Market review
Prior to August, global economic activity appeared to be progressing at a reasonable pace. The trend in data releases out of the US had picked up and growth elsewhere, especially in Europe, was holding up well.

The picture then changed markedly; US employment growth slowed sharply and housing indicators began to see an acceleration in their rate of decline. Then, in early August, the market nervousness that hit credit and stocks over the summer spread to the money market. Interbank trading dried up and Libor rates rose sharply, delivering an effective global interest rate increase of almost half a percentage point.

Against this backdrop, the Federal Reserve (the Fed) decided to cut the federal funds rate by 50 basis points at their September meeting. Outside the US, dollar weakness exacerbated the tightening in global financial conditions, especially in Europe. Central banks that were looking to tighten policy, found that most of their work was done for them by the markets.

Credit spreads led the sell-off in risky assets that hit markets from July onwards, but higher yielding bonds began to recover towards the end of the quarter. However, the problems that had begun in the subprime market continued to radiate out causing a liquidity crisis in the money market. At least one bank came close to collapse. This was only short-circuited by aggressive central bank intervention.

Fund performance
The Investec Global Opportunity Income Fund of Funds returned 1.2% in rand terms over the quarter, against the benchmark's 1.1%. The fund had a difficult quarter. Markets were exceedingly volatile, with government yields reversing very sharply as credit sold off. Surprisingly, high-quality, short-dated assets were particularly hard hit, despite normally exhibiting very little volatility. This was caused by the extraordinary dislocation in global money markets during August. Despite a low weighting to credit markets, the extent of the moves hurt performance, but much of this should be recoverable in the coming months thanks to the rise in yields. The underperformance from duration during the quarter largely offset the gains from the previous three months. Curve exposure benefited from steepening trades designed to capture an increase in risk premiums on longerdated bonds. Currency returns were impacted by the very difficult trading conditions, with a sharp pick-up in market volatility making it hard to generate positive returns.

Portfolio activity
The Investec Global Opportunity Income Fund of Funds was cautiously positioned going into the quarter, but in the ensuing storm there were very few safe havens. We added to spread exposure in August, given signs of excessive stress and attractive valuations, and this helped returns during September.

Government bond yields rallied hard from the beginning of July as the markets reacted to signs that policy tightening was starting to impact the credit market. We had reduced our short bond position into the earlier sell-off, but were a little slow in recognising that a top in yields was in place. We have remained fairly flat duration since.

In terms of positioning, our most successful decision was to be long short-dated bonds versus longer-dated bonds on the expectation that yield curves would steepen. The problems in the money market only served to exacerbate this trend. Country exposures, favouring bonds in the UK, Australia, Canada and Europe versus Sweden, Japan and latterly the US, helped performance, especially in September.

Currency market trends were initially driven by interest rate differentials and relative economic performance, with the high yielding commodity currencies trending up and the yen continuing to weaken. The dollar traded sideways to weaker against the major European currencies. The fund was underweight yen and overweight Australian and New Zealand dollars.

However, higher-yielding currencies were knocked hard by the market nervousness that had hit credit and stocks and the yen rebounded sharply. Since August, and especially since the US rate cut, these trends have once again reversed and have been exaggerated by dollar weakness, with the yen also losing ground.

Market outlook
Bonds have repriced to reflect a slower global growth outlook. In the near term, they will probably rally further, especially shorter-dated bonds, given the persistence of soft economic data. If history is a guide, however, yields should bottom some time ahead of the last rate cut in the cycle, which in the US is expected to occur before Christmas.

In this 'soft-landing' scenario, bond markets will gradually switch in the coming months from pricing in the downside risks to interest rates in the short term, to worrying about the risk of renewed rate rises in the medium term. Clearly, a harder landing for the global economy would imply a more protracted bull market in bonds.

Tactically, we favour being moderately long duration, but strategically, we are more cautious given concerns that this Bull Run is already mature. However, heightened uncertainty about the outlook suggests that it is too early to back this view strongly.

