The local fixed interest market received a boost during the quarter as investors started to anticipate the reduction of interest rates in 2009. The timing of this cut is the centre of much debate with some saying it could come as early as quarter 1 2009. With food and oil prices falling rapidly as a consequence of the intensifying financial crisis and the threat of a global recession it is likely that inflation will fall markedly in 2009. Unfortunately the Rand has weakened significantly as a result of distressed liquidations of equities and it is likely that this may offset the positive benefits of lower global inflation. This being the case then the Reserve Bank may only cut rates later in the year when the Rand and the global financial system is expected to be stable. But for now, fixed interest assets are being regarded as a default safe haven for diversified investors. The ALBI 1 - 3 year Index benchmark produced a 6.7% return for the quarter. While the Portfolio lagged marginally over this period, over longer periods it has outperformed after taking into account Portfolio management fees.

Both managers underperformed the benchmark for the quarter due to their less aggressive duration positioning in a rallying market. Clearly this positioning has helped over the past 12 months and in this regard African Harvest has produced the superior results. This Portfolio is currently well insulated from the global market turmoil through a larger than usual exposure to money market assets and should continue to produce solid results as global risk aversion increases.

The market was pleasantly surprised by the delivery of only a 0.5% interest rate hike in June as the expectation had been created for a 1% hike. This was unfortunately not enough to protect the 1-3 year area of the bond market from loss during the quarter, and a 1.3% drop in the benchmark was experienced. The Portfolio was however marginally down thanks to a strong performance from STANLIBAM in particular, which benefited from a large exposure to near cash and lower exposure at the long end. Both managers beat the benchmark for the quarter, as did the Portfolio and over the past12 months the Fund out performed by around 1% which was pleasing.

Global inflation has become the new buzz word with many central banks having to raise rates to protect against it spiralling out of control. In their defence, the SARB has been raising rates since mid 2006, but this is now starting to severely impact the SA consumer, who accounts for around 40% of economic activity. Inflation is growing faster than wages resulting in a slowdown in disposable income growth and a contraction in spending. The upshot of this is that GDP growth may slow. This may encourage the SARB to lower rates early in 2009 (an election year) as general base effects and the re-weighting of the inflation basket, in favour of services at the expense of food, positively impact the inflation outlook for January 2009. Whilst it is likely that the SARB raises rates by a further 0.5% in August we would see this as the peak and the anticipation of lower rates in 2009 could positively drive returns from the income market in the4th quarter of 2008.

There were no rate hikes in the first quarter of 2008 as the MPC reflected on the impact of the four 0.5% hikes in 2007 and the unfolding global credit crisis which claimed Bear Sterns as its biggest victim to date. Although relatively insulated SA firms suffered under the poor sentiment and consequently SA corporate bonds (-5.6%) underperformed Government bonds (-1.5%) by a significantly wide margin. Long bond yields rose sharply. Shorter dated income assets faired better with the benchmark basket of 1 - 3 year bonds returning +1.6% for the quarter. Nett of fees the Portfolio marginally underperformed the benchmark over this period but pleasingly outperformed over the past 12 months.

Pleasingly both managers outperformed benchmark with surprisingly similar returns given that their portfolios are structured fairly differently from a duration and exposure to credit perspective. Post quarter end the MPC re-continued the process of raising interest rates confirming that it was serious in the fight against inflation, which registered 9.4% in February. Admittedly some of this is from the effects of higher wage settlements, but with economic growth under threat as the consumer takes increasing strain under the pressure of higher interest rates, food and energy prices, it will be interesting to see the next move from the Reserve Bank in trying to control a problem that is largely out of their control!