Market review
Global equity markets recovered in April and May but retreated sharply in June. The ever rising price of oil led to increased anxiety about stagflation (slowing growth and rapidly rising prices) and the effect it would have on companies' earnings and valuations. Over the second quarter the MSCI World Index returned -1.4% in US dollars, -1.6% in sterling and -0.9% in euros. In local currencies, the S&P 500 returned -2.7%, the MSCI Europe ex UK -4.1%, the UK's All Share Index -1.5% and the Topix Index (Japan) gained 8.9%. The MSCI Emerging Markets Free Index returned -1.5% and MSCI Asia ex Japan -5.9 %( in local currencies).

The US dollar fell 0.1% against sterling but rose 0.6% against the euro and 6.1% against the yen. Yields on 10 year government bonds rose, ending the quarter at 3.98% in the US, 4.63% in Germany, 5.13% in the UK and 1.6% in Japan. Spreads on corporate bonds narrowed earlier in the quarter but then widened again, ending the quarter close to the peak seen in mid March. The return on the Citigroup World Government Bond Index was -4.2% in US dollars.

Growth continues to weaken, inflation has surprised on the upside, especially in emerging markets. Much of this is tied to the strength of commodity and, in particular, energy prices. There is concern that this may feed through into labour cost inflation in developed markets, hence the increased hawkishness of central banks.

Fund performance
The Investec Global Balanced Feeder Fund had a difficult second quarter, returning -4.8% over this period, while the benchmark delivered a return of -5.6% in rand terms. For the year to June the fund returned 8.3%, against the benchmark return of 11.1% in rand terms.

Asset allocation contributed to the fund's performance over the second quarter. We increased the fund's exposure to equities and bonds over this period. At the end of the quarter the fund's equity position was overweight relative to the benchmark, while the bond exposure was below the benchmark.

Market outlook
A secondary setback to equity markets had always been possible, but the extent of it was unexpected. Valuations are very supportive and there is evidence that the momentum of downward revisions to profit forecasts is lessening. Government bond yields have risen but unless inflation becomes embedded, they should now benefit from weakening economic activity.

However, there are serious risks. Corporate earnings estimates could re-accelerate downwards and it cannot be guaranteed that investors will continue to be willing to recapitalise bank balance sheets. Most importantly, the ever increasing oil price threatens to undermine both valuations and earnings. Rising supply and falling demand suggest that the oil price peak is close. However, a further upward spike in prices, with negative consequences for financial markets, remains a very real possibility.

Government bonds have become less overvalued, and investment grade corporate bonds are now attractive in absolute terms as well as relative to government issues. The high yield market is likely to be dull in the second half of the year due to rising defaults, but this should offer attractive long-term investment opportunities. The yen is again looking undervalued, and therefore we have raised our exposure to this currency. However, our main currency position is to be long the dollar and short euro exposure. We are looking for an opportunity to increase our exposure to risk assets (such as equities and corporate bonds) but are holding off for now due to the short-term risks.

Market review
The first quarter of 2008 was dominated by the financial market fallout from a faltering US housing market. Related credit concerns and an interbank market that ceased to function, precipitated aggressive policy intervention over the quarter. A surprise intermeeting interest rate cut of 75 basis points by the US Federal Reserve (the Fed) in January was followed by two further cuts with the federal funds rate closing the quarter a full 2% lower.

Economic data remains weak, while the US dollar continues to hover around all time lows against its major trading partners. European growth has been resilient. However, inflation has risen to its highest level since the inception of the euro, supporting the European Central Bank's reluctance to follow the more accommodative approach pursued by the Fed. The outlook for world growth remains uncertain with risk to the downside as lending standards rise and consumption is likely to feel the pinch from the falling wealth effect and rising unemployment.

Equity markets ended the first quarter sharply lower, driven by fears of a US recession, general risk aversion and a massive downward revision to earnings. The S&P 500 Index fell 9.4%, while the FTSE 100 Index lost 10.6% and the Japanese Topix Index shed 6.9% (in US dollar terms). The MSCI World Index declined by 8.9% over the quarter, outperforming the MSCI Emerging Markets Index, which closed down 10.9% (in US dollar terms).

Global bonds saw strong absolute returns over the quarter, closing 9.7% higher over this period (in US dollar terms). The market ignored inflationary pressures and reacted instead to aggressive policy intervention, decelerating growth and a general risk aversion.

