The recent quarter saw the risk taking switch firmly in the 'ON' position as money flowed into emerging markets. The JSE All Share Index benefitted handsomely from these flows, with a total return for the Top 40 index of 13.4% for the quarter. Pleasingly the fund outperformed, with a return of 14.4%. Year-to-date, it is up 11.5% compared to the index's 6.7% - an excellent performance in volatile markets.

The level and extent of this volatility has been surprising, and it certainly seems like the world has returned to reactionary mode. Any new snippet of information, regardless of how inconsequential, results in a change of risk appetite and fund flows. Every week, month and quarter as non-farm payroll numbers, manufacturing indices or GDP returns are published globally, the market seems to spike or fall depending on whether or not these are better or worse than forecast. While this is frustrating to a long-term investor who appreciates that the value of businesses do not shift on a weekly basis, it is in fact advantageous, as it continually throws up pricing anomalies from which our investors can benefit. Importantly one needs to be focussing on long-term valuations and performance and be prepared to stomach some short-term underperformance to achieve these benefits.

Over the past quarter the fund has moved its positioning quite significantly into the resources space, with Anglo American now being the fund's largest holding at over 12%. This is a business which offers the patient investor significant volume growth as a number of key investments come into production over the next 3 years in the base and bulk metals space. Similarly we have increased our weighting in Impala Platinum, a company we know well and had sold out of during the 2008 commodity boom. The price had declined to the point where the market was no longer appropriately valuing the increase in production to come from its new shafts and expansion within its Zimbabwe operations. After applying our mind to the fair values for these businesses, assuming a normal level of platinum group prices, we felt the margin of safety was sufficient to buy a position in the fund. Our previous top holding, MTN, had an excellent quarter, returning in excess of 20%. This was another classic case of shortterm thinking clouding what is an excellent, diversified business with access to great markets with high growth potential as well as strong cash generation. The recent announcement at the company's AGM regarding their planned significant increase in dividend payment over time was the catalyst that saw the share rerate sharply.

The fund remains exposed to the SA banking sector. The recent interim results have by and large proven our investment thesis correct that the unwind of the excessive provisions made during the past rate cycle will come through. All indications are that the consumer is recovering, albeit slowly, and the overall level of provisioning in the bank will return to 'normal' levels. On this basis they are still trading on single digit forward PE multiples and offer good value relative to a more expensive domestic share market. Finally it bears mentioning that the fund officially achieved its 10- year track record at the end of September. Over the decade the fund has delivered an annualised return of 23.6% against the Top 40 index return of 16%. Put differently, the fund has generated annualised alpha of 7.5% (excess return) after all fees. In closing, we are often asked to present the argument between actively managed funds against ETFs - we think we need not say any more.

Portfolio managers
Neville Chester and Pallavi Ambekar Client

Equity markets declined sharply in the past quarter and risk aversion resumed globally. This was led predominantly by concerns over Europe, given their difficulties to fund budget deficits and the steps that need to be taken to cut back spending. We have seen a rapid move from risk assets back to the 'perceived' safety of US treasuries. The FTSE/JSE Top 40 index declined 9.4% for the quarter, while the Top 20 fund outperformed by 1.1%, recording a decline of 8.3%. For the half year, the Top 40 has fallen by 5.9% while the fund has only declined by 2.5%.

The reason for the fund's outperformance has been our more defensive positioning. We have highlighted in a number of past quarterlies that we were concerned domestic valuations were getting stretched and that the cyclical shares, and resource shares in particular, were priced for a very strong return to growth which we felt was unlikely. As it transpires we have seen that global growth, while not going negative, is showing signs of slowing. This has driven the very rapid risk aversion trade we have seen with US treasuries outperforming and equities and other riskier assets underperforming. The upside of this is that we are once again seeing some good investment opportunities in the resource sector. While we have always known that the road to recovery will be bumpy and growth is likely to be tepid, we do not believe we are heading back to the great recession. In this framework we think the market is again focusing too much on short-term news and not on long-term intrinsic valuation.

