The Fund’s performance over the past quarter was helped by overweight positions in Standard Bank and Impala Platinum, and by underweight positions in SABMiller and MTN. It was hindered by being overweight British American Tobacco and Reinet, and by being underweight Anglo American and BHP Billiton. (All positions quoted are relative to the FTSE/JSE All Share Index).

During the quarter we bought Naspers, Sasol and Old Mutual. We sold SABMiller, as well as gold miners Sibanye, Harmony and Gold Fields. We expect to receive the cash for our remaining SABMiller shares by 13 October. We have been positioning our portfolios for this event, for example in the Balanced Fund we have upped our equity exposure. As always, we will be on the lookout for opportunities provided by the market due to the index change and high volumes on the day.

In recent months, a number of ‘high-quality’ stocks have disappointed. I use inverted commas because it is surprising how often perceptions of quality are mistaken. A high-quality stock can disappoint in two ways:

1. Very high expectations are priced in: If the company fails to meet expectations - it might still do very well, just not as well as people expected - the stock de-rates.

2. The company turns out to be an average company, or a lemon: It was flattered by some industry tailwind or by high levels of gearing.

Luxury goods company Richemont, which the Fund does not currently hold, has declined by 31% from its peak in rand terms and by 42% in dollars. It used to be described as a high-quality company, but it seems investors are wavering. We think the jury is still out on the quality of the business. Richemont has certainly benefited from a very strong tailwind in the form of Chinese spending on luxury goods, the company requires large amounts of working capital to operate, and there is implicit gearing in the leases. Despite the fall in its share price, Richemont trades at 24 times consensus forward earnings.

In contrast, we believe that the Fund’s largest holding, British American Tobacco, deserves to be called a high-quality company because it passes the following tests: It has 1) a high conversion of profits to free cash flow, after all capital expenditure, 2) a high return on equity, 3) stable and high profit margins, 4) moderate gearing and 5) management with a track record of good capital allocation.

The next time someone labels a company ‘high-quality’, ask yourself whether they don’t just mean ‘share that has gone up a lot’.

Commentary contributed by Jacques Plaut

‘Ultra-low interest rates pull consumption forward in time and push failure backward in time. They flatter the judgement of the aggressive lender and ease the burdens of encumbered borrowers. The benefits of today’s monetary experiments are mainly in the past, the costs of those benefits are yet to come.’ - Grant’s Interest Rate Observer, December 2015.

After a long bull market in any asset class, it is entirely natural for investors to focus on returns and forget about the risks taken to generate them. The events in local asset markets towards the end of 2015 and into the current year are a stark reminder of the dangers of falling into this psychological trap.

When managing our clients’ hard-earned savings, our foremost focus is always on absolute risk - the risk of a permanent loss of capital - even if this introduces risk into our performance relative to our peers. We believe that it is possible to maximise long-term returns by managing risk while thinking long term about bottom-up fundamentals and being contrarian when appropriate.

We can think of a number of long-term risks facing the Fund currently, including:
.. The lowest interest rates in 5 000 years (according to Bank of America Merrill Lynch estimates)
.. Debt and central bank balance sheets at extremely elevated peacetime levels
.. Deteriorating demographics globally
.. Accelerated technological disruption
.. Excessive leverage in China
.. Social unrest driven by the divergent fortunes of asset owners and those of the ordinary worker

We are investing during perhaps the greatest monetary experiment in history with very little precedent to use as reference for possible outcomes.

We suspect that in distorting interest rates, the most important aspect of prices in markets, there is likely to have been large misallocations of capital. As such, we remain cautious on assets that have benefited from unsustainable demand borrowed from the future, including government bonds, Chinese infrastructure, luxury goods and leveraged acquisitions (whether of other companies or share buybacks).

The Fund’s holdings of short-duration cash, hedges and high-quality offshore equities have provided liquidity to take advantage of dislocations, including oversold local equities, at various stages over the past year.

Of course, the best protection against these risks is to buy cheap assets. Assets bought at low valuations by long-term investors can better withstand bad news. As highlighted in previous commentaries, we are finding value in many local financial shares, select depressed cyclical companies, certain high-quality businesses and depressed emerging market shares. In addition, approximately 8% of the Fund is invested in precious metal exchangetraded funds (ETFs) and the miners of those metals.

