Global equity market volatility continued into September as concerns regarding the potential economic impact of the European sovereign debt crisis deepened. The mixed economic data released during the month did little to comfort investors. The negative sentiment, which impacted risky assets globally, weighed most heavily on global emerging market currencies, including the Rand. The FTSE / JSE All Share Index fell 3.6% in Rands and the MSCI World Developed Markets Index was down 8.8% in US$. Over the quarter, local equities was the worst performing asset class both locally and offshore in Rands, producing a return of - 5.84%. Given the risk aversion over the quarter, it was not surprising that global bonds were the best performing asset class, producing a return 23.4% in Rand terms. This return was predominantly achieved through rand depreciation, where the Rand declined by more than 16%.

The current market prices suggest a significant contraction in company earnings coupled with a global recession. Our view remains that the likelihood of a global recession is remote. As also previously indicated, we have used the recent market action as an opportunity to add exposure to some risky assets, particularly offshore equity. Where possible, an allcocation away from low yielding cash investments into more inflationary protected instruments like inflation linked bonds has been done as the real yield on these bonds are far more appealing than that of cash.

Price action in both the equity and inflation linked bond market over the past month has not rewarded this decision. While we acknowledge that risks to our view do exist, we remain confident that the concerns currently priced in the market with dissipate resulting in risk taking investors being rewarded.

Equities in general continued to underperform fixed income asset classes over the quarter and in June as signs of a global economic slowdown persisted and fears of a Greek debt default triggered a flight to safety. Leading economic indicators have in recent months pushed lower suggesting the "soft patch" in economic activity could continue well into 2012. Against this backdrop, global equities declined by 1.7% in USD's in June and some 2.3% in rands, marginally outperforming emerging market equities. Over the quarter, global equities declined by 0.2% in rands whereas emerging market equities declined by a more material 2.0%. The relative outperformance from developed market equities was due to more attractive valuations and still very low rates of interest. Margin-of-safety valuations are also still supportive of overweight equity positions notwithstanding their relative underperformance of fixed income asset classes over the past quarter.

Although domestic equities marginally outperformed global equities in June, they underperformed their global counterparts over the quarter yielding - 2.0% and -0.6% respectively. Domestic equities fell foul of selling pressure globally as concerns of Eurozone debt defaults and a global economic slowdown took root. Notwithstanding these concerns, the outlook for the domestic economy is still positive with growth of around 3.6% expected for the year. Buoyant growth in mining production, exports and the retail and motor trade sectors were however offset by disappointing manufacturing data and contractions in the building and construction sectors.

Global bonds continued to outperform global equities over one month and the quarter as risks intensified of a global slowdown and contagion from the Eurozone debt crisis spread beyond Greece. The upshot of the debt crisis is that banks will be exposed, which along with higher capital adequacy requirements under Basel III will cause the interbank lending market to dry up and trigger tax increases in Eurozone countries in order to recapitalise the region's banks. This along with fiscal austerity measures in the peripheral countries has raised the spectre of declining growth in the region. Despite ongoing wranglings between creditor nations, the ECB, EU, ratings agencies and the ISDA Council, a solution to the periheral country debt crisis may be in the offing.

Domestic bonds gained some 0.2% in rands during June capped by a higher sovereign risk premium and a rise in expected inflation across the yield curve. Even buoyant foreign demand for bonds totalling R11.3bn failed to stem the backup in nominal bond yields. Over the quarter however domestic bonds yielded 3.9% in rands, the second best performing asset class behind the 4.4% yielded by emerging market bonds. South Africa benefitted substantially from the carry trade during the quarter, attracting some R35.6bn in net foreign inflows, a tailwind that is expected to underpin bonds over the medium term. With interest rate differentials still wide relative to developed market bonds, the carry trade will continue to partially offset the negative effects from rising domestic inflation.

There were no significant changes to the positioning of the SMMI Defensive FoF during the quarter. We continue to prefer foreign equity over domestic equity and we remain underweight both domestic and foreign bonds.

Domestic equities yielded 1.1% in Q1, well ahead of returns from domestic bonds but marginally behind cash returns. Domestic equities came under pressure in January as contagion from the political unrest in Egypt infected the domestic market. Although domestic equities recovered somewhat in February, the market again sold off in March as the devastation from the Japan quake triggered two days of selling pressure. Despite the volatility, the JSE ended the month in positive territory after having been down 6.1% following the quake. While foreigners were net sellers of domestic equities, local investors saw the market corrections as an opportunity to increase their equity exposure. Resources were the best performing of the broad sectors yielding 2.4%, followed by financials with a 1.3% return. In contrast, industrials gained a more pedestrian 0.85% due to a 4.1% contraction in January.

