Market review
The MSCI AC World NR Index returned -0.4% in dollars over the quarter. Emerging market equities underperformed developed market equities, with the MSCI Emerging Markets NR Index losing 8.1% over the quarter. The Citigroup World Government Bond Index (All Maturities) gave up 3% over this period. The All Bond Index lost 2.3% in rands over the quarter while inflation-linked bonds shed 5% from severely overvalued levels. Cash, as measured by the STeFI Composite Index, returned 1.3% for the quarter. Listed property ended the review period almost flat, having recovered May's losses with a bounce in June. South African equities ended almost unchanged in the second quarter, but volatility was high during this period. The sector laggards remain mostly confined to resource stocks with gold (-33.5%), platinum (-23.9%), coal (-10%) and diversified miners (-10.8%) all experiencing double-digit losses in rands. Year to date, the resources sector is trailing the overall market by 19.4 percentage points. Industrial stocks mostly held their ground over the quarter and defensive stocks, on average, achieved strong absolute returns. Financials lagged, with banks down 6.2% and life insurers flat for the quarter after a particularly weak June.

Portfolio review
The second quarter of the year required active asset allocation, with May producing positive returns. However, these gains were erased and turned into losses as markets came under pressure in June. It took comments from US Federal Reserve Bank Chairman Ben Bernanke to finally get bonds to trade at more "normalised" levels. Although we believe that the bulk of the sell-off has occurred for the bond market, we hold the view that bonds are expensive and yields should rise more from here. South African inflation is at the upper end of the Reserve Bank's 3%-6% band. A 3% risk premium above inflation would take us to 9% on long bonds. Inflation at 6% seems like a generous assumption. Wages only settle above that, and the rand remains vulnerable even though it has depreciated. South Africa has high financing requirements with large current account and budget deficits. Rising US long bonds will make financing more difficult. The benign environment for financing that emerging market governments around the world have benefited from is now under threat. The low risk premium that bonds have enjoyed seems to have come to an end. Property shares eventually sold off and we think a multi-year bear market is under way in listed property. We have been running a total equity weighting of between 55% and 65% for several months now. Although the market has risen for some months, the returns have come from specific shares and sectors, so a high equity weighting has not been beneficial. We are very underweight resource shares. During the quarter we were also very underweight South African banking shares and only increased our weighting to this sector in June. The portfolio has exposure to US financials, which are also cheap. The big difference is that the macroeconomic circumstances in the US are lending more support to these shares than is the case locally. We remain concerned about China on two fronts regarding the resource shares in the portfolio. Firstly, there is a problem in the banking sector that will have an impact on the demand for commodities. Chinese banking regulation is opaque. The rest of the world adheres or attempts to adhere to various regulations under the Basel framework on banking supervision. The situation in China is unclear. Most banking systems are moving towards Basel III, while progress in China has been slow. The second source of concern is that China is starting to supply more and more of the country's own commodity needs at a time where supply is still growing from Western countries. We are positioned for a multi-year bear market in commodity prices. The weakness in commodity prices is likely to weigh on the rand. Gold had its worst quarter in 103 years. Of course, the metal could bounce back from here, but we believe the primary trend is down. Gold is an asset where sentiment is crucial. This is due to huge stockpiles above ground. Just as prices approaching the $2500-level seemed difficult to justify, so will prices near $1000 be difficult to digest. We have no exposure to gold shares in the portfolio and less than 2% exposure to the gold exchange traded fund (ETF). The ETF holding has, in the past, been as high as 8.5%. Defensive rand hedge shares performed reasonably well over the quarter, but are now also subject to earnings downgrades in hard currency terms, as the earnings from emerging markets are marked down due to negative currency movements. We have taken profits on some of our SABMiller shares.

Portfolio activity
We further reduced our exposure to South African retailers during the quarter. While most of the companies are very well run, the tailwinds they have enjoyed are turning into headwinds. With hindsight, Marikana appears to have been the straw that broke the microlenders' backs. The country really needs employment growth, which is simply not materialising. Microlenders will find funding harder to secure so growth rates are headed down. This will affect most of the local retail sector. As mentioned earlier in our commentary, we further reduced our position in resource shares.

