Small caps had another phenomenal month in October and showed an increase of 11,6% vs 9,4% for the Allshare index. Small caps are up 34% for the year to date. Despite this, valuations are not yet stretched and are well below the levels of the previous peak.

Major purchases during the month included Advtech, Steers and CS Holdings. These counters offer good value. CS Holdings has come a long way in better managing cash flow and in the fund manager's opinion, the worst seems to be over for the company. While the IT sector has shown little signs of an improvement, CS Holdings is winning new business ahead of the competition.
The fund manager's sold out of Aplitec and took profits in Johnnic and Naspers. The top 10 counters in the fund account for 36,4% of equities and the fund manager's continue to maintain a targeted number of counters of forty.

What is becoming more evident is the impact of corporate action on small caps. Money which is being received on delisting of companies has to be reinvested into fewer and fewer opportunities. This, together with lower interest rates (which encourages greater risk taking) will have a positive impact on small caps in the future.

The Sanlam Select Trust fund is one of the sector's top performers and, with a heavy exposure to construction and related sectors, is positioned for an economic rebound buoyed by lower interest rates. The third-quarter performance was helped by corporate action in two counters, Nail and Wetherlys. New Africa Capital and Alexander Forbes detracted from performance.

(Financial Mail - 31 October 2003)

Small cap shares on the JSE continue to perform very well. During the quarter small cap stocks were up 14,1% vs 6,3% for the Top 40 shares. Since the start of the small cap bull market in April 2002 small caps have outperformed the Allshare index by 69%. While many investors may be getting concerned about the potential for future out performance, we are not. Equity markets are still cheap in South Africa, and the small cap index is trading at half the Price to Earnings multiple at the peak in 1998. In addition, the current decrease in interest rates bodes particularly well for small cap stocks.

The fund is positioned to benefit from the interest rate cycle with a large weighting in construction and related sectors. We are still positive on the retail sector, but have been taking profits in selected stocks. The fund continues to remain underweight the resource sector which has been working well year to date.

During the quarter the fund benefited significantly from Nail and Wetherlys, both which were the subject of corporate action. Other shares which contributed to the performance were Illia, Group Five, Pepkor, Edgars, Naspers and Astrapak. Companies which detracted from performance were New Africa Capital and Alexander Forbes.

Looking forward, we do not believe small caps are expensive and the current interest rate environment bodes well for this asset class. We are cautious on the funds low exposure to rand sensitive stocks, especially if there were to be a considerable weakening in the currency.

The key factor contributing to the performance of the fund was an underweight in resources. More specifically, shares that contributed to the good performance during the quarter include Naspers (+34%), Nail (+30%), Transhex (+30%) and Edgars (+36%).

We continue to remain underweight in resources, focusing rather on special opportunities within the resources sector such as Afleases and Transhex. Significant purchases during the quarter were Johnnic Holding, Transhex and Edgars. The recent rand strength, while negative for resources, will continue to result in small caps outperforming large cap shares. In addition, absolute value still exists in the small cap universe. We are, however, cautious about companies that benefited solely from the weak rand last year and sold these (Metorex, Seardel, Afgem) stocks during the quarter.

Small Cap performance continued to outstrip the rest of the market during the quarter with small caps having declined by 5% relative to a 17% decline in the All Share Index. The good performance was supported by above average earnings growth being reported and attractive valuations.

We are now in the 11th month of the small cap "bull run" which started in April 2002. During this period small caps have returned 11% while the All Share IIndex has declined by 30%. The bear market for small caps which preceded this period was severe. During August 1998 and March 2002, small caps lost 40% of their value.

We managed to avoid the poor performance in the IT sector during the quarter and our lower exposure to resource stocks (particularly gold shares) also helped. On the downside however, exposure to the financial services sector cost us as well as investments in companies who are dependent on exports (Tiger Wheels, AG Industries).

In conclusion, while visibility for small caps has deteriorated and the top down outlook is not as good as a year ago, we would like to emphasise that stock picking is more important than trying to time the change in direction of the small cap cycle. In this light, we continue to seek out companies who are trading at a discount to intrinsic value, are experiencing rising free cash flow valuations and have superb management teams.

Companies in which we made new investments which we are excited about include Nail-N shares, New Africa Capital, Alex-ander Forbes and Adcorp.

The final quarter for 2002 was a good one for the Sanlam Select Fund. A number of counters contributed to the good performance during the quarter and included: Astrapak, Corpcapital, Real Africa Holdings, Afrgri, Seardel and Naspers. We took profits in the following stocks: Wetherlys, Corpcapital, Real Africa Holdings

New stocks added during the quarter included Astrapak. The company will benefit from a stronger Rand against the US dollar as well as the consolidation of Nampak and Malbak. The stock is substantially under valued. We also added Afgem, taking a medium term view on the good prospects for the Tanzanite mining industry. We recently acquired a stake in PSG Group, which we believe is undervalued. A special dividend early in 2003 should be the likely catalyst to unlock value. We also switched out of Metcash into Shoprite based on relative valuation and future prospects. Mid cap stocks delivered an excellent performance in 2002, narrowing the valuation gap between large caps. I still believe the small capitalisation shares offer better value than the mid caps and the fund is positioned with a bias to the smaller companies. The intention is to manage a focussed fund with a maximum of 40 counters. This was marginally higher at the end of 2002.

The outlook for small caps during the first half of 2003 is encouraging given the improving Rand and likely decline in interest rates during the year. Of concern however is the lower inflation, which may negatively impact on the pricing power of smaller capitalisation stocks.

Purchases:
Astrapak: Astrapak is now the second largest packaging company in South Africa. Improving fundamentals (softening oil prices and stronger Rand) bode well for the company which trades on very attractive forward PE. Naspers: The company is in the throws of turning around loss making operations as evidenced in the latest results. The share continues to offer good value.

Sales:
AST: the IT sector continues to experience difficult times. While we believe there is value it will take some time before the outlook improves.

Manager's outlook:
Our strategy is to concentrate our process on the selection of undervalued stocks in a disciplined manner; relative to predicting the timing of market changes. Furthermore, we are seeking those stocks which are both undervalued on a fundamental basis, while being supported by potential corporate activity.

At the end of November 2002, the number of counters in the Trust was 42. It is our intention to reduce the number of counters to around 40; the top 10 stocks intended to comprise approximately 45% of the equity component (this may change according to the outlook for small caps). As at end November 2002, the top 10 stocks comprise 39% of the equity component.

The sustained performance of the Fund on an ABSOLUTE basis, is dependent on the recovery of the SMALL cap universe as a whole. This is a factor which is outside our control.

In this regard, our theme/style analysis suggests that the mid cap sector is in expensive territory. Whilst the indicators do not provide insight into the exact timing of sustained small cap relative out performance, it does illustrate that small caps are currently very cheap on a relative basis, while mid caps are expensive on the same basis.

Small caps have performed exceptionally well during the current year and much in line with our expectations (see previous quarterly reports). I still see substantial value in select small cap stocks and it is on this basis that the fund has a larger weight in small caps than mid caps (relative to peers).