Domestic bonds yielded -1.6% over the quarter on foreign selling pressure and sharp increases in expected inflation. Despite positive returns from this asset class in March, SMMI retains its underweight position expecting upward pressure on yields to persist in the months ahead. The catalysts include rising inflation, especially in H2 on base effects and surging oil and food prices. Adding to inflationary concerns is the large differential between the GDP deflator and consumer price inflation. At current wide levels, SMMI believes the upside risk to inflation is elevated informing our underweight bias in bonds. SA cash yielded 1.4% in Q1, slightly ahead of the returns yielded by the All Share Index.

Global equities were the best performing of all the asset classes in Q1 yielding a return of 4.3% in USD's and 6.4% in rands. The relative outperformance was however due to a 7.75% depreciation in the rand/USD exchange rate in January that resulted in a 10.8% rand return for the MSCI World Index in that month. In subsequent months the rand strengthened by 6.2% causing global equities to underperform their domestic counterparts. Global bonds outperformed domestic asset classes over the past quarter aided by the January currency effect. Returns were pedestrian, however, with the JP Morgan Global Bond Index yielding 0.5% in USD's but 2.6% in rands. Catalysts for the pedestrian returns included USD weakness in the last two months of the quarter and an increase in inflation expectations that saw yields push higher. The primary culprits were US treasuries that yielded negative returns over the quarter as breakeven inflation (expected inflation) increased across the yield curve. 10-Year US beakeven inflation increased from 2.33% to 2.51%, while 1-year breakeven inflation increased to 3.2% from 1.5%.

The most significant changes to the positioning of the SMMI Defensive FoF was the inclusion of 3% in domestic property as well as adding 5% to the domestic bond exposure. While domestic bonds remain in expensive territory on our valuation metrics, we have used some weakness in bond yields to slowly reduce our underweight to domestic bonds.

Domestic equities were the best performing asset class in Q4 yielding a return of 9.5% in Rands and some 15.1% in USD's. Catalysts for the gains included a 17.3% gain in $-metals prices, a surge in global equity prices in USD's and a sharp rebound in the Kagiso PMI index. A steepening in the domestic yield curve also aided the rally fuelling investor perceptions of an acceleration in GDP growth in 2011. Financials (0 8%) lagged the returns of the other major sectors as contagion from the Eurozone debt crisis spread to the banks. Resource counters were gaining some 16.5% on the strong rally in $-metals prices. Net foreign demand for domestic equities totalling some R16.9bn also lent support to the domestic equity market, up from net purchases of R0.1bn in Q3.

Domestic bonds yielded 0.75% in Q4 following an 8.1% surge the previous quarter. Ireland's Euro 85bn debt bailout and a back up in breakeven inflation offset a slight gain in the country's sovereign risk premium over the quarter. Although risk aversion peaked in November, it eased somewhat in December as the Irish bailout package was announced. The sovereign risk premium declined to 1.44% from a high of 1.77% highlighting the thawing in Eurozone debt default concerns. Breakeven inflation similarly declined to 5.46% from 5.64% the month before. The improvement in breakeven inflation was due to rand strength that has seen a moderation in long term inflation expectations. SA cash yielded 1.6% in Q4, outperforming both foreign and domestic bonds. Following the 50 basis point cut in interest rates in November the FRA's are pricing in no further reductions in interest rates in the current cycle.

Global equities rallied strongly in Q4 gaining 8.5% in USD's. Most of the gains were realized in December (7.2%) as Eurozone debt concerns weighed on the market in the front-end of the quarter. In Rand terms returns were more modest increasing by 3.3% on a 5.1% appreciation in the Rand/USD exchange rate. The gains in global equities were fuelled by signs that the US economy was stablising with growth in H1 expected to accelerate somewhat from current levels. The gradual pick up in commodity prices also signalled a turnaround in the US and the G7 economies.

Global bonds were amongst the worst performing of the asset classes in Q4 yielding -1.8% in USD's and -6.6% in Rands. Emerging market bonds fared even worse yielding -2.3% in USD's and - 7.1% in Rands. The poor returns from emerging market bonds were somewhat surprising given the allure of the carry trade to investors. What this does suggest though is that investors are becoming increasingly concerned about inflation in many emerging market economies which is translating into rising short-term interest rates.

The SMMI Defensive FoF underperformed the Asset Allocation Targeted Absolute Return peers during the fourth quarter of 2010. This was mainly due to the more defensive positioning of the fund relative to some of the peers. As the fund is in the process of moving to the Asset Allocation Prudential Low Equity sector, the fund has undergone some restructuring during the fourth quarter. The most significant changes to the manager allocations were the removal of absolute return stretegies that were replaced by specialist equity and bond strategies. The fund has also now invested in foreign assets in line with its change to a low equity balanced fund.

The fund changed sectors from Domestic--Asset Allocation--Targeted Absolute and Real Return to Domestic--Asset Allocation--Prudential Low Equity on 02 Feb 2011. The fund lost its history