Market Review

After a mid-quarter slump, September's strong rally meant it was a bumper quarter for world stock markets, as fears about the imminence and likelihood of a double-dip recession subsided. Emerging markets again outpaced developed markets, with the MSCI Emerging Markets Index soaring 18.2% in dollars, well ahead of a 13.9% increase in the MSCI World Index. Meanwhile, the All Share Index rose 13.3% in local currency terms during the third quarter. The SA bond market also delivered strong returns during the quarter, with the All Bond Index up 8%, versus the 4.6% return delivered by inflation-linked bonds and 1.7% by cash.

What we did during the quarter
In August, we added 3.5% to domestic equities from cash and added 2.5% to the SIM Bond Plus fund from the SIM Active Income fund. During the quarter, we completed last quarter's decision to change weightings between the domestic equity underlying funds as and when there were cash flows. In September we changed the composition of the offshore underlying funds; exiting the Sanlam International Defensive Fund of Fund and Sanlam International Bond Fund of Fund and investing in the Sanlam Universal Bond Fund.

SIM Strategy
Local equities: We retained our neutral weighting to SA equities during the quarter. The JSE All Share Index is trading on a current price-to-earnings (PE) ratio of about 15. Company earnings are forecast to increase by 30% one year from now, which would put the market on a PE of 11 times, assuming the price index remains at its current level. Based on long-run normalised return on capital assumptions, our intrinsic valuation of the individual companies on the JSE indicates that the market as a whole is fairly priced.

Local bonds: We began the quarter with an overweight exposure to conventional bonds, with 10-year bonds yielding 8.8%. Towards the end of the quarter, 10-year bond yields strengthened to below 8%, which is below our estimate of fair value based on our longrun inflation assumptions. As a result, we initially reduced our overweight position to neutral and subsequently cut it to underweight relative to the benchmark weighting. Although inflation appears under control over a shorter time horizon (partly thanks to a strong rand exchange rate), we believe that over the longer run inflation is going to be closer to the upper end of the 3% to 6% inflation target.

Inflation-linked bonds: We reduced the magnitude of our overweight position as real yields on the medium- to longer-dated inflation-linked bonds of around 3% at the start of the quarter rallied to about 2.6% by quarter end. This is marginally above our long-run fair value assumptions of 2.5%. Inflation-linked bonds do provide a good hedge against currency weakness and inflation and we are therefore retaining our overweight position in this asset.

Local listed property: Dividend yields on listed South African property companies are trading below South African long bonds, while in most developed markets they trade above the respective long bond yields. This is partly due to the higher inflation rate in SA, resulting in higher nominal dividend growth rates for SA property companies. Dividends are expected to grow at approximately 8% over the next year and we retain our neutral position, as we believe property shares are on average fairly priced.

Global equities: We retained our overweight position during the quarter. At close to 4%, the dividend yields on European shares are attractive relative to the rest of the developed world. On a normalised earnings basis the US market is trading close to fair value.

Global bonds: We retained our underweight position in global bonds that we introduced during the fourth quarter of 2009. US 10 -year treasury yields are discounting a protracted period of extremely low inflation and the last time yields were as low was during the Great Depression and during, and in the immediate aftermath of the Second World War, when long term yields were fixed at 2.5%.

Risks and opportunities
We are currently finding few attractively valued investment opportunities. We regard this fund as being appropriately positioned according to its risk profile and fund objective.

Market Review
Fears of a double-dip recession moved centre stage during the second quarter when economic statistics disappointed and debate intensified over whether the fiscally austere policies planned in Europe could tip the world economy into recession again or whether the US, which has committed to maintaining its fiscal stimulus, is a better route to go.

These events dented already uncertain investor sentiment and thus stock markets put in a dismal performance for the quarter, with the Dow Jones Industrial Average slumping 9.4%, the FTSE 100 off 13.8%, Germany's DAX down 12.2% and Japan's Nikkei 10.7% in the red. At home, the JSE lost 8.2% in local currency terms and 12.7% in dollars given the rand's depreciation during the quarter. These negative returns merely extended a difficult run for global equity markets during the first six months of the year.

