Government bond yields rose sharply in October as the 'flight to quality' that characterised the last two quarters went into reverse. 10 year US Treasury bond yields rose from 3.61% to 3.91%, and thirty-year maturity bond yields rose from 4.67% to 4.99%. Yields in other developed markets
lagged the US market and, having fallen less, rose less, as bond markets sold off. The JP Morgan Global Government Bond Index fell by 0.4% in Dollar terms and by 5.3% in Rand terms, reflecting the latter's strength over the month. Although economic prospects remain brittle, and inflationary pressures are continuing to ebb, arguably bond yields now fully discount the risks of a 'double dip' and are therefore vulnerable to the switch in asset preferences that any improvement in economic conditions might trigger. The fund managers have reduced government bond exposure further, given the risks that current bond valuation levels imply.

Further equity market weakness propelled US Treasury bond yields to new lows. 10 year US Treasury bond yields fell from 4.14% to 3.61%, a decline of 53 basis points.

At the underlying fund level, duration was lengthened again on technical grounds, although we remain concerned that positive yield targets have either been met or exceeded. Our inclination is to take profits and cut back exposure but we look for evidence that the current move has run its course and is losing momentum.

Our currency stance remains unchanged i.e. more Dollar centric from a tactical perspective, however, we note that the Euro has traded better than anticipated, given renewed Yen weakness (normally Dollar supportive) and the dismal growth statistics coming out of Europe, particularly Germany.

Economic news released during august was sober. The US recovery appeared to have stalled and data releases in Europe suggested anaemic growth. Ex Japan, Asian region continued to buck the general trend with most economies continuing to expand at a respectable pace. Major central banks kept official interest rates on hold but significantly, the US Federal Reserve's Open Markets Committee indicated that it considered that economic weakness posed a greater risk rather than inflation. Money market rates continued to soften as the prospect of further interest rate reductions was discounted. Against this background bonds continued to perform strongly. 10 year US Treasury bond yields fell 33 basis points to 4.14% and German government bond yields fell by 18 basis points to 4.57%. There was little net movement between the major currencies and overall the JP Morgan Global Government Bond Index advanced by 1.8% in Dollar terms over the month. Geopolitical concerns caused the price of crude oil to exceed US$ 30 a barrel.

The dramatic fall in government bond yields has left bonds at yield levels that discount most scenarios other than outright deflation. One of the advantages of running a fund aiming at generating total returns is that we need not be slaves to a benchmark and hence the fund managers have reduced the fund's exposure to bonds cutting back duration to a moderately defensive level.

Bond markets continue to exhibit good momentum but poor value. Even if primary trends remain in place it seems likely that we will have the opportunity to re-engage at more favourable levels. The fund managers continue to watch the corporate high yield bond markets, which conversely offer compelling value. The fund has a modest exposure to this sector but this will not be added to until our technical analysis confirms our fundamental assessment.

Turning to currencies; although the fund managers believe that the Dollar is now in what is likely to turn out to be a multi year bear market, the initial phase is probably over. Indeed, recent data indicated that the Japanese government spent a record amount (US$ 33 billion) on intervention in the second quarter, which has eventually proved to be successful in stemming the Yen's rise against the Dollar. Whilst the underlying dynamics of capital flows continue to favour the Euro, continental European economic performance is itself less than sparkling and it we considered it appropriate to reduce our preferred anti Dollar stance temporarily in order to gauge the risks of a material counter trend move.

Having performed poorly in the first quarter of 2002, bonds finally managed a convincing advance on the back of sharply weaker equity markets and less positive economic releases. The US bond market outperformed with the 10 year US Treasury bond yield falling by 66 basis points to yield 4.81% at the end of the quarter. Euro government bond yields of equivalent maturities fell by 29 basis points. Currency movements were also material with the Dollar falling sharply against other major currencies. Over the quarter the Euro gained 13.2% against the Dollar, the Yen rose by 10.6%, the Rand by 10.2% and Sterling advanced by 7%. The fund maintained a significant exposure to bonds throughout the quarter having taken advantage of bond market weakness in late March to establish positions. Exposure to the US Dollar was also reduced sharply as it became increasingly apparent that the currency was trading poorly. The Euro, and to a lesser extent, the South African Rand, were our preferred currencies over the period under review. The Fund delivered strong returns in Dollar terms of 7.8% over the quarter, placing it well ahead of its US Dollar intermediate bond benchmark and Dollar cash returns.

However, Rand strength over this period, pushed the Rand based returns into modestly negative territory. Further equity market weakness could spur another decline in long term interest rates on the back of safe haven buying and concerns that equity market weakness might undermine recovery prospects, but at this point, markets could equally move into a corrective phase following the substantial changes which have occurred recently. In line with the flexible management approach adopted in respect of the fund, it is our intention to take profits at this juncture and reduce the fund's interest rate exposure. In a similar vein we look to take profits on short Dollar positions from a tactical standpoint, although it remains our strong belief that the Dollar has entered a multi year bear market from a strategic perspective.

After a dismal March for bond markets April witnessed a powerful rally, which retraced a significant part of the prior losses. Ten year US Treasury bond yields fell by 22 basis points from 5.83% to 5.61%.

The fund was well positioned to benefit from the rebound having established a 60% tactical bond position in late March. The fund’s US Dollar exposure was reduced in favour of Euros and Rands on evidence of weakening US Dollar momentum.

Despite the rebound in bond markets, we believe that the current bond market rally has further to go in the near term, as investors question the strength of the global economic recovery. However our strategic stance remains cautious. It remains to be seen whether current US Dollar weakness presages a decisive change in trend. The fund manager has increased the fund’s non-US Dollar exposure further since the month end but await definitive technical confirmation before making a strategic call in this context.