Market review
Local economic activity moderated, with GDP expanding by 3.2% in the second quarter, down from 4.6% in the first quarter. Concerns about the global economic recovery and subdued demand locally, coupled with the favourable inflation outlook, motivated the South African Reserve Bank to further reduce the repo rate to 6% in the third quarter. The August inflation number of 3.5% was the lowest since-mid 2005. The rand was one of the strongest emerging market currencies over the review period, gaining more than 10% against a weak US dollar. Bond yields fell sharply, boosted by foreign investor demand and continued downward pressure on inflation. The All Bond Index (ALBI) ended the quarter 8% higher, behind listed property (13.7%), but well ahead of cash which returned 1.7% over the period.

Portfolio review
The bond market had an exceptionally strong third quarter as risk appetite returned with a vengeance, expressed largely by huge inflows into local emerging market bonds across the globe. The lacklustre growth in developed markets and concomitant 'very low rates for longer' outlook, continued to underpin the good long-term emerging market story, pushing currencies higher and flattening yield curves. In South Africa, this bond positive story was helped further by the cut in the repo rate and long-bond yields rallied by a full percentage point. Overall the fund had a good quarter, with returns in line with the All Bond Index. The performance was boosted by being overweight duration for most of the quarter. We maintained our high level of exposure to corporate bonds so as to maximise the yield.

Portfolio activity
The portfolio's overall risk was reduced in August after the rally in bond yields. This allowed us to buy bonds back at more favourable yields in September. We also took the opportunity to lower the cash holding by switching into some high-yielding assets. Due to the very low yield on cash, we will maintain the high weighting to yield assets.

Portfolio positioning
The fundamentals for the bond market remain sound. Inflation has surprised on the downside and the fiscal picture is improving. Economic releases point to a continuing recovery, albeit a rather subdued one. The main domestic themes for the bond market remain unchanged. Growth will be lacklustre, inflation contained and rates will remain low, or perhaps see a further decline. The global environment also points to continued support for bonds. The slowing recovery in developed markets, close to zero interest rates and the global investor search for higher returns and diversification still underpin large flows into emerging market assets. Yields on South African bonds continue to stand out as attractive when compared to other emerging markets of a similar credit rating, ensuring that South Africa should still attract its fair share of portfolio flows.

Market review
In May the markets were spooked by the possibility of sovereign default by the one of the PIIGS (Portugal, Ireland, Italy, Greece and Spain). The ensuing risk aversion led to a sharp sell-off in the euro and other risky assets. Governments in Europe responded by promising to cut deficits, which would further jeopardise the recovery. The local bond market sold off on the back of the softer currency and weak emerging markets in general, but by the end of the month bonds had bounced off their worst levels. Over the quarter, longerdated bonds underperformed cash, while shorter-dated bonds fared better, matching cash returns. The All Bond Index returned 1.1% over the quarter, while cash gained 1.7%. Listed property rose 0.6% over this period. Year to date, listed property remains the best performing asset class (10.6%).

Portfolio review
The portfolio's returns over the second quarter were in line with the All Bond Index, but behind cash. Economic data released at the beginning of the quarter pointed to a strong recovery, with the Purchasing Managers Index well above 50 and vehicle sales growing at a +30% rate on a year-on-year basis. However, as time passed activity data started to moderate. Credit growth has stabilised but remains relatively weak, raising concerns about the sustainability of the recovery. The South African Reserve Bank kept interest rates at record lows, signalling that it is more concerned about the strength of economic growth than any upside risk to inflation posed by wages or administered prices. Fundamentals for the bond market remain sound. Inflation is surprising on the downside and the fiscal picture is improving with expenditure coming in below budget. The release of the South African Reserve Bank's Quarterly Bulletin revealed a strong bounce in household consumption, underpinned by robust real income growth. Fixed investment was weak, but the economy is forecast to grow by around 3.2%.

Portfolio activity
The market has largely been driven by foreign investors as they must invest the capital flowing into dedicated local emerging market debt funds. However, the wave of buying has not been without its hiccups as sentiment and risk appetite have varied greatly. During the quarter we traded the range where possible, but maintained a core long position. We increased exposure to credit and to the long end as the curve became even steeper.

