Market overview
The relatively good return of 4% from world markets for the third quarter disguises rather more dramatic movements on an inter-week basis. Most of the positive return came in the last two weeks of the quarter, predicated on a glowing belief that the US economy will achieve a soft landing, causing sentiment to swing markedly post the volatile markets of May and June. Investor sentiment throughout the period has been dominated by macroeconomic issues, in particular the ongoing debate surrounding the US housing market, consumer confidence and inflation. As we have discussed before, the key areas of contention are the scale and level of excess in the US housing market, the consequent shape and depth of any correction in that market, and the role that the boom and now correction has had, and will have, on consumer expenditure. At the same time, against the background of continued high levels of oil and other commodity prices, inflation levels have risen in the US in the last 6 months, casting a shadow over equity and debt markets. As if this was not sufficient, the past quarter saw a continuation of the war in Lebanon, a further escalation of the Iranian uranium enrichment saga, the exposure of a major terrorist plot in the UK, and a coup in Thailand.
Markets are definitely acting better than we would have expected so soon after the mid-year wobble, and many indices have completely erased the losses of May/June, albeit with significant increases in volatility. Hence, by definition it has not been the beginning of a bearish multi-months bear market but rather a violent and sharp correction similar to that witnessed in October 2005. There has been something of a first shift back to more cyclical stocks, implying that the global economy will weather a potential US slowdown fairly well, and reasonably low valuations already discount lower earnings next year. We believe only a much worse outcome, namely a US recession, would derail the equity markets over the next few months. The ultimate bear story, the US housing crash has now reached a level of attention that already discounts some quite bad developments. At present, it is therefore overdone to bet on such a scenario for the immediate future. While the short-term outlook is still murky, given that equities usually make a seasonal low during September/October, the medium-term outlook is probably better than it appeared a couple of months ago.
Investor sentiment does nonetheless remain fragile, and equity markets will be seriously at risk if either the US economy dips into a recession, or contrary to current expectation, it reaccelerates after a couple of weaker months. Such an outcome would again raise fear of further interest rate hikes.

Performance commentary
The Coronation International Active Fund of Funds returned 12.65% for the quarter in rand terms, while the MSCI World Index returned 13.2%. On a rolling 12-month basis the fund has returned 37.2% for investors.
In line with the second quarter, these returns were boosted by the continued weakness in the rand, which depreciated by a further 8.2% against the US dollar.
The recovery in global markets over the period was led by Asia, followed by North America, Europe and Japan. The fund's returns were negatively impacted by its underweight exposure to North America, and weak relative performance from managers.
The returns in North America over the quarter were mainly from large cap stocks, which are beginning to dominate after years of underperformance compared to small and mid cap stocks. As a result, all our US managers with considerable exposure to mid caps produced weak relative performance. Weakening energy and materials sectors did not help UOB Kinetics Paradigm fund which has significant exposure to the Canadian oil sands and other high quality commodity companies. Hippocrates, a fund which was added at the start of 2006, was flat for the quarter. While it is tempting to say that we are disappointed in the fund's performance, the reasoning for the managers' inclusion remains firm: long term view, indepth research process and long record of success.
The same cannot be said, however, for our investment in Eclectica where we are disappointed with the negative returns experienced since investing. This fund is positioned as having an absolute return focus, and the 2nd quarter's weak positive return means that there is still some way still to go in making up the large drawdown from launch.
We are very pleased with the strong returns from both Edinburgh Partners' Global and European funds which were included in April and mid-June 2006, respectively. The managers' five year investment horizon can result in their being quite contrarian; they held large positions in unloved telecom stocks such as France Telecom and Vodafone which paid off handsomely when telecom stocks enjoyed a strong rally in late September.

