The JSE Industrial Index performed exceptionally well in the third quarter, rising by 18.81%. Some of the shares that were up significantly over the quarter and which are represented in the fund are the following: Imperial (30%), Steinhoff (28%), Naspers (25%), Woolies (25%), Tiger Brands (22.6%) and Barloworld (22.4%). SABMiller also performed exceptionally well, rising by 20% over the quarter. Some of the smaller and mid-capitalisation shares that performed well over the quarter and which are represented in the fund are: Famous Brands (51%), Datatec (36%), Aveng (36%) and Murray & Roberts (40%)

The following new stocks were added to the fund: AECI and Reunert. AECI is well positioned to exploit significant growth opportunities within the specialty chemicals and mining solutions divisions. It is a strong cash generator with a solid long-term track record. It also has good rand-hedge qualities.

Reunert is well positioned to benefit from the increased focus on general infrastructure spend (mainly through CBI and African Cables). Although we are skeptical about the sustainability of the high growth experienced in the consumer-related businesses of Nashua Office, Panasonic and Nashua Mobile, we feel comfortable with the reasonable value underpin at current levels. We have also increased our exposure to Richemont, AVI, Shoprite and Woolies over the quarter. Allied Technologies was sold out of the fund during the quarter. In addition, we reduced exposure to the following shares: MTN Holdings, Aspen (some profit taking after its significant level of outperformance), Imperial (it remains in our top 10), Edgars and Sun International.

The industrial sector has rerated substantially from a PE ratio of 8.5 times in March to its current PE ratio of 14 times. Given the robust economic environment, we believe that this has been fully justified. Although the cliché "the easy money has been made" is probably a sensible statement, we continue to believe that the economic environment will remain favourable enough to justify the current valuation of the industrial index. Our bottom-up analysis indicates that earnings growth of approximately 18% is a possibility over the next 12 months. This is exceptional growth in a low-inflation environment. The industrial companies balance sheets are strong, cash flows are healthy and this should support a healthy dividend-paying environment.

Although we feel it is prudent to highlight that we're approaching long-term "fair value" for the industrial sector, we still believe that the sector will generate real returns over the next 12 months.

The JSE Industrial Index recovered in the second quarter, rising by 6.02% after a poor showing in Q1 (down 0.5%). With a bias towards a weaker ZAR during the quarter, certain rand-hedged stocks came back into favour. In particular, Richemont rose by 15.1% during Q2 after reporting results ahead of expectations. Incidentally, we had increased our exposure to Richemont during the quarter. Other companies that performed exceptionally well during the quarter (and which are represented in your fund) were Naspers (up 16.6%), Steinhoff (up 15.8%), Tiger Brands (up 15.3%) and Netcare (up 13.3%).

Finally, Rembrandt rose by 12.2% after reporting good financial results. In addition, they declared a special dividend of 600 cps (well ahead of the market's expectations). This was in addition to the final dividend of 198 cps that was declared.

The following new stocks were added to your fund: Johnnic Communications, Datatec and Bytes Technologies. We feel that the discount at which Johnnic Communications is trading relative to its net asset value is attractive. In addition, it is benefiting from a strong advertising cycle. The addition of both Datatec and Bytes Technologies was driven by their very attractive valuations and an improving outlook (albeit off a very low base). The following stocks were sold out of your fund during the quarter: Nampak and Super Group.

Our outlook for the industrial sector has not changed much from the last quarterly reporting period. We continue to believe that domestic industrials will show a positive absolute return over the next twelve months. The industrial companies' earnings growth outlook is underpinned by a robust economic environment. The consumer environment remains strong, underpinned by real wage increases, increased social grants, low interest rates (and low debt-servicing costs) and low inflation. We do not expect the current favourable environment to be derailed within the next 12 months; however, we do believe that certain risks are emerging that should not be ignored. These include rapidly increasing credit extension (growing at an annual rate of 22%). This has resulted in an increased level of debt to disposable income (currently 59% and rising). In addition, a weaker ZAR could result in a slight upward bias to inflation (which, if it gets out of hand, could result in upward pressure on interest rates). It is our view, however, that the current benign inflation and interest rate environment is intact for at least the next 12 months. As we mentioned in our previous report, government's commitment to increased spend on gross fixed-capital formation (infrastructure spend) has gained momentum. The credibility of their commitment has improved with the announcement that the Gautrain contract (estimated at R7bn) has been officially awarded.

Sanlam Industrial Fund's (SIF) slide down the performance rankings over the past six months belies the solid returns its manager, Claude van Cuyck, has delivered since it became a pure industrial fund in October 2003.

SIF's 84% capital appreciation since its conversion is well ahead of the sector's 74% average and a shade above the 82% produced by current one-year sector leader, RMB Industrial.

