As one of their basic tools, market practitioners use the studying of long-term averages and judge events relative to how they compare to those long-term averages. History will no doubt judge the third quarter of 2008 as an extraordinary one in the sense that it was far from average. This was in the context not only of overall equity market volatility, but also sector-relative performance. Indeed, the action of the bond market must also be included in the "extraordinary performance" category.

There were two main features in the equity market over the quarter, viz. the dramatic reversal of the relative performance between the Resources sector (-38.9%) and the interest-rate-sensitive sector, particularly Banks (+25.5%) and General Retailers (+26.8%). The other, of course, was the general direction of the market as a whole: the All Share Index had a disastrous September (-13.2%), making the quarter (-20.6%) one of the worst in recent times.

No further exposure was added in the resources area during the quarter. We were, however, unfortunately a little light in the interest-rate-sensitive area. Our strategy has been consistently to look for relatively secure earnings over the next 36months. The area that we still favour is the Construction sector (+10.6% for the quarter) which we have used as part of the strategy to offset the interest-rate sensitive sector. The logic behind this thinking is that we are concerned about downgrades in earnings expectations materialising in the near future in the broad domestic area of the market, excluding public sector fixed investment spending. Our theme remained the same as before, viz. to focus on a three-year time horizon and stay with those companies which we feel confident will deliver decent real earnings. We were not very active in the nominal bond market over the period. With the benefit of hindsight, this was perhaps not such a good decision in the short term as bonds had a strong quarter (+12.6%) - outperforming cash (+3.1%) rather dramatically. That said, it should be noted that cash outperformed bonds by 4% over the first nine months of 2008. As in the previous quarter, we were quite active in the cash area, extending the duration by investing again in one- and two year NCDs. The logic of these investments is that we are now, in all likelihood, near the top of the interest rate cycle. No further exposure was added to the inflation-linked bonds over the quarter as we believe that, in general, this asset class is now fully valued.

Listed property had a very volatile quarter, much in line with the other interest-rate sensitive equity sectors. Our low exposure to this asset class did not pay off over the quarter as this sector returned an excellent +23.1% over the three months. However, for the year to date (nine-month period) the return on listed property has been -11.9%, justifying our low exposure to this area.

We consistently reduced the equity exposure during the quarter and ended the period substantially lower than what we deem the long-term weighting in equities to be to achieve the required long-term return. This assisted significantly in limiting the fallout from the poor equity markets.

Some exposure, albeit small, was added to our bond exposure and our first tentative steps were taken to add some listed property to the portfolios. As mentioned in the last quarter, our current allocation was and remains essentially driven by a twin strategy of holding equities and cash.

History might well show that a broad-based equity bear market started in the fourth quarter of last year. The dominant investment themes that prevailed in the first quarter of this year, viz. slower economic growth coupled with higher than expected inflation, continued unabated into the present quarter. Inflation was driven mainly by the record high oil prices. The surprising variable was in fact the rand, as it appreciated slightly against all the major currencies over the quarter.

The main feature of the quarter was how narrow the SA equity market was, with only a handful of resource shares rising while the broad market declined. Over the first quarter resources outperformed the Industrial &Financial Index by 26.1%. This was followed by a further resources outperformance of 19.8% during the second quarter, resulting in an astonishing 47.7% differential over the first six months of the year. The broad theme was to avoid any share to do with domestic South Africa.

Note that the only way to have made real positive returns over the quarter was to have been invested only in a handful of resources shares, which obviously would have produced unacceptable risk given the inherent volatility of this sector. Our theme remained the same as before, viz. to focus on a three-year time horizon and to stay with our equity investments where we feel confident that decent real earnings will be delivered.

We were again not active in any nominal bonds over the period, which proved to be a sound decision as bonds had another poor quarter (-4.9%), underperforming cash (+2.9%) rather dramatically. Note that the comparison over the first six months of the year is that cash outperformed bonds by 12.3%.

