Litman Gregory Masters International Fund Second Quarter 2017 Attribution

During the second quarter of 2017, the Litman Gregory Masters International Fund gained 6.13% and the MSCI ACWI ex USA Index was up 5.78%. The MSCI EAFE Index returned 6.11% in the quarter and the Morningstar Foreign Large Blend Category gained 6.27%. For the first half of 2017, the fund has returned 14.83% compared to a gain of 14.09% for MSCI ACWI ex USA Index and 13.80% for MSCI EAFE Index.

Since its inception in December 1997, the fund has compounded returns at an annual rate of 7.43% after fees, while MSCI ACWI ex USA, MSCI EAFE, and its blend peers have gained 5.32%, 4.90%, and 4.35%, respectively.1

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 www.mastersfunds.com.

Themes, Trends, and Observations from the Managers*

David Herro, Harris Associates
Global equity prices rose again last quarter on continued improvement in the global economic outlook. Though equity valuations aren’t as cheap as they once were, our fundamental outlook remains positive. Our confidence is based on the strength of our companies’ balance sheets, low interest rates, low inflationary pressures, still significant global monetary stimulation, and the potential for a more favorable business climate (lower taxes, less regulation) in the United States.  

Outside of the United States, we’ve been largely re-positioning the portfolios across existing holdings in the financial, industrial, and consumer discretionary sectors. Geographically, our portfolio exposure remains tilted toward developed markets; however, we are selectively exploring different opportunities in the emerging markets. 

We continue to avoid many companies that the market views as “stable” (like those in the telecom, utility, and consumer staples sectors) due to business quality/valuation concerns. 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.

Vinson Walden, Thornburg
Markets continued from strength to strength in the second quarter, with major indexes now up significantly over the last 12 months. These broad advances have been underpinned by various factors, including accommodative monetary policies, receding risks in Europe, and favorable macroeconomic developments in many regions. Most macroeconomic indicators around the world have positively surprised in the first half of 2017, with the United States being a relative laggard. Earnings expectations for the MSCI EAFE Index portfolio for 2017 have been rising, along with global economic growth expectations. These trends continue to support a rotation of investor preferences from more defensive debt and equity assets to more economically sensitive assets. It now appears that political gridlock will persist in Washington, D.C., though the Federal Reserve has stepped up the pace of federal funds target rate hikes. Most major central banks continue to pursue very easy monetary conditions.

Howard Appleby, Jean-François Ducrest and Jim LaTorre, Northern Cross
The team did not make many significant changes during the quarter. We continue to see significant upside in Las Vegas Sands and believe that the recent data out of Macau supports our thesis of sustainable recovery. As such, Las Vegas Sands remains our largest position in the fund. Our second and third largest positions are Vivendi and Bayer, two stocks that were the largest positive contributors to performance in the second quarter of 2017 and in the first half of 2017.

Mark Little, Lazard Asset Management
International equities rose again in the second quarter, despite investors cooling on the more cyclical areas of the market. Tightening policy in China has rolled commodity prices such as iron ore, which alongside fading hopes of U.S. stimulus from the new government has dampened reflation expectations. This saw bond yields fall back, driving gains in more stable sectors such as consumer staples and weaker performance in the commodity-related sectors of materials and energy. Information technology stocks were the strongest performers, as investors increasingly view them as structural winners. Auto stocks were hurt by the rollover of U.S. auto sales volumes in an environment where they need to keep investing in electric and autonomous vehicles.

The macroeconomic picture is mixed. U.S. growth remains patchy, and so far the new government has struggled to implement a stimulative agenda. China reflated the global economy again last year, but this may be starting to fade. Core inflation remains relatively subdued, despite tight labor markets in the United States, Japan, and some European countries. In Europe, growth has finally picked up alongside credit growth, though political risk remains. The more benign commodity environment and some increased confidence is feeding into strong industrial demand. However, we need only look at U.S. car sales to see the impact slightly tighter monetary policy is having, reminding us of the overwhelming amount of debt that has continued to pile up on public and private sector balance sheets since the financial crisis.

