Market review
During the third quarter, soft economic data, low inflation and dovish central bank rhetoric reinforced the belief among investors that interest rates would be on hold for the foreseeable future and policy may be eased further, most notably in the United States. This encouraged investors to search for yield, pushing down government bond yields, credit spreads and the US dollar. The return on the Citigroup World Government Bond Index was 8.2% in US dollars.

Portfolio review
During the review period, the portfolio's credit holdings recovered strongly after the sell-off in the second quarter. Exposure to emerging market bonds performed well on falling yields. Interest rate positioning detracted modestly from returns, with yield curves steepening somewhat. Currency positioning also detracted from performance, as gains from our underweight exposure in the US dollar were offset by our underweight positions in the euro and the yen.

Portfolio activity
The portfolio was generally underweight duration, on stretched government bond valuations. However, this position was actively managed to limit losses and some of the exposure was replaced with options to limit downside risks. We also added to our inflation-linked exposure, given very optimistic inflation expectations priced into bond markets. The portfolio maintained a reasonable exposure to corporate bonds. We believe corporate bonds remain cheap on a relative basis, given the improvement in company fundamentals. New issues were bought to replace some fully valued existing positions. Exposure was maintained across a range of cheaper good quality emerging bond markets, which benefit from relatively attractive real and nominal yields. We reduced our exposure to the dollar, following the Federal Open Market Committee statement that appeared to give investors a green light to sell the US currency. Exposure remains well diversified with a focus on better valued currencies with sound fundamentals and decent yields, including a range of emerging market currencies.

Portfolio positioning
The rally in bond yields should continue for the time being. A major bond market reversal seems unlikely while central bankers still have a bias towards easing. Despite this, major government bonds look expensive at current yields. We estimate that the US, for example, is now pricing in almost a two-thirds probability of Japanese-style deflation over the medium term. In contrast, we think some inflation is a much more likely outcome, given very limited evidence of disinflation. If anything, goods price inflation is under mild upward pressure, led by increasing pricing power in developing economies. In addition, service sector inflation remains remarkably sticky given the rise in unemployment, perhaps reflecting a skills mismatch between the unemployed and growth sectors in many economies. We also think that fears of a double-dip recession look overdone, with most leading indicators holding up, and easier financial conditions providing a welcome boost. The portfolio maintains a short duration position, focusing on US Treasuries. We have also increased our exposure to short- to medium-dated inflation-linked bonds, given our caution on the outlook for deflation.

There is still value in credit and emerging market local sovereign currency debt. Yields have fallen, but this reflects the decline in major government bond yields. On a relative basis, we believe the additional yields offered by these markets more than compensate investors for the risks. The portfolio retains significant credit and emerging market debt exposure. The former is focused on non-cyclical businesses in the developed world, basic industries and capital goods producers and better quality banks. We also prefer minor currencies to either the US dollar or the euro. The US dollar is vulnerable to renewed quantitative easing and medium-term deficit concerns. The euro has deep structural flaws which may ultimately cause a break-up of the currency. The yen has stronger fundamentals than either currency, but may struggle if the Japanese are committed to intervention. Sterling still looks cheap, but is also vulnerable to more quantitative easing. Overall, we are long developed and developing currencies with less expansionary monetary policy and better growth and debt dynamics. The portfolio is underweight both the dollar and the euro.

April saw a continuation of the rally in risk assets, before a heavy sell-off began in early May. Investors questioned the durability of the expansion and the potential impact of problems in peripheral Europe and the slowdown in China. Corporate bond yields rose sharply relative to core government bond markets, which rallied on 'safe haven' buying. Most currencies weakened substantially against the dollar with the exception of the yen.

Market review
The US dollar gained against all major currencies rising by 6.5% against the sterling, 6% against the euro and 0.4% against the yen. Yields on ten-year government bonds also rose, ending the quarter at 3.8% in the US and 1.4% in Japan. Yields fell modestly to 4% in the UK, and more significantly in Germany ending the quarter at 3.09%. Spreads on corporate bonds continued to narrow, but only moderately, leaving limited further scope on high quality issues. The return of the Citigroup World Government Bond Index was -1.3% in US dollars. Activity data surprises were strongly positive in March, promising a strengthening global recovery while inflation surprises were subdued. Nevertheless, the point at which the Federal Reserve raises interest rates is rapidly approaching. Household incomes are recovering, consumption indicators are positive and unemployment is starting to fall. A modest improvement is also noticeable in the indicators for the UK, Europe and Japan. The need for governments to curb fiscal deficits is becoming more urgent if interest rates are to be kept down.

Portfolio review
In the first quarter of the year, the portfolio outperformed the average fund in its sector in rand terms. All strategies, with the exception of interest rate positioning, added to returns, with a strong contribution once again from corporate bond exposure, which continued to benefit from the economic recovery. Currency positions in emerging and commodity-linked currencies generally performed well, given the improved growth outlook. The Japanese yen weakened later in the quarter, which boosted returns, as did an underweight position in the euro against the US dollar. Our emerging market bond holdings also performed well, especially the long positions in Africa, Europe and Latin America, as well as inflation-linked bonds in Turkey.

