What many people may not realise, is what a great business Amplats is when measured on a relevant Return on Capital basis. Right now, it has delivered an underwhelming operating performance and is facing scrutiny. This is because the company was basically run for expansion at the expense of profitability for the past 10 years. Despite that, Amplats generated fantastic long-term returns on capital. It is a superb business; in fact it is one of the best businesses in South Africa. Over the years we have learnt that a pedigree horse tends to throw a bad jockey off its back. This line of events may now be unfolding as the Anglo American Holding Company recently announced a full-scale review of this subsidiary's operating performance.

The second and probably the key point that struck me in compiling and reviewing this data was how quickly the market can forget or simply ignore the past. No matter how many times I've seen this movie, it never fails to amaze and interest me anew.

Tobacco stocks were considered dead and buried 10 years ago; selling a product that was in fact medically proven to be killing people. It was assumed at the time that these businesses could not survive, and as a result they were priced as such. Today most people seem to believe that British American Tobacco is a wonderful asset, a cornerstone holding in any 'decent' portfolio.

Richemont have on two occasions over the past 10 years been considered ex-growth during global economic downturns. Today everyone seems to agree that it's a great idea because it is experiencing top of business cycle operating conditions.

Truworths has been a great investment to own for the past 10 years, but people seem to forget that in the early 2000's the whole South African retail sector was in the doldrums, priced at bargain basement prices. I recall that being a retail sector analyst was considered a very unhealthy career prospect at that time. Nobody wanted to be researching those dogs, but today they are 'must-owns' trading at prices that reflect massively inflated expectations.

At the time SA Breweries bought Miller, they were roundly criticised for doing so and the share price had been languishing and lagging the market for years, but it was an opportunity that delivered decent investment returns.

When MTN expanded into Nigeria, people thought they were crazy and that it was the worst move that the company could have made. The share price was under pressure, but again it was an opportunity.

Each one of these five businesses that the market today believes are 'must-own' businesses, were during at least one point during the past 10 years, considered 'dogs' to be avoided by intelligent investors. This short reminder of South African market history provides a timely perspective on why owning Amplats today might make more sense than is readily apparent.

Last month we dealt with three key risks the Nedgroup Investments Managed Fund faces. This month, we would like to deal with three key opportunities we see, and how the Fund is positioned to take advantage of them.
Opportunity 1: Platinum
Sometimes a picture really does paint a thousand words, especially if it’s on the front page of a respected publication. Announcements of capacity closure and funding issues are coming thick and fast in the platinum industry, suggesting that the pieces of the capital cycle that we’ve built our investment thesis on, are now being set in motion. The good news is that it is happening faster than we thought. Our experience of capital cycles has shown that they take time (five years and longer) to fully mature. Our take on this particular one is that it’s between the quarter and halfway marks.
Opportunity 2: Natural Gas
The price of natural gas plummeted to near all-time lows below the cost of extraction due to a classic squeeze created by oversupply and low demand. Our analysts have just completed an exhaustive study of the natural gas market in the USA and have come to the conclusion that there are excellent investment opportunities, specifically in a good quality listed business called Ultra Petroleum.
Opportunity 3: Europe
Increasingly, our filters are serving up a steady stream of investment ideas across South and North Western Europe. As a result, our analysts will continue doing more focused work on this region for the foreseeable future. So far, the European woes appear to be largely the result of macro-economic and political concerns, but as we have experienced many times in South Africa over the past 30 years, these are precisely the sort of ‘end of the world’ conditions that breed deeply discounted investment opportunities.
The Fund’s positioning
The Nedgroup Investments Managed Fund is a reasonable size, but exposure to the equity of high quality platinum businesses is not at its maximum. Should their prices continue to decline as a result of all the bad news flow coming out of the industry, we would have sizeable cash holdings from which to allocate more fund capital.
We are aware of the risks of industry specific exposures, specifically in an industry such as platinum with single commodity exposure and the risk of technological obsolescence. Our investment process is designed to manage the combined exposure (because it limits the amount of fund capital allocated to lesser quality commodity businesses that operate further up the industry cost curve). It will remain appropriately scaled relative to the opportunity/risk profile of the idea within the context of the Fund.
We are currently directing a fair amount of our research effort to uncovering more European investment ideas

In an unusually busy month by our standards, our portfolio managers allocated domestic fund capital to existing investment ideas Adcock Ingram, HCI, Sasol, Amplats and Sun International. We also allocated capital to two new investment ideas that finally reached our required margin of safety; Lonmin and Arcelor Mittal.

