The now much talked about "risk on - risk off" investor behaviour continued into the third quarter of 2010. July was a positive month for risky assets, August was negative, and then September brought a strong wave of upward pricing of risk, resulting in a quarterly return for the MSCI World Index of 13.9%. The South African equity market followed international counterparts with a quarterly return of 13.3%, and the rand strengthening by almost 10% against the US dollar, leading to a dollar return of almost 25% over the 3 months! Even the bond market shared in this euphoria with a third quarter return of 8% in rand terms and 19% in dollar terms. Inflation-linked bond returns were a little more subdued, with the rand number at 4.6%. Listed property returned 13.7% over the three months.

The main reason for the renewed optimism has been speculation of another round of quantitative easing about to be implemented, supposedly leading to a rerating of risky assets. In the event, one could argue that a lot of this anticipated rerating has now already happened, with physical gold also marching north on fears of inflation down the line. The dollar has also lost about 10% against the euro over the 3 months.

Within South Africa, besides the successful conclusion of the Soccer World Cup in July, the emphasis shifted to the benign outlook for inflation in the short term, with interest rates having been brought down by another 50 basis points. The announcement regarding the proposed offer by US giant Wal-Mart for the local retailing company Massmart led to another flurry of buying activity in the SA retail sector.

Against this background your fund had a great 3 months with a return of 7.5%, bringing the year-to-date number to 9.7% and the one-year lagging number to 13.7%. All these numbers comfortably outperform the benchmark of inflation plus 4%. Over the last 5 years the fund has returned 12.5% p.a.

Equity selection in the fund was good, outperforming the market in a strong upward swing. Listed property did well, although the fund did not have a large exposure to this sector. Our inflationlinked bonds continued to perform well, whilst we used the strength in the bond market to dispose of the remaining government bonds. Whilst our foreign assets performed well in dollar terms, the rand strength meant that the fund's foreign exposure once again detracted from performance. We continue to believe that having the maximum allowed offshore exposure of 20% is the right position for the longer term, and we do not intend buckling under the pressure of a view that in the short term has been wrong.

During September we have started reducing equity exposure given the sharp run in risky assets. We continued with this programme subsequent to quarter-end. Some of our larger positions have moved closer to our calculated fair value, and as such we are busy reducing these positions. We now have very little exposure to retailers, which over the last few years have been blessed with all kinds of tail winds. Whilst we expect the sector to continue to trade well, we think this positive outlook is already reflected in the sharply rerated share prices. We continue to hold inflation-linked bonds as a hedge against the anticipated increase in inflationary pressures in South Africa over the next 3 to 5 years.

Portfolio managers
Louis Stassen and Henk Groenewald

The past quarter has not been good for global equity markets as concerns about the durability of the global recovery surfaced after the complacency brought about by the 2009 rally. Investors worried about the possibility of a double-dip recession, the unfolding debt crisis in Europe and a slowdown in China. Globally, emerging markets declined 9% (in dollars) over the quarter, while most developed markets fared worse. The South African equity market (as measured by the SWIX index) declined by 7% for the period. More defensive asset classes did far better with local listed property returning 0.6%, bonds returning 1.1% and inflationlinked bonds returning 5.1%. The rand weakened by 5% against the dollar, but strengthened against the euro.

In this environment, the fund delivered a return of -1.38% for the quarter. The main contributors to the negative absolute performance were equities and listed property; offset by fixed interest and cash. The 12-month return of 15.5% is still good and ahead of our benchmark. More importantly, since inception the fund has delivered on its mandate with a return of 14.8% versus 10.4% for the benchmark.

The return from the equity portion of the portfolio was -4% for the quarter, ahead of market indices. A more defensive equity selection and the purchase of put protection when insurance was cheap helped limit the capital loss. Companies contributing to this performance were Spar, AngloGold and Vodacom, while larger declines in Naspers and MTN detracted from performance.

