Market review
Against a backdrop of accelerating inflation, the South African Reserve Bank (SARB) hiked interest rates by a cumulative 100 basis points in April and June. Prior to the June meeting markets were positioned for a 1% rise after the SARB governor cautioned that tough measures may be needed to bring inflation back into the target band. However, rates were increased by only 50 basis points. The Bank cited evidence of a substantial slowdown in growth as the reason for the lower-than-expected hike in rates. Accelerating global oil and food prices as well as a weaker rand continue to underpin the negative domestic inflation outlook. The National Energy Regulator's recommendation of a 27% hike in the electricity tariff for 2008 and similar increases in 2009 and 2010, will further add to domestic inflationary pressures.

The bond market experienced substantial weakening across all maturities as the yield curve saw an upward shift in excess of 150 basis points over the second quarter. The All Bond Index lost 4.9% over this period, while cash (as measured by the STeFI) returned 2.7%. The listed property sector took its cue from rising interest rates and higher bond yields, selling off aggressively to shed 19.6% in the second quarter.

The All Share Index closed 3.4% up over the quarter losing some of its earlier gains as inflation fears gripped global markets. Substantial dispersion in performance across the sectors was evident as resources gained 13.4% over the quarter, while the Financial and Industrial Index lost 6.4%. General mining led resources higher, closing up 18.1% over the three months to the end of June. Banks and general retailers shed close to 15% over the quarter, while the defensive food retail and telecommunications sectors ended up 3.2% and 3.4%, respectively. The telecommunications sector was buoyed by corporate activity as MTN sought a potential merger with an Indian telecoms company.

Fund performance
Cash as measured by the STeFI Index, provided a return of 2.7%. over the quarter, while the Investec Cash Plus Fund marginally underperformed, returning 2.6%. Once again cash outperformed the bond market, which returned a negative 4.9% as measured by the All Bond Index.

During most of the quarter we maintained a defensive position. We continued to remain cautious on credit spreads and remained conservative in adding exposure to this area. Although we remained defensively positioned, the fund's bond exposure contributed negatively to performance, particularly in May.

Portfolio activity
We maintained our defensive positioning adopted in the first quarter, but started to slowly increase bond exposure into weakness. We also added a small amount of longer-dated money market instruments, but mainly invested in the shorter end of the cash curve.

Due to concerns regarding global credit events our participation in local credit markets was very opportunistic, with an emphasis on liquidity. The fund continued to invest in highly rated, well priced securitisations and selected short-dated, single name credit linked notes. We reduced the fund's exposure where possible to some older, more tightly priced issues. During the quarter we continued to exploit the funding pressure felt by the banks, locking into longer-dated floating rate notes at attractive spreads.

Market outlook and portfolio positioning
Domestic activity data continues to show evidence of a slowdown in the economy with the Investec Purchasing Managers Index (PMI) contracting to 43.8 from a previous level of 49.1 and vehicle sales running at a negative 21.9% (on a year-on-year basis). We continue to remain concerned about inflation in the shorter term, with inflation peaking close to 12.5%.

We were cautious during the quarter and were thus reasonably well positioned for the sell-off. Yields have moved substantially higher and we believe that the market is now more fairly valued. We will look for opportunities to take the fund longer into weakness.

Anecdotal evidence suggests that consumers and businesses are struggling to cope with high interest rates. If official data starts to point to a more dramatic slowing of the economy this could persuade the South African Reserve Bank not to hike rates in August.

The biggest risk to our portfolio is that the bond market ignores the high inflation figures and starts to aggressively price in rate cuts by the end of 2008, as domestic growth slows sharply.

Market review
The first quarter of 2008 was dominated by the financial market fallout from a faltering US housing market. Related credit concerns and an interbank market that ceased to function, precipitated aggressive policy intervention over the quarter. A surprise intermeeting interest rate cut of 75 basis points by the US Federal Reserve (the Fed) in January was followed by two further cuts with the federal funds rate closing the quarter a full 2% lower. Economic data remains weak, while the US dollar continues to hover around all time lows against its major trading partners. Global bonds saw strong absolute returns over the quarter, closing 9.7% higher over this period (in US dollar terms). The market ignored inflationary pressures and reacted instead to aggressive policy intervention, decelerating growth and a general risk aversion.

