John Rogers Ariel Fund January 2017 Commentary – Your Saturday Superinvestor Reading


Dear Superinvestor Bulletin Follower,

Things are warming up in my neck of the woods. The sun is out, the snow is melting…perhaps winter is over.

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I like the chances of this next position further enhancing our market beating performance. You can sign up for a 2 week free trial right now and get a look at this next idea:

Today I’m going to pass along the most recent commentary from John Rogers of the Ariel Fund. I did a bit of underlining of what I thought are the most important parts:

In January, our monthly commentary typically focuses on the prior year’s asset flows, since they often a reveal a lot about investor sentiment. As we have noted before, asset flows have followed a different pattern in the wake of the great financial crisis. Specifically, bonds tended to receive inflows, domestic equity saw outflows, and passive management began dominating active management-mainly but not only in equities. More subtly, a long-standing preference for funds with strong short-term performance became even more pronounced.

Over the last year it is fair to say we have been through a lot-including Brexit, an unprecedented presidential election and all-time market highs. And yet, the flow story remains unchanged. In 2016, bonds saw inflows, while equity funds saw outflows. Passively-managed funds gained huge assets, while active funds continued to lose them. On the performance front, new money mainly went to recently strong performers or very new offerings.

More specifically, according to Morningstar data, U.S. Equity lost $152 billion and international equity lost $2 billion in 2016, while taxable bonds and municipal bonds gained $113 billion and $27 billion, respectively. Even more dramatically, across the full universe, actively managed funds had $318 billion in outflows while passive funds gained $226 billion in new assets.

Morningstar also shows flows by star rating, which captures investors’ performance sensitivity. Among rated funds (those with more than three years of history), the 10% of funds with 5-star ratings gained $136 billion in new money, while the 22.5% of funds with 4-star ratings added just $146 million in flows. Collectively, the other 67.5% of the rated fund universe, funds with 3-, 2- and 1-star ratings, saw $302 billion fly out the door. Perhaps of greatest concern: funds with less than three years of history gained $73 billion in flows. In other words, new and therefore unrated funds had more than half the inflows 5-star funds had.

Overall, we think this behavior is a bit bewildering and counterproductive. The bond fund boom began in 2008. Since which time the asset class has amassed an incredible $1.3 trillion in inflows over nine years. Meanwhile, U.S. and international equity funds have seen $29 billion depart. This push, which most agree stems from stock market losses during the great financial crisis, has hurt overall investor returns. The Barclays U.S. Aggregate Bond Index (the key benchmark) has trailed the S&P 500 Index in seven of nine calendar years over this stretch.

Bond yields continue to be near all-time lows, and the Federal Reserve has signaled it is likely to raise rates three or more times in 2017. As you know: every rate increase causes bond prices to drop in tandem.

As for the nearly wholesale abandonment of active management in favor of index funds and ETFs, we have been clear on that subject before and will offer another piece of 2016 data. In 2016, Morningstar’s Mid-Blend category, home to Ariel Fund and Ariel Appreciation Fund, saw more than $7 billion pour out of actively managed funds and nearly $7 billion flow into passively managed funds. To us, that says investors believe mid-blend managers cannot beat representative indexes. And yet, in 2016, 59% of mid-blend funds topped the Russell Midcap Index’s +13.80% gain1. And over the 3- and 5-year periods, 25% of the category topped this benchmark for both time periods. To be sure, outperformance is not the norm-but it seems a lot more common than flows suggest.

All told, we continue to believe the best game-plan is to assess one’s goals, develop a long-term asset allocation policy to achieve those goals, and stick to it while making few adjustments. We also believe that, with a little work, one can find a solid actively-managed equity fund with a track record showing experience and proficiency.

Have a great Saturday and don’t forget to sign up for a free trial of the Superinvestor Bulletin

Reese Morgan

Editor, The Superinvestor Bulletin



Berkshire’s Charlie Munger Has A Much Different Energy Plan For America Than Donald Trump

I’ve been told many times that I spend far too much time winding up my articles and not getting to the point. I’ve also been told that the problem with this is that in this internet generation that readers are only going to give me about two seconds worth of attention before deciding whether to click somewhere else so I need to get to the point quickly.

Darn it, I’ve probably done it again. Your short attention span has likely taken you elsewhere.