Portfolio positioning
The theme for the bond market remains unchanged; rates will stay lower for longer. Not only are local fundamentals supportive, but the shaky fiscal position of developed markets is resulting in large flows into emerging market assets. Yields on South African bonds stand out as being particularly high when compared to other emerging markets of a similar credit rating. This should help South Africa attract its fair share of portfolio flows. We remain fully invested so as to maximise the overall yield on the portfolio. Corporate bond yields have compressed significantly relative to government bonds, but still offer attractive returns. We will maintain our investments in these assets for now.

Market review
The South African economy is showing signs of recovery. Year-onyear comparisons indicate strong gains across most categories, boosted by very weak economic activity at the start of 2009 when the recession was in full swing. Large-scale job losses have abated, while manufacturing activity has recovered strongly off a low base. Durable goods spend, having previously faced the headwinds of tight lending standards and weak final demand, proved firm in the first quarter. House prices are showing signs of stabilisation. Fourth quarter GDP growth of 3.2% beat estimates (quarter on quarter, seasonally adjusted annualised rate). The current quarter's growth rate should further support the view that the local economy remains on the recovery track. With leading indicators at or near their peak, pointing to a more moderate second half, growth estimates for the year as a whole remain below 3%. The National Treasury will continue to focus on fiscal restraint. The collapse in tax receipts, coupled with the high public spending bill on existing projects, has placed substantial pressure on government's funding requirement. The budget deficit of just below 7% of GDP for this past fiscal year is estimated to fall to less than 4% by the 2012/2013 financial year. The South African Reserve Bank's monetary policy committee's decision to cut the repo rate to 6.5% provided a welcome boost to indebted consumers in March. Greater certainty about electricity tariff increases, slowing inflation and the negative impact of a strong rand on the economy's competitiveness were all cited as factors warranting a further cut in rates. The All Bond Index returned 4.4% over the quarter, well ahead of cash. The listed property sector added nearly 10% over this period.

Portfolio review
The portfolio enjoyed a good start to 2010 helped along by a stronger bond market. Cash lagged bonds during the quarter and we maintained a very low cash holding. The portfolio has a diverse allocation across all the various elements of the fixed income asset class. We steadily increased the portfolio's duration over the quarter as it became clear that the South African Reserve Bank (SARB) was likely to cut interest rates. There were also some opportunities to increase exposure to corporate bonds so as to maximise the yield. Performance was helped by the exposure to government and corporate bonds. In January, bonds were a drag on performance, but the market recovered well during the remainder of the quarter. Cash holdings were kept at a minimum to avoid these very low yields.

Portfolio activity
As bond yields sold off at the beginning of the quarter we added both duration and bond exposure to the portfolio. Most of this was concentrated in the middle of the curve as this area would benefit the most from rate cuts. The long end of the curve was particularly hard hit going into the budget speech in February as there were concerns that the budget deficit could grow further. The budget announcement was received positively by the market and the actual outcome at the end of the fiscal year (March) was even better than expected. These factors all helped bonds to rally over the quarter.

Portfolio positioning
The overall sentiment has improved in the bond market and this trend is likely to continue into the next quarter. The interest rate cut by the new governor has shown that the SARB is likely to be a little more unpredictable going forward. We welcome this move as the Bank appears to be focusing more broadly on the economy. The rand has continued to benefit from the increase in risk appetite for emerging market exposure, and the currency is also being rewarded for more positive fundamentals. The current account deficit has improved and inflation is now back within the targeted range. The rand is likely to remain firm as long as commodity prices continue to rise. There has been a steady increase in capital flows to emerging markets (particularly equities) and South Africa has received its fair share. With the world's attention shifting to our shores as the Soccer World Cup approaches, the local currency is likely to perform well. The strong recovery of the rand has also improved the inflation outlook. We expect CPI to fall towards 4% by mid-year and comfortably remain within the targeted band for the next year. This keeps alive the small possibility of a further rate cut. At worst, it ensures that cash will deliver a very low return for the next 12 months. Bond supply has been the main reason for the poor bond returns of 2009, and this legacy will be with us for a while yet. The overall picture is improving as the minister of finance continues to cut back on unnecessary spending. With the economy starting to recover, government revenue is also increasing. Therefore, bonds yielding between 2% - 2.5% over cash will offer decent returns for investors. The global picture is very fluid at present and the various regions are experiencing very different outcomes. The 'old' developed world is battling with ballooning budgets and slowly recovering economies that are heavily indebted. The 'new' economies in the East have recovered well and are the main drivers of the rise in commodities. We will maintain a fully invested and diverse portfolio going forward. The search for yield will continue to drive our asset prices and maintaining a high yield in this environment is essential.

