The fund returned -25.2% for the quarter versus the benchmark MSCI Emerging Markets Index total return of -17.8%. Longer-term returns remain marginally positive at 0.9% per annum since inception just under eight years ago (resulting in alpha of 2.0% p.a.). As the fund is constructed from the bottom up, based on our long-term valuations for the stocks in the portfolio, we believe long-term alpha over meaningful periods of five years or longer are more important in assessing our skill set and the rigidity of our investment process. Nevertheless, we recognise that the material underperformance in recent quarters, when combined with the poor absolute performance of emerging markets over the same period, has resulted in significant short-term losses for clients. For this reason we outline the source of these returns and why we believe there is still significant opportunity for long-term returns and alpha generation by the fund.

The fund's Brazilian holdings have been the biggest contributors to poor performance, chiefly driven by macroeconomic concerns that have seen stock prices in Brazil fall precipitously, with very few exceptions. With an average of 23% of fund invested in Brazil since the beginning of 2014 (compared to <10% in the benchmark for Brazil), the fund has been heavily impacted by events in the country. The combination of a deepening recession, high interest rates, a worsening fiscal balance and political gridlock has had an enormous impact on the Brazilian equity market and the selling has been almost indiscriminate. The domestic currency returns for many of our Brazilian stocks over the last year have in most cases been in the order of -50% or more. This was compounded by the fact that the Brazilian real has been amongst the worst performing major currencies in the world over the last 18 months - falling from R$2.20 per US dollar to a recent record low of R$4.15, a decline of over 80% for the period. Although many free floating emerging market currencies have been badly hit (such as the rand), the real has been singled out due to the factors specific to Brazil (mentioned above) as well as the significant decline in the price of commodities such as iron ore, of which Brazil is a major exporter. Currencies are notoriously difficult to call in the short term; however over the longer term economic fundamentals such as purchasing power and competitiveness tend to assert themselves. In this respect the Brazilian real is now materially undervalued in our view.

As touched on above, our view on stocks is driven by what we believe they will earn over the long term. This is because the value of a business is the sum of all future cash flows that will accrue to the investor. We are not suggesting that the fund's Brazilian holdings will not be impacted by the near-term economic deterioration, however in the case of many of these stocks the impact from the economic slowdown has been muted thanks to pro-active management. The table below shows the most recent financial results of our five largest Brazilian holdings and it is clear that the majority continue to perform very well operationally in spite of economic headwinds. It is possible that a prolonged downturn will impact them negatively in the short term, however in the long term we believe the bulk of our holdings are long-term winners in their respective industries and will emerge stronger than their competitors when the economy stabilises. Our fair values have adjusted downwards to reflect the impact of tough short-term business conditions, however in all cases the share price reactions have been far in excess of the decline in fair value. As a result, the average upside to our Brazilian holdings exceeds 100% and despite near-term earnings being below our assessment of normal (and therefore depressed in our view), the average one-year forward PE of the fund's Brazilian holdings is below 10x. The combination of depressed stock valuations and an undervalued currency makes Brazil the most attractive emerging market in our view, and we are confident that our stock picks will deliver material returns to the portfolio over the long term.

It is worth discussing the fund's holdings in Brazilian education: Kroton Educacional (the largest position in the fund), which is down close to 60% this year and also the biggest detractor to fund performance, as well as Estacio (a 3.2% position in the fund). We have previously highlighted the investment case for Brazilian education stocks in some detail, but it is worth revisiting the key points given the size of the position and its impact on the fund. Brazil is a country with a chronic shortage of skills and the government neither has the funds, nor the capacity, to offer university education to the bulk of the population. The financial returns to tertiary education in Brazil (in the form of higher career earnings) are the highest amongst the OECD, so there is a large incentive for young adults to study further. Since most young Brazilians are not in a position to fund their studies through savings or family support, the majority work during the day and study in the evenings. We have been invested in the sector without interruption since 2009 - first through Anhanguera and thereafter through Kroton, which acquired Anhanguera in 2014 to create the largest player with an estimated 13% market share. We have since added Estacio, the number two player with 6% market share.

