Market review
The All Share Index (ALSI) closed 3.4% up over the quarter, losing some of its earlier gains as inflation fears gripped global markets. Substantial dispersion in performance across the sectors was evident as resources gained 13.4% over the quarter, while the Financial and Industrial Index lost 6.4%. General mining led resources higher, closing up 18.1% over the three months to the end of June. Banks and general retailers shed close to 15% over the quarter, while the defensive food retail and telecommunications sectors ended up 3.2% and 3.4%, respectively. The telecommunications sector was buoyed by corporate activity as MTN sought a potential merger with an Indian telecoms company.

Fund performance
The Investec Equity Fund returned -0.3% over the quarter, against the ALSI return of 3.4%. The fund's return for the 12 months to the end of June was 6.3%. The Investec Equity Fund achieved top quartile performance over the 12 months, two, five, seven, ten and fifteen years to the end of June (annualised returns).
The leadership in equities was very narrow over the second quarter with the large cap shares returning 5.3% and the small cap shares falling 14%. We were fortunate to have been positioned principally in large cap shares, which benefited from geographical diversity as the local economy ran into inflationary headwinds. The Resource 20 Index returned 13.4% over the quarter and our mid 40% weighting in resource counters helped the portfolio's performance. The large capitalisation industrial shares recorded a slightly negative performance of -1.1%, while financials lost nearly 15% over the quarter. Poor inflation numbers, rising bond yields and turmoil in the global financial markets took their toll on financial shares. Earnings revisions amongst the banking shares have been very poor and we see no reversal in this trend yet. We are concerned that falling house prices will impact mortgage books and therefore earnings. There won't be much relief for the local economy on the interest rate front until the current account deficit becomes manageable. It will be difficult for interest rates to enter a sustainable downtrend with a current account deficit running at 9% of GDP. The rand will in all likelihood weaken substantially once interest rate support starts to be removed.

Our holdings in financial shares impacted negatively on performance and having fewer financials in the portfolio would obviously have been better. This is however a portfolio of South African shares and consequently we will have some exposure to financials. Exxaro and ArcelorMittal performed well over the quarter on the back of rising prices for coal and steel. We still get substantial upgrades to spot earnings. Sasol also performed well. We do not believe that speculators are to blame for high oil prices. Rather, regressive tax structures in oil producing nations such as Russia and Nigeria have limited investment. Oil price subsidies in some emerging nations have also overencouraged consumption and the Americans have been slow to realise that they should drive smaller cars. We expect global oil demand to fall in time as consumers around the world find the fuel price untenable. The oil price is the key to the future performance of the different sectors. It is currently giving consumers no respite. Extra supply is barely showing up, and a decline in demand is slow due to several nations not charging their consumers market related rates for petroleum.

On the negative side we should have had more Anglo Platinum, but we do have a large weighting in Impala Platinum. We were also underweight Naspers, which performed well over the quarter. Earnings revisions have only recently started to improve and we accumulated a position in line with our process.

Portfolio activity
As mentioned we bought some Naspers over the second quarter on the back of positive earnings revisions. We also added to our exposure in the gold exchange traded fund (ETF). Our view is that the gold price does not adequately reflect rising global inflation. We sold Standard Bank and bought BHP Billiton over the quarter, which worked well. Over this period we also sold Didata. We took some profits on our positions in Kumba Iron Ore and Exxaro, moving into more liquid resource shares as we are at a late stage in the cycle and have had incredible sectoral outperformance.

Market outlook and portfolio positioning
The All Share Index rose in the first half of 2008, but only four shares accounted for the positive return of the index. These counters are BHP Billiton, Anglo American, Sasol and Impala Platinum, which are all resource counters. Several local companies have seen their share prices halve from the second half of last year. Obviously, the question is where to from here?

US growth is sluggish. However, the US Federal Reserve chairman is talking about raising interest rates in a bid to stem the decline of the dollar and rein in inflation. It would be highly unusual for the Federal Reserve to hike interest rates in the face of rising unemployment, yet the market is pricing in a 100% chance of a rate hike in the US by September. Interest rates are scheduled to increase in the face of very weak growth in Europe. In many Asian countries interest rates are also rising. We do not expect a series of rate increases in the US; the developed world banking and housing system is simply too weak. The gold price will probably remain under pressure until the market changes its mind on interest rate hikes. In our view it is prudent to have some gold exposure. We believe that we are in for a prolonged period of weak growth in the developed Anglo Saxon world.

