'A fair day's wages for a fair day's work; it is as just a demand as governed men ever made of governing. It is the everlasting right of man.' Thomas Carlyle

The FTSE/JSE Industrial Index was up 10.48% in the quarter. The fund returned 8.9%. Over the year to September, the fund was up 34.23% versus the index at 36.70%. The compound return over three years is 22.98% versus 23.62% for the index. While it is disappointing to have lagged the index, the fund continues to hold its own against its peer group over all meaningful periods. The index is heavily weighted to a few large-cap shares, while the fund is managed without undue reference to its make-up. Thus divergences in performance are expected. The more things change in the global macro environment, the more they seem to stay the same. Stock market sentiment has benefited from the third round of quantitative easing, as announced by the US Federal Reserve. However, economic commentaries abound with statements of how impotent monetary policy has become in stimulating the economy. In short, while pump-priming may have been able to prevent economic meltdown, it has not worked well at promoting an economic recovery. The real economy certainly provides no grounds for the increased optimism of the markets. The US is slowing further, and the recession in Europe is actually deepening. That said, there is evidence that some needed rebalancing is taking place, and that gradually the foundations for a new phase of growth are being laid. What is abundantly clear is that this is far away and that the process will be gradual. In our view there are no persuasive arguments for anything but a cautious investment stance. In South Africa, the failure of leadership, political and otherwise, led to the tragic events at Marikana and an unprecedented perturbation of the labour environment, disrupting the economy on a broad front. It is a sad reality: after two decades of democracy, SA's economy is unable to create and keep jobs. No wonder the 'governed' are restless and asking tough questions of their leaders. These events have brought the most dichotomous and worrying element of the local economic scene sharply into the light: on the one hand the consumer has been buoyant, but on the other the real economy (mining, manufacturing, agriculture and other value-adding physical activity) has been under pressure. We have long felt uncomfortable with the sustainability of consumer spending against a backdrop where the real wage increases and increased indebtedness driving that spending are not matched by productivity increases. This dynamic makes our productive base increasingly uncompetitive, especially when combined with the many other challenges we have often discussed: infrastructure bottlenecks; high costs of utility services and logistics; eroded capital bases. The mining industry is the single biggest customer for what remains of our local manufacturing sector. The chaos in mining bodes ill for everyone. It is not an easy time to feel bullish about South Africa's economic future. In the fund, the challenge has been to navigate a path between the strong momentum in consumer-related sectors, where earnings have held up but valuations look stretched; global diversifieds, similarly highly valued but whose earnings bases come with far less associated risk, and the local smokestack industries which are desperately cheap in most cases, but with commensurately grim prospects. It has not been easy, but our approach does help. Once again we have been able to fall back on our bottom-up stock selection, driven by the assessment of valuation over full cycles. This has allowed us to continue to identify opportunities, despite the overall market feeling rather pricey. The fund has been a little more active in trading than normal, but this can be explained by the high degree of volatility experienced in markets. Nevertheless, the broad positioning has not changed. Much of our defensive positioning continues to be anchored in the global diversifieds MTN, Naspers, SABMiller, British American Tobacco and Richemont. Market volatility does offer trading opportunities in these names, which we are able to utilise. The fund also contains significant and increasing exposure to the healthcare sector (Medi-Clinic, Aspen, Netcare, Adcock) and food sector (Pioneer, Tongaat, Illovo, AVI). Despite our misgivings about the simultaneously high levels of earnings and ratings in the retail sector, we retain some exposure via positions in Clicks, Woolworths, Mr Price, Holdsport and Pick n Pay. The first few are high quality companies with great franchises and years of growth ahead of them, and Pick n Pay, despite near term challenges, is undervalued. Its cycle has started to turn upward. In the industrial materials space, Mondi and Omnia have done very well for the fund, and we believe there is more to come. The brutal realities of local manufacturing have been starkly mirrored in the performance of those counters we did hold in this space: Hulamin, Arcelor Mittal and AECI. Feeling gun-shy and finding little of interest in the hard economy, we have nevertheless continued to build up our exposure to the now much-maligned construction sector. Immediate prospects remain foggy; however we are convinced that ratings are forgiving and that internal house-cleaning have in most cases set the stage for an improved run in the next few years. Famous Brands has been a spectacular investment for the fund, in fact more than a '5-bagger' from first purchase. In that time it benefited greatly from the tail-wind of increased disposable incomes, but strategic and operational management have also made the most of these opportunities, delivering a very sound and competent organisation. It is hard to sell such a great business, but on 16x our assessment of normal earnings it is finally running out of valuation upside. We have reluctantly reduced its weighting, knowing that there is yet much earnings growth ahead. What a joy to be invested in winning companies! Last word goes to Trencor, an old favourite and stalwart that has done well for the fund over the last few years. Its international associate, Textainer, has continued to perform very well. The Mobile pyramid was dismantled last year and further recent corporate action saw the early phases of a tidying up of the complicated offshore holding structure. More steps will hopefully follow. While this unfolds, we are happy holders of this fine global business, with a remarkably steady track record of returns and dividends. There is much to be anxious about in financial markets. Recognising this, we continue to focus on bottom-up value and on preservation of capital. For the judicious and dispassionate investor, there are still good opportunities to deploy capital. We look forward to finding them.
Portfolio managers
Sarah-Jane Alexander and Dirk Kotzé Client