Portfolio activity
Markets were volatile during the first quarter with nervousness about the strength of the recovery, compounded by concerns about the ability of Greece to refinance its maturing debt. These concerns reached a peak in February, but eased into quarter-end, as it became clearer that the EU would provide support for Greece. Government bonds rallied initially before selling off later in the quarter and as a result, the short duration position of the portfolio had a mixed impact. Our least favourite markets, the US, UK and Canada, tended to underperform. Corporate bonds marked time whilst Greece was a concern, but rallied strongly during March helped by improving company profitability. The portfolio rotated out of some of the more expensive holdings in banks and cyclical issues into more defensive bonds, which once again offer relative value. The yen benefited from market fears at the beginning of the quarter, but then lost ground. The dollar was generally strong, especially against European currencies. The portfolio was well positioned for these developments. Emerging currencies weakened somewhat during periods of market nervousness, but generally had a reasonable quarter, especially those held by the portfolio. Emerging bond markets generally rallied, with European countries and South Africa cutting interest rates, Asian economies responding to faster growth by tightening, and Latin America staying on hold.

Portfolio positioning
Leading indicators continue to suggest that the global economic environment should improve further over the balance of 2010. This would underpin corporate balance sheets and provide support for the rally in credit spreads. We think we are perhaps 80% of the way through the bull market in the yield spreads of corporate bonds relative to government bonds. This leaves enough opportunity in yields for us to retain a significant allocation to the corporate bond market. We also expect the favourable growth environment to support capital flows into emerging markets with positive implications for the more attractive currencies and bonds in the developing world, to which we maintain exposure. Financial markets will have to contend with a gradual reduction in liquidity provision by global central banks, especially in the second half of the year, but this is not expected to lead to anything more than occasional corrections in risk assets. Ultimately, most central banks have little need to tighten policy quickly and are likely to raise interest rates cautiously, if at all. The first interest rate increase is now probably only six to nine months away in the US. The approach of even gradual policy tightening will continue to put upward pressure on Treasury yields and begin to encourage the yield curve to flatten. In addition to a short position in US government bonds, the portfolio is also short duration in the UK, which remains vulnerable to funding concerns, and Canada, which should be the next major economy to tighten monetary policy. We retain a long duration position in UK inflation-linked bonds, given the potential for a further deterioration in inflation expectations on the back of rising retail price index (RPI) inflation. In major currency markets we favour a short position in the Japanese yen, which should lose support as interest rates begin to rise elsewhere. We are long the US dollar, a number of commodity-linked currencies and sterling, which looks oversold.

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 return on the Citigroup World Government Bond Index was -1.9% in US dollars over the quarter.

Portfolio review
Over the fourth quarter of 2009, the Global Opportunity Income Fund of Funds' returns were led by a very strong performance from corporate bond exposure. Active currency management and holdings in emerging market debt also added to returns, while interest rate positioning produced more mixed results.

Portfolio activity
The global economic recovery continued to gather momentum in the last quarter of 2009. This provided ongoing support for corporate bonds, with yield spreads narrowing sharply over the quarter, albeit at a slower pace than earlier in the year. We therefore took the opportunity to reduce the portfolio's exposure to expensive corporate issues, as well as increasing its exposure to banks and attractively priced bonds issued by cyclical companies. Government bond yields traded within a volatile range, ending the quarter towards the upper end of this range. The impact of stronger economic activity was largely offset by dovish comments from central bankers who downplayed the likelihood of higher official interest rates for the foreseeable future, supporting short-dated bond processes and causing yield curves to steepen. This hurt performance as the portfolio was positioned for flatter curves, which tend to occur at this point in the cycle. The duration of the portfolio was reduced during the quarter to reflect the improving growth outlook, through sales of United Kingdom and US government bonds. The short position in duration in Japan was also closed. Emerging market bonds had a positive quarter, and the portfolio retained a moderate exposure to a number of these markets. The US dollar was initially weak and then ended the year on a stronger note, especially against the Japanese yen. The portfolio successfully moved from short to long US dollars during the period. Stronger global growth tended to support the currencies of commodity producers and developing economies to the benefit of the portfolio.

Portfolio positioning
2009 was an exceptional year for financial markets. A combination of cheap valuations, improving fundamentals and low interest rates delivered very strong returns across a broad range of asset classes. 2010 looks likely to be a less spectacular year for returns. For now, the macroeconomic environment is still improving, and monetary policy is on hold. This should enable credit and emerging market debt to continue to outperform developed government bonds, but valuations are no longer as compelling as they once were. As such, we have reduced exposure to these markets, but have still retained a larger than average position. Volatility is likely to reach its maximum as growth momentum peaks and once central banks begin to tighten liquidity. Although the cyclical environment should remain supportive, we are likely to look for opportunities to manage exposure actively throughout the year. Greater competition for funds and heavy borrowing are likely to push government yields higher, especially as we approach the turn in the rate cycle. Shorter-dated bonds should start to price in a return to positive real interest rates. Normally this would cause yield curves to flatten, but the large volume of government bonds to be issued this year may result in a more parallel rise in yields. The end of central bank buying should add to the pressure for higher yields, especially in the United Kingdom and the US. Peripheral European borrowers are also likely to feel the impact of the withdrawal of European Central Bank liquidity provision. We expect to add to our short duration positions in these markets as opportunities arise. In currency markets, we expect capital to continue to flow towards pro-cyclical commodity and emerging market currencies, especially those that have not already appreciated to expensive levels. We have exposure to a number of these currencies, funded out of short positions in Swiss francs, euros and yen. The yen, in particular, should once again become the preferred funding currency as interest rate and yield differentials begin to favour other major currencies.