MARKET REVIEW
The global recession loosened its grip slightly on world financial markets during the second quarter of 2009. Many economic indicators are pointing towards some economic stabilisation - but not yet a full blown recovery. Equity markets recovered strongly, while the US 10-year bond weakened by more than 0.5% on the back of increased risk appetite and a possible inflation threat down the line. On the domestic front, the Reserve Bank surprised many analysts by not cutting interest rates further in June. As a result, the SA yield curve flattened, with money market rates drifting higher post the announcement. Although we saw the rand strengthen significantly over the quarter, the bond market weakened. Sticky inflation and the possibility of the government needing to raise additional funding due to a 2009 revenue shortfall weighed on the bond market. The R157 nominal bond yields traded 0.3% higher for the quarter, with the All Bond Index returning 0.29% during the period. Cash delivered 2.31% and inflation-linked bonds 3.41%. We again saw strong demand for the short-dated R189 inflation-linked bond, while the longer-dated R197 weakened by 0.19%. Property stocks declined 0.88% during the three month period.

ASSET ALLOCATION
After the recent equity market gains, we are now adopting a more cautious approach over the short term. During the past three months, all additional equity exposure was implemented via protected equity structures. This provides investors with some downside protection in a falling market. Over the medium term, however, the opportunity for significant real returns still lies within equities as an asset class. We will add more corporate inflation-linked bonds if real yields are attractive but will make sure we are adequately compensated for credit and liquidity risk. We believe credit markets are presenting us with some attractive opportunities. We view property as slightly expensive given the state of the economy. Nominal bonds have weakened considerably and some value is now emerging for investors and thus we will increase the fund's low duration into further market weakness.

INVESTMENT STRATEGY
Our increase in equity exposure since the beginning of the year paid off during the quarter. We also added additional protected domestic equity exposure to the funds. As mentioned last quarter, we've been adding inflation-linked bond exposure to all our absolute return funds. We've also seen some very attractive opportunities in the primary capital market. Our view is that current credit spreads are providing value to investors - especially some of the inflation-linked bonds that were issued recently. The addition of protected equity and inflation-linked bond exposure were funded from cash. Long-dated money market investments are not offering value at the moment. We didn't change our bond or property exposure over the quarter. We are still somewhat concerned about property valuations given the underlying weak domestic economy.

Market review
The volatility that characterised global equity markets in the second half of 2008 continued into the first quarter of 2009. The MSCI World Free Index was down over 11% for the quarter. Domestic equity markets followed their overseas counterparts and the All Share Index ended the quarter down 4.2%. The market recovered by just over 11% in March after being down over 10% in February. For the quarter the JSE Resources board rose 1.6% while the Industrial and Financial boards were down 9.2% and 7% respectively. International short-term cash and long-bond rates remained at historic low levels on the back of aggressive monetary easing by central banks and continued global risk aversion. Domestic inflation continued its downward trend, albeit at a lower than expected rate. Despite supporting factors like lower inflation etc., the domestic bond market weakened during the quarter. Significant lower inflation was already discounted in the bond market at the end of December 2008 and the weaker bias came as no surprise. The yield on the bellwether R157 nominal bond rose 0.96% over the quarter. The weak bond market is reflected in the All Bond Index having returned -5.1% for the quarter. Cash returned 2.8% and inflation-linked bonds 2.4% for the first 3 months. There was strong demand for inflation-linked bonds in the latter half of the quarter. Property stocks traded roughly flat over the quarter, returning -1.40%.

Asset allocation
After last year's dramatic equity market sell-off, value emerged in local and international equity markets from a long term perspective. Over the quarter we increased our domestic equity exposure, as well as some foreign equity exposure at the margin. Some of the exposure was added via protected equity structures. These structures protect the fund against moderate equity market declines at the expense of full upside participation in market rallies. This was effected in order to fulfill our capital protection mandate. After initially reducing the nominal bond exposure in January this was again increased slightly after the significant bond market correction. We are in the process of adding some inflation-linked bonds to the fund which are currently providing very attractive real returns of approximately 5%. The increase in equities and nominal bonds was at the expense of our cash exposure.

