If you have ever wondered who the most influential person in the world is (at least for the moment), you do not have to look much further than Ben Bernanke, chairman of the US Federal Reserve. His commitment in August to flood the US and global economy again with more cash, if required, was enough of a catalyst to deliver one of the strongest September stock market returns in the US since 1939. The local market has followed suite with a return of almost 9% for the month of September.

The PSG Balanced Fund has struggled to keep up with the recent rally, although it has continued to set new highs. This cannot be said of the All Share Index yet. Investors in the PSG Balanced Fund have an equity exposure of roughly 60%. Less than 50% though is exposed to domestic equities. As we have mentioned in the previous two editions, we have been increasing the equity weighting in the PSG Balanced Fund, but with a stronger focus on good value, offshore, developed market equities.

We own no bonds in the fund as we deem the margin of safety in bonds as very low and any returns from current levels as high risk in nature. Although inflation is not an immediate threat, it looks like we are close to an inflation bottom and any rate cuts from current levels will probably be a risky move by the South African Reserve Bank. One has to be careful when extrapolating low interest rates just because the immediate inflation threat seems to have dissipated - South Africa remains a price taker when it comes to hard and soft commodity prices and this has a bearing impact on our inflation.

We believe it is actually an opportune time to start looking at potential inflation hedges in the portfolio, such as inflation linked bonds.

Our offshore allocation is being made with a long term outlook and the currency's impact on the performance during the last two months certainly is painful, but it does not concern us. To put things in perspective, from August 25th the S&P500 has rallied almost 12% in dollar terms, but when converted to rands, it has done only 4%. Currency movements have been sharp and whilst the current environment is very supportive of the rand, its gains can be quickly unwound. For us the main attraction is the cheap valuations of the assets that we are acquiring offshore when compared to local assets.

With that said though, while interest rates remain low in South Africa, stock ratings are likely to remain well supported, and the yields on lower risk asset classes will remain relatively unattractive. If the rating on stocks remains stable, average growth in company profits will yield low, but positive returns. But, it is worth remembering that domestic interest rates are at thirty year lows. Monetary policy around the world is extremely accommodative. This inevitably results in pockets of exuberance and demand for emerging market equities is currently very healthy. It is our view that the valuations of many domestic industrial stocks are more than factoring in low interest rates. We are not sure what will trigger a change in sentiment but in the absence of a margin of safety we are cautious on the medium term returns that can be achieved by in-favour domestic plays. Equities seldom deliver positive real returns when interest rates are rising. Interest rates are low. Now is not the time to be chasing stocks expecting a re-rating on the back of further rate cuts. Instead, we would advocate careful stock selection and a strong focus on margin of safety.

Neels van Schaik and Adrian Clayton

The PSG Alphen Balanced Fund will change it's name to PSG Balanced Fund, effective from 1 September 2010

Stocks at an Index level remain range bound with the All Share Index being flat for 2010 thus far. This is in line with earnings growth year-to date, also at an index level of just over 1%. We expect the earnings growth trend to accelerate in the near future, this is, however, not enough of a catalyst to tempt us to aggressively add equity exposure in the fund.

We reason as follows:

Firstly, embedded in the current market PE is high profit growth expectations. The PE of a company can be interpreted as the expectations that investors or speculators have of a company's growth. Given the high prevailing PE, we would argue that investors generally expect a lot of good news.

Secondly, we apply little attention to short term growth trends in a business as there exists little correlation between short term earnings growth trends and the long term earnings power of a company.

The companies we own currently are the ones where we feel comfortable that the market is underestimating the long term earnings power of the individual businesses. This does not mean that the stock prices of these businesses would not retreat, if the market falls, but we feel confident enough in these companies to be adding to the existing positions over time, especially considering the limited opportunities we can identify elsewhere. We have no bond exposure in the fund and we believe it is the wrong time in the cycle to be buying bonds on a 7.2% yield to maturity when cash is very likely to yield more than 7% in the not too distant future. Global Bond yields are currently being driven lower by renewed fears of a double dip recession and concomitant disinflationary pressures, which may or may not happen. The disinflationary risks that exist in offshore markets are not as big a threat in South Africa though and the correlation between global and South African bonds is expected to break down in the medium term.