We used the market correction to increase equity exposure, specifically in selected resource companies. We bought Anglo American, BHP Billiton, Impala and Sasol. BHP and Impala have not appeared in your fund for a while and the market allowed us to buy them at what we regard as attractive prices. We further increased equity exposure by selling some of the put protection we previously bought at attractive prices at much higher volatilities. We also continued our buying of selected small cap shares. Domestic equity exposure moved from 31% in the beginning of the quarter to 35% at the end. We have continued reducing our exposure to listed property and concentrated our holdings in a few selected companies. In general, we consider the listed property companies to be expensive, both on an absolute basis and relative to international property shares.

The fixed income component of the portfolio returned 3.54% for the quarter versus the All Bond Index's 1.12%. This was mainly due to a strong performance from inflation-linked bonds which continued to perform well. Over the last year, exposure to this asset class increased by a large margin, and 15% of your portfolio is now invested in inflation-linked bonds.

Due to poor international equity markets, international exposure detracted from performance. This is also the case over a 12- month period. Despite the relatively poor historic returns (and in a small measure because of it), we continue to advocate a maximum offshore exposure. We think that the rand is vulnerable to changes in risk appetite, and on top of this view we continue to prefer offshore equities to domestic equities.

Uncertainty and volatility will continue to be a factor in the months ahead. Nevertheless, we believe the portfolio is well positioned to deliver on its dual mandate of inflation-beating returns and capital protection over a rolling 12-month period.

Portfolio managers
Louis Stassen and Henk Groenewald

Whereas the calendar year started slowly for equity markets around the world, the month of March brought lots of joy. This resulted in respectable returns being produced by these markets over the first three months of 2010. The South African equity market was up 4.5% over the period, with bonds rerating strongly to produce 4.4%. Listed property returned 9.9% and preference shares 7.8%, while inflationlinked bonds showed virtually 0% return over the period. The rand strengthened by 1.5% over the quarter against the US dollar, and by a whopping 6.7% against the euro. The MSCI World Index returned 3.4% since the start of the year, with developed equity markets actually outperforming emerging markets for the first time since the rebound started. Within developed markets Japan and the United States outperformed Europe by some margin.

Against this backdrop the fund had a strong quarter. The three-month return of 3.5% exceeded the benchmark of inflation plus 4%, but more importantly, the 12-month return of 21.4% and the 5-year number of 14.2% per annum compare favourably with both the benchmark and some of our peers in the sector. Since inception the fund has returned 15.4% per annum versus the benchmark's 10.6% per annum.

Once again our equity holdings contributed strongly. Stock selection was good, with the equity portion of the fund outperforming underlying indices by a wide margin. The most significant contributors amongst the equity holdings were Standard Bank, Woolworths, Tiger Brands, Mondi, AVI, and Remgro. A gratifying aspect of the attribution analysis is the fact that very few of our equities detracted from performance in absolute terms. MTN (our biggest holding where we continue to hold a very positive view on the stock), Pan African Resources, Anglogold, and Hulamin were the only real detractors.

Domestic property contributed positively and we have used the strength in this sector to reduce the fund's exposure further. The fund's preference shares benefited from a strong rerating in that sector. The big position in inflation-linked bonds has not yielded positive results yet, but we continue to hold the view that it is an attractively priced asset over the medium term. We are accumulating more of these instruments at acceptable prices.

Our international exposure performed well in dollar terms. Unfortunately the strength of the rand pared these gains. During the period we continued to consolidate our international exposure into a few pooled vehicles managed actively by ourselves. This has already led to increased focus and a greater alignment of investment objectives. We continue to advocate a full offshore position, and will manage the fund to achieve this goal. We think that the rand is vulnerable to changes in risk appetite, and on top of this view (that at the best of times cannot be classified as a high conviction view) we continue to prefer offshore equities to domestic equities. Investors around the world are embracing risk again. Whereas the economic outlook for many of the troubled economies has improved over the last few months, one has to be wary in terms of how much of this good news has already been priced into financial markets. We have already bought quite a number of put options against the equity holdings in the fund. We have also introduced written call options on some of our equity holdings where we think the upside has reduced as a result of price action. We will continue to be true to the absolute return objectives of the fund in our future dealings.

