Cash has mostly outperformed bonds over the past year as repo rate hikes have bitten and bond yields have drifted higher. The 3-month Short Term Fixed Interest Index (STeFI) returned 2.3% this quarter and 8.9% for the past year.

The SA Reserve Bank raised the repo rate another 50 basis points in August, its sixth hike since the beginning of the interest rate hiking cycle, bringing it to 10%. While concerns around inflation lingered with a string of worse-thanexpected data releases, sentiment started turning after international factors took the lead role. As concerns about the sub-prime fall-out's impact on financial markets spread - the market started to price in a US rate cut. The Federal Reserve duly delivered, even surprising the markets with a 50 basis point cut at its September 18 Federal Open Market Committee (FOMC) meeting (most analysts had expected 25 basis points).

The Fed's move reignited interest in risky assets, with SA bonds joining a general emerging markets rally. The dollar has also come under pressure recently, and the rand has benefited handsomely from this, once again breaking through the R/$7 level. Given the importance of the rand to SA's inflation outlook, and against a background of nearrecord highs in global food and energy prices, the currency move is a welcome respite.

SA's current inflation situation remains an uncomfortable one. CPIX has been above the upper limit of its 3% - 6% target range since April, and will probably be there until March 2008: representing a full year above the target range. While much of this impetus has been driven by higher food prices and last year's rand fall, the SARB remains concerned about credibility. On a longer-term view, however, the big picture is rosier. Even with the lags involved, it is already clear that consumer spending and consumer credit cycles have turned as the effects of past rate rises start to bite. At the time of writing the October MPC has yet to take place; while it will be a close call, we think there are solid arguments for leaving rates unchanged. If they do rise again, it should clearly be the peak in the cycle. On the current outlook, we see scope for the repo rate to start falling in the second half of 2008.

Money market interest rates held their mid-10% levels after the last interest rate hike, with 1-year NCDs hovering close to 11%. The chart below shows how money market interest rates have risen since the first repo rate hike in June last year.

The fund has remained highly liquid with a significant holding in very short term deposits allowing us to keep reinvesting at ever increasing interest rates. We have also been buying top yielding 12 month NCDs where duration constraints allow. The fund's duration is close to its maximum as we expect short-term rates to be close to peaking.

International money markets reached crisis levels in both the US and Europe this quarter, with sub-prime loans hitting the short term securitisation markets (asset backed commercial paper - ABCP) severely, and drying up issuance thereof. The lack of liquidity has been a big issue in international money markets to which in some cases, banks have had to provide emergency liquidity. In SA we were somewhat shielded from the international money market volatility as SA banks are not exposed to the very risky securitisations which caused the credit crunch and default worries.

The fund has not participated in SA-listed long-term securitisation in recent months, since pricing never fully compensated us for the lack of liquidity (ability to sell) or the credit risk that these investments represent. Securitisations will come under further pressure as interest rate hikes hit the consumer, and their ability to repay loans (home-loans and vehicle loans) directly impacts the securitisation's own ability to repay noteholders' interest. It therefore remains imperative that we price for worst case scenarios and poor liquidity when approaching this sector. The pricing has since improved notably in the form of widening credit spreads, but we continue to monitor it with caution.

The Coronation Money Market Fund had a good quarter, retuning 2.3% for the quarter and 8.8% for the past year.

Tania Miglietta
Portfolio Manager

During June, higher inflation and rising interest rate worries filtered through the market. Cash returns, as determined by the STeFI index returned 0.72% for the month and 2.2% for the quarter.

The interest rate picture took a turn for the worse in the second quarter as inflation data exceeded expectations - notably, CPIX breached 6%. In response the SARB responded by raising the repo rate another 50 basis points in June (having been on hold at the February and April meetings). Pipeline pressure continues to be evident in PPI, and CPIX is expected to remain above 6% for most of the next three quarters. This, and the potential effect of higher inflation on inflation expectations, means it is likely that the SARB (also with an eye on its credibility) will raise rates again at the August MPC.

However, it is noteworthy that while consumer demand data are generally still strong there are clear signs of the peak having passed. Car sales are slumping, while other spending and consumer credit are starting to slow, hit by a perfect storm of higher rates, higher prices and (in June) the introduction of the National Credit Act. A consumer slowdown will help ease concerns both over the current account deficit and inflation further down the line, while the latter will also be helped by the recently stronger rand. Thus, if the SARB does raise rates in August there is a good chance that would be the end of the cycle.

Money market investments across the yield curve continue to provide ever more attractive yields - currently between 9.5% and 10.5% (see the chart below). The market has become increasingly bearish, pricing in up to two more interest rate hikes of 0.5% each.

The Coronation Money Market Fund is well positioned for this up-tick in interest rates, with more than 30% of the fund on overnight call it is able to return to the NCD market and buy up the higher yielding investments.