The response of the portfolio team to a period of weaker relative performance is always to focus on the key source of alpha over time, namely fundamental stock analysis. While risk control is important, rotations of the type witnessed over the second half of 2016 tend to wash out over time leaving stock selection as the key driver of returns. With the level of macroeconomic and political uncertainty still high, the team is working especially hard to identify investment ideas that have a strong internal or structural dynamic not correlated to, or dependent upon, a certain external environment. Turnover has picked up somewhat in recent months as more of these new ideas have fed into the portfolio.

Fabio Paolini and Benjamin Beneche, Pictet Asset Management
Currently, the portfolio holds equities in a wide range of businesses from Anheuser-Busch InBev and Japan Tobacco in staples to technology-focused companies such as ASML, JD.com, and Softbank. The common thread with these businesses is their ability to deliver long-term growth in cash flows and that they trade substantially below our assessment of intrinsic value. Most recently, we have identified interesting investment opportunities in Asia culminating in the addition of JD.com to the portfolio. JD.com is the clear number 2 player in the Chinese e-commerce market behind Alibaba Group Holdings, but instead of operating an open “marketplace”-type model, it has chosen to operate more like a traditional retailer: holding inventory and owning distribution. This is a more capital-intensive approach upfront but has a few key advantages: firstly, quality control both on goods and delivery and, secondly, scale merits in procurement and working capital. We believe JD.com is on the cusp of its monetization phase and expect margins and cash flow to grow very rapidly from here with negative working capital leading to supercharged free cash flow generation.

David Marcus, Evermore Global Advisors
We believe it is an exciting time to be a special situations investor, as opportunities abound across the globe, but especially in Europe. These European opportunities continue to be driven by an unprecedented amount of mergers and acquisitions and operational and financial restructuring activity (e.g., spinoffs, balance sheet recapitalizations). While there remain fundamental headaches in Europe, we believe we are able to find specific opportunities in this region that will transcend macro concerns, and we remain excited about our opportunity set going forward. The headlines have masked the real changes and the resulting substantial value creation that we believe is underway at companies across the region.

* 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

Stock selection was the primary driver behind the fund’s outperformance for the quarter. Regional and sector positioning was a modest tailwind for the fund. It is important to understand that the portfolio is built stock by stock so the sector and country weightings are a residual of the bottom-up, fundamental stock-picking process employed by each sub-advisor.

Litman Gregory Masters International Fund Sector Attribution

International Fund Sector Attribution

  • Much like in the first quarter, the fund’s overweight to consumer discretionary stocks remains in place. The sector performed in line with the broader index, resulting in a neutral allocation effect. Stock selection in the sector contributed positively to performance. Positions such as Vivendi, Las Vegas Sands, and OPAP were on the top-10 contributors list in the quarter.
  • Stock selection was particularly strong in the financials sector. The largest contributors were Lloyds Banking Group and Aurelius Equity Opportunities.
  • The information technology sector was the biggest headwind to performance. Both the fund’s individual stocks and portfolio-level underweighting were a drag on returns. The fund’s largest technology holding, ASML Holding, was down slightly in the second quarter and detracted from overall performance given the technology sector overall was up double digits during the quarter.
  • Stock selection in the industrials sector helped returns. Portfolio names generated roughly double the return of industrial positions in the benchmark. Aena and Bolloré were among the fund’s top 10 contributors in the quarter.
  • Similar to the first quarter, the energy sector was the worst-performing sector within the benchmark in the second quarter. The fund benefited from having a less-than-benchmark allocation to these stocks. However, the fund’s energy positions in Schlumberger, Teekay LNG Partners, and Frontline were each a drag on performance.
Top 10 Contributors as of the Quarter Ended June 30, 2017

Company Name

Fund Weight (%)

Benchmark Weight (%)

Three-month Return (%)

Contribution to Return (%)

