Market review
The market continued to be volatile in the second quarter, driven mostly by rising inflation and the negative outlook for interest rates. Inflation has exceeded most analysts' forecasts as key inflation drivers such as food and fuel have been difficult to forecast. Eskom's annual electricity tariff hikes are also likely to add to local inflationary pressures and further increases in interest rates. This in turn will continue to negatively affect the South African listed property market due to the correlation between interest rates and listed property.

The SA Listed Property Index (SAPY) continued to deliver a negative performance, returning -19.6% over the second quarter of 2008. This followed the first quarter's performance of -10.9%. SAPY's performance for the 12 months to the end of June was -22%.

Most interest rate sensitive sectors (retail, banks, property) locally and globally came under pressure in the second quarter. The strength in the commodities sector helped the All Share Index to achieve a positive return of 3.4%. Cash continued to be the best investment in this volatile environment. The SAPY forward yield weakened to 11.65%, a level which was last seen early in 2003.

Fund performance and portfolio activity
The Investec Property Equity Fund (IPEF) continued to deliver returns above the SAPY benchmark. The fund comfortably outperformed the benchmark over three, six and twelve months to the end of June, delivering total returns of -17.2%, -24.3% and -16.7%, respectively. Over these periods, the benchmark returned -19.6%, -28.4% and -22%, respectively. For the three years to the end of June the fund gained 17.4%, outperforming the benchmark's 14% return. The IPEF has also performed well against its peers over the comparable three year period, which has included bull and bear markets.

The cash position of the fund, at around 16%, remains high. Stock selection has played a significant role in the performance of the fund with the IPEF having overweight positions in better performing stocks such as Resilient and Hospitality-B. The IPEF has overweight positions in stable stocks Madison, Redefine, ApexHi-A and ApexHi-B, which have generally been laggards in the sector over the reporting period.

Market outlook and portfolio positioning
Some of the largest property stocks (by market capitalisation) are to be included in an EPRA/NAREIT emerging market index from July 2008. 'Candidates' are likely to be Growthpoint, Fountainhead, ApexHi-A and ApexHi-B. It is estimated that approximately €250 million tracks the EPRA/NAREIT index and a small allocation to the emerging market index will result in new cash flowing into the sector.

The listed property sector is showing more value than it has in a long time, but we are proceeding with relative caution. Listed property is a more tradable and developed asset class than it was historically and therefore is increasingly sensitive to market movements. Global market volatility is likely to continue, contributing to fluctuations in share prices. Some stocks that may benefit from the current environment include externally managed listed property companies where fees are based on enterprise value (market capitalisation + long-term debt). Lower share prices imply lower asset management fees and therefore higher distribution growth. Some companies' June results could exceed expectations. We have adjusted our forecasts and are positioning our portfolios accordingly.

In a very volatile market with an unusually high volume of external local and global market influences, timing is, as usual, more challenging than identifying the opportunity. The market expects the Reserve Bank to hike interest rates in August. Eskom's recent electricity tariff hikes are still to be accounted for in the consumer inflation numbers. We shall continue with our conservative strategy of being overweight cash in the current market despite the sector offering medium- to long-term value, relative to other asset classes. Listed property's potential for income growth over time, means that the sector should perform better than cash and bonds, which are trading at similar yields

Market review
The SA Listed Property Index (SAPY) dipped in the first quarter of the year, driven by the negative outlook for interest rates and inflation, local economic woes and turbulent global markets. Other interest rate sensitive sectors such as the financial, retail and construction sectors were also heavily affected. Investors across the globe have become more risk averse, even selling out of sectors with a high degree of income certainty, such as listed property.
The SA Listed Property Index delivered -10.9% over the first quarter and -2.6% for the 12 months to the end of March 2008. The sector was heavily oversold in January, delivering -11.2%, but showed some respite in February by being up 4.5%. March was another poor month, with the SAPY delivering -4%. The volatility in the sector has increased substantially, mainly as a result of global markets, the United States in particular.

Fund performance and portfolio activity
The Investec Property Equity Fund (IPEF) continues to be managed conservatively by retaining its high cash position. This has resulted in the fund still delivering returns above its benchmark, the SAPY, by a comfortable margin over three, six and 12 months, as well as over three years. The fund delivered total returns of -8.6%, -8.2% and 1.4% over three, six and 12 months respectively, compared with those of the SAPY, which were -10.9%, -11.3% and -2.6% over the same periods. Over three years, the fund's return of 29.5% per annum outperformed the benchmark's 27.2% return as well.

