Market review
The third quarter was dominated by the subprime housing crisis in the United States, widespread credit concerns and the growth prospects of the US economy. The general reluctance of banks to lend to each other was not confined to the US, and global banks saw a severe squeeze in liquidity. A full-blown implosion of the US credit market was narrowly averted when the US Federal Reserve (the Fed) first cut the rate at which it lends to commercial banks and later the benchmark federal funds rate, from 5.25% to 4.75%.

Amid the turmoil, global equity markets ended the quarter well in positive territory to reach record highs; bouncing off their intra quarter (August) lows. The MSCI World Index gained 2.5% in US dollar terms over the quarter. The MSCI Emerging Market Index extended its positive performance (up 14.5% in US dollars) over the quarter, mainly on the back of a very strong performance out of Asia (up 19%).

Domestically, we witnessed a modest slowdown in growth and evidence of somewhat weaker consumer spending, particularly evident in the motor vehicle retail sector. Rising inflation, mostly on the back of sharply higher food prices, and a pick-up in inflation expectations were met by a further interest rate hike in August.

Global events reflected in the SA market, causing bonds and the currency to weaken and equities to sell off as risk appetite waned and uncertainty with regard to the global outlook grew. However, the bears seemed to lose the battle yet again as US Federal Reserve governor, Ben Bernanke, provided some monetary relief. Equities recovered strongly from their August lows, gaining 6.7% over the quarter. The local market was led higher by resources (up 13.5%) and industrials (up 3.3%). Financials, which were caught up in global credit concerns were down 1.6% over the quarter. Bond and property yields pushed lower and the currency gained strongly against a falling dollar. Over the quarter the All Bond Index was 3.4% higher, listed property rose by 9.5% and cash (as measured by the STeFI) earned a return of 2.3%.

Fund performance
September was a disappointing month for the Investec Value Fund, with the fund returning -0.6%. Performance was negatively affected by the fund's underweight position in basic materials (which rose 13% over the month) and gold mining (+18%) as well as our overweight position in banks (-4%) and general retailers (-6% over the month). September's poor performance impacted the fund's quarterly return. The Investec Value Fund's 0.8% gain over the quarter lagged the average value fund's 2.8% return and the All Share Index's 6.7% return. The ongoing underperformance of banks and to a lesser extent, retailers, means that the Value Fund has underperformed year to date. Since 1 January to 30 September 2007 the fund has risen 11.7% - below the average value fund's return of 19.2% and the All Share Index's return of 22.8%.

Portfolio activity
In September we added to existing positions in Steinhoff, Foschini, Supergroup and JD Group and also added new positions in Remgro, Truworths and Exxaro. Sales included profit taking in Implats, KWV, Ellerine and Sasol.

Market outlook and positioning
After a disappointing second quarter, your fund's performance stabilised in July and August and we believed the bottom had been found. However, September proved us wrong. The federal funds rate cut on the 18th of September sent the major resource shares (Anglos and Billiton) into orbit as the market bought into commodity shares as a play on higher global growth. Both Anglos and Billiton rose around 13% in rands or Australian dollars by month end - a strange move when one considers that the average metal price only moved up by 1.5% in these currencies over the same period. (The weak US dollar resulted in much bigger US dollar movements in metals prices, but unfortunately these movements are in fact 'illusionary' in that both mining houses have costs in rands and Aussie dollars). We therefore conclude that the market must be expecting higher metals prices in future - something that historically hasn't happened after a federal funds rate cut.

At the same time that this was happening, it should be remembered that world financial markets were coming to terms with the US subprime crisis. The net result was that there was pressure on financial shares globally. We thus got hit by a 'double whammy' with the poor sentiment affecting the share price performance of domestic banks even though the 'big four' domestic retail banks are not exposed to US subprime at all. The net result of all of this is that, in our opinion, not much changed over the month, despite the fact that mining rose 14% and the domestic banks fell 4%. By month end, Billiton's PE had risen to a demanding 15 times while Standard Bank was down to 11 times earnings. We do not believe that these relative ratings reflect the non-cyclical nature of Standard Bank's earnings and the probability that we are close to the top of the resource cycle for Billiton. Hence we bought more of the underperformers in September (JD Group, Foschini and Steinhoff). We continue to believe that any moderation in the market's very bearish outlook for domestic interest rates and inflation will rekindle interest in the oversold banks and retail sectors.

