Market review
Central bank talk dominated financial markets over the past quarter. Investors reacted positively to the Bank of Japan's announcement early in the quarter about its large-scale monetary easing policies. Riskier trades were particularly well supported, and emerging market equities started to retrace some of the earlier losses. However, US Federal Reserve Chairman Ben Bernanke put a damper on rampant asset price appreciation by hinting that the market should recognise record policy accommodation as finite and data dependent. Even though his comments were merely providing guidance, markets responded immediately. Emerging markets saw one of their weakest months on record. Currencies depreciated against the US dollar and local currency debt - which has been a beneficiary of global investment flows for a long time - sold off sharply. Commodity prices followed other risk assets, first up, then down sharply in June, as global economic growth data remained mixed and the road to a rebalanced Chinese economy seemed rocky. The MSCI AC World NR Index returned -0.4% in dollars over the quarter. Emerging market equities underperformed developed market equities, with the MSCI Emerging Markets NR Index losing 8.1% over the quarter. The Citigroup World Government Bond Index (All Maturities) gave up 3% over this period. The All Bond Index lost 2.3% in rands over the quarter while inflation-linked bonds shed 5% from severely overvalued levels. Cash, as measured by the STeFI Composite Index, returned 1.3% for the quarter. Listed property ended the review period almost flat, having recovered May's losses with a bounce in June. South African equities ended almost unchanged in the second quarter, but volatility was high during this period. The sector laggards remain mostly confined to resource stocks with gold (-33.5%), platinum (-23.9%), coal (-10%) and diversified miners (-10.8%) all experiencing double-digit losses in rands. Year to date, the resources sector is trailing the overall market by 19.4 percentage points. Industrial stocks mostly held their ground over the quarter and defensive stocks, on average, achieved strong absolute returns. Financials lagged, with banks down 6.2% and life insurers flat for the quarter after a particularly weak June.

Portfolio review
The portfolio's return was positive for the quarter, led by our global equity holdings and a significantly weaker rand. The largest detractors from performance were the select resources holdings in the portfolio: NewGold and Impala Platinum. Concerns about the local mining industry remain, and the depreciation of the rand has not been sufficient to offset the effects of falling dollar commodity prices and lower production volumes. As we enter wage negotiation season, tensions among the dominant unions and between labour and management appear to be increasing. Physical gold deteriorated with rising real yields in the US. Higher real yields have increased the opportunity cost of holding the metal.

Portfolio activity
Portfolio activity over the quarter was relatively subdued. We sold the remainder of our small holding in African Bank. Our decision was based on concerns about the health of over-indebted consumers, the potential for increased unemployment due to mining sector retrenchments and the increasing risks in African Bank.

Portfolio positioning
We remain concerned about further rand weakness. Most economic indicators appear to be pointing to the US economy strengthening and a slowing of easy money. We are slightly less optimistic than most, as increases to bond yields at the long end of the curve will result in further pressure on consumers in the form of increased mortgage repayments. Nevertheless, the strengthening recovery should focus the "risk-on trade" in the US, resulting in a stronger US dollar. The risk to our local markets is that we have not yet experienced significant foreign outflows, even though we have seen a substantially weaker rand. As the US recovery gains momentum, we expect investors to become increasingly averse to risk in other areas of the global economy, and volatility to rise. On the China front, Beijing has turned its attention away from the quantity of growth, and is instead focusing on the quality of growth. Here, too, it appears that there are concerns about credit extension. Slower growth from China translates into weaker demand for resources, which is not bullish for commodity prices or the rand. Overall, the local equity market is trading at elevated price earnings multiples, with a significant divergence between resource and industrial companies. We expect increased risk to both our equity and bond markets. Given current conditions, we remain invested in opportunities that we believe will reduce the losses from any shocks, and provide investors with inflation-beating returns. While the risk inherent in equities is elevated in the current environment, they offer the best expected return, and the strongest protection against inflation in the medium to long term. A significant portion of the portfolio is therefore held in local and foreign equities with a strong valuation underpin and rand hedge qualities (55%), with smaller, offsetting positions in bonds (14%) and the gold exchange traded fund (2.5%). We have maintained our cash holding in anticipation of opportunities that will enable us to further enhance investors' overall returns. As always, we remain unwavering in our commitment to growing investors' capital in a judicious and discriminate manner.

