The fund delivered 15.8% for the quarter, trailing the 18.5% of the FTSE/JSE Industrial Index. For the 12 months to September the return was a pleasing 29.3%, ahead of the index's 28.2%. The compound return over three years stood at 9.4%, regrettably a whisker below that of the index, at 9.6%. Since inception, the fund has returned 18.9%, 4.8% ahead of the index. The fund continues to perform well relative to peers and is ranked first in its category over one, two and three years.

A period of strong returns invariably leads to a positive feeling about life, the universe and everything. The credit crisis of 2008 and its aftermath seem long forgotten. Recent events in financial markets in general and in the South African stock market in particular would suggest that we are through the worst and that the world is on the mend. While this might indeed be the case, as fund managers we need to take a rather more cynical view of the world and consider the implications for capital preservation under a variety of possible macro outcomes. Because we have no special insight into the future, the sharpest tool at our disposal is to invest in situations where there is a sufficient margin of safety to cater for all eventualities. Nothing has changed in this approach.

But it is worth considering that all is not as well as it seems. The Goldilocks era ended in 2008; what we have now is Goldilocks wandering in the woods feeling rather lost. Global capital markets seem unable to read whether the world is headed for inflation or deflation, recovery or double dip, fiscal stimulus or austerity, continued emerging market growth or an end to the Chinese miracle. Quantitative easing in the developed world has decimated yields and sent investors scurrying into riskier asset classes; at the same time they are uneasy about the risks of these strategies. This has seen an unusual degree of oscillation between 'risk on' and 'risk off', or between being brave and being fearful. In recent months the South African market has been a beneficiary of these trends. Global investors have bought local bonds and local shares, and on the corporate front HSBC's interest in Nedbank and Wal-Mart's offer for Massmart testify to continued optimism that SA companies can be used as gateway into Africa.

Other than reducing the exposure to local consumer stocks, the quarter was not a particularly active one for the fund. Our large positions in MTN, British American Tobacco and Naspers remain intact. Local manufacturing companies (or companies exposed to the heavier, non-consumer part of the economy) have had a torrid time through the economic downturn and have mostly reported poor earnings numbers. Given the strength of the rand, their challenges are not over. But a number of them appear on our value screens and are likewise reflected in the fund in increased weightings: AECI, Omnia, Hulamin, Astrapak, Eqstra, Tongaat Hulett, Group Five and Dawn. Much of the portfolio remains positioned for a weaker rand. While we remain convinced that present currency strength is unsustainable, the timing of a correction is as uncertain as ever. Considering the prospect of a more enduring period of currency strength, we have taken care to stress-test investment cases and believe that the margin of safety is sufficient to warrant holding these counters.
The fund continued to experience strong inflows during the quarter, and at times it has been challenging to deploy cash fast enough. It does however provide the luxury of diluting the weightings in winners without having to sell. One such winner, Trencor/Mobile is featured in this month's edition of our newsletter, Corospondent. Other shares that did well for the portfolio are Naspers, Richemont, Shoprite and the everrewarding Famous Brands.

As it stands, the spread of the fund across counters is as high as we can remember in recent years. This is another reflection of our hunt for value, and the degree to which bottom-up considerations compensate for macro uncertainties. We trust that this approach will continue to serve us well.

Portfolio managers
Dirk Kotzé and Quinton Ivan

The fund delivered -2.4% for the quarter versus the -4.5% delivered by the FTSE/JSE Industrial Index. For the 12 months to June, the comparatives are 28.2% versus 25.9%, and compound annual figures since inception stood at 17.8% versus 12.8%. The fund is one of the top performing funds in its sector over all meaningful periods.

Global financial markets were dominated by concerns over the sovereign debt crisis in Europe with Greece at the centre. This resulted in significant market volatility during the quarter. Concerns over sovereign debt contagion within Europe resulted in significant euro weakness and heightened risk aversion which saw equity markets selling off worldwide. This culminated in the European Union and International Monetary Fund agreeing to an unprecedented rescue package of approximately $1 trillion.

The quantum of the bailout package highlighted that governments and regulators are prepared to do everything in their power to prevent a reoccurrence of the financial crisis. This means that economic policies will be unambiguously geared to stimulating growth. Interest rates are therefore likely to remain lower for longer and while this increases the risk of higher inflation in the future, it supports the pricing of risk assets in the short term.

