The turmoil in global markets accelerated in August and September driven by the Euro crisis, fears of a global recession and a 'hard landing' in China. As is typically the case in times of crisis, emerging markets declined significantly more than developed markets, even though one could very rationally argue that the fundamentals and valuations of emerging markets are far better than those of the developed world. Year-to-date the MSCI Emerging Markets index is now -4.2% (in rand terms) and the fund is flat for the year. Since inception just over 3 years ago, the fund has outperformed the index by 4.5% per annum. This sell-off has ultimately been driven by panic and fear and stock movements are significant, with double-digit daily declines in single stocks being frequent. These are not normal conditions and although we very much consider ourselves to be long-term investors, we have found ourselves being more active in the portfolio than would ordinarily be the case. We build the portfolio on a risk-adjusted expected return basis, with position sizes being determined by the upside to our fair values (expected return) as well as consideration of the risk to the earnings streams embedded in these values. In our view, it is times like these (with forced selling resulting in irrational price moves) that one typically gets the opportunity to upgrade the quality of the portfolio, and this is what we have been doing: buying high quality businesses that we sold out of two years ago due to valuation which have now become very attractive again.

Lianhua Supermarkets (China), X5 Retail (Russia) and Anhanguera (Brazil) would all fall into this camp. These shares have as much upside to fair value as the shares we sold, but the businesses are higher quality in our view. Our conviction in the 5-year earnings streams of these businesses is also higher than that of the shares we sold, meaning that the risk-adjusted expected returns are more attractive. Lianhua Supermarkets started in 1991 in Shanghai and is a nationwide grocery retailer operating primarily in the eastern areas of China. The group is present in three retail formats - hypermarket, supermarket and convenience store, and operates under the banners Century Mart, Lianhua and Quik respectively. The company also has a joint venture with Carrefour and besides the hypermarkets sitting in this structure, the company owns all of its hypermarkets and uses a combination of self-owned and franchisees for the supermarkets and convenience stores. The performance of the hypermarkets has improved over time with operating margins having expanded from 0.1% in 2007 to 2.7% for the first half of 2011, and supermarket margins having expanded from 3.5% to 4.5% over the past few years. The group continues to roll out new stores at a rate of around 5% per annum and as the existing stores mature the margin will expand in our view. At time of purchase, the shares were trading on around 12x next year's earnings, which we believe is very attractive given the growth profile in China, where modern retail is still a relatively small portion of total retail spend. The company also has a strong balance sheet and has a large net cash position, part of which is from vouchers and the other is free cash. The stock of Russion grocery retailer X5 Retail fell 45% from its peak, which created an attractive opportunity to re-introduce it to the fund. X5 operate three formats: soft discounters, supermarkets and hypermarkets. The food retail market in Russia is very fragmented, with the top ten retailers having less than 20% market share and X5 are one of the consolidators. During 2010 the company acquired another Russian retailer, Kopeyka. This increased the group's number of stores by 35% and selling space by 19%. The integration process has resulted in below normal margins as IT platforms are merged, distribution channels are integrated, staff are trained and stores rebranded. Each store's rebranding takes around two weeks, temporarily reducing selling space. Trading densities are also well below normal and the total sales area will grow between 10-15% per annum for the next five years. At our average purchase price the stock was trading on around 15x next year's earnings which we believe is very attractive for what is a high quality asset.

Anhanguera is a private university aimed primarily at working adults and has a strong brand in Brazil's fragmented education market. The company operates from a number of campuses and on average these campuses are operating at less than 70% of capacity with 3 500 students compared to total potential capacity of 5 000 students. Mature campuses operate with gross margins of 50%, while newly acquired campuses operate on gross margins as low as 20% because small operators lack scale. This margin expansion is achieved by increased enrolment and curriculum rationalisation. Campuses use the same content per subject and share central administration which dilutes fixed costs as additional campuses are added to the network. We originally started buying Anhanguera in early 2009 and almost completely sold out after the share price trebled in the year that followed. The share price has halved over the past few months due to a number of concerns, the primary one arguably being concerns over the Brazilian economy. We believe that the long-term prospects for the Brazilian education industry are very attractive and Anhanguera is well placed within this industry. We have been buyers of the stock over the past few months to the point where Anhanguera is now a top 5 holding in the fund. We continue to search for opportunities and members of the team are scheduled to go to Asia for a two week trip in November to meet with a range of companies, both current portfolio holdings as well as potential new ideas. Other members of the team will be travelling to both Brazil and China in January.

