Market Review

Central bankers continued to take centre stage, with violent mood swings gripping financial markets due to changes in policy direction. Until May, yields rallied strong across the main developed markets. German Bunds hit record lows on signs that a global recovery was underway, leading to talks of the beginning of a great rotation from bonds into equities worldwide. Since then, however, we saw a sell-off, with US and UK yields reaching twoyear highs. However, at the end of the quarter, the Fed wrongfooted financial markets when it unexpectedly announced its bond purchase programme would continue unabated.

Globally, equity markets had a very good quarter as investors focused on the improving global economic backdrop. Major emerging market equities rebounded some 6% during the quarter, outpacing the main developed markets - except for Japan. The JSE SWIX also had a strong quarter, up more than 11% and outperforming its emerging market peers in dollar terms. The JSE was led higher by a strong rebound in resource stocks, which gained close to 18%, while financials lagged. The Platinum stocks led the way, with Amplats up 48% and Implats up 33% after their interim results surprised positively from a low base. The diversified miners saw strong gains, with Anglos up over 28% and Billiton 17% higher. However, gold miners remained under pressure, with Goldfields down more than 9% and AngloGold Ashanti declining 4% during the quarter.

However, risks remain around the political gridlock with regards to the US Budget and debt ceiling. In Europe, Italy appears to be rudderless and once again the Europeans may have to use the European Central Bank as a back stop. So far financial markets have shrugged off these risks with a sense of deja-vu given that US fiscal policy uncertainty has been with us since April 2011 when a complete shutdown was averted.

More recently a last minute deal was struck in December last year to avoid falling off the fiscal cliff. In the commodities space, the Brent oil price spiked to $116/barrel on the prospect the US would engage in military strikes on Syria. But, with such military action ultimately taken off the table and sanctions on Iran linked to their nuclear ambitions potentially being called off, supply from the Middle East could well increase and the oil price closed the quarter at around the $109/barrel mark.

In contrast to the improvement in manufacturing activity globally, the SA economic backdrop worsened during the quarter, with manufacturing production contracting in September on the back of strike action in a number of industries and the auto sector weighing heavily on the economy.

SA also faces twin deficits. The trade deficit in August widened further from R14bn to R19bn, putting further pressure on the current account deficit. It is a concern that the weak currency has not fed through to better exports. This also points to the need to rein in the import of non-return generating goods. In the case of our budget deficit, there still remains a risk of a credit downgrade. While the currency has now weakened considerably, it is remains exposed to any weakening in our terms of trade. In addition, the consumers remain over-indebted and have been relying on expensive unsecured loans for consumption.

What SIM did last quarter?

The Fund was up strongly during the quarter, gaining more than 15%, which aggregates to close to 30% over one year. The Fund has beaten its benchmark handsomely over the past year, which has beaten its benchmark handsomely over the past year, which shows the value of active fund management. Naspers is now the largest position in the Fund and gained more than 27% during the quarter. Naspers's share price has been driven largely by its stake in Tencent, the Chinese internet company, which so far has increased 63% year-to-date in Hong Kong. We upped our position in Sasol, which rose 11% after delivering strong annual results. We also increased our position in Steinhoff, which is one of the cheapest stocks in a very expensive industrial universe.

What added to, and detracted from, performance

The best performing stock in the portfolio was Steinhoff, which added close to 46% during the quarter. The company reported impressive results, with earnings almost 22% higher. The company is successfully bedding down the acquisition of Conforama in France and is now one of the largest household goods retailers in Europe. The Fund also benefitted from its holding in Mondi, which was up close to 38% during the quarter. It is one of the lowest cost integrated paper and packaging companies in Europe.

The packaging business is particularly attractive as it is less cyclical and is now targeting growth in emerging markets after bolstering its packaging business by acquisition. The Fund's position in diversified miners also paid off this quarter, with Anglo American up more than 28% after beating expectations at half year and its new CEO, Mark Cutifani, inspiring confidence in terms of a more rigorous focus on capital allocation and improving returns in the business. BHP Billiton, another large position in the Fund, was up close to 17%.

On the downside, the Fund remains underexposed to some of the more expensive industrial stocks, which has cost the fund in terms of performance. Also, the Fund is exposed to ABSA, which delivered disappointing interims and was down 1% during the quarter. SIM strategy The Fund reflects the best views of the equity unit trust portfolio managers at SIM and holds a maximum of 20 stocks. It is not benchmark cognisant but owns no offshore stocks. We believe that this portfolio provides the best of both worlds in terms of representing our investment ideas aggressively, while providing adequate diversification. The Fund's largest holdings are companies that are leaders in their respective sectors but whose valuations are below our estimate of their fair value. As value investors, the Fund consists of companies trading at a lower forward PE than the market and at a higher forward dividend yield (3.5%). As pragmatic value investors, the Fund is proof that value managers can still outperform in a market where sections of the market, for example domestic industrials are patently expensive.