Portfolio positioning
We are neutral to underweight equities and underweight bonds. We have no exposure to property and have a maximum offshore weighting. Within the equity portfolio, we are overweight US banks and underweight South African banks. We are overweight non-resource rand hedges, as we remain concerned about the rand. Outflows from the local bond and equity market have barely commenced and funding the twin deficits in this environment will be onerous. It is hard to see the rand getting stronger unless there is a resumption of lower yields in the US or a return to infrastructure-led growth in China. Liquidity concerns in China and the prospect of quantitative easing being scaled back in the US mean conditions have become more challenging. Let's hope Europe continues to bumble along. As always, we will be watching the macro environment intently and following earnings revisions.

Market review
The All Bond Index gained 1% in rands over the quarter, while cash, as measured by the STeFI Composite Index, returned 1.2%. Inflation-linked bonds gained 1.8% and the local listed property sector rose by more than 9% over the review period. South African equities recorded positive but modest returns in rands over the quarter, with the FTSE/JSE All Share Index closing 2.5% firmer. The rand weakened 9% against the US dollar and more than 6% against the euro. The resources sector's underperformance continued into the first quarter with gold (-17.9%), platinum (-13.5%) and diversified miners (-6.3%) ending sharply lower. The combined financial and industrial index rose 6.2% over the quarter, with industrials in particular performing strongly. There was a wide dispersion of returns within the broad industrial sector. Rand hedge global stocks saw double digit returns, with SABMiller and British American Tobacco rising 24.7% and 18.4% respectively. Meanwhile retailers, favoured amongst foreign shareholders, dropped nearly 10%, despite a strong performance in March. Banks marginally underperformed the FTSE/JSE All Share Index, while telecommunications lost more than 7% and healthcare gained 8.8% over the quarter.

Portfolio review
The portfolio's equity weighting was reduced by more than 10% in February and we remain concerned about emerging markets. The search for yield was closely linked to good growth rates in emerging economies, but the situation has changed. Emerging economies are on average recording less buoyant economic growth with rising levels of inflation. Structural factors and a misallocation of resources are impeding growth. China's numbers look more favourable, but we remain sceptical about the quality of the underlying data. Emerging equity markets got trounced by the US and Japanese markets this quarter. We have one of our lowest weightings ever in domestic-oriented shares, while our offshore equity exposure favours the US. It is hard to get excited about European shares. They have moved higher; growth remains non-existent and problems abound. Japanese equities are soaring on quantitative easing and the market may run further. Demographics, however, are lousy and it remains to be seen whether reflation will be successful. Although the domestic equity market rose over the review period, it was not a case of a rising tide lifting all boats. The risk-on, risk-off trade of the last few years appears to be coming to an end. We believe it is essential to buy companies that are gaining market share. Revenue is not abundant, but costs are rising. In this environment a lower equity weighting seems beneficial. Given current conditions, we believe there is a greater likelihood of achieving a better risk-adjusted return with a lower exposure to equities.

Portfolio activity
During the quarter, we reduced our exposure to emerging market plays such as Truworths, AVI, Aspen, Vodacom and MTN. Earnings revisions are negative for most of these stocks. Our position in long-term portfolio stalwart Santam was cut back, due to negative earnings revisions and an unattractive valuation. We also reduced our exposure to European banks (that have done very well in the last six months) where capital demands are still onerous. We switched Adidas into Nike and took profits on BMW and SAP, reducing our weighting in Europe. The rand weakened significantly over the quarter and we lowered our weighting in local bonds. Investors have become concerned about the weaker rand and the prospect of higher inflation.

Portfolio positioning
We have a very low weighting in resource shares and no holdings in South African gold and platinum counters. The gold price needs a weaker US economy or an escalation of the North Korean crisis, to escape from the bears' claws. The North Korean threat will hopefully be averted, and we will closely monitor the economic situation in the US. The high cost structure of the South African mining industry means that rising commodity prices are imperative to success. Labour negotiations are coming up and unlikely to be easy. The portfolio is overweight rand hedge blue chip shares. Our budget and current account deficits require substantial funding and we believe the rand will remain weak. Japan's quantitative easing programme is the wild card in the pack. This policy could bring the carry trade back into vogue, which could bolster the rand. We are underweight South African financial shares as we believe consumers are under pressure. Micro lenders are tightening lending criteria, and rising inflation is ensuring that consumers remain stressed. With the exception of FirstRand, banks' earnings revisions are flat to negative. We hold Woolworths in the consumer space, as the company benefits from its focus at the top end of the economic spectrum. We also have some exposure to Mr Price, which is largely a cash business. We are underweight South African government bonds. While growth is lacklustre, inflation is at the top of the band and the Reserve Bank is very dovish on inflation. The budget was a case of 'wishful thinking' and it is hard to see the budget deficit being achieved. We believe that 2013 is going to be more challenging than 2012. Markets have rerated and earnings need to be delivered. Growth is not abundant. Still, select equities look like the most attractive investment class. Our portfolio is positioned for a weaker rand and we are alert to dynamics that could affect the value of the local currency.

