Market and portfolio review
Macro turmoil in the US and Europe continued to dominate the global landscape over the past quarter. Politicians in the US struggled to agree over the impending debt ceiling and whether US Federal Reserve Chairman Ben Bernanke should inject more life into the economic recovery. In Europe, the debt crisis gained momentum as doubts grew about the commitment of peripheral states (including Italy and Spain) to rein in spending and implement austerity measures.

Locally, second quarter gross domestic growth of 1.3% indicated an unexpectedly sharp slowdown in economic activity, driven largely by contraction in manufacturing, mining, construction and agriculture. At its September meeting the South African Reserve Bank (SARB) stressed its commitment to growth and to maintaining price stability. The SARB has since downgraded its 2011 growth expectations to 3.2%, but stated that the inflation outlook remained unchanged.

Listed property again displayed defensive characteristics over a quarter of high volatility in both equity and bond markets. Performance was aided by a rally in the local bond market which saw the All Bond Index return 3.5% in August, as risk aversion towards an ailing European economic environment lent support to domestic bonds. Market volatility and weakness affected performance in September, but performance over the quarter remained positive. Listed property returned 2.2%, outperforming equities (-5.8%) and cash (1.4%), but came in marginally behind bonds (2.8%).


Portfolio activity
Earnings releases were largely in line with expectations, with the focus being on somewhat bearish outlook statements. Management sentiment remains mixed, signalling that the property market is not yet out of the woods. The strategy continues to be to invest in companies and funds that have defensive income streams, quality portfolios and strong management. The importance of quality assets and management has become evident recently with those funds offering good, quality space either maintaining occupancies or reducing vacancies and outperforming peers. Growthpoint, in which we have an overweight position, is a good example. Portfolio vacancies dropped from 6% to 5% and growth continues to surprise on the upside, with performance exceeding the sector average.

We increased our weighting in Growthpoint through the purchase of additional units as part of an accelerated book-build run by the company. Portfolio purchases included Vukile, Hyprop, SA Corporate, Dipula B-linked units and Sycom. We reduced our exposure to Emira and Octodec. Realignment of the portfolio was in keeping with the ongoing strategy of being overweight stocks forecast to deliver better longer-term earnings growth than the sector, with some short-term trading positions where a stock appears to be mispriced relative to peers.

Over the quarter, the strongest performers included Fortress A (10.9%), Acucap (9.9%), Resilient (7.3%), Fountainhead Property Trust (4%) and Hyprop (2.5%). Sycom is another counter to which we continue to increase our exposure, driven largely by an improving distribution growth outlook as management focuses on reducing portfolio vacancies. Counters that came under pressure in the quarter included Hospitality B (-27.1%) and Hospitality A (-8.8%). Underweight positions in these stocks remain due to the economic difficulties being experienced by the hospitality industry.

Other negative performers included Emira (-8.2%), which reported weaker than expected results and gave a bearish outlook for financial year 2012. Previously, the portfolio's cash position was high in an endeavour to participate in new listings and capital raisings, but most of this cash has been invested. One such opportunity was the listing of Dipula Income Fund where Dipula B units were acquired at a listing forward yield of 10.7%, which represented a significant discount to the listed property sector yield.

Portfolio positioning Global growth expectations have continued to moderate due to debt contagion fears in Europe. Locally, growth expectations have also been revised downwards. The inflation outlook in South Africa remains stable, but inflation is expected to breach the 3% - 6% target range into early 2012, thereafter moving back within the band. Bond markets were volatile over the quarter. Listed property remains well positioned to continue its relative outperformance for the next 12 - 24 months and possibly beyond. The forecast 10-year bond yield in 12 months is currently around 8.6% (based on consensus forecasts). Assuming bond yields remain at these levels, we would expect a 12-month total return in the region of 14%. This is based on continued improvement in underlying property fundamentals driving distribution growth with benefits of some stabilisation within global economies. We believe the portfolio is well balanced and positioned to outperform the benchmark over the next 12 - 24 months.

Market and portfolio review
The US Federal Reserve (the Fed) has signalled that it is in no rush to scale back on its economic support of the US economy. This is evident firstly from the continuing low interest rate environment, though headline inflation is creeping up. Secondly, the Fed has indicated it will not hesitate to embark on further asset purchases or on a new round of quantitative easing, which would further help the economy. The euro zone's financial woes are continuing to have a negative impact on global economic stability and financial markets. The Greek government managed to push ahead with tough austerity measures which are key to avoiding a default on its bond repayments. Greece is likely to receive a further stimulus package backed by the finance ministers of the euro zone.

South Africa's first quarter GDP numbers surprised the market by being robust, recording above consensus growth of 4.8% on the previous quarter. The manufacturing and finance sectors constituted two-thirds of the aggregate growth figure (2.2% and 1% respectively). Though inflation has threatened to rise apace, it seems that the South African Reserve Bank is willing to hold off increasing interest rates until there is some evidence of a sustained recovery across the whole economy, and not just over a few sectors. The South African listed property sector enjoyed healthy gains during the second quarter of 2011, lifting total returns to 5%. April and June were the stronger months, pulling the sector from a negative 2.2% in the last quarter to end up 2.8% for the year to date (six months). Amid increasing volatility in general markets, investors seem to favour the lower volatility and higher income certainty from listed property. Bonds gained 3.9% over the quarter, while equities and cash returned -0.6% and 1.4% respectively.

