Market review
Risk assets maintained their upward trajectory during the third quarter, thanks largely to continued support from central bankers. The MSCI World Index added 6.8% over the quarter, with the US S&P 500 Index gaining 6.4%, the German Dax 30 Index adding 14% and the UK FTSE 100 Index closing 7.2% higher over the period. (All returns are quoted in US dollars.) Local equities performed well, adding 7.3% in rands over the third quarter and returning 14.8% for the year to date. Bonds added 5% in the quarter to record gains of 13.1% for the year to date. Longer-dated bond yields fell by 50 basis points over the quarter. Cash, as measured by the STeFI Composite Index, added a marginal 1.4% over the quarter and 4.2% for the year to date.

Portfolio review
The Investec Cautious Managed Fund is a low equity, multi-asset fund that seeks to generate inflation-beating returns while protecting investors from the risk of permanent loss of capital. The low equity weighting means that we have an increased focus on generating income through the fixed interest component of the portfolio. The third quarter saw a strong rally in both equities and bonds globally. On the local front, the South African Reserve Bank surprised the market by cutting the repo rate by 50 basis points to 5%. South African government bonds' anticipated inclusion in Citigroup's World Government Bond Index exerted massive downward pressure on bond yields. Moody's downgrade of South Africa's rating by one notch from A3 to Baa1, tempered the rally in bonds. The portfolio benefited significantly from the stronger bond market, given its large exposure to interest-bearing instruments. In addition, the inflationlinked bond component of the portfolio rallied on the back of negative real short-term interest rates and concerns about inflation over the longer term. The gold exchange traded fund, the largest holding in the portfolio, benefited from the rise in the gold price. On the equity front, Impala Platinum's rally made a welcome contribution to returns and Assore held on to its gains in spite of the iron ore price declining to its lowest level since 2009. While some investors may be concerned about the seemingly pedestrian returns achieved over the past 12 months, we remain anxious about the strong returns from domestic-oriented stocks in South Africa, and more so, given the downside risks to the rand. The country's current account deficit of 6.4% of gross domestic product, falling commodity prices impacting the terms of trade, and wage increases unrelated to productivity are a concern. These risks are not in the price of certain highly rated domestic stocks that trade at over 20x earnings. We believe it is prudent to protect investors' money against potential capital losses from domestic counters, yet offer a real return opportunity from holding offshore defensive stocks, particularly if the rand moves down to our fair value of R9.50 to the US dollar.

Portfolio activity
During the quarter we took advantage of the widening gap between the rand price of oil and Sasol and increased our holding in the share. We purchased a new position in African Rainbow Minerals to gain exposure to the undervalued rump of the business. In addition, we purchased an initial stake in luxury goods company Coach in the offshore portion of our portfolio. The share is trading cheaply but the company remains highly cash generative with good earnings prospects. Discovery Holdings has run hard over the year. Following the company results, we reduced our exposure to the counter at a price above the intrinsic value of the company. We also reduced our exposure to Capital Shopping Centres and Sun International as we continue the process of aligning the Cautious Managed strategy to our core absolute return process.

Portfolio positioning
We do not make forecasts, but assess the likelihood that an investment will produce returns significantly in excess of inflation while simultaneously avoiding the permanent loss of capital. In the current environment of increased interventionist policies from governments, this focus has allowed us to avoid the knee-jerk response of most market participants. We believe that the economic fate of South Africa is directly tied to the fortunes of the largest economies (and our largest trading partners). Over the last quarter, we have become more concerned with the specific risks within South Africa. The growing unrest among labour and the actions that they have taken pose a significant threat to our economic growth. We believe that miners with the strongest balance sheets and lowest costs will survive (one of the reasons that we continue holding Impala Platinum in our portfolio). However, weaker companies may be forced to rationalise their operations, and this is something that our country cannot afford given current levels of unemployment, the widening current account deficit and anaemic economic growth. The local equity market remains fully priced, but we are still able to find opportunities that we believe will produce returns significantly in excess of inflation. Bonds are trading more expensively following a compression in yields over the last quarter. However, given the commitment from central banks to keep short-term interest rates low for an extended period, they still represent an appropriate diversifier in the portfolio. Inflation-linked bonds remain a core component of the non-equity portion of the portfolio. Sustained, low short-term rates and an excess of quantitative easing will ultimately place upward pressure on prices. Both inflation-linked bonds and our holding in gold provide a hedge against this risk. We remain most excited about the prospects for the foreign component of our portfolio where we are able to purchase high quality multinational companies trading at multi-decade lows and with dividend yields in excess of long-bond yields.

