PORTFOLIO COMMENTARY

The Cadiz Equity fund declined -3% this quarter. The Fund delivered 6% p.a. for the rolling 3-year period which significantly outperformed the benchmark Capped Swix return of 1.8% p.a. The rolling 1 year period was a decline of -3.8% which is lower than the -2.3% return of the benchmark.

We highlighted in our half year commentary that the current investment landscape is becoming more uncertain as a range of global economic, geopolitical, policy and corporate risks have increased. This has caused stock markets to remain volatile during the third quarter. A recent Bloomberg article titled “Actually, the Stock Market has Barely Moved the Last Two Years Under Trump” (3 October 2019) confirms that since Trump has ratcheted up the Trade war, the US stock market (and global equity markets) have seen large declines in performance followed by a recovery only to suffer further losses but ultimately has gone sideways. As a result, equity markets have generated mediocre returns for investors.

Our philosophy is that the market is prone to overreact to good and bad news in the short-term, which enables Cadiz to exploit these opportunities by investing our clients’ capital in predominantly good quality businesses with capable management and low financial risk at attractive prices. While volatility is uncomfortable in the short term, these investments should lead to superior returns over the next 5 to 7 years.

PERFORMANCE REVIEW

Exceptional performance was achieved from platinum and gold counters. Naspers has once again delivered a good 1 year return and while this benefits the fund in absolute terms, our large underweight position versus the Capped Swix impairs our ability to beat the benchmark when Naspers does really well. Metair delivered a pleasing 1 year return, with the business performance improving even with the poor SA economy and headwinds from the Turkish Lira devaluation. Some of the larger holdings that have performed well include the likes of Woolworths and MTN.

Of the Top 10 holdings, British American Tobacco (BTI) and Mediclinic have delivered poor share price performance over the last year. BTI’s underlying business is doing well, but regulatory issues have created negative sentiment. Mediclinic has also been impacted by changing regulations, specifically in Switzerland which has caused earnings to decline. We have been increasing exposure to select SA focused businesses (Massmart, Shoprite and Truworths) as the share prices are close to our bear case levels.

Stocks that continue to detract from performance were the US retailers, UK property counters and the offshore drilling companies.

FUND POSITIONING

Equity exposure has increased to 86% from 82%, including 2.3% in property. Our offshore equity exposure has decreased from 26% to 25%, due to fund inflows with offshore cash at 2.4% which has by and large been deployed post month end.

The fund sold out of Richemont after delivering a good return and Grindrod Shipping.

• Grindrod Shipping was a spin-off from Grindrod Ltd and was a small position in the fund. It is a cyclical business that has moderate financial risk. The US-China trade war has increased the risk of lower demand for shipping, which could further strain the balance sheet. Even though there is a lot of upside to the replacement cost of the shipping fleet, we believe that there are better risk/reward investment alternatives available in the market.

We added Massmart during the quarter as the share price suffered a large decline on the back of poor results. We also received Prosus shares from the Naspers spin-off. We summarise the investment case for Massmart below:

• Massmart (MSM) is the largest general merchandise wholesaler in South Africa. They trade through well-known outlets such as Makro, Builders Warehouse, Game, Dion Wired, Cambridge foods, Jumbo Cash and Carry. 91% of their revenue is generated in South Africa. With the South African consumer under severe pressure, low food inflation, the threat of online and strong competition, MSM was unable to grow its revenue more than its costs which caused profit margins to decline. Management have also been restructuring the business in order to reduce costs and are in the process of implementing a new IT system. Together, this has resulted in increased expenses, write-offs and further losses to the business. Although there are some structural challenges affecting the business units, Massmart has low financial risk and Walmart (the parent company) has deployed a seasoned emerging market veteran as CEO to drive the business forward. We believe the recent fall in the share price more than discounts the concerns stated above and is sufficiently low to protect investors against permanent capital loss. An improvement in the SA economy could lead to a good investment outcome.

