Davis Large Cap Value SMA PM Commentary with Chris Davis

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Chris Davis:

Hi, everyone. I'm Chris Davis and I'm co-portfolio manager of the Davis Large Cap Value SMA portfolio. And we've been proud to partner with you over the years, and so I'd like to take a few minutes of your time by sharing with you an update on our portfolio.

Now specifically I'm going to review the results, I'm going to discuss the contributors and detractors, I'm going to highlight some of the recent portfolio allocation decisions, and most importantly, I'm going to unpack why we believe that the Davis Large Cap Value SMA is so well-positioned in today's dynamic and fast-changing market. Now, I'm also going to try to share some perspectives on this environment on the investment landscape, and some of the economic uncertainty facing your clients as we look ahead.

So, let's start with results. As you can see here in 2025, the Davis Large Cap SMA outperformed the Russell 1000 Value Index by more than 500 basis points. We're pleased with that result, but of course, it's the longer term that matters. And over the past three years, we've outperformed by more than a thousand basis points. In fact, we've outperformed over the most recent five, 10, 20 years, and indeed, since inception.
Now, we've achieved these results without an overweight in the market darlings. In fact, we have well less than half of the weighting of the so called MAG7 that is in the indices.

Now, we're proud to have achieved these results for you and your clients. But of course, what really matters is what comes next. And what we want to share with you is why we think the Davis Large Cap SMA is so very well-positioned as we look forward. And the key reason for our conviction is captured in this simple slide. What you can see is the nature of our SMA is that it is selective, that we reject the vast majority of companies that are in our comparable indexes to only own those handful of companies that we think have this unusual combination of attractive characteristics.

First, they're companies that have been able to generate durable growth. Look here over the last five years at the earnings per share growth of the companies that we own and how attractive that is, especially when compared to the value indexes. And yet, despite having companies that have achieved this attractive growth, look at the last section, the valuation. This is the key to our discipline, because the lower valuation has the advantage of reducing risk. And here we have a portfolio that trades at a dramatic discount, not just to the S&P 500, but a dramatic discount to the Russell 1000 Value, which we've outgrown so dramatically over the last five years. This combination of attractive growth at bargain prices is what we call a value investor's dream. And this is what gives us the conviction of our portfolio positioning as we look forward.

Now, I'd like to take a closer look and unpack a little bit of the contributors to our recent results, and also give you a sense of some of our recent capital allocation decisions.

So let's start with contributors. Of course, there was strong performance overall in financials, but what really matters in financials is selectivity. And the select financials that we own in the Large Cap SMA outperformed even the attractive returns of the financial sector as a whole. So, some very selective investments in large cap banks, or specialty insurers, again, the selectivity was key, but those financials that we owned were strong contributors.

Within the tech sector, we all know that the MAG7 and the tech-heavy index, that that's been a big driver of returns. But again, selectivity has been key for us. We own within the tech sector stalwarts, companies that have enormous durability, whether it's large internet retailers, or the companies that have dominated a number of social media and search functions that are just embedded in the lives of their users, and generate huge amounts of cash flow, that give them the ability to invest and innovate as the AI revolution unfolds.

Now, in healthcare, an industry characterized by enormous volatility recently, again, selectivity has been key. When health insurers were in the news, we had the opportunity to selectively add there, and we've had some good returns in some of the lab testing companies that have some sorts of evergreen characteristics that we find attractive.

So those are the contributors, but let's also recognize that portfolio has detractors. But what's so appealing to us recently is that we've been adding to many of these companies that have not yet contributed to results, because in our view, they're out of the spotlight, they're overlooked, and they're oversold, and yet the nature of the underlying businesses has enormous durability. So these are not cigar butts, these are not value traps, but companies, whether they're in the energy sector, whether they're select operators of global casino franchises, manufacturers and distributors of food and protein, or even makers of brand and generic drugs. These are the sorts of businesses that are difficult to disrupt, that are embedded in the economy, and yet they're companies or sectors that are really overlooked in this very concentrated market. And many of them are under earning because of some temporary or cyclical pressure. And oversold and under earning is usually a wonderful combination for value investors like us.

And now I'd like to share with you some of our recent capital allocation decisions within our Large Cap SMA. We view energy as a commodity that's been a bit left out in some of the recent commodity booms. So, we've been building a position in a major independent E&P company, but with a specialization in the area of natural gas, which we view as a logical supplier in this move towards the need for more electrical power.

