Equities caught their breath in October, taking the 12-month returns to 23.0%. This compares favourably to bonds, which returned 10.4% over the period. Our portfolio asset allocation has been well positioned to benefit from the relatively strong equity performance. Equities seemed to struggle in the face of a stronger rand, while this, combined with better than expected consumer and producer inflation figures gave bonds a boost.
The fund had another very strong month as a result of its correct positioning vis. a vis. the improving prospects for the local economy. Local industrial stocks dominated performance. This was largely due to strong consumer numbers, the continued rand strength and the muted interest rate outlook. Industrials, with an absolute return of 5.5%, outperformed resources and financials by more than 14% and 2% respectively.
The best sector returns were Construction (18%) - mainly on the back of the medium term budget as outlined by the Finance Minister, Telecoms (11%), General Retailers (9%), Entertainment (11%), Speciality Finance (9%) and Electronics (15%). The fund was well positioned in most of these sectors with Murray & Roberts returning 26%, Imperial 12%, Altech 13%, AVI 14%, JD Group 11%, Foschini 11%, Lewis 11%, Telkom 12% and Shoprite 13%. The underweight to Resources and Gold Mining, in particular, also added to performance.
There was very little trading activity in the fund during October. The fund increased its stake in Alexander Forbes, Metropolitan, MTN and Lewis Group, reduced its stake in Remgro and Old Mutual and added one new share, Telkom. We believe that the current Telkom share price more than compensates us for the looming competition from the changes in recent legislation that intends to open the telecommunications industry. Using a market parity rating for the Vodacom business within Telkom, one ends up buying the fixed line business at a 50% discount to market. More importantly, the equity free cash flow yield is in excess of 30% for the fixed line business.

Bonds (+3.51%) recovered somewhat in August, and equities (+8.75%) enjoyed a cracking month. This takes the 12-month returns to 11.6% and 24.8% for bonds and equities respectively. Our portfolio asset allocation has been well positioned to benefit from the relatively strong equity performance. The yield curve steepened during the six months ending August 2004, given strong impetus by the surprise 50 bps cut in the Repo rate during August. It was perhaps surprising that we did not see more action from bond yields, given that they tethered bravely in a volatile rand environment, which ranged from R7.05 to R5.85 against the dollar during the period.
A strong reversion to the mean for the underlying fundamentals for bond yields, particularly the US Treasuries and the SA sovereign risk spread, suggest that this weakening trend could have a little way to go. Given our conviction for further yield curve normalization, the portfolio is currently positioned primarily in the medium area of the yield curve, where we believe the scope for relative out-performance is greatest.
The Resources Index (+13%) had an excellent month returning 7% more than the Financial (+6%) and Industrial (+6%) indices. Once again, the ALSI40 outperformed both the mid-cap and small-cap indices and over the 12-month period the ALSI40 is now ahead of the mid-cap Index - the first time since May 2002. The best sector returns were Gold Mining (+18%), Platinum Mining (+17%), Mining Houses (+12%) and Oil & Gas (+10%).
The extreme rand volatility experienced over the past few months continued, albeit that the direction changed. The unexpected interest rate cut was the major catalyst this time around. During the month the rand weakened by 7% against the Euro and by nearly 6% against the US$. This, coupled with the unexpected interest rate cut, helped the market to a spectacular 8.8% for August.
There was very little trading activity in the fund during August. The fund increased its stake in Billiton (at the expense of Sasol), and its stake in MTN and Johnnic (at the expense of Remgro). It also completed its sale of Illovo. Most other changes were due to cash flows and/or rebalancing. The strongest performers during the month were Ispat Iscor (previously Iscor) (+25%), Implats (+12%), Tiger Wheels (+12%), Bidvest (+9%), MTN (+14%) and Alexander Forbes (+10%). The main detractors were the underweight position to Gold Mining, overweight position to Banks and underweight position to the Resource Index. Specific shares that had a weak month include Murray & Roberts, Delta Electrical, Shoprite and Steinhoff.

