The third quarter of 2008 was characterised by turbulent market conditions and saw significant equity market sell-offs in July and September. The Fund's sector allocation within equities (underweight resources stocks and overweight banks) as well as its downside protection mechanism assisted the Fund over the quarter. Nevertheless, holding equity exposure, in a strongly down equity market, resulted in the Fund recording a negative return for the quarter.

World equity markets posted sharply negative dollar returns in the third quarter, with the FTSE 100 down 21.2%, the Nikkei down 16.6% and the S&P 500 down 8.4%. This was on the back of the US-housing led credit crisis deteriorating sharply into a full blown liquidity crisis, resulting in the failure of a number of large financial institutions (Fannie Mae, Freddie Mac, Lehman Brothers, AIG, and Fortis). Locally, the FTSE JSE Top 40 SWIX index was similarly down (17.3% in rand terms) along with other emerging markets.

Over the last 12 months, equity markets have been sold off significantly in dollar terms with the FTSE down 31%, the Hang Sang down 31.5% and the S&P 500 down 22%. Our local market has also performed poorly over 12 months, with the FTSE JSE Top 40 SWIX index down 28.3% in dollar terms and 13.9% in rand terms. Over this same period the Fund was down far less and recorded a return of -1.51%.

The cost of equity protection spiked up sharply over the quarter as the markets priced in extreme levels of future downside risk. This is seen in the VIX index (a US measure of implied volatility on options) which rose from an already high level of 25% at the start of the quarter to 47% by the 29th of September 2008. The local version of the VIX, the SAVI (South African Volatility index) rose from a starting level of 27% to 37% by quarter end, an all time high. The volatility of the Fund since inception has been 10% as compared to 19% for the FTSE JSE Top 40 SWIX index.

We aware that many investors are concerned about the current high and persistent rates of inflation. Latest reported CPIX figures (August 2008) surged to 13.6%, driven by rampant price increases in the heavily weighted food component (25.7% weight in CPIX basket and up 19.2% year on year in August 2008) and transport component (15.3% weight in basket and up 21% year on year in August 2008). It is our view that inflation is very close to peak levels, and that significant moderation in energy and food price increases will result in CPIX returning to the 3-6% band by 2010. Contrary to popular opinion, we are of the view that the January 2009 basket re-weighting will in the medium-term result in CPIX taking longer to reach the target band (the categories with the highest potential for moderation benefits, namely food and energy, will be the most downweighted). Since inception the Fund has outperformed CPIX + 5%, but has underperformed over shorter periods. Going forward, the combination of a moderation in CPIX and the Fund's exposure to attractively valued equities, should see the Fund maintaining its longer-term outperformance.

The Fund's underlying equity exposure benefited (relative to the market) from an underweight position in the Resources sector, particularly in: Anglo American (down 48.7%), Anglo Platinum (down 40.9%) and Exxaro (down 39.8%). Our overweight position in banks also assisted Fund performance (Standard Bank up 25.2% and FirstRand up 25.7%). The Fund remains well positioned in our best stock selections, based on our team's proven bottom-up stock picking process, which should result in the underlying equity exposure continuing to outperform the market.

We believe that the market as a whole is now reasonably valued but that continued volatility is likely and further sharp downward moves are possible. The Protector Fund is well positioned to provide investors with exposure to the equity market, with reduced volatility and downside risk. It is our view that consistent long-term outperformance of inflation will only result from equity exposure.

Jihad Javeri
Portfolio Manager

World equity markets entered the second quarter on a positive note based upon the view that the worst of the credit crisis was over. This positive sentiment, however, dissipated later in the quarter, as equity markets succumbed to significant pressure from persistently high energy prices (the oil price gained 39.4% in the quarter) and the resultant increase in inflationary concerns, as reflected in the 0.56% yield increase of the US 10 year bond to 3.96%.

Over the quarter, high volatility characterised world equity markets, as captured by the swing in S&P500 returns, gaining 7.86% by 19th May, and thereafter moving down 3.2% for the quarter. The increased volatility levels could be further gauged from the VIX index (a commonly watched US measure of implied volatility on options), which dropped to 16.4% in mid- May and then ended the quarter back above 25%, indicating that world equity markets are again pricing in heightened levels of future risk.

While the local market performed reasonably well against this volatile backdrop, it did not escape unscathed, and came under extreme pressure over the quarter. Evidence of this could be seen from the SWIX Top 40 Index which moved up 13.6% by 22nd May, and then lost most of its gains, concomitant with the inflation induced world equity market sell off. The local version of the VIX, the SAVI (South African Volatility Index) dropped to 20.7% in mid-May from 30.4% at the start of the quarter, and then climbed back up to the 30% level at quarter end, confirming that the local market, similarly to the US market, is pricing in high levels of future risk. The volatility of the Fund since inception has been 9.8%, significantly lower than the 17.5% for the FTSE/JSE Top 40 index. The impact of the high volatility levels on the Fund is significantly reduced by the Fund's asset allocation process, which has been tried, tested, and improved for more than five years.

Locally, the Industrial index fell by 1.1% and the Financial index fell by a massive 14% with South African banks continuing to be weighed down by negative global sentiment towards geared financials. The Resources index again outperformed on the back of high commodity prices and renewed rumours of corporate action amongst the majors, and posted a quarterly gain of 13.4%. The Fund's underlying equity exposure is tilted towards stocks with higher expected returns as indicated by our equity selection process. Over the quarter the Fund's underweight position in resources detracted from performance, whilst stock picking within Industrials (overweight Naspers, overweight Telkom, and underweight PPC) partially counterbalanced this.

