This month we would like to provide you with an updated broader perspective of the positioning of the overall Nedgroup Investments Managed Fund in context of its key asset classes.

At 65% of the fund we remain reasonably low on equity, bearing in mind that we can invest up to a maximum of 75% in equity in this mandate. Against the backdrop of strong equity market index performance in SA and globally this may seem somewhat on the high side, but we have found and invested in attractive pockets of value in resources and cyclical stocks; both inside and outside South Africa. Should listed equities exposed to the domestic economy continue selling off we may be able to start allocating further capital to equity. I suspect this will take some time, primarily because many sectors, for example the retailers, do not yet represent good value despite significant price declines in some cases.

At less than 3% of the fund we have a very small exposure to bonds. We remain of the view that the risk in this asset class is skewed heavily to the downside, with low levels of nominal and real interest rates, as well as low yield spreads on listed corporate debt. Increased inflation, the state of government finances, ratings agency downgrades and persistent economic and currency weakness all contribute to a very risky outlook for bonds.

At 0.2% of the fund we have a negligible exposure to property. The sector continues to produce both IPO's and M&A activity at the fastest rate of any sector in the SA market, usually an omen of weaker prospective returns. This should not surprise you, because most property stocks have been persistently valued in the stock market at large premiums to their mark-tomarket underlying asset values. Additionally the struggling domestic economy and many companies' significant exposures to the increasingly weak retail and office segments in particular will eventually put pressure on their revenues, profits and all important distributions. A spate of corporate bankruptcies and significant job losses in the economy further strengthens our argument.

At 1.1% of the fund we have a small exposure to commodities, in particular to spot platinum, where the global market is in deficit and at current prices over half of the industry's operating mines cannot survive. We expect the platinum price to respond to traditional supply / demand economics in due course.

At 25% of the fund we retain as much as this mandate allows in offshore assets. At the latest rand / dollar exchange rate of R11.35, we believe the domestic currency is somewhat undervalued, making cheap offshore assets somewhat less so - from the perspective of a rand-based investor. However, the quality and cheapness of the global equities in our portfolio remains sufficient to warrant this continued exposure.

Overall the Nedgroup Investments Managed Fund remains conservatively positioned in a non-consensus, high-conviction manner, in cheap assets wherever the market dishes them up to us.

Four key questions today for investors in balanced mandates

With local and global equity markets setting new record highs daily, do I stay in the market or cash out? What if I miss out on even more upside?

The beauty of a well-managed balanced fund is that your manager can and should be managing this process, by reducing fund exposure to overvalued equities and asset classes and increasing fund exposure to investment bargains - when they become available again. Investors in a sensibly managed balanced fund do not need to concern themselves with these matters.

What will be the impact of higher interest rates?

Historically, higher interest rates negatively impact directly on bond and property prices, and indirectly by reducing consumer demand for interest rate sensitive products and services such as vehicles, financial companies and estate agencies. The knock-on effect is typically experienced in the revenues, profits, valuation multiples and share prices of interest rate sensitive businesses. On the flipside, higher interest rates will increase nominal investment returns on cash and money market investments.

Do the recent agency ratings downgrades of South Africa matter?

Yes, they do. The markets have seemingly ignored them to date, probably because the ratings agencies lost quite a bit of credibility post the 2008 economic crisis due to the part they played in misleading investors in complex leveraged financial products. When one sees past this and looks at what the agencies have actually said in terms of the dangerous combination of excessive government indebtedness and anaemic or declining economic growth in South Africa; this is something worthy of serious consideration. A second consideration is that SA government debt is now only two more downgrades from 'junk' status, at which point some professional bond investors would become forced sellers due to their mandate and regulatory constraints.

Why does the SA equity market continue going up despite all the negative press?

The domestic equity market leadership has narrowed over the past 10 years into businesses with revenues and profits predominantly outside of SA. They dance to a completely different economic tune; and correctly so. Hidden within the market indices there have been a large number of cases across the market capitalisation ranges where the share prices of businesses with significant local economic exposures have declined meaningfully. As usual, drawing conclusions based on indices can be fraught with inaccuracies and a healthy dose of scepticism is called for.

