The fund outperformed its benchmark by 0.1% per annum over a rolling fiveyear period (14.5% versus 14.4% per annum) and by 1.9% since inception (15.7% versus 13.8% per annum). It is one of the top-performing funds in its sector over all meaningful periods.

For the third quarter of 2016, the MSCI All Country World and MSCI Emerging Markets indices returned 5.3% and 9.2% respectively in US dollars. Locally, the JSE All Share Index returned 7.6% in dollars, but rand appreciation (in line with other emerging market currencies) meant that the rise in local currency terms was more muted at 0.6% over the same period. Commodity prices, in general, ended the quarter virtually unchanged in US dollars: oil was down 1.3%, platinum gained 0.3% and copper rose slightly by 0.2%. Notwithstanding the benign moves in commodity prices and strength of the rand, resource shares performed well: the local resources index returned 8.1%, outperforming industrials (-2.1%) and financials (0.8%). The longer-term divergence in performance of resources relative to industrials and financials remains significant. Not only has the resources index lagged industrials and financials over three, five and ten years, but it has also underperformed cash over these time periods.

Nearly eight years since the global financial crisis, interest rates remain close to zero in most major economies and even negative in others. The world’s major central banks are committed to maintaining the status quo of unconventional monetary policy. The US Federal Reserve has once again delayed hiking rates while the European Central Bank and Bank of Japan continue to apply quantitative easing. Highly accommodative monetary policy represses the cost of capital and serves as a tax on the savings industry. This lack of yield encourages risk-taking as capital scours the globe in search of the best opportunities. This has the effect of distorting asset prices across the spectrum - equities, bonds, property, and currencies. This has resulted in the current disconnect between strong financial markets and tepid growth in most major economies. While monetary policy has succeeded in buoying financial markets, very little of the heavy lifting by way of fiscal and structural reform has taken place. While central bankers may have averted the great recession from becoming a depression, they are potentially sowing the seeds for another crisis in the years ahead.

At the time of writing, Theresa May, the UK prime minister, has announced she will start formal negotiations for Britain to leave the European Union by March 2017. Once she triggers Article 50, she will have two years to negotiate a new trade deal with the EU. This has once again rekindled uncertainty as market participants speculate about the terms of the UK’s departure. This uncertainty is likely to result in central bankers erring on the side of caution and keeping interest rates lower for even longer.

Domestically, economic growth remains subdued with risk to the downside given the backdrop of a weak global economy, instability caused by political infighting and the risk of a credit downgrade to junk status. Recent rand strength has improved inflation expectations and together with weak economic growth, this means that the SA Reserve Bank is unlikely to hike interest rates further.

We believe domestic equities are moderately attractive. While the JSE All Share Index is near its peak in rand terms, it has basically tracked sideways for the last five years in US dollar terms. We believe the global businesses listed in SA are attractively valued and, as such, our portfolios have healthy weightings in stocks such as Naspers, Steinhoff International Holdings, British American Tobacco and Anheuser-Busch InBev. Resource shares have performed strongly year-to-date as commodity prices recovered. Our funds were well positioned to capture this bounce, given our overweight in resource shares. Notwithstanding the recent outperformance, we believe resources remain attractive based on our assessment of fair value. However, given the uncertainties around Chinese demand, one has to manage this risk by ensuring that the weighting is sized appropriately. Our preferred holdings remain Mondi, Anglo American and the low-cost platinum producers, Northam and Impala Platinum. Both SA gold and platinum miners face enormous challenges and cost pressures (such as real increases in both electricity tariffs and labour costs without the corresponding gains in productivity). The SA platinum producers mine approximately 70% of world’s platinum supply. This affords them some pricing power. Metal prices will ultimately have to adjust higher to reflect these cost pressures in order to incentivise platinum miners to expand production to meet demand. The same is not true for gold. SA mines a tiny portion of world’s gold supply; the world does not need our gold. Prior to the recovery in the gold price, SA gold miners faced enormous pressure; balance sheets were under immense strain and many were either facing a rights issue or closure. This prompted management to run these businesses for cash - production was high-graded (at the expense of the life of the mine) and exploration capital expenditure was culled. While this is good for nearterm cash flow and profitability, it is negative long term. Mines face a declining production profile - if they don’t replace production (by sinking new shafts, as an example), unit costs will eventually blow out as lower production is spread over a similar fixed cost base. This will be detrimental to profitability. We thus remain negative on SA gold miners.

