As one of their basic tools, market practitioners use the studying of long-term averages and judge events in the context of what is average. History will no doubt judge the third quarter of 2008 as an extraordinary one in the sense that it was far from average. This was in the context not only of the overall equity market volatility, but also sector relative performance. The action of the bond market must also be included in the "extraordinary performance" category.

There were two main features in the equity market over the quarter, viz. the sharp and rather dramatic reversal of the relative performance between the Resources sector (-38.9%) and the interest-rate-sensitive sector, particularly the Banks (+25.5%) and General Retailers (+26.8%). The other, of course, was the general direction of the market as a whole. The All Share Index had a disastrous September (-13.2%), making the quarter (-20.6%) one of the worst in recent times.

No further exposure was added in the resources area during the quarter; however, we were unfortunately a bit light in the interest-rate-sensitive area. Our strategy has been consistently to look for relatively secure earnings over the next 36 months, and the area that we still favour is the Construction sector (+10.6% for the quarter), which we have used as part of the strategy to offset the interest-rate-sensitive sector. The logic behind this thinking is that we are concerned about earning downgrades materialising in the near future in the broad domestic area of the market, excluding public sector fixed investment spending. Our theme has remained the same as before, viz. to focus on a three-year time horizon and stay with the companies we feel confident will deliver decent real earnings. We were not very active in any meaningful way in the nominal bond market over the period, which proved to be not such a good decision in the short term as bonds had a strong quarter (+12.6%), outperforming cash (+3.1%) rather dramatically. Note that the comparison over the first nine months of the year is that cash has outperformed bonds by 4.0%. As in the previous quarter, we were quite active within the cash area, extending the duration by investing again in one- and two-year NCDs. The logic of these investments is that we are now, in all likelihood, close to the top of the interest rate cycle. No further exposure was added to the inflation-linked bonds over the quarter as we believe that, in general, this asset class is now fully valued. Listed property had a very volatile quarter, much in line with the other interest-rate-sensitive areas of the market. Our low exposure to this asset class did not pay off over the quarter as this sector returned an excellent +23.1% over the three months. Note that for the year to date (nine-month period) the return has been -11.9%, justifying our low exposure to this area.

We went into the quarter exceptionally low in equities, and during periods of weakness we added exposure to this asset class in the belief that the worst was being fully discounted. However, we are still well below in equity exposure relative to our peer group. Some exposure was added to our bond exposure and our first tentative steps were taken to add some listed property to the portfolio.

History might well show that a broad-based equity bear market started in the fourth quarter of last year. The dominant investment themes that prevailed in the first quarter of this year, viz. slower economic growth coupled with higher than expected inflation, continued unabated into the present quarter. Inflation was driven mainly by the record high oil prices. The surprising variable was in fact the rand, as it appreciated slightly against all the major currencies over the quarter.

The main feature of the quarter was how narrow the SA equity market was, with only a handful of resource shares rising while the broad market declined. Over the first quarter resources outperformed the Industrial & Financial Index by 26.1%. This was followed by a further resources outperformance of 19.8% during the second quarter, resulting in an astonishing 47.7% differential over the first six months of the year. The broad theme was to avoid any share to do with domestic South Africa.

We were fairly quick to add some resources exposure into the portfolio when it became clear that meaningful earnings upgrades were in the offing. This strategy undoubtedly helped the overall portfolio during the quarter but, like in the first quarter, the only way to have made real positive returns over the quarter was to have been invested only in a handful of resource shares, which obviously would have produced unacceptable risk given the inherent volatility of this sector. Our theme remained the same as before, viz. to focus on a three-year time horizon and stay with our companies where we feel confident that decent real earnings will be delivered. We were again not active in any nominal bonds over the period, which proved to be a sound decision as bonds had another poor quarter (-4.9%), underperforming cash (+2.9%) rather dramatically. Note that cash outperformed bonds by 12.3% over the first six months of the year. As in the previous quarter we were quite active within the cash area, extending the duration by investing in one- and two-year NCDs. The logic of these investments is that we are now in all likelihood near or close to the top of the interest rate cycle.

We continued to build on our exposure to inflation-linked bonds. This asset class has been rerated rather dramatically and now looks to be on the expensive side. We will hold rather than add exposure at this stage. We fortunately did not get involved in the listed property area at all during the quarter. Our low exposure to this asset class paid off over the quarter as property unit trusts (listed property) returned a very poor -19.6% over the three months. Note that for the year to date (six-month period) the return has been -28.4%.

We were very active at the asset allocation level during the quarter and ended the quarter very low in equity exposure. The reason was more of a top-down view as the environment for all asset classes except cash deteriorated and should continue to do so in the foreseeable future. We are likely to remain cautious in the quarter ahead and stay with a high cash weighting.

Sanlam Balanced Fund changed its name to SIM Balanced Fund on 1 August 2008.

