In the third quarter of 2011 market volatility rose substantially as the US Fed's massive QE2 stimulus programme ended. US and European politicians competed with each other for negative headlines - the US left it until the last minute to defer its debt problems (by raising its legislated debt ceiling) and Europe proved indecisive on dealing with the credit crisis in its South.

To add to the negative mood, Chinese economic data softened somewhat and worries about its property market increased. Consumer confidence in the US has weakened as the jobs and housing markets remain very weak. These developments are very much in line with our long held bearish view on the world economy post the financial crisis.

Equity markets had a negative quarter with August and September being particularly volatile. The S&P 500 Index was down 14.3%, its worst quarter since December 2008, and the Nikkei fell 11.4%. On average, emerging markets again underperformed developed markets.

The Kagiso Equity Alpha Fund had an above average quarter compared with its peers in the Domestic General Equity sector - due mainly to our generally defensive orientation and despite our, now, increased resources sector exposure. The fund remains number one in the General Equity sector since its inception in April 2004.

Commodity prices were very volatile but mostly weaker over the quarter. Oil prices were down 4.6% (Brent Crude), despite the prospect of a return of Libyan supply as rebel forces gained control of most of the country. Gold was up 7.4% on increased risk aversion, but platinum (-12.3%) and copper (-25.7%) were sharply down on fading growth hopes and concerns about Chinese demand. Most other commodities were significantly down.

The rand weakened against developed market currencies in line with the broad-based sell-off in emerging market currencies generally - down 16.5% against the US dollar and 9.5% weaker against the euro. The South African Reserve Bank kept interest rates unchanged at multi-decade lows, and interest rate markets reversed expectations of an increase as economic activity slowed materially.

The FTSE/JSE All Share Index was down 5.8% during the quarter, with significant sectoral diversions: resources shares (-10.0%) underperformed industrial shares (-3.3%) and financial shares (-3.1%). Equity markets experienced significant volatility, with most of the negative performance coming through in September (-3.6%). Foreigners were net sellers of equities in the quarter (-R20.1 billion), but small net buyers of bonds (R1.1 billion).

Woolworths (+20.8%), Anglogold Ashanti (+19.0%) and Mediclinic (+8.4%) were strong performers for the fund, but our exposure to Lonmin (-16.8%), Netcare (-11.7%) and Mondi (-11.4%) were a drag on performance.

Looking ahead, we remain cautious over prospects for the developed economies, with high levels of government debt, high levels of unemployment, stimulus removal and austerity measures looming and demographic trends moving slowly against them. On the positive side, we believe that there are strong prospects for companies focused on emerging market consumers, although much of this optimism seems to be priced into South African consumer stocks.

Going forward, we remain defensively positioned with a strong focus on quality, lower risk companies, which are attractively priced. We favour companies with strong balance sheets, high franchise value and/or dominant market positions, low fixed costs and defensive earnings streams. We are avoiding companies which have strongly re-rated in expectation of high earnings growth in future - growth that we believe may be elusive in the tough economic environment we expect.

The fund continues to be appropriately positioned in our best stock selections, based on our team's proven bottom-up stock picking process.

The second quarter of 2011 exhibited further volatility as global economic data releases showed a slowing in the world economy, particularly in the overly-indebted USA and Europe, but also in China - as monetary policy was further tightened. Western governments continue to grapple with their financial positions, with the European periphery and the US making the headlines in this regard. Consumer confidence in the US has weakened as the jobs and housing markets remain very weak. Inflation concerns are heightened by the rise in commodity prices, especially oil and food. Consequently, monetary policy has been tightening further in a number of economies, notably China and the Eurozone. These developments are very much in line with our long held bearish view on the world economy post the financial crisis.

Equity markets had a flattish quarter despite the negative news flow. The S&P 500 Index was down just 0.4% and the Nikkei rose 0.6%. On average, emerging markets underperformed developed markets slightly. The Kagiso Equity Alpha Fund had an average quarter compared with its peers in the General Equity sector - mainly due to certain high conviction positions underperforming the market slightly, and despite our generally defensive orientation. The fund remains number one in the General Equity sector since its inception in April 2004. Commodity prices were very volatile but mostly weaker over the quarter. Oil prices were down 5% (Brent Crude), with a record disparity between European and US prices. Gold was up 4.8% on increased risk aversion and platinum (-2.6%) and copper (-1%) held up relatively well. Most other commodities were significantly down. The rand was firm against developed market currencies - flat against the US dollar and 2.3% stronger against the euro. The euro seemed to retrace recent strength due to ongoing fiscal solvency and liquidity concerns in its highly indebted periphery. This weakness was despite continuing tightening in Eurozone monetary policy. The South African Reserve Bank kept interest rates unchanged at multi-decade lows, but rising cost-push inflation pressures indicate that the next interest rate move is up - the timing of which will depend on local economic conditions.