The investment case for both companies has been premised on a combination of organic expansion - launching new university campuses and distance learning centres (technology-driven classes in smaller cities where the economics do not favour physical lecturers), together with acquisitions of weaker players in desirable locations. As these businesses grow, they will be able to expand margins through centralising their administration and spreading curriculum and content costs over a larger student base. The sector as a whole experienced very strong growth in student numbers in the decade up to 2014, driven partly by reasonable economic conditions in Brazil, but also thanks to significant incentives by the government on both the supply and demand side. On the supply side, the government has exempted education providers from taxes on undergraduate revenues in exchange for scholarships for underprivileged students. Since the tax rate in Brazil is 34%, and the marginal cost of taking on a student on a scholarship is minimal, for the universities this is quite a generous incentive. While there is risk of this changing, the main legislation behind the scheme has recently been extended by a decade, and given the very low enrolment rates amongst poorer Brazilians, we believe the government has a strong social obligation to continue to incentivise universities to take in poorer students. Education is a key tool for social mobility in one of the most unequal societies in the world.

On the demand side, the government has offered very cheap student financing ("FIES" programme) for students below a threshold income level who study courses that meet eligibility criteria. Given the very generous terms, these loans have proved very popular and were taken up strongly. Kroton in particular has seen enrolments boosted significantly in recent years by FIES students, as Kroton's pricing points and locations are more suited toward less well-off students and their courses exceed the quality threshold established by the ministry of education in order to qualify for FIES. As the fiscal situation in Brazil has worsened over the last year, the government has cut spending across the board and FIES has not been spared. The programme has in some respects been a victim of its own success and was costing the fiscus too much. The repayment terms and interest rates were also too generous to be sustainable over the long term. The government has reduced the number of available loans to just less than half of 2014 levels (a situation we expect to persist going forward), raised the cost of new loans and has forced the education companies to accept staggered payments for current obligations, which has materially impacted their cash flows. With a combined exposure of over 8% of fund, we have spent a significant amount of time analysing the impact of these changes on the long-term prospects of the education stocks including, but not limited to, intensive interaction with both Kroton and Estacio senior management in recent months. In our view, the stocks have sold off far in excess of the impact on their respective businesses as a result of the changes to student loans and the economic slowdown. Both remain committed to expansion and should deliver small incremental student growth in their existing campuses. Kroton in particular has been very proactive in cutting costs and has only just started realising the synergies they highlighted during their bid for Anhanguera. With a combined market share of less than 20%, and with fairly healthy balance sheets, these two players are also in a position to capture students from other marginal players that fail to survive in more recent tougher times. Kroton trades on 8x forward earnings and Estacio on 7x, which believe represent an incredible long-term investment opportunity.

To conclude, we take a look at a fund holding that has been in international headlines in recent weeks, and which has had a significant negative impact on performance in the completed quarter - Porsche, whose only asset (besides cash on hand) is a stake in Volkswagen (VW). In September, VW admitted to deceiving the United States' Environmental Protection Agency's tests with respect to emissions of certain gases from their diesel engines sold in that country. The true emissions were significantly higher than what tests showed, because the company made their vehicles behave differently during the test phase compared to on the road. This is a serious infraction with a maximum fine initially thought to amount to $18bn. In the immediate aftermath, VW's market value fell by a similar amount even though this was subsequently shown to be overstated (the revised maximum fine was estimated to be $7.4bn). The company thereafter announced a provision of €6.5bn and the share fell further on concerns of contagion of the issue to Europe, bringing the loss in market capitalisation since the announcement to as much as €30bn at one point. We believe the likelihood of fines, recall costs and customer compensation of this magnitude are fairly low, given historical precedent of similar matters and our discussion with experts in the automotive and regulatory environment.

