The Coronation Optimum Growth Fund appreciated by 23.1% for the first 9 months of 2006 and 28.2% for the year to end September, which is well ahead of its target of inflation plus 5%. The primary drivers of this return have been relatively high allocation of capital to equities, strong performance from individual stock positions, particularly the international stocks, and the depreciation of the rand. Over the past 5 years the fund has produced an average annual return of 19.7%.
The rand has now depreciated by 25% against the dollar this year and as a result the decision earlier in the year to increase offshore exposure to 60% from a level of just under 50% continued to benefit the fund. The other large decision that was taken over the past several months was to increase the overall equity exposure of the fund (from 68% in March to around 84% in September), as a result of the view that we were finding very attractively valued stocks, particularly internationally.
The global market sell-off in May and June provided a great opportunity to establish new positions and these purchases have started to bear fruit, with strong performers including NYSE Group (+18% since purchase in May), MTS (+26% since purchase) and Turkcell (+24% since purchase). In addition to this, our patience with one of the fund's larger international positions, Harley Davidson, started to be rewarded with the stock appreciating by 25% over the past few months driven by very good reported results. More recently, the fund's long-held telecommunications position has started to contribute with strong double-digit gains from France Telecom, Telefonica and Vodafone. Whilst telecommunications stocks globally have been out of favour by investors, our view has been, and continues to be, that they are very attractively valued (typically single digit free cash flow multiples) and that the market is pricing in very pessimistic assumptions with regards to both the fixed-line and mobile businesses. These stocks also offer very attractive dividend yields, with France Telecom (7% yield) and Telefonica (5% yield) being particularly appealing in this regard, given European cash rates of 3% or less.
Over the past few months we added a few new names to the portfolio with the larger new positions being Netcare (South Africa), Edcon (South Africa), BHP Billiton (South Africa) Nasdaq Stock Market (US), Seat Pagine Gialle (Italy) and Legg Mason (US).
Netcare was by far the single largest purchase over the past few months (3.6% of fund). It is our view that the purchase of a majority stake in the UK hospital group, GHG, transforms the business and is a very good deal for Netcare. There is significant opportunity in the UK healthcare market (ageing population, NHS outsourcing trends, inefficient utilisation of capacity) and we have high regard for the Netcare management team and their ability to capitalise on these opportunities. The transaction is geared, and as such is not without risk, but we believe that this risk is manageable.
The market continues to be extremely short-term focused with regards to the South African interest rate sensitive shares (retailers and banks), with the result that many of these shares have declined by 20% or 30% over the past few months, Edcon being just one example. We are not particularly interested in what the earnings of Edcon over the next 6 or 12 months are likely to do: what we are very interested in is what the earnings of Edcon are likely to do over the next 5 or 10 years and what price we pay for a stake in this business today. The fund bought Edcon at a share price of R26 on a historic P/E of 9 and historic dividend yield of over 6%. Whilst it may not seem to make sense to buy Edcon today with all the bad news about depreciating currency, rising inflation and interest rates and consumer debt levels, we are strongly of the view that it is impossible to time markets and we would rather concern ourselves with making sure that we are buying significantly undervalued assets, irrespective of the short-term outlook.
Only time will tell whether the investor who was focusing on the next 6 months and sold Edcon to us at R26 is right or we are right. The purchase of a 1% position in BHP Billiton was predominantly a hedge against the implied BHP Billiton short position embedded in fund's short ALSI Futures position.
Stock exchanges are great businesses: they have dominant or monopolistic positions (depending on the country), significant positive operational gearing over long periods of time and are great free cash flow generators. In South Africa it is possible to invest in only 1 stock exchange (JSE Ltd) but internationally there are 20 listed stock exchanges. Many of these exchanges are highly rated, we have however been able to find a few that we believe offer good value. The fund bought a position in the New York Stock Exchange Group in May (2.4% of fund) and then more recently also established a position in the Nasdaq Stock Exchange (1.2% of fund). In early October we added to the small position in the JSE Ltd and this is now a 1% position. We are currently looking at adding a 4th exchange to the portfolio.
Seat Pagine Gialle is an Italian directories business (the equivalent of Telkom's white and yellow pages directories business). There are challenges facing the company, including the threat of internet and high debt levels. It is our view however that these challenges are more than priced into the share: the company will generate around EUR 400m of Free Cash Flow this year and has a market capitalisation of around EUR 3 billion, meaning that it is trading on a very appealing free cash flow multiple of just over 7.
Legg Mason is a US asset management group who owns several value-orientated asset managers including the Bill Miller Value Trust franchise, Brandywine, Batterymarch and Royce. The share has declined significantly over the past few months as a result of short-term net outflows and concerns over the integration of the Citigroup asset management business. Whilst some of these concerns are justified, the market appears to be placing excessive emphasis on what are shorter-term issues. Asset management is a business that we know and understand well and we hold the view that a good asset manager has a very attractive business model. We believe Legg Mason owns several good asset managers and after the recent share price decline we were able to buy the share on a very reasonable cash earnings multiple.
Whilst we have reduced the fund's equity exposure slightly in the early weeks of October (from 84% to 79%) we continue to hold the view that there are many stocks that are very attractively valued and as a result we are comfortable with the fund's relatively high equity exposure. The fund is now 62% invested offshore and 38% in South Africa, with 51% of the fund being invested in international equities and 33% in South African equities. We do not, at this point, intend to take more of the fund's cash offshore as we hold the view that there is substantial upside to several of the fund's South African equity holdings. In addition to this, whilst we have no idea what the exchange rate will do over the short or medium term, the recent movement in the rand does appear to be extreme and not entirely explained by fundamentals, not dissimilar to what happened in late 2001.

