Economic overview
This quarter saw the repo rate left unchanged at 5%. This somewhat masks the reality that the volatility of interest rate expectations was extreme and fluctuated from the market pricing in a cut in April to pending hikes by the time the quarter had ended. The three-month jibar rate rose slightly from 5.125% to 5.15%, while the 12-month rate rose 16 basis points to end at 5.825%. The total return from the Stefi money market index was 1.26% for the quarter. Despite the domestic backdrop being fairly benign, with slowing growth and moderately rising inflation, the global backdrop was turned on its head by the apparent start of policy stimulus withdrawal by the US Federal Reserve. The potential end to the US quantitative easing programme led global fixed-income assets to sell-off dramatically and capital to flow out of emerging markets (EMs). The resultant weakening of EM currencies and the subsequent expected impact on their inflation rates has raised expectations that monetary tightening (rate hikes) may be unavoidable and markets moved to price this in. In our view, this backdrop removes the ability of local authorities to ease rates further, but we believe they will want to keep rates on hold for as long as possible to support the flagging domestic economy. As long as inflation does not run away on the upside and the rand remains relatively stable, even if it is at weak levels, we believe that rates will be kept on hold well into 2014. The risk of a hike rises in a scenario where global capital leaves South Africa in a meaningful way. This looks as though, to some extent, what the forward rate agreement (FRA) market seems to be pricing in. According to this measure of market consensus, the first hike in the cycle will be in the fourth quarter of 2013 and this will be followed by a measured move up, taking the repo rate to 7% by June 2015. While the risk of foreign flows exiting and forcing the monetary authorities' hand has certainly increased, we view a consolidation period for EM assets as more likely and thus believe the FRA market to have moved ahead a little prematurely.

Portfolio overview
For money market investors, negative real returns are likely to linger for some time to come, although the capital stability in cash is hugely appealing in markets where everything else is falling. There are obviously few opportunities for active interest rate risk management, although the slightly steeper yield curve offers a bit of value. The search for yield continues to compress credit spreads, eroding excess money market returns and we have resisted the temptation to reduce the credit quality in the portfolio as a way to bolster the yield, as we do not think that would be prudent in the current environment of uncertainty. The yield on the portfolio has remained stable over the quarter to end the period at 5.03% per annum.

Portfolio positioning
o Duration - there is minimal interest rate risk in the portfolio with rates at such low levels. Modified duration is around 60 days, while weighted average term-to-maturity is at the 120-day maximum in order to maximise yield.
o Yield curve - exposure is concentrated in the three to six month area as the money market yield curve remains relatively flat and investors are not currently being compensated for moving out longer, considering how much of the term-to-maturity limit for the overall fund gets used up by doing this. The yield curve has steepened over the quarter given rising interest rate expectations, but we feel the yield pick-up does not compensate for the duration risk one takes when moving out longer.
o Credit - credit spreads have compressed further as the search for yield by investors makes this an issuers' market. There are still attractive opportunities in non-bank paper, but investors are not being paid as much yield pick-up as, say, 12 months ago. We continue to invest in a range of high quality and diversified exposures, balancing the need for yield with a very strong risk-cognisant approach when evaluating issuer exposure. There are definitely some sectors within the credit market in which fundamentals have been exposed by the lack of economic growth and rising uncertainty in their environments. We avoid exposure to these sectors in the portfolio.

Economic overview
This quarter saw the repo rate left unchanged at 5%, a reality we have become quite used to and one that looks likely to persist for some time to come. The backdrop driving the flat rate environment has evolved somewhat, with a deterioration in economic growth prospects being overshadowed by a rising inflation trajectory and a vulnerable balance of payments position. This is a nightmare for the monetary authorities - stagflation-lite. The economy is crying out for further easing, but rising inflation and a weak rand, resulting from the current account deficit, has put paid to any aspirations that the more dovish members of the committee may have had to ease policy further. The three-month jibar rate remained flat at 5.125% for the quarter, while the 12-month rate rose 20 basis points, as the probability of further easing declined, to end the period at 5.66%. The total return from the Stefi money market index was 1.25% for the quarter.

Our sense is that the authorities would like to ease rates further under their flexible inflation targeting mandate, but they are being severely hamstrung by the weaker rand and the risk that a further capitulation in the currency could lead to an inflation spiral. This balancing act is therefore likely to mean rates are left unchanged for some time as the rand remains on the back foot and inflation drifts through the top of the target band. As long as the CPI profile moves back into the band over the committee's forecast horizon, they will be comfortable leaving rates on hold as their contribution to the economy now that the ability to ease further has been taken away from them. We see the repo rate on hold throughout 2013, as does the market (as evidenced by the FRA curve below), although we have been surprised by how much the FRA rates have ticked up in response to the latest inflation numbers and MPC commentary. All probability of a cut has been taken off the table and the first hike brought forward slightly to Q3 2014.

