Most equity markets posted solid gains over the month on the back of positive earnings and good economic news. Commodity prices gained over the month. Gold climbed to a near 18-year high and copper hit an all-time high.

Data released recently reinforced the view that the US economy is still growing. The growth in the third quarter was 4.3%, the strongest since the beginning of 2004. Consumer spending, business investment and investment in housing were all higher than initially forecast. GDP in Euroland rose a 0.6% in the third quarter, which should lead to 1.2% growth this year and the best since 2001. The Bank of England reduced its August economic growth forecast and is now expecting annual economic growth of 2.6% next year. Several indicators reinforced expectations that the economy of Japan will keep expanding.

In the US the Federal Open Market Committee voted to lift the overnight bank lending rate to 4%, the highest since June 2001 and the 12th straight rise. The Bank of England’s Monetary Policy Committee left its main interest rate unchanged at 4.5% for the third consecutive month, as expected. For the first time since 2000, the European Central Bank raised interest rates. Rates are now at 2.25%, up from 2%.

The US dollar rose against all major currencies. Although it later fell it reached two year highs against the euro, sterling and yen.

Most world markets fell early in the month on concerns regarding the impact of continued high energy prices. Disappointing revenue forecasts also contributed to the market decline. Euroland markets rebounded late in the month on positive earnings announcements. Higher oil and copper prices boosted profit expectations in commodity related shares. Japanese markets continued their solid gains early in the month. Both the DAX and CAC posted modest drops during the month.

The US economy showed a third quarter growth of 3.8 % annual rate, up from 3.3% in the second quarter. Staying with the US, Ben Bernanke was nominated as the next Chairman of the US Federal Reserve. Treasuries fell, pushing 10-year yields to the highest since April on expectations that the Federal Reserve will keep raising interest rates. In the US European 10-year government bonds fell.

The European Commission underlined the region’s shaky economic performance when it revised growth for 2005 down to 1.2%. In the UK, the National Institute for Economic and Social Research reduced its 2005 growth forecast to 1.7%, the lowest since 1992. Bonds were flat over the month, as was sterling. The Bank of England’s Monetary Policy Committee unanimously voted to leave UK interest rates unchanged at 4.5%. The European Central Bank also left rates on hold.

The dollar rose against the major currencies, regaining ground lost earlier the month against the euro. Gold, platinum and copper prices all hit fresh highs.

September was the perfect storm, or at least that’s what we like to call it, with the vast majority of our macro calls coming right in the month. The Nikkei was up over 9% in yen, gold appreciated by 7% and the dollar continued to strengthen against a basket of currencies.

The strength in the Nikkei did not take us by surprise, as we have been expecting this for the last couple of months. The catalysts for the market’s run, despite a backdrop of weaker US markets and a rising oil prices were as follows: Koizumi’s resounding victory in the parliamentary elections; rising bank lending and the increase in Tokyo property prices for the first time in 15 years.

The gold price is now in its second phase of its bull market, as can be seen by the fact that it is moving up in almost all major currencies. Looking back, the strength in gold can be attributed to the following factors: the price of the metal starting to catch up with the move in the price of oil (as it has badly lagged for the past few months); the growing realisation that the precious metal is cheap relative to other tangible goods and finally, the feeling that inflation appears to be ticking up globally.

As for the dollar, it continues to defy all logic, at least from a fundamental point of view. If any other country in the world had a current account deficit approaching 7% of GDP its currency would be a basket case, but not the dollar. The yield spread over the yen and euro has proved appealing to investors, but with economic growth slowing in the US we could be nearer the end of tightening than many believe and consequently US dollar strength. On the back of this, we have recently removed some of our currency hedges from the portfolio.

Returns for August were pretty mixed, with the FTSE World Index down 0.6 per cent in dollar terms; the S&P500, CAC-40 and Dax were all lower by 1-2 per cent, whilst the Nikkei was up by more than 5%. Currency traders had little to keep them interested with the dollar-euro trading in a range of $1.21-$1.24 (and ending little changed on the month) and the dollar-yen hovering between Y109 and Y112.

