In the first half of 2017 the U.S. stock market advanced with the S&P 500 Index returning 9.34% and the Russell 3000 Index returning 8.93%. Davis Opportunity Fund outperformed the broader market, returning 10.23% in the period. Consumer discretionary and information technology contributed to relative results while energy was a detractor.
The U.S. economy continues to expand with relatively full employment, prompting the Federal Reserve to raise short-term interest rates earlier this year. Still, both interest rates and inflation remain subdued. At the same time, many U.S. businesses have generated what we consider robust earnings growth in recent periods. Market valuations reflect this healthy backdrop on balance. Given this fact, we believe it is perhaps more critical than at any other point in the current business cycle for investors to select companies individually using true active management as businesses differ widely in their growth rates and valuations and, as a result, in their risk and return profiles. We continue to find value on a company by company basis and are focusing heavily on areas of the market where operating margins have room to improve and where meaningful inefficiencies persist such as financial services, energy and industrial businesses. We have also made long-term investments in leading technology companies whose long-term growth is more durable than the market recognizes in our estimation.
When evaluating the investment landscape, we do not make investment decisions based on short-term forecasts, which history has shown can be unreliable. Instead, we focus on the important and knowable while maintaining a long-term perspective.
In today’s market, our long-range assumptions include:
- Equities should outperform bonds over the next decade given bond yields are at low levels not seen for centuries.2
- Within the equity universe, selectivity is critical. Durable, well-managed businesses whose true value is not recognized by the market in the near term should ultimately outperform.
- Opportunities in today’s market include global leaders selling at bargain prices, dominant lesser-known businesses in necessary economic niches, blue chips of tomorrow, and beneficiaries of short-term misperceptions.3
- Risks in today’s market include companies with near peak profit margins and overvalued dividend darlings that are riskier than they appear.
- Technology and globalization are reconfiguring industries at an unprecedented rate. Many longstanding brands and business moats that enable companies to maintain competitive advantages are being disrupted in unexpected ways. For example, in recent years, iconic companies in the newspaper, retailing and media industries have become obsolete. At the current rate of change, 75% of the companies in the S&P 500 Index could be replaced in the coming decade. To succeed, investors should avoid conventional thinking and remain flexible.
The average annual total returns for Davis Opportunity Fund Class A shares for periods ending June 30, 2017, including a maximum 4.75% sales charge, are: 1 year, 16.27%; 5 years, 15.71%; and 10 years, 5.90%. The performance presented represents past performance and is not a guarantee of future results. Total return assumes reinvestment of dividends and capital gain distributions. Investment return and principal value will vary so that, when redeemed, an investor’s shares may be worth more or less than their original cost. The total annual operating expense ratio for Class A shares as of the most recent prospectus was 0.95%. The total annual operating expense ratio may vary in future years. Returns and expenses for other classes of shares will vary. Current performance may be higher or lower than the performance quoted. For most recent month-end performance, click here or call 800-279-0279. The Fund’s performance benefited from IPO purchases in 2010, 2013 and 2014. After purchase, the IPOs rapidly increased in value. Davis Advisors purchases shares intending to benefit from long-term growth of the underlying company; the rapid appreciation of the IPOs were unusual occurrences.
This report includes candid statements and observations regarding investment strategies, individual securities, and economic and market conditions; however, there is no guarantee that these statements, opinions or forecasts will prove to be correct. Equity markets are volatile and an investor may lose money. Past performance is not a guarantee of future results. 1 Class A shares without a sales charge. Past performance is not a guarantee of future results. 2 Common stocks and bonds represent different asset classes subject to different risks and rewards. Unlike bonds, the Fund does not offer a fixed rate of return if held to maturity, and the Fund has risks not associated with holding a bond. Bonds are considered to have less risk than equities. Future economic events may favor one asset class over another. 3 While we research companies subject to such contingencies, we cannot be correct every time, and a company’s stock may never recover.
Portfolio Review
Dominant market leaders. Out-of-the-spotlight businesses. Contrarian investments.
