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PRIMECAP Odyssey Funds Letter to Shareholders from 2014 Semiannual Report

July 22, 2014
Vera Yuan

Vera Yuan

81 followers
Dear Fellow Shareholders,

For the six months ended April 30, 2014, the PRIMECAP Odyssey Stock Fund, PRIMECAP Odyssey Growth Fund, and PRIMECAP Odyssey Aggressive Growth Fund produced total returns of +7.47%, +4.79%, and +4.59%, respectively, in each case below the +8.36% return of the unmanaged S&P 500 Index.

During the fiscal year ended October 31, 2013, smaller, more aggressive, growth-oriented stocks generally outperformed the broader market. While this trend continued through most of the interim period ended April 30, 2014, a major reversal occurred in mid-March when many leader- ship stocks from the prior year suddenly began to decline, in some cases dramatically. Internet and biotechnology stocks, especially those with small market capitalizations, experienced the most substantial price declines. As these stocks declined, larger, more defensive, value-oriented stocks began to appreciate.

The Federal Reserve continued to tighten U.S. monetary policy by “tapering” the amount of its monthly bond purchases by $10 billion per month, though the central bank is expected to main- tain very low short-term interest rates for a considerable time after the asset purchase program ends. Long-term interest rates, which had risen in calendar 2013, decreased during the first part of 2014 with the 10-year Treasury Bond yielding 2.65% on April 30, 2014, down from 2.97% on December 31, 2013.

Turning to the portfolios, the aforementioned reversal in market sentiment had negative con- sequences for the funds, particularly the PRIMECAP Odyssey Aggressive Growth Fund due to its relatively higher exposure to stocks with smaller market capitalizations and higher risk- reward characteristics.

Each of the PRIMECAP Odyssey Funds continues to be overweight in the health care and information technology sectors and underweight in the consumer staples, energy, and financials sectors.

A more detailed discussion of the results of each PRIMECAP Odyssey Fund follows.

PRIMECAP Odyssey Stock Fund

From November 1, 2013 to April 30, 2014, the Stock Fund’s total return of +7.47% trailed the S&P 500’s total return of +8.36%.

Unfavorable stock selection, particularly in the health care, materials, and energy sectors, hurt the fund’s relative results. This was partially offset by positive sector allocation, including an over- weight position in health care and underweight positions in consumer staples, telecommunication services, and consumer discretionary. The largest detractors from the fund’s results were Schweitzer-Mauduit (-28%) and Amgen (-3%).

These negatives were partially offset by favorable stock selection in the industrials and financials sectors, notably Southwest Airlines (+41%), Curtiss-Wright (+29%), and Charles Schwab (+18%).

The top 10 holdings, which collectively represented 30.5% of the portfolio at the period end, are listed below:



PRIMECAP Odyssey Stock Fund



Ending % of



Top 10 Holdings as of 4/30/14



Total Portfolio*



Eli Lilly & Co.



4.2



Roche Holding AG



4.1



The Charles Schwab Corp.



3.4



Johnson & Johnson



3.4



Amgen, Inc.



3.2



Texas Instruments, Inc.



2.8



Microsoft Corp.



2.7



Carnival Corp.



2.5



Transocean Ltd.



2.2



Wells Fargo & Co.



2.0



Total % of Portfolio



30.5%

*The percentage is calculated by using the ending market value of the security divided by the total investments of the Fund.

PRIMECAP Odyssey Growth Fund

From November 1, 2013 to April 30, 2014, the Growth Fund’s total return was +4.79%, below the S&P 500’s total return of +8.36% and the Russell 1000 Growth Index’s total return of +6.95%.

Unfavorable stock selection in the information technology, health care, and consumer discretionary sectors, notably DreamWorks Animation (-30%), ImmunoGen (-21%), Stratasys (-14%), L Brands (-11%), and Amgen (-3%), accounted for most of the fund’s underperformance. These negatives were partially offset by strong stock selection in industrials, including Southwest Airlines (+41%) and Delta Air Lines (+40%).

The top 10 holdings, which collectively represented 29.7% of the portfolio at the period end, are listed below:



PRIMECAP Odyssey Growth Fund



Ending % of



Top 10 Holdings as of 4/30/14



Total Portfolio*



Seattle Genetics, Inc.



4.3



Roche Holding AG



4.2



Amgen, Inc.



3.6



Eli Lilly & Co.



3.1



Biogen Idec, Inc.



3.1



The Charles Schwab Corp.



2.6



Microsoft Corp.



2.3



Adobe Systems, Inc.



2.3



Google, Inc.**



2.2



L Brands, Inc.



2.0



Total % of Portfolio



29.7%

*The percentage is calculated by using the ending market value of the security divided by the total investments of the Fund.

