As bottom-up stockpickers, our investment decisions are based on highconviction beliefs that each individual stock in the portfolio is trading for much less than it is worth. While we firmly believe that this approach provides the best opportunity to deliver pleasing long-term returns for clients, it inevitably exposes us to the risk of underperformance at times when our best ideas perform poorly relative to the rest of the market.

This year has been one of those times. For the year to date, the Orbis Global Equity Fund has declined by 5.3% after fees, compared to the market’s return of about 5%. As we have noted previously, this has been driven in part by stock selection. Our exposure to emerging markets more broadly has also weighed heavily on performance.

Periods of poor performance and low investor confidence can often give us the opportunity to invest in high-quality companies at depressed prices. We believe that’s exactly what’s happening today. This can be seen by taking a closer look at the Chinese video game developer NetEase, which has been one of the Fund’s largest performance detractors in recent months.

Along with broader concerns about the economic slowdown in China, the country’s gaming regulator is undergoing a restructuring and has not approved any applications for new games since March this year. The impact on NetEase’s share price has been painful. Its shares have declined by close to 40% from their recent peak in December 2017 in US dollar terms. Investors fear this heralds a wave of harmful regulation.

We disagree. Discussions with a number of industry stakeholders suggest that the government is not aiming to suppress the gaming industry, and the relevant agencies are expected to resume approving games in a number of months. In the meantime, NetEase is largely insulated from the halt in approvals, as its flagship franchises have already been approved and operating for years and the company has astutely navigated similar regulatory changes over the past decade.

Our confidence is in large part driven by the stewardship of William Ding, the company’s founder, who is focused on creating long-term shareholder value through a relentless focus on product differentiation, continuous improvement and dedicated investment in research and development.

True to form, NetEase has recently been investing heavily in new areas of ecommerce and music. Whilst this increased spending has temporarily depressed margins, we believe it has seeded a promising pipeline of future earnings streams which the market has all but ignored.
As ever, the question is what we are paying for this potential. NetEase trades at 25 times our estimate of 2018 earnings, but we believe the company’s normalised earnings power is considerably higher. Today, the company’s market value is US$30bn. After deducting the US$5bn net cash it holds, NetEase trades at around 13 times the normalised earnings of its core gaming business, and those earnings should grow. In other words, we believe the games business alone will generate more in profits in under 13 years than the entire company is worth today. And if our analysis is correct, NetEase stands to earn significantly more than the profits of its gaming business as its new ventures begin to contribute in the years to come.

Since we initially invested in NetEase 10 years ago, profits have compounded at a rate of 25% per annum, which is equivalent to almost doubling every three years. Essentially all of these profits have been converted to cash, with free cash flow matching and often exceeding accounting profits. The company has shared this success with shareholders both in cash - paying over US$1.5 billion in dividends over the period - and in price appreciation, rising by an annualised 25% in tandem with its earnings growth.

It is hard to say what lies ahead in the short term for NetEase, or for China more generally. We have learned the hard way that things can always get worse before they get better. But taking a step back, what matters most to us is guarding against the permanent loss of our clients’ capital and ensuring that your capital is positioned alongside ours in our highest conviction ideas.

Over the quarter, most of the concentrations in the portfolio were unchanged. The largest individual purchase was Pacific Gas and Electric, a US-based utility company.

Adapted from Orbis commentary contributed by Stefan Magnusson.
For the full commentary please see www.orbis.com

In his excellent book The Art of Learning, former junior chess prodigy and International Master Josh Waitzkin observed: ''The stronger chess player is often the one who is less attached to a dogmatic interpretation of the principles.'' While the Orbis investment philosophy is firmly rooted in a set of core principles - taking a long-term perspective, analysing individual companies, focusing on intrinsic value, and demanding a margin of safety - we have never been dogmatic in our interpretation of these principles.

For instance, we are not dogmatic about valuation methods (e.g. discounted cash flow, multiples, replacement value), or levels (e.g. maximum multiple of earnings, minimum dividend yield), nor are we dogmatic about investment style or factors such as ''value'' or ''growth.'' Instead we recognise that markets are dynamic and discounts to intrinsic value can arise in all types of businesses. While this may frustrate those who want to categorise our investment style, we believe it affords us the agility to uncover opportunities in a variety of market environments. Indeed, we have historically outperformed in both value and growth markets.

One thing we do insist on is a significant discount to our estimate of intrinsic value - defined as the value of a business to a long-term buyer who will own it in its entirety and hold it in perpetuity - but even then we allow our analysts flexibility to use their independent judgement and creativity.

An important consequence of this less dogmatic approach is greater resilience when the traditional rules of the game appear to break down. In chess, Waitzkin would seek to create chaos by radically deviating from convention. His opponents, who were often schooled strictly in the traditional principles, would struggle amidst the chaos. Leveraging an exceptional foundation in the fundamentals, innate creativity, and a less dogmatic interpretation of the way the game was ''supposed to be'' played, Waitzkin was able to exploit the opportunities created in the disorder.

This reminds us of the current market environment, in which longstanding ''rules'' have been upended. For instance, there remain trillions of dollars of sovereign bonds with negative nominal yields, something that shouldn’t happen according to conventional economic models. Central banks have printed extraordinary amounts of money, yet inflation in the real economy has been absent until recently. Growth stocks have outperformed value stocks for the longest stretch on record. At the same time, the extraordinary growth of passive funds and the rise of algorithmic traders are impacting the market in ways that are still difficult to understand.

