third quarter 2017 - let's talk about you

CITATION THIRD QUARTER 2017

MESSAGE FROM CAM | INTERESTING INSIGHTS | ECONOMIC OUTLOOK | FEEDBACK | DISCLAIMER

COMPILED BY CITADEL ASSET MANAGEMENT

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As at 30 September 2017

CONTENT MESSAGE FROM CAM

GEORGE HERMAN

INTERESTING INSIGHTS WEALTH CREATION: THE ART OF SAVING

RIAAN CAMPBELL

TRUST IS GOOD, BUT CONTROL IS BETTER

ELSA DE KOCK

CITADEL SA BOND H4 FUND

MIKE VAN DER WESTHUIZEN

BLOCKCHAIN − SATOSHI’S GIFT

MIKE VAN DER WESTHUIZEN & NISHLEN GOVENDER

ECONOMIC OUTLOOK

MAARTEN ACKERMAN

DISCLAIMER

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MESSAGE FROM CAM George Herman - Citadel Chief Investment Officer We are currently engaging with our clients through a series of presentations around the country. Our presentation is entitled “The New Normal”. During our tour, we highlight several things that have changed during the last decade, but we also note those things that have not changed and are not new nor abnormal. Judging from the questions raised, there is a lot of apprehension with regards to the current political situation in South Africa. The maelstrom of news and speculation that floods us daily through various media has made many South Africans either extremely negative or they’ve decided to ignore it entirely. As your asset management team, we can’t resort to either of those actions or emotions. Our task is to objectively assess the risks and opportunities presented by financial markets. One of the most important questions you often ask us relates to how exactly we handle such uncertainty. The answer lies in our investment philosophy, our process and our/your investment horizon. 1. Our investment philosophy ensures that we focus on asset allocation as the major driver of long-term returns. Different asset classes will react differently during the various scenarios that lie ahead of us. A sensible combination of these asset classes have, even after facing bigger challenges than our current domestic uncertainties, delivered justifiable risk-adjusted and inflation beating returns. Our philosophy also acknowledges that the future is uncertain and that we have to prepare for different outcomes as well as effectively manage risk during these transitions. Managing portfolios during uncertain times is thus our DNA – an integral aspect of what we do at Citadel Asset Management (CAM). 2. Our investment process is rigorous and thorough, achieved as a result of a diligent series of global analyses that focus on the actual drivers of returns in each asset class. Political risk and/or uncertainty is but one of a large number of variables that gets included in the long term risk and return assessments. Uncertainty, however, is most certainly not only a domestic issue. Need I say more than Brexit, Trump and North Korea? The first graph on page four shows the Baker, Bloom & Davis Global Policy Uncertainty Index. Take note of how global policy uncertainty has been rising over the past few years. 3. The overall investment horizon over which we operate varies between anything from three to 30 years. So if immediate risks are sensibly managed, the long term picture will engulf the current volatility, should there be any. One of the unique characteristics of the financial markets currently is that actual volatility is at historic lows, whilst uncertainty is deemed to be extremely high. Many thus deduce that we may face a binary outcome going into 2018 as more clarity is gained over our political future. More about that in a moment. Accordingly, we at CAM aim to filter out the ‘noise’ by focussing on the actual long-term return drivers for the various global asset classes. This places the South African idiosyncratic risks into context and allows us to see as many opportunities as risks.

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MESSAGE FROM CAM

I CONTINUED

GRAPH 1| BAKER, BLOOM & DAVIS GLOBAL ECONOMIC POLICY UNCERTAINTY INDEX

SOUTH AFRICAN RISKS AND OPPORTUNITIES Assessing the political situation in South Africa over the next few months will be crucial in managing all financial exposures. To assist us in this process, Citadel has retained the services of the Paternoster Research Group, headed by Professor Richard Calland, Associate Professor in Public Law at the University of Cape Town. Calland and his team will be publishing a series of papers titled “The Road to Midrand” which will provide insight into the African National Congress (ANC) process as it elects its new leader. This should provide us with an assessment of where the risks lie, come December. The series will be concluded in February and will, at that time, include their view of the implications for policy following the ANC elective conference. We look forward to incorporating this insightful political analysis into our overall domestic risk assessment. It is very important to also note that South Africa is not an island. We are part of the wider emerging market universe, which has been a very popular investment theme during 2017. Global investors are starved for yield and in their search for higher income they surge towards a strategy known as the “carry trade”. This strategy refers to global investors raising cash in developed markets with low to even zero interest rates and then investing that into areas with higher yields. Hedging the currency risk subtracts from that yield, but still leaves them with a higher nett interest yield than in their own countries. The Emerging Market Carry Trade Index in graph two below, which includes South Africa, shows how popular and successful this strategy has been during 2017 year-to-date. As the Federal Reserve in the United States starts tightening financial conditions, the environment turns against this trade. The recent sharp turnaround in this index highlights the risk that the South African currency and bonds face within this changing environment as well. This highlights the fact that we shouldn’t focus too narrowly on our domestic issues only, we need to keep the global environment well and truly in our scope as well. GRAPH 2| EMERGING MARKET CARRY TRADE INDEX

CAM remains fully dedicated to providing you, our clients, with a globally focussed, institutional quality, robust and unemotional investment management process. Not only do we have all the required resources to do so, we also have a dedicated and experienced team to make that a reality.

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INTERESTING INSIGHTS

WEALTH CREATION: THE ART OF SAVING | TRUST IS GOOD, BUT CONTROL IS BETTER | CITADEL SA BOND H4 FUND | BLOCKCHAIN

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WEALTH CREATION: THE ART OF SAVING Riaan Campbell - Citadel Advisory Partner

In our wealth management feature series, we’ll take you through various aspects of managing your wealth: from creation and preservation to the challenges, pitfalls and responsibility we have to preserve our lifestyle. There are some who believe that wealth creation is different from ‘old style’ savings. In a world of high flying start-up businesses, young self-made millionaires and other highprofile business successes, saving to build up a substantial capital base may feel far removed from the glamour of fastearned riches and wealth creation. But let’s take a closer look at what happens in real life. Most of us will, in fact, accumulate or create wealth through saving our money month after month, year after year and ‘doubling down’ over the long term. Regular saving forms one of the cornerstones to creating capital to fund our lifestyles when our careers or businesses can no longer provide the income we need. Let’s brush up on some of the rules of the game. 1.

