Litman Gregory Masters Equity Fund First Quarter 2017 Attribution

During the first quarter of 2017 the Litman Gregory Masters Equity Fund rose 4.64%, lagging its Russell 3000 Index benchmark, which returned 5.74%, and the Morningstar Large Blend Category, which returned 5.56%. Since its inception on January 1, 1997, through March 31, 2017, the fund’s 7.97% return is roughly in line with the Russell 3000 Index and ahead of the Morningstar Category’s 6.52% return.i

Performance quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the funds may be lower or higher than the performance quoted. To obtain standardized performance of the funds, and performance as of the most recently completed calendar month, please visit

Themes, Trends, and Observations from the Managers*

Pat English and Andy Ramer, FMI
Stocks continued to perform well on expectations of better economic growth. Purchasing Managers’ Index numbers have improved; trade activity is reported to be higher; and, importantly, research and development and fixed business investment, as a percentage of gross domestic product (GDP), have recently improved. Unfortunately, expectations for GDP growth haven’t confirmed these figures, as the Federal Reserve Bank of Atlanta’s GDPNow forecast of the first quarter has dropped from over 3% in January to 1% at the end of March and corporate revenue growth remains in the low single digits. Earnings or rather “adjusted earnings” results are expected to continue to grow through “inorganic” means (i.e., share repurchases, write-offs of “one-time” items, and the exclusion of costs such as the amortization of intangibles and stock compensation). Stocks in general remain very expensive when measured by just about any valuation yardstick other than price-to-earnings ratios that use so-called adjusted earnings. We haven’t made significant changes in the portfolio because the relative valuations haven’t changed significantly and the long-term investment stories remain the same. Traditional defensive stocks are quite expensive from a historical perspective and are facing unprecedented growth challenges. We don’t own any of these stocks. The portfolio is exhibiting low but above-average growth in sales and earnings and below-average valuations, though it is not absolutely cheap when viewed from a long-term perspective. The portfolio’s collective balance sheet is strong. We think these positive attributes will pay off in a tough market.

Bill Nygren and Clyde McGregor, Harris Associates
Equity prices continued to climb last quarter on an improving outlook for the global economy. Though equity valuations aren’t as cheap as they once were, our outlook remains positive. We expect a combination of dividends and underlying value growth to be in the high single digits over the next couple of years. Our confidence is based on the strength of our companies’ balance sheets, low interest rates, low inflation, unprecedented global monetary stimulation, and the potential for a more favorable business climate (lower taxes, less regulation) in the United States.

In the United States, we’re finding attractive opportunities within the financial, energy, consumer discretionary, and technology sectors. We continue to avoid most companies that the market views as “stable” (like those in the telecom, utility, and consumer staples sectors) due to valuation. However, as always, we continue to view company opportunities on a case-by-case basis and believe any company can be attractive at the right price.

Scott Moore, Nuance Investments
Following several changes to the portfolio in the fourth quarter of 2016, the portfolio was stable from a sector perspective during the first quarter of 2017. We continued to add to our positions in the consumer staples sector and remain overweight as a slowdown in emerging-market economies and currency headwinds have caused modest underearning across numerous global leaders such as Unilever and Diageo. We continue to be overweight to the health care sector, as the push for health care reform following the election in November caused modest underperformance and created buying opportunities in select high-quality health care stocks, such as Abbott Laboratories and Smith & Nephew, which we continue to own. Our underweight position in financials was unchanged during the quarter as just a slight rise in interest rates and the newly recognized possibility of lessened regulation resulted in significant expectations of returns on capital and earnings expansion during the last several months. We continue to be underweight to the information technology, real estate, and consumer discretionary sectors due to valuation concerns.

Chris Davis, Davis Advisors
In the first quarter of 2017, the U.S. stock market advanced with the S&P 500 Index returning 6.07%. Our portfolio also delivered positive results but trailed the index in the first three months of the year, largely due to mixed results in energy. Our investments in, in particular, along with Alphabet and Markel were particularly accretive during the period.

