In our last quarterly update we mentioned the potential tightening bias in the United States and deflationary forces in Europe and China bringing about increased asset volatility which was extremely low at the end of June 2014. Whilst we fully expected these forces to play out we didn't expect them to come to the fore during this quarter (more accurately September) but the impression created amidst currency moves which started in August (specifically in the euro and Yen) was given further fuel by the Fed's September commentary that rates could move sooner than the market expected. The combination of the potential changes from very stimulatory policies led to some tension in Asset Markets and especially in Emerging Markets where traditionally a strong Dollar has had a negative impact on assets, further dollar strength was provided by the growing divergence between economic growth in the U.S. and the Rest of the World.

During the quarter the Johannesburg Top40 Index (equities) provided a loss of 2.87% on a Total Return basis. ALBI (Bonds) 2.21% (total return) and listed property returned 7.22% (total Return). The Rand lost 6.09% of its value to the Dollar but on a trade weighted basis actually gained slightly in value (0.07%). Over the same period the fund only lost 0.13%.

Looking Ahead

While we see the increase in volatility as something that we thought would happen in time we thought it would be a little longer before we would have to wrestle with that particular gorilla. But, assuming markets don't cascade lower from here we welcome a pick-up in volatility since it provides opportunities. We maintain that while the U.S could be moving ever closer to a normalisation of rates we do believe that growth and inflation is not robust enough globally for the U.S to hike meaningfully. The liquidity steroids are still prevalent through the ECB and the BOJ. While we have been more aggressively positioned in shorter duration Fixed Income instruments there will be opportunities to tactically earn returns along the middle part of the curve. This might be seen between now and the end of the year, especially after the significant move lower in the value of the Rand. Asset allocators will lick their lips should we see lower inflation numbers come about which we believe is possible given falling commodity prices and weaker prices (although Eskom could balance that out).

Equities remain problematic since they remain expensive on a number of metrics, but once again, correlations with the U.S. equity markets could pull us higher as we move into earnings season in the U.S. early in October especially if, as we expect, numbers should provide some semblance of support for now.

This past quarter was an exceptionally strong quarter for equity markets. Despite a reasonable amount of negative sentiment surrounding the South African economy, our equity markets produced superb returns to keep pace with other Global Emerging Markets and finished the quarter up 6.91% (Top40). This performance was driven largely by improving economic data in the U.S post the 1st quarter weather inspired soft patch, but notably aided by falling asset market volatility across the board. These levels of volatility haven't been seen since prior to the 2008 crisis and implies that risks are limited in asset markets.

Contextualising our equity market performance within an environment of ongoing industrial action, a shot across our Government's bow by international rating agencies (who downgraded our debt ratings), and continued domestic economic malaise, it shows just how addicted asset markets have become to global liquidity but it also highlights the interconnectedness of markets as South Africa continues to show a high degree of correlation in returns to other global markets.

Looking Ahead

In June, the ECB moved to try and arrest deflation concerns by engaging in measures designed to enhance "Animal Spirits," indicating a willingness to engage in some form of quantitative easing if necessary. While it is reasonable to assume that policy support from Europe will underpin asset prices at a time where the U.S is removing some of the "juice from the punchbowl," we continue to be more attracted to short duration or "value added cash-type assets" and as a result remain positioned with very short duration assets in our Fixed Income portfolios.

We remain concerned that equity multiples in SA and globally are far from cheap in absolute terms and when looking at the potential for rising rates in the U.S and the probabilities of extracting returns from equities or longer dated bonds we believe - like consensus - that equities remain the less ugly dance partner within a traditional Multi-Asset Class view. This stance should in no way be construed as us being bullish, as we do believe that returns have the potential to be poor going forward, especially should a mistake be made with global monetary policy. However, we remain pragmatic and cognisant of global liquidity and invest accordingly. Mitigating the valuation risks which exist in equities somewhat, we see volatility as offering significant multi-year value, both as a means of protecting against valuation headwinds but importantly also as an opportunity to earn Volatility Risk- Premia, protection from policy mistakes and enhancing the opportunity to dynamically manage the risk exposures within our equity or equity-type allocations to provide appropriate risk adjusted returns.

Market Commentary

January to March 2014 was characterised by uncertainty caused by yields backing up globally at the same time as the United States was going through a soft patch in economic data, caused by exceptionally cold weather. In addition, Global Emerging Markets saw broad currency weakness as capital flows headed to "Safe Havens". This currency weakness was most notable in the Fragile Five countries of Brazil, Turkey, Indonesia, India, and South Africa. Each of these countries took pre-emptive steps to prevent inflation and have increased interest rates in an attempt to manage the decline in the value of their currencies.

The move in SA rates during January took many participants by surprise given the sluggish nature of the SA economy, but if taken in the context of a broader universe increasing rates likely makes sense. Given the yield environment and uncertainty surrounding Emerging Markets we think equities (4.3%) and bond (0.9%) performance for the quarter was impressive. Mr Putin's latest jaunt into Ukraine to annex Crimea has caused additional uncertainty in the minds of investors and brought political risk back into the forefront, while the debate continues about Emerging market growth. The knock-on effects of Russia's actions could be large although the sounds made by Europe, the U.S and Russia have taken a slightly more conciliatory tone in the past few days. The equity market returned -2.4%, 4.9% and 1.8% for January, February and March respectively. The fund returned -0.7%, 2.2% and 1.9% for the same months. YTD the fund has returned 3.3% while the equity market has delivered 4.3%, illustrating our philosophy of gaining exposure in rising markets and limiting losses in falling markets.

Looking Ahead

Once again the resumption of improving economic data from North America highlights rather robust economic fundamentals in that region. Of concern however, is the continuing low inflation numbers coming from Europe. Low levels of inflation are generally good, the tipping point may be close at hand and we should expect some form of supportive measures to come from the ECB soon, especially with the "healthy" rates in the peripheral countries and the fragility of the Economic recovery in the wider region.

In South Africa, we should assume (if historical correlations hold) that economic growth will accelerate to keep pace with the well-established recovery in the U.S and the more nascent European acceleration of growth. While this bodes well for continued support of equities, it should not be forgotten that South African earnings multiples are currently at elevated levels and within an environment of potential policy mistakes from central banks everywhere, the risk of a reasonable correction shouldn't be underestimated.

The STANLIB Dynamic Return Fund will change it's name to STANLIB Absolute Plus Fund, effective from 1 March 2014