Market review
The third quarter of 2009 provided evidence that the global economy is on the mend. A sharp fall in the rate of job shedding, stabilising house prices, a turnaround in consumer confidence and expanding industrial production in developed economies, marked what is likely to be the end of a deep and protracted global recession. Over the quarter, global equity markets continued to head higher, with a 17.6% rise between July and September over and above the 21% gain in the second quarter of 2009. Cyclical stocks led markets higher, reflecting an improving economic outlook. Financials (25.9%), materials (21.5%) and industrials (19.8%) all ended strongly, while utilities (11.3%), healthcare (12.3%) and energy (12.9%) lagged the overall market. Emerging markets extended their gains over developed markets, closing the quarter 21% higher and ahead of the global composite for the third consecutive quarter. (All returns are in US dollars). Risk appetite has greatly improved over the last few months. The rand continued to benefit from massive foreign portfolio flows into the local bourse, more than offsetting the outflows seen in the second half of 2008. The local currency appreciated by nearly 3% over the third quarter, pushing the year's gains to 22% against the US dollar. The downward trend in inflation is likely to continue, but at a slower pace into 2010. Weak demand, the strong rand and the better nearterm inflation outlook, saw the monetary policy committee cut interest rates by a further 0.5% to 7% in August. The All Bond Index returned 3% over the third quarter, while cash, as measured by the STeFI, gained 2%. The domestic equity market took its cue from global markets, which benefited from the improvement in the global growth outlook and a higher risk appetite. The All Share Index added 13.9% in the third quarter and has gained 18.6% this year. Over the quarter, the All Share Resources Index (11.1%) lagged the overall market, with gold miners earning a disappointing 6%. Domestic-oriented and interest rate-sensitive sectors enjoyed good gains. Construction (19%), general retailers (19.1%) and banks (14%) stood out as strong performers, with foreigners particularly active buyers. Telecommunication (3.8%) and short-term insurers (6.1%) underperformed the market.

Portfolio review
Equity market strength over the last two quarters is in stark contrast to the conditions that prevailed during the previous six months. Central banks have done a good job in achieving stability over the last few months. We have not based our investment decisions on a speculative recovery in markets. Instead, we continue to evaluate the prospects for good businesses with whom we are prepared to partner as capital providers. We also remain focused on identifying less established enterprises that offer value. The performance numbers generated have been pleasing. Despite high inflation, the Investec Opportunity Fund's returns have been well ahead of inflation year to date. We are encouraged that inflation is moving lower, enabling investors to compound their savings at reasonable real rates. The only area which has detracted from performance has been the foreign component of the portfolio. Despite good non-rand performance from the foreign equity and bond components, the strong rand has reduced the value that has accrued to the portfolio.

Portfolio activity
We added materially to our bond position over the quarter. Our view is that the market's concerns around the size of the budget deficits and the impact of rand weakness on bond yields have been overdone. Regarding the potential for revenue shortfalls impacting on bond issuance, we note that institutional investors are massively underweight in bonds. The chart suggests that even if South Africa runs budget deficits of 7% of GDP for three years, this will only raise the government debt to GDP ratio to 33%, based on conservative growth assumptions. Europe and US debt levels exceed 70% of GDP and in the case of Japan, it is over 150%. Given the low bond weighting by local investors and their appetite to buy at higher yields, rand weakness should not lead to substantially higher bond yields. The bond market has also proved to be fairly resilient to recent episodes of rand weakness. In short, we think the downside is limited. We have also sought out insurance against a further decline in cash rates, and the potential for inflation to fall further - given the weakness in the rand prices of commodities and the local economy. The current shape of the yield curve suggests that investors are being rewarded for being in bonds versus cash for the first time in five years.

Portfolio positioning
Though equities are unlikely to be supported by further interest rate cuts, the earnings base of the market is sufficiently depressed that earnings multiples will remain high. There may be an uncomfortable patch, which could last another six months, where earnings need to first bottom out and then catch up with the levels of growth suggested by the recent market rally. We doubt that the market will sell off substantially until it becomes clearer how big the next up cycle is in earnings. It is too early to substantially lower equity weightings. Given the quality of our stock holdings, we are comfortable that the rewards offered still exceed the risks. Our investment in bonds has been at the expense of cash. In the foreign equity portfolio we disposed of our holding in Cadbury, after a 36% rise in the share price, following the bid from Kraft. It is hard to see how the price could be justified by growth and margin assumptions. The proceeds of the sale have been allocated to Nestlé and Accenture, which continue to offer great value.

