There was a dramatic turnaround this quarter in the fortunes of the equity environment. The All Share Index returned an impressive 17,4% over the three-month period. The All bond Index also rebounded strongly, returning 6,9% for the same period. This compared to 2,0% from cash and 12,0% from quoted property.

The Fund has continued to achieve its downside target of not losing capital over a 12-month period. The markets then changed dramatically in August and September with the All Share Index rising by just under 15%. This obviously resulted in the Fund's leaping ahead of its upside targets.

The current key question is: where to now with regard to strategy? Our strategy within equities is to "harvest" some of the spectacular returns that have been generated over the past two months, particularly in areas such as banks and retail. There are two reasons for this move: firstly, to lock in some of the outperformance and secondly, there is a high probability that the market will correct in the near future allowing us to buy again at lower levels as, despite the strong rise, we remain fundamentally positive on equities.

Within bonds our low exposure during August and September hurt us a little bit relative to cash and we will look to add some nominal exposure on any weakness. Inflation-linked bonds remain expensive given our expectations of future inflation and we will continue to avoid this asset class.

Our exposure to quoted property paid off as it handsomely outperformed bonds. We will hold our exposure at current levels.

We will remain defensive to the equity markets as we firmly believe that it would be inappropriate, at these levels, to chase the equity market, and that the overall volatility of equities remains high, supporting this stance.

A harsh equity environment characterized the quarter with the All Share Index down by -4.7%. Bonds as measured by the All Bond Index delivered a meagre positive return of only 0.4%. Cash returned 2.0%. The best-performing sector was the quoted property sector, returning a solid 4.1% over the quarter.

The focus during the past quarter and for the immediate future is to achieve the prime objective, namely not to lose capital over a rolling 12-month period. The secondary objective of achieving the target return of CPI + 5% over a rolling 36-month period will from time to time have to take a back seat over the very short term. This occurs periodically when the major asset classes simply do not offer the targeted real return. We believe that we are currently in such an environment and patience and discipline, with the emphasis on capital protection, are the key theme.

We are pleased to report that we have met the first key objective of not losing capital over the quarter and also for the year to date although we remain fractionally behind the target return. Note that the All Share Index returned a negative - 1.2% for the first 6 months (y-t-d) and the All Bond Index and cash returned 0.1% and 4.1% respectively.

Our strategy going forward is to be highly focused on the preservation of capital and to be cautious in allocating capital to more risky asset such as equities.

In line with the above, it is no surprise that we increased our cash holdings during the quarter. Nominal bonds remained more or less the same as at the end of the first quarter. Due to uncertainty in the outlook for inflation at the beginning of the quarter, we started to add to inflation-linked bonds. However, they appreciated rapidly, causing us to stop buying and resulting in only a small addition to this asset class. Equity exposure was reduced over the period as the markets were digesting uncertainty over the pace of global interest rate increases. In the last quarterly report we anticipated that we were beginning an exit strategy from quoted property. Sales were halted as the valuation gap between bonds opened up again in favour of property. The result of these actions is that our exposure to this asset class has remained fairly static.

The 1 st quarter of 2004 was highlighted by two significant changes in the way our suite of absolute return portfolios were structured. Firstly, we reduced most of our holding in nominal bonds in favour of cash, while also starting a slow exit from our property exposures. While we are extremely concerned with the volatility of equities as an asset class, we still believe that equities will continue to outperform bonds and cash over the next two quarters.

While most market commentators now agree that South African inflation seems to have bottomed, fund managers reduced their holdings in bonds while also reducing their duration positions within their portfolios. This, together with a broad acknowledgement that the Reserve Bank will not relax its monetary policy any further, drove bond yields higher, causing the bond index to deliver negative returns for the quarter. We are happy to say that our absolute return portfolios did not participate in the negative return of -0.31%, experienced by the bond market index.

We also started a slow, but determined exit from our property (PUT) exposure. Based on the negative returns of more than -1.5%, this too was the right decision for our portfolios. We remain concerned that while the bias to interest rates and monetary policy remains upwards in the medium term, it will have further negative effects on the pricing of PUTs.

