Over the past quarter the Capital Plus Fund produced a return of 10.24%. This return was generated in a very favourable environment for all asset classes, with the JSE All Share Index appreciating by 17.4%, the JSE Property Index by around 11.7% and the All Bond Index by 6.9%. For the one year to end September 2004, the Capital Plus Fund has returned 24.9%, which is some 17% ahead of its benchmark of inflation +4% (which has been 8% for the period, with CPIX running at 4%).
As a result of very attractive equity valuations, the equity component of the fund was maintained at around 50%, which is the maximum equity weighting the fund is mandated to hold. This view has been justified, with some exceptional returns from core equity holdings, including Primedia (+111%), Absa (+97%), Naspers (+88%), Telkom (+77%) and Metropolitan (+72%). What is interesting however is that despite the share price appreciation in these equities, we believe that they are all still undervalued. As a result, we have maintained positions in all five stocks.
The greatest contribution to performance over the past months came from the fund's position in Peermont Global. Peermont (previously named Global Resorts) operates in the Casino and Hotel industry, with its most significant asset being Caeser's Palace in Gauteng, which contributes around 85% of group profits. We hold the view that the casino industry is an attractive investment area due to the great free cash flow generation of the industry. What we particularly liked about Peermont Global was its valuation, at the time of purchasing, where the price we paid implied a Price/Free Cash Flow multiple of around 4. This was well below that of the listed competitors at the time (Sun International and Gold Reef City), but more importantly was well below the level at which we believed the company should trade based on fundamentals. We believe this level to be closer to a 9 Price/Free Cash Flow multiple. The fund purchased a stake in the then unlisted Peermont Global in April 2004 for R3.39 a share. Its listing on the JSE took place in September 2004 and now trades at around R5.90 a share. Thus, within a six month period, the fund has achieved a 74% return on this investment. We continue to hold our position in Peermont as we believe that the share is still undervalued.
Over the quarter, the fund added to its position in Telkom post the Minister of Communications announced deregulation of the Telecommunications market. Our view is that the market is pricing in a 'worst case' scenario with regards to deregulation. In other words, what is equally as important as deregulation is the valuation of Telkom. Telkom, at the current price of R75 a share is on a free cash flow yield of over 18% and it generates about R14 in free cash flow a year.
Most of this can be returned to shareholders in the form of dividends and share buy-backs, which means that after just over 5 years, an investor could have received his original investment of R75 back. And Telkom will still be around and will be worth something. Worth a lot in fact. In our view this represents an extremely compelling investment opportunity.
During the past three month period we reduced our government bond exposure as our view was that bonds were overvalued. This selling proved to be too early and bonds have continued to appreciate. We still believe that government bonds are overvalued and that money invested in bonds at this point is at risk of capital loss. As a result of this potential for loss of capital we are comfortable with our very low government bond exposure. This is reflected in the fund's Bond portfolio Modified Duration of 2.1, which is well below the 4.7 of the All Bond Index. In simple English, what this means is that with a 1% increase in bond yields (from say 9% to 10%), the All Bond Index will experience a capital loss of 4.7% of its value while the Capital Plus Fund's bond portfolio will show a capital loss of only 2.1%. It is also important to note that bonds make up only 9% of the total portfolio, so with a 1% upward move in bond yields, the loss of capital within the total fund will only be 0.19%.
Listed property exposure was maintained at around 10% of the total portfolio. Whilst being cognisant of the interest rate risk in listed property shares (due to the historical high correlation with bonds, which is around 85%), we still prefer property over bonds as a result of the strong fundamentals within the property sector and our expectation of growth in distributions of 3-6% per annum.
We have carefully considered whether the time is appropriate to reduce the fund's equity weighting given the strong performance of SA equities over the past year. However, it is our view that SA equities are still the most attractive asset class and as a result we are comfortable at this point with the fund's 50% equity weighting.

