Market review
The All Share Index (ALSI) closed 3.4% up over the quarter, losing some of its earlier gains as inflation fears gripped global markets. Substantial dispersion in performance across the sectors was evident as resources gained 13.4% over the quarter, while the Financial and Industrial Index lost 6.4%. General mining led resources higher, closing up 18.1% over the three months to the end of June. Banks and general retailers shed close to 15% over the quarter, while the defensive food retail and telecommunications sectors ended up 3.2% and 3.4%, respectively. The telecommunications sector was buoyed by corporate activity as MTN sought a potential merger with an Indian telecoms company.

Fund performance
The second quarter was again very disappointing for the value process. The Investec Value Fund returned -11% over the quarter, against the ALSI's return of 3.4%. The fund's 12 month return to the end of June was -20.8%.

South African resource shares returned 13.4% over the quarter mainly as a result of further strength in the dollar prices of a number of commodities. Against the background of two 50 basis point interest rate increases over the second quarter and the very hawkish comments made by the Reserve Bank governor in May, the banking and general retail sectors both fell close to 15% over the quarter. Our increasingly underweight position in resources (by the beginning of June we had sold our remaining resource holdings), as well as an approximate 43% exposure to banks and retailers did not fare well against this backdrop.

Portfolio activity
In line with our value philosophy of buying out of favour, inexpensive stocks we added further to our banking position (Standard Bank, FirstRand, African Bank and small purchases of ABSA). We also increased our holdings in retailers (Foschini and Mr Price), selected industrials (Aveng and Bidvest) and defensive food manufacturers (Tiger Brands and AVI). New small holdings in Sun International and Reunert were also added. To fund these purchases, we sold our remaining Impala Platinum and Telkom shares and took profits in Naspers and New Clicks Holdings.

Market outlook and portfolio positioning
Our view remains unchanged - we believe that dollar commodity prices have been inflated by massive inflows into commodity index funds and exchange traded funds (ETFs). Flows into these funds have been exacerbated by money flowing out of equities as investors seek protection from a weak US dollar. Against the backdrop of a rapidly slowing global economy, we believe lower industrial demand for commodities together with rising supply should result in lower prices. Our view is backed up by the fact that at current metals prices the payback period for new mines ranges from six months for coal to three-and-a-half years in the case of aluminium. The laws of supply and demand suggest that this situation cannot continue indefinitely.

It should also be noted that the current valuations of commodity stocks do not make provision for any potential fall in the dollar prices of commodities. Price earnings ratios (PEs) of commodity stocks at 'spot' commodity prices range from 8 PEs for Anglos/Billiton/Sasol to 11 PEs in the case of Kumba/Exxaro. We believe that these ratings do not reflect the top of the commodity cycle. It is also important to point out that the earnings base of commodity producers is very sensitive to any small downward movement in commodity prices.

On the other side of the equation, banks are trading on between six and seven times earnings and 6% dividend yields and retailers on PEs of six and 8% dividend yields. We believe that these ratings more than discount the current difficult environment for both sectors. Our view is that the market has got it the wrong way round. The market is pricing resources as annuity earners at the top of a commodity cycle and financial and industrial stocks as cyclical companies at close to the top of an interest rate cycle when history has shown that it has always been the other way round. The Value Fund's current historic PE is eight times and the dividend yield is 6% - a wide discount to the market's PE of 14 and dividend yield of 2.8%.

Market review
Equity markets ended the first quarter sharply lower, driven by fears of a US recession, general risk aversion and a massive downward revision to earnings. The MSCI World Index declined by 8.9% over the quarter, outperforming the MSCI Emerging Markets Index, which closed down 10.9% (in US dollar terms).

On the local front, the FTSE/JSE All Share Index retraced the losses sustained towards the end of 2007, closing the first quarter up 2.9%. Resources were the clear winners, returning 17.6% as commodity prices reached new highs and earnings were aggressively revised upward. The domestically focused FTSE/JSE Financial and Industrial Index lost 8.5% over the quarter, depressed by tougher trading conditions and poor sentiment towards rate sensitive sectors. Banks, tainted by global credit market woes and local policy uncertainty, closed the quarter down 10.7%, while general retailers lost 14.3%. The construction and telecommunications sectors were less affected by the slowing domestic consumer environment, losing 7.6% and 4% respectively.

Fund performance
The first quarter of 2008 was very disappointing for the value process, both in absolute and relative terms. The Investec Value Fund returned -11.5% over the quarter, against the All Share Index return of 2.9%. The fund's 12 month return to the end of March was -11.8%.

We view the developments over the quarter as very unusual. Investors were faced with rapidly rising commodity prices (gold +9.8%, platinum +30.8% and iron ore +70% over the quarter) accompanied by a rapidly weakening rand (which fell nearly 16% against a weak dollar over the quarter). The net effect of these substantial moves was that resources rose 17.6% in just three months and all other sub-sectors on the JSE declined, with interest rate sensitive sectors falling sharply (banks -10.7% and general retailers -14.3%). Our overweight position in these domestic sectors and our increasingly underweight position in resources did not fare well against this backdrop.

Portfolio activity
In line with our investment philosophy of buying inexpensive, out of favour stocks, we reduced our already small position in resources still further and added to our domestic SA exposure. Major sales included Impala Platinum, Arcelor Mittal and AngloGold Ashanti as well as MTN and Aveng (which were amongst the few domestic shares to perform and thus approached our fair value for these stocks). With the proceeds of these sales we added slightly to our existing banks and retail positions (enough to hold our weightings in these sectors in the face of underperformance). We also increased our existing holdings in Steinhoff, Bidvest and Remgro. These three domestic stocks fell as much as the average domestic stock, despite their quality offshore businesses. By quarter end these three shares comprised over 20% of the portfolio.

