The fund, run by Anthony Sedgwick of Polaris Capital, has sold its remaining resources shares, Trans Hex and Northam, and now has the highest exposure to retail shares of all the small-cap unit trusts. Sedgwick also expects increased infrastructure spending by government, which he is accessing through shares such as Group Five, PPC and Concor. Woolworths and Metair are new holdings.

Financial Mail - 10 December 2004

The JSE extended it's very powerful run, rising by an incredible 5.7% for September 2004. This brings the All Share Index's rise over the last 12 months to +36%, and +61% since the start of the Bull Run in April 2003! The mid- and small-cap indices were not to be left behind, and delivered an even more impressive +6.8% and +6.0% respectively. The fund had an excellent month relative to the market, which is pleasing on an absolute basis.
Star performer sectors were Banks (+15%) driven by the market speculation around the acquisition of ABSA by Barclays, and the Retailers (+13.4%) driven by a very robust consumer environment and fuelled by positive public statements made by some of these companies. Given that Banks are all large-cap shares, the fund could not participate in the sector, but the very heavy Retail exposure (over 25% of the fund) paid off. Notwithstanding their performance in the last two years we do not think that they are currently over-valued. Consequently, we retain a healthy exposure to the sector via Edgars, Truworths, Massmart, NuWorld, Foschini, Ellerine, JD Group and the new listing of Lewis.
While unit-holders have enjoyed strong appreciation in the value of their units in the last 18 months (which may give cause for a more cautious approach), the underlying momentum to the market remains extremely strong. With greater market anticipation of a further interest rate cut before the end of the year, the short-term outlook is positive. In addition, the portfolio currently has a weighted PE of 10.5 and a Dividend Yield (before fees) of 3.4%, which at a significant discount to the overall market still offers reasonable value!

The big surprise was the 0.5% cut in the Repo rate. Market commentators see this as a potential change in monetary policy strategy by the Reserve Bank, from a conservative approach of severe inflation targeting to one trying to generate growth, resulting in a weaker rand. Because of the unexpected rate cut, the rand weakened against the US dollar (from R6- 20 to R6-60), which predictably led to an immediate response by the more geared sectors to currency weakness - notably Gold, Platinum and the Mining Houses. Consequently, the Resource Index overall was up 13.2% for the month, leading the All Share Index, which returned +8.75%. The fund manager's see the move by the Resource shares as an overreaction, and further significant rand weakness must follow to justify the re-rating of these sectors.
Predictably (in the face of a weakening rand) the mid- and small-cap indices, which have a much lower resource component in their composition, did not keep up with the All Share Index returns, but nonetheless managed a respectable +4.86% and +4.68% respectively. The fund manager was pleased to report that the fund out-performed both of these!
While the fund manager's focus has been on good dividend paying industrial shares with a rand-hedge component such as Altron and Reunert, the fund manager's also continued to add to other attractive rand hedges such as Trencor, Uniserv, Hiveld Steel, Trans Hex and Northam. While the Industrial sector underperformed the Resource sector, the fund manager's believe that it offers better valuation and growth prospects.
The fund portfolio is still heavily exposed to the Retail sector and see consistent growth for at least another year. It is remarkable to see the movement of the LSM (living standards measurement) groups over the last five years from LSM 1 and 2 into LSM 3 and 4 - resulting in the emerging middle market driving retail sales beyond expectations. This phenomena is assisted and further fuelled by lower interest rates and low inflation, driving household and corporate spending.
The fund manager's do not believe that the broad market is in expensive territory - especially taking into account that the market earnings yield is currently around 7% - very attractive relative to the after tax yield of a cash investment. This confirms the fund manager's belief in searching for high dividend yielding shares with a rand hedge exposure, rather than buying highly priced resource counters discounting future rand weakness or further commodity price gains.

