Davis Global ADR Portfolio Commentary
Summer Update 2020

Market Perspectives

In the first half of 2020, the MSCI ACWI (All Country World Index) returned −6.25%.1 Stocks have been volatile, which is understandable, given the near-term disruption and uncertainties introduced by COVID-19. It remains to be seen how the pandemic might ultimately impact individual businesses, different industries and whole economies. Our view is that opportunities are available at very attractive prices, but it is essential to be selective and, ideally, to apply the margin-of-safety principle in terms of valuation discipline.

We are neither optimists nor are we pessimists. Rather, it is a time to be realistic, both about the near-term uncertainty and challenges economically that we face, but also taking into account how the future may improve from here in iterative fashion.

There are a number of guideposts and parameters that can prove useful in navigating crisis periods while one is in them, precepts we have learned over our more than 50 years navigating the stock market through all manners of conditions and crises:

The first lesson is to focus intensely on each and every investment one holds and to be positioned in highly durable, defensible businesses. Surviving through the period of near-term stress is the paramount goal at the outset. Invaluable attributes in environments like the present include balance sheet strength (with net cash preferably) and stable sources of funds and cash flow to support operations and necessary capital expenditures.

Second, it is important to revisit the long-term and perennial relevance of different businesses—and whole industries—looking out some number of years. Some may fit squarely in the paradigm of how consumers and businesses interface (e.g., e-commerce, semiconductors embedded in smart mobile devices worldwide, financial services, etc.). In other cases, businesses may prove more ephemeral and non-essential in leaner economic times where consumers have to make more choices. Casinos, certain areas of travel, brick-and-mortar retail (already under secular pressure from online competition) and luxury goods, for example, could in theory take longer to recover, and some of those businesses may not recover fully for a long time as they engage in “nice-to-have” products and services versus non-discretionary, “must-have” categories.

Finally, diversifying one’s portfolio with a varied set of businesses and across multiple geographies can be beneficial in our experience to prevent putting all of one’s eggs in a single basket. It is prudent in our view to hold investments with differentiated drivers of success and to diversify risk factors to reduce the likelihood of a permanent and substantial loss of capital as an additional, portfolio-level risk mitigator.

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 Davis Advisors’ Global Equity Composite, gross of fees. Inception was 1/1/05. Past performance is not a guarantee of future results.

Portfolio Positioning

The Portfolio is invested in both the proverbial tortoises and hares of the market—individual businesses that are cash-generative, have attractive returns on capital and strong competitive moats and are trading at value prices.

On the one hand, we own positions in staid, fairly mundane cash-generative industries, such as financial services and certain types of industrials, many of which have a long history of returning capital to shareholders through dividends and share repurchases, while also reinvesting at attractive, if not exceptional, returns on equity. They tend to be slower growth in nature, but extremely proven, durable, established and cash-generative, and they can deliver value to shareholders through a combination of dividends, accretive share repurchases and capital appreciation driven by reinvestment rates over the long term in our estimation, even if short-term results may reflect the impact of COVID-19. Currently, the disparity between a more normalized estimate of earnings for our businesses over a multiyear period versus this pressure point in the near term is very wide among leading financials. We have invested more in financial businesses in Europe (primarily in the Nordics and Switzerland), as well as in the U.S., where we feel significant mispricing is present. (It is worth noting that our view on the reduction to dividends and suspension of buybacks for certain types of financials in the current environment is that it should be a temporary, precautionary phenomenon that neither represents a loss of intrinsic value nor a permanent shift in capital allocation flexibility long-term.)

At the other end of the spectrum are exceptional companies that possess superior growth characteristics, in our estimation. For example, we hold a number of technology-related businesses serving a wide range of industries, from e-commerce and cloud computing to software services and semiconductors, among others. We own what we believe are world-class businesses in these areas and have found most of them in the U.S. and China. It is imperative with these types of businesses to adhere to a valuation discipline and to establish why one should feel confident those companies are likely to sustain their leading edge in the face of formidable competitive forces. We believe our companies in these industries have tremendous competitive advantages that cannot easily be competed away, possibly for years to come. Overall, we are trying essentially to capture total returns in a variety of ways involving considerations around both defense and offense in our selections.

The Portfolio is diversified consciously across 29 differentiable businesses, each with its own attractive features, according to our analysis. What unifies the entire Portfolio thematically is the concept of durability. First, we seek to own businesses that are built to last, and second, we look to them as vehicles for compounding shareholders’ capital over the long term—and in that order, starting first with defense and then proceeding on to offense. We “look down,” assessing downside risk, in other words, before “looking up” at the total return potential long-range for each investment.

Short-term market volatility has allowed us to make a number of adjustments to the Portfolio at the margin. Certain sectors, especially high-grade financials, have declined more than the overall market, and they present investors with, in select instances, single-digit valuations and possess financial strength well beyond the 2008–2009 crisis. This means, importantly, that we have a constructive view of our financial positions over the next three to five years and beyond—even if the current year proves somewhat challenging. The major banks in the U.S. have more than twice as much capital coming into this year as they did entering the 2008–2009 crisis. From a cash flow perspective, they continue to take in cash as their business models center around the activity of “making money on money,” which is really a digital product at this point, not a foot-traffic-dependent, physical product that must be sold in a store, for example. We are avoiding consciously businesses and industries that, in a new normal environment looking ahead, fail to meet the definition of “evergreen”—i.e., perennial and enduring—favoring instead contrarian areas whose financial soundness is underappreciated, in our view. Bank Julius Baer in Switzerland is one such example, among others.2 To fund new purchases, we sold Apache and other energy holdings where we feel the long-term outlook for energy businesses may be very challenging.

