The third quarter of 2002 was marked by the same extreme volatility that has been a hallmark of the year. Continued sentiment swings in international markets between growth and recession, and between war and a benign political outlook, created immense volatility in international equity markets. This was compounded in the local market, particularly in July, by increased political risk caused by the release of the draft Minerals Charter.

Inflation continued to be a major worry locally, with PPI surprising negatively on the up side, which resulted in the Reserve Bank having to hike interest rates by a further 100 basis points. This created further downward pressure on local equities as growth expectations for 2003 were reduced. Gold has continued to hold up in the low $300's due to international political risks, although it is quite volatile within the $300 to $320 range, this has enabled one to trade gold stocks fairly aggressively. Failing a conclusive result in the Middle East, we expect the gold price to remain above the $300 level.

In this incredibly volatile environment, the fund has managed to maintain a respectable return against its benchmark. The funds selected equities have generally been of a fairly defensive nature, which has enabled the fund to outperform the equity benchmark. The fund managers substantially reduced the fixed interest position during the period due to their concerns over inflation and the likelihood of further interest rate hikes. The fund managers remain firm in the view that inflation will be a concern for longer.

Overall, South African equity valuations are still attractive and the domestic economy remains fairly resilient, despite the punishing effect of higher interest rates. Nonetheless, the fund managers are extremely cautious and have remained in fairly defensive equity positions. The fund managers have not further reduced the fund's equity exposure due to the prospect of good returns in the local market over the next 12 to 18 months but, due to their expected weak outlook for international markets, they do not believe a higher weighting in equities is justified, in spite of the previously mentioned attractive valuations.

Volatility remained the key characteristic of markets throughout the second quarter of the year. The currency remained strong, which confounded most economists' earlier forecasts. However, inflation proved to be much higher and stickier than previously expected, triggering a further interest rate hike in June (with the expectation of a further interest rate hike in September strengthening). The net result was a sharp re-rating of domestic shares in April as the rand strengthened, followed by a further round of de-rating in May and June as expectations of further interest rate increases heightened.
Globally, the volatility was even more extreme as political issues in the Middle East and on the sub-continent contributed to an already strong gold price. The dollar weakened substantially as investors became concerned about the quality of reported earnings in the US, as well as the growth prospects for the US economy. Technology markets weakened further, placing greater pressure on technology companies around the world.
Within this difficult environment, the fund was able to take advantage of some of the volatility. It was positioned for the upturn in local markets in April and, having reduced exposure in early May, was able to protect most of the gains made during this period. The fund's exposure to bonds has been increased slowly, favouring better yielding corporate bonds over government bonds.
Going forward, the fund manager's are once again increasing exposure to financial shares due to their highly attractive valuations. In addition, specific non-mining resource shares are looking attractive both from a valuation and a future currency hedging perspective.
Given the fund manager's bearish outlook on international equity markets, they are cautious in moving too aggressively overweight into equities despite compelling valuations. The fund manager's believe the timing of this move will be key to achieving continued out-performance of the benchmark.

The past quarter started off no easier than the final quarter of 2001. While the currency did retrace some of its earlier losses, the delayed impact of the resultant inflationary pressure made itself felt in the local economy. This precipitated a number of sharp interest rates hikes, with a further 1% increase expected in the near future. Against this backdrop, local industrial and financial shares failed to perform, despite good earnings growth being reported.
Further pressure has been placed on equity markets due to the spectacular failures of companies locally and globally. The Enron debacle in the US has raised serious concerns over the earnings quality being reported, and locally the failure of the A2 rated banks has sparked a mini run on the banking sector. In this difficult environment, resource stocks continue to outperform. Gold shares in particular, outperformed on the back of rising gold prices and the realisation that the Rand depreciation was here to stay.
On balance, the fund was well positioned to benefit from these circumstances, although our weighting in the very attractively priced financial sector did drag performance down slightly. Nonetheless, the fund manager remains convinced that the historical low valuations in this sector will offer good returns in the future.
In early January the fund held a small position in bonds, but due to concerns over the valuations given the inflation outlook, have avoided the asset class since then. This view has been vindicated due to the increase in yields in recent months.
Going into the second quarter the fund manager remains cautious over the perceived global recovery. While most signs indicate it to be on track, the fund manager is hesitant to take an overly aggressive stance based on this view. The fund manager remains positive on specific sectors within the resources index and on the financial sector in general.