The past quarter was one of the most dramatic for investment markets in memory. The global credit crisis escalated into a real panic resulting in the US government proposing a massive rescue package to try and restore confidence in the US banking system. Other central banks have subsequently followed.

Household names of Lehman Brothers, Merrill Lynch, AIG, Washington Mutual in the US and several large banks in Europe have either filed for bankruptcy or have been taken over or nationalized.

As a result of the problems in the financial sector it is inevitable that global economic activity will decline. In Europe, Japan and the US recession now seems likely for 2009. Even China has been slowing down and with it commodity prices, including oil, have weakened sharply.
The South African financial markets also had a remarkable quarter. A key change was the rapid turnaround in expectations regarding interest rates. As soon as the market believed that interest rates had peaked, the bond market and interest ratesensitive domestic stocks rallied sharply. At the same time commodity prices started falling as expectations of slower global growth took hold. he result was a massive swing in performance away from the hot mining sector in favour of stocks tied to the domestic market.

The Balanced Defensive Fund managed to eek out a positive return of 2.7% for the quarter by maintaining a very conservative stance. Exposure to equities was kept at below 25% for most of the period. The addition of preference shares to the portfolio helped a lot as this category held up very well in the face of rapidly falling share prices. Within equities we also held little of the more volatile resources shares, while concentrating our holdings in stocks where we feel we have a more predictable earnings stream.

Returns are 2.7% for the quarter, 5.6% for the year-to-date and 6.2% for the past 12 months. In all of these periods we are behind the cash benchmark, but significantly ahead of the average for the low equity asset allocation funds of -0.54% (quarter), -0.45% (year-to-date) and 0.11% (one year).

Looking forward it is difficult to see light at the end of the tunnel amidst this global crisis. Panic selling of shares hase pushed valuations to extremely attractive levels and we are of the view that accumulating stocks at current prices will be rewarding.

Charles de Kock and Mark le Roux
Portfolio Managers

Economic and Market background
The big feature of the second quarter was the massive 38% rise in the oil price to $140 per barrel. Investors and policy makers, already surprised when oil reached three figures earlier in the year, became gravely concerned. central bankers around the world changed their rhetoric to focus on the evils of inflation rather than on providing enough liquidity to get us out of the financial crisis or to avert recession. Global financial markets immediately changed expectations of further interest rate cuts in Europe and the US to anticipating hikes. Economic growth prospects were revised downward, inflation prospects upward and the result was obviously very poor for financial markets in general.
Following a dismal first quarter global stock markets contracted more, with the MSCI world index losing 1.4% in US dollar terms. The MSCI index for emerging markets also contracted, but only by 0.8%. There was no place to hide in bonds either as inflation fears and the changed outlook for monetary policy led to a sharp rise in global bond yields. The yield on the benchmark 10 year US treasuries rose 56 basis points to close at 3.97% after peaking at just above 4.20% during June.
The domestic bond market also had a terrible quarter as the Reserve Bank hiked rates by 50 bps at the April and June meetings of the monetary policy committee in reaction to disappointing inflation numbers. The long dated R157 gained a massive 150 basis points to close the quarter at 10.70%.
The JSE continued the trend of the first quarter with resource stocks performing well while domestic stocks sold-off even more as higher interest rates and duller economic growth prospects took hold. Financial stocks declined by 14.5% following a -12.8% return in the first quarter, taking the year to date returns to -25.5%.
Listed property stocks also sold-off aggressively and declined by 19.6%, taking this sector's year-to-date losses to 28.4%.

Portfolio manager's actions
The fund received large inflows during the quarter, resulting in a more than doubling of the size of the portfolio to R226 million. In light of the deteriorating financial news around the world and bearing in mind the very conservative mandate of the fund, we allowed cash to rise from just below 50% to 63% of the portfolio. The exposure to domestic equities was reduced to 15.2% from the 20% level at the end of March, while exposure to global equities was reduced to 6.2% from 10%.
The one area where we upped exposure was to preference shares. The exposure was increased from 2.3% to 5.1% and we are likely to increase this even further. These shares trade on yields that are linked to the prime rate of interest and has consequently moved higher as the Reserve Bank has tightened monetary policy. Current yield on this portion of the portfolio is 13.2%, a yield we find very attractive.
Within equities we reduced the fund's exposure to bank shares by selling all the ABSA and FirstRand shares following the April rate hike. Bank exposure is now concentrated in Standard Bank and we also added to African Bank where we see very good value. We also added substantially to SAB Miller, Richemont, Naspers and Tiger Brands, as well as smaller amounts to a number of others. We continue to favour the more defensive and good dividend paying companies while limiting exposure to more cyclical shares.
In the bond market we maintained a very low modified duration but did add some long dated government bonds as yields approached the 10.50% level. At this level we believe the bond market is already pricing in a poor inflation outlook and could be surprised by the weakness of the local economy in the months to come.

Performance
The fund's performance for the quarter was a disappointing negative 0.06%. For the year ending June 2008 the fund returned 5.74%. This is clearly significantly behind our target of cash plus 3%, which amounted to 13.63%. We have tried to manage the risk to underperformance by adopting an extremely conservative asset allocation stance. With all major asset classes however underperforming cash for the past year, achieving our target has been particularly difficult. Investors will understand that in order to achieve and exceed the benchmark we have to take some risk in the portfolio. The current weakness in just about all financial markets provides good entry levels and we are likely to use this opportunity to add more growth assets to our portfolio.

