The MPC cut the Repo rate by 0.5% in August, but opted to leave it unchanged at the September meeting. Inflation has moderated somewhat from the 12% peak seen in August 2008 thanks to a stronger Rand and lower oil and food prices. Whilst this is positive for the economy in general, the MPC is obviously cognisant of the fact that rates have been cut by 500bps since December 2009 and the impact of this is yet to be felt on the economy. With the global economy recovering and inflationary expectations rising, thanks to higher wage settlements and recent administered price increases, we suspect that the MPC will keep rates on hold for the rest of the year, in line with current consensus. Bonds (+3%) posted modest gains for the quarter, whilst income assets (+1.9%) and cash (+1.9%) lagged somewhat relative to other more economically sensitive assets. The Portfolio marginally outperformed its benchmark for the quarter. In spite of marginally lagging the benchmark for the full year, the Fund was ranked 3/13 amongst its peers, with a return of 11.1%.

Both mandates outperformed the benchmark for the quarter. In combination the Portfolio was significantly underweight duration relative to the benchmark, implying that stock selection was a strong contributor to alpha during the quarter. Relative to peers however, this was a drag as the market rewarded longer dated assets over the quarter. Over the past 12 months, African Harvests' near 10% exposure to the 3-7 year bucket contributed to its outperformance. Structurally, there are only two bonds left in the 1-3 year income benchmark and this complicates portfolio construction for the underlying managers. As a result they tend to focus principally on the generation of yield relative to cash. Flexibility across the curve is therefore vital in generating superior returns and protecting capital. We suspect that the Portfolio is well placed to deliver both in the next 12 months.

The Monetary Policy Committee (MPC) cut interest rates twice in 1 % increments during the quarter however elected not to cut rates at their June meeting. In spite of lower rates, bond yields actually rose during the quarter, partially in sympathy with global bond yields, but also on the expectation of a massive issuance of government bonds to fund the growing tax revenue shortfall. Short dated income assets however managed to produce a positive return for the quarter (+1.39%), with the long end of the fixed interest curve absorbing most of the pressure. Domestic inflation continued to fall at a far slower rate compared to global inflation, registering 8% y-o-y in May 2009. Thanks to strong outperformance in May and June the Portfolio outperformed its benchmark during the quarter. In spite of underperforming the benchmark over the past year the Portfolio was ranked 2 /13 with a return of 15.4%.

African Harvest is currently managing two mandates for the Portfolio, a standard income mandate and an illiquid component inherited from a previous manager. This component houses 10 or so short dated income assets that, although illiquid, provide a significant yield kicker to the Portfolio relative to the other assets in the Portfolio. On maturity of these assets, the Portfolio will be cash flush thereby providing us with the opportunity of seeding the new manager. Although not ideal, the situation is being monitored closely to ensure the best outcome for the Portfolio's investors. Interestingly, both mandates produced the same return for the quarter.

PPI has fallen fast whilst CPI has lagged and as such the MPC elected not to cut rates at its June meeting. We feel this to be prudent of the MPC, but we will be watching their next move with interest. The appointment of Gill Marcus to succeed Tito Mboweni may also cast a new dynamic on monetary policy that warrants close monitoring. Should this just be a pause in the cutting cycle then, with yields now higher than in January 2009, this would be an attractive entry point into the income asset class. Assuming however that this is the bottom of the cycle then it is likely that returns from income will be more muted.

The local fixed interest markets lost their momentum in the 1st quarter. This was largely driven by the fact that lower inflation and interest rate expectations had already been priced in by the market during the tail end of 2008. Bonds lost 5.1% over the quarter, while shorter dated income assets gained 2.3% as the yield curve steepened. Nonetheless, they still underperformed cash (+2.6%).

The Portfolio outperformed the benchmark by 0.1% and the peer average by 0.2% for the quarter, ranking 6/13 with a return of 13.2%. Manager analysis, portfolio construction and stress testing continue to be an on going function of our investment process. Subsequent to conducting an in-depth portfolio analysis and review of the sector, the STANLIB AM mandate was terminated, with assets flowing to Cadiz African Harvest and another specialist income manger who we will profile in the next quarter's communication.

In line with Central banks around the world, the South African Reserve Bank implemented two 100 basis point rate cuts in February and March. The reductions in interest rates were attributed to an improving domestic inflation outlook as well as to a rapidly slowing domestic economy in a cyclical domestic downturn in addition to the impact of the global economic crisis. The South African Reserve Bank has also changed their monetary policy meeting schedule from bi-monthly to monthly, allowing them to be more proactive with monetary policy in a rapidly changing global economic environment. Additional rate cuts are expected during the remainder of 2009 as inflation expectations improve and the Reserve Bank tries to counter the slowing domestic economy. While this would ordinarily be beneficial for the Portfolio, we feel that the asset class has already priced in most of the "good news" and as such we can expect moderate returns from fixed interest assets over the next 12 months.

Positive momentum was maintained in the local fixed interest markets in the 4th quarter. This was driven by the expectation of lower inflation and interest rates, which were cut for the first time in December. Clearly the deteriorating economic growth outlook weighed more heavily on decision makers and those managers / investors who predicted the cut would happen sooner rather than later were vindicated. Bonds rallied 11.3% for the quarter. Shorter dated income assets (+5.5%) also produced strong returns and pleasingly outperformed cash (+3.0%).

Although the Fund underperformed the benchmark for the quarter, this was the case for many income funds, who were generally caught short duration. It was however pleasing to note that the Fund outperformed the peer average by over 0.5% for the quarter. The Fund improved its relative ranking during the quarter, leaving it ranked 6 / 13 for the full year with a return of 12.4%. Both Cadiz AH and STANLIBAM contributed positively to this improved outcome during the year, with STANLIBAM kicking in more recently. Cadiz AH was however the better performer over the full year.

The Rand continued to weaken as the global crisis intensified. Whilst this did not have a negative impact on the Fund, it could negatively impact the improvement in the inflationary outlook that has been widely anticipated. The debate has therefore shifted from "when" to "how much" the Reserve Bank will cut interest rates in 2009. The market is already pricing in a further 4% cut in rates during 2009, which would naturally be really positive for the Fund should this transpire, but it does leave the market vulnerable to disappointment.