September was a relatively poor month for the Investec Value Fund with the fund's 1.1% return lagging both the All Share Index's return of +2.3% and the average value fund's 1.9% return. The underperformance was due to a disappointing performance from banks stocks (+0.5% over the month) as well as a strong performance from a few sectors in which we are underweight (healthcare +5%, life assurance +8% and personal goods ie Richemont +9%). For the third quarter your fund returned +4.8% - below the average value fund return of +4.8% and the all Share Index's 6.3% return while year to date your fund's 16.4% return is 1.3% behind the average value fund and 9.8% behind the All Share Index's return.

Over the month we added to holdings on Foschini, Lewis, African Bank, Trencor, Kap International and added new positions in Nampak, Astral Foods and Aveng. Sales included profit taking in AECI, Sasol, MTN and Steinhoff as well as a switch from Firstrand to African Bank.

While your fund's performance when compared to the All Share Index's performance has been disappointing year to date, it is important to note that this has been driven by the outperformance of a few large cap mining stocks in which we have held zero or underweight positions - Anglos (which is by far the largest stock in the market) is up 50% year to date - a move which on its own has contributed nearly 8% to the index's 26% return and which on its own nearly explains the fund's underperformance against the index. While it was the incorrect decision only to have a small position in the stock at the beginning of the year (which we have sold into the run up in the share price), it is important to note that this underperformance against the index could be made up quickly in the event of any underperformance of Anglos - a scenario which we expect given the stock's historic PE of 18 times (which we believe has been driven up by rumours of a break up of the group), as well as falling dollar commodity prices.

The combination of the relatively high ratings accorded to many of the large cap resource stocks in which we hold small positions (15 to 20 times earnings for golds, 10 to 15 times for platinums and 9 to 15 times for the diversified miners) and the relatively low ratings accorded the 'domestic' stocks in which we are overweight (11 times earnings for banks, 9 times earnings for retailers and 10 to 15 times earnings for industrials) lead us to continue to be optimistic with respect to the future. We believe the domestic stocks continue to discount increases in domestic interest rates at a level ahead of what we would expect (our expectation is for a further 100bp to 200bp increase in rates, while we believe most of the banking and retailing stocks are discounting further rate increases of up to 400bp). In addition, we believe that the slowing of the US economy will slow demand for commodities across the board and that the current high levels of dollar commodity prices is not sustainable (recent weakness in a number of commodity prices is starting to lend credence to this view). While weakness in commodity prices may lead to further rand weakness, we believe the rand has already discounted some of the potential commodity weakness and also that the valuations of the financial and industrial stocks are sufficiently low so that further moderate rand weakness will not negatively affect these share prices. The average PE and dividend yield of the portfolio remains attractive at 10 times and 4% respectively.

June was a poor month for the Value Fund with the fund's 1.5% decline over the month coming in well below the All Share Index's 3.4% return. While the month was especially poor when compared to benchmark, it was nevertheless in line with the average value fund as a result of most value fund managers being underweight resources. Over the month basic materials (which is basically resources excluding oil) rose 10% while banking stocks fell 4%, property 4% and retailers 13% - one of the widest monthly dispersions on record between sectors. This dispersion in returns was caused by the surprise rise in local interest rates at the beginning of June in combination with the rapid depreciation in the rand and relatively resilient dollar commodity prices.

These three macro economic factors in combination together with uncertainty with respect to emerging markets resulted in a panic flight from interest rate sensitive sectors into rand hedge sectors, irrespective of valuation. Given your funds underweight positioning in resources and overweight position in banks, we consequently lagged the index considerably. So much for June - the big question is whether we need to alter the composition of your portfolio given these macro economic changes. After careful consideration we have left the fund basically unchanged.

While we believe that there is a high probability that the macro economic environment has changed ie interest rates will probably mover up further from here and it is unlikely that the rand will recover to its previous levels, the key reason why we will not change the portfolio is that these probable macro economic changes are more than fully discounted in the relative valuations of the different sectors.

