Market overview
Global equity markets continued their recovery during the quarter, with the MSCI World returning 16.8% in dollar terms. This quarter also saw the continued outperformance of risky assets, with the MSCI Emerging Markets index delivering an even more impressive 20% in dollars. Along with other emerging market currencies, the rand continued strengthening against the dollar, appreciating 3.1% during the quarter. The JSE All Share Index gained 13.9% in rand terms over the period. Global and local credit spreads continued to recover. The fear of an extensive recession or even depression that was being priced into risky assets has abated as economic data releases are turning more positive. Uncertainty remains regarding the effects of the quantitative easing policies followed by the central banks of the US, UK and Europe. Currently there are two polar opposite, either that a period of prolonged inflation will follow or that a period of prolonged deflation will follow. US long bonds yielded 3.3% at quarter end, while the Barclays/Lehman's global bond index returned 6.23% in dollars for the quarter.

Asset allocation
Local equities : We have had an overweight equities position since the fourth quarter 2008. The JSE SWIX Index has now rallied over 40% from its lowest point in March earlier this year. Last quarter we started reducing our overweight equity position. During this quarter we reduced it even further. Our bottom-up upside to fair value calculation has now reduced to about 5%.

Local bonds: We introduced an overweight position in bonds funded from cash during the quarter when ten-year bonds weakened to 9.3% when the Finance Minister indicated that tax collections could be R60bn below target for the year. Locally and globally there is no correlation between sovereign bond yields and bond supply and demand. There is, however, a link between sovereign bonds' real return and the government debt to gross domestic product (GDP) ratio, as this has an influence on the sovereign risk premium. As the additional debt required would not have a large impact on this ratio and as this ratio has been increasing rapidly in all developed markets, we consider the real yield on offer from bonds still to be relatively attractive. The September Monetary Policy Committee statement indicates that the SA Reserve Bank remains committed to targeting the 3% to 6% inflation band. Our calculations show that if we only manage to hit the top end of the inflation target, long bonds offer a real yield of 3.0% based on current yields.

Inflation-linked bonds : We retained an overweight position, as inflation-linked bonds do provide diversification and protection against unexpected inflation, especially in the light of the monetary policies being followed by the developed market central banks. The R197 bond maturing 2023 currently trades at a real yield of 3%.

Local listed property: We retained our neutral position to property even though the current valuation of property on an absolute basis relative to bonds remains somewhat attractive. We are, however, concerned that current vacancy rates are well below normal levels especially in the light of the current economic situation.

Global equities: We retained our overweight position in global equity markets with a preference for Europe where valuations are more attractive. Assuming earnings revert to long run trend levels, the global developed markets are more attractively priced than the SA market. Real earnings on the S&P500 have fallen to levels last seen in the 1930's. But assuming we revert back to consensus, the market does not appear expensive.

Global bonds: We retained our neutral position to global bonds; marginally preferring corporate bonds to sovereign bonds, given that the higher yield remains attractive relative to the probability of default of a diversified portfolio of corporate bonds.

Market overview
Risky assets experienced a strong recovery during the quarter. The global equity markets rebounded sharply, with the MSCI World Index rising by 21% in dollar terms. The recovery in emerging equity markets in dollar terms was even more pronounced, with the MSCI Emerging Markets Index soaring 34.8%. Some of this return stemmed from the firmer emerging market currencies. The rand was one of the strongest-performing emerging-market currencies over the quarter. The JSE All Share Index delivered an 8.6% return in rand terms. Global credit spreads recovered from extreme levels and industrial commodity and oil prices increased dramatically. For example, oil gained 50% in US dollars. The fears of an extensive recession, or even depression, which were priced into these risky assets appear to have subsided. Global deflationary fears have also waned, with US government bond yields weakening to 3.5%. The Barclays/Lehman's Global Bond Index returned 4.93% in dollars for the quarter.

What SIM did
Local equities : We have had an overweight equities position since the fourth quarter of 2008. Given the recent rally in our market we have reduced our overweight position marginally. This rally has narrowed our calculated discount to fair value to 10% to 15% versus 30% at the November 2008 and March 2009 lows. However, we still believe equities will do better than cash and bonds over a three-year period. Local bonds: We currently have a neutral allocation to domestic bonds as the current nominal yield on offer in relation to the long-run inflation target seems fair. Inflation-linked bonds : We have reduced our overweight position given the rerating in real yields since earlier this year. Our remaining overweight exposure comprises mostly corporate ILBs. Local listed property: We have retained our neutral position to property even though the current valuation of property on an absolute basis relative to bonds remains somewhat attractive. However, relative to developed markets SA listed property appears expensive. Global equities: We have retained our overweight position in global equity markets, with a preference for Europe where valuations are more attractive. Global bonds: We have retained our neutral position in global bonds. Even though the real return obtainable from sovereign bonds does appear more attractive now, we do still prefer corporate bonds to sovereign bonds. The additional yield or spread obtainable from a diversified portfolio of corporate bonds implies a default rate that is high relative to what has been experienced historically.

