The past quarter was one in which investors lost confidence in the ability of policy makers to deal effectively with the current financial crisis. The inability of the European politicians to agree on a plan of how to deal with the sovereign debt crisis was matched by the stand-off between the Republicans and Democrats on the other side of the Atlantic regarding the agreement to raise the debt ceiling for the US. The result of the dithering by policymakers led to downward revisions to growth expectations for the global economy and an increase in the likelihood of a renewed recession.

Taking the reduced growth expectations into account, risk aversion was at the top of the minds of fund managers as they sold growth assets in developed and emerging markets alike.

South Africa was no exception as foreigners turned net sellers after being strong buyers earlier in the year. The rand consequently depreciated sharply by 19.7% against the strong US dollar and by 10.5% against the euro over the quarter.

Most commodity prices also declined sharply after having held up well in the first half of the year. Oil for example declined by 5% over the quarter, copper by 25% and platinum by 12%. Gold was the exception and continued its upward trajectory by gaining another 7% over this period.

The selling pressure took its toll on equities with the result that the FTSE/JSE All Share Index posted a negative total return of 5.8% for the quarter. Bonds gave a positive 2.8% for the period even though the return in the month of September was negative. Cash returns were unchanged from previous quarters at 1.4%. In dollar terms global equities were also down sharply. The MSCI World Index gave a negative return of 16.5% and the MSCI Emerging Market Index was down an even sharper 22.5%. The weakening rand however shielded SA investors and in rand terms developed world equities gave a flat return and global emerging market equities a negative 7.2%.

Against this backdrop of very weak global markets we are pleased with the return of 2.1% achieved by the fund over the quarter and 8.5% over the past year. The three-year return is a satisfactory 10.9% per annum. The fund has a conservative mandate and our exposure to risk assets is limited to 40% of the portfolio. We stayed comfortably below this mark throughout the quarter. The positive returns from inflation-linked bonds and high yielding corporate bonds contributed positively. We added to our global equity exposure during the quarter at the expense of domestic equities. The fund now owns more global than domestic equities.

Looking forward we think the investment climate will remain very difficult. Returns from cash and bonds will likely be below the rate of inflation while a slowing economy will make it difficult for companies to grow earnings meaningfully. There is however some good news too. Many world class global businesses with pricing power are trading at attractive valuations and have healthy balance sheets. It is our view that investing in these companies will help us to protect investors' capital and grow wealth over time.

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

The second quarter of the year was marked by ongoing volatility as global markets vacillated between 'risk on - risk off' trades. This switching between a positive and negative view of the world was driven in large part by the uncertainties surrounding the European debt situation, for which the Greek crisis has been a lightening rod. However, generally weak economic data releases, political gamesmanship in the debate over raising the US debt ceiling, and most recently the decision of the IEA to release strategic oil reserves also contributed to the lack of conviction evident in asset prices.

The relatively contained declines in financial markets for the quarter belie the intra-period movements. Equity markets were broadly positive in April, but retraced in May and June, only to bounce back at the close of the quarter as the Greek parliament approved austerity measures which will enable additional funds to flow into the country's bailout package. Similarly, the US 10-year Treasury yield, a barometer for global risk appetite, rose in April only to strengthen to below 3% in June (levels last seen in December 2010) before closing the quarter at 3.16%. The outcome of the Greek crisis is pivotal to the effective longer-term functioning of the euro. While in isolation Greece is relatively small in the greater European context, the EU's ability to deal with the country's over-indebtedness carries an important read-through to other troubled European member states. It is difficult to envisage a scenario where Greece exits the euro, but similarly the current solution of reinvesting maturing debt into new Greek bonds can only really be a temporary fix. Ultimately some strong medicine needs to be taken, and until such time financial markets are likely to suffer from ongoing mood swings.

Closer to home, the uncertain outlook for global growth has been felt most in weak commodity prices, which carried through to resource stock prices. Similarly the rand has remained strong against developed market currencies.

We continue to manage the fund with the aim of protecting against this sort of volatility. For the quarter, the fund has again safeguarded investor assets and returned 2.2%, which we would consider a pleasing performance under the circumstances. Returns over 1 and 3 years amount to an annualised 12.8% and 11.1% compared to the cash +3% benchmark returns of 8.9% and 11% respectively.

The most significant asset allocation change during the quarter was to increase the fund's international equity exposure from 15.4% to 16.7% and global cash from 2.0% to 2.9%, funded by our domestic equity and cash holdings. We believe much of the uncertainty in developed markets is more than reflected in equity valuations, and we view the rand's strength as unsustainable in the medium term. Domestic property holdings have also increased, while exposure to global assets was increased to above 20%, something we had signalled in previous commentaries that we would look to do if the rand remained strong.

