Market overview Despite the overwhelming negative sentiment, the FTSE/JSE All Share Index had its best quarter this year, supported by the strong performance from the media and resource sectors. Both these sectors are benefitting from a weak rand and strong growth in offshore demand for their products. The performance of small and mid cap shares, which have a higher exposure to South Africa, continue to lag overall market performance and both sectors remain in negative territory for the year. In contrast, the Top 40 is up 15.3%.

South African companies have experienced some of the toughest times in recent history. Consumer and business confidence has taken a severe beating. Looking back over the past 20 years - when consumer and business confidence was this low it coincided with a global crisis such as the emerging market crisis in 2008, the IT bubble in 2002 and the Global Financial Crisis in 2008. It is different this time around ....this predicament is completely self-inflicted. While the rest of the globe is experiencing an economic recovery, South Africa has struggled to achieve above 1% economic growth. In the hope of partially restoring business and consumer confidence and supported by an improving inflation outlook, the Reserve Bank cut interest rates by 25bp in July, but the lack of follow through in September and the heightened political uncertainty resulted in a fairly limited impact.

Unsurprisingly our conversations with company management teams over the past quarter highlight the frustrations of business leaders and the impact that the political uncertainty is having on investor confidence. Many projects which require long term clarity have been postponed and some have been cancelled outright. No industry has escaped the negative ramifications of the cabinet reshuffle and more companies than ever are looking for alternative avenues for growth outside of South Africa. In addition, companies have become focused on managing costs in an attempt to preserve margins. Unfortunately this has negatively impacted private sector job creation (mostly in the manufacturing and construction sectors) with over 80 000 jobs been lost in the first six months of this year.

Despite the local headwinds, the South African equity market hit an all-time high during the quarter. The source of returns remains fairly narrow with only three sectors outperforming the FTSE/JSE All Share Index. These are media (essentially Naspers), consumer goods (essentially Richemont) and resources (including forestry and paper). Of a total of 170 companies making up the large, mid and small cap indices on the JSE, just 40 out performed with 130 companies failing to keep up with the overall market return. In other words: for every company that outperformed the FTSE/JSE All Share Index, another three under performed. When investment returns are so highly concentrated, it becomes difficult for active managers to keep up with the overall market returns, explaining why 90% of funds in the general equity category have underperformed the FTSE/JSE All Share Index in 2017.

Performance
The portfolio returns lagged the overall market returns largely as a result of our underweight position in Naspers and the underperformance of our investment in the Naspers core assets (through the listed stub instrument). In spite of the discount of Naspers widening to extreme levels, the investment case for the core assets continues to improve. There are various technical factors that we believe have contributed to the discount widening. One such factor is the continuing disinvestment by foreigners from South African equities. Since the discount of Naspers to its investment in Tencent turned negative in January 2016, we have seen a cumulative $13 billion flow out of South African equities by foreigners. This is far greater than the $6 billion during the Global Financial Crisis.

Other stocks which detracted from performance during the quarter include our investments in Steinhoff and Group Five. Steinhoff came under the spotlight once again due to the resurfacing of an old dispute with a former joint venture (JV) partner. This case has been heard in Amsterdam and a favourable decision is expected in the next two months. Management have provided for partial settlement with the ex JV partner and any negative outcome is not expected to have a material impact on the financials. We used recent weakness to add to our position.

Group Five has been the subject of significant shareholder activism. The board has been replaced and new management have been appointed in the various divisions. While the company remains extremely undervalued, it will take some time to restore profitability in the local construction business. The current share price attaches a negative value to the construction business and undervalues the concession business. Our investment in Anglo American and Northam contributed positively to performance for the quarter.

Outlook
This is in many respects a perfect storm. As companies have struggled to grow the top line, they have had to compete harder than ever before to attract and retain customers. This has often meant that prices have remained under pressure resulting in lower margins. In this lies the opportunity. As investors we have always looked for mispricing opportunities which tend to arise at the time of maximum pessimism. In order to find an advantage in the market, one needs to look for diversity breakdowns which happen when participants imitate one another and make the same decisions based on the same signals from the market. Diversity breakdowns represent collective overreactions and under reactions to new information. We have seen this several times in the past and in each occasion have achieved significant returns by having the moral courage to act opposite to the crowd when our judgement has told us that we were right.

In a recent radio interview, Christo Wiese said ..In the last 50 years South Africa has been through tougher times than we are currently experiencing. There is no reason to believe that in this dark night, there won..t be dawn again. Things will be better again......South Africa is currently at a cross road and while the upcoming ANC elective conference in mid-December will be key, we are of the view that the South African domiciled businesses and the currency are already reflecting a bearish scenario.

Many opportunities are emerging in the mid and small cap space and your portfolio currently has approximately 25% allocated to stocks outside the Top 40. The share prices of these companies have been under significant pressure this year and offer substantial upside for the investor.

We also acknowledge our limitations in being able to predict the outcome of the ANC elective conference and its impact on the market in December. For this reason we maintain a diversified portfolio of holdings both local and global, cyclical and defensive. While we remain of the view that SA Inc. remains grossly undervalued, the future performance of the portfolio is not only dependent on a recovery in South Africa. We have significant exposure to businesses that are listed in South Africa, but earn a significant portion of their profits outside of the country.

The objective of the portfolio is to provide the attractive risk adjusted returns to the investors, by investing across a wide range of assets both locally and internationally. The portfolio will avoid unnecessary or diversifiable macro-economic risk and aims to earn the available risk premiums expected from the various assets classes over the long term.