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Report Litman Gregory Masters International Fund Due Diligence Report with Mark Little of Lazard Asset Management

January 2013

Sub-Advisor Details
Added to the fund: January 15, 2013
Allocation: 14% to 15%
Size of Company: All sizes
Stock-Picking Style: Blend/Relative Value

Litman Gregory’s Due Diligence

Little joined Lazard as an analyst in 1997 and started managing portfolios in the spring of 2003. We started performing due diligence on Little over six years ago, in late 2006. Although he did not have a long track record we could analyze, our due diligence on him and Lazard ultimately resulted in a very high level of confidence. Our publishing affiliate, began recommending his Lazard Strategic Equity strategy to its research subscribers in 2007. Our work at the time involved many hours of calls and face-to-face meetings with Little, many global sector analysts and portfolio managers, co-director of research Ron Temple, and John Reinsberg, head of Lazard’s international business. The focus of our due diligence was on assessing the research and decision-making process, including the clarity and the consistency of the investment approach; the analysis supporting individual stock-picking decisions; the sell discipline; the approach to portfolio construction and the quality of the broader team and the interaction between Little and all available Lazard resources. Reflecting our high level of confidence, our affiliated registered investment advisor has used the Lazard International Strategic Equity strategy in its portfolios for several years.

Over the past several years, we have been talking and meeting with Little regularly, and that contact allowed us to get to know him even better, prompting our interest in him as an International Fund candidate. Given what we knew about Little and Lazard, we decided to update our due diligence on him in 2012, with a specific focus on evaluating his candidacy for the International Fund. Our due diligence mirrored what we had done originally: many hours of phone conversations and meetings with Little, with sector analysts based in London, New York, and Asia, with co-director of research Jeremy Taylor, associate portfolio manager Robin Jones — who works closely with Little, John Reinsberg, and Lazard’s CEO Ashish Bhutani. Our work included emphasis on Little’s ability to run a concentrated portfolio including his approach to doing so, and in-depth discussion of a mock International Fund portfolio that Little constructed. Through this work, we were able to increase our level of conviction that Little is a skilled investor and well-suited to run a Litman Gregory Masters Funds portfolio; that he continues to gain access to the best ideas from a large group of experienced, high-quality analysts; and that Lazard will provide Little the resources he needs to succeed and to maintain his investment focus.

Little’s Investment Philosophy and Approach

Little is a “blend” manager who has run the Lazard International Strategic Equity strategy since 2005. He believes a company that can improve and/or sustain its profitability at a relatively high level can compound returns at an attractive rate. At the same time, he believes in buying such companies only when he thinks they are trading inexpensively relative to their potential profitability.

Generally, any stock that Little buys falls into one or more of the following three categories:

  • Compounders: These are companies that Little and his team think can sustain relatively high levels of profitability. In addition, their management may enhance shareholder returns through share buybacks and dividend payments. Little will purchase these companies if he believes they can compound total return, i.e., earnings growth, dividends, and share buy backs, at a relatively high rate over the long term and if they are reasonably priced in relation to their profitability prospects.
  • Mispriced Situations: These are companies that are trading inexpensively relative to the long-term value Little and his team place on its assets and cash flows. These companies may or may not be compounders.
  • Restructuring: These are companies whose profitability is depressed relative to history and that in Little’s view are taking steps—such as cutting costs, investing in an neglected area, selling non-core businesses, etc.—to return to higher profitability. They may or may not become compounders.

Lazard’s 50-plus global sector analysts are largely responsible for generating ideas. They do so by running valuation screens in their sectors and monitoring developments at companies that fall under their coverage. They do most of the fundamental analysis, though Little is also involved. He reviews and debates the assumptions analysts use in their financial modeling, meets with company management, and leads analysis on a handful of small-cap companies. The goal of this company research and analysis is to identify Lazard’s information edge and estimate how much return can be generated from this edge. Lazard’s research edge is generally a function of its analysts having a different view than the Street on the level of profits a company can generate and for how long, and/or the company’s value.