The past quarter presented a tough environment in which to produce capital gains. The All Share Index was down by 4.7%, with resources falling by 13.6%, industrials up 1% and financials up by 2.9%. The All Bond Index was up 0.4%, cash returned 2% and listed property produced in excess of 4%. To add to the woes, the rand strengthened against the US dollar by 1.4% and 3.3% against the euro.
For the quarter the fund returned a disappointing negative 0.45%, with the currency chopping off 50 basis points in performance. The funds bond portfolio produced strong returns, outperforming the ALBI by 1.4%, and the funds exposure to property assets worked very much in the funds favour, returning 3% over the quarter. For the year to date, the fund has returned 1,67% despite challenging times, and for the 12 months to the end of June, the fund comfortably beat its performance target by returning 16,6%.
While the equity portfolio produced returns ahead of the market, they were nonetheless disappointing, -0.2% vs. the -4.7% of the ALSI. The detractors from performance were Impala Platinum which was a rand casualty; nonetheless, the fund manager's used the opportunity to buy into the weakness. Similarly, VenFin was impacted by the currency and again the fund manager's used the opportunity to increase exposure. Mvelaphanda and AECI also brought down performance (again currency related), as did Aflife on the back of an earnings warning (the fund remains holders of this stock for the longer term). Significant contributors to performance came from the media stocks, Primedia and Naspers, as a result of strong operational cash flows on the back of a strong recovery in the domestic advertising cycle and lower rand costs as a result of the stronger currency (applicable to Naspers). In addition, Telkom produced good results, with the underpin of strong cash flows and a surprisingly high dividend. During the period the fund manager's participated in the Telkom book build of the partial sale by the Thintana consortium. Other contributors were Kersaf which re-rated after the proposal to delist Sun International, and the financial shares Absa, Standard Bank, and Capital Alliance.

The fund produced an excellent return of 11.5% in the final quarter of 2003, taking the return for the year to end December to 15.93%, comfortably outperforming the target return of CPIX + 4%. This rebound in performance highlights the equity based approach taken by this fund relative to its peers, having benefited hugely from the strong run in equity markets. The fund is currently placed in the top three position in the Absolute Return category over all periods since inception.

For the 12 months to end Dec 2003, equity selection within the portfolio produced 24.4% compared to the JSE All Share index return of 16.1%. Over the past quarter, those individual stocks which contributed significantly were those in which the fund manager's have held a long term conviction, Metropolitan (previously New Africa Capital), VenFin, Telkom, Remgro, Primedia and Standard Bank. Conversely, Bridgestone Firestone detracted from performance as it released its second profit warning in a six month period. Nonetheless the fund manager's continue to see value in this stock and in fact bought into the weakness. The one stock in the portfolio which was most greatly impacted by the macro environment was Tongaat Hulett. This was due to a combination of the strong rand, a weakening in the global sugar price, a weaker US dollar leading to a fall in the company's global competitive positioning and a sharply lower (year on year) maize price. Fortunately, given the depressed share price at the time of the fund manager's building a position in the stock, fund performance was not impacted. This again highlights the benefits of a value-based investment philosophy when capital protection is the overriding investment objective.

The funds exposure to listed property continued to add to performance. Over the past period, the fund manager's increased the funds exposure to this sector through participation in large unit placements by some of the fund manager's preferred counters. The fund manager's continue to prefer listed property to bonds based on their view on the interest rate cycle, as well as their concerns about an increased supply of fixed interest instruments over the next 24 months.

Going forward the fund manager's are still bullish on the local equity market, but have taken out more insurance by means of put options on the market. Part of the reason for this is that with the strength in the rand the fund manager's are somewhat concerned regarding future earnings growth for some of the rand sensitive stocks. The other motivation for buying the put options was just to insure a part of the portfolio against an unforeseen disaster, either locally or globally. This again demonstrates the fund manager's approach to risk management in that the fund manager's are prepared to pay away some premium to reduce the fund's risk profile, even if this is contrary to the funds main stream forecast scenario. The fund manager's also purchased put options on one of the funds largest holdings, VenFin. Exposure to offshore assets will be maintained at a minimum level of 15% (subject to the availability of foreign capacity), in line with the fund manager's long term view that the currency will weaken again. Furthermore, it provides unitholders with a level of diversification in the portfolio so as to reduce overall portfolio risk.