Market Review

The third quarter of 2010 was again characterised by volatile markets, returning risk appetite and a global 'search' for yield. Emerging markets, as measured by the MSCI Emerging Market Index, soared by 18.2% in dollars compared to the 13.9% delivered by the MSCI World Index. The All Share Index returned an impressive 25.4% in dollars compared to 13.3% in rand terms. The rand strengthened by nearly 10% from R7.66 to R6.96 to the dollar.

For the quarter, nominal bonds were the best performing fixed interest asset class, delivering a return of 8.04%. Inflation-linked bonds generated 4.64%, with the R197 inflation-linked bond yield decreasing from 2.98% to 2.61%, and cash 1.68%. Property stocks followed nominal bonds higher and delivered an impressive return of 13.7% for the quarter.

What SIM did
At the beginning of the quarter we increased our equity exposure at attractive levels but during the latter half of the quarter we increased the protection of the fund's underlying equities exposure after strong equity market performance. This action should reduce downside risk in the portfolio over the next few months although this does come at the cost of giving up some potential gains should the market perform strongly from current levels.

The strong rerating of the industrial sector has pushed valuations in favour of the financial and small cap stocks. We also now see better relative value in resources versus industrials. However, we prefer not to look at valuations at an aggregate level, but rather from a bottom-up stock specific perspective. In this regard, we have been adding to Anglo, BHP Billiton, Sasol, Nampak, Lewis and Steinhoff. We further reduced our exposure to Woolies and Shoprite. Both shares have done well for us and are trading above our assessment of their best case intrinsic value. We reduced our exposure to Imperial, Mr Price and Mondi Holdings following good share price performances. We marginally increased our foreign equity holdings over the quarter, with the purchases funded from foreign cash.

Over the quarter we reduced our nominal bond exposure, as bonds reached our fair-value estimate of about 8.3%, and increased our floating-rate credit exposure at fairly attractive credit spreads. As can be seen from asset class performances, nominal bonds had a phenomenal quarter. It is, however, increasingly difficult to find value in the credit market. This is a function of improved company fundamentals, credit demand and the 'search' for yield in the current low interest rate environment. Inflationlinked bonds are trading close to fair value and are currently marginally attractive relative to nominal bonds.

SIM Strategy
Equities were probably fairly valued at the time of writing this report and thus the derivative overlays we implemented in the portfolio have increased the level of equity protection in the portfolio. Given current valuations, we are more likely to decrease equity exposure given the mandate requirements of protecting capital. Nominal bonds are expensive in our opinion and we will reduce the fund's exposure further should yields continue falling. We will maintain a well-diversified portfolio in current uncertain market conditions.

The local stock market, as represented by the SWIX index, was at its long term fair value at the end of September. Our assessment of long-term intrinsic value is calculated using a required return of 14% annualised for local shares. Our analysis shows Small Cap shares offering a potential 20% upside to fair value, Resources & Financials slightly below fair value & Industrials about 5% above fair value. Given the equity market valuation and strong recent rerating, we are comfortable having a portion of our equity holdings protected at current levels.

Market Review
The second quarter of 2010 was characterised by general risk aversion and the accompanied market volatility. The European sovereign debt crisis had many investors worried, with general market consensus that the austerity measures would impact growth negatively in the medium term. Economic indicators released during the quarter were also slightly weaker than anticipated. As a result, global equity markets weakening considerably during the quarter, with theMSCI World Index sliding 7.9% and the All Share Index slumping 8.2% but still 21.8% higher than a year ago. Domestic inflation continued its downward trend, coming in at 4.6% in May. Inflation-linked bonds were the best performing fixed interest asset class for the quarter, returning 5.1%. Cash delivered a return of 1.7% and the All Bond Index 1.1%. Property stocks delivered a positive 0.6% performance.

What SIM did
During March, we protected more of the portfolio's underlying equity as stock markets reached fair value and even became marginally expensive. This action limited the negative impact of the equity markets for the quarter. Specifically, we added to Sasol, ABSA, Mvelaphanda Resources, MTN, Anglo American Plc and British America Tobacco and began reducing the fund's exposure to Woolies and Shoprite because both shares have done well and are now trading above intrinsic value. We also reduced the portfolio's holdings in Naspers, Anglo Platinum and Anglogold.

During the second quarter, we marginally increased our global equity exposure, with a bias towards developed European equity markets. We plan to add to this position over the coming months.

We added to our nominal bond position after the steep rise in yields during the quarter. Although credit spreads continued narrowing, we increased our exposure to floating rate debt. We still see marginal value in selected debt issues, although less so than six months ago.

