FundManagement

Advisory Services

Commodities - What is the best way to access them as an investment?

Prof. Evan Gilbertrt

How to select an external investment advisorRob Macdonaldd

Sell when it is cheap, buy when it is expensive. A recipe for out-performance?

Richard (“Jerry”) Haworth CEO of 36 South

International Asset Allocation OverviewShaun McDade & Joanne Baynham

Domestic Asset Allocation OverviewRoeloff Horne

How to forget the password on your Blackberry, revisiting life on Sabbatical

Scott Campbell

Business UpdateMark Margetts-Smith

Newsletter Q32014

South Africa | Guernsey | Singapore | Isle of Man

MitonOptimal Group Index

3 IntroductionScott Campbell

4 Commodities - What is the best way to access them as an investment?Prof. Evan Gilbert

6 How to select an external investment advisor Rob Macdonald

8 Sell when it is cheap, buy when it is expensive. A recipe for out-performance?Richard (“Jerry”) Haworth - CEO of 36 South

9 International Asset Allocation OverviewShaun McDade & Joanne Baynham

13 Domestic Asset Allocation OverviewRoeloff Horne

15 How to forget the password on your Blackberry,revisiting life on SabbaticalScott Campbell

16 Business UpdateMark Margetts-Smith

17 Contact Us

Fund Management

Advisory Services

www.mitonoptimal.com2

MitonOptimal Group Introduction

IntroductionAnother busy quarter at MitonOptimal, both in South Africa and our International Operations. As we climb the wall of worry around the world of Ebola, Middle Eastern conflict, ISIL, Scottish Referendums and the exit of QE, it is not surprising that volatility is starting to rise. The almost uninterrupted, upwards movement of global equities for 3 years, until mid-year, with very low levels of drawdowns or volatility, had become unsustainable. Not surprisingly, the end of the third quarter witnessed an increase in both, with our advisory and fund management portfolios well positioned prior to the events.

This Quarterly Newsletter appropriately includes an external underlying manager comment from 36 South, our core tail risk/volatility fund manager. Principal of 36 South, Jerry Howarth, highlights what we have also been saying for some time, the cheapest asset class about is volatility, and paying a small insurance premium for future protection is sensible before the event, not after. With a South African and New Zealand pedigree, how could he go wrong? Also in this newsletter, Professor Evan Gilbert looks at commodities as an asset class, and we cover the globe with our international and domestic asset allocation reviews.

An extremely topical and important industry development for us at MitonOptimal is the growth in the use of Discretionary Investment Managers, (“DIMs”) by financial advisers, to provide optimal client portfolio management to their clients. Our Chief Operating Officer Rob Macdonald looks at the process of selecting and appointing such an external investment advisor.

Finally, it’s with great delight that I announce the promotion of Phil Penrose to Director of International Sales, across our international operations. Phil has been with MitonOptimal for 3 years and delivered beyond expectations in his previous role as Sales Director for Asia and Middle East. In his new role Phil will be responsible for the distribution of MitonOptimal’s funds and advisory services’ solutions across our core international markets, including his old patch, but will be earning some more air miles as we have added most of the globe outside of South Africa. Well done Phil and keep up the good work.

Thanks to all our clients, financial planners and institutional consultants for the support we have received in the year so far, and may the final quarter of the year prove to be as rewarding.

Advisory Services

FundManagement

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Scott campbellGroup Managing Director and

Chief Investment Officer

CommoditiesMitonOptimal Group

www.mitonoptimal.com

Commodities play an integral role in our life as consumers. As the price of oil changes, we feel it in our back pockets, through changes in the price of petrol or diesel. Similarly, when the weather goes wrong (or right!) the price of food adjusts accordingly. While the link between the price of commodities and inflation is clear, when we analyse the returns to commodities, it shows that they are similar to equities, in terms of their risk and return levels. More importantly though, from an investment perspective, they are uncorrelated, thus providing great opportunities for diversification. Somewhat surprisingly, however, the use of commodities in a long term investment portfolio, that is designed to beat inflation, is not very common. Why is this?

Part of the reason is that for a long time it was difficult to trade commodities, as not many people are really equipped to hold physical quantities of oil (or gold for that matter) to benefit from changes in their prices. Developments in local financial markets have now made this irrelevant. Furthermore, investors usually want to hold a diversified bundle of commodities – but it’s not clear exactly what the correct bundle should be. The development of commodity indices and the provision of passive investment products to track them have provided ways of dealing with these issues.

Nowadays, investors can get exposure to commodities’ price movements via Futures, exchange traded derivatives that are listed on multiple exchanges across the world. One of the most

Commodities - What is the best way to access them as an investment?

famous is the Chicago Mercantile Exchange, where you can trade the price behaviour of things like ‘Lean Hogs’, ‘Orange Juice’, oil, gold or iron ore. There are currently twelve different commodities that can be traded on the South African Futures Exchange (SAFEX).

In terms of diversified commodity indices, there are three well known international indices. In chronological order they are: the Commodities Research Bureau (CRB), S&P Goldman Sachs (“GSCI”) and Bloomberg (ex Dow Jones/UBS) commodity indices. The CRB index was created in 1957 and had a greater than 2/3rds weighting to energy products (mainly oil). The liquidity of this index was questioned and the S&P GSCI uses a liquidity filter on the underlying contracts in its index to correct for this – but it is also heavily weighted to energy. The Bloomberg (ex DJ/UBS) index addresses this concentration issue by designing its index to limit the exposure to any one commodity to between 2% and 15%. It thus provides a more diversified index.

