The fund had a tough quarter, with a number of stock calls in the domestic equity building block working against us. However local equity exposure has been reduced quite significantly the past year, mitigating some of this impact and resulting in the fund being down 0.5% against the benchmark return of -0.4%. For the year to date the fund has generated a return of 7.6%, which lags the benchmark return of 8.7%, but returns over all longer-term measures remain well ahead of the benchmark.

Given the disconnect between valuations and the outlook for the local economy, the fund has had record low levels of local equity for some time now. Within the equity component we have remained predisposed to businesses with exposure to growth outside of South Africa. Low growth, difficult and violently disruptive labour relations, lack of policy direction and a worsening employment situation all bode ill for the local economy and are increasingly becoming evident in the results of local corporates. Even those businesses which hitherto have been immune to this slowdown are at risk and valuations in certain shares remain worryingly high.

The local businesses we do own are predominantly in the resource sector, which should ultimately benefit from the weaker rand, but have been hamstrung in the short term by the disruptive labour environment. We have increased our exposure to the platinum sector and Exxaro, predominantly due to its coal assets. We hold a reasonable exposure to the banking sector, the one area where valuations are low and dividend yields remain supportive. The impact of our holding in African Bank, while negative, was small in the overall context of the portfolio and did not have a meaningful effect on the fund performance for this period.

We have maintained our exposure to offshore equity and have taken advantage of recent weakness to increase our exposure to emerging markets. The rapidly approaching end of quantitative easing in the US and prospect of higher interest rates globally have taken its toll on a number of emerging markets. As cash has started flowing out of these markets back towards developed countries, we have seen emerging markets decline to the point where the return opportunities are compelling. The long-term growth story for many emerging markets - driven by rising wealth levels as well as young and rapidly urbanising populations - remains intact and we believe it will ultimately deliver good returns for investors. On the back of these offshore equity positions and selected yield opportunities in other global markets, we have maintained a fairly high exposure to offshore assets, with the fund holding 30.4% in these assets at quarter end. We remain sceptical of nominal bonds, both those issued by the SA government and foreign sovereigns, as we still believe interest rate assumptions priced into these instruments are too low. We are exposed predominantly to floating rate notes to take advantage of what we expect will be a long but slow rising rate cycle.

Against this we do have a fairly meaningful position in listed property. Half of this position is in the locally listed but UK-run property companies of Intu and Capco. Intu still trades at a meaningful discount to its stated net asset value (NAV) and the recent sale of an underlying asset in excess of its carrying NAV gives us the confidence that this number is not overstated. Capco continues to deliver strong underlying NAV growth through its development prospects in central London, which remains a robust property market. The outlook for capital markets is not expected to improve in the short term as uncertainty locally and globally is likely to affect sentiment. As always, a long-term outlook in these uncertain times should enable one to make good investments which will deliver outperformance over the longer term.

Portfolio managers
Neville Chester and Pallavi Ambekar Client

Capital markets overall continued to perform well in the final quarter of 2013, with local and global equities delivering strong returns while property and bonds, locally and globally, were fairly lacklustre. The rand remained under pressure, which boosted the offshore returns - all of which assisted the fund in outperforming its benchmark for the quarter. The fund delivered a return of 4.9% against the benchmark return of 4.3%, which brought the total calendar year return for the fund, net of fees, to 27.5% (9.6% ahead of its benchmark over this period). Without a doubt, 2013 was a standout year and we would not expect to deliver this level of returns on a regular basis. Since inception the fund has delivered 4% alpha per annum, which we would regard as a more reasonable target to achieve over time.

A number of our core equity holdings like Naspers, MTN and Standard Bank contributed to our domestic equity performance, offset by a continued underperformance from the resource shares. We have significantly added to our position in Anglo American and Exxaro over the past quarter as we feel the market has taken too negative a view on the underlying prospects of these businesses. That said, the environment - both from a demand point of view for specific commodities and from a production point of view given continued labour unrest - remains difficult and we do not expect a dramatic turnaround in the short term. Sasol, which has been a large holding of ours for some time, has performed extremely well, and as much as we like the business we have reduced our holding given the rerating that has occurred.

Our global equity component also did well with developed and emerging market equity beating their respective benchmarks. As the end of quantitative easing (QE) has been signalled, we have seen emerging markets generally underperform their developed market peers and there is certainly an argument to be made to increase the relative exposure now to emerging markets. We have slowly started tilting the international equity exposure this way and will continue to do so based on relative valuation.

Our credit exposures in the bond space, both locally and globally, have done well for us. We generally avoided fixed rate bonds, which helped this year as the bond market sold off aggressively on the first hints of the end of QE. For the first time in a long period we have started adding South African nominal government bonds at particular points on the yield curve where we think that yields are starting to look interesting. Similarly we have added to property as well, as yields on specific stocks have kicked up. We continue to look for appropriate quality credit which is incorrectly priced, both locally and globally, but find that in the search for yield globally they are more difficult to identify.

The fund has continued to deliver on its long-term mandate of outperforming its benchmark and inflation over the long term, and we believe it is well structured to continue to deliver on this in the long term.