Market review
Risk assets experienced a torrid third quarter. Equities slumped, commodities retreated sharply, credit spreads widened materially and currencies depreciated against the US dollar. The traditional safe haven assets performed well: both US Treasury yields and German Bunds fell to record lows, closing the quarter at 1.9%. Gold added a further $125, up 8.2%, despite the slump in September. The US dollar gained 6% in trade-weighted terms over the quarter. With fears of a sharp growth slowdown and a high probability of an imminent recession in some regions, commodity prices could not hold on to the elevated levels reached in the first half of the year. Copper declined 23.3%, platinum fell 11.6% while Brent crude closed 5.3% lower. The MSCI World Index ended the quarter 16.5% weaker and emerging markets tumbled 22.5%. The FTSE 100 Index dropped 15.5%, the Dax 30 Index slumped 31%, while the Nikkei 225 Index outperformed meaningfully, closing 7.1% weaker. The S&P 500 Index shed 13.9%. (All returns are quoted in US dollars.)

South Africa remains subject to global pressures, the uncertainty about the crisis in Europe, the structural impediments to a more meaningful global recovery and asset market volatility. The South African Reserve Bank, concerned about global macro events, kept interest rates on hold at record lows. Citing a slightly higher inflationary trajectory and its continued willingness to consider all eventualities, the Bank heeded calls to maintain its mandated policy objective of stable inflation. The slump in the rand, along with the depreciation of other emerging market and commodity currencies, added support to the decision. Domestic growth remains sluggish, with manufacturing and mining output particularly weak. With average house prices falling, personal debt to income ratios high and job growth mostly absent, private sector investment continues to languish. SA GDP growth estimates for the year have now slipped to well below the 3% mark, with forecasts for 2012 being revised downward towards 3.5%. The All Bond Index gained 2.8% over the quarter and cash, as measured by the STeFI Index, edged 1.4% higher. The listed property sector rose 2.2%, buoyed by firmer bond yields.

The FTSE/JSE All Share Index closed the quarter down 5.8%, with significant rand weakness partially offsetting the sharp fall in commodity prices. The index lost 21.3% in US dollars. Significant dispersion marked the quarterly performances, with sectors most exposed to the SA economy generally outperforming the broader market. The food and general retail sectors fared particularly well, closing 6.4% and 1.7% higher, respectively. Banks lost 3.3%, while short-term insurers gained 6.9% over the three months. The health care sector, up 2.5%, continued its recent strong performance. Commodity-exposed rand hedge stocks fared poorly over the quarter, but even here there was significant dispersion. Diversified miners lost 17.3% and platinum miners shed 9.7%. The gold sector posted one of its strongest relative performances, gaining 19.5% over the review period.

Portfolio review
We have relied on defensive assets to deliver market outperformance, and investors have benefited from the holdings in the gold debenture and British American Tobacco. Gold has not reached an unsustainably high price. The price behaviour is not yet euphoric and a fair inflation-adjusted price is some $2000 per ounce. We have found more opportunities in the inflation-linked bond space. We are excited about another non-market directional source of return for investors.

Portfolio positioning
Over the past six months, the fund has been defensively positioned, matching the risk profile of investors who prefer a cash-like return. This positioning was motivated by a need to mitigate unexpected adverse effects on fund returns in the event of lower equity prices. Unfortunately, the fund does not have any offshore exposure, and the small net equity weighting has not contributed to fund performance this year.

The triggers of a wholesale change in market psychology are incredibly difficult to identify. This makes calling both stock market tops and bottoms a task fraught with error. Only with hindsight can these be identified with any degree of accuracy. It is not clear to us whether or not we have reached the market bottom. In 2008 the copper price bottomed out at $1.30 a pound, and it is currently still around $3 a pound. We know that the marginal cost of producing high cost copper is around $2.60 a pound, suggesting that if the price falls below this level, we could see a bounce. The relevance for South African investors is that this level suggests that the JSE still has 15% downside in dollar terms. Of course, the rand is likely to do half the adjustment in the process. Capital preservation remains a key priority. We are aware of a host of macroeconomic uncertainties, but we are ready to act if and when pricing on markets becomes irrational.

Market review
Developed market equities (0.7%) continued to outperform emerging markets equities (-1%) over the review period. The S&P 500 Index ended the quarter flat, while the German Dax, UK FTSE and Japanese Nikkei indices added 7%, 1.7% and 3.3% respectively. The emerging market BRIC members performed poorly. Russia lost 5.4%, Brazil 5.3%, and India ended the quarter 3.6% weaker. All returns are quoted in US dollars.

