Litman Gregory Masters International Fund Fourth Quarter 2016 Attribution

During the fourth quarter of 2016, both the Litman Gregory Masters International Fund and the MSCI ACWI ex USA Index fell 1.25%. The MSCI EAFE Index lost 0.72% in the quarter and the Morningstar Foreign Large Blend Category was down 2.28%.i

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Themes, Trends, and Observations from the Managers*

David Herro, Harris Associates
Equity prices moved higher last quarter as investors continued to gain confidence in the outlook for the global economy. Our three- to five-year outlook for global equities remains positive. We expect a combination of dividends and underlying value growth to be in the mid- to high single digits over the next couple of years. Our confidence is based on the strength of our companies’ balance sheets, low interest rates, low inflation, unprecedented global monetary stimulation, and the potential for a more favorable business climate (lower taxes, less regulation) in the United States.

Despite the price appreciation we witnessed in the fourth quarter, we continue to favor companies within the financial, industrial, consumer discretionary, and technology sectors. We continue to avoid most companies that the market views as “stable” due to valuation (like those in the telecom, utility, and consumer staples sectors) as well as most of the commodity cyclical companies. However, like always, we continue to view company opportunities on a case-by-case basis and believe any company can be attractive at the right price. Geographically, we remain primarily focused on developed markets based on our belief that they represent the best combination of price and quality. We are selectively exploring different opportunities in emerging markets, but the portfolio weighting in these markets remains modest.

Vinson Walden, Thornburg
Broadly, sector and country allocations within the portfolio are determined by stock selection. The year 2016 confirmed our view that understanding fundamentals within a business is a more predictable means of valuing a company’s equity than trying to predict macroeconomics and geopolitics. However, as we look forward to 2017, we expect that the investment landscape will continue to be dominated by macroeconomic forces—forces that will likely drive varying degrees of volatility in the markets. For example, a new president in the United States, together with key elections in France and Germany, will likely add volatility. Debates about monetary and fiscal policy will shape the backdrop for liquidity and interest rates. The Federal Reserve is stepping up the pace of rate hikes, while many central banks around the world, particularly the European Central Bank and the Bank of Japan, continue to ease.

Trying to predict fluctuations in the global economy is challenging at best and often futile. The very core of Europe is being threatened by flaring political strife and tensions of nationalist sentiment. The path to Brexit continues to unfold in the United Kingdom. In Japan, Abenomics is failing to stoke growth and inflation at the pace that is needed. With the Japanese yen having strengthened, corporate earnings growth will likely face renewed pressure.

Taking the above into consideration, we are optimistic about the long-term outlook for the portfolio. Our flexible, focused, valuation-oriented approach has led us to invest in companies where we believe the long-term potential is not reflected in the current price. At the core, we are stock pickers, aiming to uncover investment ideas through bottom-up security analysis.

Howard Appleby, Jean-François Ducrest and Jim LaTorre, Northern Cross
The Northern Cross team continues to pursue a balanced approach of looking for growth companies at a discount and consistent compounders to drive outperformance in a world that still has limited economic growth. We continue to see significant upside in Las Vegas Sands as the Macau gaming market transitions to a more sustainable mass-market base and Las Vegas Sands opens its new properties, which cater to this market. The decision by the Japanese government to allow integrated casino resorts is a key positive development for Las Vegas Sands, which should be the frontrunner in any future tenders for these projects. It remains the largest position in our portfolio.

During the quarter, we added to pharma and agriculture science company Bayer. Bayer shares have come under significant pressure given their announced acquisition of Monsanto. We think this acquisition is well timed at the bottom of the agriculture commodity cycle and believe that Monsanto has strong intellectual property, which affords it solid pricing power. We exited Roche Group in the quarter. We still believe Roche has the strongest oncology portfolio in the industry, but we do see heightened competition from other players, which may make it difficult for Roche to grow this business as some of its core drugs come off patent.

Mark Little, Lazard Asset Management
International equities rose strongly in local-currency terms in the fourth quarter of 2016, though in U.S.-dollar terms, the rise was offset by the strength of the U.S. currency. While markets had been nervous over a potential Trump election victory, when it came, the reaction was more positive. Investors focused on the parts of the president-elect’s agenda that were seen as stimulative to growth—in particular, lower taxes, less regulation, and higher infrastructure spending. Meanwhile the perceived negative parts—immigration controls, protectionism, and potentially erratic foreign policy—have been largely ignored by investors on the assumption that these policy positions were overstated during the campaign season. This reaction accelerated the market rotation into stocks perceived to benefit from rising inflation, rising rates, and maybe rising growth. The rejection of constitutional reform in Italy in early December and the subsequent resignation of Prime Minister Renzi were equally greeted with equanimity and stocks continued to rise.

