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.

The bond market weakened substantially over the quarter. The All Bond Index lost 4.9% over this period, while cash (as measured by the STeFI) returned 2.7%. The listed property sector took its cue from rising interest rates and higher bond yields, selling off aggressively to shed 19.6% in the second quarter.

Fund performance
The Investec Managed Fund returned 0.2% over the second quarter and gained 11.5% over the year to the end of June. The fund was ranked first in its sector over one and five years to the end of June (annualised returns).

We have reduced our equity weighting from close to 75% at times this year to a weighting of around 45%. We may well reduce this weighting further going forward. Our principal macroeconomic concern is stagflation (slowing growth accompanied by rising prices). Consequently, we are reducing equities and we are underweight bonds and property. We expect the bond market to weaken further. The investment environment is likely to remain difficult going forward. The one saving grace is that the equity market is not expensive. However, we would not be surprised if it remains cheap and returns are muted. Despite difficult market conditions, we should be able to achieve real returns (returns above inflation).

The rand strengthened by more than 3% against the US dollar over the quarter, which detracted from the returns of the international portfolio. We do not expect rand strength to continue. Our offshore exposure is concentrated in areas where we are not offered much opportunity in South Africa. British Gas is such an example. We are also owners of North American gold shares, which have a much better earnings profile than their South African counterparts.

We sold out of our Exxaro shares a month or two ago, which proved to be too early as the counter returned 26% in May. However, we have exposure to coal through Gloucester Coal in Australia.

Portfolio activity
We have used derivatives to help us reduce the equity exposure. The portfolio's offshore exposure was increased to 20% in line with the further relaxation of exchange controls. The portfolio is still underweight in bonds and we remain bond bears. We have no exposure to property.

Our weighting in Anglo American was increased over the quarter on the back of very firm earnings revisions. Indeed, this is the case with most resource shares. Commodity prices remain high and until the oil market sells off, this situation is unlikely to change. 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 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.

During the quarter we added to our position in steel counters. We reduced our holding in Barloworld on the back of negative earnings revisions post their results. The portfolio's holding in Standard Bank was further lightened as the earnings outlook continued to deteriorate.

Market outlook
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. 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, cash is fine and we find bonds unattractive.

Market review
Equity markets ended the first quarter sharply lower, driven by fears of a US recession, general risk aversion and a massive downward revision to earnings. The MSCI World Index declined by 8.9% over the quarter, outperforming the MSCI Emerging Markets Index, which closed down 10.9% (in US dollar terms). Global bonds saw strong absolute returns over the quarter, closing 9.7% higher over this period (in US dollar terms).

On the local front, bond yields succumbed to continued upward pressure on rising inflation, heightened risk aversion, a sharply depreciating domestic currency and potential further upside risk to monetary policy. The All Bond Index lost 1.9% over the quarter with the short-dated bonds anchored by uncertainty about the next policy move, while the longer end sold off on the elevated inflation outlook. Cash (as measured by the STeFI Index) returned a steady 2.6% over the quarter. Listed property remains under pressure from rising bond yields, rand weakness and some uncertainty with regard to income distributions as the economic outlook deteriorates. The sector lost 10.9% over the quarter, broadly in line with other interest rate sensitive sectors.

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
The Investec Managed Fund had a good first quarter. The fund returned 4.2% over the quarter and gained 16% over the year to the end of March. The Investec Managed Fund was ranked first in its sector over one year, three years, five years and ten years to the end of March (annualised returns).

The asset allocation with respect to the equity weighting was very active over the quarter, with the exposure to local equities varying from 47% to 60%. The offshore equity weighting varied from around 7% to 15%. Bonds weakened over the quarter and we have a minimal exposure to bonds. The property sector fell sharply and we have no exposure to this sector. We had up to 7% exposure to the gold exchange traded fund, which is classified as non equity. Whilst we are very fond of this instrument we took some profits recently as we believe that the gold price ran very hard over a short period.

The international allocation continues to add value. We keep the number of holdings confined to six or seven. The portfolio has exposure to the ongoing agricultural crisis through a holding in Potash Corporation of Canada and also locally through Omnia Holdings. We are excited about this area of investment although it is hard to find suitable investments. The international area of the portfolio is vulnerable to a stronger rand and we need to pick companies which can outperform in rand terms, even if the rand is strong.

Our overweight position in resources through holdings in Kumba Iron Ore, Impala Platinum and Sasol helped the performance over the quarter, as did our weighting in the gold exchange traded fund and our smaller position in the platinum exchange traded fund. The highly defensive attitude to global risk started to unwind towards the end of the quarter.

