The fund returned -1.5% for the quarter against the benchmark return of -7.1%. For the year to September, the fund returned 10.3% against the benchmark return of 7.9%. The fund has outperformed the benchmark over all meaningful periods.

The greatest contributors to quarterly performance were our overweight positions in Sappi, ArcelorMittal and Pallinghurst Resources. Our underweight position in AngloGold and Assore also contributed to performance. Detractors from performance included our overweight positions in Pan African Resources, Metmar and Buildmax as well as our underweight positions in Sasol and Gold Fields.

During the quarter we reduced exposure to BHP Billiton and Pallinghurst Resources given the strong relative outperformance and reduced margin of safety to our assessment of intrinsic value. We utilised the proceeds to add to our positions in Glencore and Impala Platinum. The returns for the resource sector have been poor, underperforming the industrial, financial and property sectors over all meaningful periods.

On the macro front, the economic outlook remains uncertain. Although the US economic statistics have positively surprised, risks around Europe and China continue to increase. China remains the most important economy for resource demand, and recent data confirms that growth is slowing. The weaker macro environment, strengthening of the US dollar and increase in mine supply across key commodities have been negative for commodity prices, and weigh heavily on the resource sector. Some notable declines (in US dollars) for the quarter were:

Iron ore - declined 18%, now trading 56% below its peak of 2011.
Brent crude - declined 14%, now trading 37% below its peak of 2008.
Platinum - declined 12%, now trading 44% below its peak of 2008.
Gold - declined 8%, now trading 37% below its peak of 2011.

In general, most commodity prices are now trading at, or below, our assessment of normalised or mid-cycle levels. In the long run commodity prices are determined by the cost of production. Our assessment of normalised commodity prices is based on a detailed analysis of the cost structure of each commodity, demand/supply outlook, incentive prices and long-term industry margins. Given the inherent risks in forecasting, we look at various scenario analyses to sense-check our assumptions and ensure our investment case for individual positions is sufficiently robust at more bearish scenarios.

Our top holding in the fund remains Anglo American. At current prices one is buying the company at 7x our assessment of normalised earnings [i.e, earnings power of the business through the cycle] and 0.8x book value. This means that the market assumes Anglo will not deliver returns in excess of their cost of capital through the cycle, which has not been the case historically. Anglo's recent track record on capital allocation has been poor; overpaying for acquisitions at the top of the cycle and subsequently having to impair those investments. The risks of further impairments are likely, however these concerns are more than reflected in the current share price. Anglo has some high quality assets, however poor capital allocation, underperformance of Anglo Platinum and weak management has detracted from the investment case. The new CEO, Mark Cutifani, comes with operational experience and we have been pleased with the operational progress delivered to date. We believe the improved focus at board level on capital allocation and fixing underperforming assets will unlock a tremendous amount of shareholder value.

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 do not (or cannot) 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

The resource sector's total return of 2.9% for the quarter lagged that of the All Share Index (7.2%), but remains ahead of the market year to date and over the last 12 months. Over all other periods, the sector still significantly lags the rest of the market.

The platinum strike was the longest in South African history, only being resolved after 5 months of lost wages for workers and production for the companies. The platinum mining index lost 5.9% of its value over the past three months. Metal ETFs fared better, with palladium and platinum increasing by 10% and 5% respectively, while rhodium was flat. Going forward, the companies still face the difficult task of normalising employee relationships, restoring production and right sizing their cost bases. We have used the weakness in share prices to add to our Impala Platinum shareholding over the quarter, but still prefer the platinum group metal (PGM) ETFs to express our belief that the strike will impact above-ground stockpiles. Owning less platinum equities than the index contributed to the fund's performance over the quarter and year.

In contrast to the first quarter of 2014, gold miners underperformed the broader index in the second quarter. Year to date, however, they have still outperformed the index and the market (delivering a healthy 42%), but over all periods longer than this, investing in gold companies have been value destructive. Our holding in Pan African Resources and not owning the other gold companies have contributed to performance over the quarter and year.

