What a difference one quarter makes. In our previous commentary we wrote that the MSCI Emerging Index fell almost 20% (in US dollar terms) from mid April to late May. This past quarter saw the index rise 18.2% and we are pleased that the fund outperformed its benchmark by 1.06%% during this period (in rand terms). We would however rather be evaluated over longer and more meaningful time periods. In this regard, the fund has outperformed the MSCI Emerging Markets Index by 5.3% p.a. (in rands) on an annualised basis over the almost 3 years since inception.

There was only one name change in the top ten holdings of the fund during the quarter. Petrobras (still a top 12 position) was replaced by Banco Santander Brazil, a holding to which we've added substantially over the period. The long-term fundamentals for the banking sector in Brazil are very positive in our view (high GDP growth rates, rising disposable incomes, declining unemployment and low banking penetration). Within the sector we believe that Banco Santander Brazil is amongst the best managed banks with the most potential to increase ROE's over time (toward the 20% level from the current 12% level). The bank is also very well capitalised, in fact overcapitalised in our view, and as such has plenty of room to grow their loan book. The bank trades on 11x what we believe it will earn over the next year, with a 5% dividend yield, which we believe is very attractive.

China Unicom, C&O Pharmaceutical and Colgate Palmolive were all introduced into the fund. We sold holdings in Telefonica on concerns that they would end up overpaying for Brasilcel (a Brazilian telecommunications company), Anadolu Efes (Turkish listed brewer and beverage company) as it reached our fair value and Brazilian education company Sistema which received an offer for their learning system division by the Pearson Group. China Unicom is a provider of both fixed and mobile telecommunication products that is trading on 8x our estimate of normalised free cash flow. While the traditional fixed line voice offering is in decline, we believe an opportunity lies in their broadband and data offering. In 2009, Chinese internet penetration reached 19%: meaning 2 out of every 10 people in China have access to the internet. Korea (an example of a more developed Asian country) reached 19% penetration in 1999. Current penetration for the US and Korea are both around 72%, while penetration in China is 25% today. Astonishingly, there are already more internet users in China (approaching 400 million) than there are in the US (220 million), yet China only has internet penetration of 25% compared to 72% in the US. China doesn't need to reach 70% penetration (US and Korea levels) for there to be significant growth ahead - a move from 25% to 50% penetration would add another 400 million internet users. Besides China Unicom, the fund also has a number of other large holdings in internet companies (portals and/or online gaming companies) that will benefit from increasing internet usage in China including Naspers (through its Tencent stake), Netease.com, Sohu.com and Perfect World. The latter 3 all have large net cash balances (ranging from 15% to 25% of current market caps) and are trading on low double-digit ratings excluding the net cash, which we believe is very attractive given expected double-digit earnings growth rates for a number of years ahead. C&O Pharmaceutical is a small Singapore-listed Chinese generic pharmaceutical company which we believe has been overlooked by investors. The Chinese healthcare market is one of the most underserviced in the world with 50% of urban residents not having sufficient healthcare and 30% of the rural population not having any form of healthcare. The 4-2-1 (grandparents, parents and child) family structure means that China has a rapidly aging population requiring increased medical spend. As part of their plan to combat the impact of the global recession, the state's healthcare spend was increased substantially to US$130 billion over the 2009-2012 period. The market for pharmaceutical products has grown in excess of 20% for the past five years. C&O core operations are focused on the production and sale of finished goods. The product portfolio include their own proprietary products and the exclusive distribution under licence for Hong Kong and Japanese pharmaceutical companies. The business is a strong cash generator and continues to distribute excess capital to shareholders having declared two special dividends this year. The share trades on 10x this year's earnings with a 4% dividend yield.

The inflows into emerging market equities have resulted in a number of stocks in our universe trading above what we believe is fair value. Whilst we are still uncovering selected very good value within emerging markets (reflected in the fact that the equity exposure is still around 90%), we do not restrict ourselves to companies listed on emerging market exchanges - we also consider those listed on developed exchanges which today generate a large portion earnings (at least 40% +) from emerging markets. Colgate Palmolive is an example where 50% of revenues are generated from emerging markets. We initially analysed Colgate Palmolive India (51%-held subsidiary of the US-based mothership), but concluded that it was too expensive and did not provide us with the margin of safety that we insist on. This however led us to take a detailed look at the holding company (US-listed Colgate Palmolive). The business owns a collection of great brands that dominate their categories in many cases. Operating margins are consistently over 20% and due to this as well as high asset turns the business generates ROE's north of 70%. Earnings per share has grown by 10.6% p.a. over the past 20 years and dividends per share by 10.4% over the same time period. Today one can buy this high quality business on just 14x what we believe the business will earn over the next year, which we believe provides an attractive riskreward payoff.