On the local front, there is the Standard Bank Commodities Index which tracks the performance of seven commodities weighted by the production quantities on the African continent. The maximum and minimum limits are also set to avoid overconcentration to any single commodity. We believe that this index is not the optimal one for South African investors as it ignores five additional commodities that are available on the local exchange, most importantly yellow and white maize.

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It also uses foreign reference prices, rather than local ones, which are often different, and it uses offshore commodities which are less relevant to local conditions (e.g. West Texas Intermediary (“WTI”) instead of Brent for oil when Brent is the price used for local petrol/diesel prices).

So, investors can get passive exposure to diversified bundles of commodities - but this approach can also work against them from an investment perspective. One reason is that commodity prices, unlike equity prices, don’t necessarily trend upwards. In the case of equities, weaker companies are winnowed out from the index but commodity prices simply fall. Secondly, earnings of companies (and thus their valuations) are generally correlated with inflation – but commodity prices can/do fall and remain very low for long periods of time. While this means they offer good inflation hedging characteristics, they can perform badly, from an investment perspective, for long periods in time.

Actively managed portfolios of commodities, on the other hand, offer the potential for achieving the ‘holy grail’ of investing, namely achieving the inflation protection when their prices go up, but can avoid suffering from the negative returns when their prices fall.

The important point to remember, however, is that this is not a guaranteed outcome. For it to be achieved in practice, the manager must be able to tell when prices are going to go up or

down in the future. As working crystal balls are rather scarce, it is lucky for managers that commodity prices tend to trend – either up or down. Consequently mangers who are able to recognize these trends are potentially able to benefit from the updrafts, and avoid the downdrafts.

In summary, investors should be looking for ways to invest in commodities, as they are a key source of inflation protection and offer good diversification potential. However, if you do so, through buying a passive index tracking product, you are taking the risk of exposing yourself to potentially extended periods of poor investment performance. This should not be a problem if you see your commodity investment as an inflation hedge. Lower commodity prices should mean lower inflation. However, if you are looking to maximize risk adjusted returns from a commodities portfolio, you will have to look for an actively managed portfolio – most probably one that uses a trend identification approach.

prof evan GilbertDirector and Head of Investment Consulting

South Africa

Advisory Services

FundManagement

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www.mitonoptimal.com

Influenced by post-RDR developments in the UK, there is a growing trend in South Africa for independent financial advisers (“IFAs”) to either outsource their investment decision-making or make use of the services of external investment advisors/ managers to assist them with their investment decision-making.

The rationale for using an external investment advisor, also called a Discretionary Investment or Fund Manager (“DIM” or “DFM”) should make sense to an IFA. By doing so, they don’t need to invest their own capital into investment resources and they free up time to do other value adding activities, such as spending more time with clients. But if they decide to follow this route, the challenge is how should they select a DIM or DFM?

Our experience suggests that the first and most important step for any IFA is to determine what you actually want from an external investment advisor. This is often not that obvious. For many IFAs their investment experience to date has been very successful – particularly on the back of the 10-year Bull Run in SA equities. They may well have made successful choices of managers and funds to date and in so doing have delivered on their clients’ investment goals. So why change a winning formula, especially if it may cost the client more?

MitonOptimal Group Case Study

Having said that, many IFAs acknowledge that their success has had as much to do with being in the right market environment as with any skill on their part. So by taking on the services of a DIM, they anticipate that there will be an increased level of skill and resources being applied to the task. But the key question is, to what specific task(s) do you want that skill to be applied?

Is it purely to help with manager selection? But what about asset allocation? Is it about trying to secure better investment performance only, or is it about reporting and communication to clients and thereby improving the efficiency of your business? Do you want somebody to simply take the problem away by setting up and running model portfolios on your behalf without your participation? Or do you want someone to help you with investment related research and analysis and sit on your investment committee? Possibly you have a succession plan problem and you hope that by engaging a DIM it will help solve that problem?

While everybody has different needs, when it comes down to it, the key decision appears to be: how much or how little are you prepared to let go when it comes to investments? Working this out is not an easy task, and we have found that IFAs often need

How to select an external investment advisor

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Business Characteristics

InvestmentCapability

Area ofSpecialization

Fees

$ £

assistance with this process. In short - there really is no point in engaging with the range of potential DIM partners if you don’t clearly know what you really want from them.

The second step in the process of finding a DIM partner would be to research the universe of DIMs that you have access to, and try to filter this universe to 3 or 4 potential DIMs that you would like to research in more depth. To understand the universe and help you filter it, we believe that it would be useful to send a comprehensive questionnaire to all the potential DIMs on your radar screen. This questionnaire could cover all aspects of the DIM’s business, some of which are listed below by way of example:

■ Business characteristics – where size and ownership model of the DIM will be important considerations. For example, do you want to deal with an independent business versus one owned by an institution? Size may be a source of comfort or discomfort, but you would want to know if you would be dealing with a call-centre or the investment professionals themselves? Furthermore you would want to know if there are any conflicts of interest in the business?

