Please note that the commentary is for the retail class of the fund.
It has been a strong year of outperformance for the fund, which delivered 14.9% for the 12 months. Its benchmark, the JSE Capped All Share Index, returned 7.2% over the same period. The last quarter was particularly exceptional, with the fund delivering 5.9% alpha. While the fund aims to achieve consistent outperformance over a longer-term time horizon, we caution investors to expect large positive and negative performance numbers over shorter-term time horizons.

Our resources positioning has delivered the bulk of the positive returns this year. Holding resources at the beginning of the year was a difficult view to defend. Headlines were pervasively negative and many questioned the sustainability of these business models if spot prices prevailed. Our focus was on company valuations based on normalised commodity prices, which suggested that resources were looking extremely cheap. This view was not indiscriminate. We held shares where underlying commodity exposure was supported by long-term supply/demand fundamentals, and where balance sheets were fairly robust. As such, we not only benefited from the resource rally, but our specific holdings in Anglo American, Exxaro and Impala have outperformed the sector. Despite the recovery we still have a healthy weighting to resources, as valuations on a through-the-cycle basis are still compelling.

Our bank holdings have also performed well this year. Recent reported earnings from Standard Bank and Nedbank indicate businesses that have managed to deliver quality earnings growth through good cost containment and conservative provisioning. Capital levels remain healthy, which means that these banks should be able to support decent dividend yields even in a tougher economic environment. A potential downgrade to SA credit by the ratings agencies should have a minimal impact on the banks' business models, as the majority of their funding is domestic. MTN continues to face negative headlines out of Nigeria. The most recent allegations are that the company took $14 billion out of Nigeria illegally over the last decade. MTN refuted these claims in a SENS announcement, saying that they are unfounded and without merit. Our calculations suggest that MTN has invested roughly $9 billion in network rollout costs and has paid $5 billion in corporate taxes in Nigeria over the last ten years. These investments far exceed the amounts they have taken out in the form of dividends and management fees. In addition, all repatriations have happened with the approval of the Central Bank of Nigeria and other regulatory authorities. While the headlines remain unhelpful, we feel the investment case for MTN remains intact.
Our global industrial holdings in Naspers, Mondi and British American Tobacco have been long-term winners for the fund. We continue to have sizeable positions despite the rerating of these shares. British American Tobacco has continued to deliver solid earnings growth in constant currencies through a combination of pricing power and cost savings. It has continued to invest in building its traditional cigarette brands, but has also developed a suite of next-generation products that provide smokers with a safer nicotine alternative. These investments have not impacted the high cash generation of the company. As such, we expect it to continue delivering decent returns through a combination of earnings growth and increasing dividends.

Globally, much uncertainty still remains. The aftermath of Brexit is still playing out, with Theresa May's latest comments indicating a 'hard Brexit' scenario. The US presidential election could also create turmoil in markets. Extreme share price movements around these events often provide us with investment opportunities, as panic and uncertainty result in unwarranted moves. Our long-term investment horizon gives us the conviction to take advantage of these opportunities quickly and decisively when they present themselves. This approach has served us well historically, and should continue to help the fund deliver long-term alpha.

Portfolio managers Neville Chester and Pallavi Ambekar as at 30 September 2016

Please note that the commentary is for the retail class of the fund. After a tough 2015, the fund has had an excellent start to the year. For the quarter to end March, the fund returned 14.05% versus the benchmark return of 4.53%. Our resource and financial holdings re-rated suddenly and strongly, and contributed to the significant outperformance over this period.

In the resource sector, pessimism continued to increase around China’s growth prospects and the country’s demand for commodities. Market sentiment about the ability of mining companies to navigate the shortterm pressures was negative. This was especially evident in counters where balance sheets were weak (e.g. Anglo American and Glencore). Speculation about imminent rights issues was rife, which saw short positioning in these shares increase. We think that as the resource companies started to report results, it became evident that they were, in fact, able to react and respond to a weakening environment in a more pragmatic manner than was expected. Markets were factoring too negative an outcome, and as a result prices had to re-rate. While the rebound was welcome, we certainly did not expect it. In past commentaries, we have repeatedly talked about ignoring short-term news flow to instead focus on long-term normalised valuations. This often means we endure periods of significant underperformance in the fund, with the understanding that eventually the fundamentals re-assert themselves. We are by no means calling the bottom of the resource cycle, but it does seem as if commodity prices have stabilised. Despite the re-rating, valuations in our select resource holdings remain attractive and our positions have largely been maintained.

Many domestic stocks, including financials, have also come back significantly following the dismissal of the finance minister in December. Banks in particular were hard hit on concerns around the downgrading of South Africa to junk status and the resultant increase in their funding costs. Once again, as the banks started to release results, it became evident that these businesses are well run, well provisioned and have good capital buffers which support their forward dividend yields. Another positive surprise was the announcement by Old Mutual regarding the breakup of the group into the underlying UK wealth and asset management business, emerging market life insurance business and Nedbank. We think this breakup will unlock value for shareholders not only through cost savings and efficiencies, but also as higher ratings are applied to the wealth and asset management business.

On the industrial front, the global rand hedges such as Naspers and British American Tobacco continue to be resilient, supported by operational delivery and rand weakness. A new position for the fund is Anheuser Busch which listed on the JSE in January. The deal with SAB Miller has yet to be concluded, but we think the business as it stands today has good fundamentals. Anheuser Busch is a big player in the beer industry and generates good returns and cash flows. The valuation for this global business is attractive and it has the potential to extract generous synergies from the SAB Miller deal. MTN has been subject to many headlines following the announcement of the fine in Nigeria. The fine continues to be negotiated with the Nigerian authorities. There is a lot of uncertainty about how this will ultimately be resolved, but it is likely that a settlement will be reached. MTN’s market capitalisation has reduced by approximately $7bn since the announcement, which is more than the initial fine of $5.2bn. At current share price levels, the payoff profile is pretty much asymmetric.

