All-Cap Portfolio Commentary
Fall Update 2020

Market Perspective

In the year-to-date period through September 30, the S&P 1500 Index returned 4.13%. This overall result is relatively favorable, given the challenges still underway. Importantly, within the market averages, a bifurcation has occurred. At one extreme are high-growth but high-valuation companies that have risen dramatically in the current year. At the same time, and at the other extreme, value stocks are down this year. This setup, somewhat reminiscent of the wide divergence between growth and value in the late 1990s, has implications for investors in terms of what positioning and investments they should choose.

There has been an extent of overshooting in both directions, in our opinion. Expensive stocks have in many instances become more expensive—priced increasingly “for perfection” and therefore introducing more valuation risk—while cheaper situations have broadly become cheaper still. Some of the inexpensive areas, in particular durable financials and select global industrials, are trading well below their true worth, in our view, yet are being priced comparably to businesses that are failing and are therefore cheap for good reason. We are seeking diamonds in the rough across the market and are finding particularly compelling opportunities in mispriced value stocks currently. As such, we have actively recycled some capital from high-growth but higher multiple holdings into companies that are extremely undervalued by our analysis.

Regarding COVID-19, the U.S. economy has shown a certain resiliency thus far in the pandemic, and we expect that treatments and eventually vaccines are forthcoming, given the global focus of investment and resources on this one problem. More than 140 vaccines are in research and development around the world, with researchers and governments acting with a sense of urgency to discover solutions to the virus. The timeframe is unknowable. Therefore, we are investing carefully and thoughtfully in businesses and industries that have great resiliency and that are extremely durable in terms of balance sheet strength and liquidity, cash flow generation, long-range returns on capital and competitive advantages, which can weather the potentially prolonged conditions of the present time and generate significantly higher earnings in the years ahead. Regardless of security price or market price volatility— which no one can predict—we are fully invested in a select set of businesses that, in our view, can withstand near-term recessionary conditions and participate well in future periods of recovery and expansion that should follow.

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. The investment strategies described herein are those of Davis Advisors. These materials are being provided for illustrative and informational purposes only. The information contained herein is obtained from multiple sources that are believed to be reliable. However, such information has not been verified, and may be different from the information included in documents and materials created by the sponsor firm in whose investment program a client participates. Some sponsor firms may require that these Davis Advisors materials are preceded or accompanied by investment profiles or other documents or materials prepared by such sponsor firms, which will be provided upon a client’s request. For additional information, documents and/or materials, please speak to your Financial Advisor.

Portfolio Positioning

At Davis Advisors, our most important goal is to increase the value of the savings entrusted to our management over the long term. We are confident in its positioning for the market cycle ahead, which will likely include periods of economic tests with periods of expansion as well over full business cycles, if the stock market’s long history is any indication.1

In the current year, the Davis All-Cap Equity strategy has trailed the S&P 1500 Index given our positioning in more value-oriented areas of the market than in growth areas. While momentum may continue to stay in favor for a time, we are not tempted to change our discipline for the simple reason that momentum is by its nature ephemeral and capricious and carries speculative risk. Because stocks represent ownership interest in real businesses and because the value of any business is determined by the earnings the business generates, the more a stock goes up in price, the lower, not higher, the future return should be. Sooner or later, the music stops, and price and value converge. Although we recognize that value investing has been out of fashion for more than a decade, we firmly believe that doing something that is logically foolish because it has worked for some time is a recipe for disaster.

Most importantly, we are sticking to our discipline because the carefully selected businesses that we own have generated strong underlying results, even as their share prices have lagged. This disconnect is simply another powerful reminder of the difference between price and value. Starting with value, we have constructed the Portfolio in a way we believe will weather any storm, including the one we are currently in. Our Portfolio companies exhibit a rare combination of durable business models, profitable long-term growth, strong free cash flow, proven, capable management and below-average valuations. Turning to price, however, even though these businesses have proven records of durability and the financial strength to weather the current storm, the fact that many have a cloudy short-term earnings outlook has led them to fall out of favor, especially compared to companies that are growing quickly in the current environment, but may have a less certain long-term future. In other words, our research indicates that we are currently seeing a tale of two markets, with a handful of companies significantly overvalued at the same time that many others are significantly undervalued.

1Davis Advisors’ Multi-Cap SMA Equity Composite, net of fees. Inception was 1/1/99. Past performance is not a guarantee of future results.

Portfolio Review

With the short term cloudy but the long term clearer, we continue to focus on companies with durable competitive advantages, proven business models, long histories of profitable growth and capable management teams. For some companies with these characteristics, particularly a number of our leading technology companies, the current environment has not impeded favorable trends driving their potential long-term earnings power.2  Despite near-term potential disruption from COVID-19, we have high conviction that demand and the market size for a wide range of technology products and services will continue to grow at high rates over an extended period of time.