Developing market growth continues to be robust on the back of a resolutely high oil price. The earnings revisions of resource counters currently remain firm, but we are concerned that certain commodity prices are not rising fast enough to offset rampant cost inflation. Inventories are generally at low levels and the underlying commodity prices should respond positively to any supply side shocks.

We still do not like local cyclical companies such as credit retailers and banks. Earnings revisions are very negative and we cannot yet see the top of the interest rate cycle. Inflation is highly problematic and we think the South African Reserve Bank is behind the curve. The rand remains vulnerable to a further downward correction, given the country's large current account deficit. South Africa's inefficient supply side will continue to restrain growth. We will be haunted by our current account deficit and high inflation until education, health care and safety can be improved, thereby enhancing productivity.

We favour the large capitalisation industrial shares such as Richemont and SABMiller where earnings revisions are positive and sales growth is benefiting from the high growth rates in developing markets. These companies have less exposure to the weak domestic sales market. Fixed investment counters are better placed than their consumer counterparts and we retain exposure to Aveng.

In summary, earnings revisions remain firm in the resource, large capitalisation industrial sector and fixed investment sectors. Banks, insurers and retailers continue to suffer from downgrades and we do not see any respite for them on the macroeconomic front. A sharp fall in the oil price would bring some relief, but this is not currently happening. Valuation levels are fine and in some cases very attractive, but until the economic environment improves, we do not think that value on its own will drive decent returns. Equity returns are set to remain pedestrian.

Market review
The FTSE/JSE All Share Index retraced the losses sustained towards the end of 2007, closing the first quarter up 2.9%. Resources were the clear winners, returning 17.6% as commodity prices reached new highs and earnings were aggressively revised upward. The domestically focused FTSE/JSE Financial and Industrial Index lost 8.5% over the quarter, depressed by tougher trading conditions and poor sentiment towards rate sensitive sectors. Banks, tainted by global credit market woes and local policy uncertainty, closed the quarter down 10.7%, while general retailers lost 14.3%. The construction and telecommunications sectors were less affected by the slowing domestic consumer environment, losing 7.6% and 4% respectively.

Fund performance
Amid volatile market conditions the Investec Equity Fund returned 0% over the quarter, which was behind the All Share Index but ahead of most of its peers. The fund achieved top quartile performance over the quarter, 12 months, two, three, five, seven and ten years to the end of March (annualised returns). The Investec Equity Fund's return for the 12 months to the end of March was 10.3%.

The sectoral underweight position in industrials added positively to the fund's performance. Our underweight exposure to consumer cyclicals enhanced performance, as inflation remains a problem and interest rates continue to surprise on the upside. We started the quarter marginally overweight in resources but increasing this weighting over the quarter would have added value. Our underweight position in financials contributed positively as financials were impacted by the continued sell-off in global financials on the back of the subprime crisis. The unfavourable local macroeconomic climate of rising interest rates and slowing economic growth also put pressure on financial stocks.

We had a large weighting in platinum through our holding in Impala Platinum, but with hindsight even more platinum shares would have been better. A heavier weighting in mining resources would also have added more value. Over the quarter our holdings in Exxaro, Impala and Sasol performed well. These are all rand hedge shares which benefit from rising commodity prices. Our holding in the gold exchange traded fund (ETF) also contributed positively as gold reached a new nominal high of US$1032 per ounce on 17 March. However, our view is that gold has moved very quickly and a period of consolidation is needed. We benefited from not owning Sanlam, Naspers and only having a few FirstRand shares. On the negative side, we should have had more Anglo Platinum and Anglo American shares and fewer Standard Bank shares would have been better. We feel that Standard Bank is the best placed local bank as it is the best capitalised. In our view Standard Bank also has the most conservatively struck accounts. In a balanced portfolio there will always be some holding in the banking sector.