In order to fund the new positions we have been reducing some of the more defensive names in the portfolio. These shares have performed extremely well and the returns available do not match those achievable from the new resource holdings. We have increased our weightings in Anglo American, the large diversified miner as well as Sasol, the oil and chemicals business. Anglos we see as being very attractively priced based on the expansion in volumes to come from its new iron ore venture as well as improved overall returns due to a renewed focus on costs and operational efficiencies. Based on our forecasts, we think Anglos trades on a single digit PE based on normalised earnings and should soon resume healthy dividend payments now that it has repaired its balance sheet.

Sasol remains one of the cheapest commodity companies in our market with great exposure to oil and rising chemical prices. Improved volumes domestically and better pricing in its international markets should see the business continue to generate very good cash flows for investors. Its recently announced progressive dividend policy should result in a good chunk of those cash flows being returned to shareholders over time.

We have also added to our position in the banking sector. Our investment case remains the same, where the recovery to normal earnings is not being priced into the domestic banking sector. The woes of the global banking sector have, by and large, missed our local banks and as the bad debt charge offs reduce locally we expect to see strong earnings growth for the next few years. The local banks' high level of capitalisation and low asset growth over the next few years also augurs well for handsome dividends to be returned to shareholders.

There is likely to be lots of noise and plenty of scary headlines in the months ahead. As always, we will try to ignore what's irrelevant and focus on identifying mis-priced assets that will deliver good returns over the long term - aiming to maintain the fund's enviable long-term track record.

Portfolio managers
Neville Chester and Pallavi Ambekar

The past quarter was another strong period for equities and the fund also performed well against its benchmark. The continuation of the 're-risking' trade has seen continued foreign inflows into the SA market as well as greater appetite for higher yielding assets, especially since the returns on cash have reduced further with the cut in local interest rates. The Top 40 Index returned 3.8% for the quarter while the fund returned 6.3%.

One of our long standing positions, Naspers, has again come through strongly for the fund. Its investment case has been stated many times on these fact sheets, but the market has now really started to appreciate the value of the underlying businesses. Given the strong performance we have started to reduce our holdings although we are still positive on the long-term fundamentals. In contrast a share that has been a major disappointment in the market, Sasol, has now become our largest holding. Sasol has spent billions on capital expenditure over the past five years without seeing a significant return on this investment, either directly in profits or even through increased volumes or efficiencies. They have been plagued by start-up issues, new technologies which by their nature are less stable, and more recently the strength of the rand. We are confident that the operational issues will be resolved and that we will see improved volumes and operating efficiencies from the group over the next few years. This alone should drive value creation for shareholders, with added optionality of a weaker rand to drive earnings growth further.

A year ago in the March 2009 commentary I made a specific point about gold and gold shares. We were at the nadir of the market decline, markets were awash with pessimism and the supposed safety of gold and gold shares was the popular opinion. The dollar price of gold did indeed do well as many investors fled equities and bonds to the yellow metal's safe haven resulting in the price of gold rising by 22% (in dollars) over that period. As an SA investor, however, the strength of the rand meant investors lost 6%. That however was a compelling investment compared to the investors in SA gold shares which over the same period returned between -11% (Goldfields) to -31% for Harmony. At the end of the commentary I made the flippant remark of the only gold I would own is All Gold (The successful product of TigerBrands the branded food company). Over the past year TigerBrands has delivered a 38% total return! The point of this is not a generous round of backslapping, but to emphasise that successful investing is not about reading the latest financial newspaper and deciding what's hot. It is about carefully assessing the long-term fundamentals of a company, reaching an appropriate valuation and only buying those businesses that are trading at a discount to that fair value. Fads come and go, and as quickly as we were through the theme buying of construction stocks and global commodity producers, we ended up in the gold buying craze. We have now come full circle and once again pundits are singing the praises of the Chinese growth miracle and the benefits of owning global commodity players to feed the Chinese dragon. While this indeed might be true, if the companies are overvalued, we have no place for them in our portfolio.

