Fund review
After a superb dollar return of 18.6% in the June quarter, the fund had another good quarter to September, returning 8.6% in dollars and 6.5% in rands. For the year to end September, the fund returned 13% in dollars, which we're very happy about because it has made a fantastic come-back after falling sharply in late 2008 and early 2009 during the credit crisis. In fact, the fund is now trading at an all-time record high in dollar terms. The fund is up a whopping 38% in dollars since the low in March and is up 25% so far in calendar year 2009. These are extraordinary returns. Although we reduced our holding in the Fidelity high yield bond funds during the quarter, we remained invested in the Fidelity International Bond Fund, with extra tilts in the Sterling and European Bond Funds. The impact of currencies was again high because the euro gained 4.3% against the euro and also 7.3% against the pound. Corporate bonds in the US, UK and Europe continued to perform strongly as their yields declined further. Private American investors have pumped large sums of money into bond funds (far more than into equity funds) in their hunt for yield because both money markets (0.05%) and government bonds (3.2%) are yielding so little.

Looking ahead
Although returns going forward should be somewhat lower, we remain positive on corporate bonds in particular over the next three to six months.

The fund undoubtedly had its best quarter ever, returning 18.6% in dollars during the quarter. The rand's extraordinary 24% gain against the dollar meant that the rand return was, however, in negative territory.

We took maximum advantage during the quarter of a sharp turnaround in risk appetite amongst global investors. From the 9th of March, stock markets bottomed and rose strongly until the end of May. This caused high yield bonds to gain 25-30% and we took a good position in both the Fidelity Euro High Yield Bond Fund, as well as the US High Yield Bond Fund, selling both funds at the end of May. Other funds that did very well during the quarter included the Fidelity Asian High Yield Fund (up over 30%) and the Fidelity Emerging Market Bond Fund, which benefited in particular from the currency appreciation of the emerging markets. Finally, the plain vanilla bond funds, the Fidelity Euro, Sterling and Dollar Bond funds also appreciated as the corporate bonds within the portfolio began to recover some of their losses incurred since the market melt-down started.

The fund also benefited strongly from a big underweight in US dollar bonds during the quarter. The dollar depreciated by 6% against the euro and by 15% against the pound during the quarter.

Government bond yields rose sharply in the first quarter of 2009, causes losses in bond values (reversing some of the good gains from 2008). For example, the US ten year government bond yield shot up from its long-time low of 2.2% at end December to 2.7% at end March. During the quarter the Citigroup World Government Bond Index lost about 4% in dollar terms.
Because the Fidelity bond funds available to us hold substantial chunks of corporate bonds (30-50% of each of the bond funds), as opposed to government bonds, the values of these bonds play a big role in the value of your fund. Despite all the best efforts of the US authorities to lower the cost of mortgages and finance in general, corporate bond yields stubbornly refused to decline and in fact rose further during the quarter, causing further capital losses. So it remains very expensive for companies to borrow money in the US and elsewhere, at least compared with the official interest rates and government bond yields.
As a result of this the fund lost 3% in dollar terms during the quarter (-18.9% for the year to end March), reaching its lowest level in dollar terms since the inception of the fund in 2001. The rand return for the year was a lot better (-7.7%) because of rand depreciation.
The stubbornly high yields on corporate bonds (reflecting the cost of borrowing for companies) in the US, Europe and UK remain one of the main obstacles to an improvement in the financial and economic environment in these countries. For example, high yield bonds (often called "junk bonds" because of their non-rated status) are yielding 19% in the US. These yields are indicating default rates similar to those that prevailed in the Great Depression of the 1930's, even though the economy is nowhere near as bad now as it was then.
In general, corporate bonds appear to be offering excellent value for reasonable risk (lower risk than equities). On that basis the fund is an excellent buy at this stage.

The fund suffered during the quarter as the corporate bonds held within the various Fidelity bond portfolios (40%-60% of total fund) dragged the funds into negative returns as the credit crisis worsened. The fund lost 9.4% in dollars during the quarter, although the rand's 13.5% depreciation against the dollar allowed for a positive rand return of almost 5%. Similarly, for the 2008 year the fund lost 13.3% in dollar terms, but the rand return was substantially boosted by the 28.5% depreciation of the rand versus the dollar during the year. While government bonds made money as yields collapsed (from 3.8% to 2.2% for the ten year US government bond) during the quarter, corporate bonds were a totally different story as the spreads or gap between corporate and government bond yields widened alarmingly to the highest since the 1930's Great Depression. Corporate bonds were sold down heavily by hedge funds and other investors. For the first couple of months of the 4th quarter, the fund's holdings were overweight in dollar-based bonds because of the strong US dollar. Thereafter we upweighted euro bonds in the portfolio to take advantage of a rally in the euro against the dollar. In particular we switched dollar bonds into the Fidelity International Bond Fund, which has a 60% weighting in government bonds (40% in corporate) and where the portfolio is 42% in euro bonds and 7.6% in UK bonds. This fund has a current yield of 4% and a modified duration of 5.6.