Q2 2024 Market Insights: Fund Managers' Perspectives on Global Economic Trends

FPA Queens Road Small Cap Value Fund Q2 2024 Commentary (undefined:QRSVX)

Following quarter end, during the five business days of July 10 - July 16, the Russell 2000 Value Index suddenly leapt higher, rising more than 1% each day and 12.28% cumulatively. The FPA Queens Road Small-cap Value Fund ("Fund") returned -2.62% in the second quarter of 2024. This compares to a -3.64% return for the Russell 2000 Value Index in the same period. For the first half of 2024, the Fund returned 0.65% versus -0.85% for the Russell 2000 Value Index. We prefer to be measured on longer time periods. As a reminder, our goal is to outperform the Russell 2000 Value Index over the full market cycle with less risk. Consistent with our historical returns, we expect to outperform in down markets and trail somewhat in speculative markets as a result of our diligent, disciplined, and patient process. 20% or Larger Russell 2000 Value Drawdowns Since Fund Inception Following quarter end, during the five business days of July 10 - July 16, the Russell 2000 Value Index suddenly leapt higher, rising more than 1% each day and 12.28% cumulatively. As is often the case in strong markets, the Fund lagged and was only up 7.73%, a 63% upside participation. We believe the causes of this sudden rally were technical - a reversal of the long Nasdaq 100 / short Russell 2000 positioning that had been wildly successful over the previous 18 months.[2] The most interesting analysis of the small-cap rally came from Societe Generale (OTCPK:SCGLF) as published by James Mackintosh in the Wall Street Journal. The magnitude of share price performance over those five days correlated extremely closely and linearly to market capitalization. Even within the small and large-cap indices, smaller performed much better than larger.[3] The Fund's holdings tend to be larger than those of the Russell 2000 Value Index, consistent with our preference for quality and our reluctance to take liquidity risk. Our positioning towards "larger small-cap companies" limited our participation in this melt up. The following chart shows the Russell 3000 bucketed by market capitalization (size) on the X axis. On the Y axis are percentage returns from July 10, 2024 through July 16, 2024. We've used the last several letters to write about the small-cap pond we fish in. To quickly reiterate: We want to highlight another piece of the puzzle that we wrote about in the Q4 2023 letter. 8 In 2015, the researchers at AQR published a paper called " Size Matters, If You Control Your Junk". 9 Their research, as quantitative investors, showed that small-caps are generally junkier than large-caps - i.e., they score lower across the quality metrics that quantitative researchers look at such as low volatility, high margins, high capital efficiency, low leverage, high cash conversion, etc. But, once you control for similar levels of quality, small outperforms large on a consistent basis. The two quality metrics we care about most are earnings consistency and high returns on capital. In this letter, let's look at earnings consistency and leave returns on capital for another day. Most investors intuitively understand that earnings consistency is a good thing. A business with consistent earnings in the past probably has a business model that can earn consistently in the future. It is evidence of a business that is both less cyclical and is less dependent on environmental or macro factors outside management's control. And earnings consistency makes it easier for the market to capitalize those earnings at a higher multiple - e.g., the bond proxy effect enjoyed by utilities and staples. Methodology We looked at earnings consistency of constituents of the S&P 500 Index, the S&P 600 Index, and the FPA Queens Road Small Cap Value Fund as of Dec 31, 2023. Then, we compared price-to-earnings (P/E) ratios for sets of similarly consistent earners in those indices and the Fund. ( Readers who aren't interested in the details of this methodology should feel free to skip to the Results section below.) Earnings data can be very noisy (especially for small-caps) and we use a couple of adjustments to help make the data easier to work with. In the end, we came up with a number that we call "Stdev of EPS to Trend," which summarizes how closely a company's earnings in each individual year adhere to the overall earnings growth trend. The lower the number, the more closely annual earnings matched the trend. The higher the number, the more volatile earnings were when measured against the trend. A couple of examples should be helpful. The top-ranking company in the S&P 600, with the lowest Stdev of EPS to Trend, is Chesapeake Utilities Corporation (CPK), a mid-Atlantic utility. Chesapeake has grown adjusted EPS at a 7.7% annual rate per the methodology above. And, over the 10 years we examined, the standard deviation of Chesapeake's adjusted EPS versus the trend line (Stdev of EPS to Trend) is only 5.5%. The biggest discrepancies were in 2017 when Chesapeake earned $3.64, 9% above the $3.33 in trend earnings, and in 2019, when Chesapeake earned $3.56, 8% below the $3.86 in trend earnings. The data represented in the charts below were used in our Stdev of EPS to Trend calculations. The 290th ranked company in the S&P 600 based on Stdev of EPS to Trend is Consol Energy (CEIX), a coal producer. Consol has grown adjusted EPS at a 25% rate, but the standard deviation of Consol's adjusted EPS versus the trend line is 61% - significantly more volatile. For Consol, we can see the exponential curve upward in the trend, the result of earnings compounding at a relatively high rate. In this analysis, we wanted to compare small-caps to large-caps on a like for like basis based on earnings consistency - our "Stdev of EPS to Trend" metric. We used the S&P 500 (the "large-cap index") as our baseline and ordered its constituents by Stdev of EPS to Trend. Over the past 10 years, the top decile (10%) has a Stdev of EPS to Trend of 12.3% or less, the top quintile (20%) has a Stdev of EPS to Trend of 13.8% or less and the top two quintiles (40%) have a Stdev of EPS to Trend of 20.1% or less. We then compared these baskets of S&P 500 holdings to baskets of companies in the S&P 600 and in the Fund with similar Stdev of EPS to Trend values. The results are summarized below. Results We are looking for stocks with consistent earnings. The small-cap index, as represented by the S&P 600 Index, has fewer stocks with low earnings volatility than the large-cap index. But, when comparing stocks of similar, low earnings volatility, we found that small stocks are cheaper than large stocks on a price to earnings basis. The Fund has a similar allocation (by weight) to stocks with consistent earnings (low earnings volatility) as the large-cap index (S&P 500) and a larger allocation to stocks with consistent earnings than the small-cap index (S&P 600). When comparing like-for-like consistent earners (low earnings volatility stocks), our Fund's holdings are slightly cheaper than those in the small-cap index (S&P 600) and are considerably cheaper than those in the large-cap index (S&P 500). Let's start with the top decile of the S&P 500, the 10% of the large-cap stocks with the lowest earnings volatility (a Stdev of EPS to Trend of 12.3% or less). On a like-for-like basis, there are considerably less of these in the small-cap index (S&P 600) than there are in the large-cap index (S&P 500). This collection of S&P 500 constituents with low earnings volatility trades at 24.5x trailing earnings. But you can find a collection of similarly consistent earners at a significantly lower P/E in the small-cap universe - roughly 20x earnings for those in the S&P 600 and approximately 18x earnings for those in our portfolio.[12] * "Count" reflects the number of securities in each category divided by the total number of securities in the index/Fund as of Dec 31, 2023. Of course, we are only looking at four stocks in the Fund (i.e., Axos Financial, Graco, SAIC, and Fabrinet) that have a Stdev of EPS to Trend of 12.3% or less, so let's zoom out to include a wider universe. We get similar results when we expand to the top quintile (20%) of low earnings volatility stocks in the S&P 500 (a maximum Stdev of EPS to Trend of 13.8%). 13 Again, there are fewer low earnings volatility stocks in the S&P 600, but those stocks are cheaper. The Fund has six holdings that match the S&P 500's low earnings volatility threshold, coming close to the proportion in the S&P 500 on a weighted basis. But the Fund's holdings were a lot less expensive, trading at 18x trailing earnings versus 27x trailing earnings for those in the S&P 500. Results are similar when we expand the universe to include the top two quintiles (40%) of the S&P 500 sorted on earnings consistency (maximum Stdev of EPS to Trend of 20.1%). Microsoft, with a 7% weight in the S&P 500, is at the threshold and including it pushes the cumulative weight of this bucket up to 44%. 14 There are fewer small-cap stocks that meet this threshold, but the ones that do are cheaper. 35% of the Fund's equity holdings meet this threshold and collectively trade at roughly 16x trailing earnings compared to 25x trailing earnings for those in the S&P 500. The data above is meant to be illustrative. We are not quants, although we are numerical. We follow the numbers as far as we can take them, but no further. The data in this analysis are backward-looking. There is no guarantee that the trajectory of a company's earnings growth in the future will match its earnings growth in the past. But studies like this provide a useful starting point for sorting out the sprawl in our small-cap universe. We don't want to own the small-cap index and we don't recommend that for other investors either. We want to own a selective collection of quality small companies, at reasonable valuations, that we believe can be more valuable in three to five years. A complete list of FPA Queens Road Small Cap Value holdings and how they fared in this study can be found in the Appendix. Trailing Twelve Months (TTM) Contributors and Detractors Fabrinet (FN) is a contract manufacturer of optical communications components and modules. The company has a dominant position in hard-to-replicate precision-manufacturing technologies and an enviable track record of execution. The majority of Fabrinet's sales are to networking equipment manufacturers, but it has been successfully diversifying into the data center, industrial, auto, and medical end-markets. FN's stock jumped after reporting June 2023 earnings - datacenter sales increased 50% sequentially and more than 100% over the previous year, driven by their 800-gigabyte transceivers for Artificial Intelligence applications. The company also announced that Nvidia is a 10%+ customer. Fabrinet was a top-five holding in the Fund before its June 2023 earnings announcement. Since then, the stock has appreciated considerably and we have trimmed in keeping with our risk management policies. Given the growth in its forward earnings estimates, Fabrinet trades in line with its historical earnings multiples and remains a top five position for us. Sprouts Farmers Market (SFM) is a natural grocer with great merchandising and best-in-class gross margins. 19 The company has attractive returns on capital, great new store economics, and they are accelerating their unit growth from 12 stores a year to 35 stores in 2024 on a base of roughly 400 stores. Over the past year, the stock has performed well after reporting strong operating results and from a low initial valuation. 20 The stock price jumped when the company reported 2023Q4 results and gave strong 2024 guidance on February 22, 2024. We have maintained our position and allowed it to appreciate. Although SFM's share price has increased faster than bottom line results, we believe SFM still trades in the "range of reasonableness" for a high-quality, non- cyclical franchise that can reinvest capital at attractive rates of return. Deckers (DECK) is a footwear and apparel company that owns the UGG, Hoka, Teva, Sanuk, and Koolaburra brands. We think management has done a terrific job growing and extending the UGG franchise. Now they are replicating that success with Hoka running shoes, which surpassed $1 billion in sales in 2023. At over thirty times forward earnings (as of June 30, 2024), we have weighed Deckers' valuation against the quality of its management team, strong brands, and net cash balance sheet and have trimmed our position. We first bought a small position in Deckers in 2015 and 2016 when the company was struggling with supply chain issues. Its stock price has increased more than ten times since then because of excellent operating performance, and we have trimmed all the way up. Given the company's exceptional financial performance and growth, the stock trades on the higher side of our "range of reasonableness" and we have continued to trim accordingly. ServisFirst Bancshares (SFBS) is a conservatively run lending franchise helmed by Tom Broughton. Tom hires local bankers but doesn't build branches - this allows for best-in-class efficiency metrics while maintaining a strong and conservative lending culture. Return on equity (ROE) and average earnings per share growth were near 20% for the 10 years through 2022 - very attractive for a conservative, plain vanilla commercial lender. 