Market review
After a mid-quarter slump, September's strong rally meant it was a bumper quarter for world stock markets, as fears about the imminence and likelihood of a double-dip recession subsided.

In the developed world, Europe was the main beneficiary of improving sentiment, with France's CAC 40 up more than 20% in total dollar terms versus the Dow Jones' 11.1% gain. Meanwhile, Japan lagged behind, advancing a "mere" 5.8% for the quarter.

Emerging markets again outpaced developed markets, with the MSCI Emerging Markets Index soaring 18.2% in dollars, well ahead of a 13.9% increase in the MSCI World Index.

Meanwhile the MSCI SA Index was the second best performer in the emerging market universe, soaring 25.4%. Rand strength played an important role, with the currency appreciating more than 10% against the dollar during the quarter. This was almost double the All Share's 13.3% performance in local currency terms during the third quarter.

The SA bond market also delivered strong returns during the quarter, with the All Bond Index up 8.0%, versus the 4.6% return delivered by inflation-linked bonds and 1.7% by cash.

SIM strategy
Local equities: We retained our neutral weighting to SA equities during the quarter. The JSE All Share Index is trading on a current price-to-earnings (PE) ratio of about 15. Company earnings are forecast to increase by 30% one year from now, which would put the market on a PE of 11 times, assuming the price index remains at its current level. Based on long-run normalised return on capital assumptions, our intrinsic valuation of the individual companies on the JSE (as calculated by our analysts) indicates that the market as a whole is fairly priced.

Local bonds: We began the quarter with an overweight exposure to conventional bonds, with 10-year bonds yielding 8.8%. Towards the end of the quarter, 10-year bond yields strengthened to below 8%, which is below our estimate of fair value based on our longrun inflation assumptions. As a result, we initially reduced our overweight position to neutral and subsequently cut it to underweight relative to the benchmark weighting. Although inflation appears under control over a shorter time horizon (partly thanks to a strong rand exchange rate), we believe that over the longer run inflation is going to be closer to the upper end of the 3% to 6% inflation target. The rand is currently trading stronger than our fair value estimate based on purchasing power parity calculations.

Inflation-linked bonds: We reduced the magnitude of our overweight position as real yields on the medium- to longer-dated inflation-linked bonds of around 3% at the start of the quarter rallied to about 2.6% by quarter end. This is marginally above our long-run fair value assumptions of 2.5%. Inflation-linked bonds do provide a good hedge against currency weakness and inflation and we are therefore retaining our overweight position in this asset.
Local listed property: Dividend yields on listed South African property companies are trading below South African long bonds, while in most developed markets they trade above the respective long bond yields. This is partly due to the higher inflation rate in SA, resulting in higher nominal dividend growth rates for SA property companies. Dividends are expected to grow at approximately 8% over the next year and we retain our neutral position, as we believe property shares are on average fairly priced.

Global equities: We retained our overweight position during the quarter, primarily expressed by an overweight position in European large capitalisation stocks. At close to 4%, the dividend yields on these shares are attractive relative to the rest of the developed world. On a normalised earnings basis the US market is trading close to fair value.

Global bonds: We retained our underweight position in global bonds that we introduced during the fourth quarter of 2009. US 10 -year treasury yields are discounting a protracted period of extremely low inflation and the last time yields were as low was during the Great Depression and both during and in the immediate aftermath of the Second World War, when long term yields were fixed at 2.5%.

Risks and opportunities ahead
We are currently finding few attractively valued investment opportunities. In fact, a substantial portion of these opportunities have become expensive if measured on normalised assumptions, and thus we have reduced our exposure to these in our portfolios. History has taught us that expensive assets can become more expensive, which may be to the detriment of our portfolio performances over the shorter term.

Market review
Fears of a double-dip recession moved centre stage during the second quarter when economic statistics disappointed and debate intensified over whether the impact on world growth of fiscally austere policies planned in Europe.

These events dented already uncertain investor sentiment and thus stock markets put in a dismal performance for the quarter, with the Dow Jones Industrial Average slumping 9.4%, the FTSE 100 of 13.8%, Germany's DAX down 12.2% and Japan's Nikkei 10.7% in the red. At home, the JSE lost 8.2% in local currency terms and 12.7% in dollars given the rand's depreciation during the quarter. These negative returns merely extended a difficult run for global equity markets during the first six months of the year.

The most visible beneficiary of global economic and financial market jitters was the US bond market, with the 10-year US Treasury firming to below 3%.

Current asset allocation
Local equities: We retained our neutral position in SA equities during the quarter. Our intrinsic valuation of the individual companies on the JSE, as calculated by our analysts, indicates that the market is fairly priced. SIM's investment philosophy and process is based on valuing investments according to long-run normalised investment metrics rather than one year earnings forecasts. Currently the consensus forecasts earnings for the SWIX Index, in one year's time, is 30% higher than current earnings.

