South African bond yields continue to be largely determined by foreign investment, which ebbs and flows as investors' views on the Euro debt crisis and US monetary policy evolve. Interest rates close to zero in developed economies make South African yields very attractive. However, the continuing stability of the rand is dependent on attracting foreign investment, which makes the currency vulnerable to unfavourable domestic political events. The parastatals Eskom and Transnet are now in a much stronger financial position and their funding requirements are putting fewer demands on the local savings pool. Credit demand is growing at a subdued pace. Accordingly, at present there is no major disequilibrium between domestic savings and credit demand. In July the SARB reacted to generally weak domestic business conditions by cutting interest rates by a further half a percent. Since then there has been a wave of industrial unrest and wage settlements which threaten price stability. Inflation risks are now on the upside. In this environment we have continued to invest in high yielding long-dated bonds. However, given the potential vulnerability of the SA bond market, we are keeping the average duration of the portfolio significantly below the All Bond Index benchmark.

South African bond yields continue to be largely determined by foreign investment, which ebbs and flows as investors' views on the Euro debt crisis and US monetary policy evolve. Interest rates close to zero in developed economies make South African yields very attractive. However, the continuing stability of the rand is dependent on attracting foreign investment, which makes the currency vulnerable to unfavourable domestic political events. The parastatals Eskom and Transnet are now in a much stronger financial position and their funding requirements are putting fewer demands on the local savings pool. Credit demand is growing at a subdued pace. Accordingly, at present there is no major disequilibrium between domestic savings and credit demand. Declining oil prices are reducing inflationary pressures, which will allow the SA Reserve Bank to continue to keep short rates at current levels. Barring a sudden currency collapse, it looks as if short rates will remain at these levels into 2013. In this environment we have continued to invest in high yielding long-dated bonds. However, given the potential vulnerability of the SA bond market, we are keeping the average duration of the portfolio significantly below the All Bond Index benchmark.

South African bond yields continue to be largely determined by foreign investment, which ebbs and flows as investors' views on the Euro debt crisis and US monetary policy evolve. Interest rates close to zero in developed economies make South African yields very attractive. However, the continuing stability of the rand is dependent on attracting foreign investment, which makes the currency vulnerable to unfavourable domestic political events. The steep SA yield curve reflects this risk premium.

The parastatals Eskom and Transnet are now in a much stronger financial position and their funding requirements are putting fewer demands on the local savings pool. Credit demand is growing at a subdued pace. Accordingly, at present there is no major disequilibrium between domestic savings and credit demand.

The appreciation of the rand since December has reduced inflationary pressures, which will allow the SA Reserve Bank to continue to keep short rates at current levels. Barring a sudden currency collapse, it looks as if short rates will remain at current levels into 2013.

In this environment we have continued to invest in high yielding long-dated bonds. However, given the potential vulnerability of the SA bond market we are keeping the average duration of the portfolio significantly below the All Bond Index benchmark.

The Euro crisis has created a very uncertain investment climate. During the last quarter of 2011 bond markets were very volatile. While there were no net foreign purchases of South African bonds over the quarter, there have been significant daily flows in and out of our market. In a world of zero interest rates SA bonds look attractive, but the impact of domestic issues is becoming increasingly important.

Inflation has broken through the 6% upper band of the Reserve Bank's target. A weak currency is stoking inflationary pressures. Political tensions in the ANC, market-unfriendly policies and declining commodity prices promote rand weakness. South Africa is experiencing stagflation, a weak economy with rising prices. The Reserve Bank is hesitant to raise rates while business conditions are poor. As such, it is likely the short rates will remain fixed at current levels for some time to come.

The slope of the yield curve reflects this situation. At the end of 201130-year SA government bonds were at about 9% and call money was at 5.5%. Investors are now compensated for taking the risk of owning longer dated bonds. Accordingly, while the Fund's duration remains below its ALBI benchmark, it does include a significant number of higher yielding longer dated bonds.