Gavin Joubert
Portfolio Manager

The Coronation Optimum Growth Fund appreciated by 12.5% for the first 6 months of 2006 and 25.9% for the year to end June, which is well ahead of its target of inflation plus 5%. Over the past 5 years the fund has produced an average annual return of 18.1%.
The decision earlier in the year to increase offshore exposure to 60% from a level of just under 50% benefited the fund over the past few months as the rand depreciated by almost 20% against the dollar. Our international equity exposure held up well during the global market declines in May and June as a result of being focused in more defensive areas (telecommunications, beverages and food), with strong valuation underpins in the form of forward P/E and P/FCF multiples in the 8-12 range and/or dividend yields north of 3% or 4%. The fund's SA equity exposure has been a detractor of performance in recent months as the emerging markets sell-off, rand depreciation and expectation for higher SA interest rates impacted the industrial and financial stocks in particular. The price declines in this particular area resulted in some attractive buying opportunities where we both added to existing positions (Naspers, Woolworths, Telkom and Standard Bank) and established new positions (Mr Price and MTN).
The decline in global markets also provided opportunities to add to existing positions and to buy several new international stocks at very attractive valuations. Most of these new purchases were in developed markets but the extent of declines in emerging markets also provided a few opportunities in this area. As a result of the buying of both SA and international stocks the total equity exposure of the fund increased significantly over the past few months from around 70% to slightly over 80%, with 35% of this being invested in SA equities and 47% in international equities and equity mutual funds. The balance of the fund is invested in cash and bonds, predominantly offshore, with a 6.5% position in US 5-year Treasuries and 7.5% in offshore cash, in a mix of foreign currencies.
The depreciation of the rand coupled with the emerging markets sell-off resulted in declines of 20% or 25% in many SA industrial and financial stocks. Naspers, the fund's largest holding, is trading on a normalised free cash flow multiple of below 10, after stripping out the cash and the associate holding in the Chinese internet company, Tencent. For a business that derives over 90% of its free cash flow from Pay-TV (in a dominant South African market and growing African markets), we consider this to be a steal and the fund added to its position. Telkom declined to the extent where the fixed-line business, after stripping out our valuation for Vodacom, was trading on a normalised free cash flow multiple of around 3. Again, this is far too cheap and assumes a severe deterioration in the fixed-line business. The fund bought more Telkom, having sold a large part of its holding in March. Standard Bank declined to the extent where the company was trading on a forward P/E multiple of close to 8 at which stage the fund purchased more.
The sell-off amongst retailers was indiscriminate, with cashbased retailers like Woolworths and Mr Price declining to the same extent as the credit clothing and furniture retailers. In our view this created an opportunity for the fund to buy more Woolworths at a price which implied a P/E of 10 and a dividend yield of 6%, as well as to initiate a position in Mr Price on a forward multiple of around 7.5 and dividend yield of over 7%.
MTN announced the acquisition of Investcom, an Africa and Middle East mobile operator with businesses in several countries with mobile penetration of below 10% including Sudan, Syria and Ghana. Our view is that the acquisition is attractive from a long-term point of view and the sell-off in May and June enabled us to buy MTN on a P/E of around 9 on normalised earnings.
It is our view that European equities are the most attractive from a valuation point of view within the developed world and as a result the fund bought a 3% position in the Edinburgh Partners European Opportunities Fund. This fund is managed by a boutique investment house of predominantly ex Templeton investment professionals with a valuation driven, disciplined investment process. We also increased our European equity exposure by adding to the fund's Telefonica and Nestle positions and buying small positions in Unilever and Unicredito Italiano. As we have stated before, we believe that telecommunications stocks globally are very attractively valued and Telefonica is no exception. The company is the incumbent fixed-line and mobile operator in Spain, but also has significant operations in higher growth Latin American countries and recently bought O2, the UK's Number 3 mobile operator. The mobile operations contribute over half of group free cash flow, yet the group is valued on a free cash multiple of 9, which in our view is more consistent with a fixed-line valuation. A similar argument applies to France Telecom. The positions in these two European mobile/fixed-line hybrid stocks (France Telecom and Telefonica) now make up 5% of the fund.
Within emerging markets we added to the fund's Samsung (Korea) and Petrobras (Brazil) positions, with both stocks trading on single digit multiples, and bought new holdings in Turkcell (Turkey), MTS (Russia) and Cemex (Mexico). Turkcell and MTS are the dominant mobile operators in Turkey and Russia respectively, and whilst subscriber growth in these markets is slowing, both of these businesses generate significant free cash flows which in turn has the potential to be returned to shareholders. The valuations of both at the time of purchase was very attractive, with Turkcell on a FCF yield of around 13% and MTS 12%. Cemex, whilst based in Mexico, is the world's 3rd largest cement producer behind Lafarge and Holcim, and only derives 20% of its revenue from Mexico, with the balance coming from the US, Europe and South America. The stock declined by 25% to the point where it could be bought on a P/E multiple of just over 8.
The fund also added a few US stocks, particularly in the large cap area including Citigroup (the world's largest financial services company, with a strong emerging market franchise and trading on a P/E of 10), Dell (global leading PC distributor trading on a P/E of 14 excluding the significant net cash position) and the NYSE Group (operator of the New York Stock Exchange with operating margins of 6% being significantly behind the 30%-60% operating margin level of other stock exchanges internationally and potential to reduce this differential over time).
The fund's equity exposure is now at what we would consider to be a high level, but it is our view that the opportunities created over recent months, both in South Africa and internationally, justify this position. We expect the fund to enjoy the benefits of significant price appreciation from these holdings in the future.

