The All Share Index declined marginally during October. However, this headline decline masked a strong divergence in the performance of the underlying components. Stocks exposed to the global economy, comprising mainly resource stocks, declined. This was evidenced in the almost 9% decline of the resources sector. Prices of stocks exposed to the local economy ran up sharply. The financial and industrial indices were up by 19% and 18% respectively. The portfolio has been very underweight the resource stocks, and very overweight the other - this boosted returns relative to the All Share Index and, more importantly, generated very good absolute returns.
Investors are currently concerned about two issues, and we would argue that neither really matters. The first is the US election. Our opinion is simple: whoever wins, inherits massive problems that are not going to go away very easily. US financial assets will remain under pressure, and the US as a growth engine for the global economy remains in doubt. The second issue is China. Having raised interest rates recently for the first time in nine years, the fear is that the Chinese economy starts slowing down rapidly. This was evident in the sell off in commodity markets. Our opinion remains the same: the Chinese authorities have, as long ago as late 2003, indicated they want to slow down their economy and continue to do so. At present, the commodity cycle is at very high levels. Although we do not rule out further gains in the short term, it is not prudent for a long-term investor to discount a continued up cycle. We do not believe this is priced into assets that reflect current strong Chinese growth (or at least the common perception of this growth), and as a result these assets (including resource stocks) offer far more downside than upside. We continue to avoid most of these stocks.
As for bonds, the fund remains very underweight. Returns from this asset class have been relatively poor, and we continue to think investors are not being paid for the inherent risks.
As usual, we were not very active during the month. We think your portfolio fully reflects our views on individual stocks, and that there is no need to continuously tinker with it.

Markets picked up where they left off in August, continuing a very strong run in September. Both the financial sector, buoyed by foreign bid activity (Barclays/ABSA) and the resources sector, buoyed by stronger commodity prices did very well. For the quarter, the All Share Index was up (+17.4%), Bonds performed less well (+6.9%), but still better than cash (+2%).
In our opinion, this strong move is completely justified based on the underlying fundamentals of the local economy, coupled with the valuation levels of the domestic equity market. A point we have been arguing for a long time - local assets are undervalued, and are due for a significant re-rating at a point in time. The important questions are: what has caused this re-rating, and what are the prospects from current levels?
In financial markets, it is well known that perceptions are nine-tenths of the law. South Africa's fundamentals have been promising, and assets have been cheap for a long time. The reason for previous poor returns, is that investors' perceptions have been quiet poor. It is exactly this poor perception of the fundamentals that caused South Africans to expatriate currency at ridiculous levels in 2000/2001, and buy offshore assets with much worse fundamentals (but better perceptions of those fundamentals).
Over the quarter, the surprise interest rate cut and Barclays' proposed bid for ABSA have acted as catalysts to change the way investors perceive the South African market landscape. The fundamentals are the same - it is just the perceptions of those fundamentals that have changed, for the positive. In our opinion, this is a powerful force, which once set in motion, takes a long time to play out. It is worth mentioning that returns from financial assets tend to be quite high during such a period, as valuations move from low (below fair value) to high (well above fair value).
The fund continues to be positioned for a re-rating of South African financial assets and should continue to benefit from this process.
Looking at returns over the past few months, it is clear that the upside has been broad - not one sector stands out from the rest. Over 12 months, financials and industrials performed far better than resources, supporting the fund's "local is lekker" positioning. Cash has been by far the worst performer over the past year.

Since June 1, the fund has been managed by Piet Viljoen, who has a defensive, low-volatility approach to investment. He has tended to outperform in bear markets and underperform in market recoveries such as this past August and September, so the lacklustre short-term returns are consistent with his record. The fund will soon merge with the Flexible fund.

