The fund generated a return (net of management fees) of 1.62% for the quarter and 6.49% over a rolling 12-month period, which is ahead of the 3- month STeFI benchmark return of 6.02%. South African fixed income markets strengthened marginally during the quarter. The All Bond Index advanced 1.1%, after delivering a negative 1.4% return in the previous quarter. Nominal bonds have outperformed inflation-linked bonds over the last 12 months, delivering a return of 5% versus the nominal bond return of 7.0% for the year. NCD levels have tightened marginally by 5 basis points during the quarter, but have widened by 7.5 basis points since the beginning of the year.

Following an already volatile August, market turmoil against a weaker global and domestic growth backdrop continued to influence market performance in September. Much attention was given to the possibility that the US Federal Reserve (Fed) would start to normalise interest rates at their September meeting, but the Federal Open Market Committee (FOMC) again left rates on hold, for the first time citing the risks posed to US growth from emerging market economic weakness and volatility in asset markets globally. The US dollar index (DXY) extended gains, but heightened general concerns about growth and disinflation. Emerging market currencies were hard hit. Following these developments, and persistently mixed US activity data, even in early-October there remains considerable uncertainty about the timing of the first Fed rate hike. Subsequent to the Fed's decision to pause, the South African Reserve Bank (SARB) also held rates steady at their September Monetary Policy Committee (MPC) meeting. The statement continued to highlight upside risk to the MPC inflation forecast, mostly from the currency, and indeed recent currency weakness resulted in an upward revision to SARB headline and core inflation forecasts for 2016 and 2017, but a short-term improvement in outlook for 2015 from lower oil prices. The SARB revised its growth forecasts lower over the forecast horizon. In its concluding remarks, the MPC acknowledged that it was cognisant of not having an undue negative impact on short-term growth prospects and that this played into the decision to remain on hold for the time being.

Economic data released in September continue to paint a picture of weak domestic growth, with few bright spots. Following supply-side data, which revealed a contraction in gross value added in the second quarter, the SARB Quarterly Bulletin provided a breakdown of the expenditure side. Most of the contraction was accounted for by a very large adjustment in inventories, but outside of this other demand drivers remain weak. Household spending accelerated off a weak base to 4.6% y/y. Household debt levels were a little lower, but the higher interest rate (announced at the July MPC meeting) put a floor under debt service costs, which were unchanged at 9.4% of disposable income. Gross fixed capital formation - notably by the private sector - remained weak at 1.3% y/y. Government spending was up just 0.2% y/y, in line with National Treasury's commitment to keeping expenditure under control. Net exports offered a glimmer of hope, with an improvement that yielded a trade surplus on the current account of the balance of payments. The services balance deteriorated in line with pressure on tourist arrivals, and the non-trade deficit was -3.5% of GDP. Taken together, the deficit on the current account narrowed to -3.1% of GDP from -4.7% in the previous quarter.

Forward-looking data remains discouraging. The PMI print for September was largely unchanged at 49 index points, describing a manufacturing sector performing below trend. Business activity fell again to 46.6 from 48.6, while prices paid ticked up to 77.6 from 76.3 - this was partly offset by rising new orders and an improvement in the employment index. After two months of big cuts in retail fuel prices, October will see a small underrecovery as the currency has weakened beyond the fall in oil prices. This bodes poorly for inflation in coming months. Vehicle sales in September contracted heavily, reflecting still-weak consumer confidence which - although an improvement on the second quarter - remains below trend at -5 index points in the third quarter. This remains a very uncomfortable position for the MPC.

The global economic backdrop remains unclear. Asia and Europe remain firmly in easing mode while the US economy seems mostly on track to start their rate normalisation process before the end of 2015. However, the timing and extent of rate normalisation in the US is still uncertain, and is expected to be very subdued and protracted in comparison to previous cycles. Market volatility has increased considerably over the last month and continues to suggest that the premium required to hold risk assets may be higher than is currently being priced into markets over the short term. We see downside risks to domestic growth, with inflation expected to remain around the top end of the band for the next few quarters. SA government bonds have now moved closer to fair value during the month of September and could present a much more attractive entry point.

We continue to seek attractive yielding opportunities for the fund while being cognisant of the liquidity constraints for a money market fund.