Market outlook and positioning
We do not believe that the combination of the current level of the rand and dollar commodity prices is sustainable. The rand's recent weakness can partially be attributed to global risk aversion, resulting in rand flight. Although the rand is one of the most liquid currencies in the world it is perceived to be one of the riskiest currencies. Negative foreign sentiment following the electricity crises, prompted massive foreign selling of domestic bonds and equities. This also resulted in the local currency taking a hammering.

A decrease in risk aversion (of which we are seeing the first signs), together with the fact that the majority of foreign selling is now behind us, should see a recovery in the local currency from very oversold levels. In addition, we believe that while the supply and demand fundamentals remain good for a number of commodities, the extreme strength over the first quarter was as a result of massive investor/speculative inflows into commodity index funds. These funds attracted around US$30 billion of new money over the first quarter. Any withdrawal of these funds would have considerable consequences for commodity prices. Hence we see upside for the rand and downside for most commodity prices.

Given this scenario and the current high valuations in the sector (the top 20 resource stocks trade on an average 20 times earnings), we believe that resources are currently a very high risk investment. On the other side of the equation, domestically orientated financial and industrial stocks are trading on extremely low valuations. The price earnings ratios (PEs) for banks are eight, the PEs for industrials are ten the PEs for retailers are seven to nine times. At current prices, FirstRand's dividend yield is nearly three times that of Anglo American's - a 20 year high and 50% above the previous high points (at which level one always outperformed the market if one bought FirstRand). Any decline in commodity prices or a recovery in the rand will benefit domestically orientated financial and industrial stocks.

Market review
Domestic equities came under pressure during the fourth quarter, with the All Share Index closing down 3%, but achieving respectable returns of 19.2% for the year as a whole. The losses were concentrated towards the end of the period, as both resources and financials became victims of the uncertain global growth outlook and continued negative sentiment associated with the global banking sector. Gold miners ended the year as the market's worst performer, losing 14.1% over the quarter and 20.6% over the year. The construction sector continued its strong run, to end the year 77.3% higher as the best performing sector.

Fund performance
December was a good month for the Investec Value Fund, with the fund's -1.3% return comparing favourably with the All Share Index's -4.4% return and the average value fund's -2.1% return. Performance over the month was assisted by our large position in general retailers (which only fell 0.9% over the month) and avoiding general miners (which fell 7.6%). For the quarter ended 31 December 2007, your fund returned -0.2% - ahead of the All Share Index's -3% return and the average value fund's -1% figure. Performance over the quarter was assisted by steady performance from banking stocks and avoiding a few of the bigger losers such as gold stocks, Naspers and Imperial.

The fund's 12-month return was 11.5%. Performance over the year was negatively affected by our large position in banking stocks, which did not deliver (banks only rose 2.6% over the year). Not being invested in the three large cap 'super winners' of 2007 (which rose between 80% and 160%) i.e. Kumba, Murray and Roberts and Exxaro also detracted from performance.

Portfolio activity
We did not materially change the portfolio over the month, with trades being limited to switching Nedcor to FirstRand and adding further to our positions in Bidvest, MTN, Steinhoff, Anglogold and JD Group. New small positions were added in Mr Price and AVI. Sales included Remgro, Aveng and Arcelor Mittal.

Market outlook and positioning
While 2007 was a disappointing year for your fund, going into 2008 we are optimistic that we can make up ground on the All Share Index. After four years of strong resource prices and economic growth in South Africa, it is important to note that the earnings bases of all stocks are very high. In the face of cooling resource prices as well as slower international and domestic economic growth, we think earnings resilience will be a key factor going forward. We are well placed in this regard, with our largest position (30% of the portfolio) being in domestic banks - an industry, which we believe, will continue to grow earnings in the face of a cyclical slowdown. Our view is that domestic banks have been unfairly treated in being sold off in line with international banks. We do not foresee the underlying problem offshore (namely rapidly declining house prices) being replicated here in South Africa.

In addition to banks, we hold large positions in Bidvest, Telkom and Steinhoff. We believe that the earnings of these stocks are resilient. These shares are also not trading at a premium to the market price earnings ratio (PE) of 14 times, despite what we believe is their defensive nature. Banks are on 9 PEs, Steinhoff and Telkom are on 8 times and Bidvest on 11 times earnings. In an environment where we believe continued earnings growth will be harder to find, we hold the view that these stocks (which make up 50% of the portfolio) are providing protection at a discount to the market.

In addition to the above-mentioned shares, we hold meaningful positions in retailers (Foschini and JD Group) and precious metals (Implats and Anglogold). While this 20% of the portfolio does not fit into the category of defensive stocks at a discount to the market, they have other attractions. In the case of retailers, we think exceptionally low valuations (8 PEs and 6% dividend yields) are attractive enough while we wait for interest rates to top out. In the case of precious metals, valuations are reasonable (12 times earnings for Implats) and there is the obvious attraction of rising precious metals in the wake of falling US interest rates and global uncertainty. We do not hold BHP Billiton and Anglos as we are concerned about base metals in the face of a weaker global economy. In addition, the PE ratings for these two stocks are in line or higher than that of Implats. The most vulnerable area of the market appears to us to be cyclical stocks trading on market PEs. Anglos, Billiton, Kumba and Exxaro look vulnerable in the event that the current global economic slowdown starts to negatively affect commodity prices.

In conclusion, we expect a difficult year for the All Share Index given the current outlook for the global economy. We are comfortable with the quality of the stocks in our portfolio on an historic PE of just 11 times and an historic dividend yield of 4.5%.