We devote the last commentary for the year to the fund’s only retail stock: Mr Price. (Before our investors spend their Christmas savings at the wrong store!) Consider the following table:

Owner managed: The two founders of Mr Price still hold large stakes in the company and serve on the board. Rapid growth: Mr Price is largely a cash retailer (hence its low receivables to revenue ratio), but is in the process of testing credit sales – with very encouraging results: the size of the average basket increased from R132 to R236 when it was purchased on credit. We believe that the rolling out of credit will enable the group to maintain its superior position in terms of earnings growth. Reasonably priced: The other three retailers have an average PE and dividend yield of 12,2 and 4,0% respectively, deeming Mr Price reasonably priced at a 12,1 PE and a 4,4% dividend yield.

It gives us great pleasure to point out that we have now established a 12 month track record as managers of the PSG Tanzanite Flexible Fund. Over the last 12 months we have grown our clients’ investments by 32.05% while being, on average, 33% invested in cash.

This month we take a closer look at Santam. The short term insurers in South Africa have been enjoying exceptionally favourable circumstances over the last two and a half years. Not only have underwriting profit margins been exceptionally high, but their investments have also benefited from a booming JSE. Santam is currently trading at a 4.3 P/E ratio, understandably the market is discounting the fact that the current conditions are not sustainable. In order to establish whether the market is not perhaps over cautious in its rating of Santam we estimated normalised earnings for the company. This was done by applying the 12 year industry average underwriting margin to Santam’s written premiums and applying normalised returns from the stock, bond and money markets to Santam’s balance sheet. The resulting earnings placed the company on a 8.6 P/E ratio, a far cry from the current 13.2 P/E of the FINI 15 (index comprising the 15 largest financial companies listed on the JSE). This implies that Santam’s share price has to add 53% just to be on par with the market’s current rating.

Due to the fund’s flexible mandate we are able to employ both asset allocation and stock selection in order to outperform our benchmark. To date we have addressed the fund’s asset allocation in numerous previous commentaries. During the months ahead we will consider the investment merits of individual stocks held in the fund. This month we will consider the fund’s third largest holding, Remgro. Remgro is an investment holding company with about 85% of its intrinsic net asset value comprising of listed companies. Remgro’s investments include blue chip companies like BAT, Firstrand, RMBH, Medi-Clinic and Implats. The Remgro management has a long term investment strategy which has served shareholders extremely well in the past. The share is currently trading at a discount of 18.6% to its intrinsic net asset value, which we estimate to be 13516 cents per share. In our opinion, Remgro should trade at a 3% discount to its intrinsic net asset value as only 3% of the dividend inflow is spent on management costs. Furthermore, management could employ Remgro’s large cash reserves to repurchase shares. This would widen the existing discount; further increasing the potential upside for investors!

Since 31 August 2003 the JSE All Share Index has grown from 9226 to 15414, an annualised rate of 29%.

According to Soren Kierkegaard “life can only be understood backwards; but it must be lived forwards.” Let us therefore look backwards over the past two years in order to develop reasonable expectations for the two years ahead. The tremendous growth in the local equity market can be attributed to two factors – a general re-rating of South African equities, and strong earnings growth. The re-rating should mainly be attributed to the reduction in the prime rate from 14.5% to 10.5% (remembering that lower interest rates imply higher asset valuations). At the same time, the lower interest rates also led to enhanced earnings. Looking ahead, we expect a more normal, but more sustainable, environment. We do not expect changes of the same magnitude in the prime rate to be repeated in the next two years. Are we switching on the safety belt lights? Not in the least. We are only expecting a reduction in cruising speed due to the fading of our tailwinds. We still feel confident that the earnings growth of the shares in the fund will propel growth in the value of your investment in excess of CPIX + 6 percent.

Investors in the PSG Tanzanite Flexible Fund enjoyed a return of 5,86% during July, while the fund’s benchmark only added 0,26%.

Since the market bottomed on 25 April 2003 we have seen the JSE All Share Index grow from 7631 to over the 15000 level at the end of July 2005. Has the JSE run too far too fast? The only logical way to answer this question is to consider the current yield on the JSE in terms of both local interest rates and the yields on international stock markets. In this regard we have performed various calculations; indications are that the JSE is slightly above fair value at the moment. Your manager has acted accordingly; the fund’s equity exposure has shrunk over the last month from 86,2% to 74,1%.

We would like to stress the following point: We are not concerned about the management or prospects of the companies which are currently held in the fund. However, when shares are expensive they can be swapped for a fair amount of cash. Cash, in turn, can be swapped for a fair amount of shares once shares start offering value again. As little as we enjoy parting with a well run company, we cannot resist the prospect of a bargain!

Unit holders in the PSG Tanzanite Flexible Fund enjoyed a return of 1.8% during June. Alexander Forbes added 13.3% and Capitec added 10.4%. During this same period our benchmark added 0.7%, while the JSE added 2.7%.