Among notable developments during the quarter, the U.S. economy showed relatively strong job growth and the Federal Reserve tightened monetary policy slightly by raising the federal funds rate another 25 basis points—only the third interest rate hike since the onset of the 2007/08 financial crisis and a reflection of growing confidence the U.S. economy has improved dramatically in recent years. Business fundamentals in a wide range of industries have also generally improved markedly since the financial crisis.

That said, the S&P 500 Index has had its longest run in recent history without experiencing a meaningful correction, and as investors we must keep in mind market volatility has been unusually muted in the last few years. We do not make predictions about future market conditions as they are unknowable, but we consider it reasonable to assume over our long-term investment horizon of several years or more, the market is likely to experience both volatility and corrections. Rather than view these facts as negatives, our view, based on almost 50 years of managing money, is periods of short-term volatility and market corrections are normal. Furthermore, such periods can be beneficial as they often present opportunities for long-term investors to purchase shares in first-class companies at attractive prices.

Frank Sands, Jr. and Michael Sramek, Sands Capital
While we monitor trends and short-term market fluctuations, our focus continues to be on our businesses’ long-term opportunities. We maintain a five-year investment outlook, resulting in low portfolio turnover even when markets are volatile. We continuously look to strengthen our portfolio by investing in businesses generating above-average growth that are powered by strong secular drivers and/or promising business spaces.

In the first quarter of 2017, we witnessed a dramatic reversal in the share price performance of U.S. large-cap growth stocks as the reflation theme or “Trump trade” that was in favor at the end of 2016 lost its momentum. The market seemed to focus once again on business fundamentals. As bottom-up, fundamental investors, this return to fundamentals benefited many of the companies we own.

While we monitor macroeconomic events, we believe the uncertainty inherent in macro-driven factors reinforces the benefits of thoroughly understanding individual companies and the secular trends from which they may benefit. Regardless of the macro environment, the foundation of our investment process will always remain our bottom-up analysis of business fundamentals. Because the only certainty in financial markets might be the constant of change, we expect that selectively owning the right businesses will be the main driver of our ability to add value for clients over time.

Dick Weiss, Wells Capital Management
The U.S. markets entered the first quarter of 2017 on a high note after rallying post the nomination of now President Donald Trump in November 2016. At the start of the year, investors were optimistic about the reflation trade, which started to work in 2016, and seemed encouraged that the late 2016 market rally would continue into 2017. As the quarter progressed, the markets reached an all-time high on March 1. As the month of March progressed, the markets pulled back as optimism turned to pessimism. However, the market finished the quarter in positive territory.

Further, large caps tended to fair better than small caps, which was a stark reversal of trend from the fourth quarter of 2016. Additionally, growth outperformed value and the reflation theme faded as financial and energy stocks tended to underperform while information technology performed well. As the quarter came to a close, the stock market had risen while the 10-year yield, U.S. dollar, and investor confidence had fallen.

For the portfolio, the whipsaw of returns among sectors has created the opportunity to deploy capital. In particular, we are seeing opportunity in the beaten up soft line retail space and subsectors of health care. On the contrary, we have avoided the banking sector post a large run in the fourth quarter of 2016 due to prospects of a steepening yield curve. However, there may be opportunity if we see a pullback in this sector and valuations become more reasonable.

* The opinions herein are those of the sub-advisors at the time the comments are made and are subject to change.

Discussion of Performance Drivers

It is important to understand that the portfolio is built stock by stock with sector and cash weightings being residuals of the bottom-up, fundamental stock-picking processes employed by each of the seven sub-advisors. That said, we do report on the relative performance contributions of both sector weights and stock selection to help shareholders understand drivers of recent performance.

It is also important to remember that the performance of a stock over a single quarter tells us nothing about whether it will be a successful position for the fund; that is only known at the point when the stock is sold.

