Fund Review
The fund did well in rands (4.9%) during the quarter, although this was entirely due to the rand's decline against other currencies (-5.9% against the dollar, -4.8% against the pound and -1.1% against the euro). In dollar terms, the fund declined by 1.3% during the quarter, but appreciated by 3.7% during the year ended June 2012 (24.8% in rands).

The fund managers, Brandywine, have continued with their overweight exposure to both the US and to the US dollar. The portfolio has 51.6% in the US, way above the benchmark's 36.4% allocation. There remains a zero allocation to Japanese bonds, versus 20.7% for the benchmark and a zero allocation to the euro currency, versus 23.5% for the benchmark. The portfolio is also very overweight in the British pound at 15.6% versus 5.8% for the benchmark and also very overweight in Australian bonds (9.3% versus 1.6% for the benchmark, although most of the currency is hedged). There is also a smattering of emerging market bonds and currency exposure, including South African bonds (3.8%), as well as Polish (5%), Mexican (5.5%), Malaysian (3.8%), Chilean (3.3%), Turkey (2.1%), Hungary (1.1%) and Brazil (2.7% in the bonds, but only 0.3% exposure to the currency). Overall, the portfolio has a modified duration (sensitivity to a 1% move in interest rates) of 5.7 and a yield of 4%, before fund management fees.

Looking Ahead
The managers have been reducing exposure to government bonds because they have had a big run over the past few months. So far the US dollar continues to dominate proceedings while the "risk-off" attitude remains in place. That may change in favour of the euro and pound if investors become more positive on equities and other risk-oriented investments.

Fund Review
After its superb performance in 2011, the fund still managed a positive dollar return of 2.3% in the first quarter of 2012, somewhat better than the JP Morgan Government Bond Index's -0.5% return. Corporate bonds did better than developed market government bonds, as did emerging market bonds. With the rand gaining 5.3% against the dollar, 2.9% against the pound and 2.4% against the euro, the rand return was -2.9% for the quarter.

The portfolio holds 55 different bonds, with a modified duration (sensitivity to changes in bond yields) of 6.85, somewhat higher than the 5.8 of the Barclays Capital Global Aggregate benchmark. Over three quarters of the portfolio is invested in A or higher-rated bonds, with 22.6% invested in BBB or lower-rated bonds. The average quality of the portfolio is A+.
The portfolio is still very overweight in the US (50.6% versus 35.8% for the benchmark) and holds zero exposure to the euro (versus 25% for the benchmark) and yen (versus 19.8% for the benchmark). Material overweight positions are held in Australia, Mexico, Poland, Malaysia, New Zealand, South Africa (3.7% of portfolio versus 0.3% for the benchmark), South Korea, Brazil and the UK. These holdings add up to over 45% of the portfolio, which more than replaces the European and Japanese exposure.

The portfolio comprises 61% government bonds, 20% corporate bonds and the balance of 19% in cash (4.7%), mortgage-backed securities and municipal bonds.

Looking Ahead
The portfolio has a nice blend of government bonds and corporate bonds, as well as a nice blend of developed market and emerging market bonds and currencies. If the global investment environment continues to be more "risk on" than "risk off", then bonds will likely at best deliver minor positive returns in dollars, like in the first quarter. However, there is always the risk of market corrections occurring, which is when bonds do well. That is why a portfolio like this represents good diversification in a balanced portfolio.

The fund had a solid quarter, delivering a positive return of 0.6% in rands or 0.9% in dollars, as the rand gained 0.3% against the dollar. In particular the fund had an outstanding year, delivering a rand return of 31.4% (7.7% in dollars) and finishing 1st in its sector out of 6 funds. The fund is also 1st over 2, 3, 4 and 5 years.

The managers of the fund over the past 17 months, Brandywine from the US, called the currencies beautifully by heavily overweighting the US dollar (and holding zero euros) earlier in 2011 and to the end of the year, at a time when most commentators were negative on the dollar because of all the quantitative easing and low interest rates. This was a brave and intuitive call and it has paid off handsomely. Currencies play a big role in bond returns. Almost 50% of the portfolio was in dollars at the end of 2011 versus 36% for the benchmark.
They were also cleverly overweight in US government bonds during the third quarter when equities got hammered. Corporate bonds represented only 11% of the portfolio, but Brandywine are keen to add more of both corporate bonds and high yield bonds. The portfolio has a good spread of currencies, including over 2% in South African government bonds, which they're keen to add to.

Looking Ahead
A year ago all market commentators were recommending staying underweight in bonds. They were wrong, as bonds did so well on the back of the European and other turmoil (the so-called "risk-off" trade). It is possible that investors go more for the "risk on" trade in 2012, where they prefer to sell cash and bonds and buy equities and commodities. However, a bond fund like this is still worth holding because economies are expected to grow slowly, if at all and inflation is receding, both positives for government bonds. Brandywine has proven to be a good currency manager and that is important going forward too. They will make a judgement call on when to switch some of their dollars into euros, for example. In the meantime, investors should earn over 2% in interest.