The most visible beneficiary of global economic and financial market jitters was the US bond market, with the 10-year US Treasury firming to below 3%.

What we did during the quarter
The benchmark of this fund changed in June and, as a result, we implemented a small asset allocation change in May, increasing the Fund's exposure to the SIM Property fund by 1% at the expense of cash.

The other change in May and June to the domestic equity underlying funds was the systematic introduction of the SIM Value fund, while reducing and changing the proportions of both SIM General Equity and SIM Top Choice Equity Funds in the overall portfolio.

SIM's Investment Strategy
Local asset classes
We retained our neutral position in domestic equities during the quarter. SIM's intrinsic valuation of the individual companies on the JSE, as calculated by our analysts, indicates that the market is fairly priced. Currently, the consensus expects earnings for the SWIX Index to be 30% higher than current earnings in a year's time. We added to domestic bonds during the quarter. Concerns about the European Union's economic stability pushed up the risk premium paid on risky assets early in May. As a result, the 10- year SA long bond weakened to a yield of approximately 9%, offering more attractive prospective real returns than cash. Based on current valuations, we retained our neutral position to domestic property.

Global asset classes.
We increased our overweight position in global equities. By late May, the European markets had fallen more than 20% off their peaks in dollar terms. European stocks are expected to pay a 4% dividend yield on average in 2010. Even assuming no earnings growth from European-based companies, which seems unlikely given the weak Euro and the fact that a large number of the bigger companies are export orientated, equities remain the preferred asset class relative to bonds and zero yielding cash.

However, in mid-April we closed our underweight position in global bonds when US long bonds reached a yield of 3.85%. By the end of May,US long bonds (10Y) had rallied to 3.15%, while German bonds reached 2.6%. The real returns offered by global sovereign bonds is now well below our required 2%.

Risks and opportunities
Overall, in terms of SIM's value-based investment philosophy, the number of attractive investment opportunities has diminished, given the rerating of assets. We regard this fund as appropriately positioned according to its risk profile and fund objective.

Market Review

Most world equity markets continued their upward movement during the first quarter, with stock markets putting in a particularly strong rally in March. The US heavyweight Dow Jones Industrial Average steamed ahead 4.8% during the quarter in dollar terms.

However, the equity markets that went against the trend were the UK's FTSE100, Germany's Dax, France's CAC, Hong Kong's Hang Seng and MSCI China indices, with declines ranging from the FTSE's 0.4% to France's 4.8% during the first three months of the year in local currency terms. The European stock markets were adversely affected by concerns surrounding fiscal debt burdens in Greece et al. All of these stock exchanges did, however, put in strong positive performances during March.

During the quarter, the MSCI World Index slightly outpaced the MSCI Emerging Market Index (both reflecting total returns in dollars) but this order was reversed during March when the MSCI World rose 6.2% versus the MSCI Emerging Market's 8.1%.

The JSE mirrored the US's positive stock market performance, gaining 4.5% during the quarter in rand and almost 8% during March. The rand's continued sharp appreciation against the dollar saw foreign investors achieve even better dollar-based SA equity market returns.

Local equity and bond market returns came in neck-in-neck for the quarter, both gaining about 4.5% but the stock market outstripped bonds by a wide margin during March (7.9% in rand versus 2.1% respectively).

What we did during the quarter

No major asset allocation changes were made to the fund during quarter. However, for compliance reasons and to remain within the 20% offshore limit, during February we moved 1.5% of the international assets from the Sanlam International Defensive FoF, placing 1% in the SIM General Equity fund and the remaining 0.5% in the SIM Active Income fund.

During the quarter, we also completed the exercise of systematically exiting the SIM World Big Blue Chip fund (which was closed in March) in favour of the Sanlam Global Equity fund.

SIM's Investment Strategy

Local asset classes

Since the end of last year we have gradually reduced the overweight exposure to domestic equities we initially introduced in the fourth quarter of 2008 - and in March we adopted a neutral position. The JSE All Share Index is trading on a current price-to earnings (PE) ratio of about 18 times and a rolling one-year forward PE of 16.5. Based on the JSE's long-run history, the returns after investing at PE's in excess of 15 have been low.

