We aim to produce a pleasing long-term return that is superior to the Fund’s benchmark. Doing so is only possible because we are willing to build a portfolio that looks very different from the benchmark. This difference doesn’t always accrue to the benefit of returns, however, and 2018 has thus far been one of those times. These periods can be painful, but also ripe with opportunity. One stock in the portfolio that illustrates this particularly well is Taiwan Semiconductor Manufacturing Company Limited (TSMC).

TSMC is the world’s largest semiconductor foundry. You won’t see its name on any product, but chances are its factories, or ‘fabs’ in industry parlance, made many of the semiconductor chips in the electronic items you use every day. TSMC manufactures the chips designed by ‘fabless’ semiconductor companies like Nvidia, Qualcomm, and AMD, as well as other customers like Alphabet, Amazon and Apple.

Since the mid-1990s, a new generation of manufacturing technology has become much more expensive to develop, leading increasing numbers of firms to hand off manufacturing to TSMC and other foundry specialists.

This has proven a double benefit to TSMC. It benefits first by being the only choice of designers like Apple, Qualcomm and Nvidia who need their chips to be the fastest, smallest and most power efficient. But TSMC benefits again as those fabs age. By the time other foundry companies build a fab to compete with TSMC’s four- or five-year-old plants, TSMC’s are fully depreciated and are operating at peak efficiency. This lets TSMC run its non-leading-edge fabs as cash cows while still pricing at levels that starve its competition of the return they need to fund research for future generations.

Being the leader has been financially rewarding for TSMC - it has historically averaged a very consistent 25% return on equity and a similarly high return on invested capital. Meanwhile, its lead over other foundry pure plays has consistently lengthened. Just a few months ago Global Foundries, the last foundry rival with aspirations of staying on the leading edge, announced it was giving up and focusing on older-technology fabs. And as more devices get smart and already-smart devices get smarter, we expect near-leading-edge semiconductor demand growth to be healthy for a long time.

Despite these attractive fundamentals, TSMC traded at just 15 times earnings during much of 2017 - a below-average price for a far-above-average company. We built a position throughout the year, but grew wary heading into year end, as investors grew too optimistic about the outlook for cryptocurrencies like bitcoin. That affected TSMC because bitcoin is facilitated by a global network of cryptocurrency ‘miners’, who use powerful computers (with TSMC-built chips) to solve difficult calculations. It was a gold rush, and TSMC was making the shovels.

As bitcoin and other ‘cryptos’ captured investors’ imagination, TSMC got caught up in the enthusiasm, at one point being highlighted as the largest position in a new cryptocurrency exchange traded fund. This pushed up the stock’s valuation, and for us, was a signal to tactically lower the weighting.

The bubble popped early this year, and those once-enthusiastic investors have grown bearish. Sentiment on TSMC overshot the other way, bringing its valuation briefly back to 14 times forward earnings and a near -4% dividend yield, despite no change to its long-term fundamental prospects. Thankful for the opportunity, we rebuilt the position - bringing the stock into the top 10 holdings. In TSMC’s case, the market’s focus on short-term issues provided us with attractive opportunities to sell as well as buy.

The curse (or blessing!) of being an intrinsic value investor is that we are always unhappy about something. When performance has been good, we tend to worry about the compression of potential in the portfolio and the prospect of that leading to underperformance. When we’ve underperformed and are out of sync with the market, of course we’re not happy, but we do enjoy the opportunities to add to high-conviction ideas. We can never tell when or if the market will get back ‘in sync’ with our portfolio views, but in our experience over many cycles, the rewards have historically been worth the wait.

TSMC was the biggest addition to the portfolio, followed by Pacific Gas and Electric, a US-based utility company. The largest sale was of the equity and selected bonds of Navient, a US-based student loan servicing company.

Adapted from Orbis commentary contributed by Alec Cutler
For the full commentary please see www.orbis.com

As we look around the world for opportunities, markets appear plenty risky but insufficiently fearful. Investing is exciting, but it tends to be less exciting when fear and risk are aligned as the opportunity set presented to active investors is not as extraordinary. The best opportunities typically arise when investors are afraid but there is far less than usual to be afraid of - times like November 1987, or years 2003 and 2009. Such periods offer target-rich environments for analysts, but require investors not to be trigger-shy because of recent bad experiences.

However, today is not one of those times. The current environment of high risk and low fear environment makes for a dangerous cocktail for sanguine investors. What does this mean for the Fund?

Scenarios and opportunities
While we aren’t in the business of making macroeconomic forecasts, we cannot stick our heads in the sand either, so we look at multiple scenarios and assess how the portfolio might behave in each of them. Rather than betting heavily on any one scenario, we aim to ensure that our positioning isn’t disastrous in any of the scenarios that appear most plausible. We are guided by a couple of pretty simple observations: 1) What are valuations telling us, and 2) What is everyone else worried about? We tend to worry most about what worries others least, and vice versa.