Remember compound returns: the most powerful man-made phenomenon on earth. You can achieve astounding results through regular savings if you have time on your side. The effect of compounding kicks in when your investment returns are being re-invested to generate even more returns. In his book The Richest Man in Babylon, George S. Glason describes the phenomenon as “To put each coin to laboring that it may reproduce its kind even as the flocks of the field and help bring to thee income, a stream of wealth that shall flow constantly into thy purse.”

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Start early Start saving as soon as you can. The longer you wait, the more of your income you will have to save in

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order to achieve meaningful results. And remember, investments don’t grow any faster in the last couple of years of wealth accumulation; it is the significant increase in the amount of capital saved in the early years that will set you on course with your sails to the wind.

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Consistency is key If there is only one take-out from this article let it be: make consistent regular contributions for as long as you can, whilst ensuring that your contributions keep track with inflation. Commit yourself to planned monthly non-negotiable payments so these funds are not available for spending.

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Look for inflation beating returns If you have time on your side, there are only two asset classes with the potential to achieve significant real returns over the long term: shares on the stock exchange and listed property, in both local and offshore markets.

Global and local equities have historically delivered, on average, real returns of 6% p.a. and property investments are expected to deliver similar returns. Unfortunately property investments come with the caveat that the income returns are taxable. But it is easy to invest in these asset classes regularly through unit trusts and direct investments. (Please note that we will be addressing direct property investments in a future article.)

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Patience can bring impressive results A client once shared his story with me: he always bought shares on the JSE with the bonuses he received over the years. Little did he know it would become one of the best performing markets in the


INTERESTING INSIGHTS WEALTH CREATION: THE ART OF SAVING I CONTINUED

world, in US dollar terms, for long periods of time. These investments turned into a small fortune.

For example: A modest amount of R1 000 per month, increased by inflation, invested in growth assets over 30 years, should produce approximately R670 000 in real terms (a real return of 4% p.a. and an inflation rate of 6% p.a. assumed). With these returns, what would you be prepared to invest?

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Don’t over think your investments − cost averaging always wins When investing remember there is no need to be concerned about the level of markets or exchange rates. Investing on a regular basis will see you buy during both the highs and the lows of the markets, resulting in an average price being paid for those assets over time. This means that although you will get less when markets are high, you will also make more when markets are cheap.

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Add more when opportunity knocks When stock markets fall and present themselves on a “fire sale”, invest a bit more than usual. Returns are normally better when starting from a low base, with recent examples being the years after major contractions in stock markets, namely 2003 and 2009.

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Look for the tax advantages Use all available tax friendly products to gain ground in the game of regular savings. Every bit of tax saving will help. A tax-free savings account, although only allowing a small amount, is a good start, while retirement funds offer the biggest benefit in terms of tax savings.

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Open a tax-free saving plan You can invest up to R33 000 annually, with a lifetime limit of R500 000, in approved unit trusts, fixed deposits or real estate investment trusts, commonly known as REITS. All returns, including interest, dividends and capital gains on the disposal of these investments, are tax free. Depending on your personal tax planning it could be beneficial to invest all or most of these savings in REITS as you’ll be avoiding tax on investment income which would otherwise have been taxed at your marginal rate.

Assuming the allowable contributions are increased with inflation over time, a significant tax free capital

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base can be created over 15 years, which is when you would reach the limit on contributions. Compounding will take care of the years after capital contributions cease.

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Retirement funds The opportunity to make tax-free contributions of up to 27.5% of your taxable income to retirement funds (limited to R350 000 per annum), especially as it can be part of your regular savings contributions, is an attractive way of saving over the long term. Retirement funds are ideal for investing in various asset classes, of which local and offshore equities and property (although limited) are the cornerstones of creating real wealth through regular savings.

The benefit of retirement funds over other discretionary investments is the tax free nature of their returns which include income, dividends, and realised capital gains. It is a wonderful way of adding extra growth to your long term capital in a manner that is tax efficient.

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Pay off your bond (compounding in reverse) When the real interest rate on your bond leans towards the potential real returns possible on equity markets, paying off your bond at a faster rate than required should generate substantial wealth in the form of your residential property. This ‘guaranteed’ return is unequaled to other growth investments’ returns over the short to medium term. Once your bond is paid off, commit whatever savings you have to growth assets in order to take advantage of the long-term benefits of compounding returns, which we discussed above.

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Beware of the pitfalls Returns don’t come in a straight line. You will go through disappointing periods over the duration of your investment. Don’t give up when returns are not coming your way. The long term is not necessarily a 10 year period, it might require 20 years, or it could all happen in year 11. Beware of the bull market. Also, keep investment fees low, every bit of return adds to the compounding of capital.

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The test of time Be consistent, add as much as you can as early as you can, and see your wealth being created without adding any personal energy. This is how you get your money to work for you. It just requires time and patience.



