The quarter was characterized by the Feds decision to leave rates unchanged at 5.25% (following 17 consecutive 25bpt hikes). A 30% decline in the oil price from its August peak also acted as a tailwind as it eased inflationary concerns. The aforementioned contributed to a rally in equity markets with the MSCI gaining 13.2% in rand terms (+4% in dollars). A combination of SA's record current account deficit and emerging market jitters resulted in the local unit being the worst performing primary currency in the world over 3 and 12 months. For the quarter it lost 7.7% against the dollar extending the 12 month loss to 18.2%. The fund therefore benefited from all major equity markets ending the 3rd quarter in positive territory as well as rand weakness. In rand terms it gained 12.4% during Q3 with the 3 year return now also pleasing with an annual growth rate of 20.1% (ahead of the sector average of 19.7% and ranked 7/17).

Our overweight position in Europe contributed to returns, as it was the best performing region during the period under review. Conversely the overweight position in Japan detracted from returns (although it was the largest contributor over the previous 12 months) as did the growth bias of the portfolio. Being underweight the US added alpha, but this has been offset by underperformance of the American Growth fund (USD -7%) under performing the S&P 500 (USD +5.2%). Our decision to change to the broader MSCI All Countries Index has already started paying off with the two top performing funds in both relative & absolute terms being the newly introduced India & China Focus funds (USD 18.8% & 7.5% respectively). We remain bullish on equities despite their 122% dollar return since October 2002. Valuations are compelling following earnings growth of 170% over the same period resulting in equities actually being cheaper than the start of the bull market (PE's have dropped from 24.5X to 16.2X).

Relative to bonds equities remain close to their most attractive levels since 1995 with European earnings yields (8.1%) more than double the 3.97% yield on the 10-year German bund! On the downside declining interest rates and reasonable equity valuations are offset to a degree by potentially slowing corporate earnings. Global growth is also expected to moderate as a downturn in the US housing market combined with synchronized rate hikes by most major central bankers affect consumer spending.

During Q2 the fund gave back some of its relative out performance as growth stocks & small caps underperformed in May & June. Despite this it remains in line with the benchmark return of 25.4% over the last 12 months placing it 7/21 in its sector (3/19 since restructuring the fund 2 years ago). For the quarter rand returns were enhanced by the currency weakening substantially against the dollar (-14.3%) on the back of news that our current account deficit ballooned to 6.4% of GDP. Emerging market jitters also put the rand on the back foot although it's interesting to note that despite the fall it's still 4.3% stronger than it was 3 years ago! Our overweight position in Japan & Emergingmarkets detracted from returns this quarter however these regions have been the biggest contributors over 12 months. Being underweight US equities continues to benefit the portfolio, but this has been offset by underperformance of our second largest position, the America fund (USD -5.8%) underperforming the S&P 500 (USD -1.4%). Being overweight Asia contributed to returns although the region was not immune to the sell off as it experienced its first decline in 8 quarters. The top performing fund in both relative & absolute terms was the Australia fund (USD +5.7%). Major changes during the period under review were the inclusion of the China & India Focus funds as well as the Latin America fund following our decision to change the benchmark to the broader MSCI All Countries Index. Looking ahead risks include concerns on how companies will accommodate record oil prices & tighter monetary policies. Rising inflation (and therefore potentially lower PE ratio's) as well as geopolitical tensions & profit taking following the MSCI's 90% gain in 3 years are also headwinds for equities. While acknowledging the risks, we believe valuations remain an underpin as earnings have grown 126% over the same period resulting in equities actually being cheaper than the start of the bull market! We are also seeing earnings surprises outweigh disappointments with free cash flow yields at multi year highs. Relative to bonds earnings yields in all major markets remain above their 10-yr bond equivalents while relative to SA, multiple compression has resulted in the Euro STOXX 50 trading on a lower forward PE (11.4) than the JSE (12.6). The dividend yield of 4% on London's FTSE 100 is also attractive relative to the JSE's 3.1% so we continue to recommend this portfolio as a core foreign equity holding.