It is of the utmost importance to us that our investors should understand and buy into our investment philosophy. This will ensure that the expectations of our investors are aligned with those of our own. Consider the game of cricket to illustrate a vital investment concept. The PSG Tanzanite Flexible Fund’s share portfolio could be thought of as a highly talented batting line up. During last month Mr Alexander Forbes scored 13.3% and Mr Capitec managed 10.4%, but Mr Price went for a duck. Just as a cricket coach cannot predict when which of his batsman will perform, we cannot predict when which of our undervalued shares will be recognised by the market. However, we patiently play all our stocks every month because we have tremendous faith in each one of them.

From 1 March 2005, the annual management fee fro the PSG Tanzanite Flexible Fund was reduced from 1.71% to 1.!4%. A performance of of 11.4% of the outperfomrnace of the high watermark was also introduced.

With the sharp downturn in the JSE during March (1,32%) our investors might have hoped that their fund manager was rapidly switching equity into cash - buckle up and hold onto your hats because your manager has been buying. The pull back in the market offered us the opportunity to acquire some of our favourite stocks at bargain prices, since topping up some have increased as much as 11%.

Should the alarm bells be ringing for contrarian investors like ourselves when a market has risen 150% over the past decade, as our market has done? Remembering that the market capitalisation of the JSE is a derivative of the South African economy, we have to consider these two variables in relation to each other. In 1995 South Africa’s GDP was 54% of the market capitalisation of the JSE. It serves as a reassurance that the market capitalisation of our stock market as a percentage of its underlying (the GDP of the local economy) has hardly moved with this ratio on 53% at the end of 2004. The JSE has simply been tracing the expansion of the domestic economy over the last 10 years.

Our investors would have noticed that there was a rather severe drop in the fund’s unit value on the 1st March, this is simply attributable to the declaration of the February distribution of 2,9547 cents per unit. This distribution is automatically reinvested on your behalf, unless you have chosen otherwise. Last month we established that the JSE currently offers an attractive return relative to local long bonds. But as (especially institutional) money flows in and out of our market, it is vital to also consider South African returns in terms of returns offered globally. Global comparisons should, however, not be viewed as absolute due to legislative, market size and political differences among countries.

With effect from 1 March 2005, the name of ths fund has changed to PSG Tanzanite Flexible Fund.

With the All Share Index currently at record high levels it may seem strange to our investors that, despite our flexible asset allocation mandate, we are 58% exposed to equities. Have shares not become expensive and risky? It is important for our investors to realise that we do not judge the attractiveness of investments in terms of historical price levels, but rather relative to current alternative investment opportunities. Consider the table below portraying the difference between the yield offered by the stock market and the yield offered by the R153 (a long term government bond).

As the earnings yield (E.Y.) is an after tax yield, the R153 was adjusted for tax (a marginal income tax rate of 30% was assumed). The table indicates that in the last three years investors received a better return on shares than on the long-term government bond. Despite the fact that the All Share Index is at record high levels, the stock market currently offers a relatively more attractive return than it has for many years.

The above study depicts the situation of the market in general. On the 2nd of February 2005, the equity portion of the PSG Opportunities Fund had a dividend yield of 3,28% and an earnings yield of 8.7%. This implies that the equity portion of the PSG Opportunities Fund currently offers a total return yield of 3.32% more than the R153, while the cash return opportunity cost, being the dividend yield less the R153 yield, is only 2.1%!

"The trouble with institutional investors is that their performance is usually measured relative to their peer group and not by an absolute yardstick. This makes them trend followers by definition.”
George Soros

When fund managers are preoccupied with the performance of their peers they tend to neglect what should be their primary objective: to make investors’ money more. No matter how well a client’s investment has performed relative to other investments, at the end of the day you can’t eat good relative performance. Consequently we have set ourselves the simple target of growing our investors’ funds by at least inflation plus 6 percentage points, so as to ensure that we both preserve and also build wealth.
Our choice of yardstick was not only to prevent us from falling in the peer tracking trap but also to ensure that we:
- expose our investors to the powerful combination of consistent positive returns and compound interest;
- focus our minds on buying good company’s at very cheap prices

Let us consider these two benefits respectively:
Expose our investors to the powerful combination of consistent positive returns and compound interest
Over the last 33 years inflation plus six percentage points would have implied an average annual return of 16,75%. Though this may seem to not be a very ambitious target, consider the effect of this return achieved consistently for a long period of time: An investment of R1 million invested at an annual rate of 16,75% with profits reinvested, will double over 5 years, grow to R22 million over 20 years and grow to R104 million after 30 years.

Focus our minds on buying good companies at very cheap prices
The only way (of which we are aware) to achieve consistent positive returns on the stock market is to buy the shares of exceptional companies when the shares are trading at low prices relative to their fundamental value. Therefore, our choice of benchmark induces a disciplined approach to stock picking, which firstly entails many hours of meticulous research to find companies which are managed by individuals with proven track records and which have some form of immunity against competition, be it in the form of intellectual property, market dominance or well established brands. Secondly it induces the discipline to resist buying exceptional companies at fair or high prices. It is by religiously following this very investment philosophy that the celebrated value investor Warren Buffett managed to only suffer one year of decline in the net asset value of his investment company, Berkshire Hathaway, over the 39 year period between 1965 and 2003.