Market review
The domestic equity market took its cue from global markets, which benefited from the improvement in the global growth outlook and a higher risk appetite. The All Share Index added 13.9% in the third quarter and has gained 18.6% this year. Over the quarter, the All Share Resources Index (11.1%) lagged the overall market, with gold miners earning a disappointing 6%. Domestic-oriented and interest rate-sensitive sectors enjoyed good gains. Construction (19%), general retailers (19.1%) and banks (14%) stood out as strong performers, with foreigners particularly active buyers. Telecommunication (3.8%) and short-term insurers (6.1%) underperformed the market.

Portfolio review
Domestic small and mid cap counters were beneficiaries of the increased risk appetite, as investors sought out attractive opportunities in counters which had been so hastily exited during the downturn of 2008. As was the case in the second quarter, cyclical counters were at the forefront of share price appreciation. It is encouraging to note that the small and mid cap sector has significantly outperformed the Top 40 Index over the past six months. The Investec Emerging Companies Fund built on its strong second quarter performance, returning 15.6% over the July to September period.

The construction sector enjoyed a strong re-rating in the third quarter, on the back of an anticipated mining and building capital expenditure upturn into the medium term. The fund was well positioned for this move through its sectoral exposures to Basil Read, WBHO and Esor, which all outperformed over the period. Steinhoff International, introduced as a top ten holding during May, was also a significant alpha generator over the period. At the time of acquiring the stake we commented that, unlike many other cyclical counters, Steinhoff was yet to price in the prospect of the global recovery. Despite the share's strong rally witnessed in recent months, we believe there is still significant scope for a further re-rating.

The fund's preferred gold exposure, Durban Deep, endured a second consecutive challenging quarter, thus detracting from relative performance. Despite a fractionally higher rand gold price, cost pressures and labour disruptions kept the share price subdued. We believe that the outlook for gold remains attractive. Concerns over continued US dollar weakness, seasonal demand from India as well as safe-haven buying for gold as an alternative currency are all key reasons why we remain bullish on the metal. Hence, with the resolution of labour disputes and the gold price breaking decisively through the key $1000 technical mark, we are confident that Durban Deep is set to deliver meaningful alpha for the portfolio going forward.

Portfolio activity
It was another active quarter of trading as the fund sought to take advantage of mispricing opportunities in the market. The fund sold out of its long-term holding in industrial distributor, Hudaco. Despite having a well-respected management team, this counter's earnings are set to suffer under the combined weight of sharply lower volumes from the domestic mining and manufacturing sectors, as well as a deflationary pricing environment. Profits were taken on a number of defensive counters that had performed admirably during the downturn. These included property counters Sycom and ApexHi as well as Capevin Investments (formerly known as KWV Investments), which holds a stake in wine and spirits manufacturer, Distell. These exposures were switched into shares which we believe are more likely to benefit from the cyclical upturn, including Peregrine Holdings and Merafe Resources.

Portfolio positioning
Attractively priced companies with solid management, sound corporate strategies and ultimately strong cash flows remain the focus of our investment philosophy. To date, the improved global outlook has been somewhat less pronounced in the local economy. However, as was the case when South Africa lagged developed markets' entry into recession, so it will be with respect to the recovery. At present, the market is largely looking through bottom-ofcycle results releases, focusing rather on the expectation of strong earnings growth, albeit off a weak base, into 2010. Certain cyclical counters are already pricing in the prospect of a strong recovery into the medium term. Hence, stock picking is becoming increasingly important, given that earnings visibility remains quite poor and not all counters will deliver on the high expectations projected by the market. In general, small and mid cap counters still offer very appealing valuation multiples, as evidenced by the fund's forward price earnings ratio of 7.3 times and forward dividend yield of 4.4%. Aided by interest rate cuts over the past year, one should continue to see a re-rating in small and mid cap counters, bringing with it the prospect of attractive real returns over the medium to longer term.

Market review
While company profits remained under pressure, equity markets rerated significantly as signs of an improvement in the global economy buoyed risk assets. The local equity market had a positive quarter (8.6%), its first in 12 months, despite giving up some of its gains during the month of June (-3.1%). Year to date, the All Share Index closed 4.1% stronger. The market's foreign currency returns for the three month to the end of June, were boosted by the rand's appreciation against the US dollar (24.1%) and the euro (16.7%). Over the quarter, the financial and industrial composite (13.4%) outperformed resources (2.8%), with gold miners (-16.2%) the largest underperformers. Other sectors lagging the composite over this period included fixed line communications (-0.8%), travel and leisure (6.6%) and food producers (7.7%). General retailers (15.6%), banks (13.8%) and the construction (16.6%) sectors all ended the quarter well above their March levels. The platinum (9.5%) and general mining (8.9%) sectors performed in line with the overall market.

