The return of risk appetite among global investors was the key feature of the third quarter. As a result, money poured into emerging market bonds in search of higher yields as well as into equities in search of faster growth opportunities. South Africa attracted its fair share of the global flows leading to a 9.7% appreciation of the rand against the US dollar over the period.

The aggressive buying of our bonds by foreigners caused yields to decline sharply resulting in a remarkable return by the All Bond Index of 8.0% for the quarter. Not to be outdone, equities also had a spectacular run with the ALSI posting a 13.3% return over the same period. It was especially domestic consumer shares that ran very hard, fuelled by foreign purchases and culminating in the Wal-Mart offer for Massmart.

Faced with an ever stronger rand and lower than expected inflation the Reserve Bank cut its key interest rate by a further 50 basis points which certainly contributed to the strong performance of domestic equities.

The global economy remains fragile and we have no special crystal ball to tell us how events will turn out. Rather than basing our asset allocation decisions on unreliable forecasts, we instead focus on valuation of the various assets classes. In the interest bearing space we hold no conventional government bonds at all. We prefer to hold inflation-linked bonds as well as floating rate assets. In our view, we are near the bottom of the inflation cycle and the rate available on government bonds does not protect the holders against the risk of a negative inflation surprise.

In the light of ever declining returns available in the money market we have searched for opportunities across all asset classes. The portfolio has a wide spread of assets including preference shares, quoted property, ordinary domestic shares and global equities. Within global equities we hold both developed and emerging market stocks. In the domestic stock market our preference is for the more defensive equities and especially those companies that pay good dividends.

The fund, although conservatively positioned, had enough exposure to growth assets to benefit from the strong markets and posted a 6.2% return for the quarter. Over the past year the fund has returned 13.1%. The fund has been a very good performer in its category since inception and is the top performer over the three-year period ending September 2010 with an annualized return of 10.1%. The fund has outperformed its cash plus 3% benchmark over all periods other than the three-year number where we are ahead of cash, but behind the cash plus 3% target.

Portfolio managers
Charles de Kock, Mark le Roux and Neill Young

The recovery in global stock markets, which started in March 2009, suffered a significant reversal during the second quarter of 2010. The turnaround in sentiment was sparked by the eurozone crisis facing large indebted governments, with Greece at the epicentre of the storm. Markets became concerned that fiscal austerity would halter the still fragile economic recovery, and that parts of the European banking system would suffer massive losses if governments defaulted on their debt.

In the US, the pace of economic recovery also slowed down as is evidenced by slower employment gains and weak home sales. Even in China there has been a slowing of growth leading to a weakening of commodity prices.

On top of the deteriorating economic news the world also had to deal with the unforeseen events of the volcanic ash cloud disrupting air travel and economic activity in Europe, as well as the disastrous oil spill in the Gulf of Mexico.

With so much negative news about, investors reduced exposure to risk assets and fled back to the so-called safety of US Treasuries. The US dollar strengthened mostly at the expense of the euro but also against emerging currencies, including the rand.

The European sovereign debt crisis was only averted at the last minute by a combined rescue package from the IMF and European Central Bank. Markets calmed down somewhat following this successful intervention but sentiment remains nervous. South African financial markets followed the global trend and the FTSE/JSE All Share Index showed a negative 8.2% return for the quarter. Gold shares and a few selected domestic cash retailers were the best performers, while diversified miners were among the hardest hit in the sell-off.

We have kept a conservative stance in the fund by restricting our exposure to risk assets to below 30% throughout the period - significantly below our 40% maximum limit. The low equity exposure succeeded in protecting the downside to a degree, but with the benefit of hindsight we should have held even less in this asset class. Following the sharp fall in prices we do find good value in many equities and have been adding into the weakness.

The fund's investment in inflation-linked bonds paid off handsomely as this asset class showed a 5.1% return for the quarter, far outstripping the 1.1% return of conventional bonds as measured by the All Bond Index and the 1.7% return of cash.

The well diversified asset structure of the portfolio was crucial in protecting investors against the sharp decline in equities. The fund's return for the quarter was still positive at 0.29%. Over the past year the return is 12.32% and over the past three years 8.75% per annum. The fund remains one of the top performers over these periods in the low equity prudential unit trust category.

Portfolio managers
Charles de Kock, Mark le Roux and Neill Young

The global economy continues its recovery in almost all regions as inventories are being rebuilt from extremely depleted levels. The increased economic activity has contributed to rising consumer and business confidence.