Tony Gibson
Portfolio Manager

Market overview
The first half of 2006 has certainly provided mixed fortunes for investors in the equity markets. By mid-May the world equity markets were up by a comfortable 12% from the start of the year, but then shares sold off sharply during the second half of May and through most of June. Not surprisingly, those markets and sectors that had performed most strongly year to date surrendered most of their gains.
Inevitably, most market participants immediately looked for a specific catalyst on which to lay the blame for this rapid deterioration in investor confidence. Again, not surprisingly, the blame was laid at the door of recently appointed Fed Chairman, Ben Bernanke. Upon Bernanke communicating his number one objective of maintaining price stability in the US (the core role of any central banker) investors became increasingly concerned that an over-zealous interest rate tightening - from an inexperienced central banker - may result in a rapid slowdown in economic activity.
The crucial question from the recent risk reduction and market fall is the obvious one of where does this alter our outlook for the coming six to twelve months? Is it the precursor to a major change in the business cycle and therefore the start of a prolonged period of negative returns from equities? Or is it merely a repeat of events from April and October 2005 where, following a sharp fall of 5% or so, markets very quickly rebounded?
We do believe that in the long run the only sure way to forecast market moves over time is to predict long run profitability. With that as a guide, we continue to believe that the current prosperous state of global economics will continue to propel markets upward over the medium term. We also do not suspect that recent market events should necessarily be treated as faint seismic shocks of a major turning point in the global business cycle.
We do however believe that it would be wrong to merely dismiss the recent price falls, and assume business as usual. Interest rates are rising, liquidity is draining rapidly, global growth will probably slow from current levels, and profit margins are at a peak. The damage done to investor confidence and risk appetite is of a more permanent nature than the small set-backs experienced during 2005. We would be increasingly wary of highly rated emerging markets, commodities with speculative interest, and over ambitious promises from private equity capital raisers. The developed equity markets look a far safer relative bet over the coming year.

Performance commentary
The Coronation International Active Fund of Funds returned 11.45% in rand terms for the quarter, against the MSCI World Index return of 15.4%. For the year-to-date the fund has returned 18.6%.
The market volatility in the second quarter which led to a sharp correction in Japan and other markets negatively affected the fund's performance. Japan equity indices recorded -9% (in local currency) over the quarter, while Asia was down approximately 1.5%. Our overweight to the region coupled with weak returns from our managers contributed to the underperformance. However, in comparing the returns of our managers with those on our 'watch list', performance could have been worse. We retain conviction on both the region and our selected managers.
More disappointing was the poor performance of our European managers, recording the worst relative performance. Although Artemis has performed strongly in the portfolio, we have elected to move away from their quant based process and have switched to Edinburgh Partners European Opportunities Fund whose long term, valuation approach is more similar to that of our own.
Our US managers were generally in-line or slightly ahead of the S&P 500. On the Global side with the MSCI World at -0.3%, performance was mixed with Edinburgh Partners Global Opportunities Fund up 1.2% and Cantillon Global Value down 1.2%.
Despite this quarter's underperformance, we are comfortable with our current portfolio of managers and regional exposure. We do however continually meet with new managers with the aim of identifying opportunities to improve the quality and
returns of the Coronation International Active Fund of Funds.
Tony Gibson
Portfolio Manager

At the end of the last quarter, we cautioned that 2006 could see somewhat of a reversal of the enormous capital flows into cyclical (riskier) assets such as commodities, emerging markets, and high yielding investments and currencies. The first quarter of this year has already given indications that some of these predictions may be playing out as a number of emerging currencies have hit multi-month lows against the US dollar and the euro, for example the New Zealand dollar has fallen by 14% since December 2005. The expected short-term correction in the Japanese equity markets also occurred as February saw a sell off in those markets following the Livedoor incident.

As we have now moved into the post Alan Greenspan environment, his successor, Ben Bernanke, inherits a new conundrum. This is that, despite a desire to communicate clearly with the market at all times, at this stage of the interest rate cycle it is hard to give clear guidance on the direction of both short and long-term interest rates in the US. As he recently stated, the forces governing long-term interest rate behaviour are "not at all clear cut". There was little doubt that Bernanke would raise interest rates in March to 4.75%, making it the Fed's 15th consecutive rise since tightening began in 2004, but the subsequent path of rates remains unclear. This confusion is clearly illustrated by the present shape of the US yield curve which, to all intents and purposes, is flat. However it is a clear signal on the direction of interest rates in the US which remains crucial to investor sentiment, despite the world becoming materially less US-centric over the last five years, especially as Europe and Japan are considering a tightening policy.

The following extract from an interview with Barton Biggs probably best sums up the consensus view of global markets. He states, "The world looks very good for investors. Growth is neither too fast to alarm the central banks and is being rebalanced away from the US to the developing countries of India and China. They will ensure economic growth runs at 4% to 4.5% a year while also creating powerful disinflationary forces. Growth in the US may slow to 2% to 2.5% in late 2006 and 2007 but that will allow the Fed to cut rates and that doesn't make for a horrendous environment for equities."

