2016 Annual Shareholder Letter

Dear Fellow Shareholder:

In a year of political upheaval, U.S. stocks delivered double-digit returns while developed foreign stock markets struggled. U.S. stocks have now outperformed foreign stocks in six of the last seven years. In the United States, the S&P 500 Index was up 11.98% and small caps did even better, with the Russell 2000 Index of small-cap stocks returning 21.31%. In foreign markets, the MSCI EAFE Index, which tracks developed non-U.S. markets, was barely positive, returning 1.51%. Emerging markets, though, were a bright spot after years of poor performance. The MSCI Emerging Markets Index returned 11.60%. Investment-grade bond returns continued to be restrained by their low yields. The Bloomberg Barclays U.S. Aggregate Bond Index returned only 2.65%.

Performance quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the funds may be lower or higher than the performance quoted. To obtain standardized performance of the funds, and performance as of the most recently completed calendar month, please visit www.mastersfunds.com.

On September 30, 2016, the Litman Gregory Masters Alternative Strategies Fund reached its five-year anniversary. As of 12/31/2013, the fund continues to be the highest-rated fund in its Morningstar category for risk-adjusted return (Sharpe ratio) since its inception. It also received a five-star Overall Morningstar Rating™ as of 12/31/2016 among 239 Multialternative funds based on risk-adjusted return.1

We’ve commented at times about the unusually long period of challenged performance on the part of active managers. It’s well established that, on average, active funds underperform their index benchmarks over the long run. This isn’t surprising since active funds collectively make up a large portion of the market. That’s why one would expect their performance, on average, to reflect market index returns on a before-fee basis while trailing indexes on an after-fee basis. But there are periods in which the percentage of funds beating the market trends higher. In essence, there is a cyclical element to environments when active does or does not do well. It’s been quite some time since we’ve experienced a positive cycle for active management.

A number of factors also influence how easy or hard it is for active managers to outperform indexes. When certain tailwinds exist for active managers, a higher proportion of active managers outperform, and these are the times when skilled managers tend to do well. Higher dispersion of stock-price performance tends to make it easier for good stock pickers. Active U.S. equity managers also tend to perform better relative to benchmarks when foreign stocks outperform, when small stocks outperform, and when value stock returns beat growth stock returns. These relationships exist because the average U.S. stock fund tends to have some foreign stock exposure and tends to own stocks with somewhat smaller market caps than its index benchmark. And when value stocks perform well, it typically means that fundamental analysis is being well rewarded—skilled analysis of a company’s prospects and valuation pay off. (A good example of that dynamic was the huge outperformance of growth stocks during the tech bubble of the late 1990s, followed by the huge outperformance of value stocks as investors refocused on what companies were actually earning and likely to earn relative to their stock prices.)

So certain environments are better for active management, and this hasn’t been the case in recent years. The dispersion of stock returns has been low. Foreign stocks, as we noted, have been very poor performers in recent years. Moreover, value stocks underperformed growth stocks for most of the post–financial crisis period. And small caps trailed large caps by a wide margin in 2014 and 2015. These trends amounted to a collective headwind for active stock pickers.

However, in the second half of 2016, these trends shifted. Value stock returns dominated growth stock returns. Small caps dominated large caps. And foreign stock returns were competitive. According to the Leuthold Group, by the fourth quarter of 2016, 55% of active managers were outperforming. While not all our funds are impacted by the same variables, three of our four funds beat their benchmarks in the second half of the year as some of the active management headwinds calmed. Over this period, our oldest fund, the Litman Gregory Masters Equity Fund, returned 10.61% versus 8.79% for the Russell 3000 Index.

