Market review
The domestic equity market took its cue from global markets, which benefited from the improvement in the global growth outlook and a higher risk appetite. The All Share Index added 13.9% in the third quarter and has gained 18.6% this year. Over the quarter, the All Share Resources Index (11.1%) lagged the overall market, with gold miners earning a disappointing 6%. Domestic-oriented and interest rate-sensitive sectors enjoyed good gains. Construction (19%), general retailers (19.1%) and banks (14%) stood out as strong performers, with foreigners particularly active buyers. Telecommunication (3.8%) and short-term insurers (6.1%) underperformed the market.

Portfolio review Risk assets continued their re-rating over the third quarter as the market indiscriminately priced out any balance sheet concerns that might have arisen. This tendency reversed somewhat in the last month of the quarter on the back of capital raising concerns. At the same time, high quality companies have become cheap relative to their cash flows and more risky peers, and this space is ripe for merger and acquisition activity. Kraft bowled the first ball in this regard with their hostile bid for Cadbury. Fixed investment spending should be more dominant than consumer spending for the next few years in both the West and the East. Consequently, we have an overweight exposure to counters which benefit from fixed investment spending, such as resources shares. We have a large holding in gold and gold shares. The demise of the US dollar is underway and gold's appeal as a currency is on the ascendancy. However, South African gold and platinum mining is not making much money due to the strength of the rand. This situation is ultimately unsustainable. The local currency appreciated by nearly 3% over the quarter to close at around R7.50 to the dollar. The rand's strength has been attributed to various factors such as the MTN/Bharti Airtel deal, the return of the carry trade and a tight correlation to the rampant stock markets. It strikes us as highly unlikely that equity markets will continue to rally strongly. The South African consumer has been under severe pressure for the past nine months. We expect the import bill to increase from here, and it's likely that there will be growing political pressure for market intervention. It appears as though the South African Reserve Bank has already started to intervene. The status quo of a rampant rand is unlikely to continue in our view.

Portfolio activity
We are more cautious on equities. Economic indicators have reached such high levels that they are likely to disappoint from here. The price earnings multiple on the JSE is over 14 times and is likely to rise to 16 times over the next quarter as earnings decline. For the market to keep its levels, it is crucial for earnings growth to be in line with expectations. However, South Africa's cost base could make this difficult to achieve. We maintained our exposure to defensive consumer shares such as Clicks and Spar. Earnings revisions are fine and the counters started to gain some momentum at the end of the quarter. We switched some Standard Bank to Absa. Although there are question marks over Absa's management, we believe that the company is being unduly penalised. We are underweight banks as we do not believe that they are particularly cheap. Whether or not earnings revisions surprise on the upside depends on how bad debts pan out. We are doing intensive work in this regard. We favour gold. The US has $11 trillion of debt. This is likely to result in further dollar devaluation, with or without inflation. We increased our holding in Gold Fields.

Portfolio positioning
Our largest stock positions relative to benchmark are the gold exchange traded fund and British American Tobacco. These positions are starting to do a little better, but we believe there is enormous value there. We like resources counters, as the financial crisis cut short the normal supply side response from mining companies when prices were strong in the middle of last year. Certain minerals such as oil, copper and coal are likely to enjoy good demand amid tight supply conditions. The portfolio has positions in Anglo and BHP Billiton. We favour SABMiller. Earnings revisions are positive and defensive counters have not done well. The re-rating phase of the market is now largely behind us and earnings revisions should start to take on increased importance.

Market review
While company profits remained under pressure, equity markets rerated significantly as signs of an improvement in the global economy buoyed risk assets. The local equity market had a positive quarter (8.6%), its first in 12 months, despite giving up some of its gains during the month of June (-3.1%). Year to date, the All Share Index closed 4.1% stronger. The market's foreign currency returns for the three month to the end of June, were boosted by the rand's appreciation against the US dollar (24.1%) and the euro (16.7%). Over the quarter, the financial and industrial composite (13.4%) outperformed resources (2.8%), with gold miners (-16.2%) the largest underperformers. Other sectors lagging the composite over this period included fixed line communications (-0.8%), travel and leisure (6.6%) and food producers (7.7%). General retailers (15.6%), banks (13.8%) and the construction (16.6%) sectors all ended the quarter well above their March levels. The platinum (9.5%) and general mining (8.9%) sectors performed in line with the overall market.