Portfolio managers
Mark le Roux and Nomathibana Matshoba

The fund generated a return (net of management fees) of 1.57% for the quarter and 6.36% over a rolling 12-month period, which is ahead of the 3- month STeFI benchmark return of 5.94%.

South African bonds remained under pressure in the second quarter of the year. The All Bond Index fell 1.4%, after posting +3% in the prior quarter. Inflation-linked bond returns remained strong, with the index posting 1.55% for the quarter and 3.12% y/y. Cash outperformed both nominal and inflation-linked bonds this quarter, with a return of 1.6%. Data published in June continued to show soft growth outcomes, but rising inflation pressure. Both the Consumer Price Index (CPI) and Producer Price Index (PPI) prints for May surprised to the upside, the former rising 4.6% y/y from 4.5% - driven mainly by food and transport costs. PPI was also higher at 3.6% y/y, from 3.0%, with food and fuel prices as well as machinery prices the main contributors to the acceleration. The weaker currency and moderately higher international oil prices will add to the cost of running transport in the next two months' data, and the July print will be exacerbated by an annual increase in electricity prices of about 13%.

Growth data remain mixed and muted. Aggregate private sector credit growth was 9.5% y/y, but the breakdown showed credit extended to businesses remains strong, whereas household credit extension is languishing at 3.2% y/y. Manufacturing production in April contracted by 2% y/y, while mining production slowed to 7.7% y/y from 19.5% in March. The combined weak economic data and deteriorating inflation trend continues to undermine confidence amongst both businesses and consumers. According to survey data from the Bureau for Economic Research, business confidence fell to 43 index points in the second quarter of this year, implying that 57% of respondents view current conditions as dissatisfactory, and consumer confidence slipped to -4, from 0 - well below the long-term average of 5 index points.

On 29 June the National Energy Regulator of South Africa (Nersa) rejected Eskom's application for an additional tariff top-up for the 2016/17 fiscal year (an implied municipal increase for July 2016), mostly on technical grounds, but also because Eskom has failed to deliver on past promises. This is not to say that Eskom cannot reapply, or that the overall inflation impact (once clawbacks are included) will be materially below the South African Reserve Bank's (SARB) current forecasts, but the upside risk from this source is perhaps somewhat diminished. That said, a combination of rising retail fuel prices, another recent spike in domestic maize prices and the persistent vulnerability of the currency to interest rate normalisation in the US remain.

This economic environment is extremely challenging for the SARB's Monetary Policy Committee (MPC). When they meet again from 21-23 July, they will have a June CPI print, which is likely to be higher than 5% y/y and rising. Despite the 'reprieve' from Nersa, the fact that two members of the committee voted in favour of a hike at the May meeting, coupled with persistent upside inflation risk, makes us believe there is a significant risk that the MPC raises the repo rate by 25bps at this meeting.

Corporate bond issuance remained muted, with banks being the major volume issuers during the quarter. Other notable issuers include the Development Bank of Southern Africa, Ekurhuleni Metropolitan Municipality (offering an amortising bond), Mercedes-Benz and Toyota Financial Services. We still believe there remains scope for credit spreads to push wider and are therefore not being aggressive in locking in cash. We continue to seek attractive yielding opportunities, while being cognisant of the liquidity constraints for a money market fund.

Portfolio managers
Mark le Roux and Nomathibana Matshoba

The fund generated a return (net of management fees) of 1.56% for the quarter and 6.21% over a rolling 12-month period, which is ahead of the 3- month STeFI benchmark return of 5.84%.

The first quarter of the year was characterised by a sharp decline and subsequent rebound in domestic bond yields following the move lower in global energy prices and decline in inflation expectations. The SA government 11yr conventional bond (R186) yield started the quarter at 7.98%, troughed at 7.03%, only to rebound to 7.71% at close. Even against this backdrop, conventional bonds outperformed both cash (1.55%) and inflation-linked bonds (0.2%) with a return of 3% for the quarter. The rand did a similar summersault: opening at $/R11.74, troughing at $/R11.30, and closing back at $/R12.20. Inflation registered a historic low of 3.9% y/y in February following the sharp decline in energy and food prices; however, the inflation trajectory in the coming months will likely increase. This is due to the outlook for food prices, until recently a strong contributor to disinflation, looking less favourable. Food inflation slowed to 6.4% y/y in February, from a recent peak of 9.4% y/y in August 2014. But the Crop Estimates Committee forecast for the current maize harvest was cut to its smallest since 2007, due to severe drought in the North West and Free State. Maize is an important component in the food basket, not only as a cereal, but also because it affects meat and dairy prices. The impact on headline inflation will likely only become evident from mid-year.