Portfolio activity
We added to our resource weighting over the quarter, funded by selling SA Breweries as we feel that valuation levels are high and earnings revisions have been fading. The portfolio has a significant holding in Remgro as we like the outlook for British American Tobacco and the rand hedge characteristics. We were also buyers of Barloworld on the back of a good earnings outlook, and topped up our MTN holding. Our view is that MTN is attractively priced and that the earnings outlook is healthy. We took profits on a portion of our holdings in the gold ETF.

Market outlook and portfolio positioning
The resource sector outperformed financials by 30% and industrials by 23% over the quarter. Is this outperformance likely to continue? We do not believe that the climate will shift back to one of high risk taking in the medium term. There has been a paradigm change. Banking crises are very serious and with the best will in the world they take time to rectify. However, it is also highly unlikely that resources will outperform their counterparts by such a wide margin over a quarter again. Inventory levels are low in resources, but financial participation has increased and is likely to make the road ahead somewhat bumpy.

Earnings revisions are very positive and forward valuation levels are attractive. Whilst a rebound in US growth would strengthen the dollar and put pressure on commodity prices in the short term, a growing US is positive, not negative for commodity prices. However, there is scant economic evidence that the US economic problem is stabilising. The consensus view is for a short US recession followed by a return to normal growth. We will only know if this is true in 2009, after the tax-induced fiscal stimulus package has worked its way through the system in the third quarter of this year.

Global inflation is rising to levels not seen in 15 years or more. South African inflation is likely to end the year above 10%, thanks to a 60% hike in electricity tariffs. With the US federal funds rate hovering near 2%, rates are negative in real terms. This is highly supportive of precious metals. Even the most ardent bulls on the US are not calling for interest rate hikes. Therefore, it seems that interest rates will remain negative once adjusted for inflation over the medium term.

Whilst South African banks are regarded as cheap, we would like to point out that banks usually trade on low multiples and the reasons for this have become most apparent in the last six months. Resource shares might be as cheap on a forward basis. Locally the economy is slowing, inflation is high and rising and rolling power blackouts will cause production inefficiencies. Earnings revisions are very poor in the financial sector and we may well get another rate hike which is not factored into current earnings forecasts. We are underweight in banks and local consumer shares and are likely to remain that way.

However, within the industrial space the large cap rand hedges have been receiving earnings upgrades and are generally attractively valued compared to their international counterparts. We are selective buyers here, switching some funds from our very overweight resource position. The portfolio's holdings in Remgro were increased and we added Bidvest as well as Barloworld. We continue to own fixed investment shares, Murray & Roberts and Aveng, but have taken a few profits as we are concerned about the Competition Commission enquiry into this sector.

We have a low weighting in bonds and until we see evidence that inflation is subsiding we will remain underweight. Inflation has consistently surprised on the upside and with a weaker rand we do not see any near term change in this trend. In our view SA bond yields are too low for the current inflation rate and the market has been consistently naive in its belief that forward inflation will return to the target band.

Despite a very difficult economic environment, equities still managed a 2.9% return (albeit in rands) for the first quarter of 2008. Returns for this year are likely to be far more modest than what we have enjoyed over the last few years. However, in a weak rand environment it is usually possible to make modest returns from SA equities. The danger points to look out for are an emerging market sell-off on the back of social unrest driven by sky high food prices. In addition, the political pressure of high food prices could result in reduced inflationary discipline among emerging market central banks.

Market review
Domestic equities came under pressure during the fourth quarter, with the All Share Index closing down 3%, but achieving respectable returns of 19.2% for the year as a whole. The losses were concentrated towards the end of the period, as both resources and financials became victims of the uncertain global growth outlook and continued negative sentiment associated with the global banking sector. Gold miners ended the year as the market's worst performer, losing 14.1% over the quarter and 20.6% over the year. The construction sector continued its strong run, to end the year 77.3% higher as the best performing sector.

Fund performance
The Investec Equity Fund performed well over the month and the quarter, beating both the peers and the benchmark. Although the Fund fell 1.9% over the month, it rose 2.4% over the quarter and 19.3% for the year. The All Share index declined by 4.4% over the month but gained 19.2% for the year. Of this 19.2% return, 40% came from Billiton and 17% from Anglo American.

