The fund returned 3.2% for the quarter, outperforming the benchmark return of 2.8%. Over more meaningful periods of five and 10 years, the fund has generated compound annual returns of 10.0% and 14.5% respectively, compared to benchmark returns of 10.9% and 13.9%. Since inception, the fund has generated a compound annual growth rate of 13.0%, while the index has generated 10.9%. The long-term track record of the fund continues to stack up well against competitors and the benchmark.

The third quarter of the year was once again a challenging one for domestic markets. Growth remains very weak, confirmed by data indicating that South Africa moved into a technical recession in the second quarter. Although inflation has remained relatively low at around 5%, the weaker rand and rising oil price suggest that inflationary pressure is starting to build, and the possibility has increased of a hike in the repo rate before the end of the year. Financials fared better than most domestic-facing sectors for the quarter. Much of the sector's 2.8% return, however, was driven by life insurers, with a total return of 12.4%, while banks were up only 1.4%.

Contributors to fund performance relative to its benchmark for the quarter include overweight positions in Discovery and Nedbank, as well as having no exposure to Absa and the underperforming property stocks Growthpoint and Redefine. Detractors from performance include underweight positions in Sanlam and FirstRand (both of which we consider to be high quality, well managed companies but comparatively fully valued), no exposure to Capitec, and overweight positions in UK property stocks Intu and Hammerson. The latter two trade at significant discounts to NAV and should provide attractive rand-hedge characteristics. They have clearly not borne fruit in this period of ongoing rand weakness, as the shares have been impacted by ongoing uncertainty around Brexit and questions over the longevity of traditional retail models. We continue to see value in both shares.

Most banks and insurers reported financial results during the quarter. In the context of the weak macro environment, the banks delivered commendable results, with their domestic operations delivering mid-single digit earnings growth. While advances growth has remained sluggish, costs were generally well controlled and impairments largely benign. Of interest in these results was the transition to a new accounting standard on nonperforming loans and bad debt provisioning (IFRS9). As the necessary adjustments to the value of loan books were taken through opening equity rather than current earnings, the transition allowed for a larger adjustment than banks may normally be willing to stomach. The move provided us with an insight into which banks were previously relatively underprovided (in our opinion Absa) and which used the opportunity to bolster provisions to benefit future earnings (in our opinion Standard Bank). The environment remains tough for life insurers, with muted equity market growth and a challenging consumer environment. As a result, new business volumes and margins remained under pressure and insurers doubled down on cost-saving efforts.

Towards the end of the quarter, Investec announced the splitting of the group into two separate listed entities: the bank and wealth and investment activities will remain in the current listing, and the asset management business will be separately listed and unbundled to shareholders. The fund has an 11% position in Investec (the fund's largest overweight position), as we feel that the market materially undervalues the sum of the group's parts. One of the reasons for this is that not all the cash flows from the capital-light, high ROE asset management and wealth and investment businesses find their way back to shareholders, but a portion is allocated to support the banking operations. The returns generated by both the South African and UK banks are below what we would consider to be normal, despite these businesses not being excessively capitalised. There is strategic rationale in retaining the wealth and investment business in the bank, but the proposed unbundling of the asset manager should create value for shareholders by providing direct access to its cashflows, and by focusing management's attention on improving returns in the bank. While this has long been part of the investment case for Investec, this action coincides with a transition to a new leadership team and has happened sooner than we had anticipated. We consider this an encouraging sign of a strong focus from the new CEOs on addressing the implicit discount that the market places on the group.

The quarter was not a particularly active one for the fund from a trading point of view. We continued to add the holding of Quilter plc and made small reductions to the fund's holdings in MMI, PSG and Old Mutual.

The South African economic environment remains challenging, and the outlook for growth is weak. While the revised Mining Charter provides some policy certainty and is a step in the right direction, more action is required to build confidence, particularly around land reform. We expect earnings growth for the financial sector to remain subdued for the remainder of this year and probably into the first half of 2019. But we are cautiously optimistic that an improved operating environment will begin to emerge subsequent to the national election, albeit off a weak base.