This approach tends to work over time because fear and valuations are linked. If everyone is worried about the same risk, that fear is likely priced into markets, making the feared outcome both less likely and less rewarding to guard against. For example, two years ago, investors were worried about a recession, and we found attractive opportunities among growth beneficiaries. Today investors appear to expect continued growth, and that makes us wary.

While attractive equity opportunities are harder to find when fear is low and risk is high, we are fortunate to have thousands of shares to choose from and our research team continues to find attractive ideas. In the current environment, typically one would expect to invest into defensive stocks, such as consumer staples (Nestlé, Coca-Cola) which are considered to be extra safe. However, these types of stocks are not attractively valued, have not grown over the past 10 years and we believe are riskier at their current valuations.

Two types of shares provide particularly good illustrations of what we’re finding in the current environment: ‘beta arbitrage’ opportunities, and our wide footprint of idiosyncratic holdings.
Beta arbitrage
Benjamin Graham and David Dodd are the godfathers of value investing. Their basic advice: buy shares of great businesses when they are temporarily thought not to be so.

In the Orbis SICAV Global Balanced Fund, we have found a moderate risk corollary: buy shares of safe businesses when they are temporarily thought not to be so. Over the past few years, we have rotated capital into integrated oil companies such as BP and then added selected pharmaceuticals such as AbbVie, both beta arbitrage opportunities.

A stock’s beta measures its market sensitivity. Simply put, a stock with a beta of 1.2 is expected to move 1.2% for every 1% move up or down in the market. But the calculation period matters. When a sector is out of favour, its beta may increase, making it look more risky. When that happens, we find it valuable to consider how the near-term number stacks up against the company’s long-term average.

For our selected ‘beta arbitrage’ shares, we believe temporarily high betas have tricked investors into thinking the companies have permanently lost their high-quality, stable fundamentals. If we are correct, the market will rediscover the stability of these companies and reward them by returning them to higher valuation levels.

Wide footprint of idiosyncratic opportunities
Investing in attractive opportunities that have very little to do with the economic cycle is another way to deal with the risk of the economic cycle rolling over. Nexon, a video game company which is due to launch a mobile version of its blockbuster game Dungeon Fighter, and Navient, the US student loans administrator currently being sued for how they went about administering loan payments, are such examples. Each of these companies has risks, but uncorrelated risks that we believe are more than accounted for in their valuation levels. By combining these investments, we hope to accrue the long-term gains that come from buying on the cheap while diversifying down the overall risk.

Staying the course
In short, we are managing risk by doing what we always do: hunting for attractively priced individual securities. It’s not an easy environment, but by focusing on bottom-up opportunities, we believe we can provide an attractive balance of risk and return.

The Fund continues to hold no long-term government bonds. At the security level, the biggest additions over the quarter were Facebook, Californian utility PG&E, and oil and gas services company Schlumberger.

Adapted from Orbis commentary contributed by Alec Cutler
For the full commentary please see www.orbis.com

A large portion of the Fund is invested in the Orbis Global Balanced Fund. But what is a ''balanced fund''? The moniker has become so common that it’s all but lost its meaning. Are we balancing stocks and bonds? Income and growth? Momentum and value?

To us at Orbis, it’s simple: we are trying to balance risk and return. Operating with a moderate risk profile, our goal is to provide the best possible return we can, in the most efficient way possible, in any market environment.

Before we go any further, it’s worth defining what we mean by ''risk.'' When normal people ask whether an investment is ''risky'', they mean, ''am I going to lose money?!'' It’s pretty simple, and no one likes losing money. But when financial professionals talk about risk, they are often speaking about something very different backward-looking statistics like beta, volatility, or tracking error. Those statistics have their uses, but they are not our primary focus. When we think about risk, we are thinking about the chance that the fund loses money. And in our view, the best way to lose money is to pay more for something than it’s actually worth.
Since we believe that yesterday’s ''safe'' assets can become today’s ''risky'' ones, we built the fund to be flexible. We are largely agnostic to labels like ''income'' and ''growth'' or even ''bond'' and ''equity''. Function is more important than form, and each security we buy must help the portfolio deliver better bang for its risk buck.

So how are we striking that balance in the current environment?

Although stock markets around the world arguably look expensive, as we discussed last quarter, we have found a number of individual stocks that appear to trade at a substantial discount to their fair value. We have found some attractive bonds too, but fewer of them. Today, we believe selected stocks offer the best potential for good long-term returns, so the portfolio has a high proportion of its assets in them. Leaving that much exposure to stock markets would be too risky, however, so we must find a way to balance this out.

