Market review
The third quarter was dominated by the subprime housing crisis in the United States, widespread credit concerns and the growth prospects of the US economy. The general reluctance of banks to lend to each other was not confined to the US, and global banks saw a severe squeeze in liquidity. A full-blown implosion of the US credit market was narrowly averted when the US Federal Reserve (the Fed) first cut the rate at which it lends to commercial banks and later the benchmark federal funds rate, from 5.25% to 4.75%.

Amid the turmoil, global equity markets ended the quarter well in positive territory to reach record highs; bouncing off their intra quarter (August) lows. The MSCI World Index gained 2.5% in US dollar terms over the quarter. The MSCI Emerging Market Index extended its positive performance (up 14.5% in US dollars) over the quarter, mainly on the back of a very strong performance out of Asia (up 19%).

Domestically, we witnessed a modest slowdown in growth and evidence of somewhat weaker consumer spending, particularly evident in the motor vehicle retail sector. Rising inflation, mostly on the back of sharply higher food prices, and a pick-up in inflation expectations were met by a further interest rate hike in August.

Global events reflected in the SA market, causing bonds and the currency to weaken and equities to sell off as risk appetite waned and uncertainty with regard to the global outlook grew. However, the bears seemed to lose the battle yet again as US Federal Reserve governor, Ben Bernanke, provided some monetary relief. Equities recovered strongly from their August lows, gaining 6.7% over the quarter. The local market was led higher by resources (up 13.5%) and industrials (up 3.3%). Financials, which were caught up in global credit concerns were down 1.6% over the quarter. Bond and property yields pushed lower and the currency gained strongly against a falling dollar. Over the quarter the All Bond Index was 3.4% higher, listed property rose by 9.5% and cash (as measured by the STeFI) earned a return of 2.3%.

Fund performance
As was the case in the broader market, the small and mid cap sector was characterised by significant volatility during the third quarter. This volatility arose on the back of global credit, domestic inflation and interest rate uncertainties. After declining by more than 7% intraquarter, the sector bounced back strongly to end the period in positive territory. The Investec Emerging Companies Fund returned 4.3% over the quarter, which, on a relative basis, was a respectable top quartile performance with the average fund in the peer group returning 3.3%.

One of the fund's largest holdings, KWV Beleggings, was a major contributor to alpha over the period. KWV has a solitary investment in wine and spirits producer Distell. During the quarter Distell released an excellent set of results which proved to be the catalyst for the subsequent share price rally. Distell continues to perform well through a combination of strong domestic volume growth and the expansion of its global brands on the back of aggressive marketing strategies.

One of the fund's recently introduced holdings, Assore Mining, rose 41% over the quarter. The company contributed significantly to fund performance as prospects in its manganese and iron ore markets continue to look buoyant.

Brait, the international investment and financial services group, struggled over the quarter, thereby detracting from fund performance. The share faced a headwind of negative market sentiment surrounding the more challenging funding environment in which private equity players find themselves.

Portfolio activity
The fund continues to seek out attractively priced shares which have exposure to gross domestic fixed investment (GDFI) spend due to occur in South Africa over the next decade. To this end, the fund took the opportunity to introduce two new GDFI oriented shares, namely Afrimat and Aveng, which we believe could be strong alpha generators in coming months. AECI, the diversified chemicals and explosives group, was also a new entrant to the portfolio. We feel the market is underestimating the growth prospects of Chemserve, AECI's previously listed chemical subsidiary, as well as the value of the group's vast property assets which it will look to realise over the next ten to fifteen years. These purchases were partially funded by the proceeds of Brandcorp Holdings, following the conclusion of the private equity deal. Exposures to Dorbyl, Astral and Hudaco Industries were reduced over the period.

Portfolio positioning and market outlook
Recent volatility in the small and mid cap sector has facilitated a switch in fund exposure between counters which have either over- or under-reacted to domestic and global news flow. Furthermore, the acceleration in initial public offerings (IPOs) of late has given rise to new investment opportunities in certain quality, previously unlisted, businesses. Given these stock-picking opportunities and the fund's forward price earnings ratio (10.8 times) and forward dividend yield (4.2%), the Investec Emerging Companies Fund should continue to enjoy capital upside from current levels.

