We continued to accumulate listed property where we saw value. The allocation to offshore was left unchanged, but the value increased as the rand depreciated. Going forward, we will look to maximise yield on the fund and look for assets with a potential for capital gains.
The yield of the fund is currently 8.68%, compared to 3.75% (due to inflation-linkers) 12 months ago.

During the month we looked to slightly increase the duration of the fund after interest rates were hiked, which we did by investing 12% in R153 bonds and doing 26% 2-year fixed rate swaps. Securitisation assets increased slightly as we participated in a new issue, while Listed Property continued to be accumulated. The allocation to offshore income was upped to 10% as the rand strengthened. We reduced the cash exposure to 5.27% as we bought Floating Rate Notes. Going forward, we will look to maximise yield on the fund and look for assets with a potential for capital gains.

The asset allocation of the fund at 30 June 2006 is as follows:

Asset Allocation- - - - - - - - - - - - Current%- - - - - - - - - - 12-mths ago %
Cash- - - - - - - - - - - - - - - - - - - - - 5.27%- - - - - - - - - - - - - -0.66%
Money Market Assets- - - - - - - -46.58%- - - - - - - - - - - - - -0.00%
Government Bonds- - - - - - - - - - -9.97%- - - - - - - - - - - - - -0.00%
Corporate Bonds- - - - - - - - - - - - -6.77%- - - - - - - - - - - - - -0.00%
Inflation-linked Bonds- - - - - - - - - 4.40%- - - - - - - - - - - - -91.21%
Listed Property- - - - - - - - - - - - - - 3.08%- - - - - - - - - - - - - -0.00%
Preference Shares- - - - - - - - - - - 0.00%- - - - - - - - - - - - - -8.13%
Securitisation- - - - - - - - - - - - - - -13.65%- - - - - - - - - - - - - -0.00%
International FI - euro- - - - - - - - - 6.20%- - - - - - - - - - - - - - 0.00%
International FI - sterling- - - - - - - -3.76%- - - - - - - - - - - - - -0.00%

Total 100% 100%

The maturity spread of the fund at 30 June 2006 is as follows:

Maturity Current % 12-mths ago%
< 1 year 75.45% 1.00%
1- 3 years 5.34% 91.00%
3- 7 years 11.40% 0.00%
7- 12 years 0.00% 0.00%
12 years + 0.00% 8.13%

Total 97.63% 100%

The yield of the fund is currently 7.55%, compared to 3.23% (due to inflation-linkers) 12 months ago.

Rates largely moved sideways, but as a result of a steepening of the yield curve the longer dated bonds underperformed. The benchmarkR153 SA government bond (2010) was basically unchanged, moving to7.30%. However, this hides the fact that the bond reached an all time low of 7.05% on the back of a stronger rand. The rand ended onR$6.13.
International factors that influenced our market were the oil price and the rise in the US 10-year bond yields. These factors put upward pressure on local bond rates. CPIX numbers were in line with expectations, rising steadily to4.5% in March. The PPI numbers were better than expected, rising to5.5% March.

The money supply and credit extension numbers remained at high levels. This, the rising oil price and the rising balance of payments deficit would have been of concern to the Reserve Bank, who left the Repo rate unchanged in their February meeting.

The corporate bond market picked up. A total of R8.88 billion was issued over the quarter with R5.5 billion being fixed rate long term paper and R3.38 billion floating rate paper.

On the money market front the 12-month NCD rate remained unchanged (7.30%), while the 3-month rate rose to 7.00%.

While inflation rose over the past few months, it is not expected to continue at that pace. The average forecast for the year is 4.2%. The Reserve Bank Governor has been making very hawkish comments, but we do not believe there is a very high risk of interest rates being increased over the short- to medium-term. Money market rates are therefore expected to move sideways for quite some time.

The risks in the bond market are much greater. The global risk-free bond rates have been under severe upward pressure for some time and this is expected to continue. This is likely to put further upward pressure on our bond rates. The rand is expected to continue having a major influence on the direction of bond rates going forward.

The quarter started with some weakness over the first three weeks of October on the back of the rand declining from R$6.35 to R$6.75 and the US 10 year bonds rising from 4.29% to 4.66%. At the same time we had the Reserve Bank leaving the Repo rate unchanged, but raising concerns over potential second round effects from the higher oil price. Over that period the R153 SA government benchmark bond rose from 7.86% to 7.97%.
Thereafter, it was one way traffic as a slew of good news strengthened the market from the high of 7.97% to an all time low of 7.31% at the end of the year. The rand strengthened to R$6.32 and the US 10 year bond to 4.35% from the levels mentioned above. On the inflation front CPIX surprised on the downside with the levels coming in lower than expected in all three months. Similarly, other than for the figure that came out in December, the PPI numbers were also lower than expected. In addition, the oil price declined from $63.77 to $57.63 over the quarter. These factors resulted in the Reserve bank once again leaving the Repo rate unchanged in December, but this time painting a much more benign inflation environment.
Money market rates were also fairly volatile over the quarter, starting off weaker at the beginning of the quarter and strengthening over November and December.
The exposure to bonds over the quarter remained largely unchanged at 55%. Likewise, the weighted duration of the fund remained largely unchanged at 1.72 years. This compares to the duration of the benchmark (60% STeFI and 40% ALBI) of 2.12 years.
On the back of commodity strength we have seen the rand continuing to appreciate against most currencies. While the rand strength persists, we can expect the bond market to remain positive, as the strength will work its way through into lower inflation expectations. There would also appear to be very little risk of short-term interest rates being raised over the foreseeable future.
The bond market is, however, very expensive. The risks associated with a deterioration of the rand against the backdrop of the very large current account deficit, and its potential negative impact on the market, loom very large. We will therefore remain invested in the shorter end of the bond market while being invested in the longer end of the money market curve.

Adré Smit,
African Harvest Fund Managers