Large Cap Growth

For the Period Ending: 06/30/2016



Our Large Cap Growth investment philosophy is centered on the following beliefs:

Generic growth stock investing is inherently challenging

  • Failure rate of growth companies is very high
  • Risk is often underestimated
  • Most growth investors overpay for short-term earnings growth and underpay for enduring, structural earnings power

Significant, long-term excess returns can potentially be achieved by:

  • Focusing on a smaller subset of unique business franchises, which typically increases the odds for success
  • Having a mindset geared to methodically avoiding common mistakes by emphasizing franchise power and earnings sustainability over earnings growth rates

The stock selection process is based primarily on fundamental research, but does use some quantitative analysis during the screening process. From a quantitative standpoint, we concentrate on profitability, capital intensity, cash flow and valuation measures, as well as earnings growth rates. Once the quantitative research is completed we turn to our internal research department for validation of our initial findings. Key to our fundamental research effort is identifying companies that we believe possess a sustainable competitive advantage, which should enable them to generate superior levels of profitability and growth for an extended period of time. Special focus is given to those companies that appear well-positioned to benefit from secular trends embedded in the marketplace (i.e., demographics, deregulation, capital spending trends, etc.).

The investment process consists of a disciplined 3-step process:

Screening for inclusion in the "Franchise Growth Universe"

The process starts with a quantitative screen that reduces the investable universe of the 1,500 largest U.S. companies down to 200 to 300. Companies with a market cap of at least $3 billion, and generally above $8 billion are filtered according to the strength of their earnings growth and a profitability matrix. This matrix, an essential part of our analysis, includes measures such as gross margin, operating margin, net margin, return on equity, and/or return on assets.

Franchise Growth Universe – Evaluation of sustainable competitive advantage

The next step consists of identifying the sustainable growth drivers that support the high levels of profitability displayed by this reduced list of 200-300 companies. These generally consist of strong brand equity, proprietary technology, high switching costs, greater access to distribution channels, larger economies of scale, and/or stronger network effects.

Building the Franchise Growth Portfolio

The final step consists of building a portfolio of 45-60 companies that have the appropriate catalysts such as a superior business model (structural advantages producing superior returns) and also attractive industry characteristics (having barriers to entry, large market opportunities and secular unit growth). The selection of these stocks is based on criteria such as profitability, growth, capital discipline and valuation factors.

Minimum Assets Accepted: $20 million


Total Returns


Total Returns1,2,3 Annualized
  YTD3 1 Year 3 Years 5 Years 10 Years
Large Cap Growth - Gross1 -3.60% -1.70% 13.46% 11.91% 8.62%
Large Cap Growth - Net1 -3.89% -2.29% 12.78% 11.24% 7.97%
Russell 1000 Growth Index2 1.36% 3.02% 13.07% 12.35% 8.78%

Calendar Year Returns


Calendar Year Returns 1,2,3,4
  Large Cap Growth
Gross1
Large Cap Growth
Net 1
Russell 1000
Growth Index2
2Q164
-0.32%
-0.47%
0.61%
YTD3
-3.60%
-3.89%
1.36%
2015
7.64%
6.99%
5.67%
2014
12.94%
12.26%
13.05%
2013
37.19%
36.37%
33.48%
2012
12.87%
12.19%
15.26%
2011
2.93%
2.32%
2.64%
2010
13.36%
12.69%
16.71%
2009
27.94%
27.19%
37.21%
2008
-35.85%
-36.25%
-38.44%
2007
25.79%
25.05%
11.81%
2006
6.31%
5.68%
9.07%

Past performance is no guarantee of future results. Returns are presented on a dollar-weighted basis and may be impacted by ongoing market volatility. Please inquire for more current performance information.

1 The Large Cap Growth composite consists of institutional portfolios seeking to provide growth of capital. Portfolios within the composite primarily invest in U.S. common stocks of large capitalization, growth-oriented companies with above-average levels of profitability and that are believed to have the ability to sustain growth over the long term. Large capitalization companies typically are companies with market capitalizations of at least $10 billion at time of acquisition. The Large Cap Growth composite was created March 28, 2005. The performance presentation is in U.S. dollars.