**Google, Inc. holdings consist of 1.1% in Google, Inc. – Class A stock and 1.1% in Google, Inc. – Class C stock.

PRIMECAP Odyssey Aggressive Growth Fund

From November 1, 2013 to April 30, 2014, the Aggressive Growth Fund’s total return of +4.59% lagged the S&P 500’s total return of +8.36% and the Russell Midcap Growth Index’s total return of +6.04%.

Unfavorable stock selection in information technology, health care, and consumer discretionary drove most of the fund’s underperformance. DreamWorks Animation (-30%), ImmunoGen (-21%), Pharmacyclics (-20%), Dyax (-20%), and Shutterfly (-17%) were the largest detractors from the fund’s relative returns. Favorable stock selection in industrials, including American Airlines (+43%), Delta Air Lines (+40%), and United Continental (+20%), partially offset these negatives.

The top 10 holdings, which collectively represented 23.4% of the portfolio at the period end, are listed below:



PRIMECAP Odyssey Aggressive Growth Fund



Ending % of



Top 10 Holdings as of 4/30/14



Total Portfolio*



InterMune, Inc.



2.6



Blackberry Ltd.



2.4



Tribune Co. Cl A



2.4



Pharmacyclics, Inc.



2.4



United Continental Holdings, Inc.



2.3



Delta Air Lines, Inc.



2.3



Sony Corp.



2.3



Roche Holding AG



2.3



QIAGEN NV



2.2



Polypore International, Inc.



2.2



Total % of Portfolio



23.4%

*The percentage is calculated by using the ending market value of the security divided by the total investments of the Fund.

Outlook

Looking ahead, we are less constructive on the outlook for U.S. equities than we have been in recent years, though we continue to believe that many individual stocks are attractively valued and that stocks represent a more attractive investment than many other investments at current prices. As of April 30, 2014, the S&P 500 was trading at approximately 16 times 2014 earnings per share (EPS) of $119, a reasonable valuation by historical standards. Yet revenue per share growth since 2011 has been tepid at approximately 2%, suggesting that the consensus expectation of approximately 10% annual earnings per share growth through 2016 may be difficult to achieve unless revenue per share growth accelerates.

We are disappointed by the recent performance of the funds, which we attribute in part to the broader reversal in market sentiment discussed at the outset of this letter. For the six months ended April 30, 2014, the Russell 2000 Growth Index, which measures the performance of the small-cap growth segment of the U.S. stock market, produced a total return of +1.27%, well below the +8.36% total return of the S&P 500 Index, as investors shunned small-cap growth stocks in favor of large-cap value stocks. Many of the holdings in the Aggressive Growth Fund and, to a lesser extent, the Growth Fund, are smaller, earlier stage companies with high growth potential but minimal or negative current period earnings. These stocks generally offer higher potential rewards but are more volatile than those of larger, more established companies.

The funds remain significantly overweight in health care and information technology, with a par- ticular concentration in biotechnology and internet stocks. We remain confident that advances in genomics, cloud computing, and other technologies should support growth in the biotechnology and internet areas for the foreseeable future.

In conclusion, we remain committed to our investment philosophy, which is based on individual stock selection. While this “bottom-up” approach can lead to periods of underperformance when the stocks in our portfolios fall out of favor, we believe it has the potential to generate superior results for investors over the long-term.

Sincerely,

PRIMECAP Management (Trades, Portfolio) Company

May 15, 2014

Past performance is not a guarantee of future results.

The funds invest in smaller companies, which involve additional risks such as limited liquidity and greater volatility. All funds may invest in foreign securities, which involves greater volatility and political, economic and currency risks and differences in accounting methods. Mutual fund investing involves risk, and loss of principal is possible. Growth stocks typically are more volatile than value stocks; however, value stocks have a lower expected growth rate in earnings and sales.

Please refer to the Schedule of Investments for details of fund holdings. Fund holdings and sector allocations are subject to change at any time and are not recommendations to buy or sell any security.

The S&P 500 is a market capitalization-weighted index of 500 large-capitalization stocks com- monly used to represent the U.S. equity market. The Russell 1000 Growth Index is an index that measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values. The Russell Midcap Growth Index measures the performance of those Russell Midcap companies with higher price-to-book ratios and higher forecasted growth values. The Russell 2000 Growth Index measures the performance of the small-cap growth seg- ment of the U.S. equity universe. It includes those Russell 2000 companies with higher price-to- value ratios and higher forecasted growth values. You cannot invest directly in an index.

Earnings per share (EPS) is calculated by taking the total earnings divided by the number of shares outstanding.

Earnings growth is not a prediction of a fund’s future performance.

The information provided herein represents the opinions of PRIMECAP Management (Trades, Portfolio) Company and is not intended to be a forecast of future events, a guarantee of future results, or investment advice.

From PRIMECAP Management’s Semiannual Report for the Six Months Ended April 30, 2014.


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