Portfolio activity
The second round of financial results did not reflect a good picture of fundamentals for the sector. Out of the seven funds that reported, only three showed positive results. Acucap (6.3%) and Vukile (9%) had strong gains, while Fountainhead increased distributions by 1.7%. Premium (-1.7%), Octodec (-0.2%) and Sycom (-1.7%) went backwards, whilst Redefine was flat. Portfolio purchases included investing into new listings Investec Property Fund and Rebosis. We also participated in a capital-raising exercise at a substantial discount of 12% to the market price in New Europe Property Investments (NEPI). Other exposures which were increased were Hyprop, Sycom and SA Corporate. Exposure to Resilient and to Emira was reduced during the quarter, whilst we sold out of Fortress A, Premium and Octodec. The main contributors to the listed property sector's strong performance over the quarter were Fountainhead (8.7%) not held in the portfolio, Acucap (7.3%), Redefine (6.9%) and Sycom (6.5%). NEPI also enjoyed good gains and was up 8.8%. The laggards of the sector were Hospitality B units (-10.7%), Octodec (-0.6%), Premium (0.3%) and Hyprop (2.2%). Rebosis, which is yet to be included in the index, was down 2.2% since listing on 17 May 2011.

Portfolio positioning
Historically, the South African listed property sector has had a strong short-term relationship with the ten-year SA government bond yield. A 100 basis points change in the government bond yield typically results in a 66 basis points change in listed property yields. Therefore, in the short term, inflation fears may drive bond yields higher, which could negatively impact share prices. Over the medium to long term, the determinant of market movement is the amount of forecasted income growth achieved by the market and the direction of bonds. Statistics South Africa released the liquidations data for May 2011. This data indicates that liquidations have reduced markedly by 14.8% year to date relative to the same period in 2010. Liquidations for companies in April 2011 were also down 23% year on year. At this point in the cycle, building activity levels are very low - reductions in liquidations should lead to lower vacancy rates across all property sectors.

The portfolio is well structured with an exposure to a strong tenant base through an overweight position in Growthpoint, Capital and Rebosis, and an underweight holding in Redefine, Fountainhead, SA Corporate and Hospitality B units. Our total return expectations are 14% to 16% for 2011, without taking any bond movement into account. This is based on the expectation of a stabilisation and in some cases a recovery in many of the major property variables, including vacancies. Increased municipal rates remain a concern and could put a dampener on distribution growth.

Market and portfolio review
The beginning of the year brought further market volatility, amid natural disasters and political tensions. The political turmoil in the Middle East has driven the oil price to well above $100 per barrel. This has increased the likelihood of higher global inflation, which could threaten the economic recovery. In the midst of uncertainty in the Middle East, Japan experienced an earthquake of great magnitude. This led to concerns about the global recovery, as Japan is a major economic player in the world. In the aftermath of the quake, a tsunami, nuclear leakages and halts to manufacturing and production in affected areas, have added to concerns surrounding the possible long-term global impact. Following the festive season and going into 2011, the South African economy has continued to show signs of improvement. At its most recent monetary policy meeting, the South African Reserve Bank raised its growth forecasts for 2011 from 3.4% to 3.7% and its 2012 figures from 3.6% to 3.9%. The decision to keep the repo rate unchanged at 5.5% was in line with market expectations. Expected average inflation for 2011 is now at 4.7% and 2012 set at 5.7% - a mere 0.3% off the upper end of the band, possibly indicating that 'loose' monetary policy in the near term may become difficult to maintain. The listed property sector retreated at the beginning of the year due to profit-taking after its stellar run of 29.6% in 2010. The months of January (-4.2%) and February (-1.2%) were both weak. The main reason for the decline in the sector was on the back of bond weakness due to global uncertainty, expectations of rising inflation and the tentative economic recovery. Once results were released and investors were more comfortable with future prospects for the property sector, prices started to recover. The month of March was stronger, resulting in a positive return of 3.4%. The listed property sector had a subdued quarter, performing the worst over the period relative to other asset classes. Listed property returned -2.2%. Bonds lost 1.6% for the quarter, while equities and cash gained 1.1% and 1.4%, respectively.