Portfolio managers
Gavin Joubert, Mark Butler and Suhail Suleman

Global equity markets suffered a difficult second quarter and emerging markets were no exception to this. From mid-April to late May the MSCI Emerging Markets Index fell close to 20%, breaking a year long trend of very good returns for investors. Given the high levels of volatility in global markets today, we have been relatively active in the fund over the past few months as individual shares move closer to, or further away from, our fair value in a short time period.

There were several noticeable moves in our Chinese holdings, most of them sales. We sold out of China Mobile as it held up quite well when the market was falling, decreasing its relative attractiveness as other stocks became cheaper. We also sold out of Ajisen, a ramen noodle restaurant chain as it reached our fair value. On the buy side we added to our small remaining position in Ports Design, a high end fashion retailer, as it had fallen by one third from the levels at which we had previously sold. We also started to accumulate a position in BaWang International. BaWang is a Chinese Household Personal Care (HPC) company currently specialising in herbal shampoos and related products. Chinese shampoo consumption is a fraction of that in other countries. For example, the average Chinese consumer uses 300ml of hair care products per year, whereas the equivalent in the US and Western Europe is 5 to 8 times this volume. Elsewhere in East Asia (Japan and South Korea in particular) the figures are also at least five times that of Chinese consumption. This large gap in consumption may not be eliminated over time, but higher year-on-year growth in Chinese consumption will see it narrow substantially. With 1.3 billion people, this is an enormous market opportunity for HPC firms. BaWang is the market leader in herbal shampoos which represent almost one fifth of the total hair care market, a share that has been rising slowly over time. These are powerful drivers for growth in BaWang's earnings. Whilst the stock may appear expensive on a one-year timeframe, over the course of our five-year forecast period BaWang offers great upside.

We increased our exposure to Korea by adding the three tigers - Hyundai Motor, Samsung Electronics and LG Electronics. These are all world class companies with operations throughout the world and increasing exposure to the fastest growing regions in emerging markets that require cars, household appliances and electronics for a growing consumer and urban middle class. From being low cost upstarts looking to take market share from the established Japanese, these three firms have moved to become high quality manufacturers with strong brands and stable margins in an otherwise cut throat industry. All three trade on single digit ratings on earnings that are not high in our view. We also purchased the preference shares which trade at large discounts to the ordinary shares, ranging from 30% in the case of Samsung to as high as 60% in the case of LG Electronics, which is at the high end of their 10-year historical ranges.

Moving west to Europe, we sold out our holdings in BAT and Unilever as they held up relatively well and we were finding better value elsewhere. One such example is Central European Distribution Company (CEDC), the leading vodka producer in Poland and one of the top five producers in Russia. We believe the opportunity in Russia in particular is significant as illegal sales still account for the largest part of the market. Aside from share gains from the illegal market, the legal market is still fragmented and the large players including CEDC should continue to take market share. This has a multiplying effect on profits as both revenue and margins increase simultaneously. There are undoubtedly risks facing CEDC including relatively high debt levels and of course country (Russia) risk, but with the stock trading on a single digit free cash flow multiple at the time of the fund's purchase we believe one was being more than compensated for this risk.

In the Americas we reintroduced two Brazilian stocks, Petrobras and Itau Unibanco. We had previously sold out of both as they had reached our estimate of fair value. In the past few months however, both had experienced sharp share price declines which made them attractive once again. Petrobras is one of the few major oil companies with a growing production profile. The share trades on less than 9x this year's earnings. The fund owns the preference share which trades at a 12% discount to this, or effectively closer to 8x this year's earnings. We believe that this is very attractive given its existing growth profile and the optionality inherent in the new, but as yet unquantified, resources. Itau Unibanco is the largest bank in Brazil. We believe that the outlook for banks in Brazil is very favourable given low banking and financial services penetration and a strongly growing economy with rising disposable incomes. We believe Itau Unibanco can grow its earnings at around 20% p.a. over the next 5 years, making it very attractive on 10x next year's earnings.

Earlier in the year we were generally sellers of equities given the significant share price moves from the bottom and as a result the fund's equity exposure declined to the high 70% level. However, given the large declines in a number of emerging market stocks over the past few months, we once again are able to find a lot of value. As such we have increased the fund's equity exposure to the 90% level and look forward to achieving above average returns from current levels.

Portfolio managers
Gavin Joubert, Mark Butler and Suhail Suleman

Emerging markets had a slow start to 2010 (up 1% in ZAR) and the fund ended the first quarter flat. Over the past 1-year period the fund has appreciated by 41.1%, outperforming the MSCI Emerging Markets Index by 3% and since the fund was launched just over two years ago, it has outperformed the index by just under 7% annualised.

