Market review
In 2012, the financial markets survived, among other events, the potential breakup of the European Union and the looming 'fiscal cliff' in the US. Equity markets began the year on a strong note but the Italian election results and the Cyprus banking crisis reminded investors that we are not out of the woods yet. Although general economic data out of the US was generally positive, we did see some softer employment data towards the latter part of the first quarter. The general feeling (also reflected in stock markets) was that the global recovery, especially in the US, is gaining traction. With central banks reiterating their accommodative monetary policy stances during the quarter, a normalisation in global interest rates is still many quarters away. The rand weakened significantly during the quarter, losing more than 70c to end at R9.23 to the dollar. On balance, inflation surprised to the upside, with a breach of the upper inflation target band of 6% a certainty. Currently the Reserve Bank Monetary Policy Committee (MPC) is still concerned about the anemic domestic growth outlook and favours an accommodative monetary policy, not unlike most other central banks in the world at this point. The SA bond market is still receiving robust foreign portfolio inflows, although not at the same pace as last year. The 10-year SA government bond yield increased slightly during the quarter from 6.76% to 6.91%. Inflation-linked bond (ILB) yields were mixed, with the R197 yields slipping from 0.91% to 0.77%. The All Bond Index returned 0.97%, inflation-linked bonds 1.84%, while cash yielded 1.25% for the quarter. Property stocks gained an impressive 9.1% for the quarter. The FTSE/JSE Shareholder Weighted Index (SWIX) delivered a return of 1.6% for the quarter. Looking offshore, developed markets, as represented by the MSCI Developed Market Index, rose 7.9% during the quarter in dollar terms, while emerging market returns, as per the MSCI Emerging Market Index, were fairly dismal, declining by 1.6% from the December close.

Asset allocation
At the end of March, the absolute return portfolios had significant maturities of inflation-linked bonds. During 2009 and 2010, corporates and banks issued significant amounts of inflationlinked bonds at very attractive levels (from 4% real and higher). Due to these maturities, our inflation-linked component reduced at the end of the quarter. We increased our nominal bond exposure slightly by buying long-dated nominal bonds and also added some credit .The SA yield curve is quite steep, with yields of 8%-plus on offer at the long-end of the yield curve. We feel we are being compensated for the inflation and issuance risk at the 20-year point compared to the 10-year area, which is trading well below 7%. During the quarter, we rolled some of our maturing derivative overlays, while at the same time increasing our overall hedging of domestic equity by a few percent. Domestic equities still appear marginally expensive from a bottom-up perspective, especially industrial shares. However, equities still remain our preferred asset class from a real return perspective. For funds with offshore exposure, we increased the offshore property further. We believe diversified overseas property is attractive compared to our domestic listed property market, which is trading at a yield of 6%. Strong performances from offshore equity markets and a weaker rand led to slightly higher foreign equity exposures for all portfolios.

Investment strategy
We reiterate the stance we have held for the past couple of quarters, namely nominal and inflation-linked bonds are expensive from a longer-term perspective. A premium is being paid for instruments delivering the certainty that capital will be safe and cash flows secure. Our focus in the fixed income component remains one of yield enhancement in the current accommodative policy environment, without taking on excessive duration risk. At the time of writing this report, the SA equity market retreated from its record highs and is trading close to our assessment of its fair intrinsic value. We believe equities, and especially international equities, offer the best source of real returns going forward. This must also be seen against the backdrop of unattractive valuations of fixed income assets in general. Hedged equity will remain part of the Fund's strategy going forward, with the aim of delivering attractive risk-adjusted returns and meeting our long-term targets.

Equities
The FTSE/JSE Shareholder Weighted Index (SWIX) delivered a return of 1.6% for the quarter. In terms of sector performance, SA industrials outperformed, gaining 6.3% for the three month period. Financials fared well too, posting a return of 5.9%, while the resource sector, beset by continued strike action and weaker commodity prices, ended the quarter 6% lower than its December close. Defensives, such as beverages (24%), forestry and paper (24%) and tobacco (19%), outperformed, buoyed by the weak rand. SIM's houseview fund outperformed the SWIX handsomely during the quarter, returning 4% versus the 1.6% delivered by the SWIX. The 2.4% outperformance during the quarter more than offset the portfolio's underperformance during 2012, with the portfolio outperforming by 1.4% for the 12 months to end-March 2013. Industrial counters were the biggest contributors to the house portfolio's outperformance at 1.8%. Within industrials, most benefit was had from the underweight position in clothing retailers and overweight positions in diversified industrials. The resource sector underperformed the SWIX by 7.6% during the quarter. However, good stock picking within the gold and platinum sectors and an underweight position in iron ore miners resulted in resource stocks outperforming by 0.5%.

