At Coronation we place a lot of emphasis on what we consider to be the long- term or normalised view. We have been very clear in our communication since the start of the global financial crisis that we do not think the policy of zero interest rates and quantitative easing will continue indefinitely. We have accordingly watched bond yields being driven to extremely low levels, but have not participated in the bubble on the view that this abnormal situation will end at some point. When chairman Ben Bernanke hinted in May of this year that the US Federal Reserve (Fed) was considering to taper the amount of quantitative easing, bond yields kicked up dramatically in both the US and emerging markets such as South Africa. But then, against market expectations, the Fed decided at their September monetary policy meeting not to taper just yet. The announcement caught the markets by surprise and prompted a big rally in US Treasuries as well as in emerging market bonds and currencies. The amazing volatility caused by short-term investors and speculators who try to get the timing of these decisions spot on has given us excellent trading opportunities. We consequently bought some long-dated government bonds after their yields had moved to what we considered to be a reasonably attractive level and sold it all again after the very strong rally. Likewise, we reduced our global US dollar exposure after the rand had weakened sharply but reversed it again during the subsequent rebound. On the equity front we maintained our positions. Our exposure to what we consider to be pretty fully valued domestic equities remains just below 10% and we add to our risk assets by owning more global equities which we consider to offer better value. The fund's total risk exposure was 31% at quarter-end; still meaningfully lower than the maximum 40% allowed by the mandate. The strong rally in most assets in September has helped the fund to post a 4.7% return for the quarter, 16.6% for the past year, 13.6% per annum for the past three years and 13.0% per annum over the past five years. Returns remain significantly above the cash plus 3% benchmark and place our fund among the best performers in its category over all meaningful periods. Looking forward, we caution once again that we expect returns to moderate. Cash will probably continue to generate a negative return in real terms for at least another year. Bond yields have run too low yet again and remains at risk to the inevitable normalisation in monetary policy mentioned before while yields on listed property are also likely to move higher in sympathy with bond yields. In addition, we are not excited about opportunities in the domestic equity space. Some value can be found in selected stocks but the market as a whole is not attractive. As always the fund will strive to protect capital over any rolling 12- month period.

Coronation clients should know that our investment approach is valuation driven. We buy assets when they trade at prices below our assessment of fair value and we sell assets when they trade at prices above our fair value. The success of our approach lies in our ability to quantify the fair value reasonably accurately, and our long-term track record suggests that we have been pretty successful in doing this. We are, however, not good at - and in fact do not even try - timing when prices are about to revert towards fair value. The past quarter has marked one of those periods during which a major adjustment in prices towards fair value occurred. In this case it was the global bond market, led by the US 10-year treasuries. Our clients will know that we have not been invested in conventional government bonds for a number of years as we believed the yields had fallen to ridiculously low levels. In other words, the price for bonds was far too high and way above our view of fair value. Prices were driven to an extreme by the zero interest rate policies followed by the Western economies in response to the global financial crisis. Although we had no idea as to when the prices would revert to more normal levels, we had high conviction that it inevitably would. The event that triggered the move was when the chairman of the US Federal Reserve, Ben Bernanke, hinted that they would consider tapering asset purchases later this year as the US economy was recovering. We were not surprised by these comments but many greedy investors, who seemed to expect the US's 'free' money policy to continue forever, were taken aback. Ten-year US treasuries consequently spiked up by 64 basis points to end the quarter at 2.5%, resulting in a negative performance of 4%. It is our view that this is merely the start of the normalising process and we expect bond yields to trade materially above current levels before it reflects fair value. The Fed's warning was not the only news that spooked the market. The slowdown in China and especially concerns about the stability of its banking sector hurt commodities, with the China dependent resources shares being particularly weak (down 11.8% over the quarter). Physical commodities were very weak, with the gold price showing the largest decline of 23.8%. Platinum fell 16.4%, while base metals were also weak although not down as severely as the precious metals. South African 10-year bonds followed the rising US treasuries, adding 78 basis points which translated to a negative total return of 2.3%. Inflation-linked bonds did even worse with a negative return of 4.9% over the quarter. Listed property shares had an extremely volatile time. The return for the quarter was only 0.4% negative, with a good rebound in June after declining 11.1% in May. The FTSE/JSE All Share Index was down 0.2% over the quarter, but this number hides a few dramatic moves such as minus 33.5% for gold and minus 23.9% for platinum shares. Industrial shares, especially rand hedges such as Naspers and Richemont, performed very well. The rand depreciated by a further 6.5% against the US dollar over the quarter as investors opted out of emerging and especially commodity based currencies. The fund experienced a return of 1.6% for the quarter, due mostly to the full allocation to global assets which performed well in rand terms. The return for the past year is 17.2%, for the three years 14.1% per annum and for the five years 12.6% per annum. All of these returns are materially above our target return of cash plus 3%. We have cautioned in the past that investors should not expect returns of this magnitude going forward. We think returns in the income yielding portion of the fund will be anchored around the 5% level of cash, a number that is below the rate of inflation. From an asset allocation point of view, the fund is conservatively managed with an exposure to South African equities of below 10%. Most of the risk exposure is taken through global equities where we still find reasonable value in dollar terms. The investment environment will certainly be challenging as the Fed starts the slow process to normalising monetary policy. Investors should expect high volatility during this time. We will however stick to our tried and tested valuation-based process to manage the fund in the best interests of investors.

