ALPHAWEALTH PRIME SMALL & MID CAP FUND COMMENTARY MONTH OF NOVEMBER December 2018

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1 ALPHAWEALTH PRIME SMALL & MID CAP FUND COMMENTARY MONTH OF NOVEMBER December 2018 AlphaWealth (Pty) Ltd. Reg. No.: 2004/ An authorised financial services provider - FSP Licence No

2 12m Historical Yield on the Fund (%) ALPHAWEALTH PRIME SMALL & MID CAP FUND INVESTOR UPDATE NOVEMBER INTRODUCTION: CASH-LIKE YIELD & FREE GEARED-BETA OPTIONALITY The AlphaWealth Prime Small & Mid Cap (AWSM) Fund was positive for the month (+1.2%) while our benchmark and, indeed, the broader All Share Index were negative (-1.4% and -3.3% respectively). The world is noisy these days so we are going to summarize: this month was more of the same globally and locally. Markets remain turbulent and politically-tuned with event-driven macro volatility at an extreme. On the upside, domestically, many positive steps are being (slowly) taken and we remain optimistic in a domestic recovery going into 2019 and, particularly, from 2020 onwards. Likewise, over the weekend, China and the USA agreed to a ceasefire on trade wars and markets are starting to rally this morning In this context, we think it is beneficial in pointing out how cheap the AWSM Fund has gotten. The AWSM Fund s distribution yield (12m-lagging, not Forward; the latter should be higher!) is currently near to cash-yielding levels. Hence, an investor is being paid to wait while getting a free option on our portfolio s growth potential and long-term upside. In a way, as small caps are more sensitive to beta than large caps, this is effectively a geared-beta option on one of the cheapest markets in the world. Figure 1: AlphaWealth Prime Small & Mid Cap Fund Distribution Yield Versus Peer Group & Other Lagging Valuation Metrics AWSM Fund's Yield per Unit & Peers (%) AWSM Fund's Valuation Characteristics (x) 6.0% 5.0% 4.0% 5.1% 4.1% 3.7% % % 1.6% % 1.3% % 0.0% Small & Mid Cap Fund Uninverse Price Earnings (x) Forward Price Earnings (x) Price-to-Book Ratio (x) 1.1 Sources: FundsData provided by Profile, Bloomberg (30/11/2018) While it is scary that our market has arrived at this depth of cheapness, it also offers an intriguing investment option in and of itself (for potential investors and existing ones that may want to add to their investment). We ve touched on the quality in the portfolio many times and on the value inherent in many of our investments, but we have rarely noted quite how cheap the actual AWSM Fund really is. I hope the above graphs simply and intuitively demonstrates the AWSM Fund s cheapness.

3 ALPHAWEALTH PRIME SMALL & MID CAP FUND INVESTOR UPDATE NOVEMBER STRADDLING A PARADOX: CONCENTRATED & DIVERSIFIED Just because a company is listed, does not mean that its shares are worth owning. In fact, often the contrary, as the best businesses tend not to share their profits with outsiders and, thus, remain private. Cynicism aside, in a concentrated portfolio, we spend most of our time deciding not to invest in companies. The reality is that with a target of 15 to 20 individual investments and around 400 listed companies to choose from, 9 ~ 90% of these companies we think are either not worth owning at all or not worth owning at their current prices. What that also means is that when we find an investment that we do think fits the AWSM Fund, we want to own a large amount of it. That way we capture the maximum amount of asset-specific upside (i.e. alpha) in the portfolio without diluting high-conviction investments with marginal-conviction or, worse, benchmark-hugging investments. Naturally, having a concentrated portfolio makes our individual investment decisions key and the portfolio riskier than a widely-held (albeit, low-alpha) portfolios. How do we control for or partially mitigate this concentration risk? Simple: we aim for (sufficient) diversification. Phrased differently, we are obsessive at avoiding duplication in the portfolio. As a small and mid cap fund, AWSM Fund will always have overweight exposure to small and mid caps. While we strongly believe in the long-term attractiveness of the small and mid cap equity class, this factor has been a major negative determinant in the last couple of years (i.e. small caps have been out of fashion). That said, in the long-term, we still believe that this factor will turn (strongly) to our benefit and see positive potential beta in this part of the market over the next couple of years. Beyond our small and mid cap exposure, though, we carefully constructed (sufficient) diversification in the portfolio across: Industries Figure 2, Geographies Figure 3, Currency exposures Figure 4, & Sometimes (only where and when it makes sense), we hold exotics, like, making use of preference shares See July Investor Letter here. Figure 2: AWSM Fund s Industry Exposure Not Dominated By Any Single Industry Preference Shares Chemicals 4% Technology 11% Cash Consumer Services 13% Financials 17% Healthcare 7% Real Estate 10% Industrials 16% Basic Materials 12% Sources: AlphaWealth workings & assumptions, Iress, Bloomberg and Various Company Reports