Local bonds: We increased our overweight positions in bonds. Concerns about the economic stability of the European Union resulted in an increase in the risk premia required for risky assets early in May. As a result, the SA 10-year long bond weakened to an approximately 9% yield. To value SA bonds we consider both SIM's and consensus one- and two-year inflation forecasts, as well as our long-run inflation assumption. We do not believe that these events have had any significant impact on these assumptions. Therefore given that SA long bonds offered attractive prospective real returns, we added further to our SA long bond position from cash and also increased the modified duration on bond portfolios. Inflation-linked bonds: Real yields on the medium- to longerdated inflation-linked bonds are around 3%.

Inflation-linked bonds remain an attractive asset class in our opinion.

Local listed property: We retained our neutral position to property based on current valuations.

Global equities:We increased our overweight position in global equities, with a strong bias towards developed European equity markets. Towards the end of May, these markets had fallen more than 20% from their peak in dollars. European stocks are expected to pay a 4% dividend yield on average in 2010. Even assuming no earnings growth from European-based companies, which seems unlikely given the weak Euro and the fact that a large number of the bigger companies are export orientated, equities are the preferred asset class relative to bonds and zero yielding cash. On a price-to-book basis European stocks are 40% below US stocks, while on a one-year forward sector adjusted price-to-earnings (PE) basis Europe trades 25% below the US.

Global bonds: Mid-April we closed our underweight position in global bonds when US long bonds reached a yield of 3.85%. By the end of May,US 10-year long bonds had rallied to 3.15%, while German bonds had reached 2.6%. We believe this very rapid drop in AAA sovereign yields was due to a change in the perception of risk rather than future inflation expectations as it went hand in hand with a large rise in the VIX(the implied options volatility on the S&P500), as well as an increase in the risk premiums in interbank trading (TED spread). Also, we do not believe that the long-run economic fundamentals could change over such a short time period.

Risks and opportunities ahead
In terms of our value-based investment philosophy, the number of attractive investment opportunities has diminished, given the rerating of assets.

Market review
Most world equity markets continued their upward march during the first quarter, with stock markets putting in a particularly strong rally in March. The US heavyweight Dow Jones Industrial Average steamed ahead 4.8% during the quarter in dollar terms. More broadly in quarter one, the MSCI World Index was up 3.4%, slightly outpacing the MSCI Emerging Market Index's 2.5% return (both reflecting total returns in dollars).

However, the equity markets that went against the trend were the UK's FTSE100, Germany's Dax, France's CAC, Hong Kong's Hang Seng and MSCI China indices, with declines ranging from the FTSE's 0.4% to France's 4.8% during the first three months of the year in local currency terms. The European stock markets were adversely affected by concerns surrounding fiscal debt burdens in Greece et al. All of these stock exchanges did, however, put in strong positive performances during March.

The JSE mirrored the US's positive stock market performance, gaining 4.5% during the quarter in rand and almost 8% during March. The rand's continued sharp appreciation against the dollar saw foreign investors achieve even better dollar-based SA equity market returns.

Local equity and bond market returns came in neck-in-neck for the quarter, both gaining about 4.5% but the stock market outstripped bonds by a wide margin during March (7.9% in rand versus 2.1% respectively) as equities gained momentum notwithstanding concerns about valuations.

SIM Strategy

Local equities: Since the end of last year we have gradually reduced the overweight exposure to equities we initially introduced in the fourth quarter of 2008 - and in March we adopted a neutral position. The JSE All Share Index is trading on a current price-to-earnings (PE) ratio of about 18 and a rolling one -year forward PE of 16.5. Based on the JSE's long-run history, the returns after investing at PE's in excess of 15 have been low. Even so, company earnings are forecast to increase by 30% one year from now, which would put the market on a more reasonable PE of 12.5 times, assuming the price index remains at its current level. However, as history has shown, earnings forecasts, and forecasting in general, usually prove to be inaccurate: that is why SIM's investment philosophy and process is based on valuing investments according to long-run normalised investment metrics rather than short-term forecasts.

Using this methodology, our intrinsic valuation of the individual companies on the JSE, as calculated by our analysts, indicates that the market is fairly priced. On a price-to-book valuation the market also appears fairly priced given our long-run normalised return-on-equity assumptions. However, if you value the market on a long-run price-to--trend earnings basis, it appears to be expensive. There is, though, a compelling argument that earnings of SA companies have been suppressed below normal levels in the past as a result of the country's isolation, especially in the two decades leading up to the mid-nineties at which point the economy opened up to the global economy.

Local bonds: We retained our overweight position in bonds during the quarter. Ten year bonds began the year trading at yields above 9% and are now trading at about 8.5%. Given our long-run inflation assumption of 5.25%, long bonds still offer value - but considerably less than at the beginning of the quarter.

Inflation-linked bonds: Real yields on the medium- to longerdated inflation-linked bonds are well above 3%. Inflation-linked bonds remain one of the cheaper asset classes in our opinion. Given the long-run historic real returns achieved by these assets in world capital markets, these real yields are attractive.

