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Fourth Quarter Newsletter 2012

unit trusts | offshore | retirement funds


Features Dear valued investor

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The price of safety and the value of distress

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Investing for income

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Convertible bonds - combining income and upside participation

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The crowd arrives

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10 Commandments for managing a bank in turbulent times 11 Revised fund classification system enables more meaningful comparisons 13 Responsible investing - bringing stewardship to the fore

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The 6 Ms and our national mood

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Our investment approach We help you find Best of BreedTM fund managers and the right investment solution When you invest, you want the most appropriate fund manager to look after your savings. We assist you in this process by actively researching and appointing fund managers to manage our fund range. Our independence is our strength Our fund manager research process helps us to identify managers with specific traits that we believe will enable them to deliver superior results over the long term. We focus on monitoring fund managers so that you don’t have to Things do change. To help you manage this, and to ensure that our range remains Best of BreedTM, we actively monitor and review the appointed fund managers. If we think it is necessary, we will replace specific fund managers that are no longer deemed appropriate.


Dear valued investor Regular readers of our newsletters are familiar with our Best of Breed™ investment approach. This philosophy sees us research, select and monitor the best available investment managers on an on-going basis to ensure that investors have the most appropriate choice available. We undertake to continually review our selected managers to ensure that the reasons for selecting them remain in place, and the investment results they are producing are consistent with their stated approach. Prescient Investment Management recently decided to consolidate its unit trust offering under its own brand. We took this opportunity to make some changes to the management of our funds managed by Prescient and announced the following: The Nedgroup Investments Positive Return Fund will be managed by Foord Asset Management. The unit trust portfolio will be realigned, and with the balloted permission from investors, merged into the Nedgroup Investments Stable Fund. The objective of both unit trust portfolios is exactly the same (both target annualised returns of Inflation + 4% with no negative 12-month periods). The Nedgroup Investments Stable Fund has been managed by Foord Asset Management since its inception in 2007 and has developed an admirable track record – it is currently the number two ranked fund in its category since inception. Foord Asset Management has been a partner of Nedgroup Investments since 2004 and currently oversees R14bn of our clients’ investments.

Nic Andrew

Head of Nedgroup Investments

The Nedgroup Investments Flexible Income Fund will be managed by Abax Investments. Abax is a long standing partner of Nedgroup Investments and has successfully managed our flagship Rainmaker equity fund for over a decade. Abax has invested substantially in their fixed income skill-set and recently appointed Rashaad Tayob to their team. Rashaad is well known to our investors as he previously worked at Prescient where he was the co-manager of the Nedgroup Investments Flexible Income Fund. Prior to joining Abax he set up his own investment firm that specialised in fixed income mandates, aspects of which have now been incorporated into Abax Investments. We look forward to Rashaad and the team at Abax building on the good results that this unit trust portfolio has managed to deliver to our investors over the past 10 years. Investors in the Nedgroup Investments Optimal Income Fund will be aware that the process to merge the Optimal Income Fund into the Flexible Income Fund is well underway and will be completed by the end of November 2012. This process remains on track and is not impacted by the change to the manager of the Flexible Income Fund. The Nedgroup Investments Bond Fund will be managed by Taquanta Asset Managers. Taquanta is the pre-eminent income manager in South Africa and currently oversees more than R15bn of our clients’ investments. Taquanta has been a partner since the formation of Nedgroup Investments. The Nedgroup Investments Bond Fund is currently the most competitively priced bond fund in the market and this fee advantage has been an important driver of the outperformance that the unit trust portfolio has managed to achieve over the longer term. We will use the opportunity to make the unit trust porfolio even more competitive, by dropping the annual management fee from 0.5% to 0.35% per annum. We would like to take this opportunity to thank the team at Prescient for the care, diligence and skill with which they have managed our investors’ savings over the years. We are excited by these developments and will ensure on behalf of our investors that we continue to monitor our managers to ensure that our unit trust portfolio range remains Best of Breed™. Our business has grown substantially over the past 10 years, with client assets under management growing from R7bn in 2003 to the current level of R110bn. This growth has been accompanied by good investment performance for clients, evidenced by Nedgroup Investments being independently awarded by Morningstar as one of three best performing large investment houses in South Africa for the past four years in a row. Many thanks for the faith you have placed in us. It is a responsibility we take very seriously. Good investing

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Fourth Quarter


The price of safety and the value of distress Johannes Visser

RE•CM Investment manager of the Nedgroup Investments Managed Fund

‘Risk is not inherent in an investment; it is always relative to the price paid. Uncertainty is not the same as risk. When great uncertainty drives security prices to especially low levels they often become less risky investments.’ ‘The single greatest edge an investor can have is a long-term orientation.’ - Seth Klarman A flight to safety has pushed up the prices of typically low risk asset classes to levels where they have become risky and have beaten down the prices of many high risk investments to a level where they offer relatively more long-term protection in real terms. Great uncertainty in the Eurozone is leading to massive risk aversion among global investors. Investors are fleeing risky assets like equities and seeking safety in what is traditionally considered low-risk investments like government bonds and cash. But the risk of any asset - the probability that it produces a permanent capital loss and the magnitude of such a loss – is not only a function of the general characteristics of the asset and the prevailing fundamentals. It is most significantly a function of the price paid relative to the value received. With ‘low risk’ investments currently in high demand and ‘high risk’ investments being avoided at all costs, ‘low risk’ investments have become less attractively priced and more risky and ‘high risk’ investments have become more attractively priced and less risky.

