The month of September punished global equity markets as the impact of a strong dollar, weak commodity prices, and tighter financial conditions took hold. The MSCI World Index lost 2.7% (in US dollar terms) in September, which resulted in a 2.1% decline for the quarter. At the same time, the MSCI Emerging Markets Index fell by 7.4% (in US dollar terms) in September, erasing gains from earlier in the quarter to end 3.4% down. Year-to-date, the MSCI Emerging Market Index gained just 2.7% compared to 4.3% for the MSCI World Index.

The only standout performers for the quarter were Japanese (+6%) and Indian equities (+5%), both measured in local currencies. Japanese equities benefited from a weaker yen as the US dollar enjoyed its best quarterly performance since the second quarter of 2008. The dollar showed its strongest gains against the yen (+8%) and euro (+8%), while in emerging markets it rose strongly against the Russian rouble (+14%) and the Brazilian real (+10%). Commodities were the worst casualty during the quarter. Soft commodities such as corn and wheat fell on average by 19%, while the oil and gold prices fell by 14% and 8% respectively. Collectively, the CRB index is down 5% for the quarter, but up by 4% year to date. While dollar strength is part of the reason behind the sharp fall in commodity prices since the start of the year, losses in growth-related commodities such as copper (-9% year to date) is perhaps more consistent with slower global growth. Looking at equities, the S&P 500 was down by more than 1% in September, translating into a quarterly gain of 1%. In developed market equities, the US year-to-date 8.3% is still a relative outperformer against Europe's 7.6% and the UK's 1.2%.

Despite the broader risk-off trade that occurred late in September, fixed income investments didn't have a good quarter. US bonds were essentially flat for the quarter and all other sovereign bonds produced negative returns due to adverse currency movements against the US dollar. Year to date the US and UK bonds have produced the highest returns at 4% and 5% respectively. Credit markets also had a bad month in September from a total return standpoint, with high-yield bonds underperforming across the board. Following a brief reprieve in August, US high-yield bonds actually weakened more in September (-2.6%) than in July (-1.7%) and went on to post its worst quarter since the third quarter of 2011 when the US was stripped of its AAA rating. September was also the second worst month for emerging market bonds this year, largely led by weakness in Latin America.

The global economy is being buffeted by two sizeable market movements: the strength of the dollar and commodity price declines. In part, these moves reflect relative shifts in demand and policy. Demand is shifting toward the US and away from commodity-intensive consumers at the same time that there is a relative shift in US monetary policy. The Fed is likely to place more weight on the falling unemployment rate than on the stagnant wage figures, whereas the ECB and Bank of Japan are more likely to institute further easing measures. A rising dollar and falling commodity prices signal the perception of a growing downside risk to global growth; a point underscored by the recent decline in risky asset prices. There are likely to be macroeconomic repercussions, the most obvious being the expectation of lower global inflation over the shorter term. Clearly, the environment for equity markets in general is changing. Two years of extremely low volatility, gradual progress on the macroeconomic front, relative quiet on the geopolitical front and constant liquidity injections by central banks (led by the Fed) appear to be coming to an end. Some of the key economies, led by China, are showing signs of slowing down again. The Fed has been reducing the pace of QE and will likely terminate the programme in the coming months. Equity valuations remain reasonable, with the MSCI World trading at 16 times forward earnings while the MSCI EM trades at 11.7 times. Your fund had a poor quarter, returning a negative 4.2% (+1.78% in ZAR). The month of September punished global equity markets, with the pain being particularly felt in our emerging market holdings. Year-to-date, the fund's return is now marginally positive at 0.55 % (+8.42% in ZAR), while the 12-month lagging number is positive 5.39% (+18.46% in ZAR). Our longer-term return numbers are still strong, aided by strong stock selection and an overweight position to equities during the earlier years of the fund's existence. Investors are reminded that we will be changing the benchmark for the equity component from the MSCI World Index to the MSCI All Country World Index (ACWI) to reflect the fact that emerging market stocks will form an integral part of our fund composition. The ACWI has about 12% exposure to emerging markets, compared to the MSCI World Index which is virtually only a developed market index.

Our equity selections have lagged the overall market by about 2.7% over the quarter, a disappointing outcome driven primarily by the sell-off in emerging markets, and particular disappointments in some of our larger holdings. Positive contributors were Tata Motors, Dollar General (discussed below), eBay and Yahoo! Notable detractors included Porsche, Arcos Dorados, Tesco, SJM Holdings, Jeronimo Martins and Adidas. We have now slipped slightly behind the benchmark on a 12- month lagging basis, but are still well ahead over the longer periods. Noticeable winners over the last year include Blackstone, Axis Bank, Kroton, Apple, JD.com, Tata Motors and Netease. Major detractors were Tesco, Arcos Dorados, Porsche, Sberbank, SJM Holdings, Adidas, and LVMH.

