During the past quarter the South African bond market as measured by the All Bond Index (ALBI) produced a return of 8%. Key drivers of the performance were inflation surprises to the downside; continued rand strength, a further cut in the repo rate, continued foreign flows into South Africa, and continued downside projections to global and local growth. The yield of the 10-year bond strengthened by 92 basis points (bps) during the quarter. During the quarter, we used market strength to reduce exposure to the bond market as we believe that most of the good news is in current yields. We especially reduced some of the overweight exposure in the 7-12 year area of the yield curve. We believe that nominal bond yields are expensive at present, and we will look for further opportunities to reduce exposure to this asset class.

Inflation-linked assets continued to perform well during the quarter. However, the asset class is trading expensively, and as a result we will not add to our existing exposure. We are now in a period of consolidation as the medium term inflation outlook as well as current demand/supply dynamics will continue to support real yields at current levels.

Our yield enhancement strategy continues to add positively to performance. We will selectively add to our existing non-government exposure in the fund, as we believe that this class of assets has certainly become less cheap in the past two quarters.

During the quarter, we had a recurrence of global risk aversion, as fears increased that global growth will remain low for a long time. Into this weakness we reduced the underweight bond position of the fund. However, we maintained its yield curve positioning - overweight in the 7- to 12-year area of the curve, and underweight in the 12-year+ area. During the quarter we started to buy inflation-linked bond exposure for the fund, although we were not able to achieve our target allocation as the market strengthened significantly soon after our first trade. However, the holding added positively to the performance of the fund. In the short term we still expect real yields to remain fairly range-bound. The introduction of the two new nominal, and two new real rate bonds during the quarter did not have any adverse impact on yields on the rest of the curve, as there was adequate demand from the market for these assets.

Our yield enhancement strategy continues to add positively to performance as we remain keen buyers of non-government, government-guaranteed and parastatal issues at current spreads, despite being relatively fully invested. During the quarter we did reduce exposures to some of our shorter dated credits as these assets did not add materially to the yield enhancement of the fund.

This past quarter produced the strongest quarterly return for the local bond market in more than a year. The market-positive data flow more than offset the negative funding story that currently persists. While the market had a very positive undertone due to the positive inflation trajectory in the short term, a major driver of bond yields during the quarter was the surprise 50 basis point (bp) repo rate cut by the South African Reserve Bank (SARB) during March 2010. The fund was underweight to modified duration during the period, and we used the strength in the market to increase the underweight tilt. In terms of the yield curve exposure, our underweight position in the 12+ area, and overweight position in the seven- to 12-year area, added positively to performance as the yield curve continued to steepen. We continue to look for short term trading opportunities, but on a longer term basis we will maintain our underweight bonds position because of our concerns regarding the longer term inflation outlook, particularly as it relates to services inflation. Our yield enhancement strategy continues to add positively to performance as we remain keen buyers of non-government, government-guaranteed and parastatal issues at current spreads, despite being relatively fully invested. The aim of our trades is getting the highest yield pick-up linked to the highest credit quality.

During the fourth quarter of 2009, we maintained an underweight bond position relative to the All Bond Index (ALBI). This proved to be a good decision as bond yields weakened and the yield curve steepened. The key drivers to this decision are the ever-worsening fiscal deficit and an inflation outlook with upside potential. In addition, we are at the bottom of the short rate cycle and expect no significant support from this market for the local bond market. We believe that, in the short term, local bonds will be rangebound and we will look for trading opportunities within our forecasted range. In terms of the yield curve, we remain underweight to the 12+ year area largely because new bond issuance will be concentrated in this area, and we anticipate further steepening as a result.

We are keen buyers of long-dated parastatal issues, although even here we are issuer specific. The aim of our trades is getting the highest yield pickup linked to the highest credit quality. The fund is relatively fully invested in credit assets at present. However, reinvestment risk is quite high during 2010, because of a large number of maturities. Thus, we continue to look for opportunities to acquire corporate debt at current spreads.