Market review
Data released during the quarter confirmed the US economy had a very weak start to the year, with GDP down 2.9% annualised in the first quarter. The market largely looked through this as recent data released indicated labour data and PMI are holding up, vehicle sales are expanding and the housing market is improving.

The European Central Bank is loosening its policy quite materially. It extended its longer-term refinancing operations, cut its key policy rates and indicated that it's paving the way for potential direct purchases in asset-backed security markets. This type of action does not necessarily rule out full quantitative easing, but at this stage it seems less likely. We also saw firmer data out of China, but its housing market is still in decline and high levels of debt remains. So, China is not out of the woods yet.

Locally, the provincial and national elections took place without much impact on the markets. There was initially some surprise at the appointment of the new finance minister, Mr Nhlanhla Nene, but he has been deputy minister under both ministers Gordhan and Manuel, and therefore has sufficient pedigree for the market to initially give him the benefit of doubt. The five-month platinum mining strike finally came to an end in June, but already fears of an elongated NUMSA strike is emerging. The S&P rating agency recently downgraded SA's credit rating from BBB to BBB-, one notch above non-investment grade, citing the platinum strikes, high account deficit and weak demand among its reasons for the decision. Inflation continues to increase, driven by food inflation, and retail sales data have lost some momentum. SA seems to be going through final demand adjustment. The rand also weakened marginally over the quarter. The INDI25 index outperformed all other sectors with its 9% (excl. dividends) return for the quarter. A number of the other bigger industrial companies delivered strong performances.

Trades for the quarter
The fund was moderately active during the quarter . Advanced Health was introduced as a new holding and the fund's holding in Telkom was increased during the quarter. Telkom was not fully discounting the recovery in the mobile business and the ongoing cost savings in the fixed line business and therefore provided an attractive opportunity. On the selling side, PPC and African Oxygen were sold outright and the holdings in Barloworld, Bidvest and EOH were trimmed during the quarter.

Performance attribution
The fund performed well during the quarter and for the year to date, beating its peers and the industrial index over both periods. What is pleasing is the contribution to performance that both long-standing bets and new holdings made over the last 12 months - with particularly strong performance coming from Telkom, sugar producers and the international furniture sector.

Our strategy
Although valuations for a number of industrial shares remain frothy, the diverse nature of the sector means that there are always counters that are mispriced, as sectors or companies fall out of favour with investors. We construct your fund based on where we see the best value, as measured by the discount at which the industrial shares trade relative to their intrinsic value. This is the primary determinant of expected future performance and the basis for constructing the portfolio. We would be more cautious on future expected performance given current valuation levels and, as always, investors should look to diversify their investments.

Market review

The third quarter saw emerging markets continue to underperform developed markets even though commodity prices increased during the quarter. Emerging markets exchange rates remained volatile but stabilised towards the end of the quarter. Developed market bond yields continued moving up, with Japan the notable exception, and political uncertainties continued to weigh on markets generally. Syria dominated the headlines in the early part of the quarter, with markets holding their breath for possible military strikes against Syria by the US and its allies for the suspected use of chemical weapons against civilians.

Towards the end of the quarter the concerns switched towards worries about whether the US would get their own house in order as politics trumped economics and resulted in a partial shutdown of the US government. The real issue is the debt ceiling and the risk of politicians leaving the issue unresolved for too long, which would then start affecting the sovereign debt rating of the US. The knock on effects of this would be massive but we would expect a compromise to be reached before this happens.

In SA, as we entered strike season during the quarter, we saw the PMI drop below 50 in September, which implies manufacturing contracted for the month. The work stoppages in the auto sector had a significant impact during the period. The trade deficit deteriorated to a hefty R19bn in August and if the worst-case US debt ceiling scenario plays out, the frailty of the South African economy would be exposed. The rand was very volatile during the quarter, trading as high as R10.32 to the dollar and as low as R9.58 but stabilised within this range by quarterend.

The market, however, continued to gain ground, with the RESI20 the best performing sector during the quarter. Despite giving up the top spot for the quarter, the INDI25 still put in a very credible 10.7% performance during the quarter, which brings the cumulative performance for the year to 26.3% (excluding the additional return from dividends). This is a very strong performance and is unlikely to be repeated in the short term.

