In selecting securities for the Sanlam Investment Management Balanced Fund, the Manager shall seek to achieve an investment medium for investors which shall have as its primary objectives a reasonable level of current income and maximum stability for capital invested.

At least 85% of the assets of this fund should be invested in South Africa at all times. The trust conforms to regulations governing retirement fund investments.

The SIM Balanced Fund will change it's name to Sanlam Investment Management Balanced Fund, effective from 25 August 2016

Market review
Our strategy The yield difference (spread) between the South African 10-year USD sovereign bonds and the US 10-year sovereign bond is at about 3% and is still 0.5% higher than where it traded on average in 2014 and 2015. This spread has recovered substantially from its high of 3.85% in the wake of the surprise dismissal of the Minister of Finance by the President in December 2015. This spread reflects the risk of default by the South African Government on its USD bonds and is referred to as the sovereign risk premium of South Africa.

That some confidence has returned to the country is also evident from the strengthening of the rand, as well as the lowering in the inflation risk premium. Ten year South African rand bonds strengthened, without any significant changes to the inflation outlook. The equity risk premium for companies that derive their income from the South African economy also improved, as is evident in the outperformance of the mid-cap and small-cap indices.

Local investments:
Local equities We retained our underweight position in South African equities. Even though South African equities are fairly priced using a bottom-up valuation of the individual companies, we continue to prefer global developed market equities ahead of SA equities. South African equities continue to trade at a substantial premium to other emerging markets on both a price to earnings and a price to book basis.

Local bonds In January we increased our overweight position in South African 10-year bonds. They traded at yields of 9.6%, thus offering a 3.6% real return assuming inflation is at the upper end of the inflation target band for the next 10 years. A holder of SA 10- year bonds since 1900 received a real return of 1.8% per annum. We believe that the policy of a 3% to 6% inflation target band will be maintained. The SA Reserve Bank's recent rate hikes are to some extend a confirmation of this. The events in December surrounding the dismissal of the Minister of Finance and the reappointment of Minister Pravin Gordhan do give confidence that the government heeds financial markets. In all likelihood National Treasury's hand has been strengthened and it would find it easier to follow a prudent macro-economic policy that will be supportive of the inflation target.

Over the next year or two, average inflation is likely to remain above the upper end of the target given the rand's depreciation and increasing food prices. There is also the possibility of a downgrade of South Africa's credit rating to sub-investment grade. Bond investors are well aware of these issues and their fears are more than likely reflected in the current bond prices.

South African bonds are furthermore attractive relative to real returns available on bonds in other developing and developed markets. Inflation-linked bonds We retain our overweight position in inflation-linked bonds, which we implemented immediately after the dismissal of the Minister of Finance in December 2015. Ten year inflation-linked bonds then traded at real yields of 2.3%. We consider the default risk on inflation-linked bonds to be low as the government is in control of the rand printing presses. These bonds have now strengthened to 1.75%, but they still trade above our current long-run assumption of fair value, which is 1.5%.

Local listed property
We retained our neutral holding in listed property. We prefer international listed property companies, which we believe are cheaper. Global investments: Even though the rand has recovered from its weakest levels it remains one of the weakest emerging market currencies relative to purchasing power parity. The rand remains more than two standard deviations cheap against the USD and one standard deviation cheap versus the GBP and EUR. We believe that purchasing power parity holds over the long run. This has been the case for the rand in 2001/2 and 2008 when it was cheap versus developed market currencies. In both cases the rand recovered to purchasing power parity. For this reason our portfolios retained their underweight position with respect to their total offshore exposure.

Global equities
We retained an overweight position in global equities. We are of the opinion that on a relative basis, global equity remains an attractive asset class. The dividend yield of developed market equities is at 2.8%. This is higher than the average dividend yield of the past thirty years. Only in 2008 were dividend yields substantially higher than current levels.
On the other hand the yields available from cash and bonds have reduced substantially over the past thirty years. In 1986 developed market sovereign bonds yielded 10% while cash yielded 6% on average. Over this period inflation in the G7 countries also declined but to a much lesser extent, as it was about 4% 30 years ago. We continue to prefer Europe and the UK to the rest of the developed world. European companies trade at a lower price to book valuation and higher dividend yields than most other developed markets. Partly due to the lower bond yields in Europe the equity risk premium is also substantially higher.

Global bonds
The real yield on offer from developed market bonds remains unattractive relative to more risky assets. We retained our underweight position in favour of international listed property.

Global property
We retained our overweight position in international properties via listed REITs. Our portfolio currently consists of nine companies that have properties in the USA, Europe and Australasia. The average dividend yield of the portfolio is 5.5%. Risks and opportunities ahead We do believe that the risk of investing in South Africa has diminished somewhat after the substantial increase in December 2015. However, the risk that the credit rating of South Africa can be downgraded to sub-investment grade remains. We are of the opinion that the risk of this is to some extent already priced into South African assets.

