Summary
•”‚ Davis Global Fund has outperformed the MSCI ACWI® (All Country World Index) over the most recent one, three, five, and 10 year periods and since the Fund’s inception in December 2004.¹
• The Portfolio holds best of breed businesses from around the world, including leading U.S. companies, European multinationals and select businesses in developing countries.
•”‚ Investment opportunities include businesses we believe represent quality on sale, blue chips of tomorrow, national giants in select developing markets, and beneficiaries of an expanding global middle class.
•”‚ In our experience, bottom-up stock selection and not mirroring an index are the keys to long-term outperformance.
•”‚ The Davis family, employees and directors are the largest shareholders in the Davis Global Fund.²
Investment Results
The Davis Global Fund has outper formed the MSCI ACWI® over the trailing one, three, five, and 10 year periods and since its inception.3
Davis Global Fund uses rigorous independent research to invest in durable, well-managed businesses with sustainable competitive advantages and attractive long-term growth prospects selling at a discount to their true value. Bottom-up stock selection performed by seasoned investment professionals—combined with our willingness not to mirror an index—has served our shareholders well over the long term. •
Global Investment Landscape
On June 23 of this year, in a 51.9% majority decision the United Kingdom (U.K.) surprised the world by deciding to end 43 years of membership in the European Union (EU) and its predecessor, the European Community. The markets had been rallying in anticipation the United Kingdom would vote to remain and experienced a rapid two-day reversal, which as of this writing was followed by a partial recovery as the initial shock wore off. The most important factor for investors to understand upfront is the long-term effects of the United Kingdom’s decision to leave the European Union, referred to as Brexit, are too complex to forecast.
With so many powerful forces at work such as investor confidence, politics, nationalism, trade relationships, currency exchange rates and more, we must be prepared for a wide range of outcomes as well as increased market volatility. However, erecting trade barriers where none existed is highly likely to have a negative impact on the U.K. economy and many British companies. The uncertainty surrounding terms of trade with the rest of Europe, London’s position as the financial center for Europe, and even whether Scotland and Northern Ireland will decide to remain in the European Union are likely to slow investment in the U.K.
The long-term impact of Brexit on the global economy, however, is likely to be limited. With the U.K. representing 3.9% of the world’s gross domestic product (GDP) and 16.7% of the EU’s GDP, an economic slowdown in the U.K. will likely have some impact but not a major one.4 The U.K.’s trading partners will also have ample time to adjust as the process for leaving is expected to last about two years. Other Western European nations such as Norway and Switzerland have already chosen not to be part of the EU and have still achieved good economic growth. The range of outcomes for Brexit, however, also includes the possibility other countries might consider leaving the EU, which is a scenario we will monitor as this development might lead to further disruption.
In the end Brexit is unlikely to have a major long-term impact on Davis Global Fund. As of June 23, before the results of the referendum were known, Davis Global Fund had less than 1% of its assets in U.K. companies and less than 5% of its assets in eurozone countries. Macroeconomic factors such as Brexit can influence the earning power of our companies but the long-term driver of value remains the durability of the business, the ability of management to adapt and the price we pay to invest. •
The Davis Investment Approach to Ever-Changing Markets
Investing around the world in leading U.S. businesses, European multinationals and select businesses in developing countries
Because economies and markets continually change, at Davis Advisors we place great importance on the resiliency and adaptability of our companies. We focus on resilient businesses because as long-term investors we know during our holding period both the global economy and our companies are likely to confront major challenges. We look for companies with strong balance sheets and strong cash generating capabilities that cannot only survive economic downturns but can also take advantage of instability to widen their competitive lead.