In South Africa, the economy is healing and inflation is now well within the target band, driven by rand strength and lower food prices. As long as inflation is contained, monetary policy will remain supportive. While we expect inflation to remain benign in the short term, we are concerned longer term given the underlying pressures from higher labour settlements, increased electricity tariffs and rising property rates and levies. Rand strength continues to be supported by global risk appetite. Longer term, we believe that the rand would have to weaken - South Africa is simply uncompetitive at current levels. Consequently, we maintain a significant rand-hedge element in our portfolios, owning attractively valued, globally diversified businesses that happen to be listed in South Africa such as MTN, British American Tobacco, Naspers, Richemont, SABMiller and Bidvest.

MTN remains the largest holding in the fund. It has performed poorly on concerns over increased competition, with the imminent entry of Bharti Airtel in Nigeria and uncertainty over corporate action, the most recent example being the failed acquisition of Orascom Telecom. We continue to believe that MTN presents an attractive opportunity and have added to our holding during the quarter. It trades on an undemanding rating two to three years out and should enjoy many years of above-average growth given its dominant position in many underpenetrated mobile markets. Our local exposures remain weighted towards quality counters with strong franchises and good management such as Spar, Shoprite, Woolworths, Mr Price and Truworths. Despite a period of strong share price appreciation for retailers, the above counters remain attractive based on our assessment of fair value using mid-cycle earnings. That said, we have used the recent run to take profits in Shoprite and Truworths. As mentioned in previous commentary, we believe small caps present a compelling opportunity to the long-term investor and own many quality companies (e.g. Dawn, Iliad and Omnia) trading at six times our assessment of normalised earnings.

The most significant buys during the quarter have been Vodacom, MTN, Lewis Stores and Naspers. Naspers remains an anchor tenant of the fund and now constitutes a 7% position. The pay-TV business (a third of which is Africa) remains a large component of the valuation. This is an annuity-based, defensive business that generates large amounts of cash and continues to show good subscriber growth despite increased competition. The remaining businesses largely comprise the internet assets, Tencent and Tradus and the print business, Media24. Tencent is a 36%-owned associate and is principally engaged in the provision of internet value-added services, including online games, to users in China. It has been a spectacular acquisition with its value increasing nearly one hundred fold over a period of six years. Recently however, the Chinese Ministry of Culture has issued new regulations impacting providers of online games. These included users being required to use their identity document when registering for services (similar to RICA in South Africa) and restricting the playing time of minors. The regulations have caused uncertainty among investors of Tencent which has weighed heavily on the Naspers share price. We have thoroughly assessed the proposed changes and believe the impact to be minimal. Carrying Tencent at roughly half the current share price, our valuation of Naspers offers a considerable margin of safety. We have used this opportunity to add to our existing position. The only sales during the quarter have been profit-taking in Shoprite, Truworths, Richemont and selling out of Remgro to fund the above purchases.

In conclusion, financial markets remain finely balanced. Global economies are united in their goal of deficit reduction, but differ as to the best path to follow - the US plans to spend big in order to stimulate growth whereas Europe has introduced significant austerity measures to rein in costs. This has created enormous uncertainty and at the time of writing, financial markets have once again sold off on concerns that the world may be headed for a double-dip recession. Uncertainty is the friend of the patient, long-term investor as it often presents opportunities when market participants lose their heads and misprice assets. We look forward to capitalising on these opportunities.

Portfolio managers
Dirk Kotzé and Quinton Ivan Client

After all the gloom of 2009, equity markets in 2010 were off to a racing start. As you may recall, at the end of 2009 we were not overly bullish on markets in general, and our conservative positioning in global diversified and local defensive shares reflected this view. Instead, the market raced away on a wave of newfound optimism.

Global monetary authorities reacted to the financial crisis with unprecedented financial stimulus and expansionary monetary policy. This has fuelled the return of optimism and the risk trade, and it is clear that offshore investors have pushed the local market hard. However, there is no denying now that underlying economic activity has been better than expected and is indeed improving further; the latest rate cut will add momentum (for now) to that trend. While certain segments such as resources and consumer-facing businesses have been on an upward track, large parts of industrial South Africa are still massively challenged, and the strong currency continues to cast its long shadow over manufacturers, exporters and employment.

