Money market interest rates have been reduced sharply, from 12% to 7% in less than a year. Money market fund yields have followed suite, despite the lag.

Given the speed and quantum of interest rate cuts to date, coupled with their effect on the consumer and relative lack thereof so far on inflation, it appears as if we may have reached the bottom of the interest rate cycle - or very close to it. The FRA market (interest rate derivatives) retraced higher following the South African Reserve Bank's decision to leave interest rates on hold at the September MPC meeting. During the quarter the repo rate was cut only once by half a percent, signalling a reduction in the urgency to lower interest rates.

However, while the bond market does not seem to have taken much notice of the stronger rand, we would emphasise that should the currency stay around these levels for any length of time, it has the potential to positively (and significantly) influence inflation going forward. We have already had a 5% petrol price cut announced for October and a number of other categories - including food prices - will be positively affected by rand appreciation. Thus the risk is that inflation falls into target sooner than the market is currently expecting and that 2010 inflation is generally better than current market forecasts.

The fund has been participating in the ever growing commercial paper market, where yields have been higher than those available from banks. Ever cognisant of the credit risks out there, we carry out ongoing proprietary research on all the credits in which we invest, not merely relying on the credit ratings agencies for an opinion. The fund currently holds just over 18% in this market largely made up of recognisable names such as Transnet, SABMiller, ACSA, Bidvest, Barloworld and Eskom.

Floating rate investments, issued by the banks, offer an attractive yield pick-up in the money market as banks continue to look for funding. Spreads of up to 0.8% over JIBAR are achievable over one year, giving investors the opportunity to earn this additional yield over and above prevailing interest rates, should they begin to rise again. These investments act as a useful interest hedge as the cycle turns.

Portfolio manager
Tania Miglietta

Cash has continued to outperform bonds this year despite money market rates falling quickly; the South African Reserve Bank (SARB) took just 6 months to unwind almost all of the tightening put in place over the two years from June 2006 to June 2008.

Consumer price inflation (CPI), even though declining, has remained persistently high this year and has yet to respond to the fast falling producer price inflation. While we may yet see some more rapid downward movement in CPI owing to the recent stronger rand, many analysts have revised their forecasts higher. While this has undermined bonds it however adds support to inflation-linked bonds.

Money market rates have bottomed at around 7.5% for now. However, the one-year NCD retraced by a percent when the SARB announced its decision not to cut the repo rate in June. Both government Treasury bill and corporate paper issuance have increased this year, taking substantial market share from the banks. This is also starting to put some upward pressure on NCD rates. We have been building up a reserve cash position in the money market portfolios so as to be able to deploy it when better value returns. This is now starting to happen.

The corporate paper (CP) market has taken off domestically with many new (but familiar names) coming to the market to raise cash in the money market since lending from banks has become more challenging for corporates. CP issuance has been around R4bn a month, much of which has been amply taken up by money market type funds. Overall yields on CP have been rising as spreads over JIBAR have widened, reflective of the tougher operating conditions facing companies.

We have been introducing corporate bonds of less than one year to maturity into the fund as in many instances they offer superior value versus equivalent term NCDs. For example, the Standard Bank senior bond SBS1 (maturing May 2010) was paying around 0.5% more yield than its equivalent NCD at the time, even though it ranks pari passu with bank deposits. We have also bought the ABSA AB04 (March 2010) at an astonishingly wide spread of 250bp over JIBAR which will act as an interest rate hedge should the repo rate start to rise.

The fund continues to be managed in a very conservative way with careful consideration of any credit introduced into the portfolio and awareness of the necessity for high liquidity in this fund.

Portfolio manager
Tania Miglietta

Despite two consecutive higher-than-expected inflation releases in the first two months of this year, expectations of rate cuts intensified heading into 2009. This occurred as local and global economic indicators continued to show significant weakness coupled with developed country central banks increasing the pace of monetary easing via both interest rates and direct liquidity injections.

Against that background, SA money market rates continued their steady fall as prospects for lower interest rates became more likely. The Reserve Bank surprised the market with its call to meet monthly rather than bi-monthly, which signalled that the bank would accelerate repo rate cuts, although Governor Tito Mboweni subsequently said that the MPC would not feel compelled to cut rates at every meeting. On 24 March, at the first of the monthly meetings, the Governor announced a 1% repo rate cut, equalling the February cut and in line with expectations. This resulted in 2.5% in interest rate cuts so far in this easing cycle, bringing the repo rate to 9.5%. The FRA market has been pricing in a quick succession of interest rate cuts, expecting the market to bottom out with the repo rate as low as 6.5% at one point. This has since been tempered somewhat, with a low of 7% now expected.

The NCD market traded below 8% for a one-year NCD, but quickly retraced to close the month at 8.30%. The market has rallied hard from its high of 14% in mid-2008, considering that it was still above 13% as recently as October 2008.

The commercial paper market has continued to be a source of yield for money market funds. A few corporate downgrades this quarter did lead to some spread widening and less take-up by investors. Increased credit risk is never welcome in this conservative market.

