Market and portfolio review
The South African market has lagged 2009's stellar performance. July's retail sales figures showed an impressive 7.9% year-on-year rise from 7.6% year on year in June 2010. This was driven partly by the 2010 FIFA Soccer World Cup. The event did not do much for GDP growth as it slowed to 3.2% in the second quarter. This prompted the South African Reserve Bank (SARB) to cut the repo rate by 50 basis points at its September monetary policy committee meeting. Other sectors of the economy, such as manufacturing and mining, remain vulnerable. On a positive note, inflation continues to be in line with the SARB's expectations and could lead to a further easing in monetary policy. The SARB leading indicator has turned positive again, highlighting the improving environmental outlook.

The listed property sector continued its unabated rally, delivering a total return of 13.7% for the third quarter. The year-to-date total returns are 25.7%, beating equities, bonds and cash which delivered 8.7%, 14.1% and 5.3%, respectively. Over the past month, ten listed property stocks declared results. Most of the results met expectations, with an underlining tone that the property sector is beginning to show signs of bottoming out and a marginal recovery. The market capitalisation weighted average distribution growth was 6.3% and within our 6% - 8% forecasted numbers. This number includes Redefine's growth, calculated on a six-month comparable figure, using the counter's previous two distributions (quarter two and quarter three ) against the equivalent period in 2009. We have noted from the results, however, that property expenses across many of the funds continue to grow beyond inflation. This is mainly as a result of administered price increases. Key to this has been the introduction of the new municipal valuation rolls that have caught most sector landlords by surprise. This has had a direct impact on property rates and taxes. Valuation rolls have recently been restructured to charge rates and taxes on property market values, which was not the case previously. Some municipalities had until recently, valued land and buildings separately.

Market conditions in the first half of 2010 appear to have been difficult, with vacancies across most funds rising, albeit at a slower rate than those experienced in 2009. Bad debts and arrears also increased, particularly in the industrial and office sectors. Many landlords channelled resources towards nursing tenants, but the fruits of these efforts have yet to materialise. There are indications that vacancies, currently around 7.2% across the sector, are approaching a peak as there has been an encouraging marked increase in enquiries for space.

Portfolio activity
Our fairly positive outlook on the sector meant that the portfolio remained almost fully invested over the past quarter, with income distributions being the source of fluctuations in the cash position. Portfolio activity was characterised by reinvesting cash distributions and realigning exposures by switching between listed property stocks.

Portfolio purchases included Growthpoint, Pangbourne and Vukile, while the exposure to Octodec, Fountainhead, Emira and Redefine was reduced marginally. The portfolio participated in a number of off-market transactions, such as the capital-raising of Emira, Fortress A and B, and Vukile, which has enhanced the overall performance of the portfolio. The new units were all issued at discounts to prevailing market prices and have gained beyond their issue prices. We elected to receive scrip in lieu of cash for the Growthpoint distribution, which was issued at a discount to market price. The scrip dividend, together with market purchases, has assisted in increasing the portfolio's weighting in Growthpoint closer to the benchmark and our model portfolio targets. We continue to increase the portfolio's exposure to Growthpoint over time and at prices deemed to be acceptable.

Portfolio positioning
With inflation forecast to be within the target range until mid to late 2012, another rate cut would not be out of the question, especially if the currency continues to be strong. This could continue to push bonds lower. Though listed property has had a stellar year to date, we forecast that the sector's good run could last for the next 12 to 24 months. This is based on the recovery in most of the major indicators, namely vacancies, arrears and lower interest rates. However, increased municipal rates could put a dampener on distribution growth.

We believe the risk-return characteristics of the portfolio are well balanced and this should result in continued outperformance relative to peers and possibly the benchmark over the next 12 to 24 months.

Market and portfolio review
Risk aversion during the second quarter remained at elevated levels, as measures announced by European central bankers and authorities to address the debt crisis have not restored confidence. Weak housing and economic data out of the United States has deepened concerns that the global economy could experience a double-dip recession, or that the recovery could take longer to gain momentum. The Federal Reserve continued to adopt a more cautious stance at their June meeting, fuelling expectations that monetary policy could remain accommodative well into 2011. The European debt crisis is likely to lead to a prolonged sideways movement in interest rates in developed economies. China also recently came under pressure when the latest production figures indicated a slowdown, thereby placing further pressure on global markets. From a South African perspective, the economy has been reflecting mixed signals, with first quarter GDP figures better-than-expected and higher than the previous three months. Quarter-on-quarter growth was 4.6%, marginally above the expectation of 4.3%. All key sectors of the economy expanded with mining and manufacturing once again leading the way. Vehicle sales have also shown persistent growth over the past six months. In addition, South Africa's monthly trade deficit narrowed to R0.3 billion in May after April's R1.9 billion deficit. However, the economy still seems fragile as indicated by months of decline in the Purchasing Managers Index, the Trade Expectations Index and the high number of job losses in 2010. While credit extension turned positive in May, it is still fundamentally weak as the consumer goes through the challenge of de-gearing. Economic recovery is likely, but there could be a bumpy ride ahead. After a stellar first quarter performance, listed property took a breather in the second quarter of the year. Despite a slowdown, the South African Listed Property Index (SAPY) delivered 0.6% for the second quarter of 2010, thereby outperforming the All Share Index at -8.2%. Over 12 months, the SAPY has significantly outperformed all major asset classes, demonstrating its resilience in difficult markets. Over the period under review, interim and year-end results were released by Acucap, Fountainhead, Hyprop, Octodec, Premium, Sycom and Vukile. The weighted average distribution growth rate over the comparable period is at the upper end of our 6%-8% projected band at 7.8%. However, guidance was revised down by two large cap funds, Redefine and Fountainhead. Redefine faces lower income from trading profits and in the case of Fountainhead, there is expected dilution from a R780 million redevelopment of Blue Route Mall (Tokai, Cape Town).