TRUST IS GOOD, BUT CONTROL IS BETTER

Elsa de Kock - Head: Citadel Group Risk, Internal Audit and Compliance

Given the recent controversy surrounding their potential interference in the United States’ (US) Presidential elections, it may not be surprising that the Russians prefer to control, rather than trust. Vladimir Lenin, former Russian head of state, is recorded as saying: “Trust is good, but control is better.” And digging deeper into the Russian language one finds the proverb: “Trust, but verify,” which ironically was a saying often repeated in speeches by former US President, Ronald Reagan. The concepts of trust and control are becoming increasingly important in the South African context as well, especially given the recent revelations regarding international auditing firm, KPMG’s ill-fated South African Revenue Service report on the so-called Rogue Unit. Citadel clients, for instance, entrust Citadel with their life savings and expect Citadel to have extensive internal controls in place to deter and detect possible fraud and theft. In order to offer our clients’ peace of mind, we have set out to answer a few frequently asked questions relating to some of Citadel’s safety measures and precautions. Should Citadel go bust, what procedures are in place to safeguard a client’s financial assets? All investments managed by Citadel Investment Services Proprietary Limited for or on behalf of clients do not form part of the Citadel balance sheet. These would, therefore, be protected from any creditors of Citadel, should Citadel go insolvent. Should a client make an investment into a collective investment scheme portfolio (often referred to as a unit trust), through a linked investment services provider (LISP) investment plan product, a nominee company will hold the investment on behalf of the client so as to separate the client’s assets from those of the LISP. The collective investment scheme portfolio itself will have a trustee/custodian, usually a bank in the case of a South African collective investment scheme, which will hold the assets of the portfolio in trust for the benefit of the portfolio. Assets held in trust in this manner will be protected on insolvency of the collective investment scheme management company, trustee or custodian. To provide further comfort to clients, Citadel maintains professional indemnity and fidelity insurance cover under the Peregrine Group’s insurance policy. What internal controls does Citadel have in place to prevent or detect fraud? All prospective employees are checked for any past criminal records and the qualifications of our advisors are verified. Employees are regularly trained and updated on the Citadel whistleblowing policy and how it protects them in the event they become aware of any irregularities and report these in the manner set out in the policy.

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INTERESTING INSIGHTS TRUST IS GOOD BUT CONTROL IS BETTER I CONTINUED Advisors are also required to complete a questionnaire at least three times a year. This enables the company to monitor whether their personal circumstances may have changed, which could give rise to potential risks of fraudulent behaviour. Possible risks are identified and addressed in all departments by developing and monitoring various controls to mitigate them. The internal audit department also regularly reviews these controls, ensuring their effectiveness, whilst making recommendations for further enhancements. How does Citadel prevent any fraudulent withdrawal from a client’s investments? Citadel has systems and procedures in place aimed at preventing fraudulent withdrawals. The Citadel finance department controls the releasing of all funds. Our finance department segregates these duties, meaning healthy checks and balances are in place as different individuals are responsible for capturing, checking and effecting any withdrawal or payment. In addition a senior financial manager is responsible in the final instance of releasing the payment or withdrawal. The finance department also has processes in place aimed at ensuring that only the client’s verified bank account details are used. In the event that the client changes their bank and/or account, then they need to sign the withdrawal instruction verifying the new bank account details. Client withdrawal requests sent to Citadel by email are personally confirmed with the client by a Citadel employee who knows the client, and this confirmation is duly recorded. How does Citadel prevent cybercrime? Citadel regularly tests and enhances its technological security systems and the security measures implemented are reviewed by independent cyber security specialists. We also recently launched our client portal, My Secure Zone, aimed at enhancing confidential communication with clients. All clients are encouraged to register on the My Secure Zone secure portal, which provides enhanced confidential internet access to a variety of useful client specific services including portfolio values, reports and notifications, from your mobile device or computer. By using My Secure Zone, the risks posed by emailing confidential client reports and other information are reduced, as client email accounts can be compromised by hackers. Click here to register. Should you require assistance in registering and using My Secure Zone, you are invited to contact your advisor. For technical support you can contact the support line on 086 110 0628, after downloading the Citadel application on your computer, smartphone or tablet. It is an unfettered priority at Citadel to continuously ensure that risks are regularly assessed and internal controls implemented. The efficacy of our systems is regularly tested, reviewed and enhanced to minimise and prevent fraud. So although trust is good, diligent Citadel controls should further enhance clients’ peace of mind.

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CITADEL SA BOND H4 FUND

Mike van der Westhuizen - Citadel Portfolio Manager

The Citadel SA Bond H4 Fund is a specialist interest bearing portfolio with the primary objective of relatively stable capital values, a reasonable level of liquidity and a return commensurate with the South African All Bond Index (ALBI). The portfolio may invest in money market instruments, government- and corporate bonds, as well as fixed income derivatives and is permitted to invest in offshore investments as legislation permits. Bonds form a crucial part of a diversified investment portfolio and are considered a “Steady Eddie”, income producing asset, albeit subject to capital movement too. In essence when buying a bond, you are lending money to a government, corporate, state owned entity (SOE) or municipality to name a few (not to be confused with a mortgage bond on your house where you are the borrower). In return you receive regular interest payments (aka coupons) and your initial capital back when the bond matures. With all of these cash flows the investor (lender) relies on the willingness and ability (creditworthiness) of the issuer/borrower to meet these obligations. Bonds are quoted as yields, and yields and underlying bond prices move in opposite directions i.e. a rising yield leads to a decline in price, while falling yields lead to price gains. The higher the yield, the more compensation the lender supposedly receives for investing in, what is perceived as, a more risky borrower (i.e. credit risk). Aside from local fundamentals playing their part in determining the value of what yield SA government bonds should trade at, it is global “fast money” that has more recently had a greater bearing on the bond price action. The low interest rate environment in developed market economies has forced global investors to hunt for yield in places where they wouldn’t otherwise have, resulting in a surge of capital into higher yielding emerging markets (EMs) in what is known as the carry trade. South Africa, as one of these EMs has received close to record year-to-date inflows with foreigners now owning the greatest proportion of South African government bonds in issue, ever, at over 40%. Bonds, by nature, are considered a lower risk asset but that’s only considering long-term relative volatility (i.e. compared to other assets like equity or listed property). What we’ve experienced in South Africa, as part of an emerging market basket or as a stand-alone investment case has been hair raising at times over the past few years. The challenges in managing a SA focussed bond portfolio, such as the Citadel SA Bond H4 Fund, stem from balancing a declining inflation and low growth environment (which are bond positives) with rising fiscal pressures and political shenanigans (which are bond negatives), as well as tussling with the volatile portfolio flows spoken about above. The first graph on page 11 illustrates just some of the points over the last few years where yields have spiked, i.e. bond prices have fallen. In hindsight it’s often difficult to ascertain whether the economic fundamentals or the politics are easier to forecast, given the sheer number of ‘red flags’ pertaining to the latter. Our view over the past 12-18 months has been that of a continuously deteriorating fiscal position, where Treasury struggles to balance revenue (i.e. from tax) with expenditure and hence has to issue more debt (government bonds) to fund the gap in the budget. The additional supply of debt has put upward pressure on yields/borrowing cost − and hence downward pressure on prices − of longer dated government bonds. This in itself perpetuates the risk of Treasury missing its budget targets, as interest payments on debt form an ever increasing portion of expenditure.