In our view, global interest rates will remain low for some time to come in an attempt to ensure that growth takes hold. The quarter's developments in Europe make this seem all the more likely, and despite the ECB having hiked rates by 25 basis points to 1.5% in July in an attempt to stave off inflation, they will in reality not move too far away from the US, who are likely to keep rates lower for longer. This probably caps the SA Reserve Bank's ability to hike rates as well. The implication for our higher yielding currency is that it is likely to continue to see inflows for as long as this persists.

In the medium to long term however, yields are likely to move higher. For this reason, we retain our negative view on both global and domestic bonds and the fund remains heavily exposed to corporate floating rate and inflation-linked bonds. Similarly an end to low global interest rates points to a weakening rand and therefore, global assets, and in particular global equities remain our favoured asset class.

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

The world was rocked by two major unforeseen events in the first quarter of 2011. The first was the outbreak of uprisings in North Africa and the Middle East which impacted the oil price. The second was the major earthquake and tsunami which hit Japan.

Financial markets slumped during the first part of March in reaction to these events and the even greater uncertainty it introduced into a global economy which still grapples with an anaemic recovery and the sovereign debt crisis affecting Europe. The initial sell-off was sharp, but global markets recovered as the nuclear situation in Japan was brought under control and the foreign intervention in Libya seemed to tilt the balance of power against its leader, Muammar Gaddafi.

Unrelated to these crises the rand was also extremely volatile and depreciated sharply in January only to recover during the second half of the quarter.

It is our task as fund managers in a conservative fund such as this to protect investors against extreme volatility as best as we can, but still to take on enough risk to enable the fund to outperform its benchmark of cash plus 3%. The fund's return during this extremely volatile period is very encouraging and bears testimony to the benefits of running a well diversified portfolio. The combination of assets protected the fund's value and we ended the quarter with a positive return of 1.7%. Returns over one and three years amount to 10.7% and 10.3% (annualised) respectively compared to the 9.2% and 11.5% of the benchmark.

From an asset allocation point of view the most important move was to take the fund's exposure to global equities from 13.4% to 14.2%. We believe global equities offer the best value among the major asset classes at present. This has been funded from domestic cash holdings. Exposure to foreign assets amounted to just less than 20% of the portfolio at quarter-end. This is the highest foreign exposure since the fund's launch in February 2007.

We remain negative on the outlook for global bonds as yields remain very low and inflation is becoming an ever increasing threat. At some point the zero interest policy followed by the large Western economies will have to change and when it does bond yields will move higher.

Domestic bonds yields have moved to more attractive levels, but in light of our negative view on global bonds and the threat of higher inflation we believe the risk to bond yields remains skewed to the upside. We therefore stay with our fairly heavy exposure to inflation-linked bonds, floating rate securities and cash.

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

Investors are often surprised by the apparent disconnect between the real economy and the prices of financial assets. The past year was a good example. Whilst economists correctly used phrases such as 'anaemic', 'sub-par' or 'jobless' to describe the state of the global economy, prices of financial assets performed very well. Developed world equities gave a dollar return of 12.3% for the year, while emerging market equities returned 19.2%.

In an attempt to bolster the struggling global economy, and in the absence of inflationary pressure, monetary authorities kept interest rates at historically low levels. Investors facing near zero interest rates and sluggish growth in the developed world looked for opportunities in the emerging world where yields were far higher and economic prospects brighter. Money flowed from the developed to the emerging world resulting in appreciating currencies and rising prices of financial assets.

The South African rand, the JSE and our government bond yields all benefitted from this global economic environment. Over the year the All Bond Index delivered a return of 15.0%, the All Share Index 19.0% and listed property a very strong 29.6%. The rand appreciated by 11.8% against the dollar and by even more against the euro.

The fund had a very good year. Strong inflows saw the fund's value rise from just over R1 billion to more than R4 billion. It remains a top performer in the Low Equity Prudential category. Returns for the quarter were 2.3% and 12.2% for the year, comfortably above its target of cash plus 3%.

Looking forward into 2011, one is still struck by the many risks facing the global economy with over-indebted governments facing very serious funding issues. Global bond markets are nervous and rightly so. We have avoided investing in conventional bonds for some time and still prefer inflation-linked bonds where we believe we get protection from the overly loose monetary policies implemented by the monetary authorities. We also hold corporate bonds which we bought at attractive yields.

Within equities our selection favours good dividend payers and companies with defensive business models.

As far as our global exposure is concerned we have kept our exposure below the maximum allowed 20% throughout the year. This was a deliberate portfolio decision based on the desire to limit the volatility of the fund's performance on the one hand and the lack of yield available off shore. We are likely to increase our global exposure during the next year, however interest rates will eventually normalise and in this process emerging currencies are likely to experience a reversal of the favourable inflows of the past year. When this will occur is impossible to predict, but when it does the rand is going to weaken. Our offshore investments will then contribute to performance.

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