21 SFBS's share price declined significantly with other regional banks in 2023 as rising rates put pressure on deposit pricing, NIMs (net interest margins), and ROE (return on equity). Shares are up since the depth of regional banking crisis, and during the Q1 2024 earnings call, management said that NIM is improving as loan growth re-accelerates and the asset side of their balance sheet reprices higher. TD Synnex (SNX) is an information technology distributor formed through the merger of Tech Data and Synnex in 2021. IT distribution is an attractive business model that grows at a GDP+ rate with the opportunity for margin improvement through selling more software and services, although with some cyclicality. The IT distributors have historically traded cheaply, usually at less than 10x earnings. 22 We have owned Synnex since 2012 and Tech Data from 2010 until it was taken private by Apollo in 2020. SNX has performed well on the back of a strengthening IT market, particularly for PCs. MasTec (MTZ) is a contractor that builds and repairs infrastructure for telecoms, electric utilities, oil and gas pipelines, and the clean energy industry. The company benefits from strong spending for 5G in telecom and government support (including the Infrastructure Investment and Jobs Act) for clean energy and the electrical grid. 23 The Mas brothers have an impressive history of rolling up smaller players and growing earnings, most recently in the electrical and clean energy spaces. However, we became uncomfortable with the low margins and competition in the electrical utility and clean energy businesses. On Aug 4, 2023, in its Q2 2023 earnings release, the company reduced guidance, and we began to exit our position, partially in Q3 2023 and fully by the end of Q4 2023. Darling Ingredients (DAR) is the world's largest rendering operation with about 17% of the global market and a higher share in the core U.S. market. 24 The business is one part industrial where scale and route density are big advantages - they collect unused animal waste from slaughterhouses and butchers, and one part commodity - their plants process this waste into fats, bone meal and ingredients that trade at prices set by the global commodity markets. Finally, DAR's Diamond Green Diesel joint venture with Valero turns animal fats into green energy - a business that benefits from renewables subsidies and tax credits. The company took on debt to make three large acquisitions in 2022, adding additional complexity as DAR integrates the acquisitions and de-levers. The stock has sold off because of weakness in DAR's commodity end markets, falling renewable identification number (RIN) prices, and lower earnings and guidance reported for the second and third quarters of 2023. 25 We first purchased Darling shares in 2008 and have watched as CEO Randy Stuewe has grown Darling from a minnow to a global behemoth. As of June 30, 2024, Darling trades at approximately 10x normal earnings and, despite the company's commodity exposure and organizational complexity, we are comfortable holding a mid-sized position. IAC is a holding company helmed by Barry Diller and Joey Levin. IAC's model is to incubate digital businesses and then spin them off tax free. Past spinoffs include Ticketmaster, Expedia, Tripadvisor and Match.com. IAC invests opportunistically and generally runs its businesses for growth, keeping margins low and minimizing taxes. IAC's current collection of businesses are eclectic, including DotDash Meredith (websites and magazines), Turo (AirBnB for cars), Care.com, Vivian (job board for registered nurses), and 20% and 84% of the publicly traded shares of MGM and ANGI respectively. We believe these pieces are worth significantly more in aggregate than IAC's share price and that management will work to maximize that value for shareholders. Arcadium Lithium (ALTM) is an integrated, low-cost, well-managed lithium producer formed by the merger of Livent, which the Fund owned, and Allkem in Australia. The merger was completed at the beginning of the year and we received, and decided to hold, shares of Arcadium. 26 The share price has declined because of volatile lithium prices that collapsed from bubbly levels at the beginning of 2023. 27 Estimates for electric vehicle production are slowing and capacity got ahead of demand; the industry is now waiting for a supply response.[28] Arcadium is an unusual investment for us. We normally avoid the commodity and materials sectors, and have kept our position in Arcadium small. But we believe Arcadium has a unique position in an industry with a strong long-term outlook. The company has low-cost production assets, is virtually debt-free, and has considerable capacity additions planned near-term. Vishay Intertechnology (VSH) is a manufacturer of discrete semiconductors and passive components, mostly for the general industrial and auto markets. Although the industry is cyclical, competitive dynamics are stable and VSH benefits from electric vehicles and industrial electrification. Vishay's products are similar to ball bearings but for a technological rather than a mechanical economy: high value-to-cost, and they go into nearly everything. Shares have followed operating performance that has drifted down from post-Covid highs following the industrial cycle and a slowdown in electric vehicle (EV) production. Management has an ambitious plan to grow capacity, sales, and margins. We are cautiously optimistic and have been incrementally adding to our position.[29] The Fund's cash position is a residual of the investment process. When we cannot find companies that meet our stringent criteria, we will allow cash to build. Over a long time horizon, we would prefer to own a diversified collection of quality companies (acquired at reasonable prices) instead of cash. But we weigh this objective against our reluctance to sacrifice a margin of safety and to risk the permanent impairment of capital. At quarter end, our cash position was 10.36%, within rounding of our 10% cap policy. We do not have a crystal ball or make short-term predictions on market direction. We work from the bottom up, looking for companies with long histories of success through diverse economic environments. Our focus on the Four Pillars - balance sheet, valuation, management and industry structure - lets us sleep well at night and gives us confidence that the Fund's holdings will be worth more in three-to-five years than they are today. As always, and as significant co-investors in the Fund, we appreciate your trust in us to be good stewards of your capital. If you would like to discuss performance or the Fund's portfolio holdings in greater detail, please let us know.

FMI Funds Q2 2024 Shareholder Letter

In the second quarter, the FMI International Funds fell 1.79% on a currency-hedged basis and 2.67% 4 currency unhedged, compared with the MSCI EAFE Index's advance of 1.00% in local currency and decline of 0.42% in US Dollars. Global stock markets were mixed in the second quarter, with U.S. Large Cap growth stocks continuing to march to their own beat, U.S. Small Cap stocks declining, and International stocks treading water. Economic growth in the U.S. has been resilient, while Europe and Japan have been softer. Inflation is stable, labor markets are easing (but still tight), and global trade is starting to rebound. Geopolitical risks remain high. Speculation is widespread with growth continuing to outperform value year-to-date across the board. Fortunately, one thing is always true about stock markets: trends don't last forever, and inflection points typically happen when investors least expect them. Our second quarter performance commentary is outlined below: In the second quarter, the FMI Common Stock Fund ("Common Stock Fund") declined by 4.01%, compared with a 3.28% and 3.64% drop for the Russell 2000 Index ("Russell 2000") and Russell 2000 Value Index ("Russell 2000 Value"), respectively. Relative to the Russell 2000, FMI's top-performing sectors included Electronic Technology, Retail Trade, and Technology Services, while Producer Manufacturing, Distribution Services, and Commercial Services each underperformed. Strong individual contributors included BJ's Wholesale Club Holdings Inc., Skechers U.S.A. Inc. - Cl A, and Fabrinet Inc., as Fortune Brands Innovations Inc. (BJ), Simpson Manufacturing Co. Inc. (SSD), and Henry Schein Inc. (HSIC) lagged the market. Small Cap stocks continue to fall behind their Large Cap counterparts thus far this year. In the second quarter, the FMI Large Cap Fund ("Large Cap Fund") lost 0.37%, compared with a 4.28% gain and a 2.20% decline for the S&P 500 Index (S&P 500) and iShares Russell 1000 Value ETF, respectively. Growth outperformed value by over 10% in the period, driven in large part by just a select few Mega Cap technology stocks. Relative to the S&P 500, sector performance was driven by Health Technology, Consumer Services, and Consumer Non-Durables, while the fund gave up ground in Electronic Technology, Retail Trade, and Distribution Services. Individual holdings Alphabet Inc. - Cl A (GOOG), Booking Holdings Inc. (BKNG), and Micron Technology Inc. (MU) outpaced the market, as CarMax Inc. (KMX), Masco Corp. (MAS), and Dollar Tree Inc. (DLTR) detracted. In the second quarter, the FMI International Funds ("International Funds") fell 1.79% on a currency hedged basis and 2.67% currency unhedged, compared with the MSCI EAFE Index's advance of 1.00% in local currency (LOC) and decline of 0.42% in U.S. Dollars (USD). The MSCI EAFE Value Index gained 1.46% in LOC and 0.01% in USD. Relative to the MSCI EAFE Index, the International Funds' Consumer Services, Consumer Non-Durables, and Health Technology sector exposures were a tailwind for performance, while Retail Trade, Distribution Services, and Transportation weighed on the results. Koninklijke Philips N.V. (PHG), Unilever PLC (UL), and DBS Group Holdings Ltd. (OTCPK:DBSDF) performed well in the quarter, while B&M European Value Retail S.A. (OTCPK:BMRRY), Ferguson PLC (FERG), and Ryanair Holdings PLC (RYAAY) - SP - ADR failed to keep pace. USD strength was additive for the currency hedged portfolio. In the U.S., the Large Cap universe continues to be dominated by just a handful of anointed stocks. Today's concentration of the S&P 500 is unprecedented. The top 10 stocks make up 37% of the iShares S&P 500 ETF. For comparison, at the peak of the 2000 tech bubble, the top 10 accounted for about 25% of the index. Performance of the S&P 500 this year has been similarly lopsided. Of the 15.29% year-to date return for the S&P 500, an astounding 30% has come from Nvidia (NVDA) alone, with 58% from Nvidia, Microsoft (MSFT), Meta Platforms (META), Amazon (AMZN), and Alphabet. The S&P 500 Equal-Weighted Index trails the S&P 500 (market-capitalization-weighted) by 10.21% this year, after losing by 12.42% last year, further illustrating the lack of breadth in the market. Historically, extremely narrow markets have been a harbinger of tougher stock markets to come. This time may be no different. We marvel at the unwavering euphoria encompassing Nvidia's stock. In under 30 trading days ending June 18, 2024, Nvidia added $1.1 trillion to its market cap. In the 6 months prior, it added over $2.0 trillion, larger than the entire market cap of Amazon! Nvidia briefly became the world's most highly valued company, worth as much as $3.3 trillion, exceeding the value of the entire UK, German, and Canadian stock markets, respectively. Nvidia is a key beneficiary of the generative artificial intelligence craze, selling expensive AI chips into data centers, with over a 70% market share. Large cloud computing providers such as Microsoft, Amazon, and Google account for almost half of Nvidia's data center revenue. Over the long-term, Nvidia's rapid growth and high margins will attract increased competition, including from some of their biggest customers, which may weigh on future