We believe the Fund’s diversified holding of undervalued assets should stand it in good stead in these uncertain times. The Fund’s positioning has not changed significantly from the previous quarter, other than an increased investment in financial shares, particularly those which were down significantly following the results of the UK referendum.

Commentary contributed by Duncan Artus

The first quarter of the year was particularly volatile, with substantial intra-quarter price moves in almost all asset classes. The rand weakened 8% in the first few weeks of January before strengthening to close the period stronger and many large companies experienced moves of over 100% between their low and high prices for the period.

The way the market's perception of fair value changes over very short periods of time is odd. Glencore is a useful example. In early January the market thought the fair value of the equity was US$15bn, while just two months later the market's assessment of the value had changed to over US$33bn, a very substantial difference in anyone's book. Over that two-month period Glencore's actual value did not change at all: it still has the same mines, the same people, the same brand. The value of a business is determined by the cash flow it will generate over the next 15 or 20 years, not the next two weeks or the previous quarter's profits. Some may argue that Glencore is a bad example as it is has a fair amount of debt and there was a risk of a capital raise. But next, consider Liberty Holdings. Liberty is a life insurance company that sells very long-dated policies. Here you can very safely say nothing changes in the short term yet the market thought the share was worth R105 in February and R144 at the end of March.

The great thing about being a value manager is that we have our own view of what each of these businesses is worth. When the market gives us the opportunity to buy a share for less than we think it is worth we do so gladly, conversely when the market value exceeds our fair value we sell. This is the process that drives the exposure to each business and asset class in the Fund. The same process is applied to the Fund's offshore exposure. In January sentiment towards the rand was particularly negative and we thought the rand was becoming quite cheap on various metrics. We took this opportunity to bring the Fund's international exposure back below 25%, in line with the prescribed legal investment limits for retirement funds (Regulation 28).

The Fund's local share exposure increased over the quarter as we bought attractively priced financial businesses and reduced the exposure to certain large industrial companies like SABMiller. The exposure to foreign assets (excluding Africa ex-SA) fell below 25% of Fund as we sold Orbis units and bought rands in January.

The black swan is a powerful metaphor first used by Latin poets long ago and more recently revived by modern financial writers, such as NN Taleb. The meaning of the metaphor has evolved over the centuries, especially since we discovered that black swans actually do exist. In today's financial parlance, most people regard a black swan event as a big surprise with a major effect, which people then try to rationalise in hindsight.

The summary removal of South Africa's respected minister of finance, Nhlanhla Nene, on 9 December would probably fit most people's definition of a black swan event. It certainly surprised us. But the real question for investors is how best to approach the risk of such events.

We do not believe that we have any special ability to predict them. So we do not try to. But this does not mean that we are not accountable to you for the impact of black swan events on your portfolio. We cannot throw our hands in the air and use a black swan as an excuse.
By giving us a broad asset allocation mandate in the Balanced Fund, you have delegated the responsibility for managing the risk of black swans to us.

So how do we try and manage the risk of unpredictable events?
The answer is to invest in a diversified portfolio of assets which are undervalued by the market, which are not priced for perfection and which present favourable odds for a rewarding investment return. The prices of these assets normally prove more robust to black swans, than those of overvalued assets.

This approach does not guarantee that we will successfully ride out every unexpected event. Oil falling below US$40 has hurt Sasol's share price and our performance over the last 15 months. But we do believe that this approach will allow us to see out more black swans than not and to deliver pleasing returns over the long term.

Although with the benefit of hindsight one could always have been even better positioned, we are pleased with the Fund's performance this quarter in light of the Nene debacle. We have explained the reasoning for our full foreign exposure in previous commentaries, and this was well rewarded in the quarter and indeed for the whole year. By maintaining a low duration on our fixed interest exposure, and keeping a low property exposure, we have sacrificed yield for a number of years, but this protected us well from the steep increase in interest rates in December.

The Fund's large holdings in JSE-listed multinationals British American Tobacco and SABMiller performed well. We have been trimming these positions and investing the proceeds into selected South African financial companies and resource and other exporting companies. The market started to recognise the potential we see in some South African export businesses such as Sappi.

We cannot reliably predict whether any black swans will visit us in 2016. Global equity market indices appear fully priced, so there is certainly a risk of negative returns from global equities. But you can rest assured that we continue to seek the best investment opportunities to deliver pleasing long-term returns on your capital.