In this environment, financial stocks, materials, autos, and energy rose strongly, the latter helped by OPEC’s decision to cut oil output. More defensive sectors such as consumer staples, health care, telecom, and utilities fell in absolute terms. The Japanese market surged in local-currency terms while rotating into riskier investments, but this rise was offset in U.S.-dollar terms by a sharp fall in the Japanese yen. The strengthening dollar also put some pressure on emerging-market stocks.

Tightening labor markets in the United States and commodity price increases, spurred in large part by China’s return to debt-fueled investment growth, has driven rising inflation. This pressures profit margins and interest rates, both negative for profits and valuations. However, the market is now assuming that inflation and fiscal loosening will lead to a generalized pick-up in growth—“good” inflation—hence the rise in cyclical stocks. The major short-term risk to this scenario is that rising rates could quickly drag down economic activity, and the ability of governments to loosen fiscally, given the very high and still rising levels of debt around the world, could be limited. In emerging markets, much of the debt is in U.S. dollars, exacerbating the risk. Over a longer period, rising inflation and rates tend to de-rate equities, while fiscal expansion may give only a temporary boost to activity, and China will have to rein in its debt growth again at some stage.

The response of the portfolio team to a period of weaker relative performance is always to focus on the key source of alpha over time, namely fundamental stock analysis. While risk control is important, rotations of the type just witnessed tend to wash out over time leaving stock selection as the key driver of returns. With the level of macroeconomic and political uncertainty very high, the team is working especially hard to identify investment ideas that have a strong internal or structural dynamic not correlated to, or dependent upon, a certain external environment. At the same time, some of the higher-return companies the portfolio tends to favor have fallen sharply through the rotation period and are starting to offer interesting relative value again.

Overall, the portfolio team remains confident that by continuing to focus on stock selection and seeking to find stocks with sustainably high or improving returns trading at attractive valuations, the strong long-term track record of the portfolio will continue.

Fabio Paolini and Benjamin Beneche, Pictet Asset Management
As a team, we are resolutely bottom-up in our approach; the shape of the portfolio has and will always reflect where we see the best individual values within the market based on our long-term, cash-orientated approach. Furthermore, although our assessment of fair value ultimately drives the positioning of the portfolio, traditional metrics of value, namely trailing earnings or book value, have a negligible impact on how we define value.

However, we also have a mantra that although we are not macro driven, we are macro aware. The market movements of the past few months have been clearly defined by a switch from growth into value. We have long been of the view that certain defensive sectors—in particular health care, consumer staples, and bond proxies—have been priced for near perfection due to their inherent stability in an uncertain world and by a chase of dividend yield that in an era of near zero rates inflated their valuations.

This has started to reverse since a peak in June last year, initially due to increased expectations of a Fed tightening cycle and more recently following the U.S. presidential elections. We won’t try to forecast what the next presidential cycle will look like, but what we can observe is that longer-duration, higher-quality businesses are now beginning to show some long-term opportunity that we didn’t have before.

As a result, we have not “chased” the sharp upward move in cyclical and financial companies but have chosen to add selectively to companies that have currently fallen out of favor. We sold our entire allocation to the financial sector (Prudential and Sompo Japan), which has benefited from the trends described above and reached levels close to our fair value estimate. On the other side, we have added two new positions—Anheuser-Busch InBev and

* The opinions herein are those of the sub-advisors at the time the comments are made and are subject to change.

Discussion of Performance Drivers

The fund benefited from its regional overweights and underweights; however, both security selection and sector allocations were a modest headwind. It is important to understand that the portfolio is built stock by stock so the sector and country weightings are a residual of the bottom-up, fundamental stock-picking process employed by each sub-advisor.

Litman Gregory Masters International Fund Sector Attribution

International Fund Sector Attribution

  • As has been the case throughout 2016, the fund’s largest sector overweight is to the consumer discretionary stocks. This sector had returns in line with the broader benchmark, resulting in a limited effect on returns. Fund holdings marginally underperformed those in the index, leading to minimal negative stock selection.
  • The top-performing sector in the quarter was energy. This is the fund’s largest sector underweight, leading to negative sector attribution.
  • Financial stocks also had a strong fourth quarter. The fund’s underweight to financial stocks hurt relative sector performance. However, financial holdings within the fund, in aggregate, slightly outperformed benchmark holdings. Positions in BNP Paribas, Credit Suisse, Allianz, and Sompo were all on the top-10 contributors list in the quarter.
  • The information technology sector contributed the most to returns in the quarter. Technology stocks fell more than the benchmark, so the fund’s underweighting there helped slightly. Also, stock selection within this sector was a positive contributor to relative performance.
  • The three worst-performing sectors during the quarter were consumer staples, real estate, and utilities. The fund is very slightly overweight to consumer staples, but underweight to the other two sectors. Overall, the fund benefited from its exposure (or lack thereof) to these three sectors.
Top 10 Individual Contributors as of the Quarter Ended December 31, 2016

