Domestic equity markets returned a healthy 6.3% in the third quarter. Once again, investors saw somewhat of a reversal of fortunes for the broad equity market sectors. After a second quarter in which resources dominated financials and industrials, the third quarter saw returns in excess of 10% from both the financial and industrial sectors compared to modest returns of less than 1% from resources. Gold-mining stocks led the decline and were among the worst performers in the All Share Index following a downturn in precious-metal prices.

The bond market outperformed cash for the quarter, returning 2.1%. Bond performance was positive despite significant depreciation in the currency, due to local yields lagging the downturn in international yields. Property rebounded in the 3rd quarter following a strong sell-off in May.

The rand depreciated by more than 8% against the US dollar while the MSCI World Index returned more than 4% in $US terms for the quarter. The strong dollar-denominated returns coupled with the depreciating currency resulted in rand-denominated returns in excess of 12% from international equities.

The Sanlam Defensive FoF invests with a combination of leading positive-return funds. The fund continues to deliver on its objectives, i.e. capital protection over any rolling one year and a return of 4% in excess of CPIX over any rolling three-year period. The defensive nature of the fund has weathered the volatile market environment experienced this quarter and has generated a healthy return in excess of cash. Investors should also note that the fund's volatility has been lower than that of the All Bond Index over the past 12 months and would continue to be defensively positioned in the light of the increased volatility in all asset classes, with a significant risk of short-term capital loss.

The fund maintains exposure to a diversified mix of absolute return managers, strategies and asset classes. It is ideal for investors seeking capital protection and inflation-beating returns over the long term, but who lack the knowledge, time and skill to select and monitor the various available absolute return funds, strategies and investment managers.

The second quarter of 2006 proved to be quite different from the first. The FTSE/JSE All Share Index ended the quarter a little over 3% up. However, this number masks a significant increase in volatility over the quarter and contrasting returns from the main sectors of the market. Compared to the first quarter when investors benefited from healthy returns (in excess of 10%) from all the broad market sectors (resources, financials and industrials), the second quarter saw financials and industrials delivering negative returns in excess of 5% while the resource sector delivered strong positive returns in excess of 21%. Clearly it was a difficult quarter for managers who were underweight resources.

The bond market ended the second quarter more than 3% down. This was on the back of a surprise rate hike in June following concerning current account numbers. Yields on the R153 government bond started the quarter at 7.3% and ended the quarter at levels in excess of 8.4%.

The MSCI World Index was down approximately 1% for the quarter in USD terms. The rand however, depreciated by 15% against the USD, which resulted in the MSCI World Index being 14% up for the quarter and investors benefiting from strong returns on rand-denominated foreign investments.

The Sanlam Defensive FoF invests with a combination of leading positive return funds. While the fund has delivered on its longer-term objectives of capital protection (over any rolling one year) and real return of CPIX + 4% (over any rolling three years), it suffered its worst quarter since inception. In difficult market conditions the fund has minimised capital loss by being defensively positioned. Investors should also note that the fund's volatility has been lower than that of the All Bond Index over the past 12 months and we will continue to be defensively positioned in the light of the increased volatility in all asset classes with a significant risk of short-term capital loss.

The fund maintains exposure to a diversified mix of absolute return managers, strategies and asset classes. It is ideal for investors seeking capital protection and inflation-beating returns over the long term, but who lack the knowledge, time and skill to select and monitor the various available absolute return funds, strategies and investment managers.

On the economic front, the start of 2006 was business as usual in SA with positive growth in terms of both output and spending. Inflation stayed within thetarget range, an expansionary budget was released to complement 24 months of expansionary monetary policy, and overall confidence ran high.

This economic stability, although earnings supportive, was not reflected in the behaviour of the local equity market as the re-emergence of some riskaversion, coupled with erratic commodity prices, resulted in much higher volatility on the JSE. Despite this, the JSE reached an all-ime high of 20327 atthe end of March, bringing the total return for the market to 12.5%. Foreigners once again supported our market with net buying of R31bn for the quarter.Relatively low exposure to South Africa combined with the search for yield should underpin foreign buying.

The recovery in gold and platinum prices to $584 and $1092 respectively underpinned the resource sector, which returned 12% for the quarter. This morethan offset the effects of rand appreciation. Broad-based market performance was evident, with attractive valuations and positive earnings growth expectations supporting the financial and industrial sectors. In fact, financials outperformed resources with a return of 13% while industrials returned 11%.

The small cap sector also benefited, outperforming the mid-cap sectors. The listed property sector continued its stellar performance as attractive financing deals, low vacancies and improving rentals continue to underpin the sector. This proved to be the second best performing sector with a return of 20% after IT, which returned 22%.

The bond market staged a brief rally in the middle of the quarter on the back of tight supply and good inflation fundamentals. This was short-lived as local yields moved up in line with global bond yields on the back of inflationary concerns and rising global short-term rates. As a result local bond yields were flat for the quarter. Although local short rates are expected to remain on hold, the full valuation of the bond market, combined with expectations that global yields could move up further, kept investors out of the market. Bond yields are expected to remain range bound, with offshore trends likely to dominate until there is a shift in short-term interest rate expectations.

After a retreat early in the fourth quarter, taking its lead from foreign equity markets, the local equity market ended the year on a high note. The FTSE/JSE All Share Index rose by over 40% for the year. The resources sector moved up more than 60%, with financials showing returns of less than half those of resources for 2005. However, in the final quarter of the year it was the financial sector that outpaced the overall market. This led to several lagging managers gaining ground in the final quarter. The sector call on resources was an important factor in determining fund managers' performance in 2006.

A major development in the fourth quarter was the shift in expectations for local inflation and hence interest rates among the investment community to a more positive outlook. This led to a rally in the bond market towards the end of the year. The 3% return for bonds in the final quarter brought the total return for the year to 8%.

While the rand weakened against the major currencies during the calendar year, it strengthened during the fourth quarter after an initial period of weakness earlier in the quarter. This strength has continued into the new year.

On the local front, inflation, interest rate expectations and growth forecasts bode well for the local equity market. Further supporting the positive outlook for the equity market is the expectation that the five-year run in the gold price could well extend into 2006. The benign inflation outlook also adds to a more positive outlook for bonds. The risks to this outlook include extreme currency volatility, a threat to global growth, and a sharp rise in global interest rates.

The Defensive Fund of Funds significantly outperformed its target of CPIX + 4% for the year as markets in general were supportive of absolute return strategies in 2005.