End of Year 2017 Report

Market Overview

The calendar year 2017 was another roller-coaster year for the investment markets in South Africa and globally. Some of the more significant events include:

• Ratings agencies downgraded South African sovereign debt to junk status, citing political and economic risks facing the country;
• Serious allegations of mismanagement and corruption in state-owned enterprises, including Eskom, Prasa, SAA and the SABC;
• President Zuma reshuffled his Cabinet resulting in amongst other changes, Pravin Gordhan and Mcebisi Jonas being replaced by Malusi Gigaba and Sfiso Buthelezi as Minister and Deputy Minister of Finance respectively;
• A volatile Rand, starting 2017 at around 13.75 to the US Dollar and ending the year at 12.35. The Rand reached 14.40 to the USD during the year;
• The resignation of Markus Jooste as CEO of Steinhoff and the related fraud at the company;
• The ANC NEC elections which ultimately resulted in Cyril Ramaphosa being elected as ANC President, but more-or-less evenly split along factional lines in the rest of the NEC.

These and other factors such as valuations and market sentiment played out in the market:

• The JSE All Share Index rose by 21% (including dividends), led by Naspers (+71.3%), Discovery (+62.4%), Capitec (+58%);
• The Nasdaq increased by 28.24% for the year in USD and by 16.02% in ZAR.

Performance

The Lunar BCI Worldwide Flexible Fund reported an increase of 9.64% (after costs and fees and including distributions) for the year and 9.47% since our inception on 1 June 2016. The following factors were the main drivers of our performance for the year:-

• We held higher levels of cash (20% as at year-end) as we were of the view that there was higher levels of risk in the market;
• Small cap shares were under severe pressure. Whilst not a big part of our portfolio, we held and subsequently sold at a loss underperforming small cap shares (Consolidated Infrastructure, Rhodes Food);
• Whilst we held no Steinhoff’s in our portfolio, our holdings in PSG and Shoprite were impacted. Steinhoff and related entities own large stakes in PSG and Shoprite and they were and still are sellers of these holdings to raise cash and meet the obligations of creditors:
  • We mitigated our risk by reducing our exposures to PSG and Shoprite, but are of the opinion that these are still great businesses.
• Our best performers during the year were:
  • South Africa in ZAR: Discovery (+64.07%), FirstRand (31.28%), PSG (27.08%)
  • Offshore in USD: NVDIA (+99.25%), AliBaba (+55.56%), Amazon (+52.32%), Facebook (+47.10%)

We would have liked to have performed better than we did but are satisfied that most of our major investments have performed well. Our positioning was somewhat risk averse during the period. Where an investment did not pan out the way we envisaged, we analysed the reason/s for it and used that to improve our investment process.

“The stock market is a device of transferring money from the impatient to the patient.” – Warren Buffett.

We have been patient, and will be until we think it is time to be more aggressive.

Portfolio

Our portfolio composition is as follows:

Outlook

There are a number of concerns in the global political and economic environments:

• Likely interest rate increases in the developed economies;
• A potential credit and related real-estate bubble in China;
• The policies that the new ANC leadership will articulate and the ability of government to execute on it is still very uncertain;
• Geopolitical tensions in Korea and the Middle east;
• High valuations in the stock markets:
  o The PE ratios of selected markets currently are:
  – S&P 500 (US) has a PE ratio above 22;
  – Nasdaq has a PE ratio above 27;
  – JSE All Share Index has a PE ratio above 22.
  These are high from a historical perspective, making the market appear to be overpriced, but there are large variations between individual stocks.

We anticipate that volatility will likely continue to feature in the market. Theme and specific stock selection will again play a key role in our portfolio composition and ultimately performance.

Theme Review

Our investment themes for 2017 were:

We believe that by-and-large these themes are still intact and we have refined these as follows:

We have refined these themes to better reflect the opportunity that they represent and the changes since we last revised our investment themes:

• Millennials stamp their economic authority
  o As millennials enter the ages when they start settling down, we believe that they will become a more important economic power. This will reflect in how they shop (on-line), where they buy homes and settle down (cities) and what they value (experiences, environment, family).
• Baby Boomers need care
  o As the Baby Boomer generation reach retirement age, they will need care (financial, health, services, drugs). In general, longevity has increased which implies that these services are required for longer and that the aged are healthier than previous generations. They will seek retirement villages that better cater for their healthier lifestyles.
• Cities are where its happening
  o The migration from rural areas and small towns to cities continues, with increased demand for housing and services (water, electricity, transport). The trend of megacities dominating economic activity globally is still intact. Foreigners continue to acquire properties in mega-cities.
• African Middle Class taste the good stuff
  o Globalisation and the increasing wealth of the middle class in Africa shape how they change their spending habits (supermarkets, global brands, travel).
• Economic power drifts and shifts
  o In the last few decades global GDP has shifted from the developed markets to developing markets by a ratio of approximately 80/20 to 60/40. China has been a large beneficiary of this shift, but other markets like India, Turkey, Brazil and Indonesia have also benefitted.
• Resource scarcity spurs innovation
  o The demand for energy has spurred the revolution in renewable energy. Agricultural technologies have also significantly improved yields in food production. We anticipate similar innovations in water and energy technologies. Commodity cycles will continue to ebb and flow providing investment opportunities.
• Technology disrupts the status quo
  o Information, pharmaceutical and genetic technologies will continue to develop and potentially disrupt industries and businesses. Blockchain technologies in particular have the potential to disrupt. It will be fascinating to watch how this plays out and what investment opportunities it will bring. The rise or death of cryptocurrencies will also potentially provide fascinating viewing and maybe opportunities. Similarly, looking out for the next block-buster drug or killer-app will be key in unlocking investment opportunities.

Where we do identify potential companies to invest in, we will apply our minds in determining what fair value is for those companies. We will only buy those that we believe provide the right rewards for the risk that we take. We wish to obtain above average and real returns at a portfolio level for our investors.

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Thank you to our clients, staff, directors, and business partners for your support, guidance and friendship. Whilst there are significant risks in the financial markets at the moment, there will be opportunities from which to profit. It is left to us to identify these risks and opportunities by continuing to improving our investment philosophies and methodologies and ultimately providing a platform for growing the wealth of our families and communities.