The listed property sector enjoyed an excellent recovery in the third quarter, producing a total return of 23.1% compared with -20.6% for the FTSE/JSE All Share Index. The sector is still ahead on a year-to-date basis (-11.9% vs. -16.6%), notwithstanding a 35% collapse between November last year and June this year.

The bond market and interest rate-sensitive sectors reacted positively to improved inflation expectations in the third quarter and the growing belief that the first cut in interest rates could be around mid-2009 - culminating in a total of reduction of some 2%. SA bonds have been stable, considering the turmoil in global financial markets and our local politics. This has served as an important underpin to the share prices of listed property stocks.

Many listed property counters have reported generally good financial results for the financial period ending June 2008. While most note the pressure on the retail sector, vacancies have not yet shown any material deterioration, but rental increases on expiring leases are not growing as aggressively. Conditions in the office and industrial sectors are holding up well. Distribution growth expectations have remained largely unchanged, slowing from 12%-13% in 2007 to 9%-10% over the next two years - notably continued positive real growth.

Listed property still offers attractive medium term value notwithstanding the substantial rally in July and August. The sector is attractively priced relative to bonds and assuming that the bond yields do not rise, investors in listed property could receive a return in the order of 15%-20% over the next 12months.

During the quarter, the fund reduced its exposure to SA Corporate, Acucap and Redefine, but increased its exposure to ApexHi and Fountainhead.

The listed property sector along with other interest rate sensitive sectors such as banks and retailers endured another poor quarter. Listed property returned -19.6% in the second quarter, taking the year-to-date total return to -28.4% compared with 6.4% for the All Share Index. The decline is principally because of the substantial deterioration in the inflation outlook and increase in interest rates rather than a material decline in property income growth prospects.

The virtues of the contractual nature of property income streams underpin our forecast for distribution growth to slow only slightly from 13% in 2007 to 9-10% per year over the next two years, before accelerating in year three. Already low vacancies are key, and while higher interest rates will have some negative impact on overall borrowing costs, it also serves to keep vacancies low by constraining development.

As prices decreased, listed property's income yield has risen and the sector now offers a projected yield (11.5%) above that of bonds (11%) with aboveinflation growth over the next few years. Prices have discounted a significant amount of bad news and listed property offers value for investors with a three- to five-year investment time horizon. Given the value, now is a bad time to sell listed property, but the sector could continue to be volatile until there are clear signs that domestic inflation has peaked and that the Reserve Bank's Monetary Policy Committee will stop raising interest rates. We expect inflation to peak within the next six months and interest rates before the end of the year. The fund increased its position in Pangbourne and reduced its holdings in several counters to raise liquidity in the second quarter.

The listed property sector fell 10.9% in the first quarter of 2008 compared with a 2.9% advance in the All Share Index. This performance must, however, be considered in the context of a rampant resources sector and weak financial & industrial sector (-7.2%).

Domestic macroeconomic factors together with global issues, rather than property specific issues, have been the cause of the poor returns. High fuel, food and commodity prices are global phenomena that continue to present significant inflationary risks. SA looks set to enter a sustained period of critical investment, especially by the public sector, that will most likely add to pricing pressure. Consequently, the cost of capital (debt and equity) is likely to continue to remain at current levels for the short to medium term. Listed property prices are expected to remain volatile in this environment for the foreseeable future.

Conditions in the physical property market remain supportive of another year of income growth of between 11% and 12%. Low vacancy rates and the increasing difficulty of developing new stock are key to keeping market rentals rising, albeit at an expected slower pace. Increased borrowing costs will pressurise income statements. Overall, we expect distribution growth to slow from 13% year on year in 2007 to around 11% in 2008, slowing to 10%- 11% by 2010 - importantly, still above inflation.

Notwithstanding some deterioration in fundamentals, listed property has already de-rated and offers attractive potential returns of around 20% over the next 12 months, assuming that bond yields do not rise further.

The fund increased its position in Pangbourne, iFour and Premium and reduced its holdings in Capital and Emira.

The listed property sector returned 26.5% in 2007, compared with 28.4% in 2006, and outperforming the All Share Index's 19.2% in 2007. The asset class eased 0.4% during the third quarter; a mild decline compared with the All Share Index's 3% fall.

Listed property experienced a roller-coaster year as inflation expectations and interest rates deteriorated. Listed property's strong income growth underpinned the continued rerating of the asset class relative to bonds. However, the sector is likely to be characterised by continued price volatility within the context of global market turbulence and sticky domestic inflation.

Conditions in the physical property market remain supportive of another year of income growth of between 11% and 12% - almost double the expected inflation rate. Property fundamentals are the best in decades, as supply is more constrained and rentals are rising. However, the rate of increase in rentals could face some resistance as the effect of higher interest rates takes hold. The retail sector remains relatively more vulnerable than offices and industrial space at present. However, retail's long term track record and the fact that the interest rate cycle is close to, or at, its peak means that we continue to have a favourable stance towards this property sector.

During the fourth quarter, the fund increased its exposure to Hospitality B to a maximum of 5% of the fund. The fund disposed of all its Sycom units to Hyprop in exchange for Hyprop and Resilient units. The fund also reduced its exposure to Growthpoint, Madison and Emira while increasing Acucap, Diversified and Pangbourne.