However, it is not possible to know with certainty what the final cost to VW will be for this event, nor can we be certain that there are no other issues in the company that may subsequently come to light. We are, however, able to look at various scenarios of probable costs and assess how these impact the long-term investment case of VW (and hence Porsche). Prior to the revelations, VW was one of the most attractive stocks in our investment universe, based primarily on our belief of long-term margin expansion thanks to scale and the implementation of MQB (a platform for producing multiple vehicle types on a shared platform, reducing costs significantly for a multi-brand operator). In our view, while these events are material (and not forecastable given VW's previous reputation for excellence), they have impacted the fair value of the business by far less than the reaction of the share price thus far. Fines paid and costs incurred will be paid over many years and in most cases will be tax deductible, reducing the impact on the valuation of the business even further. VW has adequate cash resources and generates reasonable cash every year from its manufacturing arm, and thus we believe it is unlikely that an equity raise will be required. We therefore continue to hold VW - via Porsche - in significant size in our funds and have bought additional shares in Porsche to offset most of the decline in position size as a result of the fall in its share price.

Portfolio managers
Gavin Joubert and Suhail Suleman

The fund appreciated by 0.2% in the first half of the year, compared with the index return of +9.6%. The fund's poor relative performance was driven in large part by the Brazilian exposure and by not having any investments in the Hong Kong-listed financials (banks and insurers) which have done well this year. While the Brazilian equity market is up 6% YTD in reals, the currency has depreciated by 15%, which means that Brazilian equities are down 9% in USD so far this year. In terms of the fund's underlying Brazilian stocks, the education companies (Kroton -23%, all of which came through early in the year) and the retailers (-25% on average) detracted. Tata Motors (4.9% of fund) was also a large detractor, declining by 18% YTD. In terms of positive contributors, against all expectations Russia is the best performing emerging market so far this year (+17% in USD) and the fund benefited from this. The bulk of the fund's Russian exposure comprises food retailers, and in this regard Magnit (4.2% of fund) has appreciated by 23% in USD so far this year, while X5 Retail (3.0% of fund) rose by 37% in USD. Since the fund launched 7.5 years ago it has outperformed the MSCI Emerging Markets (EM) index by 2.7% per annum.

Not having any exposure to Chinese financials detracted from the fund's performance over the past year or so. Today, no less than five out of the twelve largest companies in the MSCI EM index are Chinese financials (three state-owned banks: Bank of China, China Construction Bank and ICBC and two insurers: the state-owned China Life Insurance and Ping An Insurance). These five stocks are up anywhere between 30% (the state-owned banks) and 80% (the insurers) over the past year and not owning them has been a big relative detractor. The Hong Kong-listed Chinese shares, dominated by financials, now comprise 25% of the MSCI EM index, and while the fund does have meaningful exposure to Chinese companies (17.3% of fund in total), this is largely through US-listed ADRs (American depositary receipts) - mainly internet companies - and Hong Kong-listed mid caps in out of favour sectors (automobiles and gaming) that have not benefited from the same drivers (most recently the Southbound link: the opening up of the Hong Kong market to Chinese mainlanders) which benefited the large cap financials.

Given the size of Chinese financials in the MSCI EM index (10%), together with the fact that the fund has zero exposure in this area, we believe it is worthwhile to briefly discuss our investment views with respect to these shares.
The Shanghai stock exchange rose in total value over the past year to the end of June from $2.5 trillion to $6 trillion - the sharp rise coinciding with media reports in the Chinese state-controlled press which encouraged investment in the equity market during August/September 2014 as well as the further opening up of the China A-share market to foreigners in November 2014; the so-called 'Northbound connect').

Driven by this explosion in volume, the Shanghai market appreciated by almost 20% in April 2015 alone, and the Hong Kong-listed H shares (driven by the large cap financials, which make up 40% of the H-shares index) by 17%. This frenzy was driven by an announcement in late March that, for the first time, Chinese mutual funds could invest in Hong Kong shares (this was over and above the opening up of the Hong Kong market to mainland retail investors in late 2014). The announcement clearly resulted in momentum buying not only from mainland retail investors, but also from investors all over the world, which pushed up the large cap Hong Kong-listed financials. Index buying naturally followed as these stocks became bigger in the index. The relevant points that we would make regarding the above are:

