Fund review
The All Bond Index (ALBI) returned 2.96% over the third quarter much better than the previous quarter, due to the SARB (MPC) surprising the market by cutting the repo rate by 50 basis points against market expectation of rates remaining flat. The RSA 2015 R157 started the quarter at 8.47%, touched a worst daily closing level of 8.78% where more demand for paper increased. The market subsequently squeezed lower on improved fundamentals, touching just below 8.0% before ending the quarter at 8.29%. The Fund's modified duration was increased during the quarter to take into account the ALBI benchmark reweighting and reconstitution which increased by 0.3 years. The Fund retained the underweight exposure in the 12+ area and a bullet overweight in the middle sector of the yield curve. The Fund benefitted from a compression of corporate bond spreads. There were a number of bond friendly fundamentals that to outweighed 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. The potential corporate action between MTN and Bharti led to a slight strengthening of the rand and, consequently, was further supportive for bond yields during the quarter. The emerging market bond index (EMBI) compressed significantly as the carry trade favouring emerging markets came back in favour. Domestic corporate credit spreads, which had by the beginning of the 3rd quarter not really responded to the global tightening trend, finally started narrowing as risk aversion waned.

Looking ahead
The bond market will continue to look for a balance between bond supportive fundamentals - like slow inflation and tepid real economic growth estimation - versus an avalanche of paper supply to fund the growing budget deficit. The SARB has already cut rates by 500 basis points in the current downturn, which could signal the bottom. As a result, the Fund will maintain a short modified duration and keep the underweight position in the long end of the curve. Corporate spreads are expected to continue tightening, thereby benefiting the Fund's exposure to this asset class.

The All Bond Index (ALBI) retumed 0.29% over the quarter as the market continued to be adversely affected by the increasing supply of paper, the result of the widening fiscal deficit for this financial year. The benchmark R157 2015 paper started the quarter at 8.17%, traded down to 7.84% before ending the quarter at 8.47%. In terms of the Fund positioning, holdings in the 12+ area of the yield curve were reduced further with the proceeds placed in the money market. The Fund retained its overweight position in the middle sector of the yield curve. During the quarter, the Fund's long modified duration was reduced significantly below that of the All Bond Index benchmark as it became clear that supply was going to dominate over fundamentals. Govemment issuance outweighed other conflicting pressures to the yield curve such as the slowing economy, the compression in emerging market spreads, a 200 basis point decline in interest rates for the quarter and the thawing of volatility as measured by the VIX Index. With govemment and state owned entities issuing longer dated paper we saw the yield curve continue to normalize. The Rand remained on the front foot, pairing all the losses after the credit crisis, and ended the quarter at R7. 75 against the dollar. This appreciation was buoyed by the dollar which weakened against major currencies. Inflation continued its downward trend with the May CPI number coming in at 8.0% but this was still well above the targeted level of 6 - 3%. At the same time the oil price continued to recover and the spot price of Brent crude moved from below $50 per barrel at the end of March to end the quarter at around $70 per barrel. 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 and the repo rate was left unchanged. The next MPC meeting is at the end of August and, given the strong signal from the Reserve Bank Govemor, the SARB is more likely to leave the repo rate unchanged unless macro economic data deteriorate much further than is expected.

The bond market returns for the first quarter turned negative, which was as a result of the market responding negatively to an increase of paper supply after the government announced a larger than expected budget deficit for financial year 2009/2010. The benchmark R157 2015 bond closed the quarter at 8.17% compared to the previous quarter's close of 7.21% as supply dominated market events. Corporate bond spreads continued to widen. The Fund reduced its holdings in the long end of the yield curve to underweight. The modified duration of the Fund was cut from 6.4 years to 6.1 years as yields weakened on paper supply concerns.

During the quarter, the SARB MPC announced that it will hold frequent monthly meetings in order to better respond to the global crisis affecting the real economy. This was interpreted by the bond market as a sign of deeper cuts to come in future. Although there was subsequent volatility in the bond market as a result of supply concerns and headline inflation which was released higher than consensus expected in February, yields in the market remained well supported into weakness by an improvement in measures of risk aversion. The Rand experienced ample volatility in response to global uncertainties, but staged a late recovery to end the quarter roughly unchanged as the risk aversion trade dissipated. The oil price remained range bound during the quarter closing slightly lower than the previous quarter. Both the JP Morgan Emerging Market Bond Index (EMBI spread) and the South African sovereign spread compressed as risk aversion thawed, putting a cap on any further weakness in bond market yields. The SARB MPC's next meeting is at the end of April; with the potential for more adjustments in the repo rate remaining a strong possibility. The SARB is getting more worried about the widening output gap, and the need to use monetary policy to support the economy.

The bull market which commenced in the third quarter was further entrenched in the fourth quarter as demand for bonds saw yields on the RSA 2015 R157 paper touch all time lows below 7.0% before ending the year at 7.21%, after opening the quarter at 8.86%. The modified duration of the Fund was aggressively increased from 5.8 years to 6.4 years to take advantage of the yield decline. Holdings in the long end of the yield curve were increased further on expectations of higher capital growth. These purchases were funded by selling shorter dated instruments. Credit spreads during the quarter remained at higher levels. 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 meeting on the 12th February and the outlook is for the repo rate to be reduced further. Key to the easing cycle in 2009 will a combination of slower economic growth and lower inflation expectations, which will leave bond returns positive. Modified Duration: 6.4 Years