Litman Gregory Masters Equity Fund Fourth Quarter 2017 Attribution

During the fourth quarter of 2017, the Litman Gregory Masters Equity Fund gained 5.74%, while its Russell 3000 Index benchmark returned 6.34%.i The Morningstar Large Blend Category was up 6.42% in the fourth quarter. Over the full year, the fund saw a strong absolute gain of 21.15%, in line with the 21.13% return for the Russell 3000 Index and outperforming the 20.47% return for the Morningstar Large Blend Category. Since its December 1996 inception, the fund’s 8.43% annualized return is in line with the Russell 3000 Index’s gain of 8.45% and ahead of the Morningstar category’s 6.95% return.

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
With only a relatively minor stumble in 2011, this bull market has stretched to nearly nine years, the second longest on record. Domestic equities have tripled off the bottom from March 2009, despite well-below-average economic and earnings growth. Many investors believe historical stock valuations are no longer valid, primarily owing to a belief that interest rates and inflation will remain low for the foreseeable future. This has resulted in many valuation measures that are the highest or near the highest investors have ever seen. Today’s market is proof that stocks can stay expensive for longer than almost anyone would have predicted. Somewhat better economic performance in 2017, a rollback in growth-hindering regulations, and excitement about a tax cut launched stocks to new highs. Nevertheless, stock prices still outpaced underlying fundamentals. Growth stocks crushed value stocks in 2017 and continued their dominance over longer periods of time, much to the chagrin of value-oriented money managers. Speculative bubbles in Bitcoin and other cryptocurrencies buttress the case that caution has gone missing from this market. In terms of our portfolio, in the fourth quarter we reduced weightings in Dollar General and PACCAR after strong moves. We initiated a position in TJX in response to a softer than expected quarter. TJX is a strong retailer who has competed well in the Amazon-dominated retail world. Our cash position remains somewhat elevated, reflecting a reduced opportunity set.

Bill Nygren and Clyde McGregor, Harris Associates
Global equity prices rose again last quarter on continued optimism around global growth. Though equity valuations continue to move higher, 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.

In the United States, we’ve sold some positions on price strength and purchased more attractively priced securities. We’ve also tax traded the portfolios where we believe appropriate to capture tax losses. Despite higher equity prices, we continue to find attractive opportunities on a selective basis.

Scott Moore, Nuance Investments
During the fourth quarter, sector weights in the portfolio have remained stable, but the opportunity set has continued to narrow as we enter 2018. We increased our overweight position in the consumer staples sector as we added Colgate-Palmolive to our portfolio during the quarter. We continue to see opportunities in select global leaders like Diageo, Proctor & Gamble, and Kimberly-Clark, and we believe these companies, with their top-tier balance sheets and competitive positions, have better downside support than the market. While our exposure in the financial sector is slightly below the benchmark, we continue to see opportunities within the sector as just a small reset in future interest rate expectations during the back half of 2017 and an above-average catastrophe loss year created an opportunity in what we view as select high-quality financial institutions like MetLife, Travelers Companies, and Everest RE Group, which was added in the quarter. In the health care sector, we continue to own leaders such as Abbott Laboratories and Smith & Nephew. We have an underweight position in the energy sector as we believe that crude oil–related companies are likely facing a multiyear period of competitive transition. We continue to be underweight in the utility, information technology, real estate, and consumer discretionary sectors throughout the year due to valuation concerns.

Chris Davis and Danton Goei, Davis Advisors
In the year-to-date period ending December 31, 2017, the U.S. stock market advanced with the S&P 500 Index returning 21.82%. Our portfolios also delivered positive results outperforming the index during the period. Our investments in and Alphabet were particularly accretive to performance in the year-to-date period. Similarly, in the fourth quarter, Amazon, Alphabet, and Wells Fargo were contributors to performance, while Apache was a detractor.

We see reasons to be optimistic about many businesses today, but not all companies in the U.S. stock market represent equally good value given current valuation levels. We believe selective stock picking is the best way to navigate the current environment and is a perennial approach to investing over full market cycles.

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 we believe are powered by strong secular drivers and/or promising business spaces.