Market review
The improved growth outlook was reflected in sharply higher equity prices. The MSCI Word Index gained 21% over the second quarter. Markets were led higher by cyclical sectors. Defensive sectors, which had outperformed the market as economies collapsed, lagged the upturn, but still recorded absolute gains over the quarter. The S&P 500 Index gained 15.9%, lagging both the German Dax 30 Index (24.4%) and UK FTSE 100 Index, which gained 26% over the quarter (all in US dollars). The local equity market had a positive quarter (8.6%), its first in 12 months, despite giving up some of its gains during the month of June (-3.1%). Year to date, the All Share Index closed 4.1% stronger. The market's foreign currency returns for the three month to the end of June, were boosted by the rand's appreciation against the US dollar (24.1%) and the euro (16.7%). Over the quarter, the financial and industrial composite (13.4%) outperformed resources (2.8%), with gold miners (-16.2%) the largest underperformers. Other sectors lagging the composite over this period included fixed line communications (-0.8%), travel and leisure (6.6%) and food producers (7.7%). General retailers (15.6%), banks (13.8%) and the construction (16.6%) sectors all ended the quarter well above their March levels. The platinum (9.5%) and general mining (8.9%) sectors performed in line with the overall market. The bond market continued to struggle, with the All Bond Index returning 0.3% in the second quarter. The negative factors outweighed very weak final demand and activity data and a strong domestic currency, to push yields higher across the curve. Inflation data remained sticky around the 8% level, while the announcement of substantial tax revenue shortfalls announced by the ministry of finance provided further support to the bond bears. The decision to leave rates unchanged in June was not entirely surprising, given previous remarks by the Reserve Bank governor. Listed property underperformed equities, bonds and cash, losing -0.9% over the quarter. Cash, as measured by the STeFI, returned 2.3% for the three months to the end of June.

Portfolio review
Word market fears of a depression gave way to some cheer in the second quarter of this year. The efforts of central banks and governments around the world to ease the brunt of the downturn have meant that expectations have changed from a global economic depression to "only" a recession. The portfolio enjoyed better returns in the second quarter, elevating the performance into positive return territory, year to date. Economically sensitive equities led the charge, and the portfolio enjoyed a significant portion of the tailwind. However, we remain cautious about highly cyclical, low margin, indebted businesses. We are confident that the portfolio will see positive 12-month return figures from the end of July 2009.

Portfolio activity
We trimmed the holding in MTN taking a view that the initial indicative offer by Bharti Airtel was not destined to lead to a full offer in the near term. Our contention was also that uncertainty in respect of the deal would prevent further upside from being reflected in the price. We do not believe the current format of the deal is attractive to shareholders. We purchased a holding in Old Mutual below R8 to exploit the value on offer, but we are aware that the future share price is very dependent on a recovery in global equity and credit markets. The lack of dividend support does not allow for a bigger weighting.

Portfolio positioning
The portfolio continues to have a reasonable holding in equity and we believe that good value is being unlocked by better market conditions. The near term earnings prognosis for the companies' shares we hold is muted. However, attractively valued good businesses should at least maintain their capital value, and as the economy improves, this should translate into higher profits and better capital values in the future. Two of our largest defensive holdings, namely British American Tobacco (BAT) and the weighting in the gold exchange traded fund (ETF) have lost capital value this year. We believe that a potential leadership change in markets will be initiated by defensive assets such as these. The domestic bond market is starting to struggle again, amid sticky inflation and increased issuance of new paper emanating from the anticipated budget shortfall for 2010. We continue to wait for more attractive levels before committing money to this area of the market. Inflation expectations are also starting to rise globally. In respect of listed property, we still do not see much more upside than cash and hence we retain larger holdings in cash. The incredibly strong currency has also hurt the returns of the foreign holdings of the portfolio. The rand was the world's strongest currency in the first six months of this year. Notwithstanding rand appreciation, the foreign equity component of the portfolio delivered 17% in US dollar terms for the past quarter. The equity component is still over 11% ahead of the MSCI World Index over the past year. Above inflationary wage agreements come at a time when sales volumes are under pressure. We are concerned that this will hurt weaker local SA businesses across the board, particularly when the international competitive position has been eroded due to the strengthening rand. We expect stagflation (zero or negative growth with accelerating inflation) and potential risk aversion (i.e. investors favouring developed markets) to be negative for the currency. This makes the foreign component at the current juncture an incredibly important source of non-correlated returns.

Market review
Local economic news continued to deteriorate over the quarter. The release of fourth quarter GDP numbers confirmed the sharp slowdown experienced in the second half of 2008. Domestic demand remained under pressure in the first three months of 2009. Weak employment prospects and the slump in the manufacturing sector continued to bear down on retail spend and vehicle sales. Policy makers responded with two interest rate cuts of 100 basis points each during the quarter. The second meeting, held earlier than initially scheduled, indicated somewhat greater urgency on the part of the South African Reserve Bank to respond to the extremely weak global backdrop and evidence that the local economy was unlikely to escape a recession. The outlook continues to favour more rate cuts.

