Market review
South African equities ended almost unchanged in the second quarter, but volatility was high during this period. The sector laggards remain mostly confined to resource stocks with gold (-33.5%), platinum (-23.9%), coal (-10%) and diversified miners (-10.8%) all experiencing double-digit losses in rands. Year to date, the resources sector is trailing the overall market by 19.4 percentage points. Industrial stocks mostly held their ground over the quarter and defensive stocks, on average, achieved strong absolute returns. Financials lagged, with banks down 6.2% and life insurers flat for the quarter after a particularly weak June.

Portfolio review
The FTSE/JSE All Share Index returned - 0.2% over the quarter, while the FTSE/JSE Shareholder Weighted Index was up 0.7%. Foreign investors were, however, far worse off as the rand continued to weaken against major developed market currencies. US investors who had bought the MSCI South Africa Index would have lost 15.5% of their capital in US dollars (year to date). This loss is largely currency related. It is therefore no surprise to see rand hedge shares again being the quarter's top performers. However, investors had to own industrial rand hedges and not resources. The resource sector has been under significant pressure with local industrial unrest, sluggish Chinese economic data and falling dollar commodity prices. Basic materials underperformed financials and industrials by over 18 percentage points in the second quarter and by more than 30 percentage points year to date. Those areas of the market most exposed to the South African consumer, namely banks and general retailers, also lagged the broader market as investors became more concerned about the financial health of the local consumer. Our holdings in diversified miners Anglo American, BHP Billiton and African Rainbow detracted from performance. This was offset by our underweight positions in the quarter's two worst performing sectors - gold and platinum equities. Our industrial rand hedge stock of choice, Richemont, posted strong financial results and positively contributed to returns. We are underweight two of the largest shares in the local market, MTN and Naspers, both which performed strongly and therefore detracted from performance. The big four banks were negatively affected by the extremely poor trading update from African Bank. Even though the "big four" have only limited exposure to unsecured lending, weaker sentiment was enough to put pressure on FirstRand, to which we have a large exposure. FirstRand is our favourite banking share and is therefore a core holding. We believe the group is conservatively positioned and will again post satisfying financial results. Our holding in Coronation Fund Managers also made a major positive contribution to returns.

Portfolio activity
Global growth will remain tepid for now and, more importantly, will vary across the globe. The Chinese economy has been weaker relative to our expectations. Local Chinese authorities are taking a hard line against excessive credit extension and seem comfortable with the transition from a commodity-intensive to a consumer-driven economy. These factors have led us to moderate our outlook for commodity prices over the medium term and also our appetite for large holdings in the mining sector. We have therefore reduced our positions in Anglo American and BHP Billiton. There are, however, many tentative signs that economic prospects are much more favourable in the US, Europe and Japan. We maintain our view that the global economy should reach "escape velocity" within the next 12 to 24 months, and that the portfolio should have less exposure to defensive equities. "Escape velocity" is a term we use to indicate a stage in the economic cycle where equities and other risk assets should comfortably outperform the traditional "safe haven" assets that investors have so treasured the past few years (for example government bonds and gold). In line with this reasoning, we've reduced our position in SABMiller. The share has rerated significantly, even when compared to the broader staples universe. Its exposure to weakening emerging market currencies is also impacting its earnings outlook negatively, which can result in earnings downgrades. We increased our holding in Richemont, another rand hedge industrial stock. Richemont has, however, derated relative to its peer group. The stock should also benefit more from a cyclical upturn (particularly compared to a defensive share like SABMiller). We expect Richemont's revenue growth to accelerate towards year-end as the comparative base for Swiss watch sales becomes more favourable. It is clear that lower-end consumers are taking strain and that unsecured credit extension (a major source of consumer spending power the past few years) is being reined in. We had little exposure to African Bank going into the last quarter and fortunately we sold out of the stock almost completely by the time the company issued a profit warning. With the upper-end consumer still in good shape, we remain holders of Woolworths. We have, however, reduced the size of our holding slightly.