SIM Strategy
Developed-market governments and central banks have been engaged in unprecedented stimulus policies. The jury is still out on what effect these will have on economic growth and long-term inflation. Given this, we aim to be overweight assets where the current valuation discounts a worst-case scenario.

The Market review
Global and local equity markets declined steeply for the first two months of the quarter before rebounding in March and ending the quarter down 11.8% and 4.2% respectively, Emerging markets outperformed during the quarter, while negative sentiment prevailed in the developed world stock markets. Offshore bonds also had a disappointing quarter, with yields rising in the face of increased issuance and less foreign buying. At home, SA equities followed their offshore counterparts lower and local bonds yields traced the upward movement in global government bonds. What SIM did Local equities: Overweight. After the further fall in equity prices, local equities are now priced quite attractively. The market's forward rating is well below its long-term average and on a fundamental intrinsic valuation the market offers significant value. Local bonds: Neutral. Long bonds yields are offering decent real returns should inflation drop to well within the SARB target range. However, inflation-linked bonds offer similar returns without any inflation risk so we have moved to an overweight position in inflationlinked bonds. Local property: Small Overweight. Listed property continues to offer value. However, vacancies are very low and, as the economy surprises to the downside, vacancy risk rises. Global equities: Overweight. Global markets have de-rated further. Price-to-book valuations are between 1 and 1.5 for the developed markets and thus we added slightly to our overweight position. Global bonds: Neutral. Global sovereign bonds are currently offering fair real returns based on the long-term implied inflation assumptions of the US and European central banks.

SIM strategy
There is a risk that global inflation could rise well above average in the medium to long term. Inflation is a function of money supply and the velocity (or amount of transactions) of money. Due to the financial crisis, the velocity of money has dropped substantially but money supply is increasing rapidly.

Central banks are printing money to buy some of the burgeoning government debt issues, as well as distressed corporate debt, thus increasing money supply. As a consequence, the velocity of money will increase again when the global economy recovers, which could have serious inflationary implications, unless the central banks react quickly by destroying the money they have printed.

Moreover, given the increase in government debt, future governments might not be adverse to inflation, as this would help to inflate them out of their debt problem. Long bonds are one of the most risky asset classes in times of unexpected inflation, as they only pay a fixed nominal yield. Currently the US government and inflation-linked bond market is pricing relatively low long run inflation of 1.5%.

But if the capitalist system survives and functions properly from here, we believe equities are likely to outperform bonds.

The Market review
The FTSE/JSE All Share index lost 9.2% during a tumultuous fourth quarter, as economic news from developed economies confirmed that the world was entering a recession and emerging-market growth indicators continued to deteriorate. Resources (-12.9%) and financials (-11.4%) led the ALSI down, while industrials (-4.1%) were relatively unscathed. A clear defensive style-bias emerged looking at cross-sector performance, as non-cyclical sectors outperformed. Global equity markets also had a rough quarter, with the S&P500 losing 22.4% and the MSCI World index falling 21.7% in US dollars.
The Federal Reserve lowered the target funds rate from 2% to between 0% and 0.25%. Indicators of a sharply slowing global economy came thick and fast, with the most notable probably being a steep drop in US employment. Official measures to protect the financial sector continued and US automakers also sought public sector support. Meanwhile fiscal policy was stepped up in a number of countries. In South Africa, the SARB cut the repo rate by 50 basis points to 11.50% at its MPC meeting in December on easing inflation pressures.
Local bonds had a strong quarter, returning a healthy 11.3% for the period. Listed property was also a feature, producing 8.5% for the quarter. These returns were in response to a strong belief that the repo rate was likely to be cut meaningfully during 2009.

What we did over the quarter
In general we had a quiet quarter in terms of making any significant changes to the portfolio. Within equities our stance was not to take big stock bets as the short-term outlook and sentiment remain highly problematical. At an exposure level, for the same reasons, we sold some equities over the quarter to be underweight. Some exposure was added to bonds, which proved to be a sound move although in hindsight we should have been much more aggressive in this area.

Major performance value adders and detractors
The position that added the most value over the quarter was our low weighting in equities relative to what we believe the benchmark is. Within equities, our low exposure to resources paid off but the key detractor was that we did not have a large enough holding in the food and retail sector, which produced a stunning 16.2% return over the quarter.
In general, the major detractor from value over the quarter was our relatively low weighting in all interest-rate-sensitive assets.

Investment strategy going forward
We maintain that the ultimate fallout of the US-led financial crisis will be a sustained period of below-trend global economic growth for at least the next two to three years and the key question now is: Is this correctly priced into the equity markets? There is no doubt that pockets of value are emerging within the equity markets so the only challenge, given the no-loss capital constraint (making the time horizon much shorter), is when the value will begin to be unlocked. Regrettably it is impossible to predict this, so we believe it would be prudent to take advantage of our low weighting in equities and start adding some exposure cautiously. We believe bonds have more than fully discounted all the positive inflation and short-term interest rate movements and are now expensive. Given our low weight in this asset class, we are likely to be buyers on any material weakness.