Please note that the commentary is for the US dollar retail class of the fund. The feeder fund is 100% invested in the underlying US dollar fund. However, given small valuation, trading and translation differences for the two funds, investors should expect differences in returns in the short term. Over the long term, we aim to achieve the same outcome in US dollar terms for both funds.

The third quarter, while traditionally quiet with investors in the Northern Hemisphere going on their summer vacation, proved to be even less eventful than in previous years. While the Brexit vote jolted markets towards the end of June 2016, the next three months were spent speculating on the nature of the UK’s exit from the European Union, as well as ongoing changes in interest rate expectations in the US. The latest thinking around Brexit is that the UK will try to negotiate a fair, if slightly sympathetic deal, while European politicians are increasingly calling for conditions more aligned with a ‘hard’ exit. This has led to the pound continuing to weaken over the last few weeks, resulting in new 30-year lows as we speak. With regards to interest rate expectations in the US, the latest forward curve indicates a slight probability of a rate increase in November, and an almost certain rate hike in December. We concur with these views.

Equity markets performed well over the period, although it must be borne in mind that they were coming off relative lows after the Brexit vote. The MSCI All Country World Index (ACWI) returned 5.3% over the quarter, with the emerging markets index returning 9.2%. Year-to-date, the ACWI has returned 7.1%, significantly below the emerging markets return of 16.4%. Close to half of this performance has been due to emerging market currencies strengthening against the US dollar, after sustained weakness over the previous few years. However, over longer time periods, developed markets have consistently outperformed the emerging universe.

Sectors that stood out over the quarter were information technology and materials, while interest rate sensitive sectors like utilities and telecommunications underperformed. Consumer staples had a weak quarter, given generally greater risk appetite. Since the beginning of the year, energy and materials have done most of the running, with healthcare and financials being the laggards. The same pattern was evident in emerging market returns.
The fund performed well over the quarter, outperforming its benchmark after all fees by 5.54%. Year-to-date returns are now 3.15% ahead of benchmark, and we have succeeded in erasing most of the alpha deficit suffered during the fund’s first 12 months. We continue to work hard to move into positive relative territory since inception. In our analysis, it is clear that our high exposure to emerging markets and their currencies shortly after launch cost the fund dearly, with developed market stock picks comfortably outperforming the benchmark since inception.

Over the last quarter our holdings in alternative asset managers finally contributed positively, with some other long-term holdings like JD.com and Qualcomm also fulfilling some of their anticipated potential. Our other IT stocks like Amazon, Alphabet and Priceline also performed well. Measured since the beginning of the year the biggest contributors have been Estácio and Kroton, our holdings in the Brazilian educational sector, which announced a merger after an agreed takeover by Kroton (covered in an earlier commentary). Other winners included Apollo Global Management, Tata Motors, NetEase, Amazon and Urban Outfitters. The biggest detractors were TripAdvisor (after disappointing results), Pershing Square (due to ongoing disappointment around the Valeant Pharmaceuticals holding), JD.com (resulting from continued competitive activity in the e-commerce space in China) and LPL Financial. Apart from LPL Financial, where we sold because we lost faith in management’s ability to tackle their cost base in light of disappointing revenues, we continue to believe in these holdings. In most cases, we have used share price weaknesses to increase our holdings. A relatively new stock in the portfolio, Tempur Sealy International, provided a lot of price action since its inclusion less than a year ago. The company is one of the two leading mattress manufacturers in the US - and for that matter, the world. It owns strong brands covering the whole spectrum of price points, but is particularly strongly positioned at the top end of the range with the Tempur brand. What attracted us to the stock was that an activist investor took control of the Board through a hostile proxy vote, and immediately replaced the incumbent top management. The new CEO, Scott Thompson, has an impressive track record. He had particular success at Dollar-Thrifty, where he managed to increase operating margins significantly before the business was sold to one of its larger competitors. The reason why we think his appointment is appropriate, is because we believe that there is a big margin uplift opportunity at Tempur Sealy. When Tempur bought Sealy, its biggest listed competitor, in 2012, poor execution led to a series of manufacturing hiccups at Sealy. This has resulted in current operating margins at Sealy being just over half of what they were at the time of the deal. We are confident that this situation can be rectified through better operational management. Scott has bought equity in the business using his own balance sheet, and has displayed sound balance sheet management. The company’s more recent set of results (after June 2016) looked promising. The share price reacted positively by jumping over 20% in a few days. Unfortunately, just before this quarter-end, the company guided profit growth down again due to a very slow September. As a result of typical short-term investor orientation, the company’s share price dropped by 25% in two days. We managed our position size down after the initial positive price reaction, and could thus take advantage of the price decline. While we acknowledge that pure online players pose a threat to traditional incumbents, we think that the strength of Tempur Sealy’s brands and its innovation will endure. In our view, the company is offering a promising investment opportunity and it currently makes up about 2% of the fund.