Market review
Risk assets seemed to shrug off continued concerns about the fragile global economy, with equity markets posting strong returns over the last quarter of 2012. The MSCI World Index added 2.6% in US dollars over the quarter, with Germany (+8.1%), France (+11.6%) and the emerging market composite (+5.6%) showing particularly strong gains. The FTSE/JSE All Share Index (ALSI) ended the year at record highs, adding just shy of 27% in rands to the modest gains of 2011. The ALSI rose by 10.3% over the quarter. The SA bond market saw strong returns over the year, closing 16% higher. The All Bond Index added 2.6% over the quarter. On the back of falling bond yields, the local listed property sector did particularly well, rising by 35.9% over the year and 2.8% over the quarter. The year's gains were largely thanks to a significant rerating in the sector, rather than strong growth in distributions. Cash, as measured by the STeFI Composite Index, returned 1.3% over the quarter.

Portfolio review
The Investec Managed Fund had another successful year and quarter, thanks to a material weighting in equities and good stock selection. The stealth bull market in equities continues, with equities now delivering superior returns to bonds over most periods after 2008. However, in both local and international markets, flows are still going to bonds. In 2012, South Africa recorded around R90 billion of inflows into the bond market and modest outflows from equities. Investors are paying too much for safety, while select equities offer attractive risk-adjusted returns. We expect modest inflows into equities in 2013. The tussle between flows and reality continues. In a zero interest rate environment investors are desperate for yield. This is leading the market to fail in its role as a disciplinary force for policymakers. Politicians are not being suitably punished for investor-unfriendly policies. The craving for yield is allowing governments to get away with conduct that would not have been tolerated in the nineties. Although there are numerous worries plaguing the world, there have been some positive developments such as the political leadership changes in France and Italy and the appointment of Mario Draghi as European Central Bank President. The US fiscal situation will in all likelihood lead to a series of quick fixes and this pattern will probably continue for the next 20 years! Indeed, equity returns were not supported by earnings revisions, but by exceptionally low bond yields. Growth remains the scarce resource.

Portfolio activity
Top line growth is our first prize in equity selection. A rising tide is no longer lifting all boats and there is an increasing divergence in performance within sectors. Winners are often found where large players in the market are floundering and more nimble companies can increase their market share. Woolworths is an example of a winning stock that has contributed to the portfolio's returns over the year and quarter. The company has been well positioned, while Edgars and Pick and Pay are struggling to maintain their market share. We have also added some construction exposure through Wilson Bailey over the quarter. We favour BHP Billiton in the commodity space, and the FirstRand stable within the banking sector. Where there is no top line growth, cost-cutting is imperative. A trend we have seen in the commodity space is for market leaders such as BHP Billiton and Rio Tinto to reduce capacity by selling lower quality assets to governments and the Chinese. While this makes sense on a company specific basis, supply will remain on the market and prolong the commodity bear. Essentially, assets are being transferred to players whose primary objective is employment not profit. In the medium term, it would be better if these inefficient mines were closed.

Portfolio positioning
Given that yields are near all-time lows and deficits are high, it is difficult to justify being overweight government bonds. The bond market is complacent about inflation possibly breaching the target band. We will continue to favour shares with positive earnings revisions, supported by good dividends. Within equities, the portfolio is overweight rand hedge shares. The current account deficit is enormous and we do not think it is prudent to rely on investment inflows of R90 billion into bonds to finance this. Additionally, equities will do better than bonds in a weak rand environment. There are likely to be further retrenchments in the mining sector over the next few years, and there is a high probability of further social turmoil. We have exposure to retailers in South Africa, as top line growth is good. Our local bank exposure is supplemented by offshore holdings, as the companies are cheaper and earnings revisions are improving. The regulatory environment is becoming more realistic. We believe that stock selection based on dominating macro trends could lead to good performance. In an environment of deleveraging, which is likely to prevail for the rest of the decade, companies that can benefit from the scarce growth opportunities could trade expensively. Cheap shares are likely to keep getting cheaper. It will take time to resolve the larger economic concerns and the market will move forward very slowly.