angles & perspectives - PSG

ANGLES & PERSPECTIVES SECOND QUARTER 2017

Contents

1. Introduction – Anet Ahern

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2. Keeping an eye on long-term gains, while understanding short-term pain – Greg Hopkins and Shaun le Roux

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3. The risks of binary thinking when investing – Ian Scott

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4. Managing risk the old-school way – Paul Bosman

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5. The PSG Diversified Income Fund: a flexible income mandate for risk-managed, inflation-beating returns – Ian Scott

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6. Portfolio holdings as at 30 June 2017 10 7. Percentage annualised performance to 30 June 2017 (net of fees)

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8. Risk/return profile

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9. Unit trust summary

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10. Contact information

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It is often in times of fear and uncertainty that we are able to identify opportunities the market may be missing, and sow the seeds for future outperformance. While we understand that this may be uncomfortable in the short term, our long-term track record shows that our clients are rewarded by our patience.

Introduction

Anet Ahern

Anet has 30 years’ experience in investment and business management. After starting her career at Allan Gray in 1986, where she fulfilled various roles in trading and investment management, she worked as a portfolio manager at Syfrets, and later BoE Asset Management, where she was CIO and CEO. She also spent six years at Sanlam, where she was the CEO of Sanlam Multi Manager International, with assets totalling R100 billion in local and global mandates. Anet joined PSG Asset Management as CEO in 2013.

Volatile markets confirm the value of a proven process In our recent roadshow presentations, we built on our message of avoiding black-and-white thinking, and emphasised the importance of keeping natural biases and emotions in check with an objective checklist. For investors, the experience of the past year can be divided into two distinct parts: the second half of last year and the first half of this year. What worked last year does not seem to be working now, and vice versa. We respond to the ongoing uncertainty and volatility by sticking to our proven process and principles. As a result, we continue to find attractive long-term opportunities in local and global equity markets in particular, as well as in the local fixed income space. We believe that now, as always, is the time to look through the dominant market narrative – which can lead to poor decisions – and dissect the opportunities that arise as markets discount events well in advance. As usual, we are happy to sit in hard-working cash that delivers yields above inflation while we wait patiently for investment opportunities that meet all our requirements.

The PSG Diversified Income Fund Our featured portfolio this quarter is the PSG Diversified Income Fund. As part of our Regulation 28-compliant offering, this fund is an ideal portfolio for retirement savings with a lower risk profile. The fund has surpassed the R1 billion mark and is another example of how our investment process is applied consistently across the funds we manage. A consistent, long-term approach will continue to serve investors Uncertainty continues to dominate the markets. This brings opportunity, as emotions continue to drive many investors’ thinking and decisions. As we have written before, we believe that investors’ best allies in the current market environment are a well-considered, long-term financial plan, partnerships with asset managers that stick to their proven processes, and a good deal of patience. We trust that you will find our writings insightful and welcome your feedback. Thank you for your interest and support.

Long-term gains require long-term patience Greg Hopkins and Shaun le Roux open this edition by discussing the importance of looking past short-term concerns and noise, with a firm view on the longer-term opportunity. We re-evaluate perceptions around risk, and conclude that tough times are often good times to invest with us. Constructing portfolios for a range of outcomes Ian Scott expands on the temptation to build a portfolio around a scenario that you are convinced will play out. In this article, he also examines more than one consequence of possible further credit rating downgrades and the perennial importance of diversification. An old-school look at risk management Paul Bosman explains risk using the simple analogy of a coil spring – those of you who attended our recent roadshow events would have heard him talk about it. He also shares our checklist, which helps us to stand back and evaluate all facets of the investment under consideration.

SECOND QUARTER 2017 | 1

Keeping an eye on long-term gains, while understanding short-term pain

Greg Hopkins

Shaun le Roux

Greg is the Chief Investment Officer at PSG Asset Management and the Co-Fund Manager of the PSG Equity Fund, PSG Balanced Fund and PSG Global Equity Sub-Fund. Shaun has managed the PSG Equity Fund since 2002 and he is also Co-Fund Manager of the PSG Flexible Fund. He is a CA(SA) and a CFA charterholder. Current market conditions support long-term decisionmaking It’s a tough time for South African investors, with the country having slipped into recession and political and economic uncertainty turning market sentiment. This may make investing uncomfortable, as fear of an uncertain future elevates concerns about risk.

However, these very same conditions – and the diverse equity market valuations that have resulted – mean that this is a good environment for making long-term investment decisions. US fund manager Howard Marks talks about taking the temperature of the market. This means gauging where it is hot (where confidence and expectations are high, and the chances of finding good bargains are low) or cold (where prices are generally low and chances of finding bargains are high). Currently, we characterise significant parts of the markets as hot, while smaller, less obvious parts of the market are cold.

We are very mindful that falling share and bond prices hit investors right in the stomach, particularly when (and this is normally the case) these prices are accompanied by uncertain outlooks and terrifying newspaper headlines. Over several periods in the past (for example in 2003, 2009, 2011 and 2015), we have felt our investors' pain.

Where we think the market is cold and offers potential bargains In a recent Angles & Perspectives article (fourth quarter 2016) we wrote about the large divergence globally between shares with the highest and lowest market valuations as measured by their price-to-book ratios (which give an indication of what the market would pay for the underlying net assets of a business). These conditions remain in place, as shown in Graph 1.

Current conditions are no different, and make short-term investment decisions difficult. The political environment (not only in South Africa but also abroad) is unpredictable and can result in binary outcomes. Recent events have shown that even if you correctly predict an outcome (e.g. Donald Trump winning the US election), you may not necessarily get the market impact right (in this case, the US stock market rallying). In addition, high levels of global stock markets have given rise to some complacency, as evidenced by very low levels on the VIX volatility index.

