Rob Dower
Quarterly Commentary

2009 Q3 Comments from the chief operating officer

As I write, the JSE is more than double its March low when priced in US dollars. To justify the current stock market valuation on a PE multiple hovering around 15, with in all probability some more bad news to come in the earnings numbers, one has to be pretty optimistic about a return to the high profit levels which characterised the boom years.

The risk is not just in earnings. The last three swings in South African equity prices - the peak in July last year, the trough in October and the recovery since March - have demonstrated the extent to which short-term movements in our local capital markets are driven by global rather than local investor sentiment. Although this sentiment is currently in our favour, and there is a lot more capital out there that could flow into SA, it is also extremely fickle. And the current state is not stable: based on fundamentals, SA share prices expect a strong recovery. Yet the appetite for emerging market currencies implies a continuation of low hard currency interest rates and therefore continued economic weakness. Both of these cannot easily be true having either proved wrong would be bad news for local equities.

Simply put, share prices in South Africa have reached a point where generally we are finding more opportunities to sell shares than to buy them. This is reflected in the reduced equity exposure in our asset allocation portfolios.

Cyclical factors are only one part of the equation

This issue of our Quarterly Commentary includes two articles that demonstrate why value-based investing requires more than a simple analysis of the business cycle.

Our first example is Illovo. The world sugar market is arguably overheated, with sugar currently trading above its long-term mean of US$10.5c/lb. This favourable commercial environment is fully reflected in sugar company stock prices, so you probably would not expect to find a value-based investor like Allan Gray attracted to a sugar business like Illovo at this point in the cycle. Lonwabo Maqubela explains in his article why we believe that Illovo's African operations and favourable European market access mean that its current price is sustainable even if the global price declines, and why we favour the share despite its recent gains.

The opposite is true of the banking sector, which is experiencing depressed profits on the back of record-high bad debts. This would usually make it a good hunting ground for investors like us, as the market tends to extrapolate the bad news of today into the future. Jacques Plaut explains why, despite an expected cyclical improvement in bad debts, we believe that the outlook for South African bank earnings is even more negative than the market anticipates.

Balanced Fund's 10th anniversary

It is difficult not to be proud of the Balanced Fund. It has done a remarkable job over its history, delivering returns in line with those of equities but at a much lower level of risk. Jeanette Marais reminds us of the Allan Gray Balanced Fund's investment mandate as it celebrates its 10th anniversary. Along with the Equity Fund, which began its track record in 1998, the Balanced Fund allowed us to help many thousands of individual investors who we were not able to serve with segregated portfolios.

There are eight Allan Gray funds, and including these we have 43 local funds on our investment platform. This is an intentionally small selection when set against the 899 funds available industry-wide. Marisa Kaplan looks at how in the face of too much choice people often land up making worse decisions, or suffering from buyer's remorse that is, if they are able to make any choice at all.

I hope you enjoy this issue and look forward to your feedback. Thank you sincerely for your continued support. 

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