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INTERESTING INSIGHTS CITADEL SA BOND H4 FUND I CONTINUED FIGURE 1: SOUTH AFRICA 10 YEAR BENCHMARK BOND (R186) YIELD AND PRICE MOVEMENTS, HIGHLIGHTING SIGNIFICANT PRICE ACTION AND THE RELATED REASON | SOURCE: BLOOMBERG, CITADEL ASSET MANAGEMENT

We have also been on heightened alert when it comes to potential political risks (e.g. cabinet reshuffles), as well as further potential downgrades of South Africa’s local currency debt credit rating which could lead to a large proportion of foreign holders becoming forced sellers of our government debt (leading to sharp price declines). Given this view we have continued to sell into market strength, which in turn has led to the fund being more conservatively positioned than most of our peers. Please view this graph in conjunction with the minimum disclosure document for the Citadel SA Bond H4 Fund available here. FIGURE 2: CITADEL SA BOND FUND: ANNUALISED PERFORMANCE VS BENCHMARK AND PEER GROUP | SOURCE: MORNINGSTAR, CITADEL ASSET MANAGEMENT

Our more conservative positioning has, at times, detracted from relative performance when the bond market has rallied strongly over shorter periods of time but on balance, by mitigating drawdowns during market sell-offs the fund has delivered favourable results from both an absolute and relative-to-peers’ perspective. The payoff from being patient

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INTERESTING INSIGHTS CITADEL SA BOND H4 FUND I CONTINUED in times where the ‘madness’ of the market ensues bears fruit when the tides turn. Going into year-end we remain underweight risk, bearing in mind the upcoming ANC elective conference, potential rating agency actions and normalisation of developed market monetary policy, which will have a significant bearing on the carry trade as monetary conditions tighten. In addition to the pleasing performance of the fund, the annual management fee has recently been lowered to 0.75% (ex-VAT) from 0.9% (ex-VAT) previously. The Citadel SA Money Market H4 Fund fee has also been lowered to 0.45% (ex-VAT). The Citadel SA Bond H4 Fund remains the anchor in the prudent portfolio despite many shorter term risks abounding. With bond yields providing a handsome 3%-4% spread over inflation, it offers a compelling long-term fixed income return whilst economic growth is lacklustre and inflation muted.

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BLOCKCHAIN – SATOSHI’S GIFT

Mike van der Westhuizen - Citadel Portfolio Manager Nishlen Govender - Citadel Investment Analyst For avid readers of Citation you may have come across our Bitcoin article last quarter. This article was the first in a series that we are producing discussing cryptocurrencies from various perspectives. For those who missed the article, we discussed Bitcoin, the cryptocurrency that brought virtual currencies to the mainstream audience. It has since become a significant discussion point across various forums and has attracted significant capital due, in part, to spectacular returns. Our article relished the idea of a virtual currency, but raised concerns from an investment perspective, given the lack of valuation criteria and a market that is seemingly dominated by speculators in the currency rather than true users. This concern forms the basis for our opinion to rather not invest in Bitcoin, together with the obvious fact that unit trust regulation does not allow us to do so. In this article we take a look behind Bitcoin into Blockchain (the technology developed to facilitate Bitcoin transactions). We want to delve into the workings of the technology as well as look at other possible uses for the technology in current industries. Before doing this, however, it is important to understand the origin of Blockchain especially as it allows us to understand the success of Bitcoin. The origin of Blockchain Blockchain technology first appeared practically within the Bitcoin ecosystem as part of the original mechanism that allowed the currency to work. The inventor/s of Bitcoin, Satoshi Nakamoto, highlighted the idea of an ongoing chain, in their paper on Bitcoin, which facilitated a secure peer-to-peer version of electronic cash which allowed online payments to be sent directly from one party to another without the need for a central financial institution. While most cryptocurrencies incorporate this idea today, the initial concept was ground-breaking because it overcame many of the flaws that were apparent with digital currencies proposed prior to Bitcoin. In particular that of “doublespending”, which was the creation of false cash via duplication. Because these currencies were not tangible, or backed by physical assets, hackers could easily duplicate currencies and thus spend twice using the same individual currency. This caused significant inflation in cryptocurrency ecosystems. Double-spending is virtually impossible to do in the Bitcoin ecosystem using Blockchain. The current system and its flaws This way in which our current system is flawed is a critical question and non-trivial. The understanding of it can be simplified by starting with a simple electronic money transaction that involves the purchase of an item from your favourite website. The current system of exchange involves your bank deducting the funds from your account and transferring it to another account either at the same bank or to a different one. The information of the transfer is passed to the supplier who then transfers the goods to you. In this system all the transactions and account balances are handled by the bank (or banks) which is why we call them centralised systems. Even though the transactions themselves now take place in fractions of a second we rely still on the bank to capture the transaction, transfer the money and reflect the correct balances thereafter.