Market review
The All Bond Index gained 1% in rands over the quarter, while cash, as measured by the STeFI Composite Index, returned 1.2%. Inflation-linked bonds gained 1.8% and the local listed property sector rose by more than 9% over the review period. South African equities recorded positive but modest returns in rands over the quarter, with the FTSE/JSE All Share Index closing 2.5% firmer. The rand weakened 9% against the US dollar and more than 6% against the euro. The resources sector's underperformance continued into the first quarter with gold (-17.9%), platinum (-13.5%) and diversified miners (-6.3%) ending sharply lower. The combined financial and industrial index rose 6.2% over the quarter, with industrials in particular performing strongly. There was a wide dispersion of returns within the broad industrial sector. Rand hedge global stocks saw double digit returns, with SABMiller and British American Tobacco rising 24.7% and 18.4% respectively. Meanwhile retailers, favoured amongst foreign shareholders, dropped nearly 10%, despite a strong performance in March. Banks marginally underperformed the FTSE/JSE All Share Index, while telecommunications lost more than 7% and healthcare gained 8.8% over the quarter.

Portfolio review
South African equities delivered a real return of 16% for the ten years to March 2013. It is fair to say that the starting point of the rally in equities was an absolute low in most stocks' valuations. Bonds generated a real return of 5% over the same period. The attractive returns from equities and bonds contributed to South Africa being a favourable investment destination. The key driver of investments in South Africa has however been the resource complex, which contributed to economic growth, reasonable currency performance and an attractive interest rate environment. Industrial companies in particular have used these positive factors to expand their businesses locally and internationally. Contrary to the negative news flow, South Africa has been kind to investors. Over the past decade, equity returns have been almost twice the corporate profit performance and above trend. Given the substantial rerating that has taken place, investors today are paying high prices for future profits. Over the past five years, the consistent loss of capital in the Resource Index has suggested to contrarian investors that value is apparent and that the underperformance will likely be reversed. The question is: to what mean level will share valuations and earnings revert? Overall, valuation multiples currently seem fair, but earnings are the key to improved performance.

Portfolio positioning
The natural resource boom of 2003-2007 pushed up commodity prices and profitability. If the commodity price environment continues to normalise, as has been happening since the end of the 2008 crisis, then cost control will be crucial. If profitability in the commodity sector falls to pre-boom levels, the best businesses will still be generating exceptional margins and returns on capital. Shares could very well derate to levels last seen in 1998. The massive buying opportunity of 1998 was created by low absolute historic valuations and low absolute commodity prices. Despite commodities' poor performance, these conditions do not apply to the current commodity environment, which means investors should be cautious. There are however select opportunities, like Sasol, Assore and Impala Platinum. Holding these types of shares can help achieve appropriate balance in a balanced fund. Industrial stocks like SABMiller, Remgro and Naspers are highly valued, making quality stocks in South Africa relatively expensive. Although SABMiller is a great business, we can find similar businesses that, on average, offer a 2% free cash flow yield advantage, reasonable growth and dividends, and good capital discipline - all at a lower price. When Warren Buffet's Berkshire Hathaway purchased Heinz in March, it highlighted the attraction of these types of businesses. Local financial stocks appear reasonable, but banks in particular seem vulnerable to setbacks in unsecured lending growth or default increases, which could result from higher short-term interest rates. The overall leverage of the South African consumer is a concern, and neither this leverage nor the continued rand vulnerability is priced into retail shares. These concerns are however sufficiently reflected in the portfolio's low South African equity weighting of 35%. To ensure consistent performance in the future, we will need take all these considerations into account and find a balance.