We struggled as banks rebounded and commodities sold off. However, we think that there is solid demand for commodities as reflected in the underlying inventory positions. The fact that commodities, which are not traded on broad indices, remained firm over the sell-off also suggests good demand for commodities. We have benefited from a weaker rand and think that the rand could remain in a trading range against the euro, as it has experienced a very sharp sell-off.

Portfolio activity
We reduced the local equity weighting early in the month, which helped to ease the pain of another highly volatile month. We were buyers of Barloworld on the back of strong earnings revisions. Our weighting in MTN was also increased. Growth looks sound as earnings revisions benefit from solid demand for the product and the weaker rand. On the offshore portfolio we nibbled at JP Morgan on their take out of Bear Stearns, at what we hope will be an exceptionally cheap price. We are also very bullish on the fundamentals for steel shares and are owners of Arcelor Mittal. We reduced our weighting in RMB Holdings, on the back of downgrade concerns and also lowered our weighting in Old Mutual due to a more negative outlook for developed world equity markets. The portfolio also took a few profits on Sasol. We traded a few SAB Miller from an oversold position. The portfolio's fixed-income weighting was lowered further.

Market outlook
At the start of this year we stated that 2008 would present a considerably murkier equity environment than what we have faced in recent years. The portfolio performed relatively well as the financial environment swung to one of increased risk aversion. The rand showed its true colours, demonstrating that it is simply a play on global risk. The local currency depreciated sharply against the euro and the dollar over the quarter. Chinese growth remained firm and commodities showed strength, allowing the resource sector to outperform 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. US CPI is running at 4.3%, European CPI is at 3.5%. Emerging economies who have pegged their currency to the US dollar are experiencing inflation problems. SA 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.

The fund has been re-classified from the Domestic- Asset Allocation- Prudential Medium Equity category to the Domestic- Asset Allocation- Prudential Variable Equity category. This has been approved with effect from 1 April 2008. The fund will keep its price and performance history.

Market review
Against a backdrop of substantial volatility and heightened uncertainty, global equity markets fared poorly over the final quarter of 2007. The Global MSCI composite lost 2.3% over the fourth quarter (in US dollars). Emerging markets held up admirably on the back of domestic currency strength and somewhat different local growth dynamics. The MSCI Emerging Markets Index gained 3.7% over the quarter (in US dollars).

Domestic equities came under pressure during the 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.

The local bond market focused on inflation data and the near term direction of interest rates. With inflation accelerating and the outlook for food and energy prices deteriorating, the bond market had priced in a fourth interest rate hike in 2007. The South African Reserve Bank's monetary policy committee statement leaned towards a peak in the interest rate cycle and the yield curve shifted down, retracing some of the earlier losses. The All Bond Index returned 0.9% over the quarter and 4.2% for the year. Cash (as measured by the STeFI) returned 9.3% for the year and 2.5% over the fourth quarter.

Fund performance
The Investec Managed Fund enjoyed top quartile performance over the month, fourth quarter as well as for the 12 months to the end of December. The fund gained 2.6% over the quarter and the 12 month return was 17.1% while the monthly return was -0.2%. The Investec Managed Fund is ranked second in its sector for the quarter and third for the year.

We had a short position on the futures market most of December, which helped to limit the downside from the equity market. The local equity weighting varied during the month, but remained below 60% most of the time. The fund also had 4% in the gold exchange traded fund (ETF), which is classified as non-equity. We are happy with the performance of the ETF, as it gives us additional exposure to gold, without the concomitant risk of buying a lot of expensive shares.

The international allocation continues to add value. We keep the number of holdings confined to six or seven. This area of the portfolio is vulnerable to a stronger rand and we need to pick companies, which can outperform in rand terms, even if the rand is strong. We have 15% allocated offshore, but only 7% of this is in equities. The rest is in cash.

Our overweight position in Kumba, Sasol and Murray and Roberts helped the performance over the month. Our weighting in the gold exchange traded fund and our exposure to the platinum exchange traded fund also contributed to performance.

The First Rand stable did very badly over the last month as downgrades to earnings revisions came through. We were fortunate to have sold quite a few shares. 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.

Portfolio activity
The fund's local equity weighting was reduced early in December, which helped to ease the pain of another highly volatile month. We were buyers of Anglos and Billiton into weakness last month. We believe that the Chinese inventories of base minerals are low and that the Chinese are likely to become buyers in the New Year. We sold our holding In Rio Tinto as we think that there could be a significant short squeeze on Billiton if they do not offer the ratio the market is pricing in for Rio Tinto.

We reduced our holding in RMB, due to downgrade concerns. The fund's weighting in Old Mutual was also lowered on the back of a more negative outlook for developed world equity markets. We also took a few profits on Sasol.

Market outlook
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.