The PSG Equity Fund retains its full weighting in offshore equity. In fact, market movement has resulted in the percentage exposure to offshore stocks creeping to above 27%. We are very comfortable with this positioning largely because we have high conviction in the individual stock ideas. We anticipate attractive returns from our direct offshore investments.

We have been finding that we continue to find quality names at a reasonable price offshore whilst it is becoming increasingly difficult to do so on the JSE. Most of the quality large cap domestic names look materially overpriced to us.

Our three largest offshore holdings, Tesco, Heineken and Berkshire, all have the following characteristics that should ensure good long term returns: · High quality businesses, · Attractive valuations, and · Relatively low earnings.

Analysis of the performance attribution of the Fund's offshore stock picks over the year to 30 September 2012 indicates that they have cumulatively contributed 6.2% in absolute terms over the period. 1.2% of the gain has resulted from currency movement (the rand has weakened) whilst the balance has been derived from stock picking. The strongest contributors to Fund performance have been Ebay, Heineken, Berkshire and Tesco. The Fund has sold its Ebay shares after very strong share price appreciation, a much reduced margin of safety and the availability of better opportunities.

The failure of European leaders to find firm solutions for the European financial crisis, after yet another summit is holding global stock markets hostage. Domestic stocks have given back most of their gains achieved during the first half of June.

Despite the chaos in the global economic and political arena domestic industrial stocks remain rather expensive. Our preference is to own high quality businesses over time. We define high quality companies as those that deliver fairly stable cash profits over long periods due to the competitive advantages that exist within their businesses. These companies are unfortunately the most expensive area on the domestic stock market currently.

On the other end of the spectrum cyclical companies which tend to have very unpredictable cash flow streams have suffered the most as a result of the financial crisis. Some of these companies are pricing in a permanent impairment of their businesses, which we believe to be an incorrect assessment by the market. Given our contrarian investment approach we would rather be buyers of these companies.

MTN has been in the news for all the wrong reasons over recent weeks. A healthy increase in dividend and a share buyback announcement should have given rise to strong share price appreciation but very concerning allegations have surfaced with respect to serious corporate governance breaches and corrupt activities in Iran.

In our investment process we seek to shut out the "noise" and focus on relevant information that feeds into the structured way we look at a company. There is plenty of noise at the moment and generally, bearish newsflow can give rise to an excellent buying opportunity. We have, however, taken MTN off our Buy List and have been sellers over the past two months. Why?

MTN was a conviction PSG Asset Management stock pick at the beginning of 2012 and one of PSG Equity's largest positions. In our assessment of the margin of safety we factored in the risk of doing business in volatile countries like Syria and Nigeria. At that time, our estimate of intrinsic value using our assessment of the company-specific risk factors showed attractive upside, particularly when compared to other expensive SA industrials.

Recent revelations raise serious questions around the honesty and integrity of management, a key factor in our process. Furthermore, the possible fall-out from alleged improper dealings in Iran could result in reputational damage and have a material impact on the company's ability to do business in other countries in the future. This is not a risk that we can easily quantify and the margin of safety is not adequate to discharge this risk. Accordingly, we had sold all our MTNs by early April.

We would be buyers of the stock again if some or all of the following requirements are fulfilled: the margin of safety is larger, the downside contagion risk is capped; our concerns around management are discharged.

Our aggressive sale of what was one of the Fund's largest holdings should give insight into how a disciplined process feeds into portfolio construction. It should also illustrate that we adopt a flexible and unbiased approach to the stocks that we own. And, most importantly, it shows that as a smaller fund manager we can liquidate a large position very easily if we need to do so. We raised our Sasol exposure with the proceeds of the sale of MTN.

It was somewhat of an anti-climax that the market huffed and puffed throughout 2011 to basically end flat. The ALSI ended marginally down (-0.4%) for the year at an index level and produced 2.6% on a total return basis. It was a tough year to be managing money and hence it was pleasing that the PSG Equity Fund beat the ALSI by almost 3% over the year on a total return basis.

Analysis of 2011 portfolio performance indicates encouraging breadth, meaning that the majority of our stock picks outperformed during the year. Some of our larger positions, in particular Anglo American and BHP Billiton, were notable underperformers during the year. It is worth pointing out, however, that we were generally under-weight these two stocks in 2011 when compared to the ALSI benchmark. The poor returns for diversified mining shares were in line with global markets where global cyclical shares were significant underperformers of defensive names with more visible earnings. This underperformance can be attributed to mounting concerns over global growth and a slowdown in China.

Our larger positions within financials and industrials generally performed very well. Positive contributors to performance included: Tiger Brands, EOH, Brimstone, MTN and Sasol.

Unfortunately, we did not fully participate in some of the standout performances within the Top 40 in 2011. We sold British American Tobacco (BAT) in April/May at what we considered to be a good price. We also owned no retailers, most of which had stellar years, though our preference for Tiger Brands did mitigate this somewhat. We also sold out of SAB Miller, another standout performer, though we did buy in to Heineken which we prefer and which has been a positive contributor to performance.

The PSG Equity Fund benefited from our decision to incorporate global stocks in July/August. Not only has the rand weakened subsequently, but we were able to acquire companies that have proven themselves over many decades as very strong franchises and with excellent dividend track records at attractive prices. Most of them are cheaper than their South African peers and are offering higher dividend yields.

The higher quality JSE-listed financial and industrial stocks generally did well in 2011. Typically, these are the types of stocks that we would like to form the core of our portfolios, but our research indicates a lack of margin of safety and valuation levels that incorporate very bullish growth prospects. Given the fact that these stocks are expensive, have high levels of profits and margins and have enjoyed strong demand from foreign investors, the prospects for future returns are limited and the risk of capital loss is significant. We have a general preference for quality companies listed in the US, UK and Europe.

The Resource Sector looks cheap relative to the rest of the market after derating significantly and is currently the most attractive area to hunt for investment opportunities on the JSE. Large cap miners will be susceptible to slowdowns in China, Europe and the US, but it is our view that the margin of safety for the likes of Anglo American, BHP Billiton and Sasol is more than adequate to compensate for these risks. Longer term returns should be good for these stocks.

We expect 2012 to hold many twists and turns. The world will need to contend with significant issues on the political and economic fronts and risk premiums could rise further. Global growth is stalling and Europe looks like it is heading into recession. That said, monetary policy will remain very accommodative, liquidity is abundant and the investment opportunities in fixed income offer meager returns. Carefully selected stocks should provide reasonable returns over the medium term.