The past quarter has undoubtedly been one of the toughest the fund has experienced since the global financial crisis. African Bank (Abil) suffered a much-discussed failure in August, but there have been a number of other significant headwinds which had a greater impact on the fund's performance. For the quarter, the fund declined by 3.9%, underperforming the JSE Top 40 index return of -2.9%. For the year to date, the fund still generated a positive return of 5.4%, although this is behind the market return of 9.2% for the same period. However, over longer time periods of five and ten years, the fund remains ahead of the benchmark.

Investments in the resource sector - and in two shares in particular - were the main drivers of underperformance in the year to date. We have been adding to these shares as they continued to underperform as we firmly believe in the underlying investment case. We remain fully cognisant that it may take time for the market to appreciate the value in these businesses. The Top 20 fund has a long-term investment horizon and this continues to be a core part of our investment philosophy, which aims to maximise value by taking a longer-term outlook than the market.

The first of these shares is Impala Platinum. This has been a very tough year for all the South African platinum producers as they endured the worst strike in the sector's history, and the most disruptive in the country since the 1980's. For over five months, their mines on the western limb were effectively shut down as mass protests and intimidation by striking workers prevented any mining from taking place. During this period, investors took a remarkably sanguine view on the shares and they did not underperform the market that severely. However since the mines have started up again, and following their interim results which detailed enormous losses, we have seen consistent downward pressure on the share prices. A large part of this appears to be driven by foreign investors who are giving up on the sector given its domestic challenges.

Impala produces the majority of its platinum in the western limb and as a result was very harshly impacted. In addition, shortly after the strike ended, Implats also suffered a faulting incident at its Zimbabwean mine which will reduce production for the next year. As a result, its interim results were particularly poor. However, we believe the market is ignoring a number of key positives in the Impala investment case. Firstly, the business has a very strong balance sheet with very little debt and plenty of scope to raise gearing if needed. Secondly, Impala is coming to the end of a significant programme of capex spending which will position its future production firmly on the lower half of the cost curve, implying very good margins in the years ahead. Thirdly, while there has been a minor setback in Zimbabwe, these continue to be easily mineable, mechanised operations that deliver very low-cost ounces. The operations will be able to recover from the recent setback fairly quickly. In addition, the rhetoric around mining rights in Zimbabwe appears to have eased considerably. Impala's share price has declined by 31% since the beginning of the year, which contrasts with the PGM basket rand price increase of 7% year to date. We do not believe this anomalous situation will persist in the medium term. The other resource share which weighed on performance has been Exxaro, a company we have written about in past commentaries. Exxaro is predominantly focused on three commodities: thermal coal, iron ore and mineral sands. We like the business as it offers a more defensive exposure in the commodity space, given its fixedprice coal contracts, and the late-cycle, vertically integrated mineral sands business. Its only division which has significant exposure to global commodity price risk is the iron ore operation. This is what the market has been focusing on recently amid an iron ore price slump on the back of increasing supply and waning demand growth. In our valuation of all iron ore businesses, we use a much lower price level than the historical spot price. For the first time in seven years, the spot price is now below our assessment of normal prices and could trade there for some time. Using our assessment of normal prices, Exxaro offers significant upside. Any downside potential in its iron ore assets is offset by significant upside in its long-life, low-cost coal operations, in particular Grootegeluk, which will feed the Medupi power station. This more defensive earnings base should become evident as earnings are delivered over the next few reporting periods.

The third key detractor from the fund's performance this quarter was our holding in Abil. We have communicated extensively on its investment case over the past while. In summary, we believed the business was going through a tough cycle as the consumer credit bubble burst, but that the business - as one of the large reputable players in the industry, with the longest track record - would survive and return to profitability, especially after the capital raising in early December. Early trading indicators in February and again in May indicated the environment was still tough, but we were surprised by the scale of the losses reported in August, when it became evident to us that the business was no longer solvent. We had always recognised that there were risks in the investment case and had sized the position appropriately for these risks, which limited the impact on the fund's overall performance.

On the positive side, avoiding Richemont and BHP Billiton has contributed positively to the fund's return. After its significant underperformance this year, we have started adding Richemont but we are not yet finding value in Billiton. A long-time holding in the fund, Intu also delivered a good return for this period and the underlying results from its premier shopping centres in the UK are looking positive. Our holding in Naspers was also a big contributor to the fund's performance although we have started reducing this position given its recent strong run. The outlook for the local economy remains bleak, although the weaker rand should start to feed through to some local businesses which sell into global markets. The fund remains positioned mainly in businesses which are exposed to growth outside of South Africa given the poor outlook for local conditions.

Portfolio managers
Neville Chester and Pallavi Ambekar Client

South African equity markets continue to hit new highs with the JSE Top 40 Index returning 35.1% over the last year and 12.4% year to date. What is more amazing is that this performance comes after a decade of strong returns. While the market may look expensive, divergent sector and stock performances provides us with numerous investment opportunities. At these market levels, we have to work harder at assessing the quality of opportunities in order to filter out our best ideas. In this context, our long-term, valuation-based investment philosophy continues to stand us in good stead. The fund has lagged the benchmark over the last quarter, delivering 4.2%. However, our longer-term track record, which we think is more relevant, continues to be good, showing outperformance over 3, 5 and 10 years.