To create wealth for our investors, however, we know we must do more than just preserve wealth. For example, the purchasing power of a dollar in 1969 declined 85% by 2016.5 Well-selected businesses with the ability to adapt to our changing world, however, can offer a terrific way to combat the insidious effects of inflation. Otis Elevator, for example, was founded more than 160 years ago in 1853 and has been installed in many of the world’s most famous structures including the Eiffel Tower and the Empire State Building. The company’s brand, high quality and reliability have enabled Otis to adjust pricing over time ensuring strong profitability. United Technologies, one of Davis Global Fund’s largest holdings, has owned Otis Elevator since 1976.6
Adaptability not only results in pricing power but also the ability to create new markets. Amazon (AMZN, Financial) provides a prime example. Looking back at Amazon’s humble beginnings in 1994, clearly one of the reasons the company became the world’s largest bookseller was that Amazon created entirely new markets. The Kindle E-reader was not only a product innovation but also a business model innovation. Printing and shipping costs suddenly disappeared, combining improved convenience for consumers with higher profits for Amazon. Company founder Jeff Bezos and his team then proved they would not be satisfied to sit on their laurels by parlaying their expertise in cloud computing, gained from running their retail business, to an Infrastructure as a Service (IaaS) business for third parties. Thus, was born Amazon Web Services (AWS), which reached $10 billion in sales even faster than Amazon’s retail business and which one day might surpass the retail segment in size.7
United Technologies (UTX, Financial) is a good example of a company with both a durable business and an innovative culture. United Technologies’ four business segments are of roughly equal size and include Pratt & Whitney jet engines and aerospace parts such as landing gear and nacelles (the outer casing of an aircraft engine), Otis Elevator, and Carrier heating and ventilation systems. Pratt & Whitney, for example, enjoys solid growth prospects driven by increased global travel as well as a favorable market structure with only one key competitor in the narrow body or single aisle commercial aircraft business. Moreover, Pratt & Whitney is now rolling out its new PurePower Geared Turbofan (GTF) jet engine that, according to United Technologies, reduces fuel consumption by 16%, environmental emissions by 50% and noise levels during landing and takeoff by 75%.8 According to industry observers, Pratt & Whitney’s GTF jet engine represents one of the biggest advances in jet engines in the past 50 years, which could result in strong sales going forward. At $100 a share, United Technologies is trading at an attractive 15.5 times 2016 owner earnings.9
A third representative holding is Naspers (NPN, Financial), a company most investors would not recognize despite its $60 billion market capitalization. Naspers is a South African conglomerate that owns a diverse array of media and Internet holdings in emerging markets. The company’s satellite TV business is the largest in Africa with 10 million subscribers, and its online classified ad business operates in 31 countries with leading positions in key markets such as Brazil, India, Indonesia, and Russia. Naspers also owns 15% of Flipkart, one of the leading e-commerce businesses in India. Moreover, in 2010 Naspers invested $34 million in Tencent Holdings, one of China’s largest, most innovative and most used Internet portals, and today the company’s 34% stake is worth $72 billion. Considering that Naspers total market capitalization is $60 billion and also includes other assets, the company’s valuation is attractive in our view.
Given Tencent (HKSE:00700, Financial)’s key position in Naspers’ business, examining Tencent’s operations more closely is worthwhile. Tencent is led by Chinese entrepreneur Ma Huateng, also known as Pony Ma. The company’s messaging app WeChat has 700 million users and is the leading social media website in China. In addition, Tencent is one of the world’s largest video gaming companies with such popular games as League of Legends, CrossFire and Dungeon Fighter Online as well as an 84% stake in one of the world’s leading mobile video gaming companies Supercell. In addition, Tencent has built a highly desirable portfolio of strategic investments in other leading Internet companies such as e-commerce company JD.com, U.S. video game leader Activision Blizzard, China’s ride-sharing leader Didi Chuxing, and classified ads leader 58.com. Through our investment in Naspers we are effectively investing in Tencent at a 15% discount and paying 23 times 2017 owner earnings for a company growing revenues and earnings at 25% to 30% a year.
While we generally avoid commodity producers because these businesses are capital intensive and dependent on underlying commodity prices, these companies can be attractive when three factors are in our favor: 1) the current commodity price is well below the price necessary to supply the market over the long term; 2) the company is the low cost producer and has a large amount of reserves; and 3) management has a proven focus on shareholder returns rather than production.