Market Review

Outgoing Fed Chairman Ben Bernanke took centre stage as he warned the markets that the Federal Reserve was going to 'taper off' its quantitative easing programme. As a result, we saw a sharp bond market selloff, with liquidity exiting emerging markets faster than whistleblower Edward Snowden could get out of Hong Kong.

This quarter's economic strain was given a human face, with riots that started in Istanbul's Taksim square spreading to the streets of Sao Paulo and crowds amassing in Cairo's Tahrir square yet again, two years after toppling the previous regime - this time to get rid of the new President. The MSCI Emerging Market equity index fell more than 9% in dollars during the quarter, the worst start to the year since the 1998 Asian financial crisis. In sharp contrast, developed markets did better, with the S&P 500 ending 2.4% higher. It is no surprise that Brazil's Bovespa was down 23% and Turkey off almost 17% in dollars during the quarter, as investors were reminded that the emerging market risk premium was alive and well.

If the prospect of taking the world's largest economy off life support was not enough to scare investors, the Chinese economy went into full cardiac arrest as its money market system saw its arteries blocked up and interbank rates spike up to double-digit levels in a move reminiscent of the Lehman Brothers cash crunch that gripped financial markets in 2008. While it is evident that the new Chinese administration is trying to stem the excesses of the past and redirect liquidity to more productive economic sectors, this event was evidence that the rebalancing exercise away from investment-driven growth may bring its fair share of panic attacks and the economy stands to miss a few heartbeats during that surgical process.

The JSE SWIX ended the quarter close to flat in rand terms after a strong rally at quarter end. However, the picture looks less rosy in dollar terms, with the Index down more than 8% - which was, nonetheless, slightly better performance than its emerging market peer group. Year to date, the JSE is down close to 14% in dollar terms, due largely to the rand's sharp depreciation against the greenback - making it one of the worst performing currencies in the world. Commodities continued to suffer a rout during the quarter. Gold led the downside, declining 23% in dollars during the quarter, with platinum slumping close to 15%. Both commodities are important exports for our local economy. Industrial metals fared slightly better, with the copper price down just over 10% during the quarter. We have seen massive liquidation in ETFs as a result, with one of the largest funds in the world, the famed Spider Gold ETF shriveling to less than 1000 tonnes after having lost 40% of its holdings this year. To put that in perspective, that is more than double SA's annual gold production, which collapsed to the lowest levels seen since 1905 last year!

What SIM did last quarter?

The Fund was down marginally by the end of the quarter after a solid first quarter. We upped our positions in MTN , Sasol and Naspers during the quarter. MTN, our largest holding at more than 9% of the Fund, gained almost 14% during the quarter after losing ground during the first quarter. The company continues to trade at an attractive forward yield of 7%. Old Mutual plc is now our fourth largest holding. The stock was up strongly at the beginning of the quarter and we used the opportunity to take profits. The stock ended the quarter down almost 3%.

What added to, and detracted from, performance

The best performing stock in the portfolio was Naspers, which gained some 27% during the quarter. Naspers also produced solid results, with a strong contribution from associates Tencent (China) and Mail RU (Russia) and robust performance delivered byPay TV. The Fund also benefitted from its positions in MTN, up 14% and Sasol, up 2%. On the downside, the diversified miners, BHP Billiton and Anglo American Plc, also disappointed, with the latter shedding 20% during the quarter. Northam also declined some 19%, in line with the close to 15% decline in the platinum price im dollars. Manufacturing production in China is sputtering as the economy is being repositioned from an investment intensive economy to one where services and consumption play a greater role. Of course this could be negative for commodity demand.

SIM strategy

The Fund reflects the best views of the equity unit trust portfolio managers at SIM and holds a maximum of 20 stocks. It is not benchmark cognisant. We believe that this portfolio provides the best of both worlds in terms of representing our investment ideas aggressively, while providing adequate diversification. The Fund's largest holdings are companies that are leaders in their respective sectors but whose valuations are below our estimate of their fair value. As value investors, our Fund consists of companies trading at a lower PE (11.6x) than the market and with a higher forward dividend yield (3.7%).