Global capital markets delivered a strong performance for the quarter as a combination of new support for struggling European nations and a third round of quantitative easing (QE3) in the US saw renewed support for risk assets. SA equity markets performed strongly in line with this, as did the local bond market, which was well supported by its first time inclusion in the Citigroup World Global Bond Index, attracting strong flows from offshore tracking funds into SA. The fund performed well during this period with a return of 7.3%, ahead of its benchmark return of 6.4% and in line with the equity market's 7.3%; despite only being 65% invested in equities. This quarter brings the full-year return for the fund to 21.9%, ahead of the benchmark return of 21.2% and significantly beating inflation. Internationally the search for yield continues. The record level of cash being printed by central banks around the world has started to create more anomalies. While the market is still somewhat circumspect around equities, the flows into bonds continue unabated. We recently saw a global mining company, a highly cyclical business, issue a 30-year bond with a yield of approximately 4.3% in US dollars. To receive that meagre return in exchange for the assumption of 30-years of risk - which, to put into perspective, is close to the term of one's entire working career - is absurd. However with trillions of dollars trying to find a home, and interest rates being held artificially low through quantitative easing, these anomalies will continue. Taking advantage of this anomalous pricing, however, is to many companies' advantage. The ability to secure long-term debt at incredibly low pricing allows them to acquire businesses at immediately earnings accretive levels. This provides an underpin for mergers and acquisitions in the current market, and puts a solid floor under equity valuations. In fact, many companies around the world can borrow at yields below their own dividend yields. Concerns over global growth, and particularly growth in China, have seen resource companies broadly under pressure. However, post the announcement of QE3, we saw a strong rally in commodity company share prices, which benefitted the fund given its exposure to these shares. Unfortunately, in the last month we have seen SA miners derate once again as the tragedy at Marikana unfolded and the rampant strikes and high levels of violent protest continued unabated. While this is not good for SA overall, and especially not for the prospects of future employment growth in SA, it has caused the price of the platinum group metals to increase significantly. Part of our investment case in owning the platinum miners has been that, due to the majority of the world supply coming from SA, ultimately the global price will need to reflect SA's cost base. So far we see this thesis as holding true. By owning the lowest cost producers in SA we expect to earn good returns once the situation normalises. The fund also owns a number of rand hedge shares such as British American Tobacco and Capital Shopping Centres. It furthermore holds a significant direct allocation in offshore assets. These have all helped protect investors' capital against the sharp sell-off in the rand post the work stoppages in the mines. Even prior to the mining sector strikes the country had posted a dire current account deficit as we, as a nation, continue to live well beyond our means. Imports continue to rise strongly while exports have weakened. Given that there has been very little activity in the mining sector, we expect that exports will look even worse and the current account deficit will deteriorate even further. This will ultimately impact on the rand, which will keep the currency weak, and thus we retain our high weighting to rand hedges. Within the direct offshore allocation our equity selection has performed well, but we have done particularly well investing in various global property stocks and corporate bonds issued by SAdomiciled companies offshore. The ability to take a longer-term view and appropriately price for risk has allowed us to generate fantastic returns at much lower levels of risk. Domestically we have also done well from our inflation-linked bond holdings. As our central bank followed the lead of the US and UK by giving up on being concerned over price stability in favour of trying to promote growth, the market has appreciated the value of ILBs. As their yield directly references the inflation rate and not the arbitrarily set repo rate, ILBs offer real returns in an environment where this is hard to come by. We have continued to sell down our SA property exposure into strength as we believe on a longer-term outlook the yields in this sector are unsustainably low. Overall the fund is conservatively positioned. While we have a big weighting to resources within equities, only 43.7% of the fund is invested in local equities, which highlights our preference for offshore assets. We continue to believe the fully flexible mandate allows the fund to be well positioned to deliver on its objectives of significantly outperforming a balanced benchmark and inflation over the longer term.
Portfolio manager
Neville Chester

