The FTSE/JSE All Share index (ALSI) gained 13.25% in rands in the third quarter after losing 8.6% in the second quarter on increased expectations of further quantitative easing measures being implemented in developed markets. Globally, emerging markets (+18%) outperformed developed markets (+3.9%) by 14% over the quarter. The third quarter's performance contributed significantly to the ALSI's YTD appreciation of 8.7%.

Our equity market has benefited significantly from developed market stimulus and the concomitant search for yield on both equities and bonds. We should be wary of extrapolating this new found love with South Africa and emerging markets as a new paradigm or structural shift: it is merely a manifestation of excess liquid assets in developed markets attempting to diversify away from perceived, underperforming markets to better performing but more riskier markets. A reflection on our recent past is, therefore, very instructive: we have seen these machinations at work in 2003-2004.

In 2003, the 16% appreciation in the rand had a significantly negative impact on resources earnings, with average earnings reported between June 2003 and June 2004 showing a 40% decline (the ALSI's earnings declined by 11% over the same period). Clearly, for commodity companies and rand-hedges the rand strength over that period played a major role in the decline in earnings Recent utterances by the US central bank that it is ready, willing and able to provide more support to the economy has been interpreted and discounted by equity markets as a fait accompli. This is evident in global equity markets performance over the last month and quarter. Furthermore, the global search for yield as a proxy for safe haven assets, as well as a replacement for lost income on developed market bonds that are at near-record lows, have driven developed market investors inexorably to emerging markets and the excess yields on offer by both equities and bonds.

Mondi is one of the bigger holdings in the fund. Mondi is a paper and packaging company that has established leading positions in uncoated fine paper (UFP) in emerging markets. In particular, the company's operations in Poland and Russia provide the group with the benefits of a vertical integration through ownership and control of vast forestry assets. In addition, the quality and location of these assets gives the group access to low cost wood and have contributed to Mondi being one of the lowest cost producers of UFP and Kraftliner (used in the manufacturing of corrugated packaging). The recent completion of a 10-year asset modernisation programme that cost €3bn coincided with a revival in demand for both Kraftliner and UFP, resulting in a strong recovery in these commodities prices following the recession-induced slump. We are therefore confident that Mondi is on the cusp of substantial earnings growth and in the absence of significant capital expenditure requirements, shareholders can look forward to increased dividends.

Portfolio Manager
Abdulazeez Davids

THe JSE code for the fund changed from KIEF to KAIE on 01/10/2010

World and domestic equity markets continued the strong rally from the first quarter in 2010 until mid-April, when Greece's debt concerns again made world headlines. Since mid-April global markets have declined by between 7% to 12% as the reality of the full repercussions of the global debt orgy started to hit home. Most developed markets are grappling to come to terms with their sizeable debt burdens and are sharpening pencils to steer their respective economies to more manageable gearing levels. As Europe braces itself for austerity measures last seen before WWII, the full impact of the divisions in Europe is reflected in the weak Euro currency.

By connecting the dots, the implications for global growth and therefore corporate earnings are clear: At worst, the world is facing a second recession or, at best, a protracted period of excruciatingly slow growth as economies start to de-leverage. Global sentiment appears to be shifting from outright bullishness on prospects of a recovery to an admission that the recovery will be protracted, as is evidenced by changes to consensus earnings estimates that have now turned negative. Whilst we were early in our call to raise cash levels and focus on high quality companies with low gearing levels, this theme has not run its course and we should anticipate this view to become de rigueur fairly imminently.

The fund's relatively high cash weighting and underweight positions in resources counters contributed to relative performance for the quarter and half year to the end of June 2010. The significant decline in resources counters (minus -11.9% for the second quarter) has resulted in opportunities emerging where share prices are trading closer to their intrinsic values. However, there is a significant caveat: The extent to which the current global fiscal austerity measures impact global economic growth will ultimately dictate the pace of resources' earnings growth. We therefore remain cautious on the global diversified miners.

Illovo is one of the fund's bigger holdings and the company reported its annual results during the quarter. Illovo's investment case centres around the company's increasing exposure to the lucrative EU sugar market in addition to the group's premium-priced regional sugar markets. Illovo produces sugar in Zambia, Malawi, Tanzania, Swaziland Mozambique and South Africa, with a potential investment in Mali currently being assessed for feasibility. Most of Illovo's operations rank in the lowest quartile on the cost curve and this gives the company a clear competitive advantage over other sugar producers. The Zambian operation is expected to increase its sugar production significantly following a R1.3 billion capital expenditure program that will substantially increase Illovo's profitability in future years. We believe that Illovo's current valuation does not account for this significant earnings growth trajectory and we therefore find the share very attractively priced at current levels.

