In the third quarter of 2011 market volatility rose substantially as the US Fed's massive QE2 stimulus program ended. US and European politicians competed with each other for negative headlines - the US left it until the last minute to defer its debt problems (by raising its legislated debt ceiling) and Europe proved indecisive on dealing with the credit crisis in its South.

To add to the negative mood, Chinese economic data softened somewhat and worries about its property market increased. Consumer confidence in the US has weakened as the jobs and housing markets remain very weak. These developments are very much in line with our long held bearish view on the world economy post the financial crisis.

Equity markets had a negative quarter with August and September being particularly volatile. The S&P 500 Index was down 14.3%, its worst quarter since December 2008, and the Nikkei fell 11.4%. On average, emerging markets again underperformed developed markets. The FTSE/JSE All Share Index was down 5.8% during the quarter, with significant sectoral diversions: resources shares (-10.0%) underperformed industrial shares (-3.3%) and financial shares (-3.1%). The rand weakened against developed market currencies in line with the broad-based sell-off in emerging market currencies generally - down 16.5% against the US dollar and 9.5% weaker against the euro.

The South African Reserve Bank kept interest rates unchanged at multi-decade lows, and interest rate markets reversed expectations of an increase as economic activity slowed materially.

The bond market had another strong quarter, with the ALBI delivering 2.8% as inflation rate expectations moderated substantially as the local and global economy weakened. Looking ahead, we remain cautious over prospects for the developed economies, with high levels of government debt, high levels of unemployment, stimulus removal and austerity measures looming and demographic trends moving slowly against them.

Going forward, we remain very defensively positioned with high rand and dollar cash balances and negligible equity exposure.

This fund was launched on 1 May 2011 and, consequently, we will not be providing specific commentary as this is an incomplete quarter of performance. We look forward to delivering on client expectations of strong performance, in line with our low risk mandate, in the years to come.

The second quarter of 2011 exhibited further volatility as global economic data releases showed a slowing in the world economy, particularly in the overly-indebted USA and Europe, but also in China - as monetary policy was further tightened. Western governments continue to grapple with their financial positions, with the European periphery and the US making the headlines in this regard. Consumer confidence in the US has weakened as the jobs and housing markets remain very weak. Inflation concerns are heightened by the rise in commodity prices, especially oil and food. Consequently, monetary policy has been tightening further in a number of economies, notably China and the Eurozone. These developments are very much in line with our long held bearish view on the world economy post the financial crisis.

The rand was firm against developed market currencies - flat against the US dollar and 2.3% stronger against the euro. The euro seemed to retrace recent strength due to ongoing fiscal solvency and liquidity concerns in its highly indebted periphery. This weakness was despite continuing tightening in Eurozone monetary policy. The South African Reserve Bank kept interest rates unchanged at multi-decade lows, but rising cost-push inflation pressures indicate that the next interest rate move is up - the timing of which will depend on local economic conditions.

The FTSE/JSE All Share Index was down 0.6% during the quarter, with significant sectoral diversions: resources shares (-5.7%) significantly underperformed industrial shares (+3.7%). Within the quarter, equity markets experienced significant volatility, with the last week's significant bounce rescuing what could have been a very negative quarter.

The bond market was particularly strong, with the ALBI delivering 3.9% as foreign buying of South African bonds returned in size.

Looking ahead, we remain cautious over prospects for the developed economies, with high levels of government debt, high levels of unemployment, stimulus removal and austerity measures looming and demographic trends moving slowly against them. On the positive side, we believe that there are strong prospects for companies focused on emerging market consumers, although much of this optimism seems to be priced into South African consumer stocks.

Going forward, we are defensively positioned with below average weight in equities and bonds and a high cash position. Within equities, we have a strong focus on quality, lower risk companies, which are attractively priced. Within cash, we have a high weighting to US dollar cash deposits.

Portfolio manager
Gavin Wood