Market review
The improved global outlook has been somewhat less pronounced in the local economy. Data releases over the quarter showed falling house prices, a manufacturing sector that is yet to benefit from any rise in global demand and very weak demand for credit by the private sector. The latter reflects a consumer under pressure from a high debt burden and general job market uncertainty. The sharp improvement in the current account witnessed over the quarter is more a sign of a collapse in imports and lower dividend payments to offshore investors, than the effects of improved terms of trade and better export performance. Current estimates point to a marginal expansion in the third quarter, following a sharp contraction in the first half of 2009. Risk appetite has greatly improved over the last few months. The rand continued to benefit from massive foreign portfolio flows into the local bourse, more than offsetting the outflows seen in the second half of 2008. The local currency appreciated by nearly 3% over the third quarter, pushing the year's gains to 22% against the US dollar. The downward trend in inflation is likely to continue, but at a slower pace into 2010. Weak demand, the strong rand and the better nearterm inflation outlook, saw the monetary policy committee cut interest rates by a further 0.5% to 7% in August. The All Bond Index returned 3% over the third quarter, while cash, as measured by the STeFI, gained 2%.

Portfolio review
The Investec High Income Fund returned 2.1% over the quarter, outperforming the benchmark. We maintained some bond exposure and continued to selectively switch and add to credit exposure. The portfolio currently has some bond exposure in the 3-7 year area of the curve. The higher yield of the credit portion of the portfolio added to the overall performance of the fund and we also saw the first tentative signs of credit spread compression. We added duration to the portfolio through our bond positions. This contributed to the fund's outperformance, as bond yields fell modestly. Money market yields declined in line with the 50 basis point interest rate cut seen in the quarter. However, funding spreads remained wide, giving an attractive pick-up over three-month Jibar, also adding to outperformance.

Portfolio activity
Three-month cash yields rallied 58 basis points to 7.01% as the Reserve Bank cut the repurchase rate to 7%. The one-year area managed a more modest 23 basis point move to 8.17%, as the yield curve steepened. The bond market was largely range bound, with the benchmark R157 rallying by 18 basis points over the quarter. We added duration to the portfolio, purchasing the 2014 maturity R206 on the government curve, avoiding the shorter-dated government bonds which still look expensive. Cash duration remained largely unchanged as we continued to favour the shorter end of the cash curve and the purchase of floating rate notes. Although we are somewhat constrained by limits, we continued to seek opportunities to increase the credit spread on the portfolio yield. We purchased some short-dated corporate bonds and invested in medium-dated credit-linked notes with attractive spreads over three-month Jibar.

Portfolio positioning
The final quarter of the year is going to be very important for the fixed-income markets. We have the medium-term budget policy statement (mini budget) at the end of October which gives the new minister of finance his first opportunity to adjust the official fiscal numbers. Much has changed since February and the market will be watching to see which direction the minister takes. We also have a change of guard at the Reserve Bank and the new governor will preside over her first monetary policy committee meeting in November. The communication from both these institutions will be closely watched for any change in policy. Inflation has slowly started to fall and we are now expecting CPI to remain in the low 6% range before breaking through the upper end of the band early next year. This should keep interest rates low for a while yet. Cash rates are now very low and bonds are offering a decent pick-up in yield. The 10-year bond is trading at 9%, giving a positive 'carry' of 2%. This comes with some risk in the form of increased issuance. Investors are thus torn between low cash rates and moderate inflation on the one hand and increased issuance on the other. We therefore expect bonds to remain range bound in the short term, before rallying next year as inflation breaks down into the band. The rand continues to participate in the risk trade, recovering from last year's extreme sell-off. If the local currency stays at around current levels for the next few quarters, it will have a positive impact on inflation and cause bond yields to rally further. There may then be a chance of further interest rate cuts. The rand remains one of the biggest risks - due to its extreme volatility it could drastically change the path of interest rates. We are therefore keeping the portfolio conservatively positioned, but still looking to benefit from the higher bond yields and the attractive credit spreads on offer.

Market and portfolio review
The Investec High Income Fund returned 1.7% over the quarter, outperforming the benchmark return of 1.4%, as bonds had a poor quarter and the yield curve steepened. The second quarter saw the short end of the cash curve and shortdated bonds rally aggressively, as the market anticipated a deeper and sharper rate-cutting cycle. Against the deteriorating domestic growth backdrop, the South African Reserve Bank (SARB) cut interest rates by 1% at both the April and May monetary policy committee (MPC) meetings. This brought total interest rate cuts to 4.5% since the start of the easing cycle. However, in June the SARB surprised the market by keeping rates on hold, signalling the end of the rate-cutting cycle (at least for now). During the quarter, the shape of the curve steepened somewhat with longer-dated yields driven up by concerns over increased bond issuance, while the short end rallied in response to the rate cuts.

Portfolio activity
The overall duration of the portfolio remained between neutral and slightly underweight throughout the quarter. We reduced duration into strength in April, adding duration again as yields climbed in May. Bank issuer and corporate spreads remained under pressure and we continued to take advantage of this. We selectively increased credit exposure by buying mainly floating rate notes at attractive spreads.