Portfolio activity
After the first round of financial results and guidance on future income growth expectations, a number of the stocks started looking expensive on a relative basis. This meant that we had to review the portfolio's positioning, investing in those funds which were going to weather the storm even better. The current storm comprises higher rates and taxes, increasing pressure on the cost to income ratio of most funds. However, we were encouraged by Growthpoint's better-than-expected results, which indicate a significant improvement in fundamentals on all metrics. Although we like Growthpoint and its prospects, we took profits as we wanted to participate in the distribution re-investment programme (DRIP) which would realise more shares at better prices, in lieu of cash from distributions. Portfolio purchases included Hyprop and Acucap, while the exposure to Emira, Growthpoint (as explained), Pangbourne and Redefine was reduced to deemed appropriate weights. Pangbourne was lightened as a result of its merger with Capital, which was finalised at the end of the quarter. We continue to maintain an overweight exposure to the merged entity, relative to the increased benchmark weighting. The portfolio disposed of its investment in Fortress B. Over the quarter, positive contributors to performance were led by Premium (9.03%, with a 12.7% return in March), Fortress B units (7.92%) and Growthpoint (4.16%), while Redefine (-4.21%), Resilient (-4.06%), Hyprop (-3.13%) and Pangbourne (-2.58%) were the sector laggards.

Portfolio positioning
Capital raising is in abundance through initial public offerings (Investec Property Fund and Rebosis) and additional equity raising (Fountainhead). The portfolio had to increase the cash holding in order to participate, using the cash from the sales and distribution income. The result was a portfolio high in cash, especially towards the end of the quarter, and this created a drag on performance. The portfolio will be well structured after participating in the capital-raising initiatives and reducing the cash exposure to become fully invested in the sector. We anticipate a total return for the sector of 14% to 16% for 2011. This is based on expectations of a stabilisation and in some cases a recovery in many of the major property variables, including vacancies and rentals, with further benefits being achieved from a lower interest rate environment. Increased municipal rates remain a concern and could put a dampener on distribution growth.

Market and portfolio review
The volatility of global markets continued in the last quarter of 2010. The US committed to further stimulating the economy by introducing the second quantitative easing programme in late November. Concerns over sovereign debt in the euro zone resurfaced. The authorities imposed a rescue package on Ireland in order to deal with its ailing banking system. This appeared to stabilise markets. Meanwhile, the strength of the Chinese domestic economy was evident in GDP growth, which registered 9.6% for the third quarter. Although a slowdown is anticipated in the fourth quarter, full year growth is expected to be in the region of 10%. China's economic growth is a driving force in the Asia Pacific region and has a real impact on the global recovery.

Economic indicators released from South Africa were mixed. This prompted the South African Reserve Bank to cut interest rates in mid-November. The overall picture is one of subdued growth with generally muted business confidence, lower consumer spending and high unemployment, keeping a lid on economic activity. Private sector credit extension slowed in November for the first time in six months. There has been a slowdown in manufacturing production, in most part due to the impact of the strong rand. Based on the latter there is a possibility of a further reduction in the repo rate in 2011.

In 2010 the listed property sector repriced, in line with the decline in interest rates and firming bond yields. While the sector had a relatively subdued last quarter, its annual total return of 29.6% for the year handsomely outperformed equities (19%), bonds (15%) and cash (6.9%). It was another stellar year.

Portfolio activity The portfolio management strategy was focused on investing cash from net inflows and distributions. A significant realignment continued by switching between listed property stocks. The portfolio remained close to fully invested over the past quarter, with income distributions and continuous asset management leading to fluctuations in the cash position. Purchases included Growthpoint, Pangbourne, Emira, Vukile and Hyprop, while weightings in Octodec, Fountainhead, Premium and Redefine were reduced. The realignment of the portfolio was in keeping with the ongoing strategy of being overweight stocks forecast to deliver better longer term earnings growth than the sector.

Hyprop was a new introduction to the portfolio during December after the announcement of its acquisition of Attfund's quality retail asset portfolio. This will result in a substantial increase in its market capitalisation and weight in the benchmark. The deal should be effective in June 2011.

In 2010 positive contributors to performance were led by Vukile (46.9%), Growthpoint (41.6%) and Octodec (38.9%), while Fountainhead (20.5%), Sycom (15.8%) and Hospitality B (-5.3% - the only counter to finish the year with a negative return) were the sector laggards. Increasing the active weight in Growthpoint during the year has paid off as the stock enjoyed a rerating from May. A counter which is not in the benchmark, but is held in the portfolio, Fortress B, delivered 68.1% over the past 12 months. The total returns are better than any other counter in the sector, benefiting the portfolio. Fortress B was acquired in the last quarter in an off-market transaction at a discount to prevailing market prices.

Portfolio positioning
Inflation is forecast to be within the target 3% to 6% range until the second half of 2012. Another rate cut in the repo rate is possible, especially if the rand remains strong. This could continue to push bonds lower, especially with South Africa's membership into the emerging markets' group Brazil, Russia, India and China (BRIC). The domestic economic recovery remains fragile, although stronger than many other economies. Global developments (foreseen and unforeseen) make the South African economic outlook relatively uncertain.

Listed property had another exceptional year and we expect the sector to continue its relative outperformance for the next 12 to 24 months. Based on current bond yields, total returns of 16% over the next 12 months are possible. This is based on the expectation of a stabilisation and in some cases a recovery in many of the major property variables including vacancies and rentals. Further benefits should flow from a lower interest rate environment. Increased municipal rates remain a concern and could put a dampener on distribution growth. We believe the portfolio is well balanced, and positioned to outperform both its peers and the benchmark over the next 12 to 24 months, following a complete restructuring in 2010.