In South Africa, large parts of the market are deeply out of favour due to the political backdrop, recessionary conditions and aggressive foreign selling. We can therefore buy quality companies at a widening margin of safety (a greater discount to what they’re inherently worth). What the market is potentially missing is that earnings are depressed for many of these companies. We expect earnings to improve for most of our

Graph 1: Valuations of cheap versus expensive equities (January 1990 - June 2017) 0.35 0.30 0.25 0.20 0.15 0.10 0.05

JAN '91

JAN '93

JAN '95

JAN '97

JAN '99

JAN '01

JAN '03

JAN '05

JAN '07

Global price-to-book (cheap/expensive) Sources: PSG Asset Management, Bernstein 2|

JAN '09

JAN '11

JAN '13

JAN '15

JAN '17

A good environment for longer-term stock and bond picking We are mindful that valuations are inflated in many parts of the market. For this reason, cash levels in our multi asset funds remain high. We have, however, actively been allocating capital to higher-conviction domestic and global ideas where share prices have fallen.

South African investments despite the recessionary conditions, and the combination of low earnings and low valuations supports strong long-term investment returns. It is also worth noting that the moats (competitive advantages) of quality South African companies improve in tough times like these – the strong get stronger while the weak are hardest hit. In fact, this is one of the main reasons the JSE generates such good long-term returns: because South Africa has not been viewed as an attractive place to do business, this has meant less competition. A great example is Santam, which has compounded its share price at 18% (excluding dividends) from the beginning of 1985. Over this period, South Africa witnessed the Rubicon speech, narrowly avoided a civil war, weathered four recessions, and suffered through 86 months in which the year-on-year decline in the rand was more than 20%. Despite all this, Santam’s moat has gone from strength to strength.

Valuations of the equities in our portfolios are at attractive levels, which should mitigate downside risk. In addition, while we have moderate exposure to South African government bonds, we believe that they already price in plenty of bad news. This is evident from looking at South Africa’s credit default swap spread (effectively, the cost of insuring against the South African government) relative to peers that already have domestic junk status. Ultimately, we are mindful about not betting on binary outcomes. Bargaining on any single outcome (e.g. a collapse in the rand) could expose our investors to significant risk if the event does not materialise. Our portfolios are broadly diversified, and we manage any correlations. We believe that this positions our funds to perform in a range of different future scenarios.

Evaluating risk perceptions Perceptions of risk tend to be informed by recent share price movements (as shown in Graph 2). Market participants often perceive risk to be low when stock prices are high (as they generally are now, globally).

Historically, tough times have been good times to add to our funds We have a track record of sowing the seeds for future outperformance in tough times and when fear is prevalent (precisely as in 2003, 2009, 2011 and 2015). Indeed, our subsequent rolling longer-term returns after these periods have been significant. While it may result in shorter-term underperformance, our process has therefore been proven to work over longer time periods.

We do not view expensive stocks that are considered defensive as low-risk investment opportunities. These include some of the mega cap non-resource rand hedges on the JSE, such as Naspers, Richemont and British American Tobacco. We expect muted long-term investment returns from their current valuation levels. Indeed, using Howard Mark’s analogy, the temperature in this part of the market has increased from hot to red hot. While this is not the perception of the general market, we consider parts of the market where share prices are low (such as the out-of-favour domestic counters) as low-risk.

Graph 2: S&P 500 versus the fear gauge (VIX) (February 2000 - June 2017) 45

3 000

30

Fear

25

1 500

VIX Index

35

2 000 S&P 500

40

Fear

2 500

20

1 000

15 500

Complacency

Complacency

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0 FEB '00

5 FEB '01

FEB '02

FEB '03

FEB '04

FEB '05

FEB '06

FEB '07

FEB '08

S&P 500

FEB '09

FEB '10

FEB '11

FEB '12

FEB '13

FEB '14

FEB '15

FEB '16

FEB '17

VIX Index (smoothed)

Sources: PSG Asset Management, Bloomberg SECOND QUARTER 2017 | 3

The risks of binary thinking when investing

Ian Scott

Ian joined PSG Asset Management in 2013, as Head of Fixed Income. He first joined Stanlib in 1999 as a money market dealer, from where he moved to capital markets and was then promoted to Senior Portfolio Manager – Fixed Interest.

A prudent mindset puts risk top of mind One of the cornerstones of our investment philosophy is to be prudent when deploying client capital. This means that risk is top of mind when we allocate to any given asset class: we want to avoid not delivering on our investment mandates over the appropriate time horizons and we always want to buy assets with a margin of safety or high real yield. The odds are stacked against accurate market predictions In the fixed income market, it is very easy to become lost in the dominant narrative and end up following the herd. Current global drivers are always a lure. Simply consider the effects of the global financial crisis and market events such as quantitative easing (inflated money supply), the peripheral European debt crisis, the so-called ‘taper tantrum’ (the rise in US treasury yields in response to gradually lessening money supply) and China’s devaluation of the yuan. Over the past year or so, trend drivers have originated from politics: think Brexit, credit rating downgrades for several BRICS countries, the election of Donald Trump as US president, and recent political developments closer to home. It is very easy to follow a certain story and build a position around that story. However, black-and-white market views result in binary positioning, which increases the risk that the outcome you predict will not materialise. It is always interesting to see how strongly market participants position themselves for a certain outcome – and what the market reaction is when these predictions don’t play out. Of course, this reaction in itself is unpredictable, and may also be contrary to expectations even when a binary outcome is forecast correctly. The odds of getting both the outcome and the market reaction right are clearly low. We therefore aim to construct portfolios that can deliver on their mandates over the long term, irrespective of the binary narratives that are prevalent in the markets. We acknowledge that the reality lies somewhere in between the black-and-white scenarios. We know that interest rates, inflation and GDP growth go through cycles, and we want to understand where we are in each cycle so that we can allocate capital when the odds are in our favour. We construct portfolios that will benefit from a range of possible outcomes We will not allocate a whole portfolio to one strategy or one asset class, even when we have high conviction levels. Rather, we want clients to be diversified across a variety of instruments and asset classes. We believe that this is the departure point for constructing portfolios around non-binary views. In the fixed income market, we allocate client capital to instruments we believe have the highest margin of safety given duration risk (sensitivity to interest rate changes) and credit risk