In the 20-year life of the Litman Gregory Masters Funds, there have been periods that were friendly to active managers, and during those periods Masters Funds tended to do quite well. For example, in the six years ending in 2004, the Equity Fund returned 7.47% compared to 2.21% for its Russell 3000 benchmark. These periods of strong performance for active management contributed to the long-term records of the Equity Fund and the Litman Gregory Masters International Fund. This is why despite a very rough year of underperformance for the International Fund, its annualized return since inception exceeds its MSCI benchmark by more than two percentage points. And it is why the Equity Fund has been able to match its benchmark over its 20-year life despite struggling at times since the mid-2000s; however, it is ahead of its benchmark in the post–financial crisis periods (since the end of 2008).

  Average Annual Total Return
Performance as of 12/31/2016 Three Month One-Year Three-Year Five-Year Ten-Year Since Inception
Litman Gregory Masters Equity Fund Institutional Class (12/31/96)
3.84% 11.98% 6.87% 13.42% 5.59% 7.83%
Russell 3000 Index
4.21% 12.74% 8.43% 14.67% 7.07% 7.86%
Morningstar Large Blend Category Average
3.86% 10.07% 6.29% 12.61% 5.58% 6.32%
             
Litman Gregory Masters Equity Fund Investor Class (4/30/2009)
3.81% 11.72% 6.60% 13.21% n/a 14.18%
Russell 3000 Index
4.21% 12.74% 8.43% 14.67% n/a 15.65%
Morningstar Large Blend Category Average1
3.86% 10.07% 6.29% 12.61% n/a 13.47%

Performance quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the funds may be lower or higher than the performance quoted. To obtain standardized performance of the funds, and performance as of the most recently completed calendar month, please visit www.mastersfunds.com. As of the prospectus dated 4/30/2016, the gross and net expense ratios for the Institutional Class were 1.28% and 1.18%, respectively; and for the Investor Class were 1.53% and 1.43%, respectively. The Advisor is contractually obligated to waive management fees and/or reimburse ordinary operating expenses through April 30, 2017. All performance discussions in this report refer to the Institutional share class. *Although Morningstar categorizes the Equity Fund as Large Growth, we believe it is better categorized as Large Blend.

Over the long run we aim to do much better relative to our benchmarks, especially with respect to the Equity Fund, but the points in time when we measure performance matter. We hope that we are now measuring near the bottom of a long cycle in terms of the competitiveness of active management in general, and our funds in particular. The inference is that perhaps we are near a positive turning point. We will see.

We also continue to wait for a turning point in the relative performance of foreign stocks compared to U.S. stocks. The relative performance of these two groups also tends to be cyclical. The current up-cycle for U.S. stocks’ relative performance has been one of the longer periods over the past 50 years. During this period, U.S. stocks have returned 110.6% compared to only 5.0% for foreign stocks. The result of this huge outperformance is that foreign stocks appear to be much more attractively valued than U.S. stocks.

Based on our analysis, expected five-year returns for foreign stocks as a group are in the low double-digits compared to low-single-digit expected returns for the S&P 500. Of course, there is no guarantee that our analysis of expected returns will play out, and the strong recent trend for U.S. stocks might continue for a while—we don’t have a view on when things could turn and there is plenty to be concerned about for global equity investors. However, in aggregate, we believe risks are largely reflected in the prices of foreign stocks (though not fully discounted). Moreover, history and investment logic also tell us that highstarting-point valuations are a strong predictor of low future returns when looking out over a five-to-10-plus-year horizon. And the opposite is also true. We believe the International Fund should benefit when foreign stocks go through a more positive cycle—an environment that seems to us to be overdue.

We and the Litman Gregory Masters Funds sub-advisors continue to focus on rigorous, thoughtful, and disciplined fundamental analysis, and we believe this is the key to strong long-term investment performance. Our confidence in the Masters Funds is reflected in the collective investment of Litman Gregory’s ownership group, employees, and Masters independent trustees. As of the end of 2016, this investment totaled $21 million.

Sincerely,

Ken Gregory, Chairman
Ken Gregory Signature

Jeremy DeGroot, Portfolio Manager and Chief Investment Officer
Jeremy DeGroot Signature

Jack Chee, Portfolio Manager
Jack Chee Signature

Rajat Jain, Portfolio Manager
Rajat Jain Signature