Portfolio positioning
We believe that inflation will remain sticky in the shorter term, with the possibility of surprising on the downside over the longer term. Interest rates are likely to remain on hold for now, but again the risk is that they are cut further. With the retracement in yields, we believe the curve is now more reasonably priced. For the moment, we continue to prefer the shorter end of the yield curve, but are looking for opportunities to add duration, particularly in the 3-5 year area. Despite being relatively neutral, the portfolio holds some mediumdated bonds and performance will lag should the short- to mediumdated area of the curve steepen. We have also continued to selectively increase our exposure to credit and are therefore vulnerable to a further widening in credit spreads - bank spreads in particular.

Market and portfolio review
The Investec High Income Fund performed broadly in line with its benchmark over the first quarter of 2009. The period under review was marked by aggressive interest rate cuts across the globe, as policy makers responded to a sharply slower global economy. Concerns of a domestic recession and the weak global backdrop moved the South African Reserve Bank (SARB) to cut interest rates by 100 basis points at both the February and March Monetary Policy Committee (MPC) meetings. The SARB surprised the market by increasing the frequency of MPC meetings to monthly and bringing forward the next scheduled meeting, effectively implementing an emergency meeting in March. The market interpreted the move to mean that interest rates would be lowered earlier than expected this year, and at a much faster pace than previously anticipated. Consequently, cash yields rallied aggressively, especially at the shorter end of the curve.

The bond market, however, was driven by international risk aversion and issuance concerns, causing the market to sell off and the yield curve to steepen. Long bonds posted large negative returns over the quarter and short-dated bonds underperformed cash.

Portfolio activity
We selectively increased overall duration through the quarter, which hurt the fund's performance. The duration on the cash portion of the portfolio reduced, as we preferred to invest in the 0-3 month area of the curve and add one-year floating rate notes.

We also continued to take advantage of the wide spreads in the corporate market, adding short-dated bank paper as well as some MTN and Steinhoff.

Portfolio positioning
Domestic data could continue to be disappointing and inflation could remain sticky on the way down. However, we believe that the South African Reserve Bank will focus more on growth than inflation and that there is scope for further aggressive interest rate cuts going forward. The market has moved to discount another 2.5% cut in rates from here. The bond market reacted to both global and local factors this past quarter. Global uncertainty and panic saw foreign investors sell our bonds, which pushed yields higher. The extra issuance from government and parastatals has compounded this sell-off and long yields are now back to September 2008 levels. We will continue to invest predominantly in the shorter end of the curve. The expected cuts in interest rates should, however, support the bond market and provide positive returns. Bonds are likely to outperform cash in the coming months.

The global uncertainty remains our biggest risk. Each time there is some panic, investors reduce risk by selling emerging market assets, including South African bonds. While this trade is close to being exhausted, there is still some risk there.

The portfolio continues to hold some bonds and will underperform should bonds underperform cash. We are selectively increasing our exposure to credit and are therefore vulnerable to a renewed widening in credit spreads and bank spreads in particular.

In October the global liquidity crisis caused a massive sell-off in equity markets and emerging market currencies. The global economy faltered and risk aversion reached record highs. This caused bond yields to rise sharply, as the rand sold off aggressively. The next two months saw bonds resume their bull run as yields collapsed well through September's closing levels. Global economic data deteriorated apace, and local South African data also pointed to a sharply slowing economy. The benchmark R157 finished the quarter just off record yield lows at 7.2%, while one-year cash yields fell to 9.8%. The shape of the curve also changed dramatically as the curve disinverted and normalised.

The All Bond Index (ALBI) gained 11.3% in the fourth quarter to end the year up 17%. The ALBI (1-3 year) Index rose 5.5% over the quarter and increased by 12.9% over the year. Cash, as measured by the STeFI, gained 2.9% over the three months to end December and 11.7% for the year.

The Investec High Income Fund's quarterly return exceeded cash, but lagged the ALBI (1-3 year) Index. The strong performance from the bond market added to the fund's returns. Despite spreads not contracting over the quarter, the higher yields earned on corporate issuance contributed positively to performance.

Portfolio activity
As risk aversion gripped markets in October and into November, we reduced the duration aggressively only increasing interest rate exposure again in December. We also used the volatility to take advantage of some shorter-term opportunities and slightly increased our weighting in corporate debt.

We continued to position for the yield curve to steepen, preferring the shorter end of the curve. Hence, we bought R206s over the quarter. The portfolio's exposure to floating rate bank paper was increased and we also added some credit-linked notes as spreads stabilised at wide levels.

Portfolio positioning
The market is still reeling from the effects of the global credit crisis and the dramatic economic slowdown. The level of risk aversion has declined from the extreme levels seen in October. However, market sentiment is still fragile and the full economic extent of the slowdown will continue to be felt in the coming quarters. Emerging markets such as South Africa will remain susceptible to recurring bouts of risk aversion, keeping the rand vulnerable and volatile. The South African Reserve Bank has begun to cut interest rates, with a modest 50 basis points in early December. As the huge scope of the economic slowdown has continued to manifest itself both locally and internationally, the domestic market has quickly moved to discount a full 4% of interest rates cuts in 2009.

Domestic investors have been a big driver of the rally in bonds, increasing their exposure to the asset class, while international investors remain underweight. Bonds are likely to be volatile in the coming quarter. They bounced off historic lows into year end and are likely to correct further with any renewed risk aversion, as that impacts the rand. Such sell-offs are likely to be short-lived, if the economic slowdown continues to gather momentum and growth and inflation forecasts are revised down further.

Our positioning is fairly neutral at present. However, we are still vulnerable to an aggressive sell-off in the rand if this leads to higher inflation, as well as to a renewed widening of credit spreads.