Market review
The improved global outlook has been somewhat less pronounced in the local economy. Data releases over the quarter showed falling house prices, a manufacturing sector that is yet to benefit from any rise in global demand and very weak demand for credit by the private sector. The latter reflects a consumer under pressure from a high debt burden and general job market uncertainty. The sharp improvement in the current account witnessed over the quarter is more a sign of a collapse in imports and lower dividend payments to offshore investors, than the effects of improved terms of trade and better export performance. Current estimates point to a marginal expansion in the third quarter, following a sharp contraction in the first half of 2009. 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%.

Portfolio review
The Investec Gilt Fund return was ahead of cash over the quarter, but lagged the ALBI. We maintained a slight underweight duration position throughout the quarter and continued to add some credit exposure. The portfolio currently has a neutral curve positioning as it seems very likely that we are at the end of the interest rate cycle. The performance of the credit portion of the portfolio helped with the overall returns. The underweight duration position slightly detracted from performance as yields enjoyed a moderate rally. The allocation to cash also reduced the overall yield of the portfolio.

Portfolio activity
The bond market continues to trade in a narrow range and the 10-year bond only rallied by eight basis points over the quarter. While this was enough for the ALBI to outperform cash, the actual trading opportunities were slim. Liquidity continues to be a problem in the SA bond market. The government and parastatals are issuing more bonds and this puts a burden on funds. More investors are merely looking to buy bonds through the auctions and as a result secondary trading has dried up. We raised the portfolio's exposure to credit by increasing the holdings in the corporate bond fund. We bought the following bonds in order to achieve this: Nedbank 2019, FirstRand Bank 2023, Transnet 2027, Development Bank of Southern Africa 2020, African Bank 2016 and Airports Company South Africa 2023.

Portfolio positioning
The final quarter of the year is going to be very important for the bond market. We have the medium-term budget policy statement (mini budget) at the end of October which gives the new minister of finance his first opportunity to adjust the official fiscal numbers. Much has changed since February and the market will be watching to see which direction the minister takes. We also have a change of guard at the Reserve Bank and the new governor will preside over her first monetary policy committee meeting in November. The communication from both these institutions will be closely watched for any change in policy. Inflation has slowly started to fall and we are now expecting CPI to remain in the low 6% range before breaking through the upper end of the band early next year. This should keep interest rates low for a while yet. Cash rates are now very low and bonds are offering a decent pick-up in yield. The 10-year bond is trading at 9%, giving a positive 'carry' of 2%. This comes with some risk in the form of increased issuance. Investors are thus torn between low cash rates and moderate inflation on the one hand and increased issuance on the other. We therefore expect bonds to remain range bound in the short term, before rallying next year as inflation breaks down into the band. The rand is still confusing most traders as the currency continues its recovery from last year's extreme sell-off. If it stays around current levels for the next few quarters, this will be very good for the inflation outlook and then bond yields should rally further. There may then be a small chance of further interest rate cuts. The rand remains one of the biggest risks - due to its extreme volatility it could drastically change the path of interest rates. We are therefore maintaining a conservative duration position for now, but will buy some bonds into any weakness in order to benefit from higher yields. Given the attractiveness of credit spreads, we will maintain our holdings in corporate bonds.

Market and portfolio review
The portfolio had a positive return over the quarter, but lagged the All Bond Index. This was a very lack-lustre quarter for the bond market as yields slowly ticked up. We maintained a short duration position throughout this period. Bonds continued to weaken in light of increased issuance and the perception that riskier asset classes would outperform. There was a constant asset allocation shift out of bonds this quarter. The cash and short-dated bonds gave a positive return, but the long end of the curve sold off aggressively and was a drag on performance. Most of the activity was in the short end of the curve due to the frequent monetary policy committee (MPC) meetings. The South African Reserve Bank surprised the market in June by keeping interest rates on hold when most players expected another cut of 50 basis points. The jury is still out as to whether more cuts are needed. The economy is showing signs of continued contraction and the consumer still seems to be under pressure.

Portfolio activity
The bond market experienced one of its quietest quarters for many a year. Daily volumes have dropped substantially and trading ranges have all but disappeared. This is as a result of being close to the turning point in the interest rate cycle as well as the mixed data coming from global economies. The debate is still ongoing as to whether the global economies have bottomed or not; a recovery in the second half of the year remains uncertain. Current economic data is very weak and there is concern that National Treasury's revenue collection may not be sufficient. Any shortfall will have to be borrowed in the bond market and this is causing yields to rise. To increase the overall yield of the portfolio, we have started to shift some exposure to the longer area of the curve. We continue to reduce our exposure to banks and lower-yielding instruments in the portfolio. During the quarter we sold Nedbank 2020, Absa Bank 2020, Standard Bank 2020 and Daimler Chrysler 2011, replacing these with Airports Company 2019 and City of Cape Town 2024.

Portfolio positioning
The bond market is likely to continue trading sideways. The fear of extra bond issuance and funding will continue to push yields higher, while the stronger rand and falling inflation is likely to support the market. Inflation has remained sticky this past quarter and we expect some improvement on these numbers going forward. The rand has now recovered fully from last year's sell-off and if it remains at these levels, there should be some reduction in inflation.