The past quarter was another volatile period for capital markets globally as optimism on a global recovery collapsed into fears surrounding the Spanish banking sector, ultimately to recover on the outcome of a successful European summit at the end of June. The fund had an uninspiring quarter, returning 0.2% against the FTSE/JSE All Share return of 1% and the benchmark return of 2.2%. Domestic equities experienced a very volatile quarter, with April being a strong month followed by a sharp sell-off into May, only to recover along with global markets towards the end of June as the Spanish banking sector was given a reprieve. You may wonder what SA equity has to do with the Spanish banking sector, and with good cause. The answer is nothing other than the fact that during the global financial crises all 'risk' assets have become highly correlated so that in the short term asset prices tend to react together, not for rational reasons. The equity in the fund had a reasonable quarter with our position in banks, telco's and healthcare stocks contributing positively while our exposure to resource companies detracted. We have continued to see investor flows into retail stocks at what we think are unattractive valuations, while resource companies languish on low multiples on our assessment of normal earnings. The opportunity in the high quality diversified miners is very clear to us, but they can easily remain cheap for much longer and as always patience is required for the investment view to come through. Our overall SA equity exposure has remained at around 45% of fund as, while we see some good pockets of value, overall the market is fairly valued in our view. Our international exposure added to performance as the Rand weakened during the quarter, and we continue to favour exposure to international equities where valuations remain the most attractive. Dividend yields are mostly well above bond yields in these countries and despite most of the countries being heavily indebted, investors continue to switch from equities to bonds. We are very happy to be on the other side of this trade. Domestic property continues to perform extremely well and this has impacted our performance relative to the benchmark as we have reduced our property holdings significantly. With domestic property now yielding between 7.5% and 8.5% we don't think there is sufficient margin of safety left in these counters. In addition the flood of new listings and capital raisings in this sector is further proof of how toppish valuations are. Against the local valuations we are able to find high quality global property stocks trading on equivalent and sometimes even higher yields which make for more compelling investments. Finally in the bond markets we continue to avoid most sovereign issues. Given the high levels of government indebtedness and the artificial lowering of yield curves by quantitative easing and the long-term refinancing operation in Europe, there is no value to be had here. In certain cases we can find value in corporate bonds which we think are mispriced, and in inflation-linked bonds which offer some yield protection. The SA bond market has rallied strongly this quarter on renewed speculation around the possibility of further rate cuts and the inclusion of South Africa into the Citi World Government Bond Index. While these are short-term positives, we remain concerned about the ability of government to fund its growing budget deficit and the huge demands from parastatals to fund their growth plans. The fund remains well positioned for what are likely to remain volatile times, with sufficient diversification across asset classes and instruments to provide inflation-beating returns over meaningful periods.

Portfolio manager
Neville Chester Client

The first quarter of 2012 started with a strong rally in risk assets around the world. Too much negativity around a European debt crisis abated as the Greek debt forgiveness was passed. Emerging markets in particular have had a strong start to the year. The fund was up 6.2% for the quarter, well ahead of the benchmark return of 4.5% and ahead of the JSE All Share Index return of 6%.

The first quarter returns for our equity allocation were good as some of our key stock positions came through. Our long held position in banks paid off handsomely as they all showed very strong sets of results, with potential for earnings to continue growing in the year ahead. With strong capital bases and stable asset growth, the prospects for a continuation of their good dividends also remain intact. During this period we have also increased our exposure to Investec. The company has not seen the benefits of the benign interest rate environment as they have still been cleaning up a number of the mistakes made in their offshore businesses during the past five years. Once these are out of the way we think it will highlight the good value in the business, which remains a significant player in the high-end banking environment, and more importantly, a major player in fund management in SA and the UK. The fund management business, unlike banking is capital light and generates significant free cash.

Generally the industrial shares also had a good quarter, with our holdings in Woolworths, Tiger Brands and Famous Brands all delivering sterling returns. Mondi, one of our biggest holdings, produced an excellent set of results surprising the market with the strength of its operating assets and cash flows which support its high dividend yield. Unfortunately our largest holding, MTN, had a tough quarter on the back of negative newsflow out of Nigeria, Iran and the possibility of a lawsuit surrounding the manner in which it secured its Iranian mobile licence. While we can't go into detail into all of these issues, we have modelled MTN very conservatively, factoring in the political and macroeconomic risks it face in the various regions where it operates. Considering all these issues we still find a lot of value in the MTN investment case. Operationally the business continues to perform well and this is evidenced in its high dividend yield, which is in excess of 6%.