The fund's lower duration limit also ensures that the fund is unlikely to suffer when interest rates rise so quickly. 3-month JIBAR, (Johannesburg Interbank Average Rate), a money market reference rate has risen from 7% to nearly 10% in just 18 months - a new high since 2003. This is depicted in the chart below. Higher interest rates in South Africa are affecting asset prices everywhere, and total returns across asset classes over the next 12 months are showing that cash still remains king. The portfolio returned 2.194% for the quarter outperforming its benchmark. The 12-month returns have been steadily rising, and to the end of June 2007 was 8.72% before fees. See chart below.

Tania Miglietta
Portfolio Manager

Defensive money market exposure only.

Will only invest in money market instruments with a maturity of less than one year while the average maturity of the underlying assets will not exceed 90 days.

The Coronation Money Market Fund achieved a return of 2.09% for the first quarter, outperforming its benchmark of 2.05%. The fund yielded 9.18% effective yield, net of fees, at quarter end.

We enjoyed a bullish start to the year with money market rates trending lower. This was driven by the dovish stance taken at the February MPC meeting where the committee's decision was to leave the repo rate unchanged at 9%. By then the inflation outlook had improved, the committee highlighted that credit extension although still high, had become more corporate driven. It therefore meant that consumer borrowing was not as rife as previously recorded and since corporate borrowing is healthier for the economy than is consumer borrowing (since more investment and development is taking place). This and other important factors gave the SARB reason to leave interest rates unchanged.

Around six weeks later, the landscape started to change however, with higher oil prices, a weaker rand and later, higher maize prices creeping in. These all pose greater risks to future inflation. None of these prices have yet subsided, and effective early April, a large petrol price hike of around 68c per litre was imposed. So the risks to higher inflation remain.

In response to the changed landscape, although with a bit of a delay, the bond market sold off giving up all the gains it has achieved during the first weeks of the year. The STeFI 3 month index (and fund benchmark) achieved 2.03% for the quarter. For the last 12 months, cash (7.8%) returned more than bonds of 5.6%.

On that note, money market yields have been more volatile than usual, mostly in response to the weaker rand and the other inflation risks. The FRA curve, which acts as the market barometer for short-term interest rate expectations, is now pricing in around a 35% - 45% chance of another repo rate hike either in April or June. One-year money market yields are as high as 9.70%, up from previous weeks. The large SA banks seeking more funding to provide for their ever growing loan book are increasingly willing to pay up for long-term deposits.

Credit spreads available on securitised investments and commercial paper remain low, although pressure for these spreads to widen is noted as supply increases and as the interest rate hiking cycle remains well underway. The full set of risks around securitised investments comes into question as the implementation date of the National Credit Act (NCA) approaches - June 2007. This too has put an end to the paper thin spreads that investors have been accepting on these investments.

The Coronation Money Market Fund has remained at around 65 days duration, given the high yields available at the short end of the yield curve. The fund is composed of 12-month structured, coupon paying money market investments earning up to 9.70% pa, and a number of shorter dated NCDs all yielding above 9%. The high weighting to the Blue Titanium conduit (AAA-rated) provides a good yield of JIBAR + 0.05%, which translates to around 9.20%

Tania Miglietta
Portfolio Manager

At the year-end close we saw money market yields reach new highs. In recent months, rising short-term interest rates dominated the fixed interest market causing the yield curve to rise, especially short-term interest rates and volatility. Inflation worries are subsiding given that the repo rate has been hiked four times from June to December 2006.

The Coronation Money Market Fund is designed to benefit from the higher wholesale rates available to institutions and passes these directly onto clients, net of fees. At year-end the fund was yielding 8.85% (gross of fees). The fund returned 7.3% for the calendar year.

Lower trending long-dated interest rates were fuelled by the better than expected November CPIX and PPI figures. CPIX came out at 5.0%, unchanged from October and below forecasts of 5.4%, while PPI was 10% year on year, also better than expected. Part of the reason for the lower than expected figures was a muted increase in fresh food prices, which is an important component of the inflation measure. The oil price remained flat for the year and the currency, although depreciating at one point turned around and made back some of its losses. These two factors, as we have noted before, are big influencing factors on inflation.

Money market interest rates rose again on the news that the South African Reserve Bank hiked the repo rate to 9%. However, looking forward, as at year-end, the market is no longer expecting interest rates to continue rising, instead, it sees a possible pause in the interest rate hiking cycle and possibly a repo rate cut within 18 months to 2 years. The market will remain focused on the currency when it comes to interest rate expectations. Any weakening in the currency should very quickly result in a more bearish outlook priced into the yield curve as it responds to the effect of a weaker currency on the inflation outlook.

The money market yield curve has flattened since the beginning of December, which is an indicator that the peak in the hiking cycle is drawing closer. Such yield curve behaviour is typical at this point in the cycle.

We have invested most of the fund into fixed rate investments of between 9.0% - 9.7% per annum which means that the instruments will pay this attractive interest rate until it matures.

The Coronation Money Market Fund is invested in a wide range of good quality banks as well as some of the better-rated and more established short term securitisation vehicles, which offer a yield premium over other prevailing money market investments.

Tania Miglietta
Portfolio Manager