The PSG Alphen Flexible Fund continues to remain true to its mandate, driving long-term growth of capital, but with a bias towards capital preservation when risk vectors escalate.

Exploring P/E's and dividend yields both historic and forward on the JSE currently provides for interesting reading. From a historic perspective, the current JSE P/E of 16.5 times looks stretched. In fact, this multiple was outstripped between 1994 and early 2000 on numerous occasions during a period of extreme market hype, but P/E's only reached these heightened levels previously in 1969. A historical dividend yield analysis is equally enlightening, the market's current yield is 2.37%, a level often reached between 1994 and 2000, but prior to this achieved only in 1969. Naturally, from an extremely superficial perspective, this is worrying. More encouraging though is the forward P/E on the JSE, which is about 12.2 times. The JSE has in fact been operating in a forward P/E band of between 10.5 times and 13 times since early 2000. This must be compared to its 1994 to 2000 forward P/E band of between 13 and 18 times. So on this basis, the JSE in fact looks much cheaper than it did in the 1990's and this analysis goes a long way to undermine the view that our market is grossly overvalued.

However, we continue to believe that some caution is required in the current circumstances where the multiple on our market is not dirt cheap historically or on a prospective basis and the earnings base from South African companies is probably near to a cyclical high. Not only have domestically orientated companies enjoyed boom earnings, but so too have externally focused commodity companies and even SA dual listed stocks such as Richemont and SABMiller now trade at almost record valuation levels. Of course, the headline P/E and dividend yields of the JSE mask the de-rating experienced by many of the Findi stocks, the likes of the retailers being the most obvious.

This is reflected in a stock such as Edcon trading on a P/E currently of 10 times and a dividend yield of 5.5%, relative to its long-term mean P/E of 16 times and long-term mean dividend yield of 3.6%. Of concern is that retailers are at the top of their earnings cycle and earnings could fall going forward. Whilst we too feel that earnings have topped off, we do not see negative earnings in the near future. Thus in our view, various Findi shares have moved back into value territory against a market that does not offer huge value.

The fund's performance in September was buoyant, especially if one considers the downside protection in place with 7% short futures exposure. Taking the futures into account implies an equity weighting below 50%, a position we feel very comfortable maintaining. Investors should remain aware that Alphen's current thinking is heavily geared to capital preservation and we are prepared to under perform the peer group on a relative basis in order to achieve this end.

In May I wrote in my manager’s report about a number of factors concerning me in the market, these being:

1. The overvalued or extended price levels of physical commodities, in particular copper.

2. The fact that the world was in a one trade environment implying that the goal of risk reduction through asset diversification was less effective. To illustrate this, the local bond market had done well as inflation headed lower, but lower inflation was partially driven by a strong rand, which in turn occurred due to an appetite from investors for commodity related
markets and for emerging markets in general. Thus, in a domino-like fashion, if one part of the chain failed, ramifications would be felt across all asset classes.

3. Investor return expectations remained too high after excessively buoyant equity performances since March 2003.

4. The appetite for risk globally was too high - this was reflected in very small spreads between emerging market and developed market bond yields. A bloated appetite for risk could be seen in other areas of the market too, such as money flowing into private equity
funds.

As such our fund positioning in May was as follows:

1. We were underweight equities - 47.3% versus the benchmark at 55%.

2. We held no bonds or property - benchmark 10%.

3. Cash exposure was at 34% versus our benchmark of 20%.

4. We held the maximum allowable position offshore, that being 15% which is the benchmark level.

5. Preference shares of 3.7% were also contained within the portfolio.

This positioning proved extremely fortuitous during the collapse seen in the commodity and secular markets in May and extending into June. From the high point in the price of the PSG Alphen Flexible Fund, which corresponded with the market high on 12 May, the fund lost 2.9% to 28 June, relative to the average flexible fund, which fell 6.9% and the average of the medium equity prudential sector, where the decline was 5.43%. But whilst we weathered the storm well, what is more important for unit holders is the current positioning of the fund in a rising market. To remain consistent with our view expressed in May where we mentioned that our enlarged cash pile would be utilized during buying opportunities; this is exactly what we did during the market collapse. Equity exposure was lifted during the correction to a touch over 60%. We have subsequently utilized market strength to trim this back to the benchmark 55% level. The fund remains devoid of property and bond exposure and due to the extreme weakness in the rand, we decided to lock in profits and cut back our offshore position from 15% to 10%.

Our current thinking is that volatility in global markets will remain high whilst interest rates are lifted and global liquidity declines, but corporate profits should also remain relatively robust in the third quarter of 2006. Hopefully, the market's attention will be drawn away from what is expected to be slowing corporate profitability in the final quarter this year in the US, by the top of the current interest rate cycle and the onset of the down cycle in US interest rates. We thus see a lack of certainty and potential risks in the global macro-economic backdrop, but offsetting this, sound valuations and in some instances, improving earnings profitability due to the weaker rand, out of corporate South Africa. As such, an at-weight equity position on the PSG Alphen Flexible Fund is justified. We also feel comfortable holding cash instead of bonds and property as rates rise, but caution that we are not market timers and are not sure how far interest rates will climb. As such, we are very likely to begin to incorporate these asset classes relatively soon within the fund.

Whilst the fund was down for the month of May, we are happy to report that our asset allocation calls protected downside for investors as much as possible for a real return product.