Effective July 1, 2015 the composite definition/description was revised in order to provide further clarity of the composite’s investment strategy. Effective July 1, 2015 the composite was redefined to include only institutional accounts within the composite.

Large Cap Growth composite is comprised of 29 accounts that had $2,432.9 million in total assets as of 6/30/16. • Returns reflect the reinvestment of all dividends and other earnings. Portfolio returns are net of all foreign reclaimable and nonreclaimable withholding taxes, if applicable. Withholding taxes are recognized on an accrual basis or cash basis depending on client and/or account type. Additional information regarding treatment of withholding taxes is available upon request. Returns shown gross of fees reflect the deduction of commissions paid, but are gross of all other expenses. Net-of-fees returns are calculated by deducting the highest applicable advisory fee from the monthly gross composite return. The actual fees paid by a client may vary based on assets under management and other factors. A client’s return will be reduced by investment management fees and other expenses incurred in the management of a client’s account. Investment advisory fees are described in Part 2 of the ADV. Investment returns and the actual value of each client account will fluctuate, and at any given time an account could be worth more or less than the amount invested. • The benchmark selected for the composite is intended to provide a method to compare the composite’s performance to an index including securities that are generally similar to those that are included in the composite. However, composite holdings (and, accordingly, risk and volatility) may differ significantly from the securities tracked by its benchmark.

2 Russell Investment Group is the source and owner of the Russell Index data contained or reflected in this material and all trademarks and copyrights related thereto. The presentation may contain confidential information and unauthorized use, disclosure, copying, dissemination or redistribution is strictly prohibited. This is a presentation of Waddell & Reed Investment Management Company (WRIMCO). Russell Investment Group is not responsible for the formatting or configuration of this material or for any inaccuracy in WRIMCO’s presentation thereof.

3 As of June 30, 2016.

4 Actual composite return from April 1, 2016 through June 30, 2016.

5 Data regarding holdings reflects current ownership information only and is not intended to represent any past, present or future investment recommendation.

6 Data regarding sector diversification reflects current ownership information only and is not intended to represent any past, present or future investment recommendation.

7 Supplemental data: The Large Cap Growth percentages reflected are based on the holdings of 1 of 29 composite accounts without client specific investment restrictions and may not be reflective of the Large Cap Growth composite as a whole or of any other Large Cap Growth account currently, or in the future, included in such composite.


10 Largest Holdings 5,7
Alphabet, Inc.4.2%
Lam Research Corp.4.1%
Visa Inc. CI A4.0%
MasterCard, Inc. CI A3.9%
Home Depot, Inc./The3.9%
Allergan plc3.8%
Amazon.com Inc.3.5%
Phillip Morris International Inc.3.4%
Facebook Inc. CI A3.3%
Bristol-Myers Squibb Co.2.8%

Alphabet, Inc. represents aggregate weight of Class A and Class C securities.


LargeCapGrowthSD

Past performance is no guarantee of future results. Returns are presented on a dollar-weighted basis and may be impacted by ongoing market volatility. Please inquire for more current performance information.

1 The Large Cap Growth composite consists of institutional portfolios seeking to provide growth of capital. Portfolios within the composite primarily invest in U.S. common stocks of large capitalization, growth-oriented companies with above-average levels of profitability and that are believed to have the ability to sustain growth over the long term. Large capitalization companies typically are companies with market capitalizations of at least $10 billion at time of acquisition. The Large Cap Growth composite was created March 28, 2005. The performance presentation is in U.S. dollars.

Effective July 1, 2015 the composite definition/description was revised in order to provide further clarity of the composite’s investment strategy. Effective July 1, 2015 the composite was redefined to include only institutional accounts within the composite.

