The global market panic that started in August continued into September, driven primarily by the eurozone crisis and to a lesser extent by concerns over a possible hard landing in China. The market volatility continued to be extreme, with 5% daily moves being the norm. Fear has well and truly set in and most equity markets have now declined by more than 20% over the past few months. At the other end of the spectrum, US and German government bonds have appreciated by around 20% over this period. In the rush for the exits, most emerging market equities and currencies have seen significant declines, with the ZAR for example depreciating by 15% against the USD in a short two-week period. Year to date the MSCI World Index is +7.8% (in ZAR) and the JSE All Share Index is -5.8%. Despite the mess in the US and Europe, it is interesting to note that global equities have outperformed SA equities by some 13% already this year. Against this backdrop the fund has appreciated by 9.9% year to date. Over the past 10 years the fund has now generated a return of 10.8% p.a. in ZAR (or 12% in USD, which is almost 8% p.a. ahead of the 4% p.a. USD return from global equities). The fund continues to hold no government bonds. US 10- year government bonds are now yielding 1.75%, as are German 10-year government bonds, driven down to these levels by good old fashioned fear and herd behaviour. We would argue that the balance sheets of these assets are very poor: US sovereign debt is already at very high levels and Germany's fiscal position is likely to deteriorate if the Germans want to keep the Euro intact. To do so, would require funding contributions by Germany. Besides the poor fundamentals of these assets, the valuations do not make sense to us. With inflation at 2% plus, we cannot understand the attraction of a 1.75% yield and in our view this is a bubble as big as we have seen, that will ultimately collapse just as all bubbles do.

At the same time, we continue to believe that global equities are extremely attractively valued (even more so today than a few months ago) and as a result the fund's global equity exposure is at high levels (around 72%). Whilst the sharp depreciation of the ZAR has brought it closer to fair value, the valuations of SA assets are still far less attractive than those of global assets in our view. As a result, we have largely retained the fund's significant offshore exposure. We have brought back some ZAR from offshore, but around 80% of the fund is still invested offshore and 20% in South Africa (down from 85% and 15% respectively a few months ago). In terms of outlook, one must distinguish between the macroeconomic outlook and daily newsflow (which is poor) and valuations (which are very attractive). As previously mentioned, investors' biggest concerns today appear to be Europe and China and we will briefly discuss these two issues in more detail. Firstly, with regards to Europe, politician's inept handling of the crisis has been a large contributor to the position that we find ourselves in today. Over recent weeks however a greater sense of urgency appears to have been awakened and there are solutions to the crisis (Eurobonds, recapitalisation of the banks, etc). These solutions will require additional financial support from Germany and without this the euro as we know it will be nonexistent. Either way (closer fiscal union or a break-up of the Euro), it is our view that growth in Europe is likely to be anaemic for several years and the risks (of a recession or of a banking crisis for example) are still high. As a result, we own no European banks (and are very unlikely to do so). Most of the European shares we own are not European businesses, but global businesses that generate revenue from countries all around the world and furthermore are not significantly impacted by what is happening in Europe. A good example is Anheuser-Busch Inbev, the world's largest beer company and owner of Budweiser. The company is listed in Belgium, but today 40% of its profits come from emerging markets, most of which have growing economies and disposable incomes as well as low beer consumption. Whilst the other 60% of AB Inbev's profits come from developed markets (with the US being a large profit contributor), beer is less economically sensitive than most goods. In addition, the management team at AB Inbev run a very tight ship with a ruthless focus on costs, which will assist in protecting margins in the developed world in the event that economic conditions turn worse. AB Inbev currently trades on around 10x the free cash flow we believe it will generate over the next year, which we think is very attractive for an asset of this quality.

