Nedgroup Investments Optimal Income Fund has closed and merged into Nedgroup Investments Flexible Income Fund.

The Fund is mainly invested in a spread of floating rate notes, credit linked notes, short-dated corporate bonds, inflation-linked bonds, preference shares and offshore interest bearing assets. We maintained the short duration position on the Fund as we don't see value in short-dated bonds which continue to offer yields below money market to the magnitude of around 80 basis points.

Over the past month, we maintained the Fund's exposure to preference shares. Preference shares are offering attractive yields of around 6.9% and we will continue to invest at these levels. Preference shares outperformed cash as they were up 2.2% for the month. The Fund also continued to invest in higher-yielding credit-linked notes on good credit quality issuers.

The Fund has maintained a 12% allocation to inflation-linked bonds (ILBs). Real yields on the short end ticked up over the month, resulting in some negative performance for the month. However, with inflation at 5% and real yields at 2.3%, these two-year ILBs are currently yielding 7.3%, which is still more attractive than two-year money market assets that are yielding 5.6%.

We continue to see property as a risky asset and therefore do not have exposure to this asset class.

The Fund has 17.3% invested into the Prescient Flexible Global Income (USD) Fund, of which 3% has been hedged back into ZAR, resulting in an effective USD exposure of 14%. The offshore exposure is invested mainly in US inflation-linked debt, corporate bonds and short-dated money market instruments.

The Fund is positioned to benefit from rand weakness and its holdings in inflation-linked bonds protect investors from rising levels of inflation both here and abroad. The exposure to Credit enhances the yield of the Fund. The short duration of the Fund positions it conservatively to deliver performance in the event of any upward shift in interest rates and bond yields

The aim of the Fund is to maximise income, while at the same time protecting capital. The Fund uses a combination of money market, bonds, credit, inflation-linked bonds, property, preference shares, derivatives and offshore bonds and cash to meet this investment objective. We identify over- and under-valued areas and allocate accordingly.

We maintained the short duration position in the Fund as we don’t see value in short-dated bonds, which are currently offering yields below money market. At the end of June, the Fund had a 42% allocation to money market instruments, mainly in longer-dated floating and fixed rate notes and credit-linked notes where the yield pick-up is fairly attractive. The Fund has 31% invested in credit bonds and 18% of this is in floating rate credit bonds or long bonds that have been swapped out. The holdings in the money market assets, CLNs and floating rate bonds will perform well if rates go up. However, should rates fall, then the enhanced yield pick-up should offer some protection on the downside. The credit bond exposure of 18% will also serve as a hedge should rates fall.

The Fund has 12.4% invested in inflation-linked bonds. Real yields remained flat for the month. Since the Fund is only invested in short-dated inflation-linked bonds, it generated good performance. With CPI at 5.7% and real yields at 1%, these two-year inflation-linked bonds are currently yielding 6.7%, which is still more attractive than two-year money market assets, which are yielding 6.3%.

We continue to see property as a risky asset and, therefore, do not have exposure to this asset class.

The Fund shifted its direct offshore assets as well as its holding in the Prescient Global Income Fund into the Prescient Flexible Global Income (USD) Fund. This gives the Fund more flexibility as there are fewer restrictions on institution limits. In addition, we can manage the currency hedge more efficiently this way. The Fund has 17.2% invested directly into the Prescient Flexible Global Income (USD) Fund and 2.9% of this has been hedged out into ZAR, resulting in the Fund having an effective offshore exposure of 14.3%. The offshore exposure is invested mainly in US inflation-linked debt and short-dated money market instruments. The rand appreciated 4.3% against the US dollar for the month, which detracted performance of the offshore component.

The Fund underperformed its benchmark during June, with the offshore holding being the largest detractor of performance for the month.

The Fund is positioned to benefit from rand weakness and the holdings in inflation-linked bonds should benefit from rising levels of inflation here and offshore. The short duration of the Fund will deliver performance should there be any upward shift in interest rates and bond yields.

Benchmarked against STeFI Call plus 10%, the aim of the Nedgroup Investments Flexible Income Fund is to maximise income, while protecting capital. The Fund uses a combination of money market, bonds, credit, inflation-linked bonds, property, preference shares, derivatives and offshore bonds and cash to meet this investment objective. We identify over- and under-valued areas and allocate accordingly.

The Fund is mainly invested in a spread of fixed and floating rate notes, credit-linked notes, short- to medium-dated credit bonds and inflation-linked bonds. We reduced the duration of the Fund at the end of January by swapping out the three-year credit bond exposure. We invested an additional 7% in floating rate bank bonds and credit-linked notes in March, at attractive spreads. The Fund's duration is currently at 1.0, about one-year shorter than the relevant market index, which is at 2.1. The Fund has around 32% allocated to money market instruments, mainly in longer-dated floating and fixed rate notes and credit linked notes where the yield pick-up is fairly attractive. We continue to see property as a risky asset and therefore do not have exposure to this asset class.