Litman Gregory Masters Equity Fund Sector Attribution

Equity Fund Attribution Chart

  • Both sector allocation and stock selection detracted from relative performance for the quarter.
  • From a sector perspective, a meaningful overweight to the outperforming information technology sector was a positive contributor to relative performance. The fund’s holdings in this sector in aggregate gained 11.17% in the quarter. Strong individual contributors include top-holding Visa (a 14.12% gain), owned by Sands and Clyde McGregor, and Oracle (a 16.47% gain), owned by McGregor and Bill Nygren. See below for more detailed discussions on these names.
  • The telecommunications sector was also a contributor to relative performance in the quarter as the fund had no exposure to this declining sector. The sector fell 3.45% in the benchmark, making it the worst-performing sector after energy.
  • Energy was the worst-performing sector for the quarter, and one of only two sectors that were negative in the period, falling 6.74% in the benchmark. Stock selection within the energy sector hurt the fund’s relative performance, with Apache (owned by Davis) and Chesapeake Energy (owned by Nygren) falling 18.71% and 15.38%, respectively. Each of these names is discussed below.
  • From a stock-selection perspective, the consumer discretionary sector was a detractor in the quarter. The worst-performing individual stock in this sector (and for the fund) was Global Eagle Entertainment, owned by Dick Weiss, which fell 50.62% in the quarter. See below for a detailed discussion on this name.
  • One bright spot in the consumer discretionary sector was, which gained 18.23%. This name is owned by both Sands and Chris Davis, at an aggregate weight of around 3%. Both managers discuss this position in greater detail below.
  • The portfolio carried an average cash position of just under 7% in the quarter. This was the largest overall detractor from relative performance.


Top 10 Contributors as of the Quarter Ended March 31, 2017

Company Name
Fund Wt. (%) Benchmark Wt. (%) Three-month Return (%) Contribution to Return (%) Economic Sector Inc. 2.90 1.33 18.23 0.50 Consumer
Visa Inc. Class A 3.36 0.67 14.12 0.45 Technology
Oracle Corp. 2.41 0.51 16.47 0.38 Technology
Facebook Inc. A 1.46 1.23 23.47 0.32 Technology Inc. 1.40 0.21 20.49 0.26 Technology
The Priceline Group Inc. 1.25 0.33 21.41 0.25 Consumer
Alibaba Group Holding 1.17 0.00 22.80 0.24 Technology
TE Connectivity Ltd. 2.81 0.00 8.14 0.24 Technology
Alphabet Inc. A 3.23 1.02 6.98 0.22 Technology
Zendesk Inc. 0.73 0.01 32.26 0.20 Technology

Portfolio contribution for a holding represents the product of the average portfolio weight and the total return earned by the holding during the period. Past performance is no guarantee of future results. Fund holdings and/or sector allocations are subject to change at any time and are not recommendations to buy or sell any security.

Edited Commentary from the Respective Managers on Selected Contributors (Chris Davis, Davis Advisors)

Amazon, an e-commerce giant that has profoundly reshaped the retail industry over the years, is an example of a market leader in the portfolio. Borrowing a concept from Costco Wholesale, Amazon offers an optional membership-based business model through its Amazon Prime service. For a relatively small annual fee, Amazon Prime members can benefit from faster, less expensive shipping on purchases, which may be an increasingly key differentiator for the company by encouraging customers to aggregate their purchases in an increasingly commoditized retail world as well as providing a source of recurring revenue. 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 electronic cloud. We expect this portion of Amazon’s business to be a key profit generator in the years ahead. The primary driver of these innovations is Amazon’s founder and CEO, Jeff Bezos, whom we regard as a true visionary leader. He is fanatical about efficiency and cost savings and has invested heavily to gain and maintain advantages over Amazon’s competition. Based on our assessment of the company’s normalized margins, competitive advantages and significant growth potential, we believe Amazon’s current intrinsic value is well above its stock price. (Frank Sands, Jr. and Mike Sramek, Sands Capital)

