The past quarter saw a spectacular reversion in the long commodities, short financials and industrials trade, which had been prevalent for the past two years. In a relatively short period there has been a wholesale sell-off in the commodity complex, reversing all the gains achieved and more. Given the size of commodities in the SA equity market, this has resulted in negative returns for the index as a whole. We have been overweight equities in the fund, given their compelling valuations but, fortunately, very underweight commodities. As a result, the fund returned -1.4% for the quarter against its benchmark of -8.6%.

On the asset allocation front, bonds staged a remarkable comeback in this quarter as concerns over inflation seemed to recede, partly on the back of a new inflation measure, but more so due to the sharp decline in commodities such as oil and grains which are important constituents of the inflation basket. While the fund didn't benefit greatly from this it did do well in its holdings of preference shares. I have long pointed out the attractiveness of these investments in the current environment and part of that investment case started to play out in the quarter, with the Coronation Preference Share fund (a reasonable proxy for this fund's holdings) being up 6.9% for the quarter.

As mentioned above, the fund is currently overweight equities, both locally and internationally. What we are seeing play out in global equity markets is an unprecedented change in risk appetite as cash moves from riskier assets to the perceived safety of government bonds. The fact that any major fallout in these economies will have to be covered by the government concerned with greater issuances of debt, seems to have been ignored in favour of the safety offered by owning the bonds 'of the guy who owns the printing press!' Equity markets have never been cheaper in over 20 years and on any measure of valuation they are looking attractive. Even Warren Buffet is now putting serious amounts of capital into equity markets given the yield differentials. I cannot think of any market where equity earnings yields are not well in excess of government bond yields. In exchange for a risk premium you get to invest in a business, which will in all likelihood grow its earnings into perpetuity, compared to a finite life instrument which pays you a fixed return.
In this kind of market it would be remiss of us not to be loading up on equities. The future is without a doubt uncertain. However, it's just as uncertain as it was 12 months ago when equity markets were much higher and optimism abounded. Today all that optimism is long gone and equity valuations discount a significant downturn. Investors' cash holdings are sitting at very high levels and risk aversion is at its maximum - all the hallmarks of a great time to be investing into equities. We do not presume to try and call turning points in equity markets as human sentiment is a fickle thing. What we can do is value businesses, and our estimations show that there are great value opportunities for those with a long-term investment horizon. Our sector exposure was one of the reasons we did so well during the quarter - being underweight commodities. Given the relative price moves we are starting to look to make new investments into this sector. We are, however, being careful not to rush in just yet, as the global outlook for commodities is not great in the short term due to the effects of global deleveraging. That said, we are long-term investors and on a 5- year view we are certainly seeing some good opportunities which we are taking advantage of.

We remain very underweight bonds, preferring the preference share market and longer dated money market instruments which are yielding well in excess of similar duration bonds. Our international allocation is fully invested in global equity markets, which we believe are probably offering more value than even the SA markets.

Volatility of returns is never enjoyable; it is always preferable for returns to come on a pleasing monthly or quarterly basis. However, equity markets are not like that - they reflect the fears and hopes of investors at a specific point in time and can often move away from fundamentals for substantial periods of time.

The benefits of a flexible fund are to be able to take full advantage of these changes in sentiment. As a result, the fund is now heavily weighted towards equities so as to benefit from their superior long-term growth potential.