Our concerns around owning bonds also stems from the impact rising interest rates will have on this asset class. Although not an immediate threat, investors are becoming complacent about interest rates remaining low, a situation not too dissimilar from that which prevailed during mid 2005.

We expect to maintain the fund's equity weighting of around 55% in the near future, but will lower this if markets move higher. Lightening or increasing our exposure to equities will however continue to be done on a company by company basis. As always, our equity weighting will be a function of attractive real returns irrespective of the market levels.

We would like to point out to investors that the fund name has changed to the PSG ALPHEN BALANCED FUND (from the PSG Alphen Flexible Fund) and has moved to the Domestic Asset Allocation Prudential Variable Equity Sector. The fund has been managed within Regulation 28 guidelines for the last few years. We want to thank all our investors for their participation in the balloting process and their ongoing support.

Upbeat economic news flow continues to lend support to global equity markets which is evidenced by the gain in the All Share Index of almost 8% during March. Economic data is clearly showing that the economic recovery is gaining momentum and we expect this to start coming through in company profits during the next few months. This recovery will be off a low base though as profits on the JSE have declined by 35% from the peak in 2009 to current levels.

We are optimistic about the short term outlook for company profits, but we are aware that equities have become increasingly popular over recent months, which is reflected in the high company ratings on the JSE. These ratings reflect very optimistic expectations from investors about future returns and they are therefore willing to accept very low yields on their investments. These overly optimistic expectations are very well reflected in the dividend yield of the All Share Index, which at 1.9% is back to the low levels that we saw in 1998 before the crash, and again in early 2000.

We are very aware that the recovery in profit growth will lower the PE rating of the market, but we prefer not to rely on this recovery to bail us out of high stock ratings. We believe such a strategy carries significant risk if the recovery, for whatever reason, does not come to fruition.

Another concern we have is the market's tolerance of short term solutions for long term macro economic problems.

The willingness of the IMF and the European Union to extend €40bn of emergency financing to Greece is hiding the fact that long term solutions will be very painful. The measures that Greece needs to implement to pull itself out of the current mess will take quite some time and could potentially create significant political instability. One can't help but get the impression that relatively financially sound countries like Germany and France have been caught with their pants down and had no choice but to bail Greece out this time round. But the pressure from these countries on Greece to implement more severe austerity measures will only increase going forward. We feel that these risks are not reflected in the current rating of equities.

In deciding how much equity the fund should own, we carefully evaluate the earnings yields and the dividend yields that are achievable on the individual stocks against that of other asset classes such as cash. The earnings yield on stocks should provide an adequate margin of safety when compared to cash, for example, taking into consideration normalized profit levels and reasonable profit growth rates.

We are struggling to find stocks that adequately satisfy the above criteria, which is why we have been lightening our equity exposure as the markets have been moving higher. We will continue with this strategy as this is in the best interest of our clients. A key focus for us is avoiding ownership of overvalued stocks and in that context we have little interest in fighting with the sellers when they decide to exit.

The offshore exposure in the fund has reduced to 17% as a result of capital inflows into the fund and currency appreciation. We will be raising this exposure to benchmark.

Our cash position has been growing as we have reduced equities. We will be utilizing the cash though, whenever attractive opportunities arise in the stock market or in other asset classes.

The fund has moved from the Domestic AA Flexible to Domestic AA Prudential Variable Equity category. The fund retains its history.