Fears of default in the Eurozone and an economic slowdown in China resurfaced in the second quarter of the year. Markets panicked in May but still offered positive returns for the quarter with the industrials benchmark up 2.6% for the quarter and 19.7% over the past year. The fund performed reasonably well with three-month returns of 4.4% and the one-year return now at 21.1%, which is 1.4% ahead of the benchmark over this period. Three-year returns of 25.1% compare to 25.8% for the benchmark. The European crisis continues to unsettle global markets. European leaders are grappling with justifying budget cuts and austerity to voting populations, and several leaders have lost their positions as a result. In Germany, Angela Merkel must defend the costs of maintaining EU membership to her country. While last week's EU summit provided some comfort in moving Europe closer to a banking union, the fears that plagued the market during the second quarter are unlikely to disappear in the second half of the year. We expect the rollercoaster ride in markets to continue as investors' risk appetite fluctuates on newsflow. In South Africa, economic growth has slowed and manufacturing continues to be under pressure with high labour costs and weak demand from a number of our large trading partners. The inflation outlook is within the targeted 3% - 6% range and in the short term, a further rate cut is possible. Low interest rates combined with increased lending, particularly in the unsecured space, have driven very strong share price performances from our local fashion retailers. Despite strong earnings growth these stocks are trading on lofty multiples. We have reduced our weights in Woolworths and Mr Price accordingly and remain cautious of a change in consumer fortunes when the rates cycle turn. Apart from the dampening impact on commodities, a slowdown in the Chinese economy also resulted in the underperformance this quarter by Richemont, whose consumer base in this country is coming under pressure. This provided an opportunity to establish a position in the stock which is trading on a 13 PE; an attractive valuation for a high quality, offshore luxury goods business. We continue to hold significant positions in other rand hedges including SABMiller, MTN, British American Tobacco, Naspers and Bidvest which we feel offer good value relative to local industrials. A small position in Barloworld was established during the quarter. Barloworld is a leading distributor of Caterpillar, investing in infrastructure to support their customers. They are building facilities for training and component servicing in Southern Africa and Siberia which should underpin growth in these regions for years to come. Developments at Caterpillar, the principal, are also very supportive of the Barloworld investment case as Caterpillar focus on improving their mining product range. The stock has been punished for a slowdown in global mining capital expenditure and this has allowed us an attractive entry point. Existing names where we found buying opportunities early in the quarter include Remgro and Clicks. The discount to Remgro's net asset value widened at the start of the quarter allowing us to increase exposure to its attractive portfolio of businesses. We have previously discussed the merits of Clicks which we believe is a high quality defensive stock that will continue to grow for a number of years as corporate pharmacy gains market share. During the quarter we disposed of our stake in O-line where an offer close to our fair value for the business was made. We also reduced our weight in Netcare which performed well as the business delivered a credible set of results in its South African healthcare business and fears of a dilutive rights issue to shore up the UK hospitals business receded. With another quarter of strong market performance in industrial domestic stocks, we are cautious of elevated valuations. We continue to hold sizeable positions in quality stocks offering reasonable valuation; many of which offer protection from rand weakness. Elsewhere we have bought stocks which we feel offer attractive entry points to businesses where management are investing to build sustainable businesses and should grow earnings in the medium term. The investment cases of the latter tend to be higher risk. To better understand these business models we spend large amounts of time meeting not just management teams but also competitors, suppliers and customers. These differing views on a company provide us a framework to rigorously interrogate its prospects and form a valuable part of the input to our final decision.

Portfolio managers
Sarah-Jane Alexander and Dirk Kotzé

What a start to the year it has been! Markets have been climbing ever higher. Against this backdrop, the fund has returned 8.9% for the quarter and 20.3% for the year relative to a strong Industrials Index, up almost 21% over the last year. For the three years to March, the fund returned 29.5% versus 30.2% for the index.

While in America there are tangible signs of a recovery in employment numbers, Europe's buoyancy has come from avoiding any landmines to date. Certainly the rebound in the DAX implies that Germany is expected to avoid the worst. Here in South Africa the consumer has continued to benefit from low interest rates, growing credit extension and real wage increases. But these are not factors we believe can be sustained. Real wage increases have left no room for jobs growth and will negatively impact longer-term competitiveness. While the rand remains relatively strong we will continue to see manufacturers replace jobs with capital equipment.