Market review
Global economic data over the quarter has remained firm. Estimates of second quarter US GDP range between 3% and 4%, largely on the back of strong industrial output. The recent resurgence of the US economy coupled with steady growth in Europe and Japan bodes well for the growth outlook for the second half of the year.

Against a backdrop of steady global expansion and some inflationary concerns, monetary policy risk remains to the upside. Global bond markets sold off aggressively during the quarter, reflecting rising demand for capital and higher real yields. The European Central Bank's tightening bias pushed the euro to reach a series of record highs against the yen while at the same time climbing to two-year highs against the US dollar. The rand strengthened against major currencies over the quarter, in line with both commodity and emerging market currencies. Commodities remain generally well supported. The two main drivers of global inflation, oil and food continue to push higher. Metal prices were moderately weaker but remain well supported by supply constraints and robust growth.

The domestic inflation outlook has deteriorated over the quarter. Rising yields globally and domestic inflation concerns resulted in the local government debt curve increasing sharply. Over the quarter the benchmark R153 and R157 peaked at 9.15% and 8.58% respectively. The All Bond Index lost 1.7% over the three months ended June. We expect CPIX inflation to remain firmly above the targeted inflation band until year-end. This is likely to force the South African Reserve Bank (SARB) to tighten rates further. However, early signs of some moderation of consumption led growth, coupled with a potentially negative impact of the recently implemented National Credit Act are likely to moderate the SARB's stance on the extent of further tightening. Rising bond yields and deteriorating inflation expectations put pressure on domestic listed property. The sector was up marginally over the quarter (0.3%) but remains firmly in the black year to date at 16.1%.

After a strong first quarter, domestic equity market returns moderated slightly over the past three months. The FTSE/JSE Index gained 4.3% since the end of March. The market was driven higher by general mining (up 12.5%), oil and gas (up 9.9%), construction (up 9.9%) and life insurance (up 6.9%). Interest rate sensitive counters, in particular banks were down 6.9% and retailers lost 6.7%. This reminded investors of a similar occurrence last year, when diminishing global risk appetite coupled with higher domestic borrowing costs, caused a massive sell-off in domestic oriented sectors.

We remain positive, yet cautious, on our equity outlook over the next few quarters. Increasing volatility and fluctuations in sentiment should not deflect from a global and domestic backdrop that remains supportive of continued earnings growth and above average equity ratings.

Fund performance
The second quarter of 2007-bore witness to the emergence of a significant performance differential between the mid (+2.9%) and small cap indices (+11%). This is largely explained by the mid cap sector's significant exposure to consumer oriented shares which struggled over the quarter upon the release of poor inflation data and the market's subsequent concerns over further interest rate hikes.

The Investec Emerging Companies Fund had another solid quarter in absolute terms, returning 8.3%, however this was marginally behind the mean sector return over the period. One of the fund's largest holdings, industrial and retail distributor, Brandcorp extended its strong rally for the year when a private equity offer for the company was announced towards the end of April. This was the catalyst for the share to rally more than 28% over the period. Raubex, the road construction share re-rated strongly over the quarter (up 46%) and added considerably to alpha over the period.

Despite decreasing the fund's exposure to consumer oriented shares over the course of both the first and second quarters, fashion retailer Foschini, and furniture retailer, Ellerines, were amongst the fund's largest alpha detractors over the quarter. The potential for further interest rate increases and the introduction of the National Credit Act raised concerns in the market over slowing retail sector growth. The furniture retailers in particular came under significant pressure, falling more than 10% over the quarter.

Portfolio activity
After another solid set of results, profits were taken on chicken broiler producer, Astral. The fund's position in domestic airline carrier, Comair, was also trimmed after its exceptional run since the start of 2007. This exposure was switched into Group Five, Basil Read and Dawn Industries all of which are anticipated to benefit from increased infrastructure investment in South Africa.

Market outlook
Structurally lower financing costs, booming commodity prices and increased public and private sector spend continue to drive extremely strong earnings growth across many small and medium sized companies. Despite rapid share price appreciation in recent times, corporate earnings growth hasn't lagged far behind and hence the small / mid cap sector's rating has not reached excessive levels yet. Consequently, through careful stock picking, the potential exists for further capital upside going forward. However, returns are unlikely to reach those achieved in recent years.