Well, if you are still with me here is what my lead should be. The very wise Charlie Munger just spoke at the annual Daily Journal Annual Meeting (and on CNBC) and he advocates a much different energy policy than our new President. In fact, Munger would have us do exactly the opposite of what Trump is proposing. Probably not a surprise that these two gentlemen differ given what we know about them.

Let’s compare the two different views on what America’s energy plan should be.

Trump’s Energy Plan – An America First Energy Plan

Image Source: Youtube

Donald Trump laid out his “America First Energy Plan” during his campaign. The plan is pretty simple. Trump wants to get the government out of the way and let the oil and gas industry drill as much as possible.

The shale oil and gas miracle that the oil and gas industry provided our country was truly an incredible leap forward in terms of recoverable hydrocarbons. Trump has clearly grasped the huge potential of the shale oil resources that the United States has and how many high paying jobs that the industry could support.

During the election campaign Trump revealed the 7 core elements of his “America First Energy Plan.” Each and every one of those elements was tied to the same thing which is exploiting America’s new found (or at least newly recoverable) shale resources as fast as possible.

Here is the exact plan:

Source: Trump Campaign Website

It didn’t take long to see how serious Trump is about supporting the oil and gas business. Within days of being on the job he issued an executive order that restarted both the Obama stymied Keystone and Dakota Access Pipelines. It was a clear message for oil executives that they should feel free to open up their wallets and get back to business.

The Ever-Rational Charlie Munger – Keep It in the Ground

He is 93 years old and as sharp as a tack. Berkshire Hathaway’s (NYSE:BRK.A) Charlie Munger was at the Daily Journal annual meeting (the newspaper he runs) this week and was also on CNBC. While on CNBC specifically Munger made some interesting comments about America’s development of natural gas (and oil).

Source: CNBC

His exact words were:

I wish we weren’t producing all this natural gas, I’d be delighted to just have it lie there untapped for decades in the future and have the Arabs pay extra once they use up their oil … nobody else in America seems to feel my way, but I believe in deferred gratification, I don’t think hastening to use our oil and gas is a good idea … I don’t see any advantage.

Munger believes that the United States should have an energy strategy that involves preserving these shale resources until some point in the future when they are much more valuable. This would be a point in time after the OPEC nations have exhausted their oil and gas reserves.

Munger would have us import oil and gas now from OPEC so that we can save our oil and gas for the future when the world is going to have major shortages. That is obviously very different than the Trump plan which is to produce as much shale oil and gas as fast as we can.

Interestingly, this is not the first time that Munger has said this. A few years ago at a conference in China Munger said the following:

Oil is absolutely certain to become incredibly short in supply and very high priced. The imported oil is not your enemy, it’s your friend. Every barrel that you use up that comes from somebody else is a barrel of your precious oil which you’re going to need to feed your people and maintain your civilization. And what responsible people do with a Confucian ethos is suffer now to benefit themselves and their families and their countrymen later. The way to do that is to go very slow in producing domestic oil and not mind at all if we pay prices that look ruinous for foreign oil.

It’s going to get way worse later…

The oil in the ground that you’re not producing is a national treasure … It’s not at all clear that there’s any substitute [for hydrocarbons]. When the hydrocarbons are gone, I don’t think the chemists are going to be able to just mix up a vat and create more hydrocarbons. It’s conceivable that they could, I suppose, but it’s not the way to bet. We should spend no attention to these silly economists and these silly politicians that tell us to become energy independent.

Let me pose a question for you. It’s 1930. Oil in the United States is in glut. We have cartels to get the price up to $0.50 a barrel. Everywhere we drill we find more oil in our own country; everywhere we drill in Arabia we find even more.

What would the correct policy of the United States have been in that time? Well, the correct policy would have been to issue $150 billion of very long-term bonds and cart 150 billion barrels of Middle Eastern oil into the United States and throw it into our salt caverns and leave it there untouched until the current age.

It’s easy to see that in retrospect, but who do you see who ever points this out? Zero. We have a brain-block on this issue. We should behave now to do on purpose what we did on accident then.

 Interesting to say the least. Munger said “absolutely certain” that oil would become in very short supply and very high priced. That sounds like a table pounding recommendation to get long oil for the long term.

Where Does This Leave Investors?

