September was a terrible month on equity markets and the third quarter one of the worst in decades. The global credit crisis intensified with notable casualties including Lehman, AIG and MerrillLynch. The freezing of liquidity in financial markets has spilled over into economic activity and the prognosis for global growth is starting to look dire. Emerging Markets, including the JSE, have been amongst the hardest hit. We have seen a collapse in commodity prices and many Resource shares have halved in four months! In a reversal of the trend of the past couple of years, Resources significantly under-performed Domestics in the third quarter, and Large Caps significantly underperformed Small and Mid Caps.

The fund has been under-weight in Resources throughout 2008. This helped performance relative to the benchmark tremendously in the third quarter. Also, for the first time in a while our above benchmark weighting in very cheap small caps added to relative performance.

We viewed the aggressive sell-off in Resources as somewhat overdone and were looking for a bounce which unfortunately has not been forthcoming. Accordingly, we reduced our under-weights in BHPBilliton, Sasol and Anglo American during August and September. This impacted on absolute performance in September. We see good medium term value in these stocks and view them as very oversold at the moment, particularly in light of the vulnerability of the rand to poor market sentiment and lower commodity prices. We remain underweight Resources and our preference for more diversified commodity profiles and sustainable production growth results in our exposure being focused on the three stocks above.

Many of the domestic counters have performed extremely well on a relative basis over the past quarter. We continue to be skeptical of an early and sharp recovery in SA consumer spending. And, after the massive relative moves of recent months, many Domestics no longer stand out as obviously cheap on a relative basis. Accordingly, in September we took the opportunity to lighten some of the stocks we owned that had performed well and were offering significantly less relative value including Bidvest and Barloworld. We also cutback Richemont after its massive outperformance.

Besides Anglo, our other major purchases in the month were MTN and Telkom. We view MTN as very attractive below R110 given its superior and visible earnings growth profile in an environment where earnings are likely to disappoint across the board. Telkom looks very cheap and offers an attractive margin of safety given the high probability of corporate action and very chunky cashflow yield.

Our small cap basket has performed well in recent months. We continue to be on the lookout for bombed-out bargains though we will definitely continue to limit our stock-specific risk.

We are of the view that current market conditions and valuation levels provide an excellent opportunity to upweight exposure to equities, although we do expect volatility to be a feature of the markets for some time.

Equity markets took a beating in June to cap what has generally been a dismal year so far for investors. These losses have been extended into early July. The S&P 500 declined to 8.4% in June, taking its year-to-date loss to 11.9%. The MSCI Emerging Market Index lost 10% in June, extending its year-to-date losses to 11.6%. On the JSE, the All Share retreated by 4.4% in June, trimming gains for the first six months of 2008 to 6.4%.

The JSE's out-performance of developed global equity indices can be attributed to the significant out-performance by Resources, Financials and Industrials, both at home and abroad. The Resource 20 was up a staggering 33% in the first six months, while the Financial 15 lost 25% - a performance differential of 58%!

The June equity sell-off has been triggered by growing fears of building global inflationary pressures, on the back of spiraling oil and other commodity prices. Rising inflation, when combined with slowing profit growth, has a very negative impact on equity markets. When commodity prices are rising, Resource shares tend to insulate investors against high levels of inflation, but their retreat in June and July demonstrates that commodity prices may be peaking. With global demand slowing, commodity supply increasing and a stabilization in the US dollar looking increasingly likely, the bulk of the price performance out of Resource shares is likely behind us.

Domestic shares have been hit hard by a combination of factors including very elevated levels of domestic inflation and the resulting tightening of monetary policy; a sharp slowdown in consumer demand; rising input costs and hence lower profit margins and a wholesale liquidation of SA equities by foreign and local institutional shareholders.

Domestic Financial and Industrial shares are well off their highs, with the bulk of the losses taking place in 2008. General Retailers have lost 27% this year; Healthcare 30%; Banks 24% and Life Insurance 31%. The sell-off has coincided with aggressive cuts in earnings forecasts. There can be little argument that domestic shares are trading at very attractive valuation levels.

It is always difficult to forecast the timing of the bottom in this particular bear market and we do not expect a material recovery until interest rates start declining, but we are of the belief that the shares are particularly cheap and in most cases a worst-possible scenario has been priced in.

The bear market in domestic stocks has hit small caps hardest. The Small Cap Index is 23% down in 2008 versus a 20% loss for mid-caps and the positive 11% performance by the Top 40 (large caps).

The PSG Alphen Growth Fund has under-performed its benchmark by a disappointing margin in the first half of 2008.

Alphen, as a house, has been under-weight in Resources and over-weight in Domestic Industrials in 2008. As discussed above, Resources have out-performed by a significant margin. Our positioning was based on the substantial difference in valuations between the different parts of the market.

On a medium-term view we were (and remain) of the view that the valuation differential between the domestics and Resources is excessive. We did not foresee the strong commodity price performance of 2008 which has fed through to earnings and share price performance.

Alphen tends to specialize in stock-picking within the less-researched part of the market, which resulted in above-benchmark exposure to smaller cap companies. This has detracted from performance in 2008. As stated above, small cap shares have had a disastrous year on the back of fund redemptions and a disappearance in liquidity. Unfortunately, the PSG Alphen Growth Fund has had exposure to some small cap companies that have performed particularly badly. We have sought to limit the damage in this regard and in an effort to manage the risk around the Fund's exposure to small caps we have aggressively reduced positions in smaller companies where we have lower conviction in medium-term earnings. At the same time, the disappearance of liquidity within small caps is creating an opportunity for excellent long-term returns and we remain opportunistic buyers of the better quality businesses at bargain levels, though exposure to individual stocks remains carefully managed.