Financial markets, buoyed by the better economic news, have continued the strong recovery which started in March 2009 with a further surge in the first quarter of the 2010. Interest rates are still extraordinarily low in the developed world, prompting asset mangers to look for higher returns in the emerging world. Emerging currencies, including the rand, therefore also remain firm supported by these massive portfolio flows.

The South African economy is also on the recovery road with most recent data releases surprising on the positive side. Inflation has moved back into the target range and the South African Reserve Bank saw it fit to cut the repo rate by a further 50 basis points in late March. Following an expansionary budget tabled in February, economic policy should be supportive of the economy in the year ahead.

Looking at the better macro economic news some investors may think now is the time to increase exposure to growth assets. But asset prices have run ahead in anticipation of the better times and we do not think valuations are attractive enough to warrant adding more risk to the portfolio at this stage. From an asset allocation point of view our total exposure to 'risk' assets is 30%. That comprises domestic equities at 18%, global equities at 8% and listed property of 4%. We are therefore below our self imposed 40% limit but find it an appropriate weighting considering where current valuations are.

In the interest bearing portion of the fund domestic cash has been reduced to a comparatively low 24%. Bonds have been increased to 35% which includes 15% in inflation-linked bonds. Although inflation is more likely to surprise on the downside this year, our concern is over the longer term. Positive factors such as the strong rand and low global prices for maize and other grains will not last indefinitely and when it changes inflation will rise again. The average real yield at which the inflation linkers were purchased is 4.45% - a very attractive real yield in our view.

The return of the fund for the quarter is 3.06%, for the last 12 months 16.32% and for the past three years 9.18% per annum. It is one of the top performing funds in the prudential low equity category in which it competes.

Investment flows into the fund has been very strong allowing the fund to grow from R1.03 billion at the end of 2009 to R1.5 billion at the end of March 2010.

Portfolio managers
Charles de Kock, Mark le Roux and Neill Young

Financial markets continued the positive trend of the previous two quarters, helped along by data releases supporting the view that the global economy is indeed recovering. The South African economy also posted a small positive growth number for the third quarter thereby signalling an end to our recession too.

Stock markets, which have anticipated the return to economic and profit growth well in advance, forged ahead towards the year-end. The JSE All Share Index returned 11.4% during the final quarter with resources leading the pack with a 16.7% return. The one-year return for the All Share Index was 32.1%, a number far higher than most would have expected at the start of the year. As reported earnings were weak, the rise in the market was purely due to a substantial rerating.

The bond market suffered as risk appetite returned and the market had to absorb enormous funding pressure from the government. The result was a poor year for bonds with a negative 1.0% return for the full year. The final quarter did however see a positive 1.1% return, although still below the 1.8% return on cash.

Policy makers have with very few exceptions kept the foot on the accelerator with extremely loose monetary and fiscal policies. It is the continuation of these unprecedented loose policies that leave many investors concerned about the future. At some point interest rates will have to move higher, while financing the massive fiscal deficits will place pressure on capital markets.

The fund delivered a return of 3.03% over the quarter and 13.53% for the year. The numbers are ahead of cash for the quarter (1.8%) and for the year (8.9%). Over the year we are comfortably ahead of the fund's cash plus 3% target. We are very proud of the fact the this fund ended third out of the fifty funds that participate in the low equity prudential category of unit trusts for the 2009 calendar year. The fund is first in its category over the last two years and will have a three-year track record by the end of the first quarter 2010. The fund has attracted steady inflows and went past the R1 billion mark during December.

Looking forward to 2010 we are of the view that money market interest rates will remain fairly stable around current low levels. Cash is unlikely to return more than 7% for the full year. Bond yields will remain under pressure due to funding pressure and although returns from bonds should beat cash, it is unlikely to give investors a return much better than the current yield of around 9%.

Equities, as mentioned earlier, have already run in anticipation of the better profits to come and no longer offer great value. We have therefore reduced our equity exposure to reflect a more conservative stance. We continue to hold a diverse spread of assets including preference shares and listed property. We also have an approximate 14% exposure to foreign equities and selected global bonds and cash. Although the rand remains volatile we are of the view that it is vulnerable to a sizable depreciation from current levels. When that happens the rand value of the offshore assets will rise.

We also welcome Neill Young as co-manager of the fund. Neill has been with Coronation for more than 10 years and has managed the Coronation Financial fund for almost 6 years. We are excited about his future involvement and contribution.

Portfolio managers
Charles de Kock, Mark le Roux and Neill Young