The fund returned 10.4% for the quarter, against 11.3% for the JSE/FTSE All Share Industrial Index. For the year ended September the numbers were 44.4% versus 42.1%, and the compounded annualised return over three years was 27.6%, compared to the 28.0% of the index. It is particularly pleasing to us that the fund continues to attract inflows, such that at the time of writing, it is knocking on the milestone of R1 billion of capitalisation; a far cry from the R50 million or so that it touched some years ago at its nadir. After a long and particularly trying winter here in the Cape, spring is finally in the air. Financial markets, having weathered the long winter post the global financial crisis, also finally look ready for new beginnings. Much like the fickle Cape weather, it has however been a fitful, cold and rainy springtime so far for the markets. Back in May, Mr Bernanke's first indications of tapering the US Federal Reserve's monthly cash injection into the system were met with alarm, a big sell-off in bonds and the start of the long awaited 'great rotation' from bond markets back into equity. Since then, the new spring has run into a few late showers. The US economy seems to be in a sustained recovery, but not one that is strong enough to give policy makers the confidence to turn off the money taps quite yet. The initial comments were clarified, tempered and toned down; and the subsequent emergence of a stand-off between the Obama government and the Republican House over fiscal policy suggests that we are likely to see fiscal inaction, a continuation of easy money for now, and a slow and stuttering economy that grows, but nothing like it might have been. In Europe and Japan the news on balance is also more positive, but the economy is less robust than in the US. In the emerging world, risks to growth remain, particularly in China. Elsewhere growth continues, but at a slower rate. The initial sharp adjustment to the Fed's comments gave way to saw-tooth action as global investors react to what are supposedly better prospects in developed markets and relatively worse for emerging ones and currency weakness in the emerging market complex (South Africa, India, Brazil, Turkey, to name a few); and as they keep re-evaluating their options, given conflicting newsflow. The end result, perversely, is a local stock market that continues to grind out new highs. For us, other than the price of the market, little has really changed. We see the global macro much as we did before, and locally all the old risks (cost and productivity challenges, uncompetitive mining and manufacturing sectors, worries about the consumer) remain unchanged. The first indications of a positive impact on the economy from the weaker rand are starting to be seen, but given structural challenges and the fact that demand from the traditional export markets remains weak, this will be more muted than in previous cycles. Earnings expectations have hardly moved up as a result. The forward PE on the larger domestic industrial shares in our coverage universe is around 14.1x, too high to feel comfortable. And so with little on offer by way of margin of safety, we continue to fall back on bottom-up research, and the investment cases for individual stocks that stand up to scrutiny. Range-trading in markets create opportunities. Some of the recent market optimism about the economy (and by implication, better times for cyclicals) saw a sell-off in traditional defensives such as our old favourite, British American Tobacco. We used the opportunity to top up to the maximum allowed holding, 10%. SABMiller also lagged the market, largely on concerns around slower earnings growth, inhibited by the weakness in operating currencies like the rand, Australian dollar and Colombian peso. While it is true that forward PEs look frothy, we see this weakness of reported US dollar earnings as a bit of a red herring. The businesses continue to do well in constant currency terms, and over time these currency gyrations wash out. We continue to be enthusiastic holders of our other large multinational position, Naspers. With the share price approaching R1 000, the investment case is constantly re-evaluated, but to have maintained the weighting on the way up has proved to be correct. The fund has held Naspers since time immemorial, and where the original entry price would have been around R40 or below, Naspers has been at least a 25 bagger. Those don't come around too often. With constant fund inflows however, the actual picture is quite different, and the average in-price of the Naspers shares in the fund today is around R450, a number that suggests disciplined investing on the way up. While there is some justifiable concern about the frothy Tencent making up most of Naspers's value, by contrast the substantial unlisted internet businesses in the group are becoming increasingly valuable. Recent indications are that some of these will, after years of investment, become significantly profitable in the near future. We remain relaxed. In a recent commentary, we mentioned a new position in Kagiso Media. It proved fortuitous that a sizeable weighting was established right at the outset, as the share has subsequently become the subject of a take-out offer. We are voting in favour of the offer, which (if successful) will result in a 30% return in a short time. Luck does sometimes play a part, but there is also a lesson here about forceful implementation. While the fund has grown bigger, we still feel nimble enough to achieve our trading objectives. Elsewhere on the local front, we find little to love, given muted earnings outlooks, somewhat worrying risk sets, or high-ish ratings. The positions in food producers (AVI, Tiger, sugar) have been gradually increased into weakness. Our biggest weighting here is in Pioneer Foods and its proxy, Zeder. The market has started to recognise the potential value unlock by newly energised management, but judging by past experience, such processes most often play out over a number of years, and it is easy to underestimate the magnitude of the gains at the outset. Given a soggy local macro outlook, an element of self-help (internally generated rationalisation, improvements or dealmaking) features in a number of other investment cases, such as those of AECI, Woolworths, HCI and Murray & Roberts. And this commentary would be incomplete without registering that the long-awaited spring has finally arrived for some of our most challenged smaller positions, notably Group Five, Eqstra and even Hulamin.