With regards to China, in summary, our views on the country are mixed: whilst for example we believe that China cannot continue to spend the amount it currently does on infrastructure (which is negative for commodities), we believe that the economy will shift towards a more consumer-driven economy (as opposed to an infrastructure and export-driven economy). We don't believe that China will continue to grow at the 10% rate that it has achieved over the past 30 years, but we do think a 5% - 6% growth rate over the next several years is achievable. Although low by historical standards, this would still make it one of the fastest growing economies in the world! The Chinese consumer will continue to emerge in our view, and this is where our research efforts in China are focused. For example, the fund recently added a position in Lianhua Supermarket, a food retailer with operations mainly in the Eastern area of China. Once a market darling valued at 25x earnings, the stock has halved over recent months, primarily due to concerns over slowing sales growth and increased costs. The company is still showing same-store sales growth of 6% - 7% (an organic growth rate that would be admirable in most countries, but is seen as ex-growth in China and on the Hong Kong Exchange where the stock is listed!). The company has a very strong balance sheet (large net cash position) and in our view should be able to grow earnings in the low double-digits for a number of years to come. Yet at the time of purchase, we paid only 12x earnings for this asset (lower than this if one adjusts for the net cash position). The stock is +20% since we bought it, but is still significantly undervalued in our view. There are undoubtedly risks in China, but there are also excellent investment opportunities to be found. In summary, whilst the world appears to be in a mess, fear and panic selling have driven many assets (global equities, property and corporate bonds) down to extremely attractive levels. In our view, now is the time to be buying these assets and not selling them. One seldom makes money by investing when the outlook is rosy.

Portfolio manager
Gavin Joubert

Despite ongoing volatility in global markets, the fund delivered a good performance in the first half of the year, appreciating by 8.50% (in ZAR). As reference points, the MSCI World Index returned 7.88% year to date and the JSE All Share Index is up a rather anaemic 0.50%. In USD the fund generated a year-to-date return of 6.23%. Since the fund launched 12 years ago it has generated a return of 12.74% p.a. in rand terms.

We currently view global equities to be the most attractive asset class by far and as a result the bulk of the fund (just over 70%) is invested in this area. After 10 years of global share prices being flat (at a time when earnings have grown significantly), valuations have contracted and as a result one can buy very high quality US or global businesses on very attractive ratings. The list of opportunities is long, but a sample of the fund's current large holdings provides some flavour in this regard.

-HEINEKEN is the world's third largest brewer (after Anheuser-Busch Inbev and SABMiller). It is the global leader within the high margin premium sector and fastgrowing emerging markets contribute 50% of its revenue. In addition to a revenue line that in our view will show decent growth over the next few years, we don't believe the company has been managed efficiently from a cost point of view but that this is beginning to change. We therefore expect operating margins to improve substantially over the next few years. Despite these positive fundamentals, Heineken trades on just 12.5x the free cash flow we believe it will generate over the next oneyear period.

-SAFEWAY is the third largest supermarket retailer in the US (after Walmart and Kroger). Between 2004 and 2008, the company invested heavily in store improvement which is now largely complete. As a consequence the business is generating significant amounts of free cash flow. Operating margins are at 20-year lows and the company should benefit from rising inflation in the US. Safeway also continues to buy back large amounts of its own (undervalued) shares. Yet, one can currently buy the shares on less than 10x free cash flow.

-VODAFONE is one of the largest mobile telecommunications companies in the world. While mobile penetration is very high in most of the markets it operates in, we are very positive on the prospects for mobile data which we believe should result in some acceleration of revenue. In addition to this Vodafone currently receives no dividends from its US business (Verizon Wireless), though we believe it is just a matter of time before this changes. As a result large additional cash flows are likely to head Vodafone's way soon and a substantial part of this could be returned to shareholders in the form of increased dividends or share buy-backs. Vodafone today trades on less than 10x free cash flow and on a dividend yield of around 5.5%, which we feel is very attractive given the factors mentioned above. We acknowledge that there are still many uncertainties in the world (e.g. Greece's debt problem, US deficit, weak global economic growth and inflation risks globally), but we continue to find valuations of many global equities very attractive and, as always, valuation overrides everything else. In addition to this, the five-year free cash flow streams of businesses like Heineken, Safeway and Vodafone are unlikely to be too affected by global economic outcomes, yet the share prices continue to languish, and indeed move down on any bit of negative economic news flow. This is in our view the function of markets that are dominated by short-term focused 'investors' who think in terms of months and not years. At the same time this provides opportunity for a more patient investor.

The South African exposure in the fund continues be very low (around 15% of fund), primarily as a result of our view that SA assets are far less attractive than global assets from a valuation point of view. A secondary reason driving this asset allocation decision is our view that the ZAR is overvalued. We did add small positions in two South African resource stocks (Anglo American and Impala Platinum) over the past few months, both of which we think offer good value as a result of investors focusing excessively on shorterterm issues. We are broadly negative on commodities with our view being that current commodity prices are trading well above longterm normalised levels. The share prices of Anglo American and Impala however, still come out as being attractively valued using normalised commodity prices.