The sectoral underweight in industrials added positively to performance. Our underweight in consumer cyclicals enhanced performance, as inflation remains a problem and interest rates continue to surprise on the upside. Our position in resources detracted marginally, and financials have finally started to outperform in a very weak market. Banks declined 1.8% over the quarter compared to a 3% decline for the All Share Index. SA listed property appears to have past its peak, declining 1.8% in December and 0.4% over the quarter. Globally property prices are declining.

Over the quarter our holdings in Exxaro, Kumba and Sasol all performed well. It is fascinating that despite a very weak US economy, oil is still over US$ 90 per barrel. Our underweight position In Anglo American helped, although we were buyers at lower prices towards the end of the quarter, as Chinese base metal stocks are low and the Chinese could well return as buyers. We believe that Chinese growth will slow but remain firm, and this will support certain commodities. Gold is well positioned and we have 4% in the gold exchange traded fund (ETF) as the shares have continuous production problems.

On the negative side RMB Holdings struggled in the face of downgrades last month. Dismal inflation figures are adding to concerns that the slowdown in the economy will lead to negative earnings revisions in the banking sector. In this regard we feel that Standard Bank is best placed, with the most attractive international business of the big four banks and the most conservatively structured balance sheet. Angloplats did well despite production problems and we should have had more. We do however have a large holding in Impala Platinum.

Portfolio activity
We were sellers of RMB Holdings and SAB Miller on negative earnings revisions. The weighting in Santam fell, due to the payout of a special dividend of R20 per share on a R120 share price. The fund also sold the last remaining Telkoms. We were buyers of the gold exchange traded fund and a few Richemont as we believe that the market is underestimating the sales growth potential coming out of China.

Market outlook and portfolio positioning
The outlook for 2008 is considerably murkier than in recent years. Global growth has grown above trend for over four years, and there has been no period of global growth this strong for nearly 40 years. The principal sign of excess demand is rising consumer prices. This is at the same time that concern is mounting that the US economy could be headed for recession, on the back of the meltdown in the subprime market and the housing market. Just when policy flexibility is really needed, soaring oil and agricultural commodity prices are restricting the hands of the central banks.

Unlike previous periods of stagflation, equity markets are not expensive, particularly relative to bonds. JSE equities are on 14 times historic earnings, whilst US equities are on 18 times historic earnings. Relative to bond yields equities are showing moderate value, whereas US equities show very good value.

South Africa's current account deficit is 8% of GDP. Inflation is at 8.4%. Interest rates could well need to rise again. We think the rand will weaken against most of the major crosses. Indeed it has been struggling against the euro, having depreciated by more than 7% over 2007. A weaker rand will help the equity market. We also expect Chinese growth to remain firm, and commodities that are sensitive to this could well be fine. Shares like Exxaro and Kumba Iron Ore spring to mind. The world is better placed than it has been before to endure this US slowdown, given Chinese demand. The oil price remains firm and Sasol is one of the few oil shares globally, showing earnings growth. It will benefit if the rand sells off. The change in leadership in the ANC to a more populist government could also increase pressure on the rand in order to help the beleaguered manufacturing sector and the mining sector, particularly the gold mines. Despite a record high rand gold price gold mines are not making much money. We have exposure to the gold ETF.

In the industrial sector we are staying clear of the local consumer related sectors. Companies in these sectors are still receiving downgrades and we think that their valuations could sink even lower. In addition, we think that interest rate cuts may well be a long way off. We remain focussed on companies benefiting from fixed investment. The fund also has high weightings in Richemont and Remgro where the earnings upgrades look good.

Our outlook for banks is more muted than six months ago. Earnings upgrades are fading as rising interest rates take their toll on bad debts. Our picks are Standard Bank and African Bank. Standard Bank's international business, whilst having been an Achilles heel should be a positive differentiator going forward. In our opinion its accounts are more conservatively struck which should provide some protection in a difficult economic environment. African Bank is, on our calculations, trading on a double-digit forward dividend yield, which should prove to be defensive. In addition, this is excess capital that was on Ellerine's balance sheet and the chances of it being released are very high.

Forecast risk is as always high, but in 2008 we will be dealing with the ongoing Zuma - Mbeki saga, as Zuma takes over the presidency of the ANC. Zuma's mandate is more populist and could cause some nervousness in the markets.