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INTERESTING INSIGHTS BLOCKCHAIN - SATOSHI’S GIFT I CONTINUED Because of the reliance on a centralised system we encounter significant risks. From the risk of a simple error to that of the institution’s network failing (or being compromised) or even the systematic risk of an institution collapsing, taking with it your deposits and entire transaction history. This highlights that centralised systems are far from perfect, which has been linked to the idea of being “too big to fail”, the role large banks played in the global financial crisis, and then the need to rescue such banks in financial distress. But how does Blockchain overcome this? The Blockchain – a decentralised network Blockchain manages to overcome this by creating a decentralised network that is virtually incorruptible. Again let’s assume that you want to purchase something electronically. Via the Blockchain mechanism your transaction is sent to a network of users that will validate both the transactions and the participants in the transaction. Past transactions are stored in a chain and the most recent transaction is simply added to the chain to make it longer, thus making the history of transactions fully retrievable. Once the transaction is validated, and the Blockchain updated, the transaction is completed and the parties notified. The Blockchain itself is not owned by an individual or housed in one place – all users have a history of the database and it is continually reconciled and shared via the users. So if one user happens to be corrupted the rest of the chain will still remain intact. Further, if a hacker had to penetrate one user’s version of the database, the corrupted database would not reconcile with the entire network and would be rebuffed. Previous links of the chain cannot be adjusted subsequently which also adds significant security to the overall process. In short, consensus amongst the network is required to validate transactions instead of one single authority. This gives power to the community, hence the technology’s antiestablishment appeal. If we liken this to current technology, William Mougayar (a venture advisor and Blockchain specialist) explains the concept best by comparing it to a Google Docs spreadsheet that is owned by everyone at the same time and can be updated by the network. This means there are no issues with version control or lost documents. An important question however is: why would this peer universe exist to validate your transaction? Well it’s based on the fact that validating transactions and being a part of the network is rewarded via virtual currency – in the Bitcoin example you receive Bitcoin as part of the validation process. What does this mean for our current financial services structure? If we focus on the financial services sector it means that financial institutions can bear significantly less risk at significantly less cost by creating a network for validating transactions. This reduces risk of error as well as the significant risk of compromised security via attack (as a node can be attacked but the system cannot be compromised). On the other hand this could disrupt the financial services sector by allowing new entrants to compete for market share from dominant players by introducing the facilitation of transactions at significantly lower costs (and with much less risk). This disruption would be good for market participants as the current banking environment is dominated by large players, which in itself, contributes to systematic risk. FIGURE 1 – AN EXAMPLE OF A TRANSACTION FACILITATED BY BLOCKCHAIN | SOURCE: BLOCKGEEKS.COM

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INTERESTING INSIGHTS BLOCKCHAIN - SATOSHI’S GIFT I CONTINUED Are there other uses of Blockchain technology? The scalability of Blockchain is where the technology comes into its own, because Blockchain basically allows us to validate any form of transaction. The first appearance of this was via smart contracts which allow users to enter contracts that become validated via the Blockchain network. This makes the record of the contract safe while allowing the contract to be executed based on specific conditions. If, for instance, I wanted to purchase a property, the smart contract could be initiated and the transfer of the house would take place as soon as I have paid for it and the sale has been validated by the network. The ability to do this without the need for banks, lawyers and other parties makes the process timely and extremely cost effective. History of the transaction does not need to be lodged with a government authority, as the history of your transaction is forever embedded in the chain while each property could have a chain spanning various transactions thereby ensuring a retrievable history. The chain is the same as discussed previously so is virtually incorruptible. The scope for this type of use of Blockchain could completely revolutionise how we interact with each other and what type of institutions we would need to service the interaction. The invention of Bitcoin was more than just as a currency Bitcoin and Blockchain is more than just about a currency – it introduced the world to the idea of a decentralised ecosystem that actually works while being robust and secure. Whatever your opinion is of cryptocurrencies, Bitcoin and its investment prospects, the understanding of Blockchain and its potential to revolutionise our world cannot be underestimated. We are avid fans and followers of the technology, along with cryptocurrencies at large, and are excited about the possibilities within this space. Already we have seen institutions from various industries realise the potential of Blockchain either to disrupt their businesses or as an opportunity to develop. We remain of the view that individual currencies are difficult to value but it is clear that these technologies, either by themselves or via the ideas within their mechanisms, have the ability to shape the way we do business with each other. At Citadel we pride ourselves on taking the time to understand new technologies and offerings to allow us to provide our clients with sound advice in a world that is ever changing. We will continue to do this with any new technology and will continue to keep you updated on our thoughts and findings on cryptocurrencies in particular. If you have any questions please feel free to speak to your financial advisor who can put you in touch with us.

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ECONOMIC OUTLOOK

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ECONOMIC OUTLOOK

CONFIDENCE OUTSHINES GEOPOLITICAL RISK − FOR NOW

Maarten Ackerman - Citadel Chief Economist and Advisory Partner

Global business and consumer confidence continue to move higher supporting the recent synchronised momentum in global economic growth. With current confidence levels expanding, 2017 should end with higher economic growth, well ahead of 3%, outpacing 2016 numbers. The latest leading global economic indicators suggest that the healthy economic environment should persist. Improving global unemployment figures coupled with a notable improvement in global trade, with growth in global container traffic the highest in more than six years, should further underpin the current environment. Monetary policy also remains supportive (especially compared to historic levels) despite talks from various central banks to start eliminating some stimulation in the near future. Year-to-date global company earnings benefitted from this setting and surprised to the upside. Company earnings are likely to remain elevated, as the global cyclical upswing continues, and should record double digit growth this year. As a result, most global equity markets have rebounded strongly year-to-date with many markets reaching new all-time highs, whilst volatility (measure of uncertainty) drifted to historic lows. Unfortunately, an increase in global geopolitical risk, largely on the back of renewed tension between the United States (US) and North Korea might be the single biggest risk for the current economic expansion. The next global crisis, with negative consequences for financial markets, might well be prompted by political rather than economic issues. It is for this reason, to reduce and manage risk, that we are currently including alternative investments, like protected equity, in most of our portfolios. To be honest, American President Donald Trump is not helping. Since his inauguration earlier this year, the focus in the US, mainly Washington, has been on political rather than economic issues. From the failure of the proposed health bill to rumours of Russia’s involvement in the election outcomes, and recent staff turnover and volatility in the White House, it would seem like Trump has no real economic agenda. As Trump gets more unpopular, the risk increases that he is going to pick a fight to make a point. The Republicans are realising that they will need to deliver some economic policy before the midterm elections and we therefore think that some tax reform is still possible over the next few months. This should be positive for companies in general and support an already healthy consumer. Politics aside, the US economy remains robust largely on the back of the continued recovery in the job market. As unemployment approaches 4% and layoffs drift to decade lows, consumer confidence rebounded to multi-year highs supporting aggregate demand and underpinning economic growth. As a result, wages should soon start to rise, potentially underpinning inflation down the line. Given this backdrop, the Federal Reserve (Fed) is still on track to start shrinking its balance sheet in coming months and continue to hike interest rates over the next year or so. The Fed did, however, indicate that in light of the current uncertainty a gradual pace of adjustments is probably more appropriate. The weakness in the dollar this year should be unsustainable if the Fed continues with their planned policy tightening. Given this backdrop the US is well positioned to generate economic growth of around 2% over the next few years. The