Large Cap Growth composite is comprised of 29 accounts that had $2,432.9 million in total assets as of 6/30/16. • Returns reflect the reinvestment of all dividends and other earnings. Portfolio returns are net of all foreign reclaimable and nonreclaimable withholding taxes, if applicable. Withholding taxes are recognized on an accrual basis or cash basis depending on client and/or account type. Additional information regarding treatment of withholding taxes is available upon request. Returns shown gross of fees reflect the deduction of commissions paid, but are gross of all other expenses. Net-of-fees returns are calculated by deducting the highest applicable advisory fee from the monthly gross composite return. The actual fees paid by a client may vary based on assets under management and other factors. A client’s return will be reduced by investment management fees and other expenses incurred in the management of a client’s account. Investment advisory fees are described in Part 2 of the ADV. Investment returns and the actual value of each client account will fluctuate, and at any given time an account could be worth more or less than the amount invested. • The benchmark selected for the composite is intended to provide a method to compare the composite’s performance to an index including securities that are generally similar to those that are included in the composite. However, composite holdings (and, accordingly, risk and volatility) may differ significantly from the securities tracked by its benchmark.

2 Russell Investment Group is the source and owner of the Russell Index data contained or reflected in this material and all trademarks and copyrights related thereto. The presentation may contain confidential information and unauthorized use, disclosure, copying, dissemination or redistribution is strictly prohibited. This is a presentation of Waddell & Reed Investment Management Company (WRIMCO). Russell Investment Group is not responsible for the formatting or configuration of this material or for any inaccuracy in WRIMCO’s presentation thereof.

3 As of June 30, 2016.

4 Actual composite return from April 1, 2016 through June 30, 2016.

5 Data regarding holdings reflects current ownership information only and is not intended to represent any past, present or future investment recommendation.

6 Data regarding sector diversification reflects current ownership information only and is not intended to represent any past, present or future investment recommendation.

7 Supplemental data: The Large Cap Growth percentages reflected are based on the holdings of 1 of 29 composite accounts without client specific investment restrictions and may not be reflective of the Large Cap Growth composite as a whole or of any other Large Cap Growth account currently, or in the future, included in such composite.


Daniel P. Becker   Daniel P. Becker, CFA
  Senior Vice President, Portfolio Manager

Mr. Becker is co-portfolio manager of the firm’s Large Cap Growth investment strategy. He developed the firm’s Large Cap Growth philosophy and has been a portfolio manager of the strategy since 1995. Mr. Becker joined Waddell & Reed as an equity investment analyst in 1989 and covered industries in the Consumer Discretionary, Financials and Industrials sectors. He assumed portfolio management responsibilities in 1994.

Prior to joining Waddell & Reed, Mr. Becker was affiliated with the State of Wisconsin Investment Board from 1988 to 1989.

Mr. Becker earned a MS with an emphasis in Finance, Investments and Banking and a BS in Mathematical Economics from the University of Wisconsin at Madison. He is a CFA charterholder.


Bradley M. Klapmeyer   Bradley M. Klapmeyer, CFA
  Vice President, Portfolio Manager

Mr. Klapmeyer is co-portfolio manager of the firm’s Large Cap Growth investment strategy, appointed to this role in 2016. He has been a member of the Large Cap Growth team since 2011. Mr. Klapmeyer was appointed portfolio manager of the firm’s Tax-Managed Equity mutual funds in 2014. He held equity investment analyst research responsibilities prior to his appointment as co-portfolio manager, covering large cap growth securities and the biotechnology industry.

Prior to joining Waddell & Reed in 2007 as an equity investment analyst, Mr. Klapmeyer held equity analyst positions with Prudential Equity Group, LLC from 2006 to 2007 and with Commerce Bank from 2000 to 2006.

Mr. Klapmeyer earned a BS in Finance from Truman State University. He is a CFA charterholder.


Gage T. Krieger   Gage T. Krieger, CFA
  Assistant Vice President, Assistant Portfolio Manager

Mr. Krieger is assistant portfolio manager of the firm’s Large Cap Growth investment strategy and assists the co-portfolio managers in idea generation, research, portfolio construction, and risk management efforts. He has been a member of the Large Cap Growth team since 2016. He is also a member of the firm’s equity research team, covering industries in the Telecomm Services, Information Technology, Consumer Discretionary, Materials and Health Care sectors.

Prior to joining Waddell & Reed in 2012 as an equity investment analyst, Mr. Krieger was a senior associate, equity research covering the telecommunications services sector for Citi Investment Research from 2009 to 2012. Prior to his role at Citi Investment Research in New York, Mr. Krieger was an associate, middle market equity sales for Citigroup Global Markets in Denver, Colorado from 2006 to 2009.

