Sanlam Investment Management
The financial sector was hard hit this quarter by the risk of an economic slowdown in SA which could be exacerbated by the weak rand (falling 6% during the quarter). The Nedgroup Investments Financials Funds' unit price declined by 2% for the quarter but is still positive by 27% for the year. The worst hit were the banks (all down about 8%) and Sasfin (down 16%) - illiquid shares always get sold down more in market corrections, and then of course African Bank (-46%). The weakening rand and not being as exposed to the SA lending market helped Investec to stay almost flat whilst the three stars this quarter were Coronation (+30%), PSG (+10%) and Discovery (+7%). Global financial shares were also hard hit, but the decline in the rand helped make up for that, hence our exposure there helped the fund. We made very few changes to the Fund during the quarter, and those changes that did occur were due to the price moves.
Going forward, although prices have stood still for quite a while, SA's financial sector is still not exceptionally cheap and the outlook is not rosy either. But the companies should all deliver around 15% - 18% return on their capital, which means they are getting cheaper by the month. Politically, South Africa is approaching a cross-road and the election promises are unlikely to make offshore investors excited about South Africa. But the major call on SA will be whether USA interest rates rise further. If this happens it will be a big headwind for all emerging markets.

Despite a deteriorating economy and poor political leadership, financial shares performed fairly well during 2012. The best performing shares in 2012 were Brait (85%), Coronation (79%), Sanlam (54%) and the Firstrand Group (47%), while Old Mutual and Discovery showed gains exceeding 40%. In all cases except Old Mutual (which re-rated from being undervalued), these companies kept surprising the market with their better-than-expected operational results.

The worst performing of the larger shares were ABIL (-6%), Capitec (5%), the JSE (11%) and PSG (10%). Again, these companies (along with Absa 16%), either disappointed the market or in the case of Capitec, ABIL and PSG concerned the market about the possibility of high future bad debts in the sub-prime lending sector.

The Fund did well, generally remaining invested in the best performers with the exception of African Bank, which detracted from the very good returns.

The most significant changes during the year were the increased shareholding in Investec (from 3% in January to 15% in December) and the reduction in our Old Mutual holding (from 13% to 6%). The combined Firstrand/RMH holding was also reduced from 19% to 13% (became too expensive), while Coronation (expensive) and PSG (concerns about Capitec) were also trimmed.

It certainly is unlikely that 2013 will see a repeat of 2012's performance. However, Investec, Sasfin, African Bank and the investments in the Sanlam Global Financial Fund are undervalued and could generate excellent returns, while Standard Bank and the JSE (recently purchased) should also do well.

All in all, against the backdrop of the uncertainty introduced by the outcome of the Italian election and the Cypriot crisis, this was a good month and quarter for the fund.

What was surprising was that FirstRand and Standard Bank strengthened during the month, while Absa and Nedbank were weaker. Not surprisingly, Investec was flat on the one hand supported by a weaker rand, but on the other hand, pushed down by fears about the potential effect of the Cyprus “bail-in” on global equity markets.

Thanks to the weak rand, the Fund's investment in the Sanlam Global Financial Fund was positive despite global banks being negative this month.

South African macro-economic data (especially the trade balance) remained poor, but news flow and results regarding and reported by our banks remained positive. Sasfin (a large holding in the Fund) and Capitec (indirect holding via our PSG holding), reported good results, Sasfin gaining 15%.

The only change we made to the Fund was to further reduce exposure to Standard Bank marginally after the news that Jacko Maree is stepping down as CEO, while increasing exposure to Nedbank and Absa.

We remain positive about global markets (excluding Europe), but concerned about the outlook for the rand due to the deteriorating trade balance and the risk of increased inflation. However, shares like Investec, Discovery and Old Mutual as well as the exposure to global financial shares, should benefit the Fund in this scenario.