The fund is structured to produce returns in excess of a fixed term deposit offered by retail banks.

A surprise 50bp repo rate cut at the August MPC meeting was the big event this quarter - taking repo down a full 600bp since June last year and SA short rates to historic lows. The market was surprised by this decision due to the growing risks of higher inflation (higher oil prices, wage agreements above 6%, the narrowing gap between SA and US rates) becoming very obvious. A strong and stable rand appears to have been the catalyst to the rate cut.
Bond performance picked up this quarter, with the best performing sector being the long end of the yield curve. Cash lost ground to the bond and equity markets this time around - not surprising in an environment of continuing rate cuts. The ALBI returned 9.31% and cash only 4.22% (I-NET). The Coronation Income Fund returned 8.59% for the 12 months to September 2004 (Micropal).
Market sentiment changed significantly during the course of the quarter, particularly after August: becoming more bullish - given the Reserve Bank's view that medium term inflation faced few threats. On the back of this, the market began to price in a growing probability of yet another cut! A stable rand and weaker US economic statistics seemed to support this. We are of the opinion that a lower repo rate is neither sensible nor probable. By quarter end, the market had priced in a 50% chance of a further 50bp repo rate cut, which was quickly reversed when the Governor of the Reserve Bank announced that rising oil prices are indeed a threat to SA inflation.
We are concerned about inflation and short term interest rates, and have pencilled in the first hikes to take place in the second half of next year to stem rising inflation. The risk to our view however, is that with a strong rand, inflation will be kept in check for a while longer.
We remain short duration across all our fixed interest funds, including the Coronation Income Fund. With interest rates at unsustainably low levels, we expect the bond market to correct significantly to price in the risks of higher inflation, therein providing us with an opportunity to buy them back. Over the quarter, we introduced some inflation linked bonds into the portfolio due to their expected outperformance and the inflation hedge which they offer.
Looking ahead, we firmly believe that interest rates are not appropriately pricing in all the risks in the market, and hence remain under-exposed to bonds and overexposed to cash - even if that means accepting lower returns in the short term. We remain focused on the long term and foresee better buying opportunities in months to come.

Cash has been the star performer year-to-date and over the quarter. Providing nearly 4% in returns for the first half of the year, versus the 0.13% return from the bond market and -1.22% from equities, cash was clearly the place to be.
The low duration of the Coronation Income Fund points to a high cash weighting and minimal exposure to the bond market, thereby creating better capital preservation. Despite paltry returns from bonds, the corporate bond sector has given us strong year to date returns (11.44%). This is due to their low duration and high yield nature. The fund has held corporate bonds despite a steepening yield curve, given that over the cycle these bonds will perform.
Monthly returns on cash have been steadily declining due to lower interest rates, therein providing investors, who are often reliant on interest income, with ever declining yields. However, when compared to other asset classes, cash has outdone all its riskier counterparts.
Market expectations of aggressive monetary tightening (rising repo rate) have moderated lately. Where the market was pricing in up to a 3% interest rate increase over the next two years, this has declined to a 2% increase. This optimistic scenario has been due to a stronger R/$ exchange rate and falling oil prices. Should the rand remain at these levels, or continue to appreciate, inflation expectations will continue to decline and so stable, low interest rates can be expected going forward.
At Coronation Fund Managers, we are slightly less optimistic about inflation and short term interest rates. We expect the repo rate to be hiked in December 2004 to offset rising consumer inflation which, by then, will have started to rear its head.
The Coronation Income Fund has returned 8.52% over the last 12 months, and is expected to return around 9.2%, based on expected fixed interest returns for the next year. Our strategy going forward is to seek buying opportunities in the bond market and to gradually increase fund duration to a neutral position once the market has fully priced in our expected interest rate hikes. The fund will continue to be managed on a conservative basis.

Over the course of 2003 interest rates have declined, and this downward momentum continued into the final quarter.

South Africans saw a 2% reporate cut during the period, initiated by a 1.5% reduction in October 2003. Although expected by the market this move was nonetheless aggressive. In December South Africans saw a further 0.5% easing in the reporate, which means that interest rates in South Africa have been reduced by 5.5% for the full cycle to date. This is a significant move over a relatively short space of time (June -December) and the fund manager's now believe that there will be no further rate cuts during this easing cycle.

This activity fuelled the bond market to become a top performing asset class for the year. The All Bond index returned 18.07% for the 12 months to end December. The Income Fund had exposure to the bond market for most of the year, but this was reduced towards year-end as the fund manager's believed bonds to have run their course and that yields were looking like they had bottomed.

Money market rates reached an all time low of just over 7% during December. This was in anticipation of what the market had anticipated would be a more aggressive reporate cut at the December MPC meeting. Interest rates in the low 7% range did appear unsustainably low, and by year end money market rates had headed back towards 8%.

The Coronation Income Fund's strategy of holding a core cash fund with a selection of high running yield bonds produced very good performance for the year, returning 13.64% to end December 2003.