The Coronation Optimum Growth Fund has appreciated by 18.9% year to date. This return has come largely from some of the fund's bigger SA equity positions (in particular Naspers and Sasol) as well as from international equities, both the individual positions and the holdings in offshore funds. The impact of the rand on performance has been slightly positive. Over the one-year period to 30 September 2005, the fund has returned 28.3%, which is almost 20% ahead of its return objective of CPIX plus 5% (which has been around 9% for the past 12 months, with inflation running at 4%).

The broad asset allocation of the fund was not significantly altered during the quarter and currently 52% of the fund is invested in international assets and 48% in South African assets. We still believe that South African equities remain the most attractive asset class locally (with government bonds being overvalued and decreasing investment opportunities being available in listed property, from a valuation perspective) and, as a result, most of the fund's local cash is deployed in equities, mainly industrials. However, a few of the fund's SA equity holdings are starting to approach fair value and at the same time we are finding very few new investment ideas that provide an appropriate margin of safety. As a result, the fund has been a net seller of SA equities and the SA equity exposure of the fund is now at 42% compared to 45% at the end of June.

The fund sold out of AECI and Paracon and reduced the Telkom position, all on valuation grounds. The only new purchase was an increase in the Woolworths position which now makes up 2.5% of the fund. We believe that the Woolworths food business is an excellent business, with a dominant position in the top end of the food market, a strong brand and resultant pricing power, high barriers to entry through established R&D and store network, a growth profile through continued store rollout and ROE's north of 70%. The clothing business, on the other hand, is a reasonable business but the current underperformance of this business provides optionality in our view, and we have a high regard for management and their ability to turn this business around. The stock also offers a very attractive dividend yield of over 5% looking out one year.

The fund made a few new purchases on the international equity side with the result that the international equity exposure is now 30%, resulting in overall equity exposure of the fund of just over 70%. Our view throughout the year has been that whilst US equity markets are not attractive from a valuation point of view, the European and Asian equity markets are providing some very attractive buying opportunities and the most recent purchases reflect this view.

In this regard, the fund initiated a 1% position in China Telecom (Hong Kong listing) after returning from a research trip to China with a very positive long-term view of this country, in particular the Chinese consumer. China Telecom provides ideal exposure to the emerging Chinese consumer and, in our view, is very attractively valued, trading not far north of book value, a single digit P/E multiple and dividend yield of around 3%.

The fund also increased its Japanese exposure through buying units in the Morant Wright Japan Fund after meeting with this manager in London a few months ago. The Japanese equity exposure is now 4.5% of the total fund, at this point all held through underlying managers. This exposure is likely to increase over time given the attractiveness of Japanese stocks, several of which have net cash on their balance sheets which represent 30% or more of respective current market capitalisations.

With regards to European equity exposure the fund bought Nestlé (1.2% of fund), the Swiss-based global branded food company, and increased exposure to France Telecom (2.5% of fund), the French telecommunications incumbent. Nestlé, at time of purchase, was bought on a P/E multiple of 12 for the branded food business (excluding the group's listed holdings in L'Oreal and Alcon). We consider this to be a very attractive multiple for a business that owns some of the best global food brands including Nestlé, Nescafé and Maggi, has global market leadership in 10 categories including coffee, chocolate and mineral water and generates 30% of its sales from high growth emerging markets. France Telecom, in our view, is one of the cheapest stocks in Europe, trading on a price/free cash flow multiple of 8 and offering a dividend yield of around 5%. This business does have a declining domestic fixedline business, but it also has a growing mobile business (in France, UK and Spain predominantly) which contributes over half of the group's free cash flow, yet the stock is being priced as a pure fixed-line business and not a hybrid fixed-line/mobile group.

Given the current portfolio composition, particularly the SA industrial stocks as well as the international equity exposure focused in Europe and Asia, it is our view that the fund is well positioned to continue to achieve returns well in excess of inflation over the long term.