Market review
The domestic inflation outlook has deteriorated over the quarter. Rising yields globally and domestic inflation resulted in the local government debt curve increasing sharply. Over the quarter the benchmark R153 and R157 peaked at 9.15% and 8.58% respectively. The All Bond Index lost 1.7% over the three months ended June. We expect CPIX inflation to remain firmly above the targeted inflation band until year-end. This is likely to force the South African Reserve Bank (SARB) to tighten rates further. However, early signs of some moderation of consumption led growth, coupled with a potentially negative impact of the recently implemented National Credit Act are likely to moderate the SARB's stance on the extent of further tightening. Rising bond yields and deteriorating inflation expectations put pressure on domestic listed property. The sector was up marginally over the quarter (0.3%) but remains firmly in the black year to date at 16.1%.

After a strong first quarter, domestic equity market returns moderated slightly over the past three months. The FTSE/JSE Index gained 4.3% since the end of March. The market was driven higher by general mining (up 12.5%), oil and gas (up 9.9%), construction (up 9.9%) and life insurance (up 6.9%). Interest rate sensitive counters, in particular banks were down 6.9% and retailers lost 6.7%. This reminded investors of a similar occurrence last year, when diminishing global risk appetite coupled with higher domestic borrowing costs, caused a massive sell-off in domestic oriented sectors.

We remain positive, yet cautious, on our equity outlook over the next few quarters. Increasing volatility and fluctuations in sentiment should not deflect from a global and domestic backdrop that remains supportive of continued earnings growth and above average equity ratings.

Fund performance
Poor performances in both May and June offset a good April and the net effect was that the Investec Value Fund returned -0.9% over the quarter, well below the FTSE/JSE All Share Index return. The second quarter was uncannily similar to the second quarter of 2006 i.e. the re-emergence of interest rate fears driving investors from interest rate sensitive stocks (especially banks and credit retailers) and into resources (especially Billiton) and defensive stocks (especially SAB/Miller). Note that an attribution analysis of your fund's 5% underperformance against the All Share Index reveals that 4% of this was due to just four stocks i.e. not holding Billition as well as the negative effects of our holdings in Foschini, JD Group and Ellerine.

Portfolio activity
Over the quarter we affected a number of changes to the portfolio with the dominant theme being lightening our holdings in financial and industrial stocks, which showed resilience into the sell-off (Supergroup, Invicta, Hudaco, Rainbow and Barloworld). We also added to holdings of financial and industrial stocks, which we believe became oversold as a result of interest rate fears (Ellerine, JD Group, Steinhoff, African Bank and Bidvest) as well as made a switch from ABSA into both Standard Bank and FirstRand. New holdings over the quarter included Telkom, Grindrod, Old Mutual, BCX, MTN and Investec. We also added to our holdings in Mittal Steel, Northam and Aveng.

Market outlook and positioning
We currently have a great sense of déjà vu in that the events of last winter appear to a large extent to be repeating themselves. There is currently fear in the market about interest rates and domestic spending and a great deal of bullishness with respect to resources. The common denominator with respect to both this year and last year is the run-up in both US and SA bond yields. However, there are a few differences to last year, namely this time around the rand has held up (probably as a result of it already having weakened so much). There has also not been a universal sell-off in consumer stocks as was the case in 2006. (This time around food and general retailers have been totally unaffected, while furniture stocks and to a lesser extent banks have been sold off).