Portfolio managers
Gavin Joubert, Mark Butler and Suhail Suleman

The fund continued to outperform its benchmark MSCI Global Emerging Markets Index by 2.3% (in rands) in the second quarter of 2011. Although this performance is gratifying, we believe that the longer-term outperformance is far more relevant for our investors when assessing this fund. Since launching at the end of 2007 the fund has outperformed its benchmark by 4.9% p.a. despite being, on average, only 85% invested in equities. More importantly, for investors looking to their fund manager for the protection and growth of their capital over the long term, it is one of the few foreign funds in either the Equity Only or Asset Allocation unit trust categories to provide a positive return over the period as the strength of the rand has counted against offshore assets during this period. Over the last three years, this fund ranked number one amongst the more or less 80 funds in the various Foreign unit trust categories. During the quarter, global markets suffered a large sell-off, partly over fears that Europe would find it impossible to extricate itself from the debt crisis in its peripheral countries, particularly Greece. Markets sold off heavily before recovering slightly in June. Despite having reached a deal with the IMF and embarking on austerity measures, it is likely that Greece faces a long and painful road ahead and the debt and deficit problems in Europe, the US and Japan will continue to affect the world economy for several years. In this environment, when investors fail to differentiate between countries with very different economic (and solvency) outlooks and instead sell down all markets indiscriminately, it creates opportunities for long-term focused investors who recognise that the prospects of a Brazil (as an example) are very different from an Italy.

The fund's biggest holding remains Great Wall Motors (GWM), a Chinese manufacturer of cars, pickups and Sports Utility Vehicles (SUV). At almost 9% of fund, we have increased the position by 2% as the company's share price fell by close to one third during the period. While it has subsequently recovered partially, this underlying volatility reflects the large number of short-sellers of the stock who trade the company as a proxy for China's macroeconomic outlook due to the cyclical nature of the vehicle industry, without regard for the underlying strengths of the actual business. Although we have spoken about this company before, in the context of the position size it is worth recapping why our conviction is so high. GWM is one of China's largest domestic manufacturers in a country where car ownership is still a novelty regardless of what you may read on Beijing congestion and smog. For illustration, there are about 40 vehicles per 1 000 people in China compared to 765 in the US, 543 in Japan and 490 in the United Kingdom. Even compared to other emerging markets China is well behind as Russia has 120 and Brazil 81 (all per 1 000 people). The Chinese aggregate figure also masks a big difference in vehicle ownership between large cities where it is at Brazilian levels and the smaller cities and rural areas where it is in its infancy. With half the population still rural and slowly migrating to cities, coupled with higher growth in the smaller cities that are further behind the development curve, the medium to long-term outlook for the Chinese vehicle market is very positive since urban expansion is a big driver of vehicle ownership. GWM is the market leader in pickups and SUVs and is one of the few Chinese brands to be exported to other countries. In a price sensitive domestic market, its vehicles are up to 30% cheaper than foreign competitors' brands, but offer five-year warranties that other domestic manufacturers cannot. This business should be able to grow earnings at 20% per year for some time and has consistently generated decent returns on equity, yet can be purchased for only 8.5x next year's earnings. Elsewhere in China we bought Gome Electrical after selling out almost two years ago. The company is the largest electrical and white goods retailer in China and continues to add store space to maintain its market share in a fast growing retail sector. Like all retail sectors, scale and volume are key when negotiating prices with large suppliers like LG, Samsung and Sony, so Gome should be able to provide lower prices to its customers over time. A large part of the company is owned by a private equity concern and the management focus has shifted away from growth at all costs toward profitable growth and shareholder returns as the market becomes progressively more competitive. It is a strong cash generator and has a large net cash position that makes it very attractive at 16x earnings.

