Large Cap Value Portfolio Commentary
Winter Update 2017

Short-Term and Long-Term Results

In 2016, the Davis Large Cap Value strategy outperformed the S&P 500 Index, continuing the strategy’s long record of building shareholder wealth. A $10,000 investment at inception in the Davis Large Cap Value Portfolio would now be worth more than double a comparable investment in the S&P 500 Index.1

While no investment approach consistently outperforms the market over the short term, the longer a shareholder has been with us, the more likely our results have beaten the Index.

Looking ahead, we believe the durability and growth potential of the individually selected companies that make up the Davis Large Cap Value Portfolio position us strongly for the years and even decades to come.

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 Gross of fees. Composite performance from April 1, 1969, through December 31, 2001, is Davis Advisors’ Large Cap Value Composite which includes institutional accounts, mutual funds, and wrap accounts. Performance from January 1, 2002, through the date of this report is the Davis Advisors’ Large Cap Value SMA Composite which includes only wrap accounts. See endnotes for a description of the composites. The performance of mutual funds and other Davis managed accounts may be materially different. Past performance is not a guarantee of future results.

Investment Outlook
Equities should outperform bonds for the next decade.2 Avoid overpriced dividend darlings and expensive companies with peak profit margins. Technology and globalization are disrupting industries at an unprecedented rate.

When evaluating the investment landscape, we do not make investment decisions based on short-term forecasts, which history has shown can be unreliable. Instead, we focus on the important and knowable while maintaining a long-term perspective.

In today’s market, our long-range assumptions include:

  • Equities should outperform bonds over the next decade given bond yields are at multi-century lows.
  • Within the equity universe, selectivity is critical. Durable, well-managed businesses whose true value is not recognized by the market in the near term should ultimately outperform.
  • Opportunities in today’s market include global leaders selling at bargain prices, dominant lesser-known businesses in necessary economic niches, blue chips of tomorrow and beneficiaries of short-term misperceptions.
  • Risks in today’s market include companies with near peak margins and overvalued dividend darlings that are riskier than they appear. The 25 most commonly held stocks in the five largest dividend-focused, exchange-traded funds are valued at 25 times earnings, a P/E ratio significantly higher than the market’s.
  • Technology and globalization are reconfiguring industries at an unprecedented rate. Many longstanding brands and business moats that enable companies to maintain competitive advantages are being disrupted in unexpected ways. For example, in recent years, iconic companies in the newspaper, retailing and media industries have all become obsolete. At the current rate of change, 75% of the companies in the S&P 500 Index could be replaced in the coming decade. To succeed, investors should avoid conventional thinking and remain flexible.

2Common stocks and bonds represent different asset classes subject to different risks and rewards. Unlike bonds, the Portfolio does not offer a fixed rate of return if held to maturity, and the Portfolio has risks not associated with holding a bond. Bonds are considered to have less risk than equities. Future economic events may favor one asset class over another.

The Portfolio
Global leaders trading at bargain prices. Dominant lesser-known businesses. Blue chips of tomorrow. Beneficiaries of short-term misperceptions.3

Unlike the S&P 500 Index, which by definition must own most of the largest publicly traded companies in the United States without making distinctions based on quality or price, the Davis Large Cap Value Portfolio seeks to own a focused group of extraordinary businesses that in general offer above-average resiliency and growth with below-average prices.

Global Leaders Trading at Bargain Prices—Some of the strongest and best-known companies in the world make up the largest portion of the Portfolio. Short-term economic concerns over the past year have reduced the share prices of many global leaders to bargain levels at a time of high valuations for the average company. Buying top-tier businesses at bargain prices should be a goal for long-term investors in any environment.

An example of a global market leader in the Portfolio is Microsoft, one of the world’s largest software companies.4 While many of its products such as Microsoft Word, Excel, Skype, Bing, and Internet Explorer are widely used on a daily basis by individual PC owners, the majority of Microsoft’s revenue is generated from the company’s solid position serving businesses both large and small. Most Fortune 500 companies, for example, license an array of Microsoft products to help run their corporate, exchange and database servers as well as using software that enhances productivity such as Microsoft Office. This widespread and entrenched use of Microsoft’s information technology software by companies provides predictable and recurring revenue streams through licensing fees. In addition to its core businesses, Microsoft is building its cloud computing capabilities, which we expect will enhance shareholder returns over the long term.

Wells Fargo, the third largest U.S. bank in terms of assets, is another example of a market leader in the Portfolio. With more than 70 million customers and a large share of core deposits in most of its markets, Wells Fargo is one of the most profitable banking institutions in the world. The company is positioned to benefit from both economic expansion in the United States and potentially higher interest rates. While this century-old institution has recently been the subject of some controversy, we continue to view this business as a core long-term holding.

