Over the quarter the MSCI World Index gained 2.82% in rand terms, while the Coronation International Active Fund of Funds generated 3.55%. For the year to date, the fund has outperformed the index by 3.11% in rands, and underperformed by 2.98% for the rolling 12 months to end September 2004.
With investors believing that we had reached the peak in corporate earnings, poor liquidity over the quarter, rising oil prices and slowing global growth, it is not hard to see that the headwinds facing equity markets were more than a temporary obstacle. All developed market indices declined over the quarter in local currency terms. On a relative basis, equities associated with higher risk premia like the Nasdaq (-7.3%) and smaller cap Russell 2000 (-3.1%) underperformed the broader indices such as the S&P 500 (-2.3%). Of the developed markets, Japan faired the worst. The Nikkei 225 declined by -8.73% as the prospect of a weaker US consumer, lower revenue forecasts by Intel, and lower than expected GDP growth in Japan led by disappointing consumer spending weighed on the market over the quarter.
With no clear trends and poor underlying liquidity, investment professionals have attempted to add value at a stock level. This approach has brought with it increased stock specific risk over the quarter, as a risk averse investment community have not been patient with companies that have delivered anything but positive news on their earnings momentum. At a sector level, the rotation into commodity and commodity linked sectors was extremely strong across all markets, whereas technology, retail, and financial sectors suffered the most severe losses over the three month period.
The fund invests in both global and regional investment teams whose investment philosophies are not constrained by passive indices. The fund has been marginally overweight toward the Japanese equity market over the quarter and this detracted from performance in the short-term. Manager selection generated positive performance over the past three months with relative outperformance coming from 80% of the funds with whom we hold investments.
In the US, outperformance came from Copper Spire -0.80%, versus the S&P500 loss of -2.3% and Close Finsbury, with are return of -1.77%. Small cap specialist, Wanger, underperformed with a decline of -3.56 over the quarter.
All of our European fund managers contributed positive outperformance over the quarter against the MSCI European Index which was negative -1.2%. Odey Europe produced a positive return of 4.3% due to the fund's strong bias toward energy sectors and JO Hambro Europe returned +0.60%.
The fund's overweight exposure to Japan detracted from returns together with slight underperformance from manager selection. Although Morant Wright contributed with positive outperformance of 1.95% against the Topix which declined by -7.35%, Odey Japan suffered as a result of their positioning in reflationary property and bank stocks, causing the fund to underperform by 2.16% over the quarter.
The fund's allocation to a global manager, GLG Capital Appreciation (-0.05%), provided positive outperformance due to the fund's tactical asset allocation between fixed interest and equities.

Overview
Global capital markets entered a new and potentially difficult phase this quarter as the release of March payroll data (in April) confirmed the long awaited growth in US jobs. The immediate conclusion reached by investors was that this was a clear signal for the Federal Reserve to begin to increase interest rates from the 46-year low of 1%. Although the impact on the capital markets was anticipated, its severity and knock-on effect across the various asset classes came as a shock to most of the investing community. The common denominator to increasingly volatile markets, whether it be credit, emerging markets, currencies or fixed income, was that the surplus liquidity which has served to bolster (at ultra low rates) global demand for risky assets would begin to decline going forward. This has meant that the second quarter of 2004 has seen the commencement of a painful period, with the beginning of a decline in leverage that has built up in the financial system over the past few years. The source of such funding has been to borrow in US dollars and invest in riskier assets around the world. Initial de-leveraging has resulted in a structurally weak US dollar performing strongly over the quarter as the leverage community close out their short dollar positions. With respect to the assets being funded by these borrowed dollars, many have been indiscriminately sold off through the middle part of the quarter. As a result, seemingly diversified portfolios have lost the benefits of diversification as correlations between assets classes, geographies, and investment strategies converged over the three months. In addition to the winding down of the abovementioned 'carry trade', global markets had to face up to the prospects of higher inflation, increasing global political instability, higher oil prices and the threat of a hard landing in China. Thus it's little wonder that fundamentals were largely ignored for much of the quarter. Investors ended the period with news that global economies may indeed be slowing faster than anticipated. Many new market and economic views based on higher interest rate and inflationary expectations dealt the final painful blow to a bruising three month period.
With the outlook for higher interest rates, declining global liquidity, higher oil prices, a slowing Chinese economy and increased geopolitical risk all combined in the effective highjacking of global equity markets over much of the quarter. The MSCI recorded one down month out of three, to end the quarter at 1%. Corporate fundamentals were of little importance over the period as investors concluded that irrespective of corporate earnings being good, there was little upside going forward. It should come as no surprise that the declining liquidity hit less liquid and, co-incidentally, the best performing markets over the past year, which caused much pain as investors sitting on book profits headed for the exits in emerging market and small market capitalisation equities.
The Topix Small Cap Index had enjoyed a rise of 79% over the 17 months leading up to April 2004 as economic and company specific fundamentals showed signs of improvement combined with an overall increase in investor appetite for risk. For those investors who jumped on the bandwagon late, the experience was painful as the index declined by 12% in the early part of the quarter before staging somewhat of a recovery by the end of June. The index ended the quarter at 4.45%. In Korea, losses were even more extreme with the Korean Composite Index, capitalised at $280 billion, declining 22% from the last week of April to mid-May and ending the quarter down 12.2%. Results were similar, if not a little more muted, with respect to developed market small cap indices which underperformed large cap indices by 1.1% (Russell 200 vs. S&P 500) over the quarter, as investors moved to lock in profit in an environment of declining liquidity.
Of the developed markets, Japan still remained the investment communities' market of choice. The Japanese Ministry of Finance together with the Bank of Japan continued throughout the quarter to clean up the nonperforming loan problem which hindered Japanese banks throughout the 90s. In addition, favourable economic data, improving sentiment, a weaker yen and significant monetary stimulus all continued to tempt foreign investors to invest heavily in the local market. Japanese indices, as a result, remain the best performing developed market for the year to date. For the past quarter, the Topix rose by 0.88% and 4.45% for the Topix Small Cap Index. Significant volatility experienced in Japanese markets in May was driven to a large degree by foreign investors taking profits after strong gains in the index for the year to date. The S&P500 Index was up 1.3% whilst MSCI Europe ended up 0.95% for the quarter.

