The South African economy remains in good shape with low interest rates, high growth (4.9% in 2005), a strong Rand and increased consumerism. This has supported markets over the past quarter with equity (+13.3%), property (21.9%), bonds (+1.5%) and cash (+1.6%) all producing strong returns. Foreign fund flows continue to support both the equity market and the Rand, however the higher oil price is starting to eat into inflation, which rose to 4.5% in February. Whilst this is still comfortably within the prescribed targets, an oil price above $70 would lead to concerns of future interest rate hikes to curb inflation. Volatility in the equity market increased as these concerns were digested, with equities down sharply in February, only to bounce back and hit record highs in March. The fund produced a solid 8.1% return for the quarter and was ranked in the top quartile of its sector.

Manager performance was excellent with OMAM leading the way thanks to a higher equity weighting relative to the other managers. Although Prescient produced the lowest return, it was still comfortably positive and they have continued to raise their protection levels as the market has risen, implying that they are unlikely to experience capital downside from these lofty levels. They were our best performing manager in February, a down month for equities. All managers are comfortably ahead of their inflation plus 5% target for the year.

Effective equity exposure in the fund dropped from 59% in January to 51% in February and was then lifted to 55% in March. Following a phenomenal rally in property shares, the managers were active in taking profits and lowered the property content to 2.2% of fund. We are forecasting an average inflation rate of 4.2% for 2006, with no interest rate hikes, and believe that the fund can achieve its performance objective of inflation plus 5% for 2006.

Initial speculation regarding higher inflation was unfounded as inflation came in below expectations for November at 3.7% y-o-y. This had a positive impact on all asset classes. The equity (+7.7%) and property (+11.4%) asset classes were again the key beneficiaries however the bond (+5.0%), income (+2.7%) and cash (+1.6%) markets also performed well as the expectation of an interest rate hike in December subsided. The fund produced solid results in this environment with a net return of 4.8% for the quarter. For the 6-months to 31 December 2005 the fund produced a 15.5% return and was ranked 7/23 in the real return category of unit trusts. Assets under management totalled R93m at year end.

The managers continued to favour exposure to equity and property over bonds, a strategy that worked well over the past year. Coronation was the best performing manager for the quarter thanks to good stock selection within their equity portfolio, particularly exposure to Venfin, which rose sharply following a take out offer from Vodafone. Prescient also performed well having raised the floor on their portfolio at the end of September. This benefited them immensely when the equity market dipped off sharply in October. OMAM did sell off equity as the markets dropped, but were less protected than the other managers during October and struggled to make it up in the rest of the quarter.

South Africa is enjoying a virtuous circle of economic expansion, which is driving the local markets. Consensus suggests that interest rates will remain flat in 2006 and inflation will remain within targeted levels. The platform for further economic growth is therefore solid. We believe that the fund will continue to perform well in this environment and expect that the selected managers will adjust their asset allocations to suit current market conditions. The effective asset allocation at the end of December was 55% equity, 6% property, 8.5% fixed interest and 30.5% money market.