Company Name

Fund Weight (%)

Benchmark Weight (%)

Three-month Return (%)

Contribution to Return (%)


Economic Sector

CNH Industrial NV 2.32 0.06 21.78 0.48 Netherlands Industrials
BNP Paribas 1.97 0.37 24.16 0.43 France Financials
Incitec Pivot Ltd. NPV 1.99 0.00 15.94 0.31 Australia Materials
Altice NV A 3.27 0.04 10.66 0.29 Netherlands Consumer Discretionary
Credit Suisse Group AG 2.24 0.15 9.64 0.26 Switzerland Financials
Allianz SE 1.90 0.43 11.55 0.20 Germany Financials
Cie Financiere Richemont SA 1.89 0.21 8.67 0.18 Switzerland Consumer Discretionary
Sompo Holdings Inc. 0.72 0.01 17.82 0.15 Japan Financials
Schlumberger Ltd. 1.90 0.00 7.38 0.13 United States Energy
Daimler AG 1.86 0.36 5.84 0.11 Germany Consumer Discretionary

Portfolio contribution for a holding represents the product of the average portfolio weight and the total return earned by the holding during the period. Past performance is no guarantee of future results. Fund holdings and/or sector allocations are subject to change at any time and are not recommendations to buy or sell any security.

Edited Commentary from the Respective Managers on Selected Contributors

CNH Industrial (David Herro, Harris Associates)
CNH Industrial’s share price was boosted in the fourth quarter by the election of Donald Trump and the perceived benefits to the industrials sector. In addition, news that industry peer Deere delivered fiscal fourth quarter earnings results that handily beat market expectations drove CNH’s share price higher during the reporting period on hopes that the latter would follow suit. Additionally, non-members of the Organization of Petroleum Exporting Countries (OPEC) reached an agreement with OPEC members to further reduce oil production. As a result of the deal, an additional 600,000 barrels per day will be removed from the market in addition to the 1.2 million barrel per day cut agreed upon by OPEC earlier in the quarter. In conjunction with the recovery in oil prices during the quarter, we find that the company continues to be undervalued relative to its normalized earnings power.

We like that CNH Industrial is the second-largest agriculture equipment provider worldwide in an agriculture equipment industry that remains structurally appealing in our view. We believe improvements in the commercial vehicle (Iveco) and construction equipment segments during this period of prolonged weakness will translate into considerable upside for these businesses as the macro economy moves toward recovery. Management has worked to fortify the balance sheet while protecting pricing, and we believe the team is driven to create shareholder value through operational enhancements and other initiatives.

Credit Suisse Group (David Herro, Harris Associates)
Investors responded favorably to Credit Suisse’s Investor Day during the quarter. The company indicated that it was lowering its target operating cost base from CHF (Swiss Franc) 18 billion to CHF 17 billion and increasing its total net cost savings target from CHF 3.2 billion to greater than CHF 4.2 billion in 2018. In addition, Credit Suisse’s fiscal nine-month results benefited from effective cost controls that offset weaker revenues, while lower operating expenses helped total net income to marginally exceed our projections. We were pleased that improvements in its Global Markets division drove core operating expenses to be roughly 5% better than we estimated. Credit Suisse’s capital ratios increased, and the bank finished the third quarter with a common equity Tier 1 ratio of 12%, which reflects a 180-basis-point advance from a year ago. Furthermore, Credit Suisse reached a settlement in principle with the Department of Justice related to its legacy residential mortgage-backed securities business for an amount that was within our expectations.

Although the company’s core business is suffering from a strong Swiss franc and low investor risk appetite, we think Credit Suisse’s management team is taking the right actions to cut costs and reduce overall risk. In addition, we like that capital allocation is shifting toward the high-quality private banking business, which should boost long-term returns and value creation into the future. In our estimation, management’s more connected approach, as opposed to their previous silo approach, should result in a better customer offering with enhanced risk controls.

Altice (Vinson Walden, Thornburg Investment Management)
Altice is a company based in the Netherlands that operates as a multinational cable, fiber, telecommunications, and content provider and media company. The company provides cable-based services, such as pay television, broadband Internet and fixed-line telephony, and, in certain countries, mobile telephony services to residential and corporate customers. Its subsidiaries include, among others, a cable operator based in the United States.