For example, Quotient Technology is a leader in digital coupons, including online, print, social media and mobile coupon promotions. The company’s rapidly growing digital transactions, unique customer database and large-scale presence in digital coupon disbursement set it apart from the competition, creating a promising outlook for revenue growth, in our view, combined with a reasonable valuation. Other investments in technology within the Portfolio range from e-commerce to online search and advertising to semiconductors and cloud computing services, among other areas. One recent addition to our Internet-related holdings is Interactive Corp (IAC), which owns ANGI Homeservices, effectively a platform connecting households and vendors in the home maintenance and services industry, and Vimeo, a leader in corporate video communications technology. We believe the company is undervalued relative to its potential in both sides of its business, in addition to other investment stakes it holds.

At the other extreme, we own a number of companies for which this steep decline in economic activity has been an unpleasant but manageable reality. Here, the investment opportunities are the greatest, for the simple reason that investors are more concerned with short-term uncertainty than long-term durability. Currently, we see the biggest opportunities in two sectors: first, high-quality global industrial companies. Each have proven long-term growth records, strong balance sheets, durable business models and excellent management.

Johnson Controls International is an example of our industrial holdings. Founded in 1885, it is a global supplier of heating, ventilation and air conditioning systems, among other building systems, for commercial, industrial, retail, small business, institutional, and governmental customers around the world. Its diversification by industry and the mission-critical nature of its products and services make Johnson Controls International a particularly durable cash flow generative compounding machine in our opinion and a high-conviction long-term investment.

Second, and even more dramatically, we see a significant opportunity in select well-capitalized financial leaders, such as Wells Fargo, which currently sell at distressed prices, despite being explicitly prepared for today’s turmoil. This preparation was the result of the lessons learned during the financial crisis and ensures that these leading banks have the durability and resiliency to withstand even a worse economic scenario. Specifically, all of our major bank holdings are subject to a stress test that includes a multi-year recession in which the stock market declines 50%, commercial real estate 35%, home values 25%, unemployment rises to 10% over a three-year period and GDP shrinks 8%. The fact that our bank holdings are prepared for such a scenario should give investors great confidence. Yet, even though our banks are far more conservatively capitalized, with almost twice the capital they held before the financial crisis, and are carrying far less risk in their credit portfolios, a huge gap has developed between their price and value.

As the banks emerge on the other side of this current crisis with their balance sheets and earnings power intact, we anticipate that attitudes towards the sector could improve significantly, leading to a powerful increase in their relative valuation and a sharp closing of this enormous gap. In the meantime, we are delighted to be buying durable institutions, well-prepared for this turmoil, at distressed prices, as in doing so, we are sowing the seeds for future performance.

2Holdings 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 All-Cap 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.

Conclusion

Times of crisis are by their nature difficult and unsettling. Whether the crisis is war, natural disasters, terrorist attacks or in this case, a global pandemic, there is always an adjustment period afterwards that can change the fortunes of people and certainly of businesses and industries on a secular basis. With many unknowns in the near term, what an investor should seek to understand with a high degree of confidence, in our view, is how and why their businesses should be able to sustain themselves in recessionary conditions and then demonstrate they can resume a pattern of growing earnings thereafter.

In terms of whether this is an advantageous time to invest or not, we remain fully invested and maintain a constructive multi-year view for our businesses, especially starting from a point of modest expectations. That stated, it is advisable in our opinion to invest today with a very selective eye and on a bottom-up, company-by-company basis. That means, among other things, that investors should pay careful attention to true long-term resiliency and durability of every business, as well as factors that bolster the case for long-term sustainability, such as competitive moats and strong management teams. In our experience, the last essential component to weathering these times is applying a valuation discipline that seeks to build in a margin of safety in price.

Thank you for your confidence, and we wish all of our shareholders and their families well in this time.

This material may be shared with existing and potential clients to provide information concerning market conditions and the investment strategies and techniques used by Davis Advisors to manage its client accounts. Please refer to Davis Advisors’ Form ADV Part 2 for more information regarding investment strategies, risks, fees, and expenses. Clients should also review other relevant material, including a schedule of investments listing securities held in their account.

The performance of mutual funds is included in the Composite. The performance of the mutual funds and other Davis managed accounts may be materially different. For example, the Davis Opportunity Fund may be significantly larger than another Davis managed account and may be managed with a view toward different client needs and considerations. The differences that may affect investment performance include, but are not limited to: the timing of cash deposits and withdrawals, the possibility that Davis Advisors may not buy or sell a given security on behalf of all clients pursuing similar strategies, the price and timing differences when buying or selling securities, the size of the account, the differences in expenses and other fees, and the clients pursuing similar investment strategies but imposing different investment restrictions. This is not a solicitation to invest in the Davis Opportunity Fund or any other fund.

Davis Advisors is committed to communicating with our investment partners as candidly as possible because we believe our clients benefit from understanding our investment philosophy and approach. Our views and opinions include “forward-looking statements” which may or may not be accurate over the long term. Forward-looking statements can be identified by words like “believe,” “expect,” “anticipate,” “feel,” or similar expressions. You should not place undue reliance on forward-looking statements, which are current as of the date of this report. We disclaim any obligation to update or alter any forward-looking statements, whether as a result of new information, future events, or otherwise. 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 Davis All-Cap Equity is represented by Davis Advisors’ Multi-Cap Equity Composite.

