The bond market performed quite well in October as investors began to price in the possibility that short-term interest rates have now peaked. Having increased duration recently, the portfolio was well positioned for such an outcome. Looking ahead, the fund managers believe that bonds will continue to rally as they move past the peak of inflation. Limited supply of new bonds and, in general, low bond weightings in most domestic portfolios will add further support to the market. The fund managers will use any near-term volatility to add to their bond exposure.

Bond yields rose marginally on average in September, and the yield inverted sharply as short-dated bonds reacted negatively to the hike in the Repo Rate. The Fund was reasonably well positioned for such a move.

In the short-run, the risks to inflation and interest rates remain on the upside and at current levels bond yields appear to be pricing in a rapid reversal of this year's inflation shock. As a result, we are maintaining a defensive duration stance, but do not expect major bond market weakness, given the favorable balance of supply and demand, thanks to government's intention to redeem a portion of its domestic bond issuance. In addition, the outlook for next year is bright, with both inflation and ultimately interest rates likely to fall significantly.

We will, therefore, use any market weakness to increase bond exposure in anticipation of a rally into the new year.

Bond yields rose quite sharply during August as investors were unsettled by worse than expected inflation data.

The portfolio was somewhat defensively positioned and this will have benefited performance during the month.

Looking ahead, renewed uncertainty over the direction of monetary policy is likely to lead to significant bond market volatility in the near-term. Against this background, the bond market still appears to be overvalued. Two factors, however, should provide support. Firstly, investors remain only lightly exposed to bonds and supply is limited. Secondly, CPIX is still likely to fall sharply towards the upper end of the inflation target by late 2003. As a result, we are maintaining a moderately underweight duration stance and will look to increase bond exposure into weakness.

The bond market rallied sharply during the second quarter. The fall in bond yields was driven by annuity fund purchases and by foreigners encouraged by the recovery in the Rand. For yields to peak 7 months ahead of inflation is unprecedented in the history of the South African bond market. During the quarter, the fund managers retained a moderately underweight duration stance, but offset some of the negative impact of this through actively trading swings in the level of yields and the shape of the yield curve. At current yields the fund managers believe that the bond market has rallied too far too fast in anticipation of an unwinding of this year's rise in inflation and interest rates. Near-term, risks remain regarding the outlook for inflation, interest rates and the Rand. Any sell-off, however, is likely to be limited by the approach of the peak in CPIX and the low level of bond exposure in most balanced funds. CPIX should peak in October just below 10% and then decline sharply, reaching the upper end of the Reserve Bank's inflation target by the second quarter of next year. This will allow the bond market to resume its rally and the fund managers will look to adopt a more aggressive duration stance later this year as the opportunity arises.

The fund manager is finding government bonds attractive, as the rand was firming and yields strengthening. The fund is currently underweight relative to the All Bond index with a duration of 3 years and 10 months. To limit the negative effects of falling yields on performance the fund manager is actively trading the market to increase the fund's performance. The fund manager expects yield rates to increase by 50 to 100 basis points from their recent lows.

The bond market rallied strongly during April. The Fund had a defensive duration exposure, given the risk of higher inflation and interest rates, and this hurt performance in the short run. The rally was driven by demand from insurance funds for long-dated bonds and renewed buying by foreigners encouraged by a strengthening Rand. The fall in yields was exacerbated by the very low bond weightings of most local investors. At current levels bonds appear to be pricing too rapid a decline in inflation. As such, the fund manager believes that they are vulnerable to further weakness in the near-term and has positioned the Fund accordingly. That said, however, given the favourable supply situation, the fund manager expects any sell-off will be limited and will look to buy bonds as they rise.