The major banking stocks are currently trading on historic PE's of 10 times earnings while the large cap diversified resource shares (Anglos and Billiton) are trading on historic PE's of around 14 times. These PE's fall to around 10 or 11 times if spot rand and commodity prices are used. The key question is thus would you be willing to swap your bank shares on a 10 PE for Anglos/ BIlliton at a 10% higher valuation? We believe that the 'spot' earnings for resources (that we calculate to get to the 11 PE's) is top of the cycle ie it is unlikely that either dollar commodity prices will rise further from these high levels or that the rand will materially depreciate from these weaker levels and that the bank's earnings (while high) are not top of the cycle.

It also needs to be considered that even if it is top of the cycle for both groups, the downside to bank earnings is probably no more than 15% while in a bear market for resources the earnings could easily halve. This comparison is more accentuated when you compare an even cheaper FINDI sector like furniture retailing on 9 times earnings, to gold mining companies on 18 times earnings (even at the current spot rand price).

The bottom line is that we believe the market has more than fully discounted what could go wrong with domestic earnings as a result of the combination of a weaker rand and higher interest rates and any good news on either of these two macro variable will cause these shares to rally. The average PE and dividend yield of the fund is around 11 times and 4.3% respectively - a large discount to the market.

Fund manager John Biccard says the JSE is finally getting interesting for value investors, as there is clear mispricing. He cannot understand why retailer JD Group (his biggest purchase in July), with a 7% dividend yield, is being abandoned by investors in favour of unprofitable gold companies; and he is buying retailers on weakness. After selling Truworths in May at R28 he bought again at R20. Sasol and Mittal are the only resource shares.

Financial Mail - 18August2006

March was a rewarding month for unit holders in absolute terms and in terms of performance against peers although an exceptionally buoyant resource market made it difficult for the fund to outperform the All Share Index. The Value Fund's 5.2% return over the month compared well with the average value fund's 4.6% return. Investors should however remember that February's return relative to peers was understated due to a timing difference on month end close prices and equally March's performance against peers has consequently been slightly overstated. March's Value Fund return was below the All Share Index's 7.1% return as a result of a strong upward move in a number of large capitalisation resource stocks. Despite a disappointing March when compared to the index, the Value Fund nevertheless managed to outperform the All Share Index over the quarter (+15.3% against the index's 13.3% return) while the fund underperformed the average value fund's 16.5% return.

Investors should not lose sight of the fact that the returns currently being generated (15% in just three months!) are nothing short of incredible and it would be unrealistic for performance to continue at this pace (The funds' 15% return over the last quarter should also be seen against the 9% return generated over the previous quarter). That said, we do not believe the market is expensive yet but rather that it is overbought short term - the average PE of the top ten stocks in the fund remains at 12.5 times historic earnings - a level which we still believe is a little low given long bond yields of 7.2% and real GDP growth rates in SA of over 4%.
Over the month we realigned the portfolio quite extensively by reducing exposure to select consumer stocks and adding to select resource stocks. This realignment should not be seen as a 'wholesale' switch but rather as lightening holdings in select consumer stocks where the historic PE has got up to around 15 times earnings and thus we do not believe we are being paid to continue holding them despite the quality of the asset (we lightened holdings in Truworths and African Bank). Equally, the resource stocks purchased either represented mitigating risk via increasing the holding from zero (ie Goldfields) or buying reasonably priced assets that have recently underperformed (ie Sasol on 10 times earnings and Mittal Steel on 8 times earnings).

Sasol is one large capitalisation resource stock that we currently believe offers excellent value after 9 months of sharp underperformance against the market - the share is trading on just 10 times earnings and thus offers in our opinion a 'free' option on higher oil prices with the company's GTL technology also thrown in effectively for free. While the authorities' investigation into 'windfall' taxes remains a risk, we do not believe it will be implemented and even if it is implemented, we believe it would not affect the valuation materially. Other purchases included MTN, Standard Bank, Lewis, ABSA and Telkom.

Once the undisputed leader in its sector thanks to manager John Biccard's early adoption of a domestic focused strategy, the fund has slipped since 2003. But Biccard, who has never disappointed, remains a force to be reckoned with. His strategy, which is still heavily slanted towards domestic financials and industrials, is similar to other leading value fund contenders, leaving share selection the deciding factor in the race.

Financial Mail - 24 February 2006