■ Investment capability – these would include things like people and resources; investment philosophy and process; portfolio construction capability; and a track record in all aspects of what they offer.

■ Area of specialization (if any) - do they have a differentiator such as reporting systems; asset allocation skills or research capability that resonates with you?

■ Fees - the quantum of fees and how they are charged would be another important consideration at the early stage of filtering the universe. Although one needs to be careful not to associate price with quality.

The third step would be to short-list the DIMs on the basis of the questionnaire responses and engage in further due diligence – usually involving visits to their premises. Very often a questionnaire response is very revealing about a business – how much trouble have they taken over it? Did they complete it fully? Inevitably you will be able to identify 3 or 4 DIMs who you would like to meet. Your challenge here is to determine whether you can trust them i.e. they actually do what they say they do

in their questionnaire. This requires a thorough interrogation of all aspects of their business. On the back of the completed questionnaire, you would need to meet with and interview the DIM, ideally at their offices where you can get a good sense of who they are. This process would enable you to assess both the “hard” factors such as staffing, remuneration and research tools, and the more subtle aspects of the DIM such as their approach to business, their culture and compatibility with your business.

The fourth step would be to contract effectively with the DIM. This requires agreement on a Service Level Agreement that complements and enhances the service that you already offer your clients.

Ideally IFAs should view their DIM relationship like a marriage. It makes very little sense for their business or their clients for the engagement to be a short-term affair. The key to finding the right partner is to allow the courtship period to last as long as is needed for you understand what you need, find the right shortlist of candidates and get to know the real ‘them’. Only doing your homework properly will allow for the right choice of DIM to be made.

Advisory Services

FundManagement

rob macdonaldChief Operating Officer

MitonOptimal South Africa

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MitonOptimal Group Richard Hayworth

Sell when it is cheap, buy when it is expensive. A recipe for out-performance?

richard (Jerry) haworth B.Bus.Sc. (Hons), ACMAPrincipal CEO, CIO and PM

of 36 South Capital Advisors LLPMayfair, London, UK

36 South Capital Advisors LLP based in London is the core tail risk/volatility fund manager in our international portfolios. Jerry Haworth is the Principal CEO & CIO at 36 South. He has over 26 years of investment experience and co-founded 36 South in 2001. Jerry is well known for his thought leadership about investment volatility and he often represents 36 South, as a speaker, at high profile educational and professional events, and is a frequent guest speaker and writer on volatility in the financial media. In this article Jerry looks at how investors are often fearful to experience negative returns in the short-term, known as “negative carry”, even if this is necessary for long-term investment outperformance.

Having just returned from a marketing tour of duty, I must confess that it has been useful, but not for obvious reasons. It has reconfirmed WHY we have had a free lunch over the years in our little niche on the financial reef.

One client in particular summed it up: “Our clients will not even look at any strategy which involves them carrying negatively”. “You mean to say,...” we retorted “if we offered them the following investment profile they would not take it?”

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Return -1 -1 -1 -1 -1 -1 -1 -1 -1 +30

“Correct”, he said. “They would prefer to earn the low but known yield today and run the risk of blowing up at some indeterminate time in the future.”

As first we were perplexed, frustrated and irritated, but then we realised that their irrational bias against negative carry is EXACTLY why there is a rich vein of long term performance to be had in this niche.

So it finally makes sense… if there was a casino which offered punters the opportunity to be the “house” or to “punter”, they would all still be the “punters” even though the “house” enjoys the favourable odds!

Add to that the counter-intuitive behaviour of participants in the US$66 trillion (yes trillion) notional global options market, where they accumulate belief based on recent history, i.e. if it has been quiet they accumulated belief that it will stay quiet, and if it has been volatile they start to believe it will stay volatile, where really the opposite is true.This means that most of the participants in this market sell the most when it is cheap and buy the most when it is expensive. Hardly the stuff that consistent out-performance will be made of in the long term.

Cockles, mussels and other shellfish which behaved like this in the presence of cyclical behaviour of tides would probably last a little over 24 hours. They would open their shells at low tide where predators could pick them off with ease, and close them at high tide losing their ability to feed.We weep with joy. Well, maybe not just yet.

“Negative carry strategies are dead… long live negative carry strategies.”

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www.mitonoptimal.com

The contrasting fortunes of the world’s major economies were thrown into sharp relief by movements in financial markets during the period under review, most notably on the foreign exchanges, where the Dollar reigned supreme. On the monetary policy front meanwhile, as the Federal Reserve’s asset purchase programme wound down towards its anticipated conclusion in October, the ECB prepared for its first forays into the realms of QE, Japan’s central bank kept on printing and China pumped liquidity into its banking system.

equitieSMixed economic data made for a changeable mood within equity markets over the quarter. Latterly, concerns over the pace of global (ex-US) growth, an uneasy truce between Russia and Ukraine and the advance of Islamic State’s forces within Syria and Iraq weighed on sentiment, resulting in variable returns from major indices in both nominal and currency-adjusted terms.