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 with prudence over time.

Dick Weiss, Wells Capital Management
The final quarter of the year was undoubtedly kind to investors and put the final note on a strong 2017 for the equity markets. Several sectors, including cyclical ones, performed well in the quarter as energy, industrials, and consumer stocks were among the better-performing groups. The portfolio was well represented in these sectors, which acted as a nice tailwind to performance. In particular, several of the portfolio’s energy holdings outperformed the benchmark return on the heels of improving global demand and a rising commodity price. Further, within the industrials sector, performance was strong and broad based across several holdings. On the other hand, lack of exposure to the consumer staples sector proved to be a relative detractor, as we do not have exposure to this “bond proxy” sector.

* 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 process 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

  • All benchmark sectors saw positive returns during the fourth quarter.
  • The fund’s sector allocation contributed to relative performance during the fourth quarter, although stock selection detracted enough to leave the fund slightly behind its benchmark for the period.
  • A meaningful underweight to the lagging health care sector (5.0% vs. 13.6%) benefited relative performance, while an overweight to financials (23.1% vs. 15.1%) helped during the quarter, as the sector slightly outperformed the broad market. Three of the fund’s financial holdings gained over 17% in the quarter: Capital One Financial (up 17.9% and discussed in detail below), Bank of America (up 17.4%), and Ally Financial (up 20.3%).
  • Stock selection was weakest in the health care and technology sectors. In the former, Regeneron Pharmaceuticals (which fell 16.0%) and Alexion Pharmaceuticals (which fell 12.8%) were among the larger detractors. Both are discussed in further detail below. In technology, Itron (down 15.4%) and Baidu (down 5.0%) were among the negative contributors.
  • The fund’s cash position averaged about 11.5% in the fourth quarter, slightly higher than the previous quarter. With the Russell 3000 Index gaining more than 6% in the period, the allocation to cash was the single largest detractor from relative performance.


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

Company Name
Fund Wt. (%) Benchmark Wt. (%) Three-month Return (%) Contribution to Return (%) Economic Sector Inc. 3.30 1.63 20.93 0.64 Consumer Discretionary
TE Connectivity Ltd. 2.49 0.00 14.64 0.35 Information Technology
Capital One Financial Corp. 2.13 0.16 17.94 0.35 Financials
C.H. Robinson Worldwide Inc. 1.50 0.04 18.24 0.27 Industrials
Alphabet Inc. A 3.36 1.14 7.92 0.27 Information Technology
Visa Inc. Class A 2.92 0.76 8.76 0.26 Information Technology
Twenty First Century Fox A 0.87 0.12 29.49 0.24 Consumer Discretionary
Wells Fargo & Co. 1.98 0.94 11.60 0.24 Financials
Ally Financial Inc. 1.17 0.04 20.25 0.23 Financials
Berkshire Hathaway Inc. A 2.56 0.00 7.92 0.22 Financials

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

Amazon is one of the largest Internet-based retailers 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 that 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 higher-margin sales mix to drive above-average revenue and earnings growth over the next five years.

Amazon posted third quarter results well ahead of consensus expectations, driving share price gains. Total retail sales grew 34 percent year over year, with the international segment posting a six percent quarterly acceleration (excluding currency effects). Amazon Prime also posted year-over-year membership growth of over 40 percent. We believe these trends are clear signs that Amazon’s value proposition is leading to meaningful e-commerce share gains, while simultaneously growing the online retail market. The retail business’s margins were weaker, as expected, due to international losses and spending related to technology and content. Investment in these nascent areas will lead to sustained growth over the long term, in our view. AWS also posted strong results, with 42 percent year-over-year revenue growth, and incremental margins improving to 53 percent. Continued enterprise adoption, product innovation, and increasing scale all contribute to the cloud service’s strength. Over our investment horizon, we expect Amazon to deliver attractive annualized earnings growth.