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ECONOMIC OUTLOOK CONFIDENCE OUTSHINES GEOPOLITICAL RISK I CONTINUED risk remains that growth can disappoint to the downside given any irresponsible actions from Trump (or for that matter no action from an economic point of view) coupled with the Fed tightening policy too fast. This time Europe is no different. Business and consumer confidence have rebounded to levels last seen in 2001 as unemployment across the region improved substantially since it peaked in 2013. Strong retail sales, an almost 10% growth in annual vehicle sales, coupled with around 5% growth in industrial production over the past year would suggest that the European crisis is now definitely something of the past. Given these developments the European Central Bank should soon announce the winding down of asset purchases from next year, but given the level of inflation it will be difficult to start raising interest rates soon. Negative real rates for longer implies that the recent strength of the euro is likely to run out of steam. Europe should contribute to the global cyclical pickup by generating growth of around 2% over the next few years. On the political front, Europe actually got stronger this year as most elections turned out to be less populist than expected. Despite German Chancellor Angela Merkel’s weaker election performance, European integration will continue. This creates a headwind for the United Kingdom (UK) in current and future Brexit talks. As a result the UK economy and currency are likely to remain under pressure until Brexit uncertainty disappears. This might continue for the next couple of years. The Chinese economy remains robust despite some slowdown over the past few months. Current measures of activity such as railway traffic, excavator sales and electricity production remain healthy. Exports are doing well given the rebound in global economic activity. The consumer side of the economy remains robust with solid employment data, rising income growth coupled with a strong rebound in retail and home sales. These positive developments pushed consumer sentiment and confidence to the highest level in two decades. This should further support the government’s attempt to increase consumer spending as a portion of economic growth. However, China’s overall indebtedness remains a concern. We believe this should be manageable given the government’s fiscal spend towards income generating assets coupled with a large domestic savings pool. With this backdrop, the Chinese economy should be able to maintain growth of above 6.5% for the rest of this year. Other emerging markets have also performed well since the beginning of the year. After a difficult couple of years there are signs that consumers are finding their feet. Retail sales across most regions have rebounded to the highest level in 12 months. A drop in inflation has helped boost real incomes and many emerging central banks have loosened policy. Economic growth in emerging markets should outpace their developed market peers by about 2% over the next year, growing on average 5%. Unfortunately, political and policy uncertainty is weighing heavily on SouthAfrica’s (SA) economic outlook, and business and consumer confidence at the moment. After recording two negative quarters of economic growth, SA entered a technical recession at the end of March 2017. However, recent numbers showed that the economy rebounded by 2.5% (quarter-on-quarter annualised) during the second quarter of this year. Agriculture, forestry and fishing were the biggest contributors followed by finance and mining. The strong recovery in household final consumption (from -2.7% Q1 to 4.7% Q2) was encouraging. This is an important driver for a consumer-based economy like SA. The synchronised global economic

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ECONOMIC OUTLOOK CONFIDENCE OUTSHINES GEOPOLITICAL RISK I CONTINUED recovery seems to support a solid rebound in exports over the quarter as well. So, given latest numbers, is the recession is over? Technically yes, but, the reality is that SA has experienced an “economic drought” since about 2011. Over the past few years our economic growth has lagged that of the global economy by more than 2%. Furthermore, recent population data confirmed that over the same period the population growth outstripped economic growth – this might not be the technical definition of recession but what we call an economic drought. As a result over the past five years our economic “dams” have been running empty. Lower economic growth has resulted in less job creation or inclusive growth for that matter, less tax revenue, lower business and consumer confidence, and a stagnation in fixed investments. Recent numbers showed a 2.6% decline in gross fixed capital formation and it is worrying to see the significant decline in construction, residential and non-residential buildings – an indication that future confidence in the economy and policy remains low. This deteriorating economic environment resulted in the credit downgrade earlier this year. If we can’t reverse this underperforming economic trend soon, our fiscal position will become unsustainable. This is already evident from latest government finance statistics, the revenue shortfall and budget deficit. Given these developments coupled with continued political uncertainty another credit downgrade is almost certain over the next couple of months. This should put significant pressure on long-term government bond yields, the currency and subsequently inflation. Under this scenario the South African Reserve Bank shouldn’t be in a rush to cut interest rates significantly. The recent positive economic growth data is a start and SA growth for 2017

should be closer to 1%, which is more than most people expected earlier this year. However, the country needs a return of confidence and policy stability to ensure many more positive quarters and hopefully an end to our current economic drought. In order to grow and protect wealth in real terms, our preferred asset class remains global equity. Current valuations suggest that most markets are trading around fair value despite many equity markets reaching new highs. Valuations remain fair given a similar rebound in company profitability, especially year-to-date. Global equity is preferred over SA equity given local economic challenges. Broadly speaking many global companies are operating in faster growing regions with a better earnings outlook compared to local peers, yet many of them are trading at lower valuations. The JSE, however, remains a diverse market with some global rand hedge companies offering good diversification benefits against the local economic environment. Good opportunities do exist for an actively managed SA equity portfolio. Listed property (especially offshore) offers good yields and will act as a yield enhancer and diversifier to many equity portfolios. To reduce risk in any portfolio protected equity (locally and abroad) is currently preferred given the relatively affordable cost of protecting downside risk. We remain underweight cash and fixed income (locally and abroad). Globally both these asset classes offer no real yield and government bonds are facing headwinds from global monetary tightening (even if it happens at a slow pace). Locally we prefer cash over government bonds given the impact further rating downgrades will have on the asset class over the next few months. All our portfolios are positioned for rand weakness in light of the further downgrade risk.