Investment Strategy
Absolute Return funds have two requirements i.e. to produce inflation beating returns over the medium term and to protect capital over any rolling twelve month period. After the 2008 equity market collapse (which is probably a once in 50 year event statistically speaking) the preservation of capital has become the overriding requirement over the short term. But the opportunity over the medium term lies in having exposure to attractively priced equities that will provide high real returns (7% plus). Over the next few months these requirements will be balanced by cautiously taking on some equity exposure. Some of this equity exposure will again be via protected equity structures that will limit losses if the equity market declines further. Currently we estimate our equity market to be about 20% undervalued based on our bottom up analysis. On a price to book basis the market also appears to be attractive and thus we favour equities from a real return perspective over the medium term. We will increase our core inflation-linked bond exposure if further opportunities arise. Cash and nominal bonds are fairly valued, as are property stocks. International equities are also cheap on a number of valuation measures, whereas cash and government bonds appear to be on the expensive side. The strategy over the next few months will be to increase the current low equity position into market weakness. Credit markets are also pricing in a very high rate of company defaults and might provide opportunities over the next few months.

Market review
The FTSE/JSE All Share Index lost -9.2% during another tumultuous fourth quarter, as economic news from developed economies confirmed that the globe was entering recession and emerging market growth indicators continued to deteriorate. Resources (-12.9%) and Financials (-11.4%) led the ALSI down, while Industrials (-4.1%) were relatively unscathed. A clear defensive style-bias emerged looking at cross-sector performance, as non-cyclical sectors outperformed. Global equity markets also had a rough quarter with the S&P500 losing 22.4% and MSCI World falling 21.7% in US dollars. The Federal Reserve lowered the target funds rate from 2% to 'between 0% and 0.25%'. Indicators of a sharply slowing global economy came thick and fast, the stand-out probably being a steep drop in US employment. Official measures to protect the financial sector continued and US automakers also sought public sector support. Meanwhile fiscal policy stepped up a gear in a number of countries. In South Africa, the SARB cut the repo rate by 50 basis points to 11.50% at its MPC meeting in December on easing inflation pressures. Local bonds had a strong quarter returning a healthy 11.3% for the period. Listed property was also a feature, producing 8.5% for the quarter. These returns were in response to a strong belief that the repo rate is likely to be cut meaningfully during 2009.

What we did over the quarter
In general we had a quiet quarter in terms of making any significant changes to the portfolio. Within equities, our belief was not to take big stock bets as the short term outlook and sentiment remains highly problematical. Overall, for the same reasons, our net equity exposure was little changed over the quarter, although more downside protection was introduced. The actions taken during the quarter were mainly confined to fixed income, where some exposure was added but again sold in late December leaving the net exposure in bonds little changed. We added cautiously to our listed property exposure. Our Inflation Linked Bond exposure was unchanged.

Major performance value adders and detractors
The position that added most value over the quarter came from our low weighting to equities relative to what we believe the long-term strategic exposure ought to be. Within equities, our low exposure to resources paid off but our key detractor was that we did not have a large enough holding in the food and retailer sector, which produced a stunning 16.2% return over the quarter. The major detractor of value over the quarter was our relatively low weighting in long bonds. All in all, it was a fair quarter in terms of how the portfolio was structured relative to what returns the main asset class components delivered.

Investment Strategy going forward
We maintain that the ultimate fallout of the US led financial crisis will be a sustained period of below-trend global economic growth for at least the next two to three years and the key question now: Is this correctly priced into the equity markets? There is no doubt that there are pockets of value emerging within the equity markets so the only challenge, given the no-loss capital constraint (making the time horizon much shorter), is when the value will begin to be unlocked.