During the fourth quarter of 2021, the iMGP Equity Fund returned 1.69%, underperforming both its Russell 3000 Index benchmark (which gained 9.28%) and Morningstar Large Blend Category (up 9.41%). The Fund trailed both its index and Morningstar category in 2021 due in large part to fourth quarter performance. Since its December 1996 inception, the fund’s 9.11% annualized return slightly trails the Russell 3000 Index’s gain of 9.81%, though is ahead of the Morningstar category’s 8.20% return.
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.imgpfunds.com.
Quarterly Portfolio Commentary
Pat English and Jonathan Bloom, FMI
We remain focused on achieving attractive risk-adjusted returns. While the S&P 500 has outperformed, the risk profile of this index has been at a very high level for some time. Valuations are at or near all-time highs. Real GDP over the past two years is up approximately 1.9% cumulatively, or less than 1% compounded, assuming the fourth quarter of 2021 comes in at The Conference Board’s estimate of 6.5%—yet the S&P 500 is up 52.4%, or 23.4% compounded, over this period. Investors have been lulled into a state of complacency, expecting far higher-than-average returns, because that has been the experience in recent years. The returns are out-of-step with underlying earnings (normalized for the COVID rebound) and balance sheet quality. Equity buyers may not be fully appreciating the risks they have been taking. The absence of poor results ex-post doesn’t change the ex-ante risk. A reckless driver can repeatedly run red lights without getting into an accident, but eventually, he is almost assured of wrecking. The market has been enamored with growth—or the perception of growth—and does not appear to have much concern about valuations regressing to the mean (or worse), and balance sheet quality has been an afterthought. We experienced similar relative underperformance in the time leading up to the 2000 peak. When the air comes out of the many overpriced stocks, our relative performance should improve. That process may already have begun. We remain focused on strong businesses, with robust balance sheets, quality management, trading at discount valuations. Downside protection is a key tenet of our investment process, which may become increasingly important given the backdrop.
Bill Nygren and Clyde McGregor, Harris Associates
Global equity returns were positive in the fourth quarter despite lingering concerns around supply chain disruptions, inflation pressures and the COVID-19 variant’s impact on global growth. U.S. equities out-paced non-U.S. stocks for the quarter and for the year. The market continues to lean more on the positive longer term narrative surrounding a global growth recovery, still low interest rates (though rising), slowly rising employment, and improving consumer/corporate balance sheets. As we enter the first quarter, we believe the underlying positives will eventually prevail and gradually improving economic conditions ought to create a positive backdrop for global equity prices.
There was limited activity in the portfolios this quarter and the companies we own continue to trade at discounts to our estimates of their intrinsic values. The companies we own come from a variety of industries and have reported largely favorable earnings and cash flows as the global economy began to emerge from the worst of the pandemic. While the coming quarters may experience more mixed fundamental progress due to continued supply chain disruptions, increasing inflationary pressures, and higher interest rates, we think the overall trend remains generally positive over the next 12-24 months and should lead to higher equity prices.
Scott Moore and Chad Baumler, Nuance Investments
While our overweight and underweight sector exposures were unchanged during the quarter, we did make changes to the composition of the portfolio as risk reward opportunities shifted, in our view. Our largest overweight, relative to the benchmark, remains the consumer staples sector. Within the sector, we continue to own stocks in the food products (Sanderson Farms and Cal Maine Foods), personal products (Beiersdorf AG), and household products (Henkel AG & Co.) industries. We continue to believe the COVID-19 pandemic has caused shifts in consumer spending behavior that we view as transitory. Additionally, we added to our exposure in the sector by initiating a position in Kimberly-Clark. The company is a leading manufacturer of household supplies, and we believe the company is under-earning due to inflationary pressures. While we believe these short-term issues will compress the company’s profit margin, it is our opinion that these issues are transitory and profit margins will normalize higher over time through price increases and potentially easing commodity costs.