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DISCLAIMER

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DISCLAIMER FAIS Citadel Asset Management (CAM) is a division of Citadel Investment Services (Pty) Ltd (registration number 1996/006847/07) (“Citadel”). Citadel, Peregrine International Wealthcare Limited (registration number 39538) (“PIW”) and Peregrine Treasury Solutions (Pty) Ltd (registration number 2004/021931/07) (“PTS”) are licensed as financial services providers in terms of the Financial Advisory and Intermediary Services Act, 2002. LIMITATION OF LIABILITY This publication has been compiled for information purposes only and does not take into account the needs or circumstances of any person or constitute advice of any kind. It is not an offer to sell or an invitation to invest. Neither Citadel, H4 Collective Investments (RF) (Pty) Ltd (“H4”), Peregrine Global Funds PCC Limited (“the Company”), Peregrine Guernsey Limited (“Peregrine Guernsey”), Peregrine Treasury Solutions nor PIW accept any liability whatsoever for any direct, indirect or consequential loss arising from the use of this publication or its contents. Please be advised that this is not a full disclosure of the risks involved in making an investment in any financial product, fund or portfolio referred to in this publication. Citadel is licensed by the Financial Services Board to manage hedge funds. Hedge funds are declared collective investment schemes and unless stated otherwise, the information below relating to collective investment schemes is also applicable to hedge funds. In this publication the words “portfolio” and “fund” are used interchangeably and have the same meaning. This publication may contain information that is confidential and proprietary to the Citadel Group and neither the publication itself nor the information in it may be reproduced or distributed. Laws that restrict distribution of information about the financial products, funds and/or portfolios that are the subject of this publication may apply in certain jurisdictions. It is the responsibility of the recipient of this publication to inform him/herself of and to comply with any legal provisions, requirements and/or restrictions that may apply in any relevant jurisdiction. COLLECTIVE INVESTMENTS AND HEDGE FUNDS H4 Collective Investments Scheme Citadel has been appointed by H4 as the investment manager of various portfolios within the H4 Collective Investments Scheme. H4 Retail Hedge Fund Scheme Citadel has been appointed by H4 as the investment manager of the H4 Retail Hedge Fund Scheme. H4 Qualified Investor Hedge Fund Scheme Citadel has been appointed by H4 as the investment manager of the H4 Qualified Investor Hedge Fund Scheme. PEREGRINE FUNDS In respect of the Peregrine Global Equity Fund, the Peregrine Global Dividend Fund and the Peregrine Global Real Estate Fund (“the Peregrine Funds”) The Company is a protected cell company registered in Guernsey and has been declared by the Guernsey Financial Services Commission (“GFSC”) as a collective investment scheme of Class B. The Peregrine Funds have been approved for marketing in South Africa by the Financial Services Board in terms of section 65 of the Collective Investment Schemes Control Act, 2002 (“CISCA”). The Company has appointed Peregrine Guernsey Limited (“Peregrine Guernsey”), registration number 36784, as the principal manager and investment manager of the Peregrine Funds. Peregrine Guernsey is licensed by the GFSC as an investment manager. The Company has also appointed Citadel as the investment advisor of the Peregrine Funds. GENERAL Collective investment schemes are generally medium to long-term investments. The value of participatory interests or the investment may go down as well as up. Past performance is not necessarily a guide to future performance. Collective Investment schemes are traded at ruling prices and can engage in borrowing and scrip lending. A schedule of fees and charges and maximum commission is available on request from H4 or Peregrine Guernsey for their respective funds. No performance fees are currently levied in any of the H4 portfolios. Neither H4, the Company, Peregrine Guernsey, Citadel nor PIW provides any guarantee either with respect to the capital or the return of any of the funds. H4 has the right to close the H4 Collective Investments Scheme portfolios to new investors in order to manage them more efficiently in accordance with their mandates. Figures quoted are from Citadel, Morningstar, Datastream, Peregrine Guernsey, MSCI and Bloomberg. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This document is not approved, endorsed, reviewed or produced by MSCI. None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such. Where a FTSE/JSE index (“the FTSE/JSE index”) is referenced in this document, copyright therein vests in FTSE International Limited (“FTSE”) © FTSE 2016. “FTSE®” is a trade mark of the London Stock Exchange Group Companies and is used by FTSE under licence. “JSE” is a trade mark of the JSE Limited and is used by FTSE under licence. The FTSE/JSE index is calculated by FTSE in conjunction with the JSE. All intellectual property rights in the index