Neville Chester
Portfolio Manager

It was another difficult quarter for all asset classes, except cash. Global markets came under extreme selling pressure and domestic equities, other than resources continued to decline. Bonds and property were also hit hard by a worsening inflation outlook. The fund was down -3.3% against the benchmark of -0.3%. We have entered a remarkable period in the equity markets. Over the past few quarters we have warned that the returns earned for the past 4 years would not be repeated, however, the actual decline in SA industrial and financial stocks over the past 6 months has been extreme. It is an exciting time for investors to be able to get into the equity market and once again achieve stellar returns over a 5 year investment view (as achieved over the past 5 years to the end of 2007). The fund has increased its equity weighting and is likely to increase further as good investment opportunities arise. When equity is cheap the fund will own more, and it has not been this cheap for a good 5 years. Property, which we have avoided till now, is also starting to look attractive and we have started adding to the better quality names at good yields. Preference shares remain an attractive source of after tax yield, but bonds currently offering a negative real yield, are still not attractive. Instead 3 and 4 year NCDs offering positive real yields have been added to the portfolio. Buying opportunities are never clear cut in a market driven by sentiment. Obviously the outlook and economic expectations need to be cloudy or else the share prices would never fall to such attractive levels. The true long term investor needs to look through the short term gloom and identify truly good businesses which are trading on unrealistically low valuations. As we have said many times before, we don't buy in anticipation of 'catalysts'; this is a red herring because once a catalyst is known it is reflected in the price. Rather, we buy where we have confidence in the long term earnings power of a business and therefore confidence in its normalised valuation. Thereafter the passage of time always results in the true value being unlocked. The idea of a flexible fund like the Coronation Market Plus Fund is to take advantage of the market mispricing assets in order to achieve long-term inflation beating returns. To be moving to cash now gives one the certainty of earning 10% to 12% for the next 12 months, but one then faces the very real re-investment risk of having to invest in cash instruments yielding substantially less thereafter. At the end of 2002 call rates were yielding an attractive rate of 13% and equity markets had fallen by 10% that year. Within a year, the call rate had fallen to 7.7% and for the next 5 years the equity markets returned a compound return of 25% per annum. A lot of market participants lost out on this return, given the conservative asset allocation assumed by many investors after the volatility in 2002/2003. While the benefits of hindsight indicate a low equity weighting and high cash holding were preferable over the past 12 months, one shouldn't let this cloud one's judgement of the potential returns attainable going forward. The road ahead is likely to be bumpy, but when assessing the balance of risks and the valuations of a number of solid businesses with excellent franchises and good cash flows, the obvious asset class is equities. Both locally and offshore we will be maintaining and increasing the equity weightings to benefit from what appears to be an asymmetric payoff profile, where downside is limited and upside return very attractive.

Neville Chester
Portfolio Manager

The first quarter of 2008 was marked by a similar performance in the local equity market to what we saw in the last month of 2007. The disconnect between local industrial and financial shares and the commodity producers was stretched even further. Against the background of falling markets globally the All Share Index returned 2.9% due to the weak rand which drove the commodity shares and dual listeds. The All Bond Index returned -2% as inflation concerns spiralled and property stocks sold off 4.9%. The global MSCI index was down 9% in US dollars as global fears driven by the credit crunch in developed markets saw large scale risk aversion and switching into US government bonds. For the quarter, the fund was down 2% predominantly due to its exposure to local financial and industrial shares which performed poorly during the period.

We have been running a maximum position in international assets as allowed by the fund's mandate and have held a number of non-commodity rand hedges due to our long held view that the rand was more likely to weaken than to strengthen. This view has materialised and the fund has benefited from some of these holdings. The offshore returns were tempered by the poor international equity markets which are reflecting a mild global recession. In fact, for the global market rating to return to its long term average it would require profits to fall by approximately 20% across the board! We think global equities are offering extremely good value and are a great investment. Some of the rand hedges we own have however performed disappointingly, especially those that are not dual listed as the market tends to wait until the actual numbers come through in earnings. We are happy to remain holders of these businesses until then.

We would not be taking more money offshore at these levels though as it is likely that we will see a retracement in some of the rand's performance in the period ahead. Eskom and the mines have reached agreement on providing the necessary power and on how the mines can regain their previous productivity using less power. This will result in mines achieving close to their previous production levels. At the same time, to the extent that metals hold their higher prices, SA will be earning significantly more for its exports than three or six months ago. This will have a significant impact on the current account deficit as seen in 2002 post the previous currency crisis. Concurrently we have already seen imports fall rapidly due to the weaker rand and the impact this has on demand for expensive imported goods. Fundamentally the rand is oversold and will come back somewhat from its current levels.