Performance Commentary
Over the quarter the portfolio underperformed the MSCI World, declining by -0.29% in US dollars versus the index return of 1%. The relative underperformance in rands was 1.32%, with the index declining by -0.33%. Year to date the fund has outperformed world equity markets by 1.15% in US dollars and 1.08% in rands.
The second quarter of the year proved to be difficult for active stockpickers who focus primarily on company fundamentals, as the market largely ignored these and chose to focus on the many macro factors for most of the three month period. Two particular managers that underperformed the market for these very reasons were JO Hambro, underperforming by 3.05% over the quarter, and Close Finsbury North America who underperformed by 1.70%. The overall weakness in small and mid capitalisation stocks was another drawback to the fund during this period, as many of the active stockpickers with whom we invest tend to find better value opportunities in under-researched mid capitalisation stocks which under performed against the indices over the quarter. The portfolio is primarily made up of managers focusing on these two areas i.e. mid cap and active stock selection and, as a result, the portfolio suffered as a whole in the short term. Going against this trend, the fund's mid cap specialist Copper Spire outperformed the broader S&P 500 index by 1.93% for the quarter. The fund held a position in a gold fund which underperformed global equity markets over the quarter due to dollar strength and to, a lesser degree, a sell-off in all commodities due to the potential slow down in the Chinese economy.

Global equity markets continued to strengthen in the final quarter of the year, with our benchmark index, the MSCI World, rising by 14.4% in US dollar terms. For the same period the Coronation International Active Fund of Funds returned 9.6%. Since inception in August 1997, the fund has produced a compound annual return of 5.6% against the benchmark return of 1.3%.

Market overview
The macro environment over the past quarter was dominated by the continued strength in the US economy, the falling US dollar and rising commodities prices. This environment was understandably positive for both equity markets and credit markets fuelled by the highly favourable monetary and fiscal conditions. US consumer spending is still showing growth and, combined with stronger investment demand, the manufacturing side of the economy accelerated with a significant impact on corporate profits (given that most companies had previously cut costs and restructured balance sheets). With 2003 ending particularly strongly, there is reason to expect 2004 to be a reasonably strong year although potentially more volatile. Equities will fare better than bonds given the economic backdrop, although the greatest hurdle for both will be the commencement of the Fed's monetary tightening cycle, which is likely to take place in the second quarter of the year.

Performance commentary
The fund continues to invest with a select group of "absolute" return oriented long only managers. These managers use a variety of strategies to focus on achieving positive returns, while also preserving capital in times of turbulence. Despite the cautious positioning of many of the underlying holdings, the fund was able to harness a 9.6% return in US dollar terms.

In the US the small cap stock picking of Wanger continued to perform well with a 15.3% return vsthe S&P's11.6% as its "growth at a reasonable price" policy paid dividends. Of the funds more conservatively positioned funds, the larger cap, value oriented approach of Ed Walczack's Close Finsbury North American fund returned 9.6%, while the Copper Spire fund's "special situation" investments generated an 11.4% return for the quarter. Both these funds remain wary of current valuations and presently offer protection in a market decline.

Having benefited strongly from asset allocation to cyclical equities in the third quarter rally, the funds European managers scaled back some exposure towards the end of the year to crystalise gains and protect capital as they began to view valuations as stretched. While prices steamed ahead, Odey Pan European returned 7.2% and JO Hambro7.5%. against the MSCI Europe's 10.9% (to put this into context, this results in Odey being up 28.4% and JO Hambro16.8%, against a 12.15% rise in the MSCI Europe for the 12 months ending December 2003, in euro terms). Aberforth, the UK small cap manager, produced 5.3%, leaving the fund up 38.7% for the year against a rise in the FTSE All Share of 16.6%. the fund took profit on this position at the year-end, as the UK small cap discount to large cap stocks has now been largely eroded and other managers have stronger appeal.

In Japan, the Morant Wright fund gave back some of its third quarter out-performance, dropping 1.1% while the Topix rose 2.4%. The fund continues to offer attractive upside from a Japanese recovery while limiting the potential for loss through the price sensitivity of its stock selection. Comgest Asia also has a value focus and returned 7.1% while the MSCI Asia index, benefiting from its more volatile growth sectors, increased 9.7%.

GLG Capital Appreciation remained the only global manager in the portfolio and has the flexibility to invest in bonds as well as equities, with the aim being to limit downside. The manager continued to demonstrate the ability to anticipate market trends as the fund maintained a strong equity allocation bias. This fund returned 11.2% for the quarter, leaving a 36.3% return for the year against 30.8% for the MSCI World.