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The investment philosophy Q & A is structured in the following sections:

Equity Funds

What is your investment philosophy?

The Orbis funds seek to invest in shares of companies that trade at a significant discount to our assessment of the intrinsic value of the business. We believe the share prices of such companies will eventually appreciate to reflect the intrinsic business value. The timing of the price move is uncertain, but the funds are prepared to be patient and invest in the company with a three to five year investment horizon. If executed in a disciplined and consistent manner such an investment philosophy offers the potential for superior returns and reduced risk of loss.

Isn't the market efficient? How can the Orbis funds make money?

We believe the market is not always efficient or rational. Investors are often driven by emotions, especially fear and greed, and easily succumb to their herd instincts. They also place too much emphasis on the latest short-term news and overlook the long-term fundamental prospects of the business or the economy. As a result, many companies are out of favour, misunderstood, and spurned by investors because of excessive pessimism on recent unfavourable developments. The share prices of such companies trade significantly below the long-term intrinsic value of the underlying business. We seek such opportunities and the funds buy into these companies. Poor sentiment will eventually subside as the business fundamentals come through and investors recognise the intrinsic value of the company. The funds sell when the share price approaches the intrinsic value, and when we can identify more attractive opportunities.

How do you summarise your investment style?

We are often seen as focused, contrarian, value-oriented managers investing for the long term.

  • Focused: Each of our equity funds typically contains no more than 50 primary positions at any one time.
  • Contrarian: We often find our funds buying shares that few others like and selling them when they are popular.
  • Value-oriented: We are not 'value' managers in the sense of buying only stocks with low price/earnings ratios or avoiding companies with high growth. We focus on intrinsic value and hold shares selling at low prices relative to their intrinsic value.
  • Long term: Intrinsic value often takes time to be recognised by the broader market. We therefore do our research with at least a four-year time horizon and our funds tend to buy and hold.

How do you identify your investment ideas?

Because the funds profit from the divergence between share prices and intrinsic value of individual companies, we have a "bottom-up" process geared towards researching individual companies. The process is highly structured and dependent on intensive proprietary investment research. Potential opportunities are initially identified in various ways, including computerised screening. Our proprietary database contains prices and company fundamental data of more than 7,000 companies going back nearly 30 years. A valuation model uses the data and estimates the intrinsic value and the expected return of each equity over the next four years. The most attractive companies will be candidates for further intensive research.

This approach is in contrast to a 'top-down' process that focuses initially on macro-economic factors, such as cycles of growth and interest rates, in seeking to identify the most attractive countries and sectors. Only then are individual companies identified to match the desired country and sector positions.

What is your investment process?

The investment process is research intensive and focuses on understanding the underlying business of the company. It starts with the identification of research ideas, often with the help of our proprietary database. The attractive companies are then analysed further by our in-house investment professionals in a structured and intensive process. This final in-depth research stage typically takes two to three weeks and includes evaluating the company's perceived ability to generate superior growth in cash flow, earnings and dividends in the projected economic environment, the quality of management, its historical record, the company's competitive environment and the strength of its balance sheet. This culminates in an assessment of the business's intrinsic value. Companies whose share prices sell at a significant discount to the intrinsic value are recommended for discussion at the Policy Group, which consists of the portfolio manager, the chairman, and other senior analysts. The portfolio manager will decide independently whether to accept the buy recommendation.

How do you construct a portfolio from your buy ideas?

In constructing the equity portfolio, we look at each idea's perceived risk and reward, as well as its correlation with the rest of the portfolio. Computer tools are available for assessing the incremental impact of changing individual positions on the characteristics of the overall portfolio. Our equity portfolios are focused, usually with only about 50 primary positions of our favourite ideas. We avoid over-diversifying the portfolios with large number of stocks, as it dilutes the impact our ideas will have on the performance.

How do you manage risk?

On an individual stock level, our investment approach incorporates some inherent protection against risk of loss. When we buy companies selling at significant discount to intrinsic value, the discount offers a margin of safety. The bigger the discount, the bigger the margin of safety, and the bigger the cushion against error and uncertainties.

On a portfolio level, we regularly review the risk-return tradeoffs of large exposures to factors such as countries or industries and seek to reduce those that do not offer commensurate returns. We also conduct top-down macro-economic reviews to ensure exposures built up from our bottom-up company view do not conflict with our top-down views. The funds do not necessarily track the benchmark index if it means sacrificing potential returns. The funds may therefore differ significantly from the benchmarks. Compared with other investment firms, we focus more on managing the risk of loss in the funds and less on managing the risk of the funds underperforming their benchmarks over the short term.

What has been the risk experience of the funds?

Our investment approach usually results in the equity funds having less dramatic declines and faster recoveries than their respective benchmarks and they may at times have a beta that is significantly less than one. On the other hand, their differences to their benchmarks often create a higher tracking versus the benchmark than that of the average fund and they can therefore have a higher risk of underperformance in the short term.

Absolute Return Funds

Why do you have absolute return funds?

The main risk of investing in equities is that the stockmarket declines significantly. In this scenario, most equity funds, including the Orbis ones, are likely to lose money, irrespective of the stock-picking skills of the manager. Our equity funds can outperform relativeto their benchmarks but still lose money in the absolute sense. Our absolute return funds, on the other hand, aim to deliver a return that does not depend on trends in the overall stockmarket, but more on the skills of the manager. The better the investment skills of the manager, the higher the positive returns the funds can earn over cash. The funds are most suitable for investors wanting an absolute return with low correlation with other investments.

How do the funds deliver the absolute returns?

The key is to gain exposure to equities that can outperform the stockmarket and at the same time remove the exposure to the stockmarket. Orbis Optimal Funds achieves this simply by investing in the Orbis equity funds and then reducing the stockmarket exposure ("hedging") by selling stockmarket index futures and buying stockmarket index put options. This leaves Orbis Optimal Funds with the difference in returns between the equity funds and the stockmarkets (plus the returns on cash from the futures sold). The better our stock-picking skills, the higher the outperformance of the equity funds versus their benchmarks, and the higher the absolute returns in Orbis Optimal Funds. The Orbis equity funds' long record of earning materially higher returns than their benchmark stockmarket indices has enabled Orbis Optimal Funds to earn a satisfactory absolute rate of return.

Orbis Leveraged Funds generates its absolute returns using Orbis Optimal Funds. It provides a substantially higher risk/higher return investment by borrowing money to invest in Orbis Optimal Funds. As long as Orbis Optimal Funds' underlying equities outperform their respective stockmarkets, Orbis Optimal Funds can generate a return higher than cash, and the borrowed money in Orbis Leveraged Funds can earn a return higher than the cost of borrowing.

The structure of Orbis absolute return funds is as follows:

Are these "hedge funds" then? Aren't they very risky?

Most hedge funds pursue strategies that generate absolute returns. So in that sense, our absolute return funds are similar to the hedge funds. However, different investment strategies lead to different levels of risk. Orbis Optimal Funds' strategy aims to reduce the risk of the stockmarket through hedging, so it is a very low-risk strategy. We believe Orbis Optimal Funds offers the lowest risk of loss amongst all of the Orbis mutual funds.

Another important element of risk in a hedge fund is the financial gearing employed — the more a fund borrows to invest, the higher the risk of losing everything the investors have put in. Orbis Leveraged Funds borrows one dollar for each dollar the investors put in.