Market overview
The current market environment highlights Alan Greenspan's conundrum in that the Fed's strategy of tightening liquidity in the US has had the perverse reaction of lowering the long bond rates through decreasing inflationary fears. Given that US mortgage rates are linked to long-dated bonds, rather than short-term rates, the net effect is that the sharp rise in the Fed Fund Rate (from 1% to 3.75% over the past 15 months) has had little or no impact on slowing the ongoing boom in housing lending and so house prices remain sharply up on where they were a year ago. Alan Greenspan is rightly concerned that an emerging housing bubble in the US is an increasing risk to financial markets but his only tactic is to continue to raise short-term interest rates, while continuing to tell financial markets to heed his dire warnings of the risks associated with a 'low concern about credit risk'.

A further conundrum in today's global financial markets is the fact that they seem immune to bad news, as large injections of liquidity seem to have merely allowed the 'pool of worries' to build up more pressure against the dam wall. However, there is growing concern that the dam will burst as surely markets cannot remain impervious to many of the nasty underlying realities in the worldwide economy.

These major risks remain a permanently high oil price, a still growing current account deficit in the US, the eventual erosion of consumer spending as the Fed continues to raise rates, over-capacity in China causing its growth boom to slow, low growth in Europe, the continued threat of terrorism, and growing domestic consumption in Japan, which is a positive but at the expense of inflows into US treasuries.

At the company level, corporate balance sheets are generally strong and cash flush, which is helping to increase investments by private equity houses as well as takeover bids. In addition to increased corporate activity, institutional investors are regaining their appetite for equity market risk, following the strong market performance of recent years. While we believe that this favourable environment for financial markets will prevail in the short term, there is no doubt that, as money gradually becomes tighter and more expensive, consumer spending in the US will slow and higher commodity prices will bite leading to increased pressure on corporate profit growth.

World equity markets increased by 7.1% during the quarter (as measured by the MSCI World Index). July and September were particularly strong months whilst August was traditionally quiet. These strong returns were driven by encouraging economic data and solid corporate earnings that resulted in an improvement in investor sentiment whilst inflation pressures remained subdued. The two major macro worries over the quarter were the impact of Hurricane Katrina in the US and higher energy prices but Japanese markets had a very strong quarter despite this. In the US, the S&P 500 Index returned 3.2% and the Nasdaq generated 4.6% over the quarter. In Europe, the FTSE 100 increased by 7.1%, the CAC by 8.8% and the DAX by 10%. In Japan, the Nikkei 225 Index returned 17.2% for the quarter whilst the Topix increased by 20%. The rally in Japan was led by the large cap stocks as the Jasdaq (smaller caps) only returned 3.7% for the quarter.

Performance commentary
The Coronation International Active Fund of Funds returned +2.5% for the quarter, ahead of the MSCI World Index at +1.4% (both in rands). Year to date the fund's return of +20.7% is marginally ahead of the benchmark's performance of +17.6%.

Despite pleasing performance from all of our allocations, Comgest Nouvelle Asie, Odey Pan European and UOB Kinetics Paradigm were the real star performers over the quarter. An even more pleasing aspect of the quarterly performance is that the portfolio kept pace with the index despite the more cautious stance adopted by some of our managers who have opted to hold cash. On a look through basis, gains from being overweight Asia were offset by an underweight position in North America. On a sector basis, the fund benefited from being overweight in Energy and Materials, but missed out on a strong quarter for Healthcare.