The Kagiso Protector Fund continues to achieve top quartile performance relative to its peer group, and ranks 3rd out of 53 funds over the 1 year to 30 June 2008.

Going forward it is still our view that significant and consistent long-term outperformance of inflation will only result from equity exposure. In addition, history has shown that future equity returns are on average stronger when equities are purchased at attractive valuations. We believe that this now applies to a number of financial and industrial stocks, and have positioned the Fund accordingly.


Jihad Javeri
Portfolio Manager

Worsening credit markets and the increasing probability of a US recession saw significant market corrections across world stock markets. In dollar terms the S&P500 fell 9.4%, the FTSE 100 fell 10.6%, and the Nikkei 225 lost 8.2%. Emerging markets on average fell by a similar amount with the MSCI Emerging Markets down 10.9%. Within the emerging markets basket, MSCI China (down 23.7%), MSCI India (down 27%), and MSCI Turkey (down 38.3%) were the worst performing markets.

The US Federal Reserve acted vigorously to contain the unfolding credit crisis by drastically increasing liquidity to the market (both through significant reductions in the Fed rate and direct rescue packages in the investment banking sector). This stimulus was viewed as inflationary and consequently the US dollar weakened by 8% to the Euro and ended the quarter at 1.576 to the US Dollar. In the environment of inflation fears and financial market instability, gold rallied by 9.9% reaching an inter quarter high of $1011.

Against this backdrop the local markets performed reasonably well with the FTSE/JSE Top 40 Index up 5.1%. In dollar terms however the market was down 11.45% with the Rand depreciating by 18.7% against the dollar and 28.3% against the Euro. The Rand as well as the markets reacted to the worsening electricity shortage, rising inflation and the generally deteriorating health of the South African consumer.

Locally the Industrial Index fell by 5.5% and the Financial Index fell by 13.4% with South African banks weighed down by negative global sentiment towards banks. The Resources Index massively outperformed on the back of the weakening currency and stubbornly high commodity prices, and posted a quarterly gain of 16.5%.

It is our view at this time that Financials and Industrials have significantly less downside risk as compared to the Resource counters, and this view will be reflected in the underlying equity composition of the fund going forward.

For the quarter, the Kagiso Protector Fund returned a very satisfactory 4.39% net of fees versus CPIX + 5%, which was up approximately 3.94% (at the time of writing the CPIX figures for March 2008 have not been released and we use a consensus estimate for the March figure). The FTSE JSE Top 40 Index was up 5.1% over the quarter. The volatility of the Fund over the last five years has been 9.65% as compared to 17.12% for the FTSE/JSE Top 40 index.

Jihad Javeri
Portfolio Manager

World markets ended the quarter in negative territory with the MSCI World Index losing 2.3% in US dollar terms. The subprime fallout in early August and the resultant credit squeeze continued to be a key driver of the markets over the quarter.

The US Federal Reserve, the European Central Bank and the Bank of England moved swiftly to act against the credit squeeze by lowering policy rates and extending additional windows of credit to banking institutions. Despite these efforts, markets moved lower over the quarter as investors contemplated the impact of a slowing US economy on global growth. Across developed markets headline indices closed weaker with the S&P 500, the Nikkei 225 and the FTSE 100 closing down 3.8%, 8.8% and 0.2% respectively. The near term outlook remains uncertain and investor confidence will likely remain fragile as the sub-prime saga unfolds.

With developed markets reeling from the turmoil in credit markets, emerging markets posted a respectable return with the MSCI emerging market index closing up 3.4%. Markets such as India (up 23%) and Russia (up 17%) were the top performers over the quarter while the Chinese market (down 3.6%) moved lower on renewed concerns that key export sectors would be negatively impacted by a slowing US economy.

The local market followed developed markets into negative territory with the FTSE/JSE All-share index closing the quarter down 3.0%. The Resources index was the worst performing sector driven by a dismal performance from the local mining counters. Weaker prices for industrial metals and concerns around escalating costs, for both the gold and platinum producers, saw the FTSE/JSE Resources index close the quarter down 7.5%.

The FTSE/JSE Financials index closed the quarter down 0.7% driven by continued negative sentiment from the sub-prime crisis and higher interest rate expectations - as the local inflation outlook continued to deteriorate. Within financials, Banking stocks were the worst performers, with the FTSE/JSE Banking Index closing the quarter down 3.1%. The Insurers generally had a strong quarter with the FTSE/JSE Life and FTSE/JSE Non-Life Insurance Index returning 3.3% and 8.9% respectively.

The FTSE/JSE Industrial index continued to build on last quarter's positive momentum (+3.3%) and ended the quarter up 1.7%. Within industrials, the FTSE/JSE Mobile Telecommunications index was the star performer returning 22.3% over the period. The FTSE/JSE Leisure and Fixed Line sectors were the worst performers over the quarter losing 20.7% and 20.5% respectively.

For the quarter, the Kagiso Protector Fund returned -0.18% (net of fees) versus the FTSE/JSE Top 40 Total Return index return of -3.42%. CPIX + 5%, was up approximately 1.61% over the quarter (at the time of writing the CPIX figures for December 2007 have not been released and we use a consensus estimate for the December figure). The volatility of the Fund over the last five years has been 9.44% as compared to 16.6% for the FTSE/JSE Top 40 index. Relative to peers, the Fund continues to do well.

Jihad Jhaveri
Portfolio Manager