Market review
The yield difference (spread) between the South African 10-year USD sovereign bonds and the US 10-year sovereign bond is at about 3% and is still 0.5% higher than where it traded on average in 2014 and 2015. This spread has recovered substantially from its high of 3.85% in the wake of the surprise dismissal of the Minister of Finance by the President in December 2015. The spread reflects the risk of default by the South African Government on its USD bonds and is referred to as the sovereign risk premium of South Africa. That some confidence has returned to the country is also evident from the strengthening of the rand, as well as the lowering in the inflation risk premium. Tenyear South African rand bonds strengthened, without any significant changes to the inflation outlook. The equity risk premium for companies that derive their income from the South African economy also improved, as is evident in the outperformance of the mid-cap and small-cap indices.

What we did during the quarter
With local property having strongly rebounded in the first quarter from its indiscriminate sell-off seen in early December, we took the opportunity to bank some profits on the SIM Property Fund. This fund has returned +9.4% for the quarter and +4.9% on a trailing 12-month basis, providing a slight outperformance over the past year against its local property index. We also marginally lightened our exposures to the Sanlam Absolute Return Income Fund and the SIM General Equity Fund. We added to the SIM Enhanced Yield Fund, the performance of which is driven by the diversified blend of attractively yielding, good quality credit assets. On the international front, the rand at heightened weak levels relative to the USD saw us bring back some local currency at fairly attractive levels. Even though the rand has recovered since then, it remains one of the weakest emerging market currencies relative to purchasing power parity. The rand remains more than two standard deviations cheap against the USD and one standard deviation cheap versus the GBP and EUR. We believe that purchasing power parity holds over the long run. This has been the case for the rand in 2001/2 and 2008 when it was cheap versus developed market currencies. In both cases the rand recovered to purchasing power parity. Our low exposure to offshore bonds was further reduced and we rebalanced our position in the Sanlam Global Property Fund.

Local equities
We retained our underweight position in South African equities. Even though South African equities are fairly priced using a bottom-up valuation of the individual companies, we continue to prefer global developed market equities ahead of SA equities. South African equities continue to trade at a substantial premium to other emerging markets on both a price to earnings and a price to book basis.

Local bonds
We retained our overweight position in SA long bonds. In January, they traded at yields of 9.6%, thus offering a 3.6% real return assuming inflation is at the upper end of the inflation target band for the next 10 years. A holder of SA 10- year bonds since 1900 received a real return of 1.8% per annum. We believe that the policy of a 3% to 6% inflation target band will be maintained. The SA Reserve Bank's recent rate hikes are to some extend a confirmation of this. The events in December surrounding the dismissal of the Minister of Finance and the reappointment of Minister Pravin Gordhan do give confidence that the government heeds financial markets. In all likelihood National Treasury's hand has been strengthened and it would find it easier to follow a prudent macro-economic policy that will be supportive of the inflation target. Over the next year or two, average inflation is likely to remain above the upper end of the target given the rand's depreciation and increasing food prices. There is also the possibility of a downgrade of South Africa's credit rating to sub-investment grade. Bond investors are well aware of these issues and their fears are more than likely reflected in the current bond prices. South African bonds are furthermore attractive relative to real returns available on bonds in other developing and developed markets.

Local listed property
We retained our neutral holding in listed property. We prefer international listed property companies, which we believe are cheaper.

Global equities
We retained an overweight position in global equities. We are of the opinion that on a relative basis, global equity remains an attractive asset class. The dividend yield of developed market equities is at 2.8%. This is higher than the average dividend yield of the past thirty years. Only in 2008 were dividend yields substantially higher than current levels.

Global bonds
The real yield on offer from developed market bonds remains unattractive relative to more risky assets. We retained our underweight position in favour of international listed property.

Global property
We retained our overweight position in international properties via the Sanlam Global Property Fund managed by AllianceBernstein in the UK. The average dividend yield of the portfolio compares very favourably relative to offshore cash and bonds.