Tony Gibson
Portfolio Manager

Market overview
In assessing the current outlook for global financial markets, one is struck by the conclusion that circumstances have seldom been as opaque as they are at present. More than ever, core unanswered questions are emerging.
The first is how the equity markets will react to the world economy slowing down and, at the same time, the US Central Bank continuing to raise short-term interest rates. The current resilience of the equity market would suggest that investors increasingly believe that the end of the rate hike cycle is in sight.
The second question is that whilst risk appetite has continued to decline, spreads have continued to widen, year to date returns for many asset classes are negative, and economic indicators are at an inflection point. What does this mean in terms of liquidity and activity for the investment markets and, in particular, the US dollar? We think that the dollar will decline over time because the US current account deficit is so large that it is putting an unbearable strain on the savings of the rest of the world and the biggest strain will be between the US and Asian currencies.
The third question would be whether the US real estate market is a bubble waiting to burst as it has been one of the biggest beneficiaries of the low interest rate environment and yet, the US economy, real estate prices and cash flows are all expected to grow in the near term. The overall environment remains one of excess (albeit reducing) liquidity, coupled with a high degree of risk aversion. Investment behaviour will probably continue to be "bi-polar" until some of the key uncertainties, referred to above, resolve themselves.
World equity markets increased by 61 basis points during the second quarter of 2005, as measured by the MSCI World Index. April continued the misery of March but then May saw a bounce back followed by further consolidation in June.
Europe was particularly strong whilst small caps performed well in the US and Japan. In April there was a spike in volatility and even a sustained pace of M&A activity did not prevent the market sell off. In Europe there were further weak economic signals and, in the US, the market downturn was accelerated by IBM and General Motors' disappointing earnings announcements. Concerns about the US economy had the usual knock-on effects on the Japanese market along with a negative impact from the anti-Japanese riots in China. Most equity markets recovered in May as investors relaxed their fears and there were signs of reversal in the US' "soft patch". The euro dropped sharply over May as its long-term role came into question as a result of the "no" referendums in France and the Netherlands.

Performance commentary
The Coronation International Active Fund of Funds returned +7.4% for the quarter, in line with the MSCI World Index at +6.6% (both in rands). Year to date, the fund's return of +17.8% is marginally ahead of the benchmark's performance of +15.9%.
Despite pleasing performance from all our allocations, Comgest Nouvelle Asie, Odey Pan European and UOB Kinetics Paradigm were the real star performers over the last quarter. An even more pleasing aspect of the quarterly performance is that the portfolio kept pace with the index despite the more cautious stance adopted by some of our managers who have opted to hold cash. On a look through basis, gains from being overweight Asia were offset by an underweight position in North America. On a sector basis, the fund benefited from being overweight in Energy and Materials, but missed out on a strong quarter for Healthcare.

Market overview
World equity markets fell by 1% during the first quarter of 2005 (as measured by the MSCI World Index). This statistic however masks the underlying movements within the period. The year commenced with world markets falling for three weeks but then rising up until the end of the first week in March. This rally was buoyed by the expectation of another year of strong economic growth within an environment of benign inflation, lower oil prices, and only a mildly hawkish Fed. Alarm bells started ringing however in the equity markets about the potential fallout from rises in oil prices and bond yields. These facts were accentuated by a report from the Goldman Sachs energy team, forecasting a possible 'super-spike' in the price of oil to a level as high as US$105 per barrel. At the same time, Merrill Lynch went so far as to link current conditions to those prevailing before the 1987 stock market crash. In a gloomy note, it cited a host of negatives for equities - the twin budget and trade deficits in the US, a weak dollar, accelerating inflation concerns, firm commodity prices, rising bond yields and the prospect of further tightening by the US Federal Reserve.
"If that does not sound like 1987, we don't know what does - even the price earnings multiple is the same at just over 20 times" they stated. The effect of these events and predictions resulted in a rapid change in market sentiment from the tangible complacency which set in late in 2004, and saw the MSCI World Index retract in the last three weeks of March.
Market sector commentary
The start of 2005 saw a technical sell-off in most equity markets, reversing the trend from the end of 2004. The dominant economic features over the quarter were rising interest rates in the US, inflation fears and higher oil prices, whilst the strengthening dollar served to support the European markets, in particular, and the yen fell further against the US dollar. The US equity markets struggled, despite a slight recovery during February, to end the quarter down 8.1% for the Nasdaq and down 2.6% each for the S&P500 and Dow Jones Industrial Average indices. European markets did well across the region with the CAC in France returning +6.5% and the DAX in Germany returning +2.2% for the period. The UK indices lagged with the FTSE 100 Index generating +1.7% and the FTSE 350 Index returning +1.8% for the first quarter of 2005.
In Asia, the equity markets were mostly bouyant with the Nikkei 225 Index +1.6%, Topix +2.8% and Jasdaq +5.9%, especially strong in Japan, whilst the Hang Seng was down 5% and the Korean Composite Index was up +7.8%.
There is no doubt that higher interest rates and energy prices will ultimately weigh on discretionary and capital spending in the US but the consensus is that much of this is largely discounted into current valuation levels already. In fact company fundamentals across the more economically sensitive sectors, such as technology and retail, have shown resiliency in the face of this troublesome backdrop. In Japan, business confidence is weak and deflation re-emerged, despite the raised assessment of the economy by the Bank of Japan and a positive increase in exports, raising doubt on the sustainability of the economic recovery.
Performance commentary
Over the quarter, the MSCI World Index decreased by 1% in US dollar terms whilst the Coronation International Active Fund of Funds lost -0.8% in US dollar terms. Since inception in 1997, the fund has produced a compound annual return of 6.8% against the 2.8% produced by the MSCI World Index, resulting in an annualised outperformance by the fund of 4%.
Although our European and Asian funds performed well, their performance was overshadowed by the US funds which struggled to generate returns in a negative market environment.
In Asia, Morant Wright and Comgest Nouvelle Asie significantly outperformed their benchmarks, while in Europe, all the funds beat their benchmarks with strong performance from both Opus and Odey Pan European Fund. UOB Kinetics, a new addition this quarter, was the only US fund to achieve a positive return for the quarter which was exceptional given the -2.2% drawdown on the benchmark. GLG Capital Appreciation, a fund with a global outlook, also delivered good positive performance. During the quarter we decreased our positions in Copper Spire and JO Hambro and fully redeemed from Wanger.