-The China A-share market is showing all the classic signs of a bubble in our view (massive volumes, record number of new brokerage account openings, extensive use of leverage, record number of IPOs, intraday moves of 5% - 10%).
-The median PE of China A-shares (Shanghai) is now 30x forward earnings. The median PE is the most relevant valuation metric in our view, as the weighted average forward PE (15x) is dominated by the lower quality, and hence lower PE, financials.
-The Chinese government (through the state-controlled media) was not only encouraging individuals to invest in China A-shares, but also for them to 'Buy Hong Kong'.
-As discussed above, what is happening in the China A-share market is not happening in isolation. Besides the Northbound and Southbound links between Shanghai and Hong Kong, the Hong Kong-listed Chinese insurers (state-owned China Life Insurance and Ping An, etc.) are very geared to the China A-share market and have benefited substantially from the doubling of the China A-share market over the past year. The insurers will naturally be negatively impacted by any reversal in China A-shares.
-Our concerns regarding the Chinese state banks remain. China has undergone a state-directed credit explosion over the past few years and as such we just don't know how big the bad debts in the system are (we do however know that reported bad debts continue to increase as the economy slows, and this is just the actual reported bad debts numbers). Being state run brings its own concerns: the bank is not entirely in control of how much, and to whom, it lends. The point is often made that the Chinese state-owned banks, on 6x earnings, are cheap. They may well be, but our conviction in the size of the bad debts, and hence the correct earnings number, is very low. As a result, we simply don't know whether they are trading on 6x earnings, 16x earnings, or higher still. For us it is the unknowns (the size of the bad debts in the system) rather than the knowns (that they trade on 6x current earnings) that are worrisome.

There is quite likely to be a time when the fund will own Chinese financials and indeed select China A-shares. By June, the Chinese market had already started reversing from its highs, a process that has accelerated into the start of the third quarter despite numerous attempts by their government to prop up the market. Despite being down by more than one third since peaking, given the above points, it is our view that the risk/reward is still not attractive in these areas right now. In terms of activity in the fund over the past few months there were no material changes to our core views or the large positions: we added marginally to the fund's Indian IT services exposure (through buying Infosys and Tata Consultancy, who have been relative laggards in the strong Indian equity markets) and sold out of the Chinese property portal, Soufun, as it appreciated sharply on takeout speculation. Brazil remains the single largest country exposure (26.8% of fund) and is by far the country in which we are finding the most compelling bottom-up investment opportunities. This is largely driven by the universal dislike for Brazil, which in our opinion has made valuations extremely attractive. The Brazilian education companies in particular are very compelling in our view (10% of fund is invested in the no.1 and no.2 companies, Kroton and Estacio). Due to reduced government loans to students (which has largely caused the sell-off), the education companies will not be able to grow at their 30%+ historic rates going forward, but the long-term fundamentals of the industry remain attractive, the companies have very good management teams, and in our view can still grow earnings at 15%+ over the next 5 years. Given this, we think that on 11-13x one-year forward earnings they are extremely attractively valued. The weighted average upside to the fund's Brazilian holdings as a whole is 80% today. In August, we are again heading to Brazil to meet with the fund's holdings. This will be our fourth visit to the country over the past several months.

The global premium car companies (Tata Motors, Porsche and Brilliance China) also remain big positions (13.2% of fund in total). These three companies, specifically Tata Motors (owner of Jaguar Land Rover (JLR)), have been weak on concerns about growth in China. In June we spent a few days meeting with a number of the car companies in China (both the holdings in the fund and a number of competitors) and also met with Tata Motors in India recently. While the shorter-term prospects are tougher for these companies in China, we believe the longer-term outlook for all three in China (and indeed globally for Tata/JLR and Porsche) remain very attractive. The three companies now trade on between 6.5x and 8x the next year of earnings, which we think is very compelling, and the upside to all three is now around the 100% mark. Other areas of material upside in the portfolio include selected Chinese internet companies (9% of fund), the Russian food retailers (7% of fund) and the Macau gaming companies (3% of fund). In late June, we spent two days in Macau, having 10 meetings with a combination of Macau gaming companies, the sub-licence hotel/casino operators and property developers. Our conclusion remains that while the short-term outlook is poor, the longterm prospects for Macau remain very attractive as it evolves into a more lifestyle-oriented mass market. Eighteen months ago, when the Macau stocks were loved, we had almost no exposure, but the halving of their share prices over the past year (as gaming revenues decline) has made them very attractive in our view.