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DISCLAIMER I CONTINUED values and constituent list vests in FTSE and the JSE. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE/JSE Indices and/or FTSE ratings or underlying data. No further distribution of JSE indices data is permitted without the JSE’s express written consent. PERFORMANCE DISCLOSURES The performances calculated and shown are those of the portfolios. Individual investor performances may differ as a result of initial fees (if applicable), the actual investment date, the date of reinvestment and dividend withholding tax. Where periods of longer than one year are used in calculating past performance, certain figures may be annualised. Annualisation is the conversion of a rate of any length of time into a rate that is reflected on an annual basis. PERFORMANCE FEES In respect of the Peregrine Global Equity Fund, a performance fee of 15% of the excess performance over the benchmark is calculated daily and paid at the end of each calendar year. The H4 Focused Wealth Fund charges a performance fee of 20% of the excess total return above the fund’s benchmark over a rolling 1-year period and capped at 1% per annum, which is calculated daily and deducted monthly on a high-water mark principle. DISCLOSURES IN RESPECT OF THE CITADEL SA MONEY MARKET H4 FUND A money market portfolio is not a bank deposit account. The price of participatory interests is targeted at a constant value. The total return to the investor is made up of interest received and any gain or loss made on any particular investment, and in most cases the return will merely have the effect of increasing or decreasing the daily yield, but in the 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 – in such circumstances a process of ring-fencing of withdrawal instructions and managed pay-outs over time may be followed. The yield is calculated monthly using historical figures and is annualised. DISCLOSURES IN RESPECT OF THE CITADEL GLOBAL EQUITY H4 FUND OF FUNDS AND THE CITADEL H4 QUALIFIED INVESTOR HEDGE FUND These portfolios are a fund of funds, and a fund of hedge funds, respectively. A fund of funds portfolio invests in portfolios of collective investment schemes. A fund of hedge funds invests in other hedge funds. These other collective investment schemes and hedge funds into which the primary fund invests levy their own charges, which could result in a higher fee structure for the fund of funds or fund of hedge funds, as the case may be. DISCLOSURES IN RESPECT OF THE CITADEL SA MONEY MARKET H4 FUND, THE CITADEL SA BOND H4 FUND AND THE CITADEL SA INCOME H4 FUND The yield is historic and is calculated as at the stipulated date. DISCLOSURES IN RESPECT OF THIRD-PARTY-NAMED PORTFOLIOS A third-party-named portfolio bears the name of both the collective investment scheme manager (“the manager”) and the investment manager. The manager retains full legal responsibility for the third-party-named portfolio. TOTAL EXPENSE RATIO (TER) AND TRANSACTION COSTS The TER is a calculation of the charges, levies and fees incurred in the management of this fund as a percentage of the average NAV (net asset value). A higher TER does not necessarily imply a poor return, nor does a low TER imply a good return. The current TER may not necessarily be an accurate indication of future TERs. The TER does not include Transaction Costs, which are shown separately. Transaction Costs are a necessary cost in administering the fund and impacts fund returns. It should not be considered in isolation as returns may be impacted by many other factors over time including market returns, the type of financial product, the investment decisions of the investment manager and the TER. RISK WARNING It is important to note that there are many risks associated with investing in collective investment schemes. These can include but are not limited to the following: general market risks (such as general movements in interest rates; external factors [war, natural disasters and such like]; changes to the law and regulatory frameworks; governmental policy changes; global, regional or national economic developments), risks related to a specific security (like the possibility of a company’s credit rating being downgraded); and loss in the purchasing power of an investment as a result of an increase in the price of consumer goods (known as inflationary risks). FOREIGN SECURITIES Some of the portfolios referred to in this publication may invest in foreign securities. There are potential material risks associated with investing in foreign securities. These include but are not limited to: potential constraints on liquidity and the repatriation of funds,

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DISCLAIMER I CONTINUED macroeconomic risks, political and social instability, foreign exchange risks, tax risks, settlement risks and potential limitations on the availability of market information, all of which may have an impact on fund performance. In addition, risks associated with investing in emerging markets (which are generally less mature than those in developed markets) include but are not limited to currency risks, the possibility of expropriation, confiscatory taxation or nationalisation of assets and the establishment of foreign exchange controls which may include the suspension of the ability to transfer currency from a given country. DERIVATIVES Some of the portfolios referred to in this publication may have exposure to derivatives. Derivatives derive their value from the value of an underlying asset. Investing in derivatives involves risk because depending on how the derivative is structured, the portfolio’s losses or gains may be unlimited. To prevent this, the portfolio’s derivative positions must be “covered” at all times. This means that the portfolio must always hold the underlying asset on which the derivative is based, or have sufficient cash or “margin” to deliver if the portfolio’s derivative positions move against it. The use of derivatives in collective investment schemes is governed by regulation. Derivatives can be used only for efficiency in portfolio management, for increasing a portfolio’s yield, or to protect the portfolio against losses if the value of the shares or instruments invested in, or the market, falls. They may not be used for speculating or for enhancing the return of the portfolio by using gearing. The most common derivatives are options (puts and calls) and futures. Hedge funds use complex hedging strategies that include the use of leverage to increase the exposure of the portfolio beyond the capital that is employed to an investment. Leveraging includes the use of derivatives. Other risks to which hedge funds are exposed include counterparty risk and liquidity risk. Counterparty risk is the risk that the other party to a transaction may not be able to perform their obligations. Liquidity risk means that during volatile periods, the tradability of certain instruments may be impeded. A qualified investor hedge fund portfolio’s gross exposure to the market is unlimited. A retail hedge fund portfolio’s gross exposure to the market may be up to 200% of the total net asset value of the portfolio. CALCULATION OF THE NAV AND PRICE The value of participatory interests is calculated on a NAV basis. The NAV is the total value of all assets in the portfolio including any income accruals and less any deductible expenses (which may include audit fees, brokerage, service fees, securities transfer tax and bank charges). The price of participatory interests is calculated by dividing the NAV by the number of participatory interests in issue. The portfolios are available via certain LISPs, who levy their own fees. Investors in these portfolios may thus be liable for an initial fee and/or annual service fee levied by the third party administrator that is not reflected in the initial charge (where applicable) or NAV calculation. ADDITIONAL INFORMATION The manager of the H4 Collective Investments Scheme, the H4 Retail Hedge Fund Scheme and the H4 Qualified Investor Hedge Fund Scheme is: H4 Collective Investments (RF) (Pty) Ltd situated at The Citadel, 15 Cavendish Street, Claremont; PO Box 23388, Claremont, 7735. Peregrine Funds principal manager and investment manager: Peregrine Guernsey Limited, Canada Court, Upland Road, St Peter Port, Guernsey, C.I., GY1 3QE Citadel and H4 are members of the Association for Savings and Investment South Africa (ASISA). Peregrine Guernsey is an associate member of ASISA.

Citadel Investment Services Proprietary Limited is licensed as a financial services provider in terms of the Financial Advisory and Intermediary Services Act, 2002.

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