We believe that globally government bonds have benefited from a flight to safety and as such are overvalued. This ranges from US to German to UK government bonds. As a result the fund currently has zero exposure to government bonds as we feel they present a high probability of capital loss.

Portfolio manager
Gavin Joubert

The past few months saw disruptions in the Middle East and North Africa as well as the tragic earthquake, tsunami and nuclear threat in Japan. These events resulted in major swings in sentiment and in global markets. With this backdrop, the fund appreciated by 5.6% (in rands) in the first quarter of 2011. Given that the fund is currently largely invested offshore (85% of fund), we believe that the dollar returns of the fund are also relevant and in this regard the fund appreciated by 3.5% over the quarter. Since the fund launched 12 years ago it has generated a return of 12.8% per annum in rands and 12.0% per annum in US dollars.

The global events over the past few months have had little impact on our long-term views. We value businesses based on the earnings streams that we believe they will generate over the next 5 years or longer. In this regard we don't believe that events in either the Middle East or Japan will have an impact on the long-term earnings power of Heineken for example. A few months ago we believed that Heineken was worth around 50 euros a share (compared with the current 37 euros) and today we still believe that Heineken is worth around 50 euros a share. The most important byproduct of the disruptions in the Middle East is the oil price. A higher oil price (should it be a sustainably higher oil price) could have an impact on the valuations of a few of the fund's holdings, but it is our view that the recent spike in oil prices has been driven by speculation and short-term money, and does not represent a new permanently higher level.

With regards to Japan, the fund had very low exposure (3% of fund) prior to the tragic events the country had to face. We did increase the fund's Japanese exposure marginally to 5% of fund, mainly through buying more defensive businesses (convenience retailers, drugstore chains) that had declined by 20% or more, yet who will be largely unaffected by what is happening. Whilst there are a handful of Japanese stocks that are clearly attractive, in general we continue to hold the view that there is better value in the US and Europe. The long-term fundamentals of Japan are poor (ageing population, deflation and high debt levels), the currency is arguably overvalued and Japanese management teams continue to prefer to build empires than to focus on doing what is best for shareholders. Additionally, whilst Japanese companies look cheap on Price/Book valuations (1x P/B), that single metric in isolation is misleading in our view as one has to take into account the ROE that Japanese companies generate (the lowest in the world) as well as the fact that many Japanese companies are serial acquirers (and as such the book value is overstated due to Goodwill). Lastly, reality is that in most cases the large cash balances are unlikely to be returned to shareholders. On other valuation metrics (P/E and Free Cash Flow yields), the valuations of most Japanese companies are generally not that attractive, either in absolute terms or when compared with their Western (US/European) equivalents.

Besides marginally adding to the fund's Japanese exposure, we also bought new positions in two of the global luxury goods companies, LVMH and PPR. Both companies experienced sharp declines due to their Japan exposure (approximately 10% - 15% of revenue) as well as concerns over global growth. LVMH are the owners of Louis Vuitton, Moet Hennessy and a whole range of other luxury goods brands, including having a large stake in Hermes and potentially owning Bulgari, which they have recently offered to buy. Scale is important in the luxury goods industry and LVMH are one of the key consolidators. The revenue and earnings streams of LVMH have also proven to be more resilient to economic downturns than that of a luxury goods company like Richemont, whose focus is more on watches and jewellery as opposed to LVMH's focus on fashion and leather goods. Although we believe Richemont is a great business, in our view the share did not get cheap enough during the recent turmoil, whereas LVMH and PPR did.

PPR is much smaller than LVMH and their main brand is Gucci, which generates the majority of the group's profits. We believe the long-term prospects for the global luxury goods companies are very positive, driven by emerging markets where millions of individuals every year move into the target market of these companies. Today we estimate that between 40% and 50% of LVMH's profits come from emerging markets (directly and through travel). At the time of purchase, PPR was trading on 12x 2011 earnings and LVMH on 16x 2011 earnings. LVM's short-term valuation metrics may not appear particularly appealing, but we believe that this is a very high quality business that can grow earnings in the double digits for many years to come. We continue to hold the view that equities are by far the most attractive asset class globally and as a result the fund's equity exposure is currently reasonably high at 84%. We believe government bonds are overvalued and have no exposure to this area, with the only bond exposure being a few percent in corporate bonds. We also continue to believe that global assets (equities in particular) are more attractive than SA assets and this is reflected in the geographic allocation of the fund, with only 15% invested in SA and the balance of the fund (85%) invested offshore.

