The FTSE/JSE All Share Index returned 0.48% for the quarter and 6.59% over the past 12 months, outperforming the FTSE/JSE Industrials Index which returned -2.05% and 4.49% respectively. Resource shares continued to rise, as the likelihood of a soft landing for Chinaincreased and commodity prices rallied. The fund returned 0.67% over the past quarter and 8.44% over twelve months, delivering positive alpha of 2.72% and 3.96% over the corresponding periods. Three-year numbers for the fund show positive alpha of 2.98%.
Shares that contributed to performance over the past year include Pick n Pay, Naspers and SAB. The SAB contribution reflects the share's relative underperformance since speculation around the initial bid by Anheuser- Busch InBev (AB InBev) more than a year ago. Underweight positions in Richemont and MTN also contributed to performance. Over a three-month period, two long-held stocks, Mediclinic and Steinhoff, detracted from performance. Mediclinic, despite its geographically diversified healthcare businesses, has been hit by a slew of regulatory actions. The Middle Eastern business faces copayments for Abu Dhabi nationals, while Switzerland faces a punitive tax on private patient services in Zurich. The challenges faced by governments everywhere in providing healthcare to aging populations will result in drives to lower provision costs. Over the long term we believe that efficient providers should ultimately fare well, as they are best-placed to deliver effective and affordable healthcare.

Major trading in the period constituted the disposal of our remaining stake in SAB. The business has subsequently ceased trading as an independent company, and will now form part of AB InBev. As a combined business, this entity is a brewing powerhouse, with a 25% share of global beer volumes and almost half of the global brewing profit pool. Margins in SAB have lagged those in AB InBev, despite its global footprint, strong brands and leading market shares. AB InBev management comes with a strong track record of delivery, and SAB comes with a sizeable opportunity set in which to demonstrate this. The fund took advantage of the stronger rand in the third quarter to build its stake in AB InBev.
Markets remain volatile, and this has provided opportunities to increase our stake in selective portfolio holdings. During the period we added to Steinhoff, a business which we believe will continue to grow as an entrepreneurial and opportunistic management team build out their vision of an integrated and consolidated furniture retailer footprint. We have also added to our position in Richemont, as the stock underperformed due to concerns about consumer appetite for luxury watches. We remain convinced of the enduring, desirable nature of the brands.

Aspen has returned close to the level where we initiated a position earlier this year, despite having derisked its balance sheet, bolstered its portfolio through acquisition, and commenced significant work to reduce manufacturing complexity and costs in its attractive anti-coagulant portfolio. Management are as excited as ever about their portfolio and we felt that the stock merited a larger holding at current ratings. The fund remains very underweight SA clothing retailers. While multiples in the sector are not high, we believe that earnings are vulnerable to the challenges of a tough consumer environment, international entrants taking share and speeding up the fashion cycle (forcing more errors), a weaker rand and changes to credit regulation.

Market noise is incessant at the moment as we see gyrating currencies, index changes, daily political battles, earnings misses and regulatory actions. We continue to try and look through these, establishing and building holdings in stocks where we believe the market is mispricing the long-term ability of these businesses to deliver earnings.

Portfolio managers Sarah-Jane Alexander and Adrian Zetler as at 30 September 2016

The FTSE/JSE All Share Index returned 3.87% for the quarter and 3.17% over the past 12 months. The industrial sector underperformed the broader market during the quarter on the back of a recovery in the resource sector and declined 0.4%. However, the sector still outperformed the FTSE/JSE All Share Index over the past 12 months, returning 8.75% during this period. The rand experienced an abnormally volatile quarter as the political travails of our country played themselves out, but nevertheless, ended up appreciating 5% against the US dollar for the quarter. The risk of a credit rating downgrade to junk status hangs over the economy, and will no doubt lead to continued uncertainty and heightened currency volatility over the next few months. The domestic economy remained weak and GDP growth projections were once again revised downwards to below 1% growth now being forecast for 2016. The South African Reserve Bank raised the repo rate a cumulative 0.75% to 7% during the quarter, as inflation expectations continued to tick higher.

Against this backdrop, the fund had a reasonable quarter, returning 0.49% versus -0.40% for the FTSE/JSE Industrials Index. Over the past 12 months, the fund achieved a return of 7.28% versus 8.75% for the FTSE/JSE Industrials Index and for the three-year period, the compound annual figures are 20.23% and 19.40% respectively.

Shares that added to performance during the quarter were our positions in Steinhoff and Foschini. Our large Steinhoff position also contributed meaningfully to fund performance over the past 12 months, along with our positions in Reinet and Pick n Pay. Although we have trimmed Steinhoff into share price strength, it remains one of the largest positions in the fund and we continue to back the management team to unlock and create further value for shareholders. Although our relatively low weighting in SABMiller contributed to performance for the quarter, it remained the biggest detractor to performance over the past 12 months after it rallied strongly in September 2015 on the back of confirmation of a bid by Anheuser-Busch InBev. Furthermore, our underweight positions in MTN and Aspen were significant performance contributors over the past 12 months.

Material portfolio changes worth mentioning include further buying of Naspers and Zeder, and new positions in Datatec and Aspen.