growth rates and returns. Expectations are high, as Wall Street currently projects Nvidia's sales to increase at nearly 7-fold over the five years from 2022 through 2027, with earnings per share growing 14-fold. At a valuation of 39 times sales and 69 times trailing earnings, the margin for error is narrow. While we certainly acknowledge the vast possibilities of generative AI, and we remain in observation mode, it appears that the hype is at a fever pitch. Sequoia Capital, one of Silicon Valley's biggest start-up investors, warns of an "AI bubble" and "speculative frenzies." On an annual run-rate basis, Sequoia estimates that there is over $180 billion of data center AI spend as of the first quarter of 2024, increasing to a whopping $300 billion by year-end. There is little AI revenue to show for all this spend, with OpenAI thought to have the lion's share of generative AI revenue today, at only $3.4 billion. Sequoia estimates $600 billion of revenue would be required annually to payback the projected spending levels. We have yet to see blockbuster products get launched (admittedly, it is still early days), but the buzz reminds us of driverless cars and the metaverse in recent years. Both have come up well short of very lofty initial expectations. Another thing to consider is that the cost to run generative AI queries is extremely high, as the power requirements are substantial. Eventually, this will get factored into revenue and profit models. If companies do not ultimately see adequate sales, productivity, earnings, and returns on capital from their investments, AI expenditures should slow. Only time can tell. Unfortunately, the speculative fervor is not confined to Nvidia, AI, and Mega Cap technology. Other top-performing themes in the U.S. include Bitcoin sensitive equities, obesity drugs, and high-beta 12-month winners (i.e., momentum stocks), according to Goldman Sachs. On May 16, penny stocks also captured investor imaginations, as it was reported that 45% of the total market volume traded was in less than $1 stocks, which compares to a year-to-date average of ~12%. Additionally, meme stocks are back in vogue, with low-quality GameStop (GME) up 97% over the last three months on the heels of an endorsement from social media investment influencer "Roaring Kitty" (no, this is not a joke). GameStop currently has a market cap of$10.2 billion, yet lost money from 2019-23, with projected sales in 2024 at about half of where they were in 2017. Clearly, business fundamentals are not driving the story. Complacent, risk-seeking behavior can also be found in the spread between the S&P 500 earnings yield (earnings/price) versus the 2-year Treasury bond yield (risk-free yield). For the first time in over 20 years (since the 2000 tech bubble), the spread has turned negative, suggesting that investors are no longer requiring a sizeable risk premium (i.e., higher earnings yield) for investing in equities vs. risk-free bonds. The current reading of -0.8% is over two standard deviations below the long-term average spread of 3.9%. Lastly, with growth stocks sucking the air out of the room, it was not surprising to read that "Investors poured a net $8.7 billion into U.S. tech funds over the seven days through Tuesday [June 18, 2024] per data from EPFR, the largest weekly inflow on record. Growth-oriented mutual funds attracted upwards of $10 billion over the same stretch, likewise its most bountiful week since at least 2017," according to Almost Daily Grant's. When the good times are rolling, investors rarely contemplate whether the music will stop. Aggressive buying near the top is all but guaranteed. These recent fund flows remind us of three famous Warren Buffett quotes, all of which may prove valuable as the current cycle unfolds: Greed is running rampant as the herd rushes into today's popular trades. All roads appear to lead to technology and growth stocks ... until they don't. Eventually, this cycle, too, shall pass. Our focus on quality has really paid off in recent years. A 15-year period of interest rate suppression induced a massive wave of M&A, significantly shrinking the number of quality Small Cap companies. The Russell 2000 has been left with over 40% of its constituents losing money. As illustrated in the chart below, quality companies (high return on capital employed, or ROCE) in the Russell 2000 win over the long term. While lower-quality stocks have outperformed from time to time (most notably in 1999, 2003, 2009, and 2020), the duration is typically short-lived. When looking for a combination of quality and liquidity, we estimate that only about 20% of the Russell 2000 both make money and are liquid, so buying quality in the current environment has become more challenging. As a result, FMI and many of our peers that also focus on quality, have been investing in modestly higher market capitalizations. By simply expanding the investable universe to the Russell 2500, for example, it roughly doubles the number of profitable, liquid companies. As illustrated below, during the current cycle, U.S. Small Cap stocks have underperformed their Large Cap counterparts for the longest stretch (158 months) and largest spread (-219.4%) on record. Some of this gap is warranted, as rising interest rates and wages have negatively impacted Small Cap companies more (a higher percentage of floating rate debt, shorter debt maturities, and more labor-intensive businesses). Additionally, the quality of the Small Cap universe has deteriorated in recent years, as mentioned above. Even with these stark realities, the current valuation spread is still very wide by historical standards. Profitable Small Cap companies now trade near the lowest level to profitable Large Cap companies in over 20 years. If history is any indication, there will be brighter days ahead for Small Cap. The Japanese stock market is off to a blistering start this year, with the Nikkei 225 up 19.30%, outpacing even the tech-driven S&P 500. This has been a meaningful headwind for our International Funds' relative performance, given that we have a 16% underweight in Japanese stocks vs. MSCI EAFE. Gains in Japanese equities have been boosted by positive sentiment around improving corporate governance (which we view as modest and incremental in nature), the exit from a deflationary spiral, and profit tailwinds for exporters that are benefiting from a collapse of the Japanese yen (weakest vs. USD since 1986). We question whether the Japanese market has gotten a bit ahead of itself, as Japan now trades at a healthy premium to Europe. After its recent run, the Nikkei 225 trades at around 20 times next twelve months price-to-earnings versus the STOXX 600 at 14 times, despite having a significantly lower return profile. The return on equity (ROE) for the Nikkei 225 stands at 8.3% versus the STOXX 600 at 11.7%, according to Bloomberg. It's also worth mentioning that over 50% of the Nikkei 225's revenue is generated in Japan, where they have an aging and shrinking population, extremely low average birth rates (1.2), the developed world's largest government debt load, and expectations for slower GDP growth than Europe in the coming years. Japan's GDP declined 2.9% in the first quarter of 2024, amid sluggish consumption. We question the level of enthusiasm for the Japanese equity market and have yet to see many compelling bottom-up fundamental opportunities. We will continue to actively research new candidates in Japan but remain prudent. As described above, the speculative backdrop across today's global markets is extreme, with growth beating value handily. Over short periods of time, stock markets can reward stocks, sectors, and even countries regardless of the underlying fundamentals. When a stock or theme has momentum, people are quick to jump on the bandwagon. As investors capitulate and have all but given up on value, it makes us even more excited about the future and optimistic it will be back on top before long. Listed below are a few portfolio investments where the long-term prospects are compelling: Henry Schein is the largest dental distributor in the world, holding a leading market share position in all of its main geographies, and is also a leader in medical distribution. Henry Schein provides value to both product manufacturers and its customers. Manufacturers benefit from cost-effective access to a highly fragmented customer base, as well as sales and marketing support for products. Practitioner customers benefit from timely access to a broad range of products, a reduction in the number of vendors they need to deal with directly, inventory management services, and equipment servicing. Henry Schein also sells practice management software that is used by ~40% of dental practices in the U.S., which is a very sticky business. We expect continued strong long-term growth in spending on dental services, which will be driven by an aging population, along with a focus on preventive care and demand for cosmetic dentistry procedures. Schein's stock has been under pressure in the near term because it is still recovering from a cyber-attack that took place late last year, and the macro backdrop continues to be challenged, which has led to muted elective/discretionary sales across the business. The stock is trading well below the market, which we view as attractive given its above-average business quality. Quest Diagnostics is one of the largest independent clinical laboratory testing companies in the U.S. with a 24% market share of independent lab testing, and its scale gives it a cost advantage. The clinical testing industry sees steady volume growth, helped by increasing test volume due to an aging population, higher prevalence of chronic disease, and advancements in medical technology that continue to expand the scope of clinical testing. The broader lab industry is an $85 billion market, accounting for only 2% of total healthcare spending, yet influencing over 70% of medical decisions. Today, nearly 60% of diagnostic tests are performed in a hospital or at a hospital outreach laboratory. Importantly, performing the same diagnostic test at an independent lab can cost anywhere between two and five times less than performing the same test in a hospital lab. Quest's average revenue per requisition is under $50. There is a nationwide focus on increasing preventative healthcare and lowering healthcare costs in general. Independent labs are part of the solution, as there is a huge value to be reaped by pushing more volumes through them. In the past, Quest has seen reimbursement challenges from both government and commercial payors. We believe that reimbursement headwinds have largely abated due to all payors recognizing the large cost-benefit of higher volumes flowing through the independent labs. We expect Quest to generate mid-single-digit topline growth and expand margins, leading to high- single-digit earnings growth. With Quest's dividend and share repurchases, there are prospects for a low-double-digit total annual return, which is attractive given the defensive nature of the business and well-below market valuation. Ryanair is Europe's largest airline by passenger volume (~20% market share). It employs a very simple, yet unique business model. It flies only point-to-point, books flights almost solely through its website/app, heavily utilizes secondary airports, flies a single-variant fleet, and has a widespread geographic distribution (40 countries and 96 bases), which helps mitigate the impact of strikes or unfavorable regulations that occur in a single geography. Ryanair is one of the only international airlines to post high growth and stellar returns through a full cycle, owing mostly to the company's obsessive focus around efficiency and agility. Ryanair has created a deep cost advantage that allows it to price fares at levels that would be unprofitable for the vast majority of peers, leading to continued market share gains. The current industry setup is favorable, as the European in-service short-haul fleet is in short supply. Elevated storage rates are unlikely to revert due to aircraft age and restoration costs. Additionally, there are supply chain challenges and large backlogs that are limiting the pace of delivery of new planes. Ryanair's mid-single-digit capacity growth is locked in through 2034. Recently, its fares have been a bit softer than expected due to a weak consumer in Europe, and capacity hasn't expanded as quickly as expected due to Boeing delivery delays. We view both issues as transitory in nature. Valuation is well below historical averages and is likely to recover over a 3-5 year time horizon. Thank you for your continued support of Fiduciary Management, Inc.

