During the quarter ended 30 September, the fund lagged both its benchmark (ALSI) and its peers. This pedestrian relative performance was primarily a result of a conscious decision to reduce market exposure (beta) via a less than full equity weight and a preference for more defensive shares. Also, the Fund Manager did not anticipate the extent of the rand's move weaker over the period, which had the effect of driving the rand hedge part of the market (the majority of the JSE) higher - the JSE was basically flat in US dollar terms over the quarter.

While the cautious equity allocation strategy has not worked in the short term, it is in line with Alphen Asset Management's view that few of the shares we analyze offer a particularly attractive return profile for the risk taken. When we struggle to find shares to buy we are happy to sit in cash. It must be remembered that the Fund has been very successful at generating excess returns (alpha) over recent years, which we ascribe to our ability to identify cheap stocks and invest accordingly. It is our firm belief that long term investors are best served by a more aggressive approach when stocks are cheap and risks are lower and a more defensive approach when the opposite applies.

Ultimately, the fortunes of the JSE will be determined by two variables: earnings and valuations. We consider earnings on the JSE to be at high levels, and though resource companies will play their part in producing strong earnings growth over the next twelve months - we anticipate twelve month earnings growth of 29% for the JSE resulting in a forward Price to Earnings (PE) ratio of 12.2 - momentum in earnings growth peaked earlier this year. We expect earnings downgrades on domestic financial and industrial stocks in the months ahead as higher interest rates start to take their toll. While recent rand weakness will help to prolong the high level of earnings for commodity shares, we do not see a continuation of the bull market in commodity prices in rand terms over the next twelve months and risks lie to the downside.

It is our belief that rand hedge industrial and financial companies, including the likes of Richemont, SAB Miller, Liberty International, Remgro and Steinhoff, are trading at excessive premiums as a result of the keen appetite for rand hedge stocks. We do not envisage enough rand weakness or better than expected earnings growth to justify these valuations. In an environment of rising rates and top of the cycle profit margins, we see most valuations on the JSE as being on the full side. Interest rate sensitive stocks are showing value, but they need to deal with the headwinds of higher rates and deteriorating credit books over the months ahead, so we prefer to accumulate into weakness.

Overall, stock selection within the fund has been tilted more towards "value" over the past six months. This entails seeking out shares on lower PEs, preferably with sustainable high dividend yields, in many cases where bad news is reflected in the share price, and has resulted in the projected twelve month forward PE of the portfolio dropping to 10 and the forward dividend yield growing to 4%. Of our top five holdings: each of Telkom, Primedia and Metropolitan Life are expected to provide a dividend yield of over 5.5% over the next twelve months.

We consider Sasol to be attractively priced at current levels and believe that it offers defensive qualities, hence it emerges as the fund's largest holding. The fund is likely to continue to lag if the market surges ahead. Our cash levels are currently high, at 7% with a further 15% of market exposure hedged via futures. We will happily raise equity exposure as we identify opportunities to acquire shares at reasonable levels.

To show how volatile June was: at one stage the All Share was down 10.6% for the month and it ended up 3.4%. The volatility was driven by jitters on global markets, which incorporated the selling of emerging markets by international investors. As a result, the rand was under severe pressure; it started the month at 6.70 to the US dollar, moved as high as 7.40 before ending the month at 7.15. Within equities, locally-focussed equities extended the losses of May into June, suffering at the hands of the first rate hike since 2002 by the Monetary Policy Committee, the weaker rand and foreign selling. On the other hand, rand hedges and Resources, in particular, finished the month strongly, as commodity prices recovered and the weaker rand boosted earnings forecasts. Resources were up 10% in June, while General Retailers were down 14%!

The fund has been relatively well positioned in recent months, with good exposure to commodity shares and under-weights in banks and cyclical industrials. This was based on our bullish outlook for commodity prices (in rand terms), belief that the rand was over-valued, and concerns over the valuations of top-of-the-cycle local financials and industrials. After the vastly different performances by the various parts of the JSE, the rand's sharp moves down and worsening local interest rate outlook, the search for relative value is becoming quite tricky. Many commodities, particular the cyclical industrial metals, are looking vulnerable amidst an imminent US slowdown and as a result we find ourselves cautious of the sector after a strong run. But, we continue to anticipate healthy exposure to Resources over the medium to longer term. Within Resources, we continue to favour gold, platinum and Sasol. While SA interest rates are going to go up further, many of the stocks that are sensitive to rate hikes are discounting a significant slowdown. It is in this area of the market that the best value is starting to emerge, but while the macro outlook remains uncertain it is difficult to see a quick recovery in fortune. We are beginning to nibble at some of the hard hit local plays on an opportunistic basis.

