Page 01

CONTENTS

■ Market review ■ Portfolio performance review ■ Portfolio positioning & strategy

■ Investment rationale piece - UK Retail Property by Bjorn Samuels - Argon Equities Analyst

MARKET REVIEW

Geopolitical risks continue to weigh on growth and market performanceWe started the second half of 2019 with the much-anticipated G20 meeting between the US and China finally behind us. Although the meeting didn’t bring any clarity on the progress achieved, the anticipated escalation of tensions seemed to have been avoided. There wasn’t a detailed comprehensive deal – the US administration deferred additional tariffs of 25% on the remaining $300 billion worth of imports from China, and China committed to purchasing more US goods, providing much relief.

This was however short-lived, as tension again escalated during the quarter, stimulating fears about global growth. Global growth is already on a downward trajectory, with global GDP down from 4% in the first quarter to 3% in the second quarter. Geopolitical risks swathed headlines, from rising tensions in Hong Kong to a growing possibility of a hard Brexit, to name a few. The prevalence of uncertainty on policy – an enemy of growth – further dented confidence globally. Global trade and PMI data continued to worsen. The MSCI All Country World Index was flat for the quarter at 0.1%, with the S&P 500 delivering marginally better returns of 0.92%. The biggest drag came from the MSCI Emerging Markets Index, which was down5.1%, despite the MSCI Turkey being the best performer globally, returning 11.6%. MSCI South Africa delivered the third-worst performance, after Poland and Argentina, declining by 13.2% (all in US dollar terms).

Page 01Page 02Page 03

Page 04

Mpandekazi Maneli, CA (SA)Portfolio ManagerB Com Accounting, UCTB Com Honours (Accounting), University of Natal

Page 02

Locally, economic reforms need to be implementedFollowing a smooth local election, we started the third quarter with much anticipation of an announcement of structural reform development from government to help spur growth and lift business confidence. Evidence that growth is more of a structural rather than cyclical challenge mounted, with the unemployment rate rising to 29% – the highest level in 11 years – as mining and finance shed jobs. The 0.25% rate cut implemented by the SARB in July, together with generally higher commodity prices (which boosted our small, open, commodity-driven market), provided some reprieve in the quarter.

September started with a welcome surprise – GDP for the second quarter came out at 3.1%, beating consensus. However, these positive developments were marred by xenophobic violence and looting in Gauteng. Parts of the economic hub were brought to a standstill, heightening tensions between South Africa and its trading partners in the rest of Africa. Concerns over more structural deficiencies of a widening budget deficit and state-owned companies’ (SOCs) finances persisted, as political uncertainty continued to weigh on business confidence, with investment apathy evident in both the private and public sectors. Central bank data showed that the economy is wedged in its longest downward cycle since 1945. The FTSE/JSE All Share Index (ALSI) declined by 4.57% for the quarter, driven by financials (down 6.76%) and resources (down 6.4%). Within resources, the return was commodity-specific, with platinum and gold bucking the trend and delivering 25.8% and 12.3% respectively, while coal detracted 24.1%. This is thanks to gold’s safe-haven status amidst global trade concerns and persistent shortfalls in the supply of palladium, as the commodity continues to benefit from tighter vehicle emission standards globally.

PORTFOLIO PERFORMANCE REVIEW

Argon SA equity fund

0.19%

-1.52%

-1.33%

1 year

2.64%

0.88%

3.51%

3 years

4.57%

0.90%

5.47%

5 years

9.17%

1.14%

10.31%

7 years

Portfolio

Benchmark (SWIX)

Excess

12%

10%

8%

6%

4%

2%

0%

-2%

10.57%

0.21%

10.79%

Inception

Chart 1: Argon SA equity fund

Performance numbers are gross of feesSource: Argon Asset Management

Despite the short-term challenges, our long-term track record of generating alpha remains intact Our portfolios didn’t manage to beat their respective benchmarks for the quarter and for the year ended 30 September 2019. However, the long-term performance of alpha generation has been sustained over a 3-, 5- and 7-year period, including since inception. We are pleased with our long-term track record, which demonstrates the resilience of our investment philosophy and process.

