Spring 2010 Commentary


Portfolio Positioning
Performance Review
Long-Term Perspectives
Where We Are Finding Opportunities

Since our founding more than 40 years ago in 1969, Davis Advisors' mission as a firm has been to serve our shareholders and to do so with high integrity. Mindful of the enormous responsibility that comes with serving as a steward of others' capital, we are firmly committed to:

• Investment excellence: Davis Advisors conducts rigorous fundamental research with the goal of producing solid long-term investment results for shareholders.

• Sharing wisdom and perspectives about investor behavior: We strive to promote healthy investor behavior, which we firmly believe can positively influence the results that shareholders ultimately realize.

• Open and honest communications: We seek to communicate with our shareholders in a manner that we would desire if our roles were reversed.

As a sign of our commitment to all those who have entrusted capital to us, the Davis family, Davis Advisors, employees, and directors have more than $2 billion of their own money invested side by side with clients.1

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.1 As of December 31, 2009.



Portfolio Positioning2

Market conditions may vary from period to period, yet the core tenets of the Davis investment discipline and approach remain the same. We start with the premise that stocks represent fractional ownership in real businesses. We seek to purchase durable businesses at value prices and hold them for the long term. We believe that owning shares of well-managed businesses with attractive reinvestment rates, purchased at reasonable valuations and held for years to allow the power of compounding to work, is a reliable method for building capital over long investment horizons.

By definition, owning shares of companies for years or even decades means that some, perhaps all, of our investments will traverse rough patches along the way, whether they are specific to a company, an industry or the broader market. We know in advance that we are going to own businesses in periods of rising interest rates, falling interest rates, inflation, disinflation, a weak dollar, a strong dollar, and so forth. Therefore, when we think about purchasing shares of a company, we have to weigh carefully up front whether we think the business can withstand inevitable shocks in addition to considering the likelihood the business can grow earnings power (and therefore intrinsic worth) over full cycles. Then, company by company, we set out to build a durable, all-weather portfolio of businesses that can compound over the long term.

Our Portfolio holds three primary categories of investments:

• Market leaders with strong balance sheets
• "Out-of-the-spotlight" businesses
• Headline risk or contrarian investments

Market leaders with strong balance sheets—In many cases these are global companies with universally known brands, earnings that are well diversified from the standpoint of product line and geography, and fortress balance sheets. At this time more than 85% of the Portfolio is invested in companies with market capitalizations in excess of $10 billion and combined revenues totaling more than $1.5 trillion.5 These businesses span a broad range of global industries including financial services, consumer products and technology, among others. They provide a core foundation of stability within the Portfolio and offer in our view a high probability of long-term sustainable returns through capital appreciation and dividends.

A representative market leader in the Portfolio is Berkshire Hathaway, a diversified holding company with a market capitalization of roughly $200 billion and interests in insurance, reinsurance, railroads, utilities, manufacturing, retailing, and a host of other business lines. Under the steady leadership of Warren Buffett and team the company has grown book value at more than 20% per year on average over the past four and a half decades, more than double the return of the S&P 500® Index over the same period. Given its increasing size, the company's prospective returns will likely be lower than its historical record, but we believe Berkshire Hathaway is well positioned through its operating businesses as well as its investment portfolio to increase earnings power considerably over the next five to 10 years.

Another example of a market leader and a relatively new addition to the Portfolio is Coca-Cola (Coke), the world's most valuable brand according to the marketing research organization Interbrand. As the largest global beverage company with more than twice the annual sales of its nearest competitor, Coke has an enviable and expanding portfolio of still and carbonated products that generates consistent growth. Tracing the company's progress in recent years, in 1997 the company owned five brands that each generated $1 billion or more in annual sales. Today the company has 13 billion-dollar brands and expects to have 30 by 2020. A large portion of this growth will likely be generated in developing and emerging economies where Coke is investing heavily. Already some 75% of current revenues are derived from international markets and Coke expects this growth to continue as more and more of the world's population joins the middle class.

A third representative market leader in the Portfolio is Diageo, one of the world's largest alcoholic beverage companies, which operates in more than 180 countries marketing top-shelf brands including Smirnoff, Johnnie Walker, Captain Morgan, Baileys, and Guinness, among others.

