As one of their basic tools, market practitioners use the studying of long-term averages and judge events in the context of what is average. 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 the overall equity market volatility, but also sector relative performance. 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 sharp and rather dramatic reversal of the relative performance between the Resources sector (-38.9%) and the interest-rate-sensitive sector, particularly the 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; however, we were unfortunately a bit light in the interest-rate-sensitive area. Our strategy has been consistently to look for relatively secure earnings over the next 36 months, and 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 earning downgrades materialising in the near future in the broad domestic area of the market, excluding public sector fixed investment spending. Our theme has remained the same as before, viz. to focus on a three-year time horizon and stay with the companies we feel confident will deliver decent real earnings. We were not very active in any meaningful way in the nominal bond market over the period, which proved to be not such a good decision in the short term as bonds had a strong quarter (+12.6%), outperforming cash (+3.1%) rather dramatically. Note that the comparison over the first nine months of the year is that cash has outperformed bonds by 4.0%. As in the previous quarter, we were quite active within 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, close to 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 areas of the market. 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. Note that for the year to date (nine-month period) the return 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, thus protecting the portfolios to the downside as much as possible. 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 quarterly, our current allocation is essentially driven by a twin strategy of equities and cash.

The issue, from a big-picture point of view, is that in order to achieve our upside target (inflation +) we must have a decent weighting in equities. The reason for this statement is that this asset class provides the best long-term real return. However, by definition, given its superior return attributes, it comes at a price in the form of unexpected downside volatility. In order for us to meet the other objective of not losing any capital in the short term (rolling 12 months), we should have the entire portfolio in cash. This is the only asset class that will not lose money in the short term but will, at best, provide only a modest long-term real return. Therefore our approach has been to consistently try to balance these objectives by getting the exposure to equities correct. Unfortunately even a low exposure to this volatile asset class will detract from the portfolio's overall return when equities have a negative correction.

The main judgment call to be made now is how long this correction, or bear market, in equities will last. Regrettably, it is impossible to tell as there is some outstanding value emerging in various pockets within the equity market, countered by some very negative top-down factors, the main culprit being that we feel the markets are too sanguine about top-line economic growth. We believe the ultimate fallout of the US-led financial crisis will be a sustained period of below-trend global economic growth and the key question now is whether this is correctly priced into the equity markets.

The short term is going to be tough in terms of producing positive returns, let alone beating the upside objective. We remain confident that, over time, this method of investing will produce decent real returns coupled with low volatility during the inevitable phase in which the equity market retreats.

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.

We were fairly quick to add some resources exposure into the portfolio when it became clear that meaningful earnings upgrades were in the offing. This strategy undoubtedly helped the overall portfolio during the quarter but, like in the first quarter, the only way to have made real positive returns over the quarter was to have been invested only in a handful of resource 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 stay with our companies 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 cash outperformed bonds by 12.3% over the first six months of the year. As in the previous quarter we were quite active within the cash area, extending the duration by investing in one- and two-year NCDs. The logic of these investments is that we are now in all likelihood near or close to the top of the interest rate cycle.

We continued to build on our exposure to inflation-linked bonds. This asset class has been rerated rather dramatically and now looks to be on the expensive side. We will hold rather than add exposure at this stage.

We fortunately did not get involved in the listed property area at all during the quarter. Our low 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%.

From an equity exposure point of view, we remained consistently lower than what we deem the long-term weighting in equities to be, thus avoiding the temptation to add exposure during the quarter. As mentioned in the previous quarterly, our current allocation is essentially driven by a twin strategy of equities and cash. Latterly, we have introduced some inflation-linked bonds to complement our strategy. No major changes were made at an asset allocation level during this quarter.

The issue, from a big-picture point of view, is that in order to achieve our upside target (inflation +) we must have a decent weighting in equities. The reason for this statement is that this asset class provides the best long-term real return. However, by definition, given its superior return attributes, it comes at a price in the form of unexpected downside volatility. In order for us to meet the other objective of not losing any capital in the short term (rolling 12 months), we should have the entire portfolio in cash. This is the only asset class that will not lose money in the short term but will provide a modest long-term real return. Therefore our approach has been consistently to try and balance these objectives by getting the exposure to equities correct. Unfortunately even a low exposure to this volatile asset class will detract from a portfolio's overall return when equities have a negative correction.

The main judgment call now to be made is: for how long will this correction, or bear market in equities last? Regrettably, it is impossible to tell as there is some outstanding value emerging in various pockets within the equity market, countered by some very negative top-down factors, the main culprit being the growth-inflation trade-off. The latter will cause us to be cautious in the short term from an equity exposure point of view. We also feel it is still too early to start a meaningful investment in the deep-value part of the market.

In conclusion, the short term is going to be tough in terms of producing positive returns, let alone beating the upside objective. However, we remain confident that over time this method of investing will produce a decent real return coupled with low volatility during the inevitable phase in which the equity market retreats.

The sub-prime theme that started in August 2007 and affected the fourth quarter's investment outcome carried on into the first three months of this year, causing one of the most volatile and difficult quarters for a long time. What made matters worse was higher than expected inflation, coupled with a weak rand, higher energy and food prices, uncertain local politics and of course the Eskom saga.