For now, we prefer shorter-dated bonds, especially where we see room for further optimism on interest rates, namely in the euro area and Canada. Across markets we expect euro bonds to outperform, especially versus those of the US, Sweden and Japan.

The yield pick-up over government bonds from short-dated swaps is close to historical extremes and they provide a low risk way to benefit from an eventual return to normality in the money market. The additional yield for taking credit risk has also increased, but this reflects a less benign environment. Yields could rise further on new supply and the prospect of increased default rates. We are also increasingly cautious towards emerging market debt, which has performed well despite financial market nervousness. However, the view that developing economies are relatively immune to the problems in the US seems too complacent for our liking and we have taken profits on some of our emerging market exposure.

Within foreign exchange, we remain positive on the Australian dollar, given strong macro fundamentals and commodity support. We expect the yen to remain weak for now, but have begun to reduce our short position in US dollars against Europe on valuation and relative economic momentum concerns.

Market review
Bond markets sold off sharply before stabilising in the second half of July. Currency market trends were driven by interest rate differentials and relative economic performance, with the high yielding commodity currencies trending up and the yen continuing to weaken. Emerging currency performance was weak.

Higher yielding bond markets underperformed as the rise in volatility accompanying the bond market sell-off caused the additional yield offered by corporate and emerging market bonds to increase modestly.

Fund performance
The Investec Global Opportunity Income Fund of Funds returned -1.4% in rand terms over the quarter, outperforming the benchmark. Duration and curve positioning added to performance relative to the benchmark. Country and emerging market exposure hurt returns. The former reflected an overall short duration stance and yield curve steepening trades. The latter was due to the relatively poor performance of US and UK bonds, as well as the negative impact of higher developed market yields on emerging local market bonds. Currency performance was flat.

The fund is defensively positioned, with approximately 75% allocated to a global absolute return fund and 25% to a global bond fund. A neutral allocation would be set at around 70:30.

Market outlook and current positioning
The recent period of softer growth has done little to ease global capacity pressures. With commodity prices also rising, central banks are likely to remain on inflation alert and retain a bias to tighten policy. If the global economy remains on a firmer footing into next year, there is a clear risk that this cycle will end like previous business cycles with a move to genuinely tight monetary policy.

Strategically, we are biased to be short. We prefer bonds in countries where tightening is further advanced, such as New Zealand and to a lesser extent the UK. European and Japanese bond markets offer the least value over the medium term. Within markets, we expect some underperformance from medium-dated bonds as investors price in greater uncertainty about the future and demand a yield pickup over short-dated bonds.

A less certain future should also begin to put upward pressure on the additional yield offered by riskier corporate and emerging market bonds. Credit fundamentals should remain strong, but tighter financial conditions will put pressure on the weakest borrowers. As a consequence, we have little exposure to lower-rated issuers.

Our currency models signal further strength for high yielding currencies, especially where this is supported by strong growth. We are looking for levels to increase our European bloc currencies against the US dollar and Japanese yen on weakness, but also to raise our higher yielding Australasian exposures. In the emerging markets, we remain selective in choosing currencies with supportive economic fundamentals and relatively high interest rates.