With risk aversion and growth concerns prevalent, bonds matched a good first quarter. US treasury yields briefly dropped below the 3% mark, seemingly less focused on US credit quality and the pending debt ceiling expiry. However, lower bond yields were not evident across all countries, with those exposed to acute solvency concerns seeing their cost of borrowing shoot to record highs. Similarly, the cost of insuring against default by those governments has increased exponentially over the past few months.

While global financial markets were characterised by extreme volatility, the rand seemed almost oblivious to it all. Unchanged over the quarter against the US dollar, the local currency ended only slightly weaker against the euro. Strong portfolio flows - predominantly into the local bond market - plus Competition Tribunal confirmation of Walmart's acquisition of local retailer Massmart, added to the lustre of the rand. Local bonds rallied over the quarter, with the All Bond Index gaining 3.9%. Cash, as measured by the STeFI, returned 1.4% over this period. The listed property sector enjoyed healthy gains, lifting total returns to 5%.

The South African Reserve Bank's monetary policy remains on hold for the time being. A slow jobless recovery locally, concerns about developments in Europe and the rest of the world, and moderating near-term inflation fears have pushed expectations of a rate hike deeper into the second half of the year than had previously been priced in by the market.

The FTSE/JSE All Share Index closed 0.6% lower over the review period, with the market falling 2% in June. Resources were the biggest detractors, with gold miners and platinum stocks down 13% and 7.7% respectively. Diversified miners lost 3.3%. Health care (6.9%), food producers (4.5%) and telecommunication (5.4%) performed well. Banks gave up 0.9%, with flat returns year to date. Sasol, the only oil & gas sector constituent, fell 8.5% in the second quarter after a strong first three months of the year.

Portfolio review
The Investec Absolute Balanced Fund is a medium- to long-term alternative to money market funds. The fund aims to produce low-volatility, inflationbeating returns that are ahead of cash. Outperformance is generated by capturing the alpha generated through stock selection, while minimising the risks of a possible downward move in the market.

The fund is currently invested in a combination of equities, fixed interest and cash instruments. Since equity alpha tends to be larger and more accessible than bond alpha, our allocation to equities is usually large and somewhat static. The lack of market risk in the portfolio means that this allocation can be relatively independent of the current economic environment as there is little risk of the fund performance being significantly affected by negative markets. Stock-picking is core to generating returns which surpass those from cash.

Where cash usually offers a risk-free return, the story of the first half of the year has been more one of return-free risk, with flat local stock market returns. The fund has advanced, although at a slower rate than we would have preferred. Low levels of real yields offered by cash (especially in the developed world) have been a primary driver of continued, indiscriminate, high levels of equity investment. This has prejudiced the alpha generation in the fund.

Portfolio activity
There was minimal activity in the portfolio over the quarter. We continued to add to the equity holdings in the fund, but the relative bet sizes were unchanged. We are long-term investors, and we do not change our minds often.

Portfolio positioning
We expect interest rates to stay on hold for now and then gradually rise. This will pave the way for improved performance. As the opportunity cost of capital rises, we believe that investors will seek out the higher quality return opportunities in which the fund invests. In addition, any market softness as a result of the risks currently present in the global economy should provide a small boost to the fund, given the defensive nature of our holdings.

Market review
Equity markets performed well during the quarter considering the negative headwinds, which in preceding years would have resulted in sharp falls in risk appetite. Developed markets (4.9%) outperformed the emerging market composite (2.1%), despite a 9% drop in Japanese equities in March and a 6% weaker close over the quarter. Local equities mimicked global market volatility, recovering January's losses and ending the quarter marginally higher (1.1%). Resource counters performed best, with Sasol, the only oil & gas producer constituent in the index, rising 13.1%. Diversified miners closed 3.2% higher while paper stocks added 15.5% over the period. Platinum stocks lost 10.5%. Both the industrial and financial sectors underperformed the broader market, closing down 0.3% and up 0.7%, respectively. Again, there was substantial dispersion amongst the various sub-sectors, with construction (-25%), food producers (-4.3%) and pharmaceuticals (-11.5%) underperforming, while mobile telecommunication (3.9%), life insurance (6.4%) and industrial metals (14.5%) enjoyed strong returns.