Our original thesis behind Altice was predicated on the potential opportunities at French subsidiary SFR. We saw possible margin expansion from delayed synergies created by the SFR/Numericable merger—the company’s track record elsewhere gave us confidence in strong execution. In addition, an acceleration in network improvement presented an attractive turnaround opportunity. Along with the opportunity set revolving around SFR, Altice was generating positive free cash flow even with increased network capex (capital expenditure) spending, allowing for meaningful deleveraging. Finally, we were seeing improvements at one of the company’s recently acquired business units. More broadly, we saw the potential for industry consolidation as a positive driver.

Recent changes and developments at Altice include:

  • French network-driven subscriber trends are taking longer to turn around than anticipated.
  • We are still waiting for the remaining material cost cutting efforts at SFR (e.g., personnel cuts, network migrations, store rationalizations). Given the regulatory restrictions put in place at the time of the merger, this won’t happen until sometime in 2017.
  • U.S. prospects seem better than initially appreciated (the business should deliver faster than expected).
  • The most recent round of French telecom consolidation failed. (We still view consolidation as viable in the long run.)

The majority of the investment thesis has yet to play out. The company’s U.S. unit is performing better than anticipated and merger-and-acquisition optionality (primarily in the United States), while still a ways off, is becoming a more viable growth option as visibility toward capital structure normalization develops. We still view the valuation as attractive. With respect to recent performance, Altice’s operations in the United States have reported solid growth, and prospects for the company’s French operations are improving as its network investment efforts and expanded content strategies gain traction with customers. In December, shares of Altice advanced sharply as the company benefited from the broader trends within the U.S. cable industry. In addition, analysts see significant scope for further cost reduction at the company’s SFR unit.

Sompo Holdings (Fabio Paolini and Benjamin Beneche)
During the quarter, Sompo announced the acquisition of the U.S.-listed specialty insurance company Endurance Specialty Holdings for $6.3 billion. The deal was both strategically sound and reasonably priced at 1.36x book or 15x earnings for a business with an average underwriting profit margin of 9.8% and a stable investment portfolio. Financed through cash, the deal adds JPY (Japanese Yen) 40 billion to our normalized earnings estimate of JPY 180 billion to JPY 220 billion, with capital remaining at healthy levels. With the rapid appreciation in the stock, it now trades at 8x our normalized earnings power with a 6% total shareholder return (dividend plus buyback) which, although attractive, does not warrant a place in our sleeve of the fund, so we have sold the position.

Top 10 Individual Detractors as of the Quarter Ended December 31, 2016

Company Name

Fund Weight (%)

Benchmark Weight (%)

Three-month Return (%)

Contribution to Return (%)


Economic Sector

Shire PLC 4.19 0.31 -10.85 -0.46 United Kingdom Health Care
Essilor International SA 2.16 0.17 -12.23 -0.34 France Health Care
Anheuser Busch Inbev SA/NV 2.19 0.50 -19.72 -0.34 Belgium Consumer Staples
Carlsberg A/S B 3.00 0.06 -9.36 -0.28 Denmark Consumer Staples
KDDI Corp. 0.73 0.31 -22.42 -0.28 Japan Telecommunications
Ferrovial SA 1.62 0.08 -13.89 -0.25 Spain Industrials
Japan Tobacco Inc. 1.26 0.27 -17.62 -0.25 Japan Consumer Staples
Aena SA 3.22 0.05 -7.32 -0.23 Spain Industrials
Baidu Inc. ADR 2.19 0.26 -9.70 -0.23 China Technology
Las Vegas Sands Corp. 3.84 0.00 -5.96 -0.23 United States Consumer Discretionary

Portfolio contribution for a holding represents the product of the average portfolio weight and the total return earned by the holding during the period. Past performance is no guarantee of future results. Fund holdings and/or sector allocations are subject to change at any time and are not recommendations to buy or sell any security.

Edited Commentary from the Respective Managers on Selected Detractors

Shire (Mark Little, Lazard Asset Management)
Pharmaceutical company Shire has been hurt by the generalized concern around the pricing environment for drugs in the U.S. market, both from a commercial and political sense. In addition, investors have been cautious over the company's acquisition of rival Baxalta. For Shire specifically, these concerns look overblown in our opinion, and the stock continues to trade at a very attractive valuation.

