International equity markets responded to the $15 drop in oil prices by steadily climbing throughout the quarter.The Eurozone showed firm performance despite two rate hikes of 0.25%, which have brought the repo rate to its highest level since 2002. Growth in the region remains firm and forecasts for 2006 have been revised upwards from 2.2% to 2.7%. In the UK interest rates were unexpectedly increased by 0.25%. This was the first increase since mid-2004 and has brought the base rate to 4.75%. This unexpected rate hike and the gearing of its market to the oil sector impacted on the performance of the UK market, resulting in more muted returns relative to the Eurozone. Returns were generally positive within the region and, given the weaker SA exchange rate, local investors with foreign equity holdings fared better offshore than at home.

Within the fund we continued to prefer the Eurozone relative to the UK. We also concentrated our Eurozone exposure towards large-cap stocks by selling out of the Fidelity Germany Fund into the Fidelity Euro Blue Chip Fund. The fund remains fairly heavily invested.

The key risks to this region include a renewed build-up of inflationary fears and a significant economic slowdown as opposed to the hoped-for soft landing. We remain positive on the region as a whole, with a continued preference for the Eurozone at present.

Global financial markets were characterised by volatility, tightening liquidity and a flight to quality throughout the second quarter of 2006. This was in reaction to fears about rising inflation and interest rates, as well as a possible hard landing for the US economy.

The swing in sentiment was largely lead by growing concerns that the Fed would continue hiking rates beyond the 5.25% level. The ECB raised rates by another 0.25% in June as inflationary concerns dominated in line with still high oil prices. Synchronised global tightening shifted concerns from inflation to growth, thus negatively impacting on equities.

In general Europe was one of the best-performing regions in dollar terms for the second quarter of 2006, with 9 of the 20 best-performing global equity indices located in Europe. Eastern Europe performed particularly well, with Slovenia, Croatia, Bulgaria and Russia all within the top ten performers. The Russian Index lost 25.3% in dollar terms during May, but still managed to end the quarter 3% up. The FTSE 100, DAX and CAC indices reached 3-year highs in May but all ended the quarter in the red in local currency terms. During the quarter the dollar weakened by 5.1% against the euro and as a result these indices ended the quarter in positive territory in dollar terms.

We actively reduced our overweight exposure to Germany during the quarter towards a more neutral regional allocation because of sluggish consumer spending and the German recovery being too dependent on foreign demand. Moreover, business confidence in France and Italy, which has been lagging Germany, has begun to catch up. Given the positive expectations for growth and market performance in the Eurozone for 2006, we elect to maintain a full weighting in the UK market, a position which reflects a slightly more defensive stance given the structure of that market. Recent market movements have seen large caps keeping up with small caps. The fund still has a high exposure to blue-chip stocks, in line with our view of this trend continuing.

While we expect a more volatile outlook for earnings and the equity market, at this stage we would caution on turning too bearish but rather to see the recent pullback as a sign of a maturing bull market. Although the economic momentum in Europe remains positive, the ECB has indicated a less aggressive approach to monetary tightening in comparison to the Fed. This shift in interest rate differential expectations between the US and Europe could reduce the future attractiveness of the euro as a currency relative to the US dollar.

Despite a more volatile start to the year, world equity markets ended the quarter on a positive note, with several indices reaching five-year highs (such as the US and UK markets). Developed markets, while still outshone by emerging equity markets in general, delivered a solid performance. European equity markets were very strong during the first quarter, driven by significant M&A activity that has kept the market well supported. Macro-economic indicators showed signs of improvement during the period, leading to a lacklustre performance from European bond markets. The ECB also signalled its intention to keep inflation contained with a 0.25% interest rate increase during the quarter. The German equity market reached an all-time high in March. During 2005 exposure to the German market was increased in this fund.

This took place against a backdrop of continued growth in corporate profits, a higher oil price and surging precious metal prices. Other commodities, notably the softer ones such as agricultural commodities, put in a more muted performance, moving sideways throughout the quarter, while base-metal prices soared. Softer commodities have however started the second quarter on a more positive note.

Given the possibly overly positive expectations for growth and market performance in the Eurozone for 2006, we choose to maintain a full weighting in the UK market, a position which reflects a slightly more defensive stance.

After a welcome retreat in the early part of the fourth quarter, global equity markets continued their positive trend throughout the rest of the year. Investors continued to direct funds towards areas perceived to offer better growth prospects. As a result, emerging markets continued to outperform developed markets, a trend now in place for over four years. The Morgan Stanley Emerging Markets Free Index out-performed the general global index by nearly 4% over the quarter. Among developed markets Japan continued to perform well. The Nikkei Dow Index was up 13% (in US$) over the quarter, almost 10% more than world markets in general.

The political problems of Euroland appear to have less and less impact on the performance of companies within the area. Many of these operate on a global basis and have adapted well to the difficulties in their own countries, evidenced by the steady rise in corporate earnings. In addition, the opening up of Eastern Europe has provided companies with more flexibility as far as outsourcing and the cheaper sources of labour are concerned.

The strength of the dollar in 2005 surprised many investors. The consensus view is that the greenback will depreciate once interest rates in the US have peaked. Unfortunately, consensus is rarely proved right in financial markets. It is likely that the lack of a credible alternative to the dollar has assisted the rally in the gold price in 2005. To conclude, we see a positive outlook for world growth and reasonable value in European markets given the current level of interest rates.