'Knowing what you don't know (indeed knowing which things are unknowable) should free up work time to enable more fruitful investigation into things which can be known (such as intrinsic value of assets). It might also prevent fund managers from taking high risk 'vision bets', where the manager has a view of the world and positions clients' capital accordingly. This works fine so long as the vision is correct in both substance and timing. If not, well, it doesn't.' Howard Marks

The fund returned 3.6% for the quarter against the benchmark return of 2.9%. For the year to September, the fund returned 3.7% against the benchmark return of 3.0%. The greatest contributors to quarterly performance were our overweight positions in Mondi, Pan African Resources, Northam Platinum and Tongaat Hulett. Our underweight position in BHP Billiton detracted from performance, as did our overweight positions in ArcelorMittal and Sappi. During the quarter we took advantage of lower price levels to add to our positions in Anglo American and Metmar Trading. We used the rally post the announcement of a third round of quantitative easing (QE3) to take profits in positions that have worked well for us. Although we have taken some profits in Mondi and Pan African Resources, they remain two of the fund's top holdings. We have, however, exited our positions in Tongaat, York Timber and the Aluminium ETF given the reduced margin of safety to our assessment of intrinsic value. The third quarter was a positive period for equities, with monetary policy in the US and Europe providing a tail wind for risk assets. The economic growth outlook for the world's major economies remains uncertain. Downside risks to growth forecasts remain elevated, however central bankers seem committed to do 'whatever it takes' to stimulate economic growth. We believe the consequences of the unprecendented level of monetary stimulus we are currently experiencing will be higher inflation in the long term. In August we experienced the tragic events that unfolded at Lonmin's Marikana mine. The wildcat strike action has since spread to other industries and although there is a chance that we return to the status quo once the dust settles, we believe the probability is low. The SA labour force is becoming increasingly uncompetitive and businesses have to cope with higher labour costs coupled with reduced productivity. In addition, infrastructure costs (electricity, water, municipal rates) continue to rise at rates well above inflation. The attraction of South Africa as an investment destination is being impaired. Ultimately capital follows opportunity and if we do not create opportunity for the global mining industry, then SA production will continue to decline; notwithstanding the extraordinary mineral wealth we have been blessed with. Understandably we have fielded numerous calls from clients this quarter post Marikana. We are comfortable with the positioning of the fund and would like to highlight the following points:
> Although we run a fairly concentrated portfolio, with our top 10 holdings accounting for 82% of the portfolio, the sectoral and geographical mix is quite diverse with no high risk 'vision bets'.
> Although the fund mandate states a minimum of 75% of the fund has to be invested locally, many of our larger holdings, which are listed on the JSE and qualify as 'local' assets, are quite diversified assets and only have a minimal exposure to South Africa. Examples include Mondi and BHP Billiton, which has less than 10% of their valuations attributable to South Africa.
> Some of our larger holdings with a material exposure to South Africa, like Anglo American, present such a large margin of safety to what we believe the underlying business is worth, that we believe the negative news flow has been more than reflected in the share price.
> Although we are not complacent about the risks facing the South African mining sector, many of these risks are not unique to South Africa. The issues of increased mining royalties and costs are being felt in numerous mining jurisdictions including Australia, Chile, Ghana and many others.
In today's environment there are many 'unknowns'. The most dangerous thing we can do when investing our clients' money is to pretend that we know all the answers, because we do not. Overconfidence in investing is a dangerous thing. At Coronation we try to distinguish clearly between what we know, what we expect and what we don't (or can't) know. We diligently stick to our investment philosophy and allocate capital based on our bottom-up assessment of intrinsic value for each position in the portfolio. History has taught us that our ability to forecast the immediate future is limited. However, despite short-term market uncertainty, we will continue to strive to deliver superior returns relative to the benchmark over the long term.
Portfolio managers
Henk Groenewald and Duane Cable