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(risk of default). We like the idea that there are opportunities in more than one segment of fixed income markets at a certain point in time. And as we have written on various occasions before, we still find value in cash instruments, government bonds and certain parts of the credit curve. In addition, we try to find assets that are uncorrelated with our highest-conviction positions. Due to legislative constraints, South African portfolios are highly correlated with domestic events and rand volatility. We try to minimise this by buying assets that are not affected by South African-specific events. These assets can include offshore cash, hard-currency bonds and real offshore assets (like infrastructure projects). This allows us to diversify a portion of our portfolios away from the highprobability scenario of markets behaving in the opposite way than expected due to an unforeseen political development, disruption or legislative change. Global events in 2016 illustrate real-world binary thinking Major political events in 2016 provide good examples of binary thinking. The first was the view that there was no chance the UK would vote in favour of Brexit. The second was the view that Donald Trump would never be elected US president. In both instances, markets were positioned in a certain way because the belief in a certain result was so strong. We all know what happened next, and how markets reacted when the opposite result materialised. It served as a stark reminder of the risk involved in positioning a portfolio towards an uncertain outcome. The same kind of binary thinking entered the South African market in recent years. It was very easy to become pessimistic in December 2015, following the replacement of former Finance Minister Nhlanhla Nene. Negative political and economic news continued to flood the public domain throughout 2016. The investment case for betting against the rand and South African fixed income assets became the easy route to follow. With fears of looming rating downgrades and all-fall-down scenarios, it was seemingly obvious to be short the rand and positioned away from local fixed income instruments. However, in times like these – when fear and uncertainty dominate market sentiment – we see potential in unloved assets. We believe bonds are less risky when they are unpopular and yields are high. Non-binary thinking allows us to identify attractive opportunities in these and other fixed income markets. A binary narrative continues to play out in South Africa We believe that local fixed income markets continue to build in a binary narrative. There is growing consensus around further sovereign rating downgrades for South Africa – and on what their impact will be.

As Graph 1 shows, foreign investors are the largest single group of investors holding South African government debt. Furthermore, since the country’s inclusion in major global bond indices in 2012, the current holding is the largest that foreign investors have ever held. The black-and-white thinking around this theme is that it is only a matter of time until South Africa’s local currency rating is downgraded to junk status, which will force all these foreign investors to sell their holdings overnight. The downgrade may or may not happen, with no indication of timing. Yet the binary narrative is to be short the rand and South African bonds, as the downgrade will create a massive fallout in local fixed income and currency markets. We understand that the reality may be different to what is currently being priced into long bond yields. Firstly, South Africa comprises about 0.5% of the World Government Bond Index – a small overall weight that may not necessarily force a sell-off from all foreign investors. Secondly, if South Africa is downgraded to junk status, funds invested in South African government bonds will not have to rebalance their positions immediately; there will be a transition period. Thirdly, global investors are still in search of yield and buyers of high-yield debt may decide to enter our market due to the attractive opportunity. Finally, being rated as junk status does not mean automatic default: while South African debt metrics are deteriorating, they are still in line with or better than our emerging market peers.

We continue to find opportunities in the local fixed income market Many local investors have taken a negative stance on South Africa, grounded on firm views, forecasts and expectations. We avoid this type of thinking. Rather, we buy fixed income assets where we see a sufficient margin of safety, and we determine the weight of our allocations based on the highest-probability outcomes. However, we diversify our portfolios away from any single outcome, as this carries too much risk for our investors. We believe that there is still opportunity in the local government bond market due to factors such as credible inflation targeting by the South African Reserve Bank, bond-positive macro data, and elements of fear and uncertainty that may be distorting valuations. We also do not believe that it is prudent to have no exposure to an asset class for which all news is negative and potentially priced in, while the probability of a positive surprise is largely ignored. Owning quality assets that deliver high real yields is central to our fixed income philosophy. This approach is what we believe best positions our clients to benefit from a range of uncertain future outcomes.

Graph 1: Holders of South African government bonds as at May 2017*

• Non-residents 40% • Banks 17% • Insurers 7% • Local pension funds • Other financial institutions

27% 9%

Total 100% * Latest data available Source: National Treasury


Managing risk the old-school way Paul Bosman

Paul Bosman joined PSG Asset Management in 2004. His responsibilities include portfolio management and equity analysis. Paul is Co-Fund Manager of the PSG Balanced Fund, PSG Stable Fund and PSG Diversified Income Fund.

When it comes to managing risk for our clients, we look to the laws of physics, economics and human nature for guidance. The key for us is buying with a margin of safety, after running investments we've researched through our brief but informative checklist.

