Market review
Investors gave a collective sigh of relief during a robust first quarter of 2012. Equity markets posted very good returns and markets generally seem to have stabilised somewhat, with market volatility definitely lower over the past few months. This was on the back of generally improved economic data from the US and perceptions that the European sovereign debt crisis was waning. The US 10-year Treasury bond weakened from 1.88% to 2.21% - a broad indicator of the return to a 'risk-on' market. However, the mountains of sovereign debt have not gone away and the austerity measures are still in place. It will be interesting to see how global economies, particularly in Europe, will fare for the rest of the year. On the domestic front, inflation continues to hover above the 6% level, while the rand made up some lost ground, closing the quarter at R7.66 to the dollar from R8.07 previously.

As mentioned, equities posted very good returns. The FTSE/JSE Shareholder Weighted All Share Index (SWIX) moved ahead 7.5% during the quarter. In dollar terms, the Index returned 11.8%, while the MSCI World Index returned 11.7% and MSCI Emerging Markets Index 14.1%. In fact, global equities had the best first quarter since 1998. The SA bond market again experienced significant offshore portfolio inflows, which supported yields during January. During the quarter, the 10-year RSA bond yield decreased from 8.08% to 8.01%. The All Bond Index returned 2.4%, inflation-linked bonds 2.7%, while cash yielded 1.4% for the period. Inflation-linked bond yields declined again during the quarter, with the R197 ending the quarter at a yield of 1.97%. Property stocks gained an impressive 8.0% for the quarter. The global search for yield is still very much with us.

What SIM did
At the end of January, we took advantage of the opportunity to reduce our exposure to R186 nominal government bonds at levels below 8.2% after foreigners made some aggressive domestic bond purchases during the month. We did, however, get an opportunity late in the quarter to again add cautiously to our R186s at yields above 8.5%. At current levels, we see inflationlinked bonds as being marginally expensive and therefore reduced the fund's exposure somewhat. Most inflation-linked bonds are now trading at record low real yield levels. Money market yields were enhanced by the ongoing investment into longer-dated floating rate bank paper. Our overall equity exposure stayed largely unchanged for the quarter. Over half the Fund's domestic equity exposure is still hedged. We maintain that this approach is prudent in the current environment. For funds with offshore exposure, we increased our foreign exposure during the quarter. This increase in exposure was channeled into foreign equity. At the same time we reduced our domestic equity exposure by a similar margin. We see more value in offshore equities - especially compared with domestic industrial stocks, which look expensive at the moment.

Investment strategy
As we pointed out to investors last quarter, none of the fixed income asset class are cheap from a long-term perspective. We will continue to enhance yield (especially cash) in the current environment. The Fund's money market component is outperforming STEFI significantly and we should be able to maintain this for the rest of the year. From a valuation perspective, we prefer nominal bonds to inflation-linked bonds but we will, however, maintain our core holding of short-dated we will, however, maintain our core holding of short-dated inflation-linked bonds for the Absolute Return funds. Compared to other asset classes, equities still offer the most value from a bottom-up and longer-term perspective. Equities are trading close to our assessment of fair value. We still have a significant portion of the Fund's equities hedged for adverse market movements. We will continue to look for an opportunity to add further hedged equity to the portfolio.

Market review
Equity markets made back all of the performance given up during the volatile third quarter. The FTSE/JSE All Share Index (ALSI) gained 8.4% in rands for the quarter, Resources 7.3%, Industrials 9.2%, with Financials gaining 8.7%. The MSCI World Index advanced by 7.7% in dollars, outperforming the MSCI Emerging Market Index, which managed generate a positive 4.4% for the quarter. The All Bond Index returned 3.5% for the quarter, with inflation-linked bonds (ILBs) the best performing asset class at 4.5%. Cash returned 1.4% and property a respectable 3.7% for the quarter. For the year as a whole, ILBs were the best performing fixed interest asset class at 13.05%, with nominal bonds delivering 8.8% and cash 5.7%.

What SIM did
During the quarter, we cautiously started adding nominal bonds when yields exceeded 8.6% on the R186. Market reaction to rising inflation saw ILB yields decline to below 2.3% and we used this opportunity to reduce the Fund's ILB exposure. We still like the defensive and diversification properties of ILBs and will continue to hold some exposure to them. At current levels, we see ILB's as being marginally expensive. The fund's property exposure was largely unchanged from the previous quarter. During the third quarter we added hedged equity to the funds. Given the strong gains of the fourth quarter, hedged equity had less upside gains left, which resulted in a lower effective equity exposure. On a net basis, equity exposure therefore declined during the quarter. On the international front, we increased our international property exposure further via high yielding, diversified, large capitalisation stocks.

By the end of the fourth quarter, the JSE ALSI Index was trading on a forward PE of close to 11x, in line with its long-term average level. We expect earnings growth of slightly below 20%, driven by resilient Findi earnings growth, this year. On a sectoral basis, resources are on a forward PE of 8x. While we are less optimistic about the earnings growth prospects for stocks in this sector, resources are already discounting a pretty dire macroeconomic scenario in China and in Europe. The rand's sharp depreciation is likely to benefit those companies with rand cost bases and that earn revenues in hard currency. We believe this has not been fully discounted in resource share prices, where investors are still relatively bearish. At SIM, our investment process is geared to valuing businesses through the cycle and this allows us to pick up great opportunities when economic conditions look bleak. One such example last year was Old Mutual Plc - our biggest financial exposure and one of the best performing financial stocks in 2011, delivering a total return of 37%. The announcement that it intends to sell its non- UK Skandia businesses should lead to a further re-rating in the stock and the potential return of surplus capital by means of a special dividend.

SIM strategy
From a long-term perspective, we believe the stock market is now trading close to its fair intrinsic value. During the past year, investing in SA equities has proven especially difficult given the extreme levels of volatility and negative sentiment, which caused the downdraft in the third quarter. We believe that given the global macro backdrop, volatility could well remain at elevated levels. Our strategy is therefore to continue adding undervalued levels. Our strategy is therefore to continue adding undervalued and unloved quality assets to our portfolio as we exploit valuation discrepancies in a cautious, disciplined manner.