In reviewing the price and total returns of our domestic equity holdings over the past 12 months, it's again noticeable how significant dividend contributions are to overall investment returns. Also noticeable is how meaningfully the interpretation of comparative investment returns can change if dividends are properly brought into the equation.

Among our holdings with the highest 12-monthly contributions to portfolio total returns, the 'big yielders' are indeed very well represented. The likes of Metropolitan, Brait, Vodacom, Tiger Brands, Imperial and RMH all shared their profits with their minority shareholders in large percentage amounts that move the needle for portfolio investors. At the end of the day, we take comfort from stock market history and personal experience that dividends contribute two-thirds of the total real investment return to long-term investors. The trick of course is to be a shareholder for long enough to actually put in a claim to the dividend stream.

Only two things can influence the quantum of dividend inflows for an investor:
a) the starting yield (that depends on the price you pay); and
b) the growth in the dividend into the unknowable future.

We know we're not very good or better than anyone else at guessing future outcomes, so we prefer to focus on a critical assessment of the knowable present. We happen to think that a high starting dividend yield, supported by a sustainable level of profitability at a good quality business, is a very attractive investment proposition. How high, you may be wondering? Well, the higher the better is our answer. A higher starting dividend yield can only be available when market prices are low. Prices only get low when the market is generally very unhappy about something. It is our job as analysts to figure out whether what the market is unhappy about is worth being concerned over, or not.

As for the second part of the equation, we always focus our portfolio investments on high quality businesses. Part of our assessment involves evidencing the ability of the business to deliver above-average growth in earnings and dividends over long periods of time, 10 to 20 years or more. This is no guarantee of future delivery and we spend a lot of time and effort trying to understand what could hinder the repeatability of this outcome.

The largest transaction in domestic accounts in September was a partial sale of the equity position in Old Mutual. As with the motivation we presented last month, a reducing price-to-value relationship was again the culprit. We remain significant net sellers against a backdrop of continued positive price movements.

In our global accounts, we've allocated a portion of the portfolio's capital to a group of global pharmaceutical businesses with strong balance sheets that offered a starting dividend yield of over 4% in USD, on a single-digit earnings multiple and a double-digit free cash flow yield. The market appears to believe these businesses cannot grow very fast, especially when compared with social networking, infrastructure, commodities and the conversion of peasants to big spending consumers in China and India. In an investment world, once again apparently besotted with growth and accepting risk at any rate of return, we can understand why this segment of the markets would become so unloved.

Regardless of our or anyone else's future worldview, a starting yield of 4% that can grow in real terms is a very attractive investment proposition.

Putting us at risk of producing two pages in a monthly comment, a quick word on the recent M&A activity in South Africa. Our clients do not own Didata or Massmart, as our valuation assessments are below their market prices. We do find it odd that no-one in the business world seemed interested in South Africa's corporate assets when they were genuinely cheap back in 2002/3, with an oversold currency on top.

Despite a lot of uncertainty in the markets at present, don't lose sight of the fact that a 'boring' balanced fund process has compounded your capital at over 17% per annum after fees over the past seven years, which is not far behind the JSE All Share Index compound return over this same timeframe, with a lot less 'losing sleep risk' attached to it (also known as volatility). This return was achieved despite the global financial crisis, the massively volatile domestic currency, the commodity bubble and crash, the housing crash, the hedge fund crash, the private equity crash and Madoff et al. We think this provides an excellent perspective on the power of compounding combined with a philosophy and process that protects capital when assets are expensive.

An exciting development for our clients and our business was the recent successful listing of RE·CM and Caliber Preference shares on the JSE. The broad mandate and a new universe of investment opportunities with a lack of capital competitors that can be pursued within this instrument, we think is more than enough reason to own it.

Despite some of our client mandates already giving us permission to invest in this instrument, we deemed it prudent to approach each client individually with full disclosure, direct access to our investment team to answer questions and more than a month to evaluate their potential approval.

During this entire process we have learned a lot, in particular about human nature, but it also reinforced our belief in the value of listening to clients. One of the best questions raised was the potential negative impact on our investment team's time of this initiative. We can again assure you that how we spend our research time is front & centre in our investment team and has been from day 1 at RE·CM. This is in fact one of the main reasons for the founding of the firm and its sustenance.

From our perspective, nothing has changed - our investment team continues to generate ideas as and when the markets provide them to us. It's pretty simple really: The more good analysts we can attract and retain and the more time we can give them to do what they're paid to do, the more ideas we can generate for your benefit. In the unlisted investment universe, we have brought in private equity expertise, as you know, but we are quite excited about the potential information sharing benefits between the private equity specialists and the listed equity specialists within our business. We know this makes both parties stronger, as robust debate remains the cornerstone of our investment process.

Market price changes are something over which we have no control and consequently, lose no sleep over. We can only describe the thinking behind some of the actions we've taken on your behalf and with our own savings.

Last month we proclaimed 'nothing to add'. How quickly things can change. We will start with South Africa before considering our offshore investments.

We finished selling two small holdings in the portfolio, Winhold and Capitec, with two very different investment lessons as we conduct our internal tombstone reviews of these allocations of capital. In Winhold's case, we owned it for six years and despite buying it at a deep discount to our intrinsic value estimate at the time, the highly competitive nature of the plastic packaging and mining consumables industries they operate in has served to hold back real growth in the business and of course in its share price. We realised acceptable absolute returns, but if there's one key take-away here, it's to be reminded again that the characteristics of a business with disadvantaged economics will dominate its ability to earn a satisfactory return over the long term. Interestingly, our valuation estimate for Winhold is in fact lower in nominal terms in 2010 compared to 2004 when we first bought it. This has everything to do with the quality (or rather the lack thereof) of the business. We were fortunate to have a very able executive chairman in Bob Wenteler managing Winhold. It's no mean feat and he has performed admirably. This example highlights one of the key reasons why our investment process incorporates a limit of 30% of the equity exposure to such businesses at all times.