A recent trip to India provided us with several potential additions, one of which we purchased in May. Good quality education is highly coveted and private schooling in various guises can cater for all income segments except for the very poor. Unfortunately the quality of teaching leaves a lot to be desired even in private schools, so Educomp Solutions developed a content library covering the entire schools syllabus that, when installed with the appropriate IT systems and projector, allows a teacher to graphically illustrate and explain concepts to learners. The additional cost for schools and pupils is very small, but the boost to teaching productivity is noticeable. Their system is currently installed in 35 000 classrooms across the country and they believe they can add at least this amount every year for the next five years to get them to 300 000 classrooms. With the hardware provision effectively outsourced, the marginal cost associated with adding new classrooms is very low. As a result earnings from this flagship product should increase by 25% to 30% per year assuming they do half of what they project. They also operate several 'brick and mortar' private schools - 62 in total with a further 20 under construction, many in joint ventures with recognised international education providers. The completed schools have 25% of the students they could theoretically hold because government regulation does not allow them to fill schools up on day one, but rather stagger the enrolment program over four years. If they did not build another single school, and with the construction costs paid on the schools they already have opened, earnings in this division would still grow a cumulative 500% as the schools fill up over the period to 2014. Educomp is irrationally cheap at a single-digit earnings multiple, especially when one considers that most of the Indian market is quite expensive compared to emerging markets as a whole.

After visiting Brazil we added food producer M Dias Branco to the fund. This producer of pasta, cookies and crackers has, on average, twice the market share of its main competitors and a superior distribution system. The market is still fairly fragmented and the bigger producers are likely to consolidate the market over time, leading to higher margins and a multiplied effect on profits. In an environment where most emerging market food producers trade on at least 20x earnings, M Dias is incredibly cheap at closer to 10x. With a solid franchise and continued investment in brands and distribution we expect earnings to grow strongly for the next four to five years. We continue to look for opportunities and regularly visit countries in search of ideas. Members of the team have already undertaken five two-week trips to destinations in Asia and the Americas this year and several additional trips are planned for the remainder. In a constantly changing environment, this process is essential in order to understand the environment in which businesses operate and to speak to senior management and assess their quality and focus on delivering returns to shareholders.

Portfolio managers
Gavin Joubert, Mark Butler and Suhail Suleman

The year has started out eventfully with much focus on recent turmoil in the Middle East and North Africa and, to a lesser extent, the fallout from the natural disasters in Japan. These major global events have had a substantial impact on markets, with large swings in sentiment and valuation occurring. The fund had an excellent quarter, outperforming the benchmark MSCI Emerging Markets Index (expressed in rands) by 2.3%. Although this performance is very pleasing, we believe a longer term measurement period is more appropriate for comparing returns. Since inception in December 2008, the fund has returned 4.9% (in rands) versus 0.3% for the benchmark.

The MSCI Emerging Markets Index trades at 11.5 times this year's earnings, but this disguises large differences in valuation between certain sectors. Broadly speaking, commodity and resource-related sectors are trading at low multiples, but on earnings that are temporarily inflated by commodity prices that are above what we consider sustainable in the long term. At the opposite end of the spectrum, many consumer facing businesses are trading at valuations that can only be justified if they achieve earnings growth of 20% or more for many years to come.

We believe that in this environment a long-term investment horizon that is premised on paying reasonable multiples on sustainable 'normal' earnings is of critical importance in order to avoid buying businesses that appear cheap, but whose earnings are temporarily elevated, or that require unrealistic future profit growth in order to justify an investment today. We are confident that, on the whole, we are able to find sufficient investment opportunities for the fund. This is reflected in the equity proportion, which ranged consistently between 85% - 90% during the quarter.