The weighted average upside for the portfolio as a whole is now just over 70%, putting it well above the long-term average of 50% and reflecting the fact that we are able to find better than average opportunities in emerging markets today when compared with history, particularly in the more out of favour areas.

Portfolio managers
Gavin Joubert, Suhail Suleman, Pieter Hundersmarck and David Cook

The fund returned -2.03% in the first quarter of 2015, compared to the benchmark return of 2.28%. While part of this underperformance has been reversed in April, with the fund up 8.1% in the month so far compared to the index's return of 6.4% at the time of writing, it has undoubtedly been a tough few months for the fund. At the end of November 2014, the fund's year-to-date performance (January to November) was slightly ahead of the market, but after a poor four-month period (December to March), the fund fell behind. Short-term underperformance is always painful and we dislike it as much as anyone else. However, with a concentrated portfolio that typically looks completely different to the index, and that is invested with a valuation-driven, long-term horizon (and hence that often owns a number of out-of-favour stocks in what is a short-term focused market), it is inevitable that there will be periods of short-term underperformance. In its almost seven-year history, the fund has been through similar short-term underperformance periods before, and the same is true of Coronation's 21-year history in managing South African equities. The unfortunate reality is that often it is necessary to go through periods of short-term underperformance in order to achieve long-term outperformance, and in our view this is one of those periods.

In analysing the recent underperformance, currency moves (in particular those of the Brazilian real and the Russian rouble) as opposed to individual stock moves, have been by far the biggest negative contributors. Over the one-year period to 31 March, the Brazilian real depreciated by 45% against the USD while the Russian rouble depreciated by 60%. With 25% of the fund, on average, invested in Brazil over this period, the Brazilian real took 11% off performance, while the Russian rouble took 8% off performance as 13% of the fund, on average, was invested in Russia over the same period. The underlying operational performance of most of the fund's Brazilian and Russian holdings generally continues to be strong, as do their share prices in local currency terms. For example, Magnit (#1 food retailer in Russia and a top 10 holding in the fund), driven by excellent results, has appreciated by 49% in roubles over the past year, yet is down 9% in USD over this same period. Similarly, BB Seguridade (#1 insurer in Brazil and also a top 10 holding), again driven by very good results, has appreciated by 34% in reals over the past year, but is down 7% in USD over this same period. In fact, over the past one-year period, 14 of the fund's current top 20 holdings have appreciated in value in constant currency (and many substantially so), and only 6 of the 20 have declined in constant currency.

While Russia was the biggest detractor at the end of 2014, this year it has been Brazil, in particular its currency. Again, we would argue that these are abnormal times for Brazil. The Brazilian economy has been struggling for some time: this is not new. What is new, and which has emerged over the past few months, is the extent of the Petrobras corruption scandal (the fund does not own any Petrobras shares), the re-election of Dilma Rousseff (who did a very poor job of managing the economy in her first term) and concerns about whether political infighting between the ruling party and its coalition partners will prevent government's proposed revenue raising and cost cutting measures being implemented.

So where does all of this leave us now, particularly with regards to the fund's Brazilian exposure (29% of the portfolio) as this has become far more important than the fund's Russian exposure (now 12.30% of fund). We would make the following points on Brazil:

-While currency, political and macro factors are all important, in our view these three areas are very difficult to predict and even more difficult to make money from over the longer-term. For example, the Brazilian ruling party and its collation partners have just recently signed an agreement to commit to the austerity measures: one would not have guessed this was possible a mere few weeks ago.