The cumulative return for equities over the past 12 months became less impressive in June, with a return of 24.9%. Bonds (5.7%) continued to under-perform cash (9.8%) over the past year, although cash returns have declined markedly in recent months. A strong reversion to the mean for underlying fundamentals for bond yields, particularly the US Treasuries and the SA sovereign risk spread, suggest that this weakening trend could continue. Given the fund manager's conviction for further yield curve normalisation, the portfolio is positioned primarily in the medium-area of the yield curve where the fund manager's believe the scope for relative out-performance is greatest.
Is the Fed out to derail the re-election campaign of the incumbent in the White House? If so, it stands a good chance of success. Never before has the Fed launched a tightening in monetary policy during an election campaign. Another precedent is that rates have gone up despite the Dow Jones Index being in negative territory year-to-date.
As unpopular as an increase in the cost of funding might seem, it was expected. However, the quantum may have undershot as the interest rate futures market was discounting a year-end rate of 2.5%. The current 0.25% rise, plus numerous statements by the Fed that a gradualist approach to tightening will be followed, seems to question market expectations. A year-end target of 1.5% is more credible. Will this be enough to derail economic momentum? The fund manager's doubt it!
The equity component of the portfolio is currently underweight Resources, overweight Financials, neutral Industrials and consists of 38 shares. The effects of the persistently strong rand dominated returns with 'rand-hedge' stocks returning 10-20% less than 'local' shares. Counters with strong relative returns during the quarter include Iscor, Sasol, Firstrand, Altech and Steinhoff. Disappointments include Illovo, Truworths, Johnnic and Shoprite.
There were quite a few changes to the portfolio - it sold its stake in Anglogold, Angloplats and African Bank and reduced holdings in SAB, Richemont, Sasol and Remgro. It increased the Bidvest holding and acquired a stake in Capital Alliance and Hudaco. An example of the thought process behind one of their decisions is shared below.
Capital Alliance, whose main source of revenue is the administration of insurance policies, has proven its ability to convert and integrate insurance books onto their own platforms, resulting in lower costs per policy and an upliftment in embedded value. The current share price implies that the company will never acquire additional insurance books to integrate profitably and a degradation of the current shareholders funds.

Nedcor Retail Investments proposes on the 1 Nov 04, to amalgamate the Nedbank Balanced Fund of Funds with the Nedbank Renaissance Fund, and will be managed by Heather Jackson of African Harvest Fund Managers according to the current investment policy of the Nedbank Renaissance Fund.

The fund manager's asset allocation call over the past quarter has been spectacularly right, insofar as equities returned 17.1% against a less impressive 2.8% from bonds and 2.4% for cash. Valuations continue to strongly suggest that equities should continue to outperform. On the bond front, the quarter began with a continuation of yield curve normalization, only to be largely reversed when disappointment about the quantum of the repo rate cut set in. Given the fund manager's conviction for further yield curve normalization, the funds portfolio is currently primarily positioned in the medium area of the yield curve where the fund manager's believe the scope for relative outperformance is greatest.

The portfolio is currently underweight resources, overweight financials, neutral industrials and should have an income stream of close to 30% more than that of the market.

Since re-aligning the fund, the fund manager's added Bidvest as a new counter. Bidvest is a locally listed industrial company with primary operations in the services industry. Their stated strategy is to become a "truly integrated international foodservice distributor". To this end they currently own listed operations in the UK, Australia and Luxemborg. The group is currently trading at a 25% discount to the market - its lowest rating in six years. This implies a PE of 7x for the local operations. Furthermore, the group is cash positive and its current dividend yield is in excess of 5%. Bidvest now represents 1.8% of the total portfolio.

Two shares received special dividends during December. Brait paid 112c, representing a yield of 16% and African Bank paid 100c, representing a yield of 10%. Both shares were amongst the top performers, as the market rewarded them on their improved capital management and outlook.

Counters with strong returns during December include Sasol (+17%), Iscor (+23%), mCubed (+23%), African Bank (+16%), Brait (+25%) and Bidvest (+17%). For the first time in many months, there appear to be no underlying themes to the various pockets of strong performance. Disappointments include Metropolitan, Impala Platinum and Massmart.

The fund manager's believe that the funds focused (and risk aware) portfolio construction process adds value to the fund. This is illustrated by the emphasis the fund manager's place on monitoring the tracking error, sector/industry weightings, individual share calls, economic factor exposure levels and downside risk propensity in the funds portfolios. The funds long run performance and downside control bears testimony to this, and the fund manager's look forward to continue providing investors with excellent risk-adjusted returns in the future.