Performance shown from 1/1/99, through 12/31/05, is the Davis Advisors’ Multi-Cap Composite which includes all actual, fee-paying, discretionary Multi- Cap investing style institutional accounts, mutual funds, and wrap accounts under management including those accounts no longer managed. Effective 1/1/98, a minimum account size of $3,500,000 was established. Accounts below this minimum are deemed not to be representative of the Composite’s intended strategy and as such are not included in the Composite. A time-weighted internal rate of return formula is used to calculate performance for the accounts included in the Composite. For the net of advisory fees performance results, custodian fees are treated as cash withdrawals and advisory fees are treated as a reduction in market value. For mutual funds, the Composite uses the rate of return formula used by the open-end mutual funds calculated in accordance with the SEC guidelines adjusted to treat mutual fund expenses other than advisory fees as cash withdrawals; sales charges are not reflected.

Effective 1/1/11, Davis Advisors created a Multi-Cap (SMA) Composite which excludes institutional accounts and mutual funds. Performance shown from 1/1/06, through 12/31/10, the Davis Advisors’ Multi-Cap SMA Composite includes all eligible wrap accounts with a minimum account size of $3,500,000 from inception date for the first full month of account management and includes closed accounts through the last day of the month prior to the account’s closing. For the performance shown from 1/1/11, through the date of this report, the Davis Advisors’ Multi-Cap SMA Composite includes all eligible wrap accounts with no account minimum from inception date for the first full month of account management and includes closed accounts through the last day of the month prior to the account’s closing. Wrap account returns are computed net of a 3% maximum wrap fee. For the gross performance results, custodian fees and advisory fees are treated as cash withdrawals. A list of Davis Advisors’ Composites is available upon request.

This report discusses companies in conformance with Rule 206(4)-1 of the Investment Advisers Act of 1940 and guidance published thereunder. The companies we discuss are chosen in the following manner: starting at the beginning of the year, the holdings from a Multi-Cap model portfolio are listed in descending order based on percentage owned. Companies that reflect different weights are then selected. (For the first quarter, holdings numbered 1, 11, 21, and 31 are selected and discussed. For the second quarter, holdings numbered 2, 12, 22, and 32 are selected and discussed. This pattern then repeats itself for the following quarters. No more than two of these holdings can come from the same sector per piece.); one recent purchase and one recent sale are also discussed. A sale is defined as a position that is completely eliminated from the portfolio before the end of the quarter in question. If there were no purchases or sales, the purchases and sales are omitted from the report. If there were multiple purchases and/or sales, the purchase and sale discussed shall be the earliest to occur. If there are multiple purchases and/or sales on the same day, the one that is the largest percentage of assets will be discussed. No holding can be discussed if it was discussed in the previous three quarters.

The information provided in this report does not provide information reasonably sufficient upon which to base an investment decision and should not be considered a recommendation to buy or sell any particular security. There is no assurance that any of the securities discussed herein will remain in an account at the time this report is received or that securities sold have not been repurchased. The securities discussed do not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of any account’s portfolio holdings. It should not be assumed that any of the securities discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein. It is possible that a security was profitable over the previous five-year period of time but was not profitable over the last year. In order to determine if a certain security added value to a specific portfolio, it is important to take into consideration at what time that security was added to that specific portfolio. A complete listing of all securities purchased or sold in an account, including the date and execution prices, is available upon request.

The investment objective of a Davis Multi-Cap Equity account is long-term growth of capital. There can be no assurance that Davis will achieve its objective. Davis Advisors uses the Davis Investment Discipline to invest a client’s assets principally in common stocks (including indirect holdings of common stock through depositary receipts). The Multi-Cap Equity strategy may invest in large, medium, or small companies without regard to market capitalization and may invest in issuers in foreign countries, including countries with developed or emerging markets. The principal risks are: common stock risk, depositary receipts risk, emerging markets risk, fees and expenses risk, foreign country risk, foreign currency risk, headline risk, large-capitalization companies risk, manager risk, mid- and small-capitalization companies risk, and stock market risk. See the ADV Part 2 for a description of these principal risks.

Small cap companies have market capitalizations less than $3 billion. Mid cap companies have market capitalizations from $3 billion to $10 billion. Large cap companies have market capitalizations greater than $10 billion. Under normal circumstances, the Multi-Cap Equity (SMA) Composite invests the majority of its assets in equity securities issued by companies with market capitalizations of less than $20 billion.

We gather our index data from a combination of reputable sources, including, but not limited to, Thomson Financial, Lipper, Wilshire, and index websites.

The S&P 1500 Index is comprised of the S&P 500, MidCap 400, and SmallCap 600, which together represent approximately 90% of the U.S. equity market. Investments cannot be made directly in an index.

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