The massive rally in equity markets over the second quarter of 2009 continued into the third quarter, with the FTSE/JSE Top 40 Swix index up 13% in Q3 2009, and up 41.4% from its March 2009 lows (In Dollar terms the index has doubled from its lows).

The speed and the severity of the equity market rally (the rolling monthly return on the FTSE/JSE All Share index (ALSI) in Dollar terms at the end of August 2009, is the second best rally since 1965, after the 1982 rally) reinforces an important feature of equity investing - participation in strong equity market rallies is as important as seeking to avoid the full brunt of market declines. Since the market peak of May 2008, the Protector Fund has succeeded in its objective of asymmetric equity market participation. By having a stronger equity participation in the rally (March 2009 to September 2009) as compared to the market crash (May 2008 to February 2009), the fund produced -3.1% (net of fees) over the entire period (May 2008 to September 2009), versus -18.2% for the FTSE/JSE Top 40 Swix index. This asymmetric profile has resulted in the fund producing solid real returns ahead of inflation over longer periods, which is its objective.

Implied option volatility as measured by the SAVI (South African Volatility index), ended the quarter at 23.2% versus the October 2008 high of 58%, and is now at pre-credit crisis levels and in line with the long-term average, indicating a sharp normalisation of the cost of equity protection and hence investor fear levels. Actual realised volatility of the fund since inception is at 10.7% versus 20% for the FTSE/ JSE Top 40 index. It is our view that the apparent "old trend level" of very strong economic activity in the years prior to the credit crisis will not be reached again soon, due to the structural declines in global leverage. There are a number of stocks that (in our view) have risen to levels that price in a quick return to "old trend level" growth, and we aim to avoid exposure to these stocks.

Inflation (CPI) for August decreased to 6.37% (year on year) in August 2008, from a level of 11.96% a year prior. Over the quarter, inflation risk increased marginally to the downside, as the rand continued to remain strong and listed retailers provided evidence of moderating food inflation and even price decreases on the staple front. In October, reports of materially higher than expected electricity tariffs over the next few years began to impact negatively on inflation expectations. Nevertheless we still expect inflation to re-enter the 3% to 6% in 2010, albeit more towards the top end of the band.

A re-rating of the domestic market accounted for all of the gains in the ALSI index, with the PE multiple increasing from 10.6 to 14.5, as companies continued to report earnings declines and share prices continued to rise. Post the market rally, our research indicates the market as a whole is moderately expensive. There are, however significant differences in the level of valuation across sectors and stocks, and so it is still our view that long-term inflation beating returns will be achieved through exposure to carefully selected equities. The fund's protected equity mechanisms will also substantially dampen the impact of a possible market correction.

Portfolio manager
Jihad Jhaveri

Equity volatility continued into the second quarter of 2009 albeit on the positive side, as world equity markets staged a massive rally with the S&P 500 index up 15.9% for the quarter, and stronger returns from other developed markets (the Nikkei 225 and FTSE 100 were up 25.7% and 26% in Dollar terms respectively). Emerging markets fared even better with the MSCI Emerging Markets index up 34.8% in Dollar terms.

Locally the FTSE/JSE Top 40 Swix index was up a massive 34% over the quarter in Dollar terms and up 8.6% in Rands. Importantly, the FTSE/JSE Top 40 Swix index is still considerably down in Rand terms over one year (down 22.6%). The Fund's downside protection mechanism assisted the Fund in minimising its exposure to this equity market crash over the last year.

The rally in the US market has been accompanied by a massive fall in the VIX index (a commonly watched US measure of implied volatility on options) which retreated from the October 2008 highs of 80% to pre-credit crisis levels of 25%. A similar dramatic reduction has occurred in the SAVI (South African Volatility index) which ended the quarter dramatically lower at 29% from a 58% peak in October 2008. The cost of equity protection has thus returned to normal levels signifying an increased level of market comfort with higher equity levels. The volatility of the Fund since inception has been 10.7% per annum as compared to 20.3% per annum for the FTSE/JSE Top 40 index.

Our Fund's equity relative performance over the quarter was very positive, with overweight positions in Naspers (up 26.9%), Aveng (up 34.4%) and MTN (up 13.3%) as well as underweight positions in the gold stocks (AngloGold down 18% and Goldfields down 10.5%) adding to performance.

Inflation is still expected to return to the 3% to 6% band by the third quarter in 2009, even after taking into account the 31.3% Eskom approved tariff hike, and the significant bounce up in oil prices (Brent near futures rose 75% from their February 2009 lows to $69.3). The reasons for this are the significant strengthening of the Rand as well as expectations of lower food inflation. Although proving stickier than expected, food inflation is still expected to retreat significantly by year end.

Since inception and over five years the Fund has outperformed CPIX + 5%, which is its objective. Going forward, the combination of a moderation in inflation, together with the Fund's exposure to attractively valued equities, should see the Fund continuing to maintain longer-term outperformance.

It is our view that consistent long-term outperformance of inflation will only result from equity exposure. The Protector Fund is well positioned to provide long-term investors with exposure to equity markets, with reduced volatility and downside risk.