Chart 1: US and German 10-year Government Bond Yields and European Stock Market Earnings Yield 18.0 16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0

US 10 Year Government Bond Yield Source: Thomson Reuters Datastream

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Fourth Quarter

German 10 Year Government Bond Yield

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Chart 1 shows 10-year US and German government bonds yields, relative to the European stock market earnings yield. Currently investors are lending money to the German government for the next 10 years at a record low rate of 1.4% per year. These investors are after what is perceived to be the safest investment in Europe. However, at such high prices, or low yields, the bonds do not appear nearly as safe as their status suggests. Yields could rise significantly and prices could fall over the next 10 years. There is actually a significant risk of losing money, irrespective of whether Germany actually defaults on its mounting loan obligations or not. And even in the unlikely scenario that yields are stable and one holds until maturity, one will end up earning what it says on the label – 1.4% per annum. Locking in such a low nominal rate of return increases the odds of losing money after inflation is taken into account. The European stock market, on the other hand, is understood to be a very unsafe place at the moment. As a result, it is priced to pay investors close to a 10% initial yield plus any growth. Total returns could thus turn out to be as much as 14% per year, even if economic – and therefore corporate earnings growth – turns out to be an anaemic 4% per annum from the current low base. Evidently, the market pays little attention to price. As a result, the assets considered to be safest are in fact tremendously unsafe, while the assets that are considered most unsafe are in fact much safer than believed. The same theme evident across asset classes has manifested itself within the equity market, where there is a strong preference for low risk predictable income streams over high risk cyclical income streams. When times are tough, investors intuitively prefer to invest in companies that can withstand the downturn, like food producers, brewers, tobacco and other fast moving consumer goods (FMCG) companies as opposed to cyclical businesses that are highly leveraged to economic activity. Needless to say, in recent times the share prices of defensive companies have increased while the share prices of cyclical companies have fallen significantly. As a result, defensive companies have lost their defensiveness, while cyclical companies have become relatively safe. This is illustrated in Chart 2, which shows the market’s valuation, measured by the price-to-book (P/B) ratio, of a group of cyclical companies relative to a group of defensive companies over the past 30 years. The index has been constructed from the World Steel and Iron Index, World Paper Index, World Chemical Index, World Cement Index and World Platinum Index, relative to the World Consumer Staples Index, consisting of 200 household FMCG companies like SA Breweries, Nestlé, and Procter & Gamble.

Chart 2: World Cyclical Index P/B ratio Relative to World Consumer Staples 1.4

Property and commodity boom: ‘Cyclicals valued more highly than the highest quality global busineses’

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0.6 Property bubble burst: ‘Reality check’ Euro crisis: ‘Risk aversion’ 0.4 Tech boom / new economy stocks: ‘Cyclicals not sexy’

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Source: Thomson Reuters Datastream, RE•CM analyst

The low points on the chart are where the market has historically undervalued cyclical companies relative to defensive companies; the high points are where the market has historically paid up for cyclical companies relative to defensive companies. Currently, the market is abandoning cyclical businesses which offer a great opportunity for long term investors. Cyclical industries where the news is particularly ugly and selected opportunities particularly attractive include platinum, global steel and global cement. An investigation of these permanent inefficiencies in the market explains why a long term approach is the only real advantage investors can have.

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Fourth Quarter


Investing for income

Sean Segar

Head of Product, Cash Solutions

In an investment environment full of uncertainty, where capital growth is likely to slow after several boom years and rates seem to be structurally lower, investors are taking yield more seriously than ever. Losing out on 1% when interest rates were 12% was not as big a deal as forfeiting 1% of yield with call at 5% - which effectively means giving up 20% of the potential return. This has triggered more focus by income seeking investors as to where they place their funds. These are some rules that will help such investors invest appropriately. Use the risk-free rate as the base reference point Once you have established what the risk-free rate is, it is easier to assess if additional yield is worth the additional risk. The risk-free rate is normally the yield on government paper for the comparable period. Understand what you are investing in When investing in an interest paying instrument or unit trust portfolio ensure you take the following steps:  nderstand if the rate quoted is effective or nominal, and if it is net or gross of fees. U E nsure costs are reasonable. Income type funds are typically cheaper than equity and balanced funds.  eview the investment mandate to ensure that this does not permit investment in instruments you are R not comfortable with. For example some income funds are permitted to invest in property, preference shares, offshore, non-investment grade credit, very long dated bonds, all of which offer generous yields but come with a higher risk of capital fluctuations. Avoid fads and look beyond the marketing message.  nderstand the regulatory environment of the product and the issuer. U Make use of pooled income funds Pooled investment funds are convenient and offer the following advantages:  igher yields than call along with daily liquidity. H S pread of counterparty credit risk.  nit trusts are regulated offering an additional level of comfort to investors. U Professional, specialist investment management.  inimum investment amounts are relatively low unlike direct investments where the top interest rate M is only earned by the largest of investors, or the interest rate is subject to a minimum balance. Be comfortable with the investment mandate and the investment manager of any income fund ensuring they are reputable, credible, their investment philosophy is sound, they have a robust process and the team is suitably qualified and experienced with a good track record. Be sure that you have suitable access to your money It is tempting to earn higher yields by fixing investments for a set term, however should you for some reason need to draw on such funds there are likely to be penalties. If you make fixed term investments ensure that you will not require the funds over the life of that term. Do not ‘lock up’ your funds if you may need access to them.

