Davis Appreciation and Income Fund
Update from
Portfolio Managers
Christopher Davis, Peter J. Sackmann, CFA and Creston A. King III, CFA
Annual Review 2020

Investment Results
Davis Appreciation and Income Fund seeks to generate total returns through a combination of capital appreciation and income. We regard the Fund as an all-in-one solution for growing shareholders’ purchasing power over the long term.

For the year ended December 31, 2019, the Davis Appreciation and Income Fund returned 20.33%. By comparison, the Bloomberg Barclays U.S. Aggregate Bond Index returned 8.72%, the 60% S&P 500/40% Bloomberg Barclays U.S. Aggregate Bond Index returned 22.16%, and the Endowment Index returned 20.19%.1 The performance of the Fund, as well as the indexes during the period reflect in part the strong performance of U.S. equities. The S&P 500 Index returned 31.49%, making it one of the 10 best years in the last half century. In addition, bonds have in many instances benefited from declining interest rates.

Fund Overview

Davis Appreciation and Income Fund is benchmark-agnostic and designed as an all-in-one solution for our clients, seeking to generate satisfactory absolute returns above inflation over the long term. Our mandate, in other words, is first and foremost to preserve and grow shareholders’ purchasing power over time. We seek to achieve two main goals: (1) growth of capital through equities and (2) rising income.

Over the last several years, and against a very favorable economic backdrop, the Fund has returned close to 9% per annum versus an inflation rate of approximately 2% and a risk-free rate under 2% currently. Hence our real return and our return over prevailing interest rates have been relatively solid thus far, with purchasing power having grown over the last several years overall.

The income yield of the Fund is relatively low, with fixed income yields compressed due to the low interest rate environment. To the extent the Fund’s income yield has been rising steadily, it is being driven by rising dividends primarily, particularly in financial services. Given the current environment, it is our preference to build a growing stream of income starting from low payout ratios (in financials especially) than overpay for the privilege of owning higher dividend (but expensive) names today with stretched payout ratios.

Meanwhile, a mix of stocks and high-grade fixed income should provide a natural degree of diversification. That stated, the most important measure of downside risk is not marked-to-market share price volatility, but the potential for large and permanent impairments to capital at the position level. For this reason, the Fund holds exceptionally durable businesses with fortress balance sheets in the main. To the limited extent we hold some businesses with leverage, position sizes for those businesses are set accordingly, and those holdings tend to be few and far between. We cannot control or predict market volatility or share price fluctuations, but we can construct a diversified portfolio of businesses that are built to last and that can weather a number of economic or market conditions.

The average annual total returns for Davis Appreciation and Income Fund’s Class A shares for periods ending December 31, 2019, including a maximum 4.75% sales charge, are: 1 year, 14.62%; 5 years, 3.75%; and 10 years, 6.99%. The performance presented represents past performance and is not a guarantee of future results. Total return assumes reinvestment of dividends and capital gain distributions. Investment return and principal value will vary so that, when redeemed, an investor’s shares may be worth more or less than their original cost. The total annual operating expense ratio for Class A shares as of the most recent prospectus was 1.01%. The total annual operating expense ratio may vary in future years. Returns and expenses for other classes of shares will vary. Current performance may be higher or lower than the performance quoted. For most recent month-end performance, click here or call 800-279-0279.

This report includes candid statements and observations regarding investment strategies, individual securities, and economic and market conditions; however, there is no guarantee that these statements, opinions or forecasts will prove to be correct. Equity markets are volatile and an investor may lose money. All fund performance discussions within this piece refer to Class A shares without a sales charge and are as of 12/31/19 unless otherwise noted. This is not a recommendation to buy, sell or hold any specific security. Past performance is not a guarantee of future results. Total returns are not annualized for periods of less than one year. 1. The 60% S&P 500/40% Barclays Aggregate Index is a composite blend of 60% of the S&P 500 Index and 40% of the Bloomberg Barclays U.S. Aggregate Bond Index and represents a broad measure of the U.S. stock and bond markets, including market sectors in which the fund may invest.

Portfolio Review
The Fund is consciously positioned in 27 high-conviction equity holdings as well as a portfolio of high grade fixed income securities.

In 2019, the Davis Appreciation and Income Fund returned 20.33%. It has compounded at close to 9% for the last three years, which is close to the very long-term average return for U.S. equities and well above the 2% current domestic inflation rate.

In terms of positioning, we believe the combination of well-researched, durable businesses within our equities allocation (approximately 75% of the Fund) with prudently selected, high-grade fixed income makes the Fund an all-weather, all-in-one strategy intended to serve relatively conservative investors seeking to grow purchasing power over the long term with a moderate risk tolerance.

Equities

At a high level, and in a market that contains both undervalued and overvalued stocks, we have consciously positioned the equities in the Fund to strike an intelligent balance of select, very durable, growing businesses that are trading at value prices—a key to our long-term success over our 50-year history as an investment manager.