Portfolio positioning
Global defensive sectors - the "market leaders" of the past two to three years - seem to be struggling to continue their outperformance, particularly in the US. There are concerns that the US Federal Reserve might start tapering its third round of quantitative easing asset purchases sooner than expected. This has resulted in a sharp sell-off in US treasuries as well as "search-for-yield" equity shares like utilities, telecoms and staples. This trend has not been as prominent in the South African market, as the deteriorating domestic consumer environment, slumping commodity prices and rand weakness have taken centre stage. However, we are cognisant of this change in market leadership, even though it might be somewhat premature, and are positioned accordingly. Positive earnings revisions at reasonable valuations remain at the core of our investment philosophy.

Market review
South African equities recorded positive but modest returns in rands over the quarter, with the FTSE/JSE All Share Index closing 2.5% firmer. The rand weakened 9% against the US dollar and more than 6% against the euro. The resources sector's underperformance continued into the first quarter with gold (-17.9%), platinum (-13.5%) and diversified miners (-6.3%) ending sharply lower. The combined financial and industrial index rose 6.2% over the quarter, with industrials in particular performing strongly. There was a wide dispersion of returns within the broad industrial sector. Rand hedge global stocks saw double digit returns, with SABMiller and British American Tobacco rising 24.7% and 18.4% respectively. Meanwhile retailers, favoured amongst foreign shareholders, dropped nearly 10% despite a strong performance in March. Banks marginally underperformed the FTSE/JSE All Share Index, while telecommunications lost more than 7% and healthcare gained 8.8% over the quarter.

Portfolio review
The Investec Equity Fund was well ahead of its benchmark over the quarter. FirstRand, Old Mutual and Liberty, all core holdings in the portfolio, continued their impressive run from last year and produced solid financial results, exceeding consensus expectations. The broader portfolio benefited from the weak rand, particularly our dual-listed industrial holdings in SABMiller and Richemont. The fact that we didn't own any MTN, one of the few large-cap industrial shares that produced negative returns during the first quarter, also contributed positively to performance. Our positions in diversified mining companies detracted from performance as commodity prices buckled under the pressure of a stronger US dollar, and sector rotation away from emerging markets into developed markets (mainly the US). Our holdings in African Bank also detracted from performance as the share derated further. This was due to concerns about the health of the unsecured lending market and a disappointing trading environment for its furniture division.

Portfolio activity
We have no doubt that the road to recovery will be rocky and that economic data will occasionally disappoint. This will result in stock market volatility casting doubt in the minds of investors about whether equities should be their asset class of choice. We are of the view that the global economy should reach 'escape velocity' within the next 6 to 18 months. 'Escape velocity' indicates a stage in the economic cycle where equities and other risk assets should comfortably outperform the traditional safe haven assets that investors have so treasured over the past few years (for example government bonds and gold). In line with this view, we've been gradually adding to cyclical equities (BHP Billiton, Anglo American and Barloworld) and reducing exposure to defensives (NewGold exchange traded fund, British American Tobacco and Vodacom). In January, retailers - particularly companies exposed to lower LSM-level consumers - sold off sharply on the back of disappointing trading updates from the sector. We used this opportunity to buy Woolworths, the only retail share with positive earnings revisions as the upper-end consumer still seems to be in good shape. Although we were concerned about Sasol's aggressive investment programme last year, recent interactions with management made us more comfortable with the group's capital allocation discipline. We consequently bought more Sasol shares. Despite a further derating and disappointing performance, we sold down our position in African Bank. The furniture division (Ellerines) is likely to continue its disappointing performance and analysts will have to reduce their profit forecasts yet again.