The healthcare sector remains our largest absolute exposure in the portfolio, and we were able to increase our exposure during the quarter. According to our research, during 2020, certain companies within the sector experienced a significant decline in revenues and profits as the COVID-19 pandemic led to the postponement of elective procedures. As of this writing, procedure volumes have partially recovered but remain below normal levels as ensuing COVID-19 variants have caused further disruption to surgical capacity amid widespread care provider labor shortages. We believe this more protracted return to normal earnings power has also contributed to the underperformance in several of these stocks, but we continue to believe the decline is transitory and that procedure volumes are likely to revert back toward normal during the next several years. In our opinion, this has created opportunities within the sector, and we were able to re-initiate a position in Dentsply Sirona after a stock price pullback following our exit of our prior position in the 2nd quarter of 2021. We also initiated a new position in Universal Health Services during the quarter. We continued to hold Smith & Nephew, ICU Medical, Zimmer Biomet Holdings, and Baxter International through the period.
We also remain overweight the real estate sector due to our holding in Equity Commonwealth, which we believe offers an interesting risk reward within the sector. Though we lowered our exposure in the utilities sector by exiting our position in SJW Group in favor of what we view as better risk rewards elsewhere, the sector remains a slight overweight position relative to the benchmark. We continue to hold a position in United Utilities Group, a leading water utility serving the northwestern part of England.
We also reduced our exposure in the financials sector when we exited positions in both Chubb Limited and Everest Re Group as the stock prices approached our internal view of fair value. We remain underweight the energy sector where we believe the sector continues to face a multi-year period of competitive transition. Additionally, we remain underweight the consumer discretionary, communication services, industrials, information technology, and materials sectors primarily due to competitive uncertainty and valuation concerns.
Chris Davis and Danton Goei, Davis Advisors
Our favored approach has been to invest in companies that we believe are, in some way or another, akin to “all-weather” businesses. This means owning companies by and large that are extremely well-established and experienced with managing through recessions and crises that will occur periodically. It is a foundation of durability, resiliency and, in our view, defensive characteristics.
With inflation currently running far above 2% in normalized terms, there is reason to posit that, for the first time since the early 1980s, higher inflation will be semi-permanent and structurally built into the economy. This forces equity investors to demand compensatory returns in nominal terms to offset rising costs. Such a setup reinforces our investment positioning today and our strategy in general as we believe the solution lies in: (a) the ability of certain businesses to demonstrate pricing power on the income side of the ledger commensurate with rising expenses, (b) owning categories of companies that are capital light, and (c) leveraging to the fullest extent the combined fulcrum of selectivity, high growth, and undervalued situations.
The portfolio is positioned to capitalize on business opportunities that span a wide array of industries. Financial services, technology, communication services, and healthcare companies make up the vast majority of our holdings and the largest aggregate percentage weights. The portfolio is rounded out by a number of other, more niche industries with the common thread being the attractiveness of individual businesses. Overall, our view is that the challenges confronting today’s investors can be mitigated, offset and compensated for by owning better-quality growth businesses at value prices. With both high organic growth and the added lever of under-valued, contrarian starting points, our portfolio of businesses is well-positioned for the current environment in our view.
Michael Sramek, Sands Capital
The shift in market leadership over the course of 2021 illustrates how unpredictable markets can be in the short term. Exogenous factors and sentiment can have an outsized influence in short-term price movements, and these factors are impossible to correctly predict, we believe, with any repeatable process.
We have no differentiated insights into the market’s short-term gyrations. We do have insights into our businesses’ potential long-term growth trajectory, and nothing that we’ve seen over the past quarter has changed our views. Enterprises remain early in their digital transformation efforts, new technological offerings are enabling access to commerce and financial services, and life sciences innovations continue to change how we define, diagnose, and treat disease. We believe we will be successful in identifying businesses that will extract most of the value created by these trends.
*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
It is important to understand that the portfolio is built stock by stock with sector and cash weightings being residuals of the bottom-up, fundamental stock-picking process employed by each of the six sub-advisors. That said, we do report on the relative performance contributions of both sector weights and stock selection to help shareholders understand drivers of recent performance.
