The third quarter of 2015 was marked by deeply negative performance across all markets. Measured in US dollars, the MSCI World Index delivered a return of -8.3%, the MSCI Emerging Markets Index produced - 17.8% and the FTSE/JSE All Share Index returned -13.8% over the threemonth period. Emerging market currencies were under pressure, with the rand falling by 12.1% against the US dollar over the period. Commodity prices also continued their slide, led by oil (down 22.1%), platinum (down 15.8%) and copper (down 10.1%) to name a few.

US Treasuries were the safe haven trade amid the carnage on stock markets, with the 10-year rate falling from 2.5% to 2.07% by quarter-end. SA bond yields did not follow the US rates lower, but rose by 17bps to close the quarter at 8.4% in response to the weak rand and falling commodity prices. The rand weakness was enough to offset some of the negative US dollar returns meaningfully and once again served to protect investor returns from deeply negative numbers. Measured in rands, global cash produced a return of 12.3%, while the MSCI World Index (which delivered a negative US dollar return) also produced a positive return of 4.1% when expressed in rand terms. Viewed against this very negative backdrop, the fund's defensive characteristics came to the fore by ending the quarter with a mildly positive return of 0.51%. The longer-term returns of 11.48% p.a. over 5 years and 11.05% p.a. over 3 years remain well ahead of the fund's target, and the rolling 12-month return of 6.49% is reasonable under the tough circumstances.

Within domestic equities, returns were exceptionally divergent, with SABMiller up 25.8% (driven by the takeover offer from Anheuser-Busch InBev). Other global industrial rand hedge stocks such as British American Tobacco (up 17.6%), Intu (up 17.3%) and Richemont (up 10.7%) contributed to performance, while resource shares such as Exxaro (down 39%), Northam Platinum (down 33.1%) and Anglo American (down 32.7%) detracted.

From an asset allocation point of view we used the weakness in the market to increase our exposure to domestic equities, up from 12.7% at the start of the quarter to 14.3% by end-September. We also added to our listed property exposure (up from 5.0% to 5.6% by quarter-end). The fund's exposure to global assets at the end of the quarter was 23%, and total exposure to all risk assets rose to 37.4% (up from 34.7% at the start of the quarter). The fund's buying of more risk assets was balanced by a drop in its cash component to 19.7%.

The fund aims to achieve a cash plus 3% return over the longer term, and to not produce a negative return over any rolling 12-month period. As such, protecting capital will always form part of the mindset in managing this portfolio, and even more so in the current difficult phase of the South African economy.

Portfolio managers
Charles de Kock and Duane Cable

We have been cautioning investors for some time to prepare for lower returns. Our warning was based purely on valuation considerations, where the long period of exceptionally low interest rates has led to an overvaluation of most financial assets.

Burdened by the very high ratings, the JSE seems to have finally run out of steam. The one-year return for the All Share Index to the end of June 2015 is a mere 4.8%. Cash returned only 6.3% and bonds 8.2% over the past year. Global stock markets have also experienced lower returns, with most emerging markets suffering losses. The MSCI Emerging Markets Index showed a negative 4.8% return in US dollar terms over the past year. Developed markets performed better, lifting the MSCI World Index to a positive 2.0%.

In light of these pedestrian returns from the major asset classes, our warning of lower returns has unfortunately come to pass. Against this backdrop, the fund posted a 7.2% return over the past year, materially lower than the returns achieved over its history. The biggest change in the portfolio over the past quarter was to increase the fund's effective global exposure by 3.7%. This was achieved via currency futures, where we bought back the long ZAR/USD positions as we became more concerned about the South African rand.

On the macro front, the breakdown in negotiations between Greece and its creditors as well as the subsequent rejection by voters at the polls of the terms set by the creditors have increased the possibility of Greece leaving the eurozone. At the time of writing, there is no clarity on exactly what will happen, but the "no" vote will add more uncertainty to investors' minds.

Further adding to investor anxiety is the increased likelihood of the US Federal Reserve (Fed) hiking interest rates before the end of this year. The US economy has improved enough that the Fed feels the need to start the process of normalising rates. The expectation for rate hikes has already contributed to a stronger dollar and weakness in emerging markets.