Now, I mentioned some of the MAG7 and the excitement in technology. Well, as you would expect for investors like us with a valuation discipline, that strength leads us to take advantage and trim. So we've trimmed some tech companies that have been particularly in the news as their share prices have galloped ahead. So we've trimmed on strength simply because the higher the price, the lower the margin of safety. And we've used those proceeds to add to certain tech companies that have faced either some perception headwinds, or have been left out of some of the hype. So, moving out of the companies in the spotlight, but into companies that have attractive characteristics in the same sector, but have been somewhat overlooked.

Now, I mentioned our selectivity and financials and the strength of the sector. Well, as you would expect, we've also had the discipline to trim on some of that strength, some of the biggest movers, while continuing to hold core positions in the stalwarts there that maybe have not yet had their time in the sun.

We've maintained a contrarian approach in healthcare, and there were some healthcare companies dramatically in the news with enormous volatility in their stock prices. 

And as you can imagine, we've been trimming some of the others at a time when investor optimism is baked into valuations.

And finally, as I mentioned earlier, there's a category of oversold, overlooked, and under-earning companies that are in durable industries, but maybe facing some temporary or cyclical headwinds. So, some companies in energy, in casinos, in food, in branded generics, those sorts of durable industries, but with overlooked or oversold under-earning companies within them.

One of the key characteristics to understand about how our portfolio is positioned is to recognize its differentiation. We say simply you can't do what everybody else does and expect a different result. If you want to outperform the index, you can't look like the index. So here you can see based on sector weightings, our enormous differentiation. But you can also see when you look at our individual holdings that we are selective within those sectors. Now, the way this is talked about in the industry is the idea of active share. In other words, how different do you look than the index? And you can see we had historically a very, very high active share.

I'd now like to share with you some perspectives on today's investment landscape and how we're positioned to take advantage of it. 

In describing the investment environment, I want to make clear that we're not interested in trying to make short-term forecasts, because these have no predictive value. Let me share with you an example of what I mean. In this chart, we simply keep track of the interest rate forecasts of the top Wall Street strategists. We score those forecasts as correct if they get the direction right. In other words, they answer the question, will interest rates be higher or lower six months from now correctly?  As you can see, the forecasts of even these experts have no predictive value, and they were wrong almost 60% of the time. So we can't predict and make short-term forecasts, but what we can do is prepare for the inevitable. For example, investors should expect that a 5% market dip happens three times a year, 10% on average once a year, 20% or more on average every three and a half years. Such corrections are painful, but they are not a punishment. They're more an admission fee. They are an unpleasant but inevitable part of the investment landscape, so we need to be prepared.

Now, with those caveats, let's talk about our working assumptions as we look out at the investment and economic landscape today. We start with a view that we expect unemployment to trend higher over time. This is partly a reaction to the uncertain environment that we're in, and it's partly the impact that we'll see as AI rolls out across different industries through the economy.

We also believe that the biggest economic risk that we face is really about monetary inflation. We continue to have a mindset as a country that we can spend more than we make. We have a printing press, and that increases the risk of monetary inflation, and we keep our eye on that. We do believe AI is transformational  We believe that technology is a key economic driver for the last 30 years, and AI is an accelerant. So the idea of how AI affects the investment landscape has to factor through all investment analysis. And yet, despite the high moves in the market and a lot of the excitement and euphoria, we really believe opportunities exist but the key in this sort of environment is to focus on quality, durability, and valuation. That is the way to manage uncertainty and risk in this sort of environment.

We do see a number of potential bubbles as we look out of the investment landscape. We think the momentum strategies and the enormous flow into passive strategies which are themselves have momentum, characteristics with that enormous concentration, that there's a real risk of a bubble emerging there. We think in some of the alternative markets that have less liquidity, whether it's private equity or private credit, we do think that there may be shocks and surprises and disappointed investors in that area.

Some of the dividend darlings where people feel safe when we look through at the fundamentals of the underlying businesses, we see a lot of risk there and some overvaluation. Payout ratios are stretched and the competitive position of many of those businesses that were once stalwarts are now being challenged. And another example where there may be a bubble is in some of the hyperactive growth assumptions that we see in this AI space. With the spotlight on AI, people are projecting growth deep into the future at high rates. And one of the things I'd like to share with you is how difficult and unlikely that is. Right?

Strange things can happen. It was once said that the race is not always to the swift nor the fight to the strong, but that's sure the way to bet. We are probabilistic investors and look here at how hard it is for companies to maintain very high growth rates for long periods of time. Similarly, many of these companies where analysts are projecting high growth rates, they're also projecting that somehow very high margins will be sustained rather than competed away. As you can see here, that is a very unlikely outcome. And when you put those two things together, we do see some investors that are headed for disappointment with their rosy outlooks for many of these AI companies.