After a strong start to the quarter, markets came under pressure in the month of June. Risk appetites diminished as the US Federal Reserve indicated that quantitative easing may taper off. For the quarter, the FTSE/JSE All Share Index returned -0.2% versus 6.9% for the Industrial Index. The fund achieved a return of 7.6% for the quarter, beating the benchmark by 0.7%. The fund is ranked first quartile over 1, 3 and 5 years relative to peers and has delivered a compound annual return of 29.7% and 24.6% over three and five years relative to the benchmark's 30.6% and 21.7%. Despite the weak domestic demand environment, inflationary pressures are increasing, which have been exacerbated by a weaker rand. FRA curves have moved to indicate the high probability of a rate hike cycle but the South African Reserve Bank remains cautious on raising rates in this low growth environment. One of the major decisions we face in the fund is the level of exposure we should have to the South African consumer. At this junction, we believe the risk remains poised to the downside as credit metrics deteriorate, inflation is rising and rate rises are likely. An aggressive stance from labour unions has continued to secure real wage increases for those employed. Rising labour costs threaten longer term competitiveness and will ultimately impact job numbers. Given the domestic clothing retailers' high level of earnings, we have not yet invested but continue to monitor the sector where share prices have come back dramatically. We are also concerned about the impact of rising wages on labour intensive sectors like construction. We were fortunate enough to experience good inflows during the quarter and continued to build positions in the stocks we favour. With the weaker rand having significantly boosted the share prices of the multinationals within the portfolio during the previous quarter, our buys tended to be focused on domestic stocks. We have added to a number of defensive positions (including Spar, AVI and Tiger Brands) where we feel the valuations are reasonable for the high quality, defensive nature of the businesses which offer a degree of earnings certainty. We have also added to our positions in AECI and Hudaco Industries, both of which will benefit from the weaker rand though their share prices do not reflect this. In Hudaco's case, this is complicated by the potential tax liability it faces with the South African Revenue Service. While this poses a risk, we feel the valuation is attractive at these levels and the risk can be managed by sizing appropriately within a portfolio context. The major change in position during the quarter was the acquisition of a stake in Kagiso Media Group. We like this midcap stock for its defensive radio assets and its strong cash generation. The share is fairly illiquid and as such we were fortunate to build a position. The company has subsequently issued a cautionary announcement regarding dealing in the company's shares and we await further details. Stocks we exited during the quarter include small positions in small cap construction stocks where we felt valuation was no longer attractive. We continue to have very limited exposure to this sector. We also sold out of Imperial where challenges at the Automotive principal and a weaker rand will create headwinds to the import based distribution business. Despite these factors the share had continued to be strong and provided a selling opportunity. Volatility in the market is providing us opportunities to add to favoured names. In an uncertain environment, we continue to redeploy funds to the businesses we think offer a reasonable degree of earnings certainty at fair valuations.
Portfolio managers
Sarah-Jane Alexander and Dirk Kotzé

Markets were strong in the first quarter of 2013, with the JSE All Share Index rising 1.6% in rands (driven by industrial and financial stocks). The fund had a good quarter returning 11.3% versus the 6.3% return of the Industrial Index. The strong first quarter performance is reflected in the one-year number where the fund achieved a compound annual return of 38.5% versus the benchmark's 35.4%. Longer-term data now shows the fund achieving a compound annual return of 25.5% and 21% over three and five years relative to the benchmark's 25.9% and 19.5%. We are pleased that the fund has now outperformed the benchmark by 1.5% over five years and is positioned in the first quartile relative to peers. Our more cautious view on the rand stood us in good stead with the rand-hedge stocks performing strongly. Two of the key holdings in the fund, SABMiller and British American Tobacco at close to a 10% holding each, were among the top performing shares for the quarter. During the fourth quarter of 2012, threats of regulatory intervention had created a chance to buy significant amounts of British American Tobacco. This weakness persisted into early January and we were fortunate to be able to add further to this position. The weakening of the rand is driving inflation expectations higher. However, there has been some good news for manufacturers on the inflation front where Eskom's application for a 16% per annum electricity tariff was rejected. An 8% increase was granted providing some relief for a sector faced with many headwinds. Labour intensive industries continued to face disruptive strikes, particularly impacting our resource industry. This is having a broader effect on the economy as reflected in the widening of the current account deficit. Disappointing January sales numbers from the retailers saw significant pullback in a number of the listed retailers in the first month of the year as growth rates failed to meet high market expectations. We had lightened our exposure to retailers considerably in the second half of last year. At current levels valuations are looking more appealing and we have been reviewing our position. We remain concerned about the levels of credit being extended into the unsecured markets and the general consumer pressure as reported by the food producers in weak staple food volumes. As yet, we have made no significant new investments into this space. After another quarter of strong markets and without any improvement in the outlook for industrial company earnings, valuations in the industrial sector continue to look fairly full. As always we look at valuation on an individual basis and this allows us some opportunities. We added to our holding in Naspers, a long favoured holding of the fund, which has not performed relative to industrials over the past year. We also added to positions in a number of our mid-caps; growing our holdings in the sugar stocks Illovo and Tongaat (which are rand-hedges that have yet to respond) as well as in the diversified HCI. While strong fund flows have meant a large amount of trading activity has been focused on retaining concentrated exposure to names we favour, it has also allowed us to dilute holdings where valuation is becoming less attractive, such as Famous Brands. We sold out of AfroCentric, a much undervalued stock at the time of our purchase, but which no longer offered sufficient margin of safety. While the global outlook remains uncertain, the fund continues to hold large positions in high quality, multinational businesses. We believe these are offering reasonable earnings visibility at fair valuations.