Portfolio manager
Gavin Joubert

The fund ended the year with a return of -1.3% in ZAR, with the 10.3% dollar return of the fund being eliminated by the 11.8% appreciation of the ZAR over the year, including 7% in the month of December alone. Part of the extreme currency strength has subsequently reversed in the first few days of 2011 - it is quite likely that macro global hedge funds and other short-term market participants pushed the ZAR up in the last week or two of the year when liquidity was very low. Over the past 10 years the fund has generated a return of 11% p.a. in ZAR and 12.5% p.a. in USD.

We continue to believe that global equities are far more attractive than South African equities and that the ZAR is fundamentally overvalued. As a result, the offshore exposure of the fund has been kept at very high levels (around 90%) which in fact is the highest in the fund's 11-year history. Large cap Global/US/European equities in particular are in our view very attractive and a large part of the fund is invested in this area (the likes of Heineken, Microsoft, Johnson & Johnson, Colgate Palmolive, Tesco and Wal-Mart).

There were no substantial changes to the portfolio over the past few months: in South Africa we continued to slowly reduce the fund's long-held positions in Naspers and MTN due to share price appreciation, while we added Standard Bank. The share has has gone from being one of the market's darlings to being almost universally despised, meaning that it now trades on an attractive valuation for the investor who is prepared to take a long-term view as opposed to the market's fixation on 1 year's earnings and current (negative) newsflow.

Offshore we added to the fund's position in Heineken to the point where it is now the largest individual position at 3.7% of fund. Heineken are the owner of a number of premium brands, including the Heineken brand (the largest contributor to earnings), Amstel and Sol. Almost half of the group's business is now in emerging markets and Heineken have the largest percentage of beer volumes coming from premium brands when compared with the three other major global beer companies (Anheuser-Busch Inbev, SABMiller and Carlsberg). The EBIT (operating profit) of premium beer is around 70-80% higher than that of mainstream brands. Yet Heineken, with the largest exposure to premium brands, have the lowest operating margins in the industry (15% EBIT margin compared to the 17% of SABMiller, 20% of Carlsberg and 30% of AB Inbev). There are a number of reasons why Heineken will never achieve the 30% operating margins that AB Inbev enjoy, but we do believe that Heineken will be able to lift their margins over time to closer to the 17-18% EBIT margin level - if not higher. Heineken now trades on around 10x this year's expected free cash flow, which we believe is very attractive for an asset of this quality.

The question is often posed: why should I invest in global equities when they have given 10 years of 0% return? Our response is that this is exactly why one should invest in global equities today: because share prices have done nothing for 10 years (during a period when earnings for most companies have grown significantly) means that valuations have come down considerably over the past 10 years, making many global equities attractive today. It must also be remembered that 10 years ago the world was in the midst of one of the biggest bubbles ever seen (TMT) and that valuations were crazy in many cases. The starting point of the last 10-year period is therefore very high from a valuation point of view and investors who have seen no return from global/US equities over the past 10 years largely have themselves to blame as they were investing offshore at a time when valuations were silly.

If we take Cisco as an example: the share price in 2000 was $38.25. Today the share price is $20.55, representing a 46% decline over the past 10 years. Earnings, however, have increased materially over the past 10 years: in 2000 Cisco generated EPS of $0.48 and last year it earned $1.66 representing a 246% increase in earnings over the past 10 years (or 13% p.a. increase in EPS). Operationally, Cisco has therefore performed very well as a business, yet an investment in Cisco 10 years ago would have resulted in investors losing almost half of their capital. The reason for this is simple: valuations in 2000 were extremely high and Cisco traded on an extreme 81x earnings. Today, given the share price decline together with the growth in earnings over the years, Cisco trades on a very attractive 12.4x earnings. In addition to this, the company has a substantial net cash balance of some $25 billion. The entire market capitalisation of the company is $113 billion, meaning that cash makes up 22% of its market capitalisation. Given that cash is effectively earning no return (and as such is not contributing to earnings) one should adjust the P/E for this cash in which case the P/E of 12.4 decreases to a P/E of 9.7 - a far cry from the 81x earnings Cisco traded on in 2000! We believe selected global equities are attractive today.

Portfolio manager Gavin Joubert Client