Gavin Joubert
Portfolio Manager

The Coronation Optimum Growth Fund produced a return of 24.7% for the one-year period ended 31 March 2006, which is well ahead of the fund's return objective of CPIX plus 5%. The annualised return over the past three years is now 24.3%. The year has started off relatively well and the fund's return year to date is 5.2%.

The most significant change to the portfolio over the past few months has been the asset allocation decision to increase the international exposure of the fund. In December the fund had 50% of its assets offshore and 50% in South Africa. As a result of continued rand strength and outperformance of South African equities in relation to international equities, a further 10% was taken offshore which means that the fund now has 60% of its assets offshore and 40% in South Africa. The valuation differential between South African equities and international equities has narrowed considerably over the past few years and in particular over the past year, to the point where the South African equity market is now more expensive than the European equity market, on a forward P/E basis. Under this scenario we believe it makes sense to invest more in international equities, in particular European shares, and less in South African equities.

The cash from the sale of VenFin (around 5% of total fund) was taken offshore and, in addition to this, we reduced some of the fund's SA equity positions and took this cash offshore. The only new SA share that was bought was a small position in AVI, which declined after disappointing results. We believe that AVI owns some great brands and we have high regard for the management team and their ability to turn around the underperforming assets in their stable. As a result of the net selling of SA equities, they now make up 38% of the fund, down from 46% in December. The international equity exposure in turn is now 35% of the fund, up from 31% in December. The total equity exposure is therefore just above 70% with the rest of the portfolio in cash, mainly euro's and British pounds, as a result of unattractive bond valuations, both locally and internationally.

Over the past few months the fund increased it's exposure to a few of the existing international equity holdings and also purchased several new international shares. France Telecom, China Telecom and Vodafone were all added to as a result of price weakness without any significant change in the underlying fundamentals. France Telecom, which trades on a free cash flow multiple of 8 and dividend yield of 5%, is a hybrid mobile/fixedline business that is being valued as a fixed-line business only; China Telecom offers exposure to the emerging Chinese consumer on a single-digit multiple and Vodafone, which one is able to buy on a free cash flow multiple not far north of 10, has the potential to return significant amounts of cash to shareholders over the next few years. We believe that telecommunications stocks are one of the most attractive areas globally from a valuation point of view and the fund now has 6% of its capital invested in these three shares.

