Since inception, the fund has averaged an annualised return of 18.95% relative to its benchmark retuning 15.67%. Over 10 and five years, the fund has averaged 16.07% and 18.67%, outperforming its benchmark by 0.28% and 1.23% respectively.

The South African economy continues to be lacklustre. Relative currency stability, rate cuts and lower inflation should have offered consumers relief but a constant barrage of negative news flow has undermined sentiment. A lack of pro-growth policy means there is little reason to expect structurally higher growth but sentiment can swing quickly. Attention remains focused on the ANC’s elective conference in December although political infighting and procedural irregularities place even the event’s occurrence under threat.

Performance attributions over the past three and five years have been boosted by holdings such as Naspers, Mondi, Pick n Pay, Pioneer Food Group and MTN. The first two should come as little surprise given the coverage previously given to them in commentaries and their current strong share performance. More surprising is the positive contributions from the two domestic stocks, Pick n Pay and Pioneer, despite their recent weakness. These businesses have both been undergoing several years of significant restructuring as new management teams tackle cultural legacy and streamline organisations that had lagged competitors. We do not think earnings in either business are at normal levels and they continue to have a place in the portfolio. MTN is a stock where the fund had limited exposure until the last year and a half. The business fell behind in key markets like Nigeria and South Africa and an extensive management reshuffle created the opportunity to rebuild share and profits in key markets. Detractors from performance include Grindrod and Grand Parade Investments where despite relatively small exposures the stark underperformance of the shares has counted against the fund.

Deteriorating sentiment, earnings misses and share price declines have provided an opportunity to increase our stakes in some good quality domestic businesses. We have bought broadly in names including Spar, Netcare and Curro. Funding for these names has come predominantly from a reduction in the size of the Naspers position. This has not been an easy call to make. The Naspers investment case remains compelling with management improving focus on market dominant businesses and moving closer to monetising these. Tencent’s move into payments creates a market opportunity several times the size of gaming. The future looks exciting! However, we felt the absolute size of this position had grown too large and created stock-specific risk for investors in absolute terms.

The offshore exposure of the fund remains material. This is due to large positions in stocks like Naspers, British American Tobacco, Steinhoff, MTN and Mediclinic where we see attractive valuations. British American Tobacco (BAT) suffered some adverse regulatory news flow in the period as the FDA announced its intention to reduce nicotine consumption. BAT trades on a one-year forward PE of 15x, an attractive rating for a truly global defensive stock and in-line with many of the SA defensive businesses with single market exposure. The Steinhoff share price remains depressed with the share trading on a close to 10x PE in early October. A separate listing of the African retail portfolio has as yet done little to highlight what we see as a much undervalued ex-African retail rump. We see little reason to shift the core of the portfolio from these attractive holdings and have added to domestic stocks selectively where valuation has presented an opportunity.

Portfolio managers
Sarah-Jane Alexander and Adrian Zetler

The FTSE/JSE All Share Index returned 3.78% for the quarter and 2.53% over the past 12 months. While the Resources Index remains the major contributor over one year (up 16.67%), the quarter was dominated by industrials strength (up 6.63%). This reflects the strong rand hedge characteristics of the FTSE/JSE Industrials Index components. Financials underperformed for the quarter (down 1.08%) as political developments in the final days of March saw a rapid contraction in sector multiples. This has continued in early April.
The fund underperformed for the quarter, returning 5.65% versus a 6.63% return for the Industrials Index. However, over one and three years the fund achieved positive alpha of 3.82% and 2.48% respectively, while over the longer-term five-year period it recorded 1.93% outperformance.

Our commentaries over the past year have been dominated increasingly by political events both globally and locally. This commentary will be no exception. Brexit, Trump and the Italian referendum increased our caution on European politics going into 2017. However, the events to date have been benign. The defeat suffered by far-right politician Geert Wilders in the Dutch election was a vote against anti-immigration and anti-EU sentiment which seemed to be building in the region. Checks and balances in the US have also meant little real policy change to date, despite the change in leadership. Conversely, in South Africa, political risk has been heightened. The firing of finance minister Pravin Gordhan seriously undermines fiscal discipline as reflected in the loss of South Africa's foreign currency investment grade rating from Standard & Poor's. As the ANC leadership battle continues to play out ahead of their national conference in December of this year, we expect significant volatility and uncertainty.

