In the first quarter of this year we ended the report with a comment that value remains in the eye of the beholder. Different interpretations of returns allow active managers to earn their keep. Value, generally, takes time to unwind. Sometimes irrational behavior takes years to unwind (i.e. the technology bubble) and other times (especially with cyclical sectors i.e. commodities) the correction is swift and nasty.

For the past few quarters we have made the following references:

Equity market returns need to moderate.

We have spoken, at length, of the extent of the commodity cycle and the risk attached to a normalization of returns; especially when more than 50% of commodity consumption takes place within the developed economies.

We believed that the financial and industrial (FINDI) shares offered greater relative value (versus resources) notwithstanding the risk of moderation in our local FINDI shares as well.

We have also mentioned that we will continue the search for value.

It is uncanny how dramatically the world has "changed" within the space of three months. In the six months ending June2008, the resources sector had outperformed the FINDI by 56.6%. Within three months this changed and at the time of writing, the FINDI has now outperformed the RESI by a remarkable12.6% year to date.

Might we remind ourselves again, commodity shares are cyclical. Economics drives returns. Excess prices and margins eventually get eroded away and some form of reversion to the mean takes place. The credit crises, the corporate failures and the bailout packages have been well documented. I won't repeat what you've already read. What we need to highlight though is that when credit becomes scarce, individuals and companies are unable to raise sufficient capital to fund their working capital and capital expenditure needs. This puts the brakes on growth, it leads to a focus on cost cutting, which means retrenchments, unemployment, slower consumption expenditure and ultimately it leads to a recession-but we think a major part of this is being priced into the market already.

The outlook remains tough. The strong growth in corporate profits both locally and internationally are moderating as we speak. Share prices are following this trend (downwards). But, with the All Share Index (ALSI) down almost 36% from its peak, valuations are looking more palatable (historic dividend yields are approaching 5% and Price to Earnings multiples for the ALSI are back in single digits). Our view is that good opportunities will present themselves during the next few months.

Reflecting back on 2007, the major events that affected markets were the following:

o China's continued growth.
o Emerging economies generally outperforming developed economies.
o The oil price steadily approaching $100.
o The threat of inflation (high oil and food prices).
o And finally, the well publicised sub-prime credit crises and the threat that it poses to global growth (US).

So what holds for the year ahead? We think it is fair to assume that 2008 is likely to be a more challenging year in terms of expected returns from equities globally and locally. What we have witnessed during 2007 was a confluence of forces working together, namely low interest and inflation rates, strong GDP growth, high infrastructural and consumer spend, which all lead to exceptional earnings growth and therefore great returns from stock markets.
We believe it is difficult to predict returns for markets generally. We're much better at evaluating companies and determining whether the companies that we're invested in offer good medium to long term return prospects. Our pragmatic value investment philosophy simply means that we focus on acquiring more than what we're paying for. We remain focused on our investment style and philosophy and believe that by avoiding overvalued assets we will generate long term wealth for our clients.

We were correct last year to be cautious on interest rates and inflation given the pressures that were evident within the economy. We took a cautious view on the more cyclical consumer retailers and this paid off. We were also more positive on companies exposed to the gross fixed capital formation cycle - this too was correct and also the most significant contributor to the fund's performance.

However, we have been too early with our view of a slowdown in the commodity cycle. We did, however, point to the risks of a global developed economy slowdown and expressed the view that the commodity cycle, generally, was at an "inflection point". We will see how this plays itself out in the current year.

So what does 2008 hold for us? As we cautioned last year, we reiterate the view that investors should have more moderate return expectations. It is going to become more difficult to generate real returns off this base. Good stock picking should, however, protect our investors returns.