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Quarterly Commentary

2018 Q3 Comments from the Chief Operating Officer

A lot can happen in 20 years. The iPhone was introduced in 2007, 11 years ago. Facebook and WhatsApp, which started in 2004 and 2009 respectively, have been around for less than 20 years, while Google has been around for exactly 20 years. These companies, among others, have in many respects both changed the world we live in and, at the same time, are an indication of how much the world has changed.

Within this context, the Allan Gray Equity Fund has just celebrated its 20th anniversary. While the world changes, our investment philosophy and process remain the same. We continue to believe that investing in assets that have been undervalued or shunned by the market, and selling them when they reach fair value, is the most effective way of growing your wealth, without taking on too much risk.

Julie Campbell, who was six years into her tenure at Allan Gray when the Equity Fund was launched, takes a comprehensive look at our first-ever unit trust. In her article she reminds us how the Equity Fund started, how it is managed, and provides some interesting examples of how the portfolio has changed.

When the Equity Fund started, Julie, along with other Allan Gray employees at the time, received a gift of R1 000 invested in the new fund. The value of this investment is now worth 50 times more. But looking back reveals that these returns have not come in a straight line. Investors in an equity mandate need to be prepared to buckle up tight and endure what at times can be a bumpy or disappointing ride. Endurance certainly can pay off, but you can also get bruised if you need to access your investment unexpectedly in a downturn or expect constant, regular growth.

The current climate is a case in point. The FTSE/JSE All Share Index (ALSI) has returned a modest 6.7% per year for the past three years, against an inflation rate of 5.2% over the same period. More recently, the ALSI is down 3.8% year to date. Our Equity Fund has fared a little better, but even so absolute returns this year are low at 0.4%.

While periods such as these are stressful for investors, negative sentiment starts to reflect in share prices and value begins to emerge. This gives us the opportunity to buy undervalued companies which have the potential to deliver stronger returns over the longer term.

Valuing companies

One of the shares that have been in and out of our portfolio over the last 20 years is Naspers. The share made up 4.8% of the Equity Fund back then (versus 0.24% of the ALSI) and is now 7.9% ( versus 18.2% of the ALSI). The sheer size of this company gives credence to the time spent researching and debating its future prospects and investment potential. Ruan Stander explains how he goes about valuing Naspers, looking at price-to-earnings on the one hand and a sum-of-the-parts valuation on the other as he draws a conclusion.

Valuing a company is layered. There are many factors that need to be considered, none of which can be looked at in isolation. Good governance is an important aspect of long-term sustainability, and executive remuneration is integral to our investigation of the investment case of a company. Poorly structured incentives can cause long-term damage. We think very carefully about the executive remuneration policies of companies in which we invest our clients’ capital, as Pieter Koornhof explains in his piece.

It is not always easy to apply our philosophy

As stated earlier, we have remained true to our investment philosophy and process since the launch of our Equity Fund – and indeed since Allan Gray himself started the company in 1973. An investment philosophy – which is essentially the stated way that a fund manager invests – is one of the key aspects that can be used to determine the skill of an investment manager. There are others, as Vuyo Nogantshi discusses.

An investment philosophy in concept is quite simple, but its success is only as good as its application. Many times over our history, our resolve has been tested, and we have been made to look foolish as we have stuck to our guns in the face of underperformance. Often we have had high conviction in the potential of a company only for the price to fall further. The skill is to trust the process, to be patient and wait for the thesis to play out.

Underperformance is a normal and expected part of the cycle when you are a contrarian manager, as Stefan Magnusson from Orbis explains, using Orbis’s investment in Chinese technology company NetEase to illustrate his point.

What does the price say about your unit trust investment?

Looping back to our Equity Fund, another interesting thing to note is the change in price of a unit over time. When the Fund was launched, its units were priced at 939 c; today they sit at 41 328 c. But unit prices are not the same as share prices and the story they tell about your investment follows a different thread. Ray Mhere explains all in this quarter’s Investing Tutorial.

Twenty years in unit trust management is a milestone that could not have been achieved without the trust of you, our clients. I thank you for this and look forward to the next 20 years.

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