Richemont and Naspers have contributed substantially to South African equity market returns over the last 12 months. By virtue of their substantial weight in the FTSE/JSE All Share Index (now 8.8% and 6.3% respectively) and their share price appreciation (Richemont has doubled and Naspers is up over 80%), they contributed around one-third (8.6 percentage points) of the ALSI's total return of 27% over the period. Unfortunately the Fund missed most of these returns as over the last year it has held no Richemont and only a small Naspers position, which was acquired in the first quarter before the share appreciated by a further 50%. South Africa can be proud of the success achieved by Mr Rupert, Mr Bekker and their colleagues on the world stage. They have built high-quality global businesses with dynamic management teams, and they have grown strongly. The dilemma for investors is that the market arguably recognises this and has valued the companies accordingly. Richemont trades on 20x record high profits (which we still believe to be cyclical) and Naspers trades on over 40x historic profits (and 34x the consensus forecast for next year's profits). Such high valuations can translate into high risk if the market's optimistic expectations are disappointed. The jury is still out on whether or not the seemingly insatiable Chinese demand for Richemont's expensive jewellery and watches will be sustained under tighter credit conditions and policies aimed at reducing extravagance. Naspers is a tougher call as Chinese internet company Tencent, Naspers' key investment, is extending its dominance and growing into potentially large adjacent businesses. Thus we prefer a neutral position in Naspers in the Optimal Fund (where relative risk is translated into absolute risk by the Funds' hedging strategy - see the Optimal Fund commentary). Although it is possible that Richemont will avoid the cycle for a while longer, or that Naspers will grow into its current share price, we prefer to invest, where possible, with a margin of safety. This should help to preserve capital should life's inevitable disappointments come to pass. We see better value in stocks listed elsewhere, including stocks which will benefit from potential growth in Asian consumer demand and indeed Chinese internet usage (e.g. NetEase). Exposure to these shares is obtained through the Fund's investments in the Orbis funds. This quarter's commentary for the Orbis Asia-ex Japan Fund expands on the investment thesis for the Chinese internet stocks Orbis prefers. Closer to home, we prefer exposure to shares such as Standard Bank, which are trading on much lower multiples, where we believe the market may be undervaluing the company's growth potential. Please refer to the Equity Fund commentary for more on Standard Bank.

Central banks fulfil an important role, but the financial press seems to overestimate their importance. A layman would surely be surprised to hear that there is an expectation for central bankers to grow employment by printing money and holding interest rates low. Surely there are many other important factors which are determining unemployment rates? This overestimation of the importance of central banks and a short-term mind-set result in obsessive analysis of each word spoken by a central banker, looking for clues as to when money printing will be 'tapered' and short-term interest rates will rise back up to historical norms. We strive to look past the 'noise' and focus on factors which are important for making sound long-term investment decisions. What is important? Overall corporate profits in relation to revenues or GDP are high compared to their history. While very successful companies may resist mean reversion for generations, it is harder for an index representative of all businesses to fight the powerful pull of mean reversion. If competition or the economic cycle don't do the job of depressing profit margins, then regulators and labour stand ready to stake a greater claim on companies' value added, leaving less for shareholders. The deleveraging trend which started in 2007/08 is powerful and it continues. The low CPI inflation rates in developed markets, despite unprecedented global money creation, testify to the strength of the deflationary trend which so terrifies the central bankers. If there is widespread acknowledgement by lenders and borrowers that an economy is saddled with too much debt, can the central bankers really force continued credit expansion over the long term? The current level of sovereign budget deficits is unsustainable. In South Africa's case, our reliance on foreigners to fund our budget deficit is also probably unsustainable should our underlying economy continue to stagnate. Our efforts are focused on bottom-up stock-picking, but when making asset allocation decisions, such as the Fund's current full foreign exposure and below average equity exposure, these are the types of long-term 'big picture' factors which we consider - not whether the US Federal Reserve's quantitative easing programme will be tapered at the upcoming meeting or the next.

For most of the Fund's history its foreign holdings have proven to be a drag on its overall performance. This is mainly attributable to the long bull market in South African shares, property and bonds, which was discussed in last quarter's commentary. The Fund's foreign holdings have just not been able to keep up with the stellar returns from South African investments - but this may be changing. Over the last quarter and the last 12 months, the Fund's foreign holdings (invested in the Orbis funds) have outperformed the major portion of the Fund invested domestically. We would not be surprised if this were to become a multi-year trend for a couple of reasons: we see better value in foreign stock markets than in South Africa, and we believe that the rand exchange rate is vulnerable in the long term to any potential slackening in foreign demand for our bonds. Even if we saw similar value in foreign and local stock market indices, and even if we were indifferent on the exchange rate of the rand, there would be a compelling case to invest a quarter of the Fund offshore. Orbis has an incomparably wider choice of stocks in which to invest than we do in South Africa, and thus the Fund's foreign exposure provides diversification benefits, access to sectors that do not feature prominently on the JSE (such as technology), and a much larger universe of opportunities for outperformance. Therefore, the Fund continues to maintain a maximum exposure to foreign investments. Investors who are not constrained by retirement fund regulations (Regulation 28) can further increase their effective foreign exposure by investing rands in any of the three Allan Gray-Orbis foreign funds.

The Fund has delivered another year of inflation-beating returns. Over 2012, it returned 13.4% - substantially exceeding the CPI inflation rate of 5.6%. Since its inception over 12 years ago, the Fund has returned 19.4% per year in comparison with CPI inflation over the same period of 5.9% per year. We are pleased that the Fund has beaten CPI inflation so decisively, but we must confess to being somewhat surprised by the margin of 'victory'. The Fund has been helped in no small part by a fantastic bull market in South African shares, property and bonds for most of its existence. When the Fund was launched in October 1999, long-dated government bonds yielded 15%, listed property yielded 16%, and the FTSE/JSE All Share Index (ALSI) was priced at 6 629. In early January 2013, long bonds are yielding 6.8%, listed property is yielding 6.4% and the ALSI has just exceeded 40 000 points (up six times). We are confident that this bull market in South African assets cannot continue forever, but we have relatively little confidence in predicting when the market will turn. Rather than try to time the market, we constantly reevaluate the prospective long-term returns from all assets in our universe based on their current market prices. All else being equal: the higher the current price, the lower the prospective returns. As the bull market has marched on, we have responded by 'taking money off the table' from our winning positions in South African assets by increasing the Fund's foreign exposure as the prevailing regulations have allowed, selling South African shares and hedging South African stock market exposure. While this has resulted in the Fund's returns lagging the returns of the average fund in its sector over the last year, we believe that the Fund has assumed less risk of capital loss than the average fund in its sector. We believe that this disciplined approach is the best way to maximise the Fund's returns over the long term (which typically includes both bull and bear markets).