RiverPark Long/Short Opportunity Fund Q2 2024 Letter

Expense Ratio: Institutional: 1.89% gross and 1.85% net, Retail: 2.14% gross and 2.00% net as of the most recent prospectus, dated January 26, 2024. Gross Expense Ratio does not reflect the ability of the adviser to recover all or a portion of prior waivers, which would result in higher expenses for the investor. Please reference the prospectus for additional information. The RiverPark Long/Short Opportunity Fund (the "Fund") returned 3.43% in the second quarter, versus the S&P 500 Total Return Index, which returned 4.28%. Stock markets generally followed inflation expectations in the second quarter. April was a difficult month for equities in reaction to persistently high inflation readings. May and June saw a reversal in this trend with inflation numbers decelerating, and stocks rallied. We expect to see a similar tug of war in the second half of the year between inflation readings and economic growth numbers, with small periods of high volatility but no clear overall direction. In the meantime, we are optimistic about the growth prospects and valuations of the companies in our long portfolio and believe our short portfolio should provide good protection in a market sell off. Overall, our shorts contributed 0.99% versus our long contribution of 2.97%. Our biggest contributors in the short book were a sector hedge, iShares Expanded Tech-Software Sector ETF (IGV), and several individual names, including Surgery Partners (SGRY) and CarMax (KMX). In the short book, we continue to focus on businesses that we believe are losing competitive market share, that have business models we believe are flawed or are facing cyclical headwinds (including unprofitable technology, subscale internet media, residential real estate, cyclical industrial and consumer lending). We started the second quarter 92.74% long, 22.26% short, and 70.47% net. We ended the quarter with slightly less gross exposure and more net exposure at 94.25% long, 18.13% short, and 76.11% net. Below we describe some of our top and bottom performers. Portfolio Review Top Contributors Nvidia: NVDA shares were our top contributor in the quarter following blowout 1Q results and guidance driven by strong data center sales (+427% year-over-year). The company reported revenue of $26 billion, up 262% year-over-year, and EPS of $6.12, up 462% year-over-year and 9% ahead of expectations. Revenue guidance for 2Q of $28 billion was 5% above very high expectations. The artificial intelligence arms race kicked-off by ChatGPT and Alphabet's Bard, among others, has generated tremendous demand for Nvidia's next generation graphic processors. NVDA is the leading designer of graphics processing units (GPU's) required for powerful computer processing. Over the past 20 years, the company has evolved through innovation and adaptation from a predominantly gaming-focused chip vendor to one of the largest semiconductor/software vendors in the world. Over the past decade, the company has grown revenue at a compound annual rate of over 20% while expanding operating margins and, through its asset light business model, producing ever increasing amounts of free cash flow. Following recent results, Jensen Huang, founder and CEO of Nvidia stated in the company's press release, "a trillion dollars of installed global data center infrastructure will transition from general purpose to accelerated computing as companies race to apply generative AI into every product, service and business process." Alphabet (GOOG,GOOGL): GOOG was a top contributor in the second quarter following strong first quarter earnings driven by better-than-expected Search and YouTube revenues and a reacceleration in the company's Cloud business. AI advances helped improve targeting and measurement in the company's advertising businesses, including in YouTube's fast growing Shorts segment. Google Search revenue was $46 billion, YouTube revenue was $8 billion, and Cloud revenue was $10 billion, 3%, 5% and 2% better than expected respectively. Margins in both operating segments, Services and Cloud, were also ahead of expectations leading to $1.89 of EPS, 25% higher than estimates. With its high margin business model (42% EBITDA margins last quarter), continued strength across its core Search and YouTube franchises, and continued growth and expanding profitability in its still relatively small Cloud business, we continue to view Alphabet as among the best-positioned secular growth franchises in the market. Additionally, GOOG shares trade at a compelling 19x the Street's 2025 EPS estimate, a discount to the Russell 1000 Growth Index. Apple (AAPL): Apple shares were a top contributor in the quarter after a difficult start to the year. The stock was down nearly 11% in the first quarter, driven by factors we discussed in last quarter's update, including an antitrust case, an Apple Watch patent dispute, and slowing China iPhone sales. Ultimately the company's fiscal 2Q24 earnings report delivered a slightly better than expected quarter on both the top and bottom lines and guidance that was also better than investor expectations. Better 2Q24 revenue and gross margins were driven by stronger than expected Services revenues, which grew 14% year-over-year, continuing a multi-quarter trend of accelerating growth. Gross margins of 46.6% expanded from last quarter's decade high of 45.9%. Guidance of $90 billion of revenue for 3Q24 was roughly in line with published expectations, reassuring investors. The stock also got a boost from research reports suggesting that iPhone sales may see a boost from an upgrade cycle driven by the upcoming rollout of Apple's AI assistant. Although near-term trends are a bit muted, Apple is carrying lean inventory into an iPhone refresh cycle later this year and easing comps in the rest of its portfolio. With an installed base of 2.2 billion active devices and significant growth in the company's recurring revenue Services segment, we believe that Apple remains one of the most innovative, best positioned and most profitable companies in the mobile technology industry. Disney (DIS): DIS was the top detractor in the quarter following a mixed earnings report, with operating income, EPS, and free cash flow all roughly in line, but weakness in segment revenue and operating income. The Entertainment segment saw slightly weaker than expected revenue and operating income due to lighter Content Sales and Licensing partially offset by stronger Linear Networks and Direct-to-Consumer ('DTC'). The DTC business grew, with Disney+ Core adding more subscribers than expected (+6.3m v +5.8m) and generated $47 million of operating income versus expectations of breakeven. The Sports segment generated revenue below expectations, but operating income was better than expected, both driven by ESPN. The Experiences segment beat both revenue and operating income expectations on the back of strong international parks results, price increases at Walt Disney World and cruises, but Disneyland unexpectedly had negative growth in the quarter. In addition, guidance for slightly weaker Experiences revenue and operating income growth as visitor growth normalizes post-Covid also weighed on the stock. DIS is blessed with a deep library of unique content that includes both live sports (providing large, non-time shifted audiences) and incomparable brands, including Disney, Marvel, Pixar and Lucasfilm, as well as the ABC network, which make it among the best-positioned media companies in the new landscape to combine multi-channel and DTC distribution. In addition, its theme park, cruise and theatrical businesses continue to be generational rites of passages for children and young adults around the world. We think CEO Bob Iger is doing a steady job rationalizing investments in each of the company's segments, which should lead to higher and more consistent profitability at the theme parks, better value realization in the linear assets, and consolidation of the company's DTC assets leading to higher profitability sooner. We therefore expect DIS to grow its free cash flow significantly over the next 3-4 years, from its depressed $1 billion in 2022, to more than double 2023's $4.9 billion, exceeding its previous $10 billion peak in 2018. Adyen (OTCPK:ADYEY): ADYEN was a top detractor in the quarter following a 1Q24 trading update that included higher than expected volumes (+46% year-over year growth versus 37% expected), but with lower-than-expected take rates (147 basis points versus 155 basis points). This resulted in revenue that was slightly below consensus estimates. Payment volume growth was strong across all segments with digital leading the way at +51%. The 3-basis-point decline in take rate was attributed to existing customers growing rapidly and hitting price reduction tiers. We believe that volume growth is more important than near-term take rate movements. The company operates a global payments platform, integrating the full payments stack to serve modern global merchants. Unlike many of its legacy peers, Adyen's roots are in technology designed specifically for multi-platform sellers. The company's platform was fully built in-house on a single code base and operates as a single, integrated end-to-end network, giving it an advantage over competitors that have separate platforms for gateway, risk management, processing, issuing, acquiring and settlement. The company's single platform also allows its merchant customers to use one payment service provider globally across all commerce channels (in-store, on the web, and on mobile devices), providing them lower payment costs, a single back end, a single contract and better visibility of end customers. We believe that the transition to next-generation, single-provider, omni-channel payment processing is in its infancy, and we believe the company will continue to take market share against its competitors. The company should have healthy revenue growth in the coming quarters as it rolls out more products and features, and we expect margins to expand as it leverages its fixed cost infrastructure. Five9 (FIVN): FIVN was a top detractor in the quarter after reporting better-than-expected first quarter earnings accompanied by revenue guidance for the second quarter that was slightly below expectations. The 2Q24 shortfall is related to the pace at which some large deals will realize revenue through the year, while the company kept its full year 2024 guidance the same. FIVN reported $247 million of revenue, 13% year-over-year revenue growth and $7 million higher than estimates, and $0.48 of EPS, 17% growth and $0.10 better than estimates. Five9 is a leader in providing cloud-based software to contact centers. The company's suite of applications provides contact center agents with a unified communication platform (voice, email, text, chat, web, social) and a desktop of tools to help agents engage customers more quickly and effectively. FIVN is well-positioned as contact centers transition to the cloud and has high customer retention (112% net revenue retention last quarter). The company doubled its strategic sales team over the past year and signed new partnerships with AT&T, CDW and Microsoft. We believe the company can grow its top line in the high teens, while improving on its 1Q 61% gross margin and 11% operating income margin, leading to 20%+ EPS growth for the foreseeable future. Below is a list of our top ten long holdings as of the end of the quarter: Below is a list of the key secular themes represented on both sides of our portfolio as of the end of the quarter. We continue to believe that our secular-themed long/short portfolio is well positioned to generate strong absolute and relative performance in the years to come. We will continue to keep you apprised of our process and portfolio holdings in these letters each quarter. As always, please do not hesitate to contact us if you have any questions or comments about anything we have written or about any of our funds. We thank you for your interest in the RiverPark Long/Short Opportunity Fund.