The cash exposure in the fund dropped slightly over the quarter from 16.82% to 16.09% due mainly to repurchasing. The fund limited its trading after being repositioned in November. However, buying opportunities were taken by increasing the fund's exposure to Resilient and Octodec when share prices became attractive during the last quarter. The fund lightened its exposure to Diversified after Resilient announced that it may consider making a firm offer for the company. The chart below shows the total returns of the IPEF against the SAPY over three, six and 12 months to the end of March 2008.

Market outlook
The International Property Databank (IPD) results for 2007 showed total returns from the SA direct property market of 27.7%. These are the highest returns for 2007 from the 11 out of 27 countries that reported their figures. South Africa is seemingly only one of four countries that reported results that were up on the previous year. The retail sector lagged, delivering 26%, office gained 30.8% and industrial delivered the highest return at 33.6%.

2007 marked the latest in a series of strong returns riding the property boom. Capital growth is still robust, driven by high-income growth. The retail sector has been the first to dip, with yield compression slowing, but capitalisation rates remaining steady. The industrial sector is still strong, underpinned by low vacancies and good fundamentals in a market with supply side constraints. The office sector is returning to a period of low vacancies and increasing rents.

The key issues going forward are the market's reaction to new supply coming online in the future, and generating returns in a high interest rate and high inflationary environment. Another factor that could lead to continued returns is the electricity shortage. Eskom has indicated that it could limit or delay future developments due to its inability to supply power. This could play into the hands of landlords, especially in the office and industrial markets, which could result in an increased demand for space with power.

Based on the surprisingly high IPD income growth of 17.6%, listed property companies performed poorly. Our estimate of the average year-on-year sector annuity income growth is 13%, including gearing benefits. There was obvious growth leakage from higher management company fees on share price appreciation. There may also have been dilutive acquisitions and other activities (including BEE, staff incentives, etc).

The listed property sector seems to be heading towards mega funds as corporate activity has increased. The potential merger of Apex Hi, Redefine, Madison and Hyprop could be on the cards, as well as the acquisition of Diversified by Resilient. We support corporate action as long as it adds value to the portfolio. Our total return expectations are muted for this year, but could surprise on the upside, based on improving economic fundamentals and a more favourable outlook towards the latter part of the year.

The domestic listed property index declined by 10.9% over the quarter, as the reality of higher interest rates and a fast declining consumer economy set in.

The fund had been more defensively positioned, as mentioned in the previous quarterly review, and declined by 8.4% over the quarter. The fund benefited from the holding in Liberty International, which added significantly to performance over the period as the currency weakened. The share is still down over the past year though, and we continue to believe that the share is very attractively valued in an environment of huge pessimism to property in the UK. We still hold the maximum 10% permitted.

The A shares in the portfolio also proved to be more defensive, with ApexHi 'A' declining by only 5% over the quarter, and Hospitality 'A' shares up by 4%. These two counters jointly make up 13% of the overall portfolio. The two main detractors from performance over the quarter were Acucap and Resilient. We continue to believe that both counters offer good value for the long term. There were few transactions over the quarter - wee reduced the holding in Growthpoint, sold out of Hospitality 'B', and sold some of the Liberty International as the weighting increased above 10%.

We believe that domestic listed property is again offering reasonable value, after declining by as much as 18% since the peak in November last year. The forward yield of 8.9% is now more in line with bond yields (which now look more realistic after the recent rise), and above-average distribution growth is still expected for the next 2 to 3 years. Interestingly, share prices are now more or less in line with published NAVs, which are no longer lagging market reality as significantly as they did before.

Consolidation is on the increase, as expected, with announcements made in the Resilient stable and also the Madison group of companies, comprising Apex Hi, Redefine and Hyprop. We will be actively involved to ensure that deals proposed are in line with unit-holder interests, and that take-out prices reflect long term value for unit-holders in the respective companies we own.

Our big theme in the fund remains one of a focus on quality, which we believe will continue to add value in the current uncertain environment. There are a number of lower quality properties in some of the listed counters, which may come under pressure in the tighter economic environment that we have entered. At the time of writing we await an MPC interest rate decision which could be quite detrimental to the economy if market expectations of a further increase are met. Positions in the fund thus remain very concentrated, with a focus on quality and defensiveness, which should prove of some value going forward.

Edwin Schultz
Portfolio Manager

Market review
The SA Listed Property Index (SAPY) continued to deliver superior total returns in 2007 and relative to the general equity market. The sector managed to gain 26.5% for the full calendar year, outperforming other asset classes over the longer period.