Markets tracked sideways during the early part of the quarter, their lack of direction reflecting the mixed bag of data releases from around the world. While a 4.0% jump in second quarter US GDP exceeded forecasts and China’s corresponding 7.5% increase proved reassuring, figures from the Eurozone were less favourable. Though by no means exclusively negative (there were nuggets of good news, most notably from within Spain), declining industrial production and business sentiment, allied to further signs of deflation, pointed to deteriorating conditions in the core economies. Moreover, the impact of trade and financial sanctions imposed on Russia, following the downing of a passenger jet over Ukraine, implied a further potential drag on activity. Meanwhile, news of the bail-out and restructuring of Portugal’s second largest bank cast a shadow over the region, despite announcements of further stimulatory plans from the ECB and yet more combative rhetoric from its President, Mario Draghi (including hints of QE).

After an initial sharp sell-off, August proved to be a better month for equities. Absent any discernible improvement in the wider global economic backdrop, Wall Street led the way on the back of stronger US jobs, housing activity and consumer confidence numbers, which lifted the S&P500 index above 2,000 points for the very first time. September saw a reversal of those gains, however, as a

MitonOptimal International Asset Allocation Oveview

International Asset Allocation Overview

Index 3rd Quarter YTDMSCI World ($) -2.58% 2.25%

MSCI World (€) 5.61% 11.32%

MSCI World (£) 2.81% 4.50%

MSCI World (local ccy) 0.39% 4.67%

S&P 500 0.62% 6.70%

FTSE UK All Share -1.84% -2.10%

FT Europe Ex-UK (€) 0.08% 4.48%

Japan Topix 5.05% 1.84%

FT Pacific Ex-Japan (£) -5.88% -0.65%

MSCI Emerging Markets ($) -4.33% 0.26%

MSCI Emerging Markets (€) 3.72% 9.16%

MSCI Emerging Markets (£) 0.97% 2.47%

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www.mitonoptimal.com

worsening of the situation in the Middle East saw Western forces deployed to launch air strikes against Islamic State positions on the Syria / Iraq border and left markets on a more nervous footing.

In a continuation of the trend seen in previous quarters, corporate activity remained a prominent feature within equity markets. Although the aggregate value of M&A deals, at $1.17 trillion, fell marginally shy of the preceding period, the number of transactions reached a new peak within the current cycle. IPOs were also down in valuation terms, but generated their fair share of column inches, with the flotation of Chinese internet retailer Alibaba the stand-out event. On the earnings front, meanwhile, results were broadly mixed, with reported earnings from S&P500 companies up a meagre 0.6% over the quarter.

Little has changed, in terms of the macro environment or fundamentals, to alter our preference for equities over other asset classes. From a valuation perspective, markets in aggregate are neither cheap nor dear: the MSCI World Index’s forward P/E ratio of 15.5 is bang in line with its long-term median rating (n.b. book value and free cash flow metrics are relatively attractive versus historic levels). That said, recent movements demand that we pay closer attention within the space itself. For example, the divergence in performance between US and European stocks means that the gap between them, on a cyclically-adjusted basis, is as wide as it has ever been according to one of our managers and there are similar claims made in respect of emerging markets or at an individual sector level. Optical cheapness and actual cheapness are, however, two very different things and it is for this reason (and others) that we favour skilled and active stock-pickers over passive strategies at this particular juncture.

bondSIn textbook fashion, movements in core government bonds were the reverse of those in equity markets. Although the strength in GDP growth and other indicators, coupled with the impending cessation of QE would, in normal circumstances, be expected to send Treasury prices lower, dovish comments from Federal Reserve chair Janet Yellen as to the timing and pace of interest rate rises, together with a “risk-off” response to geopolitical events, provided support for the US bond market. After a brief move higher at the beginning of the period, the 10-year benchmark yield declined steadily during July and August from an opening 2.53% to a low of 2.34% - a level not seen since last

spring’s “taper tantrum” - before closing four basis points lower at 2.49%.

Meanwhile, a rate cut by the ECB, persistently weak data and the creeping realisation among observers that some form of QE was an inevitability, sent 10-year Bund yields from 1.25% to 0.95% (via a 0.88% all-time low) over the quarter. At the shorter end of the curve, bonds of 3 years’ maturity and below went to negative yields, with the 2-year issue ending the period at -0.07%. The Eurozone’s peripheral nations outpaced the core thanks to further falls in their yield spreads versus Bunds, with the premium on Italian and Spanish 10-year bonds declining to 139bps and 119bps respectively. Even in France, whose deteriorating fundamentals have prompted its description as “the sick man of Europe”, borrowing costs fell by more than 10bps in relative terms.

Against this trend, an increase in Greek government bond yields (up a whopping 96bps vs. Bunds at 10 years) stood out like a sore thumb. Was this the sign of a fresh crisis? Not quite: this widening in spreads followed news that Greece was seeking to end its bail-out agreement with the IMF, prompting fears that it would ease back on the reform and austerity measures that were a condition of the loan package.

Falling somewhere between the US and Eurozone markets, 10-year UK Gilt yields ended the period down 24bps (from 2.67% to 2.43%). As was the case across the Atlantic, guidance from the Bank of England appeared to rule out the likelihood of an early rise in interest rates, as wage growth and inflation showed no sign of upward pressure in spite of the increasingly healthy GDP numbers (+3.2% in Q2).

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Fig.1: 10 yr yld spreads vs. Bunds

International Asset Allocation Overview (Cont.)

