The aim of the Strategic Income Fund is to provide high income with greater diversification than a pure income fund as well as to seek opportunities to maximise capital gains. Based on this objective, the fund manager's increased the funds exposure to bonds quite significantly during the quarter at a time when bond yields retraced to levels that the fund manager's considered cheap relative to their fundamental value. The fund manager's subsequently reduced this exposure when the bond market strengthened towards the end of the quarter.

The fund manager's also increased the funds weighting of good quality property stocks throughout the second half of the quarter, based on the fund manager's view that listed property should provide attractive returns in real terms on the back of improving fundamentals and relatively low inflation.

The corporate bond market was quite active during the period, which provided the fund manager's with an opportunity to slightly increase the funds corporate exposure within the fund through the inclusion of selective high quality issues which the fund manager's felt to be attractively priced. This will enhance the yield earned on the portfolio.

The fund also benefited from the credit ratings upgrade of African Bank which provided a healthy capital gain within the fund.

At current levels, bond yields are discounting a great deal of optimism and are approaching levels where the fund manager's feel they would, at best, be fairly valued. The fund manager's intend to continue reducing the funds exposure to bonds as the fund manager's see strength in the bond market, and will increase the funds exposure to money market investments in order to protect the fund against the risk of capital losses should bond yields retrace to higher levels.

Against a backdrop of a bond-friendly international environment coupled with an increasingly positive local inflation outlook, SA bonds continued their rally, pushing yields to unprecedented levels.

The fund manager's now consider the risks in the bond market to be relatively balanced, with a fair amount of optimism already built into yields at current levels. Going forward, a cautious approach to long term yields will be adopted and the fund manager's have already implemented strategies to protect against the possibility of yields retracing to substantially higher levels.

The risks of potential weakness in international bond markets, possible stickiness in the downwards trajectory of the inflation path (due, amongst other factors, to stubbornly high wage settlements and administered prices) as well as a possible increase in bond supply pressures should be carefully balanced against the positive backdrop created by a strong currency and positive domestic economic data.

From a corporate bond perspective, the fund manager's still see value in selective issues which offer beneficial yield enhancement to the funds core portfolio position. With regard to property, the fund manager's have been steadily increasing the funds exposure as they consider property yields on balance to be an attractive source of return relative to current long term rates.

The fund manager's have reduced the funds holdings entirely in Australian and New Zealand dollar assets and intend to utilise the proceeds to bolster the funds money market exposures in order to capitalise on the attractive returns currently offered by the short end of the money market curve.

The fund benefited substantially from positions in longer-term bonds, which delivered moderate capital gains over the quarter. In addition, our property exposure provided some outperformance due to a focused approach to selected stocks.

The funds offshore exposure produced disappointing returns for the fund. While the underlying assets added value, a strengthening rand meant that, in rand terms, a substantial amount of this value was eroded via currency translation losses. From a longer-term perspective, the diversification of income sources will ultimately prove to be beneficial.

Given regulatory constraints on the ability to hedge currency risks, the manner in which the offshore exposure has been hedged has been via currencies highly correlated to the rand. As a result, the funds offshore exposure moved entirely to Australian and New Zealand dollar assets during the quarter. The currency risks, while not entirely hedged out, are now substantially reduced, and this should translate into lower volatility for the fund in the future.

Given the uncertainties surrounding global bond yields and the current levels of local bond yields, a more cautious approach to longer-term bonds will be warranted going forward. This will be reflected in the duration of the fund's bond holdings, which will almost certainly be reduced during the course of the next one to two quarters.

While the fund benefited greatly from its exposure to long-term bonds, as well as from the floating rate securities (high income coupled with moderate capital gains), a lot of those benefits were negated by the offshore exposure held in the fund.

Naturally, offshore exposure in a market where the rand was strengthening detracted from performance - especially in the last few weeks of 2002. The fund manager's underestimation of the potential strength of the rand in this context is disappointing. However, South African's are beginning to see the first signs of the effect of a stronger currency on the macro economic environment - particularly in the earnings prospects for exporters. The ultimate effect will be to see a moderate reversal of the strength in the currency and lead to, at worst, a consolidation phase. This may be realised within the first half of 2003.

The first cut in interest rates should start coming through by June 2003, at which point it is anticipated that the bond market would have already discounted the majority of potential good news. By mid-2003, it is expected that the fund's exposure to long bonds would have been reduced.