The general nervousness and see-saw movements in markets continued to prevail this quarter. This year we have seen markets sharply appreciate, followed by a big correction and then another upward move. All in all, global markets are marginally positive (in USD) year-to-date. Global bonds, particularly emerging market (EM) bonds, have continued to appreciate and as money floods into EM bonds in search of yield, EM currencies continued to strengthen. South Africa (representing over 10% of the Global EM Bond Index) has been a prime beneficiary of these flows and the ZAR has continued to strengthen as a result. Year-to-date the currency has appreciated by 6.4%. Against this background the fund is marginally positive (+0.6%) in ZAR year-to-date, and approximately +7% in USD over the same period.

We continue to believe that globally bonds are overvalued and getting more so by the day. The fund has nothing invested in global government bonds (in contrast to 2006 for example when as much as 15% of the fund was invested in bonds) and only a small amount (2% of fund) invested in corporate bonds. We believe that there is very good selected value in global equities, particularly in the large cap high quality companies and a large part of the fund is invested in this area (Johnson & Johnson, Coca-Cola, Wal-Mart, McDonalds, YUM Brands, Colgate Palmolive, Heineken and Tesco). Given the attractive valuations of so many of these businesses, the equity exposure of the fund (mid 80% level) is at the high end of its historical range.

We also believe a number of the US technology companies are very attractive and the fund has a number of holdings in this area (Symantec, Microsoft, Oracle, Hewlett Packard, IBM, Google and Cisco). Valuations for most of the companies mentioned are at multi-year lows after 10 years of flat global equity markets. IBM's share price for example just recently passed its previous all-time high in 1998. So IBM's share price has done nothing for 12 years! The starting point of course was a high valuation, driven by the TMT bubble. What is more important is that today, after growing the business year after year at the same time that the share price did nothing, IBM trades on just over 11x free cash flow. We think this is very attractive for what we would consider to be an above average business.

We also continue to find new ideas, particularly in the US, where the market seems to get more and more short-term focused every day. This of course creates opportunities if one has a longer time horizon. An example of this in our view is the recent rapid share price declines of the world's two largest card processors - Mastercard and Visa. We were buyers of both shares (together they make up 5.5% of the fund today) as we believe the market is focusing too much on one issue and ignoring all of the positives of these businesses. Although the drivers of these two companies are very similar, our discussion below will focus on Mastercard as it is the larger position.

The issue the market is currently focusing on is that of regulation, specifically in the US. A new bill was tabled in the US called the Durbin amendment, which proposes a number of new regulations that will negatively impact the card processors. Whilst we agree with the fact that the proposed changes will negatively impact the processors, it is our view that the impact is likely to be manageable. More importantly, following the share price declines, it is also our view that this impact is more than priced in. We would also make the point that whilst it is possible for regulatory pressure to increase in countries other than the US, the interchange fees (one of the key areas being targeted by the proposals) in the US are at the high end of all markets globally.

So at this point, the regulations are specific to the US, and in fact specific to debit cards only. In this regard, markets outside of the US (in particular emerging markets) are growing much faster than the US market. If we consider Mastercard, emerging markets already make up around 30% of revenue and this percentage is increasing rapidly. Total non-US revenues for Mastercard today are 55%, meaning that the US already makes up less than half (45%) the business. The US contribution will continue to decline given the fact that credit and debit card purchase volumes are growing twice as fast outside the US as they are in the US. Mastercard's US revenue grew at 10% CAGR from 2006-2009 whereas their international revenue grew at 21% CAGR over the same 2006-2009 period. Credit and debit card take-up in emerging markets (and even in Europe) is far below that of the US and will undoubtedly increase at a rapid rate over the next several years. Today for example, 40% of all consumer spend in the US is done by credit or debit card (this percentage on its own will increase over the next several years), whereas in a country like Brazil (whose economy is growing at over twice the rate of the US), only 20% of consumer spend is made using a credit or debit card.

The use of credit and debit cards has increased over the past 5 years globally (from 23% of all consumer spend in 2005 to 29% of all consumer spend in 2010). It also shows Mastercard's forecasts for what they expect over the next 5 years - for credit/debit card spend to make up 36% of all consumer spend from 29% today. Given that global consumer spend is in the trillions of dollars, a move from 29% of all spend to 36% of all spend is a huge number.