Portfolio review
The second quarter of 2009 saw a strong rebound in risk assets, as the market started to price in a return to economic growth. The US yield curve reached its steepest levels ever, the rand was one of the world's strongest currencies, and commodity prices surged. Whilst we did increase our position in high risk assets at the end of last quarter, our portfolio is more defensively positioned. We believe that the rerating of high risk assets is behind us and that we have reached a period where earnings growth will have to start delivering on expectations of an economic recovery. The portfolio's weightings in defensive shares were increased towards the end of the quarter, as these counters are now attractively priced with more secure earnings growth. The notion of China decoupling from the West has reasserted itself as the country rolls out huge infrastructure programmes in large inland cities. Demand for commodities has been firm and the bellwether copper price recorded a double digit increase this quarter. However, stocks have also been rising and we anticipate a slowdown in demand from here. Western consumers are over indebted, the oil price has risen to around US$70 per barrel from below US$40 per barrel at the start of the year and mortgage rates have also increased. It will take a long time for western consumer demand to return. In the mean time, the Chinese consumer is still being slowly weaned off their culture of saving. The Chinese stimulus package is creating supply, while the world needs demand. South Africa is placed between the West and the East. We are western in respect of our spending habits and debt levels, but supply commodities to the East. It is likely that South Africa will record a trend growth rate in GDP closer to the 2% level over the medium term than the 4.5% level.

Portfolio activity
We lowered our resource weighting into strength over the quarter, mainly by reducing our holding in Anglo American. Our view is that the share price is reflecting an improvement in margins that is far too optimistic. We also believe that a cash financed buy-out of the counter is highly unlikely and we much prefer BHP Billiton. Over the quarter we also bought back our holding in SABMiller. This well-run company offers good exposure to emerging markets and earnings will benefit from acquisition synergies. We reduced our positioning in Shoprite on earnings growth concerns. The stronger rand is likely to result in earnings coming in below forecast and the share is not cheap.

Portfolio positioning
Our largest stock positions relative to benchmark are the gold exchange traded fund (ETF), British American Tobacco (BAT) and our zero weighting in Anglo American. The latter position has only recently been established, whilst the former two have been around for some time. Our gold ETF and BAT holding added value last quarter, but hurt the performance this quarter. Gold is very interesting. The market continues to prefer the US dollar to gold as a safe haven. Over the medium term, western currencies need to de-rate against the creditor currencies, which are principally eastern. We believe this will benefit gold. Both the UK and the USA are running enormous budget deficits and economic growth projections seem far too optimistic. This should favour gold. BAT will perform better as the risk-taking trade subsides. We are underweight banking shares which have struggled to make headway recently. Earnings have been severely downgraded, but we could well be coming to the end of the downgrade cycle. In our opinion the sector is starting to look more interesting. The portfolio also has large holdings in Spar and Mr Price. Both have market share gains in common, which should support earnings growth. Spar is not facing the same currency headwinds as Shoprite. Mr Price is benefiting from down trading. After the next reporting period, the counter could well be at a discount to the market on a valuation which we do not believe is warranted. We expect the price earnings ratio of the All Share Index to rise to 15 times once the June results have been reported. The easy money in the bear market rally is behind us.

Market review
Local economic news continued to deteriorate over the quarter. The release of fourth quarter GDP numbers confirmed the sharp slowdown experienced in the second half of 2008. Domestic demand remained under pressure in the first three months of 2009. Weak employment prospects and the slump in the manufacturing sector continued to bear down on retail spend and vehicle sales. Policy makers responded with two interest rate cuts of 100 basis points each during the quarter. The second meeting, held earlier than initially scheduled, indicated somewhat greater urgency on the part of the South African Reserve Bank to respond to the extremely weak global backdrop and evidence that the local economy was unlikely to escape a recession. The outlook continues to favour more rate cuts.

