Rob Dower
Quarterly Commentary

2013 Q2 Comments from the Chief Operating Officer

We have written before about the importance of diversifying your portfolio. Diversification allows you to take individual risks (for example, investments in a country, a class of assets or even a share) that would otherwise not be palatable, since they don't impact the whole of your portfolio. Being able to take on risk, in turn, means the potential for better returns.

Big businesses that operate in South Africa face risks that are not very diversified. For example, many of our retailers, retail banks and insurers serve the same communities of consumers and therefore have in common the risk that their customers may have overstretched themselves in the recent boom in unsecured lending. Similarly, our mines face highly correlated labour and policy risk, and sell their products at correlated commodity prices.

Allocating a portion of your investment offshore spreads your risk across different economies and geographic regions and opens up the possibility of earning returns under different conditions. It also provides the potential to increase returns by offering access to industries and companies that may not be available locally, or that may be performing differently.

Without explicitly intending to do so, this issue of our Quarterly Commentary brings this to light by looking at investment opportunities in Africa and Australia. While these pieces were written by individuals miles apart, they touch on similar themes, and in fact make reference to the same graph - the relative performance of South Africa's key indices. What this highlights is how different sectors can present opportunities at different times; as you broaden your investment universe so these opportunities also increase.

Diversified opportunities in Africa

There is a lot of hype right now about the potential for investment and economic growth in Africa. It is easy to see why. We have always had an embarrassing wealth of minerals. Now, with some progress in bringing these to market and a huge backlog of unmet basic consumer and infrastructure needs, the old problems of political uncertainty, fragmented markets, corrupt bureaucracy and weak governance no longer seem so daunting to commentators. Despite this hype, our analysts are finding opportunities to invest in African markets and these are frequently better priced than their equivalents in South Africa. Almost as importantly, the underlying risks these businesses face are very diverse. For example, it is unlikely that the political and economic risks in Nigeria, Egypt, Kenya or Morocco will coincide. In the short term the prices of their shares may move up or down at the same time according to global fashion. However, for patient investors who have done their homework on the drivers of value and risk in the operations of these companies, correlated short-term price fluctuations represent opportunities and not undiversified risk.

With the Allan Gray Africa Equity Fund celebrating its 15th anniversary, Andrew Lapping and Nick Ndiritu use the opportunity to reflect on the changing landscape over this period and to discuss investment opportunities in Africa in general. While the Fund is not open to South African investors, the Allan Gray Balanced Fund and many of our segregated balanced mandates hold positions indirectly in Africa outside of South Africa.

That is not to say there are no opportunities on home soil. Our clients' largest equity investment is currently Sasol. An analysis of Sasol's long-term performance shows that historically, on average, the market has grossly mispriced the business. This has presented opportunities for us to buy shares at a discount to what we consider to be their fair, intrinsic value. With two very ambitious growth projects under consideration and an undervalued legacy business, Sasol is currently an interesting subject for analysis: in his article this quarter, Rory Kutisker-Jacobson discusses the investment case.

Be aware of the context in which you invest

Regardless of geography, when looking for shares to buy, we look at company-specific attributes, such as the competitive environment and the sustainability of earnings, and we form a view on what a fair price would be to pay for a company's normal earnings. We then compare our estimate of fair value to the company's market price to determine its attractiveness as an investment. We use this same approach locally and in the rest of Africa as do our offshore partner, Orbis, and our sister company in Australia.

This emphasis on philosophy ensures we remain focused and not easily distracted by outside noise. However, we acknowledge that it is important to be mindful of the drivers that influence market prices. Ben Preston, from Orbis, examines one of the biggest investment trends of recent times - the huge and unprecedented decline in bond yields to today's low levels.

Using entrepreneurship to drive job creation

In his update on the Allan Gray Orbis Foundation, Anthony Farr discusses the need to improve South Africa's entrepreneurial pipeline by focusing on young people's perceptions of the opportunities around them, on their capabilities and on their confidence. South Africa's very low level of entrepreneurial activity partly explains why our country has such unacceptably high levels of unemployment, and the Foundation is steadfastly committed to making sustainable changes to this situation.

On the subject of change, our Cape Town head offices will soon be moving into a single building a few hundred metres closer to the city and from late August you will be able to find us at 1 Silo Square, V&A Waterfront. Our other contact details (i.e. telephone and fax numbers, email addresses and postal address) will remain unchanged.

We remain extremely focused on your investments and thank you for the trust you place in us.

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