Please note that the commentary is for the retail class of the fund. The fund appreciated by 3.2% over the quarter, 3.9% ahead of its benchmark. For the last twelve months, the fund has returned 21.6%, 12.1% ahead of its benchmark. Over the past five years the fund has now generated a return of 21.1% per annum, which is 4.1% per annum ahead of its benchmark.

The fund's reasonably high emerging market exposure (on average 35% to 40% of the equity exposure over the past one-year period) was by far the biggest driver of performance over the past year. A number of the fund's emerging market stocks (particularly the Brazilian holdings) appreciated by 50% or more over the past year, and the Brazilian private education company Kroton was a stand-out, appreciating by 138%. Kroton was the fund's largest position at the end of June. While we have since reduced the position we continue to believe that the stock is attractive and, as such, it is still a meaningful position. The long-term fundamentals of the Brazilian tertiary private education industry are very attractive in our view (due to low tertiary education penetration in Brazil combined with an incentive for young Brazilians to obtain a tertiary qualification, as the salary uplift with tertiary education is amongst the highest in the world). In addition to this, Kroton has an exceptional management team in our view, and the proposed Kroton/Estácio merger (Kroton, the number one operator, is acquiring Estácio, the number two operator) will create a dominant operator with scale and a true national footprint plus significant synergies, both on the revenue side and the cost side.

The fund ended the quarter with 79% of its capital invested in equities, of which 43% was invested in developed market equities, 31% in emerging market equities and 6% in South African equities. The fund also has 2% invested in global property stocks, and bought a new position in one of the large UK-listed property stocks (Hammerson) during the quarter as the share price declined following UK Prime Minister Theresa May's 'hard Brexit' speech at the Conservative Party conference.

Our negative view on bonds remains unchanged and we had no exposure to the asset class throughout the quarter. Negative yields are becoming more and more prevalent in the developed world, with Switzerland in particular having negative yields across most maturities. Bond yields would have to rise materially before we would be interested in the asset class, yet during the quarter the opposite tended to happen due to risk aversion in developed markets, which resulted in the underweight bond exposure proving to be a detractor from performance.

During the quarter the fund reduced some of its emerging market exposure, in particular the Brazilian holdings which, as mentioned, have appreciated significantly over the past year. At the same time the fund made a number of new buys. One of these was LiLAC (Liberty Latin America and Caribbean). LiLAC was initially created as a tracking stock by Liberty Global to spin out its Latin American broadband, mobile and pay-TV assets. During the spinout process, LiLAC bought Cable & Wireless Communications (mobile telecoms in the Caribbean and Central America), which itself had just purchased Columbus (broadband and pay-TV in the same region). The single biggest market for LiLAC is Chile (25% of total operating profit), followed by Panama (19%) and Puerto Rico (12%), with various Caribbean islands making up the bulk of the rest. The share price is down by a third since late May after poor results and from an overhang of shares, with the latter having had the bigger impact in our view. Many of the shareholders of Liberty Global (who were the recipients of LiLAC shares due to the unbundling) may have little interest in holding onto their LiLAC shares given how small the business is/was in the context of the overall Liberty Global business (5%). Aside from revenue opportunities from rolling out services in countries where there is low penetration and also from market share gains, there are big cost saving opportunities due to the newfound scale of the business, as well as the ability to realise synergies. For these reasons we believe margins have scope to increase from current levels. In addition, capital expenditure is currently high and will reduce to a more normal level over the next few years. As a result of these factors, we believe the company will generate significant free cash flow looking a few years out, and LiLAC trades on only a high single-digit multiple of this free cash flow. In addition, we have high regard for the capital allocation skills (running an efficient balance sheet, undertaking significant share buy-backs, etc.) of John Malone (the Chairman and controlling shareholder of both Liberty Global and LiLAC) and his senior managers, and we believe that over time these same capital allocation skills will be applied to LiLAC to the benefit of shareholders.

As is often the case, there a number of developments in the world to worry about: Trump as a potential US president (although at the time of writing this prospect appears to be fading), Brexit, populism in the UK and Europe, extremely low interest rates, ISIS, etc. We simply continue to do what we have always done: while being aware of macro risks, we spend our time primarily doing detailed bottom-up research with the goal of finding attractive investment opportunities. In this regard, we continue to find good selected opportunities all over the globe.

Portfolio managers Neville Chester, Gavin Joubert, Karl Leinberger, Mark le Roux and Louis Stassen as at 30 September 2016

Please note that the commentary is for the retail class of the fund.