SIM action

The Fund was not very active during the quarter, with Telkom the only share added to the portfolio. The reconstitution of the Telkom board gave us more comfort that the board would put more pressure on the management of the business to manage costs and right-size loss making parts of the business, which should unlock some value. On the selling side, Cipla Medpro was delisted following the conclusion of the deal that saw the Indian pharmaceutical group Cipla Limited acquiring 100% of Cipla Medpro South Africa at a price that represented a 35.8% premium to the 30-day volume-weighted average price (VWAP) when the deal was announced.

Performance attribution

The Fund performed very well during the period, outperforming its benchmark for the quarter and on a year-to-date basis - with strong performance from media, IT and Steinhoff. Stocks that are largely exposed to the local consumer market continue to be a drag on performance.

SIM strategy

Industrial shares continue to perform well on an absolute basis, but we saw better relative performance from resources and smallcaps during the quarter. The valuations for industrials as a sector continue to remain elevated, but the diverse nature of the continue to remain elevated, but the diverse nature of the industrial universe means that pockets of value will always exist. We continue to apply our process of detailed bottom-up fundamental research to help us identify the best opportunities within the market. We remain cautious in the current environment and recommend that investors diversify their investments.

Market review

The second quarter saw a broad sell off in emerging markets, as economic prospects improved marginally in favour of developed markets (mainly the US and Japan). The emerging markets bore the brunt of a combination of weakening currencies, higher bond yields, political turmoil and lower commodity prices.

The weakening rand cushioned the industrial shares performance locally to some extent. In the US, where economic prospects continued to improve marginally, the Federal Reserve responded by indicating they would temper quantitative easing. The result was a pickup in bond yields and a sell-off in commodities, particularly in the gold price, which declined by $440 an ounce during the quarter. While economic prospects in Europe seem to have worsened, in Japan conditions improved as the Bank of Japan went on a massive buying spree. The Yen consequently declined but the Japanese stock market increased by more than 10% during the quarter. The sustainability of this strategy remains in question - but in the short-term it has boosted the Japanese economy.

In SA, we were impacted by similar trends evident in other emerging markets. Heightened labor unrest, particularly on the mines, further rand weakness and a spike in bond yields dampened the overall investment environment. Commodity shares were particularly badly impacted, with the RESI 20 falling 11.3% during the quarter. Economic prospects continued to weaken and became more broadly spread. Initial expectations of economic growth in the order of 3% now look unlikely. The bond market began to factor in rising inflation expectations over the short-term as the R186 increased more than 50 basis points during the quarter. Whether the SARB will look through rising inflation in the face of weak economic prospects remains unclear. Overall, however, the environment for investors has weakened. Industrial shares shrugged off the worsening economic environment and performed well during the second quarter, with the INDI 25 gaining more than 7.8% during the quarter and 14% year to date. This return excludes the additional return from dividends.

SIM action

We were fairly active in the Fund in the quarter. We added to BTI and Pick 'n Pay and established new holdings in Tongaat, KAP Industrial holdings, and Life Healthcare. We trimmed holdings in Bidvest, Rembrandt, Aspen, Naspers, MTN and sold AVI outright.

Performance attribution

The Fund performed reasonably in the period, with companies most exposed to the local market struggling slightly, while international shares performed better, assisted by the almost 7% depreciation in the rand against the dollar. Sectors that performed particularly well included the luxury goods sector, medical and related shares and the media sector. The Fund's small offshore exposure also performed well - particularly in rands.

SIM strategy

For some time now, industrial shares have performed well. It is considered unlikely that the conditions that gave rise to industrial shares performing as well as they have done over the past four years will repeat themselves. The industrial universe that the Fund is exposed to does, however, consist of companies in a range of different industries and thus there are always opportunities to invest. Valuation levels do, however, remain opportunities to invest. Valuation levels do, however, remain elevated. We seek out the best opportunities for you within the current environment by the detailed fundamental work we do. We remain cautious on balance and, as always, would remind investors to diversify their investments.