Market review
Equity markets struggled in an environment of slowing growth and accelerating inflation. Both developed and emerging markets ended the quarter somewhat lower in US dollar terms, losing 1.4% and 0.8% respectively after an aggressive sell-off in June. Europe underperformed the US, while Asian developed markets posted better returns on the back of gains in Australia and Japan. The MSCI Emerging Markets Index was led weaker by Asia, with China posting a large negative return over the quarter. Both Latin America and EMEA (Eastern Europe, the Middle East and Africa) ended the quarter in positive territory, up 11% and 6.3% respectively (in US dollar terms).

Record high oil prices, up 35% over the quarter, set the tone for commodities. The oil cartel, OPEC, continues to ascribe accelerating oil prices to speculative activity and geopolitical risk and has refused appeals by developed market finance ministers to increase production. Steel, copper and precious metals saw price gains over the period, while recent price settlements by producers of iron ore with Chinese steel mills have averaged 85%.

Locally, there was further evidence of decelerating domestic activity as rising inflation and debt servicing costs constrained consumer demand over the quarter. This was evident in the negative growth in vehicle sales volumes and real retail spend. However, mining activity and agricultural output saw some improvement after a dismal first quarter. The outlook for domestic growth remains uninspiring as business confidence is at a four-and-a-half-year low. Forward looking indicators of the manufacturing sector point to a substantial decline in output over the next few quarters. A drop in income due to inflation, pressure on jobs as the economy slows and a decline in wealth as a result of falling house prices are likely to pose further headwinds to economic activity.

Against a backdrop of accelerating inflation, the South African Reserve Bank (SARB) hiked interest rates by a cumulative 100 basis points in April and June. Prior to the June meeting markets were positioned for a 1% rise after the SARB governor cautioned that tough measures may be needed to bring inflation back into the target band. However, rates were increased by only 50 basis points. The Bank cited evidence of a substantial slowdown in growth as the reason for the lower-than-expected hike in rates. Accelerating global oil and food prices as well as a weaker rand continue to underpin the negative domestic inflation outlook. The National Energy Regulator's recommendation of a 27% hike in the electricity tariff for 2008 and similar increases in 2009 and 2010, will further add to domestic inflationary pressures.

The bond market experienced substantial weakening across all maturities as the yield curve saw an upward shift in excess of 150 basis points over the second quarter. The All Bond Index lost 4.9% over this period, while cash (as measured by the STeFI) returned 2.7%. The listed property sector took its cue from rising interest rates and higher bond yields, selling off aggressively to shed 19.6% in the second quarter.

The All Share Index closed 3.4% up over the quarter losing some of its earlier gains as inflation fears gripped global markets. Substantial dispersion in performance across the sectors was evident as resources gained 13.4% over the quarter, while the Financial and Industrial Index lost 6.4%. General mining led resources higher, closing up 18.1% over the three months to the end of June. Banks and general retailers shed close to 15% over the quarter, while the defensive food retail and telecommunications sectors ended up 3.2% and 3.4%, respectively. The telecommunications sector was buoyed by corporate activity as MTN sought a potential merger with an Indian telecoms company.

Fund performance
The Investec Absolute Balanced Fund earned a return of 2% over the second quarter and for the 12 months to the end of June the fund gained 8.6%.

As the Absolute Balanced Fund celebrates its fifth birthday on 1 July 2008, it would seem as if it were born for a time like this. Despite the rapid adverse change in the financial market landscape, the portfolio is well positioned to benefit from rising inflation and interest rates. The portfolio has delivered compelling returns, particularly to higher tax paying individuals.

Exposure to select resource names have added value this year, particularly NewGold debentures (up 26%), BHP Billiton (up 43%), Impala Platinum (up 30%) and Sasol (up 36%). (The price increases are for the six months to the end of June).

Portfolio activity
We have reduced the positive bet on BHP Billiton, which we have held against Anglos for most of 2008 so far. The weighting of Richemont has been raised to a positive bet, given the attractive valuation of the business and lower financial risk than the market is discounting.

We sold out of Telkom in June. The share has been a reasonable performer, and we note the corporate action potential. However, we are concerned about future valuations, given current credit market conditions which make funding expensive. We believe the share is trading at the upper end of the value range and we see better value elsewhere.