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Elsewhere within the sovereign bond space, confirmation of the latest in a long line of external debt defaults by Argentina (seven and counting since 1827 – that’s twice more frequent than the appearance of Halley’s comet!) caused barely a ripple in markets, having been widely anticipated for some considerable time. That said, emerging market bonds in general adopted a softer tone over the quarter. As elsewhere, geopolitical considerations were a big influence on proceedings (Russia is a sizeable component of the index) and the yield spread on the JP Morgan EM Bond Index climbed to a six month high of 334bps versus US Treasuries (+49bps).

Among corporates, investment grade issues saw little relative movement, with yield spreads in the US and UK rising modestly and those in Europe ending the period slightly tighter. High yield markets, by contrast, fell heavily. Though proponents of the asset class were quick to attribute the cause of two sizeable “corrections” within the US market to “technical factors”, citing an active new issue calendar, profit taking, negative headlines (!) and the resignation of founder Bill Gross from bond fund giant PIMCO (really?), an equally sizeable contingent of bearish commentators hailed the quarter’s price action as the harbinger of a long overdue collapse in a bubble market.

So which is right? As is so often the case, the reality lies somewhere in between the two. For the bull case, it is difficult to deny the relative attractions of a sector now yielding north of 6% that is pricing in an implied default rate two or three times that of the current actual level of just 2%. At the same time, there is no question that the investing public’s hunger for income means that the high yield bond market has attracted both the wrong sort of buyers (the re-branding of what were once known as “junk bonds” has undoubtedly helped in this regard) and some

questionable issuers. As such, although the purging of at least some of this hot money - assets within the two largest US ETFs fell almost 10% in July alone – together with the odd bond failure should be seen as healthy, many of these “bond tourists” remain in situ and there is thus the potential for further sizeable outflows. Faced with such forceful opposing arguments, it clearly makes sense to seek out a considered, unbiased, but expert view and in this regard, the positioning of the strategic bond funds that we own or follow offer an invaluable insight. Their managers’ verdict? Having sold into market strength or added shorts over recent quarters, many have been adding to their high yield exposure on a selective basis following the market’s correction, implying a more favourable outlook on their part in the short term at least.

With interest rate cycles in the US and UK poised to turn upwards after an unprecedented period of monetary largesse, the Eurozone in the grip of deflationary forces, corporate credit spreads at or near historic lows and geopolitical events flaring up on a regular basis, fixed income investing has rarely been such a tricky a prospect. As we have highlighted on many previous occasions, a pragmatic approach and flexible mandate are vital within this environment and we therefore continue to place a strong emphasis upon strategic, absolute return and macro strategies when selecting managers for our client and fund portfolios. At the same time, there remain a small number of niche areas offering interesting opportunities, away from these broader themes, which we continue to seek out and aim to exploit.

currencieSMeasured by its trade-weighted (DXY) Spot Index, the 7.72% increase in the Dollar was the strongest performance by the US currency in a single calendar quarter since the height of the global financial crisis in Q3 2008. Rather than a response to any single event or episode, the greenback climbed steadily throughout the period under review, recording gains against all sixteen of the other major world currencies listed by Bloomberg, which ranged from a modest 1.76% versus the Taiwanese Dollar to 10.85% in New Zealand Dollar terms.

Among the “major majors” (apologies to Joseph Heller), Sterling’s 5.24% decline, from $1.7106 to $1.6209, placed it ahead of the Japanese Yen (-7.59%, from ¥/$101.33 to ¥/$109.65) and Euro (-7.75%; $/€1.3633 to $/€1.2631). This represented something of a recovery, on a relative basis

Fig.2: iBOXX US High Yield Index

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Equities Bonds Commodities Currencies

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Joanne baynhamDirector and Head of Investment

Strategy - South Africa

at least, from its intra-quarter lows, which had seen the Pound suffer a sharp sell-off leading up to the September 18th Scottish independence referendum. Though late opinion polls had indicated that the outcome of vote would be far closer than previously expected, raising all sorts of potential questions over the currency unions and fiscal policies in the event of a vote in favour, a fairly comfortable win for the “nae” campaign saw order restored.

commoditieSUnsurprisingly, given the aforementioned strong Dollar backdrop, losers outnumbered the winners by around three to one on the commodity exchanges and the broad sector benchmarks all ended the period in red figures (Reuters CRB Index -9.63%, Dow Jones UBS Index -11.83%, Rogers ex-energy Index -11.83%).

In spite of the obvious potential implications for energy supplies posed by the ongoing tensions between Russia and Ukraine and the significant gains by Islamic State forces in the Middle East, the period was notable for sizeable declines in the price of Crude Oil contracts. The combination of slowing global growth, rising inventories and higher OPEC supply, together with unwinding of speculative long futures positions held sway over the aforementioned concerns and sent Brent and WTI to the bottom end of their medium-term trading ranges, down 14.92% and 13.49% over the quarter.

Fig. 3: DXY Index

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Another feature of the period was the continued decline in agricultural commodity prices, with double-digit falls in Soybeans (-34.77%), Corn (Maize, -24.13%) and Wheat (-14.65%) likely to ensure that at least the food component of inflation indices remain soft for the time being. Meanwhile, those few commodities that registered gains over the period bring bad news for Coffee lovers (+14.88%) and chocoholics alike (Cocoa +5.26%).

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Fig. 4: Brent Crude price per barrel

Shaun mcdadeManaging Director Guernsey and Head

of Portfolio Management - Guernsey

International Asset Allocation Overview (Cont.)