The FTSE/JSE All Share Index was down 0.6% during the quarter, with significant sectoral diversions: resources shares (-5.7%) significantly underperformed industrial shares (+3.7%). Equity markets experienced significant volatility, with the last week's significant bounce rescuing what could have been a very negative quarter. Foreigners were net buyers in the quarter of both equities (R6 billion) and bonds (R42.3 billion), resuming the strong inflow trend of 2010. Richemont (+11.2%), Mediclinic (+8.6%) and BAT (+7.4%) were strong performers for the fund, but our exposure to Lonmin (-15.7%), African Rainbow Minerals (-15.5%) and Tongaat Hulett (-8.7%) were a drag on performance. These underperformers are all high conviction ideas for us and we have therefore added to our holdings in these stocks, given their additional appeal at lower prices. Looking ahead, we remain cautious over prospects for the developed economies, with high levels of government debt, high levels of unemployment, stimulus removal and austerity measures looming and demographic trends moving slowly against them. On the positive side, we believe that there are strong prospects for companies focused on emerging market consumers, although much of this optimism seems to be priced into South African consumer stocks. Going forward, we remain defensively positioned with a strong focus on quality, lower risk companies, which are attractively priced. We favour companies with strong balance sheets, high franchise value and/or dominant market positions, low fixed costs and defensive earnings streams. We are avoiding companies which have strongly re-rated in expectation of high earnings growth in future - growth that we believe may be elusive in the tough economic environment we expect. The fund continues to be appropriately positioned in our best stock selections, based on our team's proven bottom-up stock picking process.

Portfolio manager
Gavin Wood

The first quarter of 2011 served up several severe global shocks and consequent market volatility. North Africa saw rapid regime changes in Egypt and Tunisia, with the revolt spreading to the Middle East and to Libya, an important oil producer. The oil price has spiked sharply as a result. Japan experienced its worst-ever earthquake and a devastating tsunami, with thousands killed and displaced and an unfolding nuclear disaster. Electricity shortages and factory damage in Japan have disrupted the production of vital electronics and automotive components needed by factories around the world.

Inflation fears have risen with the rise in commodity prices, especially oil and food. Consequently, monetary policy tightening has been experienced in a number of economies, notably China and the Eurozone.

Notwithstanding the above bad news, equity markets had a strong quarter. The S&P 500 index was up 5.4% and the MSCI World index rose 4.9%. Emerging markets underperformed developed markets in general, although Japan was particularly weak (Nikkei 225 was down 4.6%).

The Kagiso Equity Alpha Fund had a strong quarter compared with its peers in the General Equity sector, due mainly to good stock picking and generally defensive positioning, despite our lower than average resources exposure. The fund remains number one in the General Equity sector since its inception in April 2004.

Commodity prices were mostly stronger over the quarter, led by oil, which was up 25% for Brent Crude (and 17% for WTI in the US). Gold (+2.4%) and platinum (+1%) were up, but copper (-2.5%) was down after a very strong 2010 run. In South Africa, agricultural commodities firmed sharply, with yellow maize up 10.6% and wheat up 7.6%. This should feed into food price inflation in the months ahead.

The rand was weaker against developed market currencies - 2.1% weaker against the US dollar and 8% weaker against the euro. This euro strength reflects a divergence in monetary policy expectations between Europe (tightening) and the US (continued record low interest rates and quantitative easing). The SARB kept interest rates unchanged at multi-decade lows, but rising cost-push inflation pressures probably indicate that the next interest rate move is up.

The FTSE/JSE All Share index was up only 0.3% during the quarter (excluding dividends), with resource shares again performing best (+2.8%), aided by the weaker currency and better commodity prices. Industrial shares (-0.3%) then lagged financials (+0.7%) over the quarter.