The fund’s current positioning remains weighted towards consumer goods, with exposure to the consumer discretionary sector comprising the bulk of these holdings (and consumer staples forming a smaller component). While holding very few banking shares, the fund also has significant exposure to financials in the form of its holdings in alternative asset managers. In addition, it maintains a meaningful exposure to the information technology sector.

Portfolio managers Louis Stassen and Neil Padoa as at 30 September 2016

Please note that the commentary is for the US dollar retail class of the fund. The feeder fund is 100% invested in the underlying US dollar fund. However, given small valuation, trading and translation differences for the two funds, investors should expect differences in returns in the short term. Over the long term, we aim to achieve the same outcome in US dollar terms for both funds.

Financial markets experienced a great deal of volatility during the first quarter of 2016. Equities continued to decline into early February, following on from the sharp falls seen during January. The low point was reached on 11 February, when the MSCI All Country World Index was 11.39% lower than at the start of the year. Following this low point, equity markets staged a sharp ‘V-shaped’ recovery that wiped out the quarter’s losses. For the full first quarter, global equities gained 0.24%, while bonds’ total returns rose by 5.9% (aided by a weak US dollar). Over the last 12 months global equities returned negative 4.34%. Within commodities, gold was the outlier over the quarter, rising by 16.2%, while the oil price increased - after much volatility - by 9.2%. The US dollar fell 4.1% against the basket of currencies. The reversals in the performance of gold and the US dollar were noteworthy: gold fell 10.4% in 2015, whereas the US dollar rose by 9.3% last year.

Within the US equity markets, the biggest gainers for the quarter were gold shares (up by 53%), while pharmaceuticals were the biggest underperformers (down by 9%). The March short-covering rally saw strong recoveries in oversold economically sensitive US equities such as Tesla and Apple, as well as in traditionally cyclical companies. Despite the revival in investor appetite for taking on economic risk during March, for the full quarter, money-flows still favoured safe havens such as utilities, telecoms, beverages and tobacco. Investors remained cautious of financials, industrial cyclicals, energy and many momentum-driven technology companies. Meanwhile, liquidity-sensitive emerging equity markets lagged during the early-year sell-off, but outperformed during the March short-covering rebound. While the Standard & Poor’s (S&P) 500 index rose by 6.8% in March, the MSCI Emerging Markets index jumped by 13.3%. For the quarter as a whole, emerging markets outperformed developed markets by around 6% - the first time in quite a while that this has happened. Over the last twelve months emerging markets have underperformed their developed counterparts by just under 10%.

One of the major drivers of market unease over the quarter has been economic softness in China, with GDP growth slowing materially as the country attempts to transition from a manufacturing-based economy to being services-orientated. The fears are that unscrupulous lending and manipulation of reported leverage limits have placed many Chinese financial institutions, which are holding non-performing or soon-to-be nonperforming loans, in a precarious position. Accordingly, there has been elevated speculation in the Chinese yuan in the offshore currency market, which has forced the government to spend considerable foreign reserves to protect the value of its currency.

Another issue that troubled markets during the quarter is that growth in corporate profits has stalled. The first-quarter profits of S&P 500 companies are expected to be 6.2% lower than a year ago. Even if energy companies are excluded, profits will be 0.7% lower. This follows a fall of 2% in global corporate profits during 2015, while according to estimates, emerging market corporate profits were down by 12%. In response, firms have been cutting investment spending. Standard & Poor’s, a rating agency, estimates that global capital expenditure fell by 10% in 2015 and will drop further this year and next. Giving this perspective, in real terms, global capex is forecast to be no higher in 2017 than it was in 2006. The fund performed well over the last quarter, but still had a tough first year in existence. The net return of positive 1.1% for the quarter outperformed the benchmark by 0.84%. Over the last year and since inception the fund is still well below its benchmark, and we continue to work tirelessly to eliminate this deficit.

The stock positions that contributed the most to performance were Kroton (strong recovery in Brazil due to increased probability that the president will be removed through impeachment proceedings), Urban Outfitters (improved operational performance leading to strong rerating in the share), and Apollo Global Management (most alternative asset managers rerated with better outlook for equity markets). It was also pleasing to note that some of our previous laggards contributed positively (e.g. Harley Davidson, Discovery Communications, and some of the other alternative asset managers). Detractors included Tripadvisor (weaker earnings numbers in the short term), LPL Financial Holdings (very poor earnings guidance, a major disappointment for us), and Pershing Square (a new position that continued to retreat on the back of increased uncertainty over Valeant Pharmaceuticals, one of the fund’s positions which we discuss in more detail below).

The fund had a strong March, reversing the poor fortunes of the previous few months. More importantly, our stock positions added significant value, and we have now outperformed the developed market subsector benchmark since inception. We continue to find value, and hold a substantial portion of the fund in emerging market equities. At the moment this number is just over 20%, but over the last quarter we have reduced the Brazilian exposure while adding to the Chinese exposure. In light of some of the macroeconomic events regarding the Chinese yuan, we have deemed it necessary to buy currency protection for the bulk of our Chinese equity holdings.