The quarter’s performance can largely be attributed to our overweight positions in Woolworths, Hammerson, Wilson Bayly Holmes-Ovcon Limited, and British American Tobacco, together with our underweight position in Shoprite. Among the retailers, our overweight position in Woolworths and underweight position in Shoprite added much to this quarter’s alpha, demonstrating our disciplined, bottom-up stock-picking philosophy and process that steers away from sector bets.

Wilson Bayly Holmes-Ovcon Limited reported a relatively good financial year result (for the year ended June 2019). However, the outperformance was spurred by the outlook on South African construction gaining much-needed stimulus after SOCs advertised R20 billion worth of construction contracts, with gross fixed capital formation growing by an impressive 6.1% in the second quarter GDP figure, following perennial contractions since the fourth quarter of 2017. The industry has had an exodus of available skills, thanks to recent corporate failures. Wilson Bayly Holmes-Ovcon Limited stands to be one of the few companies to potentially gain from increased order books. The detractors from performance included our overweight positions in the materials sector, namely from Sasol Limited and Exxaro. Sasol Limited underperformed due to lower oil demand on the back of a dented global outlook as a result of the trade war. Oil prices did surge following the drone or missile attacks on Saudi Arabia mid-September, which accounts for just under 6% of global production. The increase however receded by month-end once Saudi Arabia confirmed that production had been restored. With a prevailing view that the market is well supplied, and fears of an economic slowdown unchanged, oil demand was muted.

Page 03

More specific to Sasol though, were idiosyncratic issues from two further overruns of the Lake Charles project and the June 2019 financial results announcement delay that continues to weigh on the stock. We maintain the view that Sasol offers a sufficient margin of safety and limited downside risk for the following reasons:

1. The stock is trading at a price-earnings (P/E) ratio of 7X, versus its long-run P/E ratio of 10X.

2. Although the delays were unexpected and the execution track record underwhelming, we are nearing the end of the project and entering a phase of de-gearing/dividend step up.

3. The company has identified a $2 billion non-core assets sale that would help improve balance sheet flexibility.

-0.60 -0.40 -0.20 0.00 0.20 0.40 0.60

Alpha contribution

-2.00 -1.00 0.00 1.00 2.00 3.00 4.00

BTI 3.19

WBO 1.04

HMN 1.63

WHL 1.13

SHP -1.13

SPG 1.30

RNI -0.64

BID -1.52

EXX 0.98

SOL 1.85

Active position

BTI 0.54

WBO 0.33

HMN 0.31

WHL 0.26

SHP 0.20

SPG -0.15

RNI -0.15

BID -0.16

EXX -0.22

SOL -0.48

Chart 2: Attribution analysis

Source: Argon Asset Management

PORTFOLIO POSITIONING & STRATEGY

We continue to use bottom-up fundamental analysis to identify attractive opportunitiesThe depressed earnings expectations within the South African market has resulted in local equity multiples derating to levels below the 10-year average. As indicated earlier, growth continues to be the much-needed panacea across all markets but is constrained by geopolitical risks. Ongoing trade tensions and the looming October 31st ‘deadline’ for Brexit continue to be an overhang globally. Our exposure to the UK market, largely through Investec, Quilter and Hammerson, continues to be developed from a disciplined bottom-up stock-picking process that steers away from making any macro calls. While we remain cognisant of the macro environment in the context of our investing process, we have found these stocks to be attractively valued and offering a meaningful margin of safety.

In South Africa, the fourth quarter has many potential events that may or may not introduce some elements of certainty. These include details of Eskom’s turnaround plan, earmarked to be released by the end of October, the Medium Term Budget Policy Statement (also due end of October), and shortly thereafter the review from Moody’s, expected in November.

We still choose to be overweight the financial sector, preferring our bank exposure to be taken through FirstRand, Absa and Nedbank. The banks continue to demonstrate defensive, diversified and resilient earnings, while trading at low price-to-book ratios. They are our preferred entry to SA Inc. We also added Discovery to the portfolio while trimming our Old Mutual weighting when the price moved in response to the latest developments related to the National Health Insurance Bill. We saw the opportunity to add to a share trading well below its historical price-to-embedded-value levels. Its network effect continues to be a strong moat for this business, the discount ascribed by the market providing us with a sufficient margin of safety.

