The main feature of September was yet again another bout of rand weakness, with the rand declining by 7.1% against the US dollar. However, unlike August this did not translate outperformance by the resource shares. Top performers were mainly non commodity rand hedge shares such as Liberty International, Old Mutual, Richemont and Remgro. Whilst we have good exposure to these counters we were hurt by holding Barloworld and Biliton. In the case of Barloworld we are less concerned as the share was simply, in our view, resting after a very strong August.

Outlook
Looking forward, we expect continued rate hikes locally. The bond market which has displayed remarkable resilience in the face of some bad inflation figures and a weak rand could well sell off, placing pressure on banking and retail shares. We need to see improvement in the current account deficit, and until such time as this happens it will be hard to determine where the top of the rate cycle is.

On a more bullish note, the outlook for the US market continues to improve, in our view. Short term interest rates have peaked, and lower oil prices and a decline in long bond yields will provide some relief to the consumer who is struggling from a very weak housing market.
We are less confident on the short term outlook for commodity prices and may well continue switching into non resource rand hedges.

Strategy
Until such time as the top of the local interest rate cycle is in view we will remain weary of the locally focussed companies. It is very hard to call when enough is enough on the rand. However, the Aussie dollar has only recently started to weaken, the copper price is still range trading, local bonds remain reasonably unconcerned about the inflation outlook and the local portfolio managers are underweight rand hedges. The rand is also not very cheap, and we think the bias is still to the downside and hence will remain overweight rand hedge shares.

This fund has been in the top quartile for each of the past five years. The year so far has not been sparkling by its high standards - it is exactly in the middle of the sector for the year to date. On a rolling basis, however, it is still ahead of last year, when it did not go above the mean until October.

Fund manager Gail Daniel's approach is an interesting blend of macro top-down research and tactical trading. For example, she says the fundamental case for Sappi is not strong but that the company is very liquid and easy to job, selling at R100 and buying back at R90. She also did some tactical buying of JD Group (since sold) when its price fell to compelling levels, even though economic fundamentals do not favour the credit retailers at the moment.

Over the past 12 months, the portfolio has been reorientated from a "local is lekker" theme to a portfolio heavy with rand hedges. She is expecting the local consumer to start to downscale as higher interest rates and inflation bite.

From an 18% exposure to retailers, dominated by credit chains, this has fallen to 8%, with cash retailers Spar, New Clicks and Mr Price the main holdings. The exposure to banks has been steadily reduced to 12%.

In principle she wants to increase exposure to construction shares, which should benefit from increased government spending, but says the shares remain expensive.

The main buying has been into non commodity rand hedges. SABMiller, which had not been held in the fund for several years, now makes up 5% of the portfolio, and she favours shares with a high pound sterling exposure such as Remgro (through BAT), Liberty International and Bidvest. Old Mutual has been bought as an endorsement of CE Jim Sutcliffe's international strategy and because Old Mutual has the opportunity to take market share from a "floundering" competitor locally (Liberty, perhaps?).

The fund still has a higher weighting in resource shares than its peer group. Daniel says the supply of many metals remains tight and even though it is late in the commodity cycle, there are no signs of a downturn yet.

Financial Mail - 08September2006

After a relatively quite first few months of 2006, the second quarter announced the arrival of a bear market in bonds. Yields sold off dramatically over the quarter and we saw the All Bond index return a negative return in both May and June resulting in the worst quarterly return since March 2002. This negative move was caused by a large sell-off in the Rand and a deteriorating investment climate amongst emerging markets. The bond market was surprised in June when the Reserve Bank hiked interest rates by 50 basis points as the governor warned the exuberant consumers to slow down their spending. The strong Rand over the last few years has led to an import boom in SA which has allowed our current account deficit to balloon above 6%. Historically, a current account deficit in excess of 5% has always led to a bout of Rand weakness.

The global environment added to the uncertainty as the new US Federal Reserve chairman made his mark on monetary policy. His statements were viewed as very hawkish and thus global markets started pricing in further rate hikes in the US. This led to a change in sentiment in emerging markets as investors started to re-price risky assets. Countries with current account deficits (like New Zealand, Turkey and SA) were hardest hit. The inflation story continued to be positive with the April CPIX inflation release coming in at 3.7%.This was not enough to appease the South African Reserve Bank (SARB) as they decided to focus on the robust consumer spending currently driving the economy. The growth in the amount of credit in the economy is clearly keeping the Governor awake at night.