Portfolio managers
Sarah-Jane Alexander and Dirk Kotzé

The fund returned 35.6% for the year. Over three years its compound annual return was 23.6% and over five years 15.8%. Amazingly, over 10 years the compound annual return comes to 24.5%. As a powerful demonstration of compounding, R1 compounded for ten years at 24.5% becomes R8.90; a phenomenal return, but clearly one that cannot be sustained. The fund continues to be in the top quartile of its peer group over five-year periods. While the fund beat the FTSE/JSE All Share Industrial Index by a whisker over ten years, it is disappointing to us that it underperformed the index over one year (by 5%) and over three years (by 1.5% p.a.). We must point out that the benchmark is heavily weighted to the global dual-listed stocks (SABMiller, Richemont, Naspers and MTN). Although we have often extolled the virtues of these stocks in this commentary, it is mostly not practical nor desirable to replicate the index to the extent that one stock makes up, say 25% of the portfolio. The fund continues to be managed on a clean-slate basis, and we remain entirely comfortable with the benefits of stock selection and risk mitigation that our broader, bottom-up approach affords us. The December holidays are always a time of reflection, taking stock and (particularly for fund managers) a time to identify what you should worry about in the coming year. Before we do that, let's just enjoy 2012 one last time. After all, the world remained intact and despite daily predictions of doom and gloom, global monetary authorities kept the economy out of depression. This was no small achievement, and financial markets signalled their relief. Equity indices, including those of the JSE, ended on all-time highs. But for investors this is not good news. Prices of assets are high. In a sluggish economic environment, most of the stock market returns have come from re-rating (or expansion of the PE multiple) and less from underlying real growth. And going forward, prospects for real economies remain very uncertain. Thus you are now invested in fully priced assets, with decreased visibility going forward. A list of everything we should worry about would make dismal reading this early in the year. So we are keeping it to the broadest possible view of the downside. In short, the world has seen unprecedented reflation and monetizing of debt and fiscal deficits. This has staved off immediate meltdown. But the problem (as Tony Boeck, formerly of the Bank Credit Analyst, says) is that the bill for this has not yet been presented. In fact, economists are very uncertain just what the bill will be, and indeed how the ultimate effects of all the monetary debasement that we have witnessed, will present. A recent cover and leader of The Economist talk of a Thelma and Louise scenario: - heroic and tragic, perhaps, but doubly sad since there can never be a sequel. The fiscal cliff movie has yet to play out. In our view, stocks and especially industrial stocks, have had a great run and now look fairly to fully priced. This is a time to be cautious and to concentrate on share selection and (to the extent that it is possible in a fully invested equity sector mandate) capital preservation. Our sense is that while ratings are higher, earnings visibility in the global multinational companies remains good. Some changes to weightings may happen, but broadly these will continue to form the core positions in the fund. The SA economy is slowly growing and emerging from the policy hiatus that preceded the ruling party's conference in Mangaung. A recovery in a few specific sectors (like construction) may help beleaguered local industrials along and create some trading opportunity, but a broader and robust recovery of the SA economy seems a while off. Indeed looking at the current portfolio there are few broad themes, and our positions rather reflect individual investment cases that stand out as robust under these mixed conditions. We increased our exposure to Pioneer Foods significantly. Nearterm prospects are glum, but this is an improving business with a sound investment case in the long term, offered at a good price. We had been buying for months and are happy to have secured a sizeable line. We also followed a new listing, Master Drilling Group, a global supplier of mining services. This quarter saw the last sliver of Mr Price exit the portfolio. It is a great business with excellent prospects but at a 20x PE no longer a good investment. The biggest increase was in British American Tobacco (BAT). Fears of regulatory intervention created an unusually attractive opportunity in this very stable business. We understand the business model well and regard it as very defensive; regulatory issues or no. Offered at a PE under 14x, and with a dividend yield approaching 5%, this is a no brainer especially in these uncertain times. Our exposure to BAT is now almost 8% of the fund. We enter the new year with some excitement and eager to grasp the challenge to grapple once again with Mr Market. But the advice that rings in our ears (and should in yours) is that of the grizzled old sergeant in Hill Street Blues: 'Let's be careful out there'.

Portfolio managers
Dirk Kotzé and Sarah-Jane Alexander