Besides having very favourable long-term drivers (a switch from paper to plastic), the card processors have a largely fixed cost base (meaning that revenue increases translate into even higher profit increases, and vice versa of course) and they also require very little capital to grow. They also generate large amounts of free cash flow and convert all of their earnings into free cash flow. Mastercard have provided 2011-2013 revenue guidance in the low double-digits and EPS growth of 20%+. We would be more conservative than this and feel that EPS growth of 15% over the next number of years is very achievable, taking into account downward pressure in the US. Today Mastercard trades on approximately 15x this year's earnings excluding their net cash position (and was trading at a much lower valuation than this at the fund's average purchase price). We feel this is very attractive for a business of this quality.

Portfolio manager
Gavin Joubert Client

Equity markets increased during the first few months of the year before the European debt crisis led to fears of a double-dip recession and a resultant significant decline in markets over the past few months. The MSCI World Index has now declined by 6.3% year to date and the SA equity market by 4.1%. Against this backdrop, the fund declined by 3.7% year to date. Similar to the market decline of September/October 2008, we believe that the selling has now become indiscriminate (largely due to the herd hedge fund trade of 'de-risking', i.e. selling equities at any cost to reduce net equity exposure). This creates significant opportunity which the fund has been taking advantage of. As a result of net buying the fund's equity exposure is back to around the 80% level. Earlier in the year the equity exposure declined to close to 70% after we reduced a number of positions as they moved closer to our fair value.

We continue to believe that global equities are far more attractive than SA equities. As a result 90% of the fund is invested offshore and only 10% in South Africa. The fund effectively owns only two South African shares - MTN and Naspers. In MTN's case we believe that the market's shorter term focus on acquisition and regulatory risk is giving one an excellent opportunity to accumulate shares in a company that we believe will grow earnings by over 15% p.a. compounded over the next 5 years on a P/E not far north of 10 on this year's earnings. In the case of Naspers we believe the group's largest earnings contributor (Pay-TV in SA and Africa) is one of the best assets in the country that will continue to compound earnings at a high rate. In addition to this we believe Tencent is a very good asset and that a number of the smaller assets have the potential to become significant contributors to earnings over time. The share price decline of Naspers has put the group on around 10x earnings two years from today which we believe is very attractive.

'Double-dip' has now become consensus. We don't believe that we can forecast the economy over the shorter term with a high degree of conviction, and so we spend our time focusing on the individual stocks in the portfolio and the earnings streams we believe they will generate over the longer term (5 years). We then value those longterm earning streams and buy those shares that are trading well below what we believe they are worth. In this regard, we don't believe that the longer-term (5 years) earnings outlook, and hence fair values for Pfizer, Johnson & Johnson, Teva, CVS Caremark, Safeway, Time Warner Cable, YUM Brands, Coca-Cola or Kraft (all portfolio holdings) have changed very much over the past several months. Yet in most cases their share prices are lower and therefore their valuations are more, not less, attractive. In terms of portfolio activity, a number of the large cap US technology stocks have become attractive again (trading on around 10x earnings ex their net cash balances in many cases) and we added small positions in a number of them including Microsoft, Cisco, Oracle and eBay after having sold them earlier in the year. We also continue to believe that the large cap pharmaceutical stocks are pricing in negative growth into perpetuity and we added to the fund's Johnson & Johnson and Pfizer positions as well as adding Merck to the portfolio. Spain is one of the markets investors hate most today. When investors are just about throwing up equities in revulsion it can be very profitable to invest in these equities and we believe that Banco Santander, the largest bank in Spain, is one such opportunity. Over the past several years, Banco Santander have expanded their operations over Europe and Latin America to the point today where only around 20% of earnings actually come from Spain. The Spanish business is where the risk primarily sits and in this regard we believe that the bank has adequate provision against further defaults in Spain. The Latin American business (operations in Brazil, Mexico and Chile which today contribute around 40% of earnings) is the jewel in the crown and is growing its NAV by 20% p.a. as a result of low banking penetration, economic expansion and rising disposable incomes. There are undoubtedly risks attached to Banco Santander, but at the fund's purchase price (1.2x Price/ Tangible Book Value, 7x earnings and a dividend yield of 8%) we believe that we were being more than compensated for such risks and that there was substantial potential upside.

Within emerging markets valuations of a number of stocks have also started to become very attractive again and we added to the fund's holdings in two of the Chinese internet gaming companies, Netease.com and Sohu.com after they experienced share price declines of 30% due to concerns of regulatory intervention and slowing growth. Internet penetration (the number of individuals who have access to the internet) has increased significantly over the past several years, as has the Chinese online gaming industry.

