The FTSE/JSE All Share Index returned -2.1% for the quarter after peaking in late July. The decline was largely due to the resource sector, with industrials and financials closer to flat over the period. The domestic economy was a difficult place to operate in; broad strikes impacted productivity in several sectors, consumers remained under pressure as reflected in the collapse of African Bank and the rand weakened further, increasing costs for imported inputs. We remain cautious on the outlook for our local businesses.

Both the benchmark and the fund were down for the quarter, reporting -0.7% and -1.35% respectively. Over one year, the fund delivered 16.72% versus 16.47% for the index, and over three years the compound return for the fund stands at 31.28%, in line with the index. The fund remains in the topquartile of its peer group over three and five years. Smaller positions in Naspers and Steinhoff versus peers have hurt short term relative performance. Major contributors during the quarter were our large holdings in Pioneer Food Group and Zeder. Pioneer is well on its way to transforming into a focused branded goods business. Management has made rapid progress on restructuring and generating cost savings. This will build the foundation for the next phase of the business where they can concentrate on portfolio growth. As Zeder's biggest single asset, actions at Pioneer also have a significant impact on Zeder. Far from being a mere passenger on this journey, Zeder's management have been busy focusing the portfolio on opportunities where they believe they can add value. Recent consolidation activity certainly has done so. We remain happy with our large holdings in BAT and Naspers, which are protected from domestic woes. We further reduced our position in SABMiller, which delivered good returns during the period on the back of speculations around further corporate activity in the global brewing sector.

Deteriorating economic conditions resulted in weakening share prices in two cyclical names we like. Barloworld and Imperial are facing tough trading conditions in their sizeable automotive businesses. Longer term, both businesses should emerge with more resilient earnings streams. Barloworld is building a bigger aftermarket business as it grows Bucyrus's market share in parts and services. Imperial is diversifying its earnings; expanding outside of South Africa by ramping up logistics investment in Africa and South America. We own both names, believing that there is long-term upside. We commented previously that the sector was looking fairly valued at an aggregate level. Recent market movements are opening valuation gaps and creating some opportunities. We are looking at some of these, though our cautious outlook makes us wary of downside risk to high earnings bases and we will tread carefully.

Portfolio managers
Dirk Kotzé and Sarah-Jane Alexander Client

"Play up, play up, and play the game" Vitai Lampada (They Pass the Torch of Light) - Henry Newbolt

The fund returned 10.80% for the quarter, compared to 9.06% for the FTSE-JSE Industrial All Share Index. Over one year, the fund returned 30.58% against 30.53% for the index, while over three years the numbers were 31.20% p.a. for the fund and 30.15% p.a. for the index. As discussed in this commentary before, we manage the fund on a clean slate basis without too much regard for the index, especially with regard to the heavy weightings that the latter has in globally diversified multinationals such as SABMiller, Naspers and Richemont. Typically these have been shares that we liked and held, although mostly not to the same degree as they are represented in the index.

Let's start with the good news. Industrials, like the rest of the market, continue to power ahead and are generally reaching new highs. So much for share price action anyway. Earnings growth has been more lackluster, leaving most stocks on stretched valuations, and with little room for error. The economic backdrop has generally not been supportive for earnings, leaving us as fund managers feeling a little challenged. Like the player in Sir Henry Newbolt's famous poem, we feel a bit like walking out onto a bumping pitch in a blinding light, ten to make and the last man in. There is little option but to soldier on, to play up, play up and play the game; or rather more prosaically, simply to focus on values, and to remain rational.

The macro environment is mixed. Globally, large economies are gradually eking their way back into growth. At home, the debilitating platinum strike is finally over. While its economic effects will reflect as a contraction in the GDP statistics, from here on things should recover, and the weaker rand must somehow help, as it always does, large sectors of the economy. But a strong growth underpin is absent, inflation remains stubbornly high and rates will have to rise. The consumer environment is fragile, and although there is some comfort in a so-called consumer 'soft landing' (as rates rise only gradually), consumers still have a tough time ahead. So will the companies that provide them with goods and services. Local manufacturing has not rebounded yet, as typically happens when the rand weakens. And given resources anxieties and strikes, demand from the mining sector (an important client for local industry) has been slow and patchy. So it is back to basics. SABMiller, a stock we have liked for a long time, has been pushed hard on speculation that ABI, the pre- eminent global beer major, might make an offer for it. Such a deal is not beyond the realm of possibility, but the rational response to such an event (and a share now trading on a 22x PE) is to let some go. This we have done, adding to Richemont. We remain constructive on Naspers, where we are believers in the e-commerce business models that management are investing in and where they will hopefully emerge victorious in at least some market segments, such as classifieds or e-tail. But the rate of cash burn is stepping up, leaving us holding on, and somewhat thankful that our weighting is relatively modest.