All the action has been in the oil market. Few would have predicted the Nymex contract could have added another $9 a barrel in the course of the month. Wolfgang Clement, Germany's economics minister, said "speculators" were partly to blame for the increase.
We think that oil might have gone too far on the back of hurricane Katrina, but at the same time acknowledge that we are in a secular bull market for oil. The rally in oil this year has not only been demand led, but also supply led with serious constraints on refining capacity. More and more strategists now contemplate a peak in global oil production, with the fact remaining that there has not been a sizeable oil field discovery for more than 35 years. Oil and gas were one of the few global equity sectors to show a positive return on the month and it undoubtedly helped shore up some markets (such as the UK) where it has a large weighting.
August turned out to be a particularly pleasing month for the fund, given that we achieved positive returns, whilst most major indices were down for the month. The Nikkei has now comfortably moved past the major physiological resistance level of 12,000. Koizumi is making all the right noises and his popularity in the polls continues to rise, which bodes well for his postal reforms. We remain bullish on the region; particularly those sectors that are domestically orientated such as banking and property.

dollar proved to be so small, that it ended up being a non-event in world markets. The 2% revaluation will hardly make any difference to the trade deficit and it certainly won’t stop certain USsenators calling for increasing trade tariffs on Chinese goods. While this might be a bit of a damp squib in the short term, it has made investors sit up and question whether Chinawill continue to be such a voracious buyer of US treasuries. Not only do they now need to buy fewer dollars, but the yuan is currently pegged to a basket of currencies as opposed to the dollar alone. By removing marginal buying of US treasuries, another longer term effect will be a slightly tighter monetary regime in Americaand a somewhat more accommodative one in Asia. Americans may soon begin saving more as Asians start spending more. It also makes foreign companies cheaper too for Chinese groups to acquire - that’s if the Yanks will let them!

July saw strong economic data coming out of the US, with the Fed praising economic growth and warning that inflation may not remain benign. The market is now pricing in a fed funds rate of 4% by year end, with some strategists even calling for 4.5%. In the face of rising short term and long term interest rates, it is fascinating (read scary) to see that the US housing market keeps moving higher and higher. We continue to believe that the UShousing market is an accident waiting to happen and therefore by default so is consumer spending.

Given this backdrop, we choose to invest in markets where the fundamentals are more attractive on a risk adjusted basis. On that note; it is pleasing to see Japanese equities reaching 15 month highs!

The month of June was characterised by a rampant oil price, climbing to over $60 a barrel! Right now, high oil prices are a headwind for equity markets, but it is not that clear cut as to whether they are overwhelmingly bearish or not.

Equity markets have so far reacted negatively, but the impact has merely been to take share prices back to the middle of their recent trading range, rather than anything more serious. Investors have not sold equities outright, perhaps as they believe central banks will come to the rescue. The recent interest rate cut by the Swedish Central Bank is seen as the precursor for moves by the Bank of England and the European Central Bank. The wild card is now the US Federal Reserve.

In the end, it looks like a battle between two automatic rebalancing forces. Oil prices may hit consumers’ pockets, but low bond yields and concomitant low mortgage rates prop up consumers’ confidence. Equity bulls clearly hope the latter effect has more impact.

We fall into the camp of reluctant equity bulls, largely based on an improving technical picture. The markets have an April 2003 feeling about them... déjà vu?

Although we are still nervous about equities, one can’t fight the wall of money that is hitting the market.

Dividend yields are already approaching the same level as bond yields in Europe and parts of Asia. Furthermore, the difference between USdividend yield and bond yields is close to a 25 year low - this despite record low payout ratios from companies. All very supportive of equities.

Following gloom on the outlook for America's economy after disappointing economic data, another interest rate rise and greater market volatility, there has been quite a turnaround in fortunes.

Everyone was expecting the much mentioned cliché of “sell in May and go away” to ring true for global equity markets yet again. Unfortunately for most, exactly the opposite happened. Optimism for a stronger second quarter in the US is growing, the dollar has rebounded, oil prices have fallen, volatility has reduced and lower long-term interest rates fuelled a robust equity market rally.

One could be forgiven for believing that earlier risk aversion had disappeared - it hasn’t. In reaction to the shock of the junking of auto makers’ bonds, many long and short positions were rapidly unwound. Recent dollar strength, oil weakness and the bond rally had more to do with this unwinding than any major change in the underlying economy. The inverse of a strong dollar has been a weaker yen. Similarly a weaker euro has helped core European markets to rally, despite concerns over stagnant growth and worries over the EU constitution following the French and Dutch ‘non/nee’ votes.

On 1 March 2005, the PSG International Fund was changed to the PSG International Flexible Fund of Funds, after a successful ballot. The management of the PSG International Fund of Funds has been given to Alphen Asset Management who will be responsible for selecting top performing offshore portfolios to be included in this fund of fund. The Fund is currently in transition phase, with gradually selling the existing assets to acquire participatory interests in the portfolios that have been selected by Alphen Asset Management. The portfolios to be selected will be offshore funds, however, the PSG International Flexible Fund of Funds will remain a rand denominated multi manager fund through which investors can receive exposure to offshore markets without making use of their R750,000 offshore allowance.