In what were tough market conditions, the fund declined marginally (-1.69%) in the first quarter of the year. In summary, the fund’s developed market exposure detracted and its emerging markets exposure was a positive contributor (emerging markets have outperformed developed markets by around 5% so far this year). Over the past one-year period the fund has appreciated by 13.4% and, more importantly, over longer-term periods returns have been strong: 21.6% p.a. over the past 5 years, and 15.3% p.a. over the past 17 years since the fund was launched.

The fund ended the quarter with equity exposure in the low-80% level, up from mid-70% where it was at the end of 2015. This increase in equity exposure was largely as a result of adding to selected developed market stocks. Our equity exposure is 57% invested in developed markets, 41% in emerging markets (excluding South Africa) and 3.9% in South Africa. The weighted average upside to the fund’s emerging markets exposure is around 75% at the time of writing, and in the case of the developed market exposure the upside is around 50%.

We continue to believe that bonds globally (without exception) are expensive and as such have no exposure to this asset class. We reduced the fund’s listed property exposure over the quarter after continued strong performance with the result that only 2% of the fund is now invested in listed property (in German residential and Brazilian retail). Over 95% of the fund’s assets are invested offshore, with less than 5% being invested in South Africa.

Given their poor returns over the past few years, we are sometimes asked why we bother to invest in emerging markets. It is interesting to note that 5-6 years ago we were continually asked why one should bother to invest in developed market stocks as they had given no return over the past 10 years at that point. Of course over the past 5 years returns from developed markets have been very good, and that is because valuations were low to start with. The same applies to selected emerging market stocks today: the asset class is disliked and valuations as a result are very attractive in selected cases. In addition to valuation, there are simply a number of rare opportunities available in emerging markets that one cannot find in developed markets. The Indian private banks are a very good illustration of such opportunities.

The fund is invested in two of the big five Indian private banks (Axis Bank and Yes Bank, together making up 2.9% of fund). The opportunity for these two banks over the next decade is significant as a result of two key points:


-Financial services penetration in India is amongst the lowest of any emerging market.
-Private banks still have very low market share (21% of the market compared to the 74% market share of the state banks with the balance being held by foreign banks).

Both Axis Bank (3rd largest private bank in India) and Yes Bank (5th largest private bank in India) have compounded earnings and dividends by around 20% p.a. over the past 10 years or so, and have consistently generated ROEs of more than 20%. Because of the two key points above, we believe their prospects for the next 10 years remain as favourable as ever. India has a large population (1.2 billion people) that is young (60% of the population are under 30 years of age), that is still in the process of urbanising (the urbanisation rate is only 31%), and that is underbanked.

In addition to this, the economy is growing at a high rate, the country is a beneficiary of lower commodity prices (being a net importer), and the government under Prime Minister Modi is slowly undertaking reforms to free up the economy and stimulate growth. The following graph shows a measure of mortgage penetration (mortgages as a % of GDP) for India and a range of other countries. The picture is the same for most banking products, whether that be the number of credit cards per individual in India or indeed number of Indians who even have a bank account. The low penetration levels of banking products in India provide a powerful tailwind for the banks over the next decade and beyond.

In addition to the low level of penetration of financial services in India, the state banks still have around 74% market share. As one would expect from most state-owned assets, these banks are inefficient, poorly managed and lethargic. They also have strained balance sheets limiting their ability to grant loans. This provides a big opportunity for the private banks like Axis and Yes to continue to take market share from the state banks. The chart below shows the market share over the past 15 years for the private and state banks respectively and in this regard the private banks have taken significant market share from the state banks over time. There is no reason to believe that this trend will not continue.

In addition to the above, the valuations of both Axis and Yes are attractive in our view:
Axis trades on c. 10.8x forward earnings and a price-to-book ratio of 1.7x while generating ROEs of just under 20%.
Yes Bank trades on c. 11.5x forward earnings and a price-to-book ratio of 2.1x while generating ROEs of just over 20%.

2016 has started off with a bang, with a sharp decline in global markets followed by a strong recovery. There appear to be many things to worry about in the world right now (China economic problems, US interest rates, Brexit, terrorism, etc.) but we continue to spend our time focusing on detailed bottom-up research and taking a long-term view on individual companies and the result of this is that we are still finding very good selected value in both developed markets and emerging markets, and remain optimistic about the potential returns from the fund.