Market review
Goldilocks economics held sway among investors in the opening days of the new year. Under the consensus macroeconomic scenario US growth was going to be just soft enough to persuade the US Federal Reserve not to raise rates any further and just strong enough to enable the other economies of the world to take up the slack created by a slowdown in the world's largest economy. Two months is all it took to shatter the confidence of investors in the perfect environment for risk assets. By the end of February it seemed quite plausible that the US housing market might go into crisis mode. All the major data releases disappointed the markets. Almost overnight, everyone heard about the appalling abuses of the sub-prime lending market. Global equity markets did not take kindly to the deterioration in the macroeconomic backdrop. By mid March most markets were 5% to 10% down from their earlier highs with investors expecting a further decline as the collateral damage from the sub-prime lending fiasco seemed to loom ever larger. However, the second sell-off never happened and by month end, equity markets were on their way back up to their earlier highs. The MSCI World Index gained 1.9% (in US dollar terms) over the month and 2.6% over the quarter. The US dollar fell 0.2% against sterling and 0.9% against the euro and the yen over the quarter. The Citigroup Global Bond Index returned 1.2% in US dollars over this period. The Federal Reserve continued to leave rates unchanged at 5.25%. Markets discount nearly 50 basis points of cuts this year. A slowdown in the US economy is clearly underway, but the extent of the slowdown remains unclear. Inflation surprise indicators have picked up, suggesting excessive complacency about the trend. Rates were increased 25 basis points in Europe, the UK and Japan to 3.75%, 5.25% and 0.5%, respectively. Economic growth outside the US remains solid. Oil prices fell below US$60 per barrel, but ended the quarter at US$66. The gold price rose to US$664 per ounce, and other metals recovered strongly at the quarter end from earlier weakness.

Fund performance
The Investec Global Balanced Feeder Fund returned 5.2% in rand terms over the quarter, while the average fund in the sector returned 5.3%, in line with the benchmark index. Asset allocation and equity stock selection contributed positively to returns while bonds detracted from performance. Equity exposure was reduced early in the quarter, but raised again in March, ending the quarter at 66.5%, compared with a benchmark weighting of 60%. Bond exposure was increased slightly to 27.9%

Market outlook
The speedy recovery from the market correction has taken investors by surprise. Analysts' earnings estimates for 2007 have been reduced to around 8.5% globally even though 2006 results were better than expected. However, preliminary forecasts for 2008 show a pick up in growth to 11%. Investors remain more cautious than analysts, even though there are signs that these growth estimates are too low. The valuation of equity markets has risen only in line with earnings, producing a historic price earnings ratio of 16.6 and a prospective one of 15.2. The 10-year US Treasury yield should remain in a trading range with a yield below 5%. UK and European yields have returned to the highs of the last 12 months, but we do not expect significant further upside. As we stated last quarter, the probability of a US recession is lower than the probability of a re-acceleration in growth and bonds should return around their coupon. With bond yields picking up and commodity prices strong, equity markets have probably gone far enough in the short term. The combination of better than expected earnings growth, a possible market re-rating and vigilant central banks should ensure further gains in the remainder of the year. However, volatility is likely to be higher than in recent years. We expect to keep an overweight position in equities for most of the year, but may reduce exposure tactically from time to time.

US economic data showed some improvement in December with a number of important figures such as payrolls surprising on the upside. As widely expected, the Fed left rates on hold for the third consecutive meeting, although the tone of the statement was softened marginally. Once again the lone dissenter was Richmond Fed President Lacker who continued to favour an immediate 25bp tightening move. Benchmark 10-year Treasury yields rose sharply from 4.40% to 4.70%, unwinding all of the declines of the preceding two months.
Dataflow in the Euro-zone remains fairly upbeat, although the relative strength compared with the US was less marked in December than in recent months. The ECB raised rates by 25bp to 3.5% at their 7th December meeting, in line with market expectations. Forward guidance was minimal, however, suggesting that there is no consensus as yet on the timing of a further move in the New Year given the uncertainties surrounding the impact of the German VAT hike. Against this background, benchmark 10-year yields backed up by around 25bp to 3.95% - a slight outperformance of the US over the month although a substantial underperformance over the quarter.

Elsewhere, the BOJ left rates unchanged in December despite a more upbeat Tankan quarterly business survey, helping the JGB market to record a strong relative performance. In the UK, gilts broadly matched the performance of Bunds despite arguably the strongest dataflow amongst the G7 economies.

Exchange rates also moved to reflect relative economic dynamism, with European and Australasian currencies out-performing. The Dollar and the Yen were relatively weak, with the latter also hurt by the expectation of continued easy monetary policy.

The Fund was reasonably well positioned for such a move, with a defensive overall bond position and currency exposure concentrated away from the weak Japanese Yen towards Europe in particular.