Our money market portfolios remain invested in the short end of the money market yield curve, with the intention that, should rates increase any further due to monetary policy or inflation fears, we would be able to capitalize on this by reinvesting at higher rates. The equity portion of our portfolios was kept at the maximum levels we believe necessary in order to achieve the different targets (CPI + 5%) at acceptable levels of risk. While many absolute return fund managers increased their equity exposures to levels characteristic of typical aggressive balanced mandates, we decided to remain true to label. Our portfolios have a dual target of firstly not making any capital losses over a 12-month period, while still achieving a real return of 5% over any 36-month period. Our funds therefore had a much lower exposure to equities than other absolute return funds in the peer group. These levels also remained stable throughout the quarter. Within the equity portions of our funds we were also structured defensively. The fund held relative overweights in the industrial and financial sectors, while keeping a relative underweight in resources. This was also in line with the views of our asset allocation team. With the financial index and the industrial index outperforming the ALSI significantly, this too proved to be the right strategy for our portfolios.

The risk of capital losses was also managed by means of actively buy/selling derivative contracts. The use of derivatives on equities was limited to listed futures and options with the FTSE / JSE Top40 as underlying index. These instruments carry no credit risk as the exchange is the legal counterparty of each transaction. Trades constituted mainly hedging activities. During February 04 we liquidated a long call position that was held since May 2003. This was replaced by a put option, to reduce the equity risk of the portfolio. The maximum effective exposure to these instruments was however kept below an overall level of 5% of the total portfolio.

February saw bonds outperforming equity and property unit trusts, as well as the money market. While we made very little change to our portfolio's asset allocations during February, our underweight in bonds did mar the performance of the portfolio. However, considering the year-to-date performance of the different asset classes, both equity and cash have outperformed bonds over the past two months. Bearing this in mind, our underweight in bonds and overweight in cash have therefore been the most prudent decision. It is also important to note that property unit trusts and property loan stocks have delivered negative returns for the year to date, and our gradual reduction in exposure early in January has therefore paid dividends.

Looking forward, we still believe that bonds have seen the bottom of the interest rate cycle. This is underpinned by the slow upward move (m-o-m change) in headline inflation, fuelled mainly by an up-tick in administrative and petrol prices as well as food inflation. In the equity market, February was characterized by mostly good earnings announcements, both in the financial and resources sectors. In the absence of any clear signs of US inflation, together with continued strong global growth and high demand for resources from China, we still remain positive on equities. However, with the SA equity market.

The Sanlam Inflation-linked fund has been a top performer in its targeted returns segment since its change in fund manager and name (it was called Sanlam Managed Flexible) two years ago. Its equity holding is on the low side even though the fund manager is positive on the outlook for equities after the strong gains made during the past nine months.

This month again saw a continued reduction in our asset allocation from cash, in favour of bonds and equities. Interest rates in the money market remain low, while the forwards are currently not pricing in any further interest rate cuts. This implies that cash rates should remain low and stable in the medium term, assuming there are no exogenous shocks. While we increased our allocation to the shorter end of the bond market yield curve during November, we again increased our allocation to the longer end of the yield curve during December. This worked well, as the expected rate cut was smaller than expected, causing the longer end of the yield curve to rally for the month of December. In fact, the longer end of the yield curve outperformed the short end by more than 1%.

Although the 50bps interest rate cut in December was less than consensus expectation, the rand weakened somewhat, triggering a rally in local equity markets. This rally was supported by strong global markets over the festive season. Although the US market is looking expensive, the South African market still seems fairly priced and any rand weakness will spur a further rally.

Our increase in exposure during November and again in December paid off handsomely, with the Alsi40 returning 4.75% for December. Although the rally was broad based the fund generated most performance from large holdings in retail, banks, selected industrials and property. Local industrials should benefit from buoyant economic activity due to low interest rates and increased government expenditure, while fundamental valuations on banks and insurance are still attractive. Diversified mining should benefit from a sustained recovery in the major global economies and growth in China, as well as expected rand depreciation.

Note
It is important at this stage that we again caution our investors against the following: Following the inception of a designated unit trust category for absolute return funds, many investors still err by comparing the different fund performances in this category with one another. It is important to understand that a CPI+5% fund and a CPIX+7% fund have two completely different targeted returns (benchmarks) and thus also very different risk/aggression profiles. The incorrect strategy for SIM would be to try and outperform the funds sharing this category with us. By doing so we would, in our view, be taking on too much risk, but we would also not be able to deliver an absolute return in all market conditions. While we have delivered consistent returns, beating our benchmark over all periods since inception and also ending 2 nd out of 10 funds in this (new) category over 12 months, we would again like to caution that we do not look at, or measure ourselves against any competitor but rather against the benchmark of CPI+5%, with positive returns. This is our only concern!