After many years of good growth, the fund has had a pedestrian year, and is down 6.6% since January 2015. We have long expected fund returns to be lower than those achieved over the past 5 years, with equity valuations and the weighted fund PE being at elevated levels. We continue to feel that the macro environment in South Africa, coupled with high listed company valuations, makes for a tricky period ahead.

The single biggest detractor to performance over the past year has been Altron, with its share price falling some 67% from around R23 to R7.50 currently. This has been a bitter disappointment. The company has destroyed significant value for shareholders. Firstly, the company embarked on an ill-conceived video-on-demand service, the Node. About a year after launch and at significant cost, this product has been terminated. Secondly, management erred in their strategic decision not to sell their cellular service provider, Altech Autopage, at the same time that Reunert sold Nashua Mobile to the cellular network operators. It has taken Altech management about a year to change their mind, which has cost Altron shareholders dearly. We estimate that the selling price for Autopage is around 30% lower today than it would have been had Autopage been sold at the same time as Nashua Mobile.

As painful as this has been, we think the market has overreacted. Altron owns some very good businesses, such as Bytes Technology and Netstar. The Autopage sale will also go a long way to reduce the high debt levels in Altron. Our conservative calculations show that the current Altron share price values Bytes, Netstar along with all the debt in Altron, but attributes zero value to Powertech and the other smaller Altech businesses. As such, we remain hopeful that the fund's position in Altron will be a contributor to performance in the years ahead. The three largest additions to the fund during the quarter were Dawn, Grand Parade and Holdsport. Dawn has been a longstanding position in the fund to which we have added as its share price has come under pressure. The company has performed poorly in the past few years, which has clouded the fact that management have concluded a fantastic transaction by selling half of their manufacturing businesses in the building division to Grohe, a large European tap (and accessories) manufacturer. Dawn achieved a fantastic price on this transaction, which not only makes huge strategic sense, but has also largely de-geared the Dawn balance sheet. We are confident that the benefits of this transaction will come through in Dawn's financial performance in the short to medium term.

Grand Parade is the license holder for Burger King in South Africa, and the owner of various other gaming related assets. It also holds a 10% shareholding in Spur. The company is in the early stages of rolling out the Burger King brand in South Africa - a process that will continue for many years to come. We think Burger King will be a very successful business for Grand Parade, and that the value of this franchise will become apparent in Grand Parade's share price in the future.

Holdsport is the holding company for Sportsmans Warehouse and Outdoor Warehouse. Sportsmans Warehouse is the leader in the sports retail market in South Africa, and a very tightly managed business. There are many things to like about Holdsport: high returns on equity and good cash flows, which translate into generous dividends and a superb management team.

We are happy with the current structure of the fund in these uncertain times. The largest holdings (Capevin, Advtech and Hudaco) are all businesses that have been around for many years and have displayed an ability to thrive regardless of the economy. In addition, the fund also holds many high quality businesses (such as Omnia, Truworths, RMI and MMI), which we believe can still grow earnings in this tough environment. We have also taken some smaller positions in riskier counters which, on a normalised earnings basis, are significantly undervalued. These would include holdings in Exxaro, Northam Platinum, Murray and Roberts, Astrapak and Bell Equipment. In our view, all of these companies are worth more than double their share price, although risks abound. As such, the position sizes of these holdings have been sized appropriately.

Portfolio managers
Alistair Lea and Siphamandla Shozi

The fund returned 2.1% for the quarter, and has delivered a return of 0.6% over the past year. Over a period of three years, the fund has returned 15% p.a., which compares to the median peer group performance of 18%.