Heavyweights Sasol and BHP Billiton were the two biggest contributors to both the quarterly and annual performance of the sector. Combined, they make up over 60% of the weight of the index but only 15% of the fund. It comes as no surprise that the fund underperformed the resource index for the last 12 months given our underweight holdings in these two counters. We believe that the rand oil price, which drove a portion of the good performance, is already at high levels.

The fund delivered 2.9% for the quarter (in line with the index) and 33.3% for the year (39.1% for the index). Over the more meaningful periods of 3, 5 and 10 years, the fund delivered above benchmark performance. Looking forward, we believe the resource sector still offers value relative to the rest of the South African market and that the companies owned by the fund are even more attractive than the general index.

Portfolio managers
Henk Groenewald and Duane Cable Client

The 2013 calendar year turned out to be another good year for most asset classes worldwide. Locally, the JSE All Share Index returned 21.4%, surging to new all-time highs in December. Global markets also had a strong year, with the MSCI World Index returning 27.4% in US dollar terms. The rand weakened by 23.2% against the US dollar over this period. Investors in the resource sector will be forgiven for thinking they have been left with a lump of coal in their Christmas stocking with the JSE Resources Index returning only 1.4% over the same period. We have for some time highlighted the divergence in performance between the resource sector and the rest of our market and this trend continued in 2013.

The decline in commodity prices continues to weigh on the resource sector. The returns for this sector have been poor, underperforming the industrial, financial and property sectors over all meaningful periods. 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.

The fund returned 0.7% for the quarter against the benchmark return of 2.1%. For the year to December, the fund returned 6.0% against the benchmark return of 1.4%. The fund has outperformed the benchmark over 3, 5 and 10 years.

The greatest contributors to quarterly performance were our overweight positions in Mondi, Sappi and Pallinghurst Resources. Our underweight position in large cap gold equities, Impala Platinum and Assore also contributed to performance. Our overweight positions in Pan African Resources, Exxaro and Anglo American detracted from performance, while our underweight position in BHP Billiton and Sasol also detracted.

During the quarter we added to our positions in Exxaro and Sappi. We have taken some profits in Sasol and Pan African Resources given the strong relative outperformance and reduced margin of safety to our assessment of intrinsic value. During the quarter we initiated a position in Glencore, a diversified mining and commodity trading business. Glencore trades at 9x our assessment of normalised earnings which we believe is undemanding for a business with one of the best management teams in the industry. Given our increased concerns around the lack of mining flexibility at the Lease Area we have switched some of our holding in Impala Platinum into Lonmin. Although both companies trade at similar valuation multiples based on our assessment of normalised earnings, we believe that Lonmin has more operational flexibility in the short to medium term and the investment case comes with less risk.

Our top holding in the fund remains Anglo American. Anglo has been a significant underperformer relative to both the benchmark and BHP Billiton. We don't believe one can build an investment case on relative underperformance alone. At current prices one is buying Anglo at 7x our assessment of normalised earnings and 0.8x book value. This means that the market assumes Anglo will not deliver returns in excess of their cost of capital through the cycle, which has not been the case historically. Anglo's recent track record on capital allocation has been poor, overpaying for acquisitions at the top of the cycle and subsequently having to impair those investments. The risks of further impairments are likely; however, these concerns are more than reflected in the current share price. Anglo has some high quality assets; however, poor capital allocation, underperformance of Anglo Platinum and weak management has detracted from the investment case. The new CEO, Mark Cutifani comes with operational experience and a much improved capital allocation track record, which should go some way to getting the business back on track. We believe the improved focus at board level on capital allocation and fixing underperforming assets will unlock a tremendous amount of shareholder value.

We believe it is important to behave counter-cyclically in a cyclical industry. While many market participants have grown increasingly cautious on the outlook for the sector, we have become increasingly bullish. Our bullishness is not simply a naïve belief in mean reversion, but based on specific opportunities we have identified based on our fundamental bottom-up research. We remain underweight gold equities despite the poor relative performance to both the underlying metal and the benchmark, as we simply do not see sufficient value (except for the company specific case of Pan African Resources) relative to other opportunities in the sector. Based on our assessment of longterm valuations, we are excited about the position of the fund and specific opportunities that have presented themselves within the resources sector.

When building your portfolio, we strive to ignore the constant noise in the market and identify undervalued and mispriced companies based on long-term valuations.