Portfolio manager
Abdulazeez Davids

The FTSE/JSE All Share index (ALSI) returned 4.5% in the first quarter of 2010, mainly led by technology and financial stocks. The domestic equity market thus continued to rally, following an 11% gain in Q4 2009 on continued indications that the domestic economy is improving and a surprise rate cut in March 2010.

The local equity market has continued to outperform global developed and emerging markets in US dollar terms, with continued Rand currency strength providing a strong underpin to our market's returns over the last quarter in US dollar terms. Developed markets rallied strongly in March as further quantitative stimulus measures provided support to equity market returns. Most developed markets have now gained more than 50% over the last twelve months with emerging markets gaining on average more than 100% over the same period.

The ALSI has continued to re-rate along with other developed and emerging markets, despite poor company fundamentals. Consequently, our domestic market is currently significantly overvalued compared to its long term history. The ALSI's current price- earnings ratio of 18x is substantially above its long-term average rating of around 11.8x and even with the most optimistic earnings growth assumptions, our market appears quite expensive. Exogenous forces like foreigners' appetite for emerging and developing market equities and global economic variables will therefore continue to shape and influence our domestic market's returns in the short-term. However, because of the liquidity stimulus mentioned above, there is still scope for global markets to continue higher in the short-term before the necessary correction ensues.

The fund's relatively high cash weighting and underweight positions in Resources counters detracted from performance over the last month. However, given our view on the domestic market as outlined above, we believe that the current fund positioning remains prudent as a bulwark against capital loss for our investors. Despite the fund's underweight position in Resources, our research indicates that selected equities in the Resources sector remain attractively priced and we will continue to increase the fund's exposure to these equities. Sasol is an example of a Resources counter that remains attractively valued by the market.

Sasol is the only oil company that has successfully converted coal to liquid fuel on a commercially viable basis and continues to expand its proprietary technology to other applications. In addition, Sasol's vertically integrated business model provides some protection against the vagaries of the crude oil market. Following the collapse of oil prices from their peak levels of $145/bbl in July 2008, sentiment towards the company has turned very negative and this has been reflected the company's share price. However, the company's solid earnings base, together with a strong balance sheet and healthy cashflow characteristics creates a defensive profile that is vastly superior and different to other Resources counters. Sasol remains one of the key holdings in the fund.

Portfolio manager
Abdulazeez Davids

The FTSE/JSE All Share index (ALSI) returned 32.1% (price return of 28.0%) in 2009, mainly led by resources (35.5%) and industrials (30.5%), with financial stocks gaining 28.0% for the year. For the ALSI, it was an unusual year, with three months (March, May and July) accounting for almost all of the year's returns. January and February were the worst performing months and, excluding these two months, the ALSI returned an impressive 53.1% over the remainder of the year.

Following the massive correction in the second half of 2008, world stock markets rebounded strongly in 2009, with most markets posting gains in excess of 35.0%. These returns were amplified after taking into account the negative returns for the first two months of 2009.

In hindsight, the major rebound in world equity markets should have been anticipated, given the massive injection of liquidity experienced in most economies as central bankers aggressively reduced their benchmark lending rates. The synchronised recovery in world markets since March 2009 is symptomatic of portfolio flows, rather than company fundamentals, driving share prices.

Our domestic market re-rated in step with other developed and emerging markets, despite deteriorating economic and company fundamentals. In addition, the local currency emerged as the second best performing currency in 2009 - a fact that many resource company valuations choose to ignore. Consequently, our domestic market is currently significantly overvalued compared to its long-term history. Exogenous forces like foreigners' appetite for emerging and developing market equities and global economic variables will therefore continue to shape and influence our domestic market's returns in the short-term. However, because of the liquidity stimulus mentioned above, there is still significant scope for global markets to continue higher in the short-term before the necessary correction ensues.

The fund remains significantly underweight in resources counters as most valuations of these counters belie the underlying commodity fundamentals. In addition, the fund has increased its exposure to companies that have lagged in the recovery (like MTN) and companies that have strong earnings recovery and growth potential from current levels, yet trade at reasonable multiples relative to the rest of the market.

Tongaat is an example of a company that has the above mentioned characteristics and is therefore a substantial holding in the fund. Tongaat has invested substantial amounts of capital in its sugar operations in countries like Mozambique and Swaziland and these investments have been timed to coincide with a significant liberalization of the European Union sugar market to the benefit of countries like Swaziland and Mozambique.

In addition, Tongaat has substantial sugar and agricultural investments in Zimbabwe. These investments are not reflected in the company's market valuation but have significant earnings growth potential that will be unlocked as economic and political stability returns to Zimbabwe. Furthermore, Tongaat's extensive sugar, starch and property businesses in South Africa provide a strong value underpin to the current market valuation of the company.

Whilst we foresee increased volatility in domestic and world markets, we are confident that our proven investment process will continue to identify investment opportunities that will outperform the market over the medium- to long-term.

Portfolio manager
Abdulazeez Davids