Nedcor Retail Investments announced that it would outsource the management of the Nedbank Entrepreneur Fund to Polaris Capital from 1 July 2004. The Fund has approximately R171 million client assets under management.
Tim Allsop, Anthony Sedgwick and Marius van Rooyen established the boutique asset management company, Polaris Capital in July 2003. Tim, with Anthony's assistance, has managed the hugely successful Nedbank Rainmaker Fund from June 2000, and prior to this the equally successful FTNIB Prime Select Fund from December 1995.
Tim qualified as a Chartered Accountant and has 17 years' investment experience. He began his investment management career as an industrial analyst at HSBC (Simpson & McKie) before joining Syfrets Managed Assets in 1995 and then African Harvest Fund Managers in April 2000. Anthony started his investment career in 1992 with Syfrets Private Bank before joining Syfrets Managed Assets, where he worked closely with Tim. Thereafter, Anthony helped to establish African Harvest Fund Managers as one of the Investment Managers, once again working closely with Tim until their departure to establish Polaris Capital in 2003.
Dave Macready, Head of Nedcor Retail Investments says: "We are particularly pleased to further cement our relationship with Polaris Capital who were one of our first "best of breed" investment management appointments and currently manage the Nedbank Rainmaker Fund. Anthony and Tim have an impressive track record of managing clients' money and have consistently achieved returns that place them in the top tier of South African fund managers. In fact, Tim has significantly outperformed both the JSE All Share Index (by some 12.77% per annum) and the General Equity unit trust average (by some 11.5% per annum) for the period since he took over the management of the FTNIB Prime Select Fund in 1995. Anthony also has specific experience in the mid and small cap sector, having specifically turned around the ABSA Specialist Growth Fund while at African Harvest between December 2000 and March 2003.
"We are confident that the Nedbank Entrepreneur Fund's mandate is particularly well suited to Polaris Capital's investment management philosophy of seeking cheap shares offering relatively strong growth prospects, and looking for investment opportunities outside the ALSI-40 universe."
Anthony Sedgwick of Polaris Capital says: "When we established Polaris, Nedcor Retail Investments was our first client. We're very excited to now extend our partnership and are looking forward to the challenge of managing the Nedbank Entrepreneur Fund.
"Our objective in the management of the Nedbank Entrepreneur Fund is to provide capital growth over the longer term by investing in small and mid-sized companies. The Fund's mandate allows us to invest in companies outside of JSE Top 40 companies, which is an area we have successfully exploited in the past and where we believe we have credible experience. This mandate differs from the Nedbank Rainmaker Fund's mandate where we aim to achieve superior medium to long term capital growth through careful stock selection and exposure to selected themes in the equity market. This we do by focusing on a core of high-growth mid-caps, surrounded by a spread of traded large-caps (ALSI-40 shares)."
Concludes Macready: "Anthony and Tim's appointment is the final change to our range of "best of breed" fund managers following the announcement by Quaystone of their proposed closure. Previous appointments were Neil Brown to continue to manage the Nedbank Growth Fund, Dave Foord to manage the Nedbank Value Fund, Graham Mason and Gary Quinn to manage the Nedbank Mining and Resource Fund, Piet Viljoen to manage the Nedbank Managed Fund, Adré Smit to manage the Nedbank Income Fund and Kokkie Kooyman to manage the Nedbank Financials Fund. These appointments, we believe, have significantly enhanced our "best of breed" investment management strategy."

Though there has been some short-term slippage, fund managers Neil Brown and Alistair Lea of Quaystone have a strong track record and a passion for small-cap shares. The fund focuses on shares with market leadership and a solid management team. The main concern for unit holders is what will happen to Brown and Lea after Quaystone closes in June. No-one knows whether they will still be running the fund.

Investors who followed the big-cap route over the past three years can be excused for looking with envy at the returns that smaller-cap funds such as Nedbank Entrepreneur Fund (NEF) have delivered. Working in their favour was a high level of insulation against the effects of a strengthening rand and exceptionally low smaller-cap valuation levels, particularly in early 2003.

Neil Brown, who manages NEF with Alistair Lea, believes the potential for smaller-cap shares to outperform is intact. "Most are growing off modest market share bases, while many top 40 big caps dominate their markets."

But Brown is also a realist. NEF's 50% return over the past year was exceptional. Undervalued shares with the potential to rerate sharply were in abundance. "This year, shares that will produce 100%-plus gains are scarce."

Against this background Brown and Lea are focused on "managing potential downside risk". They are looking mainly for companies that have sound management and high earnings quality but trade at a discount to fair value . This is seen in the NEF portfolio's average 9,7 p:e, which is below market average, and above-average 3,5% dividend yield.

"We try to keep a balance across the portfolio," says Brown. The result is that it contains elements of high-EPS growth shares and turnaround situations. "But we concentrate on solid companies that are not seen as glamour stocks."

Hudaco and Reunert are typical. "They are well-managed businesses and their managements know where they are going." This thinking is also seen in NEF's 6% IT exposure. "We wanted an exposure in the sector but wanted companies where EPS visibility is good. You won't get that in a Didata, for example, but you do in our holdings: Mustek, United Services Technology and Aplitec. This is typical of our approach ."

Despite a cautious approach, Brown offers hope of solid returns ahead. "Based on our forecasts, we expect a total return of 25,2% over the next two years," he says. This is based primarily on earnings growth and a small upward rerating of the market.

The Nedbank Entrepreneur Fund continues to have strong absolute and relative performance, with the lowest volatility in its sector due to the consistent and conservative nature of the management style. For the past year the fund is the second best performing unit trust in its sector, with a return of 41.19%.

During the past quarter several shares rose by over 30%, including the financial share Cadiz and the industrials, Pepkor, Bowler Metcalf, Nu- World, Group Five and Wilson Bayly. No share in the fund of 37 shares lost greater than 10%.

The fund benefited from three buyout bids, namely Pepkor, Afrox Healthcare and Avis. The buyouts of various listed companies during the past six months is indicative of the value being found by investors in the mid and small cap listed companies.

The fund will retain its strong positive bias towards local industrial and to a lesser extent, financial shares. The fund manager's continue to favour the construction, food and retail related sectors in South Africa, selecting shares that have a market leadership position, a proven track record, a solid management team and profit and dividend growth that is well supported by strong cash generation. Selected rand hedge shares, such as Uniserv, Alexander Forbes, Avmin and Oceana are also held in the fund to balance the strong rand, and slightly defensive positioning of the fund. The fund will probably continue avoiding the recent strongly performing gold and information technology mid cap shares, which the fund manager's believe are both overpriced and marginal in terms of their ability to be profitable.

With the expectation of a further interest rate cut, the fund manager's remain positive on the outlook for the market and the fund. The fund has a weighted market cap of R2.6bn, which means that it has slightly more of a mid cap than a small cap bias. Despite the recent strong performance, it still trades on an undemanding historic PE multiple of 9.4x and a historic dividend yield of 3.7%, both of which are comfortably more attractive than the market as a whole.