This quarter was an immensely frustrating quarter due to the 20% holding in the Global Financial Fund. The rand strengthened by 1.4% during the quarter (4.8% during June) and the Global Financial Fund depreciated by -7.8% (in US$) during the quarter. This was largely due to the fall in global financial shares particularly during April and May.

The local shares in the portfolio did well, our large Absa holding being up 10%, and recently purchased Capital Alliance up 12% in June, Alexander Forbes (caused poor performance in April and May) up 10% in June.

African Life (-17%) detracted from the good performance.

Most important is that the banks and life insurers generally reported satisfactory results. The environment remains benevolent for the banks and we believe that the valuations do not reflect the sound fundamental position they are in or the history of consistent dividend growth. Banks have proven to be excellent investments over many years due to the compounding effect of the dividends.

We believe this will continue to be the case for the patient long-term investor.

The impatient short-term investor might be rewarded over the next 6 months if the rand weakens. Besides the effect of a weakening rand, the global financial shares in which the fund is invested are generating ROEs (return on capital) exceeding 15% and are on P/NAVs (price to net asset value) averaging 1.2.

One can never be sure when the market will unlock the value, but as an investor one at least knows that the intrinsic value of the investment will grow by 15% annually.

When Sanlam Investment Management poached Kokkie Kooyman from Coronation in January, it must have hoped that six months later its financial fund would be top of the sector and enjoying significant inflows. Unfortunately, it is at the bottom.

The fund has by far the largest international exposure. It has a 22% investment in the Sanlam Global Financial fund. This opened on April 1 and has the same investment strategy that Kooyman followed when he ran Coronation Global Financial.

As well as having to face a 7% appreciation of the rand against the dollar in the year to date, the Global fund also had a bad debut quarter, falling 7,8% in dollar terms. Kooyman has a bias towards emerging markets, with 21% of assets in Korea and 7% each in Indonesia and India. These shares were sold off heavily as investors deserted emerging markets, but there has been some rebound and the global fund was up 2,3% in June.

But Kooyman says the global fund cannot take all of the blame for the poor performance in the year to date. The fund was overweight in assurers at the beginning of the year, and they have continued to underperform banks.

He held on to the African Life holding but halved that in Old Mutual and sold out of Liberty. Even though both shares look cheaper, he says he cannot justify selling Metropolitan and Sanlam, which both trade on larger discounts to embedded value, to buy Mutual or Liberty.

The fund also had a 10% weighting in Nedcor, which was sold out completely in the June quarter at a loss. Kooyman says that because of the high risk that the banking group will not deliver, he will not buy Nedcor at above R50/share. He also started to sell Alexander Forbes, but with hindsight says he should have sold the whole holding at R12,50-R13. Instead he rode the share right down below R10. Kooyman introduced African Bank Investments into the portfolio (now 2,6% of assets) and sold asset managers m Cubed and Coronation. He is not buying Discovery as he says the high valuation of the share is scarily reminiscent of the days when Investec and Nedcor were so pricey because they could do no wrong.

Towards the end of 2003 the view was taken that the life insurance sector would rerate and outperform the bank sector. Within the bank sector the largest exposure was Nedcor. In addition, due to the possibility of a weaker rand, the fund had among its largest exposures (Alexander Forbes and Liberty) - as well as 20% direct exposure to global financials.

Rand strength, Forbes's profit warning, and strong performance by banks led to a poor relative performance for the quarter: The three large banks (Standard Bank, FirstRand and Absa) all returned +/- 12%, while Nedcor fell by 3% (including the value of the rights).

The overweight position in Metlife (+9%), Old Mutual (+5%) and Sanlam (+5%) gave positive performance, whereas Liberty Life (-2%) detracted from performance.

The fund had no exposure to African Bank (+27%), and Alexander Forbes fell by 13%.

The 20% exposure to global banks and insurers detracted from performance due to the strong rand (5%) and weak international markets (generating 0.4% in $ and -4.4% in rand).

During the quarter the overweight positions in Nedcor, Liberty Life and Alexander Forbes were reduced, while the holdings in Absa, FirstRand and Standard Bank were increased. The question arises whether this is a case of closing the stable door after the horse has bolted. It is true that Nedcor, Liberty and Alexander Forbes are (in valuation terms) at their most attractive levels for many years. However, Nedcor and Forbes are currently facing very difficult periods in the next12 months and in our opinion are not as attractive as established companies Standard Bank, FirstRand and Absa, who can all benefit from the new environment of lower interest rates and stronger global growth.

While the life insurance sector is unquestionably excellent value, we are concerned about the valuation levels of global and local markets, which will continue to make it difficult for the sector to grow embedded value strongly. The banks however should continue to grow NAV at rates of 20%+, making them a more certain investment choice.