In our previous commentary we pointed out the huge divergence in valuations that the market is prepared to put on stocks of varying quality. While we agree that higher-quality stocks should be rewarded with a higher rating, we question the extent to which this divergence has been overdone. Over the past quarter, we started seeing signs of a reversal of this situation. For example, the forward multiple of MediClinic, a high-quality stock we don't own, has reduced from 24x to 20x. On the other hand, the forward multiple of Hudaco, a lesser-quality stock we own, has increased from 9x to 12x. There are many more other examples where this sort of reversal is taking place in the market at the moment. We continue to identify reasonably priced stocks with good growth prospects. One such stock that we have recently added to the portfolio is Holdsport. It is a cash retailer, and a leading seller of sporting and outdoor goods in South Africa. Through their Sportsmans Warehouse and Outdoor Warehouse stores, the business offers a unique mix of equipment (85% of sales), apparel and footwear which has allowed them to dominate their relevant categories, while achieving steady margins and being able to pass prices onto the customers. Having recently seen off the most competitive trading environment in their history, the business has a number of exciting opportunities ahead of them, including store openings in untapped locations; expansion of the private label offering; growth of their online offering; and an ungeared balance sheet. It currently trades on 8.8x our assessment of normal earnings, and 6% dividend yield, which we think is attractive.

The fund's two other biggest buys this past quarter were Grand Parade Investments and Cartrack. Grand Parade is an investment holding company whose main assets consist of stakes in Sunwest (casino operator), Slots, Burger King and Spur. The first two assets were recently sold to Sun International in a deal worth R2.5bn. However, the delay in getting regulatory approvals meant that the Sunwest (R1.55bn) portion of the deal had to be terminated. This led to significant weakening of the share price. We think this has offered us an opportunity to own a portfolio of very cash generative and defensive assets at an attractive price. Cartrack is a telematics service provider with operations in Africa, Europe and Asia. It is a business that has developed a winning formula in tackling what has become a very competitive and commoditised market. Over the past three years they have grown subscribers at a rate north of 20% p.a. while maintaining high margins and generating significant free cash flows.

The fund's three biggest sells over the past three months were Novus, City Lodge and Datacentrix. Novus is the largest commercial printing business in SA which listed on the JSE about three months ago. We participated in the IPO and subsequently the share price rose to reach fair value. City Lodge has done well for us and reached our assessment of fair value. It trades at a 16x forward PE multiple. With Datacentrix we have trimmed our position down after the share had a strong run following the announcement of a good set of financial results.

Portfolio managers
Alistair Lea and Siphamandla Shozi

The fund return was flat for the first quarter of 2015, and has delivered a return of 6.6% over the past year. This compares to the median peer group performance of 1% for the quarter and 6% for the year.

A key feature of the market today is the huge divergence in valuation the market is prepared to place on shares of varying perceived quality. It is not uncommon for high-quality companies with defensive and growing earnings to be rated on PE multiples in excess of 20x, sometimes even higher, whereas single-digit multiples are common for lower quality businesses.

The question we ask ourselves is at what stage is holding a high-quality counter on a very high multiple more risky than holding a lower-quality counter on a very low multiple. Is a holding in Hudaco more risky than a holding in Mediclinic? Conventional wisdom says yes, which is one of the reasons for the differential in valuation. However, there comes a point when the 'safe and bankable' share's valuation is so significantly more demanding than the lower-quality share, that the risk/reward profile becomes skewed in favour of the latter. Had you taken this view a year or two ago, it would not have worked out for you, but we are increasingly of the opinion that the time where it will work in your favour is close. That doesn't mean that we are selling out of all our highly rated quality shares and replacing them with high heartbeat cheap shares. We are, however, in the process of understanding why certain shares are so cheap, and where we think this is not justified, are introducing these shares into the fund.