While we do not strongly disagree with this view, the growing degree of investor complacency does concern us. The overall equity exposure of hedge funds is at its highest point since 1999 thereby highlighting their overall sanguine view of markets, as well as the low volatility in the indices and low emerging market credit spreads. These factors make equity markets increasingly vulnerable to any unexpected shocks which may come in the form of somewhat higher than expected global inflation and somewhat lower than expected economic growth from China.

Performance commentary
The Coronation International Active Fund of Funds returned +6.4% for the quarter, with the MSCI World Index at +2.9% (both in rands). All funds contributed to another strong quarter with outperformance of the index by 3.4% year to date.

As in the last quarter of 2005, the underlying managers were mostly inline or better than their respective indices. Comgest Nouvelle Asie ended the quarter +12.1%, compared to only +2.4% for the index, whilst Odey Japan and Morant Wright Japan were +5.3% and +4.8% respectively.

The best performers, relative to their respective indices, were the European and US funds where Artemis European Growth excelled with +15.8% for the quarter and UOB Kinetics Paradigm ended +13.1% in the US. Given the strong returns achieved by Artemis European Growth over the quarter, they started to replace positions where the valuations had become less compelling which therefore increased turnover in the portfolio. Of the global funds, Cantillon Global Value performed the best with +8.1% for the quarter.

Tony Gibson
Portfolio Manager

Market overview
At the start of 2005, undoubtedly the most consensual trade would have been the prediction of a continued slide in the value of the US dollar versus the euro and the yen, but, as we know, the exact opposite occurred. Other widely held views in early 2005 would have favoured a reversal in the trend of the past few years which have seen a significant investor preference for cyclical investments such as emerging markets, commodities, and yield enhancing credit investments. In fact, rather than slowing, this trend gathered momentum in 2005 as both credit and emerging market spreads fell to record lows, while all but a few of the cyclical shares (and regions) reached new highs. The reason that this momentum gathered force lies in the abundant liquidity in the world, notably generated from the policies of the US, EU/UK and Japan, as investors are given little choice but to move up the risk curve in pursuit of returns.
Taking a macro look at the western world, there was no shortage of good news towards the end of 2005. In the US, GDP growth for the third quarter was revised higher to 4.3%, mainly due to consumer spending, while the core price deflator remained at a mere 1.2%. In the UK, consumer confidence rose by the largest monthly increase in 19 months, while, in Germany, domestic orders rose over the last six months by 5.6% - the fastest growth since 1993. As ever, the overriding question mark for 2006 will again be the US economy. The yield curve has recently inverted which points to a slowdown of the economy in the medium term and house prices have begun to soften. Despite the strong probability that US consumer spending will slow materially during 2006, it is unlikely to decline sharply and, at the same time, it is unlikely that US politicians will endorse a level of interest rates which would push the US economy into recession.
In summary, as well as a likely downswing in the US dollar in 2006, we expect large cap, non-cyclical US companies to offer better value than most perceive and European equity markets, although sharply higher than where they were a year ago, to still offer a great deal of stock-specific excitement due to expected corporate activity. We fear that the possibility of a short-term correction in the Japanese markets is largely being ignored and we are aware that 2006 might see the "revenge" of the low yielding currencies.

Performance commentary
The Coronation International Active Fund of Funds returned +2.7% for the quarter, in line with the MSCI World Index at +2.6% (both in rands). Year to date the fund's return of 23.9% is ahead of the benchmark's performance of +20.6%.
Our managers had mixed results in a quarter that started off weak but finished strongly. The overweight to Japan and Asia continues to be correct but strong performance from Odey Japan (+17.6%) was offset by Morant Wright (+11.0%) which lagged the Topix for the quarter. Morant Wright continues to have faith in a Japanese property revaluation, while Odey has recently increased its technology and electronics exposure.
In the US, Copperspire had an excellent quarter with +6.8%, achieved with high cash allocation in October followed by strong performance from its top holdings in the latter half. UOB Kinetics Paradigm did not fare as well in delivering a -2.7% return, largely as a result of its energy and utilities stocks.
The European managers were disappointing in a generally strong market environment. Ruffer European was marginally positive at 0.20% and Odey European was -0.5%.
GLG Capital Appreciation delivered another good quarter at +8.4% supported by Cantillon Global Value with 3.1%. Ruffer Total Return produced 2.6%, a good result given the fund's high cash and bond exposure.

Tony Gibson
Portfolio Manager