The All Bond Index produced a surprisingly positive performance of 1.9% for the quarter ended 30 September 2013, with the September return of 3.9% being the key driver of this short-term change in sentiment. The big sell-off in bond yields during May 2013 was caused by the announcement by the US Federal Reserve (the Fed) that they intend to start reducing their quantitative easing programme (QE). However, the market started to price in the likelihood that the end of QE will start during September 2013, and when that did not happen bond yields strengthened and our local bond market joined the global yield party.

During the past quarter the fund maintained its underweight modified-duration position, which would have detracted from performance during quarter. While bond valuations have improved, we still believe there is upside risk to bond yields in the short to medium term. The key drivers of our negative view on bonds are the sticky inflation problem; the wide current account deficit and widening fiscal deficit; worsening terms of trade; the volatile labour situation, in particular the mining sector strikes; and a very volatile free floating exchange rate.

While the South African yield curve remains steep, the relative attractiveness of yields in the 12+ year sector of the index remains a risk to our view. This sector of the bond yield curve produced the worst performance for the quarter at 1.5%, with the 3 - 7 year sector producing the best performance at 2.2%. The Barclays/ABSA Government Inflation-linked Bonds Index returned 1.2% for the quarter, another meaningful performance reversal compared to the previous month, but still underperforming nominal bonds. Credit spreads moved sideways to a slightly firmer position and, as a result we remain selective in terms of buying credit risky assets as credit spreads continue to tighten.

The fund positioning is in line with our investment view, which is to be underweight to fixed rate bonds.

The second quarter of 2013 was characterised by a significant turn of the tide as investors fled risky assets and the local bond market was not spared in the process. The All Bond Index lost 1.52% and 2.3%, respectively, for the month and the quarter ended 30 June 2013. A key driver of the changed market sentiment is the expectation that the US Central Bank will start reducing the size of their quantitative easing programme towards the end of this year. This has brought an abrupt halt to the search for yield that had been a key underpin to emerging markets bond yields for the past few years.

The fund has been underweight to modified duration since the last quarter of 2012, and we moved to maximum underweight modified duration relative to the benchmark over the past three months. This boosted performance considerably as the market weakened. Our reasons for being underweight are based on purely fundamental factors like our sticky inflation problem; the wide current account deficit and widening fiscal deficit; worsening terms of trade; the volatile labour situation, in particular the mining sector strikes; and a very volatile free floating exchange rate. While the South African yield curve remains steep, it had flattened considerably at the very long end. The 7- to 12-year sector of the bond yield curve was the worst performing sector for the quarter. The Barclays/ABSA Government Inflation-linked Bonds Index returned -4.9% for the quarter, significantly underperforming nominal bonds and cash. We sold our inflation-linked exposure at the beginning of the quarter into strength, which would have contributed positively to performance. In addition, we remain selective in terms of buying credit risky assets as credit spreads continue to tighten.

The fund positioning is in line with our investment view, which is to be underweight to fixed rate bonds.

The All Bond Index gained a respectable 1% during the quarter ending 31 March 2013, despite the continued negative domestic factors. Locally, we had the release of the annual government budget during February, which came out worse than expected. Despite this, there were no rating changes by the various rating agencies, even though the market reacted to the contrary. In addition, the new CPI basket was introduced and the initial CPI data releases point to some upward pressure in the short term. The current account deficit also continues to be a cause for concern as foreign flows into the domestic market are not sufficient to offset the size of the deficit. The global search for yield is providing some measure of support for local bonds, but we don't believe that this will continue indefinitely. The currency weakened significantly during the quarter, pushing convincingly through the R9.00/US$ level and remaining one of the weakest currencies globally. Bond yields weakened, with the yield of the 10-year generic government bond trading from a low of 6.762% at 31 December 2012 to end the quarter with a yield of 6.91%. The South African yield curve remains quite steep and is one of the steepest globally, thus keeping foreign investors quite interested in our market. The 7- to 12-year sector of the bond yield curve produced the best return during the past quarter, at 1.1%. The Barclays/ABSA Government Inflation- Linked Bonds Index returned 1.8% for the quarter, thus significantly outperforming nominal bonds and cash. We maintained our exposure to inflation-linked bonds during the quarter. In addition, we remain selective in terms of buying credit-risky assets as credit spreads continue to tighten.

The fund positioning is in line with our investment view, which is to be underweight to fixed rate bonds.