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MitonOptimal South Africa Domestic Asset Allocation Overview

www.mitonoptimal.com

Domestic Asset Allocation OverviewDomestic (South Africa) Funds and Portfolios

Advisory Services

FundManagement

A Healthy Correction...Before we focus on our views on domestic and offshore asset classes, it is appropriate to comment on the correction in equity prices over the past month. Many factors play a role in the current equity market correction:

■ Global economic growth is increasingly uneven, with the US & UK pulling ahead.

■ The ever improving US economic conditions led to the US Federal Reserve (“the Fed”) deciding to end Quantitative Easing (“QE”) and to indicate that US interest rates will need to rise sometime in 2015.

■ The mere thought of increasing US interest rates spooked investors in emerging markets, especially those that did not structurally improve or address their economic imbalances. This led to diverging monetary policies, as the European Central Bank (“ECB”) cut rates to stem the potential for deflation, while the SA Reserve Bank has hiked rates in order to protect further devaluation of the Rand and seeking to prevent inflation to stay above the 3-6% target band.

■ The US Dollar strengthened, relative to most global currencies, which influences the medium-term prospects of large US corporations who benefit from globalisation of earnings in countries outside the US. This move, ahead of corporate earnings season, also led to uncertainty of earnings potential of US companies, especially when Europe and many emerging markets fail to generate satisfactory economic expansion.

■ US and SA equity prices were overvalued relative to their history. Equity markets reacted badly to the International Monetary Fund’s (“IMF”) downgrade of global growth projections, leading to a broad based sell-off in equity prices globally.

Did we take any action?We reduced our exposure to local and global equities, ahead of the correction, due to valuation concerns. We also reduced our global exposure in our Regulation 28 compliant portfolios/funds and took profit from Rand weakness. We increased our exposure to ZAR cash in anticipation of higher SA rates, which may offer real returns in the near future, as a lower inflation rate is possible, due to lower commodity and food prices globally. We also introduced more low correlation, absolute return ideas into our low risk funds and portfolios recently, by re-introducing the Allan Gray Optimal Fund.

We view the correction in local and global equity prices as a healthy correction. We expect ongoing equity market volatility in the short-term, as investors consider the prospects for widespread economic growth stimulus outside the US and the UK and reconsider the implications of a stronger US Dollar and the potential of US rate hikes in 2015. We expect more reform and stimulus from China, Europe and Japan in the near-term. We expect that SA Fiscal and Monetary authorities can do something to keep foreign investors and rating agencies happy, with reforms to improve the budget deficit (tax hikes or spending cuts?) and sustain foreign direct investment into SA. Local investors must keep in mind that more than 60% of the earnings of the Top 40 stocks on the JSE are derived from sources outside South Africa. On balance, global economic expansion is therefore more important for our stock market’s potential. The divergence in economic conditions globally and in SA, make for a selective approach in asset allocation and stock selection. Domestic Asset Allocation OverviewWhen building the asset allocations of our discretionary managed portfolios or multi-asset funds, it is important to understand that we take into consideration both strategic and tactical factors within the various asset classes. However, we also follow an optimized portfolio construction process that ensures we adhere to the desired investment objective and investment horizon of each mandate. In that context, this overview summarises our views on our short-term tactical calls by each asset class that we are invested in. These

may differ from our long-term strategic views, but we believe that a flexible

approach to asset allocation is prudent practice, in a world dominated by debt

de-leveraging and extreme policy intervention. We believe that static asset

allocation approaches carry many short-term risks in an era of such extreme

global volatility.

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roeloff horneDirector & Head of SA Portfolio Management

South Africa

SA Equities (Marginally Underweight)

SA Bonds (Large Underweight)

SA Listed Property (Neutral)

SA Cash (Large Overweight)

Global Equities (Neutral)

Global Listed Property (Neutral)

Global Bonds (Neutral)

Global Cash (Neutral)

■ We have adjusted our asset allocation down for SA Equities, as we believe we cannot expect more than CPI + 4-5% p.a. over the next 5 years, from current price levels.

■ The main conviction behind our current tactical marginal underweight position is based on our market’s relative valuation to other emerging and developed markets. We believe that other countries also offer superior earnings growth potential, as global consumer spending is slowly recovering. Within the equity sectors, we reduced our exposure to Resources dramatically in the past quarter, due to slowing demand and excess supply forces globally. We are currently overweight Industrials and Financials whilst being underweight Resources. The SA consumer is experiencing higher inflation and administrative costs and it is also the start of a rate hike cycle. We have thus reduced exposure to ‘SA incorporated’ stocks, such as small caps and consumer related stocks.

■ We continue to prefer stocks which benefit from consumers outside our borders, even if most of them are trading at a premium to their historic Price/Earnings (PE) ratios. We will use the market correction to buy SA equities at appropriate levels, which may lead to an overweight in this asset class soon. We remain of the view that equities provide investors with the best potential to generate inflation plus returns over the long term.

■ We are at the bottom of our interest rate cycle and the normalisation of the global interest rate cycle has just started. This is a difficult environment for nominal fixed rate bonds. It does not mean one should avoid them entirely, as bonds can become mispriced from time to time and bond exposure improves the diversification of our portfolios.