Foreigners were net sellers of both equities (R3.1 billion) and bonds (R7.6 billion), reversing slightly the strong inflow trend of 2010.

Mondi (+22%), Assore (+14%), Sasol (+13%) and BAT (+11%) were strong performers for the fund, but our exposure to Implats (-15%) and Tongaat Hulett (-9%), both retreating on Zimbabwe indigenisation fears, were a drag on performance. In general, we avoided most of the severe downward price movements, e.g. severe sell-offs in the construction sector (Murray and Roberts down 34% and PPC down 29%), in Aspen (-14%) and some of the retailers (JD Group down 17% and Mr Price down 8%).

Looking ahead, we remain cautious over prospects for the developed economies, with high levels of government debt, high levels of unemployment, stimulus removal and austerity measures looming and demographic trends moving slowly against them. On the positive side, we believe that there are strong prospects for companies focused on emerging market consumers.

Going forward, we remain defensively positioned with a strong focus on quality, lower risk companies, which are attractively priced. We favour companies with strong balance sheets, high franchise value and/or dominant market positions, low fixed costs and defensive earnings streams. We are avoiding companies which have strongly re-rated in expectation of high earnings growth in future - growth that we believe may be elusive in the tough economic environment we expect. The fund remains appropriately positioned in our best stock selections, based on our team's proven bottom-up stock picking process.

Portfolio manager
Gavin Wood

Global equity markets enjoyed another very strong quarter, buoyed by additional monetary and fiscal stimulus and some economic data that suggests improvement.

We remain cautious that the signs of economic recovery are distorted by government stimulus measures. It is not clear what levels of economic activity will be sustainable as this stimulus is inevitably withdrawn. Additionally, economic activity will be depressed by the need for developed country austerity measures, which are necessary if historically very high levels of debt are to be reduced.

Add to this: high structural unemployment, massive welfare and pension liabilities and other economic imbalances, and we have a tough outlook for markets. We are wary that the short-term positive impact of additional developed market monetary stimulus will be difficult to sustain. On the positive side, we believe that there are strong prospects for companies focused on emerging market consumers. We are positioned in some of these that are still priced below intrinsic value.

The Kagiso Equity Alpha Fund again had an average quarter compared with its peers in the General Equity sector, due mainly to a more defensive positioning in a strongly positive period, lower than average resources exposure and due to our tactical positioning for a weaker rand. Despite this, we ended December 2010, within our sector: 7th for 2010, 7th over 3 years and 2nd over 5 years (according to Morningstar).

Commodity prices were again significantly stronger over the quarter, encouraged by the improving economy, supply constraints and continued investment buying in anticipation of weak currencies. Copper was up 20.5%, oil up around 16%, platinum up 6.5% and gold up 8.5%. Many commodity prices hit all-time highs.

The rand was 5 - 6% stronger against developed market currencies on continued positive emerging market sentiment. This will weigh on the earnings of South African exporters, including SA commodity producers, in the coming period if sustained. The South African government significantly relaxed exchange control regulations: increasing institutional limits by 5% and allowances for individuals substantially.

The FTSE/JSE All Share index was up 9.5% during the quarter, taking the total return index to an all-time high - a massive five-fold increase over the decade in dollar terms. Resource shares performed best (+ 16.5%), with industrial shares (+7.8%) and financials (-0.1%) way behind.

Foreigners returned in force to the JSE, buying R16.9 billion of shares, but were sellers of bonds (R17.1 billion outflow) after massive bond buying in the year to date.

Implats (+29%), ARM (+25%), Assore (+21%), Nampak (+21%) and Richemont (+15%) were strong performers for the fund, but our exposure to Mondi (-5%), Investec (-1%), Standard Bank (-3%), BAT (-3%) and Discovery (+2%) were a drag on performance.

Going forward, we remain defensively positioned with a strong focus on quality, lower risk companies, which are attractively priced. We favour companies with strong balance sheets, high franchise value and/or dominant market positions, low fixed costs and defensive earnings streams. We are avoiding companies which have strongly re-rated in expectation of high earnings growth in future - growth that we believe may be elusive in the tough economic environment we expect.

The fund remains appropriately positioned in our best stock selections, based on our team's proven bottom-up stock picking process.

Portfolio manager Gavin Wood