SIM equity strategy
The JSE ALSI Index is trading on a forward PE of just above 13x, which is above its long-term average. We expect earnings growth of around 20% over the next 12 months. Of the main sectors, industrials, trading at a forward PE of 15 times, is most overvalued. In our houseview portfolio, we continue to favour exposure to the diversified miners (Billiton and Anglo American) versus the bulk miners (Kumba, Exxaro and African Rainbow Minerals). The latter remain overvalued, given the high prices and better profitability enjoyed by iron ore miners. Within industrials, we maintain overweight positions in SA Breweries, British American Tobacco and Bidvest. These businesses are defensive and stand to benefit further from rand weakness.

Equity outlook
From a long-term perspective and based on a price-to-intrinsic valuation method, SA equities appear fairly valued to slightly overvalued, with the industrial sector contributing most to the overvaluation. In summing up the individual company valuations, as calculated by our equity analysts, the market appears to be about 10% overvalued if we assume a required real return of around 7%. Despite this, the prospective real return on offer from equities is still attractive when compared to the other local asset classes. For our product suite, where capital protection is an allimportant goal, our use of hedged equity allows us the opportunity to participate in the equity upside, while still protecting capital on the downside.

International
In the US, bullish investor sentiment, buoyed by a combination of slightly better-than-expected housing and employment data, as well as Federal Reserve support for a continuation of its quantitative easing (QE) programme saw equity markets rally to new all-time highs. Euro-zone markets did not fare as well, as debt tensions resurfaced and economic data remained soft. In China, data for fourth quarter GDP growth came in higher than expected. Looking to performance in dollar terms, developed markets, as represented by the MSCI Developed Market Index, rose an impressive 7.9% during the quarter, while emerging market returns, as per the MSCI Emerging Market Index, were fairly dismal, declining by 1.6% from the December close. Global bonds, as measured by the Barclays Capital Aggregate Bond Index, declined 2.1% in dollar terms quarter-on-quarter. The rand was the worst performing currency among emerging market peers, ending the quarter at R9.23 to the US dollar from its R8.48 level just three months earlier. Despite the rand trading slightly weaker than purchasing power parity levels, which we estimate to be around R8.75 to the US dollar, we believe that selected global equity markets and listed property markets are considerably cheaper than the SA market. Global equity markets, in particular the European and UK markets, are trading well below their long-run averages on a range of valuation measures. On the international property side, global property companies remain well below their long-term average on a price-to-cash flow basis. Our international property holdings have an average dividend yield of about 6%, which is attractive compared to the 6% dividend yield offered by SA listed property.

Bonds
The rand weakened significantly during the quarter, losing more than 70c to end at R9.23 to the dollar. Currently the Reserve Bank Monetary Policy Committee (MPC) is still concerned about the anemic domestic growth outlook and favours an accommodative monetary policy, not unlike most other central banks in the world at this point. The SA bond market is still receiving robust foreign portfolio inflows, although not at the same pace as last year. The 10-year inflows, although not at the same pace as last year. The 10-year SA government bond yield increased slightly during the quarter from 6.76% to 6.91%. The All Bond Index returned 0.97%, inflation-linked bonds 1.84%, while cash yielded 1.25% for the quarter. The SA yield curve remains very steep and is discounting increased Treasury bond issuance over the medium term. At the end of March, the yield difference between R186 (2026) and R157 (2015) was 1.9%. Nominal bonds are expensive given our required yield of about 7.25% from the 10-year bond. The longer-end of the yield curve shows relative value compared to the shorter end of the curve. We did increase our nominal bond exposure slightly by buying long-dated nominal bonds. The SA yield curve is quite steep, with yields of 8% plus on offer at the long-end of the yield curve. We feel we are being compensated for the inflation and issuance risk at the 20-year point compared to the 10-year area, which is trading well below 7%.