Rob Dower
Quarterly Commentary

2014 Q2 Comments from the Chief Operating Officer

If a company keeps doing something for many years, it eventually becomes part of its wiring. One could ascribe the modest success that Allan Gray Proprietary Limited has achieved over the last 40 years in making money for its clients almost entirely to the very strong connection that we have to our purpose and to the values that our founder set out when he established this firm in 1973. These values have been our compass ever since. A few years ago Allan Gray and his wife Gill funded a Centre for Values-based Leadership at the UCT Graduate School of Business (GSB). In our first article this quarter, republished from the GSB's magazine, Allan talks about the role of ethics and purpose in business, and the role of business in society.

Many investment managers in this country, including ourselves, are beginning to sound like stuck records when we caution investors about the high level of share prices on the JSE. Our stock market is up approximately 21% per annum over the last three years, yet even at the beginning of these three years we struggled to find South African shares that we considered to be trading at a discount to fair value. The market has ignored our scepticism and powered ahead. The market also seems to have ignored reality: since 2011 our economy has been dealing with over-indebted consumers, a labour crisis and regulatory uncertainty in mining, a slowdown in China – which is the major source of demand for the basic materials that are our main exports – and the extended impact of the global financial crisis on capital markets.

A part-explanation for the disconnect between share prices and the tough realities of doing business in South Africa may be found by looking at globally diversified companies listed on the JSE separately to the rest. The top 40 shares on the JSE currently make up about 84% of the FTSE/ JSE All Share Index (ALSI) market cap. According to our estimates, 16 of these top 40 shares derive more than half of their value from outside of SA. Our calculations also show that these global firms have accounted for roughly 70% of the total gains in the Top 40 Index since the end of June 2011. Although these shares now trade at an average price-to-earnings (PE) multiple of 22, and their more local Top 40 peers trade at about 15 times earnings, we still hold substantial positions in some of them. The PE multiple that a rational investor would pay for a company must depend on the level, quality and growth prospects for its earnings; we believe some of these companies justify their higher multiples. Our investment team's jobs would be much easier if the cheaper shares were also those with a global earnings base, or even if shares with mostly local earnings were trading at or below the entire market's long-run average multiple of 12. But the current market bodes relatively well for active investors: without the benefit of fundamental research, passive index investors right now are indiscriminately buying the entire market at share prices that in most cases appear to offer poor value.

The offshore component of your investments

A small percentage of the foreign component of our Balanced and Stable Funds is invested in Africa, and some of you access African investments via our Africa ex-SA Fund.

Clients are often surprised to hear where we are finding opportunities to invest – countries such as Zimbabwe, which present obvious risks. Remember that we always use the same investment philosophy, locally in Africa, and Orbis uses it abroad, looking for opportunities where we feel the market has undervalued a company which has the potential to reach our estimate of its intrinsic value, including a margin of safety. Often these opportunities seem irrational to the outside world. Andrew Lapping discusses our approach to risk in the African region, noting that extremes in market sentiment often represent the best buying opportunities.

Our Balanced and Stable Funds and the Allan Gray-Orbis Global Fund of Funds are invested in our offshore partner Orbis' newly launched Global Balanced Fund. You can also access this Fund directly via our offshore platform. Alec Cutler, from Orbis, discusses the rationale behind the launch of this Fund, which essentially balances appreciation of capital and income generation with the risk of capital loss, as it has the flexibility to invest in a variety of asset classes.

Local shares

While good quality companies at decent prices are hard to come by these days on the local market, our research leads us to the less obvious opportunities. One such company is poultry producer Astral Foods. Leonard Krüger explains the investment case for Astral, the leader in its industry.

Time and investing

Time can work for you in the form of compounding, and against you in the form of inflation. Our perception of time changes as we get older: there is a not-so-subtle shift from feeling we have all the time in the world to save for our distant retirement, to scrambling around as this milestone nears. Time is intrinsically linked to risk. In the context of investments, market fluctuations usually smooth out over time, so if you have a lot of time on your hands, you can often afford to take on more risk. If you do not have the luxury of time, however, you will need to seek out stability – less stable investments have the potential to dip in value and, if you urgently need to cash in, you may land up locking in losses.

We talk a lot about long-term investing in our commentaries and presentations and we apply long-term thinking to your investment portfolios and to our business decisions. But 'long term' means different things to different people. In this quarter's 'Investing Tutorial', Wanita Isaacs tackles this topic.

While retirement is the beginning of the next stage of your life, it is not the end of the investing process. Just because you are making withdrawals does not mean your investment cannot continue to grow. Michael Summerton looks at suitable withdrawal rates for living annuitants and discusses how to adjust your asset allocation to give your retirement savings a longer lifespan. These are complex decisions which will have an impact on the rest of your life, so if you are uncertain what to do, I encourage you to talk to a good, independent financial adviser.

Thank you for your continued support.

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