We continue to remain disciplined in sticking to our investment philosophy and process and focus intently on protecting and growing your capital by investing in predominantly good businesses at attractive prices with capable management and low financial risk.

PORTFOLIO COMMENTARY

The Cadiz Equity fund gained 6.5% this quarter rebounding strongly from the prior quarter decline of -6.4% as global equity markets recovered. The quarterly results can be quite volatile and therefore we encourage our clients to ignore the short-term noise and focus on the longer term results that the fund is producing. The Cadiz Equity fund generated 9.3% for the rolling 3-year period which significantly outperformed the fund’s benchmark of 3.7%. For the rolling 1 year period, the fund generated 10.6% also outperforming the benchmark of 0.4%. Global recessionary fears faded as China’s economic growth seems to be stabilising. US-China trade talks have also fed positive sentiment. The US Federal Reserve paused on hiking interest rates and the US, European and Japanese central banks have communicated that monetary policy would continue to be accommodative. Collectively, these events supported equity markets. Some positive key announcements at the end of the quarter were:

-Moody’s confirmed South Africa’s credit rating as investment grade which was a major relief to local bond and equity markets. South Africa has been given time to develop credible reform initiatives to boost the economy’s growth prospects.
-The South African Reserve Bank (SARB) kept interest rates unchanged at 6.75%, as expected.

PERFORMANCE REVIEW
Stocks that contributed positively to performance were British American Tobacco, Naspers, Bed Bath & Beyond, Anheuser- Busch InBev and Facebook as well as the platinum stocks. These were some of the stocks that rebounded after a poor end to 2018.

The main detractors of performance during the quarter were Woolworths, CVS Health and Brait. As part of our process, we regularly re-evaluate each stock’s investment case to see if anything has changed and whether the investment case still holds. For these 3 stocks, we believe their investment case is sound with the potential to deliver good long-term investment returns for the fund.

FUND POSITIONING
The fund has reduced the allocation to cash from 18% to 13%. Our offshore equity exposure has increased from 21% to 28% while local equity exposure declined to 58% from 61%. Overall, total equity exposure increased to 87% from 83% as we used the market weakness to add to our equity holdings.

The fund sold out of Autozone after it delivered handsome returns to invest in other businesses with higher prospective return. We also sold our African Phoenix Preference Shares and Howden Africa was delisted. This allowed us to recycle capital into new stocks; Swatch and Shoprite. After Naspers unbundled MultiChoice, we increased this position on share price weakness. We have summarised the investment case for MultiChoice and Shoprite below:
-MultiChoice Group (MCG) was spun-off from Naspers and listed on the JSE on 27 February 2019. It is an above average business with low financial risk. It is Africa’s leading entertainment company with world-class technology and well-invested infrastructure which allows for the distribution of content across multiple platforms. The Group has a highly cash generative South African business and no financial debt. The concern is the African operations which is currently loss making, mainly due to large depreciation of the foreign currencies. MCG has built the network infrastructure in Africa and does not have to spend a lot more capital in this business. This business has a high fixed cost base and can grow earnings quickly as more subscribers are added. These concerns have kept the share price below our assessment of what we believe the business is worth which has enabled us to add to the position.
-Shoprite Holdings is an above average quality business that has a history of creating economic value for shareholders. The company is defensive in nature and generates resilient earnings and cash flows overtime. Its two main competitive advantages are economies of scale and a superior supply chain. The share price has been under pressure lately, as the Group’s earnings have been temporarily impacted by currency movements in its Rest of Africa operations, allowing us to take an initial position. Were the share price to fall further, we would add to this investment.

We continue to remain disciplined in sticking to our investment philosophy and process and focus intently on protecting and growing your capital by investing in predominantly good businesses at attractive prices with capable management and low financial risk.

Thank you for your continued support and trust.

PORTFOLIO COMMENTARY
2018 was a particularly tough year for risk assets (which include equities, property and commodities) which generated negative returns for the year. Local and global risks have seemingly increased due to the potential downgrade of South Africa's sovereign credit rating by Moody's, the trade war between the US and China, BREXIT and the unwinding of quantitative easing.