Country

Economic Sector

Vivendi SA 4.57 0.14 16.58 0.73 France Consumer Discretionary
Aena SA 2.27 0.05 25.76 0.57 Spain Industrials
Lloyds Banking Group 3.39 0.29 11.35 0.41 United Kingdom Financials
Aurelius Equity Opportunitie 0.97 0.00 41.78 0.36 Germany Financials
OCI NV 1.48 0.00 21.64 0.34 Netherlands Materials
Bayer AG 1.61 0.54 21.97 0.33 Germany Health Care
Carlsberg A/S B 2.31 0.06 15.19 0.33 Denmark Consumer Staples
Las Vegas Sands Corp. 2.38 0.00 13.21 0.32 United States Consumer Discretionary
Bollore 1.28 0.00 25.81 0.31 France Industrials
OPAP SA 0.91 0.00 37.56 0.31 Greece Consumer Discretionary

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 Contributors

Vivendi (David Marcus, Evermore Global Advisors)
Vivendi has undergone a massive transformation over the past several years from a debt-laden company with a disparate, undermanaged group of media and telecom assets to a net cash, more focused media powerhouse. This transformation has been overseen by Vivendi chairman Vincent Bolloré, a proven value creator. Vivendi’s assets include Universal Music Group, Canal+ Group (pay TV in France), 59.2% of Havas Group (one of the world’s largest global communications firms), and Gameloft (a worldwide leader in mobile games), as well as other media assets.

Vivendi shares performed well in the quarter as the company reported strong first quarter earnings and rumors continued to circulate that Vivendi would spinoff or IPO its Universal Music Group subsidiary. We believe that Vivendi remains significantly undervalued and that a Universal Music spinoff or initial public offering (IPO) combined with its continued restructuring efforts will help close the gap between its current share price and our intrinsic value estimate.

Aena (Vinson Walden, Thornburg Investment Management)
Aena is a state-controlled company that operates 46 airports in Spain, the United Kingdom, and Latin America. The Spanish government owns a 51% stake in the company. Aena manages tourism, hub and regional airports, and heliports and general aviation areas. Aena’s destination range comprises Europe, the Americas, Asia, and Africa.

As the monopoly operator of the Spanish airport network, Aena benefits from high demand for travel to Spain. Spain is the third-most visited country in the world and remains popular as an international tourist destination. Aena owns well-built airport assets with ample spare capacity, providing visibility into a long period where the company should generate positive free cash flows as traffic grows without significant reinvestment requirements.

We continue to believe the market is undervaluing Aena’s cash flows. Uncertainty about regulation has recently been reduced as the government issued detailed traffic, tariff, and spending guidelines for the next five years. We believe this clears the way for management to outline their business plan for the next few years, which could include optimizing the balance sheet, participating in international mergers and acquisitions, and/or raising the dividend payout. The stock currently generates an attractive free cash flow yield.

The company’s shares have been performing strongly. Management recently reported higher profits than estimated (0.55 cents per share versus an estimated 0.31 cents per share). Aena has seen a continued lift in traffic since this past winter and announced its expectation of a 9% rise in passenger volume for the upcoming summer season.

Aurelius Equity Opportunities (David Marcus, Evermore Global Advisors)
Aurelius is a German publicly traded private equity firm that seeks to buy non-core, non-performing orphaned assets often from large conglomerates and works on turning the companies around. The company will only acquire businesses when the problems are the kind they have the expertise to solve. They do not typically pay much, if anything, for these assets and even sometimes get paid to acquire assets. We believe that Aurelius’s founder and CEO, Dirk Markus, is a proven value creator who will continue to selectively take advantage of the opportunities arising from the high level of restructuring activity in Europe.

In late March, a short-selling firm issued a report stating why they had taken a short position in Aurelius. The company’s stock price tumbled over the next couple of days. After careful evaluation of the report, we felt most of the short seller’s allegations were off the mark and without merit. During the succeeding days and weeks, we spoke with the company on numerous occasions and met with management in London in early May. We took advantage of the decline in the company’s stock price as an opportunity to add to our Aurelius position.