Portfolio review
Market scepticism of the first 'green shoots' of global economic recovery waned during the second quarter as further evidence of a rebound came to the fore. The combination of more favourable economic data and the sheer magnitude of cash sitting on the sidelines was just the tonic to drive equity markets higher across the globe. Not surprisingly, cyclical counters were the primary beneficiaries, outperforming their defensive counterparts which had held up so well in late 2008. Domestic small and mid cap counters joined in the rally, fuelled by an increased investor risk appetite which brought with it a positive spin-off in the form of improved liquidity levels. The Investec Emerging Companies Fund enjoyed a strong quarter in both absolute and relative terms, returning 15.8% which was 1% ahead of its peer universe. One of the fund's largest holdings, recruitment specialist Adcorp, was a material alpha generator for the portfolio. At the start of the quarter, we firmly believed that the share, underpinned by a substantial dividend yield, was more than discounting the prospect of a sharp local slowdown. It was therefore encouraging to see in its full year results released in May, that despite the challenging economic climate, its growth was indeed outstripping consensus forecasts. This was the catalyst for a dramatic rally in the share price, which added significantly to overall fund performance. Cipla Medpro, the fund's preferred pharmaceutical counter, also contributed handsomely as the share benefited from an offer made by competitor Adcock Ingram to buy out the company. Even though the deal was eventually called off, the fund derived alpha as exposure was lightened when the share spiked on news of the deal. Exposure to industries suffering from global overcapacity, such as Metair Investments in the automotive components sector, detracted from relative performance. Despite this company's challenging operating environment, the share trades at a significant discount to its net asset value, and hence represents good long-term value which should emerge as conditions normalise going forward. Durban Deep retraced some of its gains of the first quarter as investors' concerns surrounding the health of the global financial system receded. This factor, combined with the stronger domestic currency, kept the rand gold price and hence Durban Deep's revenue line under pressure during the period.

Portfolio activity
Aggressive share price movements gave rise to several alpha generating trading opportunities over the quarter. The technology sector, which rallied impressively in line with its early cycle tag, led us to take profits on our favoured sector holding, Datacentrix, as well as to exit the fund's position in Dimension Data. We continue to see value in the poultry industry as input costs (especially maize) reduce and commodity prices firm, which should continue to drive margin expansion going forward. However, relative sector preferences saw the fund switch part of its exposure in Astral Chickens into Country Bird and to a lesser extent, Sovereign Food. Steinhoff was also introduced into the portfolio when it dropped out of the ALSI 40 during May. Unlike many other global cyclical shares, it is yet to price in the potential of an upturn in the global economy, and hence we feel there is significant re-rating potential going forward.

Portfolio positioning
Overall, our strategy remains unwavering as we continue to seek out those high quality, well-managed businesses with solid balance sheets and strong cash flows. Given the continued challenges surrounding funding for small and medium enterprises, our view is that the recession is still likely to leave a number of casualties in its wake, and that the subsequent upturn could be a bumpy ride. The full extent of the recent dramatic decline in the domestic environment is only likely to be revealed during the upcoming quarter's results season. Although short-term earnings are likely to remain under pressure, the market is likely to look through this and focus on the compelling longer-term valuation case. Despite the sector's recovery over the past quarter, small and mid cap valuations remain below long-term averages, as reflected by the fund's forward price earnings ratio of 6.8 times. This is further enhanced by a healthy forward dividend yield of 5.9%. The cumulative 450 basis points of rate cuts since December should be a strong catalyst for a market re-rating in time. With valuations remaining at attractive levels we continue to see an opportunity for domestic small and mid cap shares to benefit from strong real returns into the medium and longer term.

Market review
Local economic news continued to deteriorate over the quarter. The release of fourth quarter GDP numbers confirmed the sharp slowdown experienced in the second half of 2008. Domestic demand remained under pressure in the first three months of 2009. Weak employment prospects and the slump in the manufacturing sector continued to bear down on retail spend and vehicle sales. Policy makers responded with two interest rate cuts of 100 basis points each during the quarter. The second meeting, held earlier than initially scheduled, indicated somewhat greater urgency on the part of the South African Reserve Bank to respond to the extremely weak global backdrop and evidence that the local economy was unlikely to escape a recession. The outlook continues to favour more rate cuts.