In an unusually busy month, our portfolio managers allocated fund capital to new ideas Barclays Africa, Spar, Glencore Xstrata, the JSE-listed Platinum ETF and London-listed Morrison Supermarkets, while adding to existing exposures in Lewis, Anglo American and Aveng. We reduced fund exposures to Sasol, Standard Bank, Transhex, Grand Parade, Amplats, Omnia and US listed Bank of America.

London-listed food retail business Morrison entered our radar screens during the course of 2013 along with the rest of the UK retail sector, where a price war appears to be playing out. The share price is so distressed at the moment that the investment thesis basically distils down to the fact that the unencumbered property value per share works out to around GBP 2.50 by our calculations, which is quite a bit more than the latest share price of GBP 2.10. So you are getting a food retail business (usually an excellent business model with the benefit, if you have purchasing scale, of a negative working capital cycle i.e. cash from sales coming in before suppliers on credit need to be paid), with an established 10% market share, a sensible business strategy and sensible executives, for free. That's a pretty spectacular deal this investment idea represents one of the most favourable risk/return profiles that we've ever seen.

In our opinion, the incumbent CEO, Dalton Phillips, appears to have done a few sensible things to date, such as buying back 10% of the company cheaply and cancelling the shares, and converting the store formats to offer more convenience shopping and remain favourably positioned as a low-price differentiated competitor in the highly competitive UK food retail space

JD Group featured as one of our top SA equity holdings over the past year. The price kept declining, thereby significantly increasing the margin of safety and prospective investment returns on offer. We obliged by increasing our targeted percentage closer to the maximum that we would place into a business of this nature. It appears that we were not the only people who figured out that there may be good value on offer. The parent company, Steinhoff, stepped in to launch an offer to minorities to acquire up to 98% of JD Group.
We have long been admirers of the Steinhoff group of businesses and its people and were not surprised that they stepped up to the plate in the manner that they did. An important aspect of our thinking regarding investing in business turnarounds is that we readily acknowledge that most business turnarounds don't turn around. We have to figure out and understand:

a) whether our investee company has a plan,
b) whether or not that plan makes sense, and
c) places the odds on its side to realize a successful turnaround.
To this end, our thinking was that with Steinhoff owning and managing JD Group they would be the best placed party to drive a successful business turnaround and that they have the pockets to recapitalize the business as may be needed, depending on the severity of the current cyclical consumer consumption downturn.

At the time of writing, JD Group announced that Steinhoff had successfully increased their stake from 56% to 82.8% and that JD Group may require as much as R2.5bn in an equity capital injection by way of a rights offer, fully underwritten by Steinhoff.

If we get the opportunity to allocate more fund capital into this investment idea at the proposed rights offer price; we look forward to partaking.

In the spirit of the New Year, I have reminded myself of the primary intention behind these monthly commentaries. Their purpose is to tell you a) what we did, b) why we did it and c) why it is consistent with our value investment philosophy and process. I am drawing your attention to the word 'consistent' quite deliberately. If we take actions that are not consistent with our stated and proven investment philosophy and process, we would be doing two very important things wrong; we would be misleading you, and we would be misleading ourselves. Both would foretell the beginning of the end of everything we have worked and stand for.

So, without further ado, in December and early January our portfolio managers allocated fund capital to existing investment ideas Anglo American, Blue Label Telecommunications, Merafe Resources, African Bank and JD Group. These investment ideas all share the common characteristics that they are among the cheapest in our research universe and that they are early in their ownership life cycle.

One new investment idea featured on the buy side of the ledger is Inpex, a Japanese listed oil production and exploration business. The global oil and gas sector appears to have fallen out of favour with investors, but Inpex stands out as the cheapest of the group. Inpex is busy developing the massive Ichtys offshore project in Australia. As with most of these projects, there have been revisions to the expected project cost over time (upwards, of course!) and given the dim view the market is currently taking of the capital intensity of global oil companies, it comes as no surprise that Inpex is priced for very poor long term economics. Based on our work we hold a more sanguine view and are quite excited about the long term value on offer.