We believe market leaders such as Berkshire Hathaway, Coca-Cola and Diageo that possess strong brands, proven management, fortress balance sheets, and scale advantages are well positioned to create significant value for long-term shareholders.

Out-of-the-spotlight businesses—After market leaders, the next major category of investments in the Portfolio is out-of-the-spotlight businesses. These are lesser known companies with attractive economics that in our opinion should eventually command higher valuations. Their appeal may take time to gain recognition, often because these businesses are smaller or operate in a mundane non-consumer-oriented industry. Given the right leadership and attractive reinvestment rates, these low-profile holdings can provide the opportunity for the "double play" of expanding multiples on expanding earnings, which can turn a company with a solid earnings growth rate into a stellar investment. As a general rule, out-of-the-spotlight holdings tend to be boring but steady compounding machines.

An example of an out-of-the-spotlight holding is Sealed Air, one of the largest companies in the profitable yet mundane business of manufacturing an array of protective wraps and packaging used in the industrial, food and medical industries. Sealed Air's best-known products include Bubble Wrap and Jiffy mailers, although much of its protective packaging is sold directly to manufacturers and distributors who use it to protect such sensitive merchandise as personal computers from damage during transport. To help protect food, the company makes vacuum-sealed shrink wraps often used to safely seal meats as well as different types of cellophane packaging frequently found in the deli, meat and fresh produce sections of local grocery stores. What Sealed Air lacks in terms of household recognition, it more than makes up for with its favorable returns on invested capital in our opinion.

Headline risk or contrarian investments4—On a very selective basis we make contrarian investments. These often involve controversial situations where the market is discounting a company's share price to reflect a perception of risk that we think is greater than the probable economic risk to the business's long-term fundamentals. Typically a minor portion of our portfolios in percentage terms, headline risk investments can sometimes be difficult for clients to understand because they beg the question, "Don't you read the papers?" But it is precisely because so many other investors automatically sell companies with near-term challenges, however surmountable, that the potential for high returns exists in many such instances. Our job is to ferret out opportunities that represent favorable risk/reward trade-offs and do our best to avoid the value traps. We will not get every investment right. However, overall this distinctly contrarian element of our investment discipline has been an important contributor to our long-term success and can be an effective and repeatable way to capitalize on herd mentality in the market. As an example, uncertainty associated with health care reform in the United States has created opportunity in recent months. In 2009 we were able to purchase shares of several high-quality pharmaceutical businesses including Pfizer at what we believe were highly attractive valuations.

Overall, the investments we have made in the three categories described above combine to form a total portfolio that we believe is well diversified and has a high probability of producing satisfactory compound returns over full market cycles.5

2 Holdings discussed in this commentary are selected according to objective, non-performance-based criteria. They are chosen each quarter according to a consistent methodology based on their weight in the Davis Advisors Large Cap Value model portfolio as well as recent purchases and recent sales and are intended only as illustrations of the Davis investment discipline. They are not recommendations to buy, sell or hold any security. Individual account holdings may vary. 3 Source: Davis Advisors and Wilshire Atlas. 4 While we research companies subject to such contingencies, we cannot be correct every time, and a company's stock may never recover. 5 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. Equity markets are volatile and an investor may lose money.

Performance Review

For the trailing 12 month period ending March 31, 2010 the S&P 500® Index delivered very solid returns, finishing the period up 49.77%, and the Davis Large Cap Value Composite outperformed the benchmark.6 Longer term the Composite has outperformed the Index over the trailing one, five, seven, 10, 15, 20, 25, 30, 35, and 40 year periods as well as since its inception in 1969.6 The Davis Large Cap Value strategy has also outperformed the S&P 500® Index over every 10 year rolling period since 1969, a testament in our view to the effectiveness of the fundamentals-based Davis investment discipline through a variety of market and economic conditions.6 (The Davis Large Cap Value Composite is a representation of Davis Advisors' overall results using this strategy. Individual account performance may vary.)