So the million-dollar question is whether we can expect a recovery in domestic interest rate sensitive stocks as we saw at the end of 2006? Counting against a potential recovery is the fact that while CPIX was within the targeted range this time last year, at 6.4% CPIX is now outside the range, thus increasing the likelihood of further interest rate hikes. Counting in favour of a recovery is the fact that we are twelve months closer to the top of the interest rate cycle, as well as our expectation that the National Credit Act will result in a material slowdown in credit extension, thus removing a major reason for further interest rate increases. We therefore believe that it will be a close call whether interest rates go up from here or not. The inflation 'swing' factors, namely fuel and food (principally maize) will be the key determinants henceforth. While it is extremely difficult to predict oil and maize prices, we believe there is more downside than upside in both prices (record plantings in the US and probably in SA should help maize prices to come down. In respect of oil, we note that seasonal factors show that in an average year, oil peaks in July. We thus believe it is by no means a dead certainty that there will be further interest rate increases. This view is at odds with the ratings of both the banks (price earnings of 11 times) and the furniture retailers (price earnings of 8 times) - ratings, which we believe imply considerably higher rates. We therefore maintain our exposure to banks at just under 30% of the portfolio, furniture at 8% and other retailers at 7%. A moderation in interest rate expectations and /or further private equity deals (as was the case last year) could be the catalyst to unlock this value. Other large holdings remain 9% in platinum, 7% in Mittal Steel and 4% in Aveng.

Market review
Equity markets were volatile over the first quarter. During January and most of February equities were stronger. However, concern over the US housing market and the deterioration in the macro-economic backdrop put global stocks under pressure. By mid March most markets were 5% to 10% down from their earlier highs but by month end, equity markets had bounced back. The MSCI World Index gained 2.6 %( in US dollar terms) over the quarter. Local equities continued to reach new highs over the first two months of the year. However, the JSE saw heightened volatility in March. Local equities declined very sharply but as global risk aversion eased, stocks recovered strongly. The FTSE/JSE All Share Index gained 10.4% over the quarter and the 12 month return was 37.6%. For the quarter, resources were up 15.2%, financials 6.5% and industrials 5.6%. Cash (as measured by the STeFi index) earned a return of 2.1% over the quarter, against the All Bond Index return of 1.6%. The rand weakened by 4.1% against the US dollar and 4.6% against the euro over this period.

Fund performance
The Investec Value Fund performed well over the quarter, returning 11.9%. This compares favourably to both the average value fund and general equity fund's returns of 11.3% and 10.3% respectively and the All Share Index's 10.4% return. Given that your fund was underweight resources (the best performing sector over the quarter with a 15.2% return), we are satisfied with our performance and believe this is a further indication that stock picking is the key driver of performance rather than sectoral allocation. While we were underweight resources as a whole, it is important to note that within the sector we did well to be underweight the worst performer in the sector (Sasol) and overweight one of the best performers (Mittal Steel). We added to our platinum holdings aggressively over the quarter. Other positions which assisted performance were our holdings in banks (+12.2% over the quarter) and general retailers (+16.6%) as well as our underweight position in life insurers (+1%) and beverages (mainly SAB/Miller) which fell 1%.

Portfolio activity
We affected quite significant changes to the portfolio over the quarter, with a number of bottom up stock changes having the net effect of increasing our weighting in resources and reducing our weighting in industrials. The down weighting in industrials was due to the sale of the fund's holdings in MTN, Telkom, Lewis and Consol. Most of these proceeds were used to invest in Impala Platinum (now a significant 7.5% of the fund) as well as small holdings in Amplats and Northam and to repurchase a holding in Sasol at the end of the quarter after the stock massively underperformed.