Market review
Risk assets seemed to shrug off continued concerns about the fragile global economy, with equity markets posting strong returns over the last quarter of 2012. The MSCI World Index added 2.6% in US dollars over the quarter, with Germany (+8.1%), France (+11.6%) and the emerging market composite (+5.6%) showing particularly strong gains. The FTSE/JSE All Share Index (ALSI) ended the year at record highs, adding just shy of 27% in rands to the modest gains of 2011. The ALSI rose by 10.3% over the quarter. The SA bond market saw strong returns over the year, closing 16% higher. The All Bond Index added 2.6% over the quarter. On the back of falling bond yields, the local listed property sector did particularly well, rising by 35.9% over the year and 2.8% over the quarter. The year's gains were largely thanks to a significant rerating in the sector, rather than strong growth in distributions. Cash, as measured by the STeFI Composite Index, returned 1.3% over the quarter.

Portfolio review
2012 can best be described as an uncomfortable bull market. Against a backdrop of multiple potential crises, and following yet more stimuli from central banks, risk assets rallied hard. The bears calling for a market collapse were left licking their wounds. We were not equity-market bulls, but we were positive about the select local and global opportunities in our portfolio. Concerns about growth and other macro threats in the US, Europe and China, meant that we maintained an appropriately balanced portfolio that ultimately generated strong, inflation-beating returns over 2012. Had any of the risks that we were concerned about materialised, we believe that our portfolio was appropriately positioned to cushion against them. Inflation-linked and nominal bonds continued to look attractive relative to cash, but the earnings and cash-flow yields available on equities demanded a higher allocation in the portfolio. In an environment of easy money and low yields, we believe that real assets of high quality will best meet investors' investment objectives. Local equities were the strongest performer in the portfolio, followed by foreign equities (in spite of lower than expected rand depreciation), inflationlinked bonds, nominal bonds, and, in a distant last place, cash (kept artificially low by central banks). Within the equity component of the portfolio, there was a strong showing across financials, industrials and resources. Assore was the standout performer, both across sectors and within resources, compensating for the disappointing returns from Sasol and Impala Platinum. Overall, the portfolio produced real returns that were significantly ahead of our target.

Portfolio activity
We are not short-term traders. Instead, we prefer to take positions in high quality companies that are trading below their fair value. Typically, these positions are held over the medium to long term. Activity over the quarter was muted and there were no significant changes. However, we used shortterm pullbacks in prices to top up our holdings in British American Tobacco, Steinhoff and Santam. Following its strong run, we pared back our exposure to Assore slightly.

Portfolio positioning
At the best of times, we do not attempt to forecast the direction of markets. Following the unexpected bull market in 2012, we are even more reticent to attempt any form of prediction. We are in an environment marred by the artificial price of money and an artificial underpin to the price of certain assets. Central bank policy has shifted from inflation-targeting alone to include nominal GDP growth targeting. As a result, Europe is less of a basket case and is now just risky, and the US appears to have stabilised. After Obama's re-election, investors have taken comfort from the increased certainty around monetary policy and a surprising degree of bipartisanship with regard to the fiscal cliff. In China, the economy is going to perform exactly as communicated by the government: there will be neither a hard nor a soft landing. Any problems surrounding the misallocation of capital have been kicked further down the road. In other words, the global economy is slowly getting better. However, there is still the issue of dislocated or artificial prices. An improving economy and lack of yield could continue to drive the prices of risk assets upwards. Investors' nerves may be steeled by the belief that central banks' extraordinary policy measures will continue to support markets. Risk assets may even become less volatile with the open-ended stimuli from central banks. However, we remain concerned that prices supported by artificial circumstances ultimately have to correct in a disruptive, capital-destroying fashion. In the meantime, easy monetary policies are building inflationary pressures. Central banks have worked hard to remove some of the disruptive risks in the market, but, ironically, in doing so they have potentially created a greater imbalance and ultimately more risk for investors. We are invested in an appropriately balanced set of opportunities that we believe will reduce the losses from any shocks and provide investors with inflation-beating returns. While equities may appear risky in the current environment, they offer the best expected return, and the strongest protection against inflation in the medium to long term. A significant portion of the portfolio is therefore held in local and foreign equities that have a strong valuation underpin, with smaller, offsetting positions in bonds and the gold exchange traded fund. We have maintained our cash holding in anticipation of opportunities that will enable us to further enhance the portfolio's overall returns. As always, we remain unwavering in our commitment to growing investors' capital in a judicious and discriminate manner.