Our selectivity when choosing investments is evident in the fact that we hold 27 individual equity investments versus more than 500 securities in the S&P 500 Index. Our portfolio companies have generated five-year earnings per share growth of 17.4% versus the Index’s 17.1% growth rate over the same timeframe. Meanwhile, our portfolio trades at a very reasonable forward multiple of 15.7 times earnings versus a much higher multiple of 20.0 times for the S&P 500 Index. Overall, we believe our positioning is strong on a prospective basis and should benefit from an advantageous starting point into the coming decade.

At a more granular level, we have constructed a rather eclectic equity portfolio that includes:

  • High-grade financials (both U.S. and non-U.S.) such as U.S. Bancorp, Wells Fargo, DNB ASA of Norway, and DBS Holdings of Singapore which, while mundane, offer some of the best value of any sector in our view;2
  • Intensely innovative, fast-growing market leaders such as Amazon.com, Alphabet, and Microsoft, as well as workhorse technology companies such as Applied Materials, Intel, and Texas Instruments. Whether these businesses are engaged in e-commerce, cloud computing, or other large and rapidly expanding end markets tied to semi-conductors, our technology holdings are all in leadership positions that we believe will play to their advantage competitively in vast new, profitable fields.
  • Select industrial companies like United Technologies and Johnson Controls International with strong recurring revenue characteristics, defensible competitive positions, and relatively attractive margins.
  • A select healthcare business, Quest Diagnostics, which is a leader in independent lab and diagnostics services. The company’s business model relies on it delivering on the value proposition of lowering lab-related expenses and effectively serving as part of a cost solution to rising healthcare costs in the U.S.
  • A very small allocation to energy companies Apache and Encana, which have been detractors to performance in recent periods but are, in our view, trading at depressed multiples today.

Fixed Income

The Fund's fixed income allocation is diversified across a number of sectors including corporates, agencies and mortgages, among other areas. At this time, given the current interest rate environment, we are stressing capital preservation as a priority over income among our fixed income investments overall. That stated, we will look for opportunities in the fixed income markets that meet our investment criteria and will invest in such opportunities as they present themselves.

2. Individual securities are discussed in this piece. While we believe we have a reasonable basis for our appraisals and we have confidence in our opinions, actual results may differ materially from those we anticipate. The return of a security to the fund will vary based on weighting and timing of purchase. This is not a recommendation to buy, sell or hold any specific security. Past performance is not a guarantee of future results.

Conclusion

Overall, we feel confident in the durability of the Fund because of the fundamental strength of the businesses we own as well as the natural diversification created by a multi-asset class portfolio. Our main objective is to offer our shareholders an all-in-one solution that can achieve growth in purchasing power and rising income over time.

At Davis Advisors, we seek to purchase durable businesses at value prices that can be held for the long term. The more than $2 billion Davis Advisors, the Davis family and Foundation, our employees, and Fund directors have invested in similarly managed accounts and strategies remains a true sign of our commitment to and conviction in this enduring philosophy.3 We look forward to continuing our investment journey together.

3. As of 12/31/19.

This report is authorized for use by existing shareholders. A current Davis Appreciation and Income Fund prospectus must accompany or precede this material if it is distributed to prospective shareholders. You should carefully consider the Fund’s investment objective, risks, charges, and expenses before investing. Read the prospectus carefully before you invest or send money.

This report includes candid statements and observations regarding investment strategies, individual securities, and economic and market conditions; however, there is no guarantee that these statements, opinions or forecasts will prove to be correct. These comments may also include the expression of opinions that are speculative in nature and should not be relied on as statements of fact.