South African bonds followed global yields higher after reaching record lows in December. While prospects of weak growth and falling inflation continue to provide a bond-friendly environment, the market remains sensitive to the impact of a rapid increase in government spending and concomitant future funding requirements. The All Bond Index lost 5.1% over the quarter. The listed property sector (-1.4%) fared somewhat better, but could not escape deteriorating sector fundamentals. Cash, as measured by the STeFI, returned 0.9% over the quarter.

Equities weakened for the third consecutive quarter, with the All Share Index losing 4.2% year to date. Both financials (-7%) and industrials (-9.2%) ended the quarter in negative territory. Resource counters clawed back some of their losses sustained in the second half of 2008 to end up 1.6%. Gold mining (22.8%), platinum mining (9.6%) and pharmaceuticals (22.4%) were the only sectors to gain over the quarter. While general miners (-4.6%) performed broadly in line with the overall market, it was the domestic oriented sectors that fell most with banks (-9.8%), retailers (-7.6%) and the construction sector (-10.6%) all ending down.

Portfolio review
The first two months of the quarter were driven by 'end of the world' type assets delivering a positive performance, i.e. gold, cash and treasuries, and everything else collapsing. What investors really witnessed was the final movement that took the peak to trough return from global equities to a real loss of capital that even exceeded declines during the onset of the Great Depression.

The most sensible, indeed rational response from long-term investors was to continue to judiciously take on risk. During the quarter markets reflected a great deal of pessimism and concern, with some investors questioning whether capitalism and equities would survive a transition to a new world order.

The equity market rally in March was very welcome, signalling that patient equity investors may not have to wait too long to see some signs of better times. Indeed, by the end of the quarter portfolio values were on the rise again. The Investec Opportunity portfolio enjoyed strong gains in March, partially offsetting earlier losses in the quarter.

Portfolio activity
As quality investors we have resisted the temptation to accumulate assets of questionable pedigree, particularly where we see no reason to expect rising long-term intrinsic values and where the investment case is akin to a night at the roulette table where people will bet on red or black. Such assets typically are fairly controversial, have poor balance sheets, and are marginal. We continue to avoid these as we do not believe that the worst crisis in 80 years will not produce casualties.

Physical gold still represents a hedge against a weakening dollar, rising global inflation or deflation. The yellow metal is a geo-political asset that will hold value if the world returns to protectionism. We increased our weighting to gold over the quarter. The portfolio's MTN weighting was also increased. We are confident that the business will grow and flourish over the medium to long term.

Portfolio positioning
The portfolio has a very high exposure to equity assets that display incredibly attractive values. We acknowledge that there are risks in respect of corporate profits, companies' cash flows and balance sheets. We are aware that unemployment still poses a serious risk to consumers. However, we believe that a declining interest rate environment will put money into people's pockets and encourage riskseeking behaviour, including a return to real assets capable of generating above inflation returns.

For many developed world investors, just simply sitting on the sidelines is not an option, given that cash earns no return, and that inflation will be a longer-term problem that needs to be addressed. The size of the cash pile earning no return exceeds the value of all equities in the United States. One can therefore expect that when the market turns, the upside risks could be quite dramatic.

We favour high quality global franchises that sell essential items to their customers. The shares of these businesses have outperformed the MSCI World Index in the past 12 months, but have yielded capital losses. We do not believe that current share prices reflect the intrinsic values of these businesses. In addition to great amounts of cash sitting on the sidelines, we see very attractive valuations on offer and pricing that should give strong real returns for investors with a horizon of more than three years. We are still not finding reasonable riskadjusted returns from either bonds or listed property, and continue to largely avoid these asset classes.

Market review
The final quarter of 2008 brought no relief to investors, consumers or policy makers as the financial crises and concurrent economic slowdown continued to unfold. Activity data across the globe reached multi-decade lows, marking the worst global recession post World War Two. The quarter was characterised by accelerating job losses, falling house prices and tighter bank lending standards. While macro fundamentals deteriorated sharply, yields on US government debt plummeted to new depths, indicative of the ominous economic outlook. Global equities experienced one of their worst periods in history, erasing impressive gains over the last few years. The MSCI World Index fell 21.7% over the quarter in US dollars and was down 40.3% in 2008. The MSCI Emerging Markets Index lost 27.6% over the fourth quarter in US dollars to end the year down 53.2% - surpassing its previous crash during the Asian crises in the late 1990s.