Both Naspers and Zeder have featured prominently in the portfolio in the past and we have discussed our investment cases in-depth in previous commentaries. Incidentally, they are both holding company structures that own a number of underlying businesses which we believe to be very attractive with strong management teams. During the quarter, the discount to the underlying net asset value for both stocks increased dramatically to between 30% and 40%, and we used this opportunity to selectively increase our stakes in them.
Datatec reported a weak set of interim results in October 2015 on the back of a challenging operating environment and rapid currency depreciation in many emerging market countries. The stock sold off significantly and the fund purchased its stake after the share price had declined by more than 40% (in US dollars) since September 2015. We believe that management, led by CEO Jens Montanana, have done well to build a business of scale and position it in a niche segment of the IT market which still offers reasonably attractive growth prospects. After a long history of M&A, management are now shifting focus to the integration and cost rationalisation of the previously acquired businesses. This should lead to further margin improvement and comfortably support double digit earnings growth over the next few years. Datatec is currently trading on around 7x 1-year forward earnings and 5x our assessment of normal earnings, making it one of the cheapest rand hedge shares in our market.

We re-established a position in Aspen during the quarter after previously disposing of our stake on valuation grounds. Aspen is one of the great corporate success stories of South Africa. It has a phenomenal long-term track record of capital allocation and earnings delivery, and in our view houses one of the best management teams in South Africa in the form of CEO Stephen Saad and deputy CEO Gus Attridge - both of whom are also significant shareholders in the business. Concerns around emerging market currency weakness, US dollar-denominated debt and earnings dilution from business disposals have weighed on the share price over the past year. We used this opportunity to start building a position in the stock. Unfortunately, market sentiment changed quite quickly after recent results and the stock rallied strongly - before we were able to build a sizable position. Management appear focused on simplifying the business and driving synergies which should improve competitiveness and drive margins higher going forward. We remain optimistic on the anticoagulants and instant milk formula opportunities that management are pursuing. We will continue to monitor the stock closely and will add to the position should the margin of safety in the valuation be sufficient. Aspen currently trades on 14.5x our assessment of normal earnings. On the selling side, we sold a significant portion of our SABMiller holding as the discount to the ABI take-out price continued to narrow and we identified more attractive opportunities for the capital. We also sold out of our Illovo position on confirmation of an offer from Associated British Foods for the remaining shares that they do not already own in the company.

Portfolio managers
Sarah-Jane Alexander and Adrian Zetler

The FTSE/JSE All Share Index returned 1.68% for the quarter and 5.13% over the past 12 months. The industrial sector continued to outperform the broader market, returning 6.56% for the quarter and 15.31% over the past 12 months. Performance within the industrial index was more divergent. Rand hedge stocks outperformed, flattered by further currency weakness. Domestic stocks have been under pressure from a deteriorating economic environment.

This was a tough quarter for the fund, which returned 3.6% versus 6.56% for the FTSE/JSE Industrials Index. As a result, one-year returns have swung negative, with the fund returning 14.59% versus 15.31% for the benchmark. Over the longer term, returns remain positive, with the fund achieving a compounded annual return of 24.39% over three years versus a benchmark return of 22.03%.

While the portfolio retained large positions in rand hedge shares, our selective underweights in Sasol, Aspen and MTN contributed favourably for the year. MTN’s woes in Nigeria deepened when the regulator issued a large fine to the company. Our large holding in Naspers delivered a very good performance for the year (up over 40%), but this is reduced when looking at benchmark relative numbers due to its sizeable weighting. British American Tobacco put in a similarly strong performance. There are limited positive contributions from domestic facing stocks.

The major detractor from performance over the last two quarters has been SABMiller, which received a formal bid from AB Inbev (ABI) in October 2015. The fund held a position in the stock, but was underweight relative to benchmark. Strategically the transaction made sense for ABI, as reflected in their willingness to pay a hefty premium to what we felt the underlying business was worth as a standalone entity. Another detractor during the fourth quarter of 2015 was Steinhoff where we have previously highlighted the merits of its investment case. This remains a positive contributor to the fund over one year and we continue to hold a sizable position.

Purchases during the quarter were focused on adding to existing positions, largely Naspers and Mediclinic. We added to our Naspers position during the capital raise which was done at an attractive price. We are supportive of management’s actions to rationalise the portfolio; selling marginal investments and focusing on large attractive markets where they have a high likelihood of success. There is still significant value that can be unlocked in the rump, and this remains our largest position in the fund.

Mediclinic has had a busy year with the conclusion of the Spire stake purchase and the announcement during the quarter of a reverse takeover of Al Noor (scheduled to close in Q1 2016). Al Noor is a UAE-based healthcare provider listed in London. Combining Al Noor and Mediclinic’s UAE businesses creates a leading regional platform that should benefit from synergies. It provides a strong base off which to expand further into growing UAE markets. The deal has the additional hallmarks of good cultural fit and regional synergies. The transaction further diversifies Mediclinic’s earnings away from a low growth South African economy. The FTSE listing gives Mediclinic access to offshore funds, which should decrease the cost of capital facilitating further international expansion. Having increased our direct holding of Mediclinic, we reduced our holding in Remgro where prospects for a number of its domestic businesses are looking more challenging.

A further sale was our holding in Bell Equipment where trading conditions for a capital equipment business have reduced significantly, yet the share price had been resilient.

While domestic conditions are challenging, share prices retreated significantly in the fourth quarter to reflect this. Widening multiples between our rand hedges and domestic stocks are creating interesting opportunities, and we are looking to add selectively to our holdings in domestic names.

Portfolio managers
Sarah-Jane Alexander and Adrian Zetler