Davis Opportunity Fund: An Update from The Davis Research Team
Q: Please provide an overview of Davis Opportunity Fund.
A: Davis Opportunity Fund, which invests predominantly in U.S.-listed companies, has the flexibility to own companies of any size (small, mid and large cap) and to weight positions according to the managers’ level of conviction. The Fund’s management team—Christopher Davis, Danton Goei, Tania Pouschine, Ryan Brown, and Dwight Blazin—are among the most senior members of the Davis research team and exemplars in executing the Davis Investment Discipline.
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. Equity markets are volatile and an investor may lose money. Past performance is not a guarantee of future results.
Q: Please provide some perspectives on the current market environment.
Davis Opportunity Fund A: Over the past several years, stock prices have advanced steadily and now trade above their levels prior to the financial crisis of 2008–2009. From the depths of the crisis to the present time, what is most remarkable in our view is the market’s incredible resilience. Since the stock market is really a market of individual stocks, the market’s recovery reflects the resilience of the underlying individual businesses and the durability of their earnings power. Many businesses have successfully built fortress balance sheets, cut costs, strengthened and expanded their product offerings, invested in their competitive moats, and as a result significantly increased their earnings power. Even after its strong performance in 2013, the U.S. stock market is still trading at a 6% to 7% earnings yield by our estimate and remains positioned for long-term growth based on underlying business fundamentals in our opinion. Within the context of today’s extremely low interest rate and low inflation environment, stocks today represent the most attractive major asset class in our view in both absolute and relative terms.
Q: Please comment on long-term and more recent performance results.
Davis Opportunity Fund A: The Davis Opportunity Fund has outperformed the Russell 3000® Index by a wide margin since Davis Advisors began managing All-Cap portfolios in 1999.1 We believe this long-term track record demonstrates that an effective, consistently applied investment discipline can add significant value relative to passive investment alternatives over time and anchors our conviction in our investment process.
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 0.98%. 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 here or call 800-279-0279. The Fund’s performance benefited from an IPO purchase in 2013. After purchase, the IPO rapidly increased in value. Davis Advisors purchases shares intending to benefit from long-term growth of the underlying company; the rapid appreciation of the IPO was an unusual occurrence.
For the 12 month period ending June 30, 2014 the Russell 3000® Index rose 25.22%. The Davis Opportunity Fund significantly outperformed the Index over this shorter time period as well.1 On a sector basis, consumer discretionary and information technology were the leading contributors to performance. Individual contributors for this period included Google Inc (NASDAQ:GOOGL) (NASDAQ:GOOG) (a global leader in online search), Wells Fargo & Co (NYSE:WFC) (a U.S.-based financial services firm), Schlumberger Limited. (NYSE:SLB) (a leading global energy services company), UnitedHealth Group Inc. (NYSE:UNH) (the largest health care insurance business in the United States), Vipshop Holdings Ltd – ADR (NYSE:VIPS) (a Chinese online retailer), and Textron Inc. (NYSE:TXT) (a U.S.-based industrial conglomerate).2 Detractors included Experian plc (LON:EXPN) (a leading global consumer credit bureau), Angie’s List (a U.S.-based online small business ratings service), and Amazon.com, Inc. (NASDAQ:AMZN) (a U.S.-based global e-commerce business).
We are encouraged by our recent results and believe that our Portfolio is well positioned for the years ahead.
1 Class A shares without a sales charge. Past performance is not a guarantee of future results. Davis Advisors began active daily management of Davis Opportunity Fund on January 1, 1999. From May 1, 1984, until December 31, 1998, Davis Advisors had a sub-advisor that handled the active daily management of the Fund. 2 Individual securities are discussed in this piece. 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 return of a security to the Fund will vary based on weighting and timing of purchase. This is not a recommendation to buy, sell or hold any specific security. Past performance is not a guarantee of future results.
Q: Where are you finding new opportunities?
Davis Opportunity Fund A: The stock market is a market of individual stocks that represent fractional ownership interests in real businesses. The key to investment success is first and foremost to identify individual, highly durable businesses and then have the discipline to buy them when prices are attractive and the risk/reward trade-off is compelling. We invest in what we understand, continuing to pore over the universe of businesses within our many circles of competence that meet our management, capital allocation, business model, and valuation criteria. Some areas that we believe offer the greatest opportunity in terms of prospective returns include:
- Global market leaders such as Nike, Colgate-Palmolive and Philip Morris International that are beneficiaries of a growing global middle class and consumer culture. The global wealth effect, particularly in developing economies, is a real and very powerful force that should serve as a tailwind for these types of global brands over the long term.
- Well-managed financial services companies with true franchise value due to the success of their particular products or brand that have the ability and management prowess to build market share over time in a highly fragmented marketplace. Wells Fargo and Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B) are representative examples in this category. The depth of the recent financial crisis is well known. What is less understood is that certain market leaders used the downturn to dramatically strengthen their capital base and significantly grow their market share at the expense of weaker competitors.
- Certain health care-related businesses such as UnitedHealth Group and Laboratory Corporation of America that stand to benefit from growing health care spending by aging populations around the world.
- Workhorse technology companies such as Texas Instruments Incorporated (NASDAQ:TXN), Microsoft Corporation (NASDAQ:MSFT) and Google that are market leaders with durable competitive moats and that also offer an attractive risk/reward proposition at current valuations in our opinion.
Identifying investment themes is useful as they can guide investors toward areas of the market with above-average potential. Ultimately, though, investors must choose individual holdings where the risk/reward trade-off is favorable and the probability of success is high.3
In closing, we hope this update has provided useful perspectives on both our firm and the Fund, and we thank you for your support and confidence. As we have done for many