There are currently over 400 million internet users in China and internet penetration is now approaching 30%.We believe that it will ultimately reach 50% or 60%, and could go a lot higher. This means that another 300 to 500 million internet users will be added in China over the next several years. Internet gaming is a very popular, mainly social, cheap pastime in China. The industry has been growing by well over 30% p.a. over the past several years driven by increasing internet penetration and rising disposable income levels. Whilst we do not expect these historic growth rates to be repeated, we do believe that the industry will continue to show double-digit growth. All of Netease.com's earnings and over half of Sohu.com's earnings come from internet gaming. Both companies have large net cash positions (over 25% of its market capitalisation in the case of Netease.com and almost 35% in the case of Sohu.com) and both trade on low double-digit ratings on this year's earnings, which we believe is very attractive and more than prices in the market's current concern of regulatory risk.

Global bonds have continued to appreciate, with US and German bonds now yielding less than 3%. Given current government debt levels, new funding that will be needed, historical valuation ranges and our fair values for these bonds, we believe that they are ridiculously over valued and are an accident waiting to happen. As such, the fund holds no government bonds, preferring cash instead. Although cash may be yielding nothing, it also does not carry the risk of a capital loss as government bonds do.

After 10 years of no returns, we believe that global equities are very attractive and that the fund, with around 70% of its assets invested in global equities, is well placed to generate above average returns over the next few years.

Portfolio manager
Gavin Joubert

The fund had a decent start to the year, appreciating by 3.3%. Over the past year the fund has generated a return of 27.4%, which is well ahead of its target of inflation +5% and also some 10% ahead of the return of the MSCI World Index. Over the past 5 years the fund has generated a return of 9.5% per annum and in the more than 10 years since inception it has generated a return of 14.1% per annum.

We continue to find very good value in global equities in particular, and this is reflected in the fund's equity exposure in the low 80's. Although the equity exposure is reasonably high, we would make the point that the bulk of the fund's equity exposure continues to be held in more defensive businesses such as telecommunications (MTN, Vodafone, Telefonica and Vivendi), pharmaceuticals/healthcare (Pfizer, Johnson & Johnson and CVS Caremark), food retail (Safeway and Tesco), global fast food (McDonalds and YUM Brands) and pay-TV/cable (Naspers, DirectTV and Time Warner Cable), which we believe offer very attractive risk/return profiles: reasonably visible free cash flow growth over the next 4 - 5 years with attractive valuations. We continue to believe that bonds are expensive and the fund has negligible exposure in this area.

Over the past few months, the fund's largest new position was that of Qualcomm. Qualcomm are a US listed and headquartered business, but generate a large part of their revenue (over 60%) from emerging markets, in particular China and Korea. Qualcomm have two parts to their business - making and selling chipsets for mobile phones and licensing software for 3G mobile phones. The company is the leader in the supply of technology to the mobile phone industry and counts most of the global handset producers amongst their customers. In effect, Qualcomm have made it their business to perform the R&D function for the handset manufacturers - over the past 10 years R&D as a percentage of sales has increased from being less than 10% of sales to over 20% of sales. As the 3G and smartphone market continue to grow around the world, Qualcomm benefits as it is their technology that is used in these mobile phones. Extremely short-term focused market participants gave us the opportunity to buy Qualcomm at a very attractive price as the share was sold down after announcing quarterly results that were behind market expectations. Yes, quarterly results! Qualcomm has almost $20 billion ($ 12 a share) of net cash on the balance sheet and at our average purchase price of around $38 we bought the company on around 11x this year's earnings excluding the net cash position, which we believe is a very attractive price for a company of this quality.

Over the past few months the fund also increased its position in Safeway and this company is now one of the largest holdings in the fund. Safeway are the 3rd largest food retailer in the US behind Walmart and Kroger. The company has 1,730 stores and has spent the past 5 years undergoing an extensive store refurbishment programme. By the end of 2010 some 88% of their store base would have been converted to the new format (termed "lifestyle", which offers a much better shopping environment as well as a larger high margin fresh produce section). At the same time, the price points of Safeway have been reduced to closer to the level of its rivals and the combination of newly revamped stores and attractive prices should have a favourable impact on footfall over the next few years. Earnings are not particularly high, with operating margins currently around 3.3% compared to the 4% average level of the past few years. In addition to this, the business will generate a large amount of free cash flow over the next few years as the capital expenditure cycle is now largely complete. A large part of this free cash flow is being used to buy back (undervalued) shares - in 2009 alone, the company bought back over 10% of its shares in issue. In the financial year ended 31 December 2009 the business generated $1.5 billion of free cash flow (partly due to one-off amounts and below normal capital expenditure) and should continue to generate at least $1 billion of free cash flow a year going forward. The current market capitalisation is around $ 10 billion, which means that the company is therefore trading on a price/free cash flow multiple of 10x which we find very attractive.

