Market review
In May the markets were spooked by the possibility of sovereign default by the one of the PIIGS (Portugal, Ireland, Italy, Greece and Spain). The ensuing risk aversion led to a sharp sell-off in the euro and other risky assets. Governments in Europe responded by promising to cut deficits, which would further jeopardise the recovery. The local bond market sold off on the back of the softer currency and weak emerging markets in general, but by the end of the month bonds had bounced off their worst levels. Over the quarter, longer-dated bonds underperformed cash, while shorter-dated bonds fared better, matching cash returns. The All Bond Index (ALBI) returned 1.1% over the quarter, while the ALBI (1-3 year) Index delivered a 1.8% return. Cash gained 1.7% and listed property rose 0.6% over this period. Year to date, listed property remains the best performing asset class (10.6%).

Portfolio review
The Investec High Income Fund outperformed its benchmark over the quarter. The fund was also ahead of its benchmark for the 12 months to the end of June. We continued to have an underweight position in the 1-3 year area of the bond curve, favouring the 3-7 year maturities and this added to outperformance for the quarter. The higher yield of the credit portion of the portfolio also contributed to the overall performance of the fund. Money market yields edged lower through the quarter and the money market curve flattened a little. Funding spreads have narrowed slightly over the period, but still offer an attractive pick-up over three-month Jibar and this continues to add to performance.

Portfolio activity
The medium- and long-dated bonds sold off over the quarter, while the shorter-dated bonds were largely unchanged. We maintained our small overweight overall duration position in the shorter end of the curve. Although constrained by credit limits, we continue to expect credit to outperform and look to maximise the credit spread on the portfolio. We purchased some medium-dated high quality floating rate notes.

Portfolio positioning
Economic data released at the beginning of the quarter pointed to a strong recovery, with the Purchasing Managers Index well above 50 and vehicle sales growing at a +30% rate on a year-on-year basis. However, as time passed activity data started to moderate. Credit growth has stabilised but remains relatively weak, raising concerns about the sustainability of the recovery. The South African Reserve Bank kept interest rates at record lows, signalling that it is more concerned about the strength of economic growth than any upside risk to inflation posed by wages or administered prices. Fundamentals for the bond market remain sound. Inflation is surprising on the downside and the fiscal picture is improving with expenditure coming in below budget. The release of the South African Reserve Bank Quarterly Bulletin revealed a strong bounce in household consumption, underpinned by robust real income growth. Fixed investment was weak, but the economy is forecast to grow by around 3.2%. The theme for the bond market remains unchanged; rates will stay lower for longer. Not only are local fundamentals supportive, but the shaky fiscal position of developed markets is resulting in large flows into emerging market assets. Yields on South African bonds stand out as being particularly high when compared to other emerging markets of a similar credit rating. This should help South Africa attract its fair share of portfolio flows. We will continue to keep the portfolio relatively conservatively positioned, while still looking to benefit from movements in the bond yield curve and the wide credit spreads on offer.

Market review
The South African economy is showing signs of recovery. Year-onyear comparisons indicate strong gains across most categories, boosted by very weak economic activity at the start of 2009 when the recession was in full swing. Large-scale job losses have abated, while manufacturing activity has recovered strongly off a low base. The current quarter's growth rate should further support the view that the local economy remains on the recovery track. With leading indicators at or near their peak, pointing to a more moderate second half, growth estimates for the year as a whole remain below 3%. The National Treasury will continue to focus on fiscal restraint. The collapse in tax receipts, coupled with the high public spending bill on existing projects, has placed substantial pressure on government's funding requirement. The budget deficit of just below 7% of GDP for this past fiscal year is estimated to fall to less than 4% by the 2012/2013 financial year. The South African Reserve Bank's monetary policy committee's decision to cut the repo rate to 6.5% provided a welcome boost to indebted consumers in March. Greater certainty about electricity tariff increases, slowing inflation and the negative impact of a strong rand on the economy's competitiveness were all cited as factors warranting a further cut in rates. The All Bond Index (ALBI) returned 4.4% over the quarter, well ahead of cash. The listed property sector added nearly 10% over this period.

Portfolio review
It was a very good quarter for bonds which easily outperformed cash. Although shorter-dated bonds did not perform quite as well as the medium to long end of the bond curve, the ALBI (1-3 year) Index still delivered a 2.6% return. For the three months to the end of March, your portfolio performed in line with its benchmark. Over a full year the portfolio was ahead of benchmark, gaining 8.6%. We have maintained our strategy of underweighting the expensive 1-3 year area of the bond curve, favouring the 3-7 year maturities and this added to returns. The higher yield of the credit portion of the portfolio also contributed to the overall performance of the fund. Money market yields, which had been largely unchanged for most of the quarter, dropped sharply in March to reflect the unexpected rate cut. Funding spreads remained wide, giving an attractive pick-up over three-month Jibar and this also added to returns.