With a long term focus, the fund continues to follow a disciplined process to generate capital growth for its clients, while limiting the potential for permanent capital loss. The market weakness lowers the price that you are paying for an investment and a lower price in most cases translates into higher future returns. Whether these returns will come through in 2019 is unknown, but over a 3 to 5 year investment horizon business fundamentals drive the underlying share price. Fundamentally, we believe the investment cases for each asset in the fund remains intact and so we wait patiently for share prices to reach our assessment of what the asset is worth.

PERFORMANCE REVIEW
The Cadiz Equity fund generated -4.3% for the year which was a function of negative equity, commodity and property markets. This is compared to the fund's benchmark which is the FTSE/ JSE SWIX, which delivered -11.7% for the year. The fund did much better than its benchmark and hence delivered an acceptable result given the turbulent environment in 2018.

The 4th quarter 2018 was a particularly poor quarter for the fund with a loss of -6.4%. The main detractors of performance in the fourth quarter were International stocks. In particular, the oil services businesses (Transocean, Diamond Offshore Drilling and National Oilwell Varco) really suffered as the Brent crude oil price fell from a high of $82 to a low of $52 driven by good output from the US Shale oil fields and fears of a global economic slowdown. We have seen Opec+ already reinstate a supply cut of 1.2m barrels per day which has lifted the oil price close to $60, with any further supply disruption likely to result in higher oil prices.
Local stocks that were major detractors from performance were British American Tobacco, Mediclinic and Intu Properties.

-British American Tobacco (BTI) was severely impacted by the news that the US Food and Drug Administration (FDA) unveiled new steps to prevent youth access to flavoured tobacco products and plans to ban menthol in cigarettes. Regarding menthol cigarettes, when the FDA examined menthol in 2013, the published science concluded that menthol should not be treated differently to non-menthol cigarettes. The published science has not changed its position since then. Management continue to engage proactively with the FDA on its proposed plan. If anything, it will take time (years) to implement. Consequently, we believe the market has overacted to the FDA announcement and believe there is meaningful upside to the share price.
-Mediclinic has been impacted by regulatory change in Switzerland, whereby authorities have made changes to medical aid regulations. This has led to patients having shorter hospitals visits (days spent in hospital) and has encouraged certain procedures to be conducted in outpatient facilities. This has caught all hospital providers off guard including Mediclinic, impacting their profitability. Overtime, Mediclinic should be able to re-position itself to take advantage of current conditions.
-Intu properties (UK Retail Real Estate) had an offer to be bought out by a consortium of investors including Brookfield Property Group, Olayan Group and the Peel Group. After a lengthy due diligence process, the consortium decided not to buy Intu properties for £2.14 citing political concerns surrounding BREXIT. Consequently the share price fell significantly. It now trades at £1.09, 0.3x Price Book and is extremely cheap.

FUND POSITIONING
The fund has a high allocation to cash of 18%. We have not used our full offshore allocation of 30% and hence have capacity to take 8% of this cash offshore which can be invested to increase the equity weighting. This action is justified as our international investments are quite attractively priced at this point in time.

Two stocks that were added to the portfolio were Richemont and Bayer AG.
-Bayer AG is an above average quality business and operates in the areas of health care and agriculture. Its competitive advantages stem from the Group's strong R&D capabilities and patent protection, producing products and services that solve genuine customer needs. It has fairly stable revenues and earnings and has generated high returns on capital, creating economic value for shareholders.

-Richemont, a good quality luxury goods business was added to the portfolio. Its share price had fallen too much offering a sufficient margin-of-safety to have a small position. If the stock were to fall further, we would add to this position.

We sold Apple and Starbucks after these businesses share prices had run-up to levels where the expected return was not attractive versus other investment opportunities.
We continue to remain disciplined in sticking to our investment philosophy and process and focus on protecting and growing your capital by investing in predominantly good businesses at attractive prices with capable management and low financial risk. Wishing you and your family all the best for 2019.