Local listed property: We retained our neutral position to property based on current valuations.

Global equities: We retained our small overweight position during the quarter. The US market is trading at normalised earnings (long-run trend earnings) of around 23% and a price-tobook ratio of about 2 times. The market is still cheaper on these measures than the entire period from the mid-nineties until the financial crisis struck some eighteen months ago.

Global bonds: We retained our underweight position in bonds introduced during the fourth quarter of 2009. US 10-year treasury yields are discounting a protracted period of extremely low inflation and the last time yields were lower was during the Great Depression and during, and in the immediate aftermath of the Second World War when long term yields were fixed at 2.5%.

Risks and opportunities ahead
In terms of our value-based investment philosophy, the number of attractive investment opportunities has diminished, given the rerating of assets.

Market Review
Global equity markets continued their strong run during the fourth quarter, with the MSCI World Index ending the period 4.2% higher (30.8% year-on-year ("y/y")) in dollars. The gap between emerging and developed market performance continued to widen, with MSCI Emerging Markets up 8.6% for the quarter (and a massive 79% y/y). In SA, the All Share Index rose 11.4% in rand terms during the fourth quarter (32.1% y/y). The rand's appreciation contributed handsomely to the local equity market's full year performance in dollar terms, with the All Share gaining 70.1% y/y in dollars. However, MSCI figures show that SA's dollar-based equity returns lagged the BRIC countries, with Brazil, India and Russia experiencing 100% plus returns and China 62.2% during 2009. Global and local bond yields, particularly in developed markets, continued rising during the quarter and year. In the US, 10-year government yields deteriorated 53 basis points (bps) to 3.84% during the three-month period, while SA long bonds increased 20bp during the quarter to end the year at 9.08%. Cash delivered a return of almost 9% for the year, much better than the local bond market's -1% performance in 2009.

SIM Strategy
During the quarter, we changed our long-run inflation assumption - a key input to our asset allocation process - from 4.5% to 5.25%. By long run we mean a period spanning various economic cycles, in other words 10 years or longer. We previously assumed the Reserve Bank's efforts to keep inflation within the target band would result in a long-run inflation rate that tended towards the middle of the range. In reality, however, when inflation has been in the band, it has tended to be closer to the top of the band. Our current asset allocation positioning is:

Local equities
We introduced an overweight equities position in the fourth quarter of 2008. In response to the re-pricing of the equity market we have reduced this overweight position in the second and again in the third quarter, but remain marginally overweight given the market's current valuation.

Local bonds
We retained our overweight position in bonds. With ten year bonds yielding above 9%, and given our long run inflation assumption, long bonds offer a real return of just below 4%.

Inflation-linked bonds
During the fourth quarter, we increased our overweight position in inflationlinked bonds in response to a decline in yields on the RSA 2023 inflationlinked bonds to about 3.2%. SA inflation-linked bonds are attractive relative to global developed market inflation-linked bonds, which are currently at very low levels. US 10 year Tips are trading at just above 1%, while similar European bonds are trading well below 1%. These low real rates are partly a reflection of the historically low short-term policy rates in these economies

Local listed property
We retained our neutral position to property based on current valuations.

Global equities
We reduced our overweight position in international equities during the quarter. In US dollar terms the MSCI World Index has now rallied more than 65% off its low point at the beginning of March 2009, when we increased our overweight position. Over the same period, the MSCI Emerging Markets Free Index rallied almost 100%. In the last few months of 2009, developed market earnings surprised on the upside relative to consensus forecasts. The US market is now trading at a normalized earnings PE, or long-run trend earnings, of around 22. The last time the S&P 500 traded at such a low trend PE was in the mid 1990's. Based on most long run measures, however, global developed equity markets do seem fairly valued if we consider the period since the mid-1990's as an anomaly when stock markets were consistently overvalued.

Global bonds
We introduced an underweight in global bonds during the fourth quarter of 2009. US 10-year treasury yields are discounting a protracted period of extremely low inflation and the last time yields were lower was during the Great Depression and during, and in the immediate aftermath of, the Second World War when long term yields were fixed at 2.5%. The investment case that supports the current low bond yields in the US is a deflationary situation similar to Japan's. We believe the odds of a similar deflationary scenario playing out in the US and Europe are low, given the actions of the central banks and governments of the US, UK and Europe. Our underweight position does not reflect a view that inflation will become a problem globally, but rather a more agnostic view of the future. Previously our neutral position in global bonds reflected a preference for corporate bonds over sovereign bonds. This is no longer the case. Developed market credit has performed particularly well, with high yield credit spreads in particular contracting to levels that seem appropriate given the risk of default associated with these companies.

Risks and opportunities ahead
In terms of our value-based investment philosophy, the number of attractive investment opportunities has diminished, given the re-rating of assets during the last six months of 2009.