Mr. Krieger graduated from Colorado State University with a BSBA, Finance concentration in 2006. He studied German literature and language at Hannover University in Hannover, Germany in the summer 2004 Study Abroad Program. He earned an MBA from Rockhurst University in 2016. He is a CFA charterholder.

Manager(s):
Daniel P. Becker, CFA
Bradley M. Klapmeyer, CFA
Gage T. Krieger, CFA

Portfolio Review
The financial markets continued their recent trend of swift and volatile intra-quarter moves both up and down during the second quarter of 2016. Coming off the first quarter where the Federal Reserve signaled a much more gradual move upwards in short-term interest rates, it seemed like the global currency and fixed income markets were set to improve, which would provide a calming effect on the equity markets. The potential for a reduction in capital market volatility came to an abrupt end late in June with the surprise negative United Kingdom referendum result which will likely result in the U.K. leaving the European Union (EU). The result of the so-called Brexit vote produced a huge performance shock to almost all equity market participants. After a dismal first quarter, active managers in general continued to underperform across styles and capitalization ranges during the second quarter, and have experienced one of the worst relative performance slumps since the dot-com era. Our performance, while relatively strong through most of the quarter, experienced a significant negative impact from the aftermath of the Brexit vote, when volatility and correlation spiked and investors flocked to defensive, safe and low volatility assets around the world. After mounting a relative recovery in the past few years, our portfolio has now underperformed the Russell 1000 Growth Index in each of the first two quarters of 2016. During the quarter, growth stocks generally underperformed value stocks, and smaller stocks outperformed larger companies. Safety dramatically outperformed risk during the second quarter as it did for much of the first quarter.

The degree of panic and movement into assets perceived as safe has also been reflected in bond yields. Yields of government securities moved further into negative interest rate territory throughout Europe and Asia, with nearly $14 trillion of government bond principal exhibiting negative yields by quarter-end. And although the Bank of Japan has continually reduced short-term rates into negative territory, the recent extreme flight to safety boosted the Yen materially, overwhelming the central bank’s effort to depreciate the currency.

Our performance was significantly impacted by these events due to an under-representation in the defensive sectors of the market such as Consumer Staples and Telecommunications, as well as high dividend yield and low beta stocks. In the second quarter we also experienced underperformance from key portfolio holdings. Defensive stocks performed better but could not compensate for our overweight to growth. Biotechnology stocks as a group did not perform well, while other parts of the Health Care sector, some areas within Financials, and Consumer Staples companies generally drove the index.

At first glance, the Brexit vote appears negative for global GDP growth as it may place corporate investment decisions on hold in Europe. The vote could also pave the way for other countries to leave the EU. As we see it, the recent negative shock to capital markets marks the 11th massive volatility event investors have endured since the Great Recession. High government debt levels across countries combined with already low interest rates have made the global economy more vulnerable to unexpected shocks, which almost always result in a large short-term flight to safety as we saw last quarter. In past episodes, the flight to safety gradually dissipated over time as investors once again saw opportunities in riskier assets. We view the most recent shock as mostly similar to those of the past seven years, albeit with some anomalies. Our current thinking is focused on how to capitalize on the opportunities created by these recurring dislocations while identifying and avoiding their dangers.

Outlook
The most glaring result of the recent shock is that the price of safety, low beta, and low volatility has jumped, causing some of the highest valuations that we have seen in many years. We think parts of the global capital markets are out of sync with economic reality, including negative interest rates, the valuation of Consumer Staple stocks, the valuation of high dividend yield stocks or the correlations inherent in all the above relationships. As growth is fairly stable around the world, especially in the U.S., the disconnect between the fixed income market implied forecast and what we learn from company contacts makes little sense to us. It seems to be driven more by the massive amount of money managed for day-to-day investment mandates, low-risk mandates or absolute return mandates, along with the proliferation of ETF’s, computer algorithms, and the current vulnerability of the economy. The result has been a huge shift away from beta in both growth and value stocks. As we see it, the choice now is much less about value or growth and more about risk or safety.

