Sub-prime and local interest rate worries resulted in a volatile July and August for the listed property sector. However, this was followed by a steady rise in September. Overall, listed property produced an 8.3% return during the third quarter, compared with 6.7% for the All Share Index, taking the year-to-date total return to 27%.

The recent rally in bond yields, spurred by market hopes that we could be closer to the top of the interest rate cycle than previously thought, supported the latest rise in listed property prices. We would, however, caution that the risks to inflation remain on the upside and that short term capital gains could easily be eroded. Fortunately, investors in property are being rewarded with stable growing income streams that will underpin capital returns over time.

Property fundamentals are the best in decades as demand and supply dynamics favour landlords. Physical supplies are more constrained and rentals are rising with demand. Importantly, listed property companies should continue to produce an inflation-beating rate of growth in distributions in the region of 10% per year for at least another three years.

The fund completely sold its relatively small holdings in Siyathenga and Ambit and reduced its holdings in Growthpoint, Pangbourne and Capital during the third quarter. We managed to secure a meaningful stake in the very illiquid Premium and Diversified and acquired more Fountainhead, Resilient, Hospitality B and Emira.

The listed property sector experienced a tough second quarter, returning only 0.3% compared with the 4.3% of the All Share Index. The sector provided a year-to-date total return of 16% relative to the comparable period last year, similar to that delivered by the All Share Index (15%).

Bond and listed property prices were hit by a wide spectrum of worse than expected economic data leading to higher inflation expectations. The market has largely priced in another repo rate increase in August and further weakness is expected if this happens.

Listed property returns are being pulled by opposing forces. Short term capital movements are volatile and have been negative, but the underlying income streams from property companies are stable and growing. Listed property is a long term asset and return expectations should be shaped accordingly. Those with a short term outlook could be disappointed, but patient investors have the ability to buy secure growing income streams at lower prices.

Property fundamentals are the best in decades as demand and supply dynamics favour landlords. Physical supplies are more constrained and rentals are rising along with demand. Listed property companies could maintain an above inflation distribution growth rate of more than 10% per year for at least another three years.

The fund's weighting in SA Corporate, Fountainhead (previously known as Grayprop), Pangbourne, Madison and Emira rose in the second quarter. The largest one was SA Corporate because of its acquisition of SA Retail and a large property portfolio. The fund reduced its exposure to Sycom and Resilient due to unattractive relative valuations.

REVIEW OF Q1 2007

The listed property sector produced a strong total return during the first quarter compared with the FTSE/JSE All Share Index. This was despite a weaker performance in March as property reacted negatively to the rise in bond yields due to the increased probability of another hike in interest rates in April.

The underlying property fundamentals are more favourable than they have been in decades as demand and supply dynamics favour landlords. The abolition of the 9% pension fund tax rate and conservative fiscal budget support bond yields and listed property. The property sector continues to show strong distribution growth (in the region of 12% per annum) underpinned by increasingly scarce availability of well-positioned, zoned serviced land, high building costs, and rising demand for space. We believe that listed property companies could maintain an above inflation distribution growth rate of above 10% per year for at least another three years, given the strong fundamentals. The growth rate of certain listed property companies has also been given an extra boost through the distribution of non-rental related income - typically capital profits.

The fund increased its exposure to Hyprop, Grayprop and Growthpoint over the first quarter. We sold the remnants of our small holding in ApexHi B as we think that the counter will underperform as soon as the C units start to accumulate all the growth for a period of roughly two years. We took some profit in Redefine once the stock became fully valued in our view. The fund's exposure to Sycom decreased because of selling and price underperformance. Sycom has a quality portfolio but distribution performance has continued to disappoint. This underperformance could continue for another six to 12 months before showing signs of turning around.

The listed property sector markedly outperformed the All Share Index during the final quarter of 2006, with a total return (including capital and income) of 19% compared with 11.8%. Excellent returns were driven by a decline in bond yields and continued good distribution growth from the sector.

Oil, food, household consumption, the rand and the current account deficit remain key risks to inflation, but the strength of the fiscal budget is keeping the bond market short of supply and placing downward pressure on yields. This has been reflected in the inverted yield curve and bodes well for the property sector, which continues to show strong distribution growth. Good sector fundamentals lead us to believe that sector distribution growth could top 12% in 2007 as supply and demand dynamics increasingly favour landlords.

The SA Quoted Property Fund's performance improved over the last few months, but it still underperformed the index in 2006. However, the fund's performance relative to other property unit trusts improved during the year.

The fund experienced fewer changes during the fourth quarter. One of the biggest was to significantly increase our stake in Redefine. The fund also increased its position in Grayprop in December by about 1% to 6.5% of the fund.

The outlook for the property sector is positive for 2007, but property is a medium to longer term asset class and investors who buy property for its longer term capital gains based on income growth will be rewarded because property companies' earnings growth remains very healthy. The SA Quoted Property Fund is a fully invested, focused domestic property fund with comparatively low cash holdings.