After a strong third quarter total return of 9.5%, the fourth quarter slowed down. There was a marginal pull back in prices in the final three months of the year with the sector delivering a total return of -0.4%, outperforming general equities (-3.0%) but underperforming bonds (+0.9%) and cash (+2.7%). Most of the outperformance relative to general equities was as a result of a strong relative performance during December (-1.8% vs. -4.4%), despite yet another 50 basis point interest rate increase early in the month.

Institutional investors retained their interest in the sector due, in part, to the beneficial retirement tax dispensation (0%) on interest income. Trading during the quarter reflected the market view that the recent interest rate increases should not have a meaningful negative impact on one-year forward distribution growth. Further speculation on sector consolidation continued to act as a catalyst for intra-month share price volatility, with some stocks declining as much as 12% whilst others gained about 14%, during the quarter on small volumes.

Fund performance
The Investec Property Equity Fund (IPEF) delivered excellent returns, beating its benchmark, the SAPY, by a comfortable margin over three and 12 months, as well as over three years. The fund delivered a total return of 0.4% for the quarter, 27.7% over 12 months and 35.6% per annum over three years compared with the SAPY's -0.4%, 26.5% and 34.6% respectively. The continued outperformance was achieved through active but prudent fund management and a gradual decreased exposure to listed property securities in favour of cash as volatility increased during risk averse market conditions.

Portfolio Activity
During November the decision was taken to lower the equity exposure, decreasing this from 95% to 83% in favour of cash. This was partly achieved by the beneficial reduction of exposure to Growthpoint through a negotiated transaction with the purchaser for a large line of Growthpoint linked units. The exposure to Growthpoint was reduced from its then overweight position of close to 22% to just below 8% at quarter end.

The Growthpoint linked units were sold at a premium of 6% to the ruling market price and on an effective forward yield of 6.25%, which was a meaningful premium to the sector and, in the fund manager's opinion, expensive relative to the inherent risks associated with local and global markets at the time. This added a stellar 0.15% to the performance of the fund over the period, with cash contributing 0.31%.

The fund also divested out of Sycom while it increased its exposure to counters such as Acucap, Hospitality A and B, Hyprop and Resilient over the quarter. Besides the increase in cash exposure, relative positioning in a number of stocks contributed to the fund's positive performance over the quarter, particularly evident during December. These include Premium (5.0%), Acucap (3.1%), Emira (1.9%), Resilient (1.9%) and Hospitality A (0.0%), all of which outperformed SAPY (-1.8%) this month. Stocks where weightings were reduced over the quarter, such as Growthpoint (-2.7%), underperformed the benchmark, highlighting the correct strategy of reducing the exposure to this counter. The overall strategy of greater exposure to stocks with a higher growth potential has been beneficial to the performance of the fund over the years.

Market outlook
We continue to be positive about the fundamentals in the local property market despite current high levels of local inflation, the possibility of further increases in the repo rate and heightened international market cautiousness. Economic and political nervousness may continue to dampen investor sentiment. An area of local concern is the slowdown in consumer spending, which could negatively affect smaller retail centres as future retail spend aggressively shifts towards basic consumables. However, accompanying the most recent interest rate increase was a reference by the Reserve Bank governor that some members of the monetary policy committee have suggested a "wait and see" approach to further rate increases. Geopolitical conflicts could continue to affect the oil price, thus impacting the local inflation rate for longer than expected, and investors should be aware of this potential impact on global markets. We are not discounting credit liquidity issues that to date, have not impacted the South African economy but which could in due course. This would imply higher interest rate margins on listed property stocks with loans due to expire and terms with lenders needing to be renegotiated.

SAPY's performance continues to be driven by positive fundamentals in the sector as a result of supply and space shortages, especially in the office and industrial sectors. This is likely to contribute towards higher rental reversions and to support continued double digit distribution growth for the medium term (two to three years). Double-digit growth could translate into total returns of 18% and upwards. Global market volatility and local political and economic issues could result in short-term volatility.

A vote of confidence for the sector was the discussion paper published during December 2007 by the National Treasury on converting the current property unit trust (PUT) and property loan stock (PLS) structures into the internationally recognised real estate investment trust (REIT) structure. The commitment shown by the regulators will attract more international investors, which may be initially triggered by the inclusion of South Africa in the FTSE EPRA/NAREIT global property indices as from the first quarter of 2008.