Trailing 12-month profits for the companies included in the FTSE/JSE All Share Index (ALSI) have fallen by 25% from their peak in the first quarter of 2009. Despite this recent fall, they are still close to one standard deviation above the long-term trendline of inflation-adjusted earnings drawn from 1960. This suggests there is further downside risk to company profits.

Our company-specific research is similarly revealing further downside risk to company profits, particularly if the rand remains at its current level around R7.50 / US$.

The market seems to be ignoring the worrying short-term earnings prospects and looking forward to a resumption of the profit growth that characterised the bull market in South African shares over the last decade. After a sharp seven-month rally, the ALSI is trading on 14.6x trailing earnings and on a 2.6% dividend yield. On these valuation metrics, the market appears expensive when compared with the long-term average market P/E of 11.7 and dividend yield of 4.5%.

We are concerned about the downside risks to both profits and valuations. The Fund thus carries a large exposure to high quality businesses such as SABMiller, British American Tobacco and Remgro, whose profits are sustainable, and which can be bought on relatively attractive valuations.

South African mining companies are sailing into a 'perfect storm'. Many commodity prices are much lower than a year ago. For example, the dollar price of the 'basket' of platinum group metals produced by our platinum mines has more than halved from its peak last year. The recent strength of the rand will put further pressure on mines' rand receipts. Against this backdrop of falling revenues, mine managers are facing Eskom tariff hikes of 31% and union demands for 15-20% wage increases. Managing a South African mining company is a difficult job in ordinary circumstances - it is even more challenging now.

If current prices and exchange rates prevail, we estimate that some of South Africa's major mines will be loss-making or break-even at best on a cash-flow basis. The implications are important not only for the stock market, but also for the country's tax receipts (which are already under budget) and for the government's employment objectives.

However, we don't believe that South Africa's major mines will be lossmaking in 'normal' circumstances - something will have to 'give' in order to provide a return on capital. What does surprise us is that the stock market seems to be taking a sanguine view on the approaching 'storm'.

The Portfolio is significantly underweight the Basic Materials sector when compared to the benchmark FTSE/JSE All Share Index. We believe that the Portfolio's holdings in Sasol and the gold miners currently offer the most attractive value in the sector. However, their profits will certainly be under pressure too in this environment.

The ALSI was up 11% in March after being up 16% at one stage. The Fund lagged the strong market with much of the return driven by Billiton and the platinum companies which the Fund is underweight. The local equity market is caught in trading range between the November low of 17 812 and 22 500. This is typical behaviour for a market after a significant decline as investors digest losses and react daily to any new news in light of the changed environment. We continue to focus on finding opportunities within this context.

We remain upbeat but not wildly excited by the value we see in individual shares. Based on our forecasts even a number of the large shares that are not owned by the Fund are offering prospective returns higher than that offered by cash on a four year view. However, as highlighted in previous commentaries we remain aware that the current environment is different from that many businesses and indeed investors have experienced in their lifetimes.

We therefore continue to be alert to the chance that our earnings forecasts for individual companies may prove to be too optimistic and that probability of downside surprises in earnings remains above average. This view is reinforced by the fact that the overall earnings of the market remain very high by historical norms. Therefore the make up of the individual shares within the Fund remains largely unchanged and we continue to believe the current portfolio is attractive.

Given our view of individual shares prices relative to our estimate of their value we would not be surprised to see equities continue to be volatile in the short term.

The Fund suffered negative returns of 14.4% in 2008. While this is disappointing, investors in the equity markets and in this Fund should be prepared to suffer volatility and setbacks in their quest for the higher returns that have historically accrued to investors in the stock market over longer periods. However, the Fund did outperform the benchmark FTSE/JSE All Share Index by 8.8% in 2008. This is mainly attributable to the Fund being defensively positioned in companies with relatively stable demand patterns and strong franchises, and to the strong rebound in the shares of gold mining companies in the last quarter. Despite the Fund's recent outperformance, we continue to see better value in many of the Fund's holdings than we can find amongst many of the more cyclical companies on the JSE. Of course we have no way of knowing how 2009 will pan out, but we hope that the Fund will provide better protection than the FTSE/JSE All Share Index against some of the key risks to companies over the next year, such as: - a slow or shrinking global economy; - squeezing of company profit margins, by a combination of any of falling sales, negative operating leverage, weak pricing power, and increased funding costs; and, - the record deficit on the current account of South Africa's balance of payments, and the associated vulnerability of the rand.