Local bonds traded weaker over the quarter, with the All Bond Index losing 1.6%. The yield curve has continued to steepen, while inflation concerns both globally and at home have been more pervasive. The firm rand has offset gains in oil prices for now, while food prices, rising at producer level, have not been passed on to consumers. Listed property, highly sensitive to the bond market, also gave up some of its 2010 gains, closing 2.2% weaker. Commercial property fundamentals remain under pressure, though highly dissimilar across regions and asset type. A recovery in growth, coupled with a lagged onset of new supply, will lend support to the market over the next year. Cash, as measured by the STeFI, provided a steady 1.4% over the quarter.

Portfolio review
Despite the trouble in North Africa, the earthquake and tsunami in Japan, the latest unfolding episode of the European debt crisis, worldwide inflationary fears and a clear intent by China to cool its overheating economy, the SA equity market was still higher over the quarter. The Investec Absolute Balanced Fund's largest exposures are to gold and Sasol. Given the strong advance made by the price of oil to over $120 per barrel, Sasol's share price has moved higher. The rand price of gold advanced 3% over the period, despite the dollar gold price losing slight momentum, as global equity markets improved. The uncertain world continues to produce interesting winners. British American Tobacco has performed well this year. Robust brands, strong pricing power, distribution scale, and limited input cost inflation are being incrementally rewarded by the stock market.

One key holding that has not yet added any value to the fund is Naspers' ex-Tencent position. This exposure effectively allows investors access to the cash generative, high margin pay TV assets on ten times earnings, at least 50% below the fair value of these assets.

Portfolio positioning
What started as a riot against rising food prices and continued income inequality in Tunisia, rapidly spread to oil-producing countries in North Africa. A good reason for a higher oil price is rising oil demand fuelled by a stronger global economy. A bad reason is supply disruption, which is currently the dominant factor. If Saudi Arabia experiences a social revolution, the world could lose more than 10% of global oil supply with the price spiking to well over $150 per barrel. This of course, will be the tipping point that causes the global economy to stall, as consumer demand for other goods gets squashed. In the interim, the best hedge against further turmoil in the oil price is a large Sasol position, which we still hold in the portfolio. Overall, any rising inflation trend will be matched by rising short-term interest rates, which should provide a good carrier for the future performance of the fund.

Market review

After a volatile first three quarters of 2010, risky assets responded to prospects of an improved economic outlook and ended the year firmly in positive territory. During the fourth quarter, investors switched out of bonds into equities. Global equities added 8.8% over the period, while global bonds lost1.8% in US dollars. Local bonds could not shrug off the global bond sell-off, ending up only 0.7% over the quarter. Cash, as measured by the STeFI, returned 1.6% for the three months to the end of December. The best performing asset class over the past year was the listed property sector. The sector continued to show strong returns, despite weak property fundamentals. Listed property gained 3.1% in the fourth quarter to rise by 29.6% for the year. Local equities participated in the global equity rally. The FTSE/JSE All Share Index rose 9.5% in the fourth quarter on top of the 13.3% gain over the prior three months, ending the year 19% higher. Resources (16.5%) proved to be the top performing sector, with financials flat and industrials up 7.8%for the period. Amongst the resource counters, diversified and platinum miners (both up 19.2%) did best, while short-term insurers (15.4%) and some smaller industrial sectors (media and support services) beat the overall market. Stocks predominantly focused on the South African economy fared worse. Construction ended the quarter 3% higher, banks closed flat, while food and general retailers added 2.9% and 6.2% respectively.

Portfolio review

Cash returns fell to under 7% for 2010. This low level of return dragged down the base level of return for the portfolio, given that the fund is designed to produce a cash plus out performance of equities and bonds over their respective indices. If our assumption that the rand has reached a cyclical high against global currencies holds, then we believe that we have also seen the trough for the South African inflation rate. In order to see inflation surprising above the bond market's implied expectations, we would need to see the rand fall by over 20% on a trade-weighted basis, a figure that we estimate would elevate actual inflation from 3.6% at year end 2010, to around the 6% mark. We do not believe that the actual levels of returns will fall below the portfolio's current performance. If interest rates rise over the next two years from their existing levels (something we believe highly likely), we confidently expect the recent headwinds to turn quickly into tailwinds and returns to recover smartly.

Portfolio positioning

We have been keeping a healthy surplus cash weighting in the portfolio to allow swift access to any attractive opportunities that might arise. The equity weighting is positive, but carries very low equity market sensitivity. After a massive rally in both local and international stock markets, many shares do not have forward-looking return projections that exceed the returns on risk free assets. Hence, we see no reason to add risk without a reasonable probability of a high relative reward.