Little will only invest in companies that he believes are cheap or reasonably valued relative to the profits it can generate. To assess this, he evaluates absolute valuation metrics and makes comparisons with relevant peers. In absolute terms, he uses metrics such as the free-cash-flow yield, discounted-cash-flow modeling, and sum of the parts (valuing different segments of a company separately). To compare companies relative to their peers, Little uses valuation metrics such as price-to-earnings, price-to-book, and the free-cash-flow yield. There is a fair amount of judgment involved in balancing these different approaches to assessing a company’s worth and setting price targets.

Little’s ultimate objective is to pick the best ideas from Lazard’s research platform, irrespective of market capitalization or geographical constraints. In selecting “best ideas” Little balances the highest expected return with the risk associated with pursuing the return.

Litman Gregory Opinion

We have known Little since 2006 and have used his flagship portfolio of 50 to 60 stocks in our other lines of business for several years, where we have been very pleased with performance. We believe that he allows us to access the very best international stock ideas from a well-resourced high-quality research platform at Lazard.  Lazard has over 50 sector analysts spread across the globe, plus many that focus on countries and/or regions, as well as many experienced portfolio managers. We believe this deep analytical resource allows Lazard to provide in-depth coverage of a much broader international universe than most international managers. Over the years, we have spoken to many sector and regional analysts at Lazard and have been consistently impressed with the quality of their analysis. We believe Little will be successful in picking the best ideas from this strong, talented pool of analysts.

Our confidence in him is based on several factors:

First, before becoming portfolio manager on the fund in early 2003, Little was an analyst and our research suggests he was very good in this role. We think his strong analytical abilities make it more likely he will succeed in culling the best ideas from a large research platform like Lazard’s.

Second, Little is a thoughtful, disciplined investor. Short-term market fluctuations do not bother him and he is very focused on making sure he maintains confidence in the thesis underlying each of his investments.

Third, he is willing to dig into a company’s fundamentals and understand businesses across the globe, and his ability to make sound comparisons across different business models and assess what they might be worth is exceptional, in our view.

Fourth, the Lazard analysts we talked to consistently highlighted attributes that suggest Little is well-respected and liked. This is especially important in Lazard’s structure where Little depends upon analysts for ideas, fundamental company analysis, and ongoing monitoring of his portfolio holdings.

Finally, Little’s accounting background (he is a chartered accountant and worked at Coopers & Lybrand) helps him run back-of-the-envelope calculations and quickly get his arms around what a company might be worth before deciding to dig deeper; this is an advantage because it allows him to quickly assess the large pool of ideas that Lazard analysts bring to the table.

We believe Little is particularly well suited to run a Litman Gregory Masters Funds portfolio because:

  • He already runs a relatively concentrated international portfolio and narrows down to his best ideas.
  • He has the mindset to handle short-term volatility and thinks like a long-term investor.
  • He has had experience running a 10- to 15-stock portfolio.
  • He can access a broad investment opportunity set without any capitalization constraints, and so will likely bring some unique names into the portfolio, adding valuable diversification to the fund.
  • We believe he will appropriately balance upside with the higher downside risk that comes with concentrated investing.

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Mutual fund investing involves risk. Principal loss is possible.

The fund will invest in foreign securities. Investing in foreign securities exposes investors to economic, political, and market risks and fluctuations in foreign currencies. Though not a small-cap fund, the fund may invest in the securities of small companies. Small-company investing subjects investors to additional risks, including security price volatility and less liquidity than investing in larger companies. Investments in emerging-market countries involve additional risks such as government dependence on a few industries or resources, government-imposed taxes on foreign investment or limits on the removal of capital from a country, unstable government, and volatile markets. Multi-investment management styles may lead to higher transaction expenses compared to single investment management styles. Outcomes depend on the skill of the sub-advisors and advisor and the allocation of assets amongst them.

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