The interest rate curve steepened with yields falling slightly in the short-to-mid end and rising in the long dated maturities. As a result, the 7 to 12 year maturities performed best with a 1.59% return, followed by the 3 to 7 year maturities (+1.14%), then the 1 to 3 year maturities (+0.53%) and lastly the 12 year plus maturities with a 0.40% return. Overall the All Bond Index returned 0.93%.

Inflation linked bonds continued to perform very well with a 2.53% return for the index. Long dated maturities out-performed with a 3.24% return relative to short dated maturities which delivered 0.16%. At current levels, Inflation linked bonds do not look favourably valued.
After a very good run over the last couple of months, listed property stocks fared poorly during September with a -4.6% return. This is reflected in the relative yield between listed property and the 10 year government yield having shifted from -0.97% to -0.57%. With the 10 year bond yield trading at depressed levels below 7%, property yields trading at even lower levels do not indicate a good entry point for this asset class.

Equities delivered mixed returns with industrials and financials delivering a poor -0.5%. Resources however reversed prior losses with a 4.77% return. Overall, the All Share Index returned 1.04%.

Looking ahead, the question is: Do yields remain low (post the Citi World Government Bond Index inclusion) or do the ongoing waves of illegal strikes set about dissolving any perceived value global investors see in our market?

We anticipate yields may rise further and therefore the PSG Optimal Income Fund neutrally positioned relative to the 1 to 3 year bond index and will look to increase duration should the opportunity present itself.

Investors have enjoyed great returns in June, despite the ongoing European debt crisis and a slowing global economy. Investor sentiment improved on the back of the market's favourable outcome to the Greek election, EU leaders agreeing to allow rescue funds to be used directly to recapitalise Spanish banks and the introduction of a new system of banking supervision by the European Central Bank.

Local Bond yields fell as a result of strong foreign inflows (All Bond Index inclusion in the World Government Bond Index) and moderating inflation which currently stands at 5.7% (within the SA Reserve Bank's target range of 3% to 5%). The entire yield curve enjoyed a 45bps parallel shift lower, resulting in the following returns across the different maturities: 12+ year's 4.5%, 7 to 12 year's 3.8%, 3 to 7 year's 2.4%, and the 1 to 3 year's 1.3%. The net result was a 3.3% return for the All Bond Index.

Inflation Linked Bond yields remained steady during the month, translating into a 1% return for the Inflation Linked Bond Index. Interestingly, the inflation breakevens have now dropped to below 6% across the curve, with a low of 5% in the 10 year range. Corporate Bond spreads continue to contract as investors scramble for yield. Property yields fell in tandem with bond yields, resulting in a stellar 7.3% (excluding dividends) return for the SA Listed Property Index.

Equities joined the fray with a return of 2.2% for the All Share Index. Financials led the way with a return of 3.6%, followed by 2.4% for Industrials and 1.2% for Resources. The portfolio remains cautiously invested with a predominance of cash holdings equating to 52%. The balance of the portfolio is split between Corporate Bonds (21%), SA Inflation Linked Bonds (14.5%), SA Nominal Bonds (3.5%), Corporate Inflation Linked Bonds (1%), Equities (5.5%) and Listed Property (2.7%).

The PSG Optimal Income Fund is on a current yield of 7.7% and is operating with a standard deviation of 1.7%.

The surprise event for the month was Citigroup's announcement of the possible inclusion of the South African Bond Index in the World Government Bond Index. Bond yields declined sharply as a result of the potential R60bn to R70bn inflow into the local bond mark, should the index be included. The three requirements for inclusion, which the All Bond Index currently meets, are: 1) size, 2) credit quality and 3) lack of barriers to entry. Moody's recent downgrade of SANRAL is unfortunate given the potential negative impact on our sovereign credit rating, and as a result the recent inflows could well be reversed.

Returns across asset classes were favourable for the month with equities leading the way (All Share Index delivering 2.52%). Industrials outperformed (2.94%), followed by Resources (2.25%) and then Financials (1.98%). Listed Property benefited on the back of lower bond yields delivering 2.44%. The All Bond Index delivered 1.83%, with the long-end of the curve (+12 year maturities) out-performing (2.12%), 7 to 12 year maturities 1.72%, 3 to 7 year maturities 1.69% and the 1 to 3 year maturities 0.89%. The Inflation Linked Bond Index also delivered a favourable return of 1.48%.

Recent portfolio activity includes a marginal increase in modified duration through switches out of short dated maturities into longer dated maturities. Within equities, the MTN exposure was sold out (after the recent dividend payment) and switched into Anglo American, Tongaat-Hulett and Sasol, in line with stocks featured on PSG Asset Management's buy list.

The equity market gave up 2.5% during December after strong gains from their lows in August 2011. Leading the losses were Resources down 5.5% and Industrials -1.8%. Financials however gained 1.7%.

At the opposite end of the spectrum, long dated inflation linked bonds delivered 2.7%, continuing their strong rally from their October low.

Listed property also performed well with a total return of 2.1% for the index. The leaders were Octodec, Premium Properties and Fountainhead, with respective returns of 12.3%, 7.2% and 7.1%. Conversely, Capital Shop Centres, Redefine and Acucap delivered negative returns of -3.6%, -2.9% and -2.6% respectivaly once again highlighting the short-term volatility in market prices.

The All Bond Index delivered a return of 0.7%, with long dated bonds out-performing, with a return of 0.9% and short term bonds underperforming with a return of 0.6%. Cash delivered a return of 0.44%.

With real yields dipping below 2.35%, inflation linked bond exposure was sold down recently. Nominal bonds are looking more attractively priced with the implied level of inflation peaking above the 6.4% level, having been as low as 5.4% level four months ago. We remain cautious, however, of increasing exposure to longer dated nominal bonds with interest rates having reached its lows, despite the large 3% gap between the long and short ends of the yield curve.

With the recent drop in market prices, the portfolio's exposure to equity was marginally increased to holdings which are expected to show favourable real returns.