Ask me whether I would rather take the opinion of Munger or Trump and I go with Charlie every day of the week and twice on Sunday. Munger is a painfully rational, long-term, widely read, clear thinker. Trump is, well, Trump.

The problem I have on this issue is that while Charlie is exceptionally clear on the fact that he believes oil and gas prices are going to be much higher in the future there is nothing in Berkshire’s investment portfolio that shows any commitment to that fact. The only oil and gas company in the Berkshire Portfolio is Phillips 66 (NYSE:PSX), which itself isn’t even a direct play on the commodity prices. In this case, Charlie’s money isn’t where his mouth is. That gives me pause.

Trump’s policies are another reason why I’d be reluctant to get overly bullish on oil and gas prices today. If he manages to ramp up drilling that is going to bullish for oil sector jobs, but rising production is bearish for prices. I also wonder if Trump really reigniting U.S. oil production growth might cause OPEC to abandon their recent cuts. Again, very bearish for oil prices.

While getting bullish on oil and gas prices under Trump is tough for me, it is even harder to get bullish on the shale producers that will be increasing production. In the Superinvestor Bulletin, I spend all of my time focused on the stock holdings of the world’s greatest investors. I can tell you that it is very rare that I find a shale producer in one of the portfolios of these great investors.

Why the great investors don’t hold these shale producers is really not a mystery to me. From what I can tell none of them generate any positive cash flow … ever. Even when commodity prices were much higher.

So what good is knowing Munger’s pretty strong view on future oil and gas prices? To be honest, I’m not sure. If I saw that Munger was investing based on that belief, I’d be more inclined to do something with that information. For now I’ll just consider it food for thought and keep reading.

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Davis Funds 2017 Annual Investor Letter


•  In 2016, Davis New York Venture Fund returned 12.25% versus 11.96% for the S&P 500 Index.¹

•  Over the most recent one, three and five year periods, a $10,000 investment grew to $11,225, $12,316 and $18,681, respectively.¹

•  $1.97 million versus $932,077 is the value of a $10,000 investment in the Fund since inception versus the value of a $10,000 investment in the S&P 500 Index.1

•  Opportunities in today’s market include global leaders selling at bargain prices, dominant lesser-known businesses in necessary economic niches, blue chips of tomorrow and beneficiaries of short-term misperceptions.

•  Risks in today’s market include overvalued dividend darlings and companies with near peak profit margins.

Results of Our Investment Discipline

Davis New York Venture Fund returned 12.25% versus 11.96% for the S&P 500 Index in 2016.2

Davis New York Venture Fund continued its long record of building shareholder wealth. As shown in the chart below, the value of an initial $10,000 investment has increased in all periods shown.

On a relative basis, our results beat the market in 2016 as they have over the long term. Compounded over the long run, our advantage over the index has created enormous value for shareholders.

Just consider that an initial $10,000 invested in Davis New York Venture Fund at our inception would now be worth more than $1.9 million, more than twice as much as an equivalent investment in the S&P 500 Index.

While our disciplined investment approach has not always been rewarded by the market over shorter periods, this active management approach has created wealth for our shareholders in the long run. By standing apart from the crowd, keeping expenses low, investing alongside our shareholders, and ignoring short-term fads, we have built wealth for shareholders and beaten the index since 1969. •

Investment Outlook

Equities should outperform bonds for the next decade.3 Avoid overpriced dividend darlings. Focus on the important and knowable.

The last five years have been filled with the unexpected. Time and again professional forecasters and pundits have been proven wrong: from the rise of ISIS to the collapse in energy prices; from Facebook’s poorly received initial public offering to the bankruptcy of Detroit; from Brexit to the election of Donald Trump. Yet through it all, Davis New York Venture Fund has grown the value of a dollar invested in that time period by more than 80%, showing that while short-term predictions may be worthless, long-term preparation is invaluable.4

The essence of our preparation is a relentless focus on what is both knowable and important. For example, while the short-term outlook for bond markets may not be predictable, we know today’s historically low interest rates leave bondholders with less upside potential and more downside potential than at any other time in modern history. With the yield on long- term government bonds now comparable to the dividend yield on stocks, we expect stocks to outperform bonds handily in the decades ahead.