In stark contrast stands the excellent returns we've received from Capitec over a relatively short holding period of three years. The business continues to power ahead, delivering yet another superb set of financial results with significant growth far in excess of inflation in all the metrics that matter. Of course, forecasting this type of growth is best left to economists and other soothsayers. It's certainly not a core skill of any analyst at RE·CM, and is unlikely to ever be. Our key takeaways in this instance is to be reminded that:
a) we are not very good at valuing or paying for growth; and
b) it pays to be a long-term shareholder of a great business with the ability to deliver strong real growth.

In Capitec's case we identified value and received growth on top. That is a perfect outcome, but it's not one we can ever absolutely guarantee to happen and we prefer building an investment thesis that does not rely on such an outcome.

We successfully pursued an investment opportunity in the corporate bond market by investing in a new issue of African Bank bonds at a real yield of 5%. You may recall a recent monthly comment where we described our cash management process in a fair amount of detail. In this instance, we swopped the near certainty of a 1% real return on cash with the uncertainties of investing in a corporate bond. For these uncertainties we demand to be paid a significant yield sweetener and our conviction is that a real return to maturity of 5% is adequate. These are senior securities and we intend holding them until maturity in March 2015. Our exposure is limited to 3% of the total portfolio, at cost. These securities form part of the cash component of a Regulation 28 fund and does not impact on our ability to invest up to the maximum 75% in equity, should market conditions warrant it within this timeframe.

Offshore, we evaluated and invested in a new investment opportunity in the equity of Wellpoint, a large commercial health benefits business in the United States with 34 million members. To put this in perspective, Discovery in South Africa has just over 2 million members. Wellpoint is a market leader across 14 different states, and anyone that has spent a decent amount of time in the US will know that this implies they have effectively achieved scale in 14 different 'countries'. As an entrenched player, the business enjoys significant barriers to entry. We believe it is available at an attractive price to value ratio because of significant uncertainties around regulatory changes pursued by the Obama administration.

Since August 2009, our investment team found and assessed 19 new ideas. In South Africa, we assessed 11 ideas, of which two are being pursued at present. Offshore, we assessed eight ideas and invested in five.

One month is an irrelevant time period over which to provide meaningful interpretation of market price movements controlled by the collective actions of many millions of market participants. Market price changes are something over which we have no control and consequently, lose no sleep over. We can only describe the thinking behind some of the actions we've taken on your behalf and with our own savings.

It is worth keeping in mind that even though this is a monthly commentary, we will always endeavour to extend the duration of your thinking with regards to market observations.
As market prices continue climbing the walls of worry -witness the pundits claiming double-dip recessions and other such fancy words -we continue doing what we do best, keeping our heads down and focused on ranking the merchandise on offer in a filtering mechanism that at its core specifies just two things:

a) the quality of a business; and
b) what the price to value relationship is on any given day.

The combination of these two filters is essentially what determines which individual investments and how much risk fund management is prepared to accept at any given point.

This is usually the time of year to make predictions, and we have two to make. Firstly, we confidently predict that we will continue to have no clue what will happen to share prices tomorrow -or this whole year in fact. Secondly, we believe the advantaged economics of the businesses we have allocated your capital to will have made them stronger through the recessionary times of 2008/9, in some instances due to competitor failure, in others due to cost improvements. If and when demand in the world economy recovers, these businesses are well positioned to grow revenues, profit margins and dividends.

Despite strong returns over the past 18 months, we continue to see reasonably good value in select domestic and offshore equities, but in a much more concentrated dose than before. Many of our domestic portfolio holdings are trading near fund management's estimate of its fair value ranges, and our calculations show the South African index is currently priced to deliver poor returns to long term investors.

The largest capital allocations in December were to the equity of Remgro and Telkom. We described the investment thesis behind both of these in recent monthly commentaries. We undertook limited management action on the selling side.

Outside of South Africa, our investment team continues to find good quality businesses that offer good odds to long term investors. We're covering a very large piece of ground on the face of it, but by narrowing our focus to only the highest quality businesses, we can understand well enough to value with an acceptable level of confidence we have targeted a small subset of about 140 companies (at last count) out of the many thousands of listed global businesses.

Our largest capital allocations offshore over the past three months were to the equity of Familymart, Astellas Pharma and Tokyo Gas, coincidentally all in the Japanese market, where a 20-year (and counting) bear market appears to have dragged the prices of many good businesses to particularly attractive levels.

The fund continues to carry zero exposure to government bonds, property markets or alternative assets, where prices have not yet offered a decent margin of safety despite magnificently underperforming cash over the past five years in the case of long bonds and three years in the case of both property and alternative assets -quite incredible. We recall a leading buyside strategist who, as far back as 2001 and after a significant period of outperformance over equities by the bond market, advocated making bonds a dominant component of any domestic balanced fund. Total returns from government long bonds since have matched total returns from holding cash.

In a nutshell, our levels of optimism have dampened considerably compared to March of 2009, and our management actions over the past six months have resulted in a steadily increasing exposure to cash.