On the local front, bond yields succumbed to continued upward pressure on rising inflation, heightened risk aversion, a sharply depreciating domestic currency and potential further upside risk to monetary policy. The South African Reserve Bank faces rising global food and fuel prices, upward pressure on local electricity prices, as well as a depreciating rand. However, the outlook for domestic demand has deteriorated and monetary tightening in this cycle has not yet fully impacted domestic growth. This poses a dilemma for the inflation-targeting central bank. The All Bond Index lost 1.9% over the quarter with the short-dated bonds anchored by uncertainty about the next policy move, while the longer end sold off on the elevated inflation outlook. Cash (as measured by the STeFI Index) returned a steady 2.6% over the quarter.

Listed property remains under pressure from rising bond yields, rand weakness and some uncertainty with regard to income distributions as the economic outlook deteriorates. The sector lost 10.9% over the quarter, broadly in line with other interest rate sensitive sectors.

The FTSE/JSE All Share Index retraced the losses sustained towards the end of 2007, closing the first quarter up 2.9%. Resources were the clear winners, returning 17.6% as commodity prices reached new highs and earnings were aggressively revised upward. The domestic focused FTSE/JSE Financial and Industrial Index lost 8.5% over the quarter, depressed by tougher trading conditions and poor sentiment towards rate sensitive sectors.

Fund performance
The first quarter of 2008 was another tough quarter for the bond market, which substantially underperformed cash. The All Bond Index (ALBI) returned -1.9% over the quarter, while cash as measured by the STeFI Index, provided a return of 2.6%. The Investec Cash Plus Fund gained 2.1% over this period, slightly behind the benchmark. The quarter was characterised by higher than expected inflation against a backdrop of rising global oil and food prices and continuing turmoil in international credit markets. This pushed G3 bond yields lower on safe haven buying but the rand and South African bond yields were driven higher on general risk aversion. Money market yields also moved higher, largely discounting another 50 basis point interest rate hike, and the curve steepened.

Although the portfolio maintained some bond exposure throughout the quarter, exposure was lowered substantially, with both cash and bond duration contributions being reduced. We continued to remain cautious on local credit spreads and as such we have remained conservative in adding exposure to this area. The fund's positioning over the quarter meant that it outperformed cash in both January and March. However, in February when bond returns were sharply negative, the performance was hurt and the fund ended the month behind cash. During the quarter we aimed to exploit the funding pressure felt by the banks and reflected in credit spreads. We selectively added a few new issues towards the latter part of the quarter, which were priced very attractively, after having modestly reduced exposure to the sector earlier in the quarter where pricing and liquidity allowed.

Portfolio activity
Throughout the quarter we reduced the fund's bond duration substantially, largely cutting the bond exposure to the longer end of the curve. We also reduced our cash duration, preferring to invest in the shorter end of the money market curve.

Due to concerns regarding global credit events our participation in local credit markets was very opportunistic, with an emphasis on liquidity. We continued to selectively buy highly rated, well priced securitisations and selected short dated, single name credit linked notes, reducing exposure where possible to some older, more tightly priced issues.

The fund continued to take advantage of widening swap spreads to replace short dated government bonds with much higher yielding, highly rated bank notes.

Market outlook and portfolio positioning The bond market still faces significant headwinds. Given our large current account deficit we will remain vulnerable to further global shocks and the South African Reserve Bank is likely to remain cautious. Inflation expectations need to be closely watched to ensure that higher inflation does not become entrenched in the broader economy. It leaves very little room for interest rate relief for the remainder of the year. Bond yields may well pause at current levels as markets try to digest all the news, but in our view bond yields will remain vulnerable to the upside. However, there is a good chance that over the coming months the yield curve will begin to re-invert, as the market starts to anticipate the peak in short rates and inflation. We will then be looking for opportunities to move back into the longer area of the bond yield curve and invest in longer dated money market instruments to protect the yield on the portfolio.