The result is a strange and confusing environment for those who rely exclusively on rigid or formulaic interpretations of what worked in the past. But we believe there are compelling investment opportunities for those who think differently and aren’t afraid to look in less obvious places.

The US market is a good example. By any traditional valuation measures, the US market looks expensive. Yet the Orbis Global Equity Fund has retained meaningful exposure to the US market in recent years, and our stock selections there have added significant value. We have done this by being highly selective, taking a longer-term view than most, and by focusing on company-specific circumstances that others have overlooked or misunderstood.

Most concentrations in the Fund were unchanged over the quarter. In software, we trimmed positions in selected winners as they approached intrinsic value, and in biotechnology, we added to AbbVie and Celgene. Vale, Nike, and Naspers entered the top ten as we continued to build those positions. Imperial Brands and British American Tobacco fell out of the top ten, largely due to underperformance, and we trimmed Charter Communications.

Adapted from Orbis commentary contributed by Matthew Adams

For the full commentary please see www.orbis.com

As strong returns in 2017 helped to keep the current bull market alive for a ninth year, future stock market returns do not look as appealing at current valuations. With its contrarian, bottom-up approach, Orbis sees the world differently and does not need to invest in ‘the market’. Instead, the focus is entirely on finding the most compelling individual opportunities on offer. While even that exercise has become more challenging in recent years, it is a challenge that Orbis happily embraces. It is during times like these that blindly following an index can be particularly dangerous - and in which Orbis and Allan Gray’s investment style can really earn its keep. The sections below discuss the thinking behind some of the Fund’s holdings in two areas: financials and technology.

From a global perspective, few parts of the market have offered abundant bargains in recent years. Financial services is one exception. KB Financial Group, Korea’s largest bank, and American International Group, a global insurer, are both reasonable quality businesses on firmer footing than they were in the past. Orbis anticipates profitability to improve at both companies over the long term, which should allow them to grow their book value per share by 10-15% per annum. Today, each trades for less than its book value.

Sberbank, the dominant retail bank in Russia, offers the kind of investment credentials that have become all too rare these days. How often does one find a dominant, competitively advantaged market leader with 20%+ return on equity trading at only seven times earnings? What puts investors off, of course, is the unquantifiable ‘Russia risk’. While this deserves consideration and comes with some short-term volatility, Orbis believes the current discount is too severe.

A less traditional financial business is PayPal, the payments technology leader. As a newer business model, it is the hardest of the group to value. The stock looks expensive at first glance because heavy marketing and product development expenses repeatedly weigh down the company’s profits. But Orbis regards these as investments that should produce benefits well beyond the short term. PayPal’s true economic value creation, in Orbis’ view, is considerably higher than what’s captured by headline earnings in any given reporting period.

But along with greater online transaction activity, cybersecurity breaches are also becoming more common. Their cost to global economic activity is already comparable to that of narcotics, piracy and car crashes. As was recently seen with Equifax, the cost of a breach to a company can be devastating. Companies have rushed to plug gaps in their security, but despite a surplus of options, there is a scarcity of firms that can provide unified, high-quality expertise. We believe Symantec is an attractive exception.

Founded in 1982 by artificial intelligence researchers, Symantec grew into one of the world’s largest cybersecurity firms. The company sells software to consumers under the Norton brand and to enterprises under a variety of product lines. Despite its initial leadership in security over the past decade, Symantec lost its focus, its product competitiveness, its growth, four CEOs and its premium valuation. The market started pricing the company as a ‘legacy’ business with its best days behind it. Today, at 15 times adjusted earnings, or a free cash flow yield to equity of 8%, Symantec trades at a notable discount to the US market and at a substantial discount to its technology peers.

Orbis views the company differently and believes the new CEO, Greg Clark, has reinvigorated the business. He has invested more than US$80 million of his own money in Symantec and refocused the company on security by transitioning it to stickier subscription pricing and refreshing the product portfolio. Over the long term, Symantec should also benefit from the adoption of cloud computing as cybersecurity transitions away the old ‘firewalled fortress’ model to a decentralised model that requires broad, integrated coverage.
Individually, these shares represent some of the ideas that Orbis’ investment professionals find most compelling on a bottom-up basis.

There have been few material changes to the Fund’s geographical exposures or currency exposures in the last quarter. The Fund’s weight in Japan has increased, as selected value shares there such as Mitsubishi and Honda appear attractive. With regards to individual holdings, NetEase, a Chinese internet company, reentered the top 10 following strong outperformance over the past quarter. The Fund also established a significant position in UK-based tobacco company, Imperial Brands, making it a new top 10 holding. The tobacco sector has underperformed recently due to fears about potential regulatory actions, but Orbis believes these are unlikely to disrupt the sector’s uniquely attractive business model, which (thus far) has enabled companies to raise prices fast enough to offset declines in cigarette consumption.

Adapted from Orbis commentaries contributed by David Campos (San
Francisco); Stanley Lu (Hong Kong); Michael Heap, Brett Moshal and Ben
Preston, (London)