So now in finishing out what we think in the investment landscape, we think it's important to prepare for all of the sorts of normal volatility and shocks that appear over a long investment cycle. In other words, we want to make sure that we stress test all of the companies that we own for a meaningful stock market correction, for an eventual recession. We don't know when a recession will come, but we know that one will come, and we need to be prepared for that.

We know that there can be geopolitical shocks, and by nature and definition, they are unpredictable. And of course, we're an environment with enormous political and fiscal uncertainty. So this is a time that investors shouldn't be pessimistic, but they should be realistic. They should be thinking about mitigating risk and focusing on durability and quality and the ability to get through the inevitable shocks that we'll face in the years ahead.

Now, a lot of our specific portfolio allocation decisions play into the bigger portfolio positioning or themes that you see cutting across our Large Cap Value SMA. So for example, we have a category of dominant disruptive tech giants, but our focus is on those where valuation is not stretched, and where they generate enormous and durable cash flow in order to fund their investments. We also are interested as we look at the AI revolution, not in the darlings, but in the providers of the picks and shovels, the basic equipment and materials that are needed in order to enable that revolution. So, in a sense, our investing in technology is focused on the stalwarts versus the darlings, always with an overlay of valuation discipline. And similarly, when we look at the financial sector, our focus is not on owning the sector as a whole, but continuing to have this theme.

I mentioned some of our trimming, and yet we remain very focused on what we call competitively advantaged financials. Increasingly, we expect to see dispersion, a difference between the haves and the have-nots, as AI rolls through this sector.

So despite their strong performance in 2025, the financial companies that we own continue to trade at a significant discount to the averages, despite having business characteristics of durability, growth, rising dividends, that we think will continue to make them more attractive to investors. And of course, they're huge AI beneficiaries, as they are able, if they have the scale, if they have the tech-savvy management, and if they have the proprietary data, they will have huge advantages in implementing an AI strategy that will continue to differentiate them.

Within healthcare, as I mentioned, we like owning healthcare, because the demand for healthcare continues to grow. It's an enormously durable and recession resistant industry. But again, selectivity and opportunism are the key. We think that we focus on companies that provide services or provide generic drugs. We try to avoid those companies that have big single drug risk. And again, we want to have companies where AI can be a source of both reduced cost and improved services. So within this sector that has these attractive characteristics, that gives you a sense of how we position the portfolio.

Earlier, I mentioned that we view energy as the overlooked commodity. As people stampede into gold and things like that that produce no economic value, our focus has been on energy and materials that are necessary for life. So, oil has been overlooked in this commodity boom, and we've added companies that have long reserves that are well located with relatively little political risk. As AI and electrification rollout, we focused on natural gas companies or provider of copper, which is the lifeblood of electrification. And we continue to build that part of the portfolio that has exposure to this attractive industry characteristics, but only with those companies that we feel are individually optimized to the theme we see unfolding.

And finally, with all of the attention on the changing and dynamic growth industries that are out there, there's a category of companies that I described earlier as oversold and under-earning, and maybe overlooked.  Again, companies like the largest chicken processor, would be examples of durable growing companies with decent returns, but that are just ignored in this environment, and that have some cyclical pressures that we think are providing an entry point.

And I mentioned that as we have some uncertainty in global travel, maybe Las Vegas has fewer visitors in the short run, but companies that are positioned with a dominant position in places like Las Vegas or Macau, those are the sorts of industries that we think have durable long-lived assets, and we like having portfolio exposure to them when they're a little bit under a cloud or overlooked.
 

Putting it all together, one of the key characteristics of this current market environment is the bipolar nature of investor sentiment. There are people that are wildly optimistic, believing we're on a plateau of permanent prosperity, chasing momentum, chasing high growth, and they're taking enormous risk on one hand. On the other hand, we have the people that are terrified and bearish and pessimistic, that say the market has come too far, too fast, and they want to wait on the sidelines. They're taking enormous risk of missing out on being invested for the long term.

We try to build a portfolio based not on being optimistic or pessimistic, but being realistic, to be able to withstand the inevitable shocks, but also to make progress when times are good without taking the risk of the big momentum and go-go growth investors. So let's return to this fundamental picture of the portfolio because this is really the key.

The high selectivity allows us to identify just that handful of companies that combine truly attractive growth and durability with an enormous discounted valuation. To us, that puts in the best of both worlds of getting the growth that we seek in long-term investments, but not taking the risk of over-hyped high valuations, so to own above average companies at below average prices. That's the key to how we are positioning the portfolios in today's uncertain world.

So as you review our portfolios, as you meet with clients, I hope we were able to provide some information on why we can have some concern and skepticism and caution about the euphoria in today's market environment, and yet have enormous confidence, conviction, and optimism about how our portfolios are positioned for 2026 and beyond.

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