Portfolio overview
With money market rates stable at such low levels, generating active return as well as beating inflation becomes very difficult. Opportunities for active management of interest rate exposure remain non-existent in a flat rate environment and this looks set to continue if our interest rate view is correct. The net result of this is that investors continue to look to credit in order to generate yield, which in turn has compressed credit spreads and thus places further pressure on the yield of the portfolio. We have resisted the temptation to reduce the credit quality in the portfolio as a way to bolster the yield as we do not think that would be prudent in the current environment of uncertainty. The yied on the portfolio has risen slightly over the quarter to end at 5.07% for the period.

Portfolio positioning
o Duration - there is minimal interest rate risk in the portfolio with rates at such low levels. Modified duration is around 60 days, while the weighted average term-to-maturity is at the 120-day maximum in order to maximise yield.
o Yield curve - exposure is concentrated in the three to six-month area as the money market yield curve remains flat and investors are not compensated for moving out longer considering how much of the term-to-maturity limit for the overall fund gets used up by doing this. The shape of the curve is unlikely to change until there is a material change in interest rate expectations going forward.
o Credit - credit spreads have compressed further as the search for yield by investors makes this an issuers' market. There are still attractive opportunities in non-bank paper, but investors are just not being paid as much yield pick-up for this as they were 12 months ago. We continue to invest in a range of high-quality and diversified exposures, balancing the need for yield with a very strong risk-cognisant approach when evaluating issuer exposure.

Economic overview
This quarter saw the repo rate remaining unchanged at 5%, with the MPC meeting in late November dampening market enthusiasm for another cut. Governor Marcus reiterated that there is only so much that monetary policy can do for the economy and implied that the hurdle rate for a further cut is fairly high (in our view anyway). Both three and 12-month Jibar rates drifted marginally up (6 basis points) to end the quarter at 5.125% and 5.466%, respectively. The total return from the STeFI Money Market Index was 1.296% for the quarter. The monetary authorities are under pressure as long as the domestic threat of stagflation remains a risk. The local economy is likely, in our view, to experience sub-3% growth in 2013 but, despite this, inflation looks set to breach the upper end of the target band(6%) in the second half of the year. This reality means that we will have negative real short rates for the year, without a commensurate growth benefit, at a time when we have twin deficits (budget and current account) approaching a cumulative 10% of GDP. In a world of zero interest rates in developed countries and plentiful global liquidity, this may be feasible, but policy authorities need to be mindful of the distortions this may cause in asset markets and wary of the implication that, at some stage, this cycle will reverse. It is this reality that looks set to keep our repo rate on hold for some time, with authorities unlikely to pursue their flexible mandate of balancing growth and inflation any more aggressively than they already have. We see the repo rate on hold throughout 2013, broadly in line with market expectations, as reflected by the FRA market view below.

Portfolio overview
The full impact from the surprise cut in the third quarter of 2012 has filtered through to the fund and the money market space remains tough in terms of finding yield and protecting against inflation. Opportunities for active management of interest rate exposure remain non-existent in such a flat rate environment and this looks set to continue if our interest rate view is correct. The net result of this is that investors have been pushed into credit in order to generate yield, which in turn has compressed credit spreads and thus yield of the fund even further. The yield on the portfolio has fallen to end the quarter at 4.95% from 5.08% at the start of the period.

Portfolio positioning
o Duration - there is minimal interest rate risk in the portfolio with rates at such low levels. Modified duration is around 60 days, while weighted average term-to-maturity is at the 120- day maximum in order to preserve yield.
o Yield curve - exposure is concentrated in the three to six-month area as the money market yield curve remains flat and investors do not get sufficient yield pick-up for moving out longer considering how much of the term-to-maturity limit for the overall fund gets used up by doing this. The shape of the yield curve is unlikely to change until there is a material change in interest rate expectations going forward.
o Credit - credit spreads have compressed further as the search for yield by investors makes this an issuers' market. There are still attractive opportunities in non-bank paper, but investors are not being paid as much yield pick-up for this as, say, 12 months ago. We continue to invest in a range of high-quality and diversified exposures, balancing the need for yield with a very strong risk-cognisant approach when evaluating issuer exposure.