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Fourth Quarter


Match income payment dates to your needs Ensure that the frequency of the income distributions of the investment is in line with your needs. It will create unnecessary administration and even penalties should you have to tap into the investment to fund cash flow requirements. Some investments only distribute every six months or at the end of the investment term. Also invest where income is regular and reliable. Don’t leave cash on one-day call unless you might need it in one day Ensure you are not sacrificing potential yield for the luxury of having immediate access to your funds, which in fact you do not need. Cash needs to be put to work until it is required to be deployed. The yield on daily call monies is lower than that on funds placed on term. Don’t be too conservative There is such a thing as being too conservative. Most people can afford to take on an element of risk for which they will be rewarded through higher interest rates. Understand your level of risk tolerance and apply it. Consider the implications of tax Interest is taxable as are capital gains, however there are both annual interest and capital gains exemptions available to individual tax payers. Utilise such tax allowances before investing in tax structured products. Also retirement fund wrappers like retirement annuities and preservation funds offer a total shield against all taxes on interest and capital gains made within such structures. Remember the power of compounding This applies both to the length of time funds are invested and to the interest rate achieved which drive growth. To maximise the power of compounding re-invest distributions where possible. Consider the effects of inflation Inflation is the enemy of the investor and can make investing like paddling upstream. If yields are lower than inflation then real returns are not being achieved and the investor is effectively going backwards. Do not remain in income investments that do not generate a real return for too long in order to minimise wealth erosion. And finally the Golden Rule: Never chase yield – higher yields come with higher risks Indiscriminate yield chasing has been likened to trying to leap a chasm in two jumps. The markets ensure that yields are a very good indicator of risk. It is highly unlikely that individual investors or their financial advisors will come across an investment that offers a superior yield at a low risk. If such an opportunity did exist it would very quickly be priced to market by the professionals. Yield chasers will lose their money sooner or later. Rather avoid losers than try to pick winners. In cricketing terms – go for the singles! To be a more successful income investor, follow these rules to ensure that even in a low yield environment your money is not lazy, but optimally invested and that some of the potential traps are avoided.

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Fourth Quarter


Convertible bonds – combining income and upside participation Rashaad Tayob

Abax Investments Investment manager of the Nedgroup Investments Flexible Income Fund

Convertible bonds are a relatively new asset class in the South African market, although they represent a 500bn US dollar market globally. South African corporates have been issuers of convertible bonds in the offshore market over the years, and recently there has been a growing interest in issuing them locally as well. This year we have seen issuance by Shoprite and JD Group, both of whom have convertible bonds listed on the JSE. What is a convertible bond? A convertible bond is a bond with fixed cash flows and a set maturity date, with the holder having the option to convert the bond into the equity of the issuer. With convertible bonds the investor therefore has a choice to either:  hold the bond and receive the fixed coupons and the redemption price at maturity; or  convert the bond into a specified number of the underlying shares. The investor has the option to convert the bond into shares if the value of the shares received is greater than the value of the bond. This option becomes attractive in the case of the underlying equity price rising strongly, as the investor is then able to exchange the bond for shares and capture some of the upside. Convertible bonds are a unique asset class in that they allow the investor to experience the benefits of both a fixed-income and equity investment. They can therefore be a valuable addition to a wide range of income, absolute and balanced funds. Convertible bonds have an asymmetric return profile and can be very attractive if priced correctly. Valuing a convertible bond Convertible bonds are a hybrid asset whose price is determined by both the value of the bond and the value of the option enabling the holder to exchange the bond for shares. The valuation therefore encompasses several fixed income and equity factors including the level of interest rates, credit spreads, the underlying share price, dividend yield and volatility. The convertible bond will change its characteristics depending on the price of the underlying share. If the share price moves up significantly and it becomes very likely that the bond will be converted into shares, then the convertible bond will behave very much like the underlying equity. If the opposite happens and the share price moves downward significantly then the holder would not want to convert his bonds into shares. In this case the convertible bond will behave very much like normal bond, with interest rates and the credit spread becoming the main drivers of value. Many convertible bonds will be a hybrid between these two extremes, with both equity and fixed income factors having a significant impact on the valuations.

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Fourth Quarter


Shoprite Convertible: Sensitivity to Shoprite share price 180 160 140 120 100 80 60 40

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The hybrid nature of the convertible bond valuation is depicted in the chart above. The chart shows a breakdown of the valuation of the Shoprite Convertible Bond at various levels of the Shoprite share price. At low levels of the Shoprite share price the bond and credit spread are the main components of the convertible bond valuation. As the share price increases, the option to convert the bond into shares becomes increasingly attractive and this option therefore becomes a bigger component of the valuation. At Abax Investments, we use a broad range of skills across the equity and fixed income spectrum in order to analyse convertible bond valuations. The interest rate component and credit spread component are assessed by the fixed income team. The equity team analyses the fundamental outlook for the underlying equity, and will also assess the derivative market in order to estimate the fair level of volatility for the underlying stock. Due to the hybrid nature of convertible bonds it is important to have the range of equity, fixed income and derivative skills in order to analyse fair value. We track the price of the convertible bond relative to its fair value over time and we look to buy and sell when the market price moves away from fair value. The history of the Shoprite Convertible Bond price relative to its fair value is depicted in the chart below: Shoprite Convertible Bond vs Fair Value 126 124 122 120 118 116 114 112 110 108 106 104

-1 -M 2 ay 4- -12 Ju ne -1 11 -Ju 2 ne -1 18 -Ju 2 ne -1 25 -Ju 2 ne -1 2- 2 Ju l-1 9- 2 Ju l16 12 -Ju l23 12 -Ju l30 12 -Ju l6- 12 Au g 13 -12 -A ug 20 -12 -A ug 27 -12 -A ug 3- 12 Se p -1 10 -S 2 ep 17 t-12 -S ep 24 t-12 -S ep t1- 12 O ct -1 2

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We have added significant value to our income, absolute return and balanced funds through the use of convertible bonds. We find them attractive due to the asymmetric return profile, which combines downside protection with upside participation to the underlying equity. With the convertible bond asset class growing in South Africa we will remain active in this market and include them in our portfolios when they offer value.