Given the weak domestic economy, it will be a challenge for the average business to defend, let alone grow, earnings in real terms. In such an environment, high-quality businesses thrive and take market share from the weaker ones. To this extent, we hold reasonable positions in food retailers and producers as well as selected consumer-facing businesses (Foschini and Woolworths). These businesses are well managed and trade below our assessment of fair value.

Banks returned 10% for the quarter, outperforming the broader financials index. While banks are effectively a geared play on a weak domestic economy, we believe that this is more than discounted in the current share prices. Valuations are attractive on both a price-to-earnings and price-tobook basis. These businesses are well-capitalised, well-provided for and trade on attractive dividend yields. Our preferred holdings are Standard Bank, Nedbank and FirstRand. Life insurers returned -1.5% for the quarter. Our preference remains Old Mutual and MMI Holdings, both of which trade on attractive dividend yields and below our assessment of their intrinsic value.

In a low-growth, low-yield environment, equities remain our preferred asset class for producing inflation-beating returns. We prefer global to domestic equities on the basis of valuation and remain at the maximum 25% offshore limit in our global balanced funds. We believe the current rand/dollar exchange rate to be fairly valued.

The bond market returned 3.4% for the quarter, outperforming cash, which yielded 1.8%. Inflation-linked bonds yielded 0.5% for the quarter, underperforming nominal bonds. We believe that yields on global bonds are too low and do not offer value. We also believe that the real returns from cash and bonds are likely to be relatively poor over the long term, both from a local and global perspective. The fund continues to hold a reasonable position in inflation-linked bonds and selected corporate bonds where we believe that spreads adequately compensate investors for the risk undertaken.

Listed property returned -0.7% for the quarter. We expect domestic properties to grow distributions at levels close to inflation over the medium term, even if one assumes an uptick in tenant vacancies. This real growth, combined with a fair initial yield, offers an attractive holding period return. We continue to hold the higher-quality property names, which we believe will produce better returns than bonds and cash over the long term.

In conclusion, financial markets are fraught with uncertainty as investor sentiment reacts to the news of the day. During these choppy markets, our long-term time horizon and valuation-driven investment philosophy act as a compass, allowing us to navigate through the noise and make the correct decisions for the benefit of our clients.

Portfolio manager Karl Leinberger as at 30 September 2016

The fund has delivered a return of 14.1% p.a. over a rolling five-year period (outperforming its benchmark by 0.5% p.a.), 13.2% p.a. over 10 years (outperforming its benchmark by 0.65% p.a.) and 16.0% p.a. since inception (outperforming its benchmark by 1.9% p.a.). The fund is one of the top performing funds in its sector over all meaningful periods.

The first quarter of 2016 saw a recovery in most markets after a torrid 2015. We often make the point that financial markets typically turn when investors least expect it. For this reason, we believe that those trying to time the cycle inevitably miss out. The MSCI Emerging Markets Index returned 5.8% (in US dollars), the JSE All Share Index returned 9.4% (also in dollars) and commodities rallied strongly off very distressed levels. The bounce in commodity prices translated into a very strong quarter for resource shares, with many of the resource stocks that we own doubling off their lows. The local resources index returned 18.1%, compared to -0.4% from industrials and 6.2% for financials. Despite this recovery, the longer-term underperformance of resources remains significant. The resources index has delivered negative returns over one, three and five years and has underperformed cash over a 10-year period.

The global economy remains stuck in a slow growth and low inflation environment (secular stagnation). The US economy, however, remains the one bright spot. It continues to recover and has commenced the difficult task of normalising interest rates. Notwithstanding our positive view on the US economy, we believe that interest rates will remain abnormally low for a prolonged period of time.