Our fourth representative holding is the Canadian shale oil and gas company Encana (ECA, Financial), a business that fits all three of these criteria. Based on global supply and demand projections for oil, we do not believe the current price of $45 per barrel is sustainable.10 In our view, oil prices will have to increase significantly over time to provide enough supply to meet growing global demand. In addition, because Encana’s reserves are located in the core of four of the top six shale areas in North America, Encana’s costs to develop and produce oil and gas are quite low.
Moreover, Encana’s reserves of oil and gas are so large the company has decades of production ahead based on current production levels.
Finally, when Doug Suttles became CEO in 2013 he promptly reduced the territories on which the company focuses to four core areas. A willingness to shrink and focus is rare and is a key trait of successful CEOs. Suttles has also executed well by ensuring Encana’s survival during the energy downturn through hedges and asset sales and increased operating efficiency by rapidly bringing well costs down. Based on our conservative estimate of the long-term sustainable price for oil and gas, Encana is trading at 12 times 2018 owner earnings, which is highly attractive considering we expect the company to increase production at a rate of 15% a year for many years to come. •
Conclusion
As I am writing this year’s semi-annual review, I am visiting companies in Asia. We are excited by the quality and valuation of the companies that make up Davis Global Fund; we are well positioned to build on the Fund’s long-term record of growing shareholder wealth; and as always, we are mindful of our stewardship responsibility and grateful for your trust. As the largest shareholder of Davis Global Fund, we look forward to investing side by side with our shareholders over the years ahead. •
This report is authorized for use by existing shareholders. A current Davis Global 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.
Objective and Risks. Davis Global Fund’s investment objective is long-term growth of capital. There can be no assurance that the Fund will achieve its objective. Some important risks of an investment in the Fund are: stock market risk: stock markets have periods of rising prices and periods of falling prices, including sharp declines; manager risk: poor security selection may cause the Fund to underperform relevant benchmarks; common stock risk: an adverse event may have a negative impact on a company and could result in a decline in the price of its common stock; foreign country risk: foreign companies may be subject to greater risk as foreign economies may not be as strong or diversified; emerging market risk: securities of issuers in emerging and developing markets may present risks not found in more mature markets. As of June 30, 2016, the Fund had approximately 34.9% of assets invested in securities from emerging markets; foreign currency risk: the change in value of a foreign currency against the U.S. dollar will result in a change in the U.S. dollar value of securities denominated in that foreign currency; depositary receipts risk: depositary receipts involve higher expenses and may trade at a discount (or premium) to the underlying security; large-capitalization companies risk: companies with $10 billion or more in market capitalization generally experience slower rates of growth in earnings per share than do mid- and small-capitalization companies; mid- and small- capitalization companies risk: companies with less than $10 billion in market capitalization typically have more limited product lines, markets and financial resources than larger companies, and may trade less frequently and in more limited volume; headline risk: the Fund may invest in a company when the company becomes the center of controversy. The company’s stock may never recover or may become worthless; and fees and expenses risk: the Fund may not earn enough through income and capital appreciation to offset the operating expenses of the Fund. See the prospectus for a complete description of the principal risks.
The Fund is subject to a 2% short-term redemption fee for shares held for fewer than 30 days.
Davis Advisors is committed to communicating with our investment partners as candidly as possible because we believe our investors benefit from understanding our investment philosophy and approach. Our views and opinions include “forward-looking statements” which may or may not be accurate over the long term. Forward-looking statements can be identified by words like “believe,” “expect,” “anticipate,” or similar expressions. You should not place undue reliance on forward-looking statements, which are current as of the date of this report. We disclaim any obligation to update or alter any forward-looking statements, whether as a result of new information, future events, or otherwise.
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 information provided in this material should not be considered a recommendation to buy, sell or hold any particular security. As of June 30, 2016, the top ten holdings of Davis Global Fund were: Amazon.com, Inc., 6.52%; Berkshire Hathaway Inc., Class B, 5.50%; Encana Corp., 4.99%; Alphabet, Inc., 4.43%; Didi Chuxing Joint Co., Series A, Pfd., 4.35%; Naspers Ltd.–N, 4.24%; Wells Fargo & Co., 3.62%; Quotient Technology, Inc., 3.61%; JPMorgan Chase & Co., 3.06%; United Technologies Corp., 3.01%.
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