Gavin Joubert
Portfolio Manager

The Coronation Optimum Growth Fund appreciated by 10.7% in the first half of the year. This return came partly from some of the fund's large positions (in particular Naspers, Sasol and Remgro) and partly from the depreciation of the rand over the past few months. Over the one-year period to 30 June 2005, the fund has returned 29.2%, which is some 20% ahead of its objective of CPIX + 5% (which has been 8.9% for the past 12 months, with inflation running at 3.9%).
The asset allocation of the fund was not significantly altered during the quarter and currently 55% of the fund is invested in international assets and 45% in South African assets. We believe that South African equities remain the most attractive asset class locally (with government bonds being overvalued and decreasing investment opportunities being available in listed property, from a valuation perspective) and, as a result, all of the fund's local cash is deployed in equities, mainly industrials. With 25% of the total fund being invested in international equities (through a combination of direct holdings in international equities and through investments in underlying international fund managers who deploy investment philosophies similar to ours), the total equity exposure of the fund is around 70%, with the balance of the fund being invested in cash and short-duration government bonds.
The fund started buying Naspers earlier in the year and continued to add this investment over recent months to the point where this investment is by far the largest single position in the fund at 8.2% of the total portfolio. The average cost to date has been R74, which means that return of 11% has already been achieved on this investment, which has contributed to the fund's performance. What is more important however is that we believe there is a lot more to come. We believe that Naspers will generate over R8 a share in free cash flow in 18 months time which, at the current share price of R82, results in a price/free cash flow multiple on normalised free cash flows of just over 10 which decreases to 9 if the cash on the balance sheet of R10 a share is excluded. We believe that this is a very attractive valuation given the quality of Naspers' major asset, the South African and Sub Saharan Pay-TV business, MultiChoice (DStv).
The fund's second largest individual position, Remgro (5.5% of total fund) released results during the period and announced a special dividend of R6 a share, in addition to the normal dividend of R3.14 a share. We like all of the underlying investments held by Remgro (British American Tobacco, FirstRand/RMB Holdings, Impala Platinum, Robertsons Spices, etc.), believe they are all undervalued, and particularly like the fact that we are able to buy these assets at a 25% discount to their current market prices. The stake in British American Tobacco, which makes up 40% of Remgro's NAV, also provides rand hedge qualities as it is listed in London, denominated in pound sterling and, as such, provides an uplift to Remgro's NAV in times in rand depreciation. And lastly, we like the cash flow that is generated by these underlying companies and the fact that significant cash resources are building up on the Remgro balance sheet which will either be invested in new value-accretive opportunities or be returned to shareholders.
The third largest individual position in the fund is the holding in Sasol (ADR), which makes up 4.3% of the total fund. This stock was also purchased earlier during the year and has also been a significant contributor to the fund's returns (up 30% on cost price).
This unit is exactly the same as the local share listed on the JSE and the only reason why the fund bought the ADR and not the local unit was due to the fact that cash resources were available offshore and not in South Africa, where all of the cash was invested in undervalued equities. Whilst we hold the view that Sasol is no longer cheap, we also believe that, at the current share price, the market is ascribing very little value to Sasol's GTL (Gas-to-Liquid) business. In addition, in line with our investment philosophy which is both conservative and of a very long-term duration, we have valued Sasol using a conservative, long-term oil price of around US$30 which is well below the current oil price of almost US$50. Every day, week and year that passes with an oil price above US$30 adds incrementally to this conservative valuation of Sasol and further strengthens our investment case.
On the international side, the fund made small new investments in SABMiller (1.6% of total fund), General Motors (0.7% of total fund), DirecTV Group (0.7% of total fund) and Barclays (0.7% of total fund). A buying opportunity arose in SABMiller as a result of the general decline in global markets as well as a negative trading statement by Coors (a competitor to SAB's Miller brand in the US). It was our view that this short-term news flow had no impact on our long-term assessment of SABMiller's business value and the resultant widening gap between SABMiller's share price (at 795 pence when we bought the share) and our estimation of its business value (of over 1000 pence a share), presented a buying opportunity. The opportunity to purchase General Motors' shares at a very attractive price arose as a result of classic textbook investor fear and greed (in this case fear), arguably exacerbated by hedge fund shorting. At the lows of US$26.50 when the fund made its investment (share price now US$34.50 partly as a result of a bid by Kirk Kerkorian to buy an additional 5% of the company), the market was pricing in a reasonably high probability of bankruptcy of the entire group. What investors appear to forget, or overlook, is that General Motors not only has a struggling US business, they also have a successful and very profitable international business, which alone is worth far north of US$26.50. DirecTV is a US Pay-TV operator that is starting to generate significant free cash flow after years of investment and resultant losses. Barclays is a share that we got to know quite well as a result of the bid for Absa and that is very attractively valued in our view, on a P/E of below 9 and a dividend yield of 4%.
It is our view that the rand will continue to depreciate against developed market currencies in the years ahead and with 55% of the fund invested internationally in a mix of equities, bonds and cash, the fund will benefit from this depreciation. In addition, it is our view that the fund holds assets in South Africa that are still significantly undervalued, particularly the industrial equity holdings, and the fund will benefit from the growth in these assets. As a result, we expect the fund to continue to generate annual returns well in excess of inflation over the medium to long term.