It is also important to remember that the performance of a stock over a single quarter tells us nothing about whether it will be a successful position for the fund; that is only known at the point when the stock is sold.
iMGP Equity Fund Sector Attribution
| Sector Weights | Fund | Russell 3000 as of 12/31/2021 |
|---|---|---|
| Communication Services | 14.7% | 9.2% |
| Consumer Discretionary | 17.2% | 12.3% |
| Consumer Staples | 4.7% | 5.4% |
| Energy | 1.0% | 2.7% |
| Finance | 21.7% | 11.4% |
| Health Care & Pharmaceuticals | 12.0% | 13.4% |
| Industrials | 6.3% | 8.9% |
| Information Technology | 16.3% | 28.2% |
| Materials | 0.0% | 2.4% |
| Real Estate | 2.1% | 3.6% |
| Utilities | 1.0% | 2.5% |
| Cash | 2.9% | 0.0% |
| 100.00% | 100.00% |
- During the fourth quarter, both sector allocation and stock selection detracted from the fund’s relative performance.
- Stock selection within technology was among the largest detractors. The sector was among the best returning areas of the market with nearly a 14% gain in the quarter, however, fund positions within this sector fell just over 2%. Technology exposure was the most material drag from both an allocation and selection standpoint.
- The fund’s overweight to the communications services sector detracted from returns. The sector was the worst performer in the fourth quarter with a slight loss, and stocks in the fund underperformed.
- The fund’s other large overweight (twice the benchmark weight) is to financial stocks. Both the sector and stocks within the fund underperformed the broad index.
- Stock selection within the industrials sector was a bright spot in the quarter. Both Ferguson and Carlisle Companies had strong three-month returns, both of which are discussed below
Top 10 Contributors as of the Quarter Ended December 31, 2021
| Company Name | Fund Weight (%) | Benchmark Weight (%) | 3-Month Return (%) | Contribution to Return (%) | Economic Sector |
|---|---|---|---|---|---|
| UnitedHealth Group Inc | 1.43 | 0.91 | 28.92 | 0.37 | Health Care |
| Alphabet Inc Class A | 4.55 | 1.86 | 8.36 | 0.36 | Communication Services |
| Ferguson PLC | 1.36 | 0 | 28.81 | 0.35 | Industrials |
| Carlisle Companies Inc | 1.55 | 0.03 | 25.10 | 0.35 | Industrials |
| Lear Corp | 1.77 | 0.02 | 17.41 | 0.28 | Consumer Discretionary |
| HILTON WORLDWIDE HLDGS W /I COMMO | 1.60 | 0.08 | 18.08 | 0.27 | Consumer Discretionary |
| TE Connectivity Ltd | 1.64 | 0 | 17.94 | 0.27 | Information Technology |
| Berkshire Hathaway Inc Class A | 2.81 | 0 | 9.55 | 0.26 | Financial |
| INTUIT INC COMMON STOCK USD.01 | 1.26 | 0.34 | 19.22 | 0.22 | Information Technology |
| Charles Schwab Corp | 1.38 | 0.26 | 15.72 | 0.22 | Financial |
Edited Commentary from the Respective Managers on Selected Contributors
UnitedHealth (Pat English and Jonathan Bloom, FMI)
UnitedHealth is the largest, best-managed, and most-diversified managed care organization (MCO) in the U.S. and is among the largest providers of health services and technology through its fast-growing Optum businesses. In managed care (health insurance), UnitedHealth is the #1 national provider in the fast-growing Medicare Advantage (MA) market, in addition to #1/#2 positions in most other sub-segments. Today, risk selection is a diminished dimension of competition, and scale is more important than ever in delivering top benefits at competitive prices. Scaled buying power (and network building) ensures the most visibility into medical costs at a given site-of-care and scaled investment gives the company the most enhanced capabilities (tools and technology, typically from Optum) that nudge beneficiaries towards lower cost sites-of-care. UnitedHealth’s leading scale and capabilities allowed for superior navigation of COVID-related uncertainties in 2020 and 2021 and is reflected in preliminary 2022 guidance (which suggests Optum will be more than half of profits for the first time). While the company’s valuation multiples are now near their long-term highs, we see forward valuation as modestly below the market, and continue to view their long-term 13%-16% EPS growth target (including one-third from capital allocation) as more credible than most. We did not trade shares during the fourth quarter.