Whilst emerging markets are clearly not as cheap as they were a year ago, we are still able to find decent selected value within emerging markets and this is reflected in the fund's net equity exposure of around 85%. As risk appetite continues to be high the cyclical assets, in particular commodity companies, continue to appreciate. As a result, we have continued to reduce the fund's commodity exposure and sold totally out of the Brazilian steel company Usiminas, which the fund has held for the past two years. The fund's only remaining commodity exposure is to oil & gas companies (8% of fund, primarily held through the 4.5% position in Gazprom) where we are still able to find good value. While the cyclical assets continue to appreciate, many of the more defensive businesses continue to lag and as a result we added to our existing positions in the Brazilian private education businesses (Anhanguera and Kroton Educational) and the Chinese internet businesses (Sohu and Netease).

A number of the fund's long-held positions started to get closer to what we believe the businesses are worth and in this regard we reduced the fund's positions in Naspers, Femsa and Carlsberg. At the same time the fund made a handful of new purchases over the past few months, with the three most significant being positions in Qualcomm, China Resources Enterprise and Bank of Baroda.

Qualcomm are a US listed and headquartered business, but generate a large part of their revenue (over 60%) from emerging markets, in particular China and Korea. Qualcomm have two parts to their business - making and selling chipsets for mobile phones and licensing software for 3G mobile phones. The company is the leader in the supply of technology to the mobile phone industry and counts most of the global handset producers amongst their customers. In effect, Qualcomm have made it their business to perform the R&D function for the handset manufacturers - over the past 10 years R&D as a percentage of sales has increased from being less than 10% of sales to over 20% of sales. As the 3G and smartphone market continue to grow around the world, Qualcomm benefits as it is their technology that is used in these mobile phones. Extremely short-term focused market participants gave us the opportunity to buy Qualcomm at a very attractive price as the share was sold down after announcing quarterly results that were behind market expectations. Yes, quarterly results. Qualcomm has almost $20 billion ($12 a share) of net cash on the balance sheet and at our average purchase price of around $38 we bought the company on around 11x this year's earnings excluding the net cash position, which we believe is a very attractive price for a company of such quality.

China Resources Enterprise (CRE) is a Chinese conglomerate with interest in beer, food retail, food manufacturing and property. The two most important parts to the business are the beer and food retail interests - these two assets make up 70% of our total valuation for CRE. The beer business is a joint venture with SABMiller (51% owned by CRE) and is the maker of the Snow brand, which is the best selling beer in the world by volume. We believe the 10year prospects for this business are exceptional due to a) low current per capita beer consumption in China b) low current beer pricing (beer being cheaper than milk) c) a currently fragmented market and hence the opportunity for CR Snow to take significant market share. As a result of these positive drivers, we believe that the beer business can compound earnings at around 20% over the next several years. We also believe that the food retail business can grow its earnings at a high rate over the next several years due to continued store roll-out and margin expansion due to economies of scale. As a result, whilst CRE may not look particularly cheap on near-term earnings multiples, we believe the share is very attractive due to the high quality of assets that the company owns and due to the high rate that the company can compound earnings and free cash flow at over the next several years.

Bank of Baroda are a State owned Indian bank. Banking penetration in India is generally very low and against the backdrop of strong GDP growth and rising disposable incomes in India, we believe that bank of Baroda can grow their earnings and NAV at close to 20% over the next 5 years. This growth will be driven by both loan growth and growth in fees and commissions. To illustrate the size of the potential opportunity, one just has to consider that only two out of every 1 000 Indians have a credit card. This compares for example to 100 out of 1 000 South Africans, 130 out of every 1000 Chinese and every American having 4 credit cards! Fee and commission income as a percentage of average assets for Bank of Baroda is currently around 0.5% compared to the 2% level of emerging market banking peers in Brazil, South Africa and Russia. Bank of Baroda already generates ROE's of just under 20% and we expect that ROE's will increase over the next few years to around the 23% level. At the time of purchase Bank of Baroda was trading on around 6.5x our estimate of this year's earnings and a price/book value of 1.3, which we believe is very attractive and provides a good example of how good value can still be found within the global emerging markets universe.

Portfolio managers
Gavin Joubert, Mark Butler and Suhail Suleman Client

Equities in emerging markets continued to outperform during the fourth quarter and the fund had a good year, generating a rand return of 38.9%. Whilst we are still able to find selected good value in emerging markets, we are obviously finding less value today than we were in early 2009. As a result we have reduced the fund's equity exposure somewhat to around 80%, after it being as high as 94% in early 2009. This reduction in equity exposure came partly through reducing or selling out of some of the fund's holdings and partly through selling Hang Seng China index futures as an effective hedge. We remind investors that the fund has full flexibility to go to as much as 100% cash and we will use that flexibility should valuations in emerging markets warrant it. However, given current valuations and the individual undervalued stocks we are still finding, we remain comfortable with the fund's equity exposure being in the 75% - 80% range.