Market review
In sync with other commodity currencies, the rand regained its composure in 2009. Record capital inflows and higher commodity prices fuelled a 28.7% gain against the US dollar. 2009 was not a good year for bond markets, reversing some of their gains of the previous year. Bond prices fell in 2009 as economies recovered and the cost of massive fiscal and monetary stimulus started to hit home. The increase in bond issuance over the next few years and large fiscal deficits will keep the pressure on bond markets. Offsetting this over the near term, will be the improved domestic inflation outlook and expectations of growth below the historical average. The All Bond Index lost 1% over the year, but marginally outperformed cash over the second half of 2009, gaining 4.1%. In the fourth quarter, the All Bond Index returned 1.1%, underperforming cash. The listed property sector showed some resilience in a very difficult trading environment, gaining 4% in the last quarter to finish the year 14.1% higher.

Portfolio review
The Investec Gilt Fund's return for the final quarter of 2009 was in line with the bond market. The portfolio had a short duration position going into the quarter and was thus able to minimise the negative effect of bonds in October. We added some duration as yields rose in November on the back of the Dubai scare which led to a sell-off in emerging markets. We also continued to trade the range when liquidity allowed. The increase in the duration of the portfolio ensured that we were well placed for the December rally in local bonds. The longer-dated bonds were the laggards from a performance perspective and our small allocation to these detracted somewhat from the portfolio's overall performance. However, the longer-dated bonds recovered some of the underperformance in December.

Portfolio activity
The bond market remained an uncertain place over the quarter and the risk-return dynamics only started to turn favourable in the latter half as the lower trend in inflation was confirmed. We continued with our active management whereby we sold into rallies and then bought back some duration after yields had risen. We increased the overall duration of the portfolio by buying some government bonds in order to remain as liquid as possible. The portfolio's exposure to higher yielding corporate bonds was also increased as the returns from this asset class look the most attractive for the year ahead.

Portfolio positioning
2009 was a terrible year for the bond market as it experienced the first negative (-1%) calendar year since 1994. This was driven predominantly by the increase in supply from both government and parastatals. South Africa, however, appears to have suffered more than most other emerging markets. This is despite the fact that inflation fell from 9.5% to 5.8%; interest rates were cut by 4.5% and the rand firmed from a high in March of R10.72 to the US dollar, to finish the year at R7.40 to the dollar. The new year has its own challenges and supply will continue to be the central focus. Our economy remains sluggish and as a result, tax revenues are running behind budget. The global economy is showing signs of recovery and we expect to see some tentative tightening moves by central bank governors. Inflation, however, is not going to be a concern and we should see inflation settle inside the band from the second quarter onwards. This, coupled with the sluggish growth will pose some interesting questions for our new governor and we don't see any interest rate hikes in 2010. The soccer world cup will give our economy a timely boost and all the attention could focus investors on our attractive yields. Bond yields are now 2.5% above cash. We are thus happy to continue with our strategy of increasing the bond exposure of the portfolio into any selloff as the yield is offering value to investors. The current positioning of the portfolio allows us to maximise yield without taking excessive risks. There are going to be many opportunities to trade the portfolio as the market changes its focus between the supply issues (negative) and the very benign inflation environment (positive).