An unusual feature of the market has been the continued out-performance of momentum-style investing over value. Alphen's generally cautious view on equities of 2007/2008 saw us preferring value to growth. Value has performed dismally as a result of the earnings disappointments in the cheaper parts of the market. At the same time, sectors with strong relative price momentum have out-performed massively, to the extent that valuations appear particularly stretched in the sectors with the best earnings growth over the next 12 months. We continue to prefer value and just do not see the earnings disaster that is priced into our high conviction buys.

We have a high degree of conviction around the ability of the current portfolio to generate attractive returns from current valuation levels. We are of the view that market participants are overly focused on trying to time the bottom in domestic stocks. We do not see domestic stocks going much lower, though further equity redemptions may see further fall-out in some small caps. The bear market in domestic stocks is already eight months underway and the extent of the share price declines indicate that the bulk of the damage is likely behind us.

On the other side of the equation it is likely that Resources have recently topped out. Here, we continue to believe that caution is warranted in the months ahead.

We estimate that the Portfolio has a 12 month forward Price-Earnings (PE) ratio of 8.3 and a forward dividend yield of 4.6%.

Markets are tough and are expected to remain so for months to come. A re-rating of domestic stocks is not likely before interest rates start moving lower. That said, bear markets are always followed by bull markets and at current valuation levels it is difficult to make a case that we are not close to the bottom. We believe that Alphen is uniquely positioned to capitalize on the opportunities presented by the very weak sentiment in financial markets.

2007 ended up being a very bumpy year for the JSE. The JSE All Share total return for the year of 19% does not tell a tale of the volatility that investors (and fund managers) had to endure. The majority of the year's return was achieved in the first half (15.2%) and towards the end of July the market experienced a vicious sell-off that lasted into mid-August, but was followed by a swift recovery to new highs before peaking in October. Thereafter, global jitters and mounting concerns over the impact of local rate hikes combined and the market suffered an 8% loss in the bumpy ride down from mid October.

The headline return for 2007 also conceals the fact that performances by different sectors on the stock market were quite divergent. All the domestic and consumer-related stocks had a very difficult year with significant falls in their share prices as rate hikes engineered a very sharp slowdown in retail spending and mounting credit losses. On the other hand continued strong demand for raw materials globally and the ramp up in spending on SA infrastructure benefited Mining and Construction stocks which remained amongst the star performers. Food retailers also benefited handsomely from the spike in food inflation. MTN also had an excellent year.

The clear winners on the JSE in 2007 were those stocks with the highest earnings growth momentum and the best performing portfolios were those with an investment strategy that focused on earnings and share price momentum. It is worth noting that the top-performing shares of 2007 (the sectors described above) were also among the more expensive shares on the market. The result has been both massive divergences in relative performances as well as marked differences in valuation levels.

During 2007 our portfolios had a strong bias to value, being shares that were considered to be trading at a discount to their intrinsic value, generally lower PE and higher dividend yield stocks. We prefer value stocks in a relatively expensive market. This saw us dipping our toes into the water and starting to accumulate some of the bombed out domestic plays in the last four months of the year.

In hindsight, a premature move and things look like they could get a lot worse before they get better as far as newsflow in the embattled domestic consumer space is concerned. Yet, we are firmly of the opinion that the turmoil in the domestic financial and industrial space is cyclical and not structural in nature, and bargains are starting to emerge.

We have always been happy to invest in a contrarian fashion and have generally found that the best returns are to be had where fear, rather than greed, is prevalent.

The defensive nature and lower relative risk profile of the fund saw it performing well in periods of market corrections, but it under-performed notably when the market surged on the back of a few mega-cap counters as it did in July and September/October. It is worth noting that by our calculations over 75% of the JSE's 2007 return was generated by six shares (BHP Billiton, MTN, Anglo American, Sasol, Impala and SAB). Underweights were costly! BHP Billiton on its own accounted for more than 7% of the markets return!

The worst of the fund's under-performance of its benchmark came in the third quarter. This can largely be ascribed to under-weights in the abovementioned stocks. In hindsight, our lower than benchmark positioning in these counters is regrettable, but was largely a function of our perception of better value at lower risk elsewhere. The fund out-performed in the tough fourth quarter.

The fund remains the top performing General Equity unit trust over five years. This can be ascribed to our ability to position the fund aggressively in markets where attractive returns are to be had. We have been overly cautious over the past 18 months which has hurt relative performance. Yet out investment philosophy remains unapologetically focused on both risk and return.

Looking forward, we continue to tilt the fund towards shares we consider to be fundamentally under-valued. The result is a portfolio with a PE 12 months out of around 10 (vs the market's 12.2) and an expected dividend yield of around 4.4% (3.5%) over the next 12 months. These are the types of shares we prefer to own in the current environment - ones where there is plenty of bad news in the price. We expect such a portfolio to be well capable of producing healthy real returns over the next three years.

Equities as an asset class remain susceptible to further systemic corrections emanating from the global slowdown and the de-risking of portfolios. This nervous environment will lead to high levels of volatility and ultimately fantastic opportunities to buy cheap shares.

Shaun le Roux