Objective and Risks. Davis Appreciation and Income Fund’s investment objective is total return through a combination of growth and income. There can be no assurance that the Fund will achieve its objective. The Fund is subject to both equity and debt risk. Some important risks of an investment in the Fund are: bonds and other debt securities risk: Bonds and other debt securities generally are subject to credit risk and interest rate risk; changes in debt rating risk: if a rating agency gives a fixed income security a low rating, the value of the security will decline; common stock risk: an adverse event may have a negative impact on a company and could result in a decline in the price of its common stock; convertible securities risk: convertible securities are often lower-quality debt securities; credit risk: The issuer of a fixed income security (potentially even the U.S. Government) may be unable to make timely payments of interest and principal; depositary receipts risk: depositary receipts may trade at a discount (or premium) to the underlying security and may be less liquid than the underlying securities listed on an exchange; extension and prepayment risk: the pace at which borrowers prepay affects the yield and the cash flow to holders of securities and the market value of those securities; fees and expenses risk: the Fund may not earn enough through income and capital appreciation to offset the operating expenses of the Fund; foreign country risk: foreign companies may be subject to greater risk as foreign economies may not be as strong or diversified. As of 12/31/19, the Fund had approximately 8.5% of assets invested in foreign companies; headline risk: the Fund may invest in a company when the company becomes the center of controversy. The company’s stock may never recover or may become worthless; high-yield, high-risk debt securities risk: issuers of these debt securities are unlikely to have a cushion from which to make their payments when their earnings are poor or when the economy in general is in decline. These issuers are likely to have a substantial amount of other debt, which will be senior to the high-yield, high-risk debt securities. An issuer must be current on its senior obligations before it can pay bondholders; interest rate risk: interest rate increases can cause the price of a debt security to decrease; large-capitalization companies risk: companies with $10 billion or more in market capitalization generally experience slower rates of growth in earnings per share than do mid- and small-capitalization companies; manager risk: poor security selection may cause the Fund to underperform relevant benchmarks; mid- and small-capitalization companies risk: companies with less than $10 billion in market capitalization typically have more limited product lines, markets and financial resources than larger companies, and may trade less frequently and in more limited volume; preferred stock risk: preferred stock is a form of equity security and is generally ranked behind an issuer’s debt securities in claims for dividends and assets of an issuer in a liquidation or bankruptcy. An adverse event may have a negative impact on a company and could result in a decline in the price of its preferred stock; stock market risk: stock markets have periods of rising prices and periods of falling prices, including sharp declines; and variable current income risk: the income which the Fund pays to investors is not stable. See the prospectus for a complete description of the principal risks.

Davis Advisors is committed to communicating with our investment partners as candidly as possible because we believe our investors benefit from understanding our investment philosophy and approach. Our views and opinions include “forward-looking statements” which may or may not be accurate over the long term. Forward-looking statements can be identified by words like “believe,” “expect,” “anticipate,” or similar expressions. You should not place undue reliance on forward-looking statements, which are current as of the date of this report. We disclaim any obligation to update or alter any forward-looking statements, whether as a result of new information, future events, or otherwise. While we believe we have a reasonable basis for our appraisals and we have confidence in our opinions, actual results may differ materially from those we anticipate.

The information provided in this material should not be considered a recommendation to buy, sell or hold any particular security. As of 12/31/19, the top ten holdings, not including cash and equivalents, of Davis Appreciation and Income were: Berkshire Hathaway Inc., Class B, 5.65%; Applied Materials, 4.72%, Wells Fargo & Co., 4.55%; United Technologies Corp., 4.27%; U.S. Bancorp, 4.06%; Capital One Financial Corp., 3.97%; Alphabet Inc., Class C, 3.50%; Microsoft Corp., 3.47%; Intel Corp., 3.43%. Amazon.com., 3.17%; The cash and equivalents were 3.04%.

Davis Funds has adopted a Portfolio Holdings Disclosure policy that governs the release of non-public portfolio holding information. This policy is described in the prospectus. Holding percentages are subject to change. Click here or call 800-279-0279 for the most current public portfolio holdings information.

Forward Price/Earnings (Forward P/E) Ratio is a stock’s current price divided by the company’s forecasted earnings for the following 12 months. The values for the portfolio and index are the weighted average of the p/e ratios of the stocks in the portfolio or index.

Five-Year EPS Growth Rate is the average annualized earning per share growth for a company over the past five years. The values for the portfolio and index are the weighted average of the five-year EPS Growth Rates of the stocks in the portfolio or index.

The attractive growth reference in this piece relates to underlying characteristics of the portfolio holdings. There is no guarantee that the Fund performance will be positive as equity markets are volatile and an investor may lose money.

We gather our index data from a combination of reputable sources, including, but not limited to, Thomson Financial, Lipper and index websites.

The S&P 500 Index is an unmanaged index of 500 selected common stocks, most of which are listed on the New York Stock Exchange. The Index is adjusted for dividends, weighted towards stocks with large market capitalizations and represents approximately two-thirds of the total market value of all domestic common stocks. The Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate pass-throughs), ABS and CMBS (agency and non-agency). The Combined Index performance is calculated using 60% Standard & Poor’s 500 Index and 40% Bloomberg Barclays U.S. Aggregate Bond Index. The Bloomberg Barclays U.S. Aggregate Bond Index is an unmanaged index that is widely regarded as a standard for measuring U.S. investment grade bond market performance. Investments cannot be made directly in an index.

After 4/30/20, this material must be accompanied by a supplement containing performance data for the most recent quarter end.

Shares of the Davis Funds are not deposits or obligations of any bank, are not guaranteed by any bank, are not insured by the FDIC or any other agency, and involve investment risks, including possible loss of the principal amount invested.

Item #4775 12/19, Davis Distributors, LLC 2949 East Elvira Road, Suite 101, Tucson, AZ 85756, 800-279-0279, davisfunds.com