Amazon is one of the largest Internet-based retail businesses in the United States and a growing global leader in the computing infrastructure-as-a-service (IaaS) space. We believe each business is positioned to participate in a long-duration growth opportunity. As a retailer, Amazon is a customer-centric company where people can find nearly anything they want to buy online. We expect e-commerce growth to continue to outpace overall retail spending for the foreseeable future and believe Amazon should be a primary beneficiary of this global secular trend. The company’s IaaS offering, Amazon Web Services (AWS), provides organizations with on-demand access to computing, storage, and other services through its cloud platform. Over the coming decades, we expect AWS will be a key player in the paradigm shift toward shared infrastructure services. Amazon’s recently enhanced level of financial disclosures provides increased transparency, which helps strengthen our conviction in the overall health and growth prospects of Amazon’s retail business and significantly raises our expectations for the long-term potential of AWS. As a result, we view Amazon’s two core franchises as attractive and rapidly growing businesses that each meet our investment criteria. We anticipate robust top-line growth, scale-based expense leverage, and a higher-margin sales mix to drive average annual revenue growth in the high teens, with even faster earnings-per-share growth over the next five years. Our thesis on Amazon has not changed over the past three months, and we remain comfortable with Amazon’s valuation in the context of its long-term growth opportunity.

Visa (Frank Sands, Jr. and Mike Sramek, Sands Capital)

Visa operates the world’s largest payment network, processing greater than 50 percent of all credit and debit transactions globally. This network serves as the critical link connecting merchants, merchant acquirers, and card issuers. Visa generates revenue by charging licensing and transaction fees to card issuers and merchant acquirers based on the dollar volume and number of processed transactions. Importantly, its cost base is largely fixed, enabling high incremental margins. The primary driver of the company’s growth is the steady global shift from paper-based forms of payment (e.g., cash and checks) to electronic transactions. While Visa competes with other card networks such as MasterCard, the industry is essentially an oligopoly with extremely high barriers to entry. We believe Visa can deliver annual earnings-per-share growth in the mid-teens over the next five years.

In the first quarter, Visa’s share price rose after it reported a strong quarter with nearly all core operating metrics coming in ahead of consensus expectations. Our thesis on Visa has not changed over the past three months. While the company’s valuation does appear to be at the high-end of its historical range, we are comfortable with it for the following reasons: (1) our research and expected returns analysis factors in multiple compression; (2) Visa has now added debt on its balance sheet, which should allow for higher returns on equity and multiple support; (3) Visa is lapping headwinds associated with the integration of Visa Europe, and we expect synergies to start coming on line; and (5) tax reform and lighter regulations could add upside to earnings.

Visa (Clyde McGregor, Harris Associates)

  • We believe that Visa is a well-managed company and has significant competitive advantages in the banking industry through its deep payment network.
  • The accelerating trend of paper to electronic forms of payment on a global basis will promote Visa’s growth for some time to come.
  • Visa’s recent acquisition of Visa Europe will widen its global market exposure and, in our view, will provide the company with a significant value-enhancing opportunity.

Visa delivered a positive fiscal first quarter earnings report during the period. We were pleased to see that revenue ($4.46 billion versus $4.30 billion) and earnings-per-share figures ($0.86 versus $0.78) bested market expectations. In addition, reported payment volumes were up 38%, boosted by Visa Europe and Costco, and we like the progression of the Visa Europe integration. We think Visa is a high-quality business that is positioned for secular growth into the future. Overall, we believe the investment in Visa will continue to provide value for our clients.

Oracle (Clyde McGregor/Bill Nygren, Harris Associates)

  • Oracle’s management team has shifted its focus to developing the cloud-based computing business and has prioritized the engineering work and sales force realignments required to drive the transition as quickly as possible.
  • As Oracle expands its cloud business, we believe the company can grow its share of wallet with existing customers and also target new addressable markets with smaller customers that had not been able to afford its solutions in the past.
  • We like that high switching costs reduce customer turnover for Oracle, and we think the transition of sales to the cloud-based model will pay off for long-term investors.
  • By our standards, Oracle’s management team has historically demonstrated operational skill, good strategic thinking, and value creation, which should help the company maintain a strong balance sheet with excellent cash flow generation.

Oracle’s third quarter earnings report showed continued progress in managing the transition to a more cloud-based software model. This performance was consistent with our expectations, but it appears to have positively surprised others. Total revenues grew 4% in constant currency, and non-GAAP operating margins increased 110 basis points due to well-controlled expenses. Importantly, software-as-a-service/platform-as-a-service revenues grew 86%, and margins expanded to 65% from 51% during the year-ago period as the business scaled. Furthermore, Oracle increased its dividend 27% to $0.19 per quarter and repurchased $500 million worth of stock. We continue to believe Oracle is an attractive investment.