We know the classic answer: hold a bunch of government bonds. Historically that has worked extraordinarily well. On any backward-looking measure, bonds look low-risk and a 60/40 blend of stocks and bonds looks ''balanced.'' But backward-looking measures can’t tell you if an investment will lose money in the future.

While government bond yields have started to increase, we believe most continue to carry serious price risk if global interest rates keep rising. In light of this, we don’t think we can rely on a broad basket of bonds to balance the risk of our favoured equities.

That presents a challenge. If we like some equities but we don’t like most bonds, how do we maintain the portfolio’s balance?

We have sought to lower the portfolio’s risk in four ways: searching for attractive corporate bonds, hedging stock market exposure, avoiding expensive stocks and buying short-term US Treasury securities.

Taken together, these decisions result in a portfolio which looks very different from its 60/40 benchmark - hopefully it offers both lower risk and higher potential returns. And in ten years’ time, when market prices look very different than they do today, we would expect the portfolio to look very different as well. However we get there, we will always manage this Fund to the same goal: a balance of risk and return.

Over the quarter, the Fund sold several cyclical shares that had performed well, rotating some of this capital into one-year US Treasury Notes. With a 2.1% yield, minimal interest rate risk, no stock market risk, and excellent liquidity, we believe short-term Treasuries enhance the portfolio’s risk-adjusted return potential.

Adapted from Orbis commentary contributed by Ashley Lynn and Alec Cutler.

For the full commentary please see www.orbis.com

Global stock markets were up by 22% in US dollars in 2017, setting new records. Despite flat yields and scant coupons, even global government bonds returned 7% (helped by US dollar weakness). Altogether, the Orbis Global Balanced Fund’s 60/40 benchmark delivered an impressive 16% US dollar return, and the Fund fared better than that.

As one would expect, the Fund’s outperformance was driven chiefly by equity and bond selection. Currency exposures also contributed, but the impact of the asset class stances was muted. Though it was a fun year to hold stocks, equity hedging costs offset some of the benefit of being overweight equities versus bonds.

After a year of strong returns, you might expect the portfolio to look substantially different. It doesn’t. With few changes to discuss, this is a perfect time to revisit why certain companies and areas are attractive - and why Orbis has steered clear of others.

The Fund still holds zero government bonds, which offer low yields but involve substantial interest rate risk. The Fund also remains underweight the US dollar and US stocks, which continue to look expensive compared to equities in other regions.

One of those regions is Asia ex-Japan, the Fund’s biggest regional overweight. More than half of this concentration is represented by just five technologyrelated companies: e-commerce operator JD.com, Samsung Electronics, internet company NetEase, Taiwan Semiconductor Manufacturing, and social media juggernaut Tencent. Orbis believes each of these companies offers aboveaverage growth and cash generation potential, with minimal balance sheet risk.

Energy shares also continue to look attractively valued versus the wider market. While oil prices are now 13% above their levels of early 2015, US oil and gas producers have still not recovered. A continued oil price recovery is not essential for top holdings BP and Royal Dutch Shell, however. Both companies have refining businesses which have been more profitable recently than in 2013 (when oil fetched US$95 a barrel). Increased discipline has helped BP and Shell improve their free cash flow. If this gives the market confidence in the sustainability of their dividends, we would expect their yields to come down from currently high levels of 6%.

AbbVie, a biopharmaceutical company and the Fund’s largest holding, has been going from strength to strength. Investors have long fretted about competitive threats to the company’s blockbuster drug Humira. In late 2017 AbbVie reached a settlement with rival Amgen that will delay serious US competition for Humira until 2023. AbbVie’s shares have performed well since the Amgen announcement, but Orbis still believes the valuation does not fully reflect the long-term value of AbbVie’s development pipeline.

Recent fortunes have been different for Bristol-Myers Squibb, another biopharmaceutical firm. With Bristol, the key drug to assess is the biologic Opdivo. Prior to the Fund’s purchase, Bristol shot itself in the foot with a botched trial, which sought to establish new uses for Opdivo. Next year, Bristol is moving forward with a redesigned trial, which should stand a higher chance of securing new approvals. If the company successfully addresses its execution risk, the market should come to recognise the quality of the business and its development pipeline.

Orbis continues to believe that selected shares in Asia, energy, and healthcare offer potential for attractive returns without undue risks. With equity and bond valuations looking rich, Orbis believes that an active approach is a better bet in the current environment. Across asset classes, Orbis continues to build their funds from the bottom-up and remains excited by the quality of the opportunities that have been found.

There have been no material changes to the portfolio’s allocation of capital to the Orbis funds, or to its equity, currency and regional exposures in the last quarter. With regards to individual holdings, Apache, a US oil and gas production and exploration company, fell out of the top 10 after its shares were punished for slower-than-expected progress in the development of its Alpine High field in West Texas.