Over the 3 months for the quarter ended 30 September 2009 your Fund increased 9.37% in value. While it is a nice gain (especially if annualized), the JSE ALSI (J203) increased 12.98% in value, an outperformance of your Fund of 3.61%. That is a significant underperformance on our part and bears discussion as to its cause.

Since early May we had close to the maximum permissible percentage of your Fund in offshore equities (we had 18.75% offshore at the end of that month). Virtually all of those equities were US listed. Our reasons for doing this were set out in our February, March and May Information Sheets (all on our website at www.valugro.co.za . In last month’s Commentary we explained how despite our offshore shares all making nice gains in US dollars over the last few months, rand strength “wiped out” virtually all those gains in rand terms for your Fund. We also indicated in that Commentary that we would sell down our offshore stocks in coming months, something we are busy doing.

Two other reasons for your Fund’s underperformance over the last 3 months were:
1. Our 0% Fund weight in Richemont since we sold at R16. In the 3 months to end September Richemont rose over 30% from R16 to R21. We preferred Richemont’s fellow Swiss listed colleague Nestle. Our view that sales of low cost luxuries like chocolate would be more resilient than sales of expensive luxuries like high cost watches didn’t work for us in terms of share price moves. In rand terms Nestle did 9.5% over the 3 months. We have since disposed of our Nestle shares (but continue to avoid Richemont especially after its huge recent run).

2. Our 0% weight in Angloplats (up over 22% in the 3 months). We expected a total collapse in profits in the interim results (we got it, HEPS announced in July were down a mammoth 95%) and at the current rand platinum price we expect terrible full year results to be announced early next year. We can’t justify the over 100x fwd PE on the stock to
December 2009, especially as consensus even further forward to December 2010 is still nearly 40x. On valuation grounds we continue to avoid this stock. But doing so has hurt our relative performance.

As at 1 July 2009 (intra-day), the 2 year forward PE and div yields (or longer if a company's year-end is after 30 June 2011) as per the I-Net consensus are:

BHP Billiton 13.44 times and 4.64%
Anglo American 11.36 times and 1.80%
Implats 17.47 times and 3.94%
Anglo Platinum 20.25 times and 2.92%
Standard Bank 7.13 times and 5.74%
Absa 6.27 times and 6.64%
Firstrand 7.16 times and 6.26%
Nedbank 5.83 times and 7.10%
Pick n Pay 9.33 times and 7.83%
Spar 9.08 times and 7.20%
Woolies 7.68 times and 8.24%
Foshini 5.97 times and 8.64%

Looking at these numbers it appears very difficult to us to justify an overweight position in resource stocks on a forward view of 2 years or less. This becomes even more difficult to justify if it is considered that:
o resource company earnings are going to plummet in their next 6 month reporting period (due to the collapse in resource prices from their 2008 highs), and quite probably collapse again in their next full financial year thereafter (again off a high base), and
o the rand has strengthened some 18% since the start of 2009, eroding a large amount of the underlying resource price increase in dollars that has occurred since the 1st of January 2009.

Now the idea of holding a resource stock for 2 years or longer and watching its earnings and dividend collapse; receiving a much lower than "rest of market sectors" dividend yield for those years; and (due to the volatility of commodity prices and currencies) not being able to have a very clear belief that even after the next 2 years the earnings of these resource stocks will be moving consistently higher, is not particularly appealing to us. Contrast that situation with a food retailer like Pick 'n Pay which should enjoy "above market" earnings growth over the next 2 years; give investors a much higher dividend yield over that time than other "market sectors"; and which also offers a consistent "profit growth" type business thereafter. You can thus hopefully understand why on fundamentals we would prefer being overweight currently in stocks like Pick 'n Pay and underweight stocks like Anglos.

Similar to the fourth quarter of last year, the first quarter of 2009 was again characterised by immense volatility in the stock market, as global investor concerns weighed on market sentiment. Regardless of the volatility, the market only lost 4.2% over the last 3 months. It seems investors are playing the waiting game at the moment, not wanting to expose themselves too early, but eager to share in the potential upside.

During the last three months, we have made changes to the portfolio holdings, most of which have been reported on in previous monthly information sheets (available on the website). These included the increased exposure to the resource sector, in particular the inclusion of selected precious metal stocks. We do however remain cautious on the near term outlook for global growth, and therefore maintain our underweight position in the resource sector relative to our benchmark. Our exposure to the listed property sector is one that has served the fund's performance well, and subsequent to February's fund commentary, we have decreased our holdings in this sector further. We believe that given the negative global growth climate, and the lagged effect that it has on the South African economy, the outlook for this sector has deteriorated somewhat, and therefore we saw it fit to take profits and align closer to our ALSI benchmark again.

Since the end of September 2008 to the point where global markets bottomed out on 9 March 2009, the FTSE/JSE Life Insurance sector lost 36.91%. During the period the Valugro General Equity fund maintained a 0% weighting in this sector. The subsequent turn in the market spurred on by positive global news flow, along with very attractive valuations, supported our decision to realign the fund to a neutral weighting in this sector relative to the ALSI, and that way lock in the outperformance achieved relative to our benchmark.

Since the end of September 2008, Old Mutual's share price dropped from R11,50 to a low of R4,80 on 9 March 2009. Having had no Old Mutual in the fund since October 2008, our decision to buy in on 13 March at a share price of R5,69 and thus move back to a neutral position is a good example of the application of our "index grid" process.

During 2008 your fund's benchmark, the JSE ALSI delivered a total loss of 23.2%, the second worst year since the JSE began recording yearly performance in 1960. The decline in the ALSI was lead by the 31% fall in the Basic Materials index (which constitutes just over 35% of the total index by market capitalization). Other sectors that came under intense pressure were the Construction sector and Life Insurance sectors with those sector indices falling 42% and 47% respectively. Food Producers (+3%) and Food and Drug Retailers (+15%) were the only two sectors on the JSE that delivered positive returns for 2008 and with those sectors making up a paltry 3.70% of the ALSI they were never going to help much.

The ValuGro General Equity Fund delivered a negative return of 22.6% over the calendar year, slightly outperforming the JSE ALSI. While beating our benchmark objective, it wasn't our best year. Since your fund was launched in March 2005 we have managed to deliver a total return of 88% versus the return of 57% by the ALSI (incidentally your fund was the 4th best performing fund in its category over the period, something more likely to impress "category peer fund reviewers" than "benchmark-focused" people like us).

Going forward our aim is to continue to materially outperform our benchmark of the JSE ALSI over time. Your fund's notable positions at the beginning of 2009 include continued underweights in both the basic materials and consumer goods sectors, and an overweight position in listed property (all relative to the sector weightings of the ALSI).