Portfolio managers
Neville Chester, Gavin Joubert, Karl Leinberger, Mark le Roux and Louis Stassen

The fund appreciated by 21.6% in the final quarter of 2015, driven in large part by its's emerging market holdings as well as a recovery in the global car companies (Porsche and Tata Motors). The fund's return for 2015 as a whole was 19.8% compared to the fund's benchmark return of 16.6%. Over the past five years, the fund has now generated a return of 23.4% per annum and since inception 16 years ago the fund has generated a return of 15.7% per annum.

The fund ended the year with equity exposure in the mid-70% level. 57% of this equity exposure is invested in developed markets (DM) and 43% in emerging markets (EM). We continue to find good selected value in both DM and EM equities, with better value (but higher risk) in emerging markets. DM equities are clearly not as attractively as they were 3 to 5 years ago, but we are able to find many individual stocks from which we believe we will generate low double-digit annual returns. EM equities in contrast have performed very poorly over the past three years and valuations are in many cases very attractive. The prospect for well above average returns from selected EM stocks going forward is therefore high in our view. We continue to believe that bonds globally (without exception) are expensive and as such have no exposure to this asset class. Just under 3% of the fund is invested in listed property in Germany and Brazil. Over 95% of the fund's assets are invested offshore, with only 5% being invested in South Africa.

Over the past few months the fund established a new position in Ctrip, the leading online travel agent (OTA) in China. This new purchase was driven partly by continued research on the company (including two trips to China) as well as by Ctrip's acquisition from Baidu of a large stake (45%) in Qunar, its main competitor. This was a transformational deal, which completely changed the competitive landscape of the online travel industry in China. Over the past few years, the OTA space has experienced aggressive competitor behaviour, driven by high levels of "couponing" - where OTAs rebate part of their commission to the user in order to attract traffic. This reached a level of 20% of Ctrip's hotel commission revenue at its height. With Ctrip now effectively controlling both Qunar and the no.3 player eLong (in which Ctrip also purchased a stake earlier in 2015), the aggressive level of competition should decline, leading to an increase in operating margins going forward. The continued shift of travel from offline to online channels will fuel strong revenue growth, with the bulk of the benefits now accruing to Ctrip/Qunar as a result of network effects (Ctrip- Qunar have over 75% online travel market share). Another positive element to this deal is further collaboration with Baidu (who now own 25% of Ctrip, which they received for their Qunar stake) in their search and map business, which acts as a very powerful customer acquisition tool.

Ctrip have been profitable since listing in 2001, while experiencing rapid growth. Interestingly, over the past 12 years Ctrip's free cash flow conversion (what percentage of earnings has been converted into free cash) has averaged 120%. This is extremely impressive for any business, but even more so for a fast growing business. The business is also very well positioned to take advantage of the ever growing middle class in China, who have an increasing appetite to travel (a sector also strongly supported by government), making China the most attractive travel market in the world; albeit still largely serviced by offline providers presently (90% of the market still offline). Ctrip offer a superior customer experience, and have one of the largest hotel review databases. This makes them a valuable source of information for the prospective traveller, with the ability to monetise this interest via the travel services they offer. Ctrip have an unrivalled inventory of hotel rooms, both in the domestic Chinese market and the rapidly growing outbound market (the Chinese have yet to venture much further than Hong Kong, Macau, Taiwan and Korea in mass), aided by their global inventory partnerships with both Priceline (who also have an effective 15% equity interest in Ctrip) and Expedia. Ctrip have built up huge barriers to entry in their airline ticketing business as base commissions are now 0%, with airlines only paying volume commissions. Ctrip are able to push massive volumes, thus earning them 3-4% commission, while making it impossible for smaller players to survive in this market as they do not receive a base commission. Ctrip's train and bus ticketing platform is also experiencing extremely strong volume growth (150% as at Q3-15). The train ticket platform is a very cheap customer acquisition tool as it lures people onto their system, allowing an opportunity to convert them into loyal customers as it creates brand awareness. When these customers migrate to higher value travel services, they are already accustomed to transacting via Ctrip.

2016 has started off with a bang, and most equity markets are down close to 10% at the time of writing. Rising US interest rates, concerns over China and falling commodity prices have been the drivers of these declines, much as they were in 2015. At this point, we have not changed the portfolio positioning at all, but the declining markets are likely to provide new opportunities.
Portfolio managers
Neville Chester, Gavin Joubert, Karl Leinberger, Mark Le Roux and Louis Stassen