Annualized Total Returns as of March 31, 2010	1 Year	5 Years	7 Years	10 Years	15 Years	20 Years	25 Years	30 Years	35 Years	40 Years	Since Inception (4/1/69)
with a 3% maximum wrap fee	53.31%	-0.29%	5.79%	-0.35%	7.14%	8.30%	9.99%	11.56%	11.98%	9.66%	9.66%

The performance presented represents past performance and is not a guarantee of future results. Investment return and principal value will vary so that an account might realize a gain or loss. Total return assumes reinvestment of dividends and capital gain distributions. Current performance may be higher or lower. Total return updates are available quarterly. Please ask your financial advisor to contact Davis Advisors.



The Portfolio's results in the most recent 12 month period reflect strong performance among many individual holdings, particularly within the financials, energy and information technology sectors. (Sector allocations are a by-product of bottom-up stock selection and generally represent a cross section of market leaders, out-of-the-spotlight holdings and headline risk investments. We refer to sector-level performance here merely to provide a general frame work for understanding the Portfolio's aggregate performance in the most recent 12 month period.)

Our financial holdings represent a diversified set of industries and business types and reflect our conviction in individual companies. Our holdings in this sector include select money center banks, regional banks, a personal lines auto insurer, and holding companies with significant interests in utilities and insurance among other businesses. Consistent with our overall investment approach, we are interested in owning what we believe are durable, best-in-class franchises with expert managements, robust balance sheets and favorable competitive positions.

Our energy-related holdings consist predominantly of oil and natural gas exploration and production companies that have historically earned above-average returns on capital versus their peers and that in our view are trading at reasonable normalized valuations. We believe our energy holdings are capable of creating value for shareholders under a variety of economic and market conditions through the disciplined allocation of capital. They also stand to benefit potentially from the long-term tailwinds of a growing global middle class and a veritable industrial revolution taking place within certain developing economies.

Information technology has been one of the best performing areas of the Portfolio and the market over the last 12 months. Our technology holdings predominantly include workhorse category leaders in chips, online search and software. We believe these businesses stand a high probability of compounding earnings by generating relatively high returns on capital and enjoy significant competitive barriers to entry.

Regarding notable portfolio changes over the past year, we added select pharmaceutical and other businesses in the health care area to the Portfolio, initiated a position in Coca-Cola and sold our position in Comcast.

To provide our clients with timely information, we have discussed Portfolio results for the trailing 12 month period. However, our investment discipline is based on a much longer term view. We evaluate each investment in the Portfolio based on its potential to create value for our clients over multi-year holding periods. Through bottom-up stock selection and rigorous fundamental research, we aim to construct a total portfolio that we believe is well diversified and has a high probability of producing satisfactory compound returns over full market cycles.

6 The Davis Advisors Large Cap Value Composite, net of fees. Inception was April 1, 1969. Rolling 10 year returns are from the first full calendar year after inception of the Composite (January 1, 1970). See endnotes for a description of our rolling 10 year performance and a definition of the S&P 500® Index. Past performance is not a guarantee of future results.



Long-Term Perspectives

In our experience, one of the keys to building long-term wealth is to avoid making emotional investment decisions. The way in which emotions can undermine an investor's ability to build long-term wealth was evident in 2009 when cautious investors poured a record $375 billion into bond funds while pulling close to $10 billion out of stocks. As a result, many investors missed the market's 26% return in 2009.7 While such a reaction reflects human nature on the heels of a difficult decade for stocks, successful investors recognize the importance of remaining unemotional when making investment decisions.

Source: Investment Company Institute. Stocks and bonds represent different asset classes subject to different risks and rewards. Future economic events may favor one asset class over another.


Applying an unemotional, objective approach to today's market environment suggests that long-term investors would be well served adding to, or maintaining, their equity allocation over the next decade.8 Why? Because historically disappointing decades for stocks have been followed by periods of attractive returns. This is illustrated in the chart below, which shows the 10 year returns for the market from 1928-2009. Returns of at least 5% are represented by the green bars and returns of less than 5% are represented by the red bars. Here are a few key points:

• From 1928 through 2009, there have been eleven 10 year periods where the market delivered disappointing returns of less than 5%.
  
• In every case, the decade following these disappointing decades produced satisfactory returns. (For instance, the -0.2% average annual return from 1928-1937 was followed by a 9.3% average annual return from 1938-1947.) Past performance is not a guarantee of future results.
  
• These periods of recovery averaged 13% per year (ranging from a low of 7% to a high of 18%).