In other pockets the consumer is facing climbing costs in satisfying basic needs. Maize prices continue to drive food prices up. This is exacerbated by high oil prices, electricity and rate hikes. We have lightened positions in some of the consumer stocks which have run very hard, and reinvested in names which we believe offer better value.

Good inflows during the quarter gave us an opportunity to increase some of our established positions as well as add a few new names to the portfolio. We increased our weight in some of the basic material stocks such as Arcelor Mittal and Mondi.

A disappointing trading update from Clicks allowed us to increase our weight at an attractive price. Clicks should continue to grow in the South African market as corporate pharmacy takes market share. While regulatory change is a threat, its position as an efficient, cost-effective pharmacy group will offer protection.

We added to our position in Mediclinic, a high quality hospital group. Mediclinic offers defensive but steady growth as its leading hospital businesses in Switzerland, Dubai and South Africa ramp up capacity and deleverage. These offshore earnings streams offer currency diversification while reducing the risk of being exposed to a single regulator. We also added to Naspers to reflect more appropriately in the weighting how much upside this counter offers.

In terms of new stocks, we established a position in Illovo which has performed poorly relative to the market. Illovo offers exposure to Africa where isolated markets and structural support from tariffs offer the business protection as it ramps up low-cost production. We also introduced Buildmax, a player in the contract mining space, into the fund. Here strong leadership have been doing the right things in restructuring the business and repricing contracts.

During the period we disposed of a few shares; we sold Mvelaphanda Group to private equity investors better suited to extract the last bit of value from its breakup. We also sold Adcorp where we re-appraised the regulatory risk of this staffing business; risk no longer justified by the multiple at which it was trading. We expect to exit our position in O-line over the next quarter as an attractive offer has been made for the company.

With markets having run hard, valuations are looking stretched in a number of pockets in the industrial area. We continue to rotate into stocks which we believe offer value and where management are building stronger businesses for the long term. In looking forward, potential for further re-rating is limited or may even be negative in some cases. Hence most of the prospective return must come from earnings growth and the ability to pay dividends. The portfolio positioning gravitates increasingly to the business models that can sustain this. Thankfully, we are still finding such opportunities, even in this stretched market.

Portfolio managers
Sarah-Jane Alexander and Dirk Kotzé Client

'The sea is calm tonight.' - Matthew Arnold, Dover Beach

The fund ended 2011 on a positive note with a return of 8.2% for the quarter and 7.5% for the year. The FTSE/JSE Industrial Index delivered 9.2% for the year. Over three years to December, the compound annual return of the fund was 22.95% and that of the Index 21.99%.

Few years, if any, have started with the degree of global uncertainty that currently exists. In developed economies, we are seeing the start of the painful adjustment after decades of debt-driven excess, now being termed the 'Debt Supercycle'. Uncertainty extends to what should be done, what authorities actually will do, and how these actions will affect the economy and the world. As fund managers, we will undoubtedly spend much of our time this year monitoring such events and their consequences.

While we see a tough macro environment ahead just about everywhere, emerging markets will in all likelihood be spared some of the economic fall-out, and companies broadly exposed to them should fare relatively better. In the South African market, we do believe that things will continue to get tougher. Inflationary pressures are building, and interest rate hikes will follow in due course. Since we adjudge much of the consumer's resurgence of late as having been debt-fuelled, the warning lights are on. Against this background, we have been judiciously reducing our remaining consumer exposures, and bolstering selective defensive positions. 2012 is unlikely to be a year of big 'themes'. Our process, driven as it is by bottom-up selection, should serve well in a nontrending market.

We often refer to our long-term investment approach in this report. At times of great uncertainty, it is a comfort to know that the values of businesses are not changed materially by the day-today unfolding of news and events. Having returned from the annual seaside break, we have had the chance to think quietly about these things. Much as the waves 'begin, and cease, and then again begin, with tremulous cadence slow', in Arnold's immortal words, we are bombarded daily with newsflow which is nothing more than 'the turbid ebb and flow of human misery'. These sentiments tend to move market prices much more than they do fundamental values. Investors are better served by ignoring sentiment, and focusing on value.

The portfolio remains defensively positioned, and little trading has been done. MTN, SABMiller, Naspers and British American Tobacco remain the biggest holdings. The position in Aspen was increased further. Retail exposure is focused on Woolworths, Mr Price and Clicks, all of which still offer good margins of safety. We remain negative on the outlook for the rand, and continue to hold an array of rand-hedge exposures, adding where we can. Hudaco is one such addition: it is a good business at a reasonable price, with rand exposure, which over time should show good growth as domestic manufacturing recovers from presently depressed levels.

Despite the challenges in the macro environment, industrial equities are not overvalued and there are still areas of value. We are ready for the year.

Portfolio managers
Dirk Kotzé and Sarah-Jane Alexander Client