The yield of an asset is the income it generates divided by its price. A higher yield therefore indicates a more attractive market price. The flip side is that an abnormally low yield could indicate that an asset is overpriced and poses the risk of capital loss.

Our asset allocation decisions are not only driven by comparing yields across asset classes, but also by comparing current yields to long term average yields:

o Domestically listed property currently yields 6.2% which is significantly lower than the 10 year average yield of 8.5%.
o SA 10 year Government Bonds currently yield 6.9%, which is also quite materially lower than the 10 year average yield of 8.6%.
o The JSE All Share Index's current earnings yield of 7.2% is only marginally lower than the 10 year average of 7.5%.

In terms of quantifying the risk we can quote these numbers in a different way: How much would the value of the asset need to drop for the yield to be back at average levels? The All Share Index will have to give up 4%, the All Bond Index will have to retract 20% and the Property Index will need to drop a rather severe 27%.

Government Bond coupons are fixed and therefore the only factor that can change the yield is a change in price. However, in the case of equities and property these yields can also normalise if the income generated by the asset class grows faster than the price of the asset. So a lower initial yield is fair if one expects the income to grow more rapidly.

We see little reason why income from domestically listed properties should grow faster than that of listed equities. To the contrary, property companies have benefited hugely from the retail boom with retailers having significantly extended their footprint over the last number of years. Some of the added capacity may prove to be unsustainable if interest rates were to increase by a couple of percentage points. Due to the high fixed costs and leverage of property companies a marginal uptick in vacancy rates can have a large negative impact on the bottom line.

We are, however, more confident that the aggregated profit of the constituents of the All Share Index will enjoy satisfactory growth in the medium to long term. So, equities offer us a higher initial yield, pose less downside risk and should pay a rising stream of income. We think this is especially the case for the equities which we have cherry picked for the PSG AM funds.

The PSG Stable Fund has no exposure to domestic properties, only 2.9% exposure to fixed income bonds, but a more significant 36.1% exposure to equities. Generally equities are regarded the most risky asset class, property slightly lower risk and government bonds as low risk. One of the most dangerous things to do in investing is to accept an asset class's risk tag. We think the conventional risk ranking is currently somewhat inverted and are ensuring that our clients steer well clear of the capital loss which could be incurred when the situation normalises.

The fund changed sectors from Domestic--Asset Allocation--Prudential Variable Equity to Domestic--Asset Allocation--Prudential Low Equity on 01 June 2012

At the end of June Capevin Investments was the sixth largest equity position in the PSG Stable Fund. Capevin Investments is a holding company with its only asset being an investment in Distell. Capevin is our preferred entry into Distell as it offers a discount of about 16% and therefore a slightly higher dividend yield than a direct Distell investment. In our view, Distell is one of South Africa's few jewels which are still available at a reasonable price.

Over the last 10 years Distell grew dividend payment to shareholders at a compound annual rate of 17.1% and, perhaps more importantly, the dividend was never cut over this period. Though our investment case is not based on an extrapolation of past dividend growth rates, the dividend track record confirms cash flow consistency. Included in this 10 year period is three years of stagnation. From 2008 to 2011 the dividend was maintained at 256 cents per share. This somewhat uninspiring performance is still fresh in the market's memory and perhaps explains Distell's less euphoric rating than that of many of SA's other non-cyclical heavy weights. This discrepancy opens an opportunity for investors who take a longer term view.

There are a number of reasons why we believe the period between 2008 and 2011 was just a temporary lull in a long-term growth trajectory Firstly, Distell has large exposure to growth markets. 75% of revenue is generated in South Africa where the Group still enjoys very satisfactory volume growth. An additional 15% originates from the rest of Africa where volumes are growing in excess of 10%. Furthermore, Distell has a presence in the Asian, Eastern European and South American markets where it is experiencing rapid growth.

Secondly, Distell has over many years established very strong positions in the local market. The Group is the leader in whisky, brandy, cream liqueur and ciders. Distell also owns a significant percentage of the best selling wine brands. A dominant market position with entrenched brands can result in consistent and sustainable growing profit streams.

Thirdly, the Group has a wide range of products and brands spanning across demographic preferences and pricing points. This provides flexibility to push more products down the growing channels as the dynamics of the market change.