"As the pendulum swings or the market goes through its cycles, the key to ultimate success lies in doing the opposite." Howard Marks The optimism of the first quarter of the year quickly evaporated in May as doubts about European fiscal health and bank balance sheets reappeared. Political instability and resistance to imposed austerity measures called into question the ability of the fragile political consensus to take the hard decisions necessary to resolve the European crisis. Signs of faltering growth in the US and China also unsettled investors and led to greater financial market volatility and weak commodity prices. World equity markets declined by almost 5% over the quarter, with emerging markets (-8.8%) underperforming developed markets. Over the last twelve months global equity markets are back in negative territory. Returns from South African equities were also negative in dollar terms, but managed to eke out a positive 1.7% return (as measured by the FTSE/JSE Shareholder Weighted Index) for the quarter given the sharp depreciation in the exchange rate. The resource sector delivered an even worse performance than the general market, declining by 3.6% for the quarter and 10% over the past twelve months. The fund had a poor quarter, declining by 6.2%, and is now behind its benchmark over the last twelve months. More importantly, over all longer periods, the fund is still comfortably ahead of its benchmark. Main contributors to performance over the last year were the relatively more defensive holdings of Pan African Resources, Mondi and Tongaat Hulett. Arcelor Mittal and the platinum shares detracted from performance after operational issues and price declines put severe pressure on near-term earnings. Our conviction is building that the resource sector currently offers an opportunity for investors brave enough to buck the trend and invest in this unloved sector. Most commodity prices are trading at close to the marginal cost of production and it is unlikely to decline much further in the short-term. We believe that the future return of an investment is primarily determined by the price you pay. We also believe that risk should not be measured in volatility, but rather in the probability of capital loss. Resource companies are unloved at the moment, and much of the bad news is already known and priced into the shares. Given valuation levels and the large differential between our long-term value for these shares and the price they are selling at, we believe that these cyclical companies will act much more defensively in future. In many cases (Anglo American, Arcelor Mittal) these companies are trading close to or below their net tangible assets which should also limit the downside. Relative to the South African industrial shares, we believe the investment case is even more compelling after 10 years of underperformance (see chart). In relative terms, the sector now trades at lower levels than after the crash of 2008 and has seldom been cheaper.

Portfolio managers
Henk Groenewald and Duane Cable Client

"People are habitually guided by the rear-view mirror and, for the most part by the vistas immediately behind them."
Warren Buffett

"You can't see the future through a rear-view mirror."
Peter Lynch

The fund returned -0.7% for the quarter against the benchmark return of -3.3%. For the year to end-March, the fund returned -9.1% against the benchmark return of -12.0%. Those who have followed the fund for some time will be aware of the fact that we encourage investors to evaluate us over the long term, whether short-term performance is good or bad. We remain ahead of the benchmark over 3, 5 and 10 years.

The greatest contributor to quarterly performance was our underweight position in gold equities. Our overweight positions in Mondi, Sappi, Northam Platinum, Metmar and AECI also contributed to performance. Our underweight position in BHP Billiton detracted from performance, as did our overweight positions in ArcelorMittal and Diamond Corp. The performance of our offshore holdings has been disappointing, with the US Natural Gas ETF and Zimplats being the key detractors of performance. During the quarter we took some profit in Sasol and Gazprom to add to our holdings in Sappi and the US Natural Gas ETF. If one was to take a look at the rear-view mirror, the longer-term performance of both Sappi and the US Natural Gas ETF has been disappointing. Despite short-term challenges, we believe the long-term investment cases for both remain extremely attractive and have used lower price levels to add to our existing holdings. The remaining holdings of the fund were mostly unchanged from the previous quarter.

On the macro front, the economic outlook remains uncertain. Although the US economic statistics have positively surprised in the first quarter, risks around Europe and China continue to increase. China remains the most important economy for resource demand and recent data confirms the economy is slowing. Although market participants seem to be spending a significant amount of time trying to figure out whether it will be a hard or soft landing for the Chinese economy, we remain of the view that we do not have a special crystal ball. Instead of wasting our time on questions that cannot be answered, we focus our efforts on finding attractive investment opportunities in an environment where equity prices, to a large extent, already reflect the uncertain macroeconomic outlook.