Market and portfolio review
The portfolio posted a negative return over the quarter, but managed to outperform the All Bond Index. After the aggressive rally in yields at the end of 2008, we reduced some of the portfolio's duration and risk, which allowed us to outperform the benchmark.

Our positioning on the yield curve has further helped the overall performance. We reduced the portfolio's exposure to long-dated bonds. This area of the curve has performed badly in light of the extra issuance coming to market from national treasury and parastatals like Eskom and Transnet. Bond yields have risen this year, and therefore bond market returns were negative for the quarter.

Portfolio activity
We have been quite active in changing our positioning along the yield curve. At the beginning of the year we reduced the portfolio's exposure to long-dated bonds in anticipation of the yield curve normalising (i.e. long bonds have a higher yield compared to shortdated bonds). This steepening of the yield curve took place when the budget was announced and it became evident that there would be a sharp rise in government borrowing. Now that long-dated bond yields have sold off so aggressively, we have started buying some of them back as there is value in the long end again.

Most of the activity has been in the liquid government bonds, as we have changed our yield curve positioning. We have, however, also started to increase our exposure to corporate bonds. These issues have finally re-priced and are trading at attractive yields. We have thus increased our exposure to the corporate bond fund by about 1.5%.

Portfolio positioning
The bond market reacted to both global and local factors this past quarter. The global uncertainty and panic saw foreign investors sell our bonds, which pushed yields higher. The extra issuance from government and parastatals has compounded this sell-off and yields are now back to September 2008 levels. The inflation outlook is mixed. The new CPI is showing lower inflation, but some of the components are proving to be sticky. We should be below the South African Reserve Bank's target of 6% within the next six months and this will allow the Bank scope for further cuts. We are likely to get a repo rate cut of 100 basis points in April, followed by a further 100 basis point cut, spread over the next few months. This should support the bond market and we should see positive returns going forward.

The global uncertainty remains our biggest risk. Each time there is some panic, investors reduce risk by selling emerging market assets. While this trade is close to being exhausted, there is still some risk there. We continue to actively manage the portfolio's duration. Currently we are range bound and are constantly changing the position as the yields move around. This ensures that your portfolio takes full advantage of these conditions.

Market and portfolio review
In October the global liquidity crisis caused a massive sell-off in equity markets and emerging market currencies. The global economy faltered and risk aversion reached record highs. This caused bond yields to rise sharply, as the rand sold off aggressively. The next two months saw bonds resume their bull run as yields collapsed well through September's closing levels. Global economic data deteriorated apace, and local South African data also pointed to a sharply slowing economy.

The benchmark R157 finished the quarter just off record yield lows at 7.2%, while one-year cash yields fell to 9.8%. The shape of the curve also changed dramatically as the curve disinverted and normalised. For the year, the All Bond Index (ALBI) returned 17%, outperforming cash both for the quarter and for the year. The ALBI gained 11.3% over the fourth quarter. The Investec Gilt Fund had a good quarter, but marginally lagged the ALBI. When bond yields spiked in October, we were overweight the benchmark. This was the primary reason for the underperformance of the portfolio during the quarter.

We reduced duration aggressively amid the risk aversion in October and into November, cutting the underweight position in December, but still remaining underweight the benchmark. Credit spreads are still wide and we continue to be cautious.

Portfolio activity
As risk aversion gripped markets, the portfolio reduced duration aggressively, remaining underweight duration into quarter end. We also used the volatility to take advantage of some shorter-term opportunities and slightly increased our weighting in non-government debt.

During the quarter we continued to position for the yield curve to steepen, preferring the shorter end of the curve. Hence, we purchased the shorter-dated R206s. The portfolio's parastatal exposure was marginally increased at attractive levels.

Portfolio positioning
The market is still reeling from the effects of the global credit crisis and the dramatic economic slowdown. The level of risk aversion has declined from the extreme levels seen in October. However, market sentiment is still fragile and the full economic extent of the slowdown will continue to be felt in the coming quarters. Emerging markets such as South Africa will remain susceptible to recurring bouts of risk aversion, keeping the rand vulnerable and volatile. The South African Reserve Bank has begun to cut interest rates, with a modest 50 basis points in early December. As the huge scope of the economic slowdown has continued to manifest itself both locally and internationally, the domestic market has quickly moved to discount a full 4% of interest rates cuts in 2009.

Domestic investors have been a big driver of the rally in bonds, increasing their exposure to the asset class, while international investors remain underweight. Bonds are likely to be volatile in the coming quarter. They bounced off historic lows into year end and are likely to correct further with any renewed risk aversion, as that impacts the rand. Such sell-offs are likely to be short-lived, if the economic slowdown continues to gather momentum and growth and inflation forecasts are revised down further.

The portfolio is underweight the benchmark and positioned for the yield curve to continue steepening. We are therefore vulnerable to sharply lower yields and/or a re-inversion of the curve.