Market review
The third quarter of 2009 provided evidence that the global economy is on the mend. A sharp fall in the rate of job shedding, stabilising house prices, a turnaround in consumer confidence and expanding industrial production in developed economies, marked what is likely to be the end of a deep and protracted global recession.

Over the quarter, global equity markets continued to head higher, with a 17.6% rise between July and September over and above the 21% gain in the second quarter of 2009. Cyclical stocks led markets higher, reflecting an improving economic outlook. Financials (25.9%), materials (21.5%) and industrials (19.8%) all ended strongly, while utilities (11.3%), healthcare (12.3%) and energy (12.9%) lagged the overall market. Emerging markets extended their gains over developed markets, closing the quarter 21% higher and ahead of the global composite for the third consecutive quarter. (All returns are in US dollars).

Risk appetite has greatly improved over the last few months. The rand continued to benefit from massive foreign portfolio flows into the local bourse, more than offsetting the outflows seen in the second half of 2008. The local currency appreciated by nearly 3% over the third quarter, pushing the year's gains to 22% against the US dollar.

The downward trend in inflation is likely to continue, but at a slower pace into 2010. Weak demand, the strong rand and the better nearterm inflation outlook, saw the monetary policy committee cut interest rates by a further 0.5% to 7% in August. The All Bond Index returned 3% over the third quarter, while cash, as measured by the STeFI, gained 2%.

The domestic equity market took its cue from global markets, which benefited from the improvement in the global growth outlook and a higher risk appetite. The All Share Index added 13.9% in the third quarter and has gained 18.6% this year. Over the quarter, the All Share Resources Index (11.1%) lagged the overall market, with gold miners earning a disappointing 6%. Domestic-oriented and interest rate-sensitive sectors enjoyed good gains. Construction (19%), general retailers (19.1%) and banks (14%) stood out as strong performers, with foreigners particularly active buyers. Telecommunication (3.8%) and short-term insurers (6.1%) underperformed the market.

Portfolio review
Conventional wisdom in the markets currently suggests that an economic recovery is underway, which will ultimately lead to better times for all. This recovery is largely reflected in equity prices both locally and in the higher growth markets around the world.

The Investec Absolute Balanced portfolio had a good quarter. We are confident that the portfolio will continue to produce solid real returns on a consistent basis.

Portfolio activity
We note the excitement around the new all time high attained by the dollar gold price and the sporadic rallies in gold shares. However, we need to point out that the price of gold in rand terms is still well below the February 2009 level. The portfolio continues to benefit from its exposure to gold. We have a neutral weighting to gold shares and prefer exposure to physical gold.

It is likely that the equity market has completed its re-rating in the current cycle. The price to earnings ratio of the market could be as high as 18 times by December 2009, as the earnings for the market bottom out. At this juncture, it would seem that there could be a period of three to six months where the market digests the earnings outlook and moves sideways. So far the cycle has shown a remarkable resemblance to 2002-2003.

We have maintained the net exposure to equities through select ongoing sales of shares that have reached their target values. Old Mutual is one holding that we have reduced to a neutral weighting, as the performance has pushed the price to fair value.

Portfolio positioning
Distell is one of our top five positive positions. This emerging spirits franchise, houses the second best selling, but fastest growing cream liqueur brand worldwide, Amarula Cream. It can grow volumes threefold before attaining the market share of Baileys. The business is still inexpensively valued by the stock market.

We also hold Steinhoff, which is creating a formidable European furniture discount business. The stock is still valued at a fraction of its true value, due to inappropriate concerns around debt levels in the business.

One of the prominent negative positions is Sanlam, which continues to trade above fair value. The portfolio is positively exposed to Santam. Our view is that it is the best asset within the Sanlam group. Santam has produced good underwriting results and more recently, its investment returns have been strong.

Market review
The improved growth outlook was reflected in sharply higher equity prices. The MSCI Word Index gained 21% over the second quarter. Markets were led higher by cyclical sectors. Defensive sectors, which had outperformed the market as economies collapsed, lagged the upturn, but still recorded absolute gains over the quarter. The S&P 500 Index gained 15.9%, lagging both the German Dax 30 Index (24.4%) and UK FTSE 100 Index, which gained 26% over the quarter (all in US dollars). The local equity market had a positive quarter (8.6%), its first in 12 months, despite giving up some of its gains during the month of June (-3.1%). Year to date, the All Share Index closed 4.1% stronger. The market's foreign currency returns for the three month to the end of June, were boosted by the rand's appreciation against the US dollar (24.1%) and the euro (16.7%). Over the quarter, the financial and industrial composite (13.4%) outperformed resources (2.8%), with gold miners (-16.2%) the largest underperformers. Other sectors lagging the composite over this period included fixed line communications (-0.8%), travel and leisure (6.6%) and food producers (7.7%). General retailers (15.6%), banks (13.8%) and the construction (16.6%) sectors all ended the quarter well above their March levels. The platinum (9.5%) and general mining (8.9%) sectors performed in line with the overall market. The bond market continued to struggle, with the All Bond Index returning 0.3% in the second quarter. The negative factors outweighed very weak final demand and activity data and a strong domestic currency, to push yields higher across the curve. Inflation data remained sticky around the 8% level, while the announcement of substantial tax revenue shortfalls announced by the ministry of finance provided further support to the bond bears. The decision to leave rates unchanged in June was not entirely surprising, given previous remarks by the Reserve Bank governor. Listed property underperformed equities, bonds and cash, losing -0.9% over the quarter. Cash, as measured by the STeFI, returned 2.3% for the three months to the end of June.

