The fund experienced a positive return for September, which was a little less than the returns of the JSE Small-Cap and the JSE Mid-Cap Indices.
Although the fund had reasonable positions in some real winners during September 2006 (Peregrine, Datatec, Wilson Bayly Holmes and AECI), our two largest positions, Reunert (-5.6%) and Northam (-0.3%)both underperformed.
We remain comfortable with our position in Reunert, which is well exposed to benefit from the ongoing fixed investment spending program in South Africa and has lagged the general building and construction stocks over the last three months. Unfortunately for us, Reunert, as a result of the company's success, was recently incorporated into the JSE All Share-40Index, which means that due to restrictions in the fund's mandate we may no longer buy any additional shares, and should we sell any, we may not buy them back at a later stage. This means that our freedom to manage our position in the stock actively has been removed, which is disappointing. For now, we continue to hold the stock and look forward to the receipt of the recently announced special dividend of R2 per share as well as the publication of their financials for the year ended September2006.
We have positioned the portfolio aggressively to benefit from a depreciating rand, which has made a very positive contribution to the fund's performance since the end of the March 2006. More recently, although the industrial component of these rand-hedge positions has continued to work in our favour (such as Datatec, AECI and Bell Equipment), the Resource component, which is almost exclusively through direct platinum producers (Northam and Lonmin), has caused us some worry. The reason is the weakening platinum price, which has been offset as we expected by further weakness in the rand: US dollar exchange rate. For the time being we remain confident of enormous earnings and dividend growth out of these companies and the likelihood of significant share price appreciation. We expect that US dollar commodity volatility is likely to have an impact on the value of the shares in the short term, but that in the medium term the rand value of the commodities will drive the company's earnings and ultimately their share prices. Consequently, we retain our heavy exposure to this sector and our positive opinion (based on the supply versus demand fundamentals for platinum group metals over the long term) that their prices will be less cyclical than most commodities and more likely to remain high in US dollar terms.
We look forward to the final quarter of 2006 with cautious optimism.

The volatile market conditions that established themselves in May continued into June. This necessitates a more active and selective management style, which we are very comfortable with. We are pleased that it has contributed to performance in June and this was a much better performance than the JSE Mid- and Small-Cap Indices, both -5.9%, as well as the mean of the Small Cap Unit Trust Sector of -4.99.

Governor Mboweni raised the repo rate in early June under the pressure of rising international interest rates (in particular the conservative stance adopted by the American Central Bank authorities), weakening metal commodity prices and consequently an expectedly weaker rand exchange rate, and in the face of gradually mounting inflationary pressures. This is the first time that the Reserve Bank has made a change to interest rates since April 2005, and although not material in size, the important point is the change in direction and that the signal is that further increases, while perhaps not imminent, are likely. This is a negative signal for equity markets and likely to result in the market discounting lower rates of future growth in profitability as seen in the PE ratios of companies.

I feel very comfortable with the approach that we have adopted and implemented over the last two months - namely to limit our exposure as far as possible to illiquid companies, especially those that are particularly small in market-cap terms. We realised some of the profits on a few of our best performing rand hedges such as Lonmin and Mvela Resources in June, and invested the proceeds into some of the worst performing domestic financial and consumer stocks such as Ellerines, African Bank and Rainbow Chickens. Having said that, we continue to invest in quality rand hedge opportunities where they can be found in the mid- and smallcap industrial area. Recent additions include Datatec and more Bytes.

In line with the powerful bull market that continues to characterize the South African stock market, the fund had another good month relative to its peer group.

While we recognise the reality that we are in a momentum-driven bull market, as fundamental value-driven investors we are finding it increasingly difficult to find compelling investment opportunities. Although we remain fully invested, with cash at just over 2% at month end, we hold a variety of instruments that we consider quasi-cash -which provide a better yield than cash, but also provide the portfolio with protection in the event of share market weakness. These include Concor (subject to a take-over offer), Bidvest Empowerment Shares (which will be acquired at R60in December 2006) and Foord Compass Debentures, which are expected to generate an attractive yield and still offer some upside to their capital value. All combined, these cash and near cash holdings cumulatively make up 8.5% of the portfolio.

On the expectation that commodity prices are likely to remain at a high level for some time to come, supported by ongoing demand from the slower growing developed market economies as well as the fast growing, but already quite large economies of India and China, we have been progressively raising clients' portfolio exposure to Resource stocks. Because these companies usually have large market caps, the available universe for the fund is limited, but investors will find that through Northam and Lonrho Mining the portfolio is more than 10% exposed to platinum. While these companies typically display more volatility in their day-to-day trading patterns, we are confident of their earnings growth prospects. These growth prospects will be further supported by any rand currency weakness, which although unlikely to be extreme, we do anticipate. Through a variety of other smaller counters the fund has a total resource exposure of about 14%.

The industrial rand hedge component of the portfolio remains limited and was further rationalised with the disposal of Tiger Wheel, following the publication of a further set of disappointing results and bleak recovery prospects for at least the next year.

We find the local construction businesses totally over-valued and although we retain our investment in the sector's quality company WBO, we have disposed entirely of our Murray & Roberts shares for a 26% profit that were opportunistically acquired. We continue to prefer exposure to the much anticipated and hyped Fixed Investment spending deluge that seems must happen via Reunert and Altron.

The fund's unit price appreciated by a remarkable 7.2% in December 2005, which on an absolute basis would be considered extremely satisfactory. On a relative basis, however, we are a little disappointed to report that the fund marginally under-performed the All Share Index +8.1%, as well as the JSE Mid- and Small-Cap Indices +8.0% and +7.8% respectively. For the calendar year 2005, the fund returned nearly 33%.
As a result of the closure of the portfolio to new investors, the daily cash flows into the portfolio have slowed. We have consequently enjoyed spending the last month refining the fund constitution and reconsidering in depth the weightings and our levels of conviction of each of the holdings in the portfolio.
In that regard, although minor housekeeping was required on most of the shares we hold, the primary investment decisions taken were: to dispose entirely of Brait and Hudaco, add a new holding in Aspen and DAWN, and add significantly to our positions in City Lodge, Mustek, Northam and Sun International.
The market has clearly developed a sense of positive momentum and we have tried to remain as fully invested as possible in order to achieve maximum benefit from this reality. Although we have had concerns that many of the companies in which we are invested no longer offer the kind of compelling value that they did relative to interest rates and their growth prospects of 2 years ago, we nonetheless remain of the view that the equity market offers the most attractive value to domestic South African investors.
The New Year has started on a strong note with reports of reducing inflation and credit growth, combined with significant sales volume growth and swelling fiscal coffers. Expectations for an interest rate cut and substantial Fixed Investment growth run high and we remain invested for onward momentum in equity prices.