It is really time to avoid extreme optimism or pessimism. It is a time to be realists, as noted earlier. One reality is that the near-term news headlines, headline economic statistics and possibly share price performance may prove trying psychologically for investors. We are prepared for that potentiality and are focused instead on ensuring that the businesses we own do not fluctuate in their true long-term earnings power—and therefore intrinsic values—anywhere near the extent to which their share prices might vacillate. We believe that a realistic view also should leave open the possibility that from this point of extreme depression and stress, conditions can and should improve markedly for at least the right businesses in the right sectors in the coming years and possibly quarters. Starting at low multiples of normalized earnings, we feel we have an appropriate and favorable balance of risk and reward in terms of business characteristics in our Portfolios, as well as a consciously built-in margin of safety, valuation-wise. Lastly, we own a wide array of different businesses for the purpose of diversification.

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 Global SMA 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.

Portfolio Review

In the first six months of 2020, Davis Global ADR SMA Portfolio delivered modestly negative results but outperformed the −6.25% return of the MSCI ACWI Index.

During the period, the COVID-19 pandemic and economic disruption significantly impacted businesses around the globe, yet we were generally satisfied with the performance of our portfolio companies through this difficult period. Among drivers of outperformance were many of our U.S. and Chinese consumer Internet companies. Alphabet, a core long-term holding in the Portfolio, is representative of the power and competitive position we seek in our investments. Thematically, we continue to have a favorable long-term view of Internet advertising, from classified ads businesses to Alphabet’s core search business. Meanwhile, in e-commerce, online retail has been rapidly taking share globally. In 2019, the online share of U.S. retail sales reached 11.5%, while in China, it is even higher at over 20%.3 Although the lockdowns and travel bans employed to combat the spread of COVID-19 hurt consumer demand, they also accelerated the secular trends favoring e-commerce, working remotely and online learning, which are businesses where a number of our top holdings are leaders. These consumer Internet leaders are the “blue chips of tomorrow” with strong moats, good growth prospects, cash-generative business models and attractive valuations.

Banks in the U.S. and select international banks have underperformed in the first half of 2020. The market fears the impact of the looming recession on bank earnings. While loan losses will naturally rise in the coming recession, the banks are entering this recession with much higher capital ratio—often twice as high— as the last one in 2008–09. Strong balance sheets, conservative lending decisions in the years following the financial crisis and low valuations are why we see the banks as another area of opportunity. These banks have proven their durability by weathering numerous recessions, wars and some even past global pandemics.

In addition, among international financials, we also hold AIA Group, a premier brand for life insurance in China and throughout Asia-Pacific. We believe much of that region is under-penetrated in financial services in general and that life insurance, as prosaic as it may seem to those of us long accustomed to having it, serves an important function in countries like China that face the potential demographic headwinds of rising morbidity and mortality over time with the aging population. But the life insurance opportunity is far-reaching, and not surprisingly, AIA operates in close to 20 different countries, up and down the Asia-Pacific corridor from Australia to China.

In the industrials sector, we own Carrier Global, a leading global HVAC, refrigeration, and fire and security provider. The business sells to both residential and commercial customers, and by geography is roughly evenly split between the U.S. and international markets. Carrier Global has particularly strong franchises in U.S. residential/light commercial HVAC—where it has loyal customers and deep distribution networks—as well as truck-trailer/container refrigeration, and fire detection and suppression. In the first half of 2020, we added meaningfully to Carrier Global, exiting our energy holdings in part to fund those purchases.

Overall, our conviction is that the businesses in the Portfolio should, in our estimation, demonstrate their considerable earnings power over the coming quarters and years, and they are trading at very attractive valuations on fortress balance sheets by and large. Even taking into account the likelihood that near-term economic realities may prove challenging for businesses of all types, what will matter ultimately is whether investors hold businesses that are sufficiently resilient and relevant to confront the near-term realities and whether these investments have the ability to resume an expansion of earnings power in the years ahead. We are willing to be contrarians by owning such companies in volatile markets, provided the short-term challenges do not markedly alter what we see as attractive long-term economics for those companies.

Conclusion

Times of crisis, especially those that are truly unprecedented, are universally 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 recessionary conditions for a time and then resume a pattern of growing earnings thereafter—and then whether that long-term earnings accumulation is appropriately priced in.

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. This also means applying an independent, fresh lens to the broader market and being willing to avoid certain industries or sectors whose futures have changed due to the coronavirus and/or other secular forces such as competition or commoditization.

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 Global 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 Global Fund or any other fund.

Effective 9/23/14, Davis Advisors created a Global Equity SMA Composite which excludes the institutional accounts and mutual funds. Performance shown from 10/1/14, through the date of this report, the Davis Advisors’ Global Equity 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.

A time-weighted internal rate of return formula is used to calculate performance for the accounts included in the Composite. The net of fees rate of return formula is calculated based on a hypothetical 3% maximum wrap fee charged by the wrap account sponsor for all account services. For the gross performance results, custodian fees and advisory fees are treated as cash withdrawals.

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.

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 Global 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. Each of these holdings must come from a different country.); 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. If a holding to be discussed (excluding the buys/sells) is no longer in the model portfolio as of quarter end, the next listed holding is selected and discussed.

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 Global 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 portfolio principally in common stocks (including indirect holdings of common stock through depositary receipts) issued by both United States and foreign companies, including countries with developed or emerging markets. The global companies’ strategy may invest in large, medium, or small companies without regard to market capitalization. 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.

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