The fund also established new positions in Samsung (Korea), Deutsche Post (Germany) andLagardere (France). Samsung has interests in several industries, the biggest being semiconductors and mobile handsets, where it continues to take market share. We believe that 10x earnings is too cheap for this emerging brand. Deutsche Post, and its management team, have disappointed investors over the past few years, with poor operational performance and expensive acquisitions. The share now trades on a price/free cash flow multiple of 10 and at this level we believe the market is pricing in a continuation of the past, yet shareholder pressure has been building and management have started to respond to this. The stock also provides good exposure to the German domestic economy, which is showing some signs of recovery. Lagardere is a French media company with its primary business being magazine and book publishing, where it is the second largest book publisher in France. The company also owns a stake in EADS, a listed aeronautical company. Stripping out this stake, the media assets trade on a forward free cash flow multiple of around 9, which we believe is very attractive.

The US market, after another year of flat share price performance, at the same time that corporate earnings have continued to grow, is now also starting to present some reasonable buying opportunities and the fund bought positions in Harley Davidson and Nike over the past quarter. Both companies own great brands, with high barriers to entry and good free cash flow generation and both are the cheapest they have been in several years, with Harley Davidson trading on a forward P/E multiple of around 13 and Nike a 15 multiple, both at what we believe are unwarranted discounts to the S&P 500 multiple.

Given the current portfolio composition, particularly the SA industrial stocks as well as the increased 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 produced a return of 23.9% for the one year period ended 31 December 2005, which is well ahead of the fund's return objective of CPIX plus 5%. This return has come largely from some of the fund's bigger SA equity positions (in particular Naspers, Sasol and VenFin) as well as from international equities, both the individual positions and the holdings in offshore funds, particularly the Japanese and Asian investments. The impact of the rand on performance was slightly negative.
The broad asset allocation of the fund was not significantly altered during the past few months and currently 51% of the fund is invested in South African assets and 49% in international assets. Given the current continued strength of the rand, coupled with the fact that the cash for VenFin (5.7% of total portfolio) will be coming into the fund during the course of January, it is quite likely that the international portion of the fund will be increased over the coming months. The total equity exposure of the fund is currently around 75% with about 45% of this invested in South Africa and the other 30% offshore. With the continued strength of the SA equity market, we are struggling to find new investment ideas in South Africa, but at the same time some interesting opportunities are opening up internationally, particularly in Europe, to a lessor extent Japan and other Asia, and now even in the US market. So whilst we are comfortable with overall equity exposure around the 75% level, we are currently in the process of critically evaluated whether a higher proportion of that equity exposure should not be in international markets.
On the local equity side, one of the highlights of the year was the offer by Vodafone for VenFin at R47.25 per share when it had traded at around R30 a share in the months leading up to the offer. The fund held a large position in VenFin because we believed that the largest asset that it held, being Vodacom, is a great asset that grows its business value year in and year out through significant free cash flow generation. In addition, VenFin always traded at a large discount to its NAV which provided good downside protection. The market's view was that there was no 'catalyst' to unlock this discount and so VenFin would always trade at this discount to NAV. Our view is that valuation is the only catalyst that an investor needs and we were happy to buy an asset that was trading at such a large discount to the underlying value of its investments, and wait patiently for that value to be recognised. Vodafone saw that value and on the day of the announcement of the transaction the discount that had been in place for five years disappeared in the space of a few minutes with the VenFin share price appreciating by over 30% in one day. The fund today holds positions in a few other stocks that trade with these nonsensical 'holding company' discounts, including Remgro, Johnnic Communications and Johnnic Holdings. We are not sure if these investments will be as rewarding as VenFin, but what we do know is that these stocks own some great assets and are trading at a large discount to the underlying value of these respective assets.
The South African equity holdings have remained unchanged over the past few months, and as we have already mentioned, we are struggling to find new investment ideas in South Africa. Internationally however we believe that there are numerous interesting investment opportunities and during the past quarter Newscorp and Vodafone were added to the portfolio. Newscorp owns some of the best media assets globally, including 20th Century Fox Films, Fox Broadcasting and a stake in BSkyB. As is common with good media assets, this group generates large amounts of free cash flow and we feel that the normalised free cash multiple of around 15 is attractive given the quality of the underlying assets. Vodafone is the world's largest mobile telecommunications company, and although growth is now slowing, this group also generates significant free cash flow and the stock, on a free cash flow multiple of around 12, is the cheapest it has been for many years. We also added to the fund's China Telecom position: we have mentioned this company in previous commentaries and the recent share price decline provided us with an opportunity to increase the fund's position at very attractive levels. We like the exposure to the Chinese consumer that China Telecom provides and, as importantly, we like the valuation: a P/E multiple of 10, price/book value just over 1 and dividend yield of 3%.
We continue to find both SA and international bonds unattractive from a valuation point of view and therefore most of the fund's holdings besides equities are in cash, mainly British pounds, with smaller euro, Japanese yen and Swiss franc holdings.
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