The S&P 500 index reversed its second quarter loss with a gain of 10.7% over the quarter largely on the expectation of sustained monetary support i.e. quantitative easing. In general, emerging markets fared better than developed markets in local currency terms, and even better in dollar terms, with strong emerging market capital inflows causing significant emerging market currency strength. The MSCI Emerging Market index ended the quarter up 18.2% in dollar terms, with the South African market outperforming the average.

The local FTSE/JSE Top 40 SWIX index ended the quarter up 14.86% in local currency terms, and given the significant rand appreciation was up 25.4% in dollar terms. Year to date the Kagiso Protector Fund has managed to capture a satisfactory 6.02% versus 9.53% for the FTSE/JSE Top 40 SWIX index. This was achieved with lower volatility by participating more in the up months and less in the down periods.

Implied option volatility (an indicator of the cost of protecting a portfolio at current market levels), as measured by the South African Volatility index (SAVI) dropped materially to below 23.5% at the end of September from around 30% at the start of the quarter. Since inception the fund volatility has been 10.6% versus 19.7% for the FTSE/JSE Top 40 index. Globally, inflation is expected to remain subdued in the medium-term, primarily as a result of excess capacity. In South Africa the upward pressure of administered price increases (electricity and municipal rates) should be countered by the strong rand. We expect CPI to remain below 6% over the next two years.

The current rating of the FTSE/JSE All Share index (price-earnings ratio of 16.7X and still above its long-term average of 11.8X) suggests that the market as a whole is still expensive, even after accounting for strong future earnings growth, reinforcing the need for judicious stock selection. We are wary of certain valuations in the local market, particularly in the sectors that have attracted the bulk of the foreign capital inflow. The fund continues to be positioned so as to produce long-term returns in excess of inflation, whilst protecting against any potential downside and high volatility in the equity markets.


Portfolio manager
Jihad Jhaveri

The JSE code for the fund changed from KTFP to KAPF on 01/10/2010

The Dow Jones Euro Stoxx 50 index fell by 18.7% (in dollar terms) over the quarter as markets began to digest the impact of European sovereign debt concerns. It has been our long-standing view that the "old trend level" trajectory of very strong global economic activity in the years prior to the credit crisis will not be reached post the recovery, due to the necessary structural declines in global leverage. The European debt crisis this quarter has brought this realisation home, with many developed world governments (notably the new UK Conservative government) spelling out the blue print to restore longterm sovereign financial health: budget cuts, wage squeezes, reduced citizen benefits and increased taxation.

The MSCI World index was down 12.5% (in dollar terms), with the local FTSE/JSE Top 40 SWIX index down 8.6% over the quarter and down 3.8% year to date (in rands). The Kagiso Protector Fund is down 1.3% year to date.

We believe that the increases in global industrial production and consumer expenditure seen over the last quarters are off a very low base, and are in the presence of temporary unprecedented and globally co-ordinated fiscal and monetary stimulus. Early signs of the inevitable slowdowns, as governments start weaning consumers off stimulus, have already been felt in US housing starts and global vehicle sales. Implied option volatility (an indicator of the cost of portfolio insurance), as measured by the South African Volatility index (SAVI) dropped to below 19% in April, the lowest level since 2007 and well below the credit crisis peak of 58% in October 2008. Investor fear levels which were well below average in April increased substantially as the SAVI ended the quarter close to 30%. Since inception the fund volatility has been 10.3% versus 19.7% for the FTSE/JSE Top 40 index.

Globally, inflation is expected to remain subdued in the mediumterm, primarily as a result of excess capacity. In South Africa the upward pressure of administered price increases (electricity and municipal rates) should be countered by low food inflation and still low import inflation. We expect CPI to remain below 6% over the next two years.

The current rating of the FTSE/JSE All Share index (price-earnings ratio of 16X and still above its long-term average of 11.8X) suggests that the market as a whole is still expensive, even after accounting for strong future earnings growth, reinforcing the need for judicious stock selection. The fund continues to be positioned so as to produce long-term returns in excess of inflation, whilst protecting against any potential downside and high volatility in the equity markets.

Portfolio manager
Jihad Jhaveri

The FTSE/JSE Top 40 SWIX index was up 4.4% over the quarter and is now 62% higher than its March 2009 lows (in dollar terms the index is up 136% from its March 2009 lows). Developed markets showed a mixed performance in dollar terms over the quarter with the US and Japanese markets positive (S&P 500 up 5.4%, Nikkei 225 up 4.8% ), whilst European and Asian markets were generally weaker (FTSE 100 down 0.4%, CAC 40 down 4.8%, DAX down 2.6% and Hang Sang down 2.8%). Emerging markets were strong in dollar terms (MSCI Emerging Markets index up 2.5%) with the exception of China (MSCI China down 1.6%).