During June, the fund bought Angloplats into weakness. Other new acquisitions included Steinhoff and Grindrod (rand hedge industrials), as well as Absa Bank. We sold SAB, Telkom and BCX.

May 2006 was characterised by sharp swings on the JSE, including aggressive selling of our stock market that saw it losing 10% over seven down-days in a row. After taking into account a solid start to the month, and a late recovery, the JSE was down just under 3% in May, though this equated to an 11% loss in US dollar terms, with the rand weakening by more than 8%. Emerging markets, and their currencies, bore the brunt of a de-gearing of the riskier global trades amidst concerns over a slowing US economy and rising inflationary pressures. On the JSE there was nowhere to hide, with the interest rate sensitives being particularly punished, as the rand weakened (and foreigners sold), though the blows to the rand hedge part of the market were somewhat cushioned. Despite concerns over the outlook for commodity prices, resources were up on the month, with commodity prices in rand terms holding on to (and in many cases improving on) recent gains.

Investors in the fund will be aware that Alphen have been cautious on equities for some time, and that the fund had not been fully invested for much of 2006. Also, for some time we have been finding it increasingly difficult to identify where the relative value lies within the JSE, with most of the market discounting good news on the earnings front. However, when some of the quality stocks that we like over the medium term were down by 20% or so (without significant deterioration in fundamentals), and could be bought on single digit forward P/Es and 5% plus dividend yields, we became buyers of some of the local financials and industrials that we have largely neglected over the past two years. Also, a weaker rand has resulted in higher earnings prospects for much of the JSE – at the same time as share prices are declining – another reason for us being buyers into weakness. On the local side, we prefer the more defensive higher dividend yields plays, typically better quality industrial companies, and May saw us nibbling at the likes of Altech, JD Group, Edcon, Naspers, Bidvest, Telkom and Abil. In turn, we trimmed our resource exposure somewhat from an overweight 44% to an underweight 34% as at month-end. Here, we reduced exposure to the gold sector and trimmed our positions in Anglos, Billiton and Sasol. It is worth reminding investors that we remain long-term commodity bulls and would view a significant correction as a buying opportunity, but we are concerned of the prospects for industrial metals in an environment of fast slowing growth in the US. That said, we remain comfortable with on- to over-weight positions in gold, platinum and oil over the medium term, as we see further value in the share prices of the likes of Gold Fields, Anglogold, Impala and Sasol. We do not expect a slowing economy and a pause in interest rates to be good for the US dollar, and see further upside in the gold price once the consolidation phase passes.

We expect the negative sentiment currently prevailing in emerging markets to persist for some months, while global markets grapple with new parameters. In these times, we fall back on our investment process to identify cheap stocks and are happy to take advantage of the opportunities presented. With a very healthy outlook for corporate earnings, limits to the amount interest rates will increase by, and reasonable valuations on the stock market, we are happy to buy.

During April, the JSE continued its unrelenting three year march northwards. Underpinned by good earnings and booming commodities, our stock market appears unstoppable. The world remains awash with liquidity and this is encouraging speculation in many markets including: commodities (especially) and emerging markets. The degree of speculation is over-shadowing the strong fundamentals in the raw materials space, and has resulted in us becoming more cautious with respect to commodity shares. We stress that we still buy into the secular bull market in commodities, which we expect to endure for many years to come, and which would make us buyers into weakness. Having said that, a cyclical peak in commodity prices within the next twelve months is likely, and sharp correction in the prices of mining shares is on the cards, with underlying commodity prices currently moving into parabolic status. Within resources, our preferred play remains the gold sector premised on our bullish long term view on the prospects for the rand gold price. The gold shares have recently lagged the bull market in the metal, which provides some comfort that the participation in the gold shares is currently less speculative than the physical, though we anticipate a consolidation phase after the strong gains. Our preferred gold stocks are Anglogold and Gold Fields.

