Over the first six months of 2009 the slope of the yield curve has changed from extreme inversion, with one-month rates 4% higher than 10-year bonds, to an upward slope typical of recessionary conditions. The spreads between nongovernment and government bonds have also widened significantly. There is now value in longer-dated bonds, which has been absent for the past three years. We have been increasing duration. The major risk facing bond investors remains the large funding requirements of government at a time when tax revenues are stagnating. The Fund's portfolio is focussed mainly on assets with maturities of less than 10 years, and its average duration is significantly less than that of the All Bond Index.

Bond yields rose slowly throughout June and sold off sharply in the first few days of July after Finance Minister, Pravin Gordhan, warned that the budget deficit would exceed expectations because of lower tax receipts. The higher budget deficit will increase the supply of government bonds to the market, adding to the already substantial parastatal bond issuance. The higher bond yields are beginning to compensate investors for the higher duration risk of bonds relative to money market assets. For this reason, we have begun to increase the duration of the Fund.

The very weak economy is one of the most significant factors being taken into account by the SARB in determining interest rates. Since December it has reduced rates by 2.5 per cent with further cuts probable. Increasingly the term structure of interest rates is being determined by the large funding requirements of government and the parastatals. Since January long bond yields have increased in response to these pressures. We believe that the yield curve has not yet fully normalised to reflect these pressures. Accordingly the portfolio continues to be focused on short to medium term maturities.

Inflation will fall significantly in 2009, in our view, as a result of a collapse in commodity prices and recessionary conditions in South Africa. We also expect shortterm interest rates will decline. The bond market is already aggressively discounting a big cut in rates. We believe there is more value in short-dated assets than in long bonds. Also there are significant risks to long bonds due to an increasing fiscal deficit. The Fund's portfolio remains concentrated in shorter duration assets which offer higher yields, but less risk.