Market outlook and portfolio positioning
Cash, currently delivering 12% per year to investors, forms the basis of the current and future returns on this portfolio. We expect to add to this in the form of our stock selection by taking controlled positions in shares we like. These currently include Standard Bank, Sasol, Impala Platinum, and Richemont. We still expect double digit returns with no capital at risk.

Market review
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 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.

The shake-out in global markets saw investors flee the SA equity and bond market, resulting in a sharply weaker domestic currency. Over the quarter the rand underperformed emerging market peers, losing 15.9% against the US dollar and a much larger 22.4% against the euro. Facing the headwind of global market volatility and an uncertain growth path, the local economy further had to contend with severe power outages resulting in substantial costs to the local economy. Slowing domestic demand coupled with acute supply side constraints saw downward revisions of economic activity.

Bond yields succumbed to continued upward pressure on rising inflation, heightened risk aversion, a sharply depreciating domestic currency and potential further upside risk to monetary policy. The South African Reserve Bank faces rising global food and fuel prices, upward pressure on local electricity prices, as well as a depreciating rand. However, the outlook for domestic demand has deteriorated and monetary tightening in this cycle has not yet fully impacted domestic growth. This poses a dilemma for the inflation-targeting central bank. The All Bond Index lost 1.9% over the quarter with the short-dated bonds anchored by uncertainty about the next policy move, while the longer end sold off on the elevated inflation outlook. Cash (as measured by the STeFI Index) returned a steady 2.6% over the quarter.

Listed property remains under pressure from rising bond yields, rand weakness and some uncertainty with regard to income distributions as the economic outlook deteriorates. The sector lost 10.9% over the quarter, broadly in line with other interest rate sensitive sectors.

The FTSE/JSE All Share Index retraced the losses sustained towards the end of 2007, closing the first quarter up 2.9%. Resources were the clear winners, returning 17.6% as commodity prices reached new highs and earnings were aggressively revised upward. The domestically focused FTSE/JSE Financial and Industrial Index lost 8.5% over the quarter, depressed by tougher trading conditions and poor sentiment towards rate sensitive sectors. Banks, tainted by global credit market woes and local policy uncertainty, closed the quarter down 10.7%, while general retailers lost 14.3%. The construction and telecommunications sectors were less affected by the slowing domestic consumer environment, losing 7.6% and 4% respectively.

Fund performance
The Investec Absolute Balanced Fund earned a return of 1.6% over the first quarter and for the year to end of March the fund gained 8.6%.

October 2007 marked something of a turning point in the local financial markets. Since the turning point only offshore assets and inflation-linked bonds have delivered real returns to local investors. We have been concerned about inflation in the near term and raised this issue several times in our commentaries last year. However, we did not consider it prudent to attempt to buy large holdings of illiquid local inflation-linked securities on pitifully low real yields. Others that have followed this approach have been rewarded. We remain sceptical that exit opportunities exist.

We remain convinced that the underlying powerful driver of rising cash rates provides a solid basis for current and future investment returns, particularly if our security selection can add some outperformance.

In the wake of severe power outages impacting the mining sector, it was surprising that the performance of these shares has been spectacular. We have not owned the large diversified mining shares as we believe that the prices continue to discount high commodity prices, supported by production volume growth. However, the exposure to Sasol, Impala Platinum and Assore benefited the portfolio tremendously. A pure value orientation to local stock selection would have lost money in the past six months, which we simply could not afford. The value holdings like the banks still represent great long-term performance potential.

Overall, the absolute levels of returns achieved recently are becoming quite compelling, and the performance over the first quarter has been pleasing.

Portfolio activity
Strong resource share performance overshadowed poor financial and industrial share performance. Early in the quarter we added a 2% exposure to the gold exchange traded fund (ETF) and this position contributed handsomely to performance. Declining gold production levels and a steady demand from investors seeking inflation hedges in a weak dollar environment; suggest that we will continue to see a rising trend in the gold price. The fact that South Africa's gold production is falling leads us to conclude that the rand gold price must continue to rise.