Portfolio activity
During the quarter, the bond curve steepened a little. We maintained an overweight overall duration position for most of the review period, before taking some profits in the final week or two. Although we remain constrained by limits, we are still looking to maximise the credit spread on the portfolio yield, purchasing medium-dated creditlinked notes and bank paper with attractive spreads over three-month Jibar.

Portfolio positioning
Our below consensus inflation view is beginning to play out and we expect inflation to continue to surprise on the downside over the next couple of months. We anticipate that inflation will fall to the middle of the band by mid-year and then remain well behaved for the remainder of the year. Although it is not our central case, this benign inflation outlook, combined with relatively modest growth prospects and a large output gap, means that a further surprise rate cut cannot be ruled out. There will be little pressure for the repo rate to rise until early 2011. The recent improvement in the mix between government revenues and expenditure has lifted some of the funding pressure on the market. However, issuance is still heavy and is likely to remain an impediment to any further significant bond rally. The global recovery continues to unfold in a benign manner, favouring risk assets, including broader emerging currency and asset markets. We expect the rand to remain relatively strong as flows to emerging markets continue to underpin the local currency. This further supports our view of lower inflation and modest growth. However, the volatility of the rand remains one of the biggest risks to our outlook on the fixed income markets. We will continue to keep the portfolio relatively conservatively positioned while still looking to benefit from movements in the bond yield curve and the wide credit spreads on offer.

Market review
In sync with other commodity currencies, the rand regained its composure in 2009. Record capital inflows and higher commodity prices fuelled a 28.7% gain against the US dollar. 2009 was not a good year for bond markets, reversing some of their gains of the previous year. Bond prices fell in 2009 as economies recovered and the cost of massive fiscal and monetary stimulus started to hit home. The increase in bond issuance over the next few years and large fiscal deficits will keep the pressure on bond markets. Offsetting this over the near term, will be the improved domestic inflation outlook and expectations of growth below the historical average. The All Bond Index (ALBI) lost 1% over the year, but marginally outperformed cash over the second half of 2009, gaining 4.1%. In the fourth quarter, the ALBI returned 1.1%, underperforming cash. The listed property sector showed some resilience in a very difficult trading environment, gaining 4% in the last quarter to finish the year 14.1% higher.

Portfolio review
2009 was a disappointing year for bonds. Short-dated bond yields were anchored by low cash rates, with the ALBI (1-3 year) Index returning 7.7%. The long end of the market sold off dramatically, steepening the curve by close to 200 basis points. Your portfolio marginally underperformed its benchmark over the quarter. We maintained our strategy of underweighting the expensive 1-3 year area of the bond curve, favouring the 3-7 year maturities and attractively priced credit exposure. The higher yield of the credit portion of the portfolio contributed to the overall performance of the fund, while some further tentative credit spread compression also helped. The exposure to the 3-7 year area of the bond curve detracted from performance over the quarter as the curve steepened slightly. Money market yields were largely unchanged to slightly higher over the quarter. However, funding spreads remained wide, giving an attractive pick-up over three-month Jibar, which also added to outperformance.

Portfolio activity
Three-month cash yields moved some 20 basis points higher to 7.22%, as the market discounted the end of the interest rate cutting cycle, while the one-year area of the curve stayed flat at around 8.20%. The bond market although largely range bound, steepened slightly with the short-dated bonds anchored by cash rates and the long end still concerned with increased government issuance. Although overall duration remained unchanged throughout the quarter, we continued to favour the 3-7 year area of the bond curve and attractively priced bank floating rate notes in the money market space. We continued to selectively increase the credit spread on the portfolio yield, purchasing medium-dated credit-linked notes and bank paper with attractive spreads over three-month Jibar.

Portfolio positioning
Despite base effects that will push inflation higher over the next couple of months, we expect inflation to fall to the middle of the band by mid-year and to remain well-behaved for the remainder of the year. This together with a relatively modest growth outlook and a large output gap means that a further rate cut cannot be ruled out and that there will be little pressure for the repo rate to rise until early 2011. Increased government and parastatal issuance remains one of the biggest constraints on bond market performance. With budget day approaching, the market will remain focused on government finances and the size of the deficit. This is likely to keep the yield curve steep and limit the magnitude of any rally in bond yields. As the global recovery continues to unfold in a benign manner, it is likely to favour risk assets, including emerging markets and the rand. The local currency is likely to remain relatively strong as flows to emerging markets continue, albeit at a reduced pace to last year. This supports our view of lower inflation and modest growth, but as always, the volatility of the local currency remains one of the biggest risks to our outlook on the fixed income markets. We will continue to keep the portfolio relatively conservatively positioned, while still looking to benefit from the positively sloped yield curve and the attractive credit spreads on offer.