The third quarter of this year proved to be a rebound from the tough second quarter and as a consequence the fund produced a solid result.

The main positive driver of the performance came from the equity side where the All Share Index gained 6.3% over the quarter. It is interesting to note that the Financial & Industrial Index had a bigger upward correction, gaining 11.0% over the three-month period.

At an asset allocation level we stayed out of nominal bonds as we remain nervous about the immediate outlook for short-term interest rates. This strategy proved to be neutral over the quarter as bonds fared only marginally better than cash, returning 2.1% versus 1.9%.

From May 2003 to May 2006 South Africa experienced a sweet spot in terms of the broad macro-economic drivers, the most important being disinflation, an appreciating rand and, of course, lower real and nominal interest rates. Basically, all of the SA equity market shares benefited from this benign environment, particularly those that were plugged into the local economy. However, with the change in the trend of the rand this favourable environment is changing to a much tougher one, with interest rates set to rise by at least another 100 points with a distinct risk of further increases. Note that another 100 points increase is well discounted in both the equity and bond markets, but more than that will unfortunately introduce a further bout of downside volatility.

Given these short-term risks we have positioned the equity exposure to be about neutral. The reason for this stance is that, looking forward into 2007, there are definitely some positive fundamentals to be found, which should result in equities remaining the asset class of choice.

In conclusion, we are happy with our stance at present from an asset allocation point of view. We have begun to shift the focus of the equity stock picks to reflect the change in the overall macro-environment.

Finally, if the rand stabilises, the markets should start to factor in a different but solid set of economic variables and we should end the year close to our respective upside targets.

This quarter proved to be an exceptionally tough one for our portfolios. May and June were an extraordinary period with regard to our portfolios as the equity component detracted value largely from a sector point of view. It was the worst two months since inception of these funds in 2001 and we believe it was due to a market aberration rather than any flaw in our approach to their management.

Equity exposure was trimmed in April and then again in mid-May, which in total came to a reduction of over 6%. Note that the total equity exposure reduction since the beginning of the year now stands at just over 10%. We are now running well below what we think is the optimal strategic exposure to equities. As has been mentioned often before in our quarterly reports the equity exposure has generally been confined to the Domestic Financial and Industrial sectors due to the relative consistency and reliability of future earnings and dividend growth.

Over the quarter the financial and industrial sector declined by -5.6%, while the resource sector actually went up by 21.3%. Therefore, over the three-month period there was a 26.9% difference in the performance of these two sectors!

Over the quarter our negligible exposure to long bonds paid off as the All Bond Index produced one of it worst quarterly returns - a negative -3.6%. However, this is an area on which we are increasingly focusing to try and extract real returns, so we may start adding to our nominal bond positions on any further weakness.

Quoted property was the big loser over the quarter declining by -22.3%, but fortunately the fund's exposure to this asset class remained very low.

We were pleased with the overall asset allocation of the fund over the quarter but, essentially, it was having only financial and industrial exposure in the equity portion of the fund that contributed to the quarter's return.

Despite the disappointing absolute quarterly performance we remain confident that we can achieve our dual objectives of not losing capital over a rolling 12-month period and achieving our upside objective over a rolling 36-month period.

However, it is worth stressing that on a short-term, month-to-month basis, we can experience negative drawdowns when there are widespread sell-offs.

The first quarter of this year continued where we left off at the end of last year by having another positive performance over the period. The fund finished the quarter in 2nd place in addition to producing a strong absolute return.

The main driver of the performance was stock picking, as our exposure to the precious metals sector paid off handsomely, particularly in January. Other parts of the equity portfolio such as building and construction also played a positive role in the overall performance. Value was also added by switching our bonds into quoted property.

As mentioned in the previous quarterly we went into the new year with an overweight position in resources. January was an exceptional month for this sector as it returned 12%. That rate of return was clearly unsustainable and we took some profits from this sector in early February.

Our exposure to equities was reduced over the quarter mainly as a result of profit-taking in areas that we believed have run ahead of the fundamentals. Overall our exposure to domestic equities declined from 68% to 63% over the quarter. The big change from an asset allocation point of view was our switch from bonds into quoted property.

Quoted property performed exceptionally well this quarter, returning just under 22% against bonds and cash returns of 1.5% and 1.8% respectively.

In summary, the big picture is still conducive for equities and property to outperform cash and bonds over the medium term. However, we caution that there might well be a short-term correction ahead in equities as price momentum is now running well ahead of forecast earnings momentum. Our current strategy is to be relatively defensive at an asset allocation level (modest exposure to equities) and also with regard to our stock picks.

We believe that the fund is well positioned for the foreseeable future to take advantage of the potential scenario outlined above, both from an asset allocation and stockpick point of view.

The main driver of the performance was stock picking, particularly Venfin, which was one of our largest equity holdings. Venfin jumped by over 29% on 3 November on the back of the announcement that UK-based Vodafone was to acquire the whole of Venfin in order to obtain its 15% stake in locally based Vodacom.

Besides that one-off boost to performance, the core stock picks in which we believe (solid blue-chip industrials and financials) also delivered as expected. In addition, this quarter we added exposure to precious metals through gold and platinum shares. For the first time during 2005 we were slightly overweight resources. Our exposure to equities was higher at the end of this quarter than at the end of the 3rd quarter, predominantly as a result of Venfin and market moves rather than a conscious increase in asset allocation.

Bonds made a strong recovery this quarter and with hindsight we could have had more long-duration bonds and less cash over this period. The point made last quarter of adding exposure on any weakness never materialised as, in our opinion, the entry levels were not attractive enough. However, we added some quoted property in lieu of bonds, believing it to offer better value.

In summary, the big change, from an overall market-driver point of view, has been the shift in inflationary expectations as the petrol price does not seem to be spilling over into core inflation. The result has been a revision in the way the market anticipated short-term interest rates to move. At the beginning of the 4th quarter it was virtually certain that short-term rates would have to rise by at least 100 points during 2006. This view has now changed to no further hikes during 2006 and in our opinion there is a growing possibility of a 50 point cut during the first half of the new year. This has had a dramatic effect on the equity and bond markets as evidenced by their respective strong performances during the quarter under review.

Looking forward, we think that the best beneficiary of above-trend economic growth with stable interest rates will, once again, be equities. At this stage the overall value of the equity market is arguably fairly full but still far from being irrationally expensive.

We believe that the fund is well positioned for the year ahead to take advantage of the potential positive scenario outlined above, both from an asset allocation and stock-pick point of view.