-Our focus remains first and foremost on individual stocks and their long-term (5 years+) prospects. We have been to Brazil no less than three times over the past four months to meet with the management teams of the fund's portfolio holdings and we continue to assess each and every portfolio holding on an ongoing basis.
-Brazil has some great companies (many of which are owned by the fund) and amongst the best management teams we have come across in emerging markets. Corporate governance in Brazil is also among the best in emerging markets in our view.
-The main reason why good companies become attractively valued in our opinion is because of time horizon. Most investors take a short-term view and do not like investing in companies that have short-term challenges. Brazil and most Brazilian companies are as such almost universally disliked right now. As a result, their valuations are very attractive. The Brazilian economy undoubtedly faces tough times over the next year or two, but the fact is that the intrinsic value of any company is the present value of all future cash flows, not just the next year of earnings.
-The weighted average upside to the fund's Brazilian holdings is around 80%. With this sort of upside, we are being more than compensated for the risks in Brazil in our view.
-Most of the fund's Brazilian holdings continue to produce very good operational results. Things will undoubtedly be tough for them over the next year or two, but these businesses are all very well managed and should perform well in difficult times in our view. In some cases there are structural drivers that will assist their performance, while in other cases there are self-help opportunities. Bearing in mind that the economic environment has been tough in Brazil for some time, the most recent results from the fund's six largest Brazilian holdings is insightful in this regard.

The Brazilian education industry is the one sector that has been impacted by specific events. In September last year, the fund had only 4% invested in the Brazilian education industry (all in Kroton) but since then the shares have lost 35% of their value and we have added to the Kroton position (now 6% of fund). We also initiated a new position in Estacio (3% position), resulting in 9% of the fund now being invested in the Brazilian education companies. The secular drivers for the industry as a whole are amongst the best of any sector in any emerging market in our view. Brazil has amongst the lowest penetration rates for tertiary education in both Latin America and the world. As a result, there is a huge skills shortage in Brazil, providing a very strong incentive for people to further their education after high school as their lifetime earning power is multiples higher than without tertiary education (in fact, Brazil has the second highest multiplier effect among all OECD and partner countries). The state universities can only cater for between 20% and 25% of annual school graduates, leaving the private sector to educate the rest. Realising their shortcomings in tertiary education and preferring to rather concentrate on improving the quality of school education, the Brazilian government (who have consistently stated that education is their number 1 priority) have provided significant support for the private sector during the last decade in the hope of reaching their goal of doubling university enrolment by 2020. This support initially took the form of tax relief on undergraduate fees, provided institutions award a certain proportion of places to underprivileged students on full scholarships, an arrangement that has since been extended into the next decade. In recent years, to spur student growth even further, the government started providing loans to prospective students on fairly generous terms - low interest rates, a repayment holiday after graduation, and several years over which to amortise repayment.

In late December and into January, spurred on by a tough fiscal position, the government announced a raft of measures aimed at reducing disbursement of new student loans (FIES) as well as proposals that would weaken the working capital positions of the education companies (this has since been substantially watered down). In the weeks that followed, the share prices of the listed university education stocks fell significantly. The companies have been in dialogue with the government since the announcement on an ongoing basis and, of course, this brings uncertainty. Given that a significant proportion of student growth has come through the FIES programme in recent years, this does have an impact on what the businesses are worth; however, the share price declines have been far in excess of the reduction in our fair values, making the shares more attractive than they were before. The key points we would make with regards to our investment case for the Brazilian education companies are: -

-FIES makes up only around 35% of Kroton's and Estacio's revenue and this will undoubtedly be a smaller part of revenue going forward as government reduces the size of the FIES programme.
-Even assuming FIES revenue was to go to zero, the remaining 65% of revenue remain unaffected. We also believe a scenario where 35% of revenue is reduced to zero is extremely unlikely, given the following mitigating factors: the government needs the private education companies; students will find alternative funding; the education companies are already putting funding schemes in place; and simply, but importantly, FIES students are voters.
-The very attractive long-term drivers of the industry described earlier remain in place.
-The private education sector is still very fragmented (#1 Kroton has 13% market share and #2 Estacio has only 5% market share), offering opportunities for consolidation. Furthermore, in a tougher environment with reduced government funding, the strong businesses (Kroton and Estacio) will in our view only become stronger.
-Both businesses are extremely well managed (the Kroton CEO in particular is one of the most impressive CEOs we have come across in emerging markets) and have various other avenues available to grow their businesses.
-Valuation: both Kroton and Estacio trade on around 11x forward earnings, which is very attractive in our view given the still compelling long-term prospects for these businesses.