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Fourth Quarter


The crowd arrives

Charles Richardson

Veritas Asset Management Co-manager of the Nedgroup Investments Global Equity Fund

A decade ago it was difficult to persuade investors of the global opportunity set and diversification benefits of global dividendbased investing in equities. Today, ‘the crowd’ has arrived. The merits of dividend-based investing are consensually agreed upon, given the historic contribution of the dividend to total returns and the combination of a low-interest rate environment and macro uncertainty. As investors, we know about crowds. It is best to avoid them because it is usually all ‘in the price’ if the crowd is there. This crowding into yield is even more significant when governments and central bankers want to exercise financial repression. Remember Bernanke wants to inflate asset prices, including equities. The crowd comforts itself that the equity yield is ‘better than’ that of cash, better than any sovereign risk that they are prepared to take and better than most corporate bonds (where default risk is not significant). Not only ‘don’t fight the Fed’ but also ‘chase yield’ in equities. There are multiple reasons why this is cold comfort. ‘Relative to’ thinking is not a good investment mindset. It is best to think in a ‘real return mindset’ and assess an investment on its stand-alone merits. Furthermore, yield from equity is a different proposition to a bond. It ranks differently in the capital structure and also is discretionary use of cash flows. There are no guarantees and there are significant dangers in equity investing based on yield alone. With a sound investment process a difficult environment of crowded (over-valued) investments and yield traps (value that is more apparent than real) can be navigated. Investors need to be aware that dependability of cash flows is not sufficient if the overall equity is over-valued, which is the case in many global consumer goods companies. Investors need also to be on their guard for dividend cuts in unsustainable yields such is the case in European utilities at present. Two years ago we wrote the paper entitled : ‘The Policy Markets’ and pointed out that : ‘real asset and financial markets everywhere are subject to a number of different and powerful forces and not all are fundamental. Indeed, we could call all markets policy driven right now’. Today this remains the case. Recently we have seen QE3 in the US where Bernanke continues to demonstrate his ‘Rooseveltian Resolve’ in being aggressive, experimental and incremental (‘learning by doing’, in his own words).

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Fourth Quarter

Guided by some general principles and acknowledging ‘limited historical experience’ Bernanke simply does not wish to address future unintended consequences. As we write the equity markets have factored a great deal of this in, the crowd understands the policy game now. Within equity markets we have found that many of the ideas that arose from our filter of ‘Dependable Compounders’ some two years ago have become fully or overvalued. These characteristics of stable dependable cash flows are consensually sought by the crowd. Despite many qualities in companies that fit this generalisation this needs caution. Longterm outcomes to investment are determined by management of assets and free cash-flow. Fundamentals will assert themselves. Investors need to pay a discounted price to the value of assets and free cash flow in secondary markets; this is the rational thing to do. However, crowds don’t see it that way. They like the quality or the dependability or any other concept or theme they like to apply. So, second hand securities traded in public markets often become over-valued. We maintain our view that policy driven markets are treacherous. The key is a laser-beam focus on company specifics, on the context companies operate within and on assessing assets and free cashflow. The discipline is to assess carefully what price you pay for equity. We are now consolidating our themes to encapsulate this investment thesis in the current demanding capital market context where asset prices are distorted by Governments and Central Bankers. We recently introduced the theme ‘2020 Rising Tide Industry Winners’ to follow through filtering our ideas that had the key characteristics above. We wished to extend our time horizon to avoid short-term noise and we wished to identify dynamic contexts for companies to operate within out to 2020. This relates to our assessment of structural growth and our search for trends we consider to be inexorably rising: the explosion of data; the continuing burden of regulations; and the growth of online transactions or the rise of more personalised medicines are some examples. Having identified ‘rising tide’ contexts we have been analysing those companies we believe to be successfully operating in these trends and assessing the endurance of their competitive advantage.


10 Commandments for managing a bank in turbulent times Mike Brown

Nedbank Group Group Chief Executive

At the Nedgroup Investments Cash Solutions Treasurers Conference, held on 28 June this year, Nedbank Group Chief Executive Mike Brown spoke on the topic: “10 Commandments for Managing Banks in Turbulent Times”. Currently this topic is particularly appropriate, given the recent downgrades of SA’s five biggest bank’s foreign deposit ratings by Moody’s due to the revision of the country’s foreign currency deposit ceiling. We have had numerous requests for ‘Mike’s speaker notes’ and accordingly summarise below the 10 Commandments he spoke about.  Focus on all stakeholders – and don’t surprise them (especially not on the downside). Nedbank mentions all its stakeholders in its vision statement: “Building Africa’s most admired bank by our staff, clients, shareholders, regulators and communities”. In implementing this vision, Nedbank is conscious of not placing one stakeholders interests above the interests of anothers. “We aim to deliver sustainable results to all our stakeholders, whilst communicating consistently, transparently and honestly to them” said Brown. Effective stakeholder engagement, particularly in troubled times, is an imperative that in most instances is well received and appreciated. Even when there is bad news, the way it is communicated may be reputation enhancing, if approached in an honest, timely and forthright manner.  ulture is king – “ensure that you have the right people on the right seats in the bus.” C The culture of an organisation is a reflection of the values, beliefs and behaviors of its leaders, with culture representing “the way things are done around here.” Brown said: “At Nedbank we pride ourselves in being vision led and values driven. In an increasingly commoditised world, we acknowledge that having the right staff and a culture aligned to our vision to be a critical differentiator that is not easily copied by our competitors. Notwithstanding the state of the global economy, we continue to invest heavily in establishing, measuring and growing the value driven culture that is evident within Nedbank today”. L earn from your competitors but follow your clients. It was Sam Walton, founder of Wal-Mart who said: “There is only one boss… The customer. And he can fire everybody in the company, from the Chairman down, simply by spending his money elsewhere”. In formulating business propositions, a bank not only needs to understand its clients requirements but also needs to understand why they may wish to bank with its competition. “A recession limits your options” said Brown, “and it’s not particularly sustainable to shrink your business to success or to enter into an aggressive pricing strategy. In this environment, every client counts and excellent client service and having the right products is more important than ever”.  e on the right side of conservatism – and don’t push for the last rand on the table. B Banks are both financially and operationally geared, necessitating cautious management in an increasingly volatile economic and operating environment. “Banking, at its core is about risk and return. We prefer to deliver stable and sustainable year on year growth as opposed to volatile returns” said Brown.

