Rob Dower
Quarterly Commentary

2012 Q4 Comments from the Chief Operating Officer

The Allan Gray group exists to make money for our clients. This is a good objective. Mostly our clients are regular people with everyday goals: to retire with dignity, to fund their children's education, to set something aside for a rainy day. Where they have given us sufficient time to do so, for a healthy majority of clients, we have succeeded in our goal against inflation and compared to our peers. This is despite many periods of short-term underperformance, some of them extreme.

Clients look to us to deliver investment performance that beats inflation (absolute returns) and other fund managers (relative returns). Regular readers will know that for some time we have been more worried about potential absolute losses than we have been excited about the opportunities for gains on the JSE, even as the market has repeatedly made new highs, rising by almost 27% in 2012. We remain underweight on equities where our mandates allow. Net of hedging, the Allan Gray Balanced and Stable Funds are each about 10 percentage points less exposed to shares than their long-term averages. While we have delivered modest annualised absolute returns over the last three years of 12% in Balanced and 7% in Stable, our current overall scepticism about equities, particularly equities focused on the SA consumer, has caused us to lag the average of our peers. Periods of underperformance are the price we pay for long-term outperformance, but we know that you expect better. Our business and livelihoods depend on investment returns and because we charge performance fees we suffer underperformance alongside our clients: be assured, we are very focused on delivering strong long-term results.

Overall net flows in our funds were positive in 2012 and gross outflows divided by assets were at an all-time low of about 15%. This means that, on average, clients are giving us a healthy seven years to deliver returns. Clients who have confidence in long-term performance should not switch out of a fund during times of underperformance; rather those looking to earn better-than-average returns over the next five years may see this as a good time to invest in Allan Gray funds.

Philosophy, process and people

Our long-term performance depends on our philosophy, our investment processes, and the people in our investment team. We have followed the same philosophy since 1974 and our processes are mature and evolve slowly. Chief Investment Officer Ian Liddle's challenge is to build a pipeline of analysts and portfolio managers, such that each generation of Allan Gray investment decision makers is better than its predecessors. This issue of Quarterly Commentary includes an article from Ian describing how we find, develop and motivate the next generation of investment professionals. We have recently promoted two senior analysts to Associate Portfolio Manager: congratulations to Ruan Stander and Jacques Plaut. Congratulations also to Mark Dunley-Owen who will soon manage a slice of our stable portfolios in addition to his fixed interest responsibilities.

A compelling part-explanation for the prices of SA shares remains the extremely accommodative monetary policies in the US, Europe and Japan. These policies have tended to push up the prices of assets, especially in markets with prospects for growth: emerging markets like South Africa have done well because global investors currently find investments in low-growth, highly indebted developed markets relatively unattractive. Less easy money and/or an increase in expectations of growth and returns in developed markets would likely see a reversal in investment flows. In his piece this quarter, Duncan Artus points out the paradox that good news for world growth could be bad news for asset prices if it signals the end of easy money.

Milestone year for the Foundation

Last year was a significant milestone in the journey of the Allan Gray Orbis Foundation, with the first cohort of 12 Allan Gray Scholarship learners reaching Grade 12. After four years at university 98 graduated Fellows have now set out on their life journeys in the Association of Allan Gray Fellows. It is gratifying to see the impact the opportunities offered by the Foundation are having on young South Africans.

We are thankful for your confidence over the last year and remain committed to delivering you superior performance over the long term.

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