The Fund returned 1.9% for the month with long bond yields strengthening from 8.46% to 8.16% during September.


(PIX inflation is currently higher than the upper end of the 3% to 6% inflation target and is forecasted to remain above the target until the middle of 2008. The main contributors to inflation are food and energy prices. Both of these are cyclical - if food and oil prices remain at current levels inflation will drop to well within the target within the next year. In our opinion, SA long bonds are currently appropriately priced relative to long-run inflation expectations. The current levels on our long bonds also appear appropriate relative to global developed market bond yields. The SA 10year bonds trade at a yield of approximately 3.75% higher than the equivalent US bond.

Yields on high-quality corporate bonds relative to government bonds remain high. South African swap rates, which are an indicator of the rates at which local banks can fund themselves in the long term, also remained at historical highs relative to government bonds. These high spreads are consistent with the global credit markets where concerns about the US sub prime mortgage market has resulted in the repricing of corporate debt.

We believe that the current yields offered by certain corporate bonds in the SA market more than compensate for the associated credit and liquidity risk. We participated in a new eight-year Nedbank subordinate debt issue at a yield of 1.8% above the equivalent government bond.

Long-bond yields weakened from 7.54% to 7.77% during March. CPIX for February eased to 4.9% which was below consensus expectations. However, fears of another 0.5% repo rate in April have not abated. According to the forward rate agreement curve, the rates at which future deposits are contracted, three month deposit rates will be slightly higher in three to four months' time.

There are currently concerns in the US market about "sub-prime" mortgages and their impact on mortgage backed securities. Sub-prime mortgages are the lowest quality mortgages being extended in the USA market. Often the borrower is not required to, and does not have the financial means to service the full interest bill on his mortgage. The borrower usually has to rely either on mortgage rates to decline over time or the mortgaged house's price to rise, in order to service his debt. Neither of these are currently happening in the US. Often these mortgages are packaged into mortgagebacked securities and sold to investors. Currently the holders of the equity tranche and the lowest quality fixed income tranches have serious concerns about their investments.

We do own a number of South African mortgagebacked securities in the portfolio, for example the Thekwini (SA Homeloans) issues and Blue Granite (Standard Bank) issues. As opposed to the US, these mortgage books have on average very conservative loan to value as well as payment (monthly service cost of the borrowers) to income (monthly income of the borrowers) ratios. Furthermore, we currently only hold the highest rated AAA tranches of these securitisations, which do give investors a lot of protection in the case of defaults in the underlying portfolios.

Due to bad debts the SA Land Bank has announced that it requires considerable support from government to service its obligations. Even though the Land Bank's official credit rating of AA- signifies a very high credit quality, our rigorous analysis did not agree with this and the portfolio has no exposure to Land Bank debt.

During the past month Toyota, ABSA, Imperial. Eskom, ACSA as well as Private Commercial Mortgages issued new, fixed-rate bonds. We only participated in the ABSA seven-year issue (AB07) at a yield of 1.1 % above that of the equivalent government bond.

As from next month the Total Expense Ratio (TER) will be published.

The Fund returned 1.8% during December compared to the 1.5% of the All Bond Index. The yield on the R157 long bond strengthened from 8.02 to 7.85 during the month. Both headline inflation at 5.4% and CPIX inflation at 5.0% were below consensus expectations for the year to November 2006. The Reserve Bank still forecasts that the 3% to 6% CPIX target will be breached in the second quarter of 2007 after which CPIX inflation will move back down to within the target range again.

The yield curve remains inverted with the shorter-dated R194 bonds yielding almost 1 % more than the longer-dated R157 bonds. The shorter-dated bonds are priced relative to shorter-dated inflation expectations as well as cash rates. However, the fact that the yields on longer-dated bonds are lower, does signify a market belief that the inflation target of the Reserve Bank is achievable in the long run. The yields at which forward-starting deposits are trading currently reflects a market belief that the repo rate will remain on hold during the February meeting of the Reserve Bank's Monetary Policy Committee.

Relative to US long bonds yielding 4.7%, South African long bonds, at an approximately 3% higher yield appear to be fairly priced. Currently, the Fund holds a neutral duration, in other words, no strong directional views in bond yields or interest rates are embedded in the investments.

During December Metropolitan Life issued subordinate corporate bonds carrying a credit rating of A. The Fund participated in the issue as the bond was issued at a yield of 1 .28% higher than the equivalent term government bond.