The first significant news of the quarter related to the global consolidation of the brewing sector (17.5% of the fund is invested in brewing/bottlers) when Mexican brewer Femsa announced that it was in talks with several parties regarding their beer business. The two main bidders were SABMiller and Heineken, with the latter emerging as the winner at the time of writing. The Mexican beer market is one of the largest beer markets in the world and is also one of the few markets not controlled by one of the major brewers. It is a duopoly between Femsa and Modelo (42% and 58% market share respectively) and this transaction will put pressure on Modelo, who are in arbitration proceedings to sever the link with their shareholder with the largest economic interest in Modelo, ABI (Anheuser-Busch Inbev) but who do not control the board. We believe that Femsa's beer assets have been poorly managed and offer significant opportunity to the buyer. The fund holds both Femsa and Heineken, although we reduced the Femsa position over the past few months as the share moved closer to our fair value.

Remaining in Latin America we did not participate in Brazil's largest IPO offering for Banco Santander Brazil - which raised US$7 billion - as it was too expensive in our view with the market capitalisation of the Brazilian subsidiary representing 42% of the whole of the Santander Group. The offering renewed interest in Latin American banks and we sold out of holdings in both the Brazilian Bank Itau Unibanco and Bancolombia on valuation grounds. At the same time we invested in a regional state-owned bank in Brazil, Banrisul, as well another Brazilian financial services company, Cielo (formerly Visanet). Banrisul, based in the state of Rio Grande do Sul, reported encouraging third quarter results with a return on equity of 15.2% and declining default rates with a high coverage ratio. Although we would consider the bank to be of lower quality than the large privately owned banks, the valuation (less than 1.5x historic BV) more than compensates for this in our view. Cielo is the largest card provider in Brazil with a 47% market share in an underpenetrated market. This is a very good business which benefits from long-term increases in consumption spend but without taking credit risk. It is the largest card provider in Brazil (debit, credit and private label) and its 47% market share means that it generates income with every second card transaction in Brazil. The company faces pressure from imminent deregulation, but in our view this is more than priced in with the stock trading on 11x earnings.

We also added Lukoil, a vertically integrated Russian oil producer with a world class portfolio of upstream and downstream assets. Lukoil produces 2.3% of the world's annual output, or 2 million barrels per day. All the upstream assets are in Russia with 62% in Western Siberia and 15% in Timan-Pechora. It has a 20% market share in the domestic refining market and also has a strategic partnership agreement with Conoco Philips which holds a 20% stake in the company. Lukoil is trading on a mid single digit P/E ratio which we believe is very attractive for the assets it holds, even considering the country risk that inevitably comes with Russian assets.

After moving sideways for the past year, SK Telecom was reintroduced to the portfolio. SK Telecom was Korea's first mobile phone operator, starting operations in 1996. It benefits from its first mover advantage and is still the dominant player with 50.5% market share in a country with a 95% penetration rate. Whilst the market is saturated, we believe that prospects for data usage (and resultant ARPU uplift) are significant, and the Koreans are amongst the most developed in terms of internet usage. The company recently disposed of its stake in the Chinese mobile phone company, China Unicom and acquired a 49% stake in Hana credit card as it looks to expand its wireless payment business. The company is trading on a 13% free cash flow yield and a dividend yield of 5.4%.

We sold our position in Thailand's CP All due to valuation. The company has the master franchise for 7-Eleven convenience stores. The business has a phenomenal network with more than 5 000 stores - five times more than its nearest competitor and it is adding an additional 450 stores per annum. It is just that the valuation is no longer attractive. At the same time, we introduced a holding in the supermarket group Big C, who operate 67 stores in Thailand. Typically they would operate a small mall and sublet to complementary service providers e.g. a bank, restaurant and a fashion boutique, making it a destination shopping experience. The company has a strong balance sheet and is trading on just 7x free cash flow. We also continued to add to the fund's holding in Egyptian Tobacco, a statecontrolled monopoly. It has the only authorised manufacturing facility for cigarettes in the country, with all the foreign brands being manufactured under licence. It is trading on a single digit multiple which is usually associated with companies' ex-growth but the company is expanding and investing in a new manufacturing facility and additionally, the demographics in Egypt are favourable: the country has a young growing population with less cultural disdain towards smoking.

We reduced positions in Telkom Indonesia, Chinese supermarket group Lianhua and Russian food retailer Magnit and sold out of computer manufacturer Acer. The strong performance of most emerging market stocks means we have to monitor and continually assess valuations diligently to ensure that we reduce/sell out of positions where the upside to fair value is small. We are continually looking for new ideas: members of the team visited Thailand and attended an Asian conference during the quarter and as this is written a team is on route to Beijing, Shanghai and Hong Kong.

Portfolio managers
Gavin Joubert, Mark Butler and Suhail Suleman