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

Market review
The sharp sell-off in the South African bond market during December of 2015 was followed by a strong first quarter in the New Year. The local bond market traded sideways for the first few weeks of the year as global markets started the year on the back foot with the Chinese equity market selling off sharply during the first few days of the New Year - ending the month 23% lower. But as liquidity returned to the local bond market and investor sentiment started to turn more positive, the interest rate market started trading stronger towards the end of January. Local yields strengthened towards the end January and the bond market delivered a strong return for the month after delivering one of the worst monthly returns on record during December.

The bond market trended largely sideways during February, with market participants awaiting Finance Minister Pravin Gordhan to deliver the budget towards the end of the month. The budget was expected to deliver guidance as to the implementation of measures that show a credible path back to debt stabilisation. The decline in the consolidated government budget deficit to 2.4% of GDP by 2018/19 from a deficit of 3.9% of GDP in 2015/16 was a positive development. Alongside this, the main budget deficit declined from 4.2% of GDP in 2015/16 to a deficit of 2.9% of GDP by 2018/19, which is pleasing since these deficits are significantly smaller than those projected a year ago, despite a weaker real GDP growth outlook.

The local market ended the last month of the first quarter trading stronger, against a background where most emerging market and developed market assets posted strong returns. In Europe, the ECB decided to lower interest rates while in the USA Janet Yellen delivered dovish comments regarding the future path of interest rates, providing strong support for international and local asset prices. Also during March, international ratings agency Moody's put their Baa2 rating of South Africa on review for a possible downgrade. They highlighted two main drivers for the rating review: firstly to assess the likelihood that medium-term growth prospects will strengthen and secondly to assess the likelihood of stabilisation and restoration of fiscal strength.

South African CPI printed at 5.2% year on year (yoy) for December, from 4.8% yoy for November, and breached the upper end of the SARB's target band going into the New Year - increasing to 6.2% yoy for January and 7.0% yoy for February.

The Monetary Policy Committee (MPC) decided to increase the repo rate by 50 basis points to 6.75% at their scheduled meeting in January, and by another 25 basis points to 7.00% during their scheduled meeting in March. The key takeaway from the MPC's latest statement is that they expect inflation to peak in 2016 and to return to within the inflation target band by late next year. Specifically, the Bank's forecast shows headline CPI increasing to a peak of 7.3% in 4Q16, before returning to within the target range in 4Q17.

Local bond yields ended the quarter stronger: the R203 (1-year bond) traded at 8.00% at the end of the quarter, from 8.54% at the end of December, while the R186 (11-year bond) traded at 9.10% at the end of March versus 9.76% at the end of December.

Real yields on longer-dated inflation-linked bonds closed lower. The yield on the I2025 (9-year inflation-linked bond) closed at 1.80% at the end of March from 1.90% at the end of December. The 10-year implied inflation breakeven yield decreased from 7.82% at the end of December to 7.22% at the end of March.

Against this backdrop nominal bonds delivered a return of 6.55% for the quarter, outperforming cash and inflation-linked bonds, which delivered 2.19% and 1.68% respectively. Longer-dated bonds outperformed shorter maturity bonds. The 0-3 years area returned 3.22%, while the 3-7 years, 7-12 years and 12+years areas returned 5.06%, 6.68% and 7.67% respectively.

Issuance in the credit market was still somewhat subdued with new issuances pricing on the higher side of indicated ranges and the market offering better value on selected issuances.

SIM strategy
The current market conditions have resulted in opportunities becoming available at more favourable levels, and we have been able to make new investments for the portfolio to take advantage of this. We participated in new opportunities for the portfolio, which increased the yield as well as the diversification profile of the Fund. We have seen a noteworthy and sustained decline in the compensation that non-sovereign issues pay their investors in the debt capital markets during the last few years. Although this trend started reversing during the second half of 2014 and continued during 2015, we continue to be selective regarding the opportunities we participate in for the portfolio - putting an emphasis on the credit quality and valuations. The portfolio performance was driven by the diversified blend of attractively yielding credit assets that we have been able to source and invest in on behalf of clients.