Top 10 Detractors as of the Quarter Ended March 31, 2017

Company Name
Fund Wt. (%) Benchmark Wt. (%) Three-month Return (%) Contribution to Return (%) Economic Sector
Global Eagle Entertainment Inc. 0.34 0.00 -50.62 -0.22 Consumer Discretionary
Apache Corp. 0.81 0.09 -18.71 -0.18 Energy
Chesapeake Energy Corp. 0.93 0.02 -15.38 -0.17 Energy
Urban Outfitters Inc. 0.70 0.01 -16.57 -0.13 Consumer Discretionary
Frank's International NV 0.84 0.00 -14.49 -0.12 Energy
Schlumberger Ltd. 1.42 0.47 -6.40 -0.09 Energy
Noble Energy Inc. 0.84 0.07 -9.55 -0.08 Energy
Arconic Inc. 0.66 0.05 -1.05 -0.07 Industrials
Dollar General Corp. 1.23 0.09 -5.86 -0.07 Consumer Discretionary
CSRA Inc. 0.74 0.02 -8.01 -0.06 Technology

Portfolio contribution for a holding represents the product of the average portfolio weight and the total return earned by the holding during the period. Past performance is no guarantee of future results. Fund holdings and/or sector allocations are subject to change at any time and are not recommendations to buy or sell any security.

Edited Commentary from the Respective Managers on Selected Detractors

Global Eagle Entertainment (Dick Weiss, Wells Capital Management)

Global Eagle Entertainment provides content, connectivity, and digital media solutions for airlines worldwide. The original thesis for owning the stock revolved around Global Eagle being exposed to a growing market and gaining new international contracts, as the U.S. market is fairly saturated. For the quarter, the stock was a relative detractor from performance due to several factors, including change at the management level. The company is in the midst of a transformation with the recent acquisition of EMC and a multipart investment from Chinese partner Shareco. Further, the sales cycle has proven longer than expected to close large account deals, and Global Eagle has begun to diversify its business. As such, investors will need to be patient as the company grows several parts of its business and topline growth accelerates. We currently have a Private Market Value for Global Eagle in the high single digits. [Stock price was $3.19 per share on March 31, 2017.]

Apache Corporation (Chris Davis, Davis Advisors)

Apache is a North American–based energy exploration and development company focused on oil production, anchored by its excellent properties in the Permian Basin in Texas and New Mexico. Apache’s CEO, John Christmann, is properly focused on shareholder returns, and the company has recently completed a series of advantageous property sales using a substantial portion of the proceeds to reduce debt. We believe Apache is well positioned to withstand today’s low energy prices with properties offering decades of potential growth.

Chesapeake Energy (Bill Nygren, Harris Associates)

  • We are very impressed with how well Chesapeake’s management team and board of directors have navigated this challenging commodity price environment, and we remain positive about the long-term prospects for this company.
  • We appreciate Chesapeake Energy’s efforts to eliminate wasteful spending by limiting capital expenditures and operating costs.
  • The management team has also shifted the focus from acreage growth to returns and capital efficiency.
  • We think underlying company assets are high-quality with significant private market value and appreciate management’s efforts to highlight that value.

Despite no fundamental changes, Chesapeake Energy finished lower for the quarter. The company’s fiscal fourth quarter earnings results were largely in line with expectations, with production expenses and midstream costs down 28% and 7%, respectively. Capital efficiency also continued to improve, and the combination led to a 14% increase in proved reserves in 2016 despite a 20% headwind from production and price-related revisions. We believe Chesapeake Energy is among the best-managed oil and gas companies and is trading well below the value of its assets. The company has sizeable acreage holdings across the United States, and management is focused on developing these assets in a cost-effective and high-return manner. The team has successfully navigated the commodity price downturn while prioritizing the interests of equity holders, and we expect this shareholder-friendly group will continue to create value in an improving commodity price environment. With the enterprise trading at a substantial discount to our estimate of asset value, we believe Chesapeake is an attractive holding.