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Fourth Quarter


Your reputation is everything. The erosion of trust and related value destruction experienced by some global bulge bracket banks in recent times illustrates the importance of reputation. Over the last few years Banks have hit an all-time low in public trust at a time they can least afford it. Warren Buffet recently said: “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.” Brown elaborated: “At Nedbank integrity, respect and accountability are ingrained into our culture. Further, we acknowledge that on occasion we do and will make mistakes – it is how we react to mistakes, and what we do to ensure that these are not repeated that informs our reputation amongst stakeholders.” I ntegrated and centralised capital, risk and funding functions, with “one version of the truth”. Nedbank has been a leader in South Africa in the field of capital management, having been an early adopter of the various Basel accords. “Capital management, risk and funding charges are integrated into Nedbank’s accounting on a consistent and integrated basis so that our management accounts represent a ‘single version of the truth’. We operate on the basis that “if you can’t measure it, you can’t manage it” said Brown, “so it is important that the engine room of the bank is integrated with the rest of the bank and that divisional performance is consistently measured with group performance.” Data vs. knowledge vs. information vs. experience, judgement and insight. Data does not convey meaning unless one understands the context within which the data was gathered. Information extends the concept of data in its broader context and comes in a variety of forms such as statistics, diagrams and benchmarks. The way in which information is reported and used adds to the collective knowledge base of management. “At Nedbank, we strive to make educated decisions based on information which is consistently collated in a structured manner. In this way we are able to seek early warning signs, manage our risks and harness our collective management experience, insight and judgement required to navigate our way through turbulent waters” said Brown. Strong and independent risk management – “the rabbit can’t guard the cabbage patch” Independent risk management needs to be embedded in the Group’s culture and must aim to create a strong, stable and economically sustainable organisation. Nedbank has been widely recognised as a leader in risk management with this competency acting as an enabler to continued profitable business. “Our hard earned reputation amongst regulators, particularly in measuring and implementing risk management structures (such as separation of duties and independent governance) is a cherished and carefully guarded attribute and has stood us in good stead, particularly in tough times” said Brown. Keep innovating – learn to manage costs and invest through cycles. Innovation is the lifeblood of a business and should be part of the DNA of a company. Innovation should be encouraged and cannot be switched on or off, dependant on the business cycle. Equally, cost management and engraining a ‘cost culture’ is not something that is only relevant in turbulent times. In a downturn, it is tempting to make over hasty decisions to reduce costs in “soft target” areas such marketing, advertising, freezing new projects or sometimes taking more drastic actions such as staff retrenchments. These measures however can set a business back whilst having a severe, long term detrimental impact on the corporate culture. It is often more sensible to take a more restrained and strategic approach. “At Nedbank we have adopted a measured approach to cost management which we have called “Optimise to Invest”. Instead of focussing directly on short term cost cutting, we have tried to seek out the root cause of inefficiency and focus on addressing unproductive processes in the bank, often through innovative solutions. We have consciously used the resulting savings to fund new income generating investments in our business, despite the state of the global economy” said Brown. Take advantage of opportunities when you are strong. Sometimes turbulence has a silver lining, presenting acquisition opportunities. Over the last few years, Nedbank has made over R3bn worth of acquisitions and continues to invest in its sub-Saharan African footprint. These acquisitions, effected at strategically appropriate times, have each gone on to deliver strong results and have further diversified Nedbank’s earnings base. “The meeting of preparation with opportunity generates the offspring we call luck” says Brown. Mike Brown believes that sustained adherence to the 10 Commandments has positioned Nedbank well in the current turbulent times. “We have an attractive growth strategy, a competitive and value creating franchises, a strong balance sheet, a stable and experienced management team and a differentiated values-based culture that culminates in an organisation that is well positioned to continue to deliver shareholder value and competitive absolute returns”.

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Fourth Quarter


Revised fund classification system enables more meaningful comparisons Liezel Momberg Head of Legal Services

Considering that there are 966* rand denominated unit trust portfolios in South Africa, choosing an appropriate unit trust portfolios is not an easy task. To assist investors and financial planners in choosing and comparing portfolios, the industry has grouped those with similar objectives and benchmarks into sectors. This classification system has been codified in a Fund Classification Standard for South African Collective Investments Portfolios. And from 1 January 2013, revisions that simplify the classification standard come into effect. This will make it easier for investors and financial planners to understand and analyse the different types of portfolios, select the appropriate ones and compare the performance of portfolios within and across categories. This revised classification system will group unit trust portfolios based on ‘where’ the portfolio’s underlying assets are held, ie its geographic exposure and ‘what’ asset classes are included, ie equities, property or cash. It removes classification based on investment styles used by the investment manager such as value or growth. What has changed? As before, the new system consists of a three-tier structure, which is illustrated below. The first tier groups unit trust portfolios based on the geographic focus of the underlying assets into South African (previously Domestic), Worldwide, Global (previously Foreign) and Regional (new) categories. The second tier is concerned with the broad asset allocation of the portfolio and is divided into four main groupings. Equity, Multi-asset (previously Asset Allocation), Interest Bearing (previously Fixed Interest) and Real Estate portfolios. The third-tier will categorise portfolios based on their main investment focus, for example Equity – Resources, Multi-Asset – Low Equity, Interest Bearing – Money Market, or Real Estate – General. Unit trust portfolios that comply with the investment limits in Regulation 28 of the Pension Funds Act will now be flagged irrespective of the classification category.