Another fact that is both knowable and important is market dips are inevitable. For example, since 1928 the market has experienced a 10% dip about every eight months and a 20% dip every two and a half years on average. Yet, when we experience such a dip, the media act as if the world is coming to an end. As a result, many investors panic and sell at low prices creating a buying opportunity for those who can keep their heads. Since stocks are one of the best ways to build long-term wealth, the years ahead are likely to reward those investors who have a long-term perspective, flexibility and steady nerves and to penalize those investors who are frozen by indecision, committed to passive investment strategies or likely to panic during market downturns.

A final important and knowable fact is investors often feel safest when risks are greatest. From internet mania to the housing boom, what looked like a sure thing in the rear view mirror ended up a speculative bubble. Two sectors where investors feel safe today have risen to levels that appear risky to us. First, many popular dividend-paying stocks, often referred to as dividend darlings, have been bid up to premium valuations that could spell trouble for investors who assume dividends are guaranteed. Second, with regulatory encouragement, roughly a trillion dollars has been switched from actively managed funds into passive index funds since 2007. Such huge fund flows create momentum, as more money is automatically invested in those stocks whose prices have already gone up. Unfortunately, momentum-based strategies lead to bubbles and bubbles eventually burst. Moreover, while passive investing may have beaten the average manager, a select few active managers, including Davis Advisors, have beaten the market over the long term. In fact, in addition to Davis New York Venture Fund, all five of the equity strategies managed by our firm, including Davis Global Fund, Davis Opportunity Fund, Davis International Fund, and Davis Financial Fund, have outperformed their peers since their inception.5 Happily, as more money flows into passive index strategies that employ no securities analysis, more investment opportunities are available for investors like us who do. After all, finding undervalued companies is far easier when fewer investors are looking. •

The Portfolio

Global leaders trading at bargain prices. Dominant lesser-known businesses. Blue chips of tomorrow. Beneficiaries of short-term misperceptions.6

Four portfolio themes have allowed us to create a powerful combination of growth and value in Davis New York Venture Fund:

Global Leaders Trading at Bargain Prices—Some of the strongest and best-known companies in the world make up the largest portion of the Portfolio. This fact is nothing new. What is unusual though is short-term economic concerns over the past year have reduced the share prices of a handful of global leaders such as Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B), United Technologies (NYSE:UTI), American Express (NYSE:AXP), and Monsanto (NYSE:MON) to bargain levels at a time of high valuations for the average company.7 Buying top tier businesses at bargain prices is a value investor’s dream.

Dominant Lesser-Known Businesses— Davis New York Venture Fund also invests in a group of lesser-known businesses that dominate dull but necessary niches in the global economy. Whether they participate in unglamorous industries or are headquartered in different countries, these businesses are not household names to U.S. investors. As a result, their shares often trade at a discount to better-known companies despite having the same qualities of market dominance and durability as the global leaders described above. Such companies include Johnson Control’s leadership in fire and security, building controls, and car batteries; Liberty Global’s strength in European cable TV and broadband; LafargeHolcim’s dominance of the world cement industry, and Safran’s leadership in jet engines (the company has been an equal but less well-known partner of General Electric for more than 30 years). These companies combine the relevance and resilience of blue chip companies with below-average valuations.

Blue Chips of Tomorrow—Another theme is fast-moving companies that use innovation to disrupt the economics of larger but less agile competitors. Similar to evolution, capitalism is a process of constant change that rewards businesses that can adapt. Over the decades, we have seen many examples of today’s disrupters emerging as tomorrow’s blue chips. Several of Davis New York Venture Fund’s core holdings reflect this dynamic. Amazon (NASDAQ:AMZN) has not only revolutionized the retail business, but also the information and technology industry through Amazon Web Services (AWS). Alphabet (NASDAQ:GOOGL) (the parent company of Google) began by making the world’s information accessible through the internet and emerged as the largest and most profitable advertising firm in the world, the brains behind the vast majority of all smart phones, a leader in internet video, and the emerging leader in artificial intelligence and self-driving cars.

CarMax (CMX) is another example of an innovator that has been just as disruptive in the auto sector, bringing trust, choice and quality to the murky but enormous used car industry. Investors in disruptive leaders stand to benefit not just from the growth in these companies’ underlying businesses, but also from their gradual inclusion in the ranks of blue chip stocks.

