Market review
New found optimism in the developed markets saw the MSCI World Index advancing a strong 7.9% at the expense of the MSCI Emerging Markets Index, which backtracked 1.6% in total dollarbased terms. Towards the end of the quarter, investor sentiment in Europe was somewhat dented by the European Union's bail-out of the Cypriot banking industry. In the US, however, the broad-based S&P 500 and blue-chip, heavyweight Dow Jones Index ended the quarter on record highs. In SA, the All Share Index gained 2.5%, easily outperforming bonds (1.31%) and cash (1.31%). Inflation-linked bonds were the best performers in the fixed interest universe, adding 1.8% during the quarter. Industrials and financials again led the way, gaining 6.3% and 5.9% respectively, while resources lost ground again; declining 6% during the quarter.

SIM Strategy
Local
Local equities | We currently have a benchmark holding in SA equities as we believe SA equities are fairly valued to slightly expensive. In summing up the individual company valuations, as calculated by our equity analysts, the market appears to be about 10% overvalued if we assume a required real return of around 7%. Even so, the prospective real return on offer from local equities remains attractive relative to the other domestic asset classes. Local bonds | We retained our underweight bond position. We require a 2% real return for SA 10-year bonds, which is 1% higher than we require from cash to compensate us for the inflation and term risk associated with investing in long bonds. Currently the 10 -year bond trades about 0.5% below our long-run fair value of 7.25% based on our long-run inflation assumption of 5.25% Inflation-linked bonds | We currently have a neutral holding in SA inflation-linked bonds (ILBs). Ten-year SA ILBs offer a 0.75% real return, but with no inflation risk. Even though this does seem expensive relative to our long-run fair value of 1.5%, we are concerned that our long-run real return assumptions for government securities are too high, given our opinion that we have entered a protracted period of financial repression. It is difficult to judge how aggressive governments will be in pursuing financial repression. Local listed property | Property stocks are expensive relative to what we consider to be fair value, given current dividend yields. However, relative to current SA long-bond yields, the dividend yields offered by listed property seem reasonable and we therefore retained our neutral position in property.

Global
We maintained our overweight position in offshore assets even though the rand is slightly weaker than purchasing power parity levels, which we estimate to be around R8.75 to the US Dollar. Furthermore, we believe that selected global equity markets and listed property markets are considerably cheaper than the SA market. Global equities | We retained our overweight position in global equities, with a preference for Europe and the UK. Global equity markets are trading on a trailing price-to-earnings (PE) ratio of around 15. The long-term average since 1970 has been 17.5. On a cyclically-adjusted basis, the global market is trading on a 17.5 price-to-adjusted-earnings, while the long-run average is closer to 25. On a cyclically-adjusted PE basis Europe and UK are the cheapest markets and they also trading well below their long-run averages. Global bonds | We retained our underweight position in global bonds. Benchmark 10-year sovereign bonds in the US, Germany and UK offer negative prospective real returns, given the implicit inflation targets of the central banks, as well as long-run consensus inflation forecasts. Global property | We have a significant overweight position in international property via listed REITs. Currently our holdings have an average dividend yield of about 6%, which is attractive compared to the 6% dividend yield offered by SA listed property.

Risks and opportunities ahead
Given the indebtedness of the developed market governments, they have a strong incentive to promote financial repression, which inevitably results in low or negative real rates on cash and government bonds. Furthermore, governments also have an incentive to encourage inflation as this will reduce their future obligations in real terms. Even though we have made adjustments to our long-run assumptions as a result of this, it remains difficult to judge to what extent these policies will be pursued. We are therefore particularly cautious on implementing tactical asset allocation positions that would only be to the benefit of portfolios if real rates increase or inflation decreases.