The stock rebounded nicely in the second quarter due to a number of factors. First, Aurelius effectively refuted the vast majority of the short seller’s allegations. Second, the company announced the sale of one of its portfolio companies, SECOP, for 11x its invested capital over seven years—the largest asset sale in Aurelius’s history. Third, the company announced that it would double its dividend to €4.00 per share and significantly increase its stock buyback program. And finally, the company reported strong first quarter 2017 earnings. We continue to believe in the value of Aurelius’s business model and its solid history of value creation.

Bayer (Howard Appleby, Jean-François Ducrest, and Jim LaTorre, Northern Cross)
We invested in Bayer following its announced acquisition of leading agricultural science and seeds company Monsanto. While others may have been skeptical of the move, which pivoted Bayer away from a pharmaceutical company to more of a crop science company, we saw an opportunity to acquire a clear leading franchise at the bottom of the agriculture cycle. We also saw plenty of opportunities for Bayer to dispose of other non-core assets at good valuations to partially fund the Monsanto purchase. Our conviction in Bayer as a long-term outperformer remains very high. We think the strong performance in the second quarter of 2017 reflects more resilience in Monsanto’s results, continued strong execution in Bayer’s pharmaceuticals operation, and recognition that the upcoming rights issue to fund the purchase may not be as large as initially proposed.

Top 10 Detractors as of the Quarter Ended June 30, 2017

Company Name

Fund Weight (%)

Benchmark Weight (%)

Three-month Return (%)

Contribution to Return (%)

Country

Economic Sector

Scorpio Bulkers Inc. 0.76 0.00 -22.83 -0.20 Monaco Industrials
Schlumberger Ltd. 1.18 0.00 -15.08 -0.20 United States Energy
Shire PLC 3.16 0.27 -5.55 -0.19 United Kingdom Health Care
Teekay Lng Partners LP 1.34 0.00 -11.79 -0.18 Bermuda Energy
Hyundai Mobis Co. Ltd. 0.23 0.08 -13.32 -0.13 Korea Consumer Discretionary
Frontline Ltd. 0.95 0.00 -12.65 -0.13 Bermuda Energy
Altice NV A 2.37 0.04 1.58 -0.09 Netherlands Consumer Discretionary
Liberty Global PLC C 0.90 0.00 -11.02 -0.09 United Kingdom Consumer Discretionary
Incitec Pivot Ltd. 0.95 0.00 -7.12 -0.07 Australia Materials
Toyota Motor Corp. 0.83 0.72 -5.67 -0.05 Japan Consumer Discretionary

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 Detractors

Scorpio Bulkers (David Marcus, Evermore Global Advisors)
Scorpio Bulkers is a $535 million market cap dry bulk carrier that owns and operates a fleet of modern mid- to large-size dry bulk vessels, specifically Ultramax and Kamsarmax vessels (62,000 and 82,000 deadweight tonnes, respectively). Scorpio Bulkers’ vessels carry major bulks such as iron ore, coal, and grain as well as minor bulks such as bauxite, fertilizers, and steel products.

During the first six months of the year, the company took delivery of six new-build vessels and management was able to negotiate with the shipyards for additional price reductions. The company is now fully delivered on its new-build program and will not have any material future capital expenditure needs for quite some time. In April, the company took advantage of the slight improvement in asset values and sold its two oldest Kamsarmax vessels for $45 million. The company also prudently fixed out six vessels into short-duration charters for 2017’s first quarter through the third quarter at daily rates ranging from $8,500 to $11,000. With daily cash breakeven levels of less than $8,000 per day, we believe Scorpio Bulkers is one of the best-positioned companies to benefit from the recovery in the dry bulk market. The company had approximately $155 million of cash on the balance sheet and is very well positioned with excess liquidity and modest leverage (50% loan-to-value ratio).

After a strong first quarter and despite all the company’s recent accomplishments during the year, the stock declined more than 20% in the second quarter as negative sentiment prevailed around the temporarily weaker pricing environment in the iron ore and coal markets. We believe the structural demand and supply dynamics have not changed. Industry fundamentals continue to improve with both daily rates (especially in the vessel classes in which Scorpio is involved) steadily rising and asset values slowly increasing as underscored by recent transactions for secondhand tonnage. The stock ended the quarter at $7.10 per share, which represented over a 40% discount to our intrinsic value estimate of $12 per share. Management insiders, including the co-founder and president, Robert Bugbee, have been actively buying in the open market. We continue to maintain our high conviction in Scorpio Bulkers and have been opportunistically adding to the position.