Market review
Our strategy
In December the risk premia attached to South African assets increased significantly after the surprise dismissal of the Minister of Finance by the President. The yield of South African USD 10-year sovereign bonds weakened by approximately 0.6% after the announcement, which is a reflection of the increase in the sovereign risk of the country. Local 10-year bonds weakened by approximately 2% to 10.4%, offering a real return of 4.5% above the upper end of the inflation target. This reflected an increase in the inflation risk premium of South Africa. The equity risk premium for companies who derive their income from the South African economy did also increase substantially.

We are in agreement with the market that the sovereign risk premium of South Africa, the inflation risk premium and the equity risk premium required for investing in the South African markets did increase substantially given this event as it has affected investors' confidence in the country's leadership. The subsequent appointment of Minister Pravin Gordhan as the new Finance Minister should give some confidence that the government does heed the financial markets. In all likelihood, these events have strengthened the hand of National Treasury to continue with its fiscally prudent policy.

Even so, the sovereign risk premium has not recovered, as the SA 10-year USD bonds still trade about 0.5% weaker than before the surprise dismissal. The yield on randdenominated long bonds has recovered somewhat but at 9.5% it still trades about 1% weaker than before the dismissal.

Local investments:

Local equities

We retained our underweight position in South African equities. Emerging markets derated in 2015. South African equities continue to trade at a substantial premium to other emerging markets on both a price to earnings (PE) and a price to book basis. Even though South African equities are about 10% cheap using a bottom up valuation of the individual companies we do prefer global developed market equities.

Local bonds
We retained our overweight position in SA long bonds. Ten-year bonds weakened from 8.5% to 9.5% during the quarter. We are of the opinion that inflation remains contained within the inflation target. A real return of approximately 4.0% is on offer, which is attractive relative to other asset classes. The rand weakened further during the quarter and trades at very weak levels on a purchasing power parity basis. An appreciation of the rand should be positive for SA bonds as it would result in lower short-term inflation.

Inflation-linked bonds
We implemented an overweight position in inflation-linked bonds in the wake of the dismissal of the Minister of Finance in December. At that stage our major concerns revolved around government overspending and inefficiency, which would have severe negative implications for future inflation. We believe that for an investor in rand assets the best protection for unexpected future inflation is inflation-linked bonds. We consider the default risk on inflation-linked bonds to be low as the government is in control of the rand printing presses. Ten-year inflation-linked bonds then traded at real yields of 2.3%. These bonds have now strengthened to 1.85%. Our current long-run assumption of fair value is 1.5%.

Local listed property
We retained our neutral holding in listed property, even though dividend yields have weakened about 0.7% from their best levels. We prefer international listed property companies, which we believe are cheaper.

Global investments:
From a purchasing power parity perspective the rand is more than two standard deviations cheap against the USD and GBP, and one standard deviation cheap versus the EUR. We believe that purchasing power parity holds over the long run. This was the case for the rand in 2001/2 and in 2008 when it was cheap versus developed market currencies. In both cases the rand recovered to purchasing power parity.

For this reason our portfolios retained their underweight position with respect to their total offshore exposure. In addition to this, instead of converting further USD cash outright into ZAR cash, we have implemented currency hedging structures in applicable portfolios, so that they would benefit if the rand appreciated.

Global equities
During the quarter we reduced the magnitude of our overweight exposure to global equities.
Developed market risky assets and particularly equity markets are expensive relative to their own long-run history. The US market is trading at 26 times its inflation-adjusted average 10-year earnings (the Graham and Dodd PE) relative to its long-run average of 16.5. We believe the overvaluation is, to some extent, justified due to the fact that global risk-free assets, US government debt, are trading at extremely low real yields. These low real yields are partly due to central bank and government policies that are being followed in the wake of the 2007 financial crisis.

It is also useful to consider the relative valuation of various other asset classes. US and European corporate bond spreads have weakened over the past few months. US high yield bond spreads weakened by 2% and US BBB bonds weakened by 1%. Furthermore, emerging market equities have re-priced. On a price to book basis the discount at which emerging markets now trade relative to developed markets has not been this large since 2001. As the risk premium that investors require from the developed credit markets and emerging equity markets has risen, it does make developed market equities relatively less attractive.

We continue to prefer Europe and the UK to the rest of the developed world. As we reduced our exposure to MSCI World Equities, the bulk of our reduction will be from US equities as they make up almost 60% of the MSCI World Index.

Global bonds
The real yield on offer from developed market bonds remains unattractive relative to more risky assets. We retained our underweight position in favour of international listed property.

Global property
We retained our overweight position in international properties via listed REITs. Our portfolio currently consists of nine companies that have properties in the USA, Europe and Australasia. The average dividend yield of the portfolio is 5.5%.

Risks and opportunities ahead
The dismissal of the Finance Minister by the President in December has raised concerns regarding the South African investment environment. Risk premia on South African assets have increased. If a fiscally prudent economic policy is followed these risk premia might be too high.

There is also the risk that the credit rating of South Africa can be downgraded to subinvestment grade. We are of the opinion that the risk of this is to some extend already priced into South African assets.