Investing with a margin of safety is crucial but not always obvious Our investment philosophy is based on long-term thinking and our investment process is guided by our 3 Ms. These refer to the Management of a company, the Moat of the business, and the Margin of Safety between a security's price and its intrinsic value. Management (from senior leadership through to boards of directors) and Moat (a defensive barrier that wards off competitors) are easy to picture. But Margin of Safety – investing only in undervalued instruments – may feel less so. For us, there’s a simple analogy. The physics of a coil spring – maximising upside and limiting downside Prices of securities (shares and bonds) are set at the levels on which buyers and sellers agree. Both parties tend to be human, and as we know, humans are swayed by sentiment and emotion. Behavioural science has repeatedly shown that it is easy for almost anyone to get swept up in elation or halted by fear. Furthermore, many investors mistakenly extrapolate current conditions to inform their expectations for the future. It clearly follows that there is plenty of emotion or irrational thinking baked into market prices. We believe that the key to successful long-term investing is to think rationally rather than emotionally. When valuations are stretched – buoyed either by optimism or, as in recent years, the search for yield and the willingness to attain it at a price – we are cautious. When valuations are depressed – driven down by pessimism or fear – we start to show interest. This is what we refer to as the coil spring principle. A stretched spring has plenty of potential for downward travel and very limited potential for upward travel (as shown in Figure 1). This illustrates the characteristics of an overpriced security, where the price has far more downside than upside potential. The converse is that a compressed spring has significant potential to bounce up and limited potential for further downward travel, illustrating the characteristics of an undervalued security. By consistently seeking out undervalued securities, we are limiting downside and maximising upside. Avoiding broken springs Of course, some springs have lost their bounce altogether. One of the most significant risks when searching for undervalued securities is the risk of investing in those that are cheap for a reason. These are often referred to as value traps. To minimise this risk, we have distilled our collective experience and extensive research into a simple checklist. We apply this as an overlay 6|

to our 3 Ms, to ensure that we further reduce any chance of permanent capital loss. Figure 1: The coil spring principle

Source: PSG Asset Management

The four pillars of our checklist 1. Consider supply and demand dynamics While we do not forecast macroeconomic trends and do not build portfolios around predictions, we do believe that an awareness of the environment in which a company operates is critical. As part of our checklist we consider the probability that an increase in the supply of a company’s product or service could blunt its competitive edge (erode its moat) or at worst, put it out of business completely. In some cases, this is relatively simple. For example, iron ore prices will go down when there is more iron ore in the market than required. But the analysis may also be more nuanced than a simple increase in supply. It could, for example, include substitution or a structural shift in consumers’ behaviour that indirectly results in excess supply. Consider the growth in online retail, which has in some markets resulted in retailers requiring less floor space. The result is an oversupply of retail space, which puts pressure on the price of retail property. This shift is one of the reasons we are cautious of listed property in developed markets. 2. Do business with people you trust This pillar relates to our second M, Management. It helps us to avoid management teams who have the propensity to make materially poor capital allocation decisions or who have been unethical in the past. Evidence of any such behaviour rules an investment out of consideration: we don’t surf when the shark flag is out, even when the waves are exceptionally appealing. As stewards of our clients’ capital, we ensure that this capital is deployed responsibly. Equally as important is avoiding undue risk, be it reputational or the direct risk of financial loss resulting from dishonest dealings. A case in point was Volkswagen’s admission in 2015 that it had cheated in emissions testing. When the revelations came to light in the US, we exited our full position in Porsche Automobil Holding (a holding company of Volkswagen Group). The global scale of the scandal emerged later, further supporting the importance of this investment principle and our immediate exit.

3. Too much debt is deadly Elevated debt levels pose a significant risk to the stability of a business and therefore increase the probability of permanent capital loss. Consider banks as an example, which rely on highly leveraged balance sheets to make economic returns. While many investors automatically assume that big banking names are trustworthy and stable, it is important to remember that banks such as Deutsche Bank, Morgan Stanley, Citibank, Bank of America and Royal Bank of Scotland – amongst others – would all be out of business were it not for government intervention. This is not to say that banks are bad investments – we are currently invested in several local banks. Rather, it underscores the importance of a full credit review and detailed balance sheet analysis as part of the investment process. 4. Identify the impact of economic cycles It is important to distinguish between cash flows that can be attributed to management skill and an economic moat, and those arising from cyclical macro tailwinds – which are temporary. These cycles may not be immediately obvious or easily discerned. However, when they dwindle down, so too do the profits of companies riding on their coattails. The South African construction cycle leading up to the 2010 FIFA World Cup serves as a good illustration. In October 2007, the combined market value of the four largest construction companies in South Africa was R77.9 billion. At end June 2017, this figure stood at R18.3 billion. Clearly, there has been significant value destruction for investors. This is why a full understanding of a company’s operations – and the key drivers of its profits – is essential. It also shows how acting on excitement can be very costly. The rational investor would have disentangled the cycle from the quality of the companies in the sector. A checklist comes with its own risks In the world of investing, a checklist is a double-edged sword: it can help you avoid value traps but can also lead you to

making exactly the wrong decision at exactly the wrong time. A good example of this was the negative sentiment towards US banks following the subprime mortgage crisis. A checklist could easily have disqualified US banks from any investment universe at precisely the wrong time. Between April 2009 (still in the depths of the crisis) and April 2017 (now well after), the MSCI US Banks Index rose by a whopping 187%. In this instance, irrational fear would have been the expensive mistake. Emotionally, it is very tempting to conclude that you will never ride a train again the day after you witness a train crash. The rational conclusion, however, would be to find out what caused that specific train crash. Where we are currently finding coil springs We have harnessed the real yields on offer from local fixed rate negotiable certificates of deposit. In addition, we continue to find good value in offshore equities and selective local shares. Given that local government bonds are currently trading at attractive real yields, they comprise moderate holdings in the PSG Balanced, Stable and Diversified Income funds. Similarly, we hold a diversified portfolio of high-quality corporate bonds. However, we are not finding undervalued securities in foreign bond markets or in the listed property universe (as shown in Figure 2). A consistent process that maximises upside while minimising downside One of Warren Buffett’s most quoted maxims among value investors sets out his two rules. Rule number one is don’t lose money. Rule number two is not to forget rule number one. The compounding benefit of not losing money is indeed one of the wonders of the investment world. This is the reason we look for investment opportunities that offer a sufficient margin of safety and an asymmetrical payoff range – the coil springs. It’s why we apply our checklist as a further risk and quality overlay. And it’s why we ensure that we follow our process consistently – in all our funds, across all asset classes and through all market cycles.