As always, we deploy fund capital into a diversified range of cheap, predominantly high quality assets, but we don't know upfront which particular one will perform, or when. We do know that if we continue buying cheap assets in sensible amounts that a good investment outcome will be the result. We could pretend to have the answers, but that would be an experiment into uncharted waters of misleading yourselves and ourselves, which we are not prepared to implement.

On the selling side of the ledger, our portfolio managers reduced exposure to HCI, Tsogo Sun, Grand Parade and Microsoft. Following on from the news that we continue buying stocks that have declined in price, it can sometimes be easy to forget that we do have performing assets in our funds. It is also easy to forget that these same assets that we are harvesting today were the bad news stories at the time we bought them. Microsoft traded hands at $26 per share in early 2001, and that price is also where we bought it, 10 years later, when the market basically priced the company as a stodgy dinosaur with no future. We disagreed and our research conclusions were vindicated, somewhat faster than we anticipated. North of $36 per share, at a far reduced margin of safety, and following good absolute and relative returns in dollars and rands, it is consistent with our investment philosophy and process to have reduced our fund exposure.

With the rand trading hands at a 5-year low of R10.87 to the US dollar I reiterate that our PPP fair value level for the domestic currency is 9.80, making the currency around 10% undervalued. Without making any predictions, 10% is what we consider a statistically meaningful currency dislocation. The ways that we manage this in our portfolio management processes are to currency-adjust all our asset valuations and to consistently manage the portfolio to its functional investor and benchmark currency, the rand. This implies that a 10% cheap USD asset is only at fair value if considered in rands. It also implies that a 15% cheap SA asset is 25% cheap if considered in US dollars. It follows that, from a global investors' perspective, the ownership of a high quality business like Amplats, which is very cheap in Rand terms, becomes incredibly compelling.

Notes on recent developments at three global investee companies

Vivendi

Mr Vincent Bollore, the chairman and CEO of Bollore Group, has been appointed as Vivendi's vice-chairman. The Bollore Group was started in 1822 by his great grandfather as a logistics business in Africa and grew to a diversified conglomerate. Mr Bollore has a strong reputation in France as a corporate raider / activist, similar to Mr Carl Icahn but with a distinctly more European flair. The Bollore Group is itself a listed company that we admire that has delivered excellent long term returns under his stewardship. The Bollore Group sold two digital terrestrial television stations to Vivendi in exchange for Vivendi paper, making them the largest shareholder in Vivendi.

We already like what Vivendi chairman Mr Fourtou is doing to unlock value at Vivendi and our judgement was that Mr Bollore joined the board to speed things up. This has come to pass with Vivendi announcing the unbundling of SFR - the #2 cellular operator in France, leaving the Universal/Canal+/GVT rump behind. This corporate action will be put to shareholders for approval early next year. We believe that these changes support our investment thesis and are in our clients' favour.

Carrefour

The market clearly took notice of the latest set of interim results. This is another terrific example of something very small but positive happening at a formerly disliked business that results in a disproportionately positive share price change. The results implied that their market share is stabilising in their home market of France, which was a key concern. The key management change to date was the greater decentralisation of store management, which to date appears to have been the right thing to do. In other words they've moved from the corporate store mentality to be better placed to compete with the independent franchise owned business models. Carrefour remains cheap and a top holding in our funds.

Titan Cement

We have consistently experienced over many years that good things tend to happen to cheap assets. We don't have to spend much time worrying about the exact path to good things, but we spend a huge amount of time on figuring out if assets are cheap. We invested in Titan because it is a very well-run family owned business, it was incredibly cheap at the time and the whole global cement sector was bombed out, giving us a reason to understand why it was cheap. In the absence of any positive company-specific news the recent rapid share price improvement appears to us to be related to a positive shift in perceptions towards the cement industry in general and Europe in particular.