Capital One Financial (Bill Nygren, Harris Associates)

  • Capital One Financial’s revenues are spread over three business units: consumer banking, commercial banking, and its credit card business; although the credit card business generates most of its revenues, the consumer and commercial banking businesses have performed near the top of the industry.
  • Its credit card business carries strong brand recognition and, importantly, produces industry-leading profitability.
  • Despite an economic slump a few years ago, owing to management’s efforts, Capital One’s income surpassed larger-than-expected credit card charge-offs in the face of these challenges and the company remained profitable.

Capital One Financial delivered strong third quarter earnings results during the period, with 4% revenue growth and 20% adjusted earnings per share growth to $2.42. Credit card charge-offs declined 50 basis points quarter over quarter to 4.51% and the revenue margin increased 35 basis points to 16.79%. In our view, management is doing a good job controlling expenses, driving the efficiency ratio down to 51% from 53% in 2016, which contributed to expected earnings per share growth of 7%–11% in 2017. We believe the company is positioned for continued improvement in 2018 and 2019. Furthermore, several analysts upgraded their positions on Capital One later in the reporting period, pushing the company’s share price even higher. 

Capital One Financial (Chris Davis and Danton Goei, Davis Advisors)

Capital One Financial is a top-10 U.S. bank based on deposits, with branches located primarily in the New York to Washington, D.C. corridor as well as Texas and Louisiana. This out-of-the-spotlight company may be best known for its competitive credit card offerings and is among the top 10 issuers of MasterCard and Visa cards. In our view, Capital One has a strong balance sheet, has solid capital ratios, and is well positioned for future growth. During the quarter, Capital One Financial was a top-five contributor to portfolio results, returning nearly 18% in the period.

C.H. Robinson Worldwide (Clyde McGregor, Harris Associates)

  • C.H. Robinson possesses a network that is four times the size of its nearest competitor; it has continued to win new customers and expand its service offerings, rapidly gaining share in its core North American third-party logistics business (3PL).
  • The American Trucking Association projects annual freight revenue growth in the United States for the next several years, and we expect that the benefits of progressing technology will only make the outsourcing of shipping and carrying needs easier, which we see as advantageous for C.H. Robinson.
  • C.H. Robinson’s purchasing scale allows shippers to access relatively low transportation rates and improve the efficiency of their own supply chains, translating to a crucial demand for the company’s network.
  • Considering that management is well regarded in the industry and recognizes the importance of maximizing net revenue dollars while returning capital to shareholders via share repurchases and dividends, we find this to be an attractive investment.

The Cass Freight Shipment Index showed a 2.9% year-over-year increase for the month of October, providing a boost for C.H. Robinson, as the market appreciated the sign of an improving economy. As part of the company’s third quarter earnings report released earlier in the reporting period, both total revenues and earnings per share exceeded market expectations by 3% and nearly 4%, respectively. However, net income and earnings per share declined from the previous year’s levels. While contracted volume fell (as a result of poorly priced deals that are not being renewed or will be renegotiated at higher rates), spot market pricing was strong, helping to offset the lost volume. Notably, management highlighted that 3,600 new carriers joined its network, which reinforces to us that recent industry entrants are not weighing on C.H. Robinson’s business. In addition, the company increased its quarterly dividend by 2.2% to $0.46 during the reporting period.


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

Company Name
Fund Wt. (%) Benchmark Wt. (%) Three-month Return (%) Contribution to Return (%) Economic Sector
General Electric Co. 0.65 0.65 -27.09 -0.22 Industrials
Regeneron Pharmaceuticals Inc. 0.88 0.12 -16.03 -0.17 Health Care
Itron Inc. 0.36 0.01 -15.36 -0.11 Information Technology
Alexion Pharmaceuticals Inc 0.71 0.10 -12.80 -0.09 Health Care
Chesapeake Energy Corp. 0.26 0.01 -12.24 -0.07 Energy
NCR Corp. 0.61 0.01 -10.71 -0.07 Information Technology
Cerner Corp. 1.04 0.07 -5.12 -0.06 Health Care
The Priceline Group Inc. 1.06 0.33 -4.85 -0.06 Consumer Discretionary
Global Eagle Entertainment Inc. 0.10 0.00 -37.06 -0.05 Consumer Discretionary
Baidu Inc. ADR 0.87 0.00 -5.02 -0.05 Information 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 Detractors