The fund has been run at its maximum duration of 90 days during this downward move in interest rates.

Cash returned 11.7% during 2008. Bonds, returning an impressive 16.97%, were the best performing asset class during the year despite a very bearish start brought about by a surge in inflation and sharply rising interest rates. The inflation outlook improved significantly during the quarter as the oil price started to fall and Statistics SA indicated that the CPIX index would be reweighted and rebased in January 2009. Calculations showed that inflation was indeed going to fall sharply.

However, this has taken some time to materialise and only in November 2008 did we see the first convincing decline in inflation. By December, CPIX was at 12.1% - still high, but moving lower. Bond yields peaked in the 3rd quarter, falling sharply thereafter in anticipation of an imminent downward turn in the interest rate cycle. Bond market returns improved dramatically during the 4th quarter, supported by domestic investors piling in after months of being short duration. On the 11th of December SA Reserve Bank Governor Tito Mboweni announced the first 0.5% cut in the interest rate cycle, taking the repo rate to 11.5% after 10 consecutive hikes starting in June 2006. The market is pricing in a very bullish outcome for short-term interest rates over the next year and is expecting as much as a 1% repo rate cut in February, with further cuts thereafter.

The fund held around 36% in floating rate notes, which reset quarterly, allowing the yield to rise with rising interest rates. These have served the fund well acting as an interest rate hedge, during the upward move in the interest rate cycle.

This quarter saw a tremendous increase in commercial paper issuance as banks tightened their credit criteria, which included increasing the cost of borrowing even to top-rated companies. In turn, they responded by borrowing billions directly form the money market via large commercial paper programmes. Due to this increase in demand for cash from all corners, yield spreads widened significantly, benefitting money market investors. The fund held around 30% in commercial paper with an average yield of approximately 12%, to names such as Anglo American, Eskom, Transnet, SAB and Toyota Financial Services.

We continue to manage the fund ultra-conservatively, steering clear of risky securitisation, especially those with high exposure to home and vehicle finance; sectors which we have always said would be hit hard as interest rates rise. Indeed they have been hit hard and repossessions have been severe. Securitisation as an asset class has ground to a halt and we do not expect it to revive any time soon. The fund returned 3% for the quarter and 12% for 2008, thereby outperforming the STeFI index, after fees.

Tania Miglietta
Portfolio Manager

The Coronation Money Market Fund, now R1.7bn in size, is a flagship money market fund with a successful track record of almost a decade. During this period of rising interest rates the fund has produced pleasing performance. It has returned 11.5% after fees for the last 12 months and consistently outperformed the STeFI benchmark.

The fund's 12-month rolling return has risen as short-term money market rates have moved higher. It is important to note that the risk of the fund has not increased to provide this additional yield.

We pride ourselves in carefully managing investors' lowest risk assets by putting credit risk management at the forefront of all the investment objectives associated with a money market fund. Yes, we seek high yields, and aim to outperform underlying money market interest rates over the longer term, but not at the risk of losing capital.

In recent weeks, the US and European financial institutions have experienced unprecedented turmoil in the money markets in which they operate. The US Federal Reserve and Treasury, the Bank of England and the European Central Bank have all had to step-in, in one way or another to provide capital (or a rescue plan) to institutions that have had difficulty receiving daily funding in a market fraught with fear and a lack of liquidity. In some instances, the institutions have been bought up or nationalised, and in others depositors' funds have been guaranteed by the respective central banks.

We draw your attention to our view that this is very much an offshore banking problem, something from which South African banks have been largely protected. The primary reason for this is the existence of SA Foreign Exchange Controls which prevent local banks from participating aggressively in the broader international banking environment.

The SA Reserve Bank requires that SA banks be well capitalised and that international banks operating in SA do so as a full branch of the parent company, where all local deposits are fully guaranteed by the parent. Further to this, exchange controls also prevent these banks from placing excessive amounts of SA depositors' cash in the international arena.

We feel comfortable that the SA banks are sound. They are not experiencing funding difficulty and are most unlikely to suffer the same problems that their international counterparts are currently undergoing. It is also important to note that the SA banks carry a strong support rating by the SA Reserve Bank.

The Coronation Money Market Fund's credit exposure is largely concentrated in the four big SA banks. Further credit diversification is achieved via the corporate paper market, with names such as Anglo American, SAB, Toyota and Mercedes Benz, all of which are fully guaranteed by their respective holding company. The fund also invests with Transnet, Eskom and the Development Bank of SA. The Coronation Money Market Fund is better diversified now than ever before, given the recent growth in the corporate paper market.

The fund currently holds no securitisation assets. We have always held the view that securitisation was largely overpriced and therefore did not compensate investors for the associated uncertainties and risks. We were well rewarded for avoiding this market as prices fell sharply once interest rates rose and spreads widened.

We continue to approach this market with extreme caution and during these volatile times are especially averse to the risk that certain securitisation may pose. We continue to manage the fund conservatively and remain focused on minimising risk during these difficult times.

Tania Miglietta
Portfolio Manager