We believe that the increases in global industrial production and consumer expenditure seen over the last quarters are off a very low base and have occurred in the presence of temporary unprecedented and globally co-ordinated fiscal and monetary stimulus. It is our view that the apparent "old trend level" trajectory of very strong global economic activity in the years prior to the credit crisis will not be reached post the recovery, due to the necessary 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 (especially amongst the large cyclical resources and cyclical industrials) and we aim to avoid exposure to these stocks.

Since the market peak of May 2008, the Protector Fund has succeeded in its objective of asymmetric equity market participation. By having a strong equity participation in the rally (March 2009 to March 2010) as compared to the market crash (June 2008 to February 2009), the fund produced 2.7% (net of fees) over the entire period (June 2008 to March 2010), versus -6.3% 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 (an indicator of the cost of portfolio insurance), as measured by the South African Volatility Index (SAVI), is currently at 19%, the lowest level since 2007 and well below the credit crisis peak of 58% in October 2008. Investor fear levels are now well below average and the cost of purchasing protection is (in our view) cheap relative to history. The fund volatility since inception is 10.5% versus 19.7% for the FTSE/JSE Top 40 index.

Globally, inflation is expected to remain subdued in the mediumterm, primarily as a result of excess capacity. In South Africa, the upward pressure of administered price increases (electricity and municipal rates) should be countered by low food inflation and low import inflation (the Rand has strengthened by 24% over the year to March 2010). We expect CPI to remain below 6% over the next two years.

The current rating of the FTSE JSE All Share index (price-earnings ratio of 18X and significantly above its long-term average of 11.8X) suggests that the market as a whole is expensive, even after accounting for strong future earnings growth, reinforcing the need for judicious stock selection. The fund continues to be positioned so as to produce long-term returns in excess of inflation, whilst protecting against any potential downside and high volatility in the equity markets.

Portfolio manager
Jihad Jhaveri

The FTSE/JSE Top 40 SWIX index was up 9.9% over the quarter, building on its massive recovery rally, and at 31 December 2009 was up 55.3% from its March 2009 lows (In dollar terms the index has more than doubled from its low). These strong gains occurred despite a very weak domestic economic environment - a struggling consumer, manufacturers facing weak demand and resources companies likely to deliver very low levels of earnings in the medium-term. The South African economy did, however, technically emerge from recession in the 3rd quarter.

The S&P 500 index was up 6.0% over the quarter, the FTSE 100 Index was up 7.2% and emerging market indices were even stronger in dollar terms (MSCI EMF up 8.3%).

We are acutely aware that the increases in global industrial production and consumer expenditure seen over the last quarter are off a very low base, and are in the context of temporary unprecedented and globally co-ordinated fiscal and monetary stimulus. It is still our view that the apparent "old trend level" trajectory of very strong global economic activity in the years prior to the credit crisis will not be reached post the recovery, due to the necessary 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, especially amongst the large cyclical resources, and we aim to avoid exposure to these stocks.

Since the market peak of May 2008, the Kagiso Protector Fund has succeeded in its objective of asymmetric equity market participation. By having a stronger equity participation in the rally (March 2009 to December 2009) as compared to the market crash (May 2008 to February 2009), the fund produced 0.2% (net of fees) over the entire period (May 2008 to December 2009), versus -10.1% 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 (an indicator of the cost of portfolio protection), as measured by the South African Volatility index, is currently at 21.0% versus the credit crisis peak of 58.0% in October 2008. Investors fear levels are now at levels considered low, even by pre-credit crisis standards. It is interesting to observe how often in the recent past a peak in implied volatility (investor fear) corresponded to a trough in the market level and how often a low point in implied volatility corresponded to a peak in market level. Our fund volatility since inception is 10.4% versus 19.8% for the FTSE/JSE Top 40 index.

Proposed Eskom tariff increases (and their direct and secondary impact on consumers) impacted inflation risks over the quarter. It is our view that a 35.0% p.a. increase would result in CPIX slipping out of the 3.0% to 6.0% band for a period.

Over the quarter stock picking detracted slightly from performance. Our overweights in Naspers and the hospital groups added to performance, while our underweight position in resources and overweight position in MTN detracted. After the recent massive price moves, our research indicates that the market as a whole is expensive. There are, however, significant differences in the level of valuation across 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 market correction and will benefit the fund from possible market volatility.

Portfolio manager
Jihad Jhaveri