Equities weakened for the third consecutive quarter, with the All Share Index losing 4.2% year to date. Both financials (-7%) and industrials (-9.2%) ended the quarter in negative territory. Resource counters clawed back some of their losses sustained in the second half of 2008 to end up 1.6%. Gold mining (22.8%), platinum mining (9.6%) and pharmaceuticals (22.4%) were the only sectors to gain over the quarter. While general miners (-4.6%) performed broadly in line with the overall market, it was the domestic oriented sectors that fell most with banks (-9.8%), retailers (-7.6%) and the construction sector (-10.6%) all ending down.

Portfolio review
The Investec Equity Fund was well ahead of the local equity market over the quarter. The portfolio was very defensively positioned for the first two months with the split between defensives and non defensives being 61% and 39% respectively. In February we started positioning the portfolio to be more aggressive, with a 40%/ 60% split in favour of non defensives.

We did not buy into the argument that the South African economy could decouple. Over the first quarter small caps returned -6.4% compared to -4.4% for mid caps and -4.1% for the Top 40 Index. In other words, local shares performed worse than their more global counterparts.

The first quarter saw the market respond positively to stimulus packages released in the United States for the first time. We still, however, believe that the world financial system has changed. Deleveraging (reducing debt) takes time and top line growth is going to settle into a much more muted trend than what we have seen in the last ten years. There is a lot of excess capacity globally. However, the market could well rise while economic activity stabilises and moves towards this more muted trend level. Destocking has been vicious, but the demand collapse has in many instances been as bad and stock levels of houses, and metals are still too high.

Quantitative easing, i.e. when governments print money to stimulate demand, will put pressure on some currencies. This list currently includes Switzerland, the United Kingdom and the United States. It is possible that developed market currencies will underperform developing market currencies over the medium term. Companies are not positioned for this, with most manufacturing taking place in low cost emerging markets. Currency changes could see some of these markets losing some of these low cost advantages.

Portfolio activity
We took profits on a few of our gold exchange traded funds and bought some Old Mutual shares. We sold out of Reinet and increased our weighting in Standard Bank. The portfolio's weighting in Anglo American was increased at the expense of SABMiller. We successfully traded some Anglo Platinum and MTN over the quarter. Rand metal prices have been firming and we believe that we are getting to a point where we could see earnings upgrades in some sectors such as the platinum group metals.

Portfolio positioning
We increased our weighting in shares with high debt to equity where the underlying drivers are showing signs of stabilising. The platinum shares are an example of this. If fundamentals start improving we believe that these counters can easily double from current levels. However, they are not without risk; if the fundamentals do not improve most of these companies will face highly dilutive rights issues.

We still favour gold and have a significant exposure to the yellow metal. Gold does not perform well during a Goldilocks, not too hot, not too cold economic environment. This precious metal can perform well during deflation or inflation. We do not believe we are in a Goldilocks economic environment. We really like gold as a currency. Quantitative easing renders several developed market currencies unattractive and gold is a good alternative.

There are still many unresolved issues. These include:

· The fate of the US auto manufacturers.
· A planned stress test for US banks.
· The recent downturn in the Baltic Freight Index, which usually leads commodity prices.
· The funding of black economic empowerment equity in South Africa.
· The exposure of banks to elevated property prices. Stock levels are still too high and the consumer does not want to borrow.

Our holding in local retail shares is in the more defensive cash businesses as opposed to credit retailers. We have increased our exposure to global cyclical companies, but remain defensively positioned on the local front. The shock of Anglo American cutting its dividend has hit the market and as long as the copper price remains near current levels, Anglos is unlikely to need a rights issue.

The sustainability of March's rally will be tested in the next earnings season. Earnings revisions are currently very negative and we hope for some improvement, but are concerned that it is too soon for this.