South African bonds followed global yields higher after reaching record lows in December. While prospects of weak growth and falling inflation continue to provide a bond-friendly environment, the market remains sensitive to the impact of a rapid increase in government spending and concomitant future funding requirements. The All Bond Index lost 5.1% over the quarter. The listed property sector (-1.4%) fared somewhat better, but could not escape deteriorating sector fundamentals. Cash, as measured by the STeFI, returned 0.9% over the quarter.

Equities weakened for the third consecutive quarter, with the All Share Index losing 4.2% year to date. Both financials (-7%) and industrials (-9.2%) ended the quarter in negative territory. Resource counters clawed back some of their losses sustained in the second half of 2008 to end up 1.6%. Gold mining (22.8%), platinum mining (9.6%) and pharmaceuticals (22.4%) were the only sectors to gain over the quarter. While general miners (-4.6%) performed broadly in line with the overall market, it was the domestic oriented sectors that fell most with banks (-9.8%), retailers (-7.6%) and the construction sector (-10.6%) all ending down.

Portfolio review
After a brief rally at the start of January, global markets caved in under the weight of a wave of extraordinarily weak economic data and concerns surrounding the potential nationalisation of the US banking system. Markets remained under pressure until mid-March when investors took heart from improved global manufacturing numbers as well as positive comments made by a number of US banking executives. Domestic small and mid cap shares followed a similar path over the quarter, with investors primarily concerned about the amplified impact of a slowing local economy on small- and medium-sized enterprises. The Investec Emerging Companies Fund declined 8.2% over the period, but this was a solid first quartile performance versus its peer funds which on average fell 11.4% in the first quarter. It was encouraging to note that an improvement in share liquidity was evident towards the end of the quarter.

KWV was again a strong alpha (outperformance) generator for the fund, as the Distell holding reported another impressive set of results during February. Another top ten holding, Cashbuild, bucked the downtrend in the local building market by continuing to deliver exceptional growth in the lower LSM, cash-oriented building materials segment. With global risk aversion and financial system instability at elevated levels, it was not entirely surprising that gold continued its strong run. The fund's preferred exposure, in the form of Durban Deep, enjoyed an exceptional quarter, returning 42%. Durban Deep's earnings will be boosted in the year ahead by its recent sale of lossmaking divisions, lower input-cost inflation and, of course, a significantly higher rand gold price.

Portfolio activity
It was an active period of trading. Profits were taken on KWV after a sustained period of outperformance. A portion of the fund's retail exposure in Truworths was switched into another quality counter, Massmart. A number of new positions were entered into including Coronation, AdvTech and Discovery all of which are extremely wellmanaged and highly cash generative businesses underpinned by healthy dividend yields. We disposed of our holding in Bell due to concern that an oversupply of global yellow equipment could see both volumes and price declines, putting margins under severe pressure.

Portfolio positioning
The local Monetary Policy Committee reacted to sharply lower economic activity levels by cutting interest rates by 200 basis points during the first quarter. We should see further rate reductions in the coming months, which should prove to be a strong catalyst for a market re-rating in time. However, in the short term, the global and local economic environment is likely to be the most challenging in many a decade, with job losses accelerating during the course of 2009. Given this backdrop, we are more focused than ever on our consistent strategy of picking high quality, well-managed businesses backed by solid balance sheets and strong cash flows. Ultimately these companies will emerge from the downturn stronger than ever, given that some of their peers could struggle to survive this difficult trading period. Despite our focus on quality, valuations of the fund's preferred stocks are not demanding as evidenced by the fund's forward price earnings ratio of 5.9 times and forward dividend yield of 6.7%. Where feasible and without jeopardising investment quality, the portfolio's focus is shifting towards those shares which are more geared to a cyclical upturn.

Although the macro-economic environment is likely to remain tough for some time to come, global equity markets will anticipate a recovery before it happens. This should drive a significant re-rating for local small and mid cap shares and presents an opportunity to benefit from strong real returns into the medium and longer term.

Market review
The global financial crises and the ensuing slowdown in economic activity left their mark on the domestic equity market. The All Share Index lost 23.2% over the year, all of the losses sustained in the second half of 2008. The market ended 9.2% weaker over the last quarter of the year, with falling commodity prices driving down platinum (-25.8%) and general miners (-15.2%). The construction sector slumped 36.1% in the fourth quarter as companies saw their order books curtailed by weaker demand and foreign investors seemed to lose faith in the sector. Life assurers (-15.9%) continued their underperformance of the general market.