Domestic realisations of capital included that of the ordinary issued share capital of Discovery, Remgro, Imperial, Old Mutual and Omnia. All of these contributed handsomely to your investment returns over our latest ownership cycle (covering a number of years) and no longer offer a compelling margin of safety. Our investment process calls for reducing your exposure to these assets at this time.

These fund management actions raise an interesting point. To sell what is working; and to buy what is not working is contrary to the human condition. It just doesn't sit well; it is far more comfortable for a portfolio manager to keep what is working and to forget about (or sell) what is not working.

Richard Thornton of GT Management once said; "Find a great investment idea; buy as much as you feel comfortable with; buy the same amount again, so you can no longer sleep at night because of the size of your position and then - TELL EVERYONE ELSE ABOUT IT!!!"

We do not ascribe to Mr. Thornton's hypothesized investment process, but it tends to be the positions in the Fund that generate the most angst in the early months and years of our ownership cycle that eventually ends up being the strongest contributors to your full market cycle investment returns. In other words, the market tends to offer the best prospective investment returns to the owners of the most uncomfortable situations. And we've also found that the relationship is linear; the higher the generally accepted discomfort level, the higher the prospective return. Something about this outcome just feels incredibly fair to me.

To bring it back home, it is worth remembering more recent investment ideas like Old Mutual, which we started buying at R8 in late 2008 just before it fell 50% to R4 and now changes hands at near R20. We started buying Imperial at R60 in early 2008 just before it fell 30% to R40 and now changes hands at over R160. In mid-2010, our 10-year partnership with Omnia resulted in an opportunity to help fund a large capital project (the building of a new nitric acid plant) by way of a rights issue priced at R40. Not even two short years later, Omnia trades hands at R95.

Clearly, buying into Arcelor Mittal at this time must be a really daft idea. After all, the share price has collapsed from R260 to R54 over the past four years; anyone can see the price trend is negative and that the company is front page news for all the wrong reasons. Everyone hates it.
1. Can the share price go down further? Of course it can, but no-one else knows either how low it can go.
2. Is there an acceptable margin of safety to warrant allocating fund capital? Yes.

A sure sign of the nervous state of global markets was provided recently when Oracle announced missing second quarter earnings by 3 cents per share. In context of the expected 57 cents per share, this is not relevant to the valuation of Oracle at all, but Mr. Market begged to differ and promptly marked the share price down from $34 in early November to the current $25 and change. It's quite sobering (and food for thought) that $45 billion of market capitalisation can go 'awol' in just eight weeks.

During the course of 2011 we completely sold out of Tiger Brands in domestic accounts, following a holding period that started at RE:CM's inception in 2003. We always look for and appreciate a long-term partnership with such a fantastic value compounding business, but at the prevailing price it no longer offers attractive odds to long-term investors. Our investment philosophy and process compels us to say 'goodbye - until we meet again'.

Tiger Brands deserves special mention as an investment 'hall of famer'. This business not only continues to generate excess economic returns on shareholders' capital year in and year out, but it's also spawned three other quality JSE listings in the food wholesaler / brand operator Spar Group, the poultry producer Astral Foods and the consumer pharmaceuticals business Adcock Ingram. The latter remains represented in domestic accounts and has been a significant contributor to investment returns over the past couple of years.

Following up from a disclosure about a new global investment idea I provided in July, our investment thesis for Microsoft revolves around the fact that 20% of the current market capitalisation is held in cash and that it generates prodigious and reliable amounts of free cash flow every year that the company is using wisely to reduce the share count at price-to-value ratios that is value-accretive to the remaining shareholders. At current prices, we are paying less than 10 times annual free cash flow to be a part owner in this great business. Microsoft used to be a market darling, but in Steve Jobs' legacy and Apple's lengthy and sexy shadow, it has been relegated to the backbenches. At RE:CM we love sitting down and taking a very good look around the back benches, because we know from experience that this is usually where prospective value resides.

The value of any product can truly be tested when a competitor offers an alternative for free. Microsoft has not only endured free competition, but it has thrived by making its key Office product suite independent of its own operating platform, while simultaneously reinventing the platform. How do you compete against a company that can go toe to toe with a free offering and still win convincingly?