While it has been a good quarter for the fund, we continue to believe the core holdings can still deliver meaningful value. We are not complacent about risks and are continually questioning and challenging our views around the potential investment outcomes. This helps us assess whether our normalised valuations are robust enough under different scenarios. Our long-term investment horizon remains the anchor for all our investment decisions. It has stood us and clients in good stead in the past, and will continue to do so going forward.

Portfolio managers
Neville Chester and Pallavi Ambekar

The past year has been one of the most difficult years that the fund has had to deal with since 2007. The equity market was incredibly volatile and the range of dispersion between the best performing shares in the top 40 and the worst was at an extreme level (Brait being the top performer with a return of 112% and Kumba Iron Ore being the worst performer falling 83%). It was an extremely frustrating period as some of our top performing ideas were diluted by the significant underperformance of a few shares that fell dramatically in price this year, despite robust long-term fundamentals. It was also extremely frustrating to see overvalued companies, which we did not own, soar further on the back of M&A activity driven by the availability of cheap funding as opposed to any long-term strategic rationale or value. That said, we have been through periods like this before and have seen ultimately that the fundamental valuation approach taken by Coronation does come through to deliver long-term outperformance. All of the active positions we have taken in the fund, we believe, still have significant upside. We continue to analyse these companies to ensure their fair values remain intact and reasonable, and that all still offer a compelling return story.

For the quarter, the benchmark returned a positive 1.73% against which the fund delivered a negative 6.1%. This was driven by two main factors: the takeout of SABMiller and the collapse of the domestic shares in the SA market following the surprise removal of the South African finance minister. The fund had only a small position in SABMiller, as we had sold out due to the high rating and poor prospects for the business due to weakness both in economic growth and the underlying currencies in all its key regions. This did come to bear in the most recent reported results, which were down 10% in reporting currency. Unfortunately this was irrelevant as ABI made an offer to buy out the business at an incredibly rich multiple. There is always a risk with corporate action as one can never appropriately take this into account when valuing a company. One always has to value the business on a stand-alone basis based on its long-term fundamentals. At the end of the day, ABI has chosen to take advantage of the record-low borrowing costs available to large corporates to buy the SABMiller business, which should not be too dilutive in the short term. With ABI as the new long-term owner of these assets, it will be interesting to see if they can ever extract the value they have paid for this business. The price was struck in pounds, but the rand, Columbian peso, Australian dollar and yuan - all major regions where SABMiller operates - have all weakened substantially since that date.

On the 9th of December, despite having recently been downgraded by ratings agencies around concerns over our debt levels and deficit spending, the dismissal of SA's minister of finance resulted in a loss of faith in the fiscal prudence exercised thus far by the SA government, and an exodus from debt and equity markets as well as a concomitant crash in the rand. Purely domestic shares, those which do not benefit from the weakening of the currency, have been smashed to extremely low levels as foreigners dumped shares to leave SA while locals, fearing the impact of the low growth and high inflation environment brought about by the plummeting rand, reduced exposure.

Particularly hard hit have been the banking stocks. Already reeling from the recent debt downgrade, the local banks were punished by concerned investors globally and locally. The prospect of a junk debt rating is particularly impactful on the banks that fund a significant amount in the debt capital markets where bond yields have blown out by in excess of 150 basis points. The banking sector fell 10.8% in December and our two large positions, Standard Bank and Nedbank, fell in line with this. They are now trading on PE's of 7 to 8 and dividend yields of 7%, which are very compelling.

Finally, the resource sector continues to weigh on the fund's return. While the position sizes are not that large, the declines this year have been such that they have detracted significantly from the fund's overall performance. This performance was further compounded by declines in December, despite the significant weakening in the rand, which is favourable for the earnings outlook for the SA resource producers. Ultimately the SA resource producers have big gearing to the currency and the weakness in the rand should drive profitability in local currency terms as the companies run a dollar top line and rand cost model. However, sentiment towards the shares remains poor and the prices continue to be under pressure. Anglo American suffered a major sell-off in the month of December following their investor day, despite no new negative news being released and the strength of their liquidity position over the next three years being confirmed. News out of China continues to be mixed, which has not engendered much relief in the commodity markets thus far. Despite differing fundamentals in supply and demand, virtually all commodity prices have declined this year in line with this sentiment. All the commodity prices now trade below our assessment of normal, which is what drives our expectations of above-normal returns as these prices normalise over time.

The fund has been and remains positioned for rand weakness and generally a tough local economy with the majority of its exposure to global businesses or dollar-priced exporters. There is certainly very little evidence that there will be a major turnaround in the fortunes of the local economy. Despite the improved competitiveness from the weaker rand, business confidence is at an all-time low, impacted by the lack of power, irrational behaviour by policymakers, expectations of rising interest rates and increasing budget deficits.

The past year has been exceptionally difficult, and we expect times to remain so. Our first and foremost goal remains to add significant long-term value through identifying mispriced assets. There appears to be far more of these opportunities currently given the volatility in markets and the search for safe bets at the expense of all other stocks. While uncomfortable and at times frustrating, we are not prepared to look for safety in the benchmark and the highly rated defensive shares which offer no value, but will invest where we believe the price of the assets gives one significant upside with plenty of margin of safety for forecast risk.

Since inception the fund has still significantly outperformed its benchmark through following a concentrated approach to investing in our top 20 stock ideas, and we firmly believe it will deliver this high level of returns in the future. Thank you for your continued support through what is undoubtedly one of SA's most challenging periods.

Portfolio managers
Neville Chester and Pallavi Ambekar