Market review
Fixed income markets had a roller coaster ride this quarter as we experienced huge swings in yields. In April, the South African bond market had a big rally that saw the best monthly return for the All Bond Index since July 2010. The rally was driven by foreign flows after the Bank of Japan announced an extremely aggressive stimulus package designed to promote economic growth and inflation. This announcement, together with weaker economic data from China and continued evidence of a slow recovery in the US, led to emerging market bond yields reaching record lows. In May, there was a complete reversal of the exuberance experienced the previous month. Bonds had one of the worst months in over a decade, as rand weakness caused some aggressive selling in our market. There was a global sell-off in bond markets as investors came to terms with improving developed market economies and the prospect of the US Federal Reserve (Fed) scaling back its quantitative easing programme (QE). Emerging markets saw yields rise and most of their currencies lost ground to a strengthening US dollar. This triggered some selling of South African bonds by foreign investors to the tune of R4.7 billion. It is interesting to note that this was the first time since last May that foreigners were net sellers on a month. We expect these investors to remain cautious of the asset class and yields are likely to remain elevated for the next few months. There was also a sharp correction in short-dated yields as the monetary policy committee indicated that rates were likely to remain on hold at current levels for some time. While this was in line with our view, some investors had expected a rate cut, which resulted in these rates being too low. The South African Reserve Bank (SARB) remains extremely worried about the country's slow growth rate and would like to ease rates to stimulate some growth. However, the Bank is equally concerned about inflation, which is close to the upper limit of 6%. Bond markets remained under pressure in June as economic data in the US continued to point towards stronger growth. This led to bond yields rising globally as investors changed their asset allocation. The standout feature was the catch-up in real yields as inflation-linked bonds experienced their worst month since their introduction into the South African market in March 2000. This is part of the global re-pricing of rates, now that the Fed has indicated that its $3 trillion QE programme could be scaled back later this year. Rates are thus "normalising" to reflect the fundamentals. This has sparked a general sell-off, leaving cash as the only fixed income asset with a positive return on the quarter. Yields are now more realistic and are offering a reasonable return for investors. On the monetary policy front, we expect rates to remain on hold for the next 12 months as the SARB remains conflicted between rising inflation and the weak economy. Given ongoing rand weakness, we expect inflation to breach the upper band of the inflation target in coming months. It could even remain outside the targeted band for the remainder of the year. The rand will remain key, and any recovery from the current "cheap" levels will be welcomed by the SARB. The All Bond Index lost 2.3% over the quarter, while cash, as measured by the STeFI Composite Index, returned 1.3%.

Portfolio review
The Investec STeFI Plus Fund was defensively positioned over the quarter, returning 1.2%.

Portfolio positioning
We believe the move in yields is overdone in the short term and on a fundamental basis, short-dated yields are showing value. Given volatility and increased uncertainty in markets, we will continue to keep the fund defensively positioned from a duration perspective. However, we will look for opportunities in the market now that yields are more realistic.

Market review
The year started with a brief bond rally, but yields soon drifted up as investors started to worry about the weaker rand and the prospect of higher inflation. The South African Reserve Bank has become more neutral in its outlook as its tries to balance the slow growth in the economy with rising inflation. The latest CPI number is now at 5.9% and market participants are nervously watching to see when it breaches the upper end of the inflation target. Domestic growth has not yet recovered from the general global slowdown and the SA-specific strike action we experienced in the latter part of last year. These factors have all contributed to a more balanced tone from the central bank and interest rates are likely to remain on hold for the remainder of the year. The rand continued to weaken against most currencies. Labour unrest and discussions around nationalisation were followed by a huge fall in export revenue, which caused the current account deficit to balloon. This saw the rand weaken to R9.25 against the US dollar in March, the upper end of our expected range and somewhat overdone in the short term. We expect the currency to trade within a range of R8.75-R9.25 versus the US dollar. There was little room for positive surprises in February's National Budget. Revenue numbers were revised down, increasing the budgeted deficit slightly for the coming year. Slower revenue has resulted in National Treasury increasing the weekly bond auction issuance by R250 million per week. Globally, the data remains mixed with the US showing some signs of recovery. Europe continues to be a laggard and the focus has now switched to Cyprus. Asian growth is ticking along and the outlook is for a steady recovery from the emerging markets in the region. Japan has lost patience with years of no growth and deflation, and we have seen an aggressive shift in policy to create inflation and boost growth. The steadily weakening rand, coupled with some signs of economic recovery globally has led to foreign investors being somewhat more cautious on SA bonds. The All Bond Index gained 1% in rands over the quarter, while cash, as measured by the STeFI Composite Index, returned 1.2%.

Portfolio review
The Investec STeFI Plus Fund performed in line with its benchmark over the quarter. Given bond market valuations and global uncertainty, we continue to keep the fund very defensively positioned from a duration perspective. We favour credit and floating-rate notes.

Portfolio positioning
We aim to maximise the yield by holding highly rated floating-rate notes and corporate bonds. In an environment where cash yields are expected to remain low for a prolonged period, non-government spreads offer good risk-adjusted yields.

Market review
The South African fixed income market was a tale of two halves in the final quarter of 2012. The first half of the quarter was characterised by market weakness, as strikes and political uncertainty heading into the ANC conference, continued to impact local and offshore sentiment. The unfavourable macro environment saw exports falling sharply, worsening an already problematic current account deficit of 6.4% of GDP. This put pressure on the rand, which spilled over into our bond market. Inflation remained within the target band, and ended the year with CPI at 5.6%. We expect inflation to rise slightly from here, but it should remain subdued in 2013. The fortunes of our bond market changed rapidly, as labour market tensions eased and the ANC conference allayed investors' fears of any radical policy shifts. An improvement in European and US sentiment also supported the local market. Consequently, the second half of the quarter saw all of the first half losses erased, with the All Bond Index gaining 2.6% over the 3-month period and 16% for the year. Cash, as measured by the STeFI Composite Index, returned 1.3% over the quarter and 5.5% for the year.

Portfolio review
The Investec STeFI Plus Fund gained 1.3% over the quarter. We continued to keep the fund very defensively positioned from a duration perspective, given bond market valuations.

Portfolio positioning
The risks on the horizon include a failure by US politicians to agree to lift the debt "ceiling", thus inhibiting the ability of the United States to fund itself and pay its bills. Locally, the risks include a slowdown in flows into South African bonds, due to deteriorating labour unrest, further political uncertainty and unfavourable fiscal developments. Such a slowdown in flows would put pressure on bonds to weaken. We aim to maximise the yield by holding highly rated floating-rate notes and corporate bonds. In this environment where cash yields are likely to remain low for a prolonged period, non-government spreads offer good risk-adjusted yields.