Having 29% of the fund invested in Brazil may seem uncomfortable right now, but we believe the return potential is significant and the current low valuations mean the downside is limited in our view. In contrast, the universally loved Indian market, the high-quality growth companies in a number of emerging market countries with seemingly 'bulletproof' earnings and Chinese Hong Kong-listed 'Southbound' beneficiaries continue to reach new highs, driven by a combination of momentum and fear (taper tantrum, etc.). In fact, a basket of 20 high-quality emerging market companies (in India, but also in South Africa, Mexico, Philippines, Thailand, etc.) that we compiled trades on 31x forward earnings (a simple average: some ratings are far higher than this), and this basket now trades at a 43% premium to its 10-year historic average P/E (again a simple average: many trade at 50-70% premiums to 10-year historic P/E levels). In our view, it makes sense to rather have a large part of the fund invested in Brazil right now (on 7-12x forward earnings in most cases) than in this basket of high-quality, but overvalued, businesses.

Portfolio managers
Gavin Joubert and Suhail Suleman

It was a disappointing year for emerging markets and even more so for the fund. The MSCI Emerging Markets index declined by 1.8% in 2014 (but was +8.6% in ZAR due to the depreciation of the rand) and the fund was flat in ZAR. Most of the year's underperformance was realised in December. The fund was particularly impacted by its Russian holdings (13.5% of fund) as the collapse in the oil price and rouble triggered a sharp decline in most Russian stocks. Whilst we are always disappointed with poor relative performance, we do consistently make the point (in both good times and bad) that one year is a very short timeframe. To draw meaningful conclusions, we believe looking at returns over longer periods is more appropriate. In this regard, the fund has returned 10.9% per annum since inception seven years ago in December 2007, representing annualised outperformance (alpha) of 4.3% over the benchmark. The alpha over the last three years, four years and five years amounted to 4.6% p.a., 4.4% p.a. and 2.6% p.a. respectively.

Following the Ukraine crisis, the oil price slump was the second major negative development to impact Russia over recent months. The oil price more than halved over the past six months, from $110 to $50 a barrel. Russia is heavily reliant on income from the commodity and as the oil price decline accelerated in December, the rouble started to fall sharply. At one point during the panic selling, the currency reached a level of 80 to the US dollar, from around 40 at the end of September. It has since recovered somewhat to slightly above 60 roubles to the dollar. Whilst our approach to investing is very much bottom-up stock selection, we do have broad views on the major emerging market currencies (purchasing power parity valuations) as this can obviously have a large impact on returns from individual emerging market stocks. In our view, fair value for the rouble is closer to 45 than 60. In addition, we believe the oil price is undervalued at $50 a barrel. Based on longterm fundamentals (primarily the marginal cost of production), our view is that the normalised oil price is around $75, well above the current levels. Over recent years, the oil price has become increasingly volatile, due in large part to increased financial speculation in oil futures. These days, non-commercial participants (hedge funds, investment banks, money managers etc.) make up approximately half of the oil futures market. Financial speculation pushed oil from $50 to almost $150 in 2007/2008, and in our view financial speculation is now driving the oil price slump. We have no idea what the oil price will do over the next year and it may well decline further to $40, or even lower. What we do know is that an oil price of $50 is not sustainable and is way below its long-term fundamental value. The fund doesn't actually hold any oil stocks, but the oil price (and its fair value) is of course important to the rouble and hence the fund's Russian holdings.