Fund performance
The Investec Global Balanced Feeder Fund had a good first quarter, returning 15.2% over this period, while the benchmark delivered a return of 16.9% in rand terms. For the year to March the fund returned 15.5%, against the benchmark return of 18.4% in rand terms.

Asset allocation, including currency positioning (long yen) and satellite fund positions contributed to the performance of the fund. The position in equities was kept at neutral until the third week of March, when it was raised. In the bond portfolio we have started a shift into investment grade corporate credit. The equity position ended the quarter overweight relative to the benchmark, while the fund's bond exposure was below benchmark.

Market outlook
The recovery in equity markets, which started in late March at the time of the Bear Stearns crisis, has continued in April. We believe that the low point has been passed. However, the upward path from here is unlikely to be smooth. Although earnings growth is expected to weaken further, this is more than discounted in exceptionally attractive valuations, both in absolute terms and relative to bonds. It would take extreme weakness in earnings in the second half to halt or reverse the market recovery. Further support to equity markets is provided by the cautious and risk-averse attitude of most investors. This leaves plenty of room for positive surprises, despite the gloomy economic outlook.

Government bonds look increasingly overvalued, but the yield spread of investment-grade corporate bonds over them is now attractive. There has been a partial switch in our bond exposure to corporate issues and we expect to make further switches. We have taken profits on our exposure to the yen, and are looking for a signal to raise dollar exposure. This is in line with our expectation at the start of the year of dollar weakness in the first quarter, but recovery in the second half. Overall, we believe that the time has come to raise exposure to risk assets across the portfolio in expectation of much improved returns.

Market review
Against a backdrop of substantial volatility and heightened uncertainty, global equity markets fared poorly over the final quarter of 2007. The MSCI World Index returned -2.3% in dollars while the MSCI Emerging Markets Free Index returned 3.7% in dollars. In local currencies, the S&P 500 returned -3.3%, the MSCI Europe ex UK -2.1%, the Topix Index (Japan) -8.6% and the UK's All-Share Index -0.4%. Smaller companies underperformed, especially in the UK, and the FTSE Small Cap Index lost 14.4%.

The dollar rose 2.3% against sterling, but fell 2.8% against the euro, 3% against the yen and 0.9% against the rand. Yields on 10-year government bonds fell further, except in Europe, ending the quarter at 4.04% in the US, 4.32% in Germany, 4.57% in the UK and 1.51% in Japan. The return on the Citigroup Global Bond Index was 3.9% in dollars.

US rates were reduced by 0.5% to 4.25%, and the forward market is discounting further cuts to 3.5% in the first half of 2008. Forecasts for growth in 2008 have been reduced to below 2% in the US, UK and Europe, although indicators of current activity have been slow to weaken. The slowdown in Europe, but not in the US or UK, should be short-lived, while Asia and emerging economies should continue to grow strongly. The Japanese economy slowed sharply in 2007 and may even pick up in 2008. Inflation is expected to fall in 2008, but 2007 estimates were raised steadily, partly due to high commodity prices. The possibility of a US recession continues to hog an excessive amount of attention. However, global growth at actual exchange rates is likely to be close to 3% in 2008 and the greater risk may be a premature pick-up in growth before inflation pressures have truly abated. Bond yields do not point to such a problem, but will need careful watching.

Oil prices (Brent) rose to $93.8 per barrel, while the gold price climbed to $836 per ounce, close to the peak of $850 briefly reached in 1980.

Fund performance
The Investec Global Balanced Feeder Fund returned -2.3% in rands over the quarter, while the benchmark delivered -0.7% in rands. The currency position was neutral. Exposure to satellite funds and positions had a mixed effect: positive for bonds but negative for equities. The overweight position in equities was cut back early in November close to neutral, but the bond position remained underweight, reducing performance.

Over the year to December the fund returned 5.5% in rands, while the benchmark return was 7.6% in rands.

Market outlook
Markets are trading broadly sideways as investors worry that falling earnings forecasts could undermine good value. Bond markets may be too optimistic about the scale of a slowdown and the long-term threat of inflation, but their strength has persisted. Investors are pessimistic about the outlook for earnings and analysts have been sharply cutting 2007 forecasts but are currently expecting earnings growth to accelerate in 2008. Further cuts are likely but the eventual outcome is likely to be far better than valuations discount.

The dollar is oversold and may be due for a recovery. Equities are good value in both absolute terms and relative to bonds, though bonds are highly priced. Investors are cautious and risk-averse, which leaves room for positive surprises. When earnings forecasts stabilise, there will be significant upside to equity markets.