Figure 2: Where we are currently finding value according to the coil spring principle Overvalued

Upside potential

Valuation of qualitative and quantitative information

Downside potential

Undervalued Domestic NCDs

Foreign bonds

Government Corporate bonds bonds

Property

Domestic equity

Foreign equity

Capital allocations Source: PSG Asset Management SECOND QUARTER 2017 | 7

The PSG Diversified Income Fund: a flexible income mandate for risk-managed, inflation-beating returns

Ian Scott

Ian joined PSG Asset Management in 2013, as Head of Fixed Income. He first joined Stanlib in 1999 as a money market dealer, from where he moved to capital markets and was then promoted to Senior Portfolio Manager – Fixed Interest.

Basic fund information: Fund name: PSG Diversified Income Fund Fund size: R1.1 billion ASISA sector: South African – Multi Asset – Income Benchmark: Inflation +1% Managers: Ian Scott and Paul Bosman The fund’s dual objective is providing capital appreciation and attractive income returns The PSG Diversified Income Fund is a flexible fund that aims to provide a reasonable income with above-inflation capital appreciation over time. It invests predominantly in fixed income instruments, but its mandate also allows for investments into equities and property (local and foreign). This enables us to include a selection of our best investment ideas in a single fixed income fund. Investments in equities and property are both capped at 10%, with total offshore exposure limited to 25%. However, given the increased risk allocation, the fund is suited to investors who are comfortable with a small degree of exposure to market fluctuations and who have an investment horizon of two years or longer. We follow a consistent approach and philosophy We apply our long-term philosophy and 3 M investment criteria (Moat, Management and Margin of Safety) to all the funds we manage. With fixed income investments – when we lend client money to governments, banks or corporates – this translates into two key considerations. First, how likely is it that our investors will get their money back – what is the associated risk? Second, will they earn an appropriate return (coupon) given the risk profile of the lender and compared to longerterm inflation rates? To ensure that we generate real (inflationbeating) returns at appropriate levels of risk, we only accept higher yields when there is a very low chance of losing money. We recognise our role as stewards of our clients’ capital To ensure that we exercise this role responsibly, we always: • Think long term We seek out quality companies with strong leadership that are trading at discounts to their intrinsic value – the opportunities the market may be missing. Usually, the best opportunities present themselves in conditions of fear and uncertainty. While it may take time to realise mispriced value – and while it may even come at the cost of shortterm performance – we know that the patient investor is rewarded.

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• Act with prudence

This is a cornerstone of our investment philosophy and integral to our process: maximising potential upside and limiting potential downside by ensuring a sufficient margin of safety in any investment we make. Without it, we are quite willing to forego an opportunity and will hold cash in our funds until we are comfortable that we can use this cash sensibly. For example, three years ago, our funds held no government bonds – we felt that the yields were simply too low. Now, with the yield curve having risen significantly, we have added moderate bond exposures.

• Conduct thorough research

We always do our own homework to understand all the risks associated with an investment. In the fixed income market, this means that we perform extensive credit analyses alongside industry risk ratings to fully evaluate any risk of capital loss. A good illustration was our decision not to invest in African Bank, despite it being rated as investment grade. The bank’s subsequent liquidation – and the unfortunate impact this had on many investors – reaffirmed both our decision and research process.

• Build robust, diversified portfolios

Our funds are broadly diversified across countries, industries, currencies and the yield curve. This ensures that our investors are positioned to benefit from a range of possible outcomes.

We are currently finding good opportunity in fixed income markets In recent months, we have seen a repricing in the yield curves for South African government bonds, banks and corporate credit. Due to prevailing negative sentiment, investors have grown wary of local credit instruments and yields have risen as a result. However, the balance sheets of the banks and corporates we hold in our funds (75% of the PSG Diversified Income Fund as at 30 June) are healthy, while government’s debt-to-GDP ratio (of around 50%) is still at a manageable level. Similarly, we have seen a large pick-up in interest rates applicable to debt instruments with maturities of between 12 and 60 months, without significant increases in associated risk. Nonetheless, to ensure that we manage correlations within the portfolio, the fund’s offshore holdings comprise 6%. Yet again, uncertainty has given rise to opportunity. In addition, inflation expectations have fallen. This makes it more likely that the inflation rate will be contained within the South African Reserve Bank’s target band of 3% to 6% – and that investors will earn inflation-beating returns. All of this is good news for savers. In combination, it also means that investors in the PSG Diversified Income Fund now enjoy a high real yield, after fees (as shown in Graph 1).

Graph 1: PSG Diversified Income Fund – fixed income yield as at 30 June 2017 9.5%

Stable 9.37%

9.0%

Yield percentage

Diversified 8.79%

Income 8.76%

8.5%

Balanced 9.37%

8.0% 7.5% 7.0%

Call rate 6.75%

6.5%

Income Diversified Balanced Stable

6.0% 5.5% 5.0%

0

0.5

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Duration Fixed income yields and durations as at 30 December 2013

Long-term inflation

Call rate

Fixed income yields and durations as at 30 June 2017 Source: PSG Asset Management


Portfolio holdings as at 30 June 2017

PSG Equity Fund

PSG Flexible Fund

PSG Balanced Fund

Top 10 equities

Top 10 equities

Top 10 equities

Discovery Holdings Ltd Old Mutual plc Glencore plc Super Group Ltd Brookfield Asset Management Inc Tongaat-Hulett Ltd Yahoo Japan Corp Hudaco Industries Ltd Anglo American Platinum FirstRand Ltd

Discovery Holdings Ltd Old Mutual plc Brookfield Asset Management Inc FirstRand Ltd Glencore plc Super Group Ltd Tongaat-Hulett Ltd Yahoo Japan Corp Cisco Systems Inc Grindrod Ltd