The Coronation Optimum Growth Fund appreciated by 4.51% in the first quarter of 2005. This return came largely from the depreciation of the rand against the US dollar. Over one year the fund has appreciated by 22.7%.
The asset allocation of the fund was not significantly altered during the quarter and currently 52% of the fund is invested in international assets and 48% in South African assets. We believe that South African equities remain to be the most attractive asset class locally and as a result all of the fund's local cash is deployed in equities, mainly industrials.
Whilst selective value can be found in international equities, we believe that international equity markets in general are not particularly attractive from a valuation perspective, and as a result only 36% of the international assets are invested in equities. The total equity exposure of the fund is therefore 67% (48% in South Africa and 19% internationally).
We believe that bonds, both locally and internationally, are overvalued and therefore subject to the risk of capital loss. The fund's non-equity exposure is therefore invested in cash and short duration government bonds predominantly in the UK and Germany.
The most significant new purchase over the quarter was that of Naspers, which now makes up around 5% of the total fund. Naspers owns two of the best businesses in South Africa, the pay-television business, MultiChoice (DStv) and the print business, Media24. These businesses have dominant positions in their markets, pricing power, high margins and generate significant amounts of free cash flow. At around R70, we are able to buy the Naspers Group on a normalised Price/Free Cash Flow of around 9. Given the quality of the core businesses in the group, we believe a Price/Free Cash Flow of closer to 13 is a more appropriate multiple, which in turn would equate to a fair value of over R100 for Naspers.
The fund also built a new position in Sasol early in the quarter. Sasol is one of the few businesses in South Africa that has a moat around the business. This moat (or significant barrier to entry) comes in the form of their oil refineries in Gauteng: to replicate this infrastructure would cost billions of rands. As a result of this quality, we believe that Sasol is an above-average business and should trade on an above average multiple. Valuing Sasol's core business on a 12 P/E multiple and using more normal levels for the oil price (US$30 as opposed to the current level of around US$55) and the rand/US dollar exchange rate (R7.20 as opposed to the current level of R6.20) would result in a fair value of around R165, above the current share price of R145. However, what makes Sasol even more attractive is that the market, in our view, is pricing in no value for Sasol's Gas to Liquids business, which could be worth R50 a share or more. This is a great opportunity: to be able to buy a business below the fundamental value of the existing business and, in addition to this, to have a free option on a new business. The fund has already enjoyed price appreciation of 25% on the Sasol ADR purchase, and as we hold the view that Sasol is worth over R200, we believe that there is more to come.
A few interesting opportunities also opened up in international equity markets and the fund initiated new positions in Pfizer (0.5% of fund), Diageo (0.5% of fund), Petrobras (0.5% of fund), France Telecom (1.3% of fund) and Telefonica (1.2% of fund).
Pfizer is the largest pharmaceutical company in the US. The share has always traded at a significant premium to the market, reaching a P/E of 35 and higher in the past. Investors have now fallen out of love with the drug sector to the extent that it is now possible to buy Pfizer on a P/E of slightly above 12 (more than a 35% discount to the S&P 500), which we believe provides a great opportunity for the long-term investor. Diageo is a global spirits and drinks company which owns some of the best brands in the drinks market (Guinness, J&B, Johnnie Walker, Smirnoff) yet trades on a P/E multiple of only 14 and dividend yield of close to 4%. Petrobras is Brazil's national oil company and the owner of an increasingly scarce, and valuable, global resource: growing energy reserves. Yet Petrobras trades on a particularly cheap free cash flow multiple of around 6 and provides a dividend yield of over 5%.
Some of the most undervalued stocks globally in our view however are to be found in the telecommunications area, particularly the fixed-line businesses. France Telecom is France's national fixed-line incumbent and Telefonica is Spain's fixed-line incumbent. Fixed-line businesses all over the globe are struggling to show much growth as a result of competition and continued fixed-mobile substitution. They do however generate significant amounts of free cash flow. Telefonica trades on a Price/Free Cash Flow multiple of 9.6 and dividend yield of 3.9% and France Telecom is even cheaper, trading on Price/Free Cash Flow multiple of 8.2 and dividend yield of 4.1%. These valuation levels would look about fair if France Telecom and Telefonica only consisted of fixed-line businesses. However, in the case of France Telecom, around half of the group's free cash flow comes from it's growing mobile business, Orange (with it's main markets being France and the UK) and, in the case, of Telefonica half of this group's free cash flow comes from it's growing mobile operations (Telefonica Moviles, the Spanish mobile business, as well as significant mobile interests in Latin America). These mobile operations in our view should be valued on Price/Free Cash Flow multiples of closer to 15. Yet you are able to buy both France Telecom and Telefonica (with 50% of their respective businesses being mobile) on single digit free cash flow multiples. We believe that this valuation anomaly, whereby one is able to buy blended fixed-line/mobile businesses on fixed-line multiples, provides a very attractive opportunity.
It is our view that the rand will continue to depreciate against developed market currencies in the year ahead and beyond and with over 50% of the fund invested internationally in a mix of equities, bonds and cash, the fund will benefit from this depreciation. In addition, it is our view that the fund holds assets in South Africa that are still significantly undervalued, particularly the industrial equity holdings, and the fund will benefit from the growth in these assets. As a result, we expect the fund to continue to generate annual returns well in excess of inflation over the medium to long term.

An investment of R10 in the fund at its inception (March 1999) would be now worth approximately R25 today. This return should be seen against a background of massive currency and stock market volatility. In this period the fund only experienced two major draw downs.
In the past year the fund has steadily increased its exposure to offshore currencies. In time to come this will provide the South African investors a better opportunity set versus the local markets. These markets look appropriately priced and the strong rand and lower commodity prices over the long term should start to affect the economy at the margin.
Our expectation for the year is a subdued one. Some investments such as ABI and Copi were delisted and we did not reinvest these proceeds into equities choosing to remain in cash. This means our returns cannot be expected to be more than 10% for the year.