Diamond Hill International Fund Q2 2024 Market Commentary

Our portfolio's underperformance compared to the MSCI ACWI ex-US Index in Q2 can be attributed to a mix of factors as there was not one common theme that drove performance. International equity returns were mixed in Q2 2024, with some market segments posting strong returns while others were weaker. The best-performing stocks came from areas that could benefit from the growth of artificial intelligence or country markets with a combination of low valuations and improving economic data. There were many notable elections in Q2, and the results of several drove local equity markets' performance depending on the perceived market- friendliness of the winning candidate or party. Additionally, some countries experienced stagnating economic recoveries or restrictive central bank policies that caused weakness. The return of the MSCI ACWI ex-US Index was slightly positive in the quarter, up 0.96%. From a regional perspective, Asia Pacific ex-Japan had the most positive return in the quarter, driven by China, India and companies in the semiconductor supply chain. Japan lagged the return of the international benchmark as higher interest rates and currency weakness weighed on US dollar returns. The performance of European equity markets was mixed. The United Kingdom was positive due to attractive valuations and an improving economic picture. France was a notable laggard as stagnating economic growth and surprising results in European Parliamentary elections caused concern. As has been expected for several months, monetary policy among major central banks diverged in Q2 as the European Central Bank cut rates while the Bank of England and the Federal Reserve held. Further, Fed chair Jerome Powell maintained his position that US rates are likely to remain higher for longer, signaling that there is expected to be only one rate cut before the end of the calendar year. Given the US's economic resilience -- exemplified by resilient employment numbers -- and inflation's ongoing stickiness, Powell's commitment is not particularly surprising. What naturally remains to be seen is how durable the economic data prove to be in the coming months. Meanwhile, in the wake of finally exiting its protracted negative interest-rate regime, the Japanese Central Bank (JCB) faces ongoing challenges maintaining the yen's value, which has continued sliding relative to the dollar as US interest rates remain high. Though inflation in Japan has finally ticked up, which should give the JCB room to contemplate rate hikes, domestic consumer sentiment has been fragile as a weak yen has translated into high import and fuel costs. The JCB undoubtedly faces a delicate balancing act in the months and quarters ahead as it seeks to finally end decades of economic malaise. Similarly, the ongoing global monetary policy and macroeconomic mix continues complicating the picture for a Chinese government which is seeking to boost its economy while facing growing trade tensions with Western countries -- especially the US and the European Union, both of which have been ratcheting up restrictions related to electric vehicles and technology more broadly. Positively, Chinese GDP grew 5.3% year over year in Q1 -- beating expectations and incrementally better than Q4's 5.2%. However, much of the growth has been attributable to the economy's supply side, which the government has provided ample support, while the demand side and the country's consumers continue struggling to recover from a deep real estate crisis that has crimped wealth and led many to cut back on spending. It's been hard to miss the recent performance of AI-related stocks -- which has contributed to an increasingly narrow market in the US and has also driven some of the best performing areas of international markets, albeit without the concentration of US indices. We will be selective in how or if we add exposure to this area and strictly adhere to our time-tested, fundamental approach to identifying high-quality, underappreciated companies. Our portfolio's underperformance compared to the MSCI ACWI ex-US Index in Q2 can be attributed to a mix of factors as there was not one common theme that drove performance. From a country perspective, relative weakness came from holdings in the United Kingdom and Netherlands, while relative strength came from holdings in France and Belgium. Regarding sectors, our holdings in industrials and energy were a source of relative weakness. Sectors with the most positive relative contribution were communication services and consumer discretionary. On an individual holdings basis, the most significant negative contributors were Evotec (EVO), Walmex and Mitsubishi Corp. (OTCPK:MSBHF). Evotec is a Germany-based drug research, discovery and manufacturing services company. Evetoc underperformed in the quarter after lowering short-term profit expectations amidst continued weakness in the biotech funding environment. Despite the share price weakness in the quarter, we remain confident in our thesis that the current share price does not reflect the value of Evotec's multiple business lines. Additionally, the company is a leader in using AI in drug discovery, which could create additional upside for the stock. Share price weakness in Mexican retailer Walmex in Q2 was primarily due to the results of elections in Mexico, which were broadly seen as unfavorable for Mexican consumers. Despite negative perception about the new administration's impact on Mexican consumption, we continue to believe the long-term setup for Walmex's business remains attractive. Its position as the largest retailer in Mexico allows the company to use its scale to gain market share from smaller, less sophisticated competition. Additionally, the Mexican economy is well-positioned over the long term to take advantage of the nearshoring of supply chains to the US. Mitsubishi is a multinational Japanese trading company with operations spanning various industries. The company has seen strong share price performance year-to-date but issued guidance slightly below estimates for the remainder of the year, which weighed on performance. The Japanese yen was also weak in the quarter, hurting returns for dollar-based investors. We continue to believe our thesis of improving asset efficiency and better capital allocation remains underappreciated in the stock. Also, the weakness in the yen is an incremental positive for the company, given that a significant portion of its revenues are generated outside of Japan. Our top contributors in Q2 were Taiwan Semiconductor (TSM), Spotify (SPOT) and Tencent (OTCPK:TCEHY). Taiwan Semiconductor is the largest microchip fabrication company in the world. The company has substantial competitive advantages in digital chip manufacturing and possesses a broad portfolio of semiconductor processes serving various end markets. Shares of Taiwan Semiconductor outperformed due to strong financial performance and increasing optimism about the growth of AI. We continue to believe the quality of the business and growth of artificial intelligence and 5G smartphones is not fully reflected in the share price. Additionally, while we acknowledge the geopolitical concerns associated with a Tawain-based company, we believe the stock's valuation is attractive relative to other AI-exposed companies around the world. Spotify is a Swedish-headquartered global online streaming service and marketplace platform that distributes primarily audio content. Users sign up for an ad-supported or paid monthly subscription and get access to the company's industry-leading content library, which includes songs, podcasts and audiobooks. Positive performance was driven by an announcement of price increases in its core markets and a new tiered pricing structure that should allow further monetization of its user base and better margins over the long term. Tencent Holdings provides various internet, mobile and communication services in China. The company owns dominant ecosystems in messaging (WeChat), social networking (QQ and Qzone), payment services, gaming (the #1 global online gaming company) and a mobile app store. After weakness in its gaming business in the recent past, the company reported better-than-expected results and gave more promising forward guidance, which suggests gaming recovery is in sight. We continue to believe Tencent's ability to monetize this large installed user base over the long term is not reflected in the current stock price. While the MSCI ACWI ex-US Index was positive for the third consecutive quarter, and valuations have increased in some parts of the world, we continue to find stocks at attractive prices relative to the intrinsic value of their business. In Q2 2024, we added four new positions while exiting six positions. We initiated positions in CNH Industrial (CNH), Whitehaven Coal (OTCPK:WHITF), Arvind and Gerresheimer (OTCPK:GRRMF). CNH Industrial is a global capital goods company headquartered in the United Kingdom. The company specializes in equipment and services for the agriculture and construction industries. CNH is most known through its brands, Case and New Holland. In 2022, the company underwent a restructuring when it sold off its commercial and power train business to focus on its core competencies. The current management team has a solid execution track record and has embarked on a turnaround plan to improve distribution and operational inefficiencies that plagued the company over the last decade. Additionally, the stock is priced at a significant discount to peers and the cumulative value of its underlying businesses. Whitehaven Coal is an Australian coal mining company. Whitehaven owns and operates thermal and metallurgical coal (met coal) mines throughout Australia, concentrating on the highest quality types of coal. Historically, the company has focused on thermal coal, but recently acquired assets are expected to transform the company's revenue base into mostly met coal. After liabilities for the acquisition are paid off over the next three years, the company will have a significant increase in free cash flow that is not reflected in the current stock price. Demand for coal, specifically from Southeast Asia, will likely be stable or increase going forward. Conversely, the supply of new coal mines is expected to remain stable or decrease over the long term, creating a favorable demand/supply imbalance. We initiated a position in the stock given the favorable demand/supply conditions in coal and the deep discount to the stock's intrinsic value. Arvind is an Indian textile manufacturer specializing in producing fabrics and garments. Currently, most company revenues are derived from manufacturing fabrics for global clothing brands, which are then exported to other countries to assemble finished garments. However, the company has shifted its focus to its own finished garments business and Advanced Materials Division (AMD), which are less capital-intensive and more profitable than the fabrics business. As global brands focus on vertically integrated supply chains less dependent on one country, Arvind's location and ability to produce fabrics and finished garments will benefit. Additionally, Arvind has exclusive licenses from global chemical companies for compounds used in producing specialized professional uniforms such as firefighting suits, construction apparel and military uniforms. These licenses, plus a cost advantage relative to competitors in AMD, give us confidence that Arvind is well-positioned to grow this business over the long term. Hence, we initiated a position in the stock as the current valuation does not reflect the business mix shift to less capital-intensive and higher-margin areas. Gerresheimer is a German health care company specializing in pharmaceutical packaging. The company produces vials, syringes, pens, injectors and plastics to deliver therapies to patients. Pharmaceutical packing is designed and implemented during the early stages of drug development and accompanies drugs throughout the approval process. Hence, high-quality, consistent packaging is critical to drug development and approval. Gerresheimer has exposure to some of the fastest-growing pharmaceutical categories, such as biologics, biosimilars and GLP-1s. Additionally, the company has made significant investments in premium products and services, which should improve its margins. We initiated a position in the stock as we believe improving growth and profitability are not yet reflected in the current price. Pertaining to sales in the quarter, we exited two positions -- Check Point Technologies and Formento Economico Mexicano (FEMSA) -- after the stocks approached or surpassed our estimates of intrinsic value. Additionally, we exited Vitesco Technologies as Schaeffler Group, a German automotive parts company, finalized its acquisition of the company at a premium to its pre-acquisition announcement share price. Late in the quarter, we sold our shares in three other companies -- Astellas Pharma, Energy Recovery and Diageo -- primarily to realize tax losses and to fund higher conviction opportunities. 2024 is shaping up to be a pivotal year marked by significant disruptions across various sectors and countries, presenting challenges and opportunities for investors. AI advancements, particularly in the US, are creating substantial buzz. International companies essential in providing the necessary tools and hardware, especially chip makers, are poised to benefit immensely. The ripple effects of this AI revolution include a massive investment cycle and a potential global materials shortage due to skyrocketing demand. The pharmaceutical sector appears to have made significant strides in addressing obesity. This breakthrough will likely have far-reaching implications across the health care value chain, and global consumer staple companies may see considerable impacts as consumer health dynamics shift. The auto industry is undergoing a massive transformation, primarily driven by the transition to electric vehicles (EVs) and the rise of Chinese automakers. The industry's strategic importance to global markets cannot be overstated, and the upcoming years are expected to be highly competitive, described by Stellantis' CEO as "Darwinian." This sector's disruption is likely to have significant geopolitical and trade implications. Elections, central bank policies and geopolitics have already had significant impacts worldwide in 2024, which will likely continue in the year's second half. Elections in India, Mexico and Taiwan were notable, and markets quickly digested the results. The year's second half will see significant elections in the UK, France and the US. While forecasting an election's outcome is difficult, investors can be sure, they are unpredictable and create opportunities for long-term investors. Various factors influence central bank policy, and we have seen a mix of stimulative and restrictive policies worldwide. The Bank of Japan raised rates for the first time in 17 years, while the People's Bank of China was stimulative to boost growth. Many major developed markets' central banks must now weigh cutting rates to stimulate their economic growth versus the risk of easing policy too quickly, which increases inflationary pressures. Lastly, geopolitical pressures remain high, with two significant conflicts continuing in Europe and the Middle East. In either case, a resolution or easing of tensions will likely be positive for equity markets. In conclusion, 2024's landscape of disruption offers a rich terrain for long-term, value-oriented investors. Our primary focus remains maintaining our long-term perspective, valuing businesses on their future cash flows and generating better-than-market returns over the next five years through active portfolio management.