Davis Opportunity Fund is built from the bottom up, company by company, with the goal of compounding our investors’ capital at a satisfactory rate over a multiyear time horizon. In our experience, this patient, time-tested approach is a reliable method for growing shareholder wealth over the long term.
The Portfolio holds three categories of investments:
- Dominant market leaders
- Lesser-known “out–of–the–spotlight” businesses
- Contrarian investments
Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial), a representative market leader in the Portfolio, is a diversified holding company with interests in insurance, reinsurance, railroads, utilities, manufacturing, retailing, and a host of other business lines.4 Under the strong leadership of Warren Buffett (Trades, Portfolio) and team the company has compounded book value at almost 20% per year on average over the last 50 years. During that time Berkshire has quietly evolved from a textile manufacturer to a well-run insurance operation and more recently to a diversified business with almost two-thirds of its earnings generated by nonfinancial operations. We believe Berkshire is a financial powerhouse and well positioned for continued steady growth, although at a somewhat slower pace given its already large size.
Amazon (AMZN, Financial), an e-commerce giant that has profoundly reshaped the retail industry over the years, is another example of a market leader in the Portfolio. Borrowing a concept from Costco, Amazon offers an optional membership-based business model through its Amazon Prime service. In addition to its retail business, Amazon has a state-of-the-art, rapidly growing web services business that enables companies and other organizations to outsource their computer systems to Amazon’s digital cloud.
A representative out-of-the-spotlight business is Adient (ADNT, Financial), a global manufacturer of automotive seating and interiors that was spun-off from Johnson Controls in October 2016. Headquartered in Dublin, Ireland, the company is the industry’s leading seating supplier delivering 25 million seating systems per year to 40 different original equipment manufacturers. Adient is an attractive new addition to our Portfolio given its seasoned management team, dominant market share and low valuation.
Liberty Global (LBTYA, Financial) is another example of a dominant, lesser-known business. The company is a leader in cable television and broadband services throughout Europe and is controlled by John Malone, a pioneer in the U.S. cable industry with an outstanding record as a capital allocator. During the past decade, Liberty Global has opportunistically acquired several European cable TV systems, most of which were inefficiently run. We expect Liberty Global to improve the efficiency of these operations substantially over time and seek expansion opportunities in a shareholder friendly manner.
A representative contrarian investment and recent addition to the Portfolio is FedEx (FDX, Financial), one of the few U.S. conglomerates left that is still closely associated with its living founder, Fred Smith. Since the company was established in 1971, FedEx has become a leader in the integrated package delivery business, alongside the United Parcel Service (UPS) as well as the U.S. Postal Service domestically and a more fragmented array of competitors internationally. We believe FedEx is an attractive business given the industry’s high barriers to entry as well as the company’s growth potential in e-commerce and its exceptional management team. Notwithstanding the cloud FedEx faces given possible competition from Amazon’s potential entry into the package delivery industry, we believe FedEx is currently trading at a below-average valuation with an above-average potential growth rate.
Overall, we believe the durability and growth potential of the individually selected companies that make up Davis Opportunity Fund position us strongly for the years and even decades to come.
At Davis Advisors we seek to own durable businesses at attractive prices that can be held for the long term. The Davis family, our firm and our employees have more than $2 billion invested side by side with clients.5 We look forward to continuing our investment journey together.
4 Individual securities are discussed in this piece. While we believe we have a reasonable basis for our appraisals and we have confidence in our opinions, actual results may differ materially from those we anticipate. The return of a security to the Fund will vary based on weighting and timing of purchase. This is not a recommendation to buy, sell or hold any specific security. Past performance is not a guarantee of future results.5 As of June 30, 2017.
This report is authorized for use by existing shareholders. A current Davis Opportunity Fund prospectus must accompany or precede this material if it is distributed to prospective shareholders. You should carefully consider the Fund’s investment objective, risks, charges, and expenses before investing. Read the prospectus carefully before you invest or send money.
This report includes candid statements and observations regarding investment strategies, individual securities, and economic and market conditions; however, there is no guarantee that these statements, opinions or forecasts will prove to be correct. These comments may also include the expression of opinions that are speculative in nature and should not be relied on as statements of fact.
