Review

The Fund lagged the market by a wide margin during the third quarter, due to its much greater exposure to companies in emerging markets. These markets fell sharply and their currencies wilted as capital fled in response to suggestions that the Federal Reserve was planning to scale back its money creation activities. The countries that were most severely affected were those needing to finance large current account deficits, like India, Indonesia and Thailand.

Most of the pain was felt in the financial sector where the Fund had a large exposure to India and Indonesia.

Among the industrial shares there were noteworthy good performances from Nokian Renkaat (20%), Lockheed Martin (+18%), Halliburton (+15%), Total (+14%) and Illinois Tool Works (+10%), while Hewlett Packard (-15%) and the Fund's two holdings in the potash industry, ICL (-17%) and Potash Corporation of Saskatchewan (-18%), disappointed. Having risen by 74% during the first half of the year, Hewlett Packard stumbled a little when management attempted to temper rising expectations during the announcement of their third quarter results in August.

The shares of the entire potash industry suffered in response to the shock announcement in July of the fracturing of the joint marketing arrangement between Belaruskali and Uralkali. Some recovery was seen during September as rumours of a possible rapprochement between the two companies began to emerge.

The fall in emerging market currencies and equity markets was driven by the fear that emerging market interest rates were too low and that either the currencies would have to depreciate and/or interest rates would have to rise. The risk of further increases in interest rates and possible further weakness in the currencies during the next 12 months remains.

After much contemplation and debate, and having reviewed the case for each of the emerging markets shares again, we have decided that after the market corrections the valuations incorporate most of the possible further bad news and that financial shares in these markets remain particularly attractive on a long-term basis. Hence we used the opportunity to improve the quality of the exposure by switching into some high quality companies that were previously considered too expensive.

Market Review

The Fund lost 4.1% during the quarter, after experiencing a torrid last month during which its, primarily financial, emerging markets investments underperformed significantly and its largest holding, DBA Telecommunications, suffered an, as yet unexplained, meltdown.

Much of the damage to the value of our investments in emerging markets was done by the devaluation of their domestic currencies against the US dollar as a result of the flight of capital in response to higher yields in the US and fear induced by the expectation of the phasing out of quantitative easing by the US Federal Reserve. During the quarter, our Fund was negatively impacted by the movements of the Indian Rupee (-9%), Russian Rouble (- 6%), Thai Baht (-6%) and Turkish Lira (-8%) against the US Dollar. This impact was exacerbated by sharp declines in the prices of the shares, mainly in banks, owned in these countries.

DBA Telecommunications recorded a 60% share price plunge during the three days preceding its suspension on June 2, 2013, prompted by the sharp price movement and the unusually large number of shares traded (155 million versus an average daily volume of 500 000 during the preceding three months). While it has been public knowledge since April that the company has been in a dispute with its auditors regarding the extent of additional work that they are demanding to do before signing off the results for the 2012 financial year, it is unclear whether this is the reason for the dramatic change in sentiment. This development has, unavoidably, had a significantly negative effect on the portfolio. We had been consistent sellers of this share for the preceding 15 months, ever since a more than fivefold appreciation between July 2010 and May 2012 magnified its weight in the Fund from just below 2% to almost 10%. Considering the damage now wrought, it is cold comfort to reflect on the fact that, irrespective of the value of the remaining shares, a profit of HKD24 million (+21%) has already been realised on the original sum invested. (Please refer to our Market Review for July 2013 for a more comprehensive explanation of the situation.)

In sharp contrast, the Fund's American shares all outperformed handsomely. Notable performances were delivered by Berkshire Hathaway (+26%), Cisco Systems (+29%), Hewlett Packard (+45%), Lockheed Martin (+18%), Medtronic (+26%) and Microsoft (+30%). Unfortunately their combined weight in the portfolio was not sufficient to offset the negative effect of our emerging markets exposure and DBA Telecommunications.