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

Global investors started the year with a bullish attitude, buoyed by positive news from the important housing and employment indicators in the US and a growing sense of confidence that authorities in the eurozone would be successful in containing the crisis. In Japan, newly elected Prime Minister Shinzo Abe similarly inspired confidence with his aggressive stimulatory policies. The result was a strong rally in most equity markets, with the Nikkei adding 20.1% in yen (or 9.7% in US dollars) over the quarter and the S&P 500 closing the period at a new all-time high. European stocks had a strong January, but gave up most of the gains on concerns around Cyprus and the inconclusive Italian elections. The fund has held the bulk of its exposure to growth assets in global equities where we have found more value than in the domestic market. The strong gains in global equities, combined with the weak rand, were therefore the main driving forces behind the fund's excellent returns of 4.97% for the quarter and 17.73% over the past year. We plan to persist with this strategy as we continue to find better value among global stocks, despite the recent strong upward move in share prices. The fund continues to attract inflows and in order to keep our global exposure near the maximum allowed 25%, we added $25 million to our holding in the Coronation Global Capital Plus Fund. The rand is however a very volatile currency and following its weakness in late March, with the currency reaching R/$ 9.25, we reduced our dollar cash positions by around 2% of fund. We consider this a temporary move and will reinstate those dollar positions once the rand has strengthened somewhat. Within equities we trimmed positions in Aspen and Richemont. These are two outstanding businesses but strong share price performance has rendered them less attractive. We sold out of Bidvest after it too moved beyond what we consider to be its fair value. Major purchases were Spar, Murray & Roberts, British American Tobacco and RMI. In the listed property area we added to Intu Properties (the renamed Capital Shopping Centres) and Capital & Counties. We also added Delta, a new listing and a relatively small property company with a BEE management company that is very active in the governmenttenanted buildings space, trading at an attractive yield of 8.8%. On the income portion of the portfolio, the very low interest rate environment has made it increasingly difficult to generate high returns. We sold most of our position in Shoprite convertible bonds at a considerable profit of around 30% higher than our purchase price. The underlying share price of Shoprite had run very hard to above R200, which was considerably higher than our measure of fair value for the company. In February we purchased Impala Platinum convertible bonds maturing in 2018. These type of assets are attractive for a low-risk fund such as Balanced Defensive given that one has an embedded floor in the asset as it matures in 5 years' time at the price you paid for it initially; earns a coupon, in this case 5% per annum for the 5 years; and has the potential equity upside should the underlying equity perform over the next 5 years. We were also active in the preference share market, where we mainly bought the big bank preference shares namely, Standard Bank, FirstRand, Absa and Nedbank. The rationale behind why we find this asset class attractive is twofold: the yield on these assets are currently around 6.8% to 7%, which we find compelling relative to the yields available in money markets, and with the introduction of Basel III could have a positive impact on the landscape for these old-style preference shares issued by the banks. The fund has met its target of outperforming cash +3% over all periods without entering negative territory over any rolling 12 months. We have cautioned before that the very high returns achieved over the past few years is unlikely to be repeated going forward. Interest rates will start to normalise at some point, making the returns available on bonds and property much lower than that achieved recently. Domestic equity prices are also on the high side, and we also expect more muted returns in this category.

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

A brief reflection on 2012
At the start of 2012 we had many concerns about market valuations and the still fragile state of the global economy. We consequently cautioned clients to expect low returns and managed the fund in a conservative fashion. We kept our exposure to risk assets well below the mandated maximum (40%) throughout the year. In particular, we limited exposure to what we thought were fully priced domestic equities to around 10% of the total portfolio. This comparably low domestic equity weighting allowed us to utilise the risk budget to increase exposure to global equities. Our view, as expressed in previous commentaries, was that global stocks offered better value. We were also concerned about the value of the South African rand. The fund was therefore managed with an almost maximum exposure to offshore assets throughout the year, of which the bulk consisted of global equities. The abnormally low interest rate environment meant that keeping money in cash was unattractive and we worked hard to produce better returns by investing in inflation-linked bonds, corporate credit and floating rate bonds. The returns achieved in this area exceeded our expectations as yields were pushed ever lower in the global search for yield. Notwithstanding our conservative stance in 2012, the fund delivered very pleasing returns. In the final quarter of the year, it returned 4.5%, 16.4% for the full year, 12.9% per annum over 3 years and 11.8% per annum for the 5-year period. In all cases far better than our target of cash plus 3%. It is interesting to look at the contribution to total returns from the various asset classes. Over the past year the exposure to foreign assets added 5.4%, domestic bonds 6.8%, domestic cash 0.3% and SA equities including listed property 3.9%.

Looking forward to 2013
The global economy is by no means out of the woods. The era of high debt levels, sluggish growth and ultra low interest rates is likely to remain. The stronger actions by Mario Draghi, European Central Bank president, has been good for Europe and positive for financial market sentiment. Yet the inherent problems remain and another year of low growth, high unemployment and tough decisions lie ahead for this troubled region. In the US we once again had to wait until midnight before the divided congress and Obama administration agreed on a deal that prevented the US from going over the fiscal cliff - for now. But once again it is a short-term measure and more tough negotiations lie ahead. The new leadership in China and Japan also bring some hope, but the backdrop of a sluggish global economy will weigh heavily on them too. We were already concerned about domestic equity valuations last year. These concerns are even greater following the strong performance of the JSE in 2012. In a very low interest rate world, the search for yield has pushed bond and listed property yields to very low levels. Another year of strong returns for these asset classes seems highly unlikely. We continue to seek assets offering value as best we can, but again investors need to be cautioned to expect lower returns going forward.

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