Rob Dower
Quarterly Commentary

2015 Q1 Comments from the Chief Operating Officer

This Quarterly Commentary is dedicated to Simon Marais, chairman of Allan Gray Limited, who passed away on 26 February this year.

In recent issues we have printed images reflecting very long-term investments on the front cover. For our firm, and for many of our clients, Simon's career has perhaps been the best long-term investment of all. His contribution to our business was nothing short of extraordinary.

Simon submitted an impressive CV when he applied for a programming job here in 1991: Honours in both maths and physics and a Masters degree in physics, all cum laude, from Stellenbosch, and a Phd in physics from Cambridge. He had returned to South Africa with the intention of doing post-doctoral work in physics but was attracted to the field of investments – I imagine for the reasons in his quote on the inside cover: the opportunity to solve challenging problems, where if you do a good job it makes a big difference to people.

Within a few months he was pulled into the investment team as an equity analyst. By 1994 he was managing client portfolios, in 1998 he was promoted to chief investment officer and in 2001 he took over from Allan Gray as chairman of Allan Gray South Africa. Staying on as non-executive chairman, he moved to our sister company Orbis for a two-year stint in London as head of research, but soon migrated again to warmer Sydney, Australia, where he founded and grew Allan Gray Australia into a highly respected contrarian asset manager.

If he had done nothing else at all, Simon's 20-year track record of adding value in different markets was exceptional. He beat the index in South Africa, globally at Orbis and finally in Australian equities, and he did so by a wide margin and over different periods.

But of course this wasn't his only achievement. Apart from his record as an investor, Simon's distinctive gift was that he could communicate ideas simply and with wonderful clarity. He liked speaking to clients about their portfolios, and sharing his ideas on the radio or in newspapers. This is unusual: many investors are worried about looking stupid or being caught out in some way. This was not the case for Simon, maybe because he was always straight and he spoke his mind without worrying about what others thought. We have reprinted his 2008 article on ‘foresight' without edits or updating. I think you'll agree that it has weathered well.

Simon wasn't obsessive about work. His first priority was always his wife and three boys and he was lucky to have several very close friends, some of them Allan Gray colleagues. He was blessed with a very wide range of talents, which he appeared to relish. Outside of work, he considered the toughest maths problems to be a form of recreation. He was an enthusiastic and surprisingly fast touch rugby player, skilled and competitive at tennis, and a sought-after partner for lunchtime games of bridge in our Cape Town office.

Simon was a true friend for life to his colleagues and we will miss him.

Allocating between property and commodities

This issue of Quarterly Commentary includes two articles on important asset allocation decisions in our balanced portfolios. In our first piece,Tim Acker takes a look at platinum and palladium and explains why we prefer investing in these actual physical commodities to buying shares in the mining companies that produce them. In a second investment article, Yusuf Mowlana and Jacques Plaut discuss the performance and prospects of listed property companies. Our portfolios have a bigger exposure to zero-yield metal bars than to the property sector, which currently pays an average yield of 5.1%.

Although listed property has done extremely well, especially in the last year, in our view the true underlying performance of South African property companies has not been as strong as their share prices suggest. Because property companies distribute virtually all of their net rental income, they are forced to borrow to fund substantial renovations. This works well when property valuations are rising, but not when they stagnate or fall. Just as leverage has augmented returns during the up cycle, it will detract from returns in the down cycle.

On the other hand, while a platinum bar in a vault may not provide a yield today it will be just as shiny in 20 years' time. The same can't be said of a shiny A-grade office block – in 20 years' time it will probably need renovation, and may even be on the wrong side of town.

At current prices, less than half of South Africa's platinum mines generate enough revenue to cover cash operating costs and capital expenditures. South Africa has the vast bulk of the world's known platinum resources, so it is hard to see a significant new source of mine supply. Global mine supply of these metals has been falling for years already and it will probably accelerate if prices remain at these levels. Moreover, the cost to mine an ounce of platinum has grown by roughly 15% per year over the last decade, and it is likely to continue to grow. We certainly have more conviction on the potential for rand capital gains on platinum and palladium from today's valuations, than we do for further gains from property.

Orbis' share selection

While the Orbis funds performed very well in 2013, much of this was given back in a disappointing 2014, albeit on a substantially different share portfolio. Looking at the application of our philosophy in global markets, Graeme Forster, from our offshore partner Orbis, discusses how sometimes it takes time for our investment theses to play out. In some of the more painful periods, prices can become increasingly detached from their underlying value as shares which are unloved, ignored, or misunderstood by the market continue on their path of underperformance. The encouraging flip side is that this presents exciting buying opportunities. We are confident that Orbis' stockpicking abilities will add value to our portfolios over the long term.

Active versus passive

In this quarter's Investing Tutorial, we look as objectively as we can at the difference between active and passive styles of investing. Thandi Ngwane reminds us that managers who outperform also often invest in ways that are contrary to the popular opinions of the time, and their portfolios may be going down while the market is going up. If you choose an active manager you need to stick with your choice during periods of underperformance so you can enjoy the returns when they come.

Manager choice is an important aspect of your investment decisions. This is true whether you are an individual investing for yourself, or an employer looking for retirement savings solutions for your staff. Richard Carter gives us an update on retirement reform and offers some pointers for employers looking for savings solutions for their staff.

Thank you for choosing us as your manager, and for your continued trust and support.

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