4 Annual Volatility (%) ALPHAWEALTH PRIME SMALL & MID CAP FUND INVESTOR UPDATE NOVEMBER Figure 3: AWSM Fund s Geographic Exposure Over 1/3 rd Exposure Outside of South Africa South America 4% North America 7% UK Australia 1% Asia 2% Europe 12% Rest of Africa South Africa 64% Sources: AlphaWealth workings & assumptions, Iress, Bloomberg and Various Company Reports Figure 4: AWSM Fund s Currency Exposure Good Balance Between Weak, Strong & Neutral ZAR Exposure Rand Hedge 3 Includes foreign operations & exporters. Includes domestic operations (currency neutral) & importers (strong ZAR). Local Operations 6 Sources: AlphaWealth workings & assumptions, Iress, Bloomberg and Various Company Reports A benefit of this diversification is that the AWSM Fund has amongst the lowest volatilities relative to its peers (Figure 5). This relatively low volatility is despite the AWSM Fund having the most concentrated portfolio (by far!). Figure 5: AWSM Fund s Volatility Relative to Peer Group Competitor A Competitor B AlphaWealth Prime Small & Mid Cap Competitor C Competitor D Competitor E Competitor F Competitor G Small & Mid Cap Fund Uninverse* Sources: Profile Media, & AlphaWealth workings; * Competitor Funds without sufficiently long track records excluded from this calculation.

5 ALPHAWEALTH PRIME SMALL & MID CAP FUND INVESTOR UPDATE NOVEMBER Our primary aim remains to pick high-quality, fast-growing and undervalued small and mid cap stocks. Nothing has changed and we would never select an investment only because it offered us diversification. To the contrary, each individual investment has to stand on its own merits. That said, we might reject an investment because it brings duplication risk in terms of our portfolio s exposure. In closing, diversification is a key tool for us to manage risk and, despite having a concentrated portfolio, we hope that we have demonstrated that AWSM Fund also has a diversified portfolio. In the long-term, this should be a reasonable aid in protecting us against the vulgarities of the so-called unknown unknowns. IN CLOSING: QUALITY, GROWTH, VALUE & CONCENTRATION Finally, the usual reminder that our investment approach in the AWSM Fund is: Quality: Above all else, we try to find good-quality, fast-growing, listed small cap businesses. Value: We invest in the cheapest of these, though limit our investments to different industries and/or geographies to maximize diversification (as noted and demonstrated in the earlier section). Concentration: Finally, we limit the number of stocks we hold to only the very best fifteen to twenty positions. Being both fund manager and co-investor in the AWSM Fund, I remain confident in our investment methodology, our execution of this methodology and AWSM Fund s prospects. As always, the rest is just time, patience & compounding. Kind regards Keith McLachlan CA (SA) Fund Manager AlphaWealth Prime Small & Mid Cap Fund

6 ALPHAWEALTH PRIME SMALL & MID CAP FUND INVESTOR UPDATE NOVEMBER Disclaimer: Collective Investment Schemes in Securities are generally medium to long-term investments. Different classes of units apply to these portfolios and are subject to different fees and charges. A schedule of fees and charges and maximum commissions is available on request from the Company. Commission and incentives may be paid and if so, would be included in the overall costs. The price of a participatory interest is a marked-to-market value. Forward pricing is used. The purpose of the money market yield is to indicate to investors a compounded annual return for all money market portfolios on a comparable basis. The yield calculation is not used for income distribution purposes. A forward-looking yield is used. This means that the last seven days yield (less the service charges, including VAT) is taken and is annualised for the next 12 month period, assuming the income returns are reinvested. Yields for money market funds are published daily. The value of participatory interests may go down as well as up. Past performance is not necessarily an indication of future performance. Performance numbers and graphs are sourced from Global Independent Administrators (Pty) Ltd are calculated on a NAV to NAV basis and do not take initial fees into account. The Company does not provide any guarantee either with respect to the capital or the return of the portfolios. Income is re-invested on the reinvestment date. Actual investment performance will differ based on the initial fees applicable, the actual investment date and the date of reinvestment of income. Dealing prices are calculated on a net asset value and auditor s fees, bank charges and trustee fees are levied against the portfolios. The total return to the investor is made up of interest received and any gain or loss made on any particular instrument. This will have the effect of increasing or decreasing the daily yield but in case of abnormal losses it can have the effect of reducing the capital value of the portfolio. Excessive withdrawals from the portfolio may place the portfolio under liquidity pressures where a process of ring-fencing of withdrawal instructions and managed pay-outs over time may be followed. CIS are traded at ruling prices and can engage in borrowing and scrip lending. The manager may borrow up to 10% of the market value of the portfolio to bridge insufficient liquidity. Prime Collective Investment Schemes Management Company (RF) (Pty) Ltd is a registered Collective Investment Scheme Manager in terms of Section 5 of the Collective Investment Schemes Control Act and is a wholly owned subsidiary of Prime Financial Services (Pty) Ltd, a member of ASISA