The third quarter of 2007 was very eventful in world financial markets, which exhibited very high levels of volatility.

A slowdown in the US housing market and troubles with sub-prime mortgages had negative repercussions in global credit markets as liquidity tightened considerably. Investors across most asset classes immediately demanded more compensation for taking risk as evidenced by the tightening of credit spreads and the rise in volatility (the US VIX volatility index rose during the quarter from the 20 level to 32 and has eased back since then). Importantly the US Federal Reserve Bank responded by cutting interest rates and there are expectations of further monetary easing. Amid the uncertainty, the dollar weakened by 5.1% against the euro, and gold surged by 14.5% over the quarter.

As a result, developed equity markets had a very poor third quarter. The FTSE 100 index declined 2.1%, the CAC 40 index was down 5.6%, and Japan's Nikkei 225 index was down a substantial 7.5%. An outlier was the US market which reacted well to the Fed's easing monetary policy and the weak dollar. The S&P 500 index was up 1.6% and the NASDAQ was up a respectable 3.8%.

Against this back drop, the MSCI Emerging Markets index posted exceptional gains of 13.7% for the quarter. This however masks significant intra-quarter volatility. This index was down 17% from mid-July to mid-August, at the height of the crisis, and then it posted an exceptional rally, aided by the buoyant Hong Kong and Chinese equity markets. The FTSE/JSE All Share index posted a respectable 5.7% for the quarter, after being down 13% from mid-July to mid-August.

In total return terms the FTSE/JSE Top 40 index was up by 7.68% for the quarter. Resources shares surged by 13.46% and Industrials were up 3.29%. Financials performed poorly (down 1.56%) - affected by a 50 b.p. hike in interest rates during the quarter and expectations of a further rate hike in October.

The top 3 performing stocks in the FTSE/JSE Top 40 index for the quarter were: Murray and Roberts (40.4%), Exxaro (30.8%) and BHP Billiton (24.9%). The bottom 3 performing stocks were: Investec PLC (-18.7%), as the market priced down global investment banks, SAPPI (- 18.8%) and Harmony Gold (-18.6%). Harmony was down up to 38% this quarter as the market reacted to internal accounting problems and the resignation of the CEO, and then it recovered somewhat with the gold price rally.

For the quarter, the Kagiso Top 40 Protector Fund returned 5.12% (net of fees), comfortably exceeding CPIX + 5%, being 1.85% over the quarter. (At the time of writing the CPIX figures for September 2007 have not been released and we have used a consensus estimate for this). The FTSE/JSE Top 40 index was up 7.68%. The volatility of the Fund over the last four years has been 9.35% as compared to 16.6% for the FTSE/JSE Top 40 index. Relative to peers, the Fund continues to do consistently well over most periods.

The Fund did particularly well in August, where the spike in market volatility was exploited profitably. The fund was up 1.14% in August relative to the FTSE/JSE Top 40 index that was up 0.87%. The fund continues to provide outstanding real returns at low relative volatility, thereby conforming to its mandate of providing protected equity exposure.

Jihad Jhaveri
Portfolio Manager

Developed international equity markets experienced robust increases in the second quarter of 2007, with the S&P 500 Index up 6.3%, the FTSE 100 up 8% and the Frankfurt DAX up a massive 17.5%.

Developed market buoyancy carried through to emerging markets with the MSCI Emerging Market Index up 15.1% for the quarter. Locally the FTSE/JSE Top 40 Index was up by a respectable 4.3% for the quarter. Resources and Industrials performed well at 6.8% and 4.3% respectively. Resources counters were supported by the apparent consolidation of commodity prices at higher than expected levels. Financials underperformed considerably on the back of interest rate hikes and a slowing consumer expenditure market.

The top 3 performing stocks in the FTSE/JSE Top 40 Index for the quarter were all Resource counters: Kumba Iron Ore (24.2%), Lonmin (20.6%) and BHP Billiton (20.2%). The bottom 3 performing stocks reflected the poor performance of Financials and the tough cost inflation environment for gold counters: Gold Fields (-18.7%), AngloGold Ashanti (-17.8%) and RMB Holdings (-8.7%).

For the quarter, the Kagiso Top 40 Protector Fund returned 2.61% (net of fees) whilst the FTSE/JSE Top 40 Index returned 4.27%. The volatility of the fund over the last four years has been 8.3% as compared to 14.4% for the FTSE/JSE Top 40 Index. Relative to peers, the Fund continues to do well over longer periods as per the June Micropal rankings. The Fund was ranked 10 out of 46 for the quarter to June 2007, 4 out of 32 over two-years, 5 out of 24 over three-years, and 3 out of 11 since inception (59 months).

The fund continues to conform to its mandate of providing protected equity exposure.