Portfolio review
We indicated to investors last quarter that the budding market recovery could fail at any time as the root cause of the global economic problems had not yet been solved. There is too much debt in the West and too much saving in the East. Initiatives by the US Treasury and the Federal Reserve are aimed at putting more debt into the system, at a time when increased savings, higher interest rates and lower debt levels are needed to heal a fragile financial system. To solve a debt problem with more debt cannot be the solution; hence we doubt that the pace of the recovery will be as sharp as what cyclical share prices suggest. Portfolio returns to investors have lagged the strength of the local equity market returns over the past quarter. However, we continue to be encouraged by the strong level of absolute returns that investors have enjoyed over the past twelve months.

Portfolio activity
There are no macro themes that dominate the portfolio at present. We are matching equity opportunities with differing drivers, thereby ensuring that the return profile of the portfolio is stable.

Portfolio positioning
The top three exposures in the portfolio are Old Mutual, British American Tobacco (BAT) and the Gold exchange traded fund (ETF). Old Mutual provides an opportunity to exploit improving trends in global credit markets. BAT is our inflation-linked bond exposure with a proper yield of over 6% in sterling, and the gold ETF represents insurance against the onset of a deflationary environment, or a stock market setback. The portfolio's negative exposures include Bidvest and Anglo American. We believe that despite bottom of the cycle conditions in the commodity sector, the recent run in Anglo is unjustified in terms of sustainable earnings, the balance sheet is still precarious and the valuation of the business is below the current share price. Only a "normal" cycle would justify the current share price. Similarly, we are concerned that the perceived defensive nature of Bidvest may not prevail and the earnings risk of the share is high. The prices of economically sensitive commodities like copper and oil have surged, showing that China has been restocking. We may have reached a level where the restocking diminishes and commodity prices fail to make decisive gains. This would impair the ability of the resources sector to move higher. Historically, there is a close correlation between commodity prices and the resource-heavy All Share Index

Market review
Local economic news continued to deteriorate over the quarter. The release of fourth quarter GDP numbers confirmed the sharp slowdown experienced in the second half of 2008. Domestic demand remained under pressure in the first three months of 2009. Weak employment prospects and the slump in the manufacturing sector continued to bear down on retail spend and vehicle sales. Policy makers responded with two interest rate cuts of 100 basis points each during the quarter. The second meeting, held earlier than initially scheduled, indicated somewhat greater urgency on the part of the South African Reserve Bank to respond to the extremely weak global backdrop and evidence that the local economy was unlikely to escape a recession. The outlook continues to favour more rate cuts. South African bonds followed global yields higher after reaching record lows in December. While prospects of weak growth and falling inflation continue to provide a bond-friendly environment, the market remains sensitive to the impact of a rapid increase in government spending and concomitant future funding requirements. The All Bond Index lost 5.1% over the quarter. The listed property sector (-1.4%) fared somewhat better, but could not escape deteriorating sector fundamentals. Cash, as measured by the STeFI, returned 0.9% over the quarter. Equities weakened for the third consecutive quarter, with the All Share Index losing 4.2% year to date. Both financials (-7%) and industrials (-9.2%) ended the quarter in negative territory. Resource counters clawed back some of their losses sustained in the second half of 2008 to end up 1.6%. Gold mining (22.8%), platinum mining (9.6%) and pharmaceuticals (22.4%) were the only sectors to gain over the quarter. While general miners (-4.6%) performed broadly in line with the overall market, it was the domestic oriented sectors that fell most with banks (-9.8%), retailers (-7.6%) and the construction sector (-10.6%) all ending down.

