Fund review
Trades for the third quarter ending 30 September 2009 included the purchase of shorter dated money market instruments offering a higher yield. The Fund's modified duration position was reduced to shorter than the Index as the interest rate cycle neared its end. The modified duration position in government bonds was reduced through the sale of RSA 2015 R157 paper and purchase of RSA 2014 R206 bonds, cutting the exposure in the 3-7 years sector of the yield curve. Purchases of corporate bonds consisted of Standard Bank, Absa, Firstrand, African Bank, Basil Read, Barloworld and Toyota Financial Services at attractive spread levels. The exposure to floating rate notes was also increased due to the attractive levels being offered in the market and expectations of interest rates bottoming out.

There were a number of bond friendly fundamentals that were able to outweigh the supply concerns during the third quarter, namely: Positive comments from the Reserve Bank about the inflation outlook given weaker real economic growth and the widening output gap with most forecasts now indicating that inflation should fall into the 3% to 6% target band in the second quarter of 2010 and the 50 basis points cut in the repo rate that was announced during August as a result of the improved inflationary picture. But perhaps of concern to some is that the market is pricing in a 70% probability of a 50 basis points hike in twelve month's time. Shorter dated bond yields declined during the early part of the quarter as the repo rate was reduced, but later on yields traded higher as the SARB left the repo rate unchanged in the subsequent meeting. The RSA 2010 R153 started the quarter at 7.35%, touched 7.15%, before ending the quarter at 7.50%. The 12 month NCD rate traded from 8.35% to 7.75%, before ending the quarter at 8.10%.

Looking ahead
The SARB forecasts lower headline inflation for the foreseeable future particularly if growth continues to surprise on the downside, increasing the probability of another rate cut in the latter part of the year. The interest rate markets are not pricing any further rate cuts at the moment, but the headline fundamental numbers will be the key driver of any further action by the SARB. Domestic corporate credit spreads, which had by the beginning of the 3rd quarter not really responded to the global tightening trend, finally did start narrowing as risk aversion waned.

Trades for the second quarter ending 30 June 2009 included the purchase of shorter dated money market assets at higher yields. The exposure to government bonds was significantly reduced through the sale of RSA 2015 R157 bonds. Due to increased supply concerns in the long end of the yield curve, longer dated bonds were switched for shorter dated instruments thereby reducing duration at the same time. Purchases of corporate bonds consisted of Investec and Nedbank paper. The exposure to floating rate notes was maintained due to the attractive levels being offered in the market and expectations of interest rates bottoming out.

During the second quarter of 2009 the South African Reserve Bank (SARB) MPC reduced the repo rate by 200 basis points to 7.50%, a decision which was precipitated by a deteriorating local economy despite consumer inflation remaining elevated. The SARB MPC remained concerned about weak real economic growth and the widening output gap. Shorter dated bond yields rose during the quarter as the probability of further repo rate cuts was fully priced and the SARB surprised the market by leaving the repo rate unchanged. The RSA 2010 R153 started the quarter at 6.89% touched a best level of 5.87%, before ending the quarter at 7.19%. Following the disappointment from the SARB, money market rates which had seen the 12 month NCD trade down to 7.5% retraced to higher levels, ending the quarter at 8.30%. Jibar, which measures interbank lending also retraced higher. With inflation not behaving as expected, the accommodative monetary stance that saw the SARB front load the rate cuts, was abruptly changed in the June SARB MPC. The next MPC meeting is at the end of August and, given the strong signal from the Reserve Bank Governor, the SARB is more likely to leave the repo rate unchanged unless macro economic data deteriorate much further than expected.

Trades for the first quarter ending 31 March 2009 included the purchase of RSA 2015 government paper. Due to supply concerns in the long end of the yield curve, the Fund sold RSA 2018, RSA 2026 and Eskom 2033 paper and purchased shorter dated instruments. The modified duration position was significantly reduced, but a long modified duration position against the benchmark was retained. Purchases of corporate bonds consisted of Investec paper. The exposure to floating rate notes was reduced by switching to fixed rate instruments. Exposure to property was maintained at the maximum level to participate in the positive sentiment driving the property market as a result of lower long term yields. No further exposure to preference shares was taken.

During the first quarter of 2009 the SARB MPC reduced the repo rate by 200 basis points to 9.50%, a decision which was precipitated by a significant improvement in the outlook for inflation going forward, as well as further deteriorating global and local markets. The SARB MPC is putting more weight on softer economic growth concerns as inflation continues to decline, precipitating deeper cuts in the repo rate. The global credit crisis has spread to the real economy impacting it negatively. Most economic forecasts are predicting a global recession in 2009, leading to further unwind of energy and food inflation prices. Short dated bond yields declined further with the RSA 2010 (R153) paper yield trading from a high of 7.30% at the beginning of the year to close the quarter at 6.89%. The outlook for short term rates remained fairly positive with the FRA curve discounting further rate cuts in 2009. Money market rates remained elevated in relation to bond yields due to the funding constraints in the banking sector, heightened by risk aversion. The 12 month NCD rate traded a high of 10.05% at the beginning of the year, ending the quarter at 8.25%. The bond market has seen reduced demand for higher duration bonds due to supply concerns. The SARB MPC changed their meeting schedule from bi-monthly to monthly to be more proactive with monetary policy in a rapid changing global environment. Key to further rate easing in 2009 will be a combination of slower economic growth and lower inflation expectations.

Trades for the fourth quarter ending 31 December 2008 included the sale of shorter dated money market instruments to fund the purchase of longer dated bonds. Purchases of government paper consisted of RSA 2015 paper. The exposure to floating rate notes was reduced to extend the duration through the purchase of fixed rate paper to participate in the downward movement in market rates. Exposure to property was increased to participate in the positive sentiment driving the property market as a result of lower long term yields. No further exposure to preference shares was taken. The fourth quarter of 2008 saw the SARB MPC reduce the repo rate by 50 basis points to 11.50%, a decision which was precipitated by a dramatic improvement in the outlook for inflation during the quarter, as global markets weakened further, creating a friendly environment for bonds. With the global credit crisis still progressing and negatively impacting the real economy, the probability of a protracted world economic recession is elevated leading to the main drivers of inflation unwinding as the oil price receded from $147 per barrel to below $40 per barrel, a fall of 72.0%. Food prices, which have been an Achilles heel, are also set to decline, a welcome precursor to lower inflation. Bond yields declined sharply with the RSA 2010 (R153) paper yield collapsing by 2.1%, trading from a high of 9.37% at the beginning of October to close the year at 7.30%. The outlook for short term rates changed dramatically with the FRA curve discounting aggressive rate cuts in 2009. Money market rates remained elevated in relation to bond yields due to the funding constraints in the banking sector, heightened by risk aversion. The 12 month NCD rate traded a high of 12.45% at the beginning of the quarter, ending the year at 9.70%. The bond market has seen good demand for higher duration bonds as the benchmark All Bond Index was reconstituted and reweighed. The SARB MPC meets for their next interest rate decision on the 12th February and the outlook is for the repo rate to be reduced further. Key to the easing cycle in 2009 will be a combination of slower economic growth and lower inflation expectations, which will leave bond returns positive.
Modified Duration: 4.5 years