The PSG Alphen Flexible Fund will change it's name to PSG Alphen Balanced Fund, effective from 25 March 2010

Despite the bumpy ride we experienced initially in 2009, Alphen remained very optimistic that the valuation levels in the market towards the end of the first quarter in 2009 would eventually arrest the implosion in equity prices that started in mid- 2008. Needless to say our portfolios were all positioned accordingly and fortunately our clients have enjoyed a stellar year with respect to investment performance. Investors have entered 2010 on a completely different tone. The global media is swamped with positive news about the synchronised global recovery and the resultant uplift in earnings, the complete opposite of 2009 when gloom and doom reigned. Not dissimilar to the euphoria that prevailed in early 2008, China is once again leading the way on the commodities front with its almost insatiable demand for raw materials and consequently, commodity currencies and commodity markets are firmly in vogue. By extension, emerging financial markets have continued with their star performances relative to their developed peers as their economies are in much better shape and likely to stay that way for quite some time. What concerns us this year as against last year, however, are the high valuation levels of various markets across the globe. Companies are no longer priced for Armageddon as was the case in late 2008-early 2009, which made stock selection much easier. Earnings yields of many companies are not looking that attractively priced relative to bond yields and cash yields anymore. In 2008, we found companies that we purchased at or below the value of their assets, now many of these same companies trade at almost double those levels. Our view is that the margin of safety in equities for most of the market has largely disappeared. With this in mind, we firmly believe that once investors start paying for growth, the risk of capital loss increases significantly. Capital preservation for us is a key component of our investment philosophy and we therefore deem it prudent to take money off the table as the market moves higher. We have reduced the equity exposure in the fund to less than 60%, including the offshore equity. This compares to a maximum allowable equity allocation of 75% which is the level that we held in the fund from late 2008 to the 3rd quarter of 2009. We are maintaining our offshore exposure in the fund. The rand remains vulnerable to exogenous economic shocks. We are concerned about the very tight relationships that have existed for the last couple of years between the rand's performance against developed market currencies and that of emerging market stock exchanges versus the S&P500 as well as commodity prices versus developed exchanges. In a nutshell, emerging assets and in particular commodity country assets have performed extremely well relative to developed assets and the rand has been a beneficiary of this trade. Synchronised trades carry serious risk and at times we have witnessed the reverse of commodity fortunes leading to serious currency volatility. Based on the extent of re-inflated asset levels in certain markets and the degree to which this has been driven by short term capital flows, we feel that volatility and risk is unlikely to change in the near future. Whilst we fully appreciate that a sustained recovery in global stock markets and commodity prices does bode well for the exchange rate in the short term, we feel that the risk of significant depreciation is increasing. We are mindful that it is impossible to predict currency moves in the short-term, but we are very comfortable to maintain our investor's high offshore exposure simply as we deem many assets abroad as potentially offering more value than most of those in South Africa. We thus consider the potential for rand weakness at some future date as added optionality which further justifies our positioning. Bonds are fairly priced given the level of interest rates in South Africa. A lot has been said about a potential adjustment of the South African Reserve Bank's inflation-targeting mandate, to incorporate other economic factors as well. Thus far it has only been speculation and given the status quo, we maintain our view that interest rates are likely to stay on hold for at least six months, before they start moving up again. The impact of the very aggressive rate cuts between 2008 and 2009 will start impacting the real economy positively in the first half of this year and based on this could act against the performance of longer dated SA bonds. We favour cash over bonds and also continue to look for an entry point into inflation linked bonds. Contrary to the consensus view, we believe that the inflation threat is likely to come from emerging markets such as China and not as a result of rising money supply in developed markets. Although inflation globally thus far has largely been an asset price phenomenon, the most likely inflation risk which South Africa faces could in fact again emerge in soft or agricultural commodities. We are cautious, as against being overwhelmingly negative, on equities at present and we are aware that markets can indeed move higher in 2010. Our concern is that this could be for the wrong reasons. The extreme stimulus measures that have been implemented in recent years by Central Banks across the globe are likely to overstay their welcome and will be supportive of equity prices. The more realistic growth paths for individual countries will unfortunately only be witnessed with hind sight, once these artificial stimuli disappear. Our objective as always is to own the right stocks for the right reasons and at the right valuations, and to keep some powder dry when mouth watering opportunities come to the fore again; and they will.

Adrian Clayton & Neels van Schaik

PSG have decided to leave the PSG in front of the Alphen funds' names.

Alphen Asset Management have changed the names of all of their funds by removing PSG from the front of their fund names.