SIF's recent slippage shows how even one bad egg can spoil the batch. "Barloworld has hurt us," says Van Cuyck. Based on SIF's holding in the share, its negative impact on returns since mid-March was almost one percentage point.

This has not dented his determination to stay a leader by taking strong views. Of Imperial, at 8,4%, SIF's biggest holding, he says: "I feel its earnings will again surprise on the upside."

On SIF's 6% exposure to MTN, which has been sold completely by rivals such as Old Mutual Consumer Fund, he says: "It still offers value at a fair price."

Van Cuyck has a mildly contrarian view on consumer shares and has been cutting exposure to clothing retailers and favouring furniture retailers Lewis and Ellerine. "Furniture shares probably offer the best value of all industrials," he says.

Van Cuyck believes industrial shares in general are undervalued. "If you strip out dual-listed shares such as SAB and Richemont, industrials are on a forward p:e of only about 10; given current interest rates, one would have expected ratings to be far higher."

But he does not expect returns to repeat 2004's blistering pace, saying "it looks like an environment of 15% returns over 12 months".

He acknowledges there are "risk factors emerging", such as the current-account deficit and a possible peak in the commodity cycle. Despite this he adds: "I don't think risks are high enough yet to stall the economic recovery or growth in consumption spending."

But he believes it would be naive to expect the good times to roll forever. Beyond the next 12 months, he says, "you will be at risk if you don't start taking a contrarian view".

Financial Mail - 3 June 2005

The JSE Industrial Index consolidated in the first quarter of 2005, declining by 0.5% over the quarter after its exceptional performance in calendar year 2004 (the index rose by 43% last year). Although the fundamentals remain positive for the sector, it would be naïve to expect the industrial sector to generate the returns that we experienced in 2004. The low inflation environment will make it increasingly more difficult for companies to generate double-digit revenue and earnings growth in future. Notwithstanding this, we still expect at least another 12 months of strong double-digit earnings growth from the industrial sector.

Sappi was added as new stock to the fund over the quarter. We sold out of Grintek, JD Group (although we've retained our exposure to both Ellerines and Lewis), and Unitrans. We've reduced our exposure to MTN Group, but still have a healthy exposure (currently 6% of the fund). We've increased our exposure to Imperial as we continue to believe that the counter is offering value, while the fundamental outlook remains positive.

We continue to believe that domestic industrials will show a positive absolute return over the next twelve months. Although there is further scope for interest cuts, we believe that given the strong growth in money supply, the buoyant spending patterns of the consumer and the recent weakness in the rand, interest rates are likely to remain flat in the short to medium term. The longer-term prognosis remains uncertain, however. Should the inflation targeting band of between 3% and 6% be threatened, the SARB is likely to take a conservative approach and may even consider interest rate hikes.

Notwithstanding this, the generally low interest rate environment (and hence low debt service costs), low inflation rate and continued real wage increases bode well for the outlook for private consumer expenditure at least for the next 12 months. We do, however, believe that much of this is already priced into many of the consumer stocks. Government's commitment to infrastructural spend has gained momentum and is likely to support gross fixed capital formation spend over the next few years. Although the manufacturing sector is still suffering from the rand strength, we see selective value emerging in this depressed sector of the economy.

The JSE Industrial Index continued its strong performance, rising by 21.56% in the fourth quarter and by 43.1% for the 12 months ended 31st December 2004. It is pleasing to report that the Sanlam Industrial Fund generated a return of 53.49% for the 12 months ended 31st December 2004, placing it second in its category.

The strong performance is attributed to the encouraging outlook for the South African economy to which we have consistently made reference in our quarterly reports. Although the South African manufacturing sector has been negatively impacted by the strong rand (making our manufactured goods less competitive in a global context) the consumer sector has exceeded expectations. The backdrop of low inflation, low interest rates, real wage increases, substantial tax breaks and a new emerging black consumer segment has provided the tail wind necessary to support healthy domestic consumption.

The following new stocks were added to the fund over the quarter: Sun International and Business Connection. We sold out of the following stocks: Massmart Holdings, Mustek Limited, Amalgamated Appliances and Allied Technologies. Although we sold our Bidvest holding, we've retained exposure to Bidvest via the Bidvest options (BDEO).

We continue to believe that domestic industrials will show a positive absolute return over the next 12 months. This will primarily be driven by further earnings growth in the sector (between 15% and 20%) - comfortably above our expected domestic inflation rate (which we expect to remain within the targeted 3% to 6% range). The strong earnings outlook will be supported by the strong economic fundamentals that we've highlighted above. In addition to this, we do not regard the current valuation of the JSE Industrial Index as too demanding given the robust drivers supporting the sector's fundamental outlook. However, it would be imprudent to expect a repeat of last year's exceptional performance. Investors should expect more modest returns for 2005 (arguably more in line with the earnings and dividend expectations since we've already seen a reasonable rerating of the sector).