The sub-prime theme that started in August 2007 and affected the fourth quarter's investment outcome carried on into the first three months of this year, causing one of the most volatile and difficult quarters for a long time. What made matters worse was higher than expected inflation, coupled with a weak rand, higher energy and food prices, uncertain local politics and of course the Eskom saga. The big negative event was the market's indiscriminate selling down of the majority of our core stock picks in January. This resulted in the worst single month's investment return in the six-year history of running these funds. Much introspection was done on the nature of these shares and fortunately we did not join in the panic. The shares have rebounded nicely for us, particularly in March when we produced a positive return despite the All Share Index retreating by 3.0% for the month.

The other feature over the quarter was the large deviation between the Resource sector (+17.6%) and the Financial & Industrial sector (-8.5%), resulting in a massive 26.1% difference over the three-month period. In other words, the only way to have made real positive returns over the quarter was to have been fully invested in a handful of resource shares, which obviously would have produced unacceptable risk given the inherent volatility of this sector.
Our theme during the quarter was to focus on a three-year time horizon and add some exposure where we feel confident that decent real earnings will be delivered. This will be from global growth powered by the dominant emerging countries and domestically those companies that are in, or allied to, the continuing infrastructure and capital spending that has to take place. We stayed out of nominal bonds over the period, which proved to be a sound decision as bonds had a poor quarter (-1.9%), underperforming cash (+2.8%) rather dramatically. The core reason for this decision is rooted in the belief that inflation is going to remain a persistent and difficult nut to crack. As mentioned in our last quarterly we remain positive on the underlying short-term distribution drivers for listed property, but our value criterion was not met and more patience is required in this area. Our low exposure to this asset class paid off over the quarter as Property Unit Trusts (listed property) returned a very poor -13.3% over the three months.

We were not active at the asset allocation level during the quarter although we did take some exposure off the equity table during the volatile period into the strength in February. We remain near our target of 60% exposure to equities as we feel that there are enough positive drivers in the near term for this asset class to be the top performer over the next 12 months. Careful stock picking is likely to be the name of the game in 2008 rather than merely having exposure to the equity asset class.

Our decision to be shy of bonds paid off over the quarter as did being relatively light in listed property. In other words, our dual strategy of cash and equities is likely to be the core theme for the year ahead.

The trust can invest in all sectors of the FTSE/JSE, in Capital Market instruments as well as Money Market instruments and offshore investments. Up to 20% of the value of the fund may be invested in other collective investment schemes

The Sanlam Balanced Fund has been reclassified from the Domestic - Asset Allocation - Prudential Medium Equity Funds category to the Domestic - Asset Allocation - Prudential Variable Equity Funds category with effect from 1 June 2008. The fund will keep its price and performance history.

Benchmark
The fund's benchmark was the "Average of Morningstar Asset Allocation Prudential Medium Equity Category" and this has subsequently now also changed - the new benchmark is "Median of the Asset Allocation Prudential Variable Equity category".

The US housing sub-prime theme that started in August continued into this quarter, resulting in one of the worst quarterly equity performances of the past five years. The sector that underpinned the equity market for the first three quarters of this year, viz. resources, finally capitulated over this period (-7.5%). However, for the calendar year 2007 the JSE All Share Index still returned a respectable 19%.

The fund had a much better quarter than the previous one, especially in its stock picking. We were rewarded for the period under review by being low in some of the heavyweight mining shares such as Anglo American and Billiton. In addition, a stock that worked for us was the Altron group as they announced their intention of buying out the minorities in Altech and Bytes. We also added some construction shares to the portfolio on weakness as we believe that while they're discounting very good news there is still some considerable upside. One area that did detract from our performance was our underweight position in telecoms, particularly MTN.

We were not active in bonds over the quarter, which proved to be a sound decision as the All Bond Index (0.9%) underperformed cash (2.7%) over the quarter. As in the previous quarter we were quite active within cash in extending duration by investing heavily in 1- and 2-year NCDs. The rationale behind these investments is that we are now, in all likelihood, nearing the top of the interest rate cycle.

As mentioned in our previous quarterly, we remain positive on the underlying distribution drivers for listed property but our value criteria were not met and more patience is required in this area. SA listed property returned -0.4% over the quarter.

We were not active at the asset allocation level during the quarter although we reduced equity exposure during the volatile period in November and December. This was done by means of index futures rather than by selling stocks.

We remain close to our long-term target of 65% exposure to equities as we feel there are enough positive drivers in the near term for this asset class to be the top performer over the next 12 months. Careful stock picking should prove superior to asset allocation in 2008.

Our decision to be underweight bonds paid off over the quarter, as did being relatively light in listed property. In other words, our dual strategy of cash and equities is likely to be the core theme for the year ahead, unless major dislocations occur in currency and bond markets.