Our greatest concern remains China - a massive, imbalanced economy that is attempting to rebalance in a time of slowing growth. It has chosen to combat the slowdown with increased stimulus, which concerns us given the credit bubble that has been building since the financial crisis. Notwithstanding these longer term concerns, the economy appears to be responding to the stimulus and this has been positive for all commodityproducing emerging markets.

The South African economy continues to languish. The external challenges presented by weak global growth and a brutal commodity downturn have been compounded by internal issues. A laundry list of low levels of investment, low confidence, social tensions and competitiveness issues (despite a currency that has halved in value in the last five years) have combined to make the local business environment a very challenging one.

The fund benefited from a high weighting in equities and property stocks. We continue to advocate high equity weightings, with the domestic portion of our equity exposure heavily invested in the high-quality, global businesses that happen to be listed on the JSE (such as Naspers, Steinhoff, British American Tobacco, and Anheuser Busch InBev). These companies have robust business models, are diversified across numerous geographies and currencies and remain attractive based on our assessment of their intrinsic value.

As mentioned in previous commentaries, the fund has a healthy weighting in resource shares. We do not know whether the gains of the past quarter will endure. Most commodities are in oversupply in response to projects approved eight years ago at the top of the cycle. However, we believe that valuations are attractive and sufficiently discount these risks. Our preferred holdings remain Anglo American, Exxaro and the platinum producers. Many of our holdings trade at around 5-6 times our assessment of mid-cycle earnings. We continue to favour platinum over gold producers and our preference remains the low-cost producers Impala Platinum and Northam.

Banks returned 13.0% for the quarter, outperforming the broader financial index. Valuations are attractive and adequately discount the risks of a continued economic slowdown. Our preferred holdings are Standard Bank, Nedbank and FirstRand. Life insurers returned 5.6% for the quarter. Our preference remains Old Mutual and MMI Holdings, both of which trade on attractive dividend yields and below our assessment of their intrinsic value.

In terms of asset allocation, equities remain our preferred asset class for producing inflation-beating returns. We prefer global to domestic equities on the basis of valuation. We believe the benefits of diversification are particularly important in these challenging times. The fund has the maximum exposure offshore and most of this is in equities (around two-thirds in developed market equities and the balance in emerging markets). The wellunderstood challenges in emerging markets have resulted in many highquality companies, with great management teams and excellent long-term prospects trading at very undemanding levels.
The bond market returned 6.6% for the quarter, outperforming cash, which yielded 1.7%. Inflation-linked bonds underperformed nominal bonds with a return of 2.2% for the quarter. We believe that yields on global bonds are too low and do not offer value. We believe the real returns from cash and government bonds are likely to be poor over the long term, both from a local and global perspective. We continue to hold a reasonable position in selected corporate credit bonds.

Listed property returned 10.1% for the quarter. A high weighting in property stocks continues to be a major differentiator for the fund. We expect domestic properties to grow distributions in line with inflation over the medium term. This growth, combined with a fair initial yield, suggests an attractive return over the holding period. We continue to hold the higherquality property names, which we believe will produce better returns than bonds and cash over the long term.

In conclusion, market volatility is likely to remain heightened as investors react to the news of the day - Chinese economic data, Brexit, European elections and US politics. In a world of constant change, our investment philosophy remains unchanged - we remain valuation-driven and committed to the long-term. This key tenet is ingrained in our corporate culture and is the only enduring competitive advantage in a world of collapsing time horizons. It resulted in contrarian positions that served the fund very well in the last quarter and demonstrates why long-term investors should not fear volatility.

The fund has outperformed its benchmark by 0.9% p.a. over a rolling 5-year period (14.0% versus 13.1% p.a.) and by 2.0% p.a. (16.1% versus 14.1% p.a.) since inception. The fund is one of the top performing funds in its sector over all meaningful periods.