In a soft economy and the absence of a strong tide of earnings growth, company specifics offer the best hope for capturing positive returns. One such example in the fund is The Foschini Group (TFG). Our sense is that fashion management is improving, the credit component of earnings is at a cycle bottom, and that the company is on the front foot in terms of accessing growth opportunities. A well- diversified portfolio also leaves the group less exposed to the vagaries of ladies fashion, where new competitors are entering. On a single-digit PE, one is rewarded for the risks. As investors with a long time horizon, we are often enticed by holding company structures, where it is sometimes possible to get access to the underlying operating assets at a discount to the main listing. Examples in the fund are Pikwik and Capevin. The possibility of holding company discounts unlocking always do exist, and even if they don't, one still has the underlying exposure. Within holding companies, value can be created by portfolio management actions, as is the case with HCI and Remgro. Sometimes you can have both. We have long held sizable positions in both Pioneer Foods and Zeder; the latter largely to double up on the underlying Pioneer exposure, but also in its own right as a portfolio of attractive opportunities. The recently proposed Agri Voedsel transaction within Zeder is an example of how management teams can add value, even if the economy is not doing it for them.

Thus, despite a fully priced market and hence lesser returns in prospect, we remain confident that there are still some opportunities out there.

Portfolio managers
Dirk Kotzé and Sarah-Jane Alexander

Global economies continue their slow and stuttering recovery, and a return to trend growth, at least for the developed economies, is now in prospect. The removal of excessive monetary stimulus ('tapering'), which will accompany this adjustment, is likely to introduce further volatility in emerging economies. There has been a big downward step-change in emerging market currencies, including the rand, in recent weeks.

The structural challenges in the South African economy, which we have often discussed, remain an impediment to utilising whatever opportunities the global recovery may offer; but they are now better reflected in the valuation of the currency. Thus while we have long resisted to become more bullish about the earnings prospects of local export-based businesses, they must surely benefit from the current level of the rand. Domestic consumer facing businesses are likely to experience tough trading conditions, and at the time of writing anecdotal evidence around the holiday trading season seems to confirm this. Going forward, interest rates have to rise. This will not make life easier.

The fund returned 4.94% during the quarter vs. 6.70% for the FTSE-JSE Industrial All-Share Index. Over one year the fund did 38.73% vs. 34.96% of the index, and over three years the compound number for the fund stands at 26.46% vs. 27.52% for the index. The fund remains a top-quartile performer against its peers over five years.

When looking at performance in the second half of the year, among the bigger portfolio positions Naspers was once again the standout performer. Our other big portfolio positions in British American Tobacco and SABMiller held their own during the period in absolute terms, but while they preserved capital at least, they did not match the strong runs by some stocks that we do not hold (or do not hold in size), notably Nampak, Pick n Pay, Steinhoff, Grindrod and Telkom. Among the detractors, small positions in Tongaat and Illovo, Tiger Brands, and AVI took off some of the shine.

In a moribund economy, we are attracted more than usually to companies in which there is a significant internal dynamic, where earnings growth may be augmented from cost savings, restructuring or the benefit of previous capital expenditure, or where corporate activity can create value independently of how lacklustre the general economic environment might be. In previous commentaries, we discussed our attraction to HCI and Zeder, both investment trusts where smart allocators of capital are able to access opportunities not necessarily directly available to investors in the listed space. Another such example is Remgro, a stock in which we have significantly raised our weighting over recent periods. As a pre-eminent investment holding company, Remgro has access to large-scale and interesting deal flow. The management team is newly energised under Jannie Durand, and the group has been able to attract high calibre executives with topical experience in targeted fields. We sense that new ideas and the aggression with which they are pursued, have picked up. There is active management of portfolio positions, as evidenced by the Rainbow/Foodcorp/TSB merger and the pursuit of logistics infrastructure opportunities via Grindrod. In an industrial fund, the exposure to Firstrand is an added attraction at a time when banks are at the bottom of the performance cycle.

The portfolio positioning in the last year or two has been centred on globally diversified consumer staples, augmented by selective positioning in local defensives and self-help stories, while avoiding vulnerable consumer exposures. The return of the industrial index over the last few years has been spectacular, driven mostly by the large dual-listed companies. Of late, their earnings have come under pressure, due in large part to the weakening of emerging market currencies (in which these global diversifieds earn much of their revenues) as well as a general slowing of economic activity. This left some of these stocks on frothy near-term ratings. As valuations became headier, we have reduced exposure selectively. We are not yet overly concerned, believing that the business models of British American Tobacco, SABMiller and Richemont (with Naspers a somewhat different animal) will continue to deliver solid US dollar earnings growth through the cycle. But starting from much higher ratings, returns will certainly be lower than they have been in recent years.

The most difficult decision for the fund at this point is how much further to take this sector rotation, and in particular whether to increase exposure to the much-maligned consumer retail sector, by how much and how soon? Events during recent weeks, and mounting evidence of lacklustre Christmas trading, saw yet another pull-back in consumer stocks, so far vindicating our reluctance to engage too early. Some of the stocks in this grouping (Truworths, The Foschini Group, Mr Price, Woolworths and others) are now starting to offer through-the-cycle value again. We have not yet jumped, but we are closer.