Our investment approach for this fund remains to try and protect capital in these uncertain times. It is our view that the lower returns mentioned at the start of this report are likely to prevail for longer. Equities remain highly rated and cash and bond yields also offer only single-digit returns. We are conservatively positioned and will add risk exposure only at more attractive prices.

Portfolio managers Charles de Kock and Henk Groenewald

The world has been trapped in an extraordinary long period of slow growth, low inflation and excessively low interest rates as monetary policy has been pushed to extremes in an attempt to ward off deflation and rekindle some kind of economic growth.

The impact of this protracted low interest rate environment on investor behaviour has been a desperate search for yield and safety. Bond yields have fallen to unheard of levels, while prices of reasonable dividend-paying defensive businesses have soared as money chased these opportunities.

Zero, and nowadays even negative, interest rates are not normal. The long period of excessively low interest rates is likely to start changing when the US embarks on a slow process to hike interest rates later this year. Financial markets need to take heed of this pending change. In recognition of the ever steamier ratings of equities and listed property, we reduced the fund's exposure to risk assets slightly over the quarter by some net selling. The focus of the selling was on listed property and some of the high-quality stocks where we believe ratings have moved to uncomfortable levels.

We were very active in the bond market where volatility allowed us to trade in and out of bonds as the market reacted to positive or negative data releases, and consequently its view on the timing of the expected interest rate hike by the Federal Reserve Board. While we do not have a strong view on the timing of such a move, we are positioned for a rise in US interest rates. Whether it happens sooner or later than the market expects does not drive our strategy. Within the bond space, we continue to find more value in corporate bonds where spreads over government bonds are attractive. Our investments in this area have been concentrated mostly on floating-rate bonds where the capital is not at risk to rising rates.

The fund returned 3.0% for the quarter, 10.4% for the past year and 12.6% per annum over the past 5 years; well ahead of the cash plus 3% target.

Portfolio managers
Charles de Kock and Henk Groenewald

Looking back, 2014 certainly presented some choppy waters for investors to navigate. Some of the challenges included slowing economic growth in China, the outbreak of the Ebola virus, the collapse of commodity prices, the Russia/Ukraine conflict, the continued weakening of emerging market currencies, while locally we saw the demise of African Bank and disruption caused by load shedding. Despite the many challenges we faced, the year turned out to be respectable for most asset classes when measured in rands.

With the exception of listed property, most asset classes delivered very pedestrian returns when measured in US dollar terms. The significant weakening of our currency towards the end of the year had a major impact; not only making low offshore dollar returns look respectable in rand terms, but also boosting locally listed shares with a significant offshore earnings stream.

Global equity markets were volatile after peaking at new highs around the middle of the year. Emerging markets declined (in US dollar terms), significantly underperforming developed markets. Our local market performed slightly better than other emerging markets over the period, but declined almost 5% from the highs reached in July 2014.

Commodity prices declined significantly throughout the year, with iron ore and oil down by almost 50%. In this environment, it is not surprising that mining shares continued their underperformance, losing over 14% for the year.

In contrast, financials and industrial companies continued to do well with solid returns, supported by very good performance from the banks and the effect of the weaker rand on companies with global operations. The fund was relatively well positioned for events that transpired during the year and in general our asset allocation decisions added value. We increased our position in government bonds at attractive yields and added to our property exposure. We hedged back a small portion of the offshore assets into rands, which has cost us performance given the weakening of the rand towards the end of the year.
In general, our local equity selection was good. The biggest individual contributors to performance for the year were Naspers and Intu Properties. Cyclical shares detracted, notably Exxaro and Impala. The fund returned 8.8% for the year and largely stayed on the fairway. Over three and five years, the fund has returned 13.6% p.a. and 12.6% p.a. respectively; comfortably ahead of the cash + 3% benchmark. In addition, the fund has not had a negative return over any 12-month period and remains one of the top-performing funds in its category. We still consider overall valuation levels in our local equity market to be elevated. We remain cautiously positioned, with growth asset exposure well below the maximum 40% limit and low exposure to local equities.

We remain committed to our dual mandate of preserving capital over 12-month periods and achieving medium-term returns in excess of cash + 3%. We continue to caution that future returns will most likely be lower than those achieved in the past.

Portfolio managers
Charles de Kock and Henk Groenewald Client