A significant development over the quarter is that local inflation has started to rollover, registering 5.7% in May, down from 6.3% in December 2011. In stark contrast to our first quarter commentary, when the FRA market was pricing in a rate hike to occur in Q2 next year, it is now pricing in an 80% chance of a rate cut in 5 months time. A combination of softer global economic data, an as yet unresolved eurozone debt situation, and tame inflation data on the back of sharply reduced oil prices, have combined to feed the downward shift in local interest rate expectations. This translated into strong returns for the interest rate sensitive asset classes over the quarter. Property (+10.3%) was the best performing asset class, followed by bonds (+5.2%), income (+3.0%), cash (+1.3%), and equities (+1.0%).

Absa was our best performing manager for the quarter, benefiting from its exposure to property and good stock picking within equities. They have played the interest rate cycle well by maintaining exposure to retail shares in the face of valuations that appeared expensive. Prescient performed reasonably well given their protection pay-away, and the short duration of the fixed interest portion of their portfolio. Coronation lagged with the divergent stock market (financials and industrials gained on lower interest rate expectations, while resources got hurt with investors fretting over falling Chinese commodity demand) not favouring the positioning of the equity portion of their portfolio. We remain satisfied with the current positioning of the Fund.

The Fund has performed reasonably over the past 12 months, producing a return of 6.4% and ranking 27th out of 47 funds in its sector. Over the past 3 years, the Fund has produced an annualised return of 9.3% per annum, slightly behind its long term CPI plus 5% target objective of 9.9% (ranking 16th out of 43 funds in the targeted absolute and real return category). While lower oil prices have brought some inflation relief, we remain in a negative real yield environment (cash yields 5.3% vs. inflation of 5.7%). In addition rand weakness will continue to impact local inflation negatively. Looking forward, we remain cautious with the eurozone debt situation still not fully resolved, but we are encouraged by compelling share valuations provided that the current global economic slowdown does not morph into something more serious, materially denting earnings expectations.

As expected, the SARB left interest rates unchanged during the quarter. Gill Marcus made some comments in March around inflation concerns, however, CPI numbers subsequently came in lower than expectations, and the FRA market is now pricing in the first rate hike to occur in Q2 next year. Inflation is currently hanging just above the top end of the SARB's inflation band at 6.1 %. Investment returns were strong over quarter, driven largely by improved sentiment from the liquidity boost to European banks by the ECB. The Fund performed reasonably over this period, producing a return of 2.8% and ranking 24th out of 46 funds in its sector. Over the past 3 years, the Fund has produced an annualised return of 10.5% per annum, ahead of its long term CPI plus 5% target objective of 10.2%. The Fund was ranked 11 th out of 38 funds in the targeted absolute and real return category during this time.

Absa was our best performing manager for the quarter, benefiting significantly from a large exposure to ILB's and property and good stock picking within equities. They have played the interest rate cycle well by maintaining exposure to retail shares in the face of valuations that appeared expensive. Although Coronation produced a good return, it is lower than their usual expectations due to stock selection not coming through for them yet. Prescient continues to struggle with the fixed interest portion of their portfolio having a short duration and its protection pay-away detracting. During the quarter we decided to tactically tilt the portfolio in favour of Absa and underweight Prescient until the environment becomes more suitable to their strategy. We are satisfied with the current positioning of the Fund.
Moving forward, it should be noted that it will be difficult to achieve inflation plus type returns in a negative real yield environment, such as we are currently experiencing (cash yields 5.3% vs. inflation of 6.0%). Rand strength during the quarter will provide some relief on the inflation front, but it has been volatile and is still at levels near the top end of its 3 year range. We are closely monitoring the rand, and would consider initiating a tactical allocation to foreign should the rand strengthen to a more attractive entry level point. Markets have continued to perform well on a more balanced economic outlook, but we believe that caution is now warranted with stocks trading at less attractive valuation levels and the potential for eurozone woes to come back into the spotlight. On this point, it is interesting to note that our managers have been trimming back their equity exposure recently.

As expected, interest rates were not cut during the 4th quarter. The MPC is clearly worried about the looming inflationary picture, and rightfully so as inflation picked up to 6.1% in 2011 (2010: 3.5%). Typically, as inflation picks up, most asset classes produced muted returns, making it difficult to outperform inflation plus targets. Unsurprisingly therefore, investment returns were uninspiring in 2011, with property (+8.9%), income (+8.9%) and bonds (+8.8%) outperforming cash (+5.5%) and equity (+2.6%). It is within this context that the Fund produced a 4% return for the year (2010: +11.5%). Over the past 3 years, the Fund has produced an annualised return of 9.7% per annum, marginally behind its long term CPI plus 5% target objective of 10.3%. The Fund was ranked 10th out of 42 funds in the targeted absolute and real return category during this time.

For the year, ABSA was the best performing manager, benefiting significantly from a large exposure to ILB's and property and good stock picking within equities. ABSA has played the interest rate cycle well by maintaining exposure to retail shares in the face of valuations that appeared expensive. Prescient's strategy struggled to gain traction in a volatile sideways moving market and the protection pay-away hurt in a low single digit return environment. Although Coronation produced positive returns for the year it was perhaps lower than their usual expectations. None the less, we are happy with the current positioning of the Fund and pleased that the manager changes implement in April have produced better returns than what we would have experienced had we not made the changes.

Overall, the key reason why the Funds ranking has slipped a little in the last year is because we don't hold a structural weight to global assets in our portfolio and some of the peers do. Clearly recent returns from the sector have been driven by Rand weakness. The economic outlook is looking a bit more balanced now, relative to Q3 2011 and as such the markets have enjoyed a strong start to the year. The Rand has also strengthened in line with the improvement in sentiment, which has benefited the fund on a relative basis in the short term. More importantly, should Rand strength continue it will have a positive effect on inflation and this would in turn provide support to the equity and fixed interest markets.