This last quarter has been characterised by an increasing emphasis on monetary tightening both domestically and internationally. Locally we have experienced the longest economic growth trend on record; the SA economy has had a staggering 107 consecutive months of GDP growth!

This has formed the backdrop for the much talked about conspicuous consumption which can be seen in our extremely strong private sector credited growth and increasing inflation figures. This strong local consumption of domestic and imported goods combined with a lack of export revenue from a constrained mining sector has also resulted in an increasing current account deficit for the country. The reserve bank has attempted to quell local demand by rising interest rates by 1% over the quarter however the SARB's efforts have had very little effect so far. The current environment argues for continued rate increases which should result in a weaker currency which would help our current account and slow domestic demand.

Our portfolio has been more defensively positioned due to what we see as a vulnerable equity market going forward. We have maintained minimal exposure to interest rates sensitive stock preferring to be invested in local banking shares which are more defensive than the local retailers. Although retail shares do look cheap right now they face a lot of negative sentiment going forward in this rising rate environment. Our major domestically focused buys for the quarter were: Distell, a very low beta company with an established branded portfolio of products. Naspers was another counter we increased our net exposure to, the company has a large portion of the profits consisting of annuity revenue and the valuation has been attractive. Naspers has however turned out to be disappointing finishing the quarter down 1.86%, despite Tencent adding 20% for the quarter.

Global commodity prices have been at astronomical levels fuelled by supply constraints and large amounts of speculation in these markets. We have been neutral to underweight as we believe that the global monetary tightening and slowing US economy are likely to lead commodity prices lower. We have already seen the beginning of this; however the local shares have held up better than expected due to the currency keeping rand resource prices buoyant. We have preferred to be invested in defensive global businesses like SAB Miller and Richemont which we increased our weights in rather than the global cyclical resource counters. The exception to this has been Sasol which we believe should be given more credit than a pure commodity play due to the proprietary processes they utilise.

Our performance was hampered this period by some our big net positive positions underperforming while our implied net negative positions performed strongly. Our positive Standard bank position returned only 1.05% for the 3 months. With very strong food inflation coming through our net positive holding in Pick 'n Pay did surprisingly bad returning -1.03%. Our implied net short positions in Sanlam, Steinhoff and Liberty International were also large contributors to underperformance.

Currently we believe that we will see the continuation of the current theme of monetary policy tightening and one could expect some bad economic data releases over the next quarter, one to watch would be the Private Sector credit extension. The SARB should continue to raise rates while the currency should remain weaker. Our net equity weight has ticket up slightly to around 6% as a result of us buying some of the above mentioned defensive shares. The South African market does look vulnerable to emerging market / commodity outflows as forecasts are for global GDP to slow below its long term trend of 3.5%. A key thing to watch will be the impact that the slowing US economy will have on global economic growth and commodity prices.

Market volatility has become more pronounced in the past quarter, with a negative angle to performance. The fund's price has been predictably stable throughout this trying time, and whilst struggling to produce strong returns, has not provided capital loss. We have reduced the net equity weighting to 4%, to continue to allow some scope for our stock selection to add value, but to effectively lock out all the negative market risk. The overall beta sensitivity of the fund to equity markets is some 0.04, meaning a 10% decline in the market allows for only a 0.4% decline in the equity value of the portfolio.

Similarly, the fixed income portion with a duration of some -0.1 years, will benefit from higher interest rates going forward. Short term uncertainty surrounding the performance of Emerging Markets, Commodity prices, the rand and domestic interest rates will provide much fluctuation in market levels. We have a wide spread of portfolio positions across the markets, with no specific sectoral exposure. We continue to like the long term prospects for Standard Bank with its quality banking franchise, Sasol with its unique oil from coal technology, Remgro with a 50/50 domestic offshore portfolio, and Afrox, with a sound annuity business and broad pricing scope.

The first quarter of 2006 yielded two strong months and one weak month when one considers the overall equity market performance. The strong performance of the more speculative shares like Harmony impacted on overall portfolio performance, and trimmed excess equity returns for the quarter. Nonetheless, the portfolio still delivered reasonable returns.

Market volatility could become a more pertinent feature of the investment landscape over the next 12-24 months, as the market grapples with the fight over a secular commodity boom versus an extended cyclical run. The two outcomes have very different implications for overall portfolio strategy. We tend to lean towards an expectation of a commodity down-cycle, from very lofty levels, some time later this year, before we continue on the longer term upward path.

We continue to hold selective exposure to stocks across the board, including Sasol, Impala, Absa, MTN as positive bets, and Old Mutual, Richemont & Amplats on the negative side. The beta of the fund is 0.08 , implying that a 10% decline in the market could lead to a 0.08% decline in the capital value of the fund.