After the tough second quarter our portfolios rebounded more in line with what typically could have been expected and has fortunately recovered all that was lost during May and June. The feature of the 3rd quarter was the weak rand which depreciated by 7.6% against the US$ and 8.9% and 7.7% against the UK and the € respectively. The interesting feature was that the interest rate sensitive areas of our market, including bonds, held up relatively well over the period. This was most likely due to the fact these sectors were severely sold down during May and June and the 3rd quarter was more a catch up. In addition, all the currency variables and indicators point to a sentiment issue driving the rand rather than any fundamental issue. The shape of the yield curve also suggests that the rand will be stronger rather than weaker in 12 months time.

Equity exposure remained low due to the many short term risks that are still abound. These risks are predominantly caused by the currency sell off. At quarter end we were still below our strategic equity allocation. Some exposure to equities, however, was added towards the end of the quarter. The main feature for us during the quarter was the introduction of a reshaping program in the broad equity theme. Since May 2003 to May 2006, South Africa has experienced a sweet spot in terms of the broad macro economic drivers. The most important being disinflation, an appreciating rand and of course lower real and nominal interest rates. Basically, all of the SA equity market shares benefited from this benign environment particularly those that were plugged into the local economy. However, with the change in the trend of the Rand this favorable environment is busy changing to a much tougher one with interest rates set to rise by at least another 100 points with a distinct risk of further increases. Note that another 100 points is well discounted in both the equity and bond markets but more than that will unfortunately introduce a further bout of downside volatility. This is, essentially, why we remain cautious with respect to our equity exposure.

We added a bit of bond exposure during the quarter in the middle dated credit area. But fundamentally we remain cautious for the reasons outlined above. Over the quarter, the All Bond Index produced a positive one returning 2.1% against cash of 1.9%. Note that for the first 9 months of the year (year to date) bonds have been slightly negative producing - 0.1% versus cash of 5.6%. Our negative view on bonds has paid off so far. We made our first meaningful investment in inflation linked bonds for a long time. The instrument is a 5 year credit bond (First Rand Bank) with a 40 point spread over the equivalent Treasury. This gives a real yield of 3% and together with the high inflation carry expected, we anticipate that this bond will outperform cash over the forecast period.Given that the distribution in listed properties is set to remain around the 10% level over the forecast period we decided to start adding, cautiously, some exposure to this asset class. This was made even more compelling as this sector had a severe correction during the previous quarter and now offers fair value relative to cash.In conclusion we are happy with our defensive stance at present from as asset allocation point of view. We have begun to shift the focus of the equity stock picks to reflect the change in the overall macro environment. Finally, if the rand stabilizes, the markets should start to factor in a different but solid set of economic variables and we should end the year close to our respective upside targets.

This quarter proved to be an exceptionally tough one for our portfolios. May and June was an extraordinary period with respect to our portfolios as the equity component detracted value largely from a sector point of view. It was the worst two months since inception of these funds in 2001 and we believe it was due to a market aberration rather than any flaw in our approach to their management.

Equity exposure was trimmed in April and then again in mid May which in total came to a reduction of over 6%. Note that the total equity exposure reduction since the beginning of the year now amounts to just over 10%. We are now running well below what we think is the optimal strategic exposure to equities. As has being mentioned often before in our quarterly reports that the equity exposure has been generally confined to the Domestic Financial and Industrial sectors due to the relative consistency and reliability of future earnings and dividend growth. Over the quarter the Financial & Industrial sector declined by -5.6% while the Resource sector actually went up by 21.3%. Therefore over the three month period there was a 26.9% difference in the performance of these two sectors! Over the quarter, our negligible exposure to long bonds paid off as the All Bond Index produced one of it worst quarterly returns producing a negative -3.6%. However, this is an area that we are increasingly focusing on to try and extract real returns, so it is likely that we may start adding to our nominal bond positions on any further weakness. Quoted property was the big loser over the quarter declining by -22.3% but fortunately the fund's exposure to this asset class remained very low. The funds large cash holding, while not producing great positive returns, proved to a very important stabilizing influence to the portfolio as a whole. In summary, we were pleased with the overall asset allocation strategy of the fund over the quarter but, essentially, it was all to do with having only Financial & Industrial exposure in the equity portion of the fund that contributed to the quarter's poor return. Going forward we are concerned about the uncertainty of where short term interest rates are heading which will undoubtedly put pressure on bond yields and interest rate sensitive domestic shares. Our Fund is well positioned from an asset allocation point of view being low in equities; viz 21% and virtually having no exposure to the long bond area in addition to being low in quoted property. Within equities, however, our zero exposure to rand "geared" shares, i.e. resources, is potentially a problem which we are currently addressing.In conclusion, despite the disappointing absolute quarterly performance we remain confident that we can achieve our dual objectives of not losing capital over a rolling 12 month period and to achieve our upside objective over a rolling 36 month period. However, it is worth stressing, that on a short term, month to month basis, we can experience negative drawdowns when there are widespread sell offs.