In this challenging environment, the fund delivered a return of 6.2% for the quarter, versus 4.4% for the FTSE/JSE Industrial Index. Over 12 months the fund came in at 52.0% versus 50.2% for the benchmark, this period reflecting the full extent of the rebound of the market from the doldrums of the crisis. Three-year numbers are depressed by the full extent of the bear market that preceded the last year and are in single digits. Given such volatility, it is probably more instructive to look at the five-year (annualised) performance of the fund (19.9%) and the benchmark (20.9%). The fund remains one of the top performing funds in its sector over all meaningful periods.

This performance was achieved despite the macro environment being somewhat more robust than expected. This fact demonstrates something of our process: while we do have opinions about which way the world will go, these do not often affect portfolio construction significantly. The portfolio continues to be an aggregation of the best bottomup investment views, weighted by the degree of conviction that we are able to muster through our research endeavours.

This process led us to enter the quarter largely weighted to the globally diversified business models, being companies like MTN, Naspers, SABMiller and Richemont. In a volatile environment we felt more comfortable paying up a bit for the quality and defensiveness of these groups, with their robust business models and proven management teams. With the exception of Richemont, these stocks did relatively little in the quarter. Their defensiveness remains as attractive a quality as it then was, in a market that has run hard and no longer looks particularly cheap. We see these stocks as representing 'latent alpha'. Our local exposures were also weighted towards quality, and included a fair exposure to retailers such as Woolworths, Shoprite, Mr Price and Truworths. These stocks did exceptionally well for us. The volatility in construction shares continued in the quarter, with the late 2009 rebound fizzling out and share prices again falling back. Results for the period up to December 2009 revealed some of the cracks in the investment cases of the sector favourites, about which we had cautioned in previous commentaries. We largely avoided the fall-out. We are saddened that the market has not yet appreciated how the fundamentals of our single construction holding, Group Five, differ from its peers. But this will come in time.

We found significant value in the small cap space, and over the last few quarters have steadily increased our exposure to this market segment, where we hold stocks like York Timber, Hulamin, Dawn, Buildmax, O-Line, Eqstra and Advtech. The value in these stocks is compelling, but may well be realised only over time. Patience is required. A tough economy is not the time when smaller companies typically outperform on earnings growth. Indeed, given the added headwind of a strong rand, some of them have gone backwards. The heavily indebted ones among them (Hulamin and Eqstra) now face rights issues. This is somewhat unfortunate, but as long-term investors we have reexamined and stress tested our investment theses for these stocks. We remain convinced that their fair values are a multiple of their present share prices. Thus we are very comfortable following our rights to prevent value dilution.

During the period we sold out of one stock, Aspen Pharmacare. It has been a sparkling performer and still has excellent growth prospects, but since these are now more adequately reflected in the share price, other opportunities have become more compelling. One such is Vodacom, a stock seen as ex-growth by some and one that has lagged the market significantly. Our sense is that the earnings base is more defensive than is generally appreciated, and that a new resolve to keep cost increases below the rate of (modestly positive) topline growth will see decent earnings growth, substantially backed by real cash flows. On a single digit price-earnings ratio, it makes much sense to us.

The quarter also saw the release of the final results of Trencor's US-listed subsidiary Textainer Group. These revealed a far better weathering of the global downturn than was expected and confirmed the exceptional quality of this business - the world's leading lessor of shipping containers. In the depths of despair this stock fell below $4, and is now well above $20. The share price of holding company Trencor bottomed at R16, and is now just above R30. This is still nowhere near our fair value. We continue to hold a substantial position in Trencor and its pyramid company Mobile, liking the concept of discounts upon discounts (financial pyramids invariably have less longevity than the ones at Giza) and the opportunity of owning a market leading global business via an SA listing.

Going forward, we feel confident of defending capital through our large weightings in global defensives, rand hedges and value 'sleepers'. Despite significant market volatility, we remain focused on 'cutting out the noise' and focusing on the long-term objective of creating wealth for our clients.