Market review
It was one of the worst quarters on record for South African bonds due in large part to an eventful December. Yields on South African nominal bonds increased by roughly 130 basis points from the end of September, with longer dated bonds trading almost 200 basis points weaker during December. The sell-off was due to the surprise decision to replace Finance Minister Nhlanhla Nene with a mostly unknown David van Rooyen. South African assets subsequently sold off sharply - the rand weakened, equities sold off and bond yields moved up sharply. South African bonds issued offshore also sold off sharply on the back of the news. The decision was subsequently reversed and on 13 December it was announced that Pravin Gordhan would be appointed as Finance Minister. However, an irreversible blow was dealt to investor confidence and South African bonds subsequently continued to trade at weaker levels during the quiet December period.

At the beginning of December, prior to these events unfolding, S&P had already revised their outlook attached to their BBB- rating on South Africa to negative from stable, one notch above junk status, while Fitch downgraded South Africa's longterm foreign currency rating to BBB-.

The Finance Minister at the time, Nhlanhla Nene, tabled his Medium Term Budget Policy Statement (MTBPS) during October. National Treasury revised the GDP growth forecasts lower with resulting fiscal slippage: over the medium term the consolidated budget deficit narrows to -3.2% of GDP in 2017/18 (compared with the previous projection of -2.5% of GDP), while the gross debt ratio is forecast to stabilise at 49.4% of GDP in 2018/19.

In the United States, the Federal Open Market Committee (FOMC) increased the Fed Funds Target Rate to 0.25%-0.50% at its December meeting - a long awaited move and it was largely priced in by the market. This brought to an end the multiyear period of zero interest rate policy in the United States, but with the policy rate still at a historically low level it remains to be seen how the policy normalisation path continues to play out going forward.

Headline CPI printed unchanged at +4.6% yoy in September, slightly below consensus expectations of 4.7% yoy. South African CPI then increased to 4.7% yoy in October - in line with consensus expectations and 4.8% yoy in November. The upward trend in inflation is expected to continue and CPI is forecast to breach the upper end of the South African Reserve Bank's 3-6% target range during the beginning of 2016. Upside risks to inflation stem from a weaker exchange rate, uncertainty regarding electricity tariffs and drought.

GDP figures were released during the quarter and South Africa avoided a technical recession by not reporting a second successive quarter of contraction in the third quarter. However, annualised GDP growth slowed to 1.0% yoy from 1.2% yoy in the second quarter.

The South African Reserve Bank's Monetary Policy Committee (MPC) increased the repo rate by 25 basis points (bps) to 6.25% at their scheduled meeting in November. Although it was priced in by the interest rate market, it came as a surprise to some market participants. The eventual level of the inflation rate, economic performance and international monetary policy will be the main factors determining the actions of the MPC in the coming months.

Local bond yields ended the quarter weaker: the R203 (1-year bond) traded at 8.54% at the end of the quarter, from 7.23% at the end of June while the R186 (11- year bond) traded at 9.76% at the end of December versus 8.45% at the end of September. The implied inflation breakeven increased by 126 basis points during the month to 7.82%.

Real yields on longer-dated inflation-linked bonds closed higher. The yield on the I2025 (10-year inflation-linked bond) closed at 1.90% at the end of December from 1.81% at the end of September. The 10-year implied inflation breakeven yield increased from 6.56% at the end of September to 7.82% at the end of December.

Issuance in the credit market was still somewhat subdued with new issuances pricing on the higher side of indicated ranges and the market offering better value on selected issuances.

SIM strategy
The current market conditions have resulted in opportunities becoming available at more favourable levels, and we have been able to make investments for the portfolio to take advantage of this. We participated in new opportunities for the portfolio which increased the yield, as well as the diversification profile of the Fund. We have seen a noteworthy and sustained decline in the compensation that non-sovereign issues pay their investors in the debt capital markets during the last few years. Although this trend started reversing during the second half of 2014 and continued during 2015, we continue to be selective regarding the opportunities we participate in for the portfolio - putting an emphasis on the credit quality and valuations. The portfolio performance was driven by the diversified blend of attractively yielding credit assets that we have been able to source and invest in on behalf of clients.