Ferguson (Pat English and Jonathan Bloom, FMI)
Ferguson is the world’s largest distributor of plumbing and heating products to trade professionals. The business provides exposure to the building, repair, and replacement of critical components touching virtually every modern physical structure and piece of infrastructure in North America. Given its structural advantages, including its scale, branch density, distribution footprint, and technology and service superiority, we expect Ferguson will continue to take share in its growing markets over time. Our view was the strength of its business and improving end market outlook were not adequately reflected in its below-market-average valuation and discount to comparable U.S. distributors. Our thesis has been reinforced over the last quarter and year, as the company’s growth rate and share gains have accelerated with customers leaning on its capabilities during a period of stress in the supply chain. The company has also demonstrated its ability to pass through product inflation to customers. Assuming reasonably supportive end markets and continued strong execution, Ferguson should be capable of growing underlying EPS at a double-digit annual rate while maintaining 20%+ returns on capital and balance sheet strength. The stock continues to be attractively valued on a relative basis considering the quality of the business, supportive end market environment, and prospect of a primary U.S. listing (facilitating comparison to more highly valued U.S. peers). We did not trade shares during the fourth quarter.
Carlisle Companies (Clyde McGregor, Harris Associates)
Carlisle’s share price moved higher following the release of a positive third-quarter earnings report, as revenue increased 25%, adjusted earnings improved 19% and adjusted earnings per share grew 27% to $2.99. Strong pricing in the roofing segment led to a large increase in gross profit dollars, and the company also declared a regular quarterly dividend of $0.54 per share. Management continues to implement restructuring efforts with an ongoing focus on efficiency. We think they are taking the right steps to improve margins and increase organic growth. Overall, we like the Carlisle leadership team’s approach, which incorporates what we see as a thoughtful long-term strategy.
Of Carlisle’s multiple segments, we especially like its construction materials business (which includes roofing products) as this segment has benefited from annual demand growth, and the company has consistently taken market share given its strong reputation for innovation and on-time delivery.
Management has continued restructuring efforts with an ongoing focus on efficiency, and we think they are taking the right steps to improve margins and increase organic growth. Using a disciplined capital allocation process, management is reshaping Carlisle’s portfolio of businesses and has made several acquisitions and divestitures that we expect can enhance the company’s value over the long term. We like the approach that Carlisle’s leadership team has established which incorporates what we see as a thoughtful long-term strategy.
Top 10 Detractors as of the Quarter Ending December 31, 2021
| Company Name | Fund Weight (%) | Benchmark Weight (%) | 3-Month Return (%) | Contribution to Return (%) | Economic Sector |
|---|---|---|---|---|---|
| Sea Ltd ADR | 2.52 | 0.00 | -29.81 | -0.81 | Communication Services |
| Block Inc Class A | 1.33 | 0.18 | -32.66 | -0.49 | Information Technology |
| Capital One Financial Group | 4.48 | 0.15 | -10.08 | -0.47 | Financials |
| GoHealth Inc Ordinary Shares – Cla | 1.24 | 0.00 | -24.65 | -0.35 | Financials |
| Thor Industries Inc | 1.52 | 0.01 | -14.77 | -0.26 | Consumer Discretionary |
| Koninklijke Philips NV | 1.08 | 0.00 | -16.14 | -0.24 | Health Care |
| ALIBABA GROUP HOLDINGS SP ADR | 0.89 | 0.00 | -19.76 | -0.19 | Consumer Discretionary |
| Citigroup Inc | 1.16 | 0.29 | -13.32 | -0.17 | Financials |
| Twilio Inc Class A | 0.85 | 0.11 | -17.46 | -0.16 | Information Technology |
| Charter Communications Inc Class | 1.04 | 0.19 | -10.39 | -0.12 | Communication Services |
Edited Commentary from the Respective Managers on Selected Detractors
Block (Mike Sramek, Sands Capital)
Block is a digital financial services pioneer and enabler of financial inclusion. Software is increasingly replacing bank branches as the primary distribution point for financial services, and Block’s core market segments—consumers and small and midsized businesses (SMBs)—are two groups that we view as most amenable to automation and digitalization. Block’s SMB business pioneered the self-serve and software-enabled models for payment processing, enabling millions of SMBs to accept cards for the first time. It has since evolved into a suite of financial tools for SMB sellers to manage their operations. Block’s consumer-oriented Cash App has grown from a viral peer-to-peer money-transfer service into a full-service, multi-product consumer-finance business with over 40 million monthly active users. In 2021, Block announced its intention to acquire Afterpay, which we believe will combine Block’s consumer and merchant businesses into an integrated network, ultimately driving higher product adoption, customer monetization, and international expansion potential.
