The world post the global financial crisis remains one characterised by slow growth and very low inflation and interest rates. The past quarter was just another paragraph in this very long chapter, with no major changes in the general trend. If anything, the shock of the Brexit vote contributed to even greater uncertainty: global bond yields moved even lower - and in many developed nations into unprecedented negative territory.

In contrast to the exceptionally low global bond yields, some emerging market bonds still show reasonable yields and have attracted the attention of foreign investors. South Africa is one of the countries that has attracted global money in the search for yield, to the benefit of the local currency and bonds. During the quarter, the rand (although quite volatile) appreciated by 7.3% against the US dollar and by 10.1% against the weak British pound. Bond yields, in tandem with the currency, also closed the quarter stronger than at its start. We have used the volatility in the rand and the local bond market to good effect, reducing global exposure through currency futures when the rand was weaker and reversing those positions when it recovered. We were also very active in bonds, buying when the SA 10-year bond was in the 9% yield region and selling some 50 bps or more lower. The fund's effective offshore exposure increased from 24.5% to 24.9% as a result of these currency trades, while the domestic bond exposure decreased from 28.3% to 26.1% of the total portfolio. Within the bond component only, 1.9% comprises longer-dated fixed government bonds. Floating-rate stocks and corporate bonds remain the major constituents of our total bond exposure, by a significant margin. When considering domestic equities, we were small net buyers over the quarter. New holdings included Curro Holdings and Hammerson, which the fund invested in for the first time. In the case of Hammerson, this involved a partial switch with our holding in Intu. It is worth noting that the strengthening rand acts as a brake on the fund’s performance. This is due to its high exposure to rand hedge shares, as well as the fact that it holds its full quota of foreign assets. Over the past quarter, the strong rand therefore limited the fund’s return to 1.5%. Its return over the past year was 7.8%. Over longer and more meaningful periods of three and five years, the fund has returned 7.1 % per annum and 10.9% per annum respectively.

The fund aims to deliver a return of inflation plus 4%, while also attempting never to reflect a negative return over any rolling 12-month period. The global economic environment of sluggish growth and very low yields remains tough. It is in these tough times that protecting capital is vital, and the fund is managed accordingly.

Portfolio managers Charles de Kock and Duane Cable as at 30 September 2016

The first quarter of 2016 was a highly eventful and extremely volatile one. The year started off very poorly, with all global stock markets posting large negative returns in January. The month of February was fairly flat, followed by a very strong recovery in March, which more than reversed the early losses experienced in the first two months of the period.

The JSE followed the global pattern, with the All Share Index (ALSI) posting returns of -3.0%, 0.6% and 6.4% respectively for the first three months of the year. Within the ALSI, the resource sector recorded the biggest bounce by far with a return of 18.1% over the quarter, although still deeply negative over the last year.

Listed property and bonds also recovered sharply, following the hammering these sectors took late in 2015. For the quarter, the two asset classes posted returns of 10.1% and 6.6% respectively. The only negative contribution to returns came from the fund's global assets, where the strong appreciation of the rand acted as a headwind to the dollar returns.

We used the volatility as an opportunity to trade quite actively, and made a number of changes to the portfolio. Our most significant asset allocation change was to raise exposure to risk assets from 53.9% of fund at the end of December to 57.2% by end-March. This was largely achieved by adding to domestic equity and property during the January sell-off. The second major asset allocation action implemented during the quarter was to reduce the portfolio's effective global exposure from a level of 28.5% back to 25% by means of currency futures. While the effective global exposure level remained unchanged, we hedged some of the US dollar exposure back into rands as we felt the local currency was too oversold. Late in March, some of this was reversed following a strong recovery in the rand. In the bond area, we bought some longer-dated government bonds at yields that we felt had already priced in the anticipated downgrade to junk status. The exposure to government bonds remains quite modest, but at the higher yields we felt we were compensated adequately for the risk.

Within domestic equities, we switched our remaining SABMiller shares into AB InBev, and added to Old Mutual and Capital & Counties Properties. We also used the bounce in the resource sector to reduce positions in Anglo American and Exxaro.

Following a disappointing 2015, we are pleased to report that the fund was well positioned to benefit from the price recovery in risk assets during the latter part of the quarter. The return for the month of March was 3%, which lifts the return for the quarter to 1.8% and to 3.5% for the year to end March. It is interesting to note that the largest contributors to positive performance over the quarter came from the resource area (Anglo American, Exxaro, Northam, Glencore and Impala) which had disappointed for the previous year. Murray and Roberts also rebounded. As with all positions, we continually reassess the investment cases for these stocks and are not bound to any of them. The sharp recovery in these unloved stocks does, however, show how patience gets rewarded. We anticipate a continued recovery in many of these forgotten stocks, and our fair values are still far ahead of the current market prices. It is too early to call the rebound in the resource area the start of a new upswing. At this stage, we merely view it as a long overdue recovery off very depressed positions. Although we are encouraged by the rebound in the prices of some of the very depressed stocks we own, the returns over the past three years is disappointing and behind the benchmark of inflation plus 4%. The longerterm returns, measured over periods of four years and longer, remain ahead of the benchmark.

