Our feeling remains that SA banks are not good value relative to overseas banks. This was proved right by the fact that the bank index was flat (Absa and Standard Bank down 5% and Nedbank and First National gained 5%), while our investment in the Sanlam Global Financial Fund gained 9%.

In addition, our investments in a number of smaller financials (Capitec, Sasfin, PSG and Discovery) performed very well.

While other emerging market banks and many developed market banks offer better value than ours, the bad debts cycle here is also peaking and we can look forward to very impressive earnings jumps next year.

Hence South Africa's banks are good investments relative to cash or government bonds and on a one to three year view, an investment in SA banks will prove very rewarding with limited downside risk.

June closed off an amazing six months during which the rand appreciated by 17% against the US$ and Old Mutual ended up 44% (7% in June). Capitec (+50%) and PSG (+27%) were the other two shares in the financial sector that performed really well.

The banks and life assurers were relatively flat -Standard Bank being the best with 8% while Firstrand's disappointing results caused it to lose 14%.

The fund itself was helped by strong performance (about 45% in US$) of the Global Financial Fund (in which 11% of the fund's capital is invested).

From this one can see how South African banks lagged global banks. This was due to:
a)the fact that they had held up better in 2008; and
b) that South Africa is only experiencing its bad debt cycle late in 2009 while the other emerging markets seem to have weathered the worst of the storm already.

The continued strength of the rand means that we could see further downward pressure on interest rates in South Africa. This, along with the lower petrol price will stimulate consumer spending in 2009 when it is most needed.

At the moment, South African banks represent good value again (not yet excellent value). However, I think that the current forecasts ignore the impact of the FIFA World Cup tournament next year. Hence the second six months of 2010 could herald positive surprises.

The market turned positive in March, finally shrugging off its fear. Everything that was sold down during the "dark ages" was suddenly sought after, especially financials, small-cap shares and emerging markets.

Essentially everything with a "narrow doorway" was affected. Once the pushing and shoving to get out turned into a rush to enter back in as prices did the opposite.

During the past month we stuck with our belief that Standard Bank and African Bank were undervalued and added double the Old Mutual exposure. This paid off big time as these shares, along with Investec, were the best performers in the sector.

The markets were incredibly oversold; hence it seems as if the current rally could continue a bit longer. We will hold onto our "value shares" until the market unlocks the value.

December ended negative, the banks virtually all being down while the life insurers were positive - the exception being Old Mutual, which was further dragged down by concerns that it needs to raise capital.

The underlying picture contains positives and negatives. Unemployment is increasing and the economy is slowing down rapidly. However, inflation continued to decline while both the rand strengthened and the oil price fell further. This will enable the South African Reserve Bank to lower interest rates by an expected 400 - 500 basis points during 2009.

Hence, while banks will suffer from higher bad debts and slower loan growth, looking past that they will benefit from lower interest rates. For the past 45 years, banks have always outperformed the JSE during a period of declining interest rates. We do not expect 2009 to be different.

The fund is well positioned to benefit from this, but has maintained some exposure to the life insurance sector which will benefit from any upturn from a very inexpensive JSE.

In addition, we increased the funds exposure to Old Mutual believing it to be just too cheap, pricing in the risk of a capital raising.

The fund still reflects a very cautious outlook, the largest exposures being to Standard Bank and African Bank, both of which are underleveraged and will suffer the least from an unexpected severe deterioration in the South African economy.

The big disappointment during 2008 was the fund's exposure to the Sanlam Global Financial Fund, which performed poorly (in line with global financials). However, we believe that the Brazilian, Indian and Turkish economies (where most of the fund's exposure lies) will outperform South Africa. In addition, these markets are very attractively valued and we, therefore, believe this fund will contribute strongly to the Nedgroup Investments Financials Fund.