Market review
After sharp declines in May, commodity prices, with the exception of Brent crude, generally edged higher in June. Brent crude fell nearly 15% over the month, declining by more than 25% during the quarter. Gold (+2%) and copper (+3.5%) closed higher in June, but weakened over the quarter. Equity markets reversed some of the previous months' losses, with the MSCI World Index closing 5.1% higher in June. Over the quarter, the index was down nearly 5%. The FTSE 100 Index gained 7% for the month and lost 4.1% over the quarter while the S&P 500 Index rose 4.1% in June and declined by 2.8% over the quarter. Emerging markets trailed their developed market peers, gaining 3.9% for the month and losing 8.8% over the quarter. Turkey led the advance, rising 17.8% in June, up nearly 29% for the year to date. (All returns are quoted in US dollars.) Local assets showed strong absolute returns, despite significant intra-month volatility. Bond yields fell to near record lows in June, with the All Bond Index gaining 3.3% over the month and 5.2% for the quarter. Listed property continued its strong run, adding 6.9% in June and 10.3% over the quarter. Cash, as measured by the STeFI Index, gained a steady 0.5% during the month and 1.4% over the quarter. The FTSE/JSE All Share Index made modest gains over the quarter (+1%) while in June, the index rose 1.9%. General miners performed well over the month, gaining 5.6% (-1.6% over the quarter). May's strong returns from gold miners were partially reversed in June, with the sector shedding more than 9% over the month. While the sector only lost 2.2% over the quarter, it has recorded the weakest performance for the year to date (-16.7%). Healthcare added 10.9% over the quarter, general retailers rallied a further 7.3% and food retailers closed 9.2% higher. Construction (-11.3%), household goods (-10.4%) and the personal goods sector (-5.7%) were weaker over the 3-month period. Telkom fell 20% in June after the South African government blocked Korea's KT Corp from acquiring a 20% stake in the fixed-line operator.

Portfolio review
More than 30 months have passed since rising Greek bond yields first spelt financial problems for the euro zone. Europe continues to stumble from one deadline to the next, with no clear solutions at hand that can calm the financial markets. This frustrating financial scenario has now caused broader economic challenges with the world economy hitting a rather large bump in the road. The US and BRIC economies (Brazil, Russia, India and China) have all buckled under the strain. Bond yields have declined yet again, despite being at very low levels. Economically sensitive assets have performed poorly over the past 12 months. A key question is: When will these assets enjoy a recovery in market prices? While lower commodity and equity prices suggest this might be at hand, the lesson from prior crises is to wait for signs of a bottom, before leaping in headlong. We are not yet convinced that there are sufficient signs confirming a bottom. An interesting development has been the declining trend in the rand price of oil in the past 2 months, which has taken the inflation sting out of the markets. This has lowered inflation expectations, with SA bond yields enjoying a reasonable rally. The stronger bond market has contributed to the portfolio's performance. Bonds continue to outperform equities locally. Offshore holdings remain a driver of returns. We believe it is just as important to avoid losers as it is to identify winners. We are avoiding financial shares as they continue to be risky, with a high probability of permanent loss of capital. When technology shares fell in the year 2000, the valuations were high, but the earnings were still well below the levels that could be achieved. Financial shares appear to have low valuations, but funding constraints, capital inadequacy, inflated asset valuations and margin pressure will curb profitability. In the meantime, performance consistency is important. We are pleased to report that the portfolio continues to perform satisfactorily.

Portfolio positioning
Resource shares could become a key focus area for investments, but we remain fairly selective in this area. We have continued to buy Impala Platinum at attractive levels. Platinum producer Aquarius will halt operations at its unprofitable Marikana mine. Further closures could be required from high cost producers. We believe that low cost positioning on the cost curve is essential for survival, as the industry is operating at the trough of its cycle. Market conditions remain difficult, and caution is advised. However, we believe that we will find opportunities to ensure attractive future real returns.

Market review
Events in Europe and the US again took centre stage during the first quarter of 2012. Asset markets remained resilient despite continued macroeconomic uncertainty and serious doubts about the ability and willingness of failing southern European economies to meet their austerity obligations. A strong take-up of emergency funding from the European Central Bank (ECB) by hundreds of European banks boosted sentiment, driving equities higher and strengthening commodity currencies. At the margin, economic data also continued to improve in the US, where stabilising house prices and rising employment levels boosted the prospect of positive but muted growth.

The FTSE/JSE All Share Index gained 6% in the first quarter, but most of the positive performance came in January. Resource shares lagged the rally and gold miners (-14.9%), Impala Platinum (-8.9%) and Sasol (-3.9%) were notable underperformers. Financials gained 12.8% and industrials added 10.5%, driven by strong performances from consumer goods and consumer services. The All Bond and Listed Property indices returned 2.4% and 8% respectively, while the rand gained more than 5% against the US dollar, reflecting the broader rotation into riskier assets. Cash, as measured by the STeFI, returned 1.4% over the review period.

Portfolio review
High quality global franchise names have had a great 12 months. The key driver of the last year's returns for our portfolios has been the share prices of the stocks we own offshore. They have increased in value by close to 30%. Half of the gains came from dollar increases in the share prices and the balance from the weaker trend in the rand. The key performance inhibitor this year has been the holding in gold and the significant offshore weighting that has struggled in 2012 as the rand has strengthened. We continue to believe that favourable terms of trade are supporting the high value of the rand. However, this is reliant on high commodity prices: iron ore and copper in particular. A more reasonable rand/US dollar exchange rate would be 15% lower.

