September saw the rules of free market economic theory essentially rewritten as authorities stepped in to prevent a systemic collapse in the global financial system. Over the month the MSCI$ World Index fell 12%, its worst monthly return since the Asian market crisis of August 1998. Emerging Markets were the main casualty with a decline of 17.7% while the US was the best performing region despite registering a fall of 9.2%.

The month started with the bankruptcy of investment bank Lehman Brothers which was deemed not too-big-to-fail by the US authorities. However, the resulting crisis of confidence saw financial markets seize up and resulted in a disorderly financial deleveraging. This in turn led to the collapse and effective nationalisation of America's largest mortgage providers and of the world's largest insurer AIG. Broker Merrill Lynch was forced to sell itself to Bank of America and the investment banking model which hinged on high leverage was then effectively declared dead as the remaining investment houses of Morgan Stanley and Goldman Sachs announced a change of status from broker to "Bank holding" in order to seek liquidities from the Federal Reserve. At the height of this turmoil global authorities stepped in with a variety of measures aimed at boosting confidence in the financial system ranging from a ban on short selling financial stocks to massive injections of liquidity into the financial system.

It is abundantly clear from last month's events that the crisis in the financial system is reaching a critical point, and the fear is that this crisis will rapidly move from Wall Street to Main Street. However, there are two sources of comfort for investors; namely valuation and policy response. Equity valuations are discounting a full recession and look extremely attractive on a longer term basis. However, valuation by itself is not sufficient to spark a recovery in the markets; this catalyst will be provided by the various global central banks and authorities, as inaction in the face of a financial and economic collapse is not an option. This action will be in the form of the current $700bn Troubled Asset Relief Program (TARP) recently passed by Congress, the guarantees to investors bank deposits undertaken by various European governments and the likely acceleration of coordinated interest rate cuts in the developed world. The collapse in commodity prices means that inflation, a lagging indicator, should have peaked thereby allowing central banks with an inflation fighting remit the ability to aggressively lower rates.

Over the month we further reduced our weighting in financial stocks with the sale of AIG (before the effective takeover by the US Federal Reserve) and Credit Agricole. However, one silver lining in this crisis is that we can pick up quality stocks with strong balance sheets and resilient earnings that are trading at extremely attractive valuations. As such we have acquired Hewlett Packard, CVS Caremark, Peabody Energy and Richemont. We will seek to avoid those companies with short-term financing needs as they are likely to see earnings erosion as they struggle to find cheap sources of financing.

We realise in these difficult times that it is extremely hard to see any potential upside in financial markets. However, the combination of extreme falls already witnessed in the market together with the ongoing unprecedented policy moves by global authorities will result in markets returning to a semblance of normality. The only question is when?

Equity markets suffered their worst monthly performance in nearly six years as investor concerns over possible stagflation were fuelled by the continuing surge in commodity prices and fears of slower economic growth. Against this unsettled backdrop the MSCI $ World index retreated 7.9%. The major catalyst for the sell-off was the seemingly inexorable rise in commodity prices with crude oil rising 9% over the month. This prompted fears of slower economic growth on two fronts: 1) demand destruction arising directly from higher energy prices 2) the inflationary consequences of higher commodity prices limiting the ability of central banks to inject liquidity into the markets through further rate cuts. Oil has been the largest contributory factor behind recent sell-off and the inability of anyone to accurately predict its future course forces us to adopt a cautious approach and cash levels have been raised accordingly. However, there are indications that oil prices have finally reached a "choking point" where demand destruction begins to occur on a widespread basis. Should this be correct it is likely that oil supply and demand will once again return to some level of equilibrium leading to an easing of inflationary pressures and thereby granting central banks more freedom to cut rates. Over the month we cut exposure to Asia on concerns over the ability of the respective Governments to curb inflation. Energy costs in this region disproportionately higher than RoW due to large manufacturing base and lack of domestic oil reserves. On a more positive note, M&A activity is picking up once again with a series of deals being announced. Companies with strong balance sheets are in a great position to bid for weaker rivals trading on extremely low valuations as they seek market share gains and synergy benefits.

In financial markets, March 2008 will now be associated with the collapse of Bear Stearns in the same way that August 1998 is associated with the demise of the LTCM hedge fund. However the immediate effect on markets has been quite different this time. In the lead up to the collapse, fear gripped the markets, cash was hoarded and margin calls were increased. Despite assurances from Bear that it had sufficient liquidity to cover its market operations, persistent rumours resulted in continued withdrawals and ultimately forced it into the arms of JPMorgan at a knock down price. This was a scary example of how a banking crisis can develop - confidence is key. To its credit the Federal Reserve was very quick to act in brokering a deal with JP Morgan and it also put in place additional facilities through which investment banks can exchange investment grade asset backed securities for cash and Treasury bills. This response has stabilised confidence and we have seen a recovery in prices in the Financial sector both in equities and the credit space. In general equity markets recovered and bond yields have risen.

The US economy (and therefore the global economy too) is still in a difficult period and in particular we expect the newsflow from the US housing market to remain poor for several months yet as the number of mortgage interest rate resets reaches a peak. Housing transactions picked up in February but it is likely that foreclosures accounted for a large proportion so this is not yet a signal that buyers have returned. We see high risk of further price declines, higher delinquencies and a negative knock-on effect on consumer sentiment. However as we have commented before, this is not new news. Prices have factored in a lot of bad news already. Schroders recently published research which demonstrated that on average equity markets provide positive returns during recessions. This might seem strange but it reflects the fact that recessions tend to give rise to stimulatory policies by central banks and markets start to look forward to the next phase of the economy i.e. recovery. At the worst point of the cycle it sometimes seems hard to see the recovery when confidence is at such a low ebb but that is exactly what creates the opportunity. According to the Merrill Lynch Fund Manager Survey, the level of cash held by institutional investors is at its highest since 2003 - the last time markets were at a low point. We are certain that a recovery will follow this downturn - the only unknown is the timing.

It is not difficult to see where the potential opportunities might be in such a recovery. Corporate bond spreads have blown out to new record levels and the US equity dividend yield is well above the yield available on 2 year Treasury bonds. From here we will be looking to buy cheaply priced assets but we don't pretend that we will be able to call the bottom perfectly (no one can) and so any changes we make will be gradual and with consideration of the further possible downside in this uncertain environment.

During December, global equities, as measured by the MSCI World Index, returned -0.86%, underperforming the Citi World Bond Index which showed a return of 0.03%, in rand terms. The rand depreciated by 0.39% and 0.20% against the US dollar and euro respectively but appreciated against the UK sterling by 2.20%.

The Absa International Fund of Funds returned 1.11% during December, outperforming its benchmark, which returned - 0.54%. The asset allocation and currency allocation detracted from overall performance while fund selection contributed positively to the outperformance. The Fund continued to be overweight equities and had no allocation to long-dated bonds.

The past few months have been volatile for global financial markets due to the concerns regarding the impact of the collapse of the US sub-prime mortgage market and US recessionary fears. However, equities remain the preferred asset class within the Fund as the earnings yield on global equities remains favorable when compared to the yields available on cash and bonds. The equity exposure will be maintained above the benchmark level with an underweight exposure to bonds, as bonds offer limited value at current levels.

A value bias will be maintained in terms of the equity component, while the interest-bearing component of the Fund will remain focused towards shorter-dated instruments. Currency allocation within the fund will be monitored closely to determine the direction that global central banks are likely to follow in respect of their interest rate policies.