Brookfield Asset Management Inc Discovery Holdings Ltd FirstRand Ltd Old Mutual plc Nedbank Group Ltd Glencore plc Super Group Ltd AIA Group Ltd Yahoo Japan Corp Hudaco Industries Ltd

Asset allocation

Asset allocation

Asset allocation

• Domestic resources 11%

• Domestic resources 7%

• Domestic resources

5%

• Domestic financials

29%


21%


18%

• Domestic industrials

34%


24%


18%

• Domestic cash and NCDs

24%


12%

• Foreign equity

22%

• Domestic bonds

24%

• Foreign equity

22%

• Domestic cash and NCDs • Foreign equity

1% 25%

Total 100%

• Foreign cash and gold

2%

Total 100%

• Foreign cash

1%

Total 100%

Performance

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Performance

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700

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FTSE/JSE All Share TR Index ZAR

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800 600 400 200 '05

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PSG Flexible Fund

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Inflation +6%

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'03

'05

'07

'09

PSG Balanced Fund

'11

'13

'15

Inflation +5%

'17

PSG Stable Fund

PSG Diversified Income Fund

PSG Income Fund

Top 5 equities

Top 5 equities

Top 10 exposures

Brookfield Asset Management Inc Discovery Holdings Ltd FirstRand Ltd Old Mutual plc Nedbank Group Ltd

Brookfield Asset Management Inc Discovery Holdings Ltd Nedbank Group Ltd AIA Group Ltd Yahoo Japan Corp

Top 5 issuer exposures


Republic of South Africa Absa Bank Ltd FirstRand Bank Ltd Standard Bank of SA Ltd Nedbank Ltd

Standard Bank of SA Ltd Republic of South Africa Absa Bank Ltd FirstRand Bank Ltd Nedbank Ltd

Standard Bank of SA Ltd Absa Bank Ltd Nedbank Ltd FirstRand Bank Ltd Republic of South Africa Capitec Bank Ltd Imperial Group (Pty) Ltd Investec Bank Ltd Land and Agricultural Development Bank of SA MMI Group Ltd

Asset allocation

Asset allocation

• Domestic resources

Asset allocation

3%

• Fixed rate notes

53%

1%

• Floating rate notes

46%

1%



11%



10%


33%

• Domestic cash and NCDs 1%


25%

• Domestic bonds

57%

Total 100%

• Domestic bonds

36%

• Foreign equity

4%

• Foreign equity

14%

• Foreign cash

2%

• Foreign cash

3%

Total 100%

Total 100%

Performance

Performance

Performance

200

250

160

180

140

200

160

120

140

150

120

100

100

100

80

80 60

'11

'12

'13

PSG Stable Fund

'14

'15

'16

Inflation +3% over a rolling 3-year period

'17

50

'06

'07

'08 '09

'10 '11 '12 '13 '14


'15 '16 '17

Inflation +1%

60

'11

'12

'13

PSG Income Fund

'14

'15

'16

'17

STeFI Composite Index (ZAR)


PSG Money Market Fund

PSG Global Equity Sub-Fund

PSG Global Flexible Sub-Fund


Top 10 equities

Top 10 equities

FirstRand Bank Ltd Absa Bank Ltd Nedbank Ltd Standard Bank of SA Ltd Republic of South Africa Investec Bank Ltd Land and Agricultural Development Bank of SA Netcare Ltd Capitec Bank Ltd Imperial Group (Pty) Ltd

Brookfield Asset Management Inc Cisco Systems Inc Yahoo Japan Corp Berkshire Hathaway Inc AIA Group Ltd Glencore plc Colfax Corp Discovery Holdings Ltd Union Pacific Corp Babcock International Group plc

Brookfield Asset Management Inc Cisco Systems Inc Yahoo Japan Corp Berkshire Hathaway Inc AIA Group Ltd Glencore plc Colfax Corp Discovery Holdings Ltd Bank Rakyat Indonesia Perser Union Pacific Corp

Asset allocation

Regional allocation

Regional allocation

• Linked NCDs/Floating rate notes 27%

• US 40%

• US 33%

• Step rate notes

11%

• Europe 2%

• Europe 2%

• NCDs 50%

• UK 16%

• UK 13%

• Corporate paper

3%

• Asia 14%

• Asia 13%

• Bill 7%

• Canada 8%

• Canada 7%

• Call 2%

• Singapore 1%

• Singapore 1%

Total 100%

• Africa 3%

• Africa 2%

• Cash 16%

• Cash 29%

Total 100%

Total 100%

Performance

Performance

Performance

500

200

140

180

120

160

100

400 300 200 100 0

80

120

60

100

40

80 '01

'03

'05

'07


12 |

140

'09

'11

'13

'15

'17

(ASISA) South African IB Money Market Mean (Benchmark)

60

20 '10

'11

'12

'13

PSG Global Equity Sub-Fund

'14

'15

'16

'17

MSCI Daily Total Return Net World USD Index

0

'13

'14

'15

PSG Global Flexible Sub-Fund

'16

'17

US Inflation +6% USD

Percentage annualised performance to 30 June 2017 (net of fees) Local funds 1 Year