We expect to have another difficult quarter for corporate bond holdings. Against this background we will remain defensive on credit but will exploit credit opportunities that offer good value, expecting local bank and swap spreads to remain under pressure. The biggest risk to our portfolio is that the bond market continues to ignore high inflation and aggressively starts to price in rate cuts by the end of 2008, as domestic growth slows sharply.
Our view is that the bond market will be volatile and that there will be better buying opportunities in the months ahead. Inflation is going to continue to be a problem in the coming months, while global risk aversion and parastatal issuance in the long end should still push the yield curve disinversion a little further. As global credit markets start to normalise, swap spreads will begin to narrow and credit markets will outperform, but this is expected to happen gradually.

Market review
The US Federal Reserve's key interest rate cuts in the third quarter saw equity markets rally, credit spreads tighten and risk appetite resurface. However, during the fourth quarter much of the upside was reversed. Inflation fears, driven by rising energy and other commodity prices, placed a dampener on more aggressive policy accommodation near term. Policy makers however still have to contend with a decisive slowdown in fourth quarter US growth, a slumping housing market, disappointing retail sales and a credit market that has yet to normalise. Poor earnings - dominated by subprime related write-downs amongst US investment banks - are likely to continue into the New Year. Coordinated efforts by global central banks to infuse liquidity into the global banking system are achieving some temporary relief with the interbank and corporate debt market showing tentative signs of improvement.

On the local front, the bond market focused on inflation data and the near term direction of interest rates. With inflation accelerating and the outlook for food and energy prices deteriorating, the bond market had priced in a fourth interest rate hike in 2007. The South African Reserve Bank's monetary policy committee statement leaned towards a peak in the interest rate cycle and the yield curve shifted down, retracing some of the earlier losses. The All Bond Index returned 0.9% over the quarter and 4.2% for the year. Cash (as measured by the STeFI) returned 9.3% for the year and 2.5% over the fourth quarter.

Domestic equities came under pressure during the fourth quarter, with the All Share Index closing down 3%, but achieving respectable returns of 19.2% for the year as a whole.

Fund performance
The fourth quarter was a difficult one for the bond market, which substantially underperformed cash. The Investec Cash Plus Fund earned a return of 2.3%, marginally behind the benchmark. The combination of continued higher inflation, further rate hikes, local political noise and persistent global credit woes, all combined to push bond and longer dated cash yields higher.

Although the portfolio maintained bond exposure through the quarter, this did not detract too much from performance. We continued to remain cautious on local credit spreads and as such we have remained conservative in adding exposure in this area.

The fund's positioning over the quarter meant that it outperformed cash in both October and December. However, in November when bond yields rose sharply, fund performance was hurt and ended the month some 20 basis points behind cash.

Portfolio activity
We traded both duration and the yield curve actively over the quarter. Over this period we also decreased exposure to the 2-3 year area of the bond curve, preferring to buy both longer dated cash instruments and the medium dated area of the bond curve.

Due to the concern regarding global credit events our participation in local credit markets was very opportunistic, with an emphasis on liquidity. We slightly increased our exposure to highly rated, well priced securitisations and selected short dated single name credit linked notes. We took advantage of widening swap spreads to replace short dated government bonds with much higher yielding highly rated bank notes.

Market outlook and portfolio positioning
The outlook for the bond market remains uncertain in the coming months. Inflation has surprised to the upside. The market forecasts for the inflation peak, including our own, have moved higher and further out, dimming the prospects of any easing this year and increasing the risk of further hikes. This is against a backdrop where a sharp slowdown in global growth is a very real probability and the financial sector and liquidity markets remain under pressure.
The recent political developments in South Africa and increased noise that is likely to flow from that are expected to continue well into the year, adding volatility to the fixed income and currency markets in South Africa. We therefore expect bonds to be volatile over the next quarter with a bias for yields to go higher and the yield curve to begin to disinvert, with a strong probability that cash will continue to outperform bonds.

The biggest risk to our portfolio is that the bond market continues to ignore the high inflation and starts to aggressively price in rate cuts by the end of 2008, as domestic growth slows sharply. We feel that the bond market will be volatile and that there will be better buying opportunities in the months ahead. Inflation is going to continue to rise in the next few months, while political noise and global risk aversion should help the yield curve disinvert.