The fund had a strong quarter returning 1.6%. The one-year return of 6.6% still gleaned from the money market sector, continues to outpace traditional money market funds, which produced a mean return of 5.5%. With the repo rate at a 30-year low of 5%, and funding spreads over JIBAR contracting further, the resultant yield on money market investments are going to be lower. The market continues to price in lower interest rates with the FRA market expecting two further cuts of 0.25% each by December 2012 and April 2013 respectively. See chart below. August consumer inflation (CPI) rose slightly to 5%, indicating that a trough was reached in July. We expect CPI to continue moving higher from here, partly due to food price pressures, rising towards year-end and into 2013, with another breach of the target expected in the second half of next year. This forecast is at odds with what the SA Reserve Bank (SARB) provided in their latest monetary policy committee (MPC) statement; they expect an average of 5.2% next year and 5% in 2014. Given the SARB's clear tilt towards worrying about domestic and global growth risks, we cannot discount another rate cut. Moody's was the first ratings agency to act on its negative outlook, downgrading SA from A3 to Baa1 in late September (it is now on the same ratings level as Standard & Poor's and Fitch). All three agencies still have SA on negative outlook, and we expect further downgrades to come. It is likely that three important upcoming events - the Medium Term Budget Policy Statement (MTBPS) in late October, the ANC National Policy Conference in December and the Annual Budget in February 2013 - will be watched closely. We currently expect to see further downgrades between late October and late February. Note that while downgrades from the current ratings level still leaves SA relatively comfortably within the investment grade category, two notches down from the current level will mean that SA is on the lowest rung of investment grade. SA currently has one of the widest budget deficits within emerging markets, and needs to do more to rein this in to contain ratings deterioration. Corporate bond issuance slowed during the quarter, but Netcare and Mercedes Benz issued new 3-year bonds in which we participated at attractive yields. The balance of the issuance took place among the banks, but was more suitable for bond funds. We identified that the bank FRN market still offers value in the 4-year term and thus invested at the higher levels before spreads dipped lower as a result of SA banks not requiring as much long-term funding as previously. This is a function of the lower long-term lending that we are seeing in the banks' semi annual results. Money market rates are now very low and monthly returns from this asset class are under pressure. JIBAR Plus, by design, provides an additional yield of approximately 1% net of fees. This results from our having bought longer-term instruments, which capture a fixed spread over JIBAR for years down the line. In times when money market annual returns are going to be sub- 5%, an additional yield of 1% is an attractive prospect. Even if one more interest rate cut is a possibility, the most likely longer-term probability is for rates to stay low and eventually move higher. With the fund's three-month duration we are positioned for this eventuality and seek to maximise yield right through the interest rate cycle. We are now entering a period of much lower yields, which is likely to persist until interest rates have completed their cycle and have risen again. The fund is, however, appropriately positioned to protect against both interest rate volatility and, in particular, an unexpected sharp upward move.
Portfolio managers
Tania Miglietta and Stephen Peirce

The fund returned 1.5% for the quarter, contributing to its one-year rolling performance to end-June, which now totals 6.8% net of fees. The benchmark STeFI money market Index returned 5.5% for the same period. Given how low interest rates currently are, this additional yield pick-up is significant for any money market investor. Whilst the crisis in Euroland has put a dampener on any local interest rates hike expectations, and lower international bond yields (US and German) have continued to grind ever lower, local bond yields have pushed down further with the R157 (2015 maturity) breaking below a yield to maturity of 6% for the first time. Bond yields fell despite the currency having depreciated from R/$7.66 at end-March to R/$8.14 by end- June. The short end of the yield curve followed the FRA market which started to price in as much as a 60% probability of a further rate cut later in the year. This was in response to the change in stance by the Monetary Policy Committee (MPC) in their May statement from previously indicating that the next repo move would probably be upwards to now being ready to move 'in either direction' as circumstances warrant. The market has interpreted this (probably correctly) as meaning that the MPC is currently more concerned about the fallout from Europe than current SA inflation. SA money market rates have been in a holding pattern for some time now, but local bank spreads have been widening since late last year, offering a better yield pick-up for the JIBAR Plus investor. Banks continue to need longer-dated funding and thus have been paying a better rate for longerterm NCDs. The fund is an active buyer of 3 - 5 year floating rate NCDs and bonds which currently pay a spread over JIBAR of between 95 - 140 basis points in the higher quality names across the various terms to maturity. An improved short-term inflation outlook also provided support to the bond market. CPI generally came in below expectations during the quarter, largely due to stronger food disinflation than anticipated, while the sharp drop of 19% in the price of oil (Brent crude) since the beginning of the quarter will exert significant near-term downward pressure on CPI. While CPI will probably fall to around 5% in July as a result, the medium-term outlook is less comforting, as the effects of the weaker rand this year start feeding into the numbers. We now see CPI within the target range for the rest of this year, but for it to turn higher and breach 6% again next year. The fund is designed to provide investors with additional yield over that of regular money market funds, without taking on additional interest rate risk. It has achieved this outperformance by being fully invested in medium-dated floating rate investments which reset with JIBAR, and pay interest quarterly; thus maintaining a money market like duration, but achieving a higher yield over the longer term.
Portfolio managers
Stephen Peirce and Tania Miglietta

The fund returned 1.65% for the quarter and has achieved a pleasing total return of 6.82% for the last 12 months, outperforming the 3-month STeFI by 1.33% (after fees).