2 Years

3 Years

5 Years

10 Years

Inception

Inception date

12.30

4.12

5.87

15.88

9.96

18.22

01/03/2002

FTSE/JSE All Share Total Return Index

1.69

2.75

3.42

12.19

9.32

14.07

PSG Flexible Fund A

9.61

7.19

8.90

15.08

13.36

16.49

11.52

11.82

11.42

11.69

12.22

12.00

8.34

5.88

7.78

12.76

9.55

14.32

10.50

10.80

10.39

10.67

11.18

10.64

6.80

6.53

7.24

9.54

PSG Equity Fund A

Inflation +6% PSG Balanced Fund A Inflation +5% PSG Stable Fund A

9.63

Inflation +3% over a rolling 3-year period

8.50

8.80

8.39

8.67

PSG Diversified Income Fund A

8.20

8.11

7.74

8.25

7.64

Inflation +1%

6.50

6.80

6.39

6.66

7.18

PSG Income Fund A

8.52

8.05

7.56

6.61

STeFI Composite Index

7.64

7.24

6.92

6.29

PSG Money Market Fund A

7.66

7.25

6.94

6.23

7.19 7.23

South African Interest Bearing Money Market Mean PSG Global Equity Feeder Fund A

01/11/2004 01/06/1999 13/09/2011

8.66 7.88

07/04/2006

7.27 6.57

01/09/2011

6.20 8.56

7.82

7.36

6.96

6.28

14.93

6.71

8.74

17.94

14.11

22.40

20.36

19/10/1998

8.56 03/05/2011

5.75

11.37

12.80

PSG Global Flexible Feeder Fund A

11.09

7.21

9.83

14.95

US Inflation +6% (in ZAR)

-3.48

11.63

14.64

17.58

1 Year

2 Years

3 Years

5 Years

Inception

Inception date

25.82

4.48

1.90

7.93

5.30

23/07/2010

11.39

10.35

MSCI Daily Total Return Net World USD Index (in ZAR)

10/04/2013

International funds PSG Global Equity Sub-Fund A

10 Years

MSCI Daily Total Return Net World USD Index

18.21

7.19

5.24

PSG Global Flexible Sub-Fund A

22.25

4.98

2.75

5.82

7.89

7.45

6.95

7.39

US Inflation +6% (USD)

02/01/2013

Source: 2017 Morningstar Inc. All rights reserved as at end of June 2017. Annualised performances show longer-term performance rescaled over a 12-month period. Annualised performance is the average return per year over the period. Past performance is not necessarily a guide to future performance.


PSG Stable

PSG Money Market

PSG Income

PSG Diversified Income

Risk/return profile

Anticipated long-term real returns

14 |

Average risk

PSG Balanced

PSG Global Flexible PSG Flexible

PSG Global Equity

PSG Equity


Provide long-term capital growth and deliver a higher rate of return than that of the South African equity market within an acceptable risk profile

FTSE/JSE All Share Total Return Index

High

7 years and longer

• seek an equityfocused portfolio that has outstanding growth potential • aim to maximise potential returns within an acceptable risk profile

Investment objective

Benchmark

Risk rating

Time horizon

The Fund is suitable for investors who


PSG Income Fund

No

Compliance with Prudential Investment Guidelines (Regulation 28)

No

Annual management fee: Class A: 1.14% + 7.98% of outperformance of high watermark Yes

Annual management fee: Class A: 1.71%

R2 000 lump sum, or R250 monthly debit order

Bi-annually

0% - 75%

Yes



Bi-annually

0% - 40%

• focus on a shortto medium-term investment horizon

• have a low risk appetite but require capital growth in real terms

3 years and longer

Moderate

Inflation +3% over rolling 3-year period

Seek to generate a performance return of CPI+3% over a rolling 3-year period, while aiming to achieve capital appreciation with low volatility and low correlation to equity markets through all market cycles

South African - Multi Asset - Low Equity

Yes



Quarterly

0% - 10%

No



Quarterly

0%


• want to earn an income, but need to try and beat inflation • focus on a shortto medium-term investment horizon

• have a low risk appetite with an income requirement

1 year and longer

Low - Moderate

STeFI Composite Index

Maximise income and preserve capital while achieving long-term capital appreciation as interest rate cycles allow

South African - Interest Bearing - Short-term

• have a low risk appetite and an income requirement

2 years and longer

Low - Moderate

Inflation +1%

Preserve capital and maximise income returns for investors. The fund conforms to legislation governing retirement funds

South African - Multi AssetIncome

For full disclosure on all costs and fees, as well as performance fees FAQ, refer to the fund fact sheets on our website: www.psg.co.za/asset-management


Fees (incl. VAT)


Bi-annually

Bi-annually


Income distribution

Minimum investment

0% - 100%

• want long-term retirement savings

• want a balanced portfolio that diversifies the risk over the various asset classes

• have a time horizon of at least 5 years and can withstand short-term market fluctuations

• aim to build wealth within a moderate risk investment

• aim to build wealth

• focus on a mediumto long-term investment horizon

• would prefer the fund manager to make the asset allocation decisions

5 years and longer

Moderate - High

Inflation +5%

Provide long-term capital growth and a reasonable level of income

South African - Multi Asset - High Equity

• seek exposure to the equity market but with managed risk levels

5 years and longer

Moderate - High

Inflation +6%

Achieve superior medium- to long-term capital growth through exposure to selected sectors of the equity, bond and money markets

South African - Multi Asset - Flexible

80% - 100%

• focus on a long-term investment horizon

South African - Equity - General

Fund category (ASISA classification)

Net equity exposure

PSG Stable Fund


Yes


R25 000 lump sum

Monthly

0%


• need an interim investment vehicle or ‘parking bay’ for surplus funds

• seek capital stability, interest income and high liquidity through a low-risk investment

Minimum of 1 day

Low

South African - Interest Bearing - Money Market Mean

Provide capital security, a steady income yield and high liquidity

South African - Interest Bearing - Money Market

No



Annually

80% - 100%

• focus on a long-term investment horizon

• aim to maximise potential returns within an acceptable risk investment

• seek an equityfocused portfolio that has outstanding growth potential

7 years and longer

High

MSCI Daily Total Return Net World USD Index (in ZAR)

Outperform the average of the world’s equity markets, as represented by the MSCI Daily Total Return Net World USD Index (in ZAR)

Global - Equity General

No



Annually

0% - 100%

• focus on a mediumto long-term investment horizon

• want to diversify their holdings across the world

• want a managed solution in offshore markets

5 years and longer

Moderate - High

US inflation +6% (in ZAR)