General Electric (Bill Nygren, Harris Associates)

  • General Electric installed John Flannery as its new CEO, a move that we applaud as we have met with Flannery several times and find that he has done an excellent job operationally in other roles at the firm; Flannery is also a key architect of the capital allocation changes that GE is implementing, which are important components of our investment thesis for the company.
  • We like that GE’s business model includes manufacturing and selling original equipment as well as offering long-duration service contracts for that equipment, which provides ongoing revenue streams from its client base.
  • GE has recently worked to reinvent itself and possesses a renewed focus on achieving appropriate capital returns; the company completely revamped its variable compensation plan for thousands of employees who are now paid on a number of scored factors that emphasize improving its return on invested capital, which we believe will lead to much better performance.
  • We think the company has ample opportunities to boost its gross margin, and management intends to shrink costs by reducing the number of its enterprise-resource-planning systems as well as simplifying operations to lower costs in the core Industrial segment.

GE’s share price reacted negatively to (1) third quarter results that fell short of market expectations, (2) several analysts’ downgrades, and (3) news of CFO Jeffrey Bornstein’s departure. We believe Mr. Bornstein’s departure indicates that newly appointed CEO John Flannery is quickly establishing a strong culture of accountability and that “business as usual” will no longer be tolerated. Newly appointed CFO Jamie Miller has held multiple positions at GE, most recently as head of GE Transportation. In mid-November Flannery announced a “reset” during which he established a new lower base for the company’s earnings by cutting 2018 earnings guidance and its dividend by 50%. We expect Flannery to reduce costs aggressively, which should improve earnings. We like that GE’s business model includes manufacturing and selling original equipment as well as offering long-duration service contracts for that equipment, which provides ongoing revenue streams from its client base. GE has been a very frustrating holding, as business fundamentals have lagged our expectations. However, we continue to remain shareholders because we believe the stock has declined more than warranted by the fundamentals.

Regeneron Pharmaceuticals (Frank Sands, Jr. and Mike Sramek, Sands Capital)

Regeneron Pharmaceuticals develops biologic drugs for an array of debilitating medical conditions. The company’s core asset, Eylea, is currently approved to treat a variety of retinal diseases, including age-related macular degeneration and diabetic macular edema. Each indication represents a multibillion-dollar opportunity. Beyond the core Eylea franchise, we expect Dupixent to be an important growth driver. Dupixent was recently approved for the treatment of atopic dermatitis, and early data strongly suggests the drug will also be effective treating asthma and other allergic conditions. Regeneron continues to develop new therapies and has several drugs undergoing Phase 2 and Phase 3 trials, including treatments for respiratory syncytial virus and osteoarthritis pain. The company is also in the early stages of developing a variety of oncology drugs. We believe Regeneron’s strong Eylea and Dupixent franchises, its robust pipeline, and well-capitalized balance sheet will support above-average earnings growth over the long term.

Regeneron’s shares were pressured on concerns of competitive threats for its drug Dupixent, a treatment for allergic diseases. However, it does not appear to us that competitors have produced a superior drug to Dupixent. While competition could take some market share from Regeneron, we are confident in the company’s long-term growth prospects.

Alexion Pharmaceuticals (Dick Weiss, Wells Capital Management)

Alexion Pharmaceuticals is a biopharmaceutical company that focuses on helping patients with rare disorders through the development and commercialization of therapeutic products. One of its main products includes Soliris, which helps to treat life-threatening disease of the blood, which can destroy red blood cells and impair bone marrow function. Commercially, with Soliris gMG (generalized myasthenia gravis) approval secured in the European Union and likely soon in the United States, growth of Soliris should see a strong acceleration, while management has been prudent in controlling costs at the company, which should lead to strong leverage in the business model. After a strong run in the stock from May to October, a move upward of 50%, shares pulled back during the quarter. More recently, the stock has pulled back as investors focus on ALXN 1210 (an offshoot of Soliris) and additional Soliris indications, which we should gain more color on as we move through 2018. Currently, we have a private market value on the company near $190. (At year-end, the stock was trading just shy of $120 per share.)