Portfolio managers
Dirk Kotzé and Quinton Ivan Client

The fund delivered 7.7% for the quarter versus 8.5% for the FTSE/JSE Industrial Index. For the 12 months to December, the comparatives are 33.5% and 30.5%%, and compound annual figures since inception stood at 18.3% versus 13.4%. The fund continues to perform very well relative to peers and ranks third over one and first over two years.

The year began with the world facing one of the most severe recessions since the end of World War II. Global financial markets were in freefall and the entire financial system was in crisis. The financial panic quickly spread to the real economy with liquidity drying up as banks protected their balance sheets. World trade collapsed and manufacturing production came to a virtual standstill. Risk appetite waned, which resulted in emerging market sovereign debt spreads widening. In short, anything that looked remotely risky was sold off. This prompted the world's leading central banks and governments to respond with significant stimulatory measures (bank rescue packages, low interest rates) which eventually succeeded in stabilising the global banking system. As normality returned, the first 'green shoots' of economic recovery became apparent in the first quarter of 2009. Risk appetite returned and global markets reacted sharply with commodity and share prices as well as emerging market currencies all improving. This is evident in the strength of the South African rand.

While the South African rand remains very strong in the short term, we continue to believe the risks are heavily skewed to the downside. Industrial South Africa is not competitive at these levels as exports are impacted adversely. This is exacerbated by electricity prices and wage settlements likely to be substantially higher than inflation. Also, at some point, the excessive global financial stimulus has to be withdrawn and global interest rates will have to be raised. This will reduce the attractiveness of the carry trade offered by emerging markets, placing further pressure on their currencies. It is for this reason that the DNA of the fund remains intact, with almost 60% invested in rand-hedge counters such as MTN, British American Tobacco, Naspers, Richemont, SABMiller and Bidvest. These companies are globally diversified with best-in-class business models that should benefit from a depreciating rand.

The return of global risk appetite has resulted in defensive counters being sold off in favour of cyclical stocks. As mentioned in previous commentary, we believe that it will be a challenge for the average company to defend earnings. In this regard, we continue to embrace domestic defensive counters such as Famous Brands, Aspen Pharmacare, Shoprite Holdings and the Spar Group which now comprise approximately 20% of the fund. The earnings of these companies are more bankable than the average industrial company and while one does pay up for this certainty, the premium is not excessive.

The most significant new buys during the period have been small caps. We believe that small caps currently present a compelling opportunity for the long-term investor. This sector was aggressively sold off in the 1998 - 2000 period after reaching absurd levels at the top of the bull market. While some company failures are likely as the sector copes with the recession and tighter credit markets, there are many quality companies trading on very undemanding ratings based on our assessment of normalised earnings. In this regard, we bought Adcorp Holdings, Distribution and Warehousing Network, Advtech, Astrapak, Buildmax and York Timber Holdings during the quarter.

On the sales side, there was very little activity with some profittaking in Netcare, Aspen Pharmacare and Naspers. The latter has been one of the best performing shares in our market and remains a core holding. Approximately 50% of Naspers' fair value comprises the Pay TV business (DSTV and MNet). This is a high quality business which generates annuity earnings in the form of monthly subscriptions and is protected by high barriers to entry (broadcasting licence, high cost of content). The remainder of the business comprises of internet assets, including a 36% holding in Tencent, the second largest internet company in the world. These internet assets have good growth prospects due to their favourable emerging market exposure. Tencent is listed on the Hong Kong stock exchange and is up three-fold since the start of 2009. Even valuing Tencent at less than half of the spot share price, we find good value in Naspers.

MTN remains the largest individual position in the fund. Two years have elapsed since we started building the position in 2008; disappointingly the share price is around the same nominal level. Sometimes the weighing machine that is the market takes time to assess the long-term fundamentals of an investment. In such a case it is the job of the rational investor to remain focused and patient. The news flow surrounding MTN has been poor - the requirement to register cellphone SIMS in South Africa and now Nigeria, has delayed new subscriber adds. While this is negative for earnings in the short term, we remain convinced that the competitive advantages that this group enjoys remain intact and that over time it will be a very rewarding investment.

In conclusion, markets are likely to remain volatile and challenging for some time to come. As a long-term investor, this is not bad news as volatile markets often create opportunities when emotion trumps reason. We look forward to capitalising on these opportunities.

Portfolio managers
Dirk Kotzé and Quinton Ivan