The fund was the top performer in the sector in 2005 but the bias towards growth shares and small caps has not helped in the current market, in which megacaps have been the top performers. The benchmark for the fund was changed from MSCI World to MSCI All Countries, which includes emerging markets. The China Focus, India Focus and Latin American funds were all added to the portfolio on June 21, just as these markets recovered.

Financial Mail - 21July2006

During the 1st quarter the portfolio gained 4.4% (USD 7.4%), marginally ahead of the MSCI's return of 4.2% and placing it 10/22 in its sector. For the 12months ended 31/3/2006 it is up 25.1% compared to the benchmarks gain of 15.6% and ranked 2/21. Our overweight position in Emerging markets (USD +12.1%) contributed to returns as did our underweight exposure to the US (+4.2%) which was the worst performing market. Within this region the American Growth fund was however the top performing relative performer with a gain of 11.3%. Our largest holding as a result of a significant switch to the American Diversified fund also paid off handsomely as it outperformed the America Fund. Being overweight small caps (European smaller companies fund + 21.6%) added alpha however this was offset by our growth tilt during a period when value stocks did better. Unfortunately our overweight Japanese position detracted from returns as the region was affected by the Livedoor incident and experienced some profit taking following last years rally.

Looking ahead the improving growth outlook is resulting in rising bond yields and a re-kindling of the energy bull market, which historically have been headwinds for equities. Additionally higher inflation is normally associated with lower PE ratios and could result in the market derating. The aforementioned is not our base case scenario as we remain positive on offshore equities as a whole. In absolute terms they remain fair value but relative to SA are cheap due to the valuation differential between SA and global equities narrowing substantially to the point where the Euro STOXX 50 trades on a lower multiple to the JSE, while the FTSE has a higher divi yield. Relative to bonds earnings yields in all major markets remain higher than 10-yr bond equivalents despite their recent sell off. Free cash flow yields are also higher paving the way for additional M&A activity, share buy backs or capex. Finally we think the Fed is nearing the top of its tightening cycle, which could be the catalyst for a re rating in US equities. To conclude we acknowledge the risk of profit taking as the MSCI is up90%over 3 years. This should however be limited by attractive valuations.

The restructuring that took place over a year ago is paying off as the portfolio was the top performing fund in its sector in 2005 with a gain of 32.7%. In dollar terms this equated to a 17% return, which handsomely outstripped the MSCI (+10%). Despite the run equities remain cheap due to MSCI earnings growth of 14.1% in 2005 outstripping the gain of the benchmark resulting in PE's declining. Consensus earnings growth of 12% is expected this year & 9.4% in 2007.

Relative to bonds shares remain close to their most attractive level since 1995 with European earnings yields more than double the yield on the 10 year German bund! The portfolio remains underweight the US as we are concerned about consumer indebtedness. This risk could however be offset by increased capex from cash rich corporates with strong balance sheets (debt/asset ratio at an all time low of 17%). The underweight US position contributed to returns as did all 3 American managers who outperformed the S&P 500. Japan was the top performing market so value was added by being overweight the region & this was compounded by all 3 Japanese funds not just beating the Topix but also being in the top quartile! A double overweight position in emerging markets and Asia paid off as investors continued to invest in these regions due to their attractive valuations.

Looking ahead risks for the portfolio include stubbornly high oil prices coupled with fears of rising inflation & tighter monetary policies. Profit margins could also come under pressure (as a %of GDP they are the highest since 1967) & it is questionable whether companies will be able to pass higher input costs onto consumers. Any downward revisions to earnings could result in a correction & we recommend investors use this as an opportunity to up weight offshore equities - they are cheaper than local markets (divi yield of FTSE 100 (3.5) is higher than JSE (2.5), while the 13.1 fwd PE on Euro Stoxx 50 is lower than the 13.9 of the JSE, despite lower rates). We also think the Fed is nearing the top of its tightening cycle, which could be the catalyst for a re rating as US equities have on average gained 17,5% in the following 12 months after the last increase in rates. Finally the rand is considered about 10% overvalued on a PPP basis so the current exchange rate does look attractive.