There has been a global flight to consumer non-cyclical companies as investors look for safe heavens to hide until the storm has blown over. Alcoholic beverage companies like SABMiller and Diageo trade at multiples of 20 times earnings. Capevin Investments offers an opportunity to buy Distell at 13.5 times earnings and, what makes it more compelling, is that we wouldn't be surprised if Distell grows its profits faster than many beverage companies trading at higher multiples.

For us Capevin Investments is not a temporary hiding place, it's a long term investment - whether we find ourselves in the boom times or out on the icy rocks.

Why is it that managers of stable funds are prepared to invest up to forty percent of their clients' money in shares? After all, stable funds are low risk products while equities are perceived to be high risk investments.

Stable funds attempt to manage three different risks:

o The loss of money in nominal terms

o The loss of money in real terms, i.e. inflation eating into the buying power of money

o Opportunity cost

Unfortunately for stable fund managers each of these risks cannot be managed in isolation; there are conflicting forces which need to be weighed against each other. For example, investing the entire fund in cash would ensure that nominal value is protected. This would, however, increase the risk of not protecting purchasing power and drastically increase opportunity cost risk. If the manager combines cash with inflation linked bonds and wisely selects nominal bonds, the return could match inflation and therefore address risk number two. But, the third risk remains unaddressed and this could cost clients dearly over the long term. Let us explore this third risk in more detail.

Opportunity cost is often self inflicted due to inertia or fear. A fear of flying could be the deciding factor between hiking the Inca trail versus another walk around the Rondebosch Common. An investor who is investing for the longer term, but who is not prepared to invest partially in equities is possibly sacrificing wealth for short term certainty.

R1,000 which was invested entirely in South African cash in 1942 would have grown to R1,684 by the end of February 2012. This calculation has been adjusted for the effect of inflation so our hypothetical investor (blessed with longevity) would have R684 extra buying power. Interestingly, cash outperformed inflation over this period. However, if forty percent of the R1,000 had been invested in equities with the remainder in cash, the investment would have grown to R12,570 in real terms. This would have resulted in an extra R11,570 purchasing power. (We use the JSE All Share Index as a proxy for equities.) The difference between R11,570 and R684 is opportunity cost.

This period is unrealistically long and therefore exaggerates the point, but it clearly illustrates the principle: blending low risk instruments with shares results in wealth creation. This is why the PSG Stable Fund is currently 37% invested in equities.

Our November fact sheet served as an introduction to the PSG Stable Fund and in the commentary we mentioned that we will have four main levers to pull in managing this fund:

o Invest in companies with able management teams and some form of competitive advantage
o Be brutal when calculating the fair value of companies
o Have a strong preference for companies where operating profit is many multiples of interest cost
o Follow a flexible approach to asset allocation, within the mandate specifications In the first set of fact sheets we will address each of these issues in some detail. Our November fact sheet focused on our flexible approach to asset allocation, this month we will dissect the importance of a competitive advantage and a strong management team.

From a unit trust investor's point of view, risk and return is simple: risk is the probability of the unit value declining, whereas return is an increase in the value of the unit. Most unit trust investors will be aware that the unit price is calculated from the market prices of the shares or other financial instruments in which the fund is invested. Risk and return can therefore easily be read through to movement in the market prices of the underlying assets in which the fund is invested. At PSG Asset Management we, however, look yet another level deeper when we consider risk and return. In the case of shares we look at the cash flows of the company which issued the shares. In the long term a growing stream of cash flow pulls share prices higher while declining cash flow puts pressure on share prices.

So our focus is finding companies which we believe will be able to grow their profits and to avoid companies which will struggle to defend their current profits. Companies are at war for the finite amount of cash flowing in the economy, to protect profits a company needs some form of competitive advantage which serves as a moat to keep the enemy at bay. Such a competitive advantage could be a scale benefit combined with strong brands or the ownership of proprietary technology or resources. Cash flow generated behind the defence of such a moat tends, not only to grow, but also to be more predictable or therefore poses lower risk to shareholders.

The second vital determinant of a company's cash flow is the capability of its management team. We believe that there are two gauges here, honesty and ability. The first measure is binary, a yes or a no. If we are not convinced that a management team is honest we would rather avoid the stock. Corporate fraud can result in the permanent loss of capital for our investors. This is a vital risk management consideration. To judge a team's ability we will consider their track record as well as their business strategy. Ideally, a large portion of the management team's net worth should be tied up in company stock to ensure that their interests are aligned with those of shareholders.

If we are successful in picking sharp and properly motivated management teams operating behind wide moats, the fund's unit value should be dragged higher over time by a steadily growing stream of free cash.