While we do not take a view on the upcoming events, we continue to seek opportunities that offer attractive entry or exit points that can grow our clients’ wealth over the medium to long term, using our bottom-up, fundamental analysis process. In addition to the quarterly commentary, we are very excited to include our investment rationale for the UK property sector. Hammerson has been a meaningful alpha generator for the quarter. Bjorn Samuels, our Equities Analyst, provides our thesis on why we continue to see value in the stock.

“ The banks continue to demonstrate defensive, diversified and resilient earnings, while trading at low price-to-book ratios. They are our preferred entry to SA Inc. ”

Page 04

The above quote, despite being an exaggeration, highlights the simplicity and seemingly low-risk nature of real estate investments. While real estate investment trusts (REITs) were first introduced in the 1960s, they only really gained popularity over the past two decades with the shift to alternative asset classes. Their attractive characteristics include high dividend yield, relatively stable and predictable cash flows, low tax charge, and high liquidity.

The historic low-risk, high-return profile of REITs is however quickly dissipating. REIT returns have declined globally and, in some instances, even gone negative. Many REITs are currently trading at peak discounts to book values and with no black swan events (such as the great financial crisis a decade ago), one begins to question whether the current valuations indicate value or a value trap. The UK property market is among the biggest decliners in the world, with UK retail in particular looking extremely cheap. Based on proprietary research and insights from our recent trip to the UK, we expand on some of the key issues and positive factors relating to the UK retail property market.

THE UK RETAIL PROPERTY MARKET HAS BEEN HIT BY THE PERFECT STORM

UK consumer confidence is currently at a six-year low, partly due to Brexit woes. In addition to the significant level of uncertainty caused by Brexit that is affecting consumer and investor sentiment, it has also increased the cost of doing business. The exchange rate has weakened to around $1.25/£, making imports and inputs notably more expensive for businesses.

From the chart below we can see that the UK has a high e-commerce penetration rate (e-commerce sales as a percentage of total retail sales). This has not only left traditional retailers who have been slow to adapt destitute, it has also reduced demand for physical retail space. At 18%, the UK has the highest e-commerce penetration rate in the world. In addition, one should keep in mind that food retail makes up the bulk of retail sales in the UK.

‘Landlords grow rich in their sleep without working, risking or economising.’ - John Stuart Mill

UK RETAIL PROPERTY - WEATHERING THE STORM

Bjorn SamuelsEquities AnalystB Com Investment Management (cum laude) (UP)Candidate CFA Level III

Page 05

“ Given the absence of transactional evidence, outward yield shifts and expected rent declines have been the driving forces behind the meaningful UK property devaluations.”

Experts therefore estimate that the e-commerce penetration rate for clothing retail sales could be higher than 40%, which may explain the immense pressure on fashion and apparel retailers in the UK that we are currently seeing.

Chart 3: The 10 countries with the highest e-commerce penetration rates

The 10 countries with the the highest e-commerce penetration rates

UK China Norway South Korea Finland Germany Denmark Us Canada Japan

18.0%

16.6%

12.7%12.0%

11.5% 11.2%10.8%

8.9%8.2%

6.7%

Source: Statista

The decline in the profitability of UK retailers is predominantly being driven by cost pressures. Elevated occupancy costs and higher staff costs (due to the new living wage) have been the major contributors to higher operating costs for retailers.

The combined effect of these factors has led to the surge in company voluntary arrangements (CVAs) that we are currently seeing among UK retailers. A CVA is a formal procedure and a legally binding agreement between a business in distress and its creditors, which sets out how repayments of company debt should be made to these creditors. Landlords fall under this group of creditors. As a result, rent reductions through the CVA process have had a negative impact on UK REITs in recent months.

