The fund has had another remarkably good month, driven by our high exposure to Banks and some of the smaller cap stocks such as Coronation (+21%), Discovery (+19%), Capital Alliance (+13%), African Bank (9%), Aflife (+8%) and Sasfin (+7%).
We increased our weighting in Nedcor and were almost immediately rewarded with a 12% price increase.
Banks (and to a lesser extent Insurers) have had a good run this year. However, we feel that this is the beginning and not the end. Investors must not forget that the financial sector is re-rating from an extremely undervalued basis, and is still far from expensive. Besides, earnings growth over the next two years will benefit from the very stable and positive economic background. Hence we expect good earnings growth and some re-rating.

For the last 15 months, we have been saying that South African financials are cheap on an absolute (relative to interest bearing instruments such as cash and bonds) and relative basis (better value than Resource shares and the All Share index).
Finally, this month, the Barclays bid for ABSA unlocked the value of the sector and investors in financial shares were handsomely rewarded (15% in two months, 23% since January and about 44% over the past 12 months). Returns like this happens once every 10 years. Unfortunately, many investors now want to invest in financial shares (a pattern that has continuously repeated itself over the past 100 years).

What to do now?
Financial shares are still fair value both in relative and absolute terms - but, investors now have to invest for the longer-term, as further short-term gains are unlikely. However, I believe that we are seeing a repeat of the 1994-1998 cycle when global investors, seeking higher yields in a low yielding and low growth US/UK/Europe, pushed emerging markets to crazy heights. Markets usually overreact - hence the likelihood of this happening is fairly high and new investors might yet be rewarded over the next twelve months.
At least one knows that the environment in which the sector operates has seldom been better (declining interest rates, rising property prices, good economic growth, low bad debts), which will enable Banks to continue to do what they've done for the past 20 years - grow their NAV (including dividends paid) by 20% per annum.

The financial sector re-rated strongly during August, the fund being up 4%. Every share in the fund was up, the laggards being Metlife, Sanlam and African Bank (each up about 2.5%). The additions to Aflife holdings last month worked well as they moved up by 13%. We purchased Nedcor shares (a new holding) and added to the Alexander Forbes holding, selling some Old Mutual and Sanlam shares to finance the purchases.
The macro-economic environment looks much more stable. The unexpected interest rate cut had the effect of weakening the rand - enough to take off some of the overvaluation. Both the rate cut and weaker rand will be good for the growth of the financial sector.
The sector has gradually started re-rating during the past two months. The sector is undervalued; forecast growth in earnings is good and we continue to believe investments in this sector will be well rewarded.

Fund manager Kokkie Kooyman, of Sanlam Investment Management, has put life assurance into pole position. This, he says, is contrary to the group's "core view" that banks offer better value, and results from adding Aflife and Metropolitan Holdings on valuation views. This puts the fund at odds with current sector leader (over 12 months) Sage Financial Services, which has a low life office exposure. It makes for an interesting shoot-out.

Bearing in mind the ALSI's negative return (2.7%) in June, the fund performance was satisfactory.
The positive return was generated by the large holdings in ABSA (+9% including the dividend of 110c), and the next best performer being Standard Bank (+2.4%). During the month the fund manager's invested in two new holdings, Capital Alliance (built up a 4.6% holding) and Alexander Forbes (6.5%). Both these investments paid off handsomely, as both reported results considerably better than market expectations and had price increases of about 11%. Capital Alliance grew its embedded value by 17% (something that few Life Insurers have managed to do).
The fund manager's also built up a 6.8% holding in Remgro, partly to protect the fund against the possibility of a weaker rand, but mainly because of its large discount to its NAV.
Detracting from the positive performance were Aflife (-9%), Liberty Holdings (-3%), Liberty International (-2.5%) and Metlife (a new investment).
Financial shares are not as cheap as they were towards the end of last year. However, earnings growth of the Banking sector has historically (over the past 20 years) been strong and the fund manager's expect the same real growth (adjusting for inflation) going forward. Hence when one looks at the current valuations of the Banks and Life Insurance sector in relation to the growth prospects, the sector represents excellent value.

Effective from 1 June 04, Kokkie Kooiman from Sanlam Investment Managers has taken over the fund manager responsibilities for this fund.

The Financial index performed strongly during the last quarter, with Banks outperforming Life Assurers. This was despite the continued poor performance of Nedcor following the announcement of the expected poor results for the year to December and the fact that they were raising additional capital from Old Mutual. This poor performance fed through to Old Mutual, which underperformed the other big assurers.

The major purchases in the fund during the quarter were Nedcor and increasing the holding in Libhold. The fund manager's have followed a very disciplined approach to the funds purchase of Nedcor, as they believe although it offers a great long-term buying opportunity, there may be some more bad news in the immediate future. There is no doubt that there is significant potential for a turnaround in profitability over the next few years, but the short-term pain required to clean up the balance sheet and income statement will put pressure on their capital position. The fund manager's will be closely monitoring the performance of the new management to ensure that the recovery is on track.

The strong currency also had an impact on companies with big offshore operations, such as Investec, Alexander Forbes and Liberty International.

Stronger overall markets and lower interest rates are positive for Life Assurers. It should increase the demand for their investment products, and will result in growth in the capital base of the assurers.

The primary benefit to Banks from lower interest rates is an increase in the demand for credit and lower bad debts. Although the Banks' index performed strongly during 2003, it remains attractively priced.

The fund manager's continue to look for interesting long-term opportunities, which will add value to investment.