The financial markets had a fantastic month - interest rates were cut, the rand depreciated somewhat, and global markets rebounded a little, leading to an 8,75% increase in the JSE/FTSE All Share Index. Even the bond market chimed in with a 3,5% return!
The key event was the unexpected interest rate cut. We are not very good forecasters and are happy to admit to not expecting the cut in prime. However, we were surprised at the market's immediate reaction - something like, "the SARB has finally bowed to political pressure, and we are in for a huge inflation scare, and a much weaker currency".
We do not share this view and see the lower interest rate environment as one of the tangible benefits of the very stable monetary and fiscal policies that have been in place for the last 10 years. This is in addition to the lower tax rates enjoyed by both corporates and individuals. These are good things, and contribute positively to South Africa's growth potential.
The main obstacle to meaningful economic growth is the negative mindset that has permeated the domestic environment since 1998, evidenced in the very weak rand in 2001, the irrational offshore acquisitions by South African companies (in jurisdictions where they had zero competitive advantage), and the widespread lack of interest in domestic equities.
The initial reaction to the August rate cut reflected this entrenched mindset - the rand weakened, bonds sold off and rand hedge shares strengthened dramatically. Rationality only resumed in the subsequent weeks with the broad market advancing to the upside.
This is exactly why we feel that the fund is "comfortably positioned". We believe that the current macro-economic environment is very favourable to growth in South Africa. If the rand depreciates unexpectedly, it gives the growth sector a further boost. Yes, rand-hedge companies should do well over the short-term if this happens. However, according to our research, they seem to be priced as if they were expecting a weak rand. In other words, if a weak rand actually materializes, there are no excess returns available from these stocks over the long-term.
As for domestically orientated stocks, this favourable economic environment of lower (and more stable) interest rates, coupled with a moderately weakened rand will have significant stimulatory effects. Industrial (and financial) stocks are not discounting such an environment. If it materializes, they should perform very well. If we revert back into the old boom-bust scenario, there is limited downside - because this is exactly what these stocks are currently pricing in!

Nedcor Retail Investments proposes on the 1 Nov 04, to amalgamate Nedbank Flexible Asset Fund with the Nedbank Managed Fund, and will be managed by Piet Viljoen of RE:CM according to the investment policy of the Nedbank Managed Fund. Piet currently manages both portfolios.

The investment management of this fund has been outsourced to Piet Viljoen of RE:CM. Piet also manages the Nedbank Flexible Asset Fund.
Piet established the boutique asset management company, RE:CM in March 2003. He previously managed the Investec Opportunity Fund, which under his stewardship achieved an exceptional performance track record, despite extremely volatile markets. Piet has an impressive track record of managing clients' money and has consistently achieved returns that place him in the top tier of South African fund managers.
The Nedbank Managed Fund's mandate is well suited to RE:CM's investment management philosophy of seeking solid, long-term returns by investing in equities, property, bonds and cash, as the fund is able to invest into any of these asset classes.
RE:CM set themselves the benchmark of achieving positive annual returns for investors, while ensuring below average volatility. They believe that making sensible assumptions about the long-term, and ignoring the shortterm mood swings of the market leads to markedly better performance results. Risk is defined as losing money, and at RE:CM they mitigate against risk by being conservative in share valuations, placing emphasis on cash flow rather than reported earnings and avoiding the herd.

The rand retraced somewhat during December, depreciating some 3% against the US dollar, which benefited the fund with an offshore holding of 12%. The offshore component appreciated by almost 9% during the month, well in excess of other asset classes, once again highlighting the value of a properly diversified portfolio.

The low weighting in resource shares detracted somewhat from equity selection. However, this was more than compensated for by the performance of the foreign assets. Stars in the equity portfolio included Billiton, Sasol, Bidvest, Sappi, Goldfields, MTN and Naspers. Selection in the bond portfolio was also good.

At the end of December 2003, the fund was broadly exposed to 19% bonds, 64% local equities, 3% listed property, 12% offshore in a balanced fund and some 2% in cash.

Major purchases during the month included Woolworths, Supergroup, Naspers, Sappi and Goldfields. Sales included Kumba, Sasol and Nuclicks. The fund was a net seller of bonds, taking some profits after the strong appreciation in the previous months.