When one takes a look at the rear-view mirror, returns for the resources sector has been poor, underperforming the industrial, financial and property sectors handsomely over both the shorter and longer-term periods (see table). It is human behavior to extrapolate past performance when making future investment decisions. It is therefore no surprise that the industrial sector has become the darling of the market, whereas the resource sector is largely unloved. We would however caution that it is very difficult to see the future by looking through your rear-view mirror. At present, we are reasonably upbeat about the prospects for the resources sector, despite the macro uncertainty, whereas in general equity mandates we are finding it harder to identify value in the industrial and property sectors. Based on our assessment of long-term valuations we are excited about the position of the fund and specific opportunities that have presented themselves within the resources sector.

Portfolio managers
Henk Groenewald and Duane Cable

"The only function of economic forecasting is to make astrology look respectable." John Kenneth Galbraith

"Those who have knowledge don't predict.

Those who predict don't have knowledge." Lao Tzu

"Doubt is not a pleasant condition, but certainty is absurd." Voltaire

As the festive season draws to a close, forecasters typically start to emerge from their slumber to pontificate on the world economy and the prospects for the new year. Countless times during the holiday break (mostly around the fire at night) we get asked their views on the future. How will the European debt crisis play out? What will happen in China? Where is the gold price heading? Will this or that share go up this year?

While fund managers are expected to have a view on these and many other issues, we think these are exactly the wrong type of questions to ask. Investors should realise that fund managers, as intelligent and hard-working as some of them are, have no special crystal ball. Although many would be hesitant to admit it, the future is as dark to them as to anyone else. They might be slightly better informed than most on current affairs and the economy, but this does not mean they are better able to guess the future - only that they can more confidently speak about it…

Overconfidence in investing is a dangerous thing. At Coronation we try to distinguish clearly between what we know, what we expect and what we don't (or can't) know. We diligently stick to our investment philosophy and buy cheap shares. You should not expect us to tell you what commodity prices will do in the year ahead, but we should always be able to tell you what shares are pricing in. You should also expect us to be students of history for as Mark Twain reminds us: "History does not repeat itself, but it rhymes."

So what do we know about the future from the past? We know that commodity prices are cyclical. We know that the biggest determinant of share price movements is earnings, and that the biggest determinant of earnings is commodity prices. Because resource companies are currently extremely profitable and new projects are inevitable, we believe that commodity prices are not low. We also know that these high prices are where they are because supply could not adequately keep up with the increase in demand mainly emanating from China.

We know that Chinese demand is critical for commodities, but we do not know how it will evolve in future. It seems likely that the current tight conditions will relax over time as new projects get developed and supply growth catches up with demand. We therefore expect commodity prices to decline over the medium term.

If we expect commodity prices (and therefore earnings) to decline, one may ask why are we still positive on resource shares? The answer lies in the future that is discounted in the share prices. When you buy a globally diversified mining company like Anglo American and BHP Billiton today, the prices already reflect the expectation of lower future commodity prices.

We value these companies based on our expectations of normal conditions and factor in declining commodity prices. Even if prices were to decline today, we still find value in these companies. The short-term ride might be bumpy, but we expect longer-term returns to be adequate. For certain holdings of the fund (like Sappi, the platinum companies and Buildmax) their share prices reflect an even more dire view of the future and we hope to profit if these very negative events do not eventuate.

2011 was an eventful year. In March, global markets were initially jolted by the Japanese earthquake and tsunami, but recovered. The dysfunctional political process in the US regarding the debt ceiling lead to the first downgrade of US debt in history and counter intuitively was followed by a decline in equities and a rally in bonds. At the same time, the European sovereign debt crisis reignited fears of a global recession. The political landscape of North Africa and the Middle East was permanently changed by the events of the Arab Spring. In China signs of a slowdown in the property market led to more caution on global commodity stocks.

Unlike the more defensive sectors in our market, the resources sector suffered from the decline in global confidence, declining by 6.5% over 2011. Your fund did better than its benchmark, declining by 3.6%. The strong final quarter did help as the sector (+7.3%) and the fund (+7.6%) recovered from the early October lows. As we ask investors to measure us over meaningful periods, the three and five-year performance of the fund is still gratifyingly above that of its benchmark.

Happy New Year.

Portfolio managers
Henk Groenewald and Duane Cable