Dominant Lesser-Known Businesses—The Portfolio’s investments also include lesser-known businesses that dominate dull but necessary niches in the global economy operating in unglamorous industries or headquartered in different countries that are not household names. As a result, their shares often trade at a discount to better-known companies despite having the same qualities of market dominance and durability as the global leaders described above. These businesses combine the strengths and resilience of blue chip companies with below-average valuations.

A representative business in this category is Adient, a global manufacturer of automotive seating and interiors that was spun-off from Johnson Controls in October 2016. Headquartered in Dublin, Ireland, the company is the industry’s leading seating supplier delivering 25 million seating systems per year to 40 different original equipment manufacturers. Adient is an attractive new addition to our Portfolio given its seasoned management team, dominant market share and low valuation.

Liberty Global is another example of a dominant, lesser-known business. The company is a leader in cable television and broadband services throughout Europe and is controlled by John Malone, a pioneer in the U.S. cable industry with an outstanding record as a capital allocator. During the past decade, Liberty Global has opportunistically acquired several European cable TV systems, most of which were inefficiently run. We expect Liberty Global to improve the efficiency of these operations substantially over time and seek expansion opportunities in a shareholder friendly manner.

Moody’s, one of the two premier credit ratings agencies in the United States, was until recently a third example of a lesser-known business in the Portfolio with strong market share and a durable business model. Our investment in Moody’s proved quite profitable and while we still regard the business as attractive, we sold the position in the fourth quarter due 2016 due to valuation concerns.

Blue Chips of Tomorrow—Another investment theme is fast-moving companies that use innovation to disrupt the economics of larger but less agile competitors. Capitalism is a process of constant change that rewards businesses that can adapt. Over decades, we have seen many examples of today’s disrupters emerge as tomorrow’s blue chips. Several of the Davis Large Cap Value Portfolio’s core holdings, particularly in the online retailing and social media sectors, are currently in this category.

Beneficiaries of Short-Term Misperceptions—Investors with a short-term focus often avoid companies that face any type of controversy or negative near-term outlook, creating an opportunity for long-term investors willing to look beyond today’s headlines.5 Since oil prices began their steep decline several years ago, investors fled the energy sector in response to the dramatic (and unsustainable) collapse in oil prices. While oil prices are unknowable in the short term, they must exceed the cost of replacing reserves over time. This simple fact will eventually lead to higher energy prices and should drive future returns for the well-positioned, low-cost producers in the Portfolio.

Encana, a Canadian-based oil and gas exploration and production company with properties in both Canada and the United States, is a low-cost producer as well as a natural beneficiary of higher energy prices. We expect double-digit production growth in the years ahead, which could potentially generate strong returns for shareholders over a multiyear period—especially if energy prices continue to recover.

Building wealth in the coming decade will require equity investors to look beyond the market index and be selective, adaptable and flexible. Given the quality and valuations of the companies in the Davis Large Cap Value Portfolio, we believe we are well positioned to grow shareholder wealth and exceed the performance of the broader market over the long term.

3 While Davis Advisors attempts to manage risk there is no guarantee that an investor will not lose money. Equity markets are volatile and the investment return and principal value of an investment will vary.4 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. 5 While we research companies subject to such contingencies, we cannot be correct every time, and a company’s stock may never recover.

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 Large Cap Value accounts invest primarily in common stock of large companies with market capitalizations of at least $10 billion. The principal risks are: stock market risk, manager risk, common stock risk, headline risk, large- capitalization companies risk, midand small-capitalization companies risk, financial services risk, foreign country risk, emerging markets risk, foreign currency risk, depositary receipts risk, and fees and expenses 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, broker-dealers 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.

Trailing Price/Earnings (P/E) Ratio is the weighted average of the price/earnings ratios of the stocks in a portfolio. The P/E ratio of a stock is calculated by dividing the current price of the stock by its trailing 12 months’ earnings per share. Portfolio totals are computed using an inverse harmonic methodology.

Outperforming the Market. Davis Large Cap Value SMA Composite’s average annual total returns were compared against the returns earned by the S&P 500 Index at the end of each quarter for all rolling time periods from April 1, 1969 through December 31, 2016. The Composite’s returns assume an investment on the first day of each quarter. The returns are gross of fees. If fees were imposed, the reported figures would be lower. The figures shown reflect past results; past performance is not a guarantee of future results. There can be no guarantee that an account will continue to deliver consistent investment performance. The performance presented includes periods of bear markets when performance was negative. Equity markets are volatile and an investor may lose money.

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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