World markets ended the quarter in positive territory with the MSCI World index returning 4.7%. Both US and European markets continued to build on last quarter's positive performances with the S&P 500 and FTSE 100 indices closing the quarter up 5.7% and 3.1% respectively.
Commodity prices in general had a difficult quarter with the price of crude oil, in particular, coming under significant pressure. Easing concerns over geo-political tensions in the Middle East and possible supply disruptions saw the oil price retreat sharply from its previous quarters closing level. The spot price of oil closed the quarter down 16.6% while the prices of Gold and Platinum were also weaker over the period.
Local markets had a strong quarter with the FTSE/JSE All share index returning 6.3% over the period. The key contributors to performance were the financial and industrial counters which rebounded strongly after a poor performance in the second quarter of the year. The FTSE/JSE Financial and FTSE/JSE Industrial indices ended the quarter up 9.9% and 11.7% respectively.
The FTSE/JSE Resources index ended the quarter up 0.7% despite weaker commodity prices. A continued depreciation in the local currency provided support to the local resources index and largely offset the negative impact of softer commodity prices. The rand ended the quarter at 7.74 to the US dollar, 8.2% weaker than its previous quarters closing level.
For the quarter, the Kagiso Protector Fund produced a total return (net of fees) of 2.38% with volatility of 11% against the FTSE/JSE Top 40 index which produced 5.8% with 21% volatility.
We expect that the global market volatilities will remain elevated due to continued uncertainty on global economic prospects and global interest rates. The rand volatility will also induce some added pressure on the local equity markets.

Kagiso Asset Management
Portfolio Manager

The key feature over the quarter was the significant downwards repricing of risky assets and especially emerging market assets. The US Fed continued raising interest rates as it worries about inflation risks. Many emerging market central banks followed suit this quarter. This global tightening action and accompanying investor uncertainty saw world markets come under significant pressure towards the end of the quarter. In local currency terms, the MSCI World index and the MSCI Emerging Market index ended the quarter down 1.1% and 5.1% respectively.
Despite the sell-off across emerging markets the local bourse ended the quarter in positive territory with the FTSE/JSE All Share index up 4.9%. This strong performance however masks the difficult quarter that prevailed and the volatility that was experienced intra- quarter.
On a sector basis, the FTSE/JSE Resources index had a strong quarter despite only marginally firmer commodity prices. The sector ended up 21.3% - mainly as a result of a sharp depreciation in the rand. The rand ended the quarter at R7.15 to the US Dollar, 16.7% weaker than its March 2006 closing level.
While resources stocks rose strongly over the quarter, the local financial and industrial stocks came under significant pressure as global and local interest rates rose. Increasing inflation fears on the back of the weaker currency and stubbornly high oil prices, continued high credit extension growth and the very high current account balance saw sentiment shift towards further local tightening. As a result, the interest rate-sensitive financial and industrial sectors ended the quarter in negative territory. The FTSE/JSE Financial index and FTSE/JSE Industrial index ended the quarter down 6.0% and 5.3% respectively.
For the quarter, the Kagiso Protector Fund returned 4.84% with 18% volatility while its benchmark posted a return of 7.2% with 35% volatility. Over the quarter the equity exposure ranged from 66% to 26% as the fund moved out of equity markets as volatility increased.
Going forward the market remains jittery albeit muted from levels experienced in the last quarter. Oil remains high, rand remains under pressure at the back of a weak current account deficit, food inflation remains strong and the question is how far will the reserve bank go to curb the inflation? The market has priced in a further 1.5% repo rate increase over the next 12 months. With these key variables still outstanding we still foresee high market volatility. We re-emphasise the relevance of the Protector Fund for investors in these positive but volatile times. The fund aims to deliver returns equivalent to 2/3rd of the market upside and 1/3rd of its downside, over any 24- month period, with significantly reduced volatility. Emphasis is placed on the management of downside risk as opposed to achieving maximum upside potential. To achieve this objective, the fund manager utilises proprietary quantitative and risk techniques to dynamically allocate capital between equity and cash. The fund's underlying equity is invested in the constituents of the FTSE/JSE Africa Top 40 Index, which is its benchmark.

Kagiso Asset Management
Portfolio Manager

Global markets were very strong during the first quarter of 2006 with the MSCI World Index up 5.6% over the quarter. In the US, the S&P 500 and the Dow Jones returned 4.2% and 3.7% respectively. European and Asian markets were also up strongly over the quarter. The US Federal Reserve Bank and the European Central Bank hiked their lending rates by 50 points and 25 points respectively. The US Fed minutes indicated that the neutral rate would be somewhere around 5.25%.

Commodity prices were the major drivers of markets during the quarter with gold, platinum and most base metals e.g. copper and zinc, reaching record highs. This increased the foreign interest in our market, specifically foreign participation on resources stocks. On the back of this the rand gathered some strength against the US dollar. The rand/US dollar exchange rate ended the quarter at 6.10, 3% stronger than the closing level last year.

The reliance by the local bourse on resources stocks for direction meant an increase in the market's volatility over the quarter. The key drivers of the volatility surge were the rand/US dollar exchange rate, commodity spot prices and funds flows (in or out) the physical commodity markets. As the commodities were posting record highs the spot saw a lot of profit taking by investors which exacerbated the market volatility. The market volatility increased by 55% over the quarter from 18% p.a to 28% p.a.

For the quarter, the Kagiso Protector Fund returned 6.24% with volatility of 13.41% p.a versus its benchmark, the FTSE/JSE Africa Top 40 Index which was up 12.16% with volatility 23.64% p.a. The increased volatility over the quarter meant that the fund became "cautious" and maintained an average 50% equity exposure. This was deemed optimal to partake in upswings and limit exposure to the downside due to the excessive volatility.
Within the FTSE/JSE Top 40 Index, the FTSE/JSE Construction (up 35%) and the FTSE/JSE Platinum (up 31%) sectors were the top performers for the quarter. The construction sector was driven by the stellar performance from PPC which closed the quarter up 47%. The stock rallied on the back of favourable fundamentals, stronger than expected cements sales and the expectation that the company would be a key beneficiary of the government's multi-billion rand infrastructure development. The platinum sector was buoyed by good performance by both Impala Platinum and Anglo Platinum which ended the quarter 29% and 24% respectively. A strong platinum price at the back of increasing demand by car manufacturers (European diesel car manufacturers) remains a key driver behind these counters.

Going forward, fears of high oil prices as a result of the standoff between Iran and the Western countries over its nuclear programme will continue to keep markets jittery. This will help to maintain and even propel the commodity prices to fresh highs. Locally, high oil prices are likely to translate to increased petrol prices with the possibility of second round inflation in the medium term. The impact will be to the extent that the rand/US dollar exchange rate does not offset the spike in oil prices. Financial stocks are likely to respond negatively to this move and fears of an early interest rate hike emerge. Current consensus is that the next interest rate move is a hike and that the date is some time in 2007. Food and oil price are viewed as the key risk variables that the market and the Reserve Bank are watching.
Kagiso Asset Management
Portfolio Manager