Beneficiaries of Short-Term Misperceptions— Short-sighted investors avoid companies that face short-term misperceptions, creating an opportunity for long-term investors willing to look beyond today’s headlines. In banking, for example, memories of the financial crisis of 2008–2009 combined with subsequent anti-banking rhetoric and media coverage have blinded investors to the fact carefully selected banks are both cheap and safe, in our opinion. Contrary to perception, many top tier banks are not only reporting record earnings but are also far better capitalized than at any time in the last 50 years. While unloved now, we believe the leading financial companies we own will be big contributors to Davis New York Venture Fund’s future returns as the reality of their strong economic fundamentals and rising dividends eclipses current investor perceptions.

Similarly, over the past year, investors fled the energy sector in response to the dramatic (and unsustainable) collapse in oil prices. While oil prices are unknowable in the short term, they must exceed the cost of replacing reserves over time. This simple fact will eventually lead to higher energy prices and should drive future returns for the well-positioned, low-cost producers the Fund holds. As a result, we repositioned the energy portion of the Portfolio, adding to existing holdings and initiating new investments. We own a select group of innovative and well-positioned energy companies with the capital allocation discipline, management experience and low-cost, long-lived reserves that will allow them to increase production for decades to come. Our holdings include Occidental Petroleum, Apache, Cabot Oil & Gas, and Encana.

All in all, the carefully selected companies that make up Davis New York Venture Fund combine above-average resiliency and growth with below-average prices. •


Today, as always, when confronted with background noise, investors benefit from tuning out the static of short-term market predictions and company forecasts and focusing instead on the long-term opportunities and risks. Today, we see significant opportunity in areas of the markets that are over­ looked and risk in popular areas of the market where investors feel safest. This combination creates opportunity for those who can be flexible and independent. At a time when pundits and commentators are making the case that experience and judgment do not matter and that the best investors can hope for is an average result, we strongly disagree. We believe a carefully selected Portfolio of durable, well-managed businesses with competitive advantages, selling at a discount to true value and overseen by a seasoned team with proven results will lead to a better-than-average outcome. In investing, as in any other profession, skill matters. For more than 47 years, we have demonstrated the value of that skill by building wealth for our shareholders and generating results that have exceeded the market averages. With the vast majority of our net worth invested alongside our shareholders, we have every incentive and intention to build on this record in the years and decades ahead.


Seth Klarman: Raising The Warning Flag On Index Fund Valuations


I normally spend my winters in a very cold part of the world. This year I decided that I was not going to suffer through another miserable three months where every trip out to my car requires mental preparation for cold shock you are about to receive.

I packed up the entire family and we headed to Hawaii for an extended stay.

The first time we went to a beach (Big Beach in Makena, Maui) there was a sign posted that warned of unusually strong current and advised against swimming.

Yet, despite the warning there were dozens of tourists in the water.

Seeing so many people swimming, my kids became rather annoyed when I told them that they would not be going into the ocean on that day.

My explanation for why was simple.

The signs were posted by lifeguards who are at that beach every day and know exactly how risky the current conditions were. We (and most of the people who actually were in the water) on the other hand had never been to the beach before and didn’t know the risks.

For me it was an easy decision to trust the experts. The downside of keeping my kids out of the water was that they were annoyed with me for a few hours. The upside was that I made sure they didn’t put their lives on the line for the sake of a swim.

When in doubt listen to the proven, experienced voices. That advice applies to swimming in Maui – it also applies to investing the stock market today.

A Baywatch Quality Lifeguard Is Telling Investors That Now Is Not A Time For Swimming

Imagine the S&P 500 (NYSEARCA:SPY) is the beach and retail investors are all tourist swimmers. Today we have the ultimate lifeguard on duty at out beach.

Think David Hasslehoff in his prime on Baywatch.

This lifeguard doesn’t wear an orange bathing suit and carry a life-saving flotation device. He wears some khaki pants and carries a constant focus on risk aversion. Hasslehoff (at least his Baywatch character) may have been good at his craft, but our investment lifeguard is a lot better.

Our lifeguard’s name is Seth Klarman and he manages a hedge fund called Baupost Group. I’m going to tell you about his long investment track record which I hope will convince you that he is worth listening to.

Then I’m going to tell you what he is saying today which are words that I think we as investors need to take seriously. Doing so could both protect us from losing money and perhaps even find some good investment ideas.

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