The fund returned 6.82% for the last 12 months in a market where wholesale call rates are 5.2% p.a. and money market funds are now suffering the consequences of perennially low interest rates, and yielding around 1% less. The fund is designed to indentify the best short-term interest rates in the market and remains fully invested in floating rate notes (FRNs) or bonds (with 3-month JIBAR quarterly resets), thereby providing investors with a natural hedge to interest rate movements. FRNs are quoted as a spread over 3-month JIBAR and thus provide a return in excess of this widely used benchmark rate, which is currently at 5.575%, throughout the interest rate cycle. Typical investments for the fund include bank FRNs which yield around JIBAR + 0.85% for a 3-year term. Hence the overall yield achieved from this is 6.4% in a market where call rates are 5.2%. Corporate FRNs such as Netcare, Bidvest, Barloworld and Mercedes Benz SA offer an even higher spread as they present a slightly higher credit risk profile to that of a bank and thus need to compensate lenders for that. The portfolio is made up of 72% exposure to the top five banks (including Investec Bank) with the balance in corporate FRNs such as those mentioned above. The fund is optimised to provide investors with the best opportunities available along the yield curve, good diversification and liquidity. This fund is a sound alternative to a money market unit trust fund which is not able to achieve the same return given mandate restrictions.

Investors witnessed wild swings in interest rate expectations this quarter, influenced by uncertainty on the global front as well as slowing economic growth which was not anticipated early on in the quarter. In July, the Forward Rate Agreement (FRA) curve predicted that short-term SA interest rates had bottomed with the first rate hike expected in March 2012. This picture changed quickly on poor second quarter GDP figures, comments by the SARB Governor Gill Marcus in August that the SA economy remains fragile, ongoing unemployment worries, slow capital investment and a low export recovery. This statement by the SARB lead to a swing in the interest rate outlook to now price a 40% chance of further repo rate cuts in early 2012, with the first hike pushed out by another year to March 2013. This volatility afforded us the opportunity to increase the fund's weighting to better yielding instruments and sell out of those that were no longer showing good value. Inflation printed at an unchanged 5.3% year on year for August, thus remaining within the target band of 3% - 6%. The rand/dollar exchange rate weakened by as much as 15% during September, which has implications for higher inflation should the rand's weaker tone be sustained. We already expect that CPI will breach the target by the fourth quarter of this year, since the recent rand weakness will have an immediate impact of higher fuel prices and with a lag, higher food prices. However, most of the move will feed through to next year's inflation data. Should the rand's current levels be sustained, and in the absence of any significant downward move in global commodity prices, the risk of a later and higher peak in CPI is very real. Should the rand/dollar exchange rate remain above R8.25, we expect inflation to rise to as high as 7%, with little prospect of returning to within target next year.

Money market rates are at an all-time low and investors seeking yield from this asset class will have been feeling the pinch for some time now as interest rates have ground lower, see chart below. The fund has been launched to provide investors with a better opportunity to earn higher yields given this scenario Prospects for higher interest rates in the future are inevitable as interest rates are cyclical and inflation is set to move ever higher bringing on the need to raise interest rates. However, we do not expect interest rates to rise any time soon given the concerns about economic growth and poor job growth. Should interest rates move down before they move higher, this fund will return a margin over prevailing interest rates at all times, given the fund strategy.

Portfolio managers
Stephen Peirce and Tania Miglietta

The fund returned 1.6% for the quarter and 7.1% for the 12- month period, outperforming its benchmark 3-month STeFI Index by 1.3% over the latter period. It is fully invested in longer-dated floating rate notes (FRNs) and floating rate corporate bonds, all of which pay an attractive premium over JIBAR - hence the fund's ability to consistently outperform its benchmark. This strategy ensures that investors are fully hedged against a rise in interest rates, given that instrument yields reset quarterly, resulting in a maximum duration of 90 days.

Local inflation data continued on its upward trend, with May CPI at 4.6%, now above the midpoint of the South African Reserve Bank's inflation target range. We expect that CPI will approach the upper end of the target range of 6% by the end of the year. With the repo rate currently at an all time low of 5.50% and having been at this level since November 2010, and inflation heading for 6%, negative real short-term interest rates appear to be on the cards. This is unless the South African Reserve Bank elects to start raising interest rates sooner. We are of the view that interest rates are too low and that they should be raised this year in order to keep inflation in check.

With money market yields at such low levels, traditional money market funds are hindered from achieving anything more than around 6% return per annum at prevailing interest rates. The fund has been designed to capture better value from the money market, and hence a higher yield for investors, without taking any further credit or liquidity risk. This is achieved by investing in longer-dated bank issued or corporate money market instruments, which currently are paying around JIBAR + 0.83% for a 3-year term, which is substantially more than its 1-year equivalent.

The fund is fully invested in its quota of SA bank FRNs, with corporate issuer names such as Bidvest, Mercedes Benz, Growthpoint, Barloworld, Aspen Pharmacare, Netcare and Group Five which represents approximately 13% of the fund and thus providing additional yield enhancement. The fund is currently yielding 6.98% and continues to be conservatively managed with the view of providing investors with a higher interest payout than what is achievable from traditional money market products.

Portfolio managers
Stephen Peirce and Tania Miglietta

The Coronation Income Fund will change it's name to Coronation Jibar Plus Fund, effective from 01 April 2011.

The fund produced a return of 8.6% during 2010, well ahead of the 6.6% delivered by its STeFI cash benchmark.

This portfolio has been redesigned to provide investors with the maximum yield available from the longer-dated fixed interest market, whilst maintaining a 90 day duration and thereby minimising interest rate risk. We seek to achieve a substantial premium in yield over the money market in the long term. We have fully invested the fund into longer-dated floaters which means that it will function as an enhanced cash fund from hereon out. It is invested in a wide selection of 1 - 5 year floating rate instruments which all trade at a substantial premium to Jibar (Johannesburg Interbank Average Rate).

During late November the South African Reserve Bank announced a further 0.5% repo rate cut taking it to an all-time low of 5.5%. We are however concerned about a potential upward move in inflation this year and believe that ongoing interest rate cuts will further spur this on. We note that the last two CPI inflation readings have come in worse-than expected (even though the absolute level is still low at 3.6% in November), yet interest rates are still being reduced. Breakeven inflation derived from the shorter end of the inflation-linked curve (2013 and 2017 maturities) remains near the top of the inflation target range at over 5.7%, indicating that the market is expecting inflation to average this figure over the next number of years. We do not believe there is further scope for cutting interest rates. In fact, should any further repo rate cuts materialise, we would take that as another negative for the longer-term inflation outlook.

Corporate bonds had a very good year, as spreads tightened across the curve on ever improving confidence in credit and a falling risk free rate. Corporate bond issuance remained healthy during the quarter with MTN a steady issuer having reached R4 billion of issuance during 2010. A new entrant into the bond market, Growthpoint, issued a 4 year inaugural floating rate bond which was well received. The fund participated in both of these issues.

At this point in the interest rate cycle money market yields are at 30-year lows and in our view offer minimal value. Banks' funding spreads for 12 - 36 month instruments have also fallen dramatically taking out all the value in this asset class for now. We have fully invested the fund in floating rate investments at the higher spreads, where on average the fund is achieving a yield pick-up over Jibar of 2%. At the time of writing the fund was yielding 7.47% before fees. Looking forward, in this low interest rate environment we seek to achieve a steady long-term outperformance of our benchmark Jibar. However, the current low level of interest rates needs to be taken into account with regards to overall yield expectations.

Portfolio manager Tania Miglietta