The final quarter of 2015 provided little respite in what was a difficult year for global markets. The MSCI World Index returned -0.3% for the calendar year and the MSCI Emerging Markets Index -14.6%. Although the JSE All Share Index increased 5.1% in rands, the positive return was due entirely to the tailwind of a weakening currency. Commodity prices continued to decline over the year with oil falling 38%, palladium 28% and copper 26%.

We have been warning for some time that investors should expect lower returns following very strong returns achieved in the recent past. The fund was conservatively positioned at the start of the year and, for that reason, did a good job of preserving capital in a weak market environment. We believe that the recent sell-off is providing the best value we have seen in the SA market for some time, and we are increasing the fund's exposure to domestic equities and property stocks into weakness.

On the global front, the economic and geopolitical outlook remains challenging, with the US being the only bright spot. As expected, the US Federal Reserve raised interest rates by 25 basis points in December, the first hike in almost a decade. Our base case remains that the pace of interest rate normalisation will be gradual and that interest rates will remain at historically low levels for many years. We remain particularly concerned about China. China is very important for all commodity producers and faces the challenges of slowing growth and a credit bubble that the authorities seem to pretend doesn't exist.

The SA economy is particularly challenged. The external challenges of collapsing commodity prices and weak global growth have been compounded by a loss of confidence in the government's commitment to fiscal discipline. The dismissal of SA's minister of finance sparked a collapse in the bond and currency market. Confidence levels are low and the risks of a recession in the next few years cannot be dismissed. We expect the environment for domestic businesses to remain challenging in the years ahead.

As mentioned on previous occasions, China remains the key call for resource shares given its role as a significant consumer of commodities. It is an opaque, command-driven economy that is in the process of rebalancing from being traditionally investment-led to becoming more consumerdriven. Very little is being done to address the extremely high levels of debt that have accumulated in the aftermath of the global financial crisis. As a consequence, commodity markets are very stressed, with most miners making losses at current prices. Although we expect commodity markets to remain depressed for some time, we believe that the equities offer value to the patient investor who is prepared to take a long-term view. A globally diversified miner like Anglo American trades at 2-3 times our assessment of mid-cycle earnings. For this reason, we have built a reasonable position in commodity stocks - with the intention of taking it to a full position when we believe that the margin of safety has reached more compelling levels.

We continue to favour the quality global businesses that happen to be domiciled in S A such as Naspers, British American Tobacco, Steinhoff and Intu. These companies have robust business models, are typically diversified across numerous geographies and currencies, and remain attractive based on our assessment of their intrinsic value. We also continue to hold reasonable positions in the food retailers and producers as well as selected consumer-facing businesses (Woolworths and Foschini). These businesses are exceptionally well-managed and trade below our assessment of fair value.

Financials had a poor quarter, with financial stocks the most acutely impacted by the blow-out in our currency and bond markets. Banks returned -13% for the quarter. Valuations remain reasonable and we have used this weakness to increase position sizes. Our preferred holdings are Nedbank, Standard Bank and FirstRand. Life insurers outperformed the banks, and we continue to prefer Old Mutual and MMI Holdings - both of which trade on attractive dividend yields and below our assessment of their intrinsic value. In terms of asset allocation, equities remain our preferred asset class for producing inflation-beating returns. We prefer global to domestic equities on the basis of valuation and remain at the maximum 25% offshore limit. The bond market returned -3.9% for the year. We believe yields on global bonds are too low and do not offer value. Despite the sell-off in local government bonds, we do not believe that yields fully reflect the deteriorating risk profile. In our view, the real returns from cash and government bonds are likely to be relatively poor over the long term, both from a local and global perspective.

Listed property returned -4.7% for the quarter and +8% for the year. We expect domestic properties to grow distributions in line with inflation over the medium term, which, combined with a fair initial yield, offer an attractive return over the holding period. We continue to hold the higher-quality property names, which we believe will produce better returns than bonds and cash over the long term. In this down-beat market, the good news for our investors is that we are currently finding better value in the SA market than we have for many years. Much of the bad news is priced into our currency (which has more than halved in the last five years), the equity market and the property sector. Emotion and volatility are typically the friend of the long-term investor.

Portfolio manager
Karl Leinberger