These factors as well as the large current account deficit were clearly the reasons behind the rate hike decision. Inflation and robust growth internationally has caused a united effort from central bankers to talk tough on monetary policy. This has seen quite a few surprise rate hikes and in Turkey they have raised rates by 400 bpts in under a month. This shift in focus has led to and increase in yields across the board as well as an increase in spreads in riskier assets. This risk aversion trade has also led to an increase in credit spreads in SA. The credit market had traded down to yields that were too expensive as the market continued to price only the good news. With the rate hike as well as the change in sentiment we have seeing a normalisation of these spreads. At these higher spreads we are starting to see some value returning to the SA credit market.

Your portfolio was underweight duration for the quarter and has thus outperformed the index over the period. After the initial sell-off in rates we continued to sell bonds in the portfolio as the outlook for interest rates deteriorated. The market was quite volatile over the quarter which further allowed us some trading opportunities.

The outlook for bonds continues to be uncertain, but with yields trading around 8.5% the market is starting to return to fair value. If the SARB hikes by the expected 100bpts over the remainder of this year we will see value in the 10 year bonds from 8.75% upwards. The SARB is going to continue to monitor the current account and credit growth closely and will adjust rates accordingly. We will thus closely monitor these trends to determine the correct positioning of your portfolio. The inflation outlook for the next year sees CPIX rise to just above the upper band of the inflation target. This will mean that bonds will remain under pressure until the market feels that the worst is behind us.

The global markets are also extremely vigilant for any inflation surprises and we expect the central bankers to continue with their hawkish bias for the next 3 to 6 months. We will maintain a short duration position in your portfolio, but will start accumulating some bonds into the current weakness. We foresee that there will be quite a few trading opportunities as the market tries to determine whether inflation will accelerate or not.

Two themes dominate Investec Equity's portfolio: stronger for longer commodity prices, and faith in Mr and Ms SA's ability to continue spending. Its manager, Gail Daniel, has backed her view strongly, taking resource exposure to above the sector average and holding hefty chunks of banks and retailers. The fund's price is taking pain, but not much more than that of the average equity general fund in the current broad equity sell-off.

Financial Mail - 16June2006

The bull market continued in the first quarter of 2006, with the JSE All Share Index delivering a 13.3% return, bringing the 12 month return to 57.4%. Equity returns have far outstripped bond returns with the All Bond Index returning 12.7% over twelve months and cash lagging at 7.4%. The obvious question is do we see this continuing?

There are problems in the SA economy and world financial markets. The supply side ability of the South African economy is constrained by underinvestment in fixed infrastructure as witnessed by the power outages in Cape Town. Supply side problems typically take longer to resolve than demand side problems. The demand side of the South African economy remains robust with motor vehicle and retail sales remaining buoyant as new consumers gain access to finance. This is probably a differentiator of the South African economy as it is an emerging market with a highly sophisticated and established financial sector. We remain invested in the consumer and banking sector although we have altered our stock picks in the retail space.

The current account deficit is always a concern although it is clearly being easily funded with the Rand at close to R6= 1USD. The budget deficit is not a problem, the ability of the local municipalities to spend the cash allocated to them is.

Globally demand also remains firm and broad based. US interest rates must be pretty close to the top now, which could see a resumption of the dollar bear market, simultaneously supporting a rerating of the US stock markets. Commodity prices moved higher again, in a seasonally weak period. Companies are slow to bring on supply. Indeed in the recent reporting period, the big 3 London miners competed to see who could announce the biggest buy back ,and not who could bring on supply. In the face of this it is not surprising that copper made yet another high at over 240 c/lb. We have a 32% weighting in resource shares. Within this we are overweight gold as we are finally seeing a rising rand gold price. The companies have enormous operating leverage to a rising revenue line and earnings growth could surprise on the upside. Platinum shares delivered superb returns, benefiting from rumours of consolidation by the gold companies. Whilst we do not see an imminent rand collapse we do think that the currency is on the expensive side.

We have added or initiated positions in Old Mutual, Barloworld, Didata and Sappi. All have been consistent laggards. We expect mergers and Acquisitions to remain a strong trend this year.

Although US long bond yields have finally started to rise, the ability of private equity firms to outbid their listed counterparts indicates that debt is mispriced relative to equity. A rapid repricing of debt will cap equity upside and could cause a shift out of the more risky assets into the less risky assets.