Our holdings in Chinese internet-related stocks have performed exceptionally well. Sohu and Netease were 8.2% of fund at the start of 2011 and returned 45% and 31% respectively (in rands) for the quarter. We used the opportunity to halve our exposure to these companies and buy two other Chinese internet (animated) gaming stocks. Both new additions trade at less than 10 times earnings adjusting for their sizeable cash balances. Online gaming businesses are highly cash generative as users typically prepurchase the virtual 'currency' that they then redeem during gameplay to access premium features. Successful games attract large, loyal followings and can remain fashionable for several years, giving the developer a window to develop and test new offerings.

We also introduced Tsingtao, the second largest brewer in China behind CRE (which the fund previously held). The flagship Tsingtao brand is the only domestic premium brand in China and the country's only international beer brand. China's beer market is the biggest in the world by volume, but only the 9th largest by total profits. This is a result of high fragmentation (every region in the country has multiple breweries) and low pricing (entry level beer is cheaper and has a lower margin than bottled water). The county is in the early stages of both consolidation, where smaller brewers are absorbed by larger ones, and premiumisation, where consumers migrate from entry level beers towards higher margin premium beers. We believe that over time the profit pool will grow substantially as pricing becomes more rational and profits will be shared between fewer brewers as the big players start to dominate. This dynamic has played out countless times in every other major beer market in the world and there is no structural reason why China should be any different. Tsingtao should benefit greatly as consumers migrate upwards over time.

Elsewhere, we have spent much time looking at the Indian market, including a recent trip to India where we met with more than 40 companies. For much of the period since the fund launched, India has appeared expensive relative to other emerging markets, and our Indian holdings have been very limited. We do believe that the public sector banks (PSBs) offer compelling value and have added Punjab National Bank (PNB) to our existing holding in Bank of Baroda (BOB). Total PSB exposure of the fund is now at 6%. India is very underpenetrated from a banking perspective: there are over 600 000 villages and the sum total of all branches of all the banks in India comes to only 72 000 today. BOB and PNB are well respected and conservatively run, providing the opportunity to benefit from the growth in credit extension, consumer spending and infrastructure development taking place in the country. But at single digit earnings multiples they trade at a fraction of the valuation that one would pay for some of India's flagship blue chip corporate and FMCG companies.

Portfolio managers
Gavin Joubert, Mark Butler and Suhail Suleman

The fund appreciated by 2.6% in ZAR during 2010. The fund's strong dollar return (+14.7% in USD for 2010) was masked by the 11.8% appreciation of the ZAR, 7% of which came in December alone. In 2010 the fund was the second best performing foreign unit trust out of the 80 foreign unit trusts available in the Foreign Flexible Asset Allocation and Foreign General Equity unit trust categories. The fund also passed its 3-year track record on the 27th of December and since launch it has outperformed its benchmark (MSCI Emerging Markets Index) by 4.1% annualised. Over three years the fund is also the best performing foreign unit trust out of the 65 funds with at least a 3-year track record in the Foreign Flexible Asset Allocation and Foreign General Equity categories.

The biggest contributors to performance in 2010 were the Brazilian education companies (Anhanguera +65% in USD and Kroton Educacional +25% in USD), the coke bottlers (Coca-Cola Femsa +25% in USD and Embotelladora Andina +49% in USD), Naspers (+41% in USD) and Turkiye Garanti (+24% in USD). At the same time, a number of the fund's top 10 holdings performed poorly including Gazprom (0%), Banco Santander Brazil (-4%) and Netease (-4%). A slightly smaller position, China Dongxiang (a Chinese clothing and footwear sports retailer), declined by 40%. In all four cases we have readdressed the investment cases and continue to believe that there is substantial upside to the stocks (more than 50% in all four cases) and as a result we actually added to all these positions over the past few months. In only one case (China Dongxiang) have we reduced our fair value for the business and even after this reduction we believe there is material upside to the stock, which now trades on 7x current earnings excluding a significant net cash position.