Schlumberger (Howard Appleby, Jean-François Ducrest, and Jim LaTorre, Northern Cross)
Schlumberger, a leading oil services company, remains a best in class franchise, but the recovery in oil and gas capital expenditures has been pushed back, driven by the resilience of supply in both North America and from large megaprojects funded at much higher oil prices but are just now coming into production. As oil prices have suffered, analysts have pushed out the earnings recovery for Schlumberger and the stock has suffered. However, we think the company will eventually come out of this cycle stronger, through its efforts to reduce its own costs and its willingness to continue to invest in technology as the industry at large pulls back. As such, we have not changed our positioning. We think that over time the oil and gas industry will be even more reliant on Schlumberger technology and that this will drive growth in earnings power even if overall industry capital expenditure does not return to prior peak levels.

Teekay LNG Partners (Vinson Walden, Thornburg Investment Management)
Teekay is an international provider of marine transportation services for liquefied natural gas (LNG), liquefied petroleum gas (LPG), and crude oil. Teekay LNG Partners operates through two segments: its liquefied gas segment and its conventional tanker segment. The liquefied gas segment consists of LNG and LPG or multigas carriers, which generally operate under long-term, fixed-rate charters to international energy companies and Teekay Corporation. The conventional tanker segment consists of Suezmax-class crude oil tankers and one Handymax product tanker. The company's fleet, excluding newbuilds, consists of around 29 LNG carriers. Teekay has an industry leading, young, and technologically advanced fleet of specially designed LNG and LPG carriers and has secured long-term charters for its active LNG fleet with an attractive set of global oil and gas customers, most of which are Blue Chip counterparts. This should insulate the company from what could be a difficult spot market over the coming years and should make for more predictable EBITDA/earnings in what is still an oversupplied LNG shipping market. We bought the stock after the company cut their distribution in late 2015 to get through a liquidity crunch to fund their growth and upcoming debt expirations, with the expectation that they’d be able to significantly raise their distribution at some point and wouldn’t trade at a 17%–20% yield when they did so. Management’s actions to date have largely shored up the liquidity needs, and we’re starting to see the light at the end of the tunnel, so to speak, around their ability to get through their remaining cash needs and raise the distribution. The muted reaction year to date, and the reason behind the stock’s poor performance, is due to a comment during their most recent quarter that they want to complete financing for newbuilds and largely refinance 2018 debt maturities to provide a margin of safety before raising the distribution. This pushed expectations out from 2017 to potentially 2018 and most likely rattled shareholders that were looking for a short-term jump in the stock. We remain constructive on the stock and our overall thesis is unchanged.

Hyundai Mobis (Fabio Paolini and Benjamin Beneche, Pictet Asset Management)
Hyundai Mobis is the main supplier to the Hyundai Motor Group (HMG) and Kia Motors. Unlike other auto parts companies, Mobis generates upwards of 50% of its operating profit from the sale of aftermarket parts to licensed dealers globally. The fragmented nature of this business and low-price elasticity leads to consistent 20%-plus margins in this division with relatively low volatility in sales. The remainder of the business resembles a more traditional parts company and is currently suffering from weakness in the Chinese market driven by the current political environment and start-up costs associated with capacity additions. We expect both these factors to normalize over the longer term and Mobis to continue benefiting from the high exposure HMG and Kia have to emerging markets (circa 50% sales). Finally, we view a restructuring of the Hyundai chaebol as a matter of “when not if.” Mobis has 3.5 trillion Korean won in net cash and 8 trillion won of marketable securities, and currently pays a paltry dividend of 1.4%. The creation of a holding company and alignment of shareholder interests with the founding Chung family should align interests better. At 7x cash earnings, Mobis trades at a substantial discount to both peers (11x average) and, more importantly, well below our assessment of fair value.