When assessing benchmark relative performance, the concentrated nature of benchmarks in South Africa means that deciding which shares not to own is as important as deciding on which shares to own. This held true over the past quarter during which the contributors to performance largely came from positions in which we were underweight (e.g. Bidvest, Netcare, Vodacom, Spar and Imperial). In fact, of the top 10 contributors to performance for the quarter, only three were overweight positions. These included British American Tobacco and Mondi, and for long we have touted their respective virtues of strong business fundamentals and excellent capital allocation at a good rating.

Major shares that detracted from performance over the quarter were those we owned, including Richemont, Steinhoff, Mediclinic and Capevin. We hold significant overweight positions in Steinhoff, Mediclinic and Capevin. All of these remain high conviction ideas. Notwithstanding our position in Richemont, it detracted from performance given its large weighting in the concentrated industrial benchmark.

The current weakness in Mediclinic has created an opportunity to increase exposure to a high-quality, defensive hospital run by a management team that focuses on doing the right thing over the long term; prioritising clinical quality to ensure optimal patient outcomes. Mediclinic's recent acquisition in the Middle East has been a setback to earnings as the business is being restructured to eradicate unethical doctor practices and digests regional regulatory change. The focus on ethical and clinical best practice and high levels of efficiency versus state healthcare providers mean this business is well-positioned for the long term.
Our conviction in Naspers continues to build as management work hard to streamline the portfolio; disposing of non-core assets, investing in serious challenger brands and monetising market leading positions. Naspers's core holding in Tencent remains an attractive one. Tencent too, is investing to widen the moat surrounding their business, building compelling user propositions in a broad variety of formats. Their more recent foray into payments has seen them grow organically at a phenomenal rate by leveraging the strength of their platform and creating a serious contender in the payment space in a very short space of time. Valuation remains gripping.

Noise and volatility in local markets remain elevated, but given the portfolio's high exposure to offshore businesses we think the fund is well positioned with high exposure to offshore businesses. For some time, we have communicated the compelling valuation levels in many of the rand hedge stocks we hold (Naspers, Mediclinic, Aspen, MTN, Steinhoff, to name a few), funded by limited exposure to stocks that are sensitive to the domestic economy. The unfolding of political events at the time of writing saw the rand weaken significantly and domestic stocks underperforming. At this point, we see little reason to change the portfolio bias towards rand hedge stocks, which continue to offer value in the face of a challenging domestic environment.

The FTSE/JSE All Share Index (ALSI) returned a negative 2.09% for the quarter, and ended up generating only a 2.63% positive return over the past 12 months. The industrial sector underperformed the broader market and ended down 4.69% for the quarter. This capped off a rather disappointing year for the sector which returned -6.55% for the year - only its second negative year over the past decade. Notwithstanding this short-term underperformance, the industrial sector has still been the best performing sector over the past five years and has comfortably outperformed the ALSI over this period (19.04% for the sector vs. 12.97% for the ALSI).

2016 certainly proved to be the year of unpredictability as politics dominated the news headlines - both domestically and globally. Around this time last year, investors in SA were still grappling with the fallout from the Nenegate debacle. Fortunately, political developments took a turn for the better on 31 October (with the withdrawal of fraud charges against Finance Minister Pravin Gordhan) and again on 2 November (with the release of the Public Protector’s report). Increasingly, the focus will shift to ANC succession dynamics ahead of the ANC elective conference in December 2017. On the global front, 12 months ago most investors would have considered it almost impossible to imagine a scenario where, over the coming year, the UK would vote to leave the European Union, the US would elect Donald Trump as its next president, or that Italian voters would reject the reformist prime minister Matteo Renzi. But all three scenarios played out. Even more startling still, and contrary to all predictions, global equity markets soared after Mr Trump’s victory. The coming year could be equally unpredictable. France, Germany and the Netherlands will hold elections, just as support for populist candidates is swelling. Theresa May, UK prime minister, is embarking on Brexit negotiations, creating more uncertainty, and markets are waiting nervously to see what Mr Trump does (or does not) do in office, amid a host of conflicting signals.

While all the above was playing out, the rand remained volatile, but ended up being one of the best performing currencies in the world in 2016 as it strengthened 12.94% against the US dollar and 35.05% against the pound. Continued weak domestic economy activity indicators and favourable shifts in inflation - given the rand strength and potential for lower food prices as the impact of the drought reverses - have certainly opened the door for possible interest rate cuts by the SA Reserve Bank for 2017.