Quarter 2 saw a retracement in the gains made by banks and life insurers in Q1. Despite outperforming, the fund returned a negative return of -4.4% against the benchmark return of -6.0%. Over more meaningful periods of five and 10 years, the fund has generated compound annual returns of 11.2% and 15.5% respectively, which should be seen in the context of index returns of 11.7% and 14.8%. At the end of June, the fund celebrated a 20-year track record. Since inception, the fund has delivered a compound annual return of 13.0%, which compares favourably to both peers and the benchmark.

The quarter under review was a challenging one for the sector, the South African market and emerging markets in general. As the spectre of global protectionism and the threat of a trade war rises, emerging markets are caught in the crossfire. A move towards normalisation of interest rates in developed markets has also had a negative impact on emerging markets. Following a brief honeymoon period, the reality of the challenges faced by the Ramaphosa administration are becoming increasingly apparent. Uncertainty over land redistribution policy and a still-contested revised mining charter are just two examples of this. The rand ended the quarter at 13.73 to the US dollar, the same level it was at just a week before the ANC elective conference in December. The decline in share prices of banks and insurers that started in March continued into the second quarter, with banks down 7.8% and life companies down 11.0%. A more resilient performance from property and general financials cushioned the blow slightly.

Contributors to fund performance for the quarter included overweight positions in Investec, PSG Konsult and Hammerson, as well as an underweight position in Sanlam and a zero holding in Barclays Group Africa. Detractors from performance were overweight positions in MMI, Nedbank and Afrocentric and a recovery in the share prices of Resilient and Capitec, neither of which the fund holds.

At the end of June, Old Mutual completed the first step of its managed separation process - the listing and unbundling of its shareholding in the UK wealth management business, Quilter plc. The second step will come towards the end of the year when it distributes 35% of its 55% shareholding in Nedbank. In the lead up to this event, the fund held a significant position in Old Mutual (c.12%) as we felt that the market was undervaluing the sum of its parts. Quilter is an attractive asset operating in a market underpinned by strong structural growth drivers. Reforms in the UK savings industry in recent years have resulted in two supporting pieces of regulation: RDR has had the effect of reducing the supply of independent financial advice; while pensions freedom has increased demand for the same advice by placing greater responsibility on the individual to plan and save for his or her retirement.

Quilter, previously known as Old Mutual Wealth, has been built in large part by acquisition off the base of the UK business inherited when Old Mutual bought Skandia in 2006. Some misadventures have taken place along the way, but today the business is an intelligently constructed operation spanning virtually the entire savings value chain. It consists of a financial advice force of c.1 600 restricted financial planners, a platform providing administrative/reporting capabilities and tax wrappers, and an investment component providing multi-manager solutions as well as a more traditional private wealth offering. At c. £100m of AUA, Quilter is a sizable player in the market, comparable to peers St James Place and Hargreaves Lansdown. Underpinned by the changes in the UK savings market, net flows to the business have exceeded 6% of opening AUA for the last three years. Advised assets placed on a platform tend to be relatively sticky, and we expect the market to continue to grow strongly for some time. As a meaningful participant, we expect Quilter to benefit from this growth.

As is often the case, the investment case is not without risk. Revenue margins have declined for each of the last three years as competition in the space has increased. Some additional fee pressure is likely to be felt, although this should be more than offset by asset growth. Most importantly, the business will transition to a new IT platform towards the end of the current year / early next, and the risk of lasting brand damage exists if not done seamlessly. Having discussed this in some detail with company management, we believe that the steps put in place to mitigate this risk are as comprehensive as one could expect.

As part of the listing process, Old Mutual sold 10% of its shareholding in Quilter at a price that we felt meaningfully undervalued the business, in advance of unbundling the remaining holding. The fund participated in this placement, and in addition to the shares received on the unbundling, holds 4% of Quilter. In addition to the acquisition of Quilter, which was funded by the sale of Old Mutual, we increased exposure to FirstRand, Discovery and Intu during the quarter, and reduced exposure to Investec, HCI and Nedbank. In addition, we exited the fund's positions in Afrocentric and Brait.

As a general comment, following the selloff in Q2, financial share valuations now look more reasonable but we expect share prices to remain under pressure in the near term. Pre-close updates from the banks towards the end of the quarter reaffirmed our view that economic activity remains subdued, and that translating the improvement in consumer and business confidence into loan growth / new policy sales will take time. We are hopeful that this will start to manifest more clearly in 2019, but the risks to sustaining this confidence are increasingly evident.