Currently the South African political situation is uncertain, and markets don't like uncertainty.

The two key questions you will most probably have regarding your investment in the PSG Balanced Fund are:

- How has the fund fared during this time?
- What is PSG Asset Management doing with your money in light of these developments?

On the first question:

We generally don't comment on such short-term returns. We can however offer some comfort in reminding you that we build robust portfolios and avoid highly concentrated and/or correlated bets. Although the fund holds instruments which are highly impacted by the recent developments, like the equity of South African banks (6.9%) and South African government bonds (12.3%), we also hold counterbalancing instruments. These include domestic cash equivalents (12.4%), foreign cash (2.4%), offshore listed equities (22.1%) and domestically listed rand hedge companies (3.9%). So, roughly 40% of the portfolio is uncorrelated with the current South African sell-off which helps to limit the drawdown.

What are we doing at the moment?

Nothing different to what we do during any other periods of panic. We are gradually applying the large cash reserves in the funds into securities that others are selling on the market. This approach to investing has served us, and others, well in the past.

We are not predicting the outcome of the current political struggles. We are rather buying securities which are trading below a conservative estimate of their intrinsic value. We believe that owning such securities will, in the long-term, serve our clients better than owning cash. Remember that owning a piece of a good company is a far better hedge against inflation (and therefore currency depreciation) than domestic cash.

What should you be doing at the moment?

It is at junctures like these that we emphasise the importance of taking a long-term view as an investor in our funds. We cannot predict the future, but remember that generally fleeing to cash when others are fearful is a very expensive mistake. Very often, good returns are made in bad times.

Current context

Headlines around issues like land expropriation, the new mining charter and the independence of the South African Reserve Bank (SARB) - accompanied by a continuous stream of leaked Gupta-related emails - do not make for peaceful bedtime reading. Investors are understandably concerned.

Our perspective

"Be fearful when others are greedy and greedy when others are fearful." - Warren Buffett

Have you spoken to any South Africans recently who are fearful? One of the world's greatest investors says this is the time to be greedy.

In investments, 'being greedy' means that you should be a buyer when fear is driving the prices of securities (shares and bonds) lower. There are various human biases that cause irrational selling. One of these is confirmation bias: once we reach a certain conclusion or develop a specific narrative, we search for or interpret information in a way that confirms our preconception. For example, once someone has decided South Africa is going the route of Zimbabwe, they will only see information that confirms this theory. Such a person would be a hasty seller. We would like to point out three possible reasons why we believe that 'greedy' investors currently have better odds:

1. Plenty of bad news has already been discounted in to the prices of securities.
We can currently buy quality companies on the JSE at price-earnings (P:E) ratios in the high single-digit to low double-digit range, which is a standout opportunity. The weighted average P:E ratio of the JSE-listed companies in the PSG Balanced Fund is currently 13.4. These are all companies that have some form of competitive advantage and are managed by very capable teams. There are many future scenarios under which these companies fare well and will reward brave investors handsomely.

2. Uncertainty and daunting prospects reduce competition, which is the most important driver of profits.
If in the year 1900 you knew which political developments would take place in South Africa over the next 117 years, would it be your investment destination of choice? Probably not. However, a recent study by Credit Suisse found that since 1900, South African stocks have generated higher US dollar returns than any other geography. Similarly, consider the tremendous social and regulatory pressure the tobacco industry has faced over the last 20 years. Despite this, an index of listed US tobacco companies has returned an annualised total return of 15.4% over this period - significantly more than the S&P 500 Index, which has returned 7.1% when measured on the same basis. Why these unlikely outcomes? We believe that lack of competition was a significant contributor in both cases. In South Africa, sanctions and generally daunting political conditions kept new entrants at bay. In the tobacco industry, banned advertising made it impossible to enter the market. Current domestic uncertainty is scaring off competition - both from outside investors and from many South African companies that are allocating capital offshore rather than competing locally. According to SARB figures, South African companies invested R300 billion outside our borders over the past five years.