Market review
The global financial crises and the ensuing slowdown in economic activity left their mark on the domestic equity market. The All Share Index lost 23.2% over the year, all of the losses sustained in the second half of 2008. The market ended 9.2% weaker over the last quarter of the year, with falling commodity prices driving down platinum (-25.8%) and general miners (-15.2%). The construction sector slumped 36.1% in the fourth quarter as companies saw their order books curtailed by weaker demand and foreign investors seemed to lose faith in the sector. Life assurers (-15.9%) continued their underperformance of the general market.

Exposure to falling interest rates and defensive earnings streams dominated the outperformers over the quarter, with banks (-6.1%), healthcare equipment and services (5.6%), food producers (6.6%) and food retailers (16.2%) high up on the performance table. However, it was the gold miners (22%) that took the top spot over the quarter as the dollar gold price held its own and rand weakness and positive production news boosted returns to the sector.

Portfolio review
The Investec Equity Fund regained some composure after a poor third quarter. Equity returns for 2008 were the worst in real terms for fifty years. The fallout from the collapse of Lehman Brothers still reverberated through financial markets during the fourth quarter.

Locally focussed companies continued to do well over this period. Banks outperformed at a slower rate. Resources shares underperformed. Mid caps outperformed large caps. We were not positioned this way as we continue to believe that the local market is too optimistic in terms of its outlook for interest rate cuts. Interest rate sensitive shares did not respond well to the 50 basis point reduction in early December. Inflation is likely to fall at a slower pace than anticipated in South Africa. Job losses will be a major concern in 2009. The collapse in commodity prices will have a dire effect on employment. At the same time banks are going to be highly reluctant to lend (unlike last year) and we think that demand from the consumer will be more muted than anticipated.

Portfolio activity
We reduced our resources weighting over the quarter by selling Kumba Iron Ore, Exxaro and Anglo American. The industrial weighting of the portfolio was increased by buying SABMiller, Naspers and Spar. We sold the fixed investment play Aveng, where contracts are being delayed or cancelled. Margins have the potential to halve in this sector. We maintained an underweight position in financial shares.

Portfolio positioning
The gold position is starting to bear fruit. Interest rates that are set by the central banks are unlikely to rise any time in the medium term. Gold is well positioned as an alternative currency.

We are underweight bank shares. Our view is that:

· Government bonds are in a bubble.
· Local banks are going to conserve capital in anticipation of increased capital requirements.
· Local financial institutions are focussed on balance sheet strength and not earnings growth.


The market has run ahead of itself in anticipating a rebound in local shares given that we have no sign of the bottom in the business cycle, job losses are rising and advance growth is slowing. The portfolio will continue to have exposure to defensive local shares such as Tiger Brands, Shoprite and Spar.

The portfolio has a significant weighting in rand hedge shares. The global economic slowdown could result in further sell-offs in the rand. We are concerned about emerging markets going into 2009. Deficit funding will be difficult, and those countries which have spent their oil windfall unproductively are going to struggle to live in a more frugal world. Russia springs to mind.

The deleveraging process is likely to continue for two to three years and during this time global GDP will grow below trend. We are now underweight commodity shares with the exception of gold. Inventories have risen rapidly and are unlikely to unwind quickly. We have exposure to blue chip BHP Billiton in this space, as the company has by far the best balance sheet in the sector.

Within the consumer space we like low-end consumers where the collapsing fuel price will make day to day living easier as long as they keep their jobs. Lower interest rates will also help, but our concern is that job losses will impact the credit retailers far more than the likes of Spar and Shoprite.

Earnings revisions are negative across the board. They have been decimated in the resources space, but are not positive in most other sectors either. We will watch closely for sustainable positive earnings revisions.

GDP growth is very weak but this is not a global depression. Fiscal policy will eventually kick-start the economy, although there could be a time lag. We are overdue a cyclical rally within a bear market. The market is starting to respond better to bad news. However, hedge funds have broken their mandate for the first time and have capped outflows. This money will eventually be released and limit returns. 2009 is also likely to be a difficult year, albeit better than 2008.