Chris Davis Fall 2013 Update
The chart below summarizes results through June 30, 2013 for Davis New York Venture Fund. As managers of and investors in Davis New York Venture Fund, my partner Ken Charles Feinberg, our colleagues and I have two objectives: to earn a satisfactory absolute investment return and to generate relative results in excess of the S&P 500® Index. As can be seen in the chart, our performance report card might be said to resemble a barbell. Over the very long term and the very short term, results on both an absolute and relative basis are satisfactory. In the middle, however, both are below our standards and expectations. In particular, we call attention to our five year results where an anemic absolute return of 4.5% per year trailed the Index by roughly 2.5% per year.1 While we view this return as unquestionably disappointing, it is some consolation that during a five year stretch that included the collapse of residential real estate, the financial crisis and the Great Recession, the cumulative return of Davis New York Venture Fund has still been roughly 25%. Bearing in mind how many companies, funds and firms were wiped out in those years, we are glad to have made money for our clients. As a final note, it is striking that while investor sentiment continues to be overwhelmingly negative, returns for our Fund and the market have compounded at a rate in the mid-teens for the last four years. Clearly, there is much truth in the old saying that the market climbs a wall of worry. Make no mistake, however, we have ground to make up.
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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 0.90%. 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 hereor call 800-279-0279.
The Davis family, Davis Advisors, employees, and directors have more than $2 billion of their own money invested side by side with fellow shareholders in the various funds we manage.2 We have ridden through the difficult periods and are fully committed to building on the improved results of more recent periods.
In preparing these reports for shareholders, our goal is to provide the information we would want if our positions were reversed. In times when results were disappointing, our first priority was to provide an accounting, explanation and context for the Fund’s performance. Consequently, we spent a great deal of time looking backward. For example, in 2012, we highlighted the fact that while periods of underperformance are maddening, “we have gone through such periods before and…consider them an inevitable though unpleasant part of generating satisfactory long-term results.” We also provided detailed data showing because “…each past period of underperformance (had) been followed by a period of recovery…we (were) convinced that the greatest risk during periods of underperformance is to give up on a proven long-term investment discipline.”3 In other reports, we quoted legendary investor Bob Kirby who observed, “The basic question facing us is whether it’s possible for a superior investment manager to…(suffer through periods of underperformance). The assumption widely held is ‘no.’ Yet if you look at the records, it is not only possible, it is inevitable.” More recently, we quantified Bob’s observation by examining the records of the best performing managers of the last decade, noting that 96% of them underperformed for at least a rolling three year stretch and 83% underperformed for at least a rolling five year stretch during their decade of outperformance.4
With improving results, it now may be more useful and informative to turn to the future with an emphasis on providing the facts and data that give us confidence returns should continue to be satisfactory. At the most fundamental level, we believe the Fund’s results will be driven by the performance of the underlying businesses we own. In a 1994 lecture, Charlie Munger, vice chairman of Berkshire Hathaway, described this dynamic by saying, “Over the long term, it is hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you’re not going to make much different than a 6% return.… Conversely, if a business earns 18% on capital over 20 or 30 years…you’ll end up with one hell of a result.”
As a result, in this report, we thought it might be helpful to dive deeply into the investment rationale for some of the specific businesses we own. Rather than provide a cursory look at 10 or 15 holdings, we have chosen to provide a more detailed review of our three largest investments: Bank of New York Mellon, American Express and Google.5 Because these three holdings make up about 19% of the Fund’s assets, their future alone will not determine the future of the Fund as a whole. However, by sharing our analysis of these companies, we hope to provide shareholders with a better understanding of our research approach and investment process.
Legendary manager Peter Lynch used to argue investors should be able to describe all of the key elements in their rationale for owning a business in two minutes or less. While such an exercise risks being superficial, a concise investment summary can be a helpful discipline. At Davis Advisors, our research and evaluation process involves many steps and considerations. But, in the spirit of Peter Lynch, it can be roughly boiled down to three words: business, people and price. Our goal is to own good businesses (which we define based on such characteristics as return on equity, competitive advantages and growth prospects) run by capable, shareholder-oriented people (whom we identify based on such factors as past record, alignment of incentives, candor, and long-term focus) and selling at reasonable prices (which we calculate based on such factors as adjusted enterprise value, owner earnings and incremental returns on equity). Permeating this entire process is a thorough consideration of the risks facing all aspects of the business. In the pages that follow, we will do our best to provide a “two minute drill” that covers each of these factors for our three largest holdings. These descriptions include opinions as well as facts and although we have been long-term holders of each, our opinion as well as the facts described below can change. Our goal is not to provide a sales pitch or an encyclopedia of data and documentation but to give our shareholders a broader understanding of our investment process and a better sense of some of the individual businesses that make up Davis New York Venture Fund. We would also caution that the price of each of these businesses has risen quite sharply in recent periods and we have not added to