At the equity level we remain underweight commodities; looking at the greater macro picture it is evident that commodities have become an alternative asset class to equities. The negative correlation between the S&P and commodities is very clear. There is a lot of 'hot' money which has moved into commodities, helping to sustain current high levels despite the fact that growth in the world is slowing rapidly. When risk aversion reduces and we see money beginning to flow back into equities (and US equities in particular) we will see a very rapid unwind of the speculative positions in commodities, which will see these prices retreat significantly. We have seen a couple of false starts on this front already and once again it seems that this may be in the process of happening. During this recent commodity boom the commodity companies' cost of production has sky-rocketed due to a number of cost pressures; any negative move on the top line is likely to be magnified significantly on the bottom line through margin compression.

The net result is that we remain heavily skewed in our portfolio to non-commodity businesses and those commodity shares that we do own have their own specific drivers. Platinum is almost entirely SA produced and hence its cost of SA production will set the price, which gives us confidence in its ability to maintain margins. In addition our holding of Impala gives us access to its Zimbabwe operations which we believe are significantly undervalued by the market. Exxaro is one of the main independent coal producers in SA, given the planned introduction of three new coal fired power stations over the next eight years they stand to benefit significantly from the increased off-take.

In selecting companies to own it is crucial to look at the margin of safety and where the balance of the risk is skewed to the upside. We are very comfortable with the current portfolio given that most of the companies are pricing in most of the negative news and giving no credit for any potential upside. This is in contrast to a lot of the commodity shares which are priced for most of the good news and little room for disappointment.

In the rest of the portfolio we remain large holders of preference shares due to their great after tax return to unit holders, preferring these instruments over cash. We have also started to add some property as the yields on some stocks are now above that of government bonds; at last giving the investor a premium for the additional risk taken in investing in listed property. Given the available investment opportunities elsewhere we continue to have insignificant bond holdings.

Neville Chester
Portfolio Manager

The last quarter of 2007 was not kind to equities as the global malaise affecting most developed markets made its impact felt locally, and certainly political tensions in the run up to the ANC elections made foreign investors nervous. The situation was further compounded by two interest rate hikes, which have placed the consumer under pressure, and impacted the ratings of domestic interest rate-sensitive stocks.

The All Share Index lost 3% for the quarter, bringing the total return for 2007 down to 19.2%; still a great return, but one which was achieved by a few specific stocks doing extremely well and a large number underperforming. Bonds fared poorly overall for the year with a paltry 4.2% significantly underperforming the cash return of 10.1%. Remarkably, despite the usual linkage between bonds and property stocks, the SA listed property index returned 26.5% for the year, another phenomenal performance from this sector.

The Market Plus Fund managed to return -0.84% against the benchmark return of -0.44% for the quarter, and 14.2% for the year against the benchmark return of 16%. Overall, the long-term track record of the fund remains excellent and we believe that there is once again great opportunity to make some good investments in the current climate. As alluded to earlier, while the overall index is positive a number of shares have fallen significantly out of favour in the market, and have been marked down during the past year. This does not happen without reason and there are, as always with investing, risks attached to these businesses. That said the price at which one can buy these shares (in my view) significantly discounts the risks.

With the top of the interest rate cycle being very near in my estimation, buying some of the banks on forward multiples of less than 8 and dividend yields of 4% looks very attractive, especially as these shares have avoided the huge write-offs of their developed peers, yet suffered significant de-rating nonetheless.

As usual, in times of uncertainty the market has been indiscriminate in its de-rating and some sturdy defensive type names, such as Tiger Brands and Bidvest, have also de-rated and are looking very attractive as a long-term investment.

Equities remain the largest holding of the fund, having been added to during the main period of weakness in December (which appears to have been more technical futures related than true underlying price movements). The second largest holding is preference shares which I have mentioned before are offering some of the best risk-adjusted returns possible. The balance of the fund is now invested mainly in cash as property stocks do not look particularly attractive and yields in excess of 10% are available in the short to medium-term cash market.

We wish all unit holders a happy and prosperous 2008.

Neville Chester
Portfolio Manager