Charles de Kock and Mark le Roux
Portfolio Managers

The Balanced Defensive Fund is a conservative product designed to offer investors some protection against capital losses during bear markets.

The first quarter of 2008 provided the fund with a real test as most global stock markets suffered substantial losses. We are extremely pleased with the way the fund behaved during this eventful time, producing a positive return of 2.8% for the quarter and 7.3% for the past year. Although this missed our target of cash plus 3% (which was 3.4% and 13.0% for the quarter and year respectively) we remain confident of achieving this target as markets normalize.

Developed world stock markets suffered sharp declines as the following list shows:

Dow Jones Industrial -7.6%; Nasdaq -14.1%; FTSE 100 -11.7%; DAX -19.0%; and the Nikkei -18.2%. (All returns expressed in domestic currencies). Viewed against this global backdrop our own JSE held up reasonably well with the all share index up 2.9%. The major components of the JSE however showed exceptional divergence with resources returning a positive 17.5% and financials -12.8%. Property trusts also did poorly, registering -10.7% for the quarter. The all bond index gave a negative1.9% return with the long end faring the worst. Cash returned 2.6%.

The fund's positive return came largely from the high domestic cash exposure held throughout the period. In addition to domestic cash we also held some off-shore cash which offered investors good protection against the very weak rand. Within domestic equities we held some shares such as Arcelor Mittal and Impala Platinum which performed very well.
Looking ahead we are likely to use the current period of market weakness to add to domestic stocks. We find many domestic shares, especially the interest rate sensitive ones, offer excellent value. The negative sentiment prevailing among investors has pushed a number of high quality companies' prices too low in our view. We do not claim to be able to tell when these shares will bounce, but buying good businesses at cheap levels has always rewarded the investor over the long term.

In the interest-bearing field, rising inflation and the weak rand exchange rate have had a negative impact on yields. The SA Reserve Bank (SARB) is in a difficult position. Its mission is to fight inflation, but the current sources of inflation lie in ever higher energy and food prices. Something the SARB is powerless to control. South Africa runs a large current account deficit and needs foreign investment to finance it. Depressing the domestic economy by hiking interest rates again might well be counter productive. We believe the economy will be better served by keeping interest rates steady for now. The risk of policy error in our view remains high and we therefore continue to keep the modified duration of the interest-bearing component quite short. Once we have greater conviction that the up-cycle in interest rates has ended, we will go somewhat longer.

We remain aware of the vulnerability of the rand and aim to maintain our full global exposure.

Charles de Kock and Mark le Roux
Portfolio Managers

The continued rosy outlook of synchronized global economic growth has been dealt a major blow by the sub-prime induced liquidity scare that started around mid-year. The final quarter of 2007 was marked by a sharp increase in volatility in financial markets around the world reflecting the increased uncertainty. The key questions remain whether the US will avoid a recession or not, and whether the emerging world can continue its superb economic growth record of the past five years even if the world's largest economy falters.

In South Africa, the Reserve Bank went against the global trend by hiking interest rates at both monetary policy committee meetings despite evidence of already sharply declining consumer spending. As a result we are of the view that domestic economic growth is bound to slow in 2008 compared to the growth achieved in the previous two years. We are also of the view that global economic growth will slow in the wake of the liquidity crisis already mentioned.

The upshot of the above is that company profits are likely to grow at a slower pace than previously expected and will likely contract in certain areas. In order to prepare the portfolio for this more subdued outlook we felt it prudent to become more defensive in our portfolio positioning.

The biggest change made to the portfolio over the past quarter was within domestic equities where we sold a number of smaller market capitalization shares and added to some of the larger companies where we felt confident in the value underpinning the share price. Remgro is a good example where we raised the fund's exposure from 4.2% of equities to 8.4%. The total number of counters in the portfolio was reduced from 49 to 39 and it is the aim to reduce that even more. We also reduced exposure to the more volatile commodity sector with sales of Anglos, Impala Platinum and Exxaro.

During the quarter the fund grew from R73.5 million to R90.6 million, mostly due to new inflows. We partly used the inflows to build the cash holding of the portfolio to just above 50%, of which the bulk is in domestic cash with only around 5% in global cash. We also added a little exposure to domestic bonds. Total interest bearing assets now comprise two thirds of the portfolio. A further 8.3% is held in high yielding preference shares and listed property, leaving the exposure to equities at 17.3% local and 7.7% global.

The Balanced Defensive Fund is deliberately cautiously positioned and should give investors adequate protection against capital losses in the period ahead, while utilizing the high domestic interest rate environment to earn a real return. We remain concerned about the level of the rand and through certain specific stock selections in the domestic equity portion as well as the exposure to global assets we will offer some protection against rand depreciation.

It was not an easy quarter from a returns perspective, with two down months for equities out of the three. Despite this, the fund returned a positive performance of 0.6% for the quarter, holding true to its defensive nature.

Charles de Kock and Mark le Roux
Portfolio Managers