We have acted on our views and increased exposure to holdings we feel are great growth companies and have been overlooked or oversold. We continue to avoid areas that have high correlations to the bond markets as bond proxies and maintain our underweighting of the safe Consumer Staples areas. Some of these companies considered safe now have free cash flow valuations near those of companies that grow at much faster rates. Another way we look at the valuations and relative fear in the market is through price momentum. Normally the stocks with the most price momentum are drawn from many areas of the economy, but now most price momentum leaders are stocks often thought of as “safe.” While we don’t know when the current rotation to safety will end, or how it will end, we think there is more risk in the “riskless” or “safe” part of the market than any other sector, group or part.

Looking ahead, we continue to expect a slow rate of economic growth, low inflation and moderate and improving profit growth, usually ideal conditions for growth stocks. We maintain conviction in our largest holdings and believe such companies can thrive in this environment. We continue to selectively increase exposure to some of these holdings and other stocks which have been depressed by recent weakness.

The opinions expressed in this commentary are those of the portfolio managers and are current through June 30, 2016. The managers’ views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed. Past performance is no guarantee of future results.

Past performance is no guarantee of future results. Returns are presented on a dollar-weighted basis and may be impacted by ongoing market volatility. Please inquire for more current performance information.

1 1The Large Cap Growth composite consists of institutional portfolios seeking to provide growth of capital. Portfolios within the composite primarily invest in U.S. common stocks of large capitalization, growth-oriented companies with above-average levels of profitability and that are believed to have the ability to sustain growth over the long term. Large capitalization companies typically are companies with market capitalizations of at least $10 billion at time of acquisition. The Large Cap Growth composite was created March 28, 2005. The performance presentation is in U.S. dollars.

Effective July 1, 2015 the composite definition/description was revised in order to provide further clarity of the composite’s investment strategy. Effective July 1, 2015 the composite was redefined to include only institutional accounts within the composite.

Large Cap Growth composite is comprised of 29 accounts that had $2,432.9 million in total assets as of 6/30/16. • Returns reflect the reinvestment of all dividends and other earnings. Portfolio returns are net of all foreign reclaimable and nonreclaimable withholding taxes, if applicable. Withholding taxes are recognized on an accrual basis or cash basis depending on client and/or account type. Additional information regarding treatment of withholding taxes is available upon request. Returns shown gross of fees reflect the deduction of commissions paid, but are gross of all other expenses. Net-of-fees returns are calculated by deducting the highest applicable advisory fee from the monthly gross composite return. The actual fees paid by a client may vary based on assets under management and other factors. A client’s return will be reduced by investment management fees and other expenses incurred in the management of a client’s account. Investment advisory fees are described in Part 2 of the ADV. Investment returns and the actual value of each client account will fluctuate, and at any given time an account could be worth more or less than the amount invested. • The benchmark selected for the composite is intended to provide a method to compare the composite’s performance to an index including securities that are generally similar to those that are included in the composite. However, composite holdings (and, accordingly, risk and volatility) may differ significantly from the securities tracked by its benchmark.

2 Russell Investment Group is the source and owner of the Russell Index data contained or reflected in this material and all trademarks and copyrights related thereto. The presentation may contain confidential information and unauthorized use, disclosure, copying, dissemination or redistribution is strictly prohibited. This is a presentation of Waddell & Reed Investment Management Company (WRIMCO). Russell Investment Group is not responsible for the formatting or configuration of this material or for any inaccuracy in WRIMCO’s presentation thereof.

3 As of June 30, 2016.

4 Actual composite return from April 1, 2016 through June 30, 2016.

5 Data regarding holdings reflects current ownership information only and is not intended to represent any past, present or future investment recommendation.

6 Data regarding sector diversification reflects current ownership information only and is not intended to represent any past, present or future investment recommendation.

7 Supplemental data: The Large Cap Growth percentages reflected are based on the holdings of 1 of 29 composite accounts without client specific investment restrictions and may not be reflective of the Large Cap Growth composite as a whole or of any other Large Cap Growth account currently, or in the future, included in such composite.