Returns in the local fixed interest market were rather spritely in the 2nd quarter with the market gaining confidence that the interest rate hike in January was not the first in a succession of rapid hikes. Of the assets allowed in the portfolio, property (+4.4%) was the best performing asset class for the quarter, followed by bonds (+2.5%) and income (+1.8%). It is again pleasingly to note the Fund outperformed its benchmark index for the quarter and is now 112bps ahead over the past 12 months. Relative to peers, the fund is now marginally ahead over the past 6 months. With inflation accelerating to 6.6% in May 2014, it is becoming harder to produce real returns. Accordingly, we have opened up the manager mandates to allow for greater flexibility in asset selection, specifically in the use of foreign assets in line with the ASISA category guidelines.

Each of the managers outperformed the benchmark for the year. Momentum has been successful in utilising various fixed interest levers to generate alpha and it is this attribute that makes them a fantastic core manager in the mix. Investec has lagged a little as their more aggressive positioning has resulted in wider swings in a volatile market.

The path to normalisation is becoming increasingly uncertain. The Fed has consistently tapered its pace of monthly purchases of US bonds by $10bn and is now down to $35bn per month. In conjunction with the fact that US unemployment is approaching the 6% level, it is confusing as to why the Fed is intent on shifting out its expectation of eventually raising interest rates, now expected in late 2015. US inflation seems contained and growth is moderate but if either increases meaningfully interest rates will have to follow. In South Africa, the SARB is faced with a different dilemma where inflation is accelerating and growth contracting (-0.6% in Q1 2014). The market is expecting interest rates to rise by 1% by the end of the year, but we suspect that the SARB will be reluctant to hike if growth continues to disappoint. Given the exogenous factors currently influencing the economy they have hedged their bets by saying their future actions will be data dependent.

The Fund delivered 1.69c per unit to investors for the quarter, bringing the total income distributed over the past 12 months to 6.47c per unit, 3% higher than the equivalent distribution 12 months prior. This represented a net of fees historic income yield of 6.3%. Looking forward we believe the fund is well positioned to provide positive returns with a similar, if not higher yield.

We described the environment for local Fixed Interest managers in Q4 2013 as "dull". By comparison Q1 2014 has been incredibly exciting. In the face of a falling US 10 year yield, the SA 10 year yield initially rose during the quarter as investors started to discount the possibility of a rate hike and foreigners sold SA bonds aggressively, preferring the relative safety of the US bonds market.

The South African Reserve Bank obliged and raised SA interest rates by 0.5% late January, which we felt was surprising given the weak economic backdrop. Clearly, the SARB acted preemptively in response to the rapidly depreciating Rand given the likely negative impact this depreciation would have on inflation. Yields spiked following the announcement leading to the worst monthly return for bonds since the Fed announced QE Tapering in May 2013. Local managers - heavily underweight bonds - used the opportunity to buy bonds yielding inflation plus 3% or so and this had a stabilising influence over the market for the remainder of the quarter. The Rand was highly correlated to the movement in yields during the quarter, providing those managers who held offshore exposure with some protection as SA yields spiked.

Of the assets allowed in the portfolio, property (+1.8%) was the best performing asset class for the quarter, followed by cash (+1.3%), bonds (0.9%) and income (0.7%). Pleasingly the Fund outperformed both its benchmark index and peer group average for the quarter, which helped make up valuable ground lost over the past 12 months were it is now ahead of the average by 0.3%. The Fund was 1.4% ahead of its benchmark index over this time. All local fixed interest asset classes produced returns lower than inflation for the past year and accordingly the Fund lagged its inflation target.

Each of the managers outperformed the benchmark for the year. Prescient did particularly well in navigating the markets, benefiting from low duration in the first half when the market was frothy and then extending during as the market corrected in January. Lower duration was a theme amongst many fixed income managers through the course of the year, however it was the magnitude of Prescient's position that drove their outperformance.

The Fund delivered 1.67c per unit to investors for the quarter, bringing the total income distributed over the past 12 months to 6.21c per unit, roughly similar to the distribution 12 months prior. This represented a net of fees historic income yield of 6.0%.