We should start the fact sheet by illustrating our concerns about the state of the markets by way of a story about a truck driver who stops every few miles to bang on the side of his rig with a sledgehammer. A cop asks him what he is doing. “This is a 40-ton truck” the driver says “but I am carrying 41 tons of canaries. Got to keep them flying” (Source: Grant’s Interest Rate Observer ).

This story does a good job of describing how we see the developed market Central Bank Governors and Treasuries dealing with the low growth of their respective economies. Thirty per cent of sovereign debt now trades at negative yields. It was not long ago that Greek bonds were trading at double-digit yields… they now trade at below 2 per cent.

In times of such uncertainty, one should tread carefully because we may wake up one day and discover the Governors have run out of either canaries or sledgehammers!

In this environment, we prefer to own South African assets, many of which trade at record lows. Over the last six months, we have continued to add small and mid-cap stocks to the portfolio. These are companies that dominate their markets, are hard to replace, have strong balance sheets and have management teams that have faced tough times before. While the growth outlook for South Africa looks uncertain, we continue to believe our challenges are not hard to fix. It may be too optimistic to hope for the required changes to be made quickly but we won’t wait for a Reserve Bank Governor or the government to assist us before we invest. If we apply a reasonable margin of safety into our thinking we may look back and see this as one of the most significant buying opportunities.

We acknowledge that there is a risk we may be too early…but at least we don’t lie awake at night hoping to hear the sound of the sledgehammer.

MARKET OVERVIEW
As we write this, the global markets are in risk-off mode, a reaction to the dovish tone adopted by the US Federal Reserve - something we discussed as a possibility in a previous quarterly commentary. We suspect that the pause contemplated by Mr. Powell (Federal Reserve Chairman) appears related to the pressure exerted by Donald Trump and a reaction to a perceived slowdown in the US economy which has seen a weakening of the US dollar against emerging market currencies like the South African rand.

In general, low interest rates are a positive for asset prices. The market is anticipating lower US interest rates and South African rates will benchmark off this, resulting in less
pressure for local rates to rise.

THE PORTFOLIO
We have found attractive opportunities in equities, leading to an increase in our positions in Reinet, Royal Bafokeng Platinum and Melco International Development.

Reinet (8%)
Reinet is a holding company with two primary assets; British American Tobacco and Pension Insurance Corporation. While British American Tobacco will be well known to most,
Pension Corp is an unlisted company that assumes the liabilities of company pension funds for an up-front sum.

At present, Reinet trades at 40% discount to the sum of its parts, the majority of which we think are valued cheaply. BAT currently trades on 10 times earnings and management conservatively place a 20% discount on the embedded value of Pension Corp. In addition, the management team is buying back its own shares - a clear indication of rational capital allocation.

While there are many reasons why a holding company trades at a discount to the sum of its parts, we think the performance fee structure at Reinet is a significant contributing factor to Reinet’s wide discount. We note that Reinet is currently very far away from the high watermark, above which the performance fee would apply. It is not inconceivable that a change of thinking by management could remove the performance fee and reduce the discount.

Royal Bafokeng Platinum (4%)
RB Platinum is the sixth largest platinum producer in South Africa. While a relatively easy company to understand, RB Platinum has been largely ignored by the market as a result
of its small size and limited free float. Investors have tended to focus on the larger producers despite RB Platinum being a higher quality, lower risk platinum group metal producer.

Management has used its capital to purchase good assets at bargain basement prices. It has very good BEE credentials being 40% owned by the Royal Bafokeng Nation, has good labour relations and has been relatively unscathed from worker union issues. Our position has been built up over the years and this is a company that we have spent many hours getting to know. Ultimately it’s the platinum group metal prices, a group of commodities that we still believe has a bright future that will determine its success as an investment.

Melco International Development (3%)
Melco is one of six casino concessionaires in Macau. It is run by Lawrence Ho, whose family were the original casino owners in Macau and still are. The difference is that Melco is his show, and the company is driven by a different set of principles. This is mainly as a result of his western education which is evident in his capital allocation skills. Such skills have been tested and he has passed with flying colours.

The long-term prospects for Macau are good as the region becomes the established gambling destination for Chinese gamblers. This is a situation that suits the Chinese government and is acceptable to them in terms of control and regulation.

With Mr. Ho, there is always potential for something new, the effect of which is not built into their share price, and certainly not into our thinking. Ultimately, over the next ten years, we believe having exposure to one of the largest and most profitable casino markets makes sense, particularly when getting that exposure through a holding company that trades at a significant discount to the value of the underlying assets.

Transaction Capital (3%)
Transaction Capital essentially does two things; it lends money to the taxi industry and is the biggest buyer of distressed books from retailers and banks. The management team is
never content to sit still and continues to invent new ways to add value to shareholders and diversify its revenue streams. They are market leaders in their segments, dominate their markets and never cease to look for ways to delight their customers and enlarge the moat around their businesses. In addition, management is backed by the founding shareholders who themselves have proven to be remarkable capital allocators.

Berkshire Hathaway (2%)
Mr. Buffett has been clear that shareholders should expect subdued returns from Berkshire Hathaway as the law of large numbers continues to hamper its long-term record of outstanding performance. At present it is the 5th largest component of the S&P 500. Investors may then ask why we own it. We think it is a wonderful proxy for the S&P 500 and a reasonable way to obtain exposure to the US economy. It is a company we know well, run by arguably the most rational investors in the world with exceptional capital allocation skills. Berkshire has a very low head office cost and a valuation which is not far from a level where Mr. Buffett is prepared to purchase the shares back. The company is positioned for longevity and the future management teams have been selected and entrenched with the DNA of Berkshire. We suspect in times to come that the new managers may start paying dividends as they struggle to invest the prodigious excess cash flows.

OUTLOOK
The companies discussed above, along with the investment in the fund of Longleaf Asia Pacific fund, account for approximately 22% of the fund. The rest of the portfolio is also cheap, in particular the smaller positions in South African stocks such as AECI, RECM & Calibre and Bowler Metcalf.

We are optimistic about these counters and the fund stands a good chance of doing well from these positions.