Bell Equipment (Bell) would be an example of this. Bell is a manufacturer of construction and heavy lifting equipment. It recently reported a very weak result, symptomatic of the tough construction market for its products. That said, cash flows in the latest results were very strong, and Bell's balance sheet is as a result, insignificantly geared. This is different from previous down-cycles where the balance sheet became very stretched. This is a wellmanaged business with a globally recognised brand, trading at a fraction of its stated net asset value and on a low single-digit forward PE. Yes it carries risk, but the potential reward has become too large to ignore. The fund's three biggest buy trades over the past quarter were Exxaro, Howden and Bell. We have spoken in the past of the fund's low resource weighting, which has increased in the past year to around 10%. Exxaro is a company with exposure to iron ore, through its holding in Kumba Iron Ore, and coal. It owns some of the best coal assets in the country and is one of the largest suppliers of coal to Eskom. The slump in the iron ore and coal prices has resulted in a significant decline in the profitability (and share price) of Exxaro, to levels we consider attractive. Howden is a manufacturer of industrial fans and is the dominant supplier of these products to Eskom. A large part of its business involves the maintenance of these fans, which provides revenues of a consistent annuity nature. The business generates very healthy margins and returns on equity, and is currently benefiting from both Eskom's new build programme as well as the large maintenance backlog. Another feature of the company is the cash it generates, which allows for healthy dividend and special dividend payments. The company currently has in excess of R500 million in net cash on its balance sheet (the market capitalisation is R2.7 billion).

The fund's three biggest sell trades over the past three months were Pioneer Foods, Foschini and Hudaco. Pioneer and Foschini have both been significant contributors to the fund's performance over the past year, but both counters have in our opinion reached and exceeded our assessment of fair value. Pioneer now trades on a 21x forward PE multiple, with Foschini on 16x. Granted, both these businesses are doing all the right things currently, but we see limited further upside from these levels. While we have sold out completely from these two counters, in the case of Hudaco, we trimmed a large position following the strong share price reaction to the announcement that the company had reached a settlement agreement with the South African Revenue Service. Hudaco remains a top five position in the fund and we remain comfortable with this holding.

Portfolio managers
Alistair Lea and Siphamandla Shozi

The All Share Index gained 1.4% in the fourth quarter of 2014; a slight recovery after recording a decline in the prior quarter. The gain was mainly driven by financials and industrials, while resources detracted. Probably the single largest event in the final quarter of the year was the massive decline in oil prices. This has moderated inflation expectations, and expectations for the next interest rate hike have been pushed further out. In line with the US market, bond yields declined, boosting interest rate sensitive sectors such as clothing retailers and property shares, whose prices have recovered close to previous peaks.

The fund gained 1.9% over the quarter, in line with the overall market. This brings the fund return for the full year to 10.3%, which is in line with our expectations of lower returns than have been experienced over the past three years. The theme remains that of a generally expensive market, in which we continue to find it difficult to identify undervalued shares. This is against the backdrop of a tough domestic economy, plagued by strikes, with consumers remaining under pressure due to indebtedness. We remain cautious on the outlook for our local businesses.

Major contributors to performance during the year were Astral (+75%), Zeder (+77%) and Pioneer Foods (+66%). The largest detractors were Buildmax (-65%), Altron (-28%) and Dawn (-25%). In terms of portfolio changes, positions added during the quarter include Northam Platinum, Grindrod and Reunert while Phumelela and Zeder were sold after reaching our assessment of their respective fair values.

We like the long-term prospects of Northam. The company owns two high-quality assets in Zondereinde and Booysendal. Though Zondereinde is the deepest PGM (platinum group metals) mine in the world, it comes with extremely high grades. So despite high rand per ton costs, it generates high revenues per ton, implying decent free cash margins at normal price assumptions. Booysendal on the other hand, is a low-cost shallow decline mine on the lower eastern limb, with a long life and scalability. On our assumptions of normal prices and production, it should be one of the highest free cash flow margin mines in the industry. Following the consummation of the BEE deal, it will be 35% empowered, well ahead of the 26% mining charter requirement. It will also be raising R4bn in the deal, which means it will be sitting in a fairly unique position of strength to engage in consolidation within the sector, at a time that we think is a cyclical low.

Portfolio managers
Alistair Lea and Siphamandla Shozi Client