We added some exposure to preference shares during the sharp fall in preference share prices post the Budget Speech (0.2% of portfolio), when dividend tax was imposed on investors. Since then, most issuers have committed to partially compensate for the tax and preference shares have rallied. The Fund has a net 11% offshore exposure through US dollar inflation-linked notes and the Prescient Global Income Fund. The rand appreciated 2.4% versus the US dollar for the month. However, for most of the preceding months, the main trend has been rand weakness. The weaker rand resulted in the physical allocation to offshore assets moving closer to 20%. However, when the rand moved to R8.25 to the US dollar, part of the exposure was hedged back to rand, reducing net offshore exposure to around 11%. Offshore exposure is invested mainly in US inflation-linked debt and short-dated money market instruments. The Fund is positioned to benefit from rand weakness and its holdings in inflation-linked bonds should benefit from rising levels of inflation here and offshore.

S&P's downgrade of South Africa's sovereign rating watch to "negative" brought it in line with the other rating agencies, although each rating agency has different emphasis in the reasons for its rating watch downgrade decision. The decision, nevertheless, focussed some attention on the vulnerability of the bond and currency markets and contributed to a modest sell-off toward the end of the month. At the end of March 2012, the Forward Rate Agreements were pricing in flat rates for the year ahead, with rates expected to tick up in 12 months' time. Short-term bond yields were about 25 bps firmer for the quarter, with the 1-3 year All Bond Index (ALBI) sector returning 2% for the quarter versus a 1.3% return on cash. Inflation-linked bonds continued to rally, delivering 2.7% for the quarter. Foreign investors bought R9.1 billion of rand bonds in March, bringing their year-to-date purchases to R19.5 billion. Preference share prices rallied 5% in March, reversing the 4% decline in February. This was due to the issuers committing to gross up the dividends to partly compensate for the dividend tax implication.

The aim of the portfolio is to maximise income, while at the same time protecting capital. The portfolio uses a combination of money market, bonds, credit, inflation-linked bonds, property, preference shares, derivatives and offshore bonds and cash to meet this investment objective. We identify over- and under-valued areas and allocate accordingly.

The portfolio's duration remains short relative to the 1-3 year All Bond Index (ALBI) at 1.5 versus the 2.3 of the Index. The portfolio is mainly invested in a spread of fixed and floating rate notes, credit linked notes, short- to medium-dated credit bonds and inflation-linked bonds. Rates kicked up over the month, which led to the portfolio slightly underperforming its benchmark of beating STeFI Call by 10% during the month.

While the credit spreads in the market are lower than they were two years ago, they still offer good relative value to money market - hence the portfolio maintained its 30% exposure in short- to medium-dated credit bonds. The portfolio holds a 30% allocation to money market, mainly in longer-dated floating and fixed rate notes and credit-linked notes where the funding pick-up is fairly attractive.

We continue to see property as a risky asset and, therefore, do not have any exposure to this asset class.

The portfolio has around 10% offshore exposure through direct US dollar inflation-linked notes and the Prescient Global Income Fund. The rand was relatively stable against the dollar over the quarter with the offshore exposure being neutral for performance. For the year, the main trend has been rand weakness, losing 22% against the US dollar, which boosted performance. The weaker rand resulted in the physical allocation to offshore assets moving closer to 20%. However, when the rand moved to R8.25 to the US dollar, part of the exposure was hedged back to rand resulting in net exposure of 10.7%. Offshore exposure is mainly invested in US inflation-linked debt and also short-dated money market instruments.

The portfolio is positioned to benefit from further rand weakness and its holdings in inflation-linked bonds should benefit from the rising levels of inflation here and offshore.

Over the quarter, the mixed developments in growth and inflation both domestically and abroad, resulted in the South African Reserve Bank (SARB) leaving the repo rate unchanged at 5.5%. The balance of risks (ie growth versus inflation) has shifted from being "delicately balanced" at September's meeting to "upside inflation risk" at the November meeting.

Since September, we have seen inflation tick up from 5.7% to 6.1%, breaching the upper level of the SARB's inflation target of 6%. The main driver was food inflation, which accelerated from 8.7% to 11.1% over the quarter. Core inflation, however, remained contained at 3.9%, which should give the SARB some comfort. Producer price inflation (PPI) on the other hand contracted slightly over the quarter from 10.5% to 10.1%, driven by lower electricity prices.

We have seen a mix of both positive and negative economic data over the past quarter. Retail and vehicle sales remained fairly robust. Private sector credit extension ticked up from 5.4% to 6.2%, mainly driven by low interest rates and improving household balance sheets. The Purchasers Managers Index (PMI) ticked up above the 50 level to 51.6, which indicates a modest recovery in growth. Manufacturing production on the other hand fell from 5.9% to 1%, indicating that the manufacturing sector is clearly under pressure.

At the end of the third quarter, the Forward Rate Agreements (FRAs) were pricing in rate cuts of around 20 basis points (bps). The FRAs moved up slightly over the last quarter and are currently pricing in flat rates over the next year, with the first rate hike coming through in the first quarter of 2013. The three-month JIBAR moved up marginally from 5.58% to 5.60% and one-year money market rates rose by 25 bps. Credit and funding spreads ticked up marginally over the quarter.

Local bond yields rallied across the curve over the quarter. Foreigners were buyers of R11.5 billion worth of bonds over the quarter. The 1-3 year All Bond Index (ALBI) sector returned 2.2% for the quarter. The short-end of the inflation-linked bond curve continued to rally with the R189 yield falling by 50 bps over the quarter.

Preference shares were up 1.5% for the month on a total return basis as they were offering attractive yields of 6.6% relative to other asset classes.