Portfolio managers
Louis Stassen and Henk Groenewald

An exciting fourth quarter brought a fitting end to an exciting calendar year. Equity markets around the world continued to rally with global risk appetite rising further as evidence of a global economic recovery started surfacing. Global equity markets returned just over 4% over the quarter, but the emerging markets universe was very strong, with an 8.6% return over the three months (all international returns in US dollars). South Africa outperformed these markets with a return of over 10% for the JSE All Share Index. South African bonds had a far more subdued quarter, with a benchmark return of 1.1%, whilst the inflation-linked market reacted negatively to the increased supply as well as lower inflation expectations, and hence returned only 0.2%. Preference shares were strong and returned 6.1% over the period, whilst the continued strength of the rand continued to surprise commentators (and ourselves) - the currency appreciated by 1.5% against the US dollar and by 4.7% against the euro over the period.

The fund returned 3.7% for the quarter, resulting in a calendar year return of 15.5%. Our equity holdings, which outperformed the broader indices over the period, contributed the bulk of this positive return. This comes despite being more defensively positioned given the riskaverse nature of the fund. Over the last three months the following shares contributed strongly to performance: SABMiller, Naspers, Anglo American, Tiger Brands, Richemont and Spar.

We continued to reduce equity holdings into this period of strength and towards the end of the period we also bought additional option protection against these holdings. Sales comprised mainly shares like BHP Billiton, SABMilller, AVI and Naspers. All of these shares (except BHP Billiton) still appear in the portfolio, but have been reduced as their prices continued to rise. We did add selectively to some of our other holdings such as MTN and Standard Bank and introduced York Timber, Dawn, and Nedbank into the portfolio.

Our listed property holdings also contributed to the positive performance. The sector performed well as risk appetite increased and we reduced the fund's exposure to this sector as we believe the risks of tenant failures in the physical market have increased. We continued to prefer the more defensive counters to the smaller, more volatile names.

Our fixed interest component of the portfolio had a good quarter, outperforming its benchmark by some margin. We have remained nervous about the direction of the bond market and as such have been sheltered from the recent selloff in that market.

The fund continued to purchase inflation-linked bonds as Government has increased its issuance in this space. We consider the current real yields of around 3.25% to be quite attractive, even though we understand that the immediate future for inflation protection does not look that attractive given the low carry and the strength of the currency. The fund now holds just over 11% in inflation linkers, and we will continue to add to this position as long as valuation levels remain attractive.

Once again our international component of the portfolio did not contribute meaningfully to performance, given the continued strength of the rand and the outperformance of the domestic equity market over international markets. We are still strongly of the view that our portfolio will benefit over time from diversification into offshore markets, whilst at the moment we actually prefer international equities over domestic equities. We will thus continue to shift our equity exposure to reflect this view. In addition we consider the rand to be overvalued at this point, having benefited strongly from the increased global risk appetite. We are maintaining our maximum offshore exposure within the fund.

It is with mixed feelings that we also use this opportunity to thank Edwin Schultz for the enormous contribution he has made to this fund since inception. As has been communicated to the market over some time, Edwin and his family have decided to emigrate to Australia. He was instrumental in the launch of this fund and has been closely involved with it ever since. The impressive track record speaks for itself and we will endeavour to continue his good work. We wish him well in his future career.

At the same time Gavin Joubert has also formally relinquished responsibility for the management of this fund in order to focus full time on the development of the Coronation Emerging Markets initiative. We fortunately will continue to benefit from Gavin's investment acumen given that South Africa is such a big part of the emerging markets universe. Gavin has contributed hugely to the track record of this fund over the last 5 years, and again we wish him well in his new role within the Coronation family.

We also welcome Henk Groenewald as co-manager of this fund (and the other absolute return funds). Henk has been with Coronation for 5 years, having been portfolio manager of our successful Coronation Resources unit trust fund for the last four years. We are excited about his future involvement and contribution and intend continuing delivering on our promise of acceptable returns with an appropriate level of risk averseness.

Portfolio managers
Louis Stassen and Henk Groenewald