We are pleased to report, once again, a very solid quarterly performance to start the new year on a positive note. The fund achieved both of its objectives, of not losing capital in the short term and achieving its upside target over the medium term, both over the quarter and over the past 12 months.

The main driver of performance came from asset allocation as we were not "seduced" into buying more equity exposure in January. Our stock picks, as usual, were predominantly confined to industrial and financial shares. However, we caution that there might well be a short term correction ahead in equities as price momentum is now running well ahead of forecast earnings momentum. As a consequence we are likely to sit tight as far as our equity exposure is concerned. Our exposure to equities was reduced by just under 3% during the quarter.

Over the quarter, our low exposure to bonds paid off as the All Bond Index under-performed cash over this period. This is an area that we are increasingly focusing on to try and extract maximum returns, so it is likely that we may start adding to our nominal bond positions on any weakness. Our bond exposure was reduced by 2% during the quarter. Inflation linked bonds, in our opinion, continue to look extremely expensive, especially when viewed against cash, nominal bonds and interestingly, equivalent US securities. We will continue to avoid this asset class.

Quoted property was the big winner over the quarter but regrettably the fund's exposure to this asset class remains low. In hindsight, this has been a mistake as we under-estimated the interest rate cycle and the distribution growth. We added a bit more exposure during the quarter upping our holdings by about one percent.

In summary, we have stressed-tested our portfolio to various corrections or negative return scenarios and we are satisfied that we have a sufficiently diversified and defensive portfolio in place. As an example, from the end of the first quarter to the end of calendar 2006, the Financial and Industrial Index has to fall by 31% in order for the portfolio to suffer a capital loss. We think that downside protection is sufficient.

As mentioned in our first two quarterlies of this year, our philosophy of stock picking within the absolute return environment naturally steers us away from the more unpredictable and volatile resource sector. This is because the biggest price driver of resource shares is the future rand price of the underlying commodities which is, in general, always uncertain. From a relative perspective, our blue chip Financial and Industrials offers far more certainty and visibility in key variables such as future growth in earnings, dividends and cash flows.

We ended the quarter with roughly the same net exposure to equities as at the end of the previous quarter but during the period we were significantly higher. Our main strategy to reduce our equity exposure was to buy a put option on the Financial & Industrial Index. If this index falls from the current levels by approximately 8% over the next year then our exposure will decrease by 12% which would result in a comfortably defensive position.

Bonds were the laggard this quarter with the All Bond Index producing a modest return. On a year to date basis, cash and bonds have delivered the same total return. The major change on the fixed income side this quarter was the impact of the higher than expected petrol prices together with a rising base effect has resulted in a change in short term inflationary expectations. The bond yield curve continues to flatten implying that the long end is optimistic that the rise in inflation is of a transitionary nature. Our view is that the shape of the yield curve is positive for the bond market and we will use any weakness to add selectively to the longer end of the curve.

Our future strategy will be based on our tried and tested philosophy of trying to balance the portfolio in terms of its dual objectives of not losing money in the short term while achieving the upside target. It is becoming more apparent that certain equities in the non-resource area are offering compelling value with respect to the cash alternative, particularly when viewed on an after tax basis. We see this as an opportunity to add selectively to our equity exposure. Within the fixed income area we are likely to accumulate bonds on any weakness.