* ASISA Statistics September 2012

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Fourth Quarter


South African

Worldwide

Global

Minimum 70% of assets in South African investments (25% outside RSA, 5% Africa)

Invest in South Africa and/or foreign markets (complete fexibility, up to 100% either way

Minimum 80% of assets outside RSA (max 80% exposure to assets of specific geographical region)

Equity

Multi Asset

Funds • General • Large Cap • Mid & Small Cap • Resources • Financial • Industrial • Unclassified

Funds • Flexible • High Equity • Medium Equity • Low Equity • Income

Interest Bearing Funds • Variable Term • Short Term • Money Market

Regional Minimum 80% of assets outside RSA in a specific geographical region (incl. Africa)

Real Estate Funds • General

The colour codes in the table above illustrate the combinations that are possible accross the first, second and third tiers. What do the revisions mean for the Nedgroup Investments unit trust portfolios? Investors and financial planners should be aware of the investment mandates, investment risks and tax risks associated with each classification category. This will ensure that investors buy unit trust portfolios that are compatible with their risk profiles. The table below illustrates the changes to the classification of some of our Nedgroup Investments portfolios. Nedgroup Inv Fund

Current classification

New classification Tier 2

Tier 1

Tier 3

Rainmaker

Domestic Equity General

South African

Equity

General

Managed

Domestic AA Prudential Variable Equity

South African

Multi asset

High equity

Opportunity

Domestic AA Prudential Variable Equity

South African

Multi asset

Medium equity

Stable

Domestic AA Prudential Low Equity

South African

Multi asset

Low equity

Flexible Income

Domestic FI Varied Specialist

South African

Multi asset

Income

Money Market

Domestic FI Money Market

South African

Interest bearing

Money market

The mandates for classification of our unit trust portfolios are available from us. When do the changes come into effect? The revisions to the classification of unit trust portfolios were finalised at the end of October 2012. Since the reclassification did not involve a change in the investment policy of unit trust portfolios, we were not required to ballot investors to approve the change. The new Fund Classification Standard for South African Collective Investment Portfolios takes effect on 1 January 2013.

14

Fourth Quarter


Responsible investing – bringing stewardship to the fore Vuyolwethu Nogantshi

Head: Institutional and Consulting

While reform has been a key theme within the retirement funds industry, responsible investing has also found itself at the forefront of investor concerns. Also central to the investor is stewardship; which aims to ensure that: institutional investors take their responsibilities to beneficiaries seriously; the interests of beneficiaries are put first; and a positive change in the way institutional investors do things. One of the fundamental values that shareholders attach to the ownership of stock within a firm is the right to influence the decisions within that firm via voting rights. As time has progressed, the profile of shareholders has evolved to cover a broad spectrum of investors represented by institutional investors. This evolution means broader representation of issues among beneficiaries, and an increased responsibility of institutional investors towards them. At the same time, various social and communal issues have raised awareness amongst investors that, through collective representation, they could achieve positive externalities through their collective wealth. Historically, Apartheid in South Africa is one of the important landmarks of responsible investing in action. Defining responsible investing today As the proponents of responsible investing have increased, responsible investing has grown to become a global trend, with a number of bodies worldwide representing the interests of members. The means to implementation are many, but the objective is singular: to provide a framework that allows investors to incorporate environmental, social and corporate governance (ESG) issues into their decisionmaking and ownership practices and so better align their objectives with those of society at large1. The United Nations Environment Programme launched The United Nations Principles for Responsible Investing (UNPRI) in 2006. A group of 20 institutional investors from 12 countries devised the principles and both the United Nations Environment Programme Finance Initiative and the UN Global Compact backed the initiative. We cannot ignore the ESG direction provided by Regulation 28 to South Africa’s Pension Funds Act, but South Africa has also proceeded to launch its own set of principles, which form the local equivalent of the UNPRI. The Committee on Responsible Investing by Institutional Investors in South Africa launched the Code for Responsible Investing in South Africa (CRISA) in 2011. The focus of the code is on ensuring investing in a way that promotes long-term sustainability.

1

The United Nations Principles for Responsible Investing initiative.

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Fourth Quarter


The table below depicts the six UNPRI principles alongside the five CRISA principles: Principle (UNPRI)

Principle (CRISA)

We will incorporate ESG issues into investment analysis and decision-making processes

An institutional investor should incorporate sustainability considerations, including environmental, social and governance, into its investment analysis and investment activities as part of the delivery of superior riskadjusted returns to the ultimate beneficiaries

We will be active owners and incorporate ESG issues into our ownership policies and practices

An institutional investor should demonstrate its acceptance of ownership responsibilities in its investment arrangements and investment activities

We will seek appropriate disclosure on ESG issues by the entities in which we invest We will promote acceptance and implementation of the Principles within the investment industry We will work together to enhance our effectiveness in implementing the Principles

Where appropriate, institutional investors should consider a collaborative approach to promote acceptance and implementation of the principles of CRISA and other codes and standards applicable to institutional investors

An institutional investor should recognise the circumstances and relationships that hold a potential for conflicts of interest and should proactively manage these when they occur We will each report on our activities and progress towards implementing the Principles

Institutional investors should be transparent about the content of their policies, how the policies are implemented and how CRISA is applied to enable stakeholders to make informed assessments

Responsible investing in action What is clear about responsible investing going into the future is that stakeholders need to find ways of addressing the complexities of effective implementation. As a way of acknowledging this, the PRI initiative launched after the launch of the UNPRI to help investors to implement the principles. While a set of practice recommendations accompanies the CRISA principles, there are other industry initiatives that also aim to alleviate the difficulties institutional investors face in aligning themselves to CRISA. Furthermore, whether dressed as stewardship or responsible investing, we will no longer have to be concerned with compliance, but we will have to focus on entrenching a completely new way of thinking.