Market outlook and portfolio positioning
We never try to forecast short-term movements of any variables, including the direction of the stock market, as these forecasts typically prove fruitless. Market performance is very erratic at present with huge swings in monthly performance figures. We will attempt to generate consistent returns throughout this time. Commodity prices are behaving like there is no down cycle in global economic activity, yet financial shares are reacting as if the world's credit markets are shutting down permanently. Both views cannot be correct. We tend to think that the answer lies somewhere in the middle.

Market review
Against a backdrop of substantial volatility and heightened uncertainty, global equity markets fared poorly over the final quarter of 2007. All major indices closed down sharply led by the US S&P 500 Index (-3.3% in US dollars) and the Japanese Topix Index (-5.9% in US dollars). MSCI Europe outperformed other developed markets, declining by 0.4% in US dollars. The Global MSCI composite lost 2.3% over the fourth quarter (in US dollars). Emerging markets held up admirably on the back of domestic currency strength and somewhat different local growth dynamics. The MSCI Emerging Markets Index gained 3.7% over the quarter (in US dollars). Bond markets had to contend with the dichotomy of accelerating inflation and clear signs of economic deterioration. The Global Bond composite returned 3.9% in US dollars over the fourth quarter.

On the local front, the bond market focused on inflation data and the near term direction of interest rates. With inflation accelerating and the outlook for food and energy prices deteriorating, the bond market had priced in a fourth interest rate hike in 2007. The South African Reserve Bank's monetary policy committee statement leaned towards a peak in the interest rate cycle and the yield curve shifted down, retracing some of the earlier losses. The All Bond Index returned 0.9% over the quarter and 4.2% for the year. Cash (as measured by the STeFI) returned 9.3% for the year and 2.5% over the fourth quarter.

Domestic equities came under pressure during the fourth quarter, with the All Share Index closing down 3%, but achieving respectable returns of 19.2% for the year as a whole. The losses were concentrated towards the end of the period, as both resources and financials became victims of the uncertain global growth outlook and continued negative sentiment associated with the global banking sector. Gold miners ended the year as the market's worst performer, losing 14.1% over the quarter and 20.6% over the year. The construction sector continued its strong run, to end the year 77.3% higher as the best performing sector.

Fund performance
The Investec Absolute Balanced Fund delivered its 15th consecutive positive monthly performance in December. Although inflation continues to surprise on the upside, the fund is delivering stable real returns. The JSE on the other hand had three negative months in 2007. The Investec Absolute Balanced fund returned 2.6% over the quarter and 9.7% over the 12 months to end December.

Portfolio activity
We have reduced the net equity weighting in the fund to around 7%, recognising the tougher environment ahead of us, hence continuing to ensure limited beta in the fund. Where we have market exposure, it is via low risk shares that are priced for income and income growth rather than capital gains. The challenges for 2008 are continued inflation surprises, potentially flat, but volatile global equity market performance and limited underlying positive local market direction.

Portfolio positioning and market outlook
The year ended with the South African economy running above potential in many areas. Evidence of this is the current account deficit (8% of GDP), CPIX ending close to 8%, four interest rate hikes and severe pressure on productive assets like infrastructure including roads and electricity generation, ports and rail. Further capital spend in these areas will generate capacity, but will pressurise consumers (via higher prices) and capital providers (by lowering returns).

Although retail shares look cheap on a price-to-earnings basis, we continue to be concerned about the rising monetary policy cycle trend. Apart from making cash an attractive asset class, interest rate hikes reduce the scope for earnings growth and the ability of many domestic shares to attain a higher rating.

Resource shares are largely vulnerable to declining base metals prices as the world economy slows next year. Rising prices have been a strong support for the market over the past five years.

The outlook for precious metals remains more mixed. However, a return to a stronger dollar (which is unlikely) could hurt these prices. Most resource shares' earnings look unsustainably high and cost pressures, or lower commodity prices represent undiscounted risks to this sector. We continue to be underweight Anglo American.

We have been beating the drum on predictable earnings streams from quality businesses with good track records and this theme remains intact as we go into the New Year. MTN stands out in this regard and remains a key stock position for the fund, notwithstanding great performance throughout 2007. Another share that we continue to like is Distell, where the brand value of the portfolio and continued growth prospects remain unrecognised by the market.

We will look to add some counters to the fund, which have been punished by the market and we have started to nibble on JD Group shares. Our view is that patience and a high cash weighting will be rewarding to investors.