Market overview
The global markets have surprised on the upside over the last quarter. Positive developments have been the sharp fall in the US dollar, moderate falls in oil prices and of course the continued growth of the Asian dragon - China. The fulfilment of the Bush re-election as predicted by 85% of US fund managers removed uncertainty from the market and the weaker US dollar provided a welcome boost to US corporate earnings. Recent falls in the oil price have also extorted a positive influence on the markets. Just as many commentators expected the oil price to fall to USD6 per barrel in 1998 (when it was at USD10) oil bears recently predicted a price of USD100 by end-2004. This was based on a pending implosion in Iraq and rapid Chinese demand. Clearly both of these views were extreme.
The impact of China has continued to be profound. Its booming economy has had a dramatic effect on the price of most commodities, and the impact of its domestic demand has also spurred global consumption. In 1999 USD6 million of wealth was enough to make the top 100 list in China. In 2004, the figure has jumped to USD150 million - illustrating the phenomenal rate of wealth creation. If the Chinese economy is more than a mere manufacturing platform for Western corporations, and if it can prove that it now has an independent role of consumption, that would be very bullish for the rest of the world.
Performance commentary
Over the quarter the MSCI World Index was down - 2.50%, in rands, whereas the Coronation International Active Fund was down by -2.13% over the same period. On a 12-month rolling basis (to 31 Dec 2004) the fund has outperformed the MSCI World Index by 1.75% in rands.
The fund invests in both global and regional investment teams whose investment philosophy is not constrained by passive indices. Despite outperforming a rising market through the year, our managers' portfolio construction remains focused on preservation of capital and on achieving absolute returns.
The fund maintained a marginal overweight towards the Japanese equity market over the quarter, countered by an underweight in the US allocation. Although the US market showed strength through the quarter, strong manager performance in that region generally made up for the underweight position. Manager selection generated positive performance over the past three months with relative out performance with the bulk of the manager performance coming from the higher weighted holdings.
One new holding was added in the US - the UOB Kinetics Paradigm Fund. This fund has performed very strongly, driven by core holdings in the US utility and power sector, leading to a 12.25% return for the quarter against an 8.7% return from the S&P. Small cap specialist, Wanger, benefited as the small cap space rebounded from a weaker third quarter and gained 13.22%. Copper Spire outperformed with 11.3% for the quarter. The Close Finsbury North American Value Fund returned a more muted 5.3% as problems at Freddie Mac in particular hurt the portfolio.
The European manager performance was mixed over the quarter against the MSCI European Index, which gained 5.6% over this time period. Odey Europe, by far the largest European holding, enjoyed the generally positive environment for commodities and produced a return of 5.9% over the quarter. However, JO Hambro Europe under-performed slightly with 5.25% for the quarter. The Opus Fund managed a 4.4% return despite being very defensively positioned in terms of sector and cash allocations. In Japan, the quarter was mixed, with Odey outperforming and Morant Wright under-performing. Both funds finished the year ahead of the market, with Morant Wright, in particular, having benefited from renewed interest in the region in general and from specific M&A speculation surrounding a number of the fund's holdings. Asia ex-Japan was disappointing as the domestic demand oriented Comgest portfolio did not benefit from inflows into more export oriented stocks.
The GLG Capital Appreciation Fund kept apace of the global equity market through the quarter despite a prudent bond allocation through much of the period. The fund successfully increased equity exposure following the US election, correctly anticipating the subsequent market rally.