Global Financial markets experienced their worst turmoil in many years, yet markets took it in their stride and generally finished positive for both the 3rd quarter and September. This was largely due to the turmoil already being reflected invaluations, the Feds incisive cutting of rates and the 5% depreciation of the US$.

South African banks, however, marched to the beat of Tito Mboweni's higher interest rate stance, and generally declined (I think incorrectly so).The fund did well due to its large exposure to Sasfin, ABIL and Capitec. We used the large fall in Investec's share price to increase the weighting to both it and Old Mutual. Interest rates in South Africa should decline over the next 12 months, which will be a stimulus for a re-rating of financial shares.

Kokkie Kooyman
Sanlam Investment Management

The bull market in equities (and specifically emerging markets)continued in April, largely driven by continued strong GDP growth in China(+11%), but also a best-of-both-worlds scenario in the US: continued growth, but with enough weakness in the housing sector to make Fedinterest rate cuts possible later this year.

It seems as if increasing numbers of US investors are moving funds away from the weak US$ and low growth US, into the high growth emerging markets.

Driven by offshore buying, the rand strengthened by 3.5% relativeto the US$ and 1.5% relative to the euro and pound. Most other emergingmarket currencies also strengthened about 1% relative to the US$.

This pushed the JSE up 3.5% and gave especially the Insurance sector a strong push (Sanlam +18%. Liberty/Metlife +11%). Banks were"laggards", with Nedbank and Investec being up 7%, Standard Bank and Absa +4% and FNB +2.5%.

Our recent Investment in African Bank (+12%), Capitec (+11%) andSantam (+8%) were rewarded. All three are quality companies with specifically Capitec being well positioned for strong growth over the next five years (and thereafter).

Is this a bubble? The strong rand and weak US economy will keepglobal and SA interest rates low, stimulating growth and justifying high valuations.

In the short term, the market feels a bit frothy, but looking forward tothe end of the year and thereafter, the financial stocks still represent value.Banks are on PERs of around 11 (an earnings yield of 9%), certainly notbargains but not in "sell" territory.

However, bear in mind, the "goldilocks scenario" depends on continued low global interest rates.

Kokkie Kooyman
Sanlam Investment Management

2006 proved to be no exception to the general rule that bank shares underperform when interest rates are being raised. As in the past, this doesn’t mean that they generated poor returns, just poor returns relative to the rest of the market.

Surprisingly, despite a strong market, insurance shares did not perform any better. The average bank share gained 22% while Metlife was up 27%, Liberty Life, being the worst of the big 4, up only 10%. (The percentages quoted exclude a dividend gain of 4-5%).
Small cap and rand-hedge financials outperformed; JSE (120%),Peregrine (93%), Liberty International (76%), Investec (59%), PSG (64%), Remgro (46%) and Old Mutual (33%) were the top performers.

Measured in terms of 12-month share price appreciation, we made a number of mistakes - our large investment in Santam underperformed (9%), while, when one looks at the list of top performers, we only had exposure to JSE (the listed share) but had very limited exposure to Remgro and Old Mutual during the year. Besides Santam, we did avoid the poor performers (Liberty, Alexander Forbes and Discovery Health), selling our large holding in Liberty right at its peak, remaining very underweight right up to the end of the year.

Our reasoning was very simple:
- the earnings of the small caps were (and remain) very difficult to forecast (high percentage of non-recurring earnings); and
- the extent of the rand’s decline was difficult to forecast (hence we missed out on the expensive rand-hedge shares)
Generally, all the shares that outperformed in 2006 are now overpriced. The strong year-end rally in bank shares pushed them to being overpriced in the short-term especially while the possibility of two further increases in interest rates exists. Hence, we increased our cash levels and exposure to underperformer Liberty during the last week of December.
The environment for 2007 and earnings outlook remains very positive and, on a 12-month basis, we think financial shares will reward investors with a double-digit return.