■ Within this asset class we favour floating rate notes, as they inherently have no interest rate risk. Our portfolios also continue to have exposure to inflation-linked bonds (ILBs), which benefited from a contraction in real yields from 2.2% to 1.75% in the past 4 months. This re-rating generated a healthy return over the past 12 months and cemented inflation-linked bonds as a low correlation asset class in our portfolios and funds. With ongoing SA labour inflexibility, greater potential for negative downgrades of the SA risk premium exists. This may mean that higher interest rates may be part of the risks for fixed rate bonds in the short term and we do not expect any more than CPI + 1 or 2% p.a. from local fixed rate bonds in the near term.

■ We have reduced our global equity exposure in the quarter, to take profit from a weak Rand. ■ SA Equities continue to trade at a premium to its counterparts in the MSCI Emerging Market

and the MSCI World Indices. So despite our reduced exposure to global equities, relative to SA equities, we are more positive about holding global stocks, with higher earnings growth potential due to the expected global consumer spending recovery.

■ We continue to favour developed market equities above emerging market equities, but for our high risk investors, we increased exposure to China and other emerging market equities that are now trading at more than a 25% discount to their developed market counterparts. After the correction, most developed market equity indices trade at / or below their fair value, relative to their long-term history, which still provide investors with better potential for absolute returns in a low global interest rate environment.

■ In terms of return expectations, we do not expect more than Global CPI + 5% to 6% p.a. from Global Equities in the next 3-5 years.

■ This asset class tends to provide good long-term inflation protection. Currently it trades at a premium to Net Asset Value (“NAV”), but remains at fair value, relative to historic valuations. Listed property currently trades at a negative spread relative to the 10-year fixed rate bond. The current historic yield is 6.8% p.a. and assuming a 12-month distribution growth of approximately 7%, the sector offers a forward yield of 7.4% p.a.

■ We are currently using floating rate notes (which reset with interest rates) as our alternative to cash instruments. These short-term money instruments are our short-term tactical allocation given the likelihood of interest rate increases. This gives capital protection to a large portion of investor’s capital, whilst we can access these cash instruments at any time to use when buying opportunities present themselves in risk asset classes.

■ As in our SA Bond portfolios, we favour US Dollar denominated floating rate notes and inflation-linked bonds within this asset class. Global bond rates remain unattractive and we simply use a US Dollar bond allocation as a long-term risk management and diversification strategy against any unexpected risks within global capital markets.

■ We reduced our exposure to global listed property in light of the tapering of QE and the normalisation of bond yields in developed and emerging markets. The asset class remains correlated to bond yields in a period of consolidation. However, global listed property is more attractive, relative to SA counterparts, as it does not currently trade at a premium to global bond yields, but trades much closer to its NAV and will be a beneficiary of global inflation when this happens later in the cycle.

■ Global real estate currently trades at an estimated forward distribution yield of 5.2% p.a. and appears attractive relative to global 10-year developed market government bonds. We are looking to increase our exposure to this asset class as and when global economic growth improves and bond yields stabilise.

■ Global cash rates remain unattractive and we simply use US Dollar allocations as a long-term risk management strategy against any unexpected risks within global capital markets.

Domestic Asset Allocation Overview (Cont.)

For Domestic Funds and Portfolios

14

Advisory Services

FundManagement

Scott campbellGroup Managing Director and

Chief Investment Officer

After more than 10 years since taking the big step of setting up a new business, and feeling a great sense of achievement (and exhaustion!) in seeing what MitonOptimal has become today, it was time for a break. Most people who work in big organisations change jobs on a regular basis, and in so doing get a paid holiday, in the form of gardening leave on a regular basis. However, in professional firms where we ply our trade for much longer time frames in a partnership environment, we agreed that the sabbatical concept at MitonOptimal is a good idea.

Also, in a busy world where WiFi, telephones, Bloomberg, texts and Twitter are a constant communication battle, the added bonus of being able to put aside the day to day (or in some people’s cases “second by second”) grind of admin, market commentary and people management for 2 months, by leaving the Blackberry in the office, was both a terrifying but exciting prospect.

On this basis, the Campbell family set off on 13 June from Cape Town on a sabbatical for nearly 2 months. As recorded on the blog www.campbellsabbatical.wordpress.com, we landed in London and ,after spending some time with Aunty Abby, we flew to Naples that afternoon. We then had an extremely terrifying ordeal, in our first attempt to drive on the other side of the road in darkness, in a city that prides itself on unruly driving. Finally, we arrived in one piece at Positano on the Amalfi coast, in time to see England play Italy in their opening game of the Football World Cup. We then had a week of bliss, tinged with mild Blackberry withdrawal symptoms, and many delightful days swimming in the Med, a visit to the island of Capri and many amazing walks.

We managed a couple of days in Rome, which 10 year old Georgina and 7 year old Jack referred to as “tourist days”, and multiple visits to the Coliseum were very educational. In the process, I discovered the Weekend FT for sale, which helped ease the Blackberry withdrawal symptoms. After two weeks in two different Tuscan Villas, surrounded by amazing countryside, villages, wines and olives, I began to wonder… “what office?!”