RiverPark Long/Short Opportunity Fund Q2 2024 Portfolio Review

Portfolio had more net exposure at the end of the quarter.Top contributors included Nvidia, Alphabet, and Apple.Top detractors were Disney, Adyen, and Five9. We started the second quarter 92.74% long, 22.26% short, and 70.47% net. We ended the quarter with slightly less gross exposure and more net exposure at 94.25% long, 18.13% short, and 76.11% net. Below we describe some of our top and bottom performers. Nvidia: NVDA shares were our top contributor in the quarter following blowout 1Q results and guidance driven by strong data center sales (+427% year-over-year). The company reported revenue of $26 billion, up 262% year-over-year, and EPS of $6.12, up 462% year-over-year and 9% ahead of expectations. Revenue guidance for 2Q of $28 billion was 5% above very high expectations. The artificial intelligence arms race kicked-off by ChatGPT and Alphabet's Bard, among others, has generated tremendous demand for Nvidia's next generation graphic processors. NVDA is the leading designer of graphics processing units (GPU's) required for powerful computer processing. Over the past 20 years, the company has evolved through innovation and adaptation from a predominantly gaming-focused chip vendor to one of the largest semiconductor/software vendors in the world. Over the past decade, the company has grown revenue at a compound annual rate of over 20% while expanding operating margins and, through its asset light business model, producing ever increasing amounts of free cash flow. Following recent results, Jensen Huang, founder and CEO of Nvidia stated in the company's press release, "a trillion dollars of installed global data center infrastructure will transition from general purpose to accelerated computing as companies race to apply generative AI into every product, service and business process." Alphabet (GOOG,GOOGL): GOOG was a top contributor in the second quarter following strong first quarter earnings driven by better-than-expected Search and YouTube revenues and a reacceleration in the company's Cloud business. AI advances helped improve targeting and measurement in the company's advertising businesses, including in YouTube's fast growing Shorts segment. Google Search revenue was $46 billion, YouTube revenue was $8 billion, and Cloud revenue was $10 billion, 3%, 5% and 2% better than expected respectively. Margins in both operating segments, Services and Cloud, were also ahead of expectations leading to $1.89 of EPS, 25% higher than estimates. With its high margin business model (42% EBITDA margins last quarter), continued strength across its core Search and YouTube franchises, and continued growth and expanding profitability in its still relatively small Cloud business, we continue to view Alphabet as among the best-positioned secular growth franchises in the market. Additionally, GOOG shares trade at a compelling 19x the Street's 2025 EPS estimate, a discount to the Russell 1000 Growth Index. Apple (AAPL): Apple shares were a top contributor in the quarter after a difficult start to the year. The stock was down nearly 11% in the first quarter, driven by factors we discussed in last quarter's update, including an antitrust case, an Apple Watch patent dispute, and slowing China iPhone sales. Ultimately the company's fiscal 2Q24 earnings report delivered a slightly better than expected quarter on both the top and bottom lines and guidance that was also better than investor expectations. Better 2Q24 revenue and gross margins were driven by stronger than expected Services revenues, which grew 14% year-over-year, continuing a multi-quarter trend of accelerating growth. Gross margins of 46.6% expanded from last quarter's decade high of 45.9%. Guidance of $90 billion of revenue for 3Q24 was roughly in line with published expectations, reassuring investors. The stock also got a boost from research reports suggesting that iPhone sales may see a boost from an upgrade cycle driven by the upcoming rollout of Apple's AI assistant. Although near-term trends are a bit muted, Apple is carrying lean inventory into an iPhone refresh cycle later this year and easing comps in the rest of its portfolio. With an installed base of 2.2 billion active devices and significant growth in the company's recurring revenue Services segment, we believe that Apple remains one of the most innovative, best positioned and most profitable companies in the mobile technology industry. Disney (DIS): DIS was the top detractor in the quarter following a mixed earnings report, with operating income, EPS, and free cash flow all roughly in line, but weakness in segment revenue and operating income. The Entertainment segment saw slightly weaker than expected revenue and operating income due to lighter Content Sales and Licensing partially offset by stronger Linear Networks and Direct-to-Consumer ('DTC'). The DTC business grew, with Disney+ Core adding more subscribers than expected (+6.3m v +5.8m) and generated $47 million of operating income versus expectations of breakeven. The Sports segment generated revenue below expectations, but operating income was better than expected, both driven by ESPN. The Experiences segment beat both revenue and operating income expectations on the back of strong international parks results, price increases at Walt Disney World and cruises, but Disneyland unexpectedly had negative growth in the quarter. In addition, guidance for slightly weaker Experiences revenue and operating income growth as visitor growth normalizes post-Covid also weighed on the stock. DIS is blessed with a deep library of unique content that includes both live sports (providing large, non-time shifted audiences) and incomparable brands, including Disney, Marvel, Pixar and Lucasfilm, as well as the ABC network, which make it among the best-positioned media companies in the new landscape to combine multi-channel and DTC distribution. In addition, its theme park, cruise and theatrical businesses continue to be generational rites of passages for children and young adults around the world. We think CEO Bob Iger is doing a steady job rationalizing investments in each of the company's segments, which should lead to higher and more consistent profitability at the theme parks, better value realization in the linear assets, and consolidation of the company's DTC assets leading to higher profitability sooner. We therefore expect DIS to grow its free cash flow significantly over the next 3-4 years, from its depressed $1 billion in 2022, to more than double 2023's $4.9 billion, exceeding its previous $10 billion peak in 2018. Adyen (OTCPK:ADYEY): ADYEN was a top detractor in the quarter following a 1Q24 trading update that included higher than expected volumes (+46% year-over year growth versus 37% expected), but with lower-than-expected take rates (147 basis points versus 155 basis points). This resulted in revenue that was slightly below consensus estimates. Payment volume growth was strong across all segments with digital leading the way at +51%. The 3-basis-point decline in take rate was attributed to existing customers growing rapidly and hitting price reduction tiers. We believe that volume growth is more important than near-term take rate movements. The company operates a global payments platform, integrating the full payments stack to serve modern global merchants. Unlike many of its legacy peers, Adyen's roots are in technology designed specifically for multi-platform sellers. The company's platform was fully built in-house on a single code base and operates as a single, integrated end-to-end network, giving it an advantage over competitors that have separate platforms for gateway, risk management, processing, issuing, acquiring and settlement. The company's single platform also allows its merchant customers to use one payment service provider globally across all commerce channels (in-store, on the web, and on mobile devices), providing them lower payment costs, a single back end, a single contract and better visibility of end customers. We believe that the transition to next-generation, single-provider, omni-channel payment processing is in its infancy, and we believe the company will continue to take market share against its competitors. The company should have healthy revenue growth in the coming quarters as it rolls out more products and features, and we expect margins to expand as it leverages its fixed cost infrastructure. Five9 (FIVN): FIVN was a top detractor in the quarter after reporting better-than-expected first quarter earnings accompanied by revenue guidance for the second quarter that was slightly below expectations. The 2Q24 shortfall is related to the pace at which some large deals will realize revenue through the year, while the company kept its full year 2024 guidance the same. FIVN reported $247 million of revenue, 13% year-over-year revenue growth and $7 million higher than estimates, and $0.48 of EPS, 17% growth and $0.10 better than estimates. Five9 is a leader in providing cloud-based software to contact centers. The company's suite of applications provides contact center agents with a unified communication platform (voice, email, text, chat, web, social) and a desktop of tools to help agents engage customers more quickly and effectively. FIVN is well-positioned as contact centers transition to the cloud and has high customer retention (112% net revenue retention last quarter). The company doubled its strategic sales team over the past year and signed new partnerships with AT&T, CDW and Microsoft. We believe the company can grow its top line in the high teens, while improving on its 1Q 61% gross margin and 11% operating income margin, leading to 20%+ EPS growth for the foreseeable future. Below is a list of our top ten long holdings as of the end of the quarter: Below is a list of the key secular themes represented on both sides of our portfolio as of the end of the quarter.

