Volatility in equities rose dramatically in the 3rd quarter with the VIX rising to its highest level in 4 years. By mid August the MSCI had fallen 8% but the subsequent rally has been re-assuring, although the magnitude of strength did take us by surprise. In this regard the index rebounded 11.2% from its intra month low to end the quarter in positive territory (USD +2.5%) & bringing the YTD gains to 11.7%. Global bond markets (USD +7.2%) enjoyed a buoyant quarter as sub prime concerns & risk aversion encouraged a flight to safety. The greater than expected rate cut by the Fed, coupled with a consensus view that rates globally have peaked also supported fixed interest markets. Asset allocation therefore detracted from performance as we were overweight equity at the expense of bonds. Conversely the overweight position in growth stocks contributed to returns. Dollar returns (+3.5%) were diluted by the strength of the rand, which was up 2.6% against the greenback. As we enter the 4th quarter, we retain our positive outlook for shares. In addition to their favourable valuation, we believe the environment favours them due to rising liquidity & strong balance sheets. The shrinking equity float as a result of record share buy backs & declining new issuance reinforces this view. In light of these circumstances we continue to position the offshore component of the portfolio in asset classes with the greatest ability to take advantage of the current market environment i.e. overweight equity and property.

After being the worst performing currency last quarter the rand rebounded in Q2 to be one of the best performers gaining 3.4% against the US$. Fortunately this was offset by rising equity markets (USD +5.8%) as well as the portfolio outperforming its benchmark. Outperformance YTD can be attributed to our overweight position in growth stocks (USD +12.5%), which are rebounding against their value counterparts (USD +9.9%) as well as our emerging market bias, which outperformed developed markets. In this regard evidence of the global economy surprising on the upside has supported markets such as Brazil, India & China resulting in these regional funds being the largest contributors to returns. Within developed markets Asia continued to offer the best returns during the period under review followed by Europe, the US & then Japan. Our overweight position in Asia & Europe therefore added alpha as did our underweight position in the US. Conversely the tilt to Japan detracted from performance as did the Japan Smaller Companies Fund. While equity markets continued to rally on the back of investors' persistent appetite for risk, bonds (USD -1.5%) & property (USD -5.9%) lagged so asset allocation assisted in relative returns as the fund was underweight both.

We still believe the micro & macro environment favours equities due to attractive valuations, rising liquidity & strong balance sheets. The shrinking equity float as a result of record M&A activity, share buy backs & declining new issuance reinforces this view. While relative valuations have retreated on the back of a rout in bond markets they remain supportive (earnings yields still above bonds). Clearly the risk of complacency amongst investors & corporate earnings surprising on the downside are concerns, while a correction is also possible as the current bull market (MSCI 153% over 247 weeks) exceeds the median duration (123 weeks) & magnitude (57%) of the past 8 cycles. We would use a correction as a buying opportunity as we would any further strengthening of the rand - consensus forecasts 12 months out are calling for a weaker rand (ZAR/USD=7.39).

The rand started the year where it left off, being the worst performing currency in the world, as it declined 4.2% against the dollar in Q1. Currency weakness therefore had the largest impact on the portfolio. The 12 month return of 28.4% was marginally behind benchmark, due to our overweight position in growth stocks (USD +11.0%), which lagged their value counterparts (USD +18.6%), as well as our small & mid cap bias.

Conversely the 3 year return of 14.9% annually is pleasing as it is ahead of the sector average & benchmark. All asset classes started the year in positive territory, with property leading the charge (USD +5.7%). Within equities theMSCI Pacific (+4.7%) offered the best returns, followed by Europe, the UK, Japan & then USA. Our overweight position in Asia & Europe therefore added alpha, as did our underweight position in the US. The Australia & European smaller companies funds were the top contributors to returns, but this was offset by underperformance of the Japan smaller companies fund. Emerging markets continue to outperform, so the move to the broader MSCI All Countries Index continues to pay off. In this regard the India & China Focus funds, as well as the Latin America fund have been the top performers since their introduction 9 months ago. Looking ahead, STANLIB's view is themacro environment is still positive, as inflation is less problematic, the breadth of growth is good & leading indicators have stabilised. We believe attractive valuations, abundant liquidity, robust M&A activity & strong balance sheets also remain a key underpin to markets. While relative valuations have retreated, they remain supportive for equities over other asset classes (record share buy-back programs vindicate this).

Prospects for property also remain positive, as the dividend yield of (2.94%) is higher than the 2.15% of equities. While lower than bonds (3.66%), property earnings & distributions can grow, whereas bond coupons are fixed. On the downside, we are concerned that investors have become complacent & there is a chance of corporate earnings surprising on the downside. A correction is also possible, as the current bull market (MSCI 140% over 237 weeks) exceeds the average duration (141 weeks) &magnitude (84%) of the past 8 cycles. Wetherefore remain diversified across all asset classes.