The fund is currently well positioned to benefit from: continued growth in the earnings and dividends of the large banks; an almost certain re-rating of the bank sector; a possible re-rating of the life insurance sector (the fund has invested in the most undervalued life companies); continued growth in Asia through the fund's 20% exposure to (largely) Asian banks, and a decline in the value of the rand.

The strength of African Bank surprised us, despite the quality of the management, and we feel the share is now marginally expensive. The weakness of Nedcor and Old Mutual resulted from the Nedcor rights issue that was announced.

Changes to the portfolio
We used the strength in the Nedcor price during the month to further reduce the exposure. The size of the rights issue indicates that the problems are much more serious than generally believed. We maintained the fund's exposure to the bank sector by effectively switching Nedcor into FirstRand.

Internationally we swopped the holdings in "South African" counters, Old Mutual and Investec, into a number of Asian bank shares as well as UK banks and insurers.

The commonality of the purchases was that in all cases we recently visited managements and found the market to be underestimating the prospective earnings growth. This is especially true for many Asian bank shares.

The main uncertainties going forward are:
- Has the $'s slide (and the rand strength) been halted?
- Will the US economy continue growing?
- When will US (and global) interest rates start rising and what will the effect be on equity markets?

We feel strongly that due to the large US current account deficit the US$ will continue to weaken. This (together with stronger global growth) implies that the rand will remain stronger for longer, helping to keep SA inflation under control and keeping interest rates where they are (possibility of a 1% hike in the next 12 months).

Global inflation and interest rates have already reached their turning point, with the Fed most probably among the last of the central banks actually to hike rates.

The major risk now must be that inflation might kick up stronger than anticipated (hence bond yields will move up sharply). Historically this has been negative for global bank shares leading to their underperformance (not negative performance).

While the correlation of SA banks in this regard to specifically the US is fairly high, we believe that at the moment the SA cycle is sufficiently out of sync with the rest of the world for this historical correlation perhaps not to hold this time. It is important to note here that SA bank and insurance shares are still very cheap compared to the level of interest rates and relative to the rest of the market. Experience has taught us that this is always the most important cue to stay invested.

A new manager taking over a fund faces a dilemma. "You inherit positions you don't agree with and must choose to axe them or sit it out," says Kokkie Kooyman, who took over the reins of Sanlam Financial Fund (SFF) at the beginning of February.

The focus of Kooyman's concern is an overweight exposure to Nedcor, the primary cause of SFF's sharp fall in performance since August 2003. To make matters worse, Kooyman's predecessor added to the holding during the third quarter while the troubled bank's share price was collapsing.

"I see Nedcor's problems taking longer to solve than many think. The holding is too high and I will reduce it. It is just a matter of timing," says Kooyman.

Other changes to SFF's domestic portfolio structure are likely to be minor. "I may adjust the balance between banks and life assurers in favour of banks, but not by much," he adds.

But beyond avoiding mishaps such as Nedcor, the domestic financial sector offers little scope for a fund manager to do much better than anyone else. "There are only nine or 10 shares left to choose from," says Kooyman, who moved from Coronation to Sanlam Investment Management as head of its global financial services fund operations.

It is in the global arena, using SFF's 20% foreign holdings, that Kooyman sees the real opportunity to boost returns above average. "Over time, I believe a foreign exposure will produce an outperformance of the SA market. But it will require effective management."

Few will disagree that Kooyman has that ability. Over the three years to December 2003, he steered Coronation's dollar-denominated Global Financial Fund to a 63% total return compared with a 9% fall in its benchmark, the MSCI world financial index.

SFF's foreign share structure is not optimal at the moment, with Old Mutual and Investec accounting for half the offshore equity holdings.

But given Kooyman's record, SFF has the makings of the fund to beat this year in the financial sector.

The fund delivered a good return during the 4 th quarter on the back of very strong returns from the financial sector. On a relative basis the fund had a disappointing last quarter. The fund's preference for insurance stocks versus banking stocks, as well as the overweight position in Nedcor, detracted from its relative performance.

The recovery in global markets and more attractive valuations underpin our preference for the life assurance sector relative to the banking sector.

The currency remains at low levels against the dollar, but in our view it is likely to depreciate moderately going forward. With the fund having a significant exposure invested offshore and being underweight in the banking sector, it is well positioned to benefit from a depreciating currency.

The recent global stock market recovery has been a catalyst to start unlocking the attractive valuations of South African financial shares and we expect this to continue over the next 12 months. We remain positive that our stock picks will add value for the fund. We will aim to make 2004 a good year for the fund, after a disappointing 2003. We will build on the excellent performance of the fund in 2001 and 2002 and continue to maintain the fund's excellent 3-year track record.