The platinum industry has been plagued with labour issues for some time now, culminating in the recently concluded fivemonth long strike. We think the strike has largely been resolved in the industry's favour. The three-year wage deal has resulted in increases in cost to company of 8.5% to 9.5%, which is close to what the industry originally offered. A notable factor of the agreement is that there are no restrictions on restructurings or retrenchments. Post these strikes, we think the industry will attempt to 'right size' their production bases, which will inevitably lead to headcount reduction. This should reduce the impact of these wage increases on their overall wage bill. The strike has had a bruising impact on the miners, workers and the economy and the return to work is most welcome. We have used the negative sentiment and share price weakness to add to our position in Impala Platinum (Impala). Once it has ramped up to full production, Impala is well placed to benefit from the growth that comes from the new shafts they have sunk. Their balance sheet has stayed relatively healthy throughout the strike and should strengthen further as capital expenditure starts to normalize. While the near-term earnings will be impacted by the strike, we think the share continues to look attractive on 7.6x our assessment of normal earnings.

Richemont is a new position in the fund. The company is the owner of some of the best luxury watch and jewellery brands in the world, namely Cartier, Jaeger le Coultre and Vacheron Constantin. These are enduring brands that have timeless and universal appeal. Their heritage cannot be replicated. The company has an excellent track record which demonstrates the power of its brands in delivering real revenue and earnings growth over the longer term. Sales to the aspirational Chinese consumer has become an increasingly larger proportion of Richemont's total sales. More recently sales in China have been negatively impacted due to the Chinese government's crackdown on corruption and gifting. This impact is now largely in the base and we expect revenue growth to recover. The company should also benefit from the increased gain in market share of branded jewellery from smaller, non-branded, traditional jewelers. Jewellery is a higher margin product (when compared to watches) and an increase of jewellery in the revenue mix, should be supportive of margin expansion for the company. Richemont trades on 16.5x our assessment of normal earnings. In addition, the company sits on net cash which makes up 11% of its market capitalization. This cash position will protect the company in a downturn and also supports dividend growth that is faster than earnings growth.

On the financial side, Standard Bank and Nedbank continue to be our core bank holdings and have contributed to our performance over the last year. Both have built up large capital bases that are in excess of regulatory requirements. As interest rates rise, the earnings potential of this capital base naturally increases. This 'endowment effect' will positively impact the earnings growth of both companies going forward. Our other financial investment, African Bank, has been disappointing thus far. The operating results are still feeling the hangover effects of the unsecured lending party. We think valuation remains supportive, and that conditions should improve, but we have limited our position size to under 2% of fund to take cognizance of the risks surrounding this business model.

As the year progresses, we expect to see further instability in the market. We will be unemotional in selecting the most attractive investment opportunities in this volatile market. This approach has been, and should continue to be, successful in delivering long-term outperformance in the fund.

Portfolio managers Neville Chester and Pallavi Ambekar

The South African equity market has had an outstanding year, with the JSE Top 40 Index returning 22.7% over the last 12 months. Looking back, it has certainly not been a smooth ride to the top. Weak global growth and concerns over the end of quantitative easing led to significant volatility in equity market performance as investor sentiment swung from 'risk on' to 'risk off'. Our valuation-based investment philosophy has been our unwavering focal point in times of extreme mood swings and has helped the fund deliver an outstanding performance of 27.9%, which translates into alpha of 5.1% for the year. Longerterm outperformance over 3, 5 and 10 years has also been good, with our 10-year alpha standing at 4.5%.

The biggest contributor to the fund's returns over the last year has been Mondi. The company has positioned itself as a lowcost producer in the commoditised packaging portion of its business and has increased its exposure to high growth consumer packaging business. Mondi has a solid balance sheet and a conservative, shareholder friendly management team. We anticipate that they will use this to either make return enhancing acquisitions or to improve shareholder returns. Despite its strong rerating over the past year, the share still provides us with decent upside and continues to be a big holding.

In the last few commentaries we have mentioned our preference for global, defensive, diversified businesses. Our holdings in shares like Naspers, British American Tobacco and MTN have had a good year and contributed to fund performance. Even though these shares have done well, we continue to hold large positions in the fund. We are constantly re-evaluating their investment cases on an absolute and relative basis and a combination of supportive valuations, reasonable forward multiples and sound business fundamentals form the base of our conviction levels.

Despite a retailer rout in the final quarter of 2013, we have not materially increased our small exposure to this sector. After a consumer bonanza these past few years, we think the earnings bases are still high and can come under further pressure. Valuations are starting to become more reasonable and we watch this sector with interest.

Resources have had a tough year and our holdings did not escape the effects of weaker commodity prices, disappointing production, rising costs and labour unrest. While these negative factors remain relevant in the near term, these shares look attractive when valued at normalised commodity prices and production levels. The weakness in share prices in the last quarter of the year, gave us the opportunity to add to our existing holdings and increase our starter position in Exxaro. The company owns some excellent, low-cost scalable coal assets and is best placed to supply Eskom with their increasing coal needs. It trades on a very attractive normal PE multiple of 9x.

Domestic banks continued to derate significantly in 2013, especially when compared to domestic industrial shares, as concerns around unsecured lending impacted on share price performances. Our preference was to hold big banks that were well managed, well capitalised and with diversified income streams. This strategy worked relatively well, but during the past quarter we decided to replace our First Rand holding with Abil. Abil's share price more than adequately reflected investor negativity around its unsecured business model, their capital raising and threat of regulatory intervention. As such, we felt that the margin of safety was large enough for us to take a position. The business has not had a good year, but post its equity raising, it is now well capitalised and should be able to produce good earnings growth off a low base.

While the fund has had a remarkable few years, we do caution against extrapolating past performance into the future. There are still good investment opportunities available to us and we will continue to rigorously assess these according to our investment criteria. This discipline has served us well in delivering our past performance and we strive to maintain it going forward.