A return of 0.63% for the local bond market against a backdrop of weak global bond markets and a weakening currency, adds up to a very good result. This return was achieved despite further hike threatening rhetoric from the Reserve Bank. It will however be very difficult for local bonds to deliver strong performance whilst faced with weakening global bond markets, inflation pressures and a building current account deficit going forward. A defensive stance in the SA bond market continues to be the prudent option.

The Select Manager Income Plus FoF returned 0.5% for the month, matching the return of the Stefi index. The Coronation Strategic Income Fund and the Investec Opportunity Income Fund did well to outperform the index by returning 0.65% and 0.77% respectively. Both funds have held a fairly large position in cash, thereby enabling them to take advantage of higher yield opportunities as interest rate hike expectations increased.

SA bond yields squeezed out a positive return of only 0.08% for the month. The 1-3 year portion of the index delivered the best result, 0.18%. There can be little doubt that inflationary concerns are starting to creep into the behaviour of the SA bond market. This again spurred demand for inflation linked bonds, which returned 4% for the quarter versus the 1.1% of the ALBI. We continue to believe that mounting inflationary concerns, strong growth data, a widening current account deficit and ever increasing credit growth will do little to encourage investors. We remain in favour of a defensive stance in the SA bond market.
The Select Manager Income Plus FoF returned 0.5% for the month. Our underlying fund managers delivered satisfactory results matching the return of the STEFI. Only the Coronation Strategic Income Fund outperformed the benchmark notably by returning 0.68% for the month. The outperformance is attributed to the defensive bond positions in the fund as well as a significant holding in inflation linked bonds.

This fund's initial fee was reduced to 3% (3.42% incl. VAT) on 18 July 2005

With effect from 5 May 2005, the Metropolitan Select Manager Income Plus Fund of Funds has changed its name to Metropolitan Select Manager Income Plus Fund of Funds. The performance history was retained.

March saw large losses in the bond market triggered by US inflation fears which saw US treasury yields rise. The ALBI returned -3.67% with longer dated bonds (12+ yrs) down over 7%. Globally there seems to be a change in investor's appetite for risk evidenced by a weakening in emerging market currencies.
Our cautious outlook has led us to select managers who are underweight longer dated bonds, having greater exposure to the shorter end of the yield curve where capital risk is lower. During March the funds we own with the shortest duration (Coronation Strategic Income & RMB Maximum Income) were able to remain positive in a sharply falling bond market. We will maintain the low duration exposure in this fund.

The bond market rally continued into February with the longer dated bonds benefiting the most as yields decline. The converse is also true: longer dated bonds carry the greatest risk of capital loss when yields rise. At present, the bond market appears to be ignoring obvious risks such as the large current account deficit and the narrowing interest rate differential with developed nations and is taking it's queue from short term numbers such as January's pleasing consumer price inflation and producer price inflation numbers. Our cautious outlook has led us to select managers who are underweight longer dated bonds, having greater exposure to the shorter end of the yield curve where capital risk is lower. Our two flexible managers have also diversified risk and added return through marginal exposures to preference shares and property stocks.

A decision to actively allocate to resource stocks, thus overriding the current views of our underlying managers, would require a strong view. Although financial and industrial stocks had a significant rally last year and in relative terms resource stocks have not really begun to move, the outlook for resources remains murky.

Over the past few years we have experienced some significant commodity price appreciation, especially when measured in dollars. Increased Chinese demand, increasing global growth, and dollar weakness have been major factors in this appreciation. One of the key pillars underlying the above has been record low US interest rates. As US interest rates rise, global growth is expected to soften in 2005. This being the case, some of the support for global commodity prices should ease over the coming year. Nonetheless, robust demand for commodities from China is likely to continue.

The Rand is the wildcard in the whole scenario. At current levels, most of our underlying managers believe that resource counters are showing little value and only begin to do so when using R/$ of 7 or more in their valuation models. The strong rand along with other cost pressures in particularly mining stocks have led to margin compression despite high commodity prices. Currency forecasting is inaccurate at best, but there are many factors supporting the Rand at levels below R/$7. Recent Rand weakness will support the current run in resources, but if material Rand weakness does not materialize, resource stocks are likely to underperform. Furthermore, rand weakness that is the product of dollar strength (rather than broad based rand weakness against a basket of currencies), is likely to be accompanied by lower dollar commodity prices, which is what we have seen so far this year in gold prices. Therefore careful stock picking within the resource sector remains the best way to gain exposure to resource stocks.

A number of our underlying equity managers have been increasing their exposure to resources selectively over the last few months, but they are all still underweight vs. the ALSI. Careful stock picking has led them to names like BHP Billiton (diversified commodity exposure), Sasol (for oil exposure) and platinum counters. Gold stocks are not a favourite. A look at the charts on the next page shows which of the resource sub-sectors have performed well year to date, and what is clear is that diversified metals have led the sector, with platinum and energy also performing well, yet gold and steel have lagged. Thus the stock picking of the underlying fund managers has contributed positively. At the end of this comment is the current resource allocation/stock picks within the Prudential Active equity portfolio. It shows that the fund's equities are approximately 20% in the materials sector compared to the ALSI weight of over 37%. Note that this weight is about 5% greater than that shown on the factsheets, since the Materials Sector in the database used below includes paper, packaging and chemicals, which are not part of the ALSI Resources Sector.
The managers remain more comfortable being overweight industrial and financial stocks where valuations and earnings growth are clearer. Our fund managers have also been increasing exposure to rand hedges over recent months, yet have been looking more in the industrial sector, where they see better valuations. For the time being we do not intend to overrule their positions by buying a separate resource fund.

Bonds continued their strong rally during December despite the SARB keeping interest rates on hold at the most recent MPC meeting. Continued rate cut expectations into 2005 have kept the short end of the curve at very low levels. Bond yields are however still at risk of rising - the carry trade with developed economies continues to narrow; commodity prices are softening; valuations appear stretched and the SA trade account continues to weaken. Our fixed interest managers remain short duration which is in line with our strategy for the fund. They do however have enough flexibility to outperform cash (the funds benchmark).