We reduced our exposure to the listed property area, which worked well for us during the quarter. Our now zero exposure to this asset class paid off over the quarter as property unit trusts (listed property) returned a very poor -19.6% over the three months. Note that for the year to date (six month period) the return has been -28.4%.

We were very active at the asset allocation level during the quarter as we ended the quarter low in equity exposure relative to our benchmarks. The reason was more of a top-down view as the environment for all asset classes except cash had deteriorated and should continue to do so in the foreseeable future. We are likely to remain cautious in the quarter ahead and stay with a high cash weighting.

The dominant theme at an asset allocation level over the quarter was not to panic, in or out, particularly with respect to equities as the extreme volatility could only have caused loss to the portfolios. We remained slightly underweight equities over the quarter and this reflects our cautious short-term outlook.

Our decision to be underweight bonds paid off over the quarter, as did being relatively light in listed property. Our dual strategy of cash and equities is likely to remain the core theme for the year ahead.

We were active at the asset allocation level during the quarter by reducing bonds and increasing the offshore exposure to 14.5%. This proved to be the correct strategy.

The equity market is still far from clear or obvious value as both the All Share and the Financial & Industrial Indices are trading well above their long-term P/E ratios. This is against an uncertain backdrop of a now almost certain recession in the US led by the consumer. Domestically, inflation remains the key uncertain variable on the back of a weak rand, uncertain politics, and the Eskom saga. There is now a risk that short-term interest rates may have to remain at elevated levels for much longer than originally anticipated. This will have an impact on the growth outlook, especially at the consumer level. In addition, real earnings are no doubt in the process of reverting to their long-term trend, making the short-term outlook for equities unclear. However, on the positive side, the global and local fixed investment spending is huge and should provide a strong underpin to general economic growth. Therefore, taking a three-year view, real earnings should be delivered by the equity market albeit at a much-reduced rate than that experienced over the past few years. Finally, another positive point for equities, locally and globally, is that real bond yields are lower than the rate of economic growth, which should provide a strong tail wind for growth assets. Given these reasons we are comfortable to be underweight equities but we are currently not so bearish as to take an aggressive stance on this very important decision.

We are likely to maintain a cautious stance on bonds over the next quarter as many headwinds are still facing this market, the main one being that inflation will rise higher than expected. This must be seen against a framework where monetary policy (inflation rate targeting) is on the table for debate. All these issues, taken together with the possible Eskom tariff increases, make this area of the market uncertain. However, as always, there is a price for all assets and we will be looking for decent entry levels should there be a further retracement in yields.

The last quarter of 2007 was volatile with financial market uncertainty mainly due to slowing global growth, a spreading international credit crisis, rising oil prices and inflation both locally and internationally.

The most volatile asset class was equities and at the beginning of the quarter we reduced our exposure to domestic equities slightly in order to position the SIM Managed Solution Fund of Funds range more defensively. Also, as a result of property producing the best returns up to October, we decided to trim our property exposure based on near-term fundamentals. The proceeds from both equities and property went to domestic cash, which proved to be the correct strategy over the quarter - the All Share Index was negative 3.3% and property negative 0.4%, while cash delivered 2.7% over the quarter. We maintained our offshore exposure.

Equities still remain our preferred longer-term asset class but we are currently slightly underweight due to the ongoing uncertainty regarding global economic growth and earnings, as well as the heightened risk aversion flowing from the credit fears in developing economies. In the short term, we will remain overweight cash as we near the top of the interest rate cycle, and as a diversifier in the event of any unexpected volatility. We remain positive on the underlying distribution drivers for listed property but this asset class will require some patience, hence our current underweight position. However, we do expect property to outperform cash in 2008.

Internationally, the global equity asset class should deliver better returns than the fixed-interest markets over the longer term, and we will maintain our current international exposure for diversification benefits and to help reduce volatility in returns.