Exposure to falling interest rates and defensive earnings streams dominated the outperformers over the quarter, with banks (-6.1%), healthcare equipment and services (5.6%), food producers (6.6%) and food retailers (16.2%) high up on the performance table. However, it was the gold miners (22%) that took the top spot over the quarter as the dollar gold price held its own and rand weakness and positive production news boosted returns to the sector.

Portfolio review
The domestic mid and small cap sectors endured a particularly challenging October. These sectors only recovered into December, as markets took some comfort from the fiscal and monetary stimulus packages announced by global governments. Overall, 2008 proved to be a very tough period for small cap shares as investors sought comfort in cash or the local bourse's more liquid larger counters. The Investec Emerging Companies Fund had a difficult year, but was still marginally ahead of the mean return for its peer funds over the 12 months to end December. Over the quarter the fund underperformed the average fund in its sector by just less than one percent.

Two of the fund's defensive exposures, KWV and AVI, were amongst the top contributors to fund performance over the quarter. KWV, through its investment holding in Distell, has traded well in its primary product segments of brandy, wine and liqueur cream despite the economic downturn. Food producer AVI was purchased early in the quarter - this proved to be a well-timed trade. In November Tiger Brands announced its intention to make an offer for the company, which resulted in the share price rising strongly. The fund's underweight position in many of the smaller resource counters including Highveld (steel), Metorex (copper) and Grindrod (freight) paid dividends as their underlying commodity prices fell sharply over the quarter. This was as a result of markedly lower global growth expectations. Two primary areas detracted from relative performance over the final quarter. Firstly, construction counters sold off, largely due to market concerns surrounding exposure to mining and commercial building activity. Despite having significantly reduced sector exposure in prior months, the fund's remaining counters in the form of Basil Read and WBHO weren't left unscathed by the sector de-rating. We remain confident, however, that the sell-off in these two shares was overdone. Their growth prospects remain excellent, given their defensively positioned order books focussed on civil construction and road building. Secondly, fund performance was hurt through an underweight exposure to certain interest rate sensitive shares, such as general retailers Massmart and Woolworths. These shares rallied as inflation expectations moderated over the quarter.

Portfolio activity
It was an active period with respect to trading activity, with extreme share price movements creating switching opportunities. On the sell side, concerns over commodity exposure within certain of the gross domestic fixed investment counters facilitated an exit of Aveng (steel trading) and Altron (copper cables).

Buy side trades were in part focussed on adding to existing interest rate sensitive exposures (e.g. Foschini) as well as introducing new counters along this theme (e.g. Sun International). Sun International is a well-run, highly cash-generative business. The company should re-rate as a result of interest rate cuts, given that consumers, over the medium term, should have more disposable income to spend on leisure activities. Certain defensive resource exposures have also been introduced to the portfolio in the form of Oceana, Astral and Durban Deep. These three counters are set to benefit from significantly lower input costs such as fuel, while their revenue lines will gain from sharply higher rand commodity prices.

Portfolio positioning
Over the course of the last quarter, global investor attention has shifted away from the banking sector crisis to the impact upon the real economy. It has also become increasingly clear that South Africa will not escape the global downturn. Indeed, 2009 is likely to be an extremely challenging period for the domestic economy, one in which GDP growth may barely reach positive territory. Hence, it is not surprising that earnings momentum remains negative and corporate visibility low. However, there are a couple of factors which should provide a particularly strong counterbalance to these headwinds. Firstly, the recent dramatic decline in commodity prices (and oil in particular) will provide a firm catalyst for significant interest rate cuts in the year ahead. These cuts should be a strong driver of a market re-rating in time. Secondly, the valuation environment is extremely compelling. This is reflected in the Investec Emerging Companies Fund, which has a forward price earnings ratio of 5.9 times and a forward dividend yield of 7%. Indicative of the level of value is the fact that a number of the fund's investments are now offering a higher income return (i.e. dividend yield) over the next year than one could achieve in cash after tax.

Overall, our focus remains on investing in quality companies - those with solid management teams with long track records of delivery, strong cash flow generation and comfortable balance sheet risk. Global news flow, particularly in early 2009, is likely to ensure that markets remain volatile in the short term. However, the aggressive monetary and fiscal response by both Western and Eastern governments will bear fruit and drive a global recovery in time. Share markets will anticipate this recovery with the domestic small/mid cap market well positioned to benefit from this upturn. Given the current attractive valuation environment, the opportunity exists for strong positive real returns in the medium and longer term.