Large Cap Value Portfolio Commentary
Mid-Year Update 2018

Market Perspectives

In the year-to-date period the U.S. stock market returned 2.65%, continuing its long advance in an environment of heightened volatility in the capital markets.1 Currently, the U.S. economy remains strong with robust GDP growth, relatively full employment and muted inflation. At the same time, uncertainty exists with respect to interest rates, the durability of the current economic expansion and geopolitical developments, among other considerations. These are all important but unknowable factors

At Davis, we remain focused on the important and knowable, which requires understanding our portfolio holdings company by company and assessing whether the long-term earnings power of the businesses we own remains intact and able to generate satisfactory rates of return over the next five years. In other words, despite share price volatility, the underlying businesses we own are generating healthy, robust earnings with few exceptions, and are making good financial progress. In the long run and based on our experience dating back almost 50 years as an independent, research-driven investment firm, long-term earnings power matters far more to our ultimate success as investors than relatively minor share price fluctuations during shorter time periods.

Looking ahead, we believe selective stock picking is the best way to navigate the current market environment. As a result, at Davis Advisors we focus on the durability, sustainable growth, competitive moats, and management of every company in the Portfolio and continue to exercise discipline regarding the share price of each company we own.

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. 1U.S. stock market is represented by the S&P 500 Index. 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

Microsoft, one of the world’s largest software companies, is a longstanding market leader in the Portfolio.3 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 and artificial intelligence (AI) capabilities, which we expect will enhance shareholder returns over the long term.

Two other businesses in the Portfolio that dominate their industries include and Facebook, which began as upstart disruptors but have emerged as true market leaders.

Amazon is an e-commerce giant that has profoundly reshaped the retail industry over the years. Amazon offers an optional membership-based business model through its Amazon Prime service. In addition to its retail business, Amazon has a state-of-the-art, rapidly growing web services business (Amazon Web Services) that enables companies and other organizations to outsource their computer systems to Amazon’s digital cloud.

Facebook is the largest social network in the world with 2.2 billion active monthly users and an array of offerings including Instagram, Messenger, WhatsApp, and Oculus. Given Facebook’s enormous scale and expanding user base the company is in a unique position to offer advertisers extensive targeted data and analytics on consumer preferences as well as to interact with consumers directly in a large-scale, highly efficient manner. We expect Facebook’s earnings power to increase dramatically as advertisers continue to devote more of their advertising budgets to online platforms, especially the burgeoning market for mobile devices. So far we have not seen any deterioration in Facebook’s business related to recent privacy concerns and believe the business remains attractive.

Our out-the-spotlight holdings currently include fairly mundane businesses such as certain insurers as well as behind-the-scenes operators in paint coatings and automobile accessories such as seating, interiors and battery technologies.

Our contrarian investments include a number of North American shale companies that meet our investment criteria but are underearning relative to their long-term potential in our estimation.

Among recent Portfolio changes, we purchased shares in U.S. Bancorp, a well-capitalized and conservatively run U.S. Bank, and sold our position in Liberty Global in second quarter of 2018.

Overall, we believe our Portfolio is positioned to provide a diversified balance of durable, well-managed businesses with attractive growth prospects.

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 the Davis family and Foundation, Davis Advisors, and our employees have 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

2While 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. 4As of June 30, 2018.

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.

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.

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. 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. As this is primarily a domestic equity strategy, no more than one foreign holding will be discussed in any report. If more than one foreign holding would be discussed based on the criteria above, the holding with the largest percent of assets in the model portfolio would be chosen. However, if the model portfolio has an aggregate foreign holding percentage that is greater than 15% the commentary would include a discussion of the largest foreign holding in the model portfolio that has not been 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 small-capitalization companies risk, and stock market risk. See the ADV Part 2 for a description of these principal risks.

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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