Portfolio positioning
Although most investors might not even be aware of it, the global economic cycle is improving slowly but surely - and we want to be appropriately positioned when this happens. The portfolio is invested in equities that are consistent with our investment philosophy, namely reasonably valued shares where expectations of future profits are being revised upwards. We believe financials, both banks and insurers, are attractive investment opportunities. Their valuations are not expensive, in contrast with many industrial companies that are trading at 'rich' earnings multiples. Financials' earnings momentum is robust, which is in contrast with the resources sector where profit expectations have proved to be too optimistic. FirstRand remains our largest equity holding. We have high conviction that the group will continue to take primary banking market share and that dividends are likely to grow faster than earnings over the next few years. We were mostly underweight the mining sector in 2012, as we believed that consensus earnings expectations would prove to be too optimistic. Subsequently, sell-side analysts have aggressively downgraded their profit expectations for the sector. However, the rate of earnings downgrades has slowed to a large degree, and in some cases earnings expectations might be too pessimistic. This, coupled with our view that the global economy is on the (long and slow) road to recovery, has prompted us to reduce the underweight position in this sector. We don't own any shares in MTN, which could be seen as a controversial decision as MTN is a widely-held and much-loved shareholding of most South African institutional investors. However, we believe that analysts will downgrade their earnings numbers for MTN. The company faces a more competitive mobile environment in South Africa (with Cell C gaining traction and Vodacom fighting to regain lost market share), cost pressure, and a reduction in mobile termination rates in Nigeria.

Market review
The FTSE/JSE All Share Index (ALSI) ended the year at record highs, adding just shy of 27% in rands to the modest gains of 2011. The ALSI rose by 10.3% over the quarter. Resources lagged the general market, recording gains of 7.3% over the 3-month period and 3.1% for the year. The gold mining (-18.4%) and platinum mining (-7%) sectors were the weakest performers in 2012, while diversified miners added 10.9% over the quarter and 12.3% for the year. The industrials sector rose strongly, with general retailers (+50.2%), health care (+59.5%) and global luxury brand Richemont (+64%) - the only constituent of the personal goods sector - seeing exceptional returns in 2012. Mobile telecommunication increased by 32.6% over the year, with the fourth quarter adding 12.7% alone. Financials also saw market-beating returns, gaining 38.1% for the year. Banks closed up 11.8% over the quarter while the life insurance sector added 12.7%.

Portfolio review
Investors exposed to risk assets benefited from strong equity market returns in 2012. The economic backdrop remained weak and policymakers continued to fall prey to popular demand, fighting excessive debt levels by incurring even more debt. Meanwhile, investors continued to borrow cheap money, ploughing it into financial assets. It is time to question the health of the global economy in the absence of massive stimulus. The latter continues to drive markets higher. After the strong recent gains, a period of consolidation may well follow. During the past quarter there were tentative signs that the global growth outlook is improving as we head into 2013. Most notably, the US housing market seems to be staging a strong recovery, investors are clearly relieved that the fiscal cliff has been avoided (for now), and Chinese leading economic indicators have improved after the recent leadership transition. This has led to a strong recovery in cyclical, high beta sectors. It is therefore no surprise that the main detractors from performance included defensive counters like NewGold ETF (exchange traded fund), AngloGold Ashanti and British American Tobacco. Three of the portfolio holdings materially contributed to performance during the quarter. The first was Mediclinic, which delivered market-beating financial results driven by favourable debt refinancing and excellent profitability from their Middle East operations. Secondly, Richemont's strong global high-end watch sales continued to surprise the pessimists. Lastly, African Bank became exceptionally cheap in the light of fears about a looming unsecured lending bubble. So far, the bubble hasn't materialised and the share recovered from these low levels. All these top contributors still remain in the portfolio.

Portfolio activity
It is by now well known that earnings expectations for mining companies proved far too optimistic the past year, prompting analysts to revise profit forecasts for the sector downwards. In line with our investment philosophy, we remained underweight the sector for most of 2012. However, the pace of downward revisions started to slow during the last quarter, which is usually a sign that profit expectations have become more reasonable. We consequently increased our cyclical and higher beta exposure by buying BHP Billiton, platinum equities and Barloworld, while reducing exposure to our more defensive holdings like British American Tobacco and Vodacom.

Portfolio positioning
The cornerstone of our investment philosophy and process is to identify reasonable valued shares where expectations of future profits are revised upwards (positive revisions). On the other hand, we avoid shares where consensus profit expectations are being lowered (negative revisions) and where valuations are excessive. In addition to the stock selection process, we integrate and take advantage of our top-down views on macro variables such as interest rates and economic growth. The result is a blend of bottom-up fundamental company research with a focus on earnings revisions, and macro market trends. Over time this philosophy and process have added significant value to our clients' portfolios. Despite inevitable periods of underperformance, we will remain true to this investment philosophy in 2013.