Our property holdings, by and large, performed in line with the market, and slightly outperformed our equity selections. Our positions in the German residential names have continued to do well over the last year, but have been hurt by the market volatility over the last quarter. We continue to believe that property provides diversification in a balanced portfolio. The fund's asset allocation did not change much over the last quarter, averaging around 60% exposure to equity since the beginning of the year. We hold some put protection as insurance against a major equity correction, but are looking to increase equity exposure into market weakness. Property exposure has been reduced over the quarter to around 7% of fund. We hold virtually no credit or fixed interest instruments, although we are starting to see some value emerging in this space.

One of the fund's larger equity positions in recent times has been its exposure to the so-called dollar stores in the US. These are essentially limited-range convenience stores serving a lower-income consumer (at lowish price points). They have been successful in growing the store bases while achieving strong like-for-like same stores sales growth in the older stores. The most successful of these operators in our opinion is Dollar General, which has been a top-five position in the fund over the last few years. Recently merger activity in the sector heated up with an agreed take-over of Family Dollar by Dollar Tree (two other operators in this space). We used the share price strength in Dollar Tree to exit our position completely. Shortly thereafter Dollar General entered the bidding war with a hostile approach for Family Dollar at a premium to the previously announced deal. Dollar General's share price reacted very strongly to this news, as the potential synergies in this deal are expected to be material. In response, we have reduced our holding in Dollar General, and also wrote some derivative positions around our holding to capitalise on the increased uncertainty over the various merger permutations. This story will continue to play out over the next year or so, with many potential outcomes. In the meantime, however, we have been quite active in adjusting our portfolio to take advantage of the various developments.

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

The fund appreciated by 9.3% (in ZAR) in the quarter, taking its 2013 return to +48.9%. In US dollars, the fund appreciated by 20.9% in 2013, with the balance of the return coming from ZAR depreciation. Since inception just over 4 years ago, the fund has generated a return of +19.2% p.a. in ZAR (+11.4% p.a. in USD) and in doing so has outperformed its benchmark (60% MSCI World index/40% Global Bond index) by 2.9% p.a.

Our views remain broadly unchanged: we believe that global equities remain the most attractive asset class and the fund's equity exposure in the low 60% level reflects this view. The fund's equity exposure was, however, reduced over the past few months as we sold or reduced a number of positions as a result of sharp share price appreciation. Over the quarter, equity exposure moved down from 71% to 63%. We also believe that selected listed property companies are attractively valued and around 9% of the fund is invested in this asset class. Lastly, we continue to hold the view that government bonds worldwide are overvalued and as such have no exposure, and only negligible exposure to corporate bonds.

Whilst global equity markets have appreciated considerably over the past few years, we are still able to find good selected value and the fund's largest holding, Porsche (4.6% of fund), is one such example. Even though Porsche has appreciated by around 30% since our initial purchase, we continue to believe that the share is materially undervalued.

There are a number of key points we like about VW as a business:

- Owner of some of the best car brands in the world, notably the VW brand itself, Audi and Porsche (these three brands contribute 70% of group profits).
- A focus on higher-end brands (Audi and Porsche) that are better businesses than mainstream car brands, in our view, and generate higher margins and return on capital.
- Leaders in engineering and customer satisfaction, the results of which are reflected in the fact that VW's global market share has increased from around 9.5% in 2007 to almost 13% today (see adjacent graph). The fact is VW makes attractive, reliable cars that people want to own.
- Scale (enabling more to be spent on R&D and marketing) and platform sharing (resulting in efficiencies between the various brands).
- High emerging markets exposure (est. 45% of profits) where car penetration is still low.

There is no debating that the car industry is a poor industry (very cyclical, capital intensive, intensely competitive, etc.), but within this industry there are inevitably winners - in our view, VW is one of them. Despite its strong earnings track record and operating metrics (5-year ave. ROE of 12%), the share trades on just 8.5x 2014 earnings. In our opinion, the entire industry is being painted with the same brush (partly because of the poor history of US car companies and more recently a number of European car companies), whereas in reality not all car companies are equal. Whilst VW is very cheap in our view, Porsche in turn trades at a large discount to the value of its stake in VW (in effect on around 6.5x 2014 earnings). This is partly due to concerns about litigation from hedge funds arising from the short squeeze in VW shares in 2008. Even providing for the total litigation claim amounts (which is very unlikely to be realised in our view), Porsche would still be marginally more attractive than VW. If anything less than the full claim is realised, Porsche is far more attractive from a valuation point of view than VW. As such, we have taken all of the fund's exposure through Porsche.