Davis New York Venture Fund Fall Review 2024

Our portfolio includes companies with resilient growth, those with durable earnings power and significant free cash flow, and those with some combination of long-lived assets, pricing power, competitive advantage, balance sheet strength, proven management and attractive valuation. Davis New York Venture Fund (DNYVF) returned 19.59% in the year through July 31, 2024, and has grown wealth for shareholders in all periods since its inception. Historically, the longer a shareholder has been invested in the fund, the more their savings have grown (see Figure 1). DNYVF one-year results added to the fund's long-term record of outperformance since its inception in 1969. This outperformance, compounded over the fund's life, means an initial $10,000 investment made at inception would have grown to $4.24 million by end-July 2024 (see Figure 2). This is roughly 61% more than if the same $10,000 had been invested in a passively managed S&P 500 Index (SP500, SPX) fund over the same period. It is almost 3,500% higher than would have been achieved if the $10,000 had been held in money market funds for the same length of time. The fund's recent performance coincides with the overdue bursting of the easy-money bubble after more than a decade of distortions caused by near zero percent interest rates. This shift to a more normal environment began on March 16, 2022 when the Federal Reserve announced the first of 11 consecutive increases in the Federal funds benchmark rate, the steepest rate of change ever. Before discussing how our portfolio is well-positioned to take advantage of this return to normalcy, it is important to understand just how extreme the previous decade of interest rate distortion had become. During this so-called free-money era, both short- and long-term interest rates approached their lowest levels in recorded history (see Figure 3). Interest rate suppression (both directly and indirectly through a bond purchase policy known as quantitative easing) became a matter of national policy, first in response to the great financial crisis (GFC) of 2008-2009, and then the COVID-19 crisis in 2020-2021. It was accompanied by dramatic increases in government spending and ballooning federal deficits. As the cost of money approached zero despite huge increases in money supply, these policies created significant market distortions. Assets were mispriced, risks ignored, inflation allowed to metastasize, and valuation discipline penalized. Given the sheer magnitude of these distortions, the great unwinding that began in 2022 still has a long way to go. Investors should be prepared for unexpected disruptions and heightened volatility. The high valuations of many of today's market darlings rest on extremely rosy assumptions. Although the trigger may be unknowable, these assumptions can change quickly should the market's current optimism be undercut by the unpleasant appearance of one or more so-called black swans, inevitable but unpredictable shocks to the system. As for the short term, while we do not expect further interest rate increases this year, and in fact believe that interest rates may come down for a time as the inflation outlook normalizes, the free-money bubble that began in 2009 has burst and the reckoning will continue. For investors like us who have always adhered to a valuation discipline, the unwinding of the free-money bubble is an overdue but unsettling return to normalcy after more than a decade of delusion. As we return to reality and prepare for more volatile times, we are encouraged that the companies we own (including our carefully selected banks) are well-positioned for this changing environment, and that DNYVF has outperformed the indices since the free-money era ended. While short-term results signify little, it should come as no surprise that investors are once again seeking durability, profitability, cash production, valuation and balance sheet strength. It is these characteristics that allow companies to better navigate a period of higher inflation and economic uncertainty. Returning to more normal interest rates may create headwinds for many of the market darlings that led for so long, and tailwinds for the type of durable, attractively valued businesses that lie at the heart of our investment discipline. Importantly, while recent returns have been strong, our DNYVF portfolio remains significantly undervalued compared to the market averages. Our carefully selected group of companies trade at almost 15 times forward earnings (see Figure 4). This is a 36% discount to the S&P 500 despite these companies having grown their earnings per share more than 15% per year over the last five years. This rare combination of durable growth and discount prices is a value investor's dream that positions us well for the years ahead. Our long-term conviction includes the recognition that short-term corrections and surprises are an unpleasant but inevitable part of the investment landscape. History shows investors should expect a 10% correction on average once per year and a 20% correction every 3.5 years (see Figure 5). Given the excesses of the last decade, we see no reason to imagine that the future will be immune from shocks, crises, volatility and corrections. Our job is not to try to predict the unpredictable but rather to prepare for the inevitable. While we build our portfolios from the bottom up based on company-by-company research rather than top-down trends, most of the attractively valued and durable businesses we own reflect four overarching, long-term themes (See Figure 6). Financial companies represent the largest sector weighting in DNYVF and reflect a theme we describe as "Misunderstood Durability." Since the GFC, investor sentiment has tended to view financial companies in general, and banks in particular, as fragile, volatile and prone to disaster. That two large banks, Silicon Valley Bank (OTC:SIVBQ) and First Republic (OTC:FRCB, neither of which we had ever owned), collapsed less than two years ago due to company-specific mismanagement of interest rate risk reinforced a perception of fragility for all banks. This perception is understandable but inaccurate with regards to the select banks we own, such as Wells Fargo (WFC), JP Morgan (JPM), Capital One (COF) and U.S. Bancorp (USB). These actually grew their customer bases through both the GFC and the regional banking crisis of 2023. What's more, throughout the last decade, the combination of higher capital ratios, higher market shares and tighter regulation have reduced the riskiness of these well-run institutions while increasing their durability and competitive advantages. While their quarterly and even annual earnings can be volatile, such "lumpiness" does not diminish the fact that these companies generate capital through the business cycle at an attractive rate and use the capital they generate to increase shareholder value by steadily increasing dividends and buying in shares at discounted prices. Technology, broadly defined, makes up the portfolio's next largest theme. As with financials, the term technology covers a wide range of companies with diverse types of business models. Within the tech universe, we focus on a select few companies that combine proven long-term growth with reasonable valuations. This valuation discipline has led us to avoid many of the market darlings that have driven the S&P 500 in recent years, including several of the so-called Magnificent Seven tech darlings that today represent an unprecedented concentration of 31% of the S&P 500. In fact, while others have been piling into companies like Meta (META) and Alphabet (GOOG,GOOGL) , which we have owned for many years, we have used their recent outperformance as an opportunity to significantly reduce our positions in these excellent, but richly valued, companies. Instead of market darlings such as Nvidia (NVDA), Apple (AAPL) or Tesla (TSLA), our technology investments have been focused in durable, proven but less glamorous parts of the technology sector such as semiconductor manufacturing (Texas Instruments, Intel and Samsung) and capital equipment (Applied Materials). No discussion of the tech sector (or indeed of the market as a whole) would be complete without some reference to the advent of generative artificial intelligence, or so-called GenAI. While we are naturally skeptical of hype, we must begin by stating unequivocally that GenAI is likely to be one of the most transformational technological developments in modern history and one that is almost certain to drive major advances across numerous industries. However, as long-term market observers, we are also equally certain that this revolutionary technology will lead to hyperbole, irrational exuberance and unfulfilled promises. The stock market in particular is susceptible to wishful thinking and the fear of missing out ('FOMO'). FOMO leads investors to pile into companies making the most headline-grabbing claims about the future while turning their backs on those with proven businesses with demonstrated competitive advantages. "While AI stocks will likely go through booms and busts, the underlying technology is transformational and will be a permanent part of the economic landscape going forward." In particular, we believe many companies are being rewarded for being early beneficiaries of AI demand with the expectation that their revenues and earnings will continue to grow rapidly in the future. The market for AI products and services, however, is still in its very early days and competition is fierce. We believe it is very risky to project who the long-term winners and losers will be based on their past one or two years of performance. For example, the substantial technological and societal transformations heralded by the internet in the 1990s culminated in the dot-com bubble. Then, as our friend Bill Nygren, portfolio manager at Oakmark Funds, recently reminded investors, "in 2000, amidst dot-com hysteria, the largest cap market darlings were Cisco (CSCO), America Online (AOL) and Yahoo!. AOL and Yahoo! ended up nearly worthless, and Cisco, currently at a lower share price than in 2000, has lost 80% relative to the S&P 500. We think these results should give pause to anyone believing the AI winners have already been determined." We couldn't agree more. As with the internet, our approach is to avoid the "story stocks" and instead ask which companies can use this powerful new tool most effectively to build the value of their businesses and, just as importantly, which companies are most threatened by this new technology. While AI stocks will likely go through booms and busts, the underlying technology is transformational and will be a permanent part of the economic landscape going forward. As such, questions about its impact are already a standard part of our research process. By incorporating this mindset into our company analyses, we are reminded of Amara's Law which states that "We tend to overestimate the effect of a technology in the short run and underestimate the effect in the long run." The advent of GenAI will only reinforce this important adage. For decades, healthcare spending relentlessly rose from 5% of U.S. GDP in 1960 to roughly 17% in 2010. However, reflecting the wisdom of Herb Stein's famous observation that "if something cannot go on forever, it will stop," the rollout of the Affordable Care Act in 2010, along with a range of other public and private initiatives, led to a flattening of this growth. Today, while healthcare spending remains a political hot button, it is somewhat encouraging that 14 years later the industry's share of GDP still stands at 17% despite the invention of many expensive new therapies in the interim. To offset the rising costs of novel treatments and innovative (and patented) pharmaceutical therapies, the healthcare system has needed to constantly find savings elsewhere. As a result, our investments in this important sector have focused on those companies that play a part in moderating or reducing the natural rate of increase in healthcare spending. Companies such as Cigna (CI) and Humana (HUM), for example, offer programs like Medicare Advantage which delivers patients a higher quality of care at a lower cost. Given the inefficiencies and incentives of government agencies versus the private sector, we are not surprised that such companies have long records of success. Similarly, lab testing companies like Quest Diagnostics (DGX) and branded generics companies like Viatris (VTRS) continue to reduce costs in the healthcare system. On the other side of the ledger, while we marvel at the enormous profits created by novel pharmaceutical and biotech breakthroughs, we find it difficult and risky to try to predict the next winners while also quantifying the duration of those profits given the development of me-too competitors and evolving drug reimbursement policies. In an age of digitization, software, AI, content creation, online advertising and hot consumer brands, companies that operate railroads and generate electricity (Berkshire Hathaway), extract copper (Teck Resources), manufacture insulation (Owens Corning), raise food (Tyson) or produce oil (Tourmaline) may sound dull, but our civilization cannot function without their products. The necessity of these products and, in many cases, the environmental risks of producing them, creates regulatory and legal complexity. What's more, their production often requires large upfront capital investment, and the demand and supply of them in any short-term period may well be subject to cyclical swings, resulting in earnings volatility. Further, as such products are not especially differentiated, price and availability are often the only drivers of customer preference, making it difficult for any one company to maintain high returns without attracting new competition. So how do we find attractive opportunities in such a difficult category? First, because many such dull businesses are overlooked and out of favor in today's growth-driven market, carefully selected industrials currently sell at extremely low valuations despite having long-term records of growth, durable earnings power, competitive advantages driven by low cost assets or economies of scale, and some inflation protection due to long-lived assets. What's more, certain long-term trends may be accelerating the growth rates of a number of these companies. For example, in a world of massively expanding computing power, the need for electricity is markedly accelerating. Also, trends like electrification of automobiles and expansion of the electricity grid increase copper demand at a rate that is likely to continue to outstrip growth in supply (a byproduct of the enormous regulatory challenges of permitting and building new mines). Finally, in ways that are hard to anticipate, the advent of AI is almost certain to create enormous disruption in the relatively more popular and historically faster growing service sector of the economy. The low valuations of dull industrial businesses that are resistant to obsolescence compared to valuations in a service sector facing significant uncertainty may well lead people to view our industrial holdings with more enthusiasm. As one thoughtful analyst recently analogized in looking at the disruption risk facing many service companies, "At the launch of the iPhone, flashlight manufacturers were not worried." Similarly, we recently noticed a billboard outside a large commercial construction site that said, "Hey ChatGPT, finish this building..... Oh wait...", a cheeky reminder that it will be some years before GenAI can do construction, not to mention mine copper, extract oil, or raise, process and deliver food from the farm to our