Shire (Howard Appleby, Jean-François Ducrest, and Jim LaTorre, Northern Cross)
Shire was a detractor to performance this quarter. Shire has amassed a collection of unique assets primarily targeting rare diseases. We see a high level of innovation within its pipeline, which should drive strong long-term earnings growth. The market has penalized Shire for its decision to acquire hemophilia treatment provider Baxalta, as this market will face more competition in the years ahead. In addition, there is unease about pricing in general in the U.S. market, which is Shire's biggest geographic region. Based on our understanding of the hemophilia market, we think the acquisition of Baxalta makes strategic sense and gives Shire a durable franchise to complement its high-growth assets in rare diseases. We expect the stock to perform well going forward, as Shire continues to deliver on its pipeline and demonstrates the durability and cost savings opportunities within the now acquired Baxalta franchise. The stock trades on a deep discount and strong cash generation will allow the company to pay down debt taken on in the Baxalta acquisition, thus driving its equity value higher over time.

Essilor (Howard Appleby, Jean-François Ducrest, and Jim LaTorre, Northern Cross)
Essilor was a negative contributor to performance this quarter, primarily driven by a slowdown in the growth rate of its North American eyeglass lens business, which led to a de-rating of the stock. Essilor has a dominant position in the research, manufacturing, and distribution of prescription eyeglasses. Despite near-term slowing, we expect the company to sustain mid- to high-single-digit top-line growth in most macroeconomic scenarios, as the company has a balanced exposure to both lower-end lenses in emerging markets and advanced lenses in more developed markets. The company can serve both markets at the absolute lowest cost globally. Essilor’s premium valuation reflects its high entry barriers and unique ability to grow consistently. There will be some quarters in which Essilor will de-rate, and others in which it will re-rate higher, but ultimately we think the growth opportunity will last for another five to 10 years.

Anheuser-Busch InBev (Howard Appleby, Jean-François Ducrest, and Jim LaTorre, Northern Cross)
Anheuser-Busch InBev was a detractor to performance in the quarter and the year 2016. We attribute this primarily to the negative impact of currency depreciation and overall economic slowing in two of its core markets—Mexico and Brazil. In addition, there is some market concern about the earnings power of recently acquired SAB Miller, a deal which gives ABI a significant market presence in Africa. These concerns, coupled with an overall rotation out of consumer staples, has weighed on the stock. Given ABI's dominant market position, we expect the company to recoup currency depreciation through higher pricing. However, these pricing gains take time to rebuild. In addition, we think the addition of Africa provides ABI with considerable opportunity for growth in the years ahead. This is a clearly unique asset—strong cash generation from the United States funding growth in emerging markets—which we think will deliver outsized returns in the years ahead. As such, we remain highly confident in our position.

Anheuser-Busch InBev (Fabio Paolini and Benjamin Beneche)
ABI offers the typical characteristics we seek in a business model. A dominant franchise with pricing power that generates plenty of cash flow while at the same time possessing the potential to grow and reinvest in its own business at incrementally higher returns on capital. This is further enhanced by a management team aligned with shareholders that has shown an excellent track record in terms of managing the business and capital allocation.

Recent results have shown some weakness due to price competition and raw material headwinds in Brazil and continued market share losses in the United States. This, coupled with the recent selloff in defensive names, has offered us the opportunity to initiate a position at what we think is an attractive valuation. (Note: Paolini and Beneche purchased ABI in mid-November 2016. As such, the stock was not a performance detractor during their ownership period.)

ABI is the global leader by scale and profitability in the beer market. It commands 50% of the profit pool (one-third of sales) following its acquisition of SAB Miller. While scale in itself is not an attraction, its exposure to markets that have a combination of higher population growth, low spending per capita, and a premiumization opportunity will continue to drive top-line growth and margin expansion for the foreseeable future. Given this exposure and a dominant position in several markets, growth will be profitable and cash generative. The recent acquisition of SAB will reinforce this dynamic with Latin America reinforcing its dominance (ABI will sell almost two of every three beers in Latin America) and Africa underpinning future growth. The delivery of the synergies of the SAB Miller acquisition and the inherent cash generative business model will lead to a rapid deleveraging, paving the way for higher shareholder remuneration or further consolidation. With a strong franchise generating a normalized free cash flow of $12 billion (a 6.5% free cash flow yield) compounding at a high-single-digit/low-double-digit growth rate, we see the investment as attractive.

KDDI (Mark Little, Lazard Asset Management)
Japanese telecom company KDDI has enjoyed a relatively benign competitive environment and so has been able to grow revenues alongside its customers' increasing data usage. Weakness around government pricing comments have provided an opportunity to invest, as in fact, the government intervention was very helpful to profitability by eliminating handset subsidies. However, the stock fell in the period, despite better profitability, as new competition in the form of mobile virtual network operators finally started to gain some traction in the market.