On the domestic front, bond yields continued their downward move as both the weak growth and lower inflation outlook favoured the potential for significantly lower interest rates. The All Bond Index gained 11.3% in the fourth quarter to end the year up 17%. Cash, as measured by the STeFI, rose 2.9% over the quarter and 11.7% for the year. The listed property sector increased by 8.5% over the fourth quarter, but returned -4.5% over 2008.

The global financial crises and the ensuing slowdown in economic activity left their mark on the domestic equity market. The All Share Index lost 23.2% over the year, all of the losses sustained in the second half of 2008. The market ended 9.2% weaker over the last quarter of the year, with falling commodity prices driving down platinum (-25.8%) and general miners (-15.2%). The construction sector slumped 36.1% in the fourth quarter as companies saw their order books curtailed by weaker demand and foreign investors seemed to lose faith in the sector. Life assurers (-15.9%) continued their underperformance of the general market. Exposure to falling interest rates and defensive earnings streams dominated the outperformers over the quarter, with banks (-6.1%), healthcare equipment and services (5.6%), food producers (6.6%) and food retailers (16.2%) high up on the performance table. However, it was the gold miners (22%) that took the top spot over the quarter as the dollar gold price held its own and rand weakness and positive production news boosted returns to the sector.

Portfolio review
A year ago we anticipated tough market conditions in 2008 and we subsequently invested with the overall view of avoiding the biggest sources of capital loss. Despite this, we were surprised that the global equity market sell-off lasted beyond September 2008. We anticipated a global recession, but the depth and duration remain uncertain. The Investec Opportunity Fund outperformed the equity market significantly in 2008. The All Share Index lost 23.2% over the calendar year, but the portfolio only had a small drawdown. The strategy that we employ on your portfolio should provide implicit downside protection in tough times.

We fully appreciate that the returns for 2008 was below that of inflation. However, the portfolio managed to be well ahead of inflation over three and five years. We have full confidence in being able to produce superior real returns over the long term. The biggest surprise for the year was how quickly world fears about inflation (rising prices) changed to concerns about deflation (falling prices). A massive surge in commodity prices in the first half of 2008 (effectively the inflation hedge) gave way to the rally in bond markets (the deflation hedge). The bond rally in the second half of the year was nothing short of monumental, given that inflation was higher than the absolute levels of bond yields.

Bond rates are still not compensating investors for inflation. The possibility of deflation seems highly unlikely and therefore bond yields might be too low at current levels.

The portfolio only had limited exposure to resource shares, which were amongst the biggest losers for the year. However, these shares were the only ones able to generate positive market returns in the first six months of the year. In fact for the second year in a row, Assore generated a positive return in 2008 and was amongst the best performing shares for the year. Other shares in the portfolio that contributed to the positive equity performance over the year were Tiger Brands, Remgro, Naspers, Illovo and the gold exchange traded fund.

Even in this tough economic environment the capital gains from shares in the portfolio are likely to be pleasing as the ratings should improve on lower short-term interest rates. With attractive value emerging across the board within equities, the opportunity to own more shares has emerged. The market is paying patient long-term investors handsomely for taking on risk. This risk will be rewarded with superior returns in the next three to five years.

Portfolio activity
We have reduced the explicit equity protection in the portfolio, thereby raising the equity weighting. The portfolio is relatively fully weighted in equities. We see many opportunities across the sectoral spectrum, and do not have a particular preference.

Portfolio positioning
Macro-economic risks are reflected in asset prices across the board. Local bond markets are discounting inflation at the bottom end of the South African Reserve Bank's inflation band, and global bonds are anticipating deflation in the developed world. There are significant risks for businesses whose earnings are heavily dependent on strong economies, but these risks are being priced into these shares. We anticipate that 2009 will not revolve around earnings, but the focus will rather be on valuations as competing asset classes increasingly offer lower prospective returns.

We have learnt not to forecast over short periods, but rather to invest with a full appreciation of the risks and likely rewards over the longer term. The risk of capital loss from equities has diminished significantly, and in fact the upside risks to commodity prices are significant. Strong infrastructure spending by governments around the world could provide much needed demand for the resource sectors, particularly if one looks beyond the near-term risks of a synchronised global recession. Commodities are trading below the marginal cost of production, and we are seeing producer cutbacks occurring across the board. This supply side response suggests that commodity prices have bottomed. If this is the case, then a gradual upward movement in commodity prices should see a corresponding rise in the JSE.

The likely course of events in 2009 will be firmer global equity prices, a higher appetite for risk, lower debt costs, higher Treasury yields, and firmer commodity prices. We could also see stronger emerging market currencies, despite falling short-term interest rates.