Investors in this fund should understand that in addition to aiming to achieve inflation plus 4%, we also try to conserve capital over rolling 12- month periods. It is the latter aim of not losing money that guides us to maintaining a well-diversified portfolio with risk spread over many assets, and protection on a portion of the domestic equities in case of a deep downturn in the market.

Looking forward, the macro environment continues to be marked by slow global growth and a domestic economy on the edge of a recession. It is a challenging environment where companies have to work hard, contain costs and gain market share in order to show earnings growth. Achieving an inflation-beating return in this environment will not be easy, but we believe we are well positioned to meet our dual benchmarks.

Portfolio managers
Charles de Kock and Duane Cable

The final quarter of 2015 certainly provided little respite for what ended up being a much more difficult year for global markets relative to their robust performance over the last decade. In US dollars, the MSCI World Index returned 5.6% for the quarter and -0.3% for the calendar year, while the MSCI Emerging Markets Index returned 0.7% for the quarter and -14.6% for the calendar year. Locally, the JSE All Share lost 9.3% for the quarter and 21.5% for the calendar year in US dollars. Given the significant depreciation of the rand, its performance in the local currency was widely divergent: 1.7% for the quarter and 5.1% for the calendar year. Commodity prices continued to slide: oil fell 23.6%, palladium lost 15.8% and copper was down 7.9% in US dollars for the quarter.

On the global front, the economic and geopolitical outlook remains uncertain, with the US being the only bright spot. As expected, the US Federal Reserve raised interest rates by 25 basis points in December, the first hike in almost a decade. Our base case remains that the pace of interest rate normalisation will be gradual and that interest rates will remain at historically low levels for longer. The growth outlook for Europe and Japan can at best be described as sluggish. China remains the most important economy for resource demand and economic data continue to deteriorate.

The South African economic growth outlook remains anaemic. Although one can blame the impact of falling commodity prices and sluggish global economic growth, these challenges have been further exacerbated by a number of policy errors. The dismissal of SA's minister of finance sparked a collapse in the bond and currency market. The impact of the weaker currency and significant drought that has hit the country poses upside risk to inflation expectations for 2016.

For the year to December, the fund returned 4.6% compared with the benchmark return of 9.5%, which is extremely disappointing even amidst tough circumstances. The poor short-term performance can be attributed predominantly to poor local equity selection. We however believe that some of our holdings have been grossly oversold and offer excellent longterm value. The longer-term returns of 9.7% over three years and 10.6% over five years remain ahead of the fund's target. The fund aims to achieve inflation plus 4% over the long term, and not produce a negative return over any rolling 12-month period. As such, protecting capital will always form part of our mindset in managing this portfolio, and even more so in the current difficult phase of the South African economy.

The decline in commodity prices weighed heavily on resource shares with the local resources index declining 37.0%, underperforming industrials and financials that returned 15.3% and 3.9% for the calendar year respectively. The longer-term divergence in the performance of resources relative to industrials and financials remains stark. The resources index has declined over one, three and five years and has underperformed cash over a 10-year period. The greatest contributors to annual performance were our positions in Naspers (up 40.3%), British American Tobacco (up 44.6%) and Intu (up 27.1%). The greatest detractors from annual performance were our positions in Anglo American (down 65.7%), MTN (down 35.9%) and Exxaro (down 56.0%).

Although it would appear that there have been no major changes from an asset allocation perspective, on the back of strong performance by our offshore assets we exceeded the maximum exposure allowed by Regulation 28 and needed to repatriate some assets to comply with the required regulations. We utilised these proceeds to increase exposure to a discreet selection of local equities. The bond market returned -6.4% for the quarter, underperforming cash, which yielded 1.1%. We believe yields on global bonds are too low and do not offer value. Despite the sell-off in local government bonds, we do not believe that yields fully reflect the deteriorating risk profile. In our view, the real returns from cash and government bonds are likely to be relatively poor over the long term, both from a local and global perspective, and we have positioned the fund appropriately.
Listed property returned -4.7% for the quarter. We expect domestic properties to grow distributions in line with inflation over the medium term, which combined with a fair initial yield, offers an attractive return over the holding period. As we start the new year, we are bombarded with predictions from numerous financial experts about what lies ahead in 2016. Although we would agree with the market consensus that the shorter-term outlook is challenging, history has taught us that our ability to forecast the immediate future is limited. In an incredibly uncertain world, we continue to strive to build anti-fragile portfolios that could absorb a dramatic change in the strong momentum markets experienced over the last few years. We will remain focused on long-term valuations and will seek to take advantage of whatever attractive opportunities the market presents to generate long-term returns for our investors.

Portfolio managers
Charles de Kock and Duane Cable