Portfolio activity
We continue to hold the gold debenture issued by NewGold. This represents portfolio insurance, and provides a store or barometer of real value in a rudderless world. Gold shares leveraged in rands typically underperform the rand gold price. This normally happens at times of general market distress. For this reason, we do not like gold shares, particularly as the correlations to the market have risen. As gold companies become more profitable, despite production declines, the value of additional optional investment in gold shares reduces. Although there might be a trade in the shares, we prefer other investments.

Portfolio positioning
Fairly demanding local valuations and significant risks to the economic outlook is keeping our domestic equity weighting conservative. As the European economic situation ebbs and flows, so the global bank shares will act as barometers of the health of the system. After celebrating keen advances in the first two months of the year, they are now looking a little 'inebriated'. Real returns are still achievable, but we don't wish to take unnecessary risks. We think the asset allocations are appropriate for current market conditions.

Market review

Equity markets generally saw positive returns over the last quarter of the year. The MSCI World Index (developed markets) rose 7.7% in US dollars, while the MSCI Emerging Markets Index gained 4.4%. US markets ended the year in positive territory, with strong gains over the last few months. Over the quarter, the US dollar rose 0.2% against sterling, 3.4% against the euro, but fell 0.2% against the yen. The return on the Citigroup World Government Bond Index was -0.1% in US dollars.

The All Bond Index gained 3.5% over the quarter and cash, as measured by the STeFI Index, returned 1.4%. Listed property closed up 3.7%. The FTSE/JSE All Share Index added 8.4% in the fourth quarter and rose 2.6% over the year. The broad industrial grouping outperformed both financial and resources over the quarter. Food and general retailers fared particularly well, closing up 20.3% and 15.5% higher respectively. Life insurers added 16.9% over the quarter while the smaller basket of technology stocks rose 12.1%. Gold and platinum miners lagged the overall index, ending flat over the quarter. General miners performed in line with the broader market while Sasol, the only company within the oil and gas sector, ended 18.6% higher.

Portfolio review

A year ago investors were probably anxious about the modest returns that they had received for 2010, against a backdrop of strong markets. When investors review their portfolios for 2011 and digest the year's events they will understand why we took the low risk positioning and maintained it throughout the 12-month period. The portfolio produced strong absolute returns for investors in 2011, and decent relative returns as well, despite very modest market returns. To end with a solid real return for the year, when risk was most certainly not rewarded and inflation was rising, shows the value of timely capital preservation and loss avoidance.

The portfolio enjoyed a particularly strong second half of 2011, given a weakening rand and our full exposure to offshore assets. While a weak rand can hide poor dollar returns, our offshore equities delivered a positive outcome (more than 7% in US dollars) in 2011 when returns were not available in many equity indices. In fact, the MSCI All Country World Index lost more than 7% over the year. The European sovereign debt crisis also meant that some government bond indices fared poorly, as any dedicated Italian, Spanish, Greek or Irish government bond manager would testify.

Since mid-year we have raised the exposure to bonds in South Africa, as we see the steepness of the yield curve providing an attractive pick-up over cash, which is currently yielding zero in real terms. Even if the rand weakens further due to industrial commodity price declines, we foresee a scenario where bond yields could fall as local investors re-allocate from resources to local bonds. It is fair to say that certain key commodities like copper have displayed remarkable resilience, probably due to tight supply conditions. Nonetheless, falling commodity prices should lead to dissipating inflation expectations locally.

Gold has also proven to be a great haven. The large holding in the gold exchange traded fund (ETF) added to the portfolio's performance. Despite the strong run, we remain reluctant to sell the weighting out of the portfolio, as the problems in the world seem very far from resolved.

Portfolio positioning

Looking forward, we remain cautious. We would love to be able to call for a quick resolution to the European debt problems and have clarity on the prognosis for the Chinese economy. However, the outcome is not yet clear. In a worst-case scenario where money flows out of resources and commodities, this shock could cause a second leg down in all commodity currencies, rather than only have an impact on emerging market currencies.

The Chinese economy is slowing rapidly. Manufacturing, housing and exports, the three key pillars of the economy, are decelerating. It remains to be seen just how much flexibility the Chinese authorities have to mitigate this downturn. Sadly, credit-infused slowdowns are typically more difficult to solve. Lower commodity prices would be negative for the rand. However, a decline in rand commodity prices could be positive for bond yields and disinflation in South Africa.

Valuations are becoming more appealing across the board, and we will continue to add to current holdings where prices indicate attractive return prospects. Failing this, we will seek signs of a cycle bottom for the global economy. Overall, long-term investors, who share our views, and who have both patience and cash will be able to exploit these opportunities and should continue to see real wealth creation in the future.