On 1 March 2005, the PSG International Fund was changed to the PSG International Flexible Fund of Funds, after a successful ballot. The management of the PSG International Fund of Funds has been given to Alphen Asset Management who will be responsible for selecting top performing offshore portfolios to be included in this fund of fund. The Fund is currently in transition phase, with gradually selling the existing assets to acquire participatory interests in the portfolios that have been selected by Alphen Asset Management. The portfolios to be selected will be offshore funds, however, the PSG International Flexible Fund of Funds will remain a rand denominated multi manager fund through which investors can receive exposure to offshore markets without making use of their R750,000 offshore allowance.

Due to market interest, we have taken the liberty to provide further information on the newly launched PSG International Flexible Fund of Funds. Please see below for further information on this fund.


PSG INTERNATIONAL FLEXIBLE FUND OF FUNDS

Alphen Asset Management has received the mandate to manage the PSG International Flexible Fund of Funds. As per our promise to our partners we have thought long and hard as to how we could utilise our unique South African investment process on an offshore fund, acknowledging that offshore markets have certain dynamics which are not entirely applicable to South Africa. It is encouraging to report that the structure of the new fund is innovative, entirely incorporates Alphen's strategic and tactical asset allocation approach which has been so successful in South Africa, but has also accommodated unique offshore dynamics. So what have we done?

Firstly, we analysed an extended data series on offshore markets including data on global bond markets, equity markets and cash markets. This analysis was done in dollars. The rationale here, as is the case with our South African funds, is to establish exactly what asset allocation, from a strategic or long-term view would be required for this fund to satisfy a volatility level of 7.5% in dollar terms, in so doing creating a fund which can be defined perfectly as 'medium risk'.

Secondly, we looked at all the disparate funds listed in South Africa in the Foreign Asset Allocation Flexible Unit Trust Sector as defined by the ACI and realised that a space exists for a fund with a solid investment process and a risk level, as defined by standard deviation, which is lower than the rest. This is particularly relevant as prior to 2000 South African investors were accustomed to taking big risk offshore with huge expected returns. Subsequently, offshore markets began to struggle and risk has not been well rewarded, especially in rand terms. Consequently, investors have, in our opinion, begun to better understand risk in offshore markets and to seek less risky products. The annual volatility of funds within the local Foreign AA Flexible Unit Trust Sector in dollar terms ranged between 7.15% and 11.15% between March 2004 and 2005. Without any manager selection, based simply on the PSG International Flexible Fund of Funds strategic asset allocation mix, had this been instituted a year ago, the volatility of this fund would have been 5.91%. With correct manager selection, it is most feasible that this level of volatility could have been reduced even further. It is our intention to thus structure this fund as one with a lower risk profile than most competitive products.

Thirdly, the actual mechanics of the fund: The benchmark for the fund is 50% equities, 20% bonds and 30% cash. To be in line with Alphen's policy of utilising alpha driven managers, the intention in the fund is to employ our quantitative models as well as the expertise of an offshore focused manager to unearth high alpha generating global managers - equity, bond, property and cash managers. 70% of the fund will contain these managers and tactical shifts in asset allocation for this 70% of the fund will be done by these managers. So, for example, if we are at our maximum equity exposure, 35% (being 50% of 70%) of the fund will be placed with global equity managers who will themselves decide what geographic splits are relevant. The same concept is applicable on the bond, property and cash managers - 70% of all exposure will be with global managers in each asset class. The balance of the fund, that is 30%, will be used by Alphen and partners to make marginal tactical asset allocation shifts. This tactical component of 30% we have incorporated to cater for the specific characteristics which occur in offshore markets - e.g. currency volatility and to take advantage of opportunities in dynamic global markets. It is important to note, however, that we have structured the fund in such a manner as to ensure that all asset allocation calls cannot be dominated by one house view and strong rules and procedures exist.

The final point to make regarding the mechanics of the fund is to highlight the strategic asset allocation levels applicable and the maximum exposures allowed:

Strategic benchmarks:

Equities 50%
Bonds 20%
Cash 30%

Maximum allowable holdings:

Equities 50%
Bonds 44%
Cash 51%

So, by investing in this fund, we believe dual benefits are attained. Firstly, those clients believing as we do in finding the correct long-term asset allocation mix for a balanced risk profile and incorporating the best global managers that are available within the bounds set by the FSB should be elated with this product. Secondly, investors who enjoy the rules of adopting a strategic approach, but also believing in a degree of flexibility, will also be confident with our fund.

Please contact our toll free line 0800 600 168 for further information on the application process.

With effect from 1 March 2005, the name of ths fund has changed to PSG International Flexible Fund of Funds.