Low balanced fund allocation to SA equity
The SA equity building block is priced at an attractive 30% discount to intrinsic value, which represents good long term value. However, we are not fully invested in balanced fund mandates because our investment process and bottom up fund construction demands an adherence to investing in predominantly high quality businesses. The way that Mr Market has offered up investment opportunities in SA of late results in a dearth of cheap high quality assets. In addition we have made no secret of our view that most resources businesses do not meet our quality criteria. It is in fact high quality assets whose price to value ratios remains most unattractive at present, both in SA and globally.

We own very little gold stocks and no gold
Gold stocks and the commodity itself have been smashed, to be politely blunt about it. However, we are not yet interested in allocating fund capital to these because the gold price is still trading well above its long run real price and our work shows that the time to invest in gold equities is when they are priced at a 40% to 50% discount to book value. Currently none of the large investable gold businesses globally are priced at such a discount, with the single exception of Harmony Gold, which we do own a very small position in.

Currencies are important investment decisions
Our work informs us that the most attractive currencies in the world at the moment are US Dollars, Japanese Yen and Hong Kong Dollars. The British Pound and the SA Rand are marginally cheap, but not nearly enough to warrant an investment exposure (seen from a purely currency perspective). In deciding what to do with fund cash, we first take our currency views into account before we consider yields and maturities in the money markets and bond markets.

We own Anglo American but not BHP Billiton
Short and sweet, our work shows that Anglo American is very cheap and BHP Billiton is priced at fair value. Furthermore, this outcome also makes logical sense because the commodity mix in these two businesses is very different. Anglo has significant exposure to platinum, which is hated, and BHP doesn't have any exposure to platinum. As a final comment on this, we are impressed with Mr Cutifani's public statements to date. Time will tell, but it appears as if Anglo may be going back to its roots in terms of being a counter-cyclical capital allocator in the global commodity markets. This could mark an important turning point for the company and its long term shareholders.

There are stocks in our Global Fund with operations in SA
We own Implats, Amplats and Anglo American in the RE:CM Global Fund. There are a few others but their combined exposure in the fund is negligible. The first point I want to make is that all of these are in fact global businesses with revenues priced in US Dollars and affected by outcomes in global economies. Much of their operations are in SA and most of their costs are in SA Rands.

We own these in the fund because we are increasingly interested in cheap global cyclical stocks, because that is where markets are offering the best prospective investment returns. The second point is that we look at individual equity position sizing on a see-through basis in the context of an overall balanced fund mandate and regulations such as Reg 28. Other than taking mandates and regulations into account, the domicile of any investment opportunity makes no difference to us.

During December, we were buyers of new ideas Sonae Modelo (Portuguese diversified industrial), Vivendi (French media), IGD (Italian property), NTT Docomo and Intel.

We also continued allocating capital to Arcelor Mittal in SA. From the lowest price level of R25 reached in late November, it has moved to the current R39, a percentage gain of 56% within six weeks, on no positive news. Our experiences with and studies of investing in cyclical businesses, informs us that the best time to buy them is when the outlook is the bleakest. It is quite normal for much of a re-rating to normal valuation levels to occur without any obvious improvements in business conditions or operating results. We used the share price weakness to significantly lower our average cost price.

We were sellers of Aristocrat Leisure, Carrefour and Coca Cola Hellenic Bottling.

During 2012 we disclosed and discussed some of our Southwest European Fund holdings, in particular that of Greek listings Coca Cola Hellenic Bottling and Hellenic Exchanges. These unpopular stocks in a despised investment destination have delivered superb investment returns for investors, because they were effectively priced for bankruptcy and a worst case outcome. All one needs in such instances is for bad news to stop or for the situation to slightly improve in order to deliver outsized investment returns. The circle in Chart 1 represents our buying program for Hellenic Exchanges. The arrow represents the initial drawdown of 40% from the time of our first purchases. This is what value investors do, but if you can think of a way for us to reliably and consistently lower this number that would be great, just let me know!

On idea generation, we see equity and property investment opportunities in Western Europe, Japan and selected North American industry sectors like technology. Credit markets offer no value with record low base rates and corporate credit spreads. We do not have many new ideas in South American or Asian (ex-Japan) equity markets, or in physical commodities.
We remain wary of the JSE All Share Index levels as our work supports a conclusion that the index is priced well above intrinsic value, with specifically Industrials trading at valuation multiples last seen in mid-2007. Financials are slightly cheap to expensive and Resources offer decent value. Compared to a year ago, the building block of SA equities in the Fund’s mandate is better diversified, better quality and cheaper.

In summary, we continue to favour cash. The South African equity component is tilted to Resources and other depressed industry sectors like Hotels & Gambling. Offshore, we have deployed more Fund capital into equity. There are no long or short dated government bonds in any geography, a small corporate credit exposure that is nearing maturity, a very small property exposure and no physical commodities.

We allocated Fund capital to existing equity holdings Implats, JD Group, Arcelor Mittal, IGD (Italian property) and Intel, as well as a couple of smaller capitalisation companies that represent new investment ideas where we have not yet completed our buying programs.

On the capital realisation side we took advantage of strong price gains in Carrefour (French food retail), Coca Cola Hellenic (Greek bottler), Sun International, MMI Holdings and Discovery to lock in profits and reduce portfolio risk. We define risk as losing money. We manage this risk on an on-going basis by recycling less cheap or fair valued assets for cheaper ones and new investment ideas - should the markets allow. This is perhaps a sensible way to illustrate how we think about the Fund as a whole. Of course it consists of individual securities, but ultimately it is the combination of cheapness and business quality at the overall Fund level that can deliver strong prospective absolute and relative returns.

In January, we sold some of the Implats exposure; and just a few months later we are buying it back again and further increasing our exposure. This almost feels like day-trading to us, but Chart 1 provides context. At R175 per share it was offering a far smaller margin of safety than at the latest R120 and change. Let’s say, for arguments sake, that we thought it was worth approximately R200 per share. Clearly a 12% discount is not nearly as attractive as do the prevailing 40%. Given the business quality of Implats, this offers a rare and genuine bargain for long term investors.