We have been as surprised as most people with the sudden resumption of risk appetite. While we felt valuations were cheap a year ago we never forecast the spectacular returns we have seen over the past year. The result of this is that certain parts of the market are looking expensive and as a result we are sitting more defensively positioned, mainly in the industrials where we have favoured fast moving consumer goods businesses and telco's, which tend to be fairly defensive. We are still fairly big in the banking sector where our long-held view of earnings normalising over the next two years from a period of cyclically low earnings is coming through. We expect markets to remain fairly volatile and investors should expect returns to be volatile in the short term. We believe that over the long term the fund will continue to deliver on its superb track record of outperformance.

Portfolio managers
Neville Chester and Pallavi Ambekar

The calendar year 2009 turned out to be a great year for the fund as it significantly outperformed the benchmark of 31.7% with a return of 35.9%. This was despite a slightly weaker final quarter where the fund 'only' returned 8.8% against the benchmark of 12.5%. This quarterly underperformance was driven by a very strong return from commodities where the fund is currently underweight as well as a weak performance from a couple of specific industrial holdings.

We have outlined on a number of occasions in this note that the fund is being positioned more defensively, after having performed extremely well in the cyclical recovery off a very low base in 2008. The 2009 year was arguably an easier year for investors, even though the outlook was rather grim at the start; the valuation opportunity was undeniable and unmissable. Starting off in 2010 the economy, both locally and globally, still faces significant challenges and as thoughts shift towards how the unprecedented monetary and fiscal response to the crisis is removed more challenges will become evident. After the strong run in equities last year, even though it is an over used cliché, good results this year will hinge very much off good stock picking and solid fundamental research. In our opinion, the cyclical sectors have rallied very strongly in anticipation of a strong economic recovery, which is by no means confirmed. Should the recovery come through, this is already reflected in the valuations, and should there be disappointments there could be a sharp retracement in cyclical share prices.

The one exception to this is the local banking sector. We are increasingly of the opinion that in an environment where earnings growth will be hard to come by, the banking sector offers the prospect of very significant earnings growth for the next two to three years. This is predominantly being driven by the reduction in the bad debt expense line as low interest rates and some de-gearing allows the customers to heal. In addition, the global credit crisis has seen a wholesale repricing of credit which should help open margins as new business is being written on significantly better terms. Importantly these earnings prospects are not fully reflected in the valuations with most banks being on an 8 PE two years out against the market on close to a 12 PE.

One of our largest holdings, MTN has not performed particularly well from a share price perspective the past twelve months due to a number of negative news flow items which, in our view, are not significant for the long term value of the business. The reduction of mobile termination (interconnect) rates in SA, as well as the impact of subscriber registration in SA and Nigeria are likely to have a negative impact on the 2010 financial year results. However, the change in interconnect rates was always factored into our forecasts, and the impact on subscriber growth from the onerous registration is a once-off impact which will not recur post 2010. We remain convinced that MTN's excellent geographic diversification in fast growing under-penetrated mobile markets continues to make it an attractive investment. Being able to invest in a locally listed business exposed to high growth regions outside SA is not reflected in its rating which is trading at a large discount to our market.

Lastly, we have maintained a large rand hedge element in our portfolio. The rand's strength this year, while entirely explainable from fundamentals, is not likely to continue in the longer term. We think it is prudent to have exposure to attractively valued businesses (it is always about valuation first) that have exposure to hard currency earnings or are offshore businesses which happen to be listed in SA.

While the outlook for 2010 is certainly tougher, there are still plenty of opportunities in the local equity market and we are firmly of the belief that a focussed, actively managed fund like Top 20 can continue to deliver on its mandate to significantly outperform the market over the long term.

We also welcome Pallavi Ambekar as co-manager of the fund. Pallavi has been with Coronation for 7 years, currently responsible for analysing the telecommunications companies, Remgro, Richemont and the hotel & leisure sector. She also co-managed Coronation Industrial Fund in 2006. We are excited about her future involvement and contribution.

Portfolio managers
Neville Chester and Pallavi Ambekar