Achieve superior medium- to long-term capital growth through exposure to selected sectors of the global equity, bond and money markets

Global - Multi Asset Flexible

PSG Global Flexible Feeder Fund

PSG Global Equity Feeder Fund

PSG Balanced Fund

PSG Equity Fund

PSG Flexible Fund

Rand-denominated offshore

South African portfolios

Unit trust summary

Contact information Local unit trusts 0800 600 168 [email protected]

Cape Town office

Offshore unit trusts 0800 600 168 [email protected]

Physical address First Floor, PSG House Alphen Park Constantia Main Road Constantia, Western Cape, 7806

General enquiries +27 (21) 799 8000 [email protected]

Postal address Private Bag X3 Constantia, 7848

Websites www.psg.co.za/asset-management www.psgkglobal.com

Switchboard +27 (21) 799 8000 Guernsey office Address 11 New Street St Peter Port Guernsey, GY1 2PF Switchboard +44 1481 726034 Client services SA Toll Free 0800 600 168 Malta office Address Unit G02 Ground floor SmartCity Malta SCM 01 Ricasoli Kalkara SCM 1001 Telephone +356 (2180) 7586

16 |

The information and content of this publication is provided by PSG as general information about its products. The information does not constitute any advice and we recommend that you consult with a qualified financial adviser before making investment decisions. For further information on the funds and full disclosure of costs and fees refer to the fund fact sheets on our website. Disclaimer: Collective Investment Schemes in Securities (CIS) are generally medium- to long-term investments. The value of participatory interests (units) or the investment may go down as well as up and past performance is not a guide to future performance. CIS are traded at ruling prices and can engage in borrowing and script lending. Fluctuations or movements in the exchange rates may cause the value of underlying international investments to go up or down. Where foreign securities are included in a portfolio, the portfolio is exposed to risks such as potential constraints on liquidity and the repatriation of funds, macroeconomic, political, foreign exchange, tax, settlement and potential limitations on the availability of market information. The portfolios may be capped at any time in order for them to be managed in accordance with their mandate. Excessive withdrawals from the fund may place the fund under liquidity pressure and, in certain circumstances a process of ring-fencing withdrawal instructions may be followed. The fund may borrow up to 10% of the market value to bridge insufficient liquidity. Unit trust prices are calculated on a net asset value (NAV) basis, which is the market value of all assets in the fund, including income accruals less permissable deductions divided by the number of units in issue. Fees and performance: Prices are published daily and available on the website www.psg.co.za and in the daily newspapers. A schedule of fees, charges and maximum commissions is available on request from PSG Collective Investments (RF) Limited. Commissions and incentives may be paid and, if so, are included in the overall costs. Forward pricing is used. Different classes of Participatory Interest can apply to these portfolios and are subject to different fees, charges and possibly dividend withholding tax and will thus have differing performances. Performance is calculated for the portfolio and individual investor performance may differ as a result thereof. All performance data for a lump sum, net of fees, include income and assumes reinvestment of income on a NAV-NAV basis. Income distributions are net of any applicable taxes. Annualised performance show longer term performance rescaled over a 12-month period. Source of performance: Figures quoted are from Morningstar Inc. Cut-off times: The cut-off time for processing investment transactions is 14h30 daily, with the exception of the PSG Money Market Fund, which is 11h00. The portfolio is valued at 15h00 daily. Additional information: Additional information is available free of charge on the website and may include publications, brochures, application forms and annual reports. Company details: PSG Collective Investments (RF) Limited is registered as a CIS Manager with the Financial Services Board, and a member of the Association of Savings and Investments South Africa (ASISA) through its holding company PSG Konsult Limited. The management of the portfolios is delegated to PSG Asset Management (Pty) Limited, an authorised Financial Services Provider under the Financial Advisory and Intermediary Services Act 2002, FSP no 29524. PSG Asset Management (Pty) Limited and PSG Collective Investments (RF) Limited are subsidiaries of PSG Konsult Limited. Money Market: The PSG Money Market Fund maintains a constant price and targeted at a constant value. The quoted yield is calculated by annualising the average 7-day yield. A money market portfolio is not a bank deposit account. Excessive withdrawals from the portfolio may place the portfolio under liquidity pressures and in such circumstances a process of ring-fencing of withdrawal instructions and managed payouts over time may be followed. The total return to the investor is made up of interest received and any gain or loss made on any particular instrument. In most cases the return will merely have the effect of increasing or decreasing the daily yield but in the case of abnormal losses it can have the effect of reducing the capital value of the portfolio. Fund of Funds: A Fund of Funds portfolio only invests in portfolios of other collective investment schemes, which levy their own charges, which could result in a higher fee structure for Fund of Funds portfolios. Feeder Funds: A Feeder Fund is a portfolio which, apart from assets in liquid form, invests in a single portfolio of a collective investment scheme, which levies its own charges and which could result in a higher fee structure for the feeder fund. Trustee: The Standard Bank of South Africa Limited, Main Tower, Standard Bank Centre, 2 Hertzog Boulevard, Cape Town, 8001. Tel: +27 (21) 401 2443. Email: [email protected]. Conflict of Interest Disclosure: The funds may from time to time invest in a portfolio managed by a related party. PSG Collective Investments (RF) Limited or the Fund Manager may negotiate a discount in fees charged by the underlying portfolio. All discounts negotiated are re-invested in the Fund for the benefit of the investor. Neither PSG Collective Investments (RF) Limited nor PSG Asset Management (Pty) Limited retains any portion of such discount for their own accounts. The Fund Manager may use the brokerage services of a related party, PSG Securities Limited. PSG Collective Investments (RF) Limited does not provide any guarantee either with respect to the capital or the return of the portfolio and can be contacted on 0800 600 168 or on e-mail at [email protected]. © 2017 PSG Asset Management Holdings (Pty) Limited Date issued: 28 July 2017