The commodity shares had a mixed quarter with the precious metals miners, platinum and gold, coming under heavy selling pressure. These industries continue to face labour unrest, unrelenting cost pressure and declining grades. Against this, base and bulk metal producers continue to deliver massive earnings growth at huge margins. We have studiously avoided the gold sector to date which has been a wise choice. Instead we prefer platinum, where the metal price is not inflated by speculative demand and the mines are still generating profits. As the commodity sector has sold off on the back of concerns over slowing growth in China we have selectively added to the portfolio where value has appeared.

Outside of domestic equities our global equity exposure has performed well, especially our exposure to emerging markets as we see renewed investor confidence in these regions. Our portfolio of high yielding global bonds also delivered pleasing returns as spreads compressed on a number of these instruments. Our domestic portfolio of inflation-linked bonds also had a good run as investors kept paying up for inflation protection in this environment of loose monetary policy. Late last year we added exposure to selected global property stocks, the majority of which were trading at yields in excess of domestic property stocks. A number of these have also rerated in the recent risk rally, adding to the fund's overall return.

It would be foolish to extrapolate the run of the last quarter over the full year. The world remains a conflicted and uncertain place, with many sovereign states grappling with excessive debt levels and low or no economic growth. The mix of different assets in the fund allows one exposure to growth, but with a measured level of risk. This is not an environment in which one should be swinging for the fences, but rather methodically and steadily adding return based on our long-term fundamental investment approach.

Portfolio manager
Neville Chester

The fund had a strong absolute performance in the final quarter of the year, delivering a return of 6.7% which was marginally ahead of the benchmark return of 6.6%. For the year the fund delivered an excellent return of 8.5% against the benchmark return of 6.3% and the JSE All Share Index return of 2.6%.

The major positive contributor to performance throughout 2011 was our overweight position in offshore assets. For a number of quarters we have communicated our view that the rand was overvalued, and equity and other offshore assets were attractive compared to the South African market. This view came through strongly as the rand weakened against all the major currencies, which also boosted some of the SAlisted rand hedges we held.

The other big contributor was the domestic equity portfolio, where good stock selection added significant alpha to turn a poor market return into a decent equity contribution for the fund. Our big holding in British American Tobacco (BAT) as well as poorly followed smaller companies like Capital & Counties and Optimum Collieries added significantly to the alpha generation.

Finally, our holding in inflation-linked bonds, which we have also mentioned before, came through strongly as inflation in South Africa breached the upper limit of the Reserve Bank's target range. Given the weaker rand, we expect inflation to continue deteriorating.

Looking forward into 2012, we expect markets to remain volatile given the uncertain economic and political environment in all the major global economies. Against this uncertain environment we continue to focus within equities on businesses that either have very defensive earnings, or those that already price in a very negative outcome.

In the former camp we would include BAT, Tiger Brands, SABMiller and MTN - all significant positions in the fund. In the latter camp would be the domestic banks which are tainted by the global dislike for banks even though they do not face the same risks. On 9 times earnings and dividend yields of 4% - 5% they remain attractively priced investments.

Given the valuations of domestic equities overall we are slightly underweight local equity, compared to being overweight global equities, having added to our investments in developed markets as well as other emerging markets where we find much more compelling value. As a result, we also remain overweight foreign exposure relative to our benchmark.

The other attractive global asset class we are currently invested in are carefully researched credit instruments which are offering double digit returns in dollars, a very compelling investment in an environment where dollar cash is effectively yielding zero percent.

The fund is still avoiding fixed rate government debt as we expect more pressure here due to increasing amounts of debt that needs to be issued to fund growing global deficits. That said the SA yield curve has moved out and is starting to look more interesting should we see further weakness. We continue to prefer inflation-linked bonds given their ability to protect against unexpected inflation.

Our property holding remains fairly large as we continue to hold well priced assets with yields close to double digits and generally low risk of rent reversions. This means that we have high confidence in the stocks maintaining the current dividend yields.

Managing a flexible asset allocation fund is extremely rewarding in that it allows the manager the widest scope possible to try and produce inflation-beating returns. Given this we are pleased to have been able to deliver another year of returns ahead of inflation despite a difficult environment. We believe the fund is structured to be able to continue to deliver this over the longer term.

Portfolio manager
Neville Chester