Large Cap Value Portfolio Commentary
Winter Update 2018

Market Perspectives

In 2017 the U.S. stock market returned 21.83%. This progress occurred against a relatively favorable economic backdrop. The U.S. economy is growing gross domestic product (GDP) at an annualized rate of approximately 3% with relatively full employment while interest rates and inflation remain muted.

The Davis Large Cap Value Portfolio delivered strong results during the year as well, modestly underperforming the S&P 500 Index and growing the wealth and savings of our shareholders at a double-digit rate through what we feel is a time-tested, reliable long-term investment approach.1 The financial and consumer discretionary sectors were particularly strong contributors to 2017 performance. Performance in the energy sector lagged during the time period.

We see reasons to be optimistic about many businesses today, but not all companies in the stock market represent equally good value. We believe selective stock picking is the best way to navigate the current environment and is a perennial approach to investing over full market cycles.

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’ Large Cap Value SMA Composite, gross of fees. The Davis Large Cap Value SMA Composite is a representation of Davis Advisors’ overall results employing this strategy. Individual account performance may vary. Past performance is not a guarantee of future results.

Portfolio Review

The Davis Large Cap Value Portfolio holds three categories of businesses including in order of proportion:

  • Dominant market leaders
  • Lesser-known, “out-of-the-spotlight” businesses
  • Contrarian investments2

Oracle, a representative market leader, is an exceptionally durable technology business.3 The company offers a wide array of enterprise information technology solutions including cloud applications, databases, and engineered systems to 430,000 customers in 175 countries. Oracle also provides a wide choice of software, systems and cloud deployment models, including public, on-premises and hybrid clouds to allow businesses to work efficiently and simplify work flows. Oracle is the second largest enterprise software company, the largest database company by revenue and the second largest enterprise application company. Oracle’s large market share, focus on expanding cloud-based solutions and reasonable valuation make the company an attractive long-term investment in our view.

Alibaba Group, a recent addition to the Portfolio, is a dominant e-commerce company based in China with a listing on the U.S. Nasdaq exchange. The company is the largest e-commerce marketplace in the world with $700 billion of gross merchandise volume this year. As a pure marketplace, the company allows third-party merchants to sell on its platform and generates revenue mostly through advertising. Merchants greatly value Alibaba’s large and highly active user base (200 million active daily users and 500 million active monthly users), and many merchants derive the vast majority of their online sales from Alibaba’s marketplace. Given the company’s enviable competitive position, increasing use as an advertising platform, and promising investments in various areas of the world, we expect Alibaba to grow e-commerce revenues at a rate faster than the global e-commerce market overall.

Capital One Financial, an out-of-the-spotlight business, is a top 10 U.S. bank based on deposits with branches located primarily in the New York to Washington, D.C. corridor as well as Texas and Louisiana. In addition to providing a full range of banking services, the company is best known for its competitive credit card offerings and is among the top 10 issuers of MasterCard and Visa cards. In our view, Capital One has a strong balance sheet, dramatically undervalued earnings power and a history of returning vast amounts of distributable earnings to shareholders through dividends and share buybacks. Valued at less than 12 times our estimate of owner earnings, we believe Capital One is trading at a highly attractive multiple given its potential earnings growth and offers investors a favorable risk/reward trade-off given today’s prices.

Among our current contrarian investments is Wells Fargo, which we consider attractively valued given its strong position across North America in banking, insurance, investments, mortgages, and consumer and commercial finance services. Partially hidden by today’s low interest rates is what we consider the bank’s key competitive advantage: its sizable, low-cost and stable retail deposit base that has historically enabled Wells Fargo to generate one of the highest net interest margins in the industry. With a current valuation in the low teens, a strong balance sheet, a strong underwriting culture, and a large market share in key end markets—all of which we view as part of the company’s competitive moat—we believe Wells Fargo remains attractively priced even taking into account negative headlines currently associated with the company.

A second example of a contrarian investment in the Portfolio is Occidental Petroleum, a well-managed, U.S.- based energy exploration and production company with an excellent management team, a strong balance sheet and top-notch properties, especially its fields in the productive Permian Basin in southeastern New Mexico and western Texas.

Among recent portfolio changes, we sold UnitedHealth Group during the fourth quarter of 2017.

Overall, we believe the durable balance sheets and long-term earnings power of the companies that make up the Davis Large Cap Value Portfolio strongly position us to continue building shareholder wealth over time.

Since our firm’s inception nearly 50 years ago, we have adhered to the same, time-tested investment philosophy and rigorous research process of buying durable businesses at attractive prices and holding them for the long term. The more than $2 billion from the Davis family and Foundation, Davis Advisors, and our employees invested side by side with our clients’ savings in similarly managed accounts and strategies remains a true sign of our commitment to and conviction in this enduring philosophy.4

2 While we research companies subject to such contingencies, we cannot be correct every time, and a company’s stock may never recover. 3 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. 4 As of December 31, 2017.

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 New York Venture 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 New York Venture 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,” 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.

Returns from inception (April 1, 1969) through December 31, 2001, were calculated from the Davis Large Cap Value Composite (see description below). Returns from January 1, 2002, through the date of this report were calculated from the Large Cap Value (SMA) Composite.

Davis Advisors’ Large Cap Value Composite includes all actual, fee-paying, discretionary Large Cap Value investing style institutional accounts, mutual funds, and wrap accounts under management including those accounts no longer managed. Effective January 1, 1998, 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.

Davis Advisors’ Large Cap Value (SMA) Composite excludes institutional accounts and mutual funds. Performance shown from January 1, 2002, through December 31, 2010, 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 January 1, 2011, through the date of this report, the Davis Advisors’ Large Cap Value 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. The net of fees rate of return formula used by the wrap-fee style accounts is calculated based on a hypothetical 3% maximum wrap fee charged by the wrap account sponsor for all account service, including advisory fees for the period January 1, 2006, and thereafter. 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 Large Cap Value 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; 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 Large Cap Value 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) issued by large companies with market capitalizations of at least $10 billion. Historically, the Large-Cap Value strategy has invested a significant portion of its assets in financial services companies and in foreign companies, and may also invest in mid- and small-capitalization companies. The principal risks are: common stock risk, depositary receipts risk, emerging markets risk, fees and expenses risk, financial services risk, foreign country risk, foreign currency risk, headline risk, large-capitalization companies risk, manager risk, mid- and smallcapitalization companies risk, and, stock market risk. See the ADV Part 2 for a description of these principal risks.

Broker-dealers and other financial intermediaries may charge Davis Advisors substantial fees for selling its products and providing continuing support to clients and shareholders. For example, brokerdealers and other financial intermediaries may charge: sales commissions; distribution and service fees; and record-keeping fees. In addition, payments or reimbursements may be requested for: marketing support concerning Davis Advisors’ products; placement on a list of offered products; access to sales meetings, sales representatives and management representatives; and participation in conferences or seminars, sales or training programs for invited registered representatives and other employees, client and investor events and other dealer-sponsored events. Financial advisors should not consider Davis Advisors’ payment(s) to a financial intermediary as a basis for recommending Davis Advisors.

The S&P 500 Index is an unmanaged index of 500 selected common stocks, most of which are listed on the New York Stock Exchange. The Index is adjusted for dividends, weighted towards stocks with large market capitalizations and represents approximately two-thirds of the total market value of all domestic common stocks. Investments cannot be made directly in an index.

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