We retained our overweight position in domestic bonds during the quarter. Ten year bonds began the year trading at yields above 9% and are now trading at about 8.5%. Given our long-run inflation assumption of 5.25%, long bonds still offer value - but considerably less than at the beginning of the quarter.
We retained our neutral position to domestic property based on current valuations.

Global asset classes

We retained our small overweight position to global equities during the quarter. The US market is trading at normalised earnings (long-run trendline earnings) of around 23% and a priceto- book ratio of about 2 times. The market is still cheaper on these measures than the entire period from the mid-nineties until the financial crisis struck a year and a half ago.

We retained our underweight position in global bonds that was introduced during the fourth quarter of 2009. US 10-year treasury yields are discounting a protracted period of extremely low inflation and the last time yields were lower was during the Great Depression and during, and in, the immediate aftermath of the Second World War when long term yields were fixed at 2.5%.

Risks and opportunities

Overall, in terms of SIM's value-based investment philosophy, the number of attractive investment opportunities has diminished, given the rerating of assets. We maintain the fund is appropriately structured according to its risk profile.

Market Review
Global equity markets continued their strong run during the fourth quarter, with the MSCI World Index ending the period 4.2% higher (30.8% year-onyear (y/y)) in dollars. The gap between emerging and developed market performance continued to widen, with MSCI Emerging Markets up 8.6% for the quarter (79% y/y). In South Africa, the All Share Index rose 11.4% in rand terms during the fourth quarter (32.1% y/y). The rand's appreciation contributed handsomely to the local equity market's full year performance, with the All Share gaining 70.1% y/y in dollars. However, MSCI figures show that SA's 9.3% dollar-based equity returns for the quarter lagged the BRIC countries, barring India, which gained 7.7% during the period. Global and local bond yields, particularly in developed markets, continued rising during the quarter and year. In the US, 10-year government yields deteriorated 53 basis points (bps) to 3.84% during the three-month period, while SA long bonds increased 20bp during the quarter to end the year at 9.08%. Cash delivered a return of almost 9% for the year, much better than the local bond market's performance in 2009.

What we did during the quarter
Given the recent rally in the international equity markets, we marginally reduced the magnitude of our overweight position in equities in this portfolio. Therefore, in late November we: - moved 2% of the international assets from the SIM Global Best Ideas Feeder fund into the International Defensive FoF.

Investment Strategy
We retained our marginally overweight exposure to equities in fourth quarter after reducing it during the second and third quarters last year in response to the market's sharp rally. We first introduced the overweight position in the fourth quarter of 2008. We retained our overweight position in bonds because, given our long-run inflation assumption and ten year bonds yielding above 9%, long bonds offer a real return of just below 4%. We retained our neutral exposure to property based on current valuations. Globally, we reduced our overweight position in international equities during the quarter. In US dollar terms, the MSCI World Index has now rallied more than 65% off its early March low point last year, when we increased our overweight position. Over the same period, the MSCI Emerging Markets Free Index rallied almost 100%. In the last few months of 2009, developed market earnings surprised on the upside relative to consensus forecasts. The US market is now trading at a normalised earnings price:earnings (PE) ratio, or long-run trend line earnings, of around 22. The last time the S&P 500 traded at such a low trend PEwas in the mid 1990's. Based on most long-run measures, however, global developed equity markets do seem fairly valued if we consider the period since the mid-1990's as an anomaly when stock markets were consistently overvalued. In terms of global bonds, the US 10-year treasury yields are discounting a protracted period of extremely low inflation. The last time yields were lower was during the Great Depression and during, and in, the immediate aftermath of the Second World War when long term yields were fixed at 2.5%. The investment case that supports the current low bond yields in the US is a deflationary situation similar to Japan's. We believe the odds of a similar deflationary scenario playing out in the US and Europe are low, given the actions of the central banks and governments of the US, UK and Europe. Our underweight position does not reflect a view that inflation will become a problem globally, but rather a more agnostic view of the future. Overall, in terms of our value-based investment philosophy, the number of attractive investment opportunities has diminished, given the rerating of assets during the last six months of 2009. We believe the fund is appropriately structured according to its risk profile.