Portfolio review
The portfolio delivered a positive performance over the quarter, but was hurt by a negative month in February. There was no place to hide with equities and bonds performing poorly. Even gold and tobacco lost value, which are typically 'end of the world' assets. British American Tobacco (BAT), the single largest holding in the portfolio, lagged the market. This is despite BAT continuing to offer compelling growth, dividends and long-term value. We started, possibly too early, to add more economically sensitive assets to the portfolio which we would expect to lead a market recovery. However, longer term we remain concerned that the nascent market recovery could fail at any time as the root cause of the global economic problems has not yet been solved. Initiatives by the US Treasury and the Federal Reserve are aimed at putting more debt into the system, at a time when increased savings, higher interest rates and lower debt levels are needed to heal a fragile financial system.

Portfolio activity
The largest holdings continue to be shares in BAT and physical gold, which both represent defensive inflation hedges. We have exposure to Old Mutual and are satisfied that the value of the local business already exceeds the share price. With narrowing corporate bond spreads, we see positive value emerging from the US business in time.

Portfolio positioning
We have slightly raised the equity weighting in the portfolio as the possibility of near-term capital loss has declined significantly, given current equity levels. With lower inflation supporting falling cash rates in 2009, investors need to earn additional returns as the real cash returns are well below normal levels and could stay there for some time. Declining short-term interest rates typically encourage risktaking, and higher share prices as company profits improve.

Market review
The final quarter of 2008 brought no relief to investors, consumers or policy makers as the financial crises and concurrent economic slowdown continued to unfold. Activity data across the globe reached multi-decade lows, marking the worst global recession post World War Two. The quarter was characterised by accelerating job losses, falling house prices and tighter bank lending standards. While macro fundamentals deteriorated sharply, yields on US government debt plummeted to new depths, indicative of the ominous economic outlook. Global equities experienced one of their worst periods in history, erasing impressive gains over the last few years. The MSCI World Index fell 21.7% over the quarter in US dollars and was down 40.3% in 2008. The MSCI Emerging Markets Index lost 27.6% over the fourth quarter in US dollars to end the year down 53.2% - surpassing its previous crash during the Asian crises in the late 1990s.

On the domestic front, bond yields continued their downward move as both the weak growth and lower inflation outlook favoured the potential for significantly lower interest rates. The All Bond Index gained 11.3% in the fourth quarter to end the year up 17%. Cash, as measured by the STeFI, rose 2.9% over the quarter and 11.7% for the year. The listed property sector increased by 8.5% over the fourth quarter, but returned -4.5% over 2008.

The global financial crises and the ensuing slowdown in economic activity left their mark on the domestic equity market. The All Share Index lost 23.2% over the year, all of the losses sustained in the second half of 2008. The market ended 9.2% weaker over the last quarter of the year, with falling commodity prices driving down platinum (-25.8%) and general miners (-15.2%). The construction sector slumped 36.1% in the fourth quarter as companies saw their order books curtailed by weaker demand and foreign investors seemed to lose faith in the sector. Life assurers (-15.9%) continued their underperformance of the general market. Exposure to falling interest rates and defensive earnings streams dominated the outperformers over the quarter, with banks (-6.1%), healthcare equipment and services (5.6%), food producers (6.6%) and food retailers (16.2%) high up on the performance table. However, it was the gold miners (22%) that took the top spot over the quarter as the dollar gold price held its own and rand weakness and positive production news boosted returns to the sector.

Portfolio review
2008 provided an opportunity for the strategy to demonstrate its true value to investors. The Investec Absolute Balanced Fund returned close to 10%, while general equity markets delivered significant negative returns. This demonstrates how the explicit capital protection structure removes capital volatility.

Stock selection added value, but the small net equity exposure maintained over the year detracted from performance. The biggest positive contribution came from the portfolio's holding in the gold exchange traded fund. We believe that the lack of growth in the local gold industry and ongoing cost challenges will result in gold shares underperforming the rand gold price, as has been the case over the past 40 years. A rand invested in the rand price of gold would be worth R320 today, but less than R45 if invested in gold shares.

Portfolio activity
We have raised the net equity weighting in the portfolio to 10%. Our view is that subsequent to negative price action from the broad market indices, there is no longer a significant threat to capital values.

Portfolio positioning
The risk of capital loss from equities has diminished significantly, and in fact the upside risks to commodity prices are significant. Strong infrastructure spending by governments around the world could provide much needed demand for the resource sectors, particularly if one looks beyond the near-term risks of a synchronised global recession. Commodities are trading below the marginal cost of production, and we are seeing producer cutbacks occurring across the board. This supply side response suggests that commodity prices have bottomed. If this is the case, then clearly a gradual upward movement in commodity prices will see a corresponding rise in the JSE.

Of all the asset classes, government bonds are the most vulnerable to capital loss. The medium-term supply of new paper and the associated inflation risks of government sponsored bail-outs will place considerable strain on yields.