Whilst we hold the view that both the oil price and the rouble are undervalued (which gives us one level of comfort in terms of the fund's Russian holdings), ultimately we spend the lion's share of our time on assessing individual businesses. We continue to re-evaluate, on an ongoing basis, all of the long-term earnings streams of the Russian stocks held in the fund. Food retailers represent more than 9% of the fund's 13.5% exposure to the Russian market. These businesses are generally defensive and are benefiting as formal retailers continue to take market share from informal players as part of a structural shift. Our long-term earnings expectations - and hence fair values - of Magnit and X5 have not changed materially over the past few months, yet their share prices are down 30% to 40%. This makes these shares more, not less, attractive to us. A company like Sberbank (2% of fund), being a bank, will undoubtedly be more negatively impacted by events over the past few months and a further economic slowdown. Accordingly, we have substantially lowered our earnings forecasts. Sberbank's share price decline has, however, been extreme, with the result that even with reduced earnings expectations and a lower fair value, the bank still offers upside of 180% to fair value. On a risk-adjusted expected return basis, this makes Sberbank attractive enough to us to have a position of 2%. The weighted average upside to the fund's Russian holdings is now more than 100% and it is therefore one of the parts of the portfolio we are most excited about.

Brazil has been one of the worst-performing emerging markets over the past several months and as such has been a detractor for the fund. Brazil has a poor macroeconomic outlook with ongoing negative newsflow. Very few investors like investing in stocks against this backdrop and Brazil is undoubtedly one of the most disliked emerging markets. By way of contrast, India is almost universally loved. Its economic outlook is promising and the newsflow has been almost continually positive since Prime Minister Narendra Modi won the elections. In our view, expectations (and resultant valuations) in India are therefore generally high and unattractive, while expectations (and resultant valuations) in Brazil are generally low, and very attractive. Accordingly, 26% of the fund is invested in Brazil and only 4% in India (excluding the holding in Tata Motors, which in reality is a global business as Jaguar Land Rover represents more than 90% of its valuation). Our investment decisions are not based on the shorter-term macroeconomic outlook (which we would agree is poor for Brazil) or the short-term prospects for individual companies (which are also poor for a number of our Brazilian holdings), but rather on the long-term prospects and earnings streams of individual companies. In this regard we find compelling value in Brazil and very little value in India, even though we continue to look. We are doing two separate research trips to India in March, with different team members on each trip. In addition to meeting with the management of existing portfolio holdings, we will continue to reassess our existing views on the Indian stocks we cover but don't own, and look for new investment ideas. Again here we would agree with the consensual view that the prospects for India are looking up. However, in our view, the valuations of most stocks reflect this. We would love to own the high-quality Indian business like Hindustan Unilever (40x forward earnings), ITC (25x forward earnings) and Asia Paints (40x forward earnings), amongst others. But given these ratings, very high expectations are built into these shares.

Our positive view on the fund's Brazilian holdings was confirmed during a research trip to the country in early December. We met with the management teams of all our portfolio holdings and spent two days doing store visits at two of the fund's Brazilian clothing retail holdings (Hering and Marisa, together 6% of fund). Importantly, we met with a number of recent key management hires at both companies (the new CFO and the new purchasing manager at Marisa, and the head of the Hering chain at Hering) and were impressed with all of these individuals. Both companies are going through a tough period, but we believe they are doing the right things. It is likely to still take some time for these businesses to turn around, but the meetings confirmed our view that these are shorter-term issues that can be resolved and that both stocks are materially undervalued. The fund now has four Brazilian stocks amongst its 12 largest holdings: the country's leading private education business, Kroton, which now trades on 13x forward earnings with a 3% dividend yield; the biggest local life insurer, BB Seguridade, which trades on 15x forward earnings and with a dividend yield of just under 5%; Hering, one of the top five clothing retailers in Brazil, trading on 10x forward earnings with a 7% dividend yield; and the holding company of the leading private bank in Brazil, Itausa, which trades on 7.5x forward earnings and has a dividend yield of 5%. Given these valuation metrics for what are all very good businesses, we believe the fund's Brazilian holdings will be meaningful contributors to performance over time. The average upside to fair value for the stocks held (weighted by position size) is now approaching 75%. This is significantly above the historical average level of 50% for the fund. It is also close to the highest level (just under 90%) achieved since we first started tracking this measure just over four years ago. Partly due to this, we feel more optimistic about potential future returns for the fund than we have for a while.

Portfolio managers
Gavin Joubert and Suhail Suleman