The bond market rallied sharply during the second quarter, despite an increase in short-term interest rates. The fall in bond yields was driven by buying by annuity funds and by foreigners encouraged by the recovery in the Rand. For bond yields to peak 7 months ahead of inflation is unprecedented in the history of the South African bond market. During the quarter, we retained a defensive duration stance. At current yields we believe that the bond market has rallied too far too fast in anticipation of an unwinding of this year's rise in inflation and interest rates. Near-term, risks remain regarding the outlook for inflation, interest rates and the Rand. Any sell-off, however, is likely to be limited by the approach of the peak in CPIX and the low level of bond exposure in most balanced funds. CPIX should peak in October just below 10% and then decline sharply, reaching the upper end of the Reserve Bank's inflation target by the second quarter of next year. This will allow the bond market to resume its rally and we will look to adopt a more aggressive duration stance within the 2 year limit later this year as the opportunity arises. The Fund continues to be managed conservatively with respect to interest rate and credit risks.

Bond yields fell sharply during April. The Fund had a moderately defensive duration exposure, given the risk of higher inflation and interest rates, and this limited performance in the short run. The move lower in yields was driven by demand from insurance funds for long-dated bonds and renewed buying by foreigners encouraged by a strengthening Rand. The fall in yields was exacerbated by the very low bond weightings of most local investors. At current levels bonds appear to be pricing too rapid a decline in inflation. As such, the fund manager believes that they are vulnerable to further weakness in the near-term and has positioned the Fund accordingly. That said, however, given the favourable supply situation, the fund manager expects any sell-off will be limited and will look to lock in higher yields as they become available. The Fund continues to be managed conservatively with regards to both interest rate and credit risks.