With bond yields moving higher, the fund has not been able to generate capital gains over and above the usual high income levels of the past few periods. In addition, the short term bonds have suffered the most from the four interest rate hikes thus far this year. This has negatively impacted on the fund's performance for the quarter. On a positive note, the fund's exposure to floating interest rate securities has been increased, and this has provided a boost to the levels of income generated by the fund.

Given the high yields available in money market instruments, the fund is maximising these opportunities to lock in relatively high yields at very low risk.

In line with the fund manager's view that inflation would surprise on the upside during the course of this year, the fund held a larger cash weighting than normal. It was the fund manager's belief that a prudent and conservative approach would be required for at least six months after the collapse of the rand in December 2001.
As it transpired, bond yields reached their peak after only three months before rallying strongly. With the fund positioned more for capital preservation than for capital gains, this impacted negatively on the fund's relative position. While the fund has, in the past, been able to benefit from judicious management of the interest rate cycle to generate low-risk capital gains, the fund manager's were not as fortunate this time around. This rally in yields was largely as a result of two external developments: the return of foreign buying of local bonds, and local life assurers buying the very long-term R186 bond.
The fund is now well positioned to take advantage of market conditions and deliver exceptional risk-adjusted returns.

In January 2002, the Reserve Bank surprised the market with a 1% hike in interest rates. This was largely driven by the impact on inflation caused by last year's rand depreciation, and more importantly the impact on inflation expectations. These expectations had increased substantially and have to moderate if the Reserve Bank is to meet its 2003 target. Already it is clear that the 2002 target will not be achieved. Again in March, the Reserve Bank raised rates, citing identical reasons.
Over the quarter, the fund manager continued to see weakness in the bond market with the R153s ending at 13.20%. Furthermore, he saw a flattening of the yield curve. This is often indicative of an environment in which investors expect little or no growth and inflation to remain under control.
Internationally, the global economy looks set for a strong recovery this year. Already, markets have started to price in rate hikes by as early as the second quarter. However, the fund manger does not believe that the global recovery is guaranteed, particularly if oil prices remain at high levels. Furthermore, global inflationary pressures continue to remain muted providing no urgent need to raise rates. Thus, the fund manager anticipates that the major central banks will only start to increase rates in the third quarter. This backdrop provides very little support to bond yields internationally.
Locally, the market expects at least one more interest rate hike in June. The possibility of further increases during the year will depend upon whether inflation continues to surprise on the upside, and on whether inflation expectations remain high.
Inflation is only likely to peak in the third quarter of the year. Until then, bond yields are expected to trade weaker. The absolute levels will continue to be constrained by the lack of supply of paper in the market. Once again, the quarter presents low expectations of capital gains, with the focus on opportunistic type gains with consistent income levels.

The Coronation Income Fund has won the S&P 2002 award for the best fund within the Domestic Fixed Interest Income sector over a one year period.

The strategy of holding large cash positions together with medium-term liquid bonds has produced positive returns together with low volatility over the past year. The strategy will continue going forward.