Block shares traded lower due to concerns about COVID’s effect on payment volumes, and that stock pressure was exacerbated by the broader selloff in high-growth stocks. The emergence of the delta and omicron variants delayed the in-store seller volume recovery, relative to the trajectory seen after second-quarter 2021 results were reported in August. The cessation of federal stimulus payments resulted in a tough growth comparison for Cash App in 2021’s third quarter, as we expected, and the broader e-commerce growth deceleration was likely a headwind for Afterpay’s standalone sales. Importantly, we view these issues more as near-term dynamics unrelated to Block’s longer-term structural growth potential. Block remains one of our highest-conviction financial services businesses, and we expect the Afterpay acquisition to materially increase Block’s long-term earnings power as the addition of a “buy now, pay later” product will fundamentally change how users interact with Block’s services.
Capital One (Clyde McGregor, Harris Associates)
In October, investors responded unfavorably to CEO Richard Fairbank’s emphatic commentary surrounding elevated spending, the need to invest defensively in technology and the costliness of doing so given the competition for technology talent. That said, we think the company’s third-quarter earnings report highlighted strong results as charge-offs fell further off already all-time low levels, card purchase volume grew 28% year-over-year, ending loan balance improved 5% sequentially and net interest margins grew 46 basis points. In addition, Capital One executed $2.7 billion in third-quarter share repurchases (equivalent to 3.5% of its share base) and still ended the period with excess capital equal to 13% of its market cap.
We like that Capital One possesses a strong capital position with a common equity tier 1 ratio that exceeds both regulators’ requirements as well as the company’s own internal target. We appreciate the company’s good underwriting track record with a history of lower loss rates than what we would expect given its business mix and yield. In our view, Capital One’s management team is focused on the long term with consistent reinvestment in technology development, and its online/branch bank provides a stable deposit base with decent funding cost. Our investment thesis for the company remains intact and we believe it trades at a discount to our perception of its intrinsic value.
GoHealth (Clyde McGregor, Harris Associates)
In our view, GoHealth’s third-quarter earnings results were strong relative to its peers, though the market proved disappointed with the report. Revenue grew 33% and bested expectations, but adjusted earnings fell short of analysts’ estimates as the company exceeded its prior agent hiring target. Despite the earnings miss, management reaffirmed previous full-year adjusted earnings guidance as the company expects to leverage the third quarter’s increased hiring and agent training investments during the fourth-quarter annual enrollment period for Medicare. Management believes that the investments made in 2021 will set the company up well for success with lower investment in 2022 and beyond.
We like that GoHealth and other Medicare Advantage e-brokers are disrupting traditional brokers with a lower cost model that also benefits seniors. In particular, the company’s digital model allows it to acquire customers at a cost far below traditional brokers while its remote agents enroll seniors at a faster rate than independent brokers. Moreover, GoHealth possesses meaningful scale and is nearly 50% larger than the second-, third- and fourth-largest e-brokers in an industry with large barriers to entry and an attractive baseline growth rate with a long runway for market share gains, in our estimation. Furthermore, the largest brokers have the deepest and richest data to make customer value predictions, making them even more favorable in the eyes of the carriers.