Market review
Goldilocks economics held sway among investors in the opening days of the new year. However 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 subprime 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 but by month end, equity markets had bounced back. The MSCI World Index gained 1.9% (in US dollar terms) over the month and 2.6% over the quarter. The JSE saw heightened volatility in March. Local equities declined very sharply but as global risk aversion eased, stocks bounced back strongly. By month end the JSE had broken convincingly through its earlier February highs. The FTSE/JSE All Share Index returned 6.4% in March. This rally raised the first quarter return to 10.4% and the 12 month return to 37.6%. For the quarter, resources were up 15. 2%, financials 6.5% and industrials 5.6%. Cash (as measured by the STeFi index) earned a return of 2.1% over the quarter, against the All Bond Index return of 1.6%. The rand weakened by 4.1% against the US dollar and 4.6% against the euro over this period.

Fund performance
The first quarter of 2007 proved to be another strong period for the small and mid cap sector as these shares continued to rerate relative to their Top 40 peers. The Investec Emerging Companies Fund enjoyed a solid quarter, returning 15.7% which was in line with the sector average. Comair was the single largest contributor to fund performance as the share rose a massive 61% over the period on the back of an excellent set of results released early in February. Comair's impressive management team have built an enviable track record of increasing profitability in recent years, despite a challenging competitive environment and an exceptionally volatile cost base (i.e. the oil price). The fund's exposure to Altron also bore fruit as the share ran 36% in the first quarter predominantly due to its electrical engineering division, Powertech. This division is starting to benefit from a surge in public sector spend related to South Africa's power generation and transmission capability. On the downside, the fund's underweight position in construction companies, Murray and Roberts and Aveng, detracted from performance. These shares rallied hard as foreign buyers continued to seek out exposure to South Africa's building and construction related shares.

Portfolio activity
After building significant positions in Group Five and Northam Platinum earlier in the quarter, the fund took a stake in Raubex which listed on the JSE during March. This road construction business is set to benefit significantly in the next few years from increased expenditure on South Africa's road network which has been seriously neglected over the past decade. Towards the end of the quarter the opportunity was taken to reduce exposure to two of the fund's furniture retailers, namely Lewis and Ellerines, after both shares enjoyed strong recoveries post the sell-off in mid-2006. Consol Glass was also exited, as the recently approved private equity deal reached its conclusion.

Market outlook
Despite the small and mid cap sector delivering another strong quarter, the Investec Emerging Companies Fund is still well positioned to benefit from further upside going forward. The fund's valuation metrics remain undemanding as illustrated by the portfolio's forward P/E of 10.4 times and forward dividend yield of 4.6%. We continue to caution, however, that returns in absolute terms are unlikely to match the exceptional levels of recent years.

December was an excellent month for the Investec Emerging Companies fund with the fund's 6.9% return ahead of the average small and mid cap fund's return of 6.2% and sufficient to place the fund in the top position for the month. December brought to a close what has been a very successful quarter, with the fund's fourth quarter return of 21.3% coming in ahead of the average fund's return of 19.9%. Despite the strong finish to the year, 2006 was an indifferent year for the fund in relative terms, with the 42.8% return coming in below the average return of 45.5%.

Over the month we added to holdings in Comair, Ocfish, Ellerine and Altron Part Prefs while taking profits in Nampak and the sugar stocks (Illovo and Tongaat).

We are optimistic with respect to both absolute and relative performance in 2007. Despite the extent of returns generated over the last few years, it is interesting to note that the average PE of the top ten holdings in the fund (which make up 55% of the fund) is still only 11.5 times - an undemanding valuation multiple given long bond yield around 8% and real growth of 4% in the economy. We thus expect to be able to generate real returns from current levels. With respect to relative returns, our decision to stick with the large position in retailers through the 'panic' period in the middle of last year has been justified with a strong recovery over the last few months following good Christmas trade, a lower oil price and less hawkish comments from the Reserve Bank. The fund's weighting in retailers remains at a high level of 20% and we expect the continued re-rating of these stocks (especially the furniture stocks) to drive relative performance.