Against this backdrop, the fund had a slightly disappointing quarter, returning -5.61% versus a -4.69% return for the FTSE/JSE Industrials Index. Although returns were negative over the past 12 months, the fund delivered a very good relative performance and achieved a return of -1.20% versus the index return of -6.55%. For the three-year period, the compound annual figures for the fund are 11.08% and 7.96% respectively.

Shares that added to performance during the quarter were our positions in Barloworld and HCI. These two stocks also contributed meaningfully to fund performance over the past 12 months, along with our positions in Naspers, Pick n Pay and Zeder. Although our relatively low weighting in Richemont detracted from performance over the quarter, it made a positive contribution over the past 12 months. Furthermore, our underweight position in SABMiller and MTN were significant performance contributors over the past 12 months. It is also worth mentioning that a number of relatively smaller positions in the fund (i.e. Niveus, Cartrack, Curro and Datatec) also made positive contributions to performance over the past 12 months.

Material portfolio purchases for the quarter were MTN, Mediclinic and Remgro together with increased exposure to Steinhoff, Naspers and Aspen as their prices came under pressure. This was mainly funded from the selling of our Barloworld, Capevin Holdings and HCI positions - all of which were reduced on the back of strong share price performance.

We mentioned in previous commentaries that we have been watching MTN closely. During the quarter, we used the weakness in its share price to significantly add to our position. It is now the third largest position in the fund. MTN is a business that has been undermanaged for a number of years and although there have been several positive developments in recent months, this has yet to reflect in market sentiment towards the stock and in its share price. The history of operational disappointments in Nigeria and South Africa, which have decimated the earnings base; the current negative investor sentiment towards volatile markets like Nigeria, Iran and Syria; and the regulatory headwinds across its various geographies have scared off many in the market. However given this low base, coupled with the sweeping management changes that took place over the past 12 months, we are very excited about the opportunity for a significant turnaround. MTN have now appointed a new CEO (Rob Shuter from Vodafone), CFO (Ralph Mupita from Old Mutual), CTO (Chief Technology Officer - Babak Faloudi from Vodafone) and Head of Strategy (Stephen van Coller from ABSA), and significantly bolstered the depth of management across the entire business. If execution is successful, we think the upside from current share price levels will be significant.

Steinhoff had a very busy quarter from a mergers and acquisitions (M&A) perspective. It completed the acquisitions of Mattress Firm (USA), Poundland (UK), Cofel (bedding manufacturer in Spain) and Tekkie Town (SA). In October they also announced their intention to acquire Fantastic Holdings in Australia. To top it all off, in December Steinhoff announced that they have commenced discussions with Shoprite to potentially merge their respective African retail businesses to create an African retail champion with combined revenues and EBITDA of approximately R200bn and R15bn respectively. We will continue to monitor events closely as they unfold but, as we have highlighted before, this is an acquisitive management team that is looking to consolidate and grow their market share in their key geographical markets. We continue to back them and believe they can create significant value for shareholders through value accretive M&A transactions.

Aspen is a stock where we have been steadily increasing the fund’s position size on price weakness. The stock has de-rated significantly from over R430 (just less than two years ago) to below R300 today, and currently trades on an attractive 16x 1-year forward price-to-earnings multiple and 13x our assessment of normal earnings. We like how the business has transitioned from a SA-focused commoditised generic player into a global pharmaceutical business that is focusing on niche products such as injectables, specialised active pharmaceutical ingredients (APIs), hormonal products, infant milk, anti-coagulants and anaesthetics. These specialised products are difficult to manufacture which protects Aspen from the threat of Asian competitors that tend to focus on simple, long production run products. Its products are also highly cash-generative and are usually postpatent, which also reduces the risk of a revenue fall-off from generic competition. While it operates in a highly regulated industry, this risk is mitigated to some extent by its extensive geographic footprint, with key markets being Latin America, Europe (East and West), SA, Africa and Australasia. There is also still significant M&A optionality. We rate the management team highly and they have produced a fantastic long-term track record, especially when it comes to successfully buying and extracting value from acquired product portfolios. We also like the fact that management are material shareholders - thereby aligning their interests with minority shareholders.