3. There are numerous facts that don't support the failed state thesis.
If you live in a country with extreme income inequality and unemployment of close to 30%, should you be surprised to hear populist rhetoric from time to time? However, the process of moving from rhetoric to legislation is long and rigorous - and significantly easier said than done. Over and above parliamentary processes, we also have an independent judiciary and a constitution that is widely regarded as one of the most progressive in the world. And ultimately, we have a functioning democracy that gives the public the ability to hold politicians to account. The change of power in key metropoles in 2016 serves as an example.

We don't know the future for a fact, but we do believe that odds are currently better for buyers of undervalued South African equities than for sellers. We remind existing investors in our unit trusts that to enjoy the benefits of our process, you need to invest for the long term - even when it is very hard.

Portfolio positioning
We continue to have a large portion of the portfolio invested offshore (23%) in high-conviction global ideas. We have also actively been allocating capital to our higher-conviction domestic ideas, which continue to offer compelling value. The real yields offered by South African government bonds are above our required rate and the portfolio currently has an aggregate exposure of 10 percent to these instruments. Cash levels remain high and we are able to deploy 13% of the fund if new opportunities arise. We think it is a good environment for long-term stock picking, and have a track record of generating good returns for our clients in tough times when fear is prevalent (such as in 2003, 2009, 2011 and 2015). Subsequent average five-year outperformance for our funds over these periods (including 2015 to date) was 6.6% a year (5.4% excluding 2015).

"To be useful, your beliefs should be constrained by the logic of probability"
Daniel Kahneman

If a person breaks up a very healthy relationship with a good partner in a moment of emotional irrationality the decades of foregone happy cohabitation is an unnecessary tragedy. Even the best unit trusts can generate poor returns for those clients who exit the fund at the wrong time. Such a tragic break up is to the detriment of both the client as well as the asset manager.

It is common knowledge that investing in a unit trust should be a long-term endeavour. In fact, very few unit trust investors would proclaim to follow a short-term approach. Why then do so many unit trust investors panic and sell at or near the bottom?

In this commentary we explore why it is so hard to make rational long-term investment decisions and how we as investors can prevent ourselves from making irrational decisions when the heat is turned up. The heat was turned up in the beginning of 2016 and we tragically saw a number of our clients exit the fund at a very unfortunate time.

We will explore this topic at both levels of decision making, firstly at the fund manager level and secondly at the client level.

We at PSG Asset Management are also emotional beings and therefore we need to have measures in place to ensure that we remain rational when those dark clouds gather.
How does our team remain rational when market sentiment picks at our emotional cords? We go back to our decision making framework.

One example of such a situation would be when a company which is held in our funds falls out of favour due to industry or company specific challenges. In such a case we would ask a few key questions:
- Is the management team's integrity still intact?
- Is the management team still making sensible capital allocation decisions?
- Is the company's competitive advantage intact and able to generate satisfactory returns on capital?
- Does management have balance sheet wiggle room?
- Is the share pricing in an extremely unlikely scenario?

The drastic sell off in resource companies and South African financial companies during 2015, are prime examples of when we had to rely on our checklist.
Let us consider the second level of decision making, i.e. clients' decision to remain invested or exit a unit trust. If the asset manager has a long-term track record of outperforming benchmarks, we recommend our clients use the following checklist to ensure rational decision making:
- Is the asset manager remaining consistent to its investment philosophy?
- Is the manager clearly communicating the reason for poor short- and medium-term returns?
- If not, why not?
- If there is clear communication:
-What would be regarded as good reasons?
-Your manager is acting in a contrarian manner which is inflicting short-term pain for long-term gain.
-There is a prolonged dislocation between share prices and intrinsic values.

-What would be concerning justification?
-Portfolios were too highly correlated, i.e. concentrated bets.
-There has been a normalisation of multiples, i.e. your manager was invested in over-valued securities.



A recent example of when the above checklist would have been helpful was during the short-term underperformance of the PSG Balanced Fund at the end of 2015 and beginning of 2016. We invite you to reassess our commentaries written over this period and consider us in the light of the above checklist. They are available in the archives section of our website. Any comment is most welcome.

As Daniel Kahneman teaches us, our decisions should be grounded in the logic of probability. This is possible if we follow a decision making framework rather than act on emotion. We will do our outmost to continuously adhere to this wisdom. We strongly encourage you to do the same.