We had an amusing overnight train trip from Italy to France, ending in Bordeaux. We then spent the next week in an old farm house in the Dordogne wine region, near St Emillion. A complete rest, and interesting trips to French supermarkets learning “Parlez vous Francais”, ensured that the restful nature of the sabbatical took its course. Having mastered the art of driving on the wrong side of the road, at the end of the week we drove 8 hours to Provence near Avignion.

Becoming very comfortable with the good life and a life of leisure meant that by the time we reached Provence, I could not have cared less about the Blackberry. A week in a Provencal farmhouse, rafting, sightseeing and becoming reacquainted with the Mediterranean near Marseille capped an amazing time for the Campbell family.

The tour of duty then rolled on to Dijon and then Paris. As much as the parents endured Euro Disney, the kids loved it. The adults did get their reward, with a busy few days in the Parisian suburb of St Germain. The Eiffel Tower, the Louvre and Notre Dame were interwoven with lovely dinners and a relaxing time in Luxembourg Park.

We started our final week with a Euro Star train trip back to London, followed by a week in the English countryside with friends. Crabbing on the Isle of Wight, running along the canal and a couple of London trips, plus a visit to Harry Potter World capped the holiday of a lifetime.

When asked about what was the most memorable part, the unanimous conclusion was the four of us spending so much quality time, primarily in foreign language territory, without any day to day interruption from our busy lives. I’m sure Georgie and Jack would also add Space Mountain at Euro Disney! In fact, upon getting back home on 3 August I had forgotten the password to my Blackberry and needed to visit Vodacom on the Monday morning to help unlock it. Mission accomplished I guess.

How to forget the password on your Blackberry, revisiting life on Sabbatical

15

MitonOptimal Group Business Update

Business Update

MitonOptimal International, the fund management group, today announces that Phil Penrose has been appointed Director for International Sales, a promotion from his previous role with the organisation.

Phil has been with MitonOptimal for 3 years, as Sales Director for Asia & Middle East. In his new role, Phil will be responsible for the distribution of MitonOptimal’s funds and discretionary management solutions across MitonOptimal’s core international (Offshore) markets.

Scott Campbell, Managing Director & Chief Investment Officer commented “The MitonOptimal business has grown significantly in the last 3 years, based firmly on delivering long-term returns to our clients, and carefully protecting

them in times of market setbacks. Phil’s proven success and experience, over a career spanning 17 years, means we are delighted that he has accepted the opportunity to help MitonOptimal meet its ambitions to further grow and serve the needs of our clients.”

“MitonOptimal has some really exciting plans in place to develop our range of funds and DFM solutions over the coming months.”

Phil also commented “I am very excited to help lead the International distribution for MitonOptimal, in the next stage of its development. Our distinctive approach to investment solutions, offering access to both flagship multi-asset funds and discretionary management expertise, will be a powerful combination for our partners.”

MitonOptimal appoints Phil Penrose as Director for International Sales

16

DisclaimerThis document has been issued by MitonOptimal South Africa

(Pty) Ltd with registration no 2005/032750/07, which is an

authorized Financial Services Provider (“the FSP”) with License

No. 28160. MitonOptimal South Africa (Pty) Ltd complies with all the

requirements of the Financial Advisory and Intermediary Services

(FAIS) Act (Act 37 Of 2002).

The content of this document is for information purposes only and

does not constitute an offer or invitation to any person. The opinions

contained in this document are subject to change and are not to

be interpreted as investment advice. You should consult an adviser

who will be able to provide appropriate advice that is based on your

specific needs and circumstances. MitonOptimal‘s prior written

consent must be obtained before the contents of this document

are communicated to any third party. The information and opinions

contained herein have been compiled or arrived at from sources

believed to be reliable and given in good faith but no representation

is made as to their accuracy, completeness or correctness.

MitonOptimal’s respective directors, officers, employees and

associates may have an interest in the products, services or

service providers referred to herein. The value of investments and

the income from them may vary and you may realise less than the

sum invested. Past performance is not necessarily a guide to future

performance and no guarantees are offered in respect of investment

returns and/or capital invested.

Tax assumptions may change and you should rely on your own tax

adviser when considering your personal circumstances. The funds

may have exposure to securities denominated in currencies other

than their functional currency; changes in exchange rates may have

an adverse impact upon the fund performance. The investment may

not be suitable for all recipients of this publication.

Mark Margetts-SmithGroup Head of Marketing

This newsletter is produced for the MitonOptimal Group of companies as an in-house publication. If you have any queries regarding our content please contact Mark Margetts-Smith (info@mitonoptimal-ci.com) in the first instance.

MitonOptimal Group Head OfficeGreat Westerford, Suite 202, South Wing,2nd Floor, 240 Main Road, Rondebosch, 7700, South Africa

tel: +27 (0) 21 689 3579 fax: +27 (0) 21 685 6944Email: mail@mitonoptimal.comURL: www.mitonoptimal.com

South Africa

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Isle of Man

MitonOptimal Contact Us

For further information contact us via the MitonOptimal Group Head Office

MitonOptimal Group - Great Westerford, Suite 202,South Wing, 2nd Floor,240 Main Road, Rondebosch, Cape Town, 7700, South Africa

URL - www.mitonoptimal.com - Email - mail@mitonoptimal.com

South Africa: Tel. +27 (0)21 689 3579 - Fax. +27 (0)21 685 6944 Guernsey: Tel. +44 (0)1481 740044 - Fax. +44 (0)1481 727355

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