Full allowable rand hedge exposure, together with no local property or bond positions in the fund and being slightly underweight equities played a large role in curbing falls that occurred across markets in May. Property lost 5.14% and bonds were negative to the tune of 1.12% in May. Whilst our general conservative asset allocation proved superb going into a correction and the fund’s rand hedge exposure was timely, one disappointment was the poor performance from industrial shares relative to commodity stocks. Although this fund was generally spared from the industrial rot of -10% in May through stock selection, we were still overweight industrials as against financials and resources. Financials fell 4.96% in May and the Mining sector was actually up by 1.95% - this proved surprising. Notwithstanding the poor industrial market’s performance, we are retaining the fund’s industrial exposure as dividend yields and value propositions remain more compelling in this space relative to resources for example. Share price weakness in financials on the other hand will definitely result in further purchases and the fund increased holdings in Standard Bank and bought back Abil during the correction. We continue to believe that resource shares have sound long-term fundamentals, but underlying commodity prices are still too high and these need to settle at more realistic levels before we aggressively move back into that space.
We are currently comfortable with the asset and sector allocation of the fund and at present see little evidence to suggest that radical asset shifts are warranted.

The All Share Index made new highs through April driven by more than a 10% move in general mining shares. This is causing a growing chasm between value and momentum manages, both in terms of performance, but also as far as their opinion on the cyclicality or lack thereof of this cycle is concerned.
Trying to value resource shares currently is a thankless task as the rapid move in underlying commodity spot prices makes modeling futile. Whilst analysts do not include spot prices in valuation models usually, if this is done however, the feed-through to resource company earnings makes many resource stocks very reasonably priced at present. But this view is reliant on spot commodity prices remaining at historically high levels. Taking a more sanguine view on commodity prices and using long-term average prices would dramatically affect share values downwards i.e. negatively affect share prices. Using copper as an example, the extreme price movements seen in most underlying commodity prices becomes evident. Since 1972 the price of copper has been above $3000 a ton five times, with large reversals after reaching this level. $3000 was reached again in November 2004, and by October 2005, the metal reached $4000 a ton. The copper market then became parabolic and moved to $7816 in April 2006, with 10% moves within a week. Using current spot prices places Billiton on a P/E to June 2007 of 9 times as against current consensus of about 11 times. Thus the question remains: What are realistic prices for underlying physical commodities that should be used to value resource stocks? Personally, I believe that in many cases, these should be lower than current spot levels.
Having held commodity shares in the PSG Alphen Flexible Fund since the beginning of 2005, we have increasingly been reducing exposure and replacing this with selected industrials and certain financial holdings. We also remain particularly keen on building offshore positions whenever the rand shows signs of strength - that is near to R6/$ mark. Bond exposure, previously held via inflation linked bonds, has been sold and the portfolio holds no bond or local property exposure. The fund is thus at weight offshore, has no exposure to bonds or property and is at weight local equities with a bias towards cheaper areas of the market. The fund is also overweight cash.

PSG Alphen Flexible are to reduce the annual management fee of the the fund from 1.75% (excluding VAT) to 1.5% (excluding VAT) with effect from 1 June 2006.

February proved to be a tough market on the JSE for equity investors positioned in large cap shares, with the ALSI down 3.22%. This is in stark contrast to mid cap and small cap exposure, which gained 2.2% and 4.9% respectively. SA listed property returned a whopping 6.7% and bonds 0.78%.

With the PSG Alphen Flexible Fund containing exposure to a broad grouping of asset classes as well as being positioned in large, mid and small cap shares, February ended up being an uneventful month, with the fund finishing more or less flat for the month. This does not however imply that we were inactive. We have proactively been reducing our sensitivity to the market (beta) by slicing out high beta shares and have also continued a process of equity reduction. This is based on our thesis that in the wake of such an extended bull market, further gains are most reliant on dedicated stock selection rather than trying to “time the market”.

We anticipate that further gains will be made in most asset classes in 2006, as the investing environment remains friendly. Given this, however, we caution investors to reduce their expectations of continued high returns which rival the best we’ve seen in decades.

Best described as staggering is the conformity of huge returns across most South African asset classes in January, led by equities. Even more staggering is the enormity of performance from all major and sub-sectors of the JSE over the past year and in particular, January. The worst performance in January was delivered by the Beverage sector, which returned 4.97%.

The PSG Alphen Flexible Fund enjoyed an excellent January returning in excess of our 60% ALSI, 25% cash and 15% bond/cash strategic asset allocation mix. As unit holders of this fund will know, this asset mix according to Alphen’s research will over time, deliver returns in line with inflation plus 5%, being the internal benchmark for the PSG Alphen Flexible Fund. It is well worth noting how difficult it is to contain the uncapped ALSI within an asset benchmark mix due to the concentration within the index so our fund’s solid performance, which is matching the asset benchmark’s performance, is heartening.

Based on the excellent returns seen from the market over the past twelve months and the strong returns enjoyed by this fund, Alphen is taking a more cautious view on equities going forward. Equity exposure has now been reduced to below benchmark and it is envisioned that this fund will become increasingly defensive.

The JSE returned 8.1% in December, the MCI World Index 0.2% and the JP Morgan Global Bond Index -0.7% in rand terms. Global cash returned -1.8%, with local cash and local bonds providing investors with a 0.6% and 2% return respectively. The rand’s 2% appreciation in December thus hurt global asset class exposure, this despite very positive dollar returns for offshore asset classes.

From an attribution perspective, what held performance back slightly for the fund in December was exposure to offshore assets, which lost about 1% in rand terms as well as a lack of exposure to local property. Property returned 10.73% in December. December aside, over 2005 in general, of particular importance to us is that the fund continued to perfectly correlate with its benchmark of 60% equities, 25% cash and 15% bonds and property.

This fund’s asset allocation remains consistent with out-performance of inflation plus 5% over time and is well suited to investors seeking long-term capital growth at a moderate risk level with a reasonable level of income.