Balance sheet pressure has also played a significant role in UK REIT underperformance. Given the absence of transactional evidence, outward yield shifts and expected rent declines have been the driving forces behind the meaningful UK property devaluations. Stagnant debt levels coupled with declining property valuations spell disaster for loan-to-value (LTV) ratios.With rising LTV ratios, the risk of breaching debt covenants becomes more imminent. In light of asset devaluations, the only way to prevent this from happening is to reduce debt by either using proceeds from the sale of properties or injecting fresh capital via a rights issue. Unfortunately, if asset values continue to fall, this could be a vicious cycle.

Page 06

EVERY CLOUD HAS A SILVER LINING

Rents cannot continue to decline indefinitely. The chart below shows that prime retail rents, excluding central London, have fallen by 30% over the past decade in nominal terms. (In real terms these rents have halved.) Most retailers in CVAs are currently paying heavily discounted rents, creating an opportunity for landlords to re-let this space to higher-paying tenants. In the most extreme cases, landlords indicated that they can re-let CVA space at an incremental rental of more than six-fold.

Chart 4: UK rents excluding central LondonUK rents excluding central London

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

115

110

105

100

95

90

85

80

75

115

110

105

100

95

90

85

80

75

Pri

me

reta

il re

nts

(£)

Pri

me

reta

il re

nts

(£)

-30%

Source: Colliers

Page 07

Not all CVAs are bad. There are different categories of CVA leases. These span from category B leases, which are marginal stores that could have substantial lease term renegotiations and rent reductions, to category C leases, which represent unprofitable stores that will most likely be closed. It is important to note that CVA category classification occurs on a store-by-store basis. Therefore, even though the retail group as a whole may be undergoing a CVA, there could be some stores that continue to operate as normal with no change to lease terms or rents. These are classified as category A leases and are predominantly found in the flagship malls.

Rent is just one component of occupancy cost. Total occupancy cost (TOC) comprises rent, business rates and service charges. With business rates largely expected to remain unchanged, many retailers now focus on lowering or at least maintaining a reasonable TOC ratio (ratio of TOC to revenue). Fortunately, landlords have an arsenal of initiatives at their disposal to either add more value or reduce the service charge currently borne by tenants.

Shopper behaviour is changing, and brick-and-mortar stores are shifting to online. While it is necessary and natural for change to occur over time, we also acknowledge that throughout history, there have been adapters and survivors who have been able to overcome evolution. We therefore believe that flagship malls (in good locations with high footfall) will be able to survive the shift to online, akin to mechanical swiss timepieces in the advent of smartwatches or paperback novels in a world of Kindles and e-readers.

In response to changing consumer behaviour, landlords have shifted their preferred tenant mix away from traditional retailers to more leisure and experiences-led operators to attract visitors. We believe that increased footfall and dwell time will be paramount to future-proofing malls. In these malls, retailers are likely to retain even loss-making stores, as they will be viewed less as an occupancy cost and more as a marketing cost. In time, the use of stores as a point of sale will shift to that of a showroom or advertising platform, with flagship malls providing a big audience.

Lack of transactional evidence, falling property prices and Brexit uncertainty have hindered UK retail property investments. It is therefore encouraging that large UK valuation institutions such as Cushman & Wakefield and CBRE have reported a spike in interest over the past six months. However, it would appear that many investors are still sitting on the sidelines, possibly afraid of being the first to catch the falling knife. Thankfully, history has shown us that downward property cycles do turn and when they do, it happens quickly.

NAVIGATING THE STORM

Our exposure to the undervalued UK retail property sector involves the following high-quality and high-conviction companies:

Capital & Counties

We have a sizable active position in Capital & Counties (Capco). The core of this business is Covent Garden. Covent Garden’s unique, pedestrian-orientated high street location and astute asset management initiatives have created a world-class shopping destination in London’s West End that attracts over 40 million visitors per year.

As for Earls Court, we remain cautious on the satiable demand for high-end residential property in Central London. While we believe Earls Court is reasonably worth less than the last reported book value, it certainly is not worth zero as implied by the current market price. Therefore, another attractive characteristic of Capco is that the value unlock of Earls Court is imminent, either through the sale of parcels of land or via the proposed demerger scheduled to take place before year-end.

Hammerson

Hammerson owns and operates several flagship retail assets across the UK and continental Europe.