Portfolio manager
Jihad Jhaveri

The first quarter of 2009 did not provide investors any respite from the volatility in equity markets experienced in 2008. The S&P 500 index was down 11% for the quarter, but with considerable volatility (the index was down 20% year to date on 10 March 2009). Considerable inter-month volatility was also experienced in South Africa, with the market dropping significantly in early March (FTSE/JSE Top 40 SWIX index down 15% year to date on 10 March 2009) and then recovering strongly (FTSE/JSE Top 40 SWIX index down 4.3% year to date on 31 March 2009).

The Fund's downside protection mechanism assisted the Fund in minimising downside participation over yet another volatile quarter.

The VIX index (a commonly watched US measure of implied volatility on options) remained high relative to pre-credit crisis levels, ending the first quarter of 2009 at 44%, compared to an average of 26% for the first quarter of 2008. The local version of the VIX, the SAVI (South African Volatility index) ended the quarter dramatically lower at 34% from a 58% peak in October 2008, and is not far off its pre-credit crisis levels. The cost of equity protection has thus returned to normal levels this quarter in South Africa, whilst it is still high in the US. The volatility of the Fund since inception has been 10.7% per annum as compared to 20% per annum for the FTSE/JSE Top 40 index.

The key to a successful dynamic asset allocation product is to produce returns over time that have higher equity participation in positive market months (bull months) and lower participation in market down months (bear months). Since inception the Fund has succeeded in delivering this asymmetry in returns.

Our Fund's relative performance over the quarter was positively impacted by our overweight positions in Impala (up 17.2%) and our underweight positions in Anglo American (down 24.3%). The Fund's overweight positions in FirstRand (down 25.1%) and underweight positions in Anglogold Ashanti (up 36.9%) detracted from performance over the quarter.

Inflation is expected to return to the 3% to 6% band by the third quarter in 2009. Risks to the upside are that the Rand retreats significantly back to its October lows and that administered prices (especially electricity) are higher than expected. Food inflation poses a welcome downside risk to the inflation outlook with economists generally predicting that food inflation will retreat from 15.8% in February 2009 to around 5% by year end.

Since inception and over five years the Fund has outperformed CPIX + 5%, which is its objective. Going forward, the combination of a moderation in inflation, together with the Fund's exposure to attractively valued equities, should see the Fund continuing to maintain longer-term outperformance.

It is our view that consistent long-term outperformance of inflation will only result from equity exposure. The Protector Fund is well positioned to provide long-term investors with exposure to equity markets, with reduced volatility and downside risk.

Global equity markets were very weak in the fourth quarter, with the S&P 500 experiencing its largest quarterly drop (down 22.4%) and the MSCI World falling 21.7% (USD). In South Africa, the market weakness and extreme selling pressure experienced in the third quarter accelerated into October (FTSE/JSE Top 40 SWIX index down 12.6% in October). The remainder of the year saw the market post relatively flat performance (FTSE/JSE Top 40 SWIX index down 9.9% for the quarter), albeit with heightened volatility. This increased volatility saw the market post four swings in performance that were greater than 10% in the last two months of the year.

The Fund's sector allocation within equities (underweight resources stocks and overweight banks) as well as its downside protection mechanism assisted the Fund in minimising downside participation over this volatile quarter. Nevertheless our holding of equity exposure in a strongly down equity market, resulted in a negative return for the quarter.

The cost of equity protection (which had already risen significantly over the third quarter) spiked up sharply in October, as market participants charged hefty risk premiums to buyers of downside protection. This is seen in the VIX index (a commonly watched US measure of implied volatility on options) which rose from an already high level of 39% at the start of the quarter to 59% by the end of October 2008. The local version of the VIX, the SAVI (South African Volatility index) rose from a starting level of 37% to a peak of 58% by the end of October. The volatility of the Fund since inception has been 10.1% per annum as compared to 19.5% per annum for the FTSE/JSE Top 40 index.

Our Fund's relative performance over the quarter was positively impacted by our overweight positions in Tiger Brands (up 4.4 %), Naspers (up 3.3%) and Netcare (up 1.8%), as well as our underweight positions in Anglos (down 24.1%) and Angloplats (down 30.4%). Stocks which detracted most from performance were the gold shares (Anglogold - up 31.2%, Harmony - up 18.1%), in which we were underweight.

The sharp decrease in the oil price in the fourth quarter of 2008 (down 61%) and the continuing moderation in food inflation on the back of retreating global agricultural commodities, has dramatically improved the inflation outlook. The SARB now expects inflation to re-enter the 3% to 6% band by the third quarter in 2009. The November 2008 core inflation (CPI) slid to 12.6% p.a. from what is now considered the peak, in October 2008, of 13.1% p.a.

In 2008, the Fund recorded performance of -4.09%, underperforming CPIX+5% but succeeding in dramatically reducing the downside exposure to equities (the FTSE/JSE Top 40 SWIX index lost 22% over 2008). Since inception and over five years the Fund has outperformed CPIX + 5%, which is its objective. Going forward, the combination of a moderation in inflation, together with the Fund's exposure to attractively valued equities, should see the Fund continuing to maintain longer-term outperformance.

It is our view that consistent long-term outperformance of inflation will only result from equity exposure. The Protector Fund is well positioned to provide long-term investors with exposure to equity markets, with reduced volatility and downside risk.


Jihad Javeri
Portfolio Manager