Over the past few months we continued to increase the fund's international exposure, taking it to close to 90% of the fund. The reason for this is two-fold: firstly we are struggling to find undervalued SA equities (and still finding very good value in selected global equities) and secondly we believe the rand is too strong and fundamentally overvalued. The remaining 10% SA exposure is the lowest in the fund's history and we believe that the decision to invest such a large portion of the fund offshore will reap rewards for unitholders over the next few years.

Portfolio manager
Gavin Joubert Client

The fund had a good year, appreciating by 17.7%. Additionally the fund's returns were depressed by the strong rand, which appreciated by 30%. In dollar terms the fund appreciated by around 50%. The year's return of 17.7% is well ahead of the fund's inflation plus 5% (at around 11%) target and also some 15% ahead of the return of the MSCI World Index of 1.6%. Additionally, the fund was the second best performing fund out of the 20 or so funds in the Worldwide Flexible category and was the fourth best performing fund out of the broader peer group of the 70 funds in the Worldwide Flexible, Foreign Flexible and Foreign Equity categories. Since inception just over 10 years ago the fund has produced a return of 14% p.a. compounded.

Although we continue to find very good value in selected global equities, we did reduce the fund's equity exposure somewhat over the past few months, partly through reducing a few of the fund's holdings as they approached fair value and partly through selling Hang Seng China index futures. The fund's equity exposure is now around 75%, after being in the 80% - 90% range throughout most of 2009.

The fund's largest new purchase over the past few months was that of a holding in CVS Caremark which is now one of the largest positions in the fund. CVS Caremark was formed in 2007 through the merger of two businesses - CVS, which is the largest drug store chain in the US with 6 200 stores and Caremark, which is the second largest PBM (Pharmacy Benefits Manager) in the US. The drug store part of the business (CVS, which is very similar to Clicks in South Africa) generates around 60% of the company's earnings and is a high quality asset in our view: this business has a stable earnings stream and generates large amounts of free cash flow. The PBM business (the other 40% of earnings), effectively manages the filling of prescriptions for company health care plans and is a lower quality business (due to the somewhat commoditised nature of the service as well as the short duration of the contracts which are on average up for renewal every three years or so). This business however will benefit from positive long-term drivers (primarily the desire to drive down healthcare costs in the US) and in addition to this the market has become more consolidated over time with a few large providers emerging.

The fact that CVS Caremark own both a drug store business and a PBM business should be a competitive advantage and should benefit both the PBM part of the business (through being able to offer PBM plan participants choice of both mail delivery and physical collection at a drug store) and the drug store part of the business (through increased footfall). However, it is partly the failure of these benefits to be realised from the merger that has resulted in the market becoming disillusioned with CVS Caremark. At the fund's average purchase price of just below $31, CVS Caremark was trading on around 11x 2010 earnings. As reference points, CVS's largest competitor in the drug store area (Walgreen) trades on approximately 16x this year's earnings and Caremark's two largest competitors in the PBM business (Express Scripts and Medco Health) trade on around 19x this year's earnings. Whilst we do not use relative valuations to justify purchases, we point out these valuation metrics to highlight what we believe is a significant valuation anomaly in CVS Caremark, which we believe is worth closer to $50 than the current share price of $33. We are not sure when sentiment towards CVS Caremark will change, but we do believe that the company's strategy makes sense and that the valuation is very attractive, with the drug store assets alone being worth around $30 - not far off the current share price.

Over the past few months we continued to increase the fund's international exposure, taking it to around 85% of the fund. The reason for this is two-fold: firstly we are struggling to find undervalued SA equities (and still finding very good value in selected global equities) and secondly we believe the rand is too strong and fundamentally overvalued. The remaining 15% SA exposure is the lowest in the fund's history and we believe that the decision to invest such a large portion of the fund offshore will reap rewards for unitholders over the next few years.

Portfolio manager
Gavin Joubert