A relatively new investment that might have caught the eye is Pershing Square Holdings. This actively managed investment trust is managed by the legendary Bill Ackman, who until recently has had an impeccable reputation as an asset manager. Of late, one of his larger positions, Valeant Pharmaceuticals, has been in the headlines for all the wrong reasons. This acquisitive group has been accused of misrepresenting its financials, and has had to delay the publication thereof. The flamboyant CEO initially went on sick leave, but shortly after returning has been suspended by the board. While we do not have any additional insight into the situation at Valeant, we do believe that the current share price is not an accurate indication of the company’s true value. In buying Pershing Square, we were buying into a portfolio of mostly high-quality equity holdings at a discount of bigger than 10%, managed by a great portfolio manager, and at an attractive fee schedule (seeing that the fund is so far below its high water mark). Taking a long-term view, we hope to generate good returns from this position.

Portfolio managers
Louis Stassen and Neil Padoa

Please note that the commentary is for the US dollar fund. The feeder fundis 100% invested in the underlying US dollar fund. However, given smallvaluation, trading and translation differences for the two funds, investorsshould expect differences in returns in the short term. Over the long term,we aim to achieve the same outcome in US dollar terms for both funds.

The fund returned 6.7% in US dollars in the fourth quarter of 2015,outperforming the benchmark (MSCI All Country World index) by 1.7%.

Following a period of sizeable and sustained emerging market underperformance (which actually accelerated in the third quarter of 2015,with the index declining by 17.8%) and our overweight position in emerging market stocks, one might think the fund's out performance would have been driven by an emerging market snap back. In fact, investor preference for developed markets continued in the final quarter of the year, with developed market stocks outperforming by another 5%, on top of the third quarter's 9%. Our gains were actually broad-based, with contributions from our structural growth internet businesses (Baidu, TripAdvisor, Amazon, Google), the premium auto manufacturers (Porsche and Tata) as well as defensive staples (Dollar General and Japan Tobacco).

Developed markets have now outperformed emerging markets by 12.7%per year over a five-year period (or 86% cumulatively). Although the quantum of this relative performance is not unprecedented (in 1988 and 1998-2001 for example, the inflection point was only after further developed market gains)it should not be surprising that our research process, which assesses businesses on their long-term sustainable earnings power (allowing us to look through the current fog of uncertainty and fear), has uncovered select opportunities that are very attractive in our view. Among these are the Brazilian education stocks Kroton and Estacio, which are down over 50% in USD over the last year. As the no.1 and no.2 players in a very fragmented market, with market shares of 13% and 6% respectively, we believe the long term earnings growth potential of these companies is among the most attractive in the emerging market investment universe. The private education businesses are benefiting from the rising propensity of recent high school graduates to complete tertiary education in an attempt to raise their earnings potential. This in a country where the returns to education are among the highest in the OECD thanks to a severe skills shortage. Yet the companies have sold off significantly as the government has scaled back student loans that helped increase enrolments for the private universities in recent years. We believe that although near-term growth will be impacted, over the longer term the main drivers of earnings remain intact: organic expansion in the form of new campuses, acquisition of good smaller operators and market share gains from weaker players. There is also potential for the change in government's student loan payment terms to hurt smaller players with weaker balance sheets much more. This could see some of these players close or merge with larger businesses on terms more favourable than what seemed possible a year ago (when asking prices were much higher). Kroton and Estacio are performing well operationally despite significant economic headwinds affecting the rest of the economy. They now trade on 7-8x forward earnings, well below their fair multiples and boths tocks are capable of delivering 15-20% earnings growth for several years. We have devoted much time to emerging markets in our fund commentaries(to highlight the differentiated opportunity set we see, and also to explain contribution to underperformance) but it is important to remember that Global Equity Select is a global fund, and as such the developed markets of the US, Europe and Japan will always comprise the bulk of our investments. Today, stocks in these regions represent approximately 80% of our portfolio, with the US accounting for over 60%.The US (specifically the S&P500) has been the converse, delivering five-year cumulative returns 100% ahead of emerging markets. Gains in the US, as shown in the chart below (courtesy of Morgan Stanley) are increasingly driven by the biggest stocks, with the difference in returns between the 10largest mega-caps and the remaining 490 stocks as wide as it has ever been, at least in the last 15 years. Given this return dispersion, some commentators may proclaim 2016 "a stock-picker's market". But another way of dissecting overall market returns is to look at the difference between the top and bottom performers. The chart below shows this over time (taking the average return of the 50 best performing S&P stocks less the 50 worst performing stocks). With alpha always greater than 75%, and averaging 100%, it becomes clear that every year is, in fact, a stock-picker's market.

As a reminder to investors in the fund, we do not buy the market - we invest in a selection of rigorously researched stocks on behalf of clients. This means that over certain periods performance will diverge from the benchmark. But staying true to our investment process, which focuses on assessing the long term, sustainable earnings power of a business, and then backing our highest conviction ideas with meaningful position sizes is, in our view, the surest way of achieving our goal of long-term out performance.

Portfolio managers
Louis Stassen and Neil Padoa