16

Fourth Quarter


The 6 Ms and our national mood

JP Landman Political Analyst

The currency is pummelled, the national mood is sombre and uncertainty hangs over all. This is the result of several forces all playing out at the same time. Let‘s call them the 6 Ms. Mining (and other) strikes At the end of July about one million man days were lost in strike action. By 30 September that number has grown to 1.6 million man days. That is half the 3.3 million man days lost on average every year for the past 18 years. October will no doubt add more lost man days as several strikes are still on-going, but that 3.3 million is a useful point of reference. In September 2011 the lost man days stood at 5.4 million. (Andrew Levy & Associates). Marikana The Judicial Commission of Inquiry started its work and has 4 months to complete it. So its Report will probably be submitted by Feb 2013. It will then be talked to death during the first half of next year. In the meantime the Marikana fall-out has already ignited a process of ‘creative destruction’. NUM has been exposed as the union that lost touch with its members. Whilst Cosatu campaigned about e-tolls and the Mangaung succession, mine workers deserted it. The new union AMCU has also been exposed. Once favourably looked upon by some as a real workplace union in touch with workers, it was cast aside by its very own members when they asked Bishop Joe Seoka from the SA Council of Churches to negotiate on their behalf with Lonmin management. AMCU officials were missing when they had to go up the hill to tell Lonmin workers that they were on an illegal strike and could be dismissed. It was left to CCMA officials to do that. Some idealists saw in AMCU the new vanguard of the left. It is unclear to me how you are the vanguard if you are missing in action. The platinum mines have been forced into a process of more bargaining with unions on a wider range of topics than they ever imagined. Rather than less collective bargaining, there is now much more. New world for them. The wildcat strikes expose the fallacy that unions can be ‘smashed’ and there will be peace. Or that wages can be suppressed by supply and demand like the prices of other commodities. Wheat, milk or gold cannot cause trouble, people can.

The practice of dealing only with a majority union (winner-takesall) will have to be re-visited. It will be hell for management who will have to bargain with two or three different unions in the same room, each trying to outbid the other. But that is the new world taking shape. The notion that management can outsource their social responsibilities, for example by paying a cash housing allowance to workers rather than working to build decent houses, has been thoroughly discredited. There will be more social involvement, not less. Local governments who do not provide bulk services where houses can be built and do not facilitate development also stand exposed. Mangaung I stick to the view that I have held for some months now – wait for the branch nominations to be in. Then, and only then, will we see which way the wind blows. In the meantime rumours of ‘a deal’ between Zuma and Motlanthe are circulating in the political market place. Branch nominations will also influence such a deal. Malema The SA media’s favourite personality, Julius Malema, grabbed the headlines with his post-Marikana speeches. Since then he had to appear in court on criminal charges and the taxman got a court order to recover some R15 million from him. Several of his cronies also appeared in court on various charges related to tenderpreneurism. (The contrast with Greece where nobody has been in court yet for all the tax shenanigangs preceding their financial collapse is striking.) The one constant about Malema is that the media and chattering classes keep talking his support up. Facts suggest differently. Absolutely nothing came of all the predictions that there will be an uprising and violence should Malema be charged. The same predictions were made when he was first charged in the ANC’s internal disciplinary process. Of the 15 000 people expected at the night vigil before his court appearance only 2 000 turned up. This is his home town. At Marikana the strikers listened to him, then sang songs about Bantu Holomisa and asked Bishop Seoka to negotiate on their behalf.

17

Fourth Quarter


T he Reputation Institute’s surveys found consistently low ratings across all groups and segments of the economically active population for Malema’s leadership. T NS found 20% support for the statement “I support what Julius Malema says and does”. That is less than the DA’s support base. T he Friends of the Youth League has established a fund to settle Malema’s tax bill. It will be interesting to see how much money comes in. I wish he would go off and form his own political party. With 10% to 20% of the vote that will really get SA’s democracy going! Moody’s The Moody’s downgrade brings its rating of SA in line with that of the other two agencies, Fitch and S&P. (Moody’s used to have SA a notch higher.) SA bonds are still rated above the lowest investment grade, and so qualify for the investment portfolios of most of the world’s pension funds. With enormous amounts of money being printed by the Fed and the ECB and that money looking for a yield, plus the fact that the whole world is looking bad, could mean that capital inflows into the SA bond market will continue. From Marikana to the end September R4 billion has left SA from the equity market and R9.7 billion came in via the bond market. The real risk for SA is that these inflows dry up. Then both the currency and interest rates will deteriorate. Money The last of the 6 Ms is the money going into President Zuma’s Nkandla home. It is clearly out of all proportion, even if legal. The Public Protector is investigating. More embarrassment awaits. Not the leadership the country now needs. However, it was consistent revelations by the media over many months that flushed the Nkandla story out. Add that to the Constitutional Court’s unanimous decision that Mr Simelane’s appointment as head of the NPA was invalid and one has a strong testimony to SA’s open society institutions (media, Public Protector, Constitutional Court). The pundits who thought Chief Justice Mogoeng Mogoeng would just do Mr Zuma’s bidding must feel a bit sheepish. So What? We see the impact of the 6 Ms in the weaker Rand and to some extent in the bond market. It is a risky time for SA, but the country experienced much worse in 1996 and 2001. The 6 Ms, combined with global forces, may still drive us to a repetition of those times, but we are certainly not there yet. The Arab proverb used by General Smuts comes to mind: “the dogs bark, the caravan moves on”.

18

Fourth Quarter


Nedgroup Investments Unit Trust Portfolios Unit trust portfolio

Investment manager

Risk

Benchmark

Minimum recommended term

Income unit trust portfolios: aim to provide investors with high levels of income (at low levels of capital volatility), by investing primarily in fixed income asset classes. These portfolios are often appropriate for investors with shorter investment horizons. Nedgroup Investments Money Market Fund

Taquanta Asset Managers

1

STeFI Composite Mean

None

Nedgroup Investments Core Income Fund*

Taquanta Asset Managers

1

STeFI Composite

6 months

Nedgroup Investments Flexible Income Fund

Abax Investments

1

110% STeFI Call Rate

6 months

Nedgroup Investments Bond Fund

Tanquanta Asset Managers

2

All Bond Index

2 years

Nedgroup Investments Property Fund

Grindrod Asset Management

4

Domestic Real Estate General Unit Trust Mean

5 years

Asset allocation unit trust portfolios: aim to provide investors with moderate levels of income and capital growth (at moderate levels of capital volatility), by investing in a range of different asset classes. These portfolios are often appropriate for clients with medium to longer investment horizons. Nedgroup Investments Positive Return Fund*