Other larger holdings in the fund include Sasol, Anglos, Billiton, Impala, Barloworld and MTN. We do not believe that the market is appropriately pricing in Sasol’s standing in the global energy market, and we see value in the stock even if oil prices retreat somewhat. Anglo and Billiton offer exposure to commodity baskets at a reasonable price, but given the speculation in commodities and sharp share price appreciation we are starting to reduce exposure. We like the fundamentals for the platinum market tremendously, and Impala is our preferred counter. Having been long of the infrastructure theme stocks over the past year, we recently reduced exposure to the shares we held, with the exception of Barloworld, which we consider to offer relative value. MTN is an attractive play on emerging market mobile communication, a very exciting growth industry. The stock is not without its risks, but we view the prospective returns as being worthy of the inherent risks.

After the strong moves in March and April, we reduced our equity exposure to a net 86% long position. This was a result of large cap stocks hitting our price targets and a perceived lack of opportunity to acquire cheap mid and small caps. We continue our hunt for bargains.

February saw volatility returning to the JSE. Jitters ran through equity and bond markets worldwide, with emerging markets including South Africa taking the biggest hit, as markets moved to accommodate synchronized monetary policy tightening across the US, Europe and Asia. This represents a significant shift in the global economic status quo and bond yields have started to move up in sympathy. We consider such changes worthy of careful scrutiny as the JSE has reaped the benefits of high liquidity and healthy appetite for risky emerging market assets (as well as commodities) over the past three years. Recent earnings results from domestic companies have continued to be excellent and will continue to underpin the equity market, while the earnings momentum is strong. Given equity valuations at the top-end of historic norms and our expectations for higher bond yields going forward, we expect returns to start to underperform growth. So, the fund retains a cautious bias, and as at the end of February 13% of the fund’s nominal value was hedged against by selling futures. We expect market volatility to continue to rise.

In February, the fund’s commodity exposure was trimmed by cutting back some of the more cyclical plays: Billiton, Anglo and Sasol, in particular. Gold shares had a torrid time, and the fund suffered on account of its overweight position, although it still outperformed its benchmark, the All Share Index. With the benefit of hindsight recent speculation in this area warranted a reduced exposure, but our positive view on the outlook for gold bullion had resulted in the fund staying long gold shares, which we expect to continue to outperform the JSE once the consolidation period is behind us. We have upped our exposure to the local infrastructure theme through Barloworld, Group 5 and Murray & Roberts, and elected to continue adding rand hedge industrials (SAB and Richemont) at the expense of local consumer plays (JD Group, Woolies and Standard Bank). We remind investors that we believe that commodities are enjoying a long-term secular bull trend, and while prices will be subject to short-term corrections, we expect to retain exposure over the medium to longer term.

The worst performing sub-sector on the JSE, beverages, returned 5% in January and the best, gold, was up 24%. It is official, this is a bull market! On the twelve months to end January 2006 there is not much to choose performance-wise between the Top 40, the mid-caps and the small-caps, with each returning between 55% and 60%. The key observation is that participants have enjoyed excellent returns as long as they have been exposed to decent counters. It is becoming apparent to us that average expectations for the JSE remain very high. Global liquidity levels and risk appetite are at historically high levels and warrant caution over the medium term as far as risky assets such as emerging stock markets are concerned.

To our mind, the PSG Alphen Growth Fund’s feature attribute over the past four years has been its ability to make the “easy money”. Usually, this involves deviating from the herd, ignoring the headlines and actively seeking the relative value within the stock market. At different times over the past four years we have had active bets in small caps, consumer stocks, industrial growth stocks, and more recently commodities. Alas, the lack of clear cut future “easy money” on the JSE (to us anyway) makes it very difficult to comfortably allocate capital to different stocks. One is cognisant that momentum in the market is strong and that further upside is probable, yet we find little to get us excited from a valuation perspective. Whilst our present unwillingness to join the current momentum-buying spree may see the fund lagging its competitors in the short-term if the current euphoria persists, we are optimistic that we can continue to beat the benchmark All Share Index going forward, something we have managed to achieve over each of the past four years. If, on the other hand, our local bourse enters choppy waters, the fund will be relatively well positioned.

We continue to see value in the gold and oil counters (Sasol) relative to the rest of the market. We view the current global dynamic of high liquidity, aggressive industrialization by developing countries, strong global growth and lack of new supply as being highly supportive of commodity prices over the medium term, and precious metals and oil in particular. Short-term corrections in commodity prices are long-overdue and some nimbleness may come in handy.

During the past month we cut back our positions in some of the local plays such as Woolies, Edcon, Consol and Standard Bank and reduced our effective month-end market exposure to 78%, mainly by selling futures. We believe that our current caution will serve our long-standing investors well.

