Our goal is to preserve capital in real terms and to earn a satisfactory return on that capital. We are pleased to report that, although one year is not a long time to judge performance, this goal has been achieved.
It is pleasing to report that much of the fund's return was generated by taking an unpopular decision to move money offshore. It is even more satisfactory to note that while the fund was only exposed 72% to equity, it produced almost the same return for the All Share year-to-date. While we do not believe we should be compared to the All Share, we can safely say our risk on a subjective level was a lot lower than the All Share.
Looking forward, we have yet to see the benefit from investing in Japan and to a lesser extent in the USA. Large-cap shares in the US are certainly cheaper than they have been for the last ten years, and the fund is definitely tilted towards this asset class. Normally we prefer to invest in smaller companies, but one seldom has an opportunity to purchase franchises that dominate their respective markets with very strong brands.
A word of caution needs to be sounded: we may be too early. These large-caps are cheap relative to other classes of equity and are not a dead steal. Operating margins are very high by historic standards and could come off.

Over the last six weeks I am not quite sure what to make of what happened in the South African market. If you know anyone who believes in the efficient market theory, you are quite welcome to give them our phone number and we will have a "happy debate".

Companies were being sold and bought as if they were part of some stock exchange game. Even cash was being sold at a discount. We purchased a preference share that went down after the rate hike was announced. This does not make sense because it meant that the claim to higher income went up. A week later it was 7% higher from where we bought it. This investment has characteristics similar to cash with the bank, linked to prime.

Valuations in South Africa are still high. Opportunities are far more attractive in global markets. Furthermore, interest rates for sovereign debt are going up. There will come a time to own the treasuries of governments that offer the investor greater comfort than certain developing markets.

Finally, as an avid reader of all financial news, I am astounded how many people quote Mr. Buffet, preach his philosophy and give investors an impression that they think like him. On close inspection of these fund manager's portfolios, their allocation of funds don't seem to tie up to their marketing efforts and investment actions. At Aylett&Co, we don't try emulate the man, just purchase his company, Berkshire Hathaway.

Every month we, as fund managers, are requested to write a short report on the activities in the fund. Normally, most writers of the various funds tend to focus on the positive actions taken. We on the other hand, would like to write about a 'mistake' made by ourselves over the last six months.

We hate losing money and, therefore, our errors tend to be mistakes of omission and not commission. But a different type of constraint hindered our relative performance: the time it takes to construct a fund with capital preservation in mind. One does not simply put a portfolio together overnight. In our attempt to be rational, we underestimated the enthusiasm with which investors were prepared to pay for counters in the New Year. It therefore begs the question: has anything changed in our minds? Only that the risks of overpaying for companies has increased to the extent that similar companies offshore are now cheaper than in South Africa. In conclusion, our mistake can be interpreted in a different manner: we tend to do well when the market does poorly, and satisfactorily when everyone else does well.

The fund is now starting to take shape and investors can expect the portfolio to be more exposed offshore than onshore.

The fund return for the quarter was negative. Much of the return can be ascribed to a strong rand and underexposure to equities. Furthermore, the fund has experienced strong inflows, which coupled with our inability to execute the investment of these assets at acceptable prices, this has not assisted the fund's return in rands. We do, however, appreciate the vote of confidence.
To my mind, the strength of the rand is giving us, that is, South African investors, a wonderful opportunity to invest in some very good assets offshore.
Coca-Cola (KO) is a case in point. If one considers the last ten years, the market capitalisation of Coke has grown from 93 billion to 99 billion dollars. This translates into a total return of 6% for the entire period. Not that spectacular. In rand terms the growth has been 6% per annum or, if you wish, a total return of 77% (the rand went from R3.64 to R6.03 to the dollar over this period).
Coke should grow between 5% and 10% per annum. Furthermore, Coke is very much an international company we would wish to own. It should do better should the dollar continue to weaken, and only a third of its revenue is derived from the US consumer.
The company has not been this cheap since 1994. This parallel can be seen in many of the large caps in the USA. In recent research undertaken by Citibank the P/E multiple of the 25 largest companies of the S&P 500 was at its lowest since 1987! Expect more on this subject from us.

Walter Aylett
Aylett & Co