index and 30.0% FTSE-A All Stocks UK Gilts Index; the first three year rolling period will be completed in 2009.

Western Asset's fixed interest portfolio has the objective of out-performing its 'benchmark' by 1% over rolling three year periods (net of base fees). The 'benchmark' is made up of UK and Overseas Fixed Interest securities and comprises the following indices: 70.0% Merrill Lynch Sterling Non-Gilts Index and 30.0% FTSE-A All Stocks UK Gilts Index. Over the rolling three year period, Western Asset underperformed its objective. Western Asset's fees are market value-based with a performance-related element.

State Street Global Advisors' objective is to deliver a return to within 0.5% of the rolling annual total return and within 0.25% per annum over rolling three-year periods of its 'benchmark'. The 'benchmark' is made up of UK and Overseas Fixed Interest securities and comprises the following indices: 57.0% FTSE Actuaries British Government Gilts (All-Stocks) Index and 43.0% Merrill Lynch Sterling Non-Gilts All Stocks. Over the year State Street Global Advisors met its objective. State Street is remunerated on the basis of a fixed fee.

Property
Morley Fund Management's property portfolio has the objective of out-performing the CAPS Pooled Property Median by 0.5% (net of fees) per annum over rolling three year periods. Over the year Morley outperformed its objective. Morley is remunerated on a fixed fee basis.

Trustee's Cash
The Trustee maintains a current account to meet the day-to-day benefits and expenditure payments. Any monies in the account that are not required for immediate use are placed on an overnight Money Market account.

Investment Performance

Money Purchase Section

All the assets attributed to the Money Purchase section, including members' AVCs but excluding cash required for transaction purposes, are presently invested in a range of funds managed by Standard Life. Members have the option to invest in one of three lifestyle approaches or select from a range of individual funds, listed below. Each of the lifestyle approaches represents investment in a range of funds, comprising the first five funds listed below. It is not possible to compare the performance of each lifestyle approach with a stated objective.

Consensus Lifestyle
This approach attempts to balance the opportunity for maximizing returns whilst reducing the volatility as retirement approaches.

Cautious Lifestyle
This approach takes a more cautious approach to investing whilst still delivering above average returns in the early years.

Consensus plus Lifestyle
This approach strives for maximum possible returns whilst accepting greater volatility throughout its life.

FTSE Tracker One Fund
The fund invests in a broad spread of UK listed equities which are constituents of the FTSE All-Share. The fund's objective is to closely track the performance of the FTSE All-Share Index. Over the year the fund met its objective.

Overseas Tracker One Fund
The fund is a fund of funds investing in the US Equity Tracker, European Equity Tracker, Japanese Equity Tracker, Pacific Basin Equity Tracker funds. The objective is to match the returns of the FTSE World (ex UK) Index. Over the year the fund did not meet its objective.

Corporate Bond Fund
The fund invests in the UK non-gilt fixed interest market. Its objective is to outperform the Merrill Lynch Non Gilt Sterling All Stocks Bond Index by 0.8% pa. gross of fees. Over the year the fund met its objective.

UK Gilt Tracker Fund
The fund invests in UK gilts. The objective of the gilt tracker fund is to match the return within 15 basis points of the FTSE All Stocks Gilt Total Return index over all periods before all costs. Over the year the fund met its objective.

Index Linked One Fund
The fund's objective is to outperform the FTSE-A Index Linked Gilt over 5 Year index by 0.6% pa gross of fees in each calendar year by investing in an actively managed portfolio of mainly index linked fixed interest securities. Over the year the fund did not meet its objective.

Global Equity (50:50) One Fund
The Global Equity 50:50 Fund is an equity fund split equally between the UK and overseas equity markets. The proportions held are decided after reviewing the prospects for each market and will vary from time to time around the long term strategic asset allocation of 50% in UK equities and 50% in overseas equities. The fund is benchmarked equally between the FTSE All Share Index and FTSE All World (ex UK) Index and aims to outperform the benchmark by 2% per annum. Over the year the fund met its objective.

Global Equity (50:50) Tracker One Fund
The fund invests in a broad range of equities which are constituents of the FTSE All-Share and FTSE World (ex UK) indices. The fund's benchmark is to closely track the performance of the FTSE All-Share and FTSE World (ex UK) indices. Over the year the fund met its objective.

Global Equity Manager of Managers Fund
The fund is a 50:50 fund with 50% in the UK benchmarked against the FTSE All Share index and the other 50% benchmarked against the FTSE World ex UK Index. This is done by holding the underlying regional funds of US, Europe, Japan and Pacific Basin. Over the year the fund did not meet its objective.

UK Equity Manager of Managers Fund
The objective of the fund is to provide capital appreciation, investing in an actively managed portfolio in a broad range of mainly UK Equities to give a spread over the market's most attractive sectors. The UK fund is benchmarked against the FTSE All Share Index. Over the year the fund did not meet its objective.

Pension Protection One Fund
The fund invests in long-dated government gilts. The fund's objective is to track broadly long term interest rates. Over the year the fund met its objective.

Pension Sterling One Fund
The fund's objective is to outperform the median over periods up to and including one year of the ABI Money market sector by investing in an actively managed portfolio of mainly short dated Sterling deposits. Over the year the fund met its objective.

Invesco Perpetual High Income Fund
The fund's objective is to achieve a high level of income, together with capital growth. The fund intends to invest primarily in companies listed in the UK, with the balance invested internationally. Over the year the fund met its objective.

UBS Global Optimal Fund
The fund's objective is to achieve long-term growth through active management of a diversified portfolio invested primarily in non-UK equities. Over the year the fund did not meet its objective.