Cash, which is yielding around 5.5%, has significantly underperformed other yielding assets during the quarter and over the last year. Note that the real return on cash has barely been positive over the past 12 months, and on a forwardlooking basis out to one year, current cash rates are expected to show negative real returns. In spite of real returns falling on money market instruments, this fund has achieved a positive real return after fees. Inflation-linked bonds (ILBs) rallied further during the month, particularly in the shorter-dated R189 where its real yield moved deeper into negative territory. It closed the quarter at -0.5% on a combination of higher inflation and potential buybacks of the bond ahead of its maturity in March 2013. The fund has had exposure to this asset class in the form of the ABSA 31/03/2013 maturity ILB, which tracks the R189 and offers a real yield of +0.5%. The instrument has been a very good performer.

Locally, a focus was the annual budget speech in February. This surprised markets on the positive side, with the Minister reigning in the deficit projections. It has since been announced that the expected deficit for the fiscal year just ended (2011/12) is 4.5%, slightly better than expected at the time of the budget. Funding requirements still remain high, and there is some scepticism over the extent to which public sector wage increases can be contained - this being an important contribution to the expected lower deficit numbers. Soon after the budget and despite the improved numbers, Standard & Poor's joined Moody's and Fitch in attaching a negative outlook to its credit rating on South Africa. These agencies cited structural problems and the potential for politics to put pressure on the budget sometime in the future.

On the monetary policy side, although there is clearly no desire to raise interest rates anytime soon, the SARB has started expressing its concern about more broad-based inflation. We continue to see inflation remaining above target through the first half of next year. The rand could be a game-changer, but continued pass through from oil and food price hikes as well as the increasing likelihood of further second-round effects from petrol prices keeps us cautious. We continue to believe that with inflation above target and growth at around 3%, a negative real repo rate is too accommodative and we expect interest rates to start being normalised later this year.

The fund has achieved a good outperformance of regular money market investments by being fully invested in long dated floating rate investments (FRNs), which earn a substantial spread over JIBAR for their full term. The fund is exposed to both bank and corporate FRNs thereby maximising the fund's diversification while improving the yield. FRNs pay a quarterly interest rate that resets every three months as underlying interest rates move, thus hedging out duration and keeping interest rate risk to no more than 90 days.

The fund offers a substantial yield premium over regular money market funds, by increasing the allowable term of the instruments, but without adding to the interest rate risk of the client's funds. We view this as an excellent alternative to money market funds that are subject to very low prevailing interest rates at the moment.

Portfolio managers
Stephen Peirce and Tania Miglietta Client

This fund is designed to give investors an additional yield pick-up over traditional money market funds. Over the last year this objective has been met with a return of 6.8%. The fund outperformed the Coronation Money Market Fund by 1.13% and the 3-month STeFI money market index by 1.3%, all after fees. This was achieved by investing in floating rate investments, locking in an attractive yield over JIBAR for a longer term.

2011 was characterised by a combination of rising inflation, a depreciating currency (the rand lost 22% against the US dollar), rocketing food prices and a materially increasing fiscal deficit; all of which would normally be negative for interest rates. Despite this, global growth concerns, worries over the fiscal situation in a number of European countries, the continued foreign bond investor appetite for yield along with record low domestic short-term interest rates, resulted in a decent offset to the fundamental negative backdrop for bonds.

As we move ahead into the new year, we expect inflation to remain above the upper end of the 3% - 6% target range during the course of 2012. The main drivers appear to be a combination of rising food prices and the currency depreciation experienced last year. The maize price again reached new highs in December, with the year-on-year percentage change at 99% for the last 12 months. This has a direct and negative impact on inflation.

The next move in short-term interest rates is likely to be up. However, given the relatively dovish stance of the Monetary Policy Committee, this will most likely only take place towards the second half of the year. Should the Reserve Bank wait to take action against the rising inflation trend there could be major ramifications for the local bond market - the longer they wait, the more entrenched higher inflation expectations become. This is a dangerous scenario as it leads to higher wage settlements which then fuels inflation even further.

The fund is fully invested in a series of liquid, good quality floating rate investments for up to five years term to maturity, currently offering a weighted average yield of around 6.7%. We acknowledge that investors in this fund seek interest yield, thus we aim to deliver a good long-term interest rate over money market, an objective achieved in the recent past with a 1.1% outperformance of 3-month STeFI on average per annum over the last three years.

The philosophy of this fund is to outperform regular money market funds by investing in a part of the yield curve that is inaccessible to traditional money market funds - the 1 - 5 year term. Investors thus benefit from more favourable pricing for the slightly longer term without incurring a great deal more risk.

Portfolio managers
Stephen Peirce and Tania Miglietta