Not owning any GEM food or clothing retailers cost the fund as this area of the market was one of the strongest performing areas. We have done detailed work on a number of the GEM retailers and whilst we would agree that many of them are great businesses, the current valuations (typically 20-30x 2011 earnings) just don't offer the margin of safety that we require. For example, Magnit (Russian food retailer) and Wal-Mart Mexico (Mexican and Central American hypermarket retailer) are two businesses that we would love to own, but at the right price. In both cases our fair values are some 10% below the current share prices. We want to buy assets at 30-40% below what we believe they are worth, which means that Magnit and WalMex would have to decline by some 40% before we would consider them to be attractive investment opportunities. The fund has indeed owned Magnit in the past: we bought the shares at around $4 a share during the panic of 2008 and sold them in the $18-20 range around a year later. Many of those same investors who were throwing away Magnit at $4 a share are now prepared to pay $30 for the exact same business a mere two years later.

Over the past few months we marginally reduced a few positions as they moved closer to what we believe the businesses are worth - the fund's positions in Turkiye Garanti, Naspers and MTN were reduced and we completely sold out of Coca-Cola Femsa and Qualcomm as they reached our fair values.

The fund's largest new position (1.7% of fund) was that in Bimbo Foods, who are the largest baker in the Americas with operations in their home country Mexico (over 60% of profits), Central/Southern America and the US. The group produce a range of products including bread, pastries, buns, cookies and confectionery. There are a number of qualities that we like about the business including the fact that it has dominant positions and resultant economies of scale, a defensive earnings stream, a long track record of consistent profitability (EBIT margins have been in a 12-14% band for the past 15 years) and shareholder-friendly management (the business is family owned and despite a number of acquisitions over the years the company has never once issued shares). The share trades on 15x what we believe it will earn in 2011 and whilst this may not appear to be particularly cheap, this is a quality business that we believe can grow its earnings by 17% p.a. compounded over the next 5 years. This will be driven by a number of factors including continued market share gains of packaged bread from fresh bread and synergies from the recent acquisition of the Sara Lee US baker business.

We also added to the fund's position in Heineken to the point where it is now the largest individual position at 5% of fund. Heineken are the owner of a number of premium brands, including the Heineken brand (the largest contributor to earnings), Amstel and Sol. Almost half of the group's business is now in emerging markets and Heineken have the largest percentage of beer volumes coming from premium brands when compared with the three other major global beer companies (Anheuser-Busch Inbev, SABMiller and Carlsberg). The EBIT (operating profit) of premium beer is around 70-80% higher than that of mainstream brands. Yet Heineken, with the largest exposure to premium brands, have the lowest operating margins in the industry (15% EBIT margin compared to the 17% of SABMiller, 20% of Carlsberg and 30% of AB Inbev). There are a number of reasons why Heineken will never achieve the 30% operating margins that AB Inbev enjoy, but we do believe that Heineken will be able to lift their margins over time to closer to the 17-18% EBIT margin level - if not higher. We believe Heineken owns, or part owns, some extremely attractive assets, notably its African business (it is #2 on the continent after SABMiller and has a very strong Nigerian business) as well as its joint ventures in India with United Breweries (Kingfisher being the primary brand) and its stake in the Southeast Asian brewer, Asia Pacific Breweries (where Tiger is the primary brand). We believe that these assets will show substantial growth over the next several years, with additional growth coming from continued premiumisation globally (particularly in emerging markets), revenue and cost synergies from the FEMSA deal and finally cost efficiencies across the business (particularly in the mature European operations). Heineken now trades on around 10x this year's expected free cash flow, which we believe is very attractive for an asset of this quality.

Finally, we added substantially to the fund's existing positions in the Chinese car companies (Great Wall Motors and Guangzhou Automobile Group, which together make up 6% of fund) as they experienced sharp share price declines at the end of the year in large part due to new restrictions on car vehicle licences in Beijing. Both companies have large net cash positions (20-25% of current market caps) and trade on single digit multiples excluding the cash positions. We believe that both companies can grow their earnings well into the double digits for a number of years and as a result current valuations in our view provide a great buying opportunity.

Portfolio managers Gavin Joubert, Mark Butler and Suhail Suleman