SIM strategy
Although still cautious about the equity market given the volatility experienced during the second quarter, we will add to our exposure should stock markets fall further. We have a similar stance on nominal bonds and will add further to the asset class should bond yields weaken from current levels. Inflation-linked bonds are attractively priced above 3%. However, we do see slightly better value in nominal bonds at the moment. We will also continue to look for attractively priced credit in the primary debt market.

Market Review

The SA economy is showing signs of a respectable recovery. The 550-basis point (bp) reduction in interest rates, including the last one (which was a positive surprise), is likely to provide muchneeded support to a highly indebted consumer. Inflation is in check, helped by the strong rand, and it is likely to remain benign in the short- to medium-term. The strong rand, however, may pose a risk to the manufacturing sector, as our exports become less competitive. We believe the rand is overvalued at current levels.

The FTSE JSE All Share Index had a solid start to the year, up 4.5% on a total return basis) and up 7.4% in March alone. The All Bond Index marginally underperformed local equities, with a return of 4.4%, SA cash returned 1.8%, while the Barclays Inflation Linked Bond Index moved sideways for the quarter. The increased issuance of government inflation-linked bonds (ILB's) at the long end of the yield curve put pressure on real yields, especially the real yields of long-dated ILB's (R210 maturing 2028 and R202 maturing 2033).

Asset Allocation

As equities continued to rerate over the quarter, our assessment of the market's expected upside to intrinsic value became too low to justify retaining our gross equity exposure. Thus we used the market strength as an opportunity to lighten our holdings in a number of shares that we have held for some time now and that have added significant value to the portfolio. All the counters we reduced our exposure to had approached our assessment of their respective intrinsic values - and in certain instances exceeded our best-case measure of fair value. Currently half of our equity exposure is protected against market declines.

Our nominal bond exposure was tactically reduced as we banked profits on some of the R186's bought earlier in the quarter, as well as R203's purchased at levels above 9% in the previous quarter. We still see value in selected credit placements and participated in some non-government bond issues during February and March. Cash was increased via floating rate notes at attractive spreads.

SIM Strategy

The JSE may not be in bubble territory but it is, at best, fairly valued to expensive. So unless the global economy delivers positive surprises and/or there are extraordinary developments in the local economy, near-term equity returns are likely to be muted. SA nominal and inflation-linked bonds offer real returns of about 3% but if the growing issuance of bonds is not soaked up by the market, the nominal yield will have to rise - denting prospective returns from this asset class.

All in all, the risk of lower returns has gone up and volatility is likely to be a continued feature of financial markets going forward. After a period of high nominal returns, particularly in the SA market, investors are going to have to adapt to a period of lower nominal returns.

Although at this point we have no clear preference for any one of the asset classes, we do have a marginal preference for equities over the others and continue to believe that long dated inflationlinked bonds and selected credit placements do offer some value.

Market Review
The global economic recovery continued during the fourth quarter of 2009, with the mayhem of nine months earlier nearly forgotten. . Equity markets continued their upward trajectory, while developed market long-bond yields weakened towards their long-term normalised levels. SA headline inflation dipped inside the 3% to 6% target range during the fourth quarter for the first time in nearly three years. It seems that the local bond market is currently focusing on two opposing forces, i.e. an improving inflation picture and a deteriorating fiscal situation, with increased government borrowing requirements. Over the quarter the bond market was fairly stable, with the R157 weakening by only 10 basis points. For the quarter, the All Bond Index returned 1.08%, cash 1.85% and inflation-linked bonds 0.2%. Long-dated inflation-linked bond yields continued creeping upwards, with the R197 21 bps weaker at 3.2% at the end of December. Property stocks delivered returns of 4.05% during the period. The All Bond Index recorded a negative return for the year (-0.99%), cash a positive 9.13%, inflation-linked bonds 7.66% and property 14.07%.

What SIM did
During the quarter, we increased our nominal bonds exposure by about 1.1% at levels above 8.5% on the R157, while property exposure was decreased slightly. During the quarter, our holdings of inflation-linked bonds were increased by 3% via selected credit opportunities and the longer-dated R197 (trading at 3% and higher).

SIM Strategy
Although credit is still fairly attractively priced, we are unlikely to see the opportunities of 2009 repeated in 2010. With market valuations becoming cheap, we are likely to increase the fund's nominal bond exposure into market weakness. Property is probably fairly priced, but we remain cautious on the asset class given the weakness in the real economy. The longer-dated R197 is still our preferred stock in the inflation-linked bond market and we will be adding to our position into market weakness.