All in all we were reasonably well positioned from an exposure point of view during the volatile period in the quarter. However, the big negative event was the market's indiscriminate selling down of the majority of our core stock picks in January. This resulted in the worst single month's investment return in the six-year history of running these funds. Much introspection was done on the nature of these shares and fortunately we did not join in the panic. The shares have rebounded nicely for us, particularly in March when we produced a positive return despite the All Share Index retreating by 3.0% for the month.

The other feature over the quarter was the large deviation between the resources sector (+17.6%) and the financial and industrial sector (-8.5%), resulting in a massive 26.1% difference over the three-month period. In other words, the only way to have made real positive returns over the quarter was to have been fully invested in a handful of resources shares, which obviously would have produced unacceptable risk given the inherent volatility of this sector.

Our theme during the quarter was to focus on a three-year time horizon and add some exposure where we feel confident that decent real earnings will be delivered. This will be from global growth powered by the dominant emerging countries and domestically those companies that are in, or allied to, the continuing infrastructure and capital spending that has to take place.

We were not very active in nominal bonds over the period, which proved to be a sound decision as bonds had a poor quarter (-1.9%) underperforming cash (+2.8%) rather dramatically. Within the cash area, as in the previous quarter, we were quite active, extending the duration by investing heavily in one- and two-year NCDs. The logic of these investments is that we are now, in all likelihood, at the top of the interest rate cycle.

A new area of activity in this area has been the introduction of inflation-linked bonds. The logic for this investment is that it will capture unexpected inflation over the term of the bond as we believe the risk to this scourge remains high.

As mentioned in our last quarterly we remain positive on the underlying short-term distribution drivers for listed property, but our value criterion was not met and more patience is required in this area. Our low exposure in this asset class paid off over the quarter as Property Unit Trusts (listed property) returned a very poor -13.3% over the three months.

As mentioned in the last quarterly our current allocation is essentially driven by a twin strategy of equities and cash. Lately we have introduced inflation-linked bonds to complement our strategy. Equities, and to a certain extent inflation-linked bonds, should provide the required long-term real return. Cash is the balancing asset class to manage the risk of not losing any capital. In other words, cash is the only true diversifier to the unexpected volatility from equities.

Given the massive infrastructure and capital expenditure programmes taking place both globally and locally we feel these should still provide a solid underpin for economic growth. In the short term, the US and domestic consumer is under pressure and we would not be at all surprised if this area in both countries produced a recession in 2008. However, taking a three-year view, real earnings should therefore be delivered by the equity market, albeit at a much lower rate than that experienced over the past few years.

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 tailwind for growth assets. This outlook should be contrasted with the fact the market has currently lost obvious value as real earnings are no doubt in the process of reverting to their long-term trend, making the short-term outlook for equities unclear. For this reason we are comfortable to stay below our long-term strategic equity exposure levels. We are confident this approach will enable the fund to meet its dual objectives of providing inflation-beating returns over a rolling three-year period and to provide capital protection over a rolling 12-month period.

Class was last price on 14/03/08.

The US housing sub-prime theme that started in August continued into this quarter, resulting in one of the worst quarterly equity performances over the past five years. The sector that supported the equity market for the first three quarters of this year, viz. resources, finally capitulated over this period by declining by more than 7%. During the quarter financials also dropped by slightly less than 1% while industrials increased by just more than 1%. The All Share Index declined by more than 3% over the quarter. However, for the calendar year 2007 the JSE All Share Index still returned a respectable 19%.

As mentioned in the previous quarterly our current allocation is currently driven by a barbell strategy of equities and cash. Equities should provide the required long-term real return, with cash balancing the risk of losing any capital. In other words, cash is at present the best diversifier for the unexpected volatility from equities.

On the positive side, we believe the current massive infrastructure and capital expenditure programmes both globally and locally should provide a solid underpin to economic growth. Taking a three-year view, the equity market should therefore deliver real earnings, albeit at a much lower rate than during the past few years.

Another positive point for equities, locally and globally, is that real bond yields are lower than the rate of economic growth. This should provide a strong tailwind for growth assets. This outlook should be contrasted with the fact that the market has currently lost obvious value as there is a high probability that real earnings will revert to their long-term trend, making the short-term outlook for equities unclear. For this reason we are comfortable about staying around our long-term strategic equity exposure levels.

We are confident that this approach will enable the fund to meet its dual objectives of providing inflation-beating returns over a rolling 3-year period and to provide capital protection over a rolling 12-month period.

All in all we were well positioned from an exposure point of view during the volatile period during the quarter. Given the way we have structured the portfolio, we have fared reasonably well over the period under review. Our strategy, firstly, has not been to panic and withdraw from the market when is falls or to re-enter when the market rebounds. Secondly, we have remained at what we deem the long-term neutral exposure level to equities, as from a top-down perspective it appears that numerous bearish factors are balanced out by bullish factors. During the quarter a few shares were added to or trimmed but no major equity purchases or sales were undertaken.

We were not active in bonds over the quarter, which proved to be a sound decision as the All Bond Index (0.9%) underperformed cash (2.7%) over the quarter. As in the previous quarter we were quite active within cash in extending duration by investing heavily in 1- and 2-year NCDs. The rationale behind these investments is that we are now, in all likelihood, nearing the top of the interest rate cycle.

As mentioned in our previous quarterly we remain positive on the underlying distribution drivers for listed property, but our value criteria were not met and more patience is required in this area. SA listed property returned -0.4% over the quarter.