Foord Asset Management

2

Inflation + 4% per annum over rolling 3-year periods

3 years

Nedgroup Investments Stable Fund*

Foord Asset Management

2

Inflation + 4% per annum over rolling 3-year periods

3 years

Nedgroup Investments Managed Fund*

RE-CM

3

Average of Prudential Medium & Variable Equity Unit Trust Mean

3 - 5 years

Nedgroup Investments Opportunity Fund*

Abax Investments

3

Domestic Asset Allocation Medium Equity

3 - 5 years

Nedgroup Investments Bravata Worldwide Flexible Fund

Aylett & Co Asset Management

3

Inflation + 5% per annum over rolling 3-year periods

3 - 5 years

Equity unit trust portfolios: aim to provide investors with high levels of capital growth (at high levels of capital volatility) by investing in listed equities. These portfolios are often appropriate for investors with longer investment horizons. Nedgroup Investments Rainmaker Fund

Abax Investments

4

Domestic Equity General Equity Unit Trust Mean

5 - 7 years

Nedgroup Investments Value Fund

Foord Asset Management

4

Domestic Equity General Equity Unit Trust Mean

5 - 7 years

Nedgroup Investments Growth Fund

Electus (a member of the Old Mutual Investment Group)

4

Domestic Equity General Equity Unit Trust Mean

5 - 7 years

Nedgroup Investments Quants Core Equity Fund

Taquanta Asset Managers

4

Domestic Equity General Equity Unit Trust Mean

5 - 7 years

Specialist equity unit trust portfolios: are equity portfolios that are invested according to a specific sector or theme. They tend to display higher levels of price volatility.

Nedgroup Investments Entrepreneur Fund

Abax Investments

5

Domestic Equity Smaller Companies Unit Trust Mean

5 - 7 years

Nedgroup Investments Mining & Resource Fund

Prudential Portfolio Managers

5

Domestic Equity Smaller Companies Unit Trust Mean

5 - 7 years

Nedgroup Investments Financials Fund

Sanlam Investment Management

5

Domestic Equity Smaller Companies Unit Trust Mean

5 - 7 years

International rand-denominated unit trust portfolios: If you wish to have exposure to offshore investment opportunities, you may consider the following range of rand-denominated unit trust portfolios that provide this exposure for lower minimum investments and without the hassle of having to apply for foreign exchange control approval. Nedgroup Investments Global Cautious Feeder Fund

J.P. Morgan Asset Management

3

USD Libor 1 month (rand equivalent)

3 - 5 years

Nedgroup Investments Global Balanced Feeder Fund

Sarasin & Partners

3

Foreign Asset Allocation Flexible Unit Trust Mean

3 - 5 years

Nedgroup Investments Global Equity Feeder Fund

Veritas Asset Management

4

Foreign Asset Allocation Flexible Unit Trust Mean

5 - 7 years

1 = Low, 2 = Low to medium, 3 = Medium, 4 = Medium to high, 5 = High

*Comply with Regulation 28 of the Pension Funds Act

DISCLAIMER: Unit trusts (collective investment schemes in securities) are generally medium- to long-term investments. The value of units (participatory interests) may go down as well as up and past performance is not necessarily a guide to the future. Fluctuations or movements inexchange rates may cause the value of underlying international investments to go up and down. Unit trust prices are calculated on a net asset value basis, which is the total value of all assets in the portfolio including any income accruals and less any permissible deductions(brokerage, Securities Transfer Tax, VAT, auditor’s fees, bank charges, trustee and custodian fees and the annual management fee) from the unit trust portfolio, divided by the number of units in issue. Unit trusts are traded at ruling prices and forward pricing is used. Unittrust portfolios are priced daily at 15:00. Instructions must reach us before 14:00 (12:00 for Nedgroup Investments Money Market Fund) to ensure same business day value. Unit trusts can engage in scrip lending and borrowing. Different classes of units may apply to theseunit trust portfolios and are subject to different fees and charges. A schedule of maximum fees and charges is available on request from us. Fees and incentives may be paid, and if so, are included in the overall costs. These unit trust portfolios may be closed. A member of the Association for Savings and Investment South Africa (ASISA). Manager: Nedgroup Collective Investments Limited; Registration Number 1997/001569/06; PO Box 1510, Cape Town, 8000. Trustee: The Standard Bank of South Africa Limited; PO Box 54, Cape Town, 8000. *OCT2012/vs001


Client Service Centre

Tel: 0860 123 263 (RSA only) or +27 21 416 6011 (outside RSA) Fax: 0861 119 733 (RSA only) or +27 11 263 6067 (outside RSA) Email: clientservices@nedgroupinvestments.co.za

Cape Town (Head Office) Physical address Nedbank Clocktower Clocktower Precinct V&A Waterfront Cape Town 8001 Postal address P O Box 1510 Cape Town 8000

Gauteng

Physical address Nedbank Building 2nd Floor I Block 135 Rivonia Road Sandton 2001 Postal address P O Box 2242 Houghton 2041

Durban

Physical address Nedgroup Investments 3rd Floor Ridgeside Campus 2 Ncondo Place Umhlanga Rocks 4320 Postal address P O Box 50995 Musgrave 4062

www.nedgroupinvestments.co.za

Q4NED_006

unit trusts |

offshore | retirement funds

Collective investment schemes in securities (CIS) are generally medium to long-term investments. The value of participatory interests (units) may go down as well as up and past performance is not necessarily a guide to the future. Units are traded at ruling prices and a CIS can engage in scrip lending and borrowing. Some of these portfolios may be closed. Different classes of units apply to these portfolios and are subject to different fees and charges. A schedule of fees and charges and maximum commission is available on request from Nedgroup Collective Investments. Commission and incentives may be paid and, if so, would be included in the overall costs. Forward pricing is used. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. Nedgroup Collective Investments limited is a member of the Association for Savings and Investment South Africa. Nedgroup Collective Investments limited Reg No 1997/001569/06. Nedgroup Investment Advisors is an authorised financial services provider (FSP number 1652). Address: PO Box 1510, Cape Town, 8000. Trustees: The Standard Bank of SA limited, PO Box 54, Cape Town, 8000.


Nedgroup Investments Q4 2012 Newsletter