We entered 2005 with limited expectations for the stock market after the stellar performance of the previous two years, so a 51.8% return by the fund over 2005 was a pleasant surprise. All the more pleasing was our ability to beat the benchmark All Share in a year where the heavyweight resources made most of the running. Investors will be aware that our investment philosophy is based on a desire to actively seek out the best value on the JSE and a willingness to invest where we perceive the best returns are to be had for the amount of risk taken. In late 2004 we started to perceive that some of the best value lay in the resource part of the market, given attractive company valuations, our bullish outlook for commodity prices and belief that the bulk of the rand’s recovery was behind it. Increasing our resource exposure, largely at the expense of consumer stocks, turned out to be the right call, and in the second half of the year the fund’s gold stocks really came to the party. Unfortunately, we missed out on the Venfin-induced bonanza in the telecoms sector. Late in the year we started to up our weightings in interest-rate sensitive local stocks on the back of a marked improvement in the outlook for inflation and interest rates largely due to an improvement in the rand’s fundamentals as witnessed by a technical break to the upside (stronger).

Unfortunately, managing money does not get any easier in 2006! While the JSE’s fundamentals are strong: earnings growth will be excellent; the economy is in good shape; interest rates should stay low for a while yet; and global demand for SA equities is on the up – to our minds this is largely reflected in share prices. We are finding it increasingly difficult to identify areas of value within the market. Whilst, one cannot discount a further positive re-rating of the market amidst these supporting factors, returns from here come at significantly higher risk - the market is more expensive than it was! Accordingly, we will likely be selling into strength and, as per usual, preferring to sit on cash and waiting for opportunities to present themselves. Globally, equities need to contend with high oil prices and a slowing US economy. We suspect that at some stage in the not too distant future things are going to get tougher on equity markets!

The fund starts the year roughly onweight resources, slightly overweight industrials and slightly underweight financials. The largest relative bet within resources is on the gold sector and is premised on our optimistic view of the fundamentals for the gold price and is backed up by technical indicators. We are becoming increasingly cautious on the twelve month outlook for the cyclical commodities that have had such a strong run and are subject to much speculative activity. Nevertheless, we like the commodity story on a long term view. On the local front we have been raising our exposure to the cyclicals and banks and the fund has positions in the likes of JD Group, Woolies, Edcon, Firstrand and Standard Bank. Other local companies that have been identified by our process as offering value, hence their inclusion in the fund, include: Mittal, Tongaat, Consol, Mvela Group, Super Group, Met Life and Liberty.

Investors should be aware that while the fund is required to be at least 75% invested in equities at all times, the fund manager is inclined to reduce market exposure from time to time within these restrictions, and does make use of derivatives.

For the second year running, the top fund in the general equity category has been a fund that moved from another sector. In 2004 it was the Old Mutual High Yield Opportunity Fund; last year it was PSG Alphen Growth. To some investors it must look as though both funds went category shopping and moved to the general equity category because they were in a position to come top of the category.

But PSG Alphen fund portfolio manager Shaun le Roux says he does not believe the JSE is large enough to cater for different styles of equity unit trusts - particularly as there is only a handful of true growth shares on the JSE.

However, the mandate of PSG Alphen Growth is not limited to growth shares. It looks for relative value across the JSE. It takes advantage of the size of the fund relative to its main competitors - Allan Gray Equity is almost 20 times bigger, for example. This allows Alphen to take chunky positions in mid-cap shares such as Mvelaphanda Group and Consol - Allan Gray would need to own 10% of each of these companies before it made any impact on them.

Alphen is also prepared to go liquid when it is appropriate - if equity markets become overpriced, it will move to the maximum 25% cash holding. Le Roux says he will sell into strength as there is significantly higher risk in equities than there was 12 months ago.

The main driver of the fund's strong performance has been its heavy weighting in resources based on a bullish view on commodities, and especially gold.

Le Roux says his biggest regret was that he did not hold any telecom shares when the sector surged on the news that Vodafone was buying Venfin's holding in Vodacom.

The fund is now rotating back into banks and consumer cyclicals, particularly Standard Bank, Liberty, Metropolitan, Bidvest, Edcon and JD Group.

In the resources sector, Trans Hex and Kumba were sold but BHP Billiton and Western Areas increased. The fund will close to new investors when it reaches R1bn.

Financial Mail - 20 January 2006