The fund returned 1.2% for the quarter and 10.3% over a one-year period, substantially outperforming its cash benchmark. It continues to provide positive returns ahead of cash and is largely focused on capital preservation.
Economic and market overview
Volatility across global financial markets increased over the quarter following heightened speculation around the timing and extent of US monetary policy normalisation. The rand dropped sharply in September, posting a 5.7% decline for the quarter against a generally strong US dollar. Although their rhetoric continues to signal a tightening bias in the face of higher inflation, the SARB kept rates on hold this quarter. A weak growth and employment outlook remains a significant threat and we therefore expect the moderate rate hiking cycle to continue. Local market news was dominated by African Bank over the period as the business was placed under curatorship. Equity holders (ordinary and preference) and junior debt holders lost all of their investments, while senior bondholders were subject to 10% losses and deposit holders did not suffer any losses. The fund had zero exposure to African Bank equity, preference share or debt instruments. While the SA equity market reached an all-time high in late July, it experienced a sharp pull-back in September, resulting in a 2.1% quarterly loss. This decline was led by the resources sector, which was down 7.1% over the period.
The platinum mining sector was down nearly 20% for the quarter. Given the recovering demand for platinum group metals (PGMs) and the decline in supply this year (due to the five-month strike at the large Rustenburg mines), the weakness in the platinum price is surprising. It is clear that existing above ground stocks were higher than we had initially estimated and this depressed platinum prices when the striking mines started producing again. The labour strikes have caused large cash drains to the heavily affected miners (Impala and Lonmin) and seem to have led to market concerns about whether these companies will need to raise equity capital at a time when their share prices are very low. We maintain our view that future SA platinum supply will be severely constrained by current underinvestment in new shafts. As demand continues to recover, PGM prices will rise substantially, boosting company cash flows. We therefore believe that PGM miners are currently significantly undervalued. Aided by a slight compression in longer dated yields, the ALBI returned 2.2% over the quarter, outperforming cash by 1.5%. Conventional government bonds outperformed inflation-linked bonds over the period.
Fund performance and positioning
The fund has a particularly large exposure to PGM miners and platinum and palladium ETFs. Given the weakness in the platinum sector, equity stock selection was disappointing this quarter, with Lonmin, Anglo Platinum and Aquarius Platinum all detracting. However, this was largely offset by strong performances from Tongaat, Sun International and FirstRand - the fund's top performing holdings over the quarter. Exposure to certain real estate counters, notably New Europe Property Investments, contributed to performance. The fund's offshore assets also performed well, particularly Growthpoint Australia, Deutsche Annington and Deutsche Wohnen. The fund's substantial position in AECI differentiates it from many of its larger competitors. AECI is well positioned for improvements in operating efficiencies, potential volumes and product quality due to its investment in modern technology and capacity. Our assessment of normalised earnings is substantially higher than current levels. The company's Chemserve division supplies specialist chemicals to the SA mining and industrial sectors and is increasingly expanding its reach into Africa. Its explosives division, AEL, is a leading producer of commercial explosives, initiating systems and blasting services for the mining, quarrying and construction markets in Africa, Indonesia and Australia. In addition, AECI has a significant cash balance from the sale of its land in Modderfontein, providing management with interesting strategic options.
SA equity markets are generally looking vulnerable due to very high ratings and elevated earnings bases. Many sectors are expensive and we therefore remain defensive - prioritising capital protection while restricting exposure to undervalued opportunities. We have largely reduced concentration in the fund and are finding more opportunities in mid-cap stocks relative to their larger counterparts. We retain some hedging through put option strategies as an alternative to cash. We are gradually increasing the fund's holdings in fixed-rate bonds as inflation appears to be peaking and foreign holdings are being sold down. However, South Africa's deteriorating fiscal position remains a concern and capital flight remains a risk given the relatively high foreign holding. The fund retains a significant allocation to foreign assets, where we are finding opportunities in certain technology stocks, healthcare stocks, oil refiners and pipeline operators as well as specific listed property exposures. Listed property's recent underperformance of equities has improved the relative attractiveness of this sector. We are therefore selectively increasing the fund's exposure to foreign property (Intu, New Europe Property Investments and Capital & Counties) and certain high quality local counters.

The Stable Fund had a good second quarter, returning 3.4%. Over a one-year period, the fund delivered 14.4%, placing it in the top quartile of funds in the same category. The fund recently marked its three-year anniversary and has outperformed its benchmark by 6% pa since its inception. This was achieved despite a very defensive positioning in domestic equity, which continues to run ahead of our assessment of reasonable valuation.

Economic and market overview
Global and local equity markets continued their grind higher at a faster pace than economic improvements. During the quarter, geopolitical tensions in the Ukraine, between China and its neighbours and in the Middle East were notable. Monetary policy developments continued to influence asset prices. The US Federal Reserve left its tapering programme unchanged, the Bank of Japan continued with asset purchases and the European Central Bank cut short-term rates and announced it was looking at quantitative easing-style interventions. In South Africa, the rand ended the quarter only slightly weaker, with the country acting as a relative safe haven in the emerging market context. The crippling five-month platinum sector strike, which came to an end during the quarter, has had broad negative consequences for a wide swathe of the local economy. NUMSA's subsequent strike in the metals and engineering sector will place further pressure on SA's uncomfortably large current account deficit and slow economy. The SARB kept rates on hold at 5.5% over the period, but instituted its own form of forward interest rate guidance, highlighting that we are now in an upward rate hiking cycle. Given the ongoing economic weakness and in the absence of a significant currency shock from here, we expect a fairly shallow and gradual rate hiking cycle of around 1.5% over the next two years.

Fund performance and positioning
Tongaat, FirstRand and Pick 'n Pay were the fund's strongest performers over the quarter, while Lonmin, Metair and Anglo Platinum detracted. Offshore holdings performed well, particularly Apple, Unibail-Rodamco and Intel, as did the fund's PGM ETF holdings.

The fund's position in Metair offers significant value as the company is likely to benefit from the global automotive sector's response to tightening vehicle emission standards, particularly by manufacturing batteries for start-stop engine management systems. Metair's subsidiary, First National Battery, has developed the technology to manufacture these batteries and Metair has made acquisitions that give it relevance in Europe's significantly larger vehicle market. Demand for start-stop batteries is expected to increase by 20% pa over the next five to 10 years and Metair is investing to expand production. At the current price, the stock is trading at below 10 times our estimate of normalised earnings.

Listed property has recently underperformed equities, improving the relative attractiveness of this sector. We have increased the fund's exposure to property companies with foreign operations (Intu Properties and New Europe Property Investments) and certain high quality domestic companies, which we think will fare better in the difficult operating environment we see ahead. The fund's preference share holdings provide a good alternative to cash, with a yield pickup of around 3%.

Overall, levels in the SA equity market are now even more expensive than a quarter ago and we are finding very few undervalued stocks in the local market. The fund retains a significant allocation to global assets, where we are finding opportunities in certain technology, healthcare and listed property stocks, as well as oil refiners and pipeline operators.