The Monetary Policy Committee (MPC) left the repo rate unchanged at 5.75% following its March 26 meeting, but the issued statement highlighted deterioration in the inflation outlook. The MPC revised its forecast for inflation from 3.8% to 4.8% in the current year, and to 5.9% in the next two years. Compared to the context in which the January meeting took place, when the committee concluded that the lower oil price would allow them a pause in the cycle of rate normalisation, the March meeting conceded that the room to pause had narrowed. The committee also highlighted concerns that a change in US monetary policy may put renewed pressure on the exchange rate. Growth prospects remain poor. Despite the weaker currency, manufacturing and mining sector output has been weak year-to-date. At this stage, the weak growth outcome, coupled with Eskom's supply constraint, offers some muting effect to inflation. The MPC nonetheless rang a cautionary note that it would continue to normalise policy rates in coming meetings. Bank funding spreads pushed up an average 60bps from the start of the year. Given that corporate issuance is generally priced off the bank curve, the cost of funding for other corporate institutions has increased. We are starting to see normalisation in the credit markets, following the tightening of spreads experienced in the past three years. We continue to seek attractive yielding opportunities for the fund while being cognisant of the liquidity constraints for a money market fund.

Portfolio managers
Mark le Roux and Nomathibana Matshoba

The fund generated a return (net of management fees) of 5.92% over a rolling 12-month period, which is ahead of the 3-month STeFI benchmark return of 5.65%.

The fourth quarter of the year was dominated by the plunge in the oil price, as brent crude oil closed the quarter at historical lows of $57/bbl (having opened the quarter at $96/bbl). Following this, global inflation forecasts were revised downwards and uncertainty prevailed around the likely path of global monetary policy. Local nominal bonds were the major beneficiary of falling inflation expectations, managing to outperform both cash (1.5%) and inflation-linked bonds (2.2%) after producing 4.2% for the quarter. Short-term rates followed this path, as 3- and 5-year bank NCD yields closed on average 16bps lower for the quarter. This was despite a further 2.5% weakening in USDZAR spot levels, as the dollar strengthened against almost all developed and emerging market currencies.

Year-on-year inflation decreased from 6.4% to 5.8% over the quarter, primarily due to lower fuel and food prices. This downward trend for inflation is expected to continue into 2015 and should provide a meaningful anchor for short-term yields. Despite reiterating that South Africa (SA) is in an upward rate cycle, the SA Reserve Bank (SARB) will find it difficult to hike rates given anaemic growth and falling inflation; headline inflation is expected to average 4.7% in 2015, compared to an expectation of 6.1% in 2014.

The slower pace of inflation also implies a slower pace of monetary policy normalisation. Having raised interest rates by 75bps to reach a repo rate level of 5.75% in 2014, we expect the SARB Monetary Policy Committee to pause while inflation moderates, but to hold the line as price pressures re-emerge later in the year. The current account was badly affected by lost mining and manufacturing production, and this further undermined the performance of the local currency. The current account deficit had a modest recovery to -6.0% in the third quarter of 2014. For the year as a whole, the deficit is forecast at about -5.8%.

Disappointing economic activity has put pressure on profits and revenue collection, leaving government with another large fiscal deficit, and rising debt stock. Growth in 2014 is expected to reach just 1.4%, from 1.9% in 2013. Ratings agencies responded to this bleak series of events by downgrading SA's credit ratings in mid-2014. Moody's downgraded the credit rating in November to Baa2 from Baa1. All three agencies (viz. Moody's, Fitch and S&P) cited worsening growth prospects, the weakened fiscal position and long-term growth constrains of limited electricity capacity, as well as fragile labour relations and low employment growth as risks to the sovereign rating. As managers of the fund, we continue to seek attractive yielding opportunities while minimising interest rate risk.

Portfolio managers
Mark le Roux and Nomathibana Matshoba