As explained above, all UK REITs have declined in value, including Hammerson. Hammerson is now trading close to its lowest price-to-book ratio over the last decade (at levels similar to those during the great financial crisis). We believe that this is completely unjustified given that the bulk of its assets are located outside the UK.

“In light of asset devaluations, the only way to prevent this from happening is to reduce debt by either using proceeds from the sale of properties or injecting fresh capital via a rights issue.”

Page 08

The chart above shows that Hammerson only has 37% exposure to UK retail. Of this, 8% is exposure to retail outlets that are already up for disposal, and the balance comprises high-quality flagship UK malls. These malls have a high footfall and have already started plans to transform into experiential and leisure-led shopping destinations. Relative to its peers, Hammerson has fewer balance sheet pressures. The management team has been among the most reactive in the sector in terms of deleveraging to improve balance sheet strength, and to date, Hammerson is already ahead of its December 2019 disposal target. They also have the option of selling additional high-quality assets outside of the UK (including premium outlets), which could be done at current book values and would provide sufficient covenant headroom to ride out even the lengthiest property cycles.

Chart 5: Hammerson’s portfolio split by value

UK retail

France retail

Ireland retail

Premium outlets

Developments and UK other

37%

15%10%

29%

9%

Source: Company reports

Chart 6: Hammerson is currently trading at a deep discount to its net asset value

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Price to book

1.20

1.10

1.00

0.90

0.80

0.70

0.60

0.50

0.40

0.30

0.20

Mean

1.20

1.10

1.00

0.90

0.80

0.70

0.60

0.50

0.40

0.30

0.20

We constantly probe our investment case when new information presents itself and run multiple scenario analyses to stress test our assumptions and intrinsic value. Based on the current lofty discount to net asset value, we believe Hammerson is extremely undervalued with a sufficient margin of safety. Hammerson is therefore one of our high-conviction ideas and currently one of the largest active bets across our funds.

Source: Bloomberg

Page 09

Our Awards

Awarded by World Finance

Best Investment Management Company South Africa 2014, 2015 and 2016

Awarded by ABSIP

Best Company with Global Significance 2015

Awarded by Imbasa Yegolide

Best Absolute Returns Manager 2015

Awarded by Global Banking & Finance

Best Asset Manager South Africa 2014 and 2015

Awarded by IAIR

Best Asset Management Company in Africa 2015

Awarded by Global Brands Magazine

Best Asset Management Brand, South Africa 2015

Contact details

Luyanda Joxo, CFADeputy CEOT +27 21 670 6576 | M +27 84 701 1271E luyanda@argonasset.co.za

Switchboard +27 21 670 6570 | General info@argonasset.co.za | Website www.argonassetmanagement.co.za

DisclaimerInformation contained herein is for information purposes only and is merely illustrative. It is not deemed as advice as defined in the Financial Advisory and Intermediary Services Act (FAIS Act). Argon Asset Management

(Pty) Ltd and its employees shall not be held responsible for any losses sustained by any person acting based on the information. Past performance of any of our funds is not indicative of their future performance.

Persons are advised to contact Argon directly should they wish for Argon to conduct an analysis with a view to facilitating investing in any of our funds. Argon Asset Management (Pty) Ltd is an independent investment

management company registered in South Africa, company registration number 2002/016801/07 and an authorised financial services provider under the Financial Services Board (FSB) registration number 835

as well as the FSB’s section 13B Pension Funds Act ; administrator registration number 24/434. The main business of Argon Asset Management is the provision of investment management services to institutional

clients and retail investors. Argon Asset Management’s domestic product range includes an equity fund, bond fund, absolute return fund, domestic balanced fund, flexible income fund and a money market fund. The

offshore product set consists of a range of global equities, global fixed income and the global balanced/multi asset class funds.

Jeremy JutzenClient Relationship ManagerT +27 21 670 6592 | M +27 83 703 8523E jeremy@argonasset.co.za

Awarded by IAIR

Excellence in Asset Management Corpoarte Social Investment Africa 2014

Awarded by ABSIP:

Best Black-Owned Investment Firm of the year 2017