Market Review & Portfolio Activity
The third quarter was a relatively benign month for global equities. However, this continued to mask some interesting underlying trends and a shift in leadership that has been taking place since May of this year, with large-cap stocks performing well. The most significant event of the quarter was the fall in the oil sector where, after years of strong performance, the price of oil fell back sharply. The main factors put forward to explain this pull-back included an easing of geo-political risks, an absence of hurricanes in the Gulf of Mexico, slowing US economic growth and relatively high inventory levels. These effects seem to have been compounded by speculative selling pressure as the significant 'hot money' that has moved into the commodity areas swiftly moved in the other direction. The near bankruptcy of energy-trading hedge fund Amaranth only served to exacerbate matters. Elsewhere, the rest of the equity market performed relatively well, as investors shifted their attention to the fact that US interest rates may well have peaked for this cycle. Consequently, retailers, as a sector, was the best-performing sector over the quarter, driven by US retailers as investors assumed the US consumer would resume spending.
Performance Review
The Fund marginally underperformed its benchmark during the quarter. This was primarily due to performance in the Industrials sector where the Fund was impacted by holdings in both Oil & Gas and Steel. US refiner Valero was the biggest detractor from performance as the falling oil price is likely to translate into lower margins. Concerns about slowing US economic growth pushed Commercial Metals, a US steel producer, lower even though the company's growth prospects remain strong. The negative performance was offset by the rumoured takeover of AWG (since confirmed) but this was not enough to offset the dramatic move in oil stocks.

Market Outlook & Fund Strategy
The Fund's strategy remains focused on high quality, attractively valued companies with improved operating performance, which are receiving increasing investor attention. At present, our largest overweight position is in the tobacco sector where a combination of attractive valuations, solid cash-flow characteristics and an improving litigation environment have all contributed to drive share prices higher in the sector. Although smoking The European banking sector is also providing a source of attractive investment opportunities. Many of the larger European banks are undertaking comprehensive restructuring programmes which, when combined with improving economic growth, has created a strong foundation for future profit growth. Many of these companies have the added benefit of strong dividend yields - such as HSBC's 5% yield - reinforcing their strong valuation case.
Overall, we remain positive on global equities. However, with central banks around the world simultaneously tightening monetary policy, we expect to see heightened volatility and reduced returns as investors digest how far interest rates need to rise and whether the US Federal Reserve (Fed) can engineer a soft landing for the US economy. Markets are likely to remain focused on the Fed's actions as a result. However, at present, news-flow at the corporate level remains reasonable and valuations are attractive.

Judging from the returns of Investec's two rand-denominated global equity general funds, picking winning unit trusts is far harder than picking winning shares. Each year for the past three years, Investec Global Equity Fund of Funds' returns have lagged behind those of Investec World Wide Equity (IWW) by an average of 4,5%/year. Things may change, but for now IWW remains top choice in the stable and a top sector choice.

Financial Mail - 01September2006

The second quarter proved to be a volatile time for global equity markets even though the MSCI World ended up essentially flat over the period in US dollar terms (down 0.3%). All areas of the capital markets underwent some form of stress. The dollar was weak in April and this then flowed through into bond and equity markets which took fright at comments from various members of the Federal Reserve that inflation has moved out of their respective comfort zones.

With interest rising across the world equity investors have focused on one key question - will the Fed now tighten too hard in the attempt to tame inflation and what impact will this have on economic growth? This will continue to be a recurring question until the Fed believes inflation is under control and, as such, investors should expect more volatility over the coming months than we have seen in recent years. Against this backdrop less liquid, higher risk assets were sold off most aggressively. Emerging markets were the most severely impacted with the MSCI Emerging Markets index falling 4.3% in US dollar terms over the quarter. At the sector level both Industrials and IT underperformed Overall, we remain positive on global equities.

However, with Central Banks around the world simultaneously tightening monetary policy we expect to see heightened volatility and reduced returns compared to the strong bull market of the past three years. Though markets are likely to stay keenly focused on the Fed, news at the corporate level remains strong and valuations remain attractive. This should provide a reasonable underpinning to the market even as investors digest ongoing interest rate increases.

Enthusiasm for equities continued unabated in December as investors continued to take heart from the prospect of a halt in the ratchet like tightening process being undertaken by the US Federal Reserve. Confidence that US rates may be near their peak was bolstered by an inversion in the US yield curve which should demonstrate that money policy is tight and that growth is about to slow. For various reasons, primarily the appetite for US paper from far eastern central banks, we are unconvinced that growth prospects are quite as dire as suggested by the relationship between short and long rates however we do concur that corporate earnings growth in the US is likely to slow this year.

However with price earnings multiples at near 20 year low much seems have been discounted and the prospect of multiple expansion accompanying a stabilisation in rates make equities look extraordinarily appealing to investors starved of attractive alternatives. At the same time evidence of a recovery in Europe continues to accumulate and the prospect of world growth being sustained at current levels through a change in drivers from the US to the European and Japanese consumer looks like a viable outcome and one which can only give equity market investors more to cheer about. However be warned that any negative inflation surprise could upset the whole apple cart. Although price conditions appear benign at this stage and companies seem unable to pass on raw material cost increases there is a consequence in terms of margin compression in this environment but again we feel at current levels markets have over discounted this slowing earnings growth scenario.

At the sector level Industrials were the standout performer up 3.4% as investors became more confident about economic growth in 2006. On the negative side telecoms were down once again by 0.5% taking them to a substantial 9.2% fall over the year. Tough competition, regulation and the ongoing technological change are all weighing heavily on the sector.

We remain positive on global equities. Corporate fundamentals remain positive, as suggested by continued upward revisions to global corporate earnings forecasts and the long-term technical trends as measured by moving averages are firmly in place.

Valuation remains attractive in many segments of the market, and near all time high cash-flow return levels confirm the current strategic strength of global corporates. In summary therefore, with earnings continuing to be revised upwards, reasonable valuations and long-term share-price momentum still in an uptrend, we remain positive.

The Fund's strategy is to focus on high quality, attractively valued companies with improving operating performance, which are receiving increasing investor attention. The Fund continues to be overweight in Insurance where a combination of a strong premium growth environment combined with improving combined loss ratios (lower cost of claims) is providing strong earnings enhancement opportunity. Our largest underweights are, as always, in sectors where there are relatively few stocks exhibiting these attractive characteristics, being in particular the Banks and Diverse Industrials.