Portfolio activity
Our fairly positive outlook on the sector meant that the portfolio remained almost fully invested over the past quarter, with income distributions being the source of fluctuations in the cash position. Portfolio activity was characterised by reinvesting cash distributions and realigning exposures by switching between listed property stocks. Positions were added to Emira, Pangbourne, and Vukile, while the exposure to Acucap, Growthpoint, Premium and Redefine was reduced slightly. We took some profits in Redefine, as the share price rose to around 800 cents per unit before retreating below 750 cents per unit. The portfolio also participated in an off-market capital raising exercise by Fortress A and B, which were at substantial discounts to the market price at 4% and 10%, respectively. These stocks are currently trading at 3% and 22% above issue price, respectively. The portfolio started with a cash exposure of around 2.1% having received distributions, but this has fallen to 0.6%, consistent with the current asset allocation strategy.

Portfolio positioning
The composite business cycle indicator, which points to the future health of the economy, grew by an encouraging 21.3% in March yearon- year. This bodes well for growth in economic activity in six to 12 months. As we get closer to the mid-year reporting season for the listed property sector, our view is that listed property remains defensive over the medium term with 2010 likely to form a trough in operational performance. Key indicators such as vacancies, arrears and bad debts appear to have peaked and are likely to start falling towards the end of the year. The portfolio has been positioned accordingly with a bias towards companies that are likely to show above average distribution growth over the medium term.

Market and portfolio review
The South African economy has followed the global trend and has shown signs of improvement. In the third quarter of 2009, the economy moved out of recession, growing 0.9% on a quarter-onquarter seasonally adjusted annualised basis. Recent retail and motor vehicle sales figures point to a stabilisation in demand and prospects of a moderate acceleration in 2010 with interest rates expected to remain relatively low. However, construction and private sector investment continues to lag. Over the fourth quarter, CPI inflation moved back into the target band of 3%-6% with the October and November figures coming in at 5.9% and 5.8% (year-on-year) respectively. An interest rate cut may be on the cards in the near future, especially since economic data is not conclusive with respect to a recovery from the economic recession. The full impact of Eskom's proposed tariff hikes on the CPI remains unclear. If granted, these increases may offset some disinflation. For listed property, the proposed electricity tariff hikes reduce bargaining power for landlords as tenants' occupancy costs rise. The softer economic activity has had an impact on the demand for industrial and retail space and has consequently also affected market rentals.Tenant retention continues to be the main theme in property with specific focus on smaller companies, line shops and industrial mini unit tenants who are typically the first to default in a difficult economic environment. Markets were undeterred by the surprise announcement from Dubai World, a quasi-sovereign institution and global property investor, requiring a potential bailout in November. Listed property had a good year globally, delivering returns of 28.6% (US dollar returns), driven primarily by Europe (36.6%), Asia (29.5%) and the Americas (28.3%) (Source: Global Property Research, Quarterly Review, 31 December 2009). The South African Listed Property Index (SAPY) delivered total returns of 14.1% over the year, continuing to outperform bonds (-1%) and cash (8.9%). This can mainly be attributed to the lower interest rate environment and expected economic recovery over the next 12 to 18 months. Equities were the only asset class to outperform listed property delivering 32.1%, driven by healthcare (76.8%), technology (53.6%) and consumer services (45%). Results were released by Acucap, Octodec, Premium, Redefine and Sycom over the fourth quarter. Octodec and Redefine were the only companies to disappoint during this period, posting results below expectations. Acucap, Premium and Sycom delivered income growth of 6.1%, 9.4% and 9.2% respectively over the corresponding period.

Portfolio activity
Two of our core holdings, namely Acucap and Capital, have shown positive and above-sector total returns over the last quarter. All portfolios have an overweight exposure relative to the benchmark in both stocks. Redefine continued to underperform the benchmark over the last quarter delivering only a 0.9% total return versus the benchmark return of 4%. The company continues to look cheap on a relative basis. Income will form a greater portion of total returns to investors over the medium term. Hence our investment strategy focuses on income certainty and exposure to companies, forecast to deliver relatively stronger distribution growth over the next 18 months. Over the last quarter, the exposure to Capital, Resilient and Acucap was increased, while the exposure to Growthpoint was reduced. We invested in newcomer Fortress in October. Fortress, which is made up of new and existing properties previously owned by Capital and Resilient, listed two types of linked units (A and B). The A units have guaranteed income growth of 5%, while the B units will have varying growth and offer a lower yield. In keeping with the strategy of ensuring income certainty, the A units were selected as the entry point. The cash exposure has been reduced to its current target of 2%, and this is likely to benefit the portfolio in future.

Portfolio positioning
Our view is that listed property remains defensive over the medium term with respect to distribution growth. However, earnings visibility has begun to wane as some tenants remain under pressure and market rental growth begins to taper off. We believe that the shortterm outlook is positive as interest rates and inflation remain at historically low levels. In addition, the Reserve Bank's leading indicator, which provides a barometer of the future state of the economy, grew by an encouraging 3.7% in October month-on-month, moving the index back into expansion mode. This bodes well for growth conditions in approximately six months' time. As a result, the portfolios have been restructured to take this potential recovery into account.