Market outlook
The strong run up in the prices of financial and industrial stocks since the lows of mid 2006 as a result of the combination of a less hawkish Reserve Bank governor and the effects of private equity activity has in many cases left stocks in these sectors more fairly valued. As a consequence of this, we have sold out of a number of our large industrial stocks at close to fair value. We have used most of the proceeds on two stock specific ideas, namely Implats (which on our purchase price of nearly R200 was trading on close to a 12 P/E to June 2007) and Sasol (which has massively underperformed and is now offering reasonable value on an historic P/E of 10 times). The net effect of these changes is a more 'balanced' portfolio than that of nine months ago, with the current sectoral breakdown being around 20% resources, more than 30% financials and under 50% industrials with the resources breakdown being 11% platinum, 4% Sasol and 5% Mittal. Given the fund's strong returns relative to the index over the last nine months, we believe this is a natural result of our strategy of selling stocks which have relatively outperformed and buying relative underperformers. The result should in no way be seen as a conscious change of sectoral weightings. Looking at the market as a whole, despite the further 10.4% gain over quarter one, we remain optimistic with respect to further real returns. However, future returns are unlikely to be at the levels of the last few years. We wish to point out that the fund's top ten holdings continue to trade on a relatively undemanding historic P/E of 13 times and dividend yield of 3.7%.

December brought to a close what has been a very rewarding quarter for the Value Fund with December's 7% return bringing the quarterly return up to a substantial 21.6% - well ahead of the All Share Index's return of 11.8% and sufficient to place the fund as the top performing Value unit trust over the quarter. After a disappointing second quarter of the year, the strong finish to the year enabled the fund to end the year as the second best value unit trust with a return of 41.7% - in line with the All Share Index's return of 41.2% and a good result when one considers that at mid year the fund was around 10% behind the index. Investors should also note that 2006's return was sufficient to place the fund in position 6 out of 54 funds if the fund is to be compared to funds in the General Equity sector. Over five years the fund remains the best performing equity fund across all sectors with a 41.8% compound return.

Performance over the last quarter of the year was driven by the fund's large positions in banks (+24% over the quarter), general retailers (+28%) and mobile telecoms (+35%) as well as our small positions in the underperforming areas of oil and gas (+3%), general mining (+3%) and life insurance (+4%). The strong run up in domestic interest rate stocks over the last quarter was the main feature of the quarter and reflected the combination of a deeply oversold position at mid year together with a moderation in the market's panic with respect to rising inflation and interest rates (which in turn was due to rapidly falling commodity prices - especially oil - as well as the Reserve Bank's slightly less hawkish comments at the back end of 2006). The rapid fall in commodities had a 'double whammy' positive impact on your portfolio, as it not only assisted in the rally in domestic interest rate sensitive stocks (although we will argue that the sub 10 PE's that were applicable on a number of these stocks also assisted the rally), but it also prompted profit taking in resources in which we remain underweight.

Over the month we added to our holdings in Steinhoff, Ellerine, JD Group, and Foschini and introduced a small holding in DRD Gold and took profits in Bidvest and Naspers. In addition, given the massive run up in share prices and valuations over the last quarter, we have made the decision to up the cash holding in the fund to around 10% and as a result we sold out our holdings entirely in four stocks which had reached our price targets namely MTN, Telkom, Illovo and Barloworld.

Looking ahead, importantly we emphasise that, given the fund's more than 40% compound return over the last five years, that returns over the next few years are expected to be substantially lower. That said, the fair value of our holdings remains above current share prices and for the portfolio as a whole, we estimate approximately 15% upside to full valuations. It should also be noted that there is a very real possibility that the market overshoots fair value and so our advice is for unit holders to hold on but with tempered expectations. The average PE of the top 10 stocks (which make up nearly 60% of the portfolio) is still only 12 times - a 25% discount to the market and a reasonably low absolute level given the quality of the top ten holdings. With respect to stock selection, despite the strong outperformance of financial and industrial stocks over the last quarter of 2006, we are not tempted to switch into resources as all that has in fact happened is that financial and industrial stocks have recouped the ground they lost over the first half of 2006. Given that resource stocks are not trading at a discount to the 12 PE of our top ten holdings and that dollar resource prices are falling (thus resulting in some question marks with respect to resources' 2007's earnings) - in contrast to our conviction that the financial and industrial stocks we hold will continue to grow, we stick to our financial and industrial overweight and resource underweight. Note that these good fundamentals for financials and industrial stocks are further enhanced by the rash of private equity buy outs (which are currently focussed on the FINDI sector) as well as the fact that the 2010 soccer World Cup and its associated euphoria is now only three years away.