Rob Dower
Quarterly Commentary

2015 Q2 Comments from the Chief Operating Officer

The Greek crisis dominated the headlines for much of the second quarter, along with the slowdown in growth and massive stock market volatility in China. Greece's relationship with its creditors makes for distracting news, but it will resolve itself, one way or another. On the other hand, slower growth in China and developed markets may well be a permanent feature. Sandy McGregor argues in his article this quarter that without growing populations, nor much unfulfilled human need, nor a virtuous cycle of productivity-increases-driving-more-skilled-employment, the economies of Japan and of the rich countries in Europe are pulling the world into a much lower 'normal' growth rate than we are used to. On top of this, as populations age, many developed economies – and also China – will struggle with an increase in social security and health costs and a decline in the number of economically active younger people to pay for this.

Back on home soil we face many challenges but, arguably, none so intractable as an ageing population or a state of development that questions the need for further growth. Instead, we have a youth bulge crying out for better skills and better employment. And, while there are some people in South Africa who want for nothing, the vast majority have to make trade-offs each month between quite basic needs. Even those in our growing middle class are not that well off: they are spending on improvements to basic urban housing and small luxuries to improve their general health and well being.

It is a fact to celebrate that our middle class is growing. Unfortunately our best engines for that growth – the industries that employ skilled workers and artisans – are in deep trouble. The symbiotic relationship between mining, manufacturing and infrastructure development should be positive. Instead, right now these sectors are in a downward spiral. Poor performance in mining businesses means less procurement from manufacturers. Inefficient and insufficient infrastructure (for example energy and transport infrastructure) means our mines and our manufacturers are not competitive on global markets. Manufacturers losing volume are less competitive on price and lose orders for infrastructure components or mining supplies to international competitors. The more inputs we import the less a weaker rand helps us. Simon Raubenheimer's article describes the impact of this on South African manufacturing in more detail, and I'm afraid it makes for depressing reading.

The South African economy has always been very dependent on mining. Mining drives industrial demand directly and consumer demand by employing large numbers of people directly and also indirectly in suppliers. With demand for commodities in cyclical decline and many of our gold mines nearing the end of their lives, we have to find sources of growth in new businesses. The Allan Gray Orbis Foundation's vision is to produce high-impact entrepreneurs, with the idea that these individuals will start and lead businesses to drive South Africa's economic growth and employment in the future. The Foundation is now 10 years old and Anthony Farr reports on the great progress they have made in his article. He has included a few profiles of promising Allan Gray Orbis Foundation entrepreneurs; with about 100 new Fellows graduating each year, it is possible to imagine how they could make enough impact to significantly shift this country's prospects.

As bottom-up investors we try not to get too distracted by macroeconomic and political events. While we need to be cognisant of the environment in which we invest, we make our investment decisions based on thorough research of individual investment opportunities. One of the factors we consider is the 'price-to-earnings' (PE) ratio. In the Investing Tutorial, Wanita Isaacs explains why this can be a useful ratio to assess if a particular share presents good value.

The case for active management

Many valuation-conscious active managers around the world have had a difficult time recently. Adam Karr and Matt Adams, from Orbis' San Francisco office, tackle the question of whether or not active managers add value. They argue that although active management is a zero-sum game, and thus mathematically cannot add value 'on average', this does not mean that some skilled managers cannot do so over time. It will come as no surprise to longstanding investors that we firmly believe that our own active stock picking trumps investing in the index over the long term.

Capital preservation is key

Jack Mitchell, a previous leader of our firm, quipped that he would rather lose a client than a client's money. Capital preservation is key to our investment philosophy and approach. This can lead to periods of underperformance when markets are running. Nevertheless, through the cycle, remaining focused on preserving capital, and thus preserving the base for future growth, delivers a better return than risking a permanent loss of capital. We know this doesn't make you feel better about earning less return than your neighbour when markets are running, but we believe our portfolios are appropriately positioned given the current balance between risk and reward. Shaun Duddy's piece offers a more detailed explanation of the importance of capital preservation.

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