A surprise 50bp repo rate cut was the big event this quarter - taking repo down a full 600bp since June 2003 and SA short rates to historic lows. This move by the MPC surprised the market 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.
Cash lost ground to the bond and equity markets this quarter (having outperformed last quarter), with the 3 month STeFI index returning 1.93%, and 8.20% for the 12 months ended September 2004. The Coronation Money Market Fund has consistently outperformed the index since the beginning of the year, returning 1.99% for the quarter and 8.67% for the 12 months. The fund has returned 10.81% for the last two years, and 10.77% for the last three years.
The returns on cash have been steadily declining due to lower interest rates providing investors, who are often reliant on interest income, with ever declining yields.
Market sentiment changed significantly during the course of the quarter, especially after August: becoming more bullish - given the SARB'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 SARB governor 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.

Cash outperformed all other asset classes during the second quarter, providing a return of 2% versus 0.4% returned by the bond market and -4.7% by the equity market. Cash was clearly the place to be.
The 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 higher risk asset classes, cash has been the better performer, both year to date and over the shorter term, preserving capital along the way. All in all, despite lower yields, cash investments have been very attractive.
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 more optimistic scenario has been due to a stronger Rand/Dollar exchange rate, a stronger trade weighted rand, 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 than the market. We expect the repo rate to be hiked in December to offset rising consumer inflation, which by then will have started to rear its head. The risk to our view however, is that with a strong rand, inflation will be kept in check.
The Coronation Money Market Fund has returned 9.46% over the last 12 months to end June 2004, and is expected to return around 9%, based on expected money market returns for the next year. The expected return for the bond market for the same period is very similar thus, at these levels, it would be prudent to be in cash as the risk of capital loss is negligible.
The Coronation Money Market Fund has outperformed the 3 month STeFI money market index. This was achieved by positioning our fund's duration to benefit from a steepening money market yield curve during the year.

Money market yields have fallen dramatically this year and during the last quarter continued their same momentum.

South Africa 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 Africa 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.

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 Money Market Fund performed well for the year, returning 11.96% in an environment of rapidly falling interest rates. Over the course of the year the fund manager's utilised some unique market opportunities and trade ideas which enhanced the returns of the fund. This same strategy will be applied going into 2004.

Credit exposure was further diversified as the fund manager's added a number of bank, parastatal and rated corporate names to the fund, thereby improving the fund's risk profile and increasing the yield.