A unified plan to stabilize Europe continues to elude the policymakers in the core European economies. The resulting market uncertainty is reflected in the heightened volatility across asset classes and cross rates between currencies.

During September, local equity and bonds sold off -3.6% and -2.1% respectively. The rand weakened dramatically (-13.6% vs the dollar) in a landscape where the US dollar and Japanese yen appreciate against all other major global currencies. As a result of a major shift in global currencies, respectable returns were enjoyed by local investors in dollar cash (15.7%), global equities (5.8%) and global bonds (14.0%).

Although the net equity exposure in the PSG Optimal Income Fund resulted in a drag on returns for the month, a sharp draw-down was negated with a very low bond exposure. The entire yield curve shifted up between 36bps on the short-end and 51bps on the long-end resulting in yields of 6.31% on the short-end (Jan 2014 maturity) and 8.93% on the long-end (March 2036 maturity).

Looking ahead we are likely to increase our bond exposure at yields above 8% in the mid range of the curve and 9% on the longer end. Our equity weighting is also likely to increase from a current neutral position to an over-weight position should a contagion event unfold.

Global equity markets pulled back sharply during March with the Japanese earthquake, tsunami and nuclear accident as well as the tensions in Libya weighing heavily on global risk appetite. From the end of February till the middle of March, the S&P 500 and MSCI World Index fell -5.3% and -6.8% respectively in USD. The All Share Index similarly fell -6.4% in ZAR. As quickly as these indices fell, they quickly recovered, with the S&P 500 and the All Share Index ending essentially flat for the month.

Although the unprecedented disaster and strife that is affecting parts of the world has had an impact on certain local markets, global markets have continued to move upwards. The key risk to financial markets going forward is the threat of higher global inflation. This inflation is evident amongst emerging market countries where the average (of the normal survey of 24 countries) is at 6%, up from 4.8% in early 2010. These increases have resulted in several emerging economies having already reacted by raising policy rates and bank reserve requirements; with further rate hikes expected.

Gold and Oil continued their massive run with both commodities moving higher during March. Gold hit a new high of USD 1444 during the month, but fell back slightly to end at USD 1435 per oz. Oil moved up to USD 117 per barrel - the highest price since early August 2008. The nuclear problem in Japan has led to increased expectations of increased demand for traditional sources of energy - gas, coal and oil - not only as emergency alternative fuels for Japan but also for the medium term as many countries re-examine their nuclear energy policies. While demand persists, the risks of crude oil supply disruption keeps the price elevated.

On a more positive note, the US economy added more jobs than expected in March: the jobless rate fell to 8.8%, a twoyear low, from 8.9% in February. Euro zone unemployment declined for the fourth month in a row in February. The seasonally adjusted jobless rate in the 17 countries that use the single currency fell to 9.9%, down from 10% in January. German unemployment fell particularly sharply, pushing the jobless rate down to 7.1%. This is the country's lowest rate since figures were first published for unified Germany two decades ago. In Asia, China's manufacturing sector regained momentum in March, calming fears of a pointed slowdown, on strengthening demand for machinery and autos. On the currency front, the rand strengthened against all major currencies during March to end at R6.75 to the US dollar, R10.84 to pound sterling and R9.58 to the euro.

Against this backdrop, the PSG Optimal Income Fund performed well with low exposures to the preference share, listed property and equity markets which all experienced sharp declines recently. The current asset allocation within the portfolio is 80% cash & cash equivalents, 8% bonds, 6% equity, 4% preference shares and 1% property. At present the portfolio is conservatively positioned with 11% of the portfolio outside of cash and bonds versus the portfolios upper limit of 20%.

Within a global context, South African assets were amongst the top performers for the year 2010. The rand appreciated against almost all major currencies with the exception of a decline of -2.8% vs. the yen and -1.9% vs. the Australian dollar. The rand strength can largely be explained by the continual flow of capital out of slower growing developed market economies to developing markets which are offering greater growth potential and higher yields on fixed income assets.

As a result local bonds delivered a favourable 15.0% return, the All Share Index delivered 19.0% and the local listed Property Index gained 29.6%. Local cash delivered a paltry 6.4%, however, the return for US investors would have been 19.0% versus the 0.34% return they would have received from cash in their own currency or 4.8% in US denominated government bonds.

Against this backdrop, the PSG Optimal Income portfolio delivered a reasonable pre-tax return of 7.0% and a post-tax return of 5.8% (40% marginal tax rate) vs. a pre and post tax cash return of 6.3% and 3.8% respectively. Small capital gains were realised through small exposures to listed property and net exposures to local equities. Exposure to inflation linked bonds also resulted in a small contribution to capital appreciation.

The portfolio, however, did not benefit from the gains in the bond market as a result of very low exposures to this asset class.

Looking forward we remain concerned about the diminished support offered by equity valuations. The local market is trading on a price to earnings ratio in excess of 17 and is becoming more and more reliant on strong earnings growth for the market to realise appreciable price gains from current levels. As a result net equity exposure is likely to be reduced with a continued focus of maintaining exposure to favourably priced companies which are able to deliver sustainable and stable earnings.

We remain cognisant of the global investor's prevailing preference for emerging market assets as global interest rates remain low. Central banks have shown to be heavy handed (and are likely to continue) in their support of the global economy, preferring to run the risks of future asset bubbles and price appreciation rather than allowing the onset of a deflationary environment. We will therefore continue to hold risky assets in measured amounts with the increased appreciation of the value inflation linked bonds may bring to the portfolio.