Gavin Wood
Portfolio Manager

International markets ended the quarter in positive territory (S&P 500 up 0.2%, the FTSE 100 up 1.4% and the Nikkei 225 up 0.4%). This, despite a sharp sell off in late February where the S&P 500 Index fell 5.8% and the Morgan Stanley Emerging Markets Free Index fell a massive 10.6%. Market commentary suggests that the sell-off was triggered by weak housing data in the US, and concerns of a speculative bubble on the Chinese stock exchange. What does seem clear is that after a strong price appreciation across developed and emerging markets investors are becoming more cautious. This can be seen in the movement of the Chicago Board Option Exchange Volatility Index (CBOE VIX) which dipped close to all time lows in January at just above 10 (indicating investor risk complacency), and then spiked to 19 on February 27 and ended the quarter at 15 (indicating a significant rise in risk aversion).

Local economic data surprised on the upside with Q4 2006 GDP accelerating to 5.6% annualised from 4.7% in the previous quarter. Against this backdrop, the South African FTSE/JSE All Share index returned a spectacular 10.4%, this after its 11.8% for the previous quarter. The South African market strongly outperformed the majority of its emerging market peers, with the MSCI Emerging Markets index returning only 1.8% over the quarter

The FTSE/JSE Industrial index and FTSE/JSE Financial index continued to gain this quarter: up 7.1% and 7.3% respectively. The FTSE/JSE Resources index delivered a massive 15.2% on the back of strong commodity prices (The Economist Commodity Index gained 6.7% over the quarter to end at all time highs). On a stock level, the top performing stocks in the Top 40 index were Kumba Iron Ore (up 33.9%), Anglo Platinum (up 33.7%) and BHP Billiton (up 26.0%). The major laggards were Harmony Gold (down 8.9%), Imperial (down 7.6%) and Liberty International (down 6.9%).

For the quarter, the Kagiso Top 40 Protector Fund returned 5.38% (net of fees) whilst the FTSE/JSE Top 40 Index returned 9.71%. The volatility of the fund was 10% annualised as compared to 17% for the FTSE/JSE Top 40 Index. Relative to peers, the Fund continues to do well over longer periods as per the March Micropal rankings. The Fund was ranked 5th out of 37, 5th out of 25 and seventh out of 21, over one-year, two-year and three-year periods respectively. The commonly watched CPIX +5% measure for the twelve months to February 2007 was 9.77% (CPIX for March 2007 was not released at the time of writing). Over this same period the fund returned 20% net of fees.

The fund continues to conform to its mandate of providing protected equity exposure.

Kagiso Asset Management Portfolio Manager

Developed markets surged in the fourth quarter with the S&P 500, FTSE 100 and Nikkei 225 returning 6.2%, 4.4% and 6.8% respectively. Emerging markets experienced an even stronger quarter with the MSCI Emerging Markets index up 17.3%.

Against this backdrop, the South African FTSE/JSE All Share index returned 11.8% for the quarter. This, despite a 1% hike in interest rates by the Reserve Bank that cited high credit growth and inflation risk as key concerns. On the positive side, the quarter saw surprisingly good corporate results from a number of stocks including SAB, Naspers and Sun International.

The FTSE/JSE Industrial index and FTSE/JSE Financial index soared this quarter returning 18.9% and 17.3% respectively, whilst the FTSE/JSE Resources index delivered a relatively subdued 4.5%. On a stock level the top performing stocks in the Top 40 were Naspers (up 38.8%), MTN (up 35.4%) and Edcon (up 30%). The major laggards were BHP Billiton (down 3.5%), Goldfields (down 3.4%) and Old Mutual (down 1.2%).

For the quarter, the Kagiso Protector Fund returned 6.43% (net of fees) whilst the FTSE/JSE Top 40 Index returned 10.7%. The volatility of the fund was 8% annualised as compared to 13.2% for the FTSE/JSE Top 40 Index. Importantly, the quarter saw volatilities decrease markedly, with the implied volatility of the SAFEX near futures contract decreasing to 17.75% from highs of 38% in the second quarter of 2006. In this environment of upward trending and relatively low volatility markets, the Protector Fund underperformed the stock market as a whole, but continues to deliver low volatility, consistent positive real returns. Relative to peers, the Fund continues to do well over longer periods as per the December Micropal rankings. The Fund was ranked 2nd out of 38, and 3rd out of 38 over two- and three-year periods respectively in the Domestic Asset Allocation Targeted Absolute Return Category.

Going forward, we continue to invest resources in continually monitoring and refining our proprietary absolute portfolio management process. The Fund remains well positioned to react sharply in the event of a market correction.

Kagiso Asset Management Portfolio Manager