homes. Recently our friend and author Shane Parrish shared a striking quote that seems to capture the current mood of our country: "It is a gloomy moment in the history of our country. Not in the lifetime of most men has there been so much grave and deep apprehension; never has the future seemed so incalculable as at this time. The domestic economic situation is in chaos...Prices are so high as to be utterly impossible. The political cauldron seethes and bubbles with uncertainly. Russia hangs, as usual, like a cloud, dark and silent, upon the horizon. It is a solemn moment. Of our troubles, no man can see the end." What makes this description so striking is that it was written in Harper's Weekly in 1857. Pessimism, fear and uncertainty are nothing new. And yet we live far better lives today than ever before. For long-term investors, it has always been a mistake to bet against humanity in general and the United States in particular. While it is true that we currently face significant challenges, it is equally true that we are living through a period of enormous global progress. Technology and innovation have contributed enormously to human progress, and with breakthroughs like GenAI, genomics and alternative energy (including compact nuclear reactors) still in their infancy, we see no reason to believe that the record of the last 2,000 years should not continue. At a time when many feel the world has been getting worse, the data tells a different story (see Figures 7 and 8). Our confidence that our country and our species has not come to the end of our forward progress does not make us blind to the risks we face. In fact, our awareness of these risks is the very reason that we seek out companies with proven records of durability, resilience and profitability. From 2008-2022, artificially suppressed interest rates created a period of unprecedented economic and market distortion. Throughout that period, fundamental investment analysis-which rests on discounted present value, cost of capital and risk management-became largely irrelevant. Valuation discipline fell out of favor and the market increasingly rewarded momentum and speculation. All that changed in the first quarter of 2022 when interest rates began a long overdue period of normalization. The effects of this return to normalcy will be volatile and will unfold over a long period of time. Companies and investors that are not well-prepared face big problems, only some of which have come to light. As this bubble bursts, we expect many more unpleasant surprises, particularly in the most levered and speculative areas of the market and economy. For Davis Advisors, this transition marks a return to normalcy. The key pillars of success in this tumultuous environment are the cornerstones of our investment discipline: cash generation, conservative capital structure, durable business model, low valuation and proven management. We are pleased that our fund has outperformed during this transition, and is strongly positioned to build wealth in the decade to come as our carefully selected group of companies combine attractive valuations with long-term growth. For more than fifty years, we have navigated a constantly changing investment landscape guided by one North Star: to grow the value of the funds entrusted to us. We are pleased to have achieved strong results thus far and look forward to the decades ahead. With more than $2 billion of our own money, we stand shoulder to shoulder with our clients on this long journey. We are grateful for your trust and are well-positioned for the future. Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

Diamond Hill Large Cap Concentrated Fund Q2 2024 Market Commentary

Still-rising valuations have made identifying attractively valued, high-quality companies increasingly challenging. Market Commentary Markets moved modestly higher in Q2, delivering positive returns across most regions and countries. US stocks rose +3% (as measured by the Russell 3000 Index) - though gains were primarily thanks to large-cap stocks, which were up nearly +4%. Down the cap spectrum, returns were negative, with mid caps and small caps each down roughly -3%, as measured by their respective Russell indices. From a style perspective, growth maintained its sizeable lead over value, with large-cap growth up +8%, while large value was down -2%; mid-cap growth and value each fell roughly -3%, while small-cap growth fell -3% and small-cap value fell nearly -4% (all returns as measured by the respective Russell indices). From a sector perspective, technology (+13%), communication services (+9%), utilities (+5%) and consumer staples (+1%) were in the black in Q2 - the first three tied partly to meaningful momentum around AI-related technologies and the implied energy demand, which helped boost utilities. The relative resilience of utilities and staples is also likely due somewhat to a growing preference among investors for more defensive sectors as the economic and market cycles get increasingly long in the tooth. Conversely, materials (-5%), industrials (-3%) and financials (-2%) led the way down. Energy (-2%), real estate (-2%), health care (-1%) and consumer discretionary (<-1%) were also in the red. As has been expected for several months, monetary policy among major central banks diverged in Q2 as the European Central Bank cut rates while the Bank of England and the Federal Reserve held. Further, Fed chair Jerome Powell maintained his position that US rates are likely to remain higher for longer, signaling that there is expected to be only one rate cut before the end of the calendar year. Given the US's economic resilience - exemplified by resilient employment numbers - and inflation's ongoing stickiness, Powell's commitment is not particularly surprising. What naturally remains to be seen is how durable the economic data prove to be in the coming months. Meanwhile, in the wake of finally exiting its protracted negative interest rate regime, the Japanese Central Bank (JCB) faces ongoing challenges maintaining the yen's value, which has continued sliding relative to the dollar as US interest rates remain high. Though inflation in Japan has finally ticked up, which should give the JCB room to contemplate rate hikes, domestic consumer sentiment has been fragile as a weak yen has translated into high import and fuel costs. The JCB undoubtedly faces a delicate balancing act in the months and quarters ahead as it seeks to finally end decades of economic malaise. Similarly, the ongoing global monetary policy and macroeconomic mix continues complicating the picture for a Chinese government which is seeking to boost its economy while facing growing trade tensions with Western countries - especially the US and the European Union, both of which have been ratcheting up restrictions related to electric vehicles and technology more broadly. Positively, Chinese GDP grew 5.3% year over year in Q1 - beating expectations and incrementally better than Q4's 5.2%. However, much of the growth has been attributable to the economy's supply side, for which the government has provided ample support, while the demand side and the country's consumers continue struggling to recover from a deep real estate crisis that has crimped wealth and led many to cut back on spending. It's been hard to miss the recent performance of AI-related stocks - which has contributed to an increasingly narrow market as a small number of massive technology stocks drive the majority of index returns. Against this market backdrop, it's natural to question whether and how long the bull market can continue. However, this affords us an opportunity to add value for our clients as we avoid the temptations of swimming with the tide and maintain our disciplined adherence to our philosophy, which looks out past the latest trends to the longer term. We also believe it offers an increasingly interesting environment to deploy our time-tested, fundamental approach to identifying high-quality, underappreciated companies that may be easy to miss when they aren't necessarily on the obvious front lines of the latest fad. Performance Discussion Our portfolio trailed the Russell 1000 Index in Q2. Relative weakness was tied primarily to our below-benchmark exposure to technology, which was the index's top-performing sector in the quarter - though it's worth noting our holdings in the sector delivered nicely positive returns, in line with benchmark peers' returns. Our industrials holdings also detracted from relative returns. Conversely, our materials and real estate holdings were additive to relative performance in Q2. Among our top individual contributors in Q2 were Texas Instruments (TXN), Amazon (AMZN) and Bank of America (BAC). Shares of semiconductor manufacturing company Texas Instruments rose in Q2 as demand in several of the company's end markets show signs of recovering. Given the company's long-term prospects, competitive positioning and scale advantages, we believe the outlook for the company from here is strong. Internet retail and cloud infrastructure company Amazon (AMZN) is benefiting from strong profitability, particularly in its Amazon Web Services (AWS) business. Shares also received a boost amid growing optimism around the demand for AWS as Amazon customers' investments in generative AI projects continue growing. Shares of financial services company Bank of America rose in the quarter as it looks increasingly likely net interest income will inflect and begin growing again in 2024's back half and into 2025. Other top Q2 contributors included Extra Space Storage and General Motors. Self-storage real estate investment trust Extra Space Storage (EXR) rose alongside storage companies as street rates show signs of stabilizing - which, given Extra Space Storage's sector-leading occupancy rate, would benefit EXR most. Shares of automobile manufacturer General Motors (GM) rose as its internal combustion engine business has also received a boost from the recent slowdown in electric vehicle adoption among consumers. GM also announced additional share repurchases in Q2, reinforcing its commitment to returning cash to shareholders. Among our bottom Q2 contributors were Abbott Laboratories (ABT), ConocoPhillips (COP) and Allstate (ALL). Shares of diversified health care company Abbott Labs declined during the quarter in the face of new litigation risk as an Illinois court ordered competitor Reckitt Benckiser (OTCPK:RBGPF) to pay $60 million to the mother of a baby who died from necrotizing enterocolitis (NEC). Abbott is currently involved in over 900 lawsuits involving injury or death related to NEC, many involving Reckitt Benckiser as a co-defendant. However, this is not a contamination issue and is unrelated to Abbott's 2022 infant formula recall - rather, NEC is an issue affecting less than 10% of pre-term babies and may be due to feeding them cow's milk (i.e., formula) instead of mother's milk, though a clear link has yet to be established. These babies are fed formula when there are no other options and is prescribed by a doctor as part of the standard of care. Given Abbott's significant cash on hand, we don't believe these lawsuits (or resulting damages) will have a major impact on the company and maintain our conviction in the company's diverse business mix and fundamental growth prospects. Shares of oil and gas exploration and production company ConocoPhillips declined against a backdrop of lower oil prices in Q2, as well as concerns about the expensive though strategically sound acquisition of Marathon Oil. Allstate, one of the US's largest auto and homeowners' insurance providers, has seen the pace of premium price increases decelerate, weighing on investor sentiment around the stock. However, the company's underlying fundamentals are intact, margin expansion should continue through the year, and the outlook remains constructive. Other bottom Q2 contributors included Caterpillar (CAT) and Home Depot (HD). Shares of heavy construction machinery manufacturer Caterpillar fell as dealer inventories have declined and the market wrestles with concerns construction activity may be decelerating. Similarly, home improvement retailer Home Depot faces growing concerns about the consumer spending environment - particularly for home improvement expenditures. However, we believe the company's long-term prospects and multi-year fundamental outlook are unchanged. Portfolio Activity Still-rising valuations have made identifying attractively valued, high-quality companies increasingly challenging. However, we initiated one new position in Q2, Sysco Corporation, that we believe the market is overlooking amid its increasingly narrow focus on the mega-cap technology stocks dominating the major indices. Sysco is the US's leading food-service distributor. We have followed the company for many years, and we believe it is a high-quality business. As investors' concerns about slowing quick-service restaurant traffic have pressured shares, we capitalized on what we believe to be a temporary headwind to initiate a position at an attractive valuation. We funded this purchase in part with the proceeds from the sale of our position in homebuilder NVR as its shares have approached our estimate of intrinsic value. Market Outlook Strong corporate earnings and economic growth continued in Q2, which helped bring the Russell 1000 Index's year-to-date performance to +14.2%. However, the market has narrowed again, with a large portion of returns driven by a small handful of mega-cap tech stocks. Nearly two-thirds of this year's return has been driven by six stocks: NVIDIA, Meta Platforms, Microsoft, Alphabet, Amazon and Apple. Year to date, NVIDIA (NVDA) alone has contributed nearly one-third of equity market returns with its +150% increase. Over the past 10 years, growth stocks' outperformance relative to value stocks has been astounding at over 8 percentage points annually. However, it is interesting to note this has not been driven by value stocks' poor performance. On the contrary, the Russell 1000 Value Index has increased more than 8% annually over the past 10 years - in the range of long-term equity returns. Similar to the performance disparity among growth and value stocks, small caps continue to underperform large caps. Year to date, small caps have underperformed by more than 12 percentage points, and over the past 10 years, they have underperformed by about 5.5 percentage points, annualized. By some measures, small caps are trading near a historically low valuation premium relative to large caps. Corporate earnings are expected to grow at a double-digit rate in 2024, driven by mega-cap tech stocks, a rebound in health care sector earnings after a large decline in 2023 and growth from the financial services sector. With the continued rally, equity market valuations remain at above-average levels. While this has been somewhat supported by the fall in interest rates since their peak in October 2023, it may still be difficult to generate returns from current levels that match historical averages over the next five years. However, we continue to seek attractive opportunities with the potential to generate above-average returns over that period. Our primary focus is always on achieving value-added results for our existing clients, and we